For Ross Mandell and Sky Capital, a Long Trip Indeed…Too Long

Most major media outlets reported this morning that Ross Mandell and several of his colleagues were arrested for a $140 million investment fraud scheme.  Mr. Mandell is the founder of Sky Capital and its former CEO.  The government alleges that Sky Capital was nothing more than a boiler room.

Mr. Mandell and his background on Wall Street is a case study for why there has to be regulatory reform.  What most media outlets didn’t report is that Mr. Mandell is historically one of the most penalized brokers in history.  He was the subject of a 5,649-word story in the Wall Street Journal which disclosed that as of March of 1996 (which is when the story was published) customers had filed 14 known complaints and he had switched jobs at least 13 times during a twelve year career, having been terminated four times for “alleged misconduct.”

There’s no question this guy should have been banned from the industry right then and there.  Either the SEC or the so-called self-regulatory agencies, including the NASD and NYSE (which were later combined to form FINRA), were powerless or too lazy to do it - neither of which is an adequate explanation.

Back to Mr. Mandell…

He blamed his woes on an addiction to cocaine and alcoholism and in 1990 entered rehab.  Nevertheless a year later despite being sober the NYSE investigated him for unauthorized trading in customer accounts and he faced multiple customer complaints thereafter.  Many states wouldn’t license him to trade stocks but through his various employers’ connection with industry regulators he always found a way to continue working on Wall Street.  In 1995 he served a six-month suspension for “churning,” which is the act excessive buying and selling of securities in customer accounts for the purpose of generating commissions.

Mr. Mandell again made headlines in 2002 when he launched Sky Capital, a full service brokerage firm which he described as “a more traditional, more personalized alternative to the major financial institutions.”  The NASD was apparently powerless to stop him.  He told reporters that he had turned over a new leaf and with predictable audacity criticized tech-bubble analysts and CEO’s of being “irresponsible.”  He then took Sky Capital public on the London Stock Exchange (LSE).

Sky Capital’s office was later raided in 2006 by the FBI allegedly because customer funds were being used to finance operations after a client filed a related $130,000 arbitration claim.  Sky Capital’s answer to that problem was to sue the NASD for $300 million, a lawsuit that was later dismissed by the SEC.  The LSE later suspended trading of Sky Capital.

This latest arrest appears to be his last as he faces a potential 20-year sentence.  According to the 1996 Wall Street Journal story, Mr. Mandell’s high school yearbook quote was from the Grateful Dead: “Lately it occurs to me what a long, strange trip it’s been,” is what he inserted.  Way too long actually; he should have been banned years ago.  Now its up to tax payers to clean up this mess.

The story of Ross Mandell is an embarrassment of riches for anyone seeking support to an important clause found on page 72 of President Obama’s plan to reform financial regulation.  The clause would “support the SEC in pursuing authority to impose collateral bars against regulated persons across all aspects of the industry rather than in a specific segment of the industry.”

I guess this can be filed into the “better late than never” drawer.

Bank of America: “Bank of Opportunity for Convicted Fellons” Part 2

We’ve discovered that it’s no accident that Bank of America is the “Bank of Opportunity” for convicted felons. The bank’s modus operandi  is to “See No Evil, Hear No Evil, Speak No Evil.”

As outlined in the class action suit we filed last month, Bank of America (NYSE:BAC), the nation’s largest bank, substantially assisted Nicholas Cosmo’s $400 Ponzi scheme and played a major role in the loss of investor funds. The evidence is substantial that Bank of America knew, or should have known, that Cosmo was committing fraud. Cosmo was indicted earlier this week for mail and wire fraud. 

Our investigation has progressed and in the amended complaint we filed yesterday, we allege that Bank of America not only opened the proverbial barn door to Cosmo’s victims, the bank personally guided them through the barn.

Cosmo is a convicted felon who after completing a nearly two year stint in federal prison founded Agape World, Inc., a Long Island company specializing in making short-term “bridge” construction loans carrying high interest rates. Through a network of about a dozen brokers, Cosmo gathered some $400 million from investors who wanted to realize the attractive rates of returns. Unbenounced to the investors, Cosmo re-sold the same interests hundreds, if not thousands, of times. 

Although Bank of America ostensibly has “know your customer” rules and procedures, our complaint alleges that employees were routinely pressured to ignore obvious red flags such as a customer whose rap sheet includes securities fraud. 

Once upon a time BoA had a special unit based in Boston dubbed the “High Risk Group” whose mandate was to ferret out fraudsters like Nick Cosmo.  But we’ve learned that in 2006 Bank of America summarily shut the unit down because conscientious employees were resisting pressure to circumvent the bank’s purported “know your customer” rules.

Bank of America’s shuttering of its “High Risk Group” might also explain how in 2008 Florida fraudster Andy Bowdoin managed to use Bank of America as a conduit for his Ponzi scheme.   At Bank of America revenues apparently supersede all other obligations and considerations.

Our amended lawsuit also alleges that Bank of America apparently provided Cosmo access to information about the cash balances of Agape investors who had accounts with Bank of America.  Agape investors routinely received aggressive solicitations from Cosmo when their balances swelled.  So much for client confidentiality. 

Bank of America’s privacy problems are particularly alarming because back in July of 2007, the bank settled a lawsuit with the Utility Consumers Action Network, who alleged Bank of America disclosed consumers’ personal, private, confidential information to third parties without consumers’ consent. As part of the multi-million dollar settlement Bank of America made changes to its various privacy policies, it’s Web site and its procedures

Generating revenues to the detriment of customers is quite common on Wall Street. One of the best documented examples is the Commonwealth of Massachusetts’ complaint against Merrill Lynch regarding that firm’s peddling of auction rate securities.   ”Time after time, when confronted with conflicts of interest, Merrill Lynch was consistent in that it placed its own interests ahead of its investor clients,” the administrative complaint charged.

Bank of America acquired Merrill Lynch earlier this year.  When it comes to customer exploitation, it’s a marriage made in heaven.

Congress’ Task: An Honest Debate over ‘Stoneridge’

When a murder for hire crime is committed, two trials usually proceed.  The prosecutor’s office brings a criminal case and the victim’s family usually sues the defendant’s in civil court for monetary damages.  Unfortunately, it doesn’t work like that in the corporate world due to a Supreme Court ruling labeled, “The Stoneridge Decision,” which declared that “third-party liability” is limited to those that directly influenced investment decisions.  In other words, even though lawyers, investment bankers and auditors may have aided a corporate fraud, because a corporation interacts directly with shareholders, service providers don’t have any liability. I think there is something fundamentally wrong with this picture.

Lest anyone say the comparison I’ve just described is overly dramatic, I’ve excerpted below Federal Judge Gerald Lynch’s opinion regarding a fraud case he was forced to dismiss because of the crippling Supreme Court Stoneridge snub:

There are accomplices and there are accomplices: after all, in the criminal context when the Godfather orders a hit, he is only an accomplice to murder - one who ‘counsels, commands, induces or procures’  but he is nonetheless liable as a principal for the commission of crime. Likewise, some civil accomplices are deeply and indispensably implicated in the wrongful conduct.

 The fraud case Judge Lynch is referring to involves Mayer Brown, a large law firm, which was one of the law firms that has been alleged to have helped Refco, a now defunct brokerage giant, hide over $1 billion in losses from shareholders.

In addition to shareholders, the Stoneridge Decision has a huge impact for investors that have fallen victim to Ponzi Schemes and fraudulent hedge funds.  In almost all these cases there is nothing left of the funds leaving penniless victims without any recourse, even if the individuals responsible for ripping them off had help from outside sources?

Unfortunately a law on the books as influential as the Stonebridge Decision doesn’t gain the attention it deserves compared with the A.I.G. bonuses, for instance, but this law’s implications are greatly felt on Main Street U.S.A.

In related news, Bernard Madoff’s accountant was arrested earlier this week and charged with aiding and abetting investment adviser fraud and four counts of filing false audit reports. He faces up to 105 years in prison if convicted.  Reportedly, the accountant received $186,000 a year in fees for audit work, bookkeeping and tax services.

These fees and other assets owned by the allegedly crooked accountant are likely out of the reach for investors who took his audits at face value.  Indeed, while the accountant is likely to be sitting in a warm jail cell, the victims are left out in the cold.

The next session of Congress is likely going to be focused on reforming regulation of the financial services industry.  An honest discussion over the consequence of the Stoneridge Decision needs to be at the forefront of the agenda. I urge Congress to take meaningful steps to addressing this immensely important issue.

Hedge Fund Regulation: It’s going to take an act of Congress

Recent events have made it clear that hedge funds pose systemic risk to the financial industry, individual investors and the general public.  A rash of hedge fund blow-ups and frauds show that self-regulatory and market-discipline principles aren’t effective.  Left unchecked, hedge funds will continue to damage the markets.  In January 2009 Senators Levin and Grassley introduced The Hedge Fund Transparency Act which would close a loophole left open by the Investment Company Act of 1940 that allowed hedge funds to evade the definition of an “investment company”. Congress should adopt this bill or something very similar. Otherwise, hedge funds will continue to abuse the shortfalls of our regulatory system.

This is why I’m looking forward to tomorrow’s Senate Banking Committee Hearing entitled “Investor Protection and the Regulation of Securities Markets.”  Hedge fund regulation ought to take center stage.

Hedge funds, by far, have more capital in the equities market then any other asset class. Their transactions are often so large that the impact in the broader markets can be and is quite impactful. Therefore the risks they take are not only their own. That’s why reform needs to start with registration. Under former SEC Chairman Christopher Cox, the SEC’s attempt at hedge fund registration requirements was thwarted by the aforementioned loophole.  Naturally, Mr. Cox chose to drop the issue altogether rather then lobby Congress for change.

If investment advisors are required to register, hedge fund managers should be as well, no matter how many “official” clients they have. Regulators can and should periodically audit firms to ensure risk isn’t out of control.  Risk disclosures must be more transparent. Enough is enough with the creative micro-text found at the end of an offering memorandum. 

Once hedge funds fall under regulatory authority, enforcement of the law is paramount. Unfortunately, the SEC has fallen short of enforcing Wall Street effectively even though those institutions fall under their regulatory authority. This must change for Wall Street and hedge funds alike. The punishment must fit the crime and investors should have a clear and fair process to challenge any perceived wrongdoing.

Thus, investors and employees of hedge funds should be able to file arbitration claims against hedge funds. Arbitration claims, though not perfect, are more cost efficient than litigation and are heard in a much shorter period of time.   

Hedge fund regulation is clearly vital to any future functioning financial system in this country but it can’t end there. There also must be more scrutiny given to the esoteric derivatives market like credit default swaps. Look no further than AIG to see the problems this largely unregulated market has created. Just this week, Chairman Ben Bernanke called AIG “a hedge fund basically” that “exploited a huge gap in the regulatory system”.

If AIG, a public, “regulated” company can operate “like a hedge fund” due to regulatory gaps, then reform is clearly way past due. I trust that Congress will do the right thing and enact legislation that will close regulatory loop holes, protect investors and strengthen our financial system in the process.

Joseph Forte: Bernie’s got Company

Just as Bernie Madoff proved, and others before him, the Ponzi scheme did not end with Charles Ponzi and it appears it won’t end with Bernie Madoff either. The Pennsylvania fund manager, Joseph Forte, seems to be the latest alleged fraudster.

According to the SEC, Forte began Joseph Forte LP in 1995 and obtained $50 million from roughly 80 investors. He lured his investors by giving them a limited partnership in his firm and employed an investment strategy that traded S&P. 500 stock futures in addition to foreign currency futures and other futures contracts. He promised unbelievably generous returns between 19% and 38% annually, according to the SEC. Amazingly, these returns would make Forte’s fund, however fraudulent, appear to be an even better investment than Madoff Securities.

Ironically, it may have been Madoff’s downfall that led Forte’s investors to reveal his alleged fraud. As an aside, the SEC might try to take credit for bringing down Forte but I’m skeptical. According to the Philadelphia Inquirer, an investor sent Forte an email asking that he confirm assets in the supposedly inflated $150 million fund. It’s suspected that many investors filed suit and Forte realized then his alleged fraud would become exposed. According to the Commodities Futures Trading Commission (C.F.T.C), Forte then promptly turned himself in.

As I’ve said before, fraudsters usually get exposed eventually. But the trick is not to get caught up in one of these schemes in the first place. The most important take away for any investor is that they should take exceptional care when choosing where to invest their money. They should understand their money manager’s investment strategy and should expect realistic returns on their investment. This may all seem very obvious to some but too often smart investors are taken advantage of by a seemingly safe investment or are blinded by lavish returns. One lesson I hope will last is that investors should not allow someone who they consider to be a friend, manage their money. This can only lead to clouded judgment. .

Like Madoff and Forte or before them, Peter Dawson in Long Island, NY and Joseph Shereshevsky of WexTrust, perpetrators of financial fraud don’t only strike the ultra-high net worth individuals or institutional investors. They also hit mom and pop investors, religious communities, public institutions and non-profit organizations. I’ve been an investor advocate for a long time and while I’ve seen it all, I still cringe when I hear about these cases.

Hopefully, a small silver lining will be that the people who deceive investors’ confidence for their own benefit will be slowly exposed and eliminated. And while I’m certain that is of no solace to investors who lost their money with Forte, there still might be options on the table for investors to recoup some of their lost funds.

The SEC has Failed Us: What now?

The alleged Ponzi scheme perpetrated by Bernie Madoff should be the death-knell for the SEC. The SEC ignored numerous red flags waved by investors going back ten years. It was a not-so-well-kept secret across Wall Street that Mr. Madoff’s reported returns were fictitious and in 2001, Barron’s published a story entitled, “Don’t Ask, Don’t Tell; Bernie Madoff is so secretive, he even asks investors to keep mum.”

The signs were there. Period. And the SEC decided to lazily ignore the problem and is continuing to claim jurisdictional road blocks. It argued that Mr. Madoff didn’t register as an investment advisor, but that is not true. He was registered in 2006 and the SEC was required to examinie his operation then, and every five years thereafter.

In light of its recent performance, to make excuses at this point this is nothing less than insulting to investors.

Our financial regulatory system has failed. Therefore, steps must be taken to correct the problem now. If the United States wishes to remain the financial capital of the world, we must take a leadership role immediately.

Many factors such as securitization, leverage, asset bubbles, conflicts and outright fraud contributed to the economy’s downfall. But in general, I believe that it is self-regulation and inadequate oversight that provided the essential glue for the confluence of issues that have led to the economy’s collapse. One needs to not look any further than the fact that Bernie Madoff himself presided over the NASDAQ, which at the time served as one of the key financial regulators overseeing him and those of his ilk. Moreover, he was able to perpetrate his alleged schemes knowing the SEC was asleep at the wheel.

Nearly at every turn there are examples of Wall Street’s influence over regulation:

For example, in 2002 Wall Street successfully lobbied the SEC to adopt directives that would be “equivalent” to proposed European Union (E.U.) regulation that would have put the big five U.S. investment banks under the umbrella of E.U. regulatory authority. In response, the SEC, perhaps unwittingly, created as a result the Consolidated Supervised Entity (”CSE”), which relaxed net capital requirements and green-lighted unlimited debt/equity ratio leverage. This action permitted firms like Merrill Lynch and Bear Stearns to leverage their assets up to 40:1 with cataclysmic results for the financial system.

Another long-term and distressing trend is that the SEC Chairman and its top regulatory executives moved freely between the financial services industry and government positions. This resulted in a failure to manage conflicts. For example, in a scathing report issued by the Commission’s inspector general’s office, it was determined that the SEC’s Miami office found Bear Stearns improperly priced its collateralized debt obligations in 2005. An SEC official who later joined a major securities law firm gleefully informed Bear Stearns that the SEC would squash the investigation saying, “Christmas came early.”

The report went on to disclose numerous situations where conflicts clearly affected the SEC’s judgment including that an employee improperly used her position with regard to a family member’s dispute with a broker, potential insider trading and even one instance where one of the SEC’s own attorneys had not maintained his bar status in 14 years. The well documented case of the SEC’s handling of the Pequot insider trading allegations is another black eye.

Most of these scandals occurred under the watch of Chairman Christopher Cox, who prior to serving in the U.S. House of Representatives was a partner a Lanthan & Watkins, a go-to securities law firm for much of Wall Street. Chairman Cox’s laissez-faire oversight of the securities market makes Harvey Pitt’s famous “kindler, gentler” SEC look downright forceful. Plainly put, if Chairman Cox were the coach of a professional sports team, he would have been fired a few weeks into his first season.

Regulatory reform does not stop with the SEC. The current Secretary of the Treasury is easily the poster child of Wall Street’s “regulation domination.” In 2006, Secretary Paulson established the “Committee on Capital Markets Regulation,” a.k.a. “The Paulson Committee”, which set out to reduce the regulatory burden on the financial services industry. The Committee consisted exclusively of representatives of investment banks, auditors and corporate issuers. There were no representatives of either institutional or individual investors. Their targets were:

Ø Sarbanes-Oxley Act - particularly reforms designed to improve internal controls and the ability for Attorney Generals to prosecute corporate malfeasance

Ø Reducing litigation liability for auditors

Ø Making it harder to “prove” securities fraud

The proposals would have basically left securities and corporate fraud unchecked, which is exactly what Wall Street wanted. Though Wall Street’s meltdown has tempered Secretary Paulson appetite for additional deregulation, his oversight of the TARP funds appears to be engineered by the industry as well. Wall Street banks were provided billions in direct funding without any questions asked. And instead of using the funds to break the credit log jam, Wall Street is hoarding the money for its own purposes.

The key to a new Obama regulatory regime is expanded rules of play and stronger leadership. New regulation must be written on the basis of transparency, full disclosure and an end to conflicts of interest all together. Among the key focal points, I recommend:

Ø There has to be a complete overhaul of all the “grey” areas that continue to slip through the cracks. Indeed, it’s unclear whether the SEC should have had oversight of Mr. Madoff’s investment business because it was structured separately from his broker-dealer operation.

Ø There needs to entirely be more transparency for investment advisors, the credit default swaps market and hedge funds. Hedge fund regulation must go further than the so-called “Goldstein Rule,” which was a feeble attempt by the SEC to require fund managers simply to “register.” It’s notable that when the SEC was told it couldn’t require hedge funds to register as a matter of law, the agency choose to “punt” and not pursue such powers with Congress. To rein-in the damage they can cause, hedge funds, broker-dealers, market makers and investment advisors alike should be subject to periodic audits for systemic risk and “style drift.” Such an audit would expose Ponzi schemes, ala Mr. Madoff.

Ø And if there are breaches of regulations, the penalty must fit the crime. Gone should be the days when thirteen of the largest investment banks are fined a paltry $15 million collectively for violations, as was the case when the SEC found evidence of wrongdoing related to auction rate securities (ARS) years before the market froze. Paltry fines have been the cost of doing business for too long. Enforcement action should be discouraging enough to prevent violations.

Ø Finally, let investor arbitration be a stronger check for industry wrongdoing. FINRA must eliminate the requirement of one industry arbitrator sitting on each three member panel. This will make arbitration hearings fairer for investors - creating a more level playing field because the industry arbitrator is inherently partial.

What is going to give the Madoff scandal major impact is that very influential people have been profoundly affected including Senator Frank Lautenberg, real estate magnate and Daily News editor Mort Zuckerman, movie director Stephen Spielberg, among others. While there are countless individual investors that learned long ago of the SEC’s dormant ways, the agency’s negligence in the Madoff case has dramatically raised awareness of the agency’s ineffectiveness. I’m hopefully that the investor protection I’ve long been calling for is finally implemented.

Madoff Securities Alleged Ponzi Scheme Exposed: What’s an investor left to do?

In a bull market, investors are happy and tend not ask many questions. But when times get tough, they start wanting answers and Ponzi schemes are inevitably discovered.

The latest, of course, involves Bernard Madoff, a fixture on Wall Street for decades and one of the creators of the NASDAQ exchange. Mr. Madoff is the founder of Bernard L. Madoff Investment Securities. He was arrested by Federal Bureau of Investigation agents and charged with criminal securities fraud by federal prosecutors in Manhattan. The SEC has shown up late to the party once again and filed a civil suit, years after they were alerted of suspicious activity at Madoff Securities’ investment arm. All told, the alleged Ponzi scheme totaled $50 billion, possibly half of which was investor funds.

Naturally, Bernard Madoff’s clients are wondering if there’s anything left, and if so, how they can get their money back. Some investors will have an up-hill road to travel but for others there are legal options they can immediately pursue.

Firstly, to the extent that there are any funds left, claims can be filed against Madoff Securities directly. But it’s unlikely that there will be any money left. “It’s all a lie,” Mr. Madoff told investigators who were there to arrest him.

And it is doubtful there will be any recourse through the Securities Investor Protection Corporation (SIPC) because the money management function at Madoff Securities was held outside of the brokerage unit.

But investors that were placed into the Madoff Funds through other “fund-of-funds” or by another hedge fund manager could have more maneuverability. Indeed, managers of fund-of-funds could have liability for failing to perform a reasonable amount of due diligence on Bernard Madoff’s dealings. They had an obligation to research Mr. Madoff, his firm, and his returns. Managers of fund-of-funds were compensated to do this and likely marketed their due diligence capabilities to their clients.

The red flags were very clear in this case. Perhaps the most compelling was the fact that Mr. Madoff was generating such high returns using a strategy tied to the S&P 500. And this was all happening while the overall market sank in 2008!

The magnitude of Mr. Madoff’s deception is astounding. And the destruction of wealth that has apparently occurred here is shockingly awful. But if there is a silver lining to this at all, it’s that during this economic crisis the unnecessary middle men, fraudsters, hucksters and Wall Street’s ugly underbelly are being exposed and eliminated.

While that is likely of no consolation to Madoff Securities clients and investors, rest assured, they will also have their day in court.