The Questionable Activities of For-Profit Schools

Federal prosecutors in Manhattan and Georgia last week scored a major Medicare fraud bust with the indictments of 44 members of an Armenian-American crime syndicate who billed Medicare for more than $100 million of treatments that were never performed or received. The group reportedly succeeded in stealing $35 million in Medicare reimbursements, making it the largest Medicare fraud operation conducted by a single group to result in criminal fraud charges.

“With 118 phantom clinics and over $100 million in bogus billings, this group of international gangsters allegedly ran a veritable fraud franchise,” Preet Bharara, the United States attorney in Manhattan, said in a statement announcing the charges. “As charged, they stole taxpayer dollars earmarked for the elderly and infirm and got away with it, until now.”

If Bharara and his federal colleagues are genuinely concerned about misuse of taxpayer money, it is my sincere hope that they are taking a close look at the GAO’s allegations that many of the nation’s leading for-profit schools engaged in equally deceptive practices involving taxpayer dollars.

As someone who has investigated Wall Street for more than three decades, I’ve seen an incredible amount of wrongdoing. However, the activities of for-profit education schools appears to take the cake. Most Wall Street wrongdoing involves firms or brokers simply ripping off their customers; there is considerable evidence suggesting that for-profit education companies may have systematically defrauded the Department of Education, ruined, possibly forever, the finances of already hard-pressed low-income students, and deceived investors about the true condition of their business. The extent and the magnitude of the wrongdoing could possibly rival the sub-prime mortgage debacle.

The GAO reported in August that undercover tests at 15 for-profit colleges found that all made “deceptive or otherwise questionable statements” to the agency’s undercover applicants. One admissions representative told an applicant to fraudulently remove $250,000 in savings on a financial aid form. A student interested in a massage therapy certificate costing $14,000 at a for-profit college was told that the program was a good value, but the GAO said the same certificate from a local community college cost $520. Recruiters at these schools also frequently engaged in aggressive marketing tactics to pressure these students, who had few options and limited financial flexibility, into enrolling. To review the extent of the alleged wrongdoing, here’s a link to the GAO report. Warning: the accompanying video will make your blood boil.

My firm represents investors who bought for-education stocks that were aggressively touted by their brokers. The clients were told that for-education stocks would prosper in the wake of the downturn because millions of people would seek vocational retraining. The investors, of course, were never told that for-education companies were boosting their financials using questionable sales and marketing practices. The stocks of these companies have plummeted.

President Obama has repeatedly been bashing Wall Street for its greed and unscrupulous practices but so far his rhetoric rings hollow. The SEC remains as ineffective as ever under his administration, merely meting out wrist slaps to alleged fraudsters like Goldman Sachs and Angelo Mozilo. I say alleged because despite agreeing to pay fines of $550 million and $67.5 million respectively, they weren’t required to admit any wrongdoing.

If President Obama truly cared about curbing Wall Street’s reckless and ruinous behavior, he’d be at the forefront calling for a public investigation of for-profit companies and criminal prosecutions for defrauding any government program, not just Medicare.

More Half-Baked Justice from the SEC

Last year, Judge Jed Rakoff of the United States Southern District of New York struck a blow on behalf of all investors when he ordered the SEC and Bank of America back to the negotiating table. He deemed the settlement agreement the SEC submitted for Bank of America’s alleged failure to disclose billions of dollars of losses at Merrill Lynch as inadequate and poorly constructed. When the SEC and Bank of America went back to the drawing board and agreed to somewhat stricter terms, still without admission of guilt, Judge Rakoff reluctantly approved. But not without a last salvo.

Judge Rakoff proclaimed that the revised settlement represented “very modest punitive, compensatory, and remedial measures that are neither directed at the specific individuals responsible for the nondisclosures nor appear likely to have more than a very modest impact on corporate practices or victim compensation…While better than nothing, this is half-baked justice at best.”

The same “half-baked justice” Judge Rakoff described last year was evident in the SEC’s recent settlement with Citigroup. The SEC alleged Citigroup executives hid $40 billion in toxic mortgage industry assets from its shareholders. Citigroup paid a $75 million fine for what might be one of the biggest accounting scandals on record and managed to avoid using the word “fraud” to describe its actions. Carefully crafted by Citigroup’s attorneys, the terms of the settlement were clearly designed to protect executives from liability and undermine shareholder’s seeking to recover their losses.

Goldman Sachs executives similarly managed to escape blame stemming from the SEC’s accusation that the firm inappropriately constructed the ABACUS CDO transaction. To recall, Goldman created ABACUS so that its clients would unknowingly invest in securities design to fail. To avoid admitting fraud and spare the reputations of senior-level executives, Goldman paid a fine of over $500 million. The settlement was so favorable to Goldman Sachs that its stock price rose 5% percent.

The SEC’s lackluster enforcement record during the financial crisis stands in stark contrast to the country’s state regulators. Attorneys General and securities regulators from many states have done all the heavy lifting, and have extracted meaningful settlements along the way. Most notable is Massachusetts Secretary of State William Galvin. Among Mr. Galvin’s accomplishments is ordering Bear Stearns to pay back 100 percent of any losses suffered by Massachusetts residents who invested in the firm’s infamous, sub-prime laden, hedge funds that spectacularly collapsed in 2007. He also was among the earliest regulators to take action against Wall Street for misleading investors about auction rate securities and he has ordered the Madoff feeder-fund Fairfield Greenwich to pay its investors every penny they lost.

Another active state enforcement official is Mark Connolly, Director of Securities Regulation for New Hampshire, who has accused UBS of fraud for its sales practices related to Principal Protected Notes issued by Lehman Brothers. His case is especially notable because unlike the SEC, he isn’t afraid to use the word “fraud” to describe “misleading investors.”

I could write for hours about all of the significant cases filed by state regulators, but there is a common theme: state securities regulators help investors recover losses from fraudulent schemes and seek to deter it from happening again within their borders.

Unfortunately the same cannot be said of the SEC.

Goldman Sachs’ Worst Nightmare: Adoption of a Fiduciary Standard

Though Goldman Sachs claims it merely acted as a market-maker for the ABACUS deal, they really acted much more like “issuer” with an obligation to disclose all pertinent facts and risks, including the fact that the architect who helped choose the underlying securities was betting they would fail.  Goldman claims that there was no absolute certainty the ABACUS deals would implode and has repeatedly said that they lost more than $90 million by owning some of the securities themselves (the result of the firm failing to find enough suckers to sample it’s toxic cooking).

For a firm with no moral qualms about betting against its own clients, it comes as no surprise that Goldman Sachs is lobbying hard against Congress passing a so-called fiduciary standard that would require the firm to always act in the best interests of its clients.   Kicking off what is sure to be a full-court press on Capital Hill, Goldman’s President and COO Gary Cohn has warned that if market makers were forced to adhere to a fiduciary standard, the markets would stop functioning.

I wholeheartedly agree.  Imposing a fiduciary standard on market makers would not be wise legislation.  However, better defining the roles of “issuer” and “market-maker” and imposing a fiduciary standard on “issuers” would serve the best interest of all investors. Had this been done years ago, it’s highly unlikely Goldman would have dared to unload the ABACUS transactions.

On regulatory reform, Wall Street is pitching a shut out against investors.  Congress needs to step up to the plate.

Ethical Showdown: Goldman vs. Bear

Goldman Sachs has long reigned supreme on Wall Street because of the widespread perception and belief that they employed the smartest guys in the business.  But the SEC’s fraud charges against the firm have exposed another possible reason for the firm’s stratospheric success: The firm is more ethically challenged than some of its rivals.

We will let the courts decide the legal merits of the fraud charges the SEC filed against Goldman last week, but let’s consider the moral propriety of the firm selling its clients mortgage securities that hedge fund powerhouse John Paulson had determined were most likely to fail.  Goldman steadfastly maintains that it had no legal obligation to disclose that Paulson was the designer of the CDOs, but at least one competitor reportedly couldn’t stomach concocting such an arrangement.

In his book, “The Greatest Trade Ever,” Wall Street Journal reporter Greg Zuckerman discloses that Paulson first approached Bear Stearns trader Scott Eichel to structure  a package of highly toxic securities with a high likelihood of failure, but Eichel and his colleagues apparently wouldn’t do the deal.  According to Zuckerman:

Mr. Eichel said he felt it would look improper for his firm. “On the one hand, we’d be selling the deals to investors, without telling them that a bearish hedge fund was the impetus for the transaction, Mr. Eichel told a colleague; on the other hand, Bear Stearns would be helping Mr. Paulson wager against the deals.”

Zuckerman says that Deutsche Bank and other unnamed banks also worked with Paulson to structure CDOs that he could short, which, if true, raises the question as to why the SEC has singled out only Goldman for fraud.  Bears Stearns was hardly the paragon of ethical propriety (it marketed hedge funds filled with dubious subprime mortgage securities to unsuspecting retail investors), but its impressive that they chose to turn down a lucrative fee arrangement rather than engage in a transaction they perceived as morally wrong. Goldman and Deutsche Bank apparently had no such ethical compunctions.

Ironically, Eichel now reportedly works for Royal Bank of Scotland, which acquired a business unit of ABN AMRO that was on the losing side of the Paulson designed instruments.  Goldman maintains that it also lost $90 million on the deal, but I’m skeptical about the validity of the claim; the firm has long bragged about its risk management and its ability to hedge its trades. So while perhaps Goldman did indeed lose $90 million on one side of the transaction, it’s more than likely that they made it up on another.

Goldman Sachs and the “Fabulous Fab”

Goldman Sachs’ first day of reckoning may be dawning.  Today the SEC filed charges that a hedge fund seeking to short the mortgage market helped Goldman Sachs build a product so toxic, it would collapse in the matter of months…a plan executed with precision.  The arrangement was not disclosed to investors, who are otherwise known as Goldman Sachs’ customers.

Though the victims in this case are institutional investors, the SEC’s allegation that Goldman Sachs withheld material information from its clients is as much about fraud as it is restitution for the millions of families whose nest eggs were destroyed because of Wall Street’s greed.

I’m heartened the SEC is finally taking a critical look at Goldman Sachs’ activities, but it’s noteworthy the only person named in the complaint is a pretty small fry, albeit one with an outsized ego.  His name is Fabrice Tourre, or the “fabulous Fab” as the 31 year-old banker likes to call himself.  ‘Fabulous Fab’ was a lowly vice president, and he was likely following the ethical direction and guidance of his superiors.

Nevertheless, the allegations against Goldman Sachs are devastating in that it confirms what everyone suspected: the firm has little regard for disclosure rules and thinks nothing of ripping off customers if the price is right.  So let’s hope the SEC is up to the challenge. Indeed, it’s one thing for the SEC to bring charges, but the real test will be if the agency has the talent, resources and resolve to take on the mighty and politically connected Goldman Sachs.

Regardless, a bigger worry for Goldman Sachs are the inevitable private lawsuits from investors.  Institutions that purchased Goldman Sachs’ allegedly fraudulent securities will be seeking recourse for billions in damages of investment losses.

On cue, Goldman Sachs’ much ridiculed PR apparatus responded to the SEC’s charges by saying that, “The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation.”

We’ll see about the charges, but as far as Goldman’s reputation, there’s not much to defend there.

Some Questions for President Obama’s Financial Crisis Probe Panel to Consider

Tomorrow, A Who’s Who of Wall Street executives, including the top honchos from Goldman Sachs, Morgan Stanley, and Bank of America will parade before a bi-partisan panel of 10 wise men and women appointed by members of Congress to determine the root causes of our country’s brush with economic collapse last year.  Speculation is rife that the commission could create initiatives as meaningful as the Glass-Seagall Act and the creation of the SEC which were headed by Ferdinand Pecora in the midst of the Depression. Regretfully, I’m skeptical that will be the case.

Although the U.S. was on the brink of economic disaster again in 2008, the stock market’s subsequent surge has given Americans a false sense of confidence.  Wall Street understands that investors have short memories and that their anger has subsided, hence the decision to pay themselves big, fat bonuses again. The fact that Timothy Geithner remains Treasury Secretary speaks volumes about how Washington still serves at the behest of Wall Street.

Nevertheless, the members of President Obama’s Financial Crisis Inquiry Commission (FCIC) are an impressive bunch, and I have no doubt they will ask some pointed questions and elicit some headline grabbing answers.  A good start would be for them to read today’s column in The New York Times by Andrew Ross Sorkin.  He identifies several important questions we’ve yet to get a clear answer on.

Nevertheless, I remain skeptical that this commission will have lasting impact.

A Beantown Slugger Worthy of Yankee Pinstripes

The New York Yankees these days have overtaken the Boston Red Sox as decidedly the best team in baseball.  There is, however, one bright spot in Beantown - a homerun regulatory slugger who is having a “career year.” His name is William Galvin.

Galvin, Massachusetts’ chief financial regulator, has established an impressive track record serving the best interests of investors.  His list of accomplishments is too numerous to mention here, but suffice it to say that he has been at the forefront of investigating and aggressively pursuing Wall Street wrongdoing, sometimes recovering as much as 100 percent of the losses sustained by Massachusetts investors. As I’ve repeatedly noted, Galvin’s complaint against Merrill Lynch regarding the firm’s marketing of auction rate securities ranks among the best primers on how Wall Street firms routinely put their interests ahead of their clients.

Galvin now has set his sights on Goldman Sachs’ weekly trading huddles, which I wrote about earlier this week. As reported by the Wall Street Journal, Goldman analysts routinely hold a weekly “trading huddle” to give “tips” to the firm’s traders and 50 most-favored clients, including SAC Capital Advisors and Citadel Investment Group.  Some of these tips are reportedly at odds with the published recommendations of Goldman’s widely disseminated research reports.

Galvin is the real deal and he already has some insight as to how Goldman treats its less-than-favored customers.  His agency has reached a settlement with Goldman regarding its peddling of auction rate securities, though the details are still being finalized.

It is my hope that in addition to examining the trading huddles, Galvin’s investigation will include the entire range of services Goldman provides its biggest clients and the criteria these firms use to evaluate these services.  Hedge funds have a fiduciary obligation to get the best execution on their trades and it might behoove Galvin and his people to investigate whether that is in fact happening.

As the saying goes, where there is smoke there is often fire, but that’s not always true.  If, after investigating Goldman’s huddles, Galvin concludes that no wrongdoing occurred, investors can take comfort in knowing that the practice was properly vetted.  Sadly, the same probably can’t be said about the investigations of the SEC and FINRA.