Meltdown fraud

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The ethical dimension of the market crisis

A Q&A from the Practitioners’ Perspective: A Resource for Financial Professionals

By CFA Institute Standards of Practice Council member volunteers and the CFA Institute Centre for Financial Market Integrity

Q. Is the current crisis in global capital markets the result of a systemic failure of market institutions, or of widespread misconduct by market participants?

A. The historic meltdown of the global capital markets is the result of a number of factors, including the actions, and inactions, of a variety of market participants. In many ways, the current collapse echoes the mistakes made in past crises: ignorance of risk coupled with widespread use of leverage.

When such wide-reaching events occur, there is a temptation to discount the role of the individuals’ actions, concluding instead that there were systemic failings compounded by a series of extraordinary circumstances that no individual or entity could have reasonably foreseen. Managers did not deliberately make bad investments; most probably believed they were doing the right thing with the information given to them. Behavior biases are likely at play in this crisis, and perhaps a herding instinct led investment professionals to make certain investment decisions because they believed that “if everyone is doing this, it must be okay.”

Q. What role does the CFA Institute Code and Standards play?

A. The economic impacts of the crisis have been discussed a great deal, but considerably less attention has been paid to the ethical dimension. An examination of the root causes of the crisis highlights a number of ethical concerns about which the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards) can provide guidance. Among the fundamental tenets of the CFA Institute Code of Ethics that may have been ignored are those that state (in part):

“Act with integrity, competence, diligence, respect, and in an ethical manner”; “Use reasonable care and exercise independent professional judgment”; and, “Practice and encourage others to practice in a professional and ethical manner.”

While there are many players and regulatory flaws that contributed to the turmoil, only CFA charterholders and CFA Program candidates are obligated to abide by the Code and Standards. We believe that the industry could have benefited, and the severity of the crisis been mitigated, had these concepts and the CFA Institute standards of professional conduct been observed more broadly.

Q. Were the people who created the toxic securities aware of the risks involved? Once the products were created, was the proper analysis done (or could it have been done) when either rating or investing in these complex securities?

A. Investment Banks designed, developed, and sold new securities to meet market demand for products that could help investors manage risk or provide higher yields in a low-yield environment. The toxicity of these securities came about from the downward spiral of the housing market coupled with the scale of leverage and illiquidity that counter-parties ultimately could not tolerate. Compensation schemes based on volume rather than on quality — of borrower or collateral — stimulated many of the structured products and other derivative instruments that ultimately proved toxic.

The current crisis demonstrates that the competitive nature of the financial markets that underlies the new product development process must be balanced by principled conduct rooted in the ideas of ethical behavior and market integrity. Certainly innovation is not inherently bad, but the resulting products do impact salespeople and purchasers of these securities. Closer attention must be paid to proper analysis and disclosure at all levels.

Many investment professionals apparently did not fully understand the acronym-heavy securities — CDOs, CDO-squared, etc. — they were creating, rating, or purchasing, despite the fact that many came with a prospectus of 1,000 pages or more. Many purchasers of the securities seemingly over-relied on credit rating agencies (CRAs) to determine the product quality and safety without demanding better information or performing their own in-depth analysis. Further, the CRAs may have lacked the data and expertise to properly analyze these complex structured products, missing the reality that these highly leveraged securities were being sold to leveraged buyers who financed the products by mismatching their assets and liabilities.

Credit analysts were directed to replicate and use models developed by external parties without verifying the robustness and applicability of those models. These actions could be deemed as violations of Standard V(A), which requires the use of diligence, independence, and thoroughness in conducting investment analysis and when making investment recommendations. This standard also requires a reasonable and adequate basis supported by appropriate research and investigation for any investment action. Those responsible for the rating should understand the full features of the model and test the results against multiple scenario assumptions.

The current market crisis highlights the role of technical models in the development and rating of credit-based investment vehicles. As the rating analysis is completed, the models used need to be fully understood and tested. This includes having adequate knowledge of the information being fed into the model, as well as an adequate basis for stress-testing the model’s basic assumptions. For example, while the recent decline of the housing market is unprecedented by historical averages, some level of decline should always be included as a possible scenario. A greater level of testing on a wider range of situations could assist in reducing the magnitude of future market events.

Q. Investors were eager for the high returns these products paid, but were they made aware of and/or able to fully understand the associated risk?

A. Investment professionals have the fundamental responsibility to provide appropriate guidance and direction. Some investment professionals must have understood that the positive return pyramid was built upon an already high — and unaffordable to buyers — base of rising real estate prices. Yet the realities and risks were ignored or discounted. Standard II(C), which addresses suitability, dictates that investment professionals determine whether an investment is suitable to the client’s investment situation and consistent with the client’s written objectives, mandates, and constraints.

In hindsight, it is easy to claim that investment portfolios stuffed with unprofitable investments are “unsuitable,” but more care should have been taken. Highly leveraged, risky investments were recommended as “investment grade” based on the AAA-ratings assigned to those investments. With additional, diligent analysis, the investment profession may have questioned these structures and their placement in certain portfolios.

To complicate matters, the liquidity risks of auction-rate securities were minimized when determining the suitability of the investment. When the true value of the securities became clear, investment banks chose to offload their holdings of auction-rate securities to unsuspecting clients, despite an impending collapse of the market. This reduced the liquidity of these securities and the clients’ ability to redeem the investment on a short-term basis.

Q. Was the value of the securities knowingly misrepresented? Should there have been more disclosure earlier in the process?

A. Standard I(C), which addresses misrepresentation, prohibits investment professionals from knowingly making misrepresentations or false statements. This principle would certainly apply to statements about the value of investment holdings. If the CRAs involved withheld information about the risks of the investments, then they misrepresented the true economic value and risks of the mortgage-related securities they had rated. Knowingly omitting information that would impact a rating reflects poorly on the integrity of the firm and the decision-making process. It is essential that investment professionals obtain complete disclosure of the ratings process so they have the full complement of resources required to help inform their investment decisions.

Good ethical practice dictates more disclosure rather than less, so the recent trend away from market value accounting brings a rather alarming “Alice in Wonderland” dimension to the process. Simply stating that securities have a certain value does not make it so. The valuation of the toxic securities held on the books came into serious question when institutions were asked to apply fair value accounting and mark those assets to market. Indeed, at that point, in a declining housing market, the quickly eroding value of the securities became clear. As the markets conduct “price discovery” on these exotic instruments, we can expect to see further write-downs.

Future ratings disclosures could better reveal the assumptions used in the model, and demonstrate increased sensitivity to the results of those assumptions. Such information should clearly indicate the expectations used in assigning the ratings, and inform investors of possible impacts if the market moves in another direction.

Q. Are the individuals who played a part in the market collapse guilty of misconduct?

A. While certain investment professionals may have exercised poor judgment in creating, evaluating, or investing in these credit-related securities, it remains to be seen whether any of their actions rose to the level of unethical or unprofessional conduct. Though there may have been potential breaches of the CFA Institute Code and Standards in more than one area, individuals must look in the mirror and judge their own conduct. It is insufficient to fall back on the general view that this was a “train wreck” and we are all victims.

The CFA Institute Code and Standards establish, among other fundamental ethical principles, high expectations for due diligence, investment with a reasonable basis, suitability of investments, and prohibitions against misrepresentation. These are the core values and principles that CFA Institute stands for. CFA Institute will investigate where it has specific knowledge of misconduct by individual CFA Institute members or CFA Program candidates who failed to meet the high standards of conduct established by the Code and Standards. But, at the end of the day, good judgment plays a critical role in a successful investment decision-making process and no code of ethics can ensure that investment professionals universally make the correct decisions at all times.

Specter amendment would provide private right of action

An amendment offered to the Restoring American Financial Stability Act (S 3217) by Senator Arlen Spector (D-PA) would overturn two US Supreme Court opinions and provide a private right of action for aiding and abetting securities fraud. The amendment essentially mirrors the Liability for Aiding and Abetting Securities Violations Act, S. 1551, introduced by Sen. Spector in 2009. The amendment (SA 3776) would legislatively overrule what the senator calls ``two errant decisions of the Supreme Court’’, namely the 1994 Central Bank of Denver v. First Interstate Bank ruling and the 2008 ruling in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. The immunity from suit that Central Bank confers on secondary actors, said the senator, has removed much-needed incentives for them to avoid complicity in and even help prevent securities fraud; and all too often left the victims of fraud uncompensated for their losses.

The Specter Amendment would take the limited, but important, step of amending the Exchange Act to authorize a private right of action under §10(b), the antifraud provision, and other, less commonly invoked, provisions of the Act, against a secondary actor who provides substantial assistance to a person who violates the securities antifraud rule. Any suit brought under the proposed Specter Amendment would be subject to the heightened pleading standards, discovery-stay procedures, and other defendant-protective features of the Private Securities Litigation Reform Act of 1995.

Until the Central Bank ruling, noted the senator, every circuit of the Federal Court of Appeals had concluded that §10(b)'s private right of action allowed recovery not only against the person who directly undertook a fraudulent act, the primary violator, but also anyone who aided and abetted the actor. A five-Justice majority in Central Bank narrowed §10(b)'s scope by holding that its private right of action extended only to primary violators.When Congress debated the legislation that became the Private Securities Litigation Reform Act of 1995, then-SEC Chair Arthur Levitt and others urged Congress to overturn Central Bank, said Sen. Specter, but Congress declined to do so. Cong. Record, July 30, 2009, S8564.

The PSLRA authorized only the SEC to bring aiding and abetting enforcement litigation. But in the senator’s view, SEC enforcement actions have proved to be no substitute for suits by private plaintiffs. The SEC's litigating resources are too limited for the SEC to bring suit except in a small number of cases, he averred, and even when the SEC does bring suit it cannot recover damages for the victims of fraud.

Senator Specter urged Congress to revisit the judgment it made in the 1995 Act. The massive frauds of the past decade at Enron and other companies have taught that secondary actors, such as an issuer's auditors, bankers, business affiliates, and lawyers, all too often actively participate in and enable the issuer's fraud. He cited a federal judge’s recent observation that secondary actors are sometimes deeply and indispensably implicated in wrongful conduct. In re Refco, Inc. Sec. Litig., 609 F. Supp. 2d. 304, 318 n.15, S.D.N.Y.In Stoneridge, the Court ruled that secondary non-speaking actors said to have participated with a company in a securities fraud scheme were not liable in a private action under Rule 10b-5 since the acts of suppliers said to have participated in the fraud were too remote to satisfy the antifraud rule’s reliance requirement.

Since the company was free to do as it chose in preparing its books, conferring with its auditor, and issuing its financial statements, reasoned the Court, the investors cannot be said to have relied upon any of the deceptive acts of the suppliers said to have assisted the fraud.Senator Specter said that the Stoneridge opinion made matters still worse for defrauded investors. While Central Bank had at least held open the possibility that secondary actors who themselves undertake fraudulent activities could be held liable as primary violators, he said, Stoneridge largely foreclosed that possibility.

In Stoneridge, a divided Court held that §10(b)'s private right of action did not reach two vendors of a cable company that entered into sham transactions with the company knowing that it would publicly report the transactions in order to inflate its stock price. The Court conceded that the suppliers engaged in fraudulent conduct prescribed by §10(b), but held that they were not liable in a private action because only the issuer, not they, communicated the transaction to the public. According to Sen. Spector, that "remarkable conclusion put the Court at odds with even the Republican Chairman of the SEC."

Senate Judiciary Committee to hold hearing May 4

"Sen. Arlen Specter said Thursday that he'd hold a hearing next month to examine Wall Street firms' potential conflicts of interest when they secretly bet against products similar to those they sold, and into whether investment banks were being penalized too lightly for their roles in wrecking the economy.

Specter's announcement opened a new front for Goldman Sachs and other banks that already are facing scrutiny from the Securities and Exchange Commission, the Senate Permanent Subcommittee on Investigations and House of Representatives oversight panels.

"In my judgment, Congress should examine these complicated transactions with a microscope and make a public policy determination as to whether such conduct crosses the criminal line," the veteran Pennsylvania Republican-turned-Democrat, who's facing a tough re-election race, said in a Senate floor speech.

Contending that major companies consider fines "a cost of doing business," the former Philadelphia district attorney said: "I have long been concerned about the acceptance of fines instead of jail sentences in egregious cases."

Last November, McClatchy reported that Goldman sold more than $40 billion in risky mortgage securities to institutional investors in 2006 and 2007 while secretly betting that the U.S. housing market would sink and depress the value of the securities.

Specter said he'd convene a hearing May 4 before a Senate Judiciary Committee subcommittee to explore the assertions by Goldman and other such banks that sophisticated investors such as pension funds and insurance companies "have a duty to protect themselves without relying on the investment counselor."

Asset valuation fallout

Senate panel probes banks for fraud

"A Senate panel has subpoenaed financial institutions, including Goldman Sachs Group Inc. and Deutsche Bank AG, seeking evidence of fraud in last year's mortgage-market meltdown, according to people familiar with the situation.

The congressional investigation appears to focus on whether internal communications, such as email, show bankers had private doubts about whether mortgage-related securities they were putting together were as financially sound as their public pronouncements suggested. Collapsing values for many of those securities played a big role in precipitating last year's financial crisis.

According to people familiar with the matter, the Senate Permanent Subcommittee on Investigations also has issued a subpoena to Washington Mutual Inc., a Seattle thrift that was seized by regulators in last year's financial crisis and is now largely owned by J.P. Morgan Chase & Co. It appears likely that several other financial institutions also have received subpoenas. Subcommittee investigators declined to comment. A Goldman Sachs spokesman declined to comment on the subpoena. Deutsche Bank didn't immediately respond to a request for comment.

J.P. Morgan Chase spokesman Thomas Kelly declined to comment on whether the firm, which acquired the banking assets of Washington Mutual last September, had received any subpoenas, saying only "we cooperate with government agencies."

A subpoena from the subcommittee raises a number of factual questions and asks for various company correspondence, according to a person who reviewed it.

The subpoenas are the latest in a series of moves by Congress to trace the roots of the financial crisis. Goldman has been a favorite target for criticism in Washington.

A House panel voted this week to allow regulators to bar banks from offering executive-pay plans that encourage too much risk. The move came after Goldman Sachs reported record profits for the second quarter and said it has set aside $11.4 billion during the first half of the year to compensate employees.

Earlier this week, a bipartisan group of 10 members of Congress sent a letter to Federal Reserve Chairman Ben Bernanke, questioning whether Goldman Sachs is being too lightly regulated and too generously backed by taxpayers.

An idea for taxing high-value health insurance plans has even become known on Capitol Hill as the "Goldman Sachs tax," after criticisms of its executives' $40,000 health plans. A Goldman Sachs spokesman declined to comment on the criticisms from Congress.

The subcommittee is headed by Sen. Carl Levin (D., Mich.), who has been a driving force behind many of its probes.

Write to John D. McKinnon at

Former Fannie execs law bills paid by taxpayers

It is still unclear what the ultimate cost of this bailout will be. But thanks to inquiries by Representative Alan Grayson, a Florida Democrat, we do know of another, simply outrageous cost. As a result of the Fannie takeover, taxpayers are paying millions of dollars in legal defense bills for three top former executives, including Franklin D. Raines, who left the company in late 2004 under accusations of accounting improprieties. From Sept. 6, 2008, to July 21, these legal payments totaled $6.3 million.

With all the turmoil of the financial crisis, you may have forgotten about the book-cooking that went on at Fannie Mae. Government inquiries found that between 1998 and 2004, senior executives at Fannie manipulated its results to hit earnings targets and generate $115 million in bonus compensation. Fannie had to restate its financial results by $6.3 billion.

Almost two years later, in 2006, Fannie’s regulator concluded an investigation of the accounting with a scathing report. “The conduct of Mr. Raines, chief financial officer J. Timothy Howard, and other members of the inner circle of senior executives at Fannie Mae was inconsistent with the values of responsibility, accountability, and integrity,” it said.

That year, the government sued Mr. Raines, Mr. Howard and Leanne Spencer, Fannie’s former controller, seeking $100 million in fines and $115 million in restitution from bonuses the government contended were not earned. Without admitting wrongdoing, Mr. Raines, Mr. Howard and Ms. Spencer paid $31.4 million in 2008 to settle the litigation.

Banks mismarking asset values - cleanup costly

There was a stunning omission from the government’s latest list of “problem” banks, which ran to 416 lenders, a 15-year high, as of June 30. One outfit not on the list was Georgian Bank, the second-largest Atlanta-based bank, which supposedly had plenty of capital.

It failed last week.

Georgian’s clean-up will be unusually costly. The book value of Georgian’s assets was $2 billion as of July 24, about the same as the bank’s deposit liabilities, according to a Federal Deposit Insurance Corp. press release. The FDIC estimates the collapse will cost its insurance fund $892 million, or 45 percent of the bank’s assets. That percentage was almost double the average for this year’s 95 U.S. bank failures, and it was the highest among the 10 largest ones.

How many other seemingly healthy multibillion-dollar community banks are out there waiting to implode? That’s impossible to know, which is what’s so unsettling about Georgian’s sudden downfall. Just when the conventional wisdom suggests the banking crisis might be under control, along comes a reality check that tells us we’re still flying blind.

The cost of Georgian’s failure confirms that the bank’s asset values were too optimistic. It also helps explain why the FDIC, led by Chairman Sheila Bair, is resorting to extraordinary measures to replenish its battered insurance fund.

Georgian, which had five branches catering to local businesses and wealthy individuals, was chartered in 2001. By 2003, the closely held bank had raised $50 million from an investor group led by a longtime local banker, Gordon Teel, who remained chief executive officer until last July. It grew at a breathtaking pace, fueled by the real-estate bubble.

From 2004 to 2007, total assets almost tripled to $2 billion from $737 million. Annual net income rose seven-fold to $18.3 million. The bank touted its philanthropy, including a $1 million pledge to a local children’s hospital, and boasted of a growing art collection showcasing Georgia painters.

As recently as its March 31 report to regulators, Georgian said it met the FDIC’s requirements to be deemed “well capitalized.” By June 30, that had dropped to “adequately capitalized,” after a $45 million second-quarter net loss.

Georgian also reported a 12-fold jump in nonperforming loans to $306.4 million from $24.7 million three months earlier, mostly construction loans. Georgian’s numbers made it seem as if the surge arose from nowhere. On its March 31 report, the bank said just $79.1 million of its loans were 30 days or more past due. That included the loans it had classified as nonperforming.

Georgian’s new CEO, John Poelker, downplayed any concerns. “Whether there is enough capital for the bank to be a survivor isn’t an issue,” he told Bloomberg News for an Aug. 5 article.

What wasn’t made public until Sept. 25, the day it closed, was that Georgian Bank had agreed to a cease-and-desist order with the FDIC on Aug. 31 after flunking an agency examination. The 19-page order described various “unsafe or unsound banking practices and violations of law and/or regulations,” including failing to record loan losses in a timely manner. Georgian neither admitted nor denied the allegations.

The FDIC updates the public about the number of banks on its problem list once a quarter. An FDIC spokesman, David Barr, said Georgian was added to the FDIC’s internal list in July. He said the agency adds banks to the list based on exam ratings, not the data in their financial reports.

As for the 416 banks on the list as of June 30, up from 305 a quarter earlier, the FDIC said their combined assets were $299.8 billion. (The FDIC didn’t name the banks, per its usual practice.) If Georgian’s experience is any guide, the real-world value of those assets probably is much less.

Supreme Court takes fraud case

"The Supreme Court has agreed to decide whether Australian investors can use U.S. securities law and American courts to sue an Australia-based bank for fraud.

The justices said Monday they will use the lawsuit against Melbourne-based National Australia Bank to clarify whether and when U.S. law can apply to international dealings.

Several Australian stockholders sued the bank in federal court in New York over alleged financial fraud by a bank-owned mortgage servicing company in Florida.

The stockholders say that HomeSide Lending Inc., which the bank has since sold, fraudently overvalued its assets. The bank later reduced the value of its assets by $2.2 billion because of what it called mistakes by HomeSide. The bank's stock price dropped sharply as a result.

The investors say American courts should have jurisdiction to hear their lawsuit because the alleged fraud was committed in the United States.

But the federal appeals court in New York threw out the lawsuit, reasoning that the alleged fraud had too tenuous a connection to the United States. Any losses suffered by investors resulted more from decisions made by the bank in Australia than what happened in Florida, the court said.

The high court agreed to hear the case over the objection of the Obama administration. The case will be argued in March or April.

The case is Morrison v. National Australia Bank, 08-1191.

Trustee losses - Bank of America

" Bank of America Corp., the largest U.S. bank by assets, was sued by BNP Paribas Mortgage Corp. and Deutsche Bank AG over hundreds of millions of dollars in losses they sustained by investing in asset-backed commercial paper.

BNP Paribas and Deutsche Bank today filed separate lawsuits in Manhattan federal court. They say they bought a total of $1.6 billion in asset-backed notes issued by a special-purpose entity known as Ocala Funding LLC, which provided funding for mortgage loans originated by Taylor, Bean & Whitaker Mortgage Corp. To reduce risk, they say they insisted that Ocala hold $1.6 billion in cash or mortgage loans as collateral to be deposited with Bank of America, the deal’s trustee.

Deutsche Bank “trusted that BofA, one of the nation’s largest and most well-known financial institutions, would perform the gatekeeper function reasonably and responsibly,” the Frankfurt-based bank says in its complaint. “In myriad ways, BofA failed to carry out its various duties designed to protect DB’s investment.”

Deutsche Bank, Germany’s biggest bank, said in its third- quarter earnings statement on Oct. 29 that it lost about 350 million euros ($527 million) in the deal. Edwina Frawley- Gangahar, a spokeswoman for Paris-based BNP Paribas, France’s largest bank, declined to comment on the bank’s losses.

Misled Banks

Ocala was a commercial-paper vehicle sponsored by now- bankrupt Taylor Bean, which was the 12th-largest U.S. home lender. Taylor Bean received funding from Colonial Bank, an Alabama lender under U.S. investigation. The commercial paper, or short-term IOUs, was backed by residential mortgages.

William Halldin, a spokesman for Charlotte, North Carolina- based Bank of America, denied wrongdoing.

“We share BNP and Deutsche Bank’s concern about the handling of funds by Taylor, Bean and Whitaker and Colonial Bank and have been actively pursuing recoveries in the Colonial and TBW bankruptcies on behalf of these and other investors in the Ocala facility,” he said in a statement.

“BNP and Deutsche Bank’s effort to hold Bank of America responsible, however, is misguided,” he added. “We fulfilled our contractual obligations in our limited administrative role with respect to the Ocala facility.”

BNP Paribas and Deutsche Bank claim that Bank of America improperly transferred billions of dollars out of Ocala accounts; didn’t track mortgages it was holding as security, as it promised to do; issued false statements about the amount of collateral it held; and took other steps that misled the two banks.

Sued Colonial

In August, Bank of America sued Colonial for more than $1 billion in cash and loans and won a court order barring the Alabama lender from selling or otherwise disposing of the funds.

Colonial, based in Orlando, Florida, said Aug. 7 that the U.S. Securities and Exchange Commission issued subpoenas for documents related to the bank’s accounting for loan loss reserves and its participation in the Troubled Asset Relief Program, or TARP.

Colonial is also under criminal investigation.

The lawsuits are Deutsche Bank v. Bank of America, 09-cv- 9784, and BNP Paribas v. Bank of America, 09-cv-9783, U.S. District Court, Southern District of New York (Manhattan).

"...Starting in late 2007, Deutsche Bank invested $1.2 billion in a mortgage financing vehicle known as Ocala Funding; alongside it was BNP Paribas, a French bank that put $481 million into the same vehicle.

Ocala issued short-term notes and from the proceeds, bought mortgages that it could promptly sell to Freddie Mac, the government-sponsored enterprise. Bank of America was trustee, collateral agent, custodian and depositary agent to Ocala — its back office, in essence.

Ocala was busy: roughly $1 billion in mortgages flowed in and out of it each month. Because of its structure, Deutsche Bank and BNP viewed Ocala as a fairly low-risk investment. For example, Ocala could not hold mortgages that it was waiting to sell to Freddie Mac for more than 60 days, and it could buy only loans that had been reviewed and were physically held by the original lender.

But there were a couple of problems with the set-up: the company writing the mortgages funneling through Ocala was Taylor Bean & Whitaker, a lender that filed for bankruptcy last August. And to make its loans, Taylor Bean used money from Colonial Bank, a Montgomery, Ala., institution that also went belly-up. The Federal Deposit Insurance Corporation took over Colonial in August.

Sorting through the wreckage of those related failures has generated more questions than answers so far. Taylor Bean was shut down by the Federal Housing Administration, citing possible mortgage fraud. According to people briefed by those winding down Taylor Bean’s operations, who requested anonymity in order to preserve professional relationships, there are signs that the company sold some of its loans to more than one buyer. Lawyers representing Taylor Bean did not return phone calls seeking comment.

In any event, Ocala says mortgages worth more than half a billion dollars are missing. And the F.D.I.C. is withholding the release of mortgages worth hundreds of billions held at Colonial that Ocala investors say are theirs. The government contends that it is not clear that Bank of America — as a representative for Ocala — paid for them...."

State Street pays $663 million for disclosure problems

Boston-Based Firm to Settle Charges by Repaying Fund Investors More Than $300 Million

The Securities and Exchange Commission today charged Boston-based State Street Bank and Trust Company with misleading its investors about their exposure to subprime investments while selectively disclosing more complete information to specific investors.

--- SEC Order Against State Street Bank and Trust Company

State Street has agreed to settle the SEC's charges by paying more than $300 million that will be distributed to investors who lost money during the subprime market meltdown in 2007. This payment is in addition to nearly $350 million that State Street previously agreed to pay to investors in State Street funds to settle private claims.

"State Street led investors to believe that their investments were more diversified than a typical money market portfolio, when instead they were invested almost entirely in subprime investments that ultimately caused hundreds of millions of dollars in losses," said Robert Khuzami, Director of the SEC's Division of Enforcement. "Investigating potential securities law violations arising out of the credit crisis remains a high priority for the SEC Enforcement Division."

State Street Bank and Trust Co. has agreed to pay more than $300 million to investors who lost money during the subprime meltdown in 2007 under a settlement announced today by the Securities and Exchange Commission. State Street was charged with misleading investors about their exposure to subprime investments while selectively disclosing more complete information to specific investors.

Under the terms of the settlement, State Street has agreed to pay a $50 million penalty, more than $8.3 million in disgorgement and prejudgment interest and more than $255 million in additional payments to compensate investors. Combined with nearly $350 million that State Street has already paid (or agreed to pay) some investors through settlements of private lawsuits, the total compensation to harmed State Street investors is approximately $663 million, the SEC said.

“State Street led investors to believe that their investments were more diversified than a typical money market portfolio, when instead they were invested almost entirely in subprime investments that ultimately caused hundreds of millions of dollars in losses,” Robert Khuzami director of the SEC's Division of Enforcement, said in the release.

In reaching the settlements, State Street neither admitted nor denied the allegations made by the regulators.

The enforcement action is the result of a joint effort by the SEC, the Massachusetts Securities Division and the Massachusetts attorney general's office, which also announced related charges against State Street today.

While the company misled many investors about the subprime exposure in its Limited Duration Bond Fund, the company provided some investors with accurate and more complete information about the fund's subprime concentration, the SEC alleged in its complaint, which was filed in the U.S. District Court for the District of Massachusetts.

The investors who were given the more complete disclosures included clients of State Streets' internal advisory groups, which provided services to some of the investors in the fund, the complaint said.

“State Street's internal advisory groups subsequently decided to redeem or recommend redemption from the fund and the related funds for the clients,” the complaint said.

State Street Corp.'s company pension plan was one of those clients.

Mortgage fraud

"Diane Kosch had one of the most thankless jobs in the subprime lending craze.

Sitting elbow to elbow with colleagues at a conference table in a northern California office building, Kosch's job was to review a huge stack of loans each day at Long Beach Mortgage for problems, including evidence of fraud. She was given 15 minutes per file.

However, even when Kosch noticed clues of mortgage fraud - suspicious income, questionable appraisals or missing documents - the loans usually got approved anyway. Senior managers at Long Beach Mortgage, one of the nation's biggest subprime lenders, aggressively pushed loans through. As far as the company was concerned, Kosch's quality-assurance team was just slowing things down.

"We were basically the black sheep of the company, and we knew it," said Kosch, an industry veteran.

"Most of the time everything that we wanted to stop the loan for went above our heads to upper management," Kosch said. Quality team members became so suspicious, she said, that they started making copies of problem files to protect themselves. Later, Kosch said, they would see that some of the original files were missing pages - though she didn't know who took them out or why.

Bad loans ultimately led to the collapse of Long Beach Mortgage and its owner, Washington Mutual, in the biggest bank failure in history.

An inside look at Long Beach Mortgage - many of whose lending practices were common among subprime loan companies - adds another dark chapter to the evolving narrative of the financial crisis..."

FDIC charges former Indymac executives with negligence

Bank regulators have accused four former executives of failed IndyMac Bank of negligence in making loans to homebuilders and are seeking a total $300 million in damages.

The Federal Deposit Insurance Corp., which took over California-based IndyMac when it collapsed two years ago, filed the civil lawsuit against the four executives in federal court in Los Angeles. The suit, filed July 2, is the FDIC's first legal volley related to the wave of bank failures in the financial crisis, and an FDIC spokesman said Wednesday that more can be expected in the future.

The FDIC alleges in the suit that the four IndyMac officers "negligently" approved loans to homebuilders around the country that had slim chance of being repaid.

The four deny the FDIC's allegations.

The collapse and seizure of IndyMac in July 2008, with about $30.2 billion in assets, was one of the biggest bank failures in U.S. history. It also was the costliest failure in the current wave for the federal deposit insurance fund, with an estimated loss of $12.7 billion.

The four former officials of the bank's Homebuilder Division are Scott Van Dellen, president and CEO of the division until the seizure of IndyMac; Richard Koon, its chief lending officer from July 2001 to July 2006; Kenneth Shellem, chief credit officer; and William Rothman, chief lending officer from July 2006 to July 2008.

WaMu executives knew of rampant mortgage fraud

One of the central unanswered questions of the financial crisis is whether bank executives knew fraud was rampant within their mortgage loans.

A Senate committee tomorrow will present evidence that in the case of Washington Mutual Bank, the largest bank failure in history, executives knew about the fraud - and in some cases failed to take much corrective action. By doing nothing, the bank could report higher profits and employees could earn higher bonuses.

So far no criminal charges have been brought against any senior executives as a direct result of the subprime meltdown. And today Sen. Carl Levin, the Michigan Democrat who will chair the hearing, sidestepped questions about whether Washington Mutual executives broke criminal laws.

But Levin's committee has unearthed documents that show that in 2005, WaMu's own internal investigation of two top-producing offices making subprime loans in southern California found that fraud was out of control. At one office in Downey, Calif., 58 percent of mortgages were found to be fraudulent. At an office in Montebello, Calif., the rate was even higher: 83 percent.

Accurate representations of loan pool data contested

AMID the legal battles between investors who lost money in mortgage securities and the investment banks that sold the stuff, one thing seems clear: the investment banks appear to be winning a good many of the early skirmishes.

But some cases are faring better for individual plaintiffs, with judges allowing them to proceed even as banks ask that they be dismissed. Still, these matters are hard to litigate because investors must persuade the judges overseeing them that their losses were not simply a result of a market crash. Investors must argue, convincingly, that the banks misrepresented the quality of the loans in the pools and made material misstatements about them in prospectuses provided to buyers.

Recent filings by two Federal Home Loan Banks — in San Francisco and Seattle — offer an intriguing way to clear this high hurdle. Lawyers representing the banks, which bought mortgage securities, combed through the loan pools looking for discrepancies between actual loan characteristics and how they were pitched to investors.

You may not be shocked to learn that the analysis found significant differences between what the Home Loan Banks were told about these securities and what they were sold.

The rate of discrepancies in these pools is surprising. The lawsuits contend that half the loans were inaccurately described in disclosure materials filed with the Securities and Exchange Commission.

Securities fraud

Goldman sued by insurer over Fannie preferred shares

Goldman Sachs Group Inc was sued by Liberty Mutual Insurance Co, which accused the Wall Street bank of fraudulently misleading it into buying preferred stock of mortgage financier Fannie Mae that would become "virtually worthless."

In a lawsuit filed Thursday in Boston federal court, Liberty Mutual said it deserves to be reimbursed for losses on the $62.5 million of Fannie Mae preferred stock it had bought in late 2007 through offerings underwritten by Goldman.

Liberty Mutual, one of the nation's largest insurers, said Goldman knew of "significant problems" in subprime and other risky mortgages in late 2006 and throughout 2007, and generated large profits for itself by betting against the market.

It also said Goldman falsely stated that the purpose of the offerings was to let Fannie Mae raise excess capital, when in fact Fannie Mae "was severely undercapitalized" and needed to raise money to stay in business.

"As a knowledgeable and sophisticated investor in the U.S. real estate financial markets, and with access to Fannie Mae's financial records, Goldman Sachs knew or recklessly disregarded the actual status of Fannie Mae's capital structure," Boston-based Liberty Mutual said. "As a result of plaintiffs' reliance on Goldman Sachs' material misrepresentations, plaintiffs' investments are virtually worthless."

Goldman must pay some hedge fund fraud losses

Goldman Sachs has been ordered to pay $20.58 million to creditors of a failed hedge fund to settle claims that the bank helped the fund perpetrate a Ponzi scheme.

The award represents the first time that a bank has been held accountable for a Ponzi scheme because of its role as a middleman.

Goldman cleared trades and lent money to the Bayou Group, a Connecticut hedge fund that collapsed in 2005, when state and federal investigators said the firm defrauded investors of hundreds of millions of dollars.

The Bayou fraud resurfaced in 2008 when its founder, Samuel Israel III, faked his own suicide after being sentenced to 20 years in prison for fraud. He later turned himself in and is now serving 22 years.

Bayou’s creditors filed a complaint against Goldman two years ago, saying the bank either knew or should have known of Bayou’s fraud. Goldman, the complaint said, had access to Bayou’s trading records, which showed losses, as well as its marketing materials, which showed profits.

The award, in a decision by an arbitration panel of the Financial Industry Regulatory Authority issued on Thursday, may put other banks on notice to better scrutinize their hedge fund clients’ activities.

“This case shows that you can’t just stick your head in the sand when a fraud is going on in your shop,” said Ross B. Intelisano, a lawyer at Rich & Intelisano, who brought the arbitration against Goldman. The bank “argued that you could, and the panel disagreed.”

A Goldman spokesman pointed to the bank’s filing in the case, which questioned whether the creditors could use bankruptcy laws to hold Goldman accountable for the $20.58 million of investor money that Bayou transferred among its Goldman accounts. The money was never actually conveyed to Goldman, the bank said, so it should not be considered a fraudulent transfer.

Financial meltdown: Prosecuting those responsible

"...As I will discuss in more detail below, in the enforcement area the SEC is moving on five primary fronts to advance these objectives.

  • First, we are investigating and pursuing enforcement cases based on unlawful conduct related to the financial crisis.
  • Second, we are enhancing our historically close working relationship with other law enforcement authorities, including the DOJ, in order to maximize the efficient use of limited resources, as well as to deliver a united and forceful response to those who would violate the federal securities laws.
  • Third, we are implementing several initiatives, including the creation of national specialized units that will make the Division of Enforcement more knowledgeable and efficient in attacking both the causes of the recent financial crisis, as well as better arming us to address current and future market practices that are a potential cause for concern.
  • Fourth, our staff is proposing various legislative reforms to provide the Division with improved tools to address securities fraud and related misconduct, including nationwide service of process, a whistleblower program and improved access to grand jury material.
  • Last, in light of the magnitude and importance of the task of regulating and policing our capital markets and financial system, as well as the growing size, complexity, and number of market participants, we are seeking to address the compelling need for additional resources within the Division and throughout the SEC...."

Justice Department eyes possible fraud in securitizations

Turning its scrutiny to bigger fish in the subprime mortgage scandal, the Justice Department is investigating whether lenders or Wall Street firms defrauded investors in the sale of risky mortgage securities, its Criminal Division chief said last week.

"We absolutely are looking at the conduct of the securitizers themselves, and what did they say to those who purchased the (securities)," Assistant Attorney General Lanny Breuer told a commission created by Congress to investigate causes of the nation's economic collapse.

"Candidly, (we) have been looking at that for awhile and are looking at that right now in a very key matter."

Breuer didn't identify any company under scrutiny, but Wall Street's biggest investment banks bought many of the $2 trillion in home mortgages issued to shaky borrowers, converted them to high-yield bonds and sold the bonds to investors including pension funds, insurers and foreign banks. Many of the securities have since defaulted, and investors have lost billions of dollars.

Attorney General Eric Holder, who also appeared before the commission, said the economic crisis has brought concern about financial fraud "to the forefront." Holder, who recently announced the creation of a financial fraud task force, said the Justice Department "is using every tool at our disposal, including new resources, advanced technologies and communications capabilities."

Breuer said the FBI received upward of 70,000 "suspicious activity reports" relating to possible mortgage fraud in 2009 and has 2,800 investigations under way.

The Justice Department disclosures came on the second day of Financial Crisis Inquiry Commission hearings, as federal and state enforcement officials laid bare the loopholes, blunders and lack of foresight that allowed the subprime mortgage industry to churn out millions of loans.

Those lapses included:

  • Failing to rein in what the Federal Deposit Insurance Corp.'s chairwoman, Sheila Bair, called a "shadow banking system" in which major banks ramped up their risks by making hundreds of billions of dollars in exotic, off-the-books bets.
  • Deciding to scale back the FBI's resources for tracking white-collar crime after the Sept. 11, 2001, terrorist attacks and assigning scant personnel at the Securities and Exchange Commission to monitor major investment banks after they were given new freedom in 2004 to take on added risks.
  • Adopting rules in 2004 that restricted state regulators from policing predatory lending and other mortgage abuses, prompting some major lenders to seek federal charters to avoid tough scrutiny.
  • Relying too much on the credit ratings of Wall Street agencies, which had financial incentives to bestow high ratings on dubious mortgage-backed securities.
  • Failing to monitor major banks' compensation arrangements that gave bonuses for completing mortgage securities sales, regardless of the risks of default.
  • Ignoring a warning to Congress by the FBI's investigation chief in 2004 that widespread subprime-related mortgage fraud would lead to a financial crisis.

"I mean, everybody missed everything," said the panel's vice chairman, Bill Thomas, a retired Republican congressman from California.

Bair and the SEC's chairwoman, Mary Schapiro, described a series of fixes under way, including some to address the widespread losses incurred by investors around the world in subprime mortgage securities. They also outlined several proposals to narrow the roles of major Wall Street credit ratings agencies: Moody's Investors Service, McGraw Hill-owned Standard & Poor's and Fitch Ratings.

Both women also urged the creation of a systemic risk council in which financial regulatory agencies would share information so they could identify major risks across the financial system.

Former executive sentenced to two years in prison over insider trading

A former top executive at a $1 billion hedge fund investment firm was sentenced to more than two years in prison Friday in the first sentencing to result from what prosecutors have called the largest hedge fund insider trading case in history.

Mark Kurland, 61, of Mount Kisco, N.Y., was sentenced Friday to two years and three months in prison and ordered to forfeit the $900,000 he made through illegal trades by a judge who blamed the attitudes of people like Kurland on the country's financial collapse two years ago.

U.S. District Judge Victor Marrero said Kurland, a co-founder of New Castle Partners hedge fund in Manhattan, "frankly should have known better" than to join an inside trading scheme that led to the arrests of top executives including one-time billionaire Raj Rajaratnam.

"He had a choice as a leader of the financial industry. He could have led by example. Instead, he chose to follow. He became a joiner, surrendering to the spree of the financial market's virtual mob mentality that nearly brought down this country's financial industry in the quest for ever bigger and faster gains," Marrero said.

Kurland, who had pleaded guilty to conspiracy to commit securities fraud and securities fraud, was among 11 people who have pleaded guilty in the case. Many of the others had agreed to cooperate with the government, a step which delays their sentencing.

Rajaratnam, the portfolio manager for the Galleon Group hedge fund, has pleaded not guilty and disputed government claims that he pocketed as much as $50 million through a network of cheating executives at financial firms and companies privy to inside information.

The judge criticized pleas for leniency on Kurland's behalf on the grounds that he had a minimal role, that he did not benefit much financially, that others were more at fault and that there was no real harm to the markets.

"To some extent, this country's financial meltdown was fueled precisely by the attitudes manifested by Mr. Kurland in this proceeding, and repeated by defendants in other related cases," the judge said.

"Mr. Kurland's actions, stemming from a recognized leader of the industry, compromised the financial market's integrity at a time of financial crises and widespread concern about corruption, rampant recklessness, and arrogant greed at the highest levels of the industry," he added.

Massive insider trading by hedge fund alleged by SEC

"The Securities and Exchange Commission today charged billionaire Raj Rajaratnam and his New York-based hedge fund advisory firm Galleon Management LP with engaging in a massive insider trading scheme that generated more than $25 million in illicit gains. The SEC also charged six others involved in the scheme, including senior executives at major companies IBM, Intel and McKinsey & Company.

The SEC’s complaint, filed in federal court in Manhattan, alleges that Rajaratnam tapped into his network of friends and close business associates to obtain insider tips and confidential information about corporate earnings or takeover activity at several companies, including Google, Hilton and Sun Microsystems. He then used the non-public information to illegally trade on behalf of Galleon.

“This complaint describes a web of fraud that has been unraveled,” said SEC Chairman Mary L. Schapiro.

“What we have uncovered in the trading activities of Raj Rajaratnam is that the secret of his success is not genius trading strategies. He is not the astute study of company fundamentals or marketplace trends that he is widely thought to be. Raj Rajaratnam is not a master of the universe, but rather a master of the rolodex,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “He cultivated a network of high-ranking corporate executives and insiders, and then tapped into this ring to obtain confidential details about quarterly earnings and takeover activity.”


The Ponzi scheme orchestrated by Bernard L. Madoff was the largest fraud by anyone in American history, involving $65 billion and damaging the finances of thousands. Victims were mainly individuals and charities, and included many people prominent in the Jewish community.

See Madoff.

Ex-Credit Suisse Broker Butler Gets Five-Year Prison Sentence

Former Credit Suisse Group AG broker Eric Butler was sentenced to five years in prison for fraudulently selling subprime securities to corporate clients that cost investors more than $1.1 billion in losses.

Butler was found guilty in August after a three-week trial in federal court in Brooklyn, New York. Butler, convicted of conspiracy to commit securities fraud, securities fraud and conspiracy to commit wire fraud, faced a maximum sentence of 45 years in prison, prosecutors said.

“I deeply regret that my actions brought me here before this court,” said Butler, wiping tears from his face just before the sentence was imposed yesterday.

“I was a bond salesman, I purchased AAA-rated securities and my belief was that those securities were infallible,” Butler said. “In my career I had never experienced a failed auction,” he said. “I had faith in the market and I invested client’s money in what I truly believe was the safest product.”

U.S. District Judge Jack Weinstein said he could have imposed a term of as long as nine years in prison and concluded a lesser term was warranted, citing Butler’s family background. The judge also fined Butler $5 million, and ordered him to forfeit $500,000.

“The defendant abused a position of power and influence, took advantage of his clients’ trust, and defrauded them out of amounts of money which are impossible to calculate,” Weinstein said. “The defendant disregarded his responsibility to the financial well-being of his clients for the sake of his own short-term financial gain.

“The court imposed a non-guideline sentence, taking into account the defendant’s personal situation and characteristics and the circumstances of the financial industry in which he worked,” Weinstein said.

‘Pernicious’ Culture

The judge said Butler’s trial “laid bare the pernicious and pervasive culture of corruption in the financial-services industry” which he said is “beset by avarice.”

“The blame for this condition is shared not only by individual defendants like Butler, but also the institutions that employ them,” he said.

Weinstein cited several factors that he said may have contributed to Butler’s crimes, including a failure by government regulators and legislators to monitor and supervise the markets, the investors who didn’t “exert reasonable control and supervision” over transactions and “a failure by Credit Suisse, Butler’s employer, and other financial institutions to adequately supervise.”

High Commissions

Butler and Julian Tzolov were indicted in 2008, charged with conducting what prosecutors said was an illegal scheme in which they falsely told clients their products were backed by federally guaranteed student loans and were a safe alternative to bank deposits or money market funds. The products were actually linked to auction-rate securities and generated high commissions for the two, witnesses testified during Butler’s trial.

Ex-Bear fund managers not guilty of subprime fraud

Former Bear Stearns Cos. hedge-fund managers Ralph Cioffi and Matthew Tannin were found not guilty of misleading investors who lost $1.6 billion, the first major test of a U.S. effort to obtain convictions tied to the subprime mortgage crisis and subsequent recession.

A jury of eight women and four men deliberated less than a day before reaching a verdict today. Cioffi, 53, the portfolio manager for the hedge funds, and Tannin, 48, their chief operating officer, went on trial Oct. 13 in federal court in Brooklyn, New York, on charges of conspiracy, securities and wire fraud. Each faced as many as 20 years in prison if convicted. When the verdicts were read, the two men didn’t visibly react. Their wives burst into tears.

The trial was the first stemming from a federal probe of the collapse of the subprime mortgage-market, which cost investors as much as $396 billion. The men were indicted in June 2008 in a case brought by Brooklyn U.S. Attorney Benton Campbell a year after their hedge funds failed. The acquittal may make it more difficult for the Justice Department to bring additional prosecutions for fraud related to the subprime market and the various financial instruments that were based upon it.

“Any time the government undertakes a major prosecution in a new area, the outcome certainly influences its thinking about the prosecutability of other potential defendants,” said Jacob Frenkel, a former U.S. Securities and Exchange Commission lawyer now in private practice. “Acquittals force prosecutors to rethink their theories and charges.”

Juror Aram Hong said e-mails sent by Cioffi and Tannin showed that the men were working “24-7” to save the funds in the months before they collapsed.

“Just because you’re the captain of a ship and it gets hit doesn’t mean you should be blamed,” said Hong, 27, a food and beverage director at the Iroquois Hotel in midtown Manhattan.

Bears Stearns collapsed less than a year after the funds failed, and was purchased by New York-based JPMorgan Chase & Co.

Serphaine Stimpson, another juror, works as an office coordinator at Brooklyn College. Stimpson, 27, said she initially entered the case thinking both men were guilty. As the trial unfolded, she said she began to have second thoughts.

“As the witnesses began to testify I had my doubts,” Stimpson said. “The defense tore the government witnesses apart.” She added that the jurors “just weren’t 100 percent convinced” by the prosecution case.

The defendants, Stimpson said, “were scapegoats for Wall Street.”

"A criminal trial involving two former Bear Stearns executives could help answer a key question stemming from the financial crisis: How far can Wall Street firms go to put a positive spin on bad news?

The two executives, Ralph Cioffi and Matthew Tannin, will fight securities-fraud charges in a widely anticipated trial beginning on Tuesday in a Brooklyn, N.Y., federal court. The money managers unsuccessfully scrambled to keep two mortgage-heavy Bear Stearns hedge funds afloat in 2007 amid sinking mortgage-market prices, the first of several blows that eventually felled Bear Stearns and marked the start of the credit crisis. J.P. Morgan Chase & Co. bought the firm in a March 2008 fire sale.

Prosecutors accused Messrs. Cioffi and Tannin of misleading investors about the health of the two funds, testing the degree to which Wall Street should disclose bad news to investors.

"This case will be viewed by many as a test of where the boundary lies between acceptable, positive spin and outright fraud," says David Siegal, a former federal prosecutor who now is a defense lawyer at Haynes & Boone LLP. "Much of the government's case appears poised to rely on what many previously believed was just spin."

Two years since the crisis began and after dozens of government investigations of the financial industry, the Bear Stearns defendants are the only executives of a major Wall Street firm to face the threat of prison. The short list underscores the difficulty of assigning blame for Wall Street's mistakes.

Wall Street firms long have put poor results in a positive light. Such activity ordinarily is considered acceptable, particularly when dealing with sophisticated investors such as those in hedge funds. But critics say a defining feature of the credit crisis was how some Wall Street firms failed to timely acknowledge the sinking value of mortgage-related securities and other hard-to-trade investments.

The question in this case: whether Messrs. Cioffi and Tannin actively misled investors with the intent to defraud them.

In an April 2007 conference call, prosecutors say Mr. Tannin lied in saying he was "comfortable" with the funds' performance, days after emailing Mr. Cioffi that if an internal report prepared by a colleague is "ANYWHERE CLOSE to accurate, I think we should close the funds now."

Lawyers for Messrs. Cioffi and Tannin will argue that their clients made honest mistakes but didn't intentionally mislead investors. They will say the email about closing the fund was taken out of context and that Mr. Tannin also wrote that he believed there might still be an opportunity to invest aggressively, a person familiar with the matter says.

The case could hinge on whether statements made by Messrs. Cioffi and Tannin about their financial interests in the funds, or how many investors had asked to withdraw money from the funds, were clear misrepresentations that violated securities laws.

Mr. Cioffi, 53 years old, and Mr. Tannin, 47, would face a maximum of 20 years in prison if convicted of any of the eight fraud counts against them. The men, who pleaded not guilty and have said they themselves were victims of a soured market, aren't expected to testify at trial.

Mr. Cioffi also is charged with insider trading for withdrawing $2 million of his own money from one of the funds in March 2007 without disclosing it to investors, who collectively lost about $1.5 billion.

Prosecutors have alleged that Mr. Cioffi lied during the April 2007 investor conference call by saying there were just a "couple of million" dollars of redemptions requested by investors in June, when one investor, Concord Management, had informed Bear Stearns it wished to withdraw its entire $57 million investment.

Mr. Cioffi later told Bear's outside lawyers that he pulled the couple of million dollars amount "out of thin air," prosecutors say. Mr. Cioffi's lawyer didn't respond to requests for comment.

Investors also are expected to testify that they relied on statements about how much of the managers' personal money was invested in the funds. To raise more money from investors, prosecutors say, Mr. Tannin allegedly told investors several times in March 2007 he was "adding more" of his own money into one of the funds, but never did.

Mr. Cioffi is accused of telling Bear Stearns brokers, whose clients were invested in the funds, he had $5.5 million of his money in one of the funds in May 2007, when he had taken out $2 million months earlier.

Some legal experts say Messrs. Cioffi and Tannin could benefit from having the case assigned to federal Judge Frederic Block, a 75-year-old jurist who has criticized federal sentencing guidelines -- which are advisory but very influential -- as being harsh on white-collar criminals.

Prosecutors have said they plan to allege at trial that the defendants' notebooks or computer equipment, in which they kept notations about their work, "suspiciously" disappeared after the funds collapsed. Judge Block said he was inclined not to allow the government to include such evidence.

On Oct. 5, the judge said he would allow prosecutors to present evidence that Mr. Cioffi, who once had about $6 million of his own money in one of the funds, had a second motive to keep the funds alive. In December 2006, Mr. Cioffi pledged his stake as collateral for a real-estate loan he needed because a Florida construction project he was involved in was on the verge of foreclosure. Mr. Cioffi risked losing the collateral if the fund failed, prosecutors say.

Numerous former Bear Stearns employees could take the witness stand -- including former Co-President Warren Spector, who oversaw asset-management operations -- as prosecutors try to show the defendants misled them.

The defendants will have at least one heavyweight in their corner: R. Glenn Hubbard, an economic adviser to President George W. Bush and now dean of Columbia University's business school. Mr. Hubbard's expert testimony is expected to help justify some of the defendants' actions, including some of their comments on the April investor call, according to people familiar with the matter. Mr. Hubbard declined to comment.

CA AG sues State Street Bank for FX markups

Brown Sues State Street Bank for Massive Fraud Against CalPERS and CalSTRS

SACRAMENTO - Seeking to recover more than $200 million in illegal overcharges and penalties, Attorney General Edmund G. Brown Jr. today announced that he has filed suit against State Street Bank and Trust -- one of the world's leading providers of financial services to institutional investors -- for committing "unconscionable fraud" against California's two largest pension funds -- CalPERS and CalSTRS.

The suit, which was unsealed today by a Sacramento Superior Court judge, contends that Boston-based State Street illegally overcharged CalPERS and CalSTRS for the costs of executing foreign currency trades since 2001.

"Over a period of eight years, State Street bankers committed unconscionable fraud by misappropriating millions of dollars that rightfully belonged to California's public pension funds," Brown said. "This is just the latest example of how clever financial traders violate laws and rip off the public trust."

The case was originally filed under seal by whistleblowers - "Associates Against FX Insider Trading," who alleged that State Street added a secret and substantial mark-up to the price of interbank foreign currency trades. The interbank rate is the price at which major banks buy and sell foreign currency.

Subsequently, Brown launched an independent investigation into the allegations.

Brown's investigation revealed that State Street was indeed overcharging the two funds. Despite being contractually obligated to charge the interbank rate at the precise time of the trade, State Street consistently charged at or near the highest rate of the day, even if the interbank rate was lower at the time of trade.

Additionally, State Street concealed the fraud by deliberately failing to include time stamp data in its reports, so that the pension funds could not determine the true execution costs by verifying when State Street actually executed the trades. Commenting on this deception, one State Street senior vice president said to another executive that "…if providing execution costs will give [CalPERS] any insight into how much we make off of FX transactions, I will be shocked if [State Street] or anyone would agree to reveal the information."

Brown's office estimates that the pension funds were overcharged by more than $56.6 million over eight years. The lawsuit asks for relief in the amount of triple California's damages, civil penalties of $10,000 for each false claim; and recovery of costs, attorneys' fees and expenses. It is estimated that damages and penalties could exceed more than $200 million.

Under California's False Claims Act, anyone who has previously undisclosed information about a fraud, overcharge, or other false claim against the state, can file a sealed lawsuit on behalf of California to recover the losses. They must notify the Attorney General as well.

Such a case is called a "qui tam" case. If there is a monetary recovery, the law provides that the whistleblower "qui tam plaintiff" receives a share of the amount recovered if the requirements of the statute are met.

A copy of the complaint.

Petters gets 50-year term for $3.5B fraud

"Petters Group Worldwide LLC founder Thomas Petters, convicted of orchestrating a $3.5 billion fraud scheme, was sentenced to 50 years in prison.

Petters, 52, was found guilty in December of 20 counts in what prosecutors said was the biggest fraud in Minnesota’s history. Prosecutors said he used his Petters Company Inc. to lure investor funds for fake deals to buy shipments of consumer goods and then used the money to support his lavish lifestyle.

“This was a massive fraud. There are victims who have been devastated here,” U.S. District Judge Richard Kyle in St. Paul said yesterday at Petters’s sentencing hearing. “There’s nothing wrong with having three houses and airplanes and all of that, so long as it’s your money.”

Petters ran a Minnetonka, Minnesota-based business empire that bought companies including Sun Country Airlines Inc. and Polaroid Corp. until federal agents raided his home and offices on Sept. 24, 2008. Petters was found guilty by a federal jury in St. Paul of all charges filed against him, including money laundering and conspiracy.

“I will work the balance of my life, free or in prison, to repay what was lost,” Petters told Kyle before learning of his sentence. “Every day I am filled with pain and anguish for all whose lives were affected by this.”

Didn’t React

Petters, who sat with his head down, chin resting on his hand, didn’t react when Kyle announced the 50-year sentence. Members of Petters’s family broke down in sobs outside the courtroom afterward.

With time off for time already served and for good behavior, Petters may be released after 41 years, Kyle said. At Petters’s request, Kyle said he will recommend that he serve his sentence in Minnesota..."

"Bankers Said ‘Anything’ to Get High Rating"

Just past midnight on May 3, 2005, Standard & Poor’s analyst Chui Ng e-mailed co-workers to broker a solution to demands by Goldman Sachs Group Inc. bankers that he said violated two or more of the ratings company’s internal guidelines.

Goldman Sachs was adding $200 million in debt at the “last minute” to a $1.5 billion bond pool called Adirondack Ltd., Ng wrote. That meant the New York investment bank would originate 13 percent of the pool itself, two-and-a-half times the 5 percent limit set by S&P.

Goldman Sachs also balked at Ng’s request to pay in advance for an insurance policy known as a credit default swap, which was being used to create the additional debt obligation.

The e-mails from Ng, who negotiated a compromise on Goldman Sachs’s requests, provide a rare window into the back-and-forth between the bank and a rating company assessing the risks in a financial product linked to subprime mortgages. The exchange was among 581 pages of private communications released last week by Senate investigators.

Global fraud issues

Fraud in financial services soars 22%

Financial services executives have reported a big spike in fraud, telling an annual global survey that average company losses in the the sector during the past three years totalled $15.2m, up 22 per cent from 2008’s tally.

The sector, which was at the epicentre of the world economic crisis, was by far the hardest hit of the 10 sectors surveyed by the Economist Intelligence Unit for Kroll, an international security company...

...The troubles wrought by the financial crisis have led to increases in fraud in two ways, Kroll officials said. Employees and executives under pressure appear more likely to resort to fraud, and tighter financial times often lead to more detection of ongoing schemes.

“Financial services companies are taking more of a look at how they are spending their money, and they are becoming much more aware of what is going on,” said Blake Coppotelli, senior managing director in Kroll’s business intelligence and investigations unit.

The survey drew on interviews with 729 senior executives around the world, including roughly one-third in North America, one-quarter each in Europe and Asia-Pacific and 11 per cent in the Middle East and Africa. Three in 10 companies reported the financial crisis had directly increased their exposure to fraud...."

KPMG and PwC Reykjavik offices are raided by Icelandic police

"Police have raided the offices of KPMG and PricewaterhouseCoopers (PwC) in Reykjavik, seizing documents and computer data as part of an investigation into alleged criminal activity at three collapsed Icelandic banks.

The targets of the raids were the firms' banking clients Kaupthing, Glitnir and Landsbanki, but the move is nevertheless likely to cause embarrassment for the two companies, both among the "big four" accountancy names in the world.

The Reykjavik branches of KPMG and PwC are owned by its partners, common with most accountancy practices, but are also part of the multinational network of firms.

The office of Olafur Thor Hauksson, the Icelandic investigator charged with examining the collapse of the three banks a year ago, confirmed that 22 policemen and six foreign accountants took part in the searches yesterday.

"The purpose of the searches was to look for and secure evidence related to the investigation of several charges which have been investigated by the office," a statement said.

Among the matters being investigated are "violation of laws on accounting and annual reports, violation of laws on financial institutions and securities transactions and violations of laws on public limited companies". PwC Iceland could not be reached for comment.

Sigurdur Jonsson, the chief executive of KPMG Iceland, told The Daily Telegraph that the raids related to some of his clients and that none of his staff had been questioned. He refused to comment further on the investigation.

Mr Jonsson has already become embroiled in controversy after it emerged that KPMG Iceland had been responsible for investigating events leading up to the collapse of Glitnir, despite the fact that his son was chief executive of the bank's largest shareholder. KPMG later resigned from the case.

The UK Serious Fraud Office (SFO) agreed last month to send a team of investigators to Iceland to help "get to the bottom" of whether there were any criminal intentions in the country's collapsed banks, which had extensive links with London.

The Icelandic banks, which had large customer bases in the UK, failed last October, leaving 300,000 British savers unable to access their money and institutions nursing billions in losses. Following the crisis, the Treasury had to pay out £7.5bn to compensate UK savers, although £2.3bn of this will be repaid by Iceland over the next 15 years.

Allegations of fraud, embezzlement and market manipulation have been under investigation in Iceland since February. The SFO has separately been gathering intelligence on the Icelandic banking sector and its UK operations both involving investors and borrowers, which intensified after the leak of Kaupthing's loan book on to the internet last month.

FSA inquiries

Australian regulator targets directors for accounts falsification

"Australia's corporate watchdog has launched legal action against eight directors and executives of companies in the Centro shopping centre group, claiming their 2007 accounts failed to correctly classify more than $2 billion of debt.

The Australian Securities and Investments Commission revealed this morning that it is seeking to have the men disqualified from being able to manage companies, and wants them fined by the courts.

Those in ASIC’s sights include several high profile Melbourne directors including Centro Properties’ former chairman, Brian Healey, and its departed chief executive, Andrew Scott.

Centro, which has more than 20 centres in Victoria alone, found itself in financial difficulties in late 2007 because it struggled to refinance the massive debts taken on to fund a major US shopping centre group purchase.The company’s search for long-term finance coincided with the beginnings of the global financial crisis when bank lending began to dry up.

In a statement this morning, ASIC said Mr Healey, Mr Scott, former directors Sam Kavourakis, Peter Graham Goldie and Louis Peter Wilkinson, along with two current directors, Paul Ashley Cooper and James William Hall, and Centro’s then chief financial officer, Romano George Nenna "failed to discharge their duties with due care and diligence".

The regulator said that the financial reports of Centro properties, Centro Property Trust and Centro Retail Trust for the financial year to June 30, 2007, "contained material misstatements".

"Specifically, a significant amount of interest-bearing liabilities of each of the relevant entities were wrongly classified as non-current liabilities, rather than current liabilities," ASIC’s statement said.

That meant that in Centro properties and Centro Property Trust, more than $1.5 billion of liabilities which were due to be either repaid or refinanced within the year, appeared on the companies’ balance sheets as long-term debt.

The effect of incorrect classification is that Centro’s accounts indicated, under ASIC’s measures, the amount of debt the company had to refinance within the year was half of what it actually had to persuade banks or others to lend it.

In the case of Centro Retail trust, almost $600 million of liabilities should, said ASIC, have been treated as current.

ASIC charges against public company spread to auditor

"The Australian Securities and Investments Commission announced yesterday it had launched civil proceedings in the Federal Court against eight former and current Centro directors and executives after claims that more than $2 billion worth of debt was incorrectly classified in its 2007 financial year accounts.

The proceedings, set for hearing on November 20, are the first against directors of a listed company since the global financial crisis began.

The directors face fines of up to $200,000 each and indefinite bans from serving on boards or in executive positions of public companies.

ASIC, which will also seek costs, is making the allegations against former chief executive Andrew Scott, former chairman Brian Healey, Centro's former chief financial officer Romano Nenna (a previous executive at Coles Myer), former David Jones chief executive Peter Wilkinson, former non-executive directors Samuel Kavourakis (a former Optus non-executive director), and Graham Goldie (a former Myer general manager), and current non-executive directors James Hall and Centro's current chairman, Paul Cooper.

Maurice Blackburn senior associate Martin Hyde said yesterday a class action against PwC was under consideration.

This would add to an existing class action case against Centro.

Mr Hyde said the action being taken by ASIC was "a significant development ... We think that our view as to the strength of the case has been vindicated."

Separate shareholder class actions, one run by Maurice Blackburn and the other by Slater & Gordon, were launched against Centro over its near-collapse at the end of 2007 after the company revealed it was unable to refinance $3.9bn of expiring debt.

The actions claim Centro engaged in misleading and deceptive conduct. The largest is by Maurice Blackburn, which represents about 1000 group members, ranging from individuals to Australia's largest financial institutions. Parties are seeking as much as $1bn in compensation.

A year after actions by the law firms were launched, Centro officially made a cross-claim in May against its auditor, PricewaterhouseCoopers, alleging PwC was wholly or partly responsible for failing to disclose information to investors.

PwC, which would not comment yesterday, then filed a counter-claim, placing the blame back on Centro's directors.

Mediation for the class actions was held in July and the case has been further adjourned until December.

Mr Hyde said the ASIC case and the class actions would run parallel to each other and any evidence or findings that came from the ASIC hearing could be used in the class action case.

As part of ASIC's case, it alleges Centro's financial reports in the 2007 fiscal year contained "material mis-statements".

ASIC said, concerning Centro Properties and Centro Property Trust, their respective balance sheets at June 30, 2007, did not correctly classify $1.514bn of interest-bearing liabilities as current, in addition to the $1bn already classified as current.

Centro Retail Trust's balance sheet at June 30, 2007, did not correctly classify $598 million of interest-bearing liabilities as current.

The directors and executives should have known these liabilities were incorrectly classified, ASIC said. "This resulted in the relevant entities not complying with the applicable accounting standard," the regulator said.

ASIC "Registers of Banned & Disqualified Persons"

To browse for 'disqualified persons': type the first letter or all the letters of the family name, as all names are ordered by family name, then given names. Both current and past entries will be provided. NB. Persons referring to this register should note carefully that it contains details only of those persons who are disqualified from managing corporations under the Corporations Act where ASIC receives express notice of the disqualification under the terms of that Act.

There are other circumstances in which a person may be disqualified from managing corporations, for example where the person is an undischarged bankrupt or has been convicted of certain offences involving dishonesty. ASIC does not receive statutory notice of such disqualifications, and so they are not able to be recorded in this register.

If searching the remaining professional registers i.e. Banned securities representatives, Banned futures representative, AFS banned/disqualified persons, Credit banned/disqualified persons, type in the family or organisation name. Only current entries are provided and some people or organisations may be under temporary suspension.


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