The Securities and Exchange Commission’s (SEC) Fort Worth Office repeatedly failed to act on overwhelming evidence pointing to the massive Ponzi scheme orchestrated by R. Allen Stanford, according to an Office of Inspector General (OIG) investigative report made available to the public on Friday.
The OIG’s report was released just as the SEC announced its headline-grabbing decision to file charges against Goldman Sachs for fraudulently marketing an investment product tied to subprime mortgages.
SEC Chair Mary Schapiro responded quickly to the OIG’s findings and assured the public that corrective action had already been taken. But while the agency is surely eager to leave the past behind and focus on high-profile cases such as the Goldman lawsuit, it will never be able to fully fix its systemic enforcement problems if it doesn’t learn from past mistakes.
Coming on the heels of other recent
reports on the
to detect the Bernie Madoff Ponzi scheme, its lax
supervision of Bear Stearns, its failure to take
action in a massive insider trading case, and its botched
investigation of Allied Capital, the OIG’s latest report on the
investigation highlights many of the same systemic problems that have
turned the SEC into a toothless regulator in recent years.
SEC officials repeatedly failed to act on red flags uncovered by their own examiners
The SEC’s first examination of Stanford’s operations began in 1997, just two years after the Stanford Group Company (SGC) registered with the SEC. The examination conducted by the SEC’s Fort Worth Office found numerous red flags that ought to have triggered follow-up enforcement action:
Bank (SIB), an offshore bank located in Antigua, was
certificates of deposit (CDs), resulting in interest rates and
fees that were way too high for the supposedly safe and liquid
- SGC received a
annual “trailer” or “referral” fee for referring CD investors to
- SGC didn’t maintain
and records for the CD sales, and claimed to have no information
SIB or the incredible returns generated by the CDs, even though
recommending the CDs to their clients; and
- Stanford personally made a $19 million cash contribution to SGC in 1996, and there were several loans made from SIB to Stanford’s personal account.
In the SEC’s internal tracking system, the Examination group flagged SGC as a “possible Ponzi scheme,” and referred their report to the Fort Worth Enforcement group. However, Enforcement didn’t open a matter under inquiry (MUI) until May 1998, eight months after the Examination group sent over its referral. In the end, they did nothing more than issue a voluntary request for documents and information. Stanford refused to comply, and the MUI was officially closed in August 1998.
Over the next few years, the Fort Worth examiners continued to uncover many of the same red flags: consistent, above-market returns for the SIB CDs, unusually high commissions paid to SGC advisers, the SGC’s lack of information about the CDs and SIB’s investment portfolio, and so on.
By the end of the fourth examination in 2004, the examiners had concluded that SGC’s sale of the CDs violated numerous federal securities laws and rules. But once again, the Fort Worth Enforcement group simply sent SIB a voluntary request for documents, even though SIB attorneys had written to the SEC six days earlier making it clear that the offshore bank would not produce any documents on a voluntary basis.
Eventually, the new head of Enforcement decided to seek a formal order to advance the investigation. But her staff rejected the possibility of filing an emergency action against SIB, and did not even consider bringing an injunctive action under the Investment Advisers Act that would have stopped the sale of Stanford International Bank CDs, and could have potentially given investors a heads up that the SEC considered the sales to be fraudulent. In fact, the OIG found that many SGC investors continued to invest in the CDs because financial advisers assured them that the fund had been given a “clean bill of health” by the SEC.
By the time the SEC got around to filing
Stanford in February 2009, investors had lost some $7.2 billion,
which is unlikely to be recovered.
Enforcement was delayed because of pressure to bring “quick-hit” cases and protect the SEC’s image
The OIG found that part of the reason Enforcement was slow to investigate Stanford was due to the “preference for ‘quick hit’ cases as a result of internal SEC pressure, and the perception that Stanford was not a ‘quick hit’ case.”
Even when the Fort Worth office took the small step of sending Stanford a voluntary request for documents, officials were mainly concerned with protecting their own image, as illustrated by a 2005 email from the office branch chief:
we need to
make voluntary request for docs from bank. If we don’t and close case,
later Stanford implodes, we will look like fools if we didn’t even
As the OIG writes, "The Enforcement staff sent the
request even though it recognized that its efforts to obtain the
requested documents voluntarily were 'moot.'"
The OIG also found that the decision
not to seek
action against Stanford under the Investment Advisers Act was due in
the fact that the new head of Fort Worth Enforcement was unaware of
examinations conducted by the Investment Adviser Examination group. In
she only learned that SGC was registered as an investment adviser while
by the OIG in January 2010.
Outside tips also fell on deaf ears
The SEC also received several “legitimate” outside complaints about Stanford’s operations, but failed to investigate them.
At one point, Enforcement apparently
complaint to the Texas State Securities Board, but the OIG couldn’t find
proof that it was actually sent. Additional outside tips arrived in
instead of pursuing the tips, Enforcement called for yet another
Investigation undermined by the revolving door
The OIG also found that the former head of Enforcement at the Forth Worth office, who had a big part to play in delaying and limiting the investigation of Stanford, later sought to represent Stanford, despite repeated warnings from the SEC Ethics Office.
In June 2005, just two months after he left the SEC, the former Fort Worth Enforcement head informed the Ethics Office that he had been asked to represent Stanford. Amazingly, he claimed he was not aware of any conflicts and could not even “remember any matters pending on Stanford while [he] was at the commission.”
The Ethics Office had the good sense to deny his request. But he ended up representing Stanford just one year later, billing him for several hours of work. He belatedly asked the Ethics Office for permission, and was denied for the same reasons as before. A few years later, he contacted the Ethics Office for a third time seeking to defend Stanford against the SEC’s lawsuit, and was denied once again.
One SEC Ethics official testified to the OIG that “he could not recall another occasion in which a former SEC employee contacted his office on three separate occasions trying to represent a client in the same matter.”
When asked why he was so insistent on representing Stanford, the former Enforcement head replied: “Every lawyer in Texas and beyond is going to get rich over this case. Okay? And I hated being on the sidelines.” The OIG has referred the matter to the SEC’s Ethics Counsel for possible referral to the appropriate state bar and disciplinary counsels.
The OIG also recommended possible
against the employees named in the report who still work at the SEC, and
recommended that the SEC leadership clarify the agency’s procedures with
regards to several issues identified by the report, including the need
better coordination within the Commission and with other regulatory and
Private self-regulator also failed to crack down on Stanford
It’s worth mentioning that the private self-regulatory organization (SRO) for the broker-dealer industry also missed numerous opportunities to crack down on Stanford’s Ponzi scheme, according to an internal review conducted by the Financial Industry Regulatory Authority (FINRA) last fall.
Between 2003 and 2005, FINRA’s predecessor, the National Association of Securities Dealers (NASD), received “credible” information from at least five different sources alleging that the Stanford CDs were a fraud. NASD examiners had also uncovered many of the same red flags during routine examinations that were highlighted by the examination groups in the SEC’s Forth Worth Office.
But follow-up enforcement action was often curtailed due to a questionable determination by NASD’s Dallas office that Stanford’s offshore CDs were not “securities” regulated under federal securities laws, and were therefore outside of NASD’s jurisdiction.
In another instance, a lead NASD examiner backed off from investigating the Stanford CDs simply because he misinterpreted a five-page referral letter sent by the SEC in 2005. NASD’s Dallas office did not forward the SEC referral letter to senior management in D.C. until three years later.
The internal review also found that the the former head of NASD’s Dallas office eventually joined Stanford’s broker-dealer firm as a Managing Director of Compliance
Oh, and did we mention that Mary Schapiro was the Vice Chairman of NASD during this time?
It all adds up to another pathetic performance by the SEC and the financial self-regulators, and another reason why so much is riding on the Goldman Sachs case.
-- Michael Smallberg