By Michael Smallberg
The Securities and Exchange Commission (SEC) has posted an investigative report by the Office of Inspector General (OIG), first released by CNBC, that describes how an SEC regional office failed to uncover a Ponzi Scheme during a 2005 examination of Westridge Capital Management.
In February 2009, the SEC took emergency action and froze the assets of Paul Greenwood, Stephen Walsh, and their companies—Westridge Capital Management, WG Trading Investors, and WG Trading Company—for misappropriating as much as $554 million in investor assets in the operation of a Ponzi scheme.
But the OIG discovered that the SEC’s Los Angeles Regional Office (LARO) missed a key opportunity to uncover the Ponzi scheme back in 2005, failed to conduct a thorough examination of the investment adviser, Westridge Capital Management, and did not take the necessary steps to ensure that a follow-up examination of the broker-dealer, WG Trading, was conducted.
We’re still combing through the OIG’s report of investigation, but here are some initial highlights:
- “The 2005 LARO examination team also identified numerous ‘red flags’ during the course of the Westridge examination, which they noted in the report. One of the most significant concerns identified related to the poor compliance culture at Westridge. The examination staff concluded that Westridge had ‘ineffective compliance procedures and practices.’ They also concluded that Westridge ‘did not consider compliance with the federal securities laws to be a priority.’ Yet, even though they further documented that Westridge, a $1.3 billion company, had hired a completely inexperienced compliance officer and purportedly could not afford compliance seminars, these concerns did not trigger further scrutiny or examination.”
- “The OIG investigation further found that after conducting the examination, the 2005 LARO examination team actually not only failed to follow-up on obvious red flags but, inexplicably, decided to lower Westridge’s risk rating to ‘risk group 2—medium risk’ as a result of their examination.”
- “While the LARO examination team dismissed the red flags relating to the investment adviser, Westridge, they did have enough concerns about the operations at WG Trading that they decided to recommend that the Boston Regional Office (‘BRO’) conduct a broker-dealer examination of WG Trading....However, the OIG found that the referral never happened. The OIG investigation determined that none of the members of the 2005 LARO examination team could recall actually referring the matter to the BRO and no one in the BRO ever received a referral.”
- “The OIG investigation further found that in the timeframe of the 2005 Westridge examination in the LARO, there were no policies or protocols that governed the referral of examination findings and no instructions on how a referral was to be made....Thus, no examination was conducted of WG Trading, allowing the fraud to continue.”
- “The OIG found that after Bernard Madoff confessed to operating a $50 billion Ponzi scheme and the OIG issued a report of investigation regarding the failure of the SEC to uncover Bernard Madoff’s Ponzi scheme, SEC examiners focused more acutely on custody of assets, conducted more joint examinations and were more aggressive in seeking records form unregistered firms. Unfortunately, the OIG investigation found that the 2005 Westridge examination was conducted under ‘pre-Madoff’ procedures by examiners, who were aware of and had in their hands evidence of potential fraud, but did not take the basic steps necessary to investigate the matter further and, as with Madoff, a significant fraud was not uncovered at that time.”
- “In the course of its investigation, the OIG also found evidence that many LARO employees had significant concerns [about] [OCIE Supervisor’s] management style in general. Yet, the OIG also found that there was little, if any, evidence that any action was taken by management to resolve or even address these concerns. We found that many LARO employees were fearful to complain because of possible retaliation.”
The OIG has previously reported on the SEC’s failure to follow up on red flags uncovered during its examinations of Bernie Madoff and Allen Stanford. This Thursday, the IG will be appearing before the House Appropriations Subcommittee on Financial Services and General Government to discuss the SEC’s budget.
For more on the SEC’s history of bungled examinations, check out POGO’s resource page of OIG investigative reports.
Michael Smallberg is a POGO Investigator.
- The SEC at Its Worst
- Unposted Inspector General Reports Showcase SEC Misconduct
- New Report Discloses Recent Investigations by SEC Inspector General
- SEC Inspector General Uncovers Whistleblower Retaliation at Fort Worth Office
- SEC Describes Possible Criminal Activity in Unprosecuted Hedge Fund Case
- IG Slams SEC for Inexcusable Delays in Cracking Down on Stanford Ponzi Scheme