The SEC at Its Worst

The Securities and Exchange Commission (SEC) should be ashamed of its abominable investigation and enforcement of Allied Capital. As detailed in a damning report by the SEC Office of Inspector General (OIG), made available today by The Washington Post, the SEC completely dropped the ball in its investigation despite having overwhelming evidence of Allied’s wrongdoing. To make matters worse, an SEC enforcement attorney even took outrageous steps to investigate the person who alerted the agency to the problems at Allied.

The OIG launched its investigation based on allegations made by Greenlight Capital President David Einhorn in his book, Fooling Some of the People All of the Time: A Long Short Story. (Disclaimer: Einhorn and employees of Greenlight are major contributors to POGO.)

The dispute between Einhorn and Allied dates back to 2002, when Einhorn gave a speech at a charity investment conference announcing that Greenlight had sold short its shares of Allied, a private equity firm based in Washington, DC. Over the next few years, Einhorn sent about a dozen letters to the SEC detailing how Allied overvalued many of its investments. But rather than following up on his tips, the SEC decided to launch an investigation into Einhorn looking into possible stock manipulation. In his book, Einhorn claimed that Allied pressured the SEC into investigating him, and that the enforcement attorney who had led the investigation soon left the agency and became a registered lobbyist for Allied, a claim verified by the OIG report.

In fact, the report confirms nearly all of Einhorn’s allegations, painting a picture of an enforcement agency that’s beyond dysfunctional. Here’s just a sampling of what the OIG found:

• In June 2002, Allied successfully lobbied the SEC’s Enforcement Division to launch an investigation of Einhorn and Greenlight, despite having no evidence of wrongdoing other than Einhorn’s speech. Over the next few months, an SEC enforcement attorney aggressively questioned Einhorn in testimony, subpoenaed several boxes of documents, and sought his telephone records and list of clients. After failing to find any credible evidence of wrongdoing, the Enforcement Division effectively closed its investigation into Einhorn in mid-2003, but didn’t formally close it until December 2006. Einhorn was never notified that he was no longer the subject of an investigation, as is required by the SEC enforcement manual.
  
  
• In 2003, the enforcement attorney who headed the investigation into Einhorn was asked to leave the SEC due to “performance problems,” and soon became a registered lobbyist for Allied. Although the attorney’s name and future position as a lobbyist are redacted in the report, Einhorn’s book and subsequent media reports revealed that it was Mark K. Braswell, who joined Venable LLP in 2003 and became a registered lobbyist for Allied in October 2004. Braswell got clearance from the SEC’s Ethics Office to register as a lobbyist for Allied after hiding the fact that he had led the investigation into Einhorn at Allied’s request.
  
  
• At around the same time the Enforcement Division began investigating Einhorn, the SEC’s Office of Compliance Inspections and Examinations (OCIE) began its own examination of Allied based on Einhorn’s tips. The OIG described OCIE’s examination as “unusual in many ways.” It was conducted by only one headquarters examiner supervised by the OCIE Associate Director. Although the examination lasted a full 18 months, the SEC never paid a single visit to Allied’s office just a few blocks away. The examiner told the OIG she received “pushback” from the Associate Director despite finding evidence that Allied’s method for utilizing cash to pay dividends was akin to a Ponzi scheme. And all of the work papers from the investigation were subsequently and inexplicably deleted from the OCIE’s computer drive. Nonetheless, in April 2004, the OCIE referred three findings from its examination to the Enforcement Division, which launched its investigation into Allied the following month, nearly two years after Einhorn first alerted the agency to Allied’s wrongdoing.
  
  
• In March 2005, Einhorn wrote a letter to Allied’s board claiming that the company had gained access to his telephone records by engaging in an illegal act of identity theft known as “pretexting.” Although Allied initially denied any wrongdoing, after a grand jury was convened in 2007 the company acknowledged in a 10-Q filing that “an agent of Allied Capital obtained what were represented to be telephone records of David Einhorn and which purport to be records of calls from Greenlight Capital.” Allied’s lawyers informed the SEC that the “agent” responsible for this pre-texting was in fact Braswell, the former enforcement attorney who led the inquiry into Einhorn. However, the SEC took no action against Allied in response to this shocking admission.
  
  
• By mid-2006, the Enforcement Division had determined that more than a dozen of Allied’s investments were incorrectly valued, and that the company had materially overstated its income for several years. But in October 2006, Allied requested and obtained a “pre-Wells” meeting with the Enforcement Division, in which a team of attorneys representing Allied, including a former SEC Enforcement Director, convinced the agency to bring nothing more than a “books and records” charge against the company.
  
  
• In June 2007, despite the overwhelming evidence of Allied’s wrongdoing and the admission by Allied that its lobbyist had engaged in pretexting, the SEC entered into a settlement agreement with Allied in which the company merely agreed to continue to employ a Chief Valuation Officer and third-party valuation consultants. The SEC neglected to impose any penalties and subsequently took no actions to monitor Allied’s compliance with the settlement agreement.
  
  

This is just the latest example of unthinkable incompetence and possible corruption at the SEC, an agency that also failed to detect the Madoff Ponzi scheme despite receiving numerous credible tips, failed to adequately supervise Bear Stearns and other firms at the heart of the financial crisis, failed to investigate overwhelming evidence of insider trading at Pequot Capital Management while maintaining improper contacts with former Enforcement officials, failed to protect whistleblowers who came forth with allegations of wrongdoing, and so much more.

The OIG is recommending that the Directors of OCIE and Enforcement clarify the agency’s investigation and examination procedures, especially in regards to contacts with outside parties and former officials, but given the agency’s recent history of ignoring the OIG’s recommendations, we aren’t exactly holding our breath.

As Congress turns its attention to overhauling the nation’s financial regulatory system, they should keep in mind that strengthening the regulatory rules won’t mean much if the SEC is unwilling or unable to actually enforce them. We hope the OIG’s latest report is all the evidence Congress needs to ramp up its oversight of an agency in utter disrepair.

-- Michael Smallberg

Comments

[Bob Burns]

It's so depressing to see the fed being taken over by the corporatists. The SEC is just the tip of the iceberg. It's pretty clear to me that virtually every regulatory agency has been co-opted by those that are supposed to be regulated.

Name your alphabet agency and the story is pretty much the same.

[Opey]

An interesting development is that, even after two months, STILL no media has touched the biggest lawsuit ever filed in world history. The Securities and Exchange Commission was slapped with a $3.87 TRILLION PONZI SCHEME Lawsuit on January 27th, 2010, filed in UNITED STATES DISTRICT COURT,CENTRAL DISTRICT OF CALIFORNIA, Case Number CV10-00031 JVS (MLGx). Makes me wonder if even this post will be allowed to appear in this blog.

[Joe Carson]

When do we see the bigger picture? The "merit systems principles" - the core values of the federal civil service - are battered, as a result of U.S. Office of Special Counsel and U.S. Merit Systems Protection Board renouncing, at their creation in 1979, vital statutory duties to protect federal employees from agency violations of the "merit system principles" which are termed "prohibited personnel practices (PPP's)" and includes the whistleblower reprisal type PPP.

As a result, the current and former Chairmen of SEC, since 1979, have been unable to comply with their statutory duty to "prevent PPP's" in SEC as documented in Carson v. SEC, docket no. 09-615, Eastern District of TN at Knoxville.

Until 31 years of lawbreaking at U.S. Office of Special Counsel and U.S. Merit Systems Protection Board is exposed and stopped, SEC cannot be fixed.

[Nelson]

Wow. Just incredible. The fact that congress (both Republicans and Democrats), the president, the SEC itself, the Attorney generals AND THE FREAKING PUBLIC, continue to be quieter than a church mouse regarding this case and others (recent Lehman news) speaks loud warnings that corruption runs rampant and that unfortunately America is broken.

[na]

This is not the SEC at it's worst. That investigation is ongoing and will top even Madoff's deal based on the intent of the outcome of a case designed by the SEC and outside parties.