This post was written by Simon van Norden of HEC-Montréal.
The news last week that the SEC was filing charges against Goldman Sachs was a bombshell; it dominated the day's headlines and continues to fill blog-space. As it happens, that announcement came the same day as a report that the SEC would prefer that everyone forget about. The SEC issued a press release about that report which stated (in its entirety)
"This report recounts events that occurred at the Commission between 1997 and 2005. Since that time, much has changed and continues to change regarding the agency's leadership, its internal procedures and its culture of collaboration. The report makes seven recommendations, most of which have been implemented since 2005. We will carefully analyze the report and implement any additional reforms as necessary for effective investor protection."
It was long ago....times have changed....the problem has since been fixed.....and if it hasn't been, we'll be sure to fix it now.....so there's no nothing to discuss.....
The report is by the SEC's Office of the Inspector General (OIG) Case No. OIG-526 "Investigation of the SEC’s Response to Concerns Regarding Robert Allen Stanford’s Alleged Ponzi Scheme." Sir Stanford (he has a knighthood) is the man behind the Stanford Group Company (SGC) and the alleged Ponzi scheme that was exposed shortly after Bernie Madoff was exposed. In the Madoff case, inquiries showed that the SEC did a spectacularly bad job, including failing to follow up on repeated warnings (notably by Harry Markopolous) that Madoff was running the world's biggest Ponzi scheme. In the Stanford Case, the Ponzi scheme was smaller (still in the billions of dollars), but the failure was worse in some ways.
In 2002 and against in 2003, outsiders warned the SEC that they felt Stanford was running a Ponzi scheme. In 2003, an insider at Stanford Group Company (SGC) warned that Stanford was operating "a Massive Ponzi Scheme." SEC examiners had determined as far back as 1997 that the company was most likely running a large Ponzi scheme. Three follow-up examinations by the SEC confirmed that the operation was almost certainly a fraud and that it was growing. Despite that, no actions were taken to protect investors until February 2009, when SGC was abruptly shut down by regulators.
Here's how the the report summarizes what happened
The OIG investigation found that the SEC’s Fort Worth office was aware since 1997 that Robert Allen Stanford was likely operating a Ponzi scheme, having come to that conclusion a mere two years after Stanford Group Company (“SGC”), Stanford’s investment adviser, registered with the SEC in 1995. We found that over the next 8 years, the SEC’s Fort Worth Examination group conducted four examinations of Stanford’s operations, finding in each examination that the CDs could not have been “legitimate,” and that it was “highly unlikely” that the returns Stanford claimed to generate could have been achieved with the purported conservative investment approach. Fort Worth examiners dutifully conducted examinations of Stanford in 1997, 1998, 2002 and 2004, concluding in each case that Stanford’s CDs were likely a Ponzi scheme or a similar fraudulent scheme. The only significant difference in the Examination group’s findings over the years was that the potential fraud grew exponentially, from $250 million to $1.5 billion.
While the Fort Worth Examination group made multiple efforts after each examination to convince the Fort Worth Enforcement program (“Enforcement”) to open and conduct an investigation of Stanford, no meaningful effort was made by Enforcement to investigate the potential fraud or to bring an action to attempt to stop it until late 2005. In 1998, Enforcement opened a brief inquiry, but then closed it after only 3 months, when Stanford failed to produce documents evidencing the fraud in response to a voluntary document request from the SEC. In 2002, no investigation was opened even after the examiners specifically identified multiple violations of securities laws by Stanford in an examination report. In 2003, after receiving three separate complaint letters about Stanford’s operations, Enforcement decided not to open an investigation or even an inquiry, and did not follow up to obtain more information about the complaints.
It gets worse. The 1998 inquiry was evidently opened not because of the examination group's findings, but because another federal agency was concerned that SGC was involved in money-laundering. It seems that outside counsel for SGC, Wayne Secore, was the former head of the SEC's Fort Worth office. The man at the SEC responsible for shutting down the inquiry, Mr.Barasch, reportedly told colleagues that this was because Mr. Secore assured him that "there was nothing there." Enforcement efforts were consistently avoided until Mr. Barasch left the SEC in 2005. When the successor to Barasch showed interest in pursuing SGC, SGC tried to hire Barasch as legal counsel. Three times Barasch tried to get permission to work for SGC, which could normally be a violation of ethics guidelines for federal employees. He was told three times that he could not, despite the fact that in at least one case he had already begun work.
The report is an accessible mine of more worrying information.
- Frustrated by their inability to get the SEC to take enforcement action, some examiners try to get the Federal Reserve Board to act via its banking supervision responsibilities. The responses from the FRB are among the most heavily redacted parts of the report, but it is clear that, after long delays in responding to SEC concerns, the FRB did nothing.
- One reason advanced for not pursuing enforcement actions against SGC was that the majority of investors were not US citizens. (In 2005, it was estimated that US investors had only invested a bit over $200 million; other investors, particularly Mexicans, had invested over $1 billion.)
- After another worrying report by examiners in 2002, enforcement proceedings were deflected by deciding to refer to the matter to the Texas State Securities Board, but not actually contacting that body.
- Those who were responsible for blocking many of the enforcement actions over the years argued that this was because they understood that they were not to waste resources pursuing Ponzi games.
Meanwhile, Julie Dickson, Canada's Superintendent of Financial Institutions, is arguing that the debate about what rules are required overlooks the important role of supervision in banking. Given that the examiners in the case of SGC seemed to have been so right for so long, I need to read her arguments again and think hard about them.