Category: Fraud

The Subprime Boomerang: After the Writedowns Comes the Litigation

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Securities Docket put on a great webinar on The Subprime Boomerang: After the Writedowns Comes the Litigation.

Bruce Carton moderated a panel of Veronica Rendon of Arnold & Porter, Richard Swanson of Arnold & Porter and Jeff Nielsen of Navigant Consulting, Inc.

Jeff started off my showing how much complicated the picture is for securitized lending compared to traditional lend hold lenders. There is now a dozen + parties involved with very different interests. There are lawsuits between many of these relationships with fingers being pointed in many different directions.  There are also lawsuits within the parties as shareholders are bringing securities class action suits against the investors. Some of the parties changed roles through the the lifecycle of the loan. (Such as the originator becoming an investor.) Here is a snapshot of the parties:

securitization

Jeff identified 866 subprime related federal filings, including borrower class actions, securities class actions, contract claims, employee class actions and bankruptcy related claims. Of those 576 are in 2008. California has 17% of the suits and New York has 33%. (California has some tough laws that are the basis of borrower lawsuits.) They are also seeing two new cases for every case that is resolved.

Veronica pointed out that the securitization market grew from $157 billion in 200 to $1200 billion in 2006. That was staggering growth over a very short period of time.

Now we are in a period of rising interest rates, declining home prices, rising unemployment and forced sales.

Unfortunately 50% of adjustable rate mortgage originations over past four years have been subprime. There was some bad underwriting with lots of no-doc loans and high debt-to-income ratios.

The current bulk of suits are now “stock drop” case because the institutions failed to disclose their exposure to subprime risk.

Richard focused on some interesting aspects of the pleadings, hearings and decisions coming out of the cases.

There are increasing suits by purchasers of subprime assets. Lots of the focus on misrepresentations in the offering documents and a failure to disclose risks. These are generally very sophisticated parties doing war including state law claims.

There are also criminal investigations on the horizon. Both the FBI and SEC are looking at possibly bringing charges.

You can listen to webcast and see the slides on the  Securities Docket Webcasts page.

Corporate Compliance Fraud in Georgia, Florida and Massachusetts

Just like the Corporate Compliance Fraud in Ohio, Compliance Services is also targeting companies in Georgia, Florida and Massachusetts.

The Daily Citizen is reporting Georgia corporations warned about solicitations. The Georgia Secretary of State issued a warning:

“Several corporations registered with the Corporations Division of the Office of the Secretary of State received a letter from Georgia Corporate Compliance, a private company offering to complete corporation meeting minutes on behalf of registered corporations.”

The Attorney General of Florida also issued a warning:

Over the past several months, the Attorney General’s Office has received numerous complaints against several of these companies. Last week the Attorney General settled a lawsuit against one such company, Corporate Compliance Center, over allegations that the company misled Florida businesses relating to the sale of corporate minutes reports. Two other companies, Corporate Minutes Compliance Service and Corporate Minute Services, were prevented from operating in Florida when the Attorney General’s Office threatened litigation.

Bill Galvin, the Secretary of the Commonwealth of Massachusetts issued his warning:

Recently, an entity calling itself “Compliance Services” mailed solicitations entitled “Annual Minutes Requirement Statement Directors and Shareholders” to numerous Massachusetts corporations. This solicitation offers to complete corporate meeting minutes on behalf of the corporation for a fee. Despite the implications contained in the solicitation, Massachusetts corporations are not required by law to file corporate minutes with the Secretary of State.

Thanks to Corporate Compliance Insights: Compliance Scam Alert in Georgia: Corporate Minutes Hoax Not Limited to Ohio.

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Corporate Compliance Fraud in Ohio

logo_clevelandThe Cleveland Plain Dealer is reporting a fraud that uses the cover of corporate compliance: ‘Corporate Compliance’ form not from any government agency. According to columnist Sheryl Harris, businesses are receiving official-looking mailings with a form requesting a $150 fee to comply with the annual meetings under state law.

As the story points out, not all companies need to have an annual meeting and even if they did, filling out a form is not a sufficient replacement for an annual meeting.

The Ohio Secretary of State has posted an alert on her website: Alert: Annual Minutes Disclosure Solicitation. She has also published an example of the fraudulent mailing (.pdf).

As with the fraudulent SEC Examiners stories we are hearing about, it is sad to see fraudsters using compliance to dupe their marks.

Thanks to Corporate Compliance Insights for pointing out this story:Attention: Beware of Corporate Compliance Form Hoax Circulating in Ohio.

SEC Warns Investors and Financial Firms of Government Impersonators

sec-sealThe Securities and Exchange Commission issued a warning  about con-artists who may use the names of actual SEC employees to mislead potential victims. The SEC is already beaten down by the Madoff scandal. Now it has to deal with scam artists further dragging mud across the reputation of the SEC.

Investors should be aware that the SEC never makes or endorses investment offers or participates in money transfers. Nor does the SEC send e-mails asking for detailed personal information, or financial information such as PIN numbers.

Take steps to protect your self:

If you have reason to suspect that a caller claiming to be an examiner or other member of the staff is not a member of the SEC’s staff, consider taking the following steps. You can ask for the caller’s name, office, and telephone number, and tell the caller that you will return his or her call. The telephone numbers of all SEC offices are available on the SEC’s web site at: http://www.sec.gov/contact/addresses.htm. Using the telephone number on the SEC’s website, call the main number of the particular office that the caller identified, and ask to speak to the SEC staff person.

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SEC Charges Operators of Multi-Billion Dollar Real Estate Enterprise With Fraud

sec-sealThe SEC charged Oregon-based Sunwest Management Inc. with securities fraud and is seeking an emergency court order freezing its assets.

According to the SEC Complaint, the recent collapse of a real estate enterprise once valued at approximately $2 billion in assets, run by Sunwest Management Inc.and its CEO, Jon M. Harder, revealed a massive fraud that led to losses of hundreds of millions of dollars for investors. Sunwest, Harder and certain related entities operated several hundred retirement homes nationwide. From January 2006 through June 2008, they raised at least $300 million from more than 1300 investors, primarily through the sale of tenancy-in-common interests (“TICs”). The company represented that individuals were obtaining an interest in a specific property which would generate a steady income stream. Instead the defendants ran Sunwest as a single enterprise, commingling all investor funds and operational revenue into a single fund from which all operating expenses and investor returns were paid. Sunwest paid investors steady returns on their investments from cash generated in the operations of other facilities, from funds obtained in refinancings, and from funds raised through offerings to new investors. With the credit crisis, new funding sources began drying up. Despite the dire financial condition, defendants continued to raise additional money from investors. By June 2008, they operated Sunwest virtually as a Ponzi scheme. The money they raised in the final offerings (supposedly for new properties) was used to pay old investors their 10 percent return and fund operations at existing facilities. As of January 2009, over 100 retirement homes have been placed in foreclosure, receivership or bankruptcy, resulting in the effective elimination of the TIC investors’ interests in them. Approximately 32 facilities have filed for bankruptcy.

The Commission’s complaint charges all of the Defendants with violating the antifraud provisions of the federal securities laws, including Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

On December 31, 2008, Jon M. Harder filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”). The case was assigned case number 08-37225 (the “Bankruptcy Case”) and is currently pending before the Honorable Trish M. Brown in the United States Bankruptcy Court for the District of Oregon.

The SEC complaint include a pleading to freeze assets and appoint a receiver to oversee Sunwest and related entities. According to a press release from Sunwest, both requests were denied by the court. Sunwest welcomes serious discussions with the SEC about a form of cooperative receivership that would allow the current Sunwest restructuring to continue.

“The judge denied the temporary restraining order motion in its entirety including denial of the appointment of a receiver,” said Stephen English, special counsel for Jon Harder. “We see this as a big win for the restructuring work at Sunwest.”

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Madoff and Markopolos on 60 Minutes

markopolosOn Sunday night, 60 Minutes aired an interview with Harry Markopolos: The Man Who Figured Out Madoff’s Scheme. Last month, Markopolos supplied similar information to a Congressional panel.

By its vary nature, the SEC does not stop a financial crime until happens. As with all prosecutions, the bad act needs to happen before there is a crime. The failure with Madoff is that the fraud appears to be so big and appears to have been happening for over a decade. Usually, the SEC stops fraud before it gets so big.

If you think the SEC is ineffective, take a look at the SEC litigation releases. Quickly browsing through the list, you can see that the SEC is filing to stop a few securities fraud schemes every week.  Hardly ineffective.

The SEC can no sooner prevent securities fraud than the police can prevent a robbery. You hope your patrols and effective prosecutions will deter potential bad actors. But people will always be enticed to take short cuts.

Markopolos spotted the problem and the SEC blew it. Let’s move on and find out how Madoff did it so we can learn some lessons. The sound bites and preachings from Markopolos are not contributing to the prevention of future securities fraud.

Thanks to Bruce Carton and Securities Docket for pointing out the interview: Sunday Night: Harry Markopolos on 60 Minutes.

The Stanford Fraud

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Yesterday, the SEC filed a complaint against R. Allen Stanford and three of his companies: Antiguan-based Stanford International Bank, Houston-based broker-dealer and investment adviser Stanford Group Company, and investment adviser Stanford Capital Management.

Tuesday morning, the Wall Street Journal reported on Stanford Depositors head to Antigua or Redemptions. Word had gotten out that the authorities were investigating the Stanford International Bank and depositors were nervous.

They should have been nervous when they first made the investments. According to item 31 in the SEC complaint, SIB was offering very high rates of return on CDs. On November 28, 2008 SIB was offering a 5.375% rate on a 3 year CD, while other US banks were offering rates under 3.2%. At the same time, SIB was saying the investments were safe and invested in very liquid assets. [Investing 101. The greater the risk the greater the rate of return you should expect.]

Unfortunately it looks like the problem has been in place for years. According to the SEC complaint [item 4] , SIB had identical returns in 1995 and 1996.

Bruce Carton points out that one of Stanford’s own lawyers has emerged as a key figure in the matter: Attorney for Stanford’s “Disaffirmation” of Prior Statements Was Red Flag for SEC. Bruce cites a Bloomberg report that Thomas Sjoblom, a partner at law firm Proskauer Rose doing work for Stanford’s company’s Antigua affiliate, told authorities that he “disaffirmed” everything he had told them to date.

Felix Salmon, of Portfolio.com, first pointed the problems with Stanford International Bank on February 10: What’s Going On at Stanford International Bank? Felix noted that Stanford had very consistent returns that seemed to not be impacted by any of the gyrations of the market over the last few years. Feliz also dug up a report by Alex Dalmady that highlighted the problems.

I see many similarities to the Madoff scheme. The principal was well respected. (Antigua even bestowed knighthood on him.) Investors were promised safety. Investors were shown reasonable, consistent returns. The investment technique was obscure.

Unlike Mr. Madoff, it looks like Mr. Stanford took off in one of his private jets and authorities are still looking for him.

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Why Don’t Sanctions Deter Fraud?

Meric Craig Bloch theorizes that punishing people who are caught committing fraud is not an effective way to deter fraud. The reasons behind his theory:

  • Employees who commit fraud don’t anticipate getting caught. The threat of sanctions does not deter them because they don’t expect to face them. To deter them, you have to raise the “perception of detection” – people who believe they will be caught committing fraud are less likely to commit it.
  • Employees who commit fraud rationalize their conduct so that it seems legal or justified. They do not see their actions as wrong.
  • Because employees who commit fraud are primarily motivated by status, the greatest threat they face is that their crime will be detected.
  • Sanctions are reactive – you are punishing someone after the damage to the company has been done.

Is Your Organization Adequately Prepared to Fight Today’s Workplace Fraud?

EthicsPoint published this webinar focusing on proper and efficient investigations.

The presenter was Meric Craig Bloch, VP Compliance and Corporate Investigations of Adecco Group North America.

Meric predicted more fraud coming into the workplace as part of this down economy. Managers are focused on making their numbers and it is harder to do.

Profile of a fraudster:

  • Likely acts alone
  • Likely a male over 40
  • Has worked at the company for a number of years
  • Some college (and probably more) education
  • no criminal record
  • no history of job discipline

It is obvious from this that fraud risk is less on the person and more on the internal situation and pressures. The fraud triangle is a combination of:

  • opportunity – compliance programs are in place to remove opportunities
  • rationalization – when dissonance happens and gets justified as not stealing (for instance –  entitlement, revenge, minimal damage, everyone else is doing it)
  • pressure – how and when fraud happens when the pressure to commit fraud is greater than the pressure to not

In this down economy the pressure is increased. So we need to remove the opportunities.

What is the ideal opportunity for a fraudster:

  • weak internal controls or ability to override
  • Pressure to be dishonest
  • perceived reward is relatively high
  • perception of detection is low
  • potential penalty is low

What is the best way to respond

  • good internal controls
  • raise the perception of detection
  • manage pressures and incentives (this includes treated employees during layoffs and not setting difficult targets)
  • focus on identified risks
  • zero tolerance for fraud

Meric calls for doing a fraud risk assessment. Learn about the potential fraud risks inside your company and the impact on the external view of your company. You need to determine your own tolerance for fraud risk. You need assess both the likelihood and impact of the fraud. Then you can evaluate your internal controls to see if they are designed effectively and are they operating effectively. Then you need to address the residual risks that are not mitigated by existing controls or anti-fraud programs.

Meric points out that you need to take steps to detect fraud. One tool is a whistleblower hotline. But hotlines are passive. You need someone sufficiently motivated to pickup the phone and make the call. You should make fraud reporting a mandatory requirement.

Fraud generally continues until detected. Half of fraud schemes are discovered by accident.

Fraud allegations can come from many sources, so you should have a consistent protocol for investigating fraud. Your organization should have a best practice for investigations. You need to make sure the investigations are run consistently and are well-documented.

The investigator is not the police. As the investigator you need to think about the business needs. Your investigation should lead to process improvements and better internal controls.

One of the questions was how to prove ROI. Of course, compliance is all about preventing fraud and loss. So it is hard to show savings for events that did not happen.

Madoff in Limerick Form

freakonomicsFreakonomics ran a contest for the best definition for Bernie Madoff in limerick form.

They had special guest judge Chris J. Strolin, founder and editor-in-chief of The Omnificent English Dictionary In Limerick Form announce The Winning Definition of “Madoff,” in Limerick Form.

The best of the best was #98 by sqlman:

His investments’ ascent: like a rocket.
His method: his hand in your pocket.
His scheming: detested.
His freedom: arrested.
His future: a day on the docket.

With rhyme and meter perfect throughout, this limerick encapsulates a complex story in just five lines, giving the details very well and in an interesting format. This one shimmers!

Second place goes to #104 by The Tortoise:

The Madoff scam: what’s it about?
Paying Paul (and thus fending off doubt)
By robbing poor Peter;
And what could be neater?
But it palled when the funds petered out

Presenting a strong summing up of the situation, this limerick ends with double wordplay in the fifth line so elegant that I can overlook the lack of an ending period.

And lastly, the title of Miss Congeniality (a.k.a. third place) goes to #78 by Robin:

With Bernie’s cachet as the lure,
Even smart folks invested, quite sure
That with Madoff, funds grow
And sweet dividends flow.
Now they find themselves swindled … and poor.

More perfect rhyme and meter throughout and an accurate telling of the history of this event, but with an interesting pause for dramatic effect at the end — very nice touch!