Friday, September 30, 2011

Saving the SEC by Outsourcing Its Investigations

With the SEC admitting defeat and announcing a change strategy to target negligence instead of  the harder to prove fraud, I thought it was a good time to discuss my idea of saving the SEC by outsourcing its work. I am developing  my idea with the help of the community reporting site, Spot.us.

Private lawyers would be allowed to present a SEC staffed tribunal with customer complaints or credible allegations of violations of securities law. The tribunal would then put it to a vote to decide if the investigation by the private lawyers should proceed.. Once the investigation is authorized, the lawyers would be armed with full investigative powers of the government including subpoena. Upon the finding of wrong doing,  the staff tribunal would impose punishment. The lawyers would be paid from the fines imposed.

Everyone knows about the failure of the SEC to detect the Madoff fraud. More recently, SEC attorney Darcy Flynn blew the whistle and revealed that the SEC has hindered investigations and broken National Archive rules by destroying documents that are required to be kept for 25 years.

 My personal experience of  trying to inform the SEC about a potential fraud might be more illustrative of the reasons that government oversight of the securities markets is not enough. When I discovered several years that serial con man Glenn Manterfield of England had registered the hedge fund Lydia Capital that he co-founded with Evan Andersen with the SEC, I immediately contacted and alerted them that he had stolen money from me and clients of mine.

I also informed them that he lied about his criminal history on the SEC  form ADV. The form asks about the applicant's criminal history and requires registrants to update the SEC about any developments. He had checked that he had no criminal history and had not informed him of his latest arrest, which occurred after his registration. The SEC indictment later said he lied about his extensive criminal record.

Although we regularly throw around the term international financial markets, the SEC has not adjusted to the globalization,. The SEC can only access American fingerprint databases so there was no way to discover Manterfield's British criminal history. A SEC lawyer told me that they had to get special  permission to make a transatlantic call so they have no regular ability to check on international applicants for registration. It is negligent to register international applicants if you can not run the proper background checks.

Requiring hedge funds to register was one of the knee jerk responses of Congress to the Wall Street bailouts, but it is not the right answer. No one contemplated the pitfalls of registration. Manterfield's bone chilling retort to why he registered shows the downfall of this lack of foresight - "We were just two guys with an idea. The SEC registration gave us credibility."

When the SEC did not proceed with an investigation, I contacted the office of William Galvin, the Secretary of the Commonwealth of Massachusetts. After Galvin's office started the prosecution, a light finally went on at the SEC and they took over the prosecution. They later apologized to me for ignoring my tip.

The SEC closed Lydia and appointed a receiver to recover assets. They imposed a lifetime ban and a $2.91 million fine on Manterfield for defrauding 60 investors of $34 million. 

Unfortunately, this was not the end of the story. Even though I warned the SEC that Manterfield could be running multiple cons at once, they didn't check. I complained again to Galvin's office. They issued a cease and desist order for his second entity, Osiris FX.  The US Attorney of Massachusetts, which rarely prosecutes securities violations, declined to prosecute even though they had the cooperation of the British police.

Without my intervention and a little luck, Lydia Capital could have defrauded investors for years. Lydia Capital happened to be headquartered in Boston. Massachusetts' Galvin is one of the few state law enforcement officials aggressive about prosecuting securities crimes. Anywhere else in the country, my warnings would have also been ignored by the state authorities.

Galvin stepping in might have saved the day for Lydia's investors but it is not a permanent solution. We need cops patrolling the securities beat. From my varied interactions with the SEC, I do not think that they are up to the job. After SEC investigator Gary Aguirre was fired after he vigorously pursued Morgan Stanley CEO John Mack too aggressively, they may no longer feel safe challenging big names on Wall Street. The revolving door between the SEC and Wall Street may also play a role in their lackadaisical attitude.

Outside lawyers need to step in and supplement the investigative staff of the SEC, We already outsource some aspects of  law enforcement such as bounty hunting and allow private contractors like Blackwater defend our country.  Private SEC investigations would be the next logical step.

If you have any doubts, remember "Inside Job" direct Charles Ferguson's Oscar acceptance speech. He said, "Forgive me, I must start by pointing out that three years after a horrific financial crisis caused by fraud, not a single financial executive has gone to jail - and that's wrong."







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