Wednesday, September 2, 2009
The SEC Admits They Helped Madoff Attract Suckers!
From Case OIG-509, SEC office of Inspector General’s Report of Investigation:
“Moreover, we found that Madoff proactively informed potential investors that the SEC had examined his operations. When potential investors expressed hesitation about investing with Madoff, he cited the prior SEC examinations to establish credibility and allay suspicions or investor doubts that may have arisen while due diligence was being conducted. Thus, the fact the SEC had conducted examinations and investigations and did not detect the fraud, lent credibility to Madoff’s operations and had the effect of encouraging additional individuals and entities to invest with him.” link to full document here: cbsnews.com
In other words, the SEC admitted today that by bungling investigations, they actually helped Madoff sucker more people in. This outrage is not unusual, it happens everyday in a hundred ways as the SEC blesses the products that Wall Street sells to the unsuspecting public.
Below is my Blog entry from a couple of months ago, which said the same thing. I never imagined the SEC would agree with me, and put it in writing.
From the movie Casablanca:
Captain Renault: “I’m shocked, shocked to find that gambling is going on in here!”
Croupier: “Your winnings, sir”
Captain Renault: “Oh. Thank you very much.”
The SEC was created in 1934, after the great crash of 1929. According to their website, “there was a consensus that for the economy to recover, the public’s faith in the capital markets needed to be restored.” In other words, the public lost a boat-load of money and were tired of being scammed by the people that were manipulating the markets. So the government had a brilliant solution – put a fox in charge of the hen house – and they did, with Joseph Kennedy, bootlegger and inside trading king, as the first Chairman of the SEC.
The SEC – there to protect investors, right? Well, let’s take a closer look at that idea. The Securities and Exchange Commission is the Federal Agency responsible to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation” according to their website. The very existence of the SEC lulls investors into a false sense of security, fooling them with the false notion that markets are fair, orderly and efficient.
This very mission statement is preposterous. Are the markets really fair? Do you think individual investors have a fair shot against the trading desks at Goldman Sachs which know who owns what and at what price? Orderly markets? The crash of 1987, in which the Dow dropped 22% in one day would make that idea seem like a fairy tale. Efficient? Nice academic principle, but statisticians on the stock market would tell you that the conditions in the markets that occurred in 1998 that imploded Long Term Capital Management would have occurred only once in a billion years. Some of the volatility of the S&P, according to Wall Street models, would happen only if the history of the world was re-run a billion times, yet we’ve had about 5 of these “black swans” in the last 20 years.
A kind-hearted soul would say the SEC is understaffed, charged with a nearly impossible mission. They do the best they can, but human nature can’t be legislated away. Their well-intentioned public servant lawyers and financial staff are no match for the sophisticated, highly-paid criminal minds on Wall Street.
I’m tempted to take a more cynical view. The SEC, due to its very existence, ludicrous mission, and gross incompetence, is worse than not having one at all. The SEC, like the ratings agencies, gives investors a false sense of security that they are being “protected.” Need some examples?
The most galling example of SEC incompetence is the Madoff case. Bernard Madoff ran a multi-billion dollar Ponzi scheme under the noses of the SEC for decades. The SEC never did catch Madoff. His sons turned him into the SEC. (Some have speculated the whole manner he was turned in by his sons was part of a ruse to protect the rest of his family). It wasn’t as if the SEC didn’t have warnings – more than once people sent them letters pointing out the fact that the Madoff scam was a Ponzi scheme.
The SEC failed in dozens of cases to fulfill their mission. I’ll share some examples without using names, to protect the guilty, and myself from their lawyers. The world’s biggest hedge fund hired a former Microsoft employee as analyst, who got inside information from a friend at Microsoft. The fund quickly earned large profits by buying options. Then when investigated, it came out that they paid off the analyst more than a million dollars for his silence after he left the firm. The founder of the firm eventually closed the fund, but the SEC has yet to file charges. The original case was closed due to strong-arm tactics from a man who currently runs one of the largest firms on Wall Street, which owes its continued existence to government largesse of the TARP program. As they say, you can’t make this stuff up.
The SEC is the lapdog of the major brokerage firms. When Lehman Brothers and Morgan Stanley were on the ropes during the credit crunch due to their ill-advised “bet the firm” foray into mortgages, the executives blamed the evil short sellers. They promised to cause them pain. One highly vocal short-seller of Lehman Brothers stock, hedge fund manager David Einhorn, was investigated and hassled by the SEC. Of course, he ultimately proved to be right about Lehman, as they filed the largest bankruptcy in history. David Einhorn also chronicles his travails with the SEC in his book “fooling some of the people.” He uncovers fraud at a company, makes it public, shorts it, and for his efforts got hassled by the SEC.
The list of SEC failures is long, the successes few. Wait, I guess they did get Martha Stewart, although she spent less actual time in the slammer than Paris Hilton did for parking tickets.
Investors cannot rely on the SEC to protect them. We cannot even count on them to “keep things fair.” The stock market is not a fair game, anymore than Caesars Palace is. But like the game of Black Jack, or Poker, a lot of money can be made despite the tough odds. I will get into specifically how next chapter. For now, let me say the best way to think about the SEC’s role in the markets is to assume they will do nothing to protect you. Every investment must be analyzed using your own rational thought process, with no expectations of “bail outs” or proper policing by the SEC.
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