No One Would Listen: A True Financial Thriller (47 page)
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Authors: Harry Markopolos
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I actually had fun in the remaining few minutes of this hearing. Trying to make a long point in a brief statement, I resorted to the use of very descriptive metaphors, which everybody not working for the SEC seemed to enjoy. In response to the director’s defense of the agency and its employees, for example, I pointed out, “It’s very hard to soar like an eagle when you’re surrounded by turkeys, and there’re a lot of turkeys that need to be let go.” When Schumer asked me to elaborate, I added, “Most of these attorneys at the SEC—I don’t think they could find steak in an Outback.”
As I left the hearing that day, all in all I thought it was probably a good thing that at that moment I was not going over to the SEC Building.
Officially, at least, that was it for me and Bernie. Madoff was in jail for the next 150 years, with good behavior perhaps 140 years; Thierry was dead; and the tens of thousands of people who had lost their savings will recover only a portion of it at best. The Madoff story was far from done, though, as a large posse of lawyers had ridden into town, armed with loaded briefcases. The litigation has barely even started as those lawyers try to figure out which people and what organizations may bear some responsibility for these losses. There certainly will be more civil cases filed, more criminal indictments, and even more deaths like that of Thierry de la Villehuchet and that of Jeffrey Picower, who had received $7 billion from Madoff and was found on the bottom of his swimming pool in late October 2009. The SEC already has made substantial changes in the way it does business, and there will be many more changes to come if it intends to survive as an independent agency. The federal government will also be instituting new regulations and procedures for overseeing government financial institutions. Some of those industries—unregulated hedge funds, for example—undoubtedly will be trying to police themselves in an effort to keep the government out. And Gaytri has become very active in helping establish the first international financial court through the Global Alliance to deal with cross-border financial claims.
And unfortunately, other financial frauds will be uncovered. Soon after the story of our investigation became public, each member of the team began receiving letters and tips offering evidence of other financial frauds, including several Ponzi schemes. I’ve gotten a large pile of them that allege frauds in a variety of industries. Unfortunately, I’m so busy with active cases that I don’t have time to even look at the mail that comes my way.
What has become apparent to me and to Frank and Neil and Mike and Gaytri is that there is an overwhelming desire among the majority of people in the financial industry to clean up the mess. Most people who work in the industry actually are proud to be part of it, and a scandal like this one taints all of them. While a few people make money, scandals make the business harder for everyone else. So there is widespread support for these suggested changes. For Neil’s efficient markets theory to function, it is essential.
On October 20, 2009, five years after I became a full-time fraud investigator, the very first whistleblower case that I developed became the first of my cases to be unsealed. California’s attorney general, Jerry Brown, charged the State Street Corporation with a $56.6 million fraud against the state’s two largest pension funds, announcing that he hoped to receive $200 million in overcharges and penalties. Brown said, “State Street bankers committed unconscionable fraud by misappropriating millions of dollars that rightfully belonged to California’s public pension funds.”
This amount was only the tip of what my team and I believe was nothing more than a fraudulent iceberg. Basically, our complaint alleged that the bank has executed more than $35 billion in currency trades for the pension systems since 2001, and what foreign exchange traders were doing was falsely claiming that buy trade orders were made at or near the highest exchange rates of that particular day while sell orders were executed at or near the lowest exchange rates of the day, allowing the bank to pocket the difference. It remains to be seen whether the bank will choose to go to a jury trial to prove its innocence or will settle the matter before it goes to trial.
Two days after Brown unsealed the lawsuit, the bank’s chairman and CEO, Ron Logue, announced he would retire the following March. There was no mention of the lawsuit in this announcement, and if anybody had asked about the odd timing, certainly the answer would have been that there was no link between the two events. And clearly that is possible. But it is quite a coincidence.
I have many other cases in the pipeline. There will be a lot more announcements and lawsuits just like this one to come in the future. In fact, I intend to be in this business until I can’t find anymore financial or Medicare frauds—which makes me think I’m going to be in the whistleblower business for a long, long time.
Epilogue
Mr. Pinkslip Goes to Washington
I’ve seen the failures of the Securities and Exchange Commission (SEC) from both inside and outside the industry. I know how the agency was supposed to function, and by this time I certainly knew how it actually worked—or, more accurately, didn’t work. So when I was asked numerous times to suggest ways in which the SEC could improve, I was able to offer a long and fairly detailed list of ideas.
SEC Commissioner Mary Schapiro has begun making the necessary changes. The agency is trying to get better and, for a government agency, it is moving at an enviable pace. But you have to crawl before you can walk, and you have to walk before you can run. The SEC has to learn how to crawl again. It has suffered through decades of sloth, abysmal leadership, underfunding, and benign neglect, and realistically it will take several years for it to begin functioning as the effective, efficient cop on the financial beat that both investors and industry professionals expect.
As I told Congressman Kanjorski’s House subcommittee, the Senate Banking Committee, David Kotz, Mary Schapiro, and reporters for several newspapers and magazines, there are numerous concrete steps that need to be taken as soon as possible if the SEC is to be transformed into a respected agency.
First, banish the lawyers from the land.
Currently the SEC, like most Washington agencies, is dominated by lawyers. In 2009 all five SEC Commissioners were lawyers. Now, I have nothing against lawyers. I’m sure they are good to their children, and many of them contribute to charities. But putting them in charge of supervising our capital markets has been an unmitigated disaster. It would be like putting a political appointee in charge of the Federal Emergency Management Agency and expecting him to handle a flood. Very few SEC lawyers understand the complex financial instruments of the twenty-first century, and almost none have ever sat on a trading desk or worked in the industry other than doing legal work. A primary reason the SEC has reached this point is that historically the SEC Commissioners have been lawyers who may know where to find the best power lunches in Washington, D.C., but don’t have a clue as to how the financial industry actually operates on a day-to-day basis.
Currently the SEC, like most Washington agencies, is dominated by lawyers. In 2009 all five SEC Commissioners were lawyers. Now, I have nothing against lawyers. I’m sure they are good to their children, and many of them contribute to charities. But putting them in charge of supervising our capital markets has been an unmitigated disaster. It would be like putting a political appointee in charge of the Federal Emergency Management Agency and expecting him to handle a flood. Very few SEC lawyers understand the complex financial instruments of the twenty-first century, and almost none have ever sat on a trading desk or worked in the industry other than doing legal work. A primary reason the SEC has reached this point is that historically the SEC Commissioners have been lawyers who may know where to find the best power lunches in Washington, D.C., but don’t have a clue as to how the financial industry actually operates on a day-to-day basis.
Maybe lawyers know the difference between a tort and a tortilla, but there is a reason that most firms in the industry are run by businesspeople with capital markets or banking expertise—it’s because they’re experts. Obviously that didn’t prevent the industry from barely surviving the 2008 crisis, but just about anything would be an improvement over lawyers attempting to lead an industry whose complexities they don’t understand.
Of course there is a place for lawyers inside the SEC. They should be in charge of making sure the rules and regulations promulgated by financial experts are followed, and that those people who don’t follow them get penalized. The director of enforcement should be a lawyer, but the other departments should be led by people knowledgeable about what they actually do in those departments. Lawyers need to be removed from most positions of senior leadership and replaced with people who understand the markets and institutions being regulated.
Anyone who doubts this should simply read David Kotz’s report for evidence that the SEC’s enforcement lawyers did not have a clue as to what Bernie Madoff was telling them about his trading strategy. As a basketball coach once scolded a poor shooting guard, “You couldn’t hit the ocean if you were standing in it.” Most lawyers couldn’t recognize a Ponzi scheme if they were having dinner with Charles Ponzi. They couldn’t recognize Madoff’s obvious lies because none of them had the financial expertise to understand the capital markets. The typical SEC attorney would have trouble finding fireworks on the Fourth of July, so asking them to uncover financial frauds was well beyond their pay grade. There were a lot of financial experts who knew that Madoff was doing something illegal—even if they didn’t publicly expose him. But at least we should put those people in position to stop these scams—and then make it worth it for them to do it.
The purpose of laws is to define the lowest form of acceptable behavior between people, but ethics are the higher standard that the SEC’s securities lawyers have successfully ignored. For example, mutual fund market timing isn’t illegal, so the SEC ignored it while individual investors lost billions of dollars to market timers and hedge funds engaged in the practice. But within the industry the professionals with a moral compass knew this activity was unethical, that it cheated investors and needed to be stopped. Lawyers are trained to follow the black-letter law and regulation the way Hansel and Gretel tried to follow the bread crumbs home from the forest. But the SEC has to do more than just follow the technical bar set by the rules; it has to lead in regulating industry behavior so that it embodies the highest standards of transparency and fairness for all.
There certainly is an important role for lawyers to play in the SEC, just not the part they’ve been playing. Securities laws are outdated almost as soon as they go into effect, because new financial instruments are created to skirt these new laws. Lawyers should focus on using regulations to establish a standard of behavior for the industry that is substantially higher than now exists. But it would be tough to do a worse job running the show than they’ve done, so we really should put professionals in charge. The lawyers should have a separate enforcement unit in which they can prosecute both civil and criminal cases of securities and capital markets fraud. Let lawyers prosecute, not investigate.
Second, smart is as smart does.
The people who should fill the positions created when we clean up the SEC should have industry experience, not resemble a clown car filled with college degrees. These college greenhorns couldn’t find a steer in a stampede. This is actually a great place for reverse age discrimination. For the broker-dealer exam teams, the people who actually go into an office to conduct an investigation, we should be hiring experienced brokers with as many years of experience as can be found. These people know the tricks and the hiding places; they may even have used some of them themselves when they were on the other side of the investigation. So put veteran traders and veteran back-office personnel on these investigative teams to conduct trading floor exams. For the money management and hedge fund teams, hire experienced portfolio managers, analysts, and buy-side back-office personnel to conduct asset manager examinations. Hire experienced accounting professionals to examine required corporate filings.
The people who should fill the positions created when we clean up the SEC should have industry experience, not resemble a clown car filled with college degrees. These college greenhorns couldn’t find a steer in a stampede. This is actually a great place for reverse age discrimination. For the broker-dealer exam teams, the people who actually go into an office to conduct an investigation, we should be hiring experienced brokers with as many years of experience as can be found. These people know the tricks and the hiding places; they may even have used some of them themselves when they were on the other side of the investigation. So put veteran traders and veteran back-office personnel on these investigative teams to conduct trading floor exams. For the money management and hedge fund teams, hire experienced portfolio managers, analysts, and buy-side back-office personnel to conduct asset manager examinations. Hire experienced accounting professionals to examine required corporate filings.
Hire experienced leaders. Most people in the industry considered William Donaldson a capable chairman—and he came from the industry. He knew where the skeletons were buried, and he allowed his staff to dig them up.
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