December 3, 2020

DealBook: S.E.C. Rejects Its Own Deal With Hedge Fund Manager

Philip Falcone, chief of Harbinger Capital Partners, at the SALT hedge fund conference last year.Steve Marcus/ReutersPhilip Falcone, chief of Harbinger Capital Partners, at the SALT hedge fund conference last year.

The Securities and Exchange Commission overruled its own enforcement division’s decision to settle a civil case with the high-flying money manager Philip A. Falcone and his flagship hedge fund, a rare reversal that signals a broader crackdown by the agency.

The S.E.C. recently notified Mr. Falcone and the fund, Harbinger Capital Partners, that the agency’s five commissioners had rejected “the previously disclosed agreement in principle,” according to a public filing his company made on Friday. The charges stemmed from allegations that Mr. Falcone manipulated the market, used hedge fund assets to pay his own taxes and secretly favored select customers at the expense of others.

The S.E.C.’s rejection of the settlement — a move that will prompt the agency to either enforce a tougher penalty or take Mr. Falcone to trial– suggested that its preliminary deal did not match the gravity of the crime. The deal, announced by Mr. Falcone in May, came with an $18 million penalty from the S.E.C., a rounding error to a hedge fund billionaire. Mr. Falcone was set to personally pay $4 million of the penalty, according to people briefed on the matter, while the fund’s management company would have paid the rest.

While the deal also included at least a two-year ban from raising new capital, a potential death knell to a hedge fund manager, that punishment came with a number of caveats. And in a a moral victory for Mr. Falcone, the deal also omitted a common provision that prohibits defendants from committing future violations with fraudulent intent.

When Mr. Falcone announced the deal, it raised concerns that the S.E.C.’s results fall short of its ambitions. It also reignited criticism of an agency that failed to thwart the financial crisis and Bernard L. Madoff’s Ponzi scheme.

But the rejection of Mr. Falcone’s deal could assuage such concerns and demonstrate a marked shift under its new chairwoman, Mary Jo White, a former federal prosecutor who has vowed to take a hard line against financial fraud.

Already, Ms. White has moved to address a central criticism of the agency: that it allows defendants to neither “admit nor deny” wrongdoing. In a departure from a longtime practice, Ms. White recently announced that the agency would in some cases force Wall Street firms to admit to their crimes.

The leaders of the S.E.C. enforcement unit detailed the policy shift in a memo, saying there might be cases that “justify requiring the defendant’s admission of allegations in our complaint or other acknowledgment of the alleged misconduct as part of any settlement,” noting that such cases arise “particularly when the defendant engaged in egregious intentional misconduct.”

A spokesman for the S.E.C. did not respond to a request for comment. Mr. Falcone’s spokesman declined to discuss the case.

For Mr. Falcone, the agency’s shift will prolong a painful chapter in his long Wall Street career.

It was not long ago that Mr. Falcone, who rose from rural Minnesota to the Harvard hockey team, was seen as one of the shrewdest investors on Wall Street. His prophetic bet against the subprime mortgage market made Mr. Falcone a fortune, success that cemented Mr. Falcone status in Manhattan’s social elite.

Mr. Falcone and his wife, Lisa Maria, soon became fodder for New York tabloids drawn to his rising star power. Their flashy taste for fashion and real estate — to say nothing of a charitable streak that included a $10 million gift to the High Line in Manhattan — reinforced the fascination swirling around him.

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David Kotz, Inspector General, to Leave S.E.C.

WASHINGTON — The inspector general of the Securities and Exchange Commission, who has been a thorn in the side of the agency over its fumbling of early inquiries into the Madoff and Stanford cases, will leave the commission at the end of January to join a private investigations firm.

H. David Kotz, who has been inspector general for the S.E.C. since December 2007, will join Gryphon Strategies, an investigative company, as a managing director in its Washington office, he said Tuesday. He will focus on corporate fraud investigations and “assisting whistle-blowers in exposing fraud and improving government accountability,” an S.E.C. announcement said.

Mary L. Schapiro, chairwoman of the S.E.C., called Mr. Kotz “a committed public servant who has served the agency with great distinction for the past four years.”

“His work helped us to identify areas where we needed to improve the way we operate, bolster our resources and upgrade our technology,” she said.

In addition to lengthy reports documenting the S.E.C.’s failure to act on tips that the investment firms of Bernard L. Madoff and R. Allen Stanford may have been running huge frauds, Mr. Kotz also exposed more than 30 S.E.C. employees, including more than a dozen senior officers, who had been using their workdays and government computers to regularly visit Internet pornography sites.

Other investigations focused on the lack of significant oversight of Bear Stearns before its collapse and on insider trading and conflicts of interest among S.E.C. employees.

Most recently, Mr. Kotz criticized the commission for hiring a general counsel who had an interest in settlements related to the Madoff fraud, and for leasing $556 million of office space for the S.E.C. without competitive bids and before Congress had appropriated money to pay for it.

Senator Charles E. Grassley, an Iowa Republican who frequently tangled with the S.E.C. over its shortcomings, praised Mr. Kotz for staying on top of the agency’s failures, and urged the agency to hire another inspector general who would be a strong policeman of the agency.

“David Kotz produced strong, conclusive reports, even as critics claimed he was too aggressive,” Mr. Grassley said. “An aggressive, independent inspector general is best for the agency in the long run, even if that’s uncomfortable for management.”

Mr. Kotz, who at various times recommended substantial changes in the S.E.C.’s organizational structure, said he was “gratified to know that nearly every aspect of the S.E.C. has significantly improved in the four years since I was named inspector general.”

“The reports we have issued have not only been significant to the agency, Congress and the investing public,” he added, “but they have also directly resulted in a transformation of many of the divisions and offices of the commission.”

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Justice Dept. Won’t Investigate David M. Becker’s Madoff Ties

The Justice Department has decided not to pursue an investigation into the role played by a former top lawyer at the Securities and Exchange Commission in the calculation of payouts to victims of Bernard L. Madoff’s Ponzi scheme.

The potential investigation was referred to federal prosecutors this fall after a report by the inspector general of the S.E.C. That report raised questions about why David M. Becker, the agency’s general counsel from 2009 until early this year, was allowed to participate in commission discussions about the compensation of Madoff victims, despite Mr. Becker’s own financial interest in the result. Mr. Becker inherited money in a Madoff account from his mother several years before Mr. Madoff’s fraud became public.

The Justice Department contacted Mr. Becker’s lawyer last Thursday to say that the department was not opening an investigation into the matter, said William R. Baker III, a lawyer at Latham Watkins, who represents Mr. Becker.

“We’re gratified,” said Mr. Baker. “It’s consistent with our view that Mr. Becker discharged his obligations in a very responsible fashion.”

A spokeswoman for the Justice Department declined to comment. A representative for H. David Kotz, the S.E.C.’s inspector general, said in an e-mail that the commission had been informed by the Justice Department that it had reviewed the material but “decided not to pursue a criminal prosecution with respect to the Becker matter.”

Mr. Becker joined the commission as general counsel early in the Obama administration, returning to a role he previously held. He announced in February that he would return to private practice, and he now works as a partner at Cleary Gottlieb.

Shortly after Mr. Becker announced that he was leaving the commission, it became public that he had been named in a lawsuit filed by the trustee for the Madoff estate. That trustee is working to reallocate money among Madoff victims. Because Mr. Becker and his two brothers closed their mother’s account before the fraud was discovered, they received more money than they were entitled to, according to the trustee’s suit.

The trustee, Irving H. Picard, is seeking to recover about $1.5 million of the roughly $2 million the Beckers received from the account.

Mr. Becker was involved in discussions at the commission about the formulas that should be used to determine payouts to Madoff victims. When his financial stake became public this year, Mr. Becker said that he had disclosed his financial interests to the commission’s chief ethics officer and to the commission’s chairwoman, Mary L. Schapiro.

Still, the potential conflict was not disclosed to all the S.E.C. commissioners, according to the inspector general’s report.

The potential conflict became the subject of a Congressional hearing in the fall, and Ms. Schapiro said that she should have handled the matter differently. She agreed to a new vote on the Madoff payout formula.

A spokesman for the S.E.C. said the date for the vote had not been set.

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DealBook: New Scrutiny for S.E.C. and Trades at SAC Capital

Steven A. Cohen, the billionaire who runs SAC Capital Advisors.ReutersSteven A. Cohen, the billionaire founder of SAC Capital Advisors.

6:40 p.m. | Updated

Senator Charles E. Grassley, Republican of Iowa, has stepped up his inquiry into trading at the hedge fund SAC Capital Advisors.

In a letter sent Tuesday, Mr. Grassley asked the Securities and Exchange Commission to explain how it handled past referrals about SAC’s trading activity.

Mr. Grassley is examining 20 stock trades by SAC that were provided to him by the Financial Industry Regulatory Authority, Wall Street’s own regulatory body. Last month, Mr. Grassley asked the agency, known as Finra, for information about the “potential scope of suspicious trading activity” at the hedge fund, which is run by the billionaire investor Steven A. Cohen out of Greenwich, Conn.

The SAC transactions, which took place after Jan. 1, 2000, had been previously referred to the S.E.C. by Finra. They included stock sales and purchases made around the time of merger announcements or other market-moving events. Mr. Grassley did not provide details about which SAC trades were involved, at the request of the investigative agencies.

Mr. Cohen’s firm, which manages about $12 billion in assets, has become entangled in the government’s insider trading investigation at hedge funds. Two SAC portfolio managers pleaded guilty this year to making illegal trades based on confidential information. Neither SAC nor Mr. Cohen has been accused of wrongdoing. A spokesman for the firm has said that SAC was “outraged” by the conduct of the two portfolio managers, Noah Freeman and Donald Longueuil.

Mr. Grassley has been a leading critic of the S.E.C., saying it was not vigilant enough in protecting investors, including the agency’s failure to uncover frauds like the Ponzi scheme perpetrated by Bernard L. Madoff. In 2009, the senator pursued a similar inquiry to the one involving SAC when he examined Pequot Capital Management, a prominent hedge fund that has since shut down.

Mr. Grassley asked Mary L. Schapiro, the S.E.C. chairwoman, to respond to his recent request by June 7 by providing a written explanation as to how the S.E.C. had resolved Finra’s referrals, how the number of referrals compared with other hedge funds and whether a so-called Wells notice had ever been drafted with regard to any of the referrals. A Wells notice from the S.E.C. is an indication that the agency is considering an enforcement action.

“The function of Congressional investigations is not to establish whether any private firms have violated the law, but rather to examine particular facts and circumstances in order to assess how well the agencies created by Congress are executing the authorities granted to them,” Mr. Grassley wrote in his letter to Ms. Schapiro. “Looking into specific examples is essential for Congress to understand how effectively the S.E.C. pursues referrals such as these.”

This month, SAC executives met with staff members in Mr. Grassley’s office to discuss his inquiry.

“We welcomed the opportunity to meet with the staff to educate them about the firm and our compliance efforts, and had an entirely appropriate, professional and cordial meeting. We will continue to cooperate in any way we can,” SAC said in a statement.

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