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S.&P., Accused of Faulty Math, Fights Error Disclosure Rule

August 10, 2011 by Leave a Comment

In a letter to the Securities and Exchange Commission dated Monday, Deven Sharma, the president of S. P., said that while it believed the company should disclose “significant errors” that affect ratings, the S.E.C. should avoid rules that would define what types of errors were significant enough to require disclosure.

The letter was in response to proposed S.E.C. regulations that would tighten oversight of major ratings firms like S. P., Moody’s and Fitch Ratings. The proposals are part of the Dodd-Frank Act, the overhaul of securities law passed last year by Congress, which resulted from the 2008 financial crisis.

By coincidence, the period for comments on the proposed S.E.C. rule expired on Monday. Three days earlier, S. P. downgraded its long-term rating on United States Treasury bonds, to AA+ from AAA, but only after the Treasury Department challenged the assumptions that went into the S. P. decision.

The Treasury Department said its analysis revealed “a basic math error of significant consequence,” while S. P. argued that it was not an error but simply a change in assumption that did not affect its final decision to cut the rating.

Even before the downgrade, Congress was pressing regulators to finish rules governing credit ratings and the rating agencies. S. P.’s argument that it should decide how much information it discloses could prompt lawmakers to increase their scrutiny of the agencies.

Two Congressional committees, one each in the House and the Senate, are reviewing the actions of the ratings agencies since the 2008 financial crisis. Senator Tim Johnson, Democrat of South Dakota and chairman of the Senate banking committee, began gathering information about the S. P. downgrade decision this week, said Monday that he was “deeply disappointed” in what he called an “irresponsible move” by S. P., one that could increase interest rates on consumer loans and raise financing costs for state and local governments.

The oversight and investigations subcommittee of the House financial services committee also has been examining the performance of ratings agencies since the financial crisis. At a hearing late last month, Republican members raised questions about whether Treasury officials tried to intervene to discourage S. P. from putting United States debt securities under review for a downgrade. That investigation is continuing, Republican committee staff members said this week.

At the July 27 hearing, some committee members said they felt regulators were moving too slowly to put into effect parts of the Dodd-Frank Act that would lessen the reliance of investors on credit ratings. Specifically, regulators at the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the S.E.C., among others, are being asked by lawmakers to delete references to specific credit ratings in securities regulations

The proposed S.E.C. rules would require ratings agencies to submit regular self-assessments of their internal controls to regulators.

Among the issues on which the S.E.C. asked for comment was whether the ratings agencies should be required to notify the public of “significant errors” that they find in their methodologies, and whether the S.E.C. should define what exactly constitutes a “significant error.”

Mr. Sharma, the S. P. president, said in his response to the S.E.C. that the company agreed that ratings agencies should be required to disclose “significant errors” in their methodologies. But, he added, the S.E.C. should not impose an “arbitrary definition” of what constitutes a significant error, but rather leave it to the agency to decide what is significant and what is minor.

“Because credit ratings reflect the subjective opinions of a committee of ratings analysts and often incorporate both quantitative and qualitative factors, we believe it would be difficult, if not impossible, for the commission to establish a principled definition for what might have constituted a ‘significant error,’ ” Mr. Sharma wrote.

He added, “We have found that our error correction policy has proven to be effective and, where errors have occurred, our practice of reacting swiftly and transparently has benefited the market.”

The Treasury Department might beg to differ. After it discovered the flaw in the deficit projections used by S. P. to justify its downgrade, the Treasury argued against the downgrade.

Catherine J. Mathis, a Standard Poor’s spokeswoman, said on Tuesday that while the firm did change its assumptions regarding the pace of discretionary spending growth based on its discussions with Treasury on Friday, its rating change “was not affected by the change of assumptions.”

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Fair Game: Some Bankers Never Learn

July 30, 2011 by Leave a Comment

YOU’D think the mortgage bust would qualify as a teachable moment.

But some people refuse to learn from mistakes — a list that apparently includes certain mortgage bankers. Their industry is fighting a new rule that might prevent a repeat of the lending binge that helped drive our economy off a cliff.

In case you just arrived from another planet: America’s mortgage mania was fueled by home loans with poisonous features that made them virtually impossible to repay. It was fun while it lasted, at least for the financial types who profited by making dubious loans and selling them to investors.

But the Dodd-Frank financial overhaul last year barred lenders from making home loans before determining that people could probably repay them.

(It’s depressing that we have to legislate common sense, but, hey, that’s the world we live in.)

Dodd-Frank also required regulators to define the characteristics of loans that would most likely be repaid. The idea was to ensure that banks had skin in the game when they bundled risky mortgages into securities.

The proposal was this: If a mortgage security contains only high-quality loans, the banks can sell the entire offering. If the investments included riskier mortgages, the underwriters must keep 5 percent of the issue on their own books.

Basically, Wall Street would have to eat a bit of its own cooking.

Earlier this year, the Federal Reserve, the Federal Deposit Insurance Corporation, the comptroller of the currency, the Securities and Exchange Commission, the Federal Housing Administration, the Federal Housing Finance Agency and the Department of Housing and Urban Development all agreed on what makes a mortgage most likely to perform well. They examined how different types of loans defaulted, and the attributes of the borrowers in question. Then they invited the public to comment on their proposal; that comment period ends tomorrow.

One attribute of safer loans, the regulators found, was that homeowners had made a down payment of at least 20 percent. Another was that their housing debt did not exceed 28 percent of their monthly income, and that their total debts did not exceed 36 percent.

In other words, regulators said, a relatively low-risk mortgage should look an awful lot like the ones that local banks made before the days of securitization on steroids. Regulators also said that the origination costs on low-risk mortgages should no more than 3 percent of the amount borrowed.

THE mortgage industry squawked. It would prefer that we return to the days of high-fee, anything-goes lending. That is not surprising. But what is surprising is that mortgage bankers are leaning on the same tired argument — that saner lending requirements will undermine the goal of expanding homeownership.

In a comment letter filed with regulators last week, David Stevens, the president of the Mortgage Bankers Association, warned that the requirements on down payments and debt-to-income ratios were “unnecessary and not worth the societal costs of excluding far too many qualified borrowers from the most affordable mortgage loans to achieve homeownership.”

Mr. Stevens, who last March left his job as federal housing commissioner at the Department of Housing and Urban Development, didn’t mention the enormous costs associated with reckless lending. We are still tallying the bills, but to date, taxpayers have funneled $154 billion to Fannie Mae and Freddie Mac. Investors have suffered even greater damage.

While we are discussing societal costs, let’s not forget how minority borrowers and first-time homebuyers were the targets of predatory lenders who lured them into toxic loans loaded with fees.

A study issued last week on the widening wealth gap between minorities and white Americans points to the costs of predatory lending. Conducted by the Pew Research Center, a nonpartisan organization, the study noted that housing woes were the principal cause of precipitous declines in household net worth among both Hispanics and blacks from 2005 through 2009. The organization found that, adjusted for inflation, the median wealth of Hispanic households fell by two-thirds during that period. The wealth of black households declined 53 percent. The net worth of white households fell only 16 percent.

And yet, Mr. Stevens noted in his letter that the mortgage bankers were “working in harmony with a very wide coalition of consumer advocates, civil rights groups and other industry associations, to educate policy makers and legislators concerning this rule.”

One wonders how people who have lost their homes because of abusive lending practices feel about their “advocates” forming an alliance with mortgage lenders on this issue.

Mr. Stevens also argues that restricting mortgage fees to 3 percent, as proposed, would hurt borrowers by reducing their access to credit. Noting that his association opposes excessive fees, he wrote that his group “knows of no data evidencing that points and fees have affected borrowers’ ability to repay their loans.”

He told a different story when he was at HUD overseeing the portfolio of loans insured by the F.H.A.

Testifying before Congress in May 2010, Mr. Stevens cited five years of F.H.A. data showing that loans in which the seller of the property helped defray a borrower’s origination costs by more than 3 percent, known as a sellers’ concession, experienced significantly greater default rates.

In 2008, for example, F.H.A.’s insurance claims on loans where sellers covered 3 percent to 6 percent of buyers’ costs were 50 percent higher than claims on loans where concessions from sellers fell below 3 percent.

The higher concessions created “incentives to inflate appraised value,” Mr. Stevens testified. In other words, high costs do have consequences.

Mr. Stevens, through a spokesman, declined to comment.

As the advocate of the mortgage banking industry, Mr. Stevens is entitled to express the industry’s views. But it would be troubling if such arguments gained traction with regulators. In the years leading up to the crisis, the Mortgage Bankers Association and other financial trade groups persuaded regulators to postpone or water down rules that could have reined in subprime lending relatively early. We all know the consequences — and surely do not need to repeat past mistakes.

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DealBook: Regions Settles S.E.C. Case Over Former Morgan Keegan Funds

June 23, 2011 by Leave a Comment

Robert Khuzami, director of the S.E.C.’s enforcement division, in February.Lucas Jackson/Reuters Robert Khuzami, director of the S.E.C.’s enforcement division, in February.

As regulators announced a settlement Wednesday with Morgan Keegan of charges that it defrauded customers during the financial crisis, its parent put the brokerage firm on the block.

Morgan Keegan, a unit of Regions Financial, the big Alabama-based bank, agreed to pay $200 million to resolve a case brought by the Securities and Exchange Commission. It accused the brokerage firm and two former executives of mispricing risky mortgage-backed bonds in supposedly conservative mutual funds.

One of those executives, the funds’ portfolio manager, James C. Kelsoe Jr., agreed to a lifetime ban from the securities industry.

“The falsification of fund values misrepresented critical information exactly when investors needed it most — when the subprime mortgage meltdown was impacting the funds,” Robert Khuzami, the director of enforcement at the S.E.C., said in a statement. ”Such misconduct does grievous harm to investors.”

Also Wednesday, Regions announced that it was putting Morgan Keegan up for sale in an effort to raise money to repay the $3.5 billion government loan it received during the financial crisis.

“The resolution of this legacy regulatory matter gives Regions great flexibility with respect to the Morgan Keegan franchise,” said Grayson Hall, the chief executive of Regions, which sold the bond funds connected to this case in 2008 to another asset management company.

Regions, which has owned Morgan Keegan since 2001, has retained Goldman Sachs to handle the sale of the brokerage firm. The firm, which is based in Memphis, could fetch as much as $1.5 billion, according to a person briefed on the business.

The action against Morgan Keegan is just one of a spate of enforcement actions taken against firms related to their mispricing of mortgage securities in their mutual funds during the financial crisis. The S.E.C. has brought similar cases against the Charles Schwab Corporation, Evergreen Investments and the State Street Corporation.

Federal authorities have recently stepped up actions against large banks related to their crisis-era conduct. On Tuesday, JPMorgan Chase agreed to pay about $150 million to settle civil accusations that it misled investors in a complex mortgage securities transaction in 2007.

Last month, federal prosecutors in Manhattan filed a civil action against Deutsche Bank, accusing it of lying about the quality of home loans it handled for the Federal Housing Administration. The bank is fighting the case.

Still, authorities continue to field questions about why they are not bringing criminal charges against bank executives and others who may have engaged in illegal practices during the mortgage boom.

During a conference call with regulators on Wednesday, a reporter asked why the government did not bring criminal charges in the Morgan Keegan case. The government officials declined to comment.

Investors in the five Morgan Keegan bond funds are said to have lost about $1.5 billion. These funds, which were marketed as relatively safe investment vehicles, lost more than half their value when the market for mortgage securities first seized up in 2007.

Two former Morgan Keegan executives — Mr. Kelsoe and Joseph Thompson Weller, a controller — were accused in the case.

Mr. Kelsoe, who started managing the Morgan Keegan funds in 1999, was a vocal booster of mortgage securities during the housing boom and became one of Wall Street’s top-ranked mutual fund managers. Investors reaching for extra yield during last decade’s persistently low-interest-rate environment flocked to Mr. Kelsoe’s funds.

But regulators said that Mr. Kelsoe ignored the funds’ charter by investing predominantly in the risky structured products that became popular during the credit bubble, including pools of subprime mortgage-backed securities.

The S.E.C. action also accused him of instructing Morgan Keegan’s accounting department to make fake “price adjustments” to inflate the value of the funds’ mortgage-backed securities holdings as the housing market began to sour.

Mr. Kelsoe became an early, prominent casualty of the crisis in subprime mortgage bonds.

“What was an ocean of liquidity has quickly become a desert,” wrote Mr. Kelsoe in a report to his investors in October 2007 as the fund was plummeting. He once compared his “intoxication” with low-grade mortgage securities to that of fund managers seduced by dot-com stocks.

Mr. Kelsoe, 49 and a resident of Memphis, agreed to pay a $500,000 penalty and accept a permanent ban from the securities industry. Mr. Weller agreed to pay a $50,000 fine.

Regulators from the Financial Industry Regulatory Authority, or Finra, as well as regulators from five Southern states were involved in the Morgan Keegan investigation and settlement.

Federal and state authorities continue to pursue separate claims against Morgan Keegan related to its sale of auction-rate securities, another risky investment product that soured during the financial crisis.

Although buffeted by the government’s accusations, Morgan Keegan has performed well. Potential buyers could include a bank or brokerage firm looking to bolster its presence in the Southeast, or a private equity firm. A number of buyout shops have previously made successful investment in brokerage firms and asset managers, including Hellman Friedman, TA Associates and Lightyear Capital.

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DealBook: S.E.C. Approves New Reporting Requirements for Hedge Funds

June 22, 2011 by Leave a Comment

A divided Securities and Exchange Commission approved new rules on Wednesday that would impose sweeping disclosure requirements on large hedge funds and other private investment advisers, a first for an industry that has long eluded Washington oversight.

The rules will require hedge funds, private equity shops and other advisers that manage more than $150 million to register with the agency and turn over crucial information, including the funds they oversee and their investors. Venture capital funds and some small hedge funds are excused from the rules, although these firms will still have to report some basic information to regulators.

“Today’s rules will fill a key gap in the regulatory landscape,” Mary L. Schapiro, the agency’s chairwoman, said at a public meeting in Washington.

The new oversight came as no surprise to the industry. The long-awaited rules were outlined in the Dodd-Frank act, the financial regulatory law enacted last year, and largely spelled out in November when the S.E.C. first proposed the rules.

“The rules at the end of the day are not enormously onerous,” said Laura Corsell, a former S.E.C. lawyer who now represents investment advisers as a partner at the law firm Montgomery McCracken.

Still, regulators agreed to delay the start date of the rules until March 30, 2012, a reprieve of nearly nine months.

The S.E.C. also approved a definition for the venture capital industry, offering those entities relief from some reporting requirements. A venture capital fund, according to the new description, is one that invests in “qualifying investments,” mainly shares in private companies. But it may invest up to 20 percent of its capital in “nonqualifying investments” and have some short-term holdings.

The rules do provide regulators a rare peek into venture capital funds. Exempt funds will have to file periodic reports that provide basic information, like the name of its owner, potential conflicts of interest and disciplinary problems.

Larger firms that manage more than $150 million will disclose the size of their funds and the type of clients who invest in them. The funds will also name their “gatekeepers” — the auditors, prime brokers and marketers that service the funds.

The requirements are a sharp change for most hedge funds and private equity firms. Until now, federal regulators kept tabs only on firms with 15 or more funds.

The S.E.C. unanimously agreed on the definition of venture capital funds, but the agency was split 3 to 2 on broader reporting requirements for money managers.

Kathleen L. Casey, a Republican commissioner, said the rule “pays lip service” to the exemption.

While the new rules will not begin until next March, many hedge funds say they are ready to register in July when the rules were originally supposed to take effect.

“Given that this deferral just happened today, most firms were prepared several weeks ago to press the button to file,” said Steve Nadel, a partner at the law firm Seward Kissell, which represents hedge funds.

Azam Ahmed contributed reporting.

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Chief Executive Leaves Beazer Homes

June 13, 2011 by Leave a Comment

NEW YORK (AP) — Beazer Homes has fired its CEO about three months after he agreed to give back $6.5 million in bonuses and profits from the sale of company stock in a deal with federal regulators.

Ian McCarthy had accrued those gains at a time when investigators said the company was committing accounting fraud. He acknowledged no wrongdoing.

Chief Financial Officer Allan Merrill will take over, the company said Monday. Beazer spokeswoman Carey Phelps said the company’s board of directors terminated McCarthy.

“This is a direction they wanted to go in,” Phelps said. “It was time for a change.”

McCarthy did not have a listed phone number in the Atlanta area, where Beazer is based.

The surprise announcement sent shares sliding 5 percent, or 15 cents, to $3 per share Monday.

“Our understanding is that this was not a long-planned transition and that the board had met a handful of times without management’s knowledge in order to decide what changes would be in the best interest of (shareholders),” said Josh Levin, an analyst with Citi Investment Research.

Still, most industry watchers believe McCarthy’s departure is a positive.

The change should help Beazer focus on long-term growth, said UBS Investment Research analyst David Goldberg. His replacement Merrill has served as chief financial officer for the last four years, and should help the company solidify changes it has made after restating several years’ worth of earnings.

“We continue to believe the company’s underperformance relative to peers will reverse over time …” Goldberg said wrote.

In 2008, Beazer restated its financial earnings reports covering the fiscal years between 2002 and 2007, according to filings with the Securities and Exchange Commission.

In March, the SEC announced a settlement with Beazer in March, seeking to “claw back” cash and stock incentive payments that McCarthy earned during a period when the company’s financial reports were in error.

Regulators said Beazer had inflated profits in the 2006 fiscal year by falsely recording home-financing transactions and manipulating other results. McCarthy wasn’t personally charged, but anti-fraud laws require senior executives to repay bonuses, incentive pay and stock profits during the period of the accounting violation.

The Atlanta homebuilder said that Robert Salomon also has been tapped as executive vice president and CFO. Salomon joined Beazer in 2008 as the company’s chief accounting officer.

Phelps said McCarthy will receive a severance package, the terms of which will soon be filed with federal regulators. She said McCarthy is eligible for the severance package laid out in his employment agreement because he was not fired “for cause,” but was replaced because the board wanted a leadership change.

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DealBook: Muddy Waters Research Is a Thorn to Some Chinese Companies

June 10, 2011 by Leave a Comment

SHANGHAI — Carson C. Block makes even Wall Street cringe.

Last week, the founder of the investment firm Muddy Waters Research issued a scathing report on a Chinese forestry company, calling it a “pump and dump” scheme that has been “aggressively committing fraud.”

The remarks set off a sharp sell-off in shares of the company, Sino-Forest, prompting Canadian authorities to temporarily halt trading. Since the report, the stock has fallen more than 70 percent, erasing billions of dollars in value from a company whose investors include Paulson Company, the hedge fund run by the billionaire John A. Paulson.

“They overstated assets by billions of dollars and funneled money to an undisclosed subsidiary,” said Mr. Block, whose firm is based in Hong Kong and the United States.

Carson C. Block of Muddy Waters Research

Sino-Forest vehemently denies his assertions and released evidence to support its position. Canadian regulators, following the Muddy Waters report and the stock volatility, opened an investigation into the matter.

Mr. Block is delivering a controversial message to investors enamored with Chinese companies: buyer beware.

He has set his sights on a specific group of stocks that access the public markets through a back-door method known as a reverse merger. In such deals, private companies acquire a public shell company in the United States or Canada. They can quickly raise capital while avoiding the scrutiny and the cost of the traditional listing process. Today, there are more than 500 such Chinese companies in the United States, collectively worth billions of dollars.

On Thursday, the Securities and Exchange Commission warned about the potential risks of investing in reverse-merger companies, including murky financials and complicated ownership structures. The S.E.C. says it has suspended trading on more than a dozen stocks in this category, which lacked “current, accurate information about these firms and their finances.”

“This is an area of heightened scrutiny for us,” said Kara N. Brockmeyer, an assistant director in the agency’s division of enforcement.

Troubled Audit Opinions

Requiring more detail from auditors could help investors evaluate Sino-Forest Corporation, a company cleared by Ernst Young but called a fraud by Muddy Waters Research, Floyd Norris writes.

Research firms like Mr. Block’s Muddy Waters, Citron Research and GeoInvesting are taking direct aim at reverse mergers they say have dubious practices. The organizations are issuing research reports, posting surveillance videos and collecting corporate documents. The firms say it is regulation in an area with little oversight.

“We had counted on the fee collectors — the investment banks, the accountants and the lawyers — to tell us what was right,” says Dan David, vice president at GeoInvesting, a micro-cap research and investment house. “Now, we’re doing our own due diligence, and hiring people in China to investigate.”

But critics contend this emerging force has a financial motive to exaggerate and even fabricate information. Players like Mr. Block often place bets against the companies. The so-called short-sellers profit when the shares decline. Some fear their bearish research amounts to market manipulation.

“There are fly-by-night analysts that are rumor-mongering because they are admittedly short the stock,” says Perrie M. Weiner, international co-chairman of the securities litigation practice at DLA Piper, who represents reverse-merger companies in regulatory disputes. “If you’re short the stock and you’re spreading negative rumors about the company, you better be right.”

Mr. Weiner said cases involving reverse mergers now composed a third of his entire workload, up from a small fraction just two years ago.

Sino-Forest has said it is considering legal action against Muddy Waters, calling its report “inaccurate, spurious and defamatory.” The company has also been posting documents on its Web site to refute Mr. Block’s accusations, including bank statements and land purchase agreements.

Mr. Block, 35, is the unofficial spokesman of this contentious movement.

The son of a Wall Street broker, he grew up in New Jersey, studied finance and Chinese at the University of Southern California, and earned a law degree from Chicago-Kent College of Law. In the 2005, he joined the Shanghai offices of the law firm Jones Day. Tired of being a corporate lawyer, Mr. Block started his own self-storage company, Love Box, and co-wrote a book, “Doing Business in China for Dummies.”

Then early last year, his father, William, the founder of W.A.B. Capital, asked him to research a potential investment, Orient Paper. As part of the due diligence, Mr. Block and a friend traveled to China to visit the company’s headquarters. He said it was a Potemkin Village, littered with “junk machinery” and “trash.”

“They appeared to be transparent, but they had fake transparency,” Mr. Block said. “The funniest thing was they had a large heap of scrap cardboard. They listed this on the books as raw material worth millions of dollars.”

Shortly after the trip, Mr. Block wrote a sensationalistic report describing what he saw as fraud at Orient Paper and encouraged traders to sell shares of the company. He shorted the American-listed stock, which plummeted to around $4 from $15 in late 2010.

Orient Paper called the report “reckless” last November. It also suggested that Mr. Block and his father had tried to extort money from the company before publishing the report. Mr. Block denies the allegation.

The experience led to a new career. Since then, Mr. Block has issued damaging reports on four other companies. He approaches each case like an investigation, sifting through corporate registration documents and even hiring private investigators to pose as potential business partners.

“It’s amazing what edge you can get when you just read,” he said referring to company financial statements.

In the Sino-Forest case, he and his team of lawyers and private investigators spent two months poring over 10,000 pages of documents. His 39-page report concluded that Sino-Forest lied about assets and timber holdings. He posted photographs, charts and diagrams on the firm’s site in support of his claims.

“As Bernard Madoff reminds us,” Mr. Block wrote in the introduction to the Sino-Forest research, “when an established institution commits fraud, the fraud can become stratospheric in size.”

After the series of negative calls decimated the stocks of the Chinese companies, Mr. Block says he has received death threats and harassing phone calls and e-mails.

But he said he would continue to publish his research. He says he believes investors and auditors need to understand how businesses operate in China.

He explains by way of the firm’s name, Muddy Waters. It’s derived from a Chinese phrase that says the easiest way to catch fish is by muddying the water, forcing it to the surface.

“You kick up the silt, and they rush to the top of the water,” he said of the Chinese proverb.

“This explains a lot about how things work in China,” Mr. Block added. “Business deals are rife with value subtraction layers. The more opaque they make it, the easier it is for them to siphon off money.”

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S.E.C. Case Stands Out Because It Stands Alone

June 1, 2011 by Leave a Comment

Hundreds of employees worked closely in teams, devising mortgage-based securities — billions of dollars’ worth — that were examined by lawyers, approved by management, then sold to investors like hedge funds, commercial banks and insurance companies.

At one trading desk sat Fabrice Tourre, a midlevel 28-year-old Frenchman who was little known not just outside Goldman but even inside the firm. That changed three years later, in 2010, when he achieved the dubious distinction of becoming the only individual at Goldman and across Wall Street sued by the Securities and Exchange Commission for helping to sell a mortgage-securities investment, in one of the hundreds of mortgage deals created during the bubble years.

How Mr. Tourre alone came to be the face of mortgage-securities fraud has raised questions among former prosecutors and Congressional officials about how aggressive and thorough the government’s investigations have been into Wall Street’s role in the mortgage crisis.

Across the industry, “it’s impossible that only one person was involved with fraudulent activities in connection to the sales of these mortgage securities,” said G. Oliver Koppell, a New York attorney general in the 1990s and now a New York City councilman.

In the fall of 2009, when Mr. Tourre learned that he had become a target of investigators for helping to sell a mortgage security called Abacus, he protested that he had not acted alone.

That fall, his lawyers drafted private responses to the S.E.C., maintaining that Mr. Tourre was part of a “collaborative effort” at Goldman, according to documents obtained by The New York Times. The lawyer added that the commission’s view of his role “would have Mr. Tourre engaged in a grand deception of practically everyone” involved in the mortgage deal.

Indeed, numerous other colleagues also worked on that mortgage security. And that deal was just one of nearly two dozen similar deals totaling $10.9 billion that Goldman devised from 2004 to 2007 — which in turn were similar to more than $100 billion of such securities deals created by other Wall Street firms during that period.

While Goldman paid $550 million last year to settle accusations that it had misled investors who bought the Abacus mortgage security, no other individuals at the bank have been named. Now, however, as criticism has grown about the lack of cases brought by regulators, the scope of the inquiries appears to be widening. The United States attorney general, Eric H. Holder Jr., has said publicly that his lawyers were reviewing possible charges against other Goldman officials in the wake of a Senate investigation that produced reams of documents detailing other questionable decisions that were made in the firm’s mortgage unit.

The Senate inquiry was one of several in the past three years. These investigations by Congressional leaders and bankruptcy trustees — into the likes of Washington Mutual, Lehman Brothers and the ratings agencies — were undertaken largely to understand what had gone wrong in the crisis, rather than for law enforcement. Yet they uncovered evidence that could be a road map for federal officials as they decide whether to bring civil and criminal cases.

One person who already has come under investigation is Jonathan M. Egol. A senior trader at Goldman who worked closely with Mr. Tourre, he had a negative view on the housing market early on, and took a lead role in creating mortgage securities like Abacus that enabled Goldman and certain clients to place bets that proved profitable when the housing market collapsed.

Last year the S.E.C. examined Mr. Egol’s role in the Abacus deal in its lawsuit, according to a report by the commission’s inspector general. But Mr. Egol, now a managing director at the bank, was not named in the case, in part because he was more discreet in his e-mails than Mr. Tourre was, so there was less evidence against him, according to a person with knowledge of the S.E.C.’s case.

Though Mr. Tourre was a more junior member of the Goldman team, the S.E.C. case against him was bolstered by colorful e-mails he wrote, calling mortgage securities like those he created monstrosities and joking that he sold them to “widows and orphans.”

The S.E.C. declined to comment about its focus on Goldman and Mr. Tourre, beyond pointing to a section in its complaint that said that Mr. Tourre had been “principally responsible” for the Abacus deal in the case.

A spokesman for Goldman, Lucas van Praag, did not dispute that Mr. Tourre had worked on the Abacus deal as part of a collaborative team. But he said that the bank had disagreed with many of the conclusions about its mortgage unit contained in the recent Senate report. Mr. Egol and his lawyer did not respond to inquiries for comment.

As the government continues to investigate the activities of Goldman and other banks, it is uncertain whether other individuals will be named. Neil M. Barofsky, who as the first inspector general of the Troubled Asset Relief Program, the federal bank bailout program, investigated whether banks had properly obtained and handled the money they received, said prosecutors should look as high up as possible.

“Obviously in any investigation that results in charges against a company,” he said, “you’d like to see the highest-ranking person responsible for the conduct at the company to be held accountable.”

A Booming Market

A math whiz who got his undergraduate degree at the École Centrale in Paris, Fabrice Tourre joined Goldman in 2001 after getting a master’s degree at Stanford. As the housing market and the demand for mortgages boomed over the next few years, Goldman went from creating just $3 billion of mortgage securities called collateralized debt obligations in 2002 to at least $22 billion in 2006, according to Dealogic, a financial data firm.

Tom Torok contributed reporting.

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DealBook: Former Nasdaq Executive Pleads Guilty to Insider Trading

May 27, 2011 by Leave a Comment

Shannon Stapleton/Reuters

Donald L. Johnson had a privileged role at the Nasdaq Stock Market.

When companies that trade on Nasdaq wanted to understand how impending news would affect their share prices, they would consult with Mr. Johnson, who was a senior executive on the exchange’s so-called market intelligence desk.

Over a three-year period, Mr. Johnson took that secret corporate information and, directly from his work computer, traded in an online brokerage account in his wife’s name, reaping illegal profits of about $750,000.

On Thursday, Mr. Johnson pleaded guilty to the brazen insider-trading scheme in Federal District Court in Alexandria, Va. He was also sued by the Securities and Exchange Commission. The 56-year-old Mr. Johnson, who lives in Ashburn, Va., faces up to 20 years in prison.

“He was a gatekeeper,“ Lanny A. Breuer, assistant attorney general of the Justice Department’s criminal division, said at a news conference. “This was a particularly shocking abuse of trust.“

Nasdaq’s failure to protect its corporate clients’ secret information is an embarrassment for the exchange, which competes fiercely with the New York Stock Exchange and foreign exchanges for public company listings.

“We’re cooperating with authorities,“ said a Nasdaq spokesman, who declined to comment further on the case.

The Nasdaq has an insider trading policy that prohibits employees from trading on confidential information about its listed companies, and requires that they disclose all brokerage accounts and holdings that they control. The government says that Mr. Johnson did not disclose his wife’s brokerage account to Nasdaq.

Jonathan Simms, a lawyer for Mr. Johnson, did not immediately return a phone call seeking comment.

Mr. Johnson’s case is the latest in the government’s far-reaching investigation into insider trading, which has not only rattled Wall Street but reached beyond its canyons to ensnare doctors, management consultants and railroad workers. Last month, the Justice Department brought criminal charges against a longtime Food and Drug Administration chemist and his son for using sensitive information about drug approvals to earn millions of dollars in profits. Another case was brought against a corporate lawyer, who was accused of feeding confidential data about merger deals to traders over a 17-year period.

Earlier this month, the United States attorney in Manhattan won the highest-level conviction to date in their recent efforts when a jury found Raj Rajaratnam, a billionaire hedge fund manager, guilty of earning more than $50 million in illegal trading profits.

“The Department of Justice is watching you and we will find you and prosecute you to the fullest extent of the law,” said Neil H. MacBride, the United States attorney for the Eastern District of Virginia.

Such tough talk from federal prosecutors has been backed up with aggressive tactics being used to prosecute white-collar crime, including wiretapping traders’ phones.

Here, federal prosecutors worked with the S.E.C. and the Financial Industry Regulatory Authority, Wall Street’s own regulatory authority, to catch Mr. Johnson. The agencies pursued the case after observing suspicious trading activity in Mr. Johnson’s wife’s account surrounding market-moving news about several publicly traded companies.

Mr. Johnson traded on confidential information in nine separate cases from 2006 to 2009, according to the S.E.C.

In one instance, on Oct. 30, 2007, Mr. Johnson had a phone conversation with the chief financial officer and general counsel of United Therapeutics about the successful completion of a drug trial. The next day, Mr. Johnson bought 10,000 shares of United Therapeutics stock in his wife’s brokerage account. After the company issued a statement on Nov. 1 announcing the news, Mr. Johnson began selling the stock from his office computer, booking $175,000 in profits.

In another example, Mr. Johnson met with a senior executive at Digene, who told him about the pending resignation of the company’s president and the senior executive’s promotion to chief financial officer. Suspecting that the news would hurt the company’s stock price, Mr. Johnson sold short about 10,000 shares of Digene stock in his wife’s account, meaning that he bet the price of the stock would drop. After the public announcement, which drove down Digene’s shares, Mr. Johnson covered his short position and booked a $34,000 gain.

The government says that other companies Mr. Johnson illegally traded include the Central Garden and the Pet Company and Idexx Laboratories.

Federal authorities said that Mr. Johnson made the illegal trades only episodically over the three-year period in the hopes that authorities would not detect a questionable pattern of trading in his wife’s account. The S.E.C. named his wife, Dalila Lopez, a “relief defendant,“ meaning that the agency has not sued her, but will seek to recover the illicit profits in her possession.

Mr. Breuer, the assistant attorney general, and Robert Khuzami, director of the S.E.C.’s enforcement division, used identical metaphors in their statements to describe Mr. Johnson’s activity.

“This case is the insider-trading version of the fox guarding the henhouse,“ Mr. Khuzami said.


U.S. v. Donald Johnson


S.E.C. v. Donald L. Johnson

“Mr. Johnson was a fox in a henhouse,“ Mr. Breuer said.

Article source: http://feeds.nytimes.com/click.phdo?i=34a57f7a337af460a4ee5c62a9cdeec9

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DealBook: S.E.C. Adopts Its Revised Rules for Whistle-Blowers

May 26, 2011 by Leave a Comment

Kathleen L. Casey, above, and Troy A. Paredes, the S.E.C.’s two Republican commissioners, voted against the rules.Joshua Roberts/Bloomberg NewsKathleen L. Casey and Troy A. Paredes, the S.E.C.’s two Republican commissioners, voted against the whistle-blower rules.
Astrid Riecken/Bloomberg News

7:52 p.m. | Updated

WASHINGTON — A divided Securities and Exchange Commission narrowly approved rules on Wednesday to create a $300 million whistle-blower program.

Supporters of the program said it would help the agency crack down on wrongdoing, but opponents contend it would actually hamper the ability of companies to police themselves.

The final rules, which were approved by a 3-to-2 vote, included several changes from rules first proposed by the S.E.C. last year after passage of the Dodd-Frank regulatory law that provided for the program. One of the changes included a potential bonus if corporate employees first report suspected wrongdoing through their company’s internal compliance system.

Business groups worried that bypassing internal reporting procedures would undercut the multimillion-dollar investments they have made to strengthen their compliance departments in response to tougher post-Enron corporate rules and laws, including the Sarbanes-Oxley Act.

But the new rules still drew complaints as opponents contended that the program would still require a whistle-blower to report wrongdoing to the S.E.C. as well as to a company’s internal systems in order to guarantee eligibility for a reward.

Mary L. Schapiro, the S.E.C. chairwoman, said the rules were important to the agency because it has limited resources and therefore needs “to be able to leverage the resources of people who may have first-hand information about potential violations.”

The whistle-blower provisions were written partly in response to the agency’s failure to uncover Bernard L. Madoff’s Ponzi scheme and other similar frauds.

Previously, the S.E.C. had authority to reward tipsters only in insider trading cases and was limited to paying 10 percent of the penalties collected.

The new rules provide for payment of 10 percent to 30 percent of the collected amount when the sanctions imposed by regulators exceed $1 million. In determining the size of the reward, the agency can take into account the value of the tips offered and a whistle-blower’s cooperation with the company’s internal notice program.

The changes from the original proposals, which attracted 240 comments and more than 1,300 form letters, were not enough for the S.E.C.’s two Republican commissioners, Kathleen L. Casey and Troy A. Paredes, who both voted against the rules.

“The final rule permits a whistle-blower to knowingly bypass a company’s good-faith attempts to identify and investigate alleged violations,” Mr. Paredes said, and does not require the S.E.C. to reward an employee for first going to his employer with a tip. Rather, the rule says the agency “may increase” the reward based on that cooperation.

Ms. Casey noted that companies could usually investigate wrongdoing far more quickly than the S.E.C., and that by giving tipsters an incentive to go to the commission, frauds could be allowed to grow worse because of the slower response.

The new program also “significantly overestimates our capacity to effectively triage and manage whistle-blower complaints,” Ms. Casey said. Predicting that the number of complaints flowing into the S.E.C. will grow “as we begin writing some very large checks,” Ms. Casey said “too little has been done here to anticipate” that result.

Robert Khuzami, the S.E.C.’s director of enforcement, said the S.E.C. had seen “an uptick” in the number of complaints since the Dodd-Frank Act went into effect last July, but there had not been a flood. The quality of the tips has improved as well, he said, and they are often accompanied with detailed corroboration.

Sean McKessy, the chief of the S.E.C.’s new whistle-blower office, said the agency’s ability to separate out credible tips also will be enhanced by requirements that potential whistle-blowers identify themselves as seeking a possible reward, and providing a sworn statement, under penalty of perjury, that the information is true.

The United States Chamber of Commerce, which lobbied against the proposed rules, expressed continued dismay. “We have already seen trial lawyers running advertisements and training seminars on how to profit from bounty programs adopted under these rules,” the chamber said in a statement. The new rule will lead lawyers to urge whistle-blowers to keep their company in the dark, it said.

That statement, however, appears not to take into account provisions that allow the S.E.C. to increase a bounty if a whistle-blower notified a company’s compliance program first.

Erika A. Kelton, a lawyer with Phillips Cohen in Washington, said that in more than two decades representing whistle-blowers, her firm has found that “in almost all cases, employees have reported their concerns about misconduct and fraud to managers and supervisors first.”

“It has only been after they have been retaliated against for doing so that they have come to us,” Ms. Kelton added.

The rules also exclude certain people from being eligible for the awards, including people involved in the wrongdoing, lawyers who gain privileged information from clients, foreign government officials and compliance and internal audit employees.

There are exceptions, however. Compliance and internal audit workers or public accountants, who see that a company has not acted on tips of wrongdoing, could be eligible, as could an informant who believes that a company is trying to obstruct an investigation.

Article source: http://feeds.nytimes.com/click.phdo?i=23f2fe3a5cdf10a10db3f8a257d05020

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New York Investigates Banks’ Role in Fiscal Crisis

May 17, 2011 by Leave a Comment

Officials in Eric T. Schneiderman’s, office have also requested meetings with representatives from Bank of America, Goldman Sachs and Morgan Stanley, according to people briefed on the matter who were not authorized to speak publicly. The inquiry appears to be quite broad, with the attorney general’s requests for information covering many aspects of the banks’ loan pooling operations. They bundled thousands of home loans into securities that were then sold to investors such as pension funds, mutual funds and insurance companies.

It is unclear which parts of the byzantine securitization process Mr. Schneiderman is focusing on. His spokesman said the attorney general would not comment on the investigation, which is in its early stages.

Several civil suits have been filed by federal and state regulators since the financial crisis erupted in 2008, some of which have generated settlements and fines, most prominently a $550 million deal between Goldman Sachs and the Securities and Exchange Commission.

But even more questions have been raised in private lawsuits filed against the banks by investors and others who say they were victimized by questionable securitization practices. Some litigants have contended, for example, that the banks dumped loans they knew to be troubled into securities and then misled investors about the quality of those underlying mortgages when selling the investments.

The possibility has also been raised that the banks did not disclose to mortgage insurers the risks in the instruments they were agreeing to insure against default. Another potential area of inquiry — the billions of dollars in credit extended by Wall Street to aggressive mortgage lenders that allowed them to continue making questionable loans far longer than they otherwise could have done.

“Part of what prosecutors have the advantage of doing right now, here as elsewhere, is watching the civil suits play out as different parties fight over who bears the loss,” said Daniel C. Richman, a professor of law at Columbia. “That’s a very productive source of information.”

Officials at Bank of America and Goldman Sachs declined to comment about the investigation; Morgan Stanley did not respond to a request for comment.

During the mortgage boom, Wall Street firms bundled hundreds of billions of dollars in home loans into securities that they sold profitably to investors. After the real estate bubble burst, the perception took hold that the securitization process as performed by the major investment banks contributed to the losses generated in the crisis.

Critics contend that Wall Street’s securitization machine masked the existence of risky home loans and encouraged reckless lending because pooling the loans and selling them off allowed many participants to avoid responsibility for the losses that followed.

The requests for information by Mr. Schneiderman’s office also seem to confirm that the New York attorney general is operating independently of peers from other states who are negotiating a broad settlement with large banks over foreclosure practices.

By opening a new inquiry into bank practices, Mr. Schneiderman has indicated his unwillingness to accept one of the settlement’s terms proposed by financial institutions — that is, a broad agreement by regulators not to conduct additional investigations into the banks’ activities during the mortgage crisis. Mr. Schneiderman has said in recent weeks that signing such a release was unacceptable.

It is unclear whether Mr. Schneiderman’s investigation will be pursued as a criminal or civil matter. In the last few months, the office’s staff has been expanding. In March, Marc B. Minor, former head of the securities division for the New Jersey attorney general, was named bureau chief of the investor protection unit in the New York attorney general’s office.

Early in the financial crisis, Andrew M. Cuomo, the governor of New York who preceded Mr. Schneiderman as attorney general, began investigating Wall Street’s role in the debacle. But those inquiries did not result in any cases filed against the major banks. Nevertheless, some material turned over to Mr. Cuomo’s investigators may turn out to be helpful to Mr. Schneiderman’s inquiry.

Article source: http://feeds.nytimes.com/click.phdo?i=99e58ca07168bd1e714066626b7f21c8

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