FINANCIAL CRIME

Fraud Busters Get To Work

With public anger rising over mortgage swindles, Ponzi schemes, and securities scams, the feds are picking up the investigation pace.

by Peter H. Stone

Saturday, July 18, 2009


When a new sheriff rides into Washington, the scenario often unfolds like this: Members of the posse settle into their offices, figure out what's going on at their agencies, and then check out the political lay of the land on Capitol Hill before starting high-profile crime-busting.

But something different has happened in the first few months of the Obama administration. With public ire rising over continuing revelations of mortgage fraud, Ponzi schemes, and securities scams, the Justice Department and the Securities and Exchange Commission have acted quickly on white-collar crime, picking up the pace of probes, turning up the investigative machinery, and grabbing headlines by fingering big-name defendants.

Last month, the SEC and Justice pulled the trigger on two major cases. On June 4, the SEC's new chief of enforcement, Robert Khuzami, announced civil charges against Angelo Mozilo, the former CEO of Countrywide Financial. The government charged Mozilo, who built the company into the nation's leader in subprime mortgages, with securities fraud and insider trading. He and two former associates charged with defrauding investors have pleaded not guilty.

On June 19, Lanny Breuer, the new assistant attorney general in Justice's Criminal Division, joined Khuzami and other law enforcement officials at a briefing on the 21-count indictment against Robert Allen Stanford, the Texas financier who the government alleges masterminded a $7 billion Ponzi scheme that bilked 30,000 investors. The indictment named five others, including a former regulator from Antigua, where Stanford International Bank was based. Stanford and the others have pleaded not guilty.

The back-to-back announcements underscored the administration's aggressive, quick-off-the-mark approach to probing and prosecuting a range of mortgage-related frauds and other financial crimes that have led to home foreclosures and decimated the investment portfolios of untold numbers of Americans.

In an interview, Breuer told National Journal that Justice officials feel a special obligation to pursue these cases. "We're facing a challenging financial climate," he said. "Taxpayers have a legitimate right to know that those who contributed to the crisis [will] be held accountable." At a "time of economic duress and challenge, fraud schemes begin to unravel," Breuer said. "I think we'll find more."

Arthur Levitt, a former SEC chairman who is now a senior adviser to the Carlyle Group, a private global investment firm, agrees that this is the time to pursue financial misconduct. A steep decline in the stock market "brings a lot of frauds to center stage which otherwise might not have appeared," he said. "Frauds were more egregious than those we've seen in recent years. I'd expect there will be a lot of actions coming."

As evidence, Justice and the SEC, along with the FBI and other federal and state law enforcement agencies, are stepping up their coordination, hiring more prosecutors and investigators, and developing other tools to go after financial fraud.

The FBI is throwing more resources into the fight and is working increasingly closely with other federal authorities and with the states on investigating crimes that may have contributed to the nation's economic woes. The bureau has 43 investigations under way focusing on large companies that may have been involved in such misconduct as accounting fraud, deceptive sales practices, or insider trading. As of April 1, the FBI was also conducting 2,346 probes of potential mortgage-related fraud.

Law enforcement agencies are banking on receiving millions of dollars in additional funding from Congress's recent enactment of the Fraud Enforcement and Recovery Act. The law allocates more than $500 million over two years to the Criminal Division, the SEC, the FBI, and other agencies to hire investigators and prosecutors, as well as boost other resources.

Sen. Patrick Leahy, D-Vt., chairman of the Senate Judiciary Committee and a lead sponsor of FERA, expects the FBI to be tough. At a hearing last September at which FBI Director Robert Mueller testified, Leahy, a former prosecutor, said, "If people were cooking the books, manipulating, doing things they were not supposed to, then I want people held responsible."

Some prominent lawyers specializing in white-collar crime see the spike in law enforcement activity as a classic Washington response to a crisis. "The way that the Washington scandal machine works, it's always looking for someone who is responsible," said defense lawyer Robert Bennett of Skadden, Arps, Slate, Meagher & Flom. "You want to have scalps."

Momentum to thwart financial crimes is likewise growing at the state level, especially in the area of mortgage fraud. Attorneys general in California, Florida, Illinois, and New York got a jump on Washington on some big cases. Eleven state attorneys general who filed predatory lending suits against Countrywide (which was acquired last year by the Bank of America) reached an $8.4 billion settlement last fall that provides loan relief to an estimated 400,000 borrowers.

"They agreed to keep people in their homes," Florida Attorney General Bill McCollum said of the settlement with Countrywide, noting that the company was the biggest home lender in his state. "We believe we saved thousands of people from losing their homes to foreclosures."

Back in Washington, fears about potential financial fraud appear to be weighing on Neil Barofsky, the special inspector general for the Troubled Asset Relief Program that Congress passed late last year. A longtime prosecutor who ran a mortgage fraud unit in the U.S. Attorney's Office for the Southern District of New York, Barofsky is tasked with monitoring the spending trail of $700 billion in federal bailout funds and with ferreting out waste and fraud. (See "Stopping Fraud Before It Happens," p. 34.)

The Madoff Lesson

Former regulators and Justice officials say that the crackdown on fraud is a logical response to the public's and the politicians' anger at financial and mortgage firms that left investors high and dry and homeowners under water.

"It's pretty clear that public concern is going to ratchet these investigations up on the priority list," said former Attorney General Dick Thornburgh. "The scrutiny will be greater because of the outrage. The law enforcement community sets its priorities based on what people are concerned about."

Levitt predicts a busy period ahead for his former agency. "A lot of cases that should have been brought over the last few years weren't," he said, "and this SEC will reverse that trend."

Exhibit A, which the SEC, to its great chagrin, missed for many years was the $50 billion Ponzi scheme masterminded by now-imprisoned Wall Street financier Bernard Madoff. Pushing promises of high returns and low fees, Madoff badly burned many rich and middle-income investors. The SEC's black eye is particularly painful because the agency began but failed to diligently pursue at least five inquiries, going back to the early 1990s. An outside whistle-blower and an SEC lawyer both tried to warn the agency about Madoff's scheme.

Ultimately, the Justice Department charged Madoff last December with multiple counts of criminal fraud, and the SEC also filed civil charges against him. In March, he pleaded guilty to 11 criminal counts, including international money laundering, and securities, wire, and mail fraud. After running what has been described as the longest-lived and largest Ponzi scheme ever, Madoff was sentenced in June to 150 years in prison. Wide-ranging criminal and civil investigations are continuing into firms and individuals who may have abetted his frauds.

"A number of us have said that we greatly regretted the consequences of Madoff," Khuzami told National Journal. "There was a massive fraud that we failed to detect." The SEC wants to "decrease the possibility" of that happening again, he said, stressing that when laws are broken, "it's important that investors and the public see that there's swift accountability."

SEC Chairman Mary Schapiro chose Khuzami to head that mission. He is a veteran federal prosecutor who once led a key white-collar crime unit at the U.S. Attorney's Office for the Southern District of New York. Since President Obama tapped Schapiro to take over the battered agency, she has taken this and other actions to rebuild credibility and morale.

To improve enforcement, Khuzami said, he has launched a range of initiatives, including setting up advisory task forces aimed at making the SEC "swifter and smarter. We're looking at our management structure to make us more nimble." That's important because Khuzami oversees some 700 lawyers responsible for probing allegations of securities fraud, insider trading, and other types of market manipulation at the nation's financial firms and public companies. To bolster its efforts, the Division of Enforcement may create specialized units to focus on different markets, practices, and products.

More broadly, the SEC is looking to expand its use of and protections for whistle-blowers beyond insider trading cases, and it wants greater authority to issue subpoenas. Schapiro intends to seek the legislative authority for both actions.

Still, the SEC isn't simply waiting for Congress to beef up its powers. The agency in May brought its first insider trading case involving the multitrillion-dollar market in credit default swaps -- the insurance-like contracts that were a major contributor to the huge financial losses at Wall Street firms. The SEC is probing other cases involving credit default swaps, sources say.

Also last month, the financial services firm State Street said in a regulatory filing that it had received a "Wells" notice from the SEC -- an indication that the agency is considering an enforcement action against the firm. According to State Street, the notice said that the SEC may charge the firm's major subsidiary with securities law violations. The SEC has been looking into possible securities violations related to State Street's past investments in subprime mortgages.

Some SEC-watchers think that Khuzami's background as a prosecutor who secured high-profile indictments involving Mafia influence on Wall Street will boost the number of cases that the agency takes to trial rather than settling out of court. "The SEC has a dominant settlement culture," said John Coffee, a Columbia Law School professor who teaches securities law. "That's going to change. There will be a willingness to take more cases to trial."

As the dust settles from the implosion of some of Wall Street's most-storied investment banks, the securities commission has a lot riding on what it does next. "The SEC has been under such attack that they have to prove that they're tough and aggressive," Bennett said. "I'm sure internally they're feeling that their entire reputation is at risk."

More Muscle

The SEC isn't the only law enforcement player trying to bolster its credentials. At Justice, Breuer sounds bullish about tackling financial fraud cases. He predicts that the Criminal Division will get a nice boost in resources from the new anti-fraud legislation. "FERA is great for us," he said.

Breuer is hiring a half-dozen additional prosecutors for the Fraud Section to focus heavily on financial cases. The section now employs about 55 prosecutors, and Breuer says he expects to create more positions when Congress appropriates the FERA funds.

The new law, Breuer points out, broadens fraud statutes to cover mortgage companies as well as banks. FERA also makes it easier for prosecutors to seek forfeiture of assets in cases of money laundering. "Our goal is to recover funds to get money to the victims," said Breuer, who spent much of his career as a white-collar defense lawyer at Covington & Burling but who was also a prosecutor for five years in the Manhattan district attorney's office.

Josh Hochberg, who was head of Justice's Fraud Section for part of the Bush 43 administration, says that FERA will pack a big punch because "$500 million buys a lot" of prosecutors, investigators, and other resources. "They'll try to make big cases," he said. "Lanny is bringing in really serious people." The Criminal Division may be feeling pressure to make up for perceived previous laxity toward white-collar crime, Hochberg said. "There's a perception that white-collar prosecutions were shortchanged in the last years of the Bush administration."

Looking ahead, Breuer points out that cooperation with other agencies and with local prosecutors and state attorneys general is critical to Justice's pursuit of financial crimes. "The key is to figure out ways to coordinate." To help cement such links, Breuer said, Attorney General Eric Holder is planning to assemble a multi-agency task force on financial fraud later this year.

Meanwhile, the SEC and Justice are both tapping the investigative muscle of the FBI, which for several years has been stepping up its efforts to probe mortgage fraud and other financial crimes.

Sharon Ormsby, chief of the Financial Crimes Section in the FBI's Criminal Investigative Division, says that the bureau has been working closely with the SEC and state authorities to uncover mortgage fraud and Ponzi schemes. "We're always developing investigative techniques to better go after Ponzi schemes," Ormsby said. "Some of the schemes that have unraveled due to the downturn in the economy could lead to more cases." The FBI is scrutinizing 43 large companies for possible accounting fraud and other misconduct; reportedly among them are American International Group, Lehman Brothers (which collapsed last year), Fannie Mae, and Freddie Mac.

Ormsby says that the FBI has 260 agents investigating suspected fraud involving mortgage lenders, mortgage brokers, and bond insurers. To expand its clout, she added, the bureau has 68 working groups or task forces that include local and state law enforcement officials.

More recently, the FBI has been "slowly seeing an uptick" in companies that bill themselves as mortgage "rescue" firms to help distressed homeowners but prey on them instead. These schemes seem to have proliferated in big states such as Florida, which has 74 mortgage rescue fraud probes under way, according to McCollum, the state's AG.

In one typical scam, McCollum said, so-called mortgage rescue firms charge big fees up front, sometimes amounting to thousands of dollars, to conduct "forensic" studies for homeowners. Florida has just passed a law barring these kinds of up-front fees, and McCollum's office has gone to court to shut down some companies that have engaged in deceptive practices.

Bennett of Skadden, Arps foresees an increased number of probes, prosecutions, and enforcement actions against financial fraud in Washington and in a number of states where attorneys general have been "tremendously aggressive." Among the most active state attorneys general, lawyers say, are Andrew Cuomo of New York and Jerry Brown of California.

More to Come?

Some analysts say that the financial crisis and the lax regulation that played a role in breeding it demand an even stronger legal and regulatory response. "We've created an environment that cries out for redress," Levitt said. "I think this is far more meaningful than recent crises."

Levitt's view seems well-founded, judging by the wealth of detail and documentation that has surfaced in the charges against Mozilo and Stanford, as well as in the still-unfolding Madoff probe.

The SEC charges against Mozilo and two of his former lieutenants paint a dark picture, illustrated by internal company e-mails, of the large gap between public and private statements about the safety of the mortgage giant's standards and operations. "This is a tale of two companies," Khuzami said in announcing the charges. "Countrywide portrayed itself as underwriting mainly prime quality mortgages, using high underwriting standards. But concealed from shareholders was the true Countrywide, an increasingly reckless lender assuming greater and greater risk."

The SEC complaint revealed that, contrary to Mozilo's public statements extolling his company's impeccable business practices, as early as 2006 he privately but repeatedly worried about Countrywide's heavy reliance on high-risk loans. In a September 2006 e-mail to a former Countrywide president, David Sambol, whom the SEC also charged with fraud, Mozilo wrote, "The bottom line is that we are flying blind in how these loans will perform in a stressed environment of higher unemployment, reduced values, and slowing home sales."

Justice is still investigating Mozilo, who has denied any wrongdoing.

As for Stanford, separate civil and criminal charges filed by the SEC and Justice allege that he engaged in a Ponzi scheme that may soon become a textbook case.

Stanford had an international reputation as a flamboyant figure; last year Forbes ranked him No. 205 on its list of the 400 wealthiest Americans. The SEC has accused him of running a massive fraud through his Antigua-based Stanford International Bank involving "improbable and unsubstantiated" promises of high interest returns on the bank's certificates of deposit.

Last month, Justice released its own indictment, charging Stanford and five conspirators with bilking 30,000 investors to underwrite a "personal playground" that featured Caribbean villas and cricket tournaments. The charges include fraud, conspiracy to obstruct justice, and conspiracy to launder money.

Justice said that Stanford's bank offered "too-good-to-be-true" interest rates and bribed a former Antigua regulator with $100,000 in cash payments, trips on private jets, and free tickets to the Super Bowl. Stanford's investors, according to the indictment, were from more than 130 countries, including many in South America.

Even the multiple charges against Stanford are dwarfed, however, by the 11 counts on which Madoff copped a plea. SEC, Justice, and state-level officials are continuing to probe the web of hedge funds and wealthy investors who dealt with Madoff over the years to determine whether any of those funds or individuals abetted his scams.

To date, the only other person facing criminal charges is Madoff's accountant, who is under arrest. But the SEC has filed civil suits against several of Madoff's long-term investors, accusing them of intentionally steering other investors into the fraud schemes for their own financial gain.

Separately, a trustee overseeing the bankruptcy of Madoff's former investment firm is trying to help Madoff's victims recover some of their assets. The trustee has filed suits against at least half a dozen large investors and hedge funds to try to recoup more than $10 billion that was withdrawn from Madoff's investment company in its final years and months. As of an early-July deadline, the trustee had received 15,400 claims from Madoff's victims.

Looking ahead, some legal scholars and former officials caution that the federal probes under way into possible misconduct by executives at some Wall Street firms are likely to be lengthy and very complex -- and may yield only a handful of significant cases.

Legal analysts point out, for example, that the economic meltdown involved many highly arcane financial instruments, such as credit default swaps and securitized mortgages. Investigators and prosecutors may have a difficult time distinguishing executives whose lousy management and poor judgment caused huge financial losses from those who knowingly committed fraud, the experts say.

"In many ways, Enron and WorldCom were easier fraud cases, with intentional wrongdoing of a traditional type," said former SEC Commissioner Harvey Goldschmid, referring to two famous cases from earlier in this decade. "One part of the complexity here is that unwise risk and investments decisions are not likely to result in major fraud cases."

Still, Goldschmid, who teaches securities law at Columbia Law School, believes that fraud charges are likely against several Wall Street executives whose firms saw their fortunes plummet. "Some major disclosure cases will probably develop," he said. "As our markets were unraveling, firms and individuals may have misstated or failed to disclose the dangers to given companies, and investors could have been fraudulently deceived."

In terms of building mortgage fraud cases, analysts point out some notable differences between current probes of companies involved in subprime lending and the 1980s-era investigations of the savings and loan industry, which was federally regulated. At the peak of the subprime mortgage boom, for starters, almost 50 percent of subprime mortgages were not federally regulated, because they originated with private mortgage providers.

Nonetheless, some parallels exist. During the wave of savings and loan failures, federal prosecutors brought 600-plus cases against more than 1,000 defendants. The most famous was banker Charles Keating, who went to prison for four years after the collapse of American Continental. Keating became the symbol of wrongdoing in the S&L industry.

By contrast, the FBI says that from early 2007 through the first three months of this year its mortgage fraud investigations have netted 830 convictions. For now, at least, the SEC charges against Mozilo have made him the symbol of mortgage chicanery. "Mozilo is the poster boy for irresponsible mortgage lending practices," said Coffee of Columbia Law School.

Given the number of active federal and state probes into financial and mortgage fraud, however, others will likely emerge.

  •  
  •