Hearing on the Stanford Ponzi Scheme - A Madoff victim's observations

A member who had the opportunity to attend the May 13th Oversight and Investigations Hearing on “The Stanford Ponzi Scheme: Lessons for Protecting Investors from the Next Seucrities Fraud”, has been kind enough to summarize his observations below:I’ve been lobbying my Congressman, Mike Fitzpatrick, for quite some time now so when he invited my mother and me to Washington for the Subcommittee on Oversight and Investigations hearings on “The Stanford Ponzi Scheme: Lessons for Protecting Investors from the Next Securities Fraud,” We jumped at the opportunity.

Here are some of my observations:

Stanford investors share a common bond with Madoff investors. Both groups were betrayed by the SEC. The SEC failed to discover the frauds even when presented with multiple opportunities and information ranging from financial irregularities to whistleblower warnings. The behavior of the SEC does differ in a meaningful way. In the Madoff fraud, the examiners conducted multiple investigations and never “put two and two together” to uncover the fraud. In the Stanford case, one particular examiner in the Fort Worth office did raise warnings and asked her supervisor to open a more invasive examination. The failure occurred in that management would not advance the investigation.

Indeed, the examiner (Julie Preuitt) was actually berated by her superiors, and when she continued to push for an examination she was given a letter of reprimand and transferred. Surprisingly, she is now back at the Fort Worth office but has been given very few responsibilities, reports to a supervisor in a different office, and still has to work with the manager who issued the letter of reprimand. This sends a chilling message to any current examiners as to just what can happen when you attempt to do your job and repeatedly ask management to do theirs.

Stanford was a licensed broker-dealer. Like the Madoff situation, Stanford had the SIPC logo printed on statements provided to customers. Stanford was arrested in early 2009. His investors applied for SIPC insurance coverage. More than 2 years later they are still waiting to see if they are covered. Apparently the rationale for denying SIPC coverage is that Stanford told investors that he purchased CDs, meaning that Stanford investors are being denied SIPC coverage because Stanford lied and told investors he bought “the wrong securities”, i.e. ones that were not covered by SIPC. Had Stanford lied by saying he bought NYSE stocks instead of lying and saying he bought CDs the Stanford investors would be covered by SIPC insurance.

If SIPC coverage is approved it presents a very interesting dilemma for the Stanford trustee. Since Stanford never purchased the securities (just like the Madoff situation), then Stanford investors could be faced with SIPC applying the “net equity” definition to determine the amount that would be reimbursed by SIPC. Stanford investors would not be compensated based on their last statement, but the trustee would likely look at investments minus withdrawals to determine coverage. The result of Net Equity versus Final Statement value does great harm to investors but provides great benefits to SIPC and thus the brokerage industry which funds SIPC. HR 757 would force SIPC to honor an investor’s last statement and provide comfort to all investors that their brokerage statement is meaningful.

If SIPC is approved for Stanford and the trustee DOES NOT apply the Net Equity approach for compensation then it may open the door for Madoff investors to seek redress for the decision of the trustee in that fraud. Perhaps some of the lawyers here can chime in.

The similarities in the failures of the SEC in both the Madoff and Stanford cases are striking. Indeed one could draw the conclusion that the problems with SEC investigator, investigations and management are systemic and not confined to a single office. The written testimony of David Kotz (excerpts shown below) show that SEC examiners clearly thought that Stanford was a fraud. Management would not pursue the case because it would require too many resources and take too much time – and, investors lost a lot of money because the SEC simply refused to do their job. Unlike the Madoff SEC investigative report which found no signs of complicity by SEC personnel, the Stanford report did show that a senior SEC manager worked for Stanford after leaving the SEC.

SEC witness, not surprisingly, apologized for the failures of the SEC to discover the Stanford crime. But of course, this provides no monetary benefits to investors.

There are a few interesting quotes in the opening statement of those who served in the panels during this hearing.

David Kotz (Inspector General of the SEC).
The first SEC examination occurred in 1997, just two years after Stanford Group Company began operations. After reviewing Stanford Group Company’s annual audited financial statements in 1997, SEC examiner Julie Preuitt, who is a witness in this hearing, stated that, based simply on her review of the financial statements, she “became very concerned” about the “extraordinary revenue” from the CDs and immediately suspected the CD sales were fraudulent.

The SEC’s Fort Worth examiners conducted examinations of Stanford in 1997, 1998, 2002, and 2004, concluding in each instance that Stanford’s CDs were likely a Ponzi scheme or similar fraudulent scheme. The only significant difference in the examination group’s findings over the years was that the potential fraud was growing exponentially, from $250 million to $1.5 billion.

The OIG’s investigation determined that the SEC’s Fort Worth Office was aware since 1997 that Robert Allen Stanford was likely operating a Ponzi scheme, having come to that conclusion a mere two years after Stanford Group Company, Stanford’s investment adviser, registered with the SEC in 1995. We found that over the next eight years, the SEC’s Fort Worth Examination group conducted four examinations of Stanford’s operations, finding in each examination that the certificates of deposit (CDs) Stanford was promoting could not have been “legitimate,” and that it was “highly unlikely” that the returns Stanford claimed to generate could have been achieved with the purported conservative investment approach utilized.

(Relative to the 2002 investigation:) The Enforcement group decided not to open an investigation or even an inquiry. The Enforcement branch chief responsible for the decision explained his rationale as follows:

Rather than spend a lot of resources on something that could end up being something that we could not bring, the decision was made to – to not go forward at that time, or at least to – to not spend the significant resources and – and wait and see if something else would come up.

In late 2005, after a change in leadership in the Enforcement group and in response to the continuing pleas by Ms. Preuitt and the Fort Worth Examination group, who had been watching the potential fraud grow in examination after examination, the Enforcement group finally agreed to seek a formal order from the Commission to investigate Stanford. However, even at that time, the Enforcement group missed an opportunity to bring an action against Stanford Group Company for its admitted failure to conduct any due diligence regarding Stanford’s investment portfolio, which could have potentially completely stopped the sales of the Stanford International Bank CDs through the Stanford Group Company investment adviser, and would have provided investors and prospective investors with notice that the SEC considered Stanford Group Company’s sales of the CDs to be fraudulent.

The OIG also found that the former head of Enforcement in Fort Worth who played a significant role in multiple decisions over the years to quash investigations of Stanford, sought to represent Stanford on three separate occasions after he left the Commission, and in fact, represented Stanford briefly in 2006 before he was informed by the SEC Ethics Office that it was improper for him to do so.

This individual while working at the SEC was responsible for decisions: (1) in 1998 to close an inquiry opened regarding Stanford after the 1997 examination; (2) in 2002, in lieu of responding to a complaint or investigating the issues it raised, to forward it to the Texas State Securities Board; (3) also in 2002, not to act on the Examination staff’s referral of Stanford for investigation after its investment adviser examination; (4) in 2003, not to investigate Stanford after a complaint was received comparing Stanford’s operations to a known fraud; (5) in 2003, not to investigate Stanford after receiving a complaint from an anonymous insider alleging that Stanford was engaged in a “massive Ponzi scheme;” and (6) in 2005, to bluntly inform senior Examination staff after a presentation was made on Stanford at a quarterly summit meeting that Stanford was not a matter the Enforcement group planned to investigate.

Yet, in June 2005, a mere two months after leaving the SEC, this former head of the Enforcement group in Fort Worth e-mailed the SEC Ethics Office that he had been “approached about representing [Stanford].

Robert Khuzami, Director, Division of Enforcement
The Commission oversees the activities of the Securities Investor Protection Corporation (“SIPC”), which plays a critical role in protecting customer property when a broker-dealer enters liquidation under the Securities Investor Protection Act (“SIPA”). In the Stanford matter, SIPC has indicated that, in its view and based on the facts presented, there is no basis for SIPC to initiate a proceeding under SIPA.3 The Commission is taking the concerns of the Stanford Victims Coalition (“SVC”) members, and all other Stanford victims, very seriously, and the staff is investigating closely their status under SIPA.

Additional questions for the panels (30 days following the hearing on May 13th to submit written questions to those in the panel.

CLICK HERE for archived video of the hearing and witness testimonies.