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August 24, 2016

Financial Reform Newsletter: Another example of the SEC seeming to do its job while actually doing it poorly and more…

Ripping off “Clients” is Still too Often the Business Model of too Many on Wall Street and the SEC Needs to Get Serious About Stopping it:  Yet againheadlines reported on the latest Securities and Exchange Commission (SEC) enforcement action against a private equity (PE) firm for ripping off its clients.  Just reading the SEC releasewon’t really tell you what is going on here, but reading Bloomberg’s Matt Levine will: “Apollo Paid Itself Some Fees and Gave Itself Some Loans.”

As Levine sums it up, “the main problem is that Apollo charged its portfolio companies accelerated monitoring fees without adequately disclosing to investors that it would do that.”  In addition, they failed to disclose an intricate lending scheme designed to help dodge taxes. 
It should be a crime to use all this brainpower on little more than ripping off “clients” as much as possible by getting as close to the legal line as possible regardless of how dishonorable, unethical or sleazy.  Or as Mervyn King said in his recent book, “what kind of person takes pleasure in separating a fool from his money?”  Put differently, how do these people who are already richer than the Pharaohs of Egypt live with themselves when they effectively steal money from their “clients” to enrich themselves even more, based on loopholes, complex agreements, and disclosure so carefully crafted that they conceal rather than disclose the facts.  They are abusing their “clients” by taking advantage of the asymmetrical knowledge, experience and sophistication that they have.
This is also another example of the SEC seeming to do its job while actually doing it poorly.  Yes, this case is, as the New York Times points out, “a continuation of the SEC’s crackdown on private equity misdeeds.  Over the last few years, the agency has taken action against nearly 10 private equity firms, including prominent players as the Blackstone Group and Kohlberg Kravis Roberts and Company.” 
But, they aren’t “misdeeds.”  This is lawbreaking.  This is knowing illegal conduct.  Indeed, often it appears to be fraud and other crimes.  Compounding all this is that it appears to be an accepted industry-wide practice.  Yet the SEC still handles these cases as nothing more than disclosure cases and lets the lawbreaking firms pay a fine without admitting or denying anything.  Worse, the settlement agreements with the SEC are as carefully crafted as the PE agreements that gave rise to the nondisclosure charges: they conceal more than they reveal.
The SEC has to get serious about this repeated pattern of illegal conduct ripping off clients, often pension funds and similar types of investors.  At a minimum, if it must settle, then the SEC must begin to detail publicly exactly who did what and how it was done.  That means naming names, including violators, supervisors, compliance personnel, lawyers, executives and anyone else involved or responsible.   
Moreover, the SEC simply must require lawbreaking firms to admit to the facts and their lawbreaking.  The SEC must also stop their indefensible practice of seeing serious violations of the law as nothing more than disclosure violations and start bringing fraud and other substantive charges against firms and, most importantly, against individuals.  Lawbreaking simply will not stop unless and until individuals are charged and seriously punished-and that means holding supervisors and executives accountable, not not just scapegoats and junior employees.  After all, where were they while the violations occurred and where was compliance, legal, and risk management?  Until the SEC starts to go after lawbreaking individuals, these actions are mostly for show and PR, not punishment and deterrence.  



Former Deutsche Risk Officer Courageously Turned Whistleblower Turns Down Millions of Dollars, Blowing Whistle on the SEC: Proving the point made above regarding the SEC, Mr. Eric Ben-Artzi, a former Deutsche risk officer, recently declined his half of the $16.5 million whistleblower payout from the SEC. Why? Because of the SEC’s failure to punish executives at Deutsche Bank. 
In an eloquent Financial Times Op-Ed Mr. Ben-Artzi wrote:
“Although I need the money now more than ever, I will not join the looting of the very people I was hired to protect. I never intended to turn a job in risk management into a crusade, but after suffering at the hands of the Deutsche executives I will not join them simply because I cannot beat them. I request that my share of the award be given to Deutsche and its stakeholders, and the award money clawed back from the bonuses paid to the Deutsche executives, especially the former top SEC attorneys.”
It cannot be denied that this is rarely seen courage and self-sacrifice.
For background, Mr. Ben-Artzi was one of three whistleblowers who in 2010-11 reported improper accounting internally and then to regulators around the globe. The SEC was informed that employees at the bank had been inflating the value of its massive portfolio of credit derivatives.  As a result, top executives were able to retire with multimillion-dollar bonuses based on the misrepresentation of the bank’s balance sheet, but also at the expense of shareholders and rank-and-file employee’s jobs and livelihoods. After a long investigation in 2015 helped by multiple whistleblowers, the SEC imposed a fine on Deutsche Bank, which, of course, gets paid by the shareholders not the employees, managers or executives responsible.
Mr. Ben-Artzi raised another incredibly important issue:  the corrosive, pernicious revolving door where senior government officials rotate between private and public sector jobs where the public interest appears to be subordinated to their private sector interests.  For example, take a look at this list of connections:
  • Deutsche’s top lawyers “revolved” in and out of the SEC before, during and after the illegal activity at the bank.
  • Robert Rice, the chief lawyer in charge of the internal investigation at Deutsche in 2011, became the SEC’s chief counsel in 2013.
  • Robert Khuzami, Deutsche’s top lawyer in North America, became head of the SEC’s enforcement division after the financial crisis.
  • Their boss, Richard Walker, the bank’s longtime general counsel (he left the bank this year) was once head of enforcement at the SEC.
  • In this case, top SEC lawyers had held senior posts at the bank, moving in and out of top positions at the regulator even as the investigations into malfeasance at Deutsche were ongoing.
  • This took place on the watch of Mary Jo White, the current chair of the SEC, whose relationship with Mr. Khuzami and Mr. Rice dates back 20 years.
Shockingly, that’s the revolving door at just one global too-big-to-fail bank.   
The Consumer Financial Protection Bureau (CFPB) Created by the Dodd Frank law is Trying to Stop Industry From Forcing Injured Consumers to Give Up Legal Rights: Calling attention to the divide and conquer strategy that forces injured consumers to fight corporations on their own, Better Markets this week filed a comment letter with the CFPB on a proposed rule related to restrictions on arbitration.

The Proposed Rule establishes two important reforms: It stops the use of class action waivers in pre-dispute arbitration clauses, and it requires financial services firms to collect and report data on the consumer arbitration proceedings that will continue even after the Proposed Rule goes into effect.
Better Markets, released a statement in conjunction with the comment letter, stating in part that consumers should not be forced to give up their legal rights to participate in class action lawsuits when they are injured. 

The Proposed Rule is a strong measure that will significantly increase protections for consumers, but the CFPB shouldn’t stop there.  The CFPB should go further and end the practice of financial companies forcing injured consumers with individual claims into binding arbitration proceedings.  Arbitrations are too often little more than kangaroo courts run directly or indirectly by industry, for industry, and to the detriment of consumers and the integrity of the markets.

IEX is now Open and Operating as an Exchange – Predatory HFT, You May Now Exit Stage Left: The Investor’s Exchange (IEX) made its debut Friday as a public stock exchange, bringing legitimate competition to all those facilitating and profiting off predatory high frequency trading (HFT).   Better Markets’ CEO and President Dennis Kelleher recently congratulated IEX founder and CEO Brad Katsuyama and President Ronan Ryan (pictured right).

IEX is where investors can trade without being ripped off by predatory HFT using high speed technology to prey on their orders. Predatory high frequency traders currently cost investors tens of billions of their hard-earned money.  By taking away their unfair advantages, IEX levels the playing field and aligns the markets once again with the interests of long-term investors rather than millisecond traders. 
Although rarely mentioned, it is important to remember that IEX is a market based, private sector solution to a market problem, albeit one that may have been an unintended consequence of sensible regulation.  While it would be nice if there were never any unintended consequences (in the public and private sectors), everyone should applaud and encourage more market based, private sector solutions to market problems, particularly those that prioritize investors interests rather than fast-buck artists.  For example, it is long past time that the CFTC would enable competition and a level playing field in the SEF space for trading derivatives, rather than the two-tied oligopoly that persists to this day to the detriment of the markets and market participants (as Better Markets’ detailed in this Policy Brief).
So let’s all celebrate IEX:  Friday was a landmark day for investors both large and small. 



Better Markets in the News:

Crunch time on Wall Street rules for SEC The Hill by Peter Schroeder and Sylvan Lane 8/24/16

Pressure on CFPB over arbitration rule builds Politico Pro by Colin Wilhelm 8/23/16




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