Fraud Enforcement and Recovery Act (FERA) Picks Up Speed; Madoff Update

Last week, the U.S. House of Representatives passed its own version (containing certain amendments from the Senate version) of S. 386, the Fraud Enforcement and Recovery Act of 2009 (FERA). The Senate voted 92-4 in favor of the bill on April 28, and the House voted 367-59 in favor of its version of the bill on May 6.

Both versions of the bills would increase funding by over $500 million in aggregate over a two year period (fiscal years 2010, 2011) for certain law enforcement agencies, including U.S. Attorneys Offices, DOJ, FBI, U.S. Postal Inspectors, HUD and the Secret Service.

AMENDED PARAGRAPH: UPDATED MAY 21, 2009: This paragraph originally said only the House version of FERA contained additional funding for the SEC, as we cited from the Senate Judiciary Committee report dated March 23, 2009, "Senator Schumer also offered an amendment to add funding for the Securities and Exchange Commission to the bill, but withdrew the amendment after Senator Grassley opposed it." However, according to "Anonymous" who posted a comment on this original blog post (see "Comments" below) the provision for approximately $20 million in additional funding for the SEC was approved by voice vote in the Senate bill, thus consistent with the House version, and ultimately included in the Act signed by the President on May 20, 2009 (see our May 20, 2009 post).

It also appears some provisions of the bill could potentially increase the SEC’s scope, including amendments to the securities statute “to cover fraud schemes involving commodities futures and options, including derivatives involving … mortgage backed securities.” It is also notable (although not part of the proposed securities law changes) that the bill would broaden the definition of ‘financial institution’ in the criminal code, to sweep in currently unregulated institutions for purposes of federal fraud laws.

Key provisions of the bill
Based on the Senate version of the bill (unless otherwise noted) FERA would:
1. Authorize over $500 million in additional funding for the DOJ, USAO's, FBI, U.S. Postal Inspector, and Secret Service, to fight mortgage related fraud and certain other financial fraud. [The House version of the bill includes $20 million in additional funding (in 2010, and 2011) for SEC investigations and enforcement proceedings involving financial institutions, and $1 million additional funding in 2010, 2011 for the SEC's OIG.
2. Amend the definition of ‘‘financial institution’’ in the criminal code (18 U.S.C. § 20) to extend Federal fraud laws to mortgage lending businesses that are not directly regulated or insured by the Federal Government.
3. Amend the false statements in mortgage applications statute (18 U.S.C. § 1014) to make it a crime to make a materially false statement or to willfully overvalue a property in order to influence any action by a mortgage lending business.
4. Amend the major fraud statute (18 U.S.C. § 1031) to protect funds expended under the Troubled Asset Relief Program and the economic stimulus package, including any government purchases of preferred stock in financial institutions.
5. Amend the Federal securities statute (18 U.S.C. § 1348) to cover fraud schemes involving commodities futures and options, including derivatives involving the mortgage backed securities that caused such damage to our banking system.
6. Amend the Federal money laundering statutes (18 U.S.C. §§ 1956, 1957) to - as stated in the bill: "correct an erroneous Supreme Court decision in 2008 that significantly weakened these statutes. In United States v. Santos, the Supreme Court misinterpreted the money laundering statutes, limiting their scope to only the ‘‘profits’’ of crimes, rather than the ‘‘proceeds’’ of the offenses. 128 S. Ct. 2020 (2008). The Court’s decision was contrary to Congressional intent and will lead to criminals escaping culpability simply by claiming their illegal scams did not make any profit. Indeed, proceeds of ‘‘Ponzi schemes’’ like the Bernard Madoff case, which by their very nature do not include any profit, would be out of the reach of the money laundering statutes under this decision. This flawed decision needs to be corrected immediately, as dozens of significant money laundering cases have already been dismissed.”
7. Amend the False Claims Act (18 U.S.C. § 3729 et seq.). As stated in the bill: "The effectiveness of the False Claims Act has recently been undermined by court decisions which limit the scope of the law and, in some cases, allow subcontractors paid with Government money to escape responsibility for proven frauds. The False Claims Act must be corrected and clarified in order to protect from fraud the Federal assistance and relief funds expended in response to our current economic crisis."

Financial Crisis Inquiry Commission May Explore Accounting, Much More

Mark-to-market accounting is one of over 20 issues that would be potentially be explored by a Financial Crisis Inquiry Commission (as named in the House version of the FERA bill; with a slightly different name in the Senate version).

Cady North, FEI's Manager of Government Relations, explains: "The bill includes $5 million for the creation of a Select Committee to investigate the economic crisis. The panel would have 10 members, six chosen by congressional Democrats and four by Republicans. The chairman and vice chairman would be from different parties. No elected officials could serve on the panel, which would have subpoena power."

According to the House version of the bill, excerpted below, the Financial Crisis Inquiry Commission (FCIC) would be charged with: "examin[ing] the causes of the current financial and economic crisis in the United States, specifically the role of--
(A) fraud and abuse in the financial sector, including fraud and abuse towards consumers in the mortgage sector;
(B) Federal and State financial regulators, including the extent to which they enforced, or failed to enforce statutory, regulatory, or supervisory requirements;
(C) the global imbalance of savings, international capital flows, and fiscal imbalances of various governments;
(D) monetary policy and the availability and terms of credit;
(E) accounting practices, including, mark-to-market and fair value rules, and treatment of off-balance sheet vehicles;
(F) tax treatment of financial products and investments;
(G) capital requirements and regulations on leverage and liquidity, including the capital structures of regulated and non-regulated financial entities;
(H) credit rating agencies in the financial system, including, reliance on credit ratings by financial institutions and Federal financial regulators, the use of credit ratings in financial regulation, and the use of credit ratings in the securitization markets;
(I) lending practices and securitization, including the originate-to-distribute model for extending credit and transferring risk;
(J) affiliations between insured depository institutions and securities, insurance, and other types of nonbanking companies;
(K) the concept that certain institutions are `too-big-to-fail' and its impact on market expectations;
(L) corporate governance, including the impact of company conversions from partnerships to corporations;
(M) compensation structures;
(N) changes in compensation for employees of financial companies, as compared to compensation for others with similar skill sets in the labor market;
(O) the legal and regulatory structure of the United States housing market;
(P) derivatives and unregulated financial products and practices, including credit default swaps;
(Q) short-selling;
(R) financial institution reliance on numerical models, including risk models and credit ratings;
(S) the legal and regulatory structure governing financial institutions, including the extent to which the structure creates the opportunity for financial institutions to engage in regulatory arbitrage;
(T) the legal and regulatory structure governing investor and mortrgagor protection;
(U) financial institutions and government-sponsored enterprises; and
(V) the quality of due diligence undertaken by financial institutions;

Additionally, the bill specifies the FCIC would be required to:

• examine the causes of the collapse of each major financial institution that failed
• submit a report,
• refer potential violations of the law to the U.S. Attorney General and State attorney generals, and
• build upon -but not duplicate - the work of other entities (such as congressional committees, GAO, other agencies) to avoid duplication in conducting its examination of these matters.

As to the current status of the bill, FEI's North notes, "From a parliamentary perspective, the House took up the Senate version of the bill (S 386) after replacing the text with its own substitute amendment, incorporating language from several bills." She adds, "As it stands, the Senate has to take up the House version of the bill and either accept their changes or elect to appoint a conference committee to work out differences between the two bills. However, the Senate does not have this bill on their calendar yet, and it is unclear if or when the Senate might take up the House-amended version of the measure. In short, it’s not in conference committee yet, and the ball is in the Senate’s court now. " FEI members interested in following developments with respect to Financial Regulation Reform, contact Cady North at cnorth@financialexecutives.org .

MADOFF UPDATE: Analysis, Response
While we're on the subject of fraud, here's a few items that relate directly and indirectly to admitted Ponzi schemer Bernard L. Madoff.

The cover story in the current (May/June) issue of Fraud Magazine is: Chasing Madoff: An Interview with Harry Markopolos, CFE, CFA. Markopolos (source: wikipedia, which in and of itself is interesting in that Markopolos has practically become a household name) is the analyst who provided detailed analysis to the SEC regarding his suspicions that Madoff was, at best, front running, and at worst, running the world's largest Ponzi scheme. Fraud Magazine is published by the Association of Certified Fraud Examiners (ACFE); the article is written by Dick Carozza, Editor-in-chief of the magazine. Among highlights in the article, here are a few excerpts from Carozza/Markopolos' Q&A's (these are brief exerpts only from Markopolos' detailed responses in the wide-ranging, 8-page interview)

• What tipped you off? Madoff's name was never on the marketing materials; that was clue No. 1-I've never seen a product offering where the manager's name wasn't listed up front."
• What were the factors that allowed this scheme to continue for so long? The important thing you have to know about Madoff is that he is a brilliant con artist who knew how to prey on human nature like few others. The main emotion he appealed to was human greed, but he was smart enough to address investors fears by showing them a strategy that owned stock market index put options... such that if the stock market ever crashed they would be protected."

[NOTE: on the subject of greed, it was recently reported that a sequel to the movie Wall Street with Michael Douglas reprising his role as Gordon Gekko ('greed is good') is in the works. On the question of whether art imitates life or vice versa, see Michael Smerconish's article in the May 10 Philadelphia Inquirer, "Did Hollywood Inspire the Meltdown Men?" ]

Other subjects addressed in the Fraud magazine interview include red flags discovered by Markopolos, how his investigative team operated, and his interview with the SEC's inspector general, on which he says: "I've spent an entire day giving sworn testimony to the SEC's inspector general team and they impressed me. I was interview No. 60 for them. ... This particular IG has written hard-hitting reports in the past that have pulled no punches, and I am expecting to see his team's best work in the upcoming Madoff report." Markopolos and Michael Chertoff, former Secretary of U.S. Homeland Security and former federal prosecutor, are among the keynoters slated for ACFE's annual fraud conference & exhibition July 12-17 in Las Vegas.

Tonight (May 12), you can tune into The Madoff Affair: Frontline Investigates Madoff Global Fund. The story will air at 9:00 pm ET on PBS. I learned about the upcoming airing of this show in Bernard Madoff's Blog (aka ‘fake Bernie Madoff’s blog;’ ghost written and self-described as 'infotainment').

This Thursday (May 14), the SEC will consider proposing certain rules to strengthen oversight of investment advisers. According to the SEC's May 14 Open Meeting Agenda: "The Commission will consider custody-related matters, including whether to propose amendments to rule 206(4)-2 under the Investment Advisers Act of 1940 and related forms and rules. The proposed amendments would enhance the protections provided advisory clients when they entrust their funds and securities to an investment adviser. If adopted, the amendments would:

• require investment advisers having custody of client funds and securities to obtain a surprise examination by an independent public accountant, and,
• unless the client assets are maintained with an independent custodian, obtain a review of custodial controls from an independent public accountant."
  

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