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Fraud on the Street

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Tuesday, 30 March 2010 17:30
Portrait, Robert Reich, 08/16/09. (photo: Perian Flaherty)

Portrait, Robert Reich, 08/16/09. (photo: Perian Flaherty)


he Securities and Exchange Commission announced Monday it had begun an inquiry into two dozen financial companies to determine whether they followed accounting practices similar to those recently disclosed in an investigation of Lehman Brothers.

Where on earth has the SEC been?

It's now clear Lehman Brothers' balance sheet was bogus before the bank collapsed in 2008, catapulting the Street and the world into the worse financial crisis since 1929. The Lehman bankruptcy examiner's recent report details what just about everyone on the Street has known since the firm imploded - that Lehman defrauded its investors. Even Hank Paulson, in his recent memoir, referred to Lehman's balance sheet as bogus.

In order to look like it could borrow $30 for every dollar of its own money, Lehman shifted liabilities off its books at the end of each quarter. Its CPA, Ernst and Young, approved of this fraud against the advice of its own whistle blower, whom Ernst and Young fired.

Lehman's practices couldn't have been all that different from those of every other big bank on the Street. After all, they were all competing for the same business, and using many of the same techniques. Lehman was just the first to go under, causing a financial run that led George W. to warn "this sucker could go down" unless the federal government came up with hundreds of billions to bail out the others.

In other words, the TARP covered the other bankers' assets and asses.

We now know, for example, Goldman Sachs helped Greece hide its public debt and then placed financial bets that Greece would default, using credit-default swaps to avoid risking its own capital. It's the same tactic Goldman used for (and against) American International Group (AIG): Hide the ball, and then bet against the ball and fob off the risk to investors and taxpayers, using derivatives to remove the risky tactics from the balance sheets. Even today no one knows the fair value of the complex derivatives underlying these and related maneuvers, which is exactly the point.

Congress is now struggling to come up with legislation to stop this from happening again. And the Street is struggling to stop Congress. As of now, the Street's political payoffs seem to be working. Proposed legislation still allows secret derivative trading in foreign-exchange swaps (similar to what Goldman used to help Greece hide its debt) and in transactions between big banks and many of their corporate clients (as with AIG).

But wait. We already have a law designed to stop this sort of fraud. It's called the Sarbanes-Oxley Act of 2002.

Think back to the corporate looting scandals that came to light almost a decade ago when the balance sheets of Enron, WorldCom, and others were shown to be fake, causing their investors to lose their shirts. Nearly every major investment bank played a part in the fraud - not only advising the companies but also urging investors to buy their stocks when the banks' own analysts privately described them as junk.

Sarbanes-Oxley - Sarbox, as it's come to be known - was designed to stop this. It requires CEOs and other senior executives to take personal responsibility for the accuracy and completeness of their companies' financial reports and to set up internal controls to assure the accuracy and completeness of the reports. If they don't, they're subject to fines and criminal penalties.

Sarbox is directly relevant to the off-the-balance-sheet derivative games the Street played and continues to play. No bank CEO can faithfully attest to the accuracy and completeness of its financial reports when derivatives guarantee that the reports are incomplete and deceptive.

So where has the SEC been?

I was on a panel a few weeks ago with a former chair of the Securities and Exchange Commission who was asked why the commission has so far failed to enforce Sarbox against Wall Street. He had no response except to mumble that legislation is meaningless unless adequately enforced. Exactly.

Bottom line: While financial reform is needed, there's no reason to wait for it. Sarbox is already there. And even if financial reform is enacted without loopholes, there's no reason to think it will be enforced if laws already on the books, such as Sarbox, aren't.

(Adapted from my column in The American Prospect.)


CORRECTION: I stated that a whistle-blower who'd alerted Ernst & Young to fraud had been fired by Ernst & Young. It's actually worse than that. The whistle blower was from Lehman Brothers itself, and he was fired by Lehman when he tried to blow the whistle. Apologies to Ernst & Young. Even bigger condemnation of Lehman.


Open Article On Originating Site

Robert Reich is Professor of Public Policy at the University of California at Berkeley. He has served in three national administrations, most recently as secretary of labor under President Bill Clinton. He has written twelve books, including "The Work of Nations," "Locked in the Cabinet," and his most recent book, "Supercapitalism." His "Marketplace" commentaries can be found on publicradio.com and iTunes.

 

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+4 # Guest 2010-03-30 21:57
Spot on! All the regulatory laws that may be created to prevent the frauds that nearly took the economy down mean little if they are going to be as unenforced as laws already in place.

Unenforced law only encourages lawlessness. But of course, we must speculate that much of the government is in the back pocket of the bankers and corporations. When will government grow a back bone and act on the historical mandate to protect the best interests of the people?

There is no such thing as a bank or banking system that is too big to fail. If the banking system cannot avoid being corrupt, it should be nationalized as yes, the government could do the job better if only it would. At least then the government would be accountable to the electorate, a reality that the banks need not face. My guess is that if the people could vote on banking regulations and could vote on which banks should survive and which should go bust, things would improve rather quickly.
 
 
+10 # Guest 2010-03-30 22:28
Mr. President, why isn't Professor Reich in your cabinet?
 
 
+6 # Guest 2010-03-31 00:57
In answer to Reich's rhetorical question where has the SEC been: It has been presided over by scandal-ridden Bush appointees like Harvey Pitt, William Donaldson, and Christopher Cox. The last of these was profoundly derelict in his regulatory duties in the years immediately preceding the great collapse of October 2008. Cox willfully ignored repeated warnings from Wall Street whistle-blowers . In fact, his incompetence as a regulator or outright collusion with wrongdoers ranks him with Bush disgraces like Michael "You're doing a heckuva job" Brown, Director of FEMA. Yet Cox has thus far escaped with little condemnation. And his Wikipedia profile is an Orwellian whitewash.
 
 
+3 # Guest 2010-03-31 01:27
When the banks "own this place" kind of rhetoric is justified there really is no hope of change in sight. Our political donor class, forget the Repugnicans in this case, has to step away from their careerist thinking and do what's right. I doubt that those pols who think of Main Street first will have trouble raising funds for re-election when the people find out that they have acted in their interest. It's time that we had the chance to find this out. Does the Corporatocracy own the USA or do the people, once they are engaged, own it? In view of the recent SC decision this issue has to come to a head once and for all. Is there a pol who will step up to the plate and set the standard? I wonder.
 
 
+3 # Guest 2010-03-31 17:43
That's why it's called the marketocracy.- the replacement of representative government with the consent of the governed by corporate-owned government with no consent of the governed and no due process.
 
 
+3 # Guest 2010-03-31 02:50
Arthur Anderson was punished for the debacles of Enron et al. Obviously this failed to deter other from taking the same actions.

When no one wathes the watchers, they will nap away the whole day.

So long as it is necessary to raise millions to win a seat in Congress we are doomed to a repetition of current behavior. Those with massive resources will destroy this nation's ethics, morals and integrity in search of ever greater wealth.
 
 
+3 # Guest 2010-03-31 02:59
All this is played so far above the heads of the average citizen. Even top financial journlist didn't know initially what deriatives were. (Financial commodity futures contacts.) As ever, Leo
 
 
+2 # Guest 2010-03-31 03:04
These deriatives they talk about
were something not even financial journalitst quite grasped. (They were sort of
financial commodity futures contracts) As ever, Leo
 
 
0 # Guest 2010-03-31 03:51
Sure! I want to invest in American Companies!
 
 
+4 # Guest 2010-03-31 03:55
Is there a public CPA firm that is not corrupt?
 
 
+3 # Guest 2010-03-31 04:23
I understand that international finance is something the person on the street is not supposed to understand. The financial industry is too complicated to understand,we are told,and no doubt that is true. However, the ignorant person on the street still uses common sense once in a while and we wonder why it wouldn't be prudent to simply re-instate all of the regulations that were 'deregulated.' They worked for many years. All we really need are regulators to regulate the regulators. There is even an old adage on the public street passed down from generation to generation, "Don't try to fix something if it ain't broke!"
 
 
+12 # Guest 2010-03-31 04:25
As to enforcement, Tim Geitner, Larry Summers, Hank Paulson, and othters are too wed to the industry to crack down. Hank Paulson's bold demand that no accountability be in place for his requested bailout monies was ludicrous. Business continues as usual as we wait for the next meltdown. Being greedy to the point of hurting all Americans is not only morally wrong, it is treasonous. Send some people to prison for their actions. Disgrace those who have bilked us. Free enterprise doesn't work when the system is "fixed." Put the trust back in government by punishing those who have abused and broken laws.
 
 
+6 # Guest 2010-03-31 05:10
Serious jail time for many prosecuted and convicted Wall Street frauders will change illegal greedy behavior (for a while). The high-level fix must come off.
 
 
+8 # Guest 2010-03-31 05:36
It is ironic that whistle blowers continue to go jobless while the perps and their collaborators continue to run things.

It is frightening that leaders are not making hard but necessary choices. That is where history repeats itself.
 
 
+5 # Guest 2010-03-31 05:41
Heads should roll. I shudder when I think of all the people, hundreds of thousands, who have been financially and emotionally scarred because of these goons. And we're not doing anything? They're not going to pay a price? Where on earth is Justice???
 
 
+4 # Guest 2010-03-31 06:15
"Its CPA, Ernst and Young, approved of this fraud against the advice of its own whistle blower, whom Ernst and Young fired." My understanding is that the whistle-blower was a Lehman vice president.
 
 
+6 # Guest 2010-03-31 06:52
The SEC looked the other way just as it did in the Bernard Madoff caper. Don't think for a second that this inattention was accidental; it was the POLICY of the Bush-Cheney administration and the Republican Party mantra of untrammeled, out-of-control "free market capitalism" calculated to make the wealthy super-rich and lay the cost on the backs of working people.
 
 
+4 # Guest 2010-03-31 07:50
Two words: Harry. Markopoulos.
Make him head of SEC enforcement tomorrow and clean out the pigsty.
 
 
+2 # Guest 2010-03-31 08:01
And we wonder why the militia/hate types are so het up?! Perhaps if Sarbox were actually enforced & regulators could regrow their spines, some of the fury at the government would cool. Seeing a few of these major miscreants in the dock and then in prison might be just the tonic needed to restore faith in the essential value of government.
 
 
+1 # Guest 2010-03-31 16:01
HE is absolutely right.
 
 
+1 # Guest 2010-03-31 16:48
The United States may never have been a country whereby the rule of law is rightfully known. Too big to prosecute: Too powerful to touch. When this becomes overt and the perception that we have democracy, fair elections, rule of law, etc., fades so fast, we cannot believe our eyes, what happens? Anarchy? Declination? Facing the truth of what we truly have as a Nation, clinical depression may set in for the masses.
Thank you Robert Reich for your efforts in communicating truth to those who want to know.
 
 
-3 # Guest 2010-04-01 00:10
What's with the NEWSWEEK spamming ("Militia Charges Show Upsurge in Hate Groups" by Michael Isa Whore)
April Fools Day?
Some of us left America precisely to get away from that kind of MSMedia crap.
 
 
0 # Guest 2010-04-02 15:12
Please visit www.deepcapture.com to learn more about how Wall St. is completely rigged. The entire financial mess can be attributed to Wall St's running wild, without regulation or fear of accountability. The SEC and FINRA have ignored the repeated warnings of whistleblowers (e.g. Gary Aguirre re: John Mack/Pequot Capital/Samberg ), has permitted the practice of naked short selling, which has destroyed equity values, and at worst, regulators have been complicit, knowing that huge paying private sector jobs were awaiting to reward their "wink and a nod".

Bottom line, the SEC and others knew what was going on, and looked the other way.

There is someone who is genuinely fighting for fair markets who needs our help - Senator Ted Kaufman, Delaware, is doing his best to stop the practices of manipulative naked short selling, while permitting legal short selling.

Support Senator Kaufman & visit deepcapture.com
 
 
0 # Guest 2010-04-04 13:05
DAVID E on 04/02 said "...the SEC knew what was going on and looked the other way". Entirely true. But had the ChrisCoxCrew not done so the Bush white house, on demand or at behest of Wall St., would have replaced any and all at the SEC wishing to perform as expected of them. In that sense the Bush white house saw Cox as "reliable". Ugh.
 

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