The Stanford Ponzi Scheme: The Whistleblower’s View

"In August 1997, I assigned an experienced and highly skilled examiner to go to Houston to analyze Stanford’s revenue stream, its methods of product distribution, and its sales practices. In only a week the examiner was able to collect enough evidence to suggest that Stanford was engaged in a fraudulent scheme – most likely a Ponzi scheme. Our conclusion was based on a significant capital infusion of funds into the broker-dealer, the source of which appeared to be investor funds. We also noted apparent misrepresentations regarding the safety and security of the investments. It was highly unlikely that the high returns being paid to investors from the CDs along with the high recurring referral fees being paid to Stanford’s broker-dealer could be generated without engaging in significant risk."

Julie Preuitt

by Julie Preuitt, Fort Worth Regional Office
U.S. Securities and Exchange Commission

Before the Subcommittee on Oversight and Investigations, Committee on Financial Services, U.S. House of Representatives

May 13, 2011

Introduction

Thank you for the opportunity to testify before this subcommittee with respect to my work for the Securities & Exchange Commission (SEC or Commission) as it relates to R. Allen Stanford and his affiliated companies as well as my experience as a whistleblower within the Commission. Since 1992 I have been employed by the Commission in its Fort Worth office. In my testimony I am stating my personal views which do not necessarily reflect the views of Commission staff, the Commission, or its Commissioners.

My Role with the Commission

I would like to begin my testimony by explaining my role at the Commission. Starting as a staff accountant my duties were to conduct examinations of registered broker-dealers and transfer agents. The examinations were designed to determine the registrants’ compliance with the Securities Act of 1933 and the Securities Exchange Act of 1934, with particular emphasis on the anti-fraud provisions. I became a first line supervisor (branch chief) in 1997, where I became deeply involved in making many of the decisions regarding the direction of the Fort Worth broker-dealer examination program. In 2003 I was promoted to an assistant director position where I became responsible for running the broker-dealer program. In that role two first line supervisors as well as nine examination staff and one support person reported to me.

The Stanford Examinations

First, I would like to note that I am just a representative of the many highly experienced and skilled examiners who have done their best to protect all investors including those defrauded by Stanford. I know this may not provide comfort and certainly doesn’t lessen the Stanford victims’ losses in any way, but I and the examination staff truly care about being an advocate for the investor. Behind the public, impersonal face of a large institution like the SEC are many individuals that truly mourn your loss.



The intertwining of my career with Stanford started simply enough. In August 1997, I had just been promoted to the position of first line supervisor. One of my responsibilities was to select broker-dealers in the Fort Worth Region for examination. In an effort to familiarize myself with the registrants and to target high risk firms for examination, I began by reviewing the annual filings required by all registered broker-dealers. Stanford’s filings immediately stood out in the review process because the firm was generating millions of dollars in revenue although it had only been in existence for two years. Furthermore, the firm had generated all of the revenue by engaging in a business model which typically offered very little revenue – selling certificates of deposit (CDs). In a more typical situation at the time, a broker-dealer would receive perhaps $50 to $100 for the sale or referral of a CD.



In August 1997, I assigned an experienced and highly skilled examiner to go to Houston to analyze Stanford’s revenue stream, its methods of product distribution, and its sales practices. In only a week the examiner was able to collect enough evidence to suggest that Stanford was engaged in a fraudulent scheme – most likely a Ponzi scheme. Our conclusion was based on a significant capital infusion of funds into the broker-dealer, the source of which appeared to be investor funds. We also noted apparent misrepresentations regarding the safety and security of the investments. It was highly unlikely that the high returns being paid to investors from the CDs along with the high recurring referral fees being paid to Stanford’s broker-dealer could be generated without engaging in significant risk.



Before the end of September 1997, we reported our findings to enforcement in the Fort Worth office. Although the examiner, the associate regional director and I were anxious to get enforcement to act on our concerns, we were met with little enthusiasm. By January of 1998, when the associate regional director retired, we had yet to persuade enforcement to open an investigation. However, before the associate regional director left the Commission, she repeatedly reiterated her concerns to both the examination and enforcement staff. She also encouraged me to keep fighting for the Stanford investors.



In May 1998, after receiving an inquiry from another agency regarding Stanford’s activities, enforcement decided to open a preliminary investigation. Then, in June of that same year, Fort Worth’s investment advisory examination group started an examination of Stanford to, in part, follow up on the broker-dealer examination findings. By the beginning of July the investment advisory group also had substantial concerns regarding Stanford’s business model.



In July of 1998, I was summoned to the office of the associate director for enforcement for a meeting. I recall that he discussed some of the reasons why a decision had been made to close the investigation, but I don’t recall what any of those reasons were. Unfortunately, my clearest memory of that meeting is leaving his office feeling absolutely heartsick.



In November of 2002, the investment advisory examination group again conducted an examination of Stanford. The group found significant problems at the firm including failing to meet its fiduciary duty to clients. As I had in 1998, I was involved in multiple discussions with the investment advisory lead examiner about how obvious the fraudulent scheme seemed to be, but how difficult it seemed to get action from enforcement regarding this particular set of circumstances. In fact, rather than opening an investigation, enforcement advised the investment advisory examination group that it would be referring their findings to the Texas State Securities Board. I was disappointed in enforcement’s decision. It made no sense to me that enforcement would refer such a complicated scheme to an agency which had a far more limited jurisdictional reach.



In approximately September of 2004, the associate director for examinations asked me to make Stanford an examination priority. This was the same associate director for examinations who was in place at the time of the 2002 examination program and he was gravely concerned about Stanford’s activities. I considered this assignment to be a tremendous challenge. I had no doubt that we would find numerous indicia of fraud, but I was extremely concerned about how I could convince the same associate director of enforcement, who had declined to investigate Stanford three times earlier, that there was any reason to pursue an investigation this time? However, we both concluded that my concerns were trivial compared to our mission to protect the investing public.



In October 2004, two examiners who I considered to be some of the best in the Commission went to Houston and began another examination. Meanwhile, an attorney advisor assigned to the examination staff and I began to develop alternate strategies to pursuing the investigation so that we could overcome any previous objections raised by enforcement staff. Since we could not gain access to financial records held in a foreign country, we worked with examiners to develop objective analytical methods to demonstrate what we believed to be the impossibility of Stanford’s purported returns.



In March of 2005, as we were nearing completion of the examination, a summary of our findings and conclusions were presented at a regional regulators’ meeting. The immediate reaction from both the Fort Worth regional director and the associate director for enforcement was decidedly negative.



Around the time of this fourth unofficial declination to pursue an enforcement investigation, the associate director for enforcement announced his imminent departure from the Commission. I decided that the best course of action was to wait until he departed the Commission to officially refer our findings.

Opening the Stanford Investigation

Within two or three weeks of the just mentioned meeting, when the associate director for enforcement departed, I referred the examination to an assistant director in enforcement who I believed would be more likely to tackle an investigation into Stanford. The assistant director immediately responded to the referral; however, he too, was also soon departing the Commission so it was referred to another assistant director in enforcement. The new assistant director initially reacted with great enthusiasm and even considered filing an emergency court action which would halt the apparent fraud immediately. However, he soon took on a much more negative view of the facts and circumstances. Eventually, enforcement asked us to refer the case to the self-regulatory organization FINRA. Although we complied with the request, we remained undaunted in our determination to move Stanford forward into an SEC investigation. Just as in the case of the referral to the Texas State Securities Board, it seemed difficult to imagine that an agency with a smaller jurisdictional net could be as well-equipped as the SEC to tackle such a significant investigation. We continued to work on developing legal theories and case strategies. Despite our efforts, in approximately October of 2005, the assistant director announced his decision to close what had been up to now only an informal, or preliminary, investigation.



I did not accept his decision. I implored the new acting regional director of the Fort Worth office as well as the new head of enforcement to keep the investigation open and moving forward. It was agreed that I and the assistant director of enforcement would each prepare a memo explaining our opposing viewpoints and discuss them at a meeting. I’d like to believe that I wrote a very compelling memo and that is why it was ultimately decided to keep the case open, but the truth is that where there are that many indications of fraud, it is easy to be persuasive.



It should be noted that despite the decision to move forward with the investigation, it took another eleven months with little activity occurring on the investigation before a formal investigation was finally opened.

Institutional Influences Affecting the Stanford Investigation

Before I discuss my views on the causes for the long delay of the Stanford investigation I want to take a moment to express my personal admiration for the enforcement staff members who were able to overcome significant obstacles and obtain the critical evidence necessary to bring an action against R. Allen Stanford and his companies. Their hard work has continued in both the current litigation and in efforts to build cases against others involved in the Stanford fraud. It would be difficult to imagine a more talented or dedicated group of professionals. I believe that the public is well-served by having such individuals devote their life’s work to investor protection.



Much has been made of the former SEC-wide institutional influence that created an institutional bias against matters that were resource intensive and whose outcome was less than certain. Stanford was such a matter. There is no question that during the early Stanford timeframe, the Fort Worth office’s management firmly believed that the office’s success was measured strictly by the number of cases filed each year. Additionally, In Fort Worth, “beating” other offices by filing a greater number of cases was the highest goal. That is not to say that the Fort Worth staff did not bring meaningful cases; they did, and they should be credited for doing so. A prime example is the office’s 2002 case against a Houston energy company, Dynegy Inc., for accounting improprieties involving special-purpose entities and “round-trip” or “wash” trades. Another example is the office’s 2004 enforcement action against foreign-based oil companies Royal Dutch Petroleum Company and The “Shell” Transport and Trading Company, p.l.c., in connection with their overstatement of 4.47 billion barrels of hydrocarbon reserves. The companies paid a $120 million penalty.



The good news is that things are changing. In that regard, I want to commend Mr. Khuzami’s recognition that the evaluation of an office’s performance should include factors such as the quality, difficulty and programmatic significance of cases; the consideration of “quantity” has been placed in proper perspective. This can only encourage management decisions to be aligned with the public good.



I also want to express my appreciation to Mr. Khuzami for publicly acknowledging that the Commission could have taken a more imaginative approach to investigating Stanford. I urge Mr. Khuzami to carry that sentiment forward in the Commission’s approach to investigating other novel situations. A culture that has greater appreciation for thinking “outside the box” will well serve the interests of investors.

Raising Concerns about a “Quick-Hit” Mentality in Examinations

Unfortunately, the mentality that motivated managers in Fort Worth to sometimes ignore the best interests of the public in favor of a race for numbers has not been limited to the enforcement program.



In Mid-2006, after nearly nine years of on-again off-again battling with enforcement regarding Stanford, a new Associate Director for Examinations was hired. In short order it became clear that the new Associate Director wanted to create a culture within the examination program that mirrored enforcement’s emphasis on generating numbers. I feared the consequences of shifting from focusing on high risk examinations such as Stanford, to competing with other regional offices for statistical superiority. I expressed my concerns regarding this new approach, but my concerns were dismissed.



In the fall of 2007, the associate director for examinations announced her plan to have us conduct a new type of broker-dealer examination which would consist of interviewing a few senior personnel at brokerage firms over the course of a half day while reviewing limited, if any documentation. I found that plan to be nothing short of a subversion of the core mission of the examination program.



I had always focused Fort Worth’s regional broker-dealer examination program on the primary goal of protecting investors by rooting out fraud and other serious issues. This approach was based on the same tried and true core principles espoused by Director di Florio, recommended by the SEC’s Inspector General in the wake of the Madoff Ponzi scheme, and exemplified by the Fort Worth examination program’s work on Stanford. For example, during my tenure in management in Fort Worth: Examinations were selected based on high risk brokerage practices;



■Examinations were staffed by capable, well-qualified examiners;

■There was meaningful interaction and coordination with the investment advisory examination group;

■There was regular and consistent communication with enforcement staff;

■There was frequent coordination with other regulatory agencies; and

■Examinations were completed in a timely, efficient, and well-documented manner.

These practices quickly identified concerns about Stanford and they were key in developing other significant cases. For example, in 2006, the broker-dealer and investment advisory examination teams along with input from FINRA’s enforcement division devoted significant resources to the review of the sales practices and the investment products being sold to military members. We were successful in helping to bring not only an enforcement action against one of the largest brokerage firms selling to military members, but also our findings were instrumental in Congress’s 2006 decision to enact the Military Personnel Financial Services Protection Act which prohibited future sales of periodic payment plans.



I, and one of the first line supervisors who worked at my direction, Joel Sauer, explained why these mini-examinations would offer no discernable value to the broker-dealer program. We already had extensive information on each firm through past examinations, through quarterly filings, and through the information provided by FINRA which conducted routine examinations on a regular, frequent schedule. Furthermore, such examinations would be at the expense of meaningful program priorities. The Associate Director stated that she wanted a significant increase in numbers and this is how we would do it. The Regional Director concurred with the Associate Director.



Since local management refused to even discuss our concerns, I contacted headquarters, about the Associate Director’s examination proposal. Despite protracted resistance from the Associate Director, OCIE ultimately quashed the mini broker-dealer examinations for some of the same reasons that Mr. Sauer and I had initially expressed.



I paid a heavy price for complaining. First I received a Letter of Reprimand for not being supportive of the Associate Director’s “program initiatives” and for contacting OCIE regarding the Associate Director’s failure to follow OCIE guidelines. Two months later, in June 2008, I was transferred to a new position.



Mr. Sauer complained to the then Chairman, Executive Director and the Director for OCIE for the mistreatment I received. In response he received a Letter of Counseling, daily monitoring, and a Letter of Reprimand for complaining about the Regional Director and the Associate Director. The associate director and regional director made the situation so antagonistic that Mr. Sauer was eventually left the Commission. Only the year before Mr. Sauer had received an award for examination excellence, submitted by these same individuals.



I believe my new position was truly an attempt to drive me out of the Commission. I was assigned to report to the Regional Director (who retired last month) who would at times go weeks or even months intentionally avoiding any contact with me. At times I was not only ignored, but was actively rebuffed in my attempts to perform at a fully functioning level. My responsibilities and duties have generally been undefined and those that have been assigned are generally not commensurate with my pay grade and salary. I have been excluded from training and participation in management meetings or decisions.



Despite these limitations, I have done my best to be productive and effective as well as taking every advantage to learn and grow. I have become more involved in the enforcement investigative process. I have developed relationships with the public affairs office and become more extensively involved in investor education. I have organized training sessions for local staff and other regulators in the region on oil and gas fraud. I took advantage of the opportunity to lead or be involved in four examinations, two of which were with examiners in other regional offices. I’m proud to say that all four resulted in enforcement referrals and the respondents are in the process of settling charges with the Commission or are being actively investigated. There is no doubt in my mind, though, that my situation has diminished my ability to serve the investing public.



The Inspector General released a report in September, 2009 which recommended potential discipline for the associate Director and the regional director (who has since retired), for retaliating against Mr. Sauer and myself. The Commission has failed to discipline any one, at least not visibly, nor has there been any effort made to restore me to a position with similar duties and responsibilities to the one held before.



My situation should not be viewed in isolation. It is part of a cultural problem which continues to impact the Commission’s effectiveness. As Mr. di Florio pointed out in his testimony before the Senate’s Committee on Banking, Housing and Urban Affairs in September of 2010, in a self-assessment of OCIE it was concluded there was a need to create an environment for the staff to have open, candid communication and personal accountability for quality. I urge you to seek the trust of the staff by acting on those situations, such as the one in Fort Worth, where management has not fostered the desired environment.



I believe I have been very successful in serving the investing public. I have spearheaded many examinations that resulted in significant findings of fraud and monies recovered for investors. The types of cases I’ve worked on have varied from misconduct on the part of municipal officials, market manipulation, late trading in mutual funds, churning variable annuities, theft, selling inappropriate mutual fund share classes, issuer fraud in private securities, Ponzi schemes and misrepresentations and omissions in the sale of securities to name just a few. I’m proud to say that I have worked on cases where I helped stop fraud against the elderly, military members, municipalities and public institutions, affinity groups and hard-working blue-collar and professional individuals.



Many have asked me why I haven’t left the Commission over the course of the last several years. My answer has always been the same. I believe passionately in the mission of the SEC. I am proud to have devoted most of my professional life to the service of the investing public. I have tried to serve with honor and integrity. I am grateful for the many strong relationships I have developed with managers and staff throughout the Commission, which have kept me going through this difficult period. I am proud of the many accomplishments of the examiners and managers with whom I have worked all of these years. I hope I am fortunate enough to spend the remaining part of my career in the service of the Commission.

Source: Securities And Exchange Commission

Preuitt says she paid ‘heavy price’ for protesting SEC handling of Stanford probe

An SEC employee who fought for years to get the agency to stop an alleged massive Ponzi scheme told a House panel that she “paid a heavy price” for protesting her boss’s weak approach to exposing such scams.

In prepared testimony on Friday, Julie Preuitt, a longtime employee in the Securities and Exchange Commission’s Fort Worth office, said she was given a letter of reprimand and in 2008 was reassigned to report to a regional director “who would at times go weeks or even months intentionally avoiding any contact with me.”

She said she interpreted her transfer as an effort to drive her out of the agency, and she argued that the move was “part of a cultural problem” that continues to undermine the SEC’s effectiveness.

Preuitt was called to testify before the oversight panel of the House Financial Services Committee on the SEC’s failure to stop Robert Allen Stanford’s alleged $7.2 billion Ponzi scheme. The SEC’s bungling of the Stanford case and the alleged retaliation against Preuitt were the subject of news stories and SEC inspector general reports almost a year ago. House Republicans revisited the subject Friday against the backdrop of a largely partisan battle over how much funding the agency should receive.

Democrats have generally argued that the agency needs a substantial budget increase to prevent more big financial frauds and crises like the 2008 meltdown that left the nation’s economy reeling.

Some Republicans have countered that the agency’s past failures render it undeserving of such a funding boost. They have invoked such embarrassments as the SEC’s failure to stop Bernard Madoff’s Ponzi scheme and a scandal in which agency employees were viewing pornography at work.

On Friday, Republicans pressed SEC officials on such sore points as the revolving door between the agency and the industry it oversees and a wasteful SEC office lease.

The SEC didn’t need a bigger budget or more regulations to stop Stanford’s alleged scam, Rep. Randy Neugebauer (R-Tex.), chairman of the oversight and investigations subcommittee, said. The problem was that “people just didn’t do their job,” he said.

The Stanford case was in a sense more egregious than the Madoff fraud because SEC employees recognized for years that Stanford might be running a Ponzi scheme, Neugebauer said.

Preuitt reviewed the Stanford Group in 1997 and concluded that Stanford’s stated financial returns were “absolutely ludicrous,” SEC inspector general H. David Kotz said in testimony Friday. The SEC then flagged Stanford Group as a “possible Ponzi scheme,” Kotz said.

In the years that followed, SEC examiners repeatedly pressed the agency to investigate, but the SEC enforcement staff made little if any meaningful effort to do so, Kotz said. Senior officials in Fort Worth thought they were being judged on the number of cases they brought, and they discouraged work on cases that were not quick hits or or slam dunks, Kotz said.

In fall 2007, one of Preuitt’s superiors announced a new type of brokerage examination, “which would consist of interviewing a few senior personnel at brokerage firms over the course of a half day while reviewing limited, if any documentation,” Preuitt said in written testimony. Preuitt said the plan was “nothing short of a subversion of the core mission.”

Her superior, Preuitt said, called the plan part of the emphasis on “numbers.”

When Preuitt was reprimanded, another SEC official who complained about the way Preuitt had been treated was also reprimanded, Preuitt said.

The plan for mini-examinations was ultimately quashed, and the inspector general recommended potential disciplinary action against officials for retaliating against Preuitt and her colleague, she said.

But Preuitt said she is unaware of any disciplinary action, and she has not been restored to her former position.

The SEC took enforcement action against Stanford in 2009, after the Madoff fraud heightened awareness about Ponzi schemes.

Committee member Rep. Bill Posey (R-Fla.) asked SEC officials: “Have we canonized Julie Preuitt yet? ... She should probably be running the agency.”

Carlo di Florio, who heads the SEC examination program, said Preuitt showed the kind of determination the agency encourages, and said that the agency is working to give her new responsibilities.

SEC officials said new management at the agency has addressed the problems that the Stanford matter illustrated.

Rep. Michael Capuano (D-Mass.) objected to any implication that the Stanford story is an argument for loosening regulation.

The attitude that the markets will police themselves and “that somehow regulation is not necessary ... is just wrong,” Capuano said.

2nd US House Panel Presses SEC Over Stanford Fraud

WASHINGTON -(Dow Jones)- A former Securities and Exchange Commission official who was faulted for blocking attempts to investigate jailed money manager R. Allen Stanford may be the target of federal criminal inquiry, SEC officials told lawmakers Friday.
Former Fort Worth Regional Office Enforcement Chief Spencer Barasch, after leaving the SEC, sought three times to represent Stanford as he fought the agency's case, and he briefly represented Stanford in 2006. The SEC made referrals to the Texas state bar and the Washington, D.C., bar as well as to criminal authorities to investigate the matter, SEC Enforcement Chief Robert Khuzami said in testimony before the U.S. House Financial Services Oversight Panel.
SEC Inspector General David Kotz told senators in a hearing last fall that he had spoken with the U.S. Justice Department about opening a probe into Barasch.
During the hearing, Rep. Randy Neugebauer (R., Texas) asked Khuzami if he knew Barasch had represented a client before the commission last Friday. "I was not aware of that," Khuzami said.
Neugebauer said that he doesn't believe the Texas state bar has received a referral regarding Barasch.
Lawmakers at the hearing, many of whom said they represent investors in $7 billion of bogus certificates of deposit issued by Stanford International Bank Ltd., expressed dismay that the SEC hadn't disciplined Barasch and other senior enforcement managers who allegedly stifled attempts to investigate the scheme.
"I don't think the agency is going to change much because I don't see anything where people are being held accountable and responsible," Rep. Steve Pearce (R., N.M.) said.
Khuzami and SEC Examination Chief Carlo di Florio testified the SEC couldn't punish people who have left the agency. Barasch left the SEC in 2005. He now leads the corporate governance and securities enforcement team at Dallas law firm Andrews Kurth LLP.
Khuzami noted that SEC ethics rules bar former employees from ever representing clients before the commission on matters in which they had been heavily involved when they worked there.
SEC spokesman John Nester said the SEC can't move to bar a lawyer from appearing before the commission in the absence of a finding in an SEC administrative hearing that the person acted improperly or unethically or if another court enters into a judgment against the person after being sued by the SEC. Lawyers who have been criminally convicted or disbarred also cannot appear before the commission.
Neugebauer asked whether the ethics rules prohibited former employees from advising clients on SEC matters even if they don't serve as the client's agent before the commission. Khuzami said he believed former employees could advise clients on their dealings with the SEC in some situations.
Neugebauer said the rules should be tightened.
Senior enforcement staff in the SEC's Fort Worth office failed for years to open an investigation into the Stanford bank's certificate of deposits despite numerous red flags, including the conclusions of SEC examiners stretching back to 1997 that they were bogus, the SEC's internal watchdog concluded in a March 2010 report.
Stanford has pleaded not guilty to criminal charges, detailed in a 14-count indictment, that he operated the fraud. He is now awaiting trial, set for September, in a federal medical facility in North Carolina where he is receiving psychiatric treatment.
The SEC will soon determine whether victims of the Ponzi scheme should be covered by federal insurance meant to compensate people missing securities held by brokerages, SEC Deputy Solicitor Michael Conley told lawmakers at the hearing.
The SEC will determine "in the next few weeks" whether the Securities Investor Protection Corp. is wrongly refusing coverage to victims of the fraud, he said. Victims of the fraud have argued for years they deserve compensation from SIPC for the amounts they invested, but SIPC found they aren't covered by federal insurance for failed brokerages because the certificates of deposit were being held at a bank.
Julie Preuitt, an employee of the Fort Worth office who used to manage examination staff, testified as part of a second panel of witnesses that she was still being retaliated against for raising concerns a few years ago about a new "quick-hit" approach to broker-dealer examinations being pushed by her superiors. Preuitt tried to bring the alleged Stanford fraud to the attention of investigators in her office several times, beginning in 1997. Her supervisory duties were removed after she confronted her superiors about the broker examinations.
Preuitt told lawmakers she still has little work and no supervisory duties and that her superiors continue to isolate her.
Di Florio praised Preuitt for doing a "terrific job" attempting to uncover Stanford's fraud. He said, "We are working closely with Ms. Preuitt right now to structure a portfolio of responsibilities that we think demonstrate her talents to the fullest potential," including exams "of national significance."

The SEC Doesn't Care About Your Ponzi Schemes

How corrupt, cartelized, and conflict-ridden are industry oversight and enforcement practices in the financial sector? You could set about answering that question by poking through the lurid headlines surrounding Goldman Sachs-the latest being the release of Goldman emails openly contradicting the firm's alibi of first resort, that it lost money on the collapse of the housing market and therefore couldn't have been defrauding investors in its short-shelling Abacus fund, as the Securities and Exchange Commission alleges. Or you could look at the ridiculously conflicted status of credit-rating agencies-which collect their fees from the very investment concerns they're supposed to be clinically and impartially sizing up, and which, in the latter stages of the housing bubble, saw said investment firms hire a steady stream of their former employees to structure their stake in the CDO market. Oh, and these newly minted fund analysts would typically come bearing their own intimate knowledge of the computer models that credit raters employed to grade risk-exposure in the investment world-an arrangement that, as the New York Times' Gretchen Morgenstern notes, "gave bankers the tools to tinker with their complicated mortgage deals until the models produced the desired ratings."

Still, to get a real close-up and personal sense of the deeply rigged game of financial oversight, it's hard to beat the SEC's Inspector General's report on the agency's flubbed investigation of R. Allen Stanford, the Texas-born, Antiguan-knighted lord of an offshore Ponzi scheme that bilked investors of more than $7 billion. That report, as it happened, dropped the same day that the SEC announced its fraud complaint against Goldman, which would explain why you haven't heard much about it since.

As detailed in the IG report, the Stanford fund operated pretty much on the same basis that the operatic frauds of Bernie Madoff did, promising investors returns on Antiguan certificates of deposit that far outstripped normal market returns. And much as was the case in Madoffland, there was simply no there there in Stanford's business model-he was just using the money of new fund investors to artificially inflate returns for their forerunners.

The shadiness of the Stanford operation first caught the eye of an SEC investigator named Julie Preuitt back in 1997-yes, twelve years ago, in the Clinton era. She investigated the returns Stanford claimed for the fund, pronounced them "absolutely ludicrous," and recommended that the agency launch a formal probe.

The good news is that the SEC's enforcement division tried to do that, eight months after Preuitt's recommendation. The bad news is that when Stanford refused to comply with any of the SEC investigators' requests for documents, they simply let the matter drop

It gets worse, of course. Spencer Barasch, the director of the SEC's Fort Worth office-which had jurisdiction over securities cases in Texas and three other states– reportedly told a fellow SEC attorney that he declined to green light the initial Stanford probe in 1998 after he called Stanford's own attorney, Wayne Secore (himself a former lawyer with the SEC) to ask if there was a case against his client. When Secore, astonishingly enough, replied in the negative, that was evidence enough for Barasch, according to the IG report-though Barasch, solicitous to preserve a reputation for minimal professional competence, told the IG's office that he had no memory of such an exchange, and that it sounded "absurd."

Despite Barasch's best efforts, the Stanford case wasn't going away, though. Investor complaints surfaced against the fund in 2002 and 2003, and Barasch duly shrugged them off. Likewise, when his staff attorneys made fresh pitches for investigations in 2002 and 2005, Barasch declined to pursue them. In the latter instance, Victoria Prescott, the lawyer presenting the case for a Stanford probe, recalled that Barasch looked "annoyed" during her talk, and told her he had "no interest" in the idea. "And I no sooner sit down, shut up and the meeting ended, but then I get pulled aside and was told this had already been looked into and we're not going to do it," Prescott told the inspector general's office.

There were institutional reasons behind the Fort Worth office's dilatory handling of the case, the report notes-the division's managers liked more direct and simpler prosecutions that helped boost its enforcement stats, and the challenge of getting subpoenas executed in an offshore investment haven like Antigua promised a number of grinding procedural headaches.

Still, the principal inconvenience a Stanford investigation seemed to present was to Barasch's resume. He left the agency in 2005 to follow the Wayne Secore career path in white-collar criminal defense work-and according to the IG report, made three separate pitches to represent Stanford himself. After the second such pitch in 2006, Stanford indeed hired Barasch on, and the lawyer billed the fund manager for analyzing "documentation received from company about SEC and NASD matters." Barasch even called his former assistant director, who by this time was trying to revive inquiries into the Stanford fund, with the ham-handed request "[c]an you work on this?" The patient soul on the other end of the line then told Barasch, "I'm not sure you can work on this." Barasch's interlocutor was right: When he belatedly put in for ethical clearance from the SEC to represent Stanford, it was denied.

Barasch was undaunted, though-he actually contacted Stanford a third time, in 2009, after the SEC finally got around to swearing out a complaint against the fund manager. Again, an ethics official at the SEC refused to clear the arrangement-telling the inspector general that "he could not recall another occasion when a former SEC employee had contacted his office on three separate occasions trying to represent a client on the same matter." As he pushed to get the request approved, Barasch assured the agency that the 2009 case "was new and was different and unrelated to the matter that had occurred before he left" the SEC-somehow neglecting to note that his consistent posture regarding Stanford during his tenure was to deny each and every request for any Stanford-related "matter" to proceed in the first place. Barasch was at least admirably candid in his reply when the ethics official asked him to explain his persistence in seeking to sign on Stanford as a client: "Every lawyer in Texas and beyond is going to get rich on this case. OK? And I hated being left on the sidelines."

It's hard to imagine any better summing-up of a regulator's dominant worldview during the deregulatory binges of the Clinton-Bush age. Unless, that is, one were to choose the testimony of Hugh Wright, Barasch's predecessor as head of enforcement in the SEC Fort Worth office. "Spence was a real bright guy," Wright told Dallas Morning News reporters Eric Torbenson and Dave Michaels, "but I didn't trust him, because he lied a lot."

“The Stanford Ponzi Scheme: Lessons for Protecting Investors from the Next Securities Fraud"

Friday, May 13, 2011 10:00 AM in 2128 Rayburn HOB
Oversight and Investigations


Click here for the Archived Webcast of this hearing.

WITNESS LIST

Panel I

Mr. H. David Kotz, Inspector General, Office of the Inspector General, U.S. Securities and Exchange Commission

Mr. Robert Khuzami, Director, Division of Enforcement, U.S. Securities and Exchange Commission

Mr. Carlo di Florio, Director, Office of Compliance Inspections and Examinations, U.S. Securities and Exchange Commission

Mr. Richard Ketchum, Chief Executive Officer, Financial Industry Regulatory Authority


Panel II

Ms. Julie Preuitt, Assistant Regional Director, U.S. Securities and Exchange Commission Fort Worth Regional Office

Mr. Charles Rawl, former employee Stanford Group Company

Mr. Stanford Kauffman, victim of the Stanford fraud

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Divided Fort Worth office of SEC was plagued by inaction

FORT WORTH -- Julie Preuitt is into NASCAR, stopping con men and doing what she believes is right -- even when it meant flushing her career down the SEC commode.

She was an SEC branch chief examining securities brokers and dealers when a routine look at a company put her on high alert. Preuitt believed her staff had found a scam: An off-shore bank was offering CDs with payoffs that were, to her thinking, "absolutely ludicrous."

It should have been a Tom Clancy moment. But in the Fort Worth regional office of the Securities and Exchange Commission where Preuitt worked, leaders regarded the case as what they called a "goat screw." They passed on orders to kill it.

Snap a picture: It's June 2009. The SEC announces bad news for a Texas billionaire. He's being sued, accusing of running a Ponzi scheme that any aspiring Bernie Madoff could appreciate. Singled out for hard work on the case was the Fort Worth office. Plaudits went to many, including two high-ranking Fort Worth officials.

What the picture doesn't show: The lawsuit against R. Allen Stanford came 12 years and about $7 billion too late.

And the praise didn't go to Preuitt, who first raised concerns in 1997. Instead, two people who pushed Preuitt aside enjoyed the acclaim. That is, until it began biting them on the ankles.

Soon after the announcement, the SEC's watchdog, the inspector general, began getting complaints that the office had not diligently pursued a probe until the SEC came under fire for failing to spot Madoff's Ponzi scheme.

Now, a starkly different image of the Fort Worth office is emerging from the watchdog report, government documents obtained by the Star-Telegram, and interviews with current and former staff members.

They show a troubled organization where senior managers for years resisted efforts to pursue complex cases in favor of the quick and easy that could run up its stats -- and they badly botched the Stanford case in its early years.

"The commission is very interested in a 'fraud of the day.' And [Stanford] wasn't ever the fraud of the day," Preuitt told the inspector general.

Stanford steadfastly maintains he did nothing wrong.

While Preuitt and the examination staff repeatedly flagged the Stanford companies as a Ponzi scheme, enforcement attorneys wouldn't budge. They ignored tips, largely disregarded state and federal concerns, and tried to fob off the matter to a private, less powerful financial regulator. The enforcement staff failed twice to read examiners' reports on Stanford.

All the while, investor losses swelled, the watchdog report says.

While the Fort Worth office was once gun-shy, SEC officials say those failings have largely been resolved since leadership changed and investigative powers were streamlined. They also say that the matter was complex, entangled in international law and a criminal investigation by the Justice Department, among other obstacles.

"I would say the public has every reason to be confident in both the performance and productivity of that office," said Robert Khuzami, head of the SEC's enforcement division in Washington.

"To the extent that there are personnel or other issues, those will be dealt with appropriately," he said. But "the performance of the office has been overwhelmingly positive."

Less focus is now placed on competing with other SEC offices' statistics for the number of cases closed, an SEC document says.

And Rose Romero, a former assistant U.S. prosecutor who now leads the Fort Worth office, said it is operating at its peak in spotting and stopping fraud, even though it has limited resources and a broad region.

"I think right now our staff is probably the best qualified staff that this office has probably ever seen," she said.

The office has rolled out some solid cases. Last year, it halted what it called frauds of $31 million, $24 million and $8.4 million, among others in Texas. An investigator even used Google to root out fraud at a major company.

Yet Romero and Kimberly Garber, who beat out Preuitt to become associate district administrator for examinations, are criticized by current and former staff members as being even more concerned with style over substance. When Preuitt opposed their decision to conduct quick-hit examination reviews, the office divided into two camps.

And Romero and Garber struck back, according to the inspector general.

Some staff members, speaking on the condition of anonymity, said they have no confidence in senior leadership. In Fort Worth, the office's strength had historically been in people like Preuitt, who were impolitic, willing to speak their minds and push co-workers and the D.C. bureaucracy to get things done. Management instead wants "tools to do away with people who have a dissenting opinion," one employee said.

And a lingering issue is how Romero has depicted the Stanford investigation. Testimony she gave to a U.S. Senate committee conflicts with records of her own office.

Apparent red flags

To its earliest investors, Stanford International Bank must have looked like some West Indies gold mine. The Antigua bank offered CDs paying interest rates markedly higher than those of U.S. banks. The Stanford Group Co., which registered with the SEC as a broker-dealer and investment adviser in 1995, was paid high referral fees for selling the CDs.

As early as the mid-1990s, the Texas State Securities Board passed along a tip to the SEC about Robert Allen Stanford's companies. "We actually found problems with Stanford," said Texas Securities Commissioner Denise Voigt Crawford.

By 1997, the Stanford companies caught Preuitt's attention. She wondered how the bank had gained nearly $307 million in deposits in a couple of years.

The watchdog report on Stanford details dogged efforts by Preuitt and the examination staff over ensuring years to find answers and prod enforcement to take action.

The first examination found apparent red flags. Preuitt concluded that the CDs were fraudulent. The staff labeled it a "Possible Ponzi scheme." The examination report was forwarded to enforcement, where it sat for eight months.

At the time, the Fort Worth office was led by Harold Degenhardt. He believed that the SEC was a beast that fed on a constant diet of cases. "As a result, cases like Stanford, which were not considered 'quick-hit' or 'slam-dunk' cases, were not encouraged," the inspector general concluded.

The Stanford case fell into the too-complex category. Getting bank records from Antigua would be a problem, enforcement said, and besides, the scheme didn't appear to affect U.S. investors. Preuitt's view: Why would that matter, if a broker-dealer in Houston was committing fraud?

In May 1998, with Degenhardt's approval, enforcement opened a matter under inquiry -- a preliminary look at whether an investigation would be appropriate. The inquiry went something like this:

The SEC asked for documents to be handed over voluntarily.

Stanford's bank refused.

Enforcement didn't try to get permission to issue subpoenas.

The office closed the inquiry three months later.

Meanwhile, another examination scrutinized Stanford's investment adviser operation. An examiner concurred that Stanford "was operating some kind of fraud," the watchdog report says.

Enforcement attorneys didn't bother to read the new 1998 examination, the inspector general reported. And yet they also suspected fraud.

"As far as I was concerned at that period of time, in enforcement we all thought it was a Ponzi scheme to start with. Always did," Hugh Wright, former assistant district administrator for the office's enforcement group, told the inspector general.

Still, the case was seen as too messy. The only thing left was to tell Preuitt because an enforcement chief "didn't expect a very happy response."

She was shocked, she later told the inspector general.

An unread report

In November 2002, the examination staff made a third swing at Stanford, and the matter was assigned the SEC's highest risk rating. But at enforcement, examiners struck out -- their report wasn't even read. Leaders thought the Texas State Securities Board could handle the case.

Enforcement also decided to refer to the state a letter from a woman worried that the life savings of her mother, about 75, were at risk.

The letter went to the state, Crawford said. The exam didn't.

In 2003, more complaints came, including one with dire warnings from a purported Stanford insider: "Stanford financial ... is a massive Ponzi scheme ... that will destroy the life savings of many."

Enforcement referred the letter to exam staff, the watchdog report says.

Preuitt felt she was being asked to go to battle with enforcement. She received a chain of e-mails showing enforcement wasn't interested in a Ponzi scheme that wasn't collapsing. "I love this stuff," Preuitt wrote in an e-mail. "We all are confident that there is illegal activity but no easy way to prove [it]. Before I retire, the Commission will be trying to explain why it did nothing. Until it falls apart all we can do is flag it every few years."

Another crimson flag was hoisted in December 2004. An exam concluded that the Stanford companies were violating numerous securities laws. By March 2005, Degenhardt and the office enforcement chief lowered the boom. The case would not be pursued, they said.

In April, the enforcement chief left, and the examination staff made yet another push.

By June, the office decided to pass the matter to a private regulator with no subpoena power. Enforcement did ask Stanford's bank to volunteer documents -- six days after the bank said it wouldn't provide them.

Tense meetings

Over the next few months, the office was in an all-out battle, as the examination staff -- Preuitt in particular -- fought to keep the investigation alive, even after Degenhardt departed in September.

A case was finally opened. But enforcement was getting cold feet by October 2005.

Upset, Preuitt started an e-mail campaign, the watchdog report says. An enforcement attorney complained that Preuitt's objections were forcing work on him. "Julie is just really passionate about this and is fighting hard ... and so we have to do all this stuff," the attorney said in an e-mail. "It's frustrating."

In early 2006, Romero was named regional director. As the investigation was crawling along, Preuitt, who had become an assistant regional director for exams, and Garber, a branch chief, vied to become associate district administrator for examinations.

Garber won.

Preuitt allies insist she was supportive of Garber. Whatever the case, it got ugly quickly. A conflict shaped up over a Garber initiative to do quick-hit reviews of broker dealers. Preuitt saw them as pointless.

During management meetings, Preuitt and Joel Sauer, a branch chief, voiced disagreements over the initiative, sometimes hotly.

Meetings became tense, with raised voices and "finger shaking" during one gathering.

By June 2008, Preuitt had been written up, pushed aside and stripped of supervising all but one employee, who later left.

Sauer wrote SEC officials in Washington to complain about her fate. The "culture of fear in the ... exam program is pervasive," he wrote. He also complained that Garber used agency funds to book employees at her brother's Kansas bed and breakfast; Romero knew of the family connection but did not object.

Garber responded by writing a letter of reprimand against him for making false statements. She ordered him to be monitored daily.

The inspector general found separately that Garber and Romero had acted inappropriately toward Preuitt and Sauer because of their objections.

Those "improperly led to actions taken against them," according to a September 2009 report. It recommended Garber and Romero face possible disciplinary action. However, they didn't because they cleared their moves with human resources.

On the matter of the Kansas stay, the inspector general found Garber had violated the code of federal regulations by "using her public office for her family members' private gain," according to government documents obtained by the Star-Telegram. She was referred for disciplinary action.

"Appropriate action was taken," Garber said, declining to elaborate.

Preuitt declined to be interviewed. In a statement, she said, "Every working day, I get to devote my energies to thinking of and carrying out ways to prevent, find or stop fraud."

Sauer left the agency. He declined to comment on the matter.

'Performance failures'

Degenhardt and Romero both drew blanks last year on the history of the Stanford case. In a Star-Telegram interview, Degenhardt had indicated he was unfamiliar with it.

"I quite frankly don't know whether the Stanford organization had ever been examined," he said.

He did not respond to messages seeking further comment.

Romero's August testimony to a U.S. Senate committee about the case firmly established its beginning as 2004 and said it was triggered by four tips or complaints. She also said the SEC had followed up on tips over the years. She did not mention the 1997, 1998 or 2002 examinations. She did not explain that enforcement repeatedly tried to ditch the case. Romero declined to comment on her testimony. An SEC spokesman in Washington backed her account.

"The written and oral testimony accurately reflect that the investigation was prompted by several things, including the 2004 exam and tips that were received during the course of that exam. As noted in the inspector general's report, none of the previous examinations resulted in an investigation," he wrote in an e-mail.

It is unclear whether anyone in the Fort Worth office was ever disciplined for the Stanford miscues, even though the inspector general recommended that "performance failures" result in "appropriate action."

Romero declined to talk about any discipline or the inspector general's findings. "What I can say from my personal experience [is] ... both the exam staff and enforcement staff were working together really, really hard to investigate what was a very, very difficult case."

Preuitt remains at the Fort Worth office, with some role in the office's oil and gas task force.

Romero's first version of Preuitt's job: "She is an assistant director and right now she is in charge of the oil and gas task force in implementing" that initiative.

Romero's second version: "I'm in charge of it."

This was also with this article

SEC discontent

As recently as April, a survey showed that discontent in the Fort Worth office persists, according to an e-mail from manager Kim Garber obtained by the Star-Telegram. Personnel complained:

The SEC (and particularly the exam program) has developed a paternalistic culture.

People are being forced to work around those with performance problems, either because they lack tools or management lacks the will to address problems. When managers try to do the right thing, they suffer the consequences, with grievances or complaints to the inspector general.

While confidentiality of personnel actions is critical, high-performing examiners want a strong message to be sent regarding accountability/consequences.

Staffers have learned to effectively use the union as a "threat" to keep managers off their back when addressing destructive/wasteful practices, such as excessive chitchat, long lunches and shortened exam hours.

SEC officials said the survey was part of an effort to be candid about problems.

How this article was reported

This article is based on internal SEC e-mails, a transcript of a Senate banking committee hearing, confidential documents, inspector general reports, and interviews with numerous current and former SEC staff members, among other sources.

SEC's regional offices present managerial problems, become an obstacle to reform

For nearly a decade, Julie Preuitt told her colleagues at the Securities and Exchange Commission's Fort Worth office that she had found problems at a fabulously successful investment firm in Houston, saying its unmatched returns were probably the result of fraud.

But officials in the agency's enforcement division weren't interested in complex cases, just quick-hit lawsuits that would make the regional office look active, according to a review by the SEC inspector general. They brushed off her warnings about the Houston enterprise run by R. Allen Stanford -- only much later exposing it as one of the largest scams ever: an $8 billion Ponzi scheme.

So Preuitt was dismayed in 2007 when the Fort Worth office decided to extend what she feared was the same quick-hit approach to other work. Her complaints centered on a new method of inspecting financial firms that she protested was motivated only by a desire to boost the office's exam statistics. Preuitt was also essentially demoted after vocalizing her complaints, according to a second report by the inspector general.

The introduction of the new inspections, dubbed raves, followed by Preuitt's reassignment, opened a rift between Fort Worth managers and staff that continues today, undercutting the effort by SEC leaders in Washington to rebuild the agency and promote coordination after years of setbacks, according to current and former SEC officials and internal agency documents, including three separate reports by the SEC's inspector general.

Managing the SEC's 11 regional offices has long posed a difficult challenge. Breakdowns in coordination among the New York, Boston and Washington offices, for example, helped Bernard Madoff get away with his Ponzi scheme for years.

These failures are among various agency shortcomings documented over recent years in internal reviews and media reports. The accounts have in part blamed an agency culture that favored easy cases over difficult ones, as well as a deadening bureaucracy and a workload that has overwhelmed the staff.

The Fort Worth office investigates alleged wrongdoing by public companies and financial firms in Texas, Oklahoma and Arkansas and conducts periodic reviews, or "exams," of financial companies. The region is home to some of the country's largest public companies, and most financial firms have major offices there.

Fort Worth's fumbling of the Stanford fraud investigation was discussed in an inspector general's report published two months ago. But its findings that the office failed to act on credible concerns about Stanford -- potentially costing investors more than a billion dollars -- only hinted at broader problems within the office.

Tensions in Fort Worth escalated in 2006 after Preuitt, an assistant regional director for exams, was beaten out by her colleague, Kimberly Garber, for the job of overseeing the office's exams of financial companies. Soon after, Garber told the staff she was interested in boosting the number of exams the office conducted, and later decided to introduce a new half-day exam for brokerage companies that sold investments to customers or traded on their behalf. In these exams, SEC officials would interview management and review company policies for complying with securities rules, but did not examine company records. The end result was a page-long summary.

Several lower-ranking officials, including Preuitt and her deputy, Joel Sauer, protested the new type of review, according to agency documents and current and former officials. Preuitt and Sauer said that the rapid-fire exams were an artificial way of boosting the number of exams the Fort Worth office conducted, were cursory at best and duplicated work being done by other regulators.

Garber decided to proceed with the exams. Preuitt protested vocally and repeatedly, contacting agency officials in Washington to complain about the raves. But agency officials in Washington let them proceed in the hope of spotting more cases of financial fraud, according to SEC spokesman John Nester.

Her superiors -- Rose Romero, head of the Fort Worth office, and Garber -- considered Preuitt antagonistic in the way she voiced her objections. They took action against her, removing Preuitt, a 16-year veteran, from the exam program and placing her in a job with far fewer responsibilities, according to the inspector general's report.

The inspector general said the way Preuitt raised her concerns could be proper grounds for disciplinary action, but not the substance. He concluded that "the connection between [Preuitt's] complaints about program functions and the personnel actions against her" was "inappropriate."

"It's bad whenever you take someone who's got experience and knows what they're doing and kind of put them on the sidelines," said Hugh Wright, a 28-year SEC veteran who formerly ran the examination and enforcement programs in Fort Worth.

Garber and Romero declined to be interviewed for this story. They said Nester spoke on their behalf.

After Preuitt was reassigned, Sauer wrote to Christopher Cox, the SEC's chairman at the time, to raise concerns about the situation and, more broadly, about Garber's management.

In the letter, Sauer also complained about a trip Garber had arranged for her staff to visit state regulators in Kansas. She'd had the team stay in Baldwin City, well outside Topeka, at a turn-of-the-century bed and breakfast called Three Sisters Inn. The inn was owned by Garber's brother and sister-in-law.

In a later review, the SEC's top ethics lawyer concluded that Garber violated the agency's rules by using her public office for private gain of her relatives, the inspector general reported. Nester said "appropriate action was taken" in connection with the Kansas trip but provided no details.

Sauer's letter of concern was forwarded to Romero; Sauer was told by Washington officials that Romero would work on the issues he raised.

But Sauer's supervisors, Romero and Garber, took disciplinary action against him and issued a letter of reprimand for insubordinate behavior, the inspector general found. Sauer quit in 2008. "I am proud of my work at the SEC and the work of the [Fort Worth] examination staff. I will let my record of 13 years of service to the SEC and Texas State Securities Board speak for itself," Sauer said in a statement.

Nester said senior officials in the office had "acted appropriately" by taking the guidance of the SEC's human resources department before taking action against Preuitt and Sauer. Preuitt did not respond to phone calls seeking comment.


Current and former Fort Worth SEC officials said the clash between Preuitt and Garber kicked off a period of ill will between managers and their staff. One official said there was "a lack of trust," saying many front-line examiners disagreed with how Garber treated staff and how she has run the exam program

In Washington, SEC chairman Mary Schapiro and her team have espoused a different approach. They suspended rave inspections across the whole agency, in favor of programs to verify assets claimed by investment companies in the wake of the large number of Ponzi schemes disclosed in the past two years.