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Moral Hazard at the SEC

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Moral Hazard at the SEC


Moments after first mention of the word “bailout” came the first of many references to the inevitable outcome: moral hazard, which is the term used to describe the direct correlation between the irresponsibility of one’s behavior and the degree to which one is insulated from responsibility for said behavior.

Moral hazard is observed in any decision-making entity – including individuals, corporations and even government regulatory agencies – and in extreme cases helps to explain many of their otherwise inexplicable actions. Indeed, when attempting to understand much of what happens at the Securities and Exchange Commission (SEC), I believe moral hazard is nearly as important a factor as the much more frequently-discussed matter of regulatory capture.

The following case illustrates this quite aptly.

In his most recent report to Congress, David Kotz, Inspector General of the SEC, summarized an internal report prepared by his office in which two unnamed enforcement attorneys were found to have provided information on non-public SEC investigations to an unnamed short-seller and an FBI agent. It’s apparent that the short-seller and FBI agent are the infamous Anthony Elgindy and Jeffrey Royer, respectively. The identities of the two SEC investigators who enabled them, on the other hand, are not clear.

Hoping to learn more, longtime SEC critic Dave Patch requested and received the IG’s full report on the matter (get your copy here!). Months later, the report arrived, though redacted by SEC censors (not affiliated with the IG’s office) to the point of near incomprehensibility. None the less, thanks to a single missed redaction and extensive cross-referencing of facts mentioned in the report, we’ve established the identities of both SEC employees.

They are: Douglas Gordimer and Robert Long, both senior investigators at the SEC’s Fort Worth regional office. Knowing this, it’s possible to fill in almost all of the holes left by SEC censors, and better understand the enabling role that organization played in the Elgindy/Royer scams.

It all began in March of 2000, when Royer, then a special agent with the FBI’s White Collar Crime Unit, contacted Gordimer about Broadband Wireless (BBAN), a public company Royer was investigating. We know from other sources that Royer would later inform Elgindy associate Derrick Cleveland of the subsequent SEC investigation into BBAN, and that both Cleveland and Elgindy illegally (and profitably) used that information to short the company’s stock ahead of the investigation’s disclosure.

The BBAN situation apparently gave Elgindy a really bad idea: to use Royer as a conduit for acquiring negative, confidential information about potential shorting targets, and as a catalyst for launching SEC investigations into companies Elgindy was already shorting.
According to the IG report:

During the course of the BBAN investigation, Royer began to contact Gordimer to “try to get the Commission to investigate” various other companies and individuals based on information that Royer provided to Gordimer. Royer would tell Gordimer that “he had some information about [alleged securities laws violations by public companies] that he wanted to pass along” and would ask “who at the SEC might have an open investigation about the company.” (OIG-512 report p.4)

In response to Royer’s requests, Gordimer acknowledged that he would perform a search in the NRSI database, which he described as “an internal SEC database that shows all the open investigations and closed investigations and filings of different entities,” to determine if the SEC currently had an open investigation for the company or individual. (OIG-512 report p.5)

In addition to providing this information, according to Gordimer if there was an existing investigation of the company or individual about which Royer had inquired, Gordimer would refer Royer to the SEC staff attorney conducting the investigation. If the SEC did not currently have an open investigation of the company or individual about which Royer inquired, Gordimer would take the information from Royer and look into it himself. (OIG-512 report p.5)

Gordimer testified that he knew Royer lacked the proper authorization to request such confidential information, but that he freely provided it anyway.

In September 2000, Royer’s involvement in the FBI’s White Collar Fraud unit ceased as he was transferred to Gallup, NM, tasked with investigating crimes on an area Indian reservation. And yet, Royer’s calls to the SEC continued, and in January 2001, Royer also began calling Robert Long, probing for information on confidential investigations and lobbying to get others started.

During this period, Gordimer and Long also began to deal directly with Elgindy, and both became frequent readers of his website, insidetruth.com.

Later in 2001, Gordimer acknowledged that he became aware of a correlation between the stocks that Royer asked him to investigate and the stocks that Elgindy discussed on insidetruth.com. Despite knowing about this correlation and Elgindy’s background, Gordimer insisted that Royer “wasn’t just fishing” for information by continuing to bring information to him, particularly as some of this information had resulted in the opening of a few “legitimate investigations.” (OIG-512 report p.7)

Royer informed Gordimer in January 2002 that “he was leaving the Bureau to go work for some investigative agency which…was associated [with] Elgindy. Gordimer later learned that Royer had received a job offer from Elgindy directly and that Royer would be working with…the company running Elgindy’s insidetruth.com. (OIG-512 report p.7)

Meanwhile, Royer’s requests for information about investigations into public companies slowed but did not stop, though Gordimer felt it prudent to no longer tell Royer exactly who was handling any active investigations, opting instead to provide the relevant SEC staffer with Royer’s number and instructions to get in touch with him. Either way, the outcome is the same: disclosure of confidential, highly material information to a business partner of known short seller Elgindy, despite past evidence of a correlation between such disclosures and shorting activity by Elgindy.

But wait, there’s more.

Despite the fact that Royer left the FBI altogether, Gordimer contacted Royer about an alleged false press release issued in March 2002. Gordimer said he needed information about the company “quickly” in order to determine whether the SEC should suspend trading of its stock.

The IG’s report summarizes the situation nicely as follows:

Therefore, by disclosing information to Royer about whether certain companies and individuals were under investigation, Gordimer released non-public information to Royer. Royer would then provide this information to Elgindy and his associates, and they would sell short the companies’ stock in order to earn illegal profits…By discussing non-public information with Royer without appropriate agency authorization on numerous occasions, the OIG finds that Gordimer repeatedly violated SEC policy. (OIG-512 report p.9)

Normally, such an overt pronouncement of culpability would equate to an explicit demand for one’s resignation, if not one’s termination. But lacking such authority, Kotz was forced to pass the baton to just about every one of Gordimer’s and Long’s superiors.

In light of the foregoing, these matters are being referred to the Director of Enforcement…the Associate Executive Director for Human Resources, the Associate General Counsel for Litigation and Administrative Practice, and the Ethics Counsel for consideration of disciplinary action against Gordimer and Long. (OIG-512 report p.13)

The outcome?

According to Kotz, “[Gordimer and Long] were issued written counseling memoranda and were required to attend training.” (OIG Semi-annual report, April 2010 p.67)

In other words, neither was held responsible for their deeply irresponsible behavior. And, in such a setting, the principle of moral hazard dictates that behavior will become increasingly irresponsible.

And it’s about to get much worse.

The only reason we know what little we do about the SEC’s culture of irresponsibility is the Freedom of Information Act (FOIA), which imposes much transparency on government by empowering citizens seeking access to official records. It was through FOIA that we were finally able to grasp of the true depth of the illegal naked shorting problem. FOIA also helped to identify the motives behind the illegal firing of SEC investigator Gary Aguirre and the extent of the Commission’s failures in stopping the Madoff and Stanford Ponzi schemes. And not least, FOIA made it possible for Dave Patch to acquire the above-cited internal report detailing the SEC’s role in supporting Anthony Elgindy’s illegal trading racket.

In each of these cases, the SEC was held responsible for its screw-ups only after documentary evidence was revealed – and that was only possible through FOIA requests submitted by the public and news organizations.

Today, Fox Business reports that the SEC is claiming Section 929I of the recently-signed financial reform bill exempts it from complying with FOIA. In other words, the SEC currently finds itself in a regulator’s wonderland: all of the authority and none of the accountability. If ever there was a reason to urgently contact your representative in Congress, this is it. That body must be made aware of the disaster of unintended consequences buried in the legislation they just passed. Please contact yours immediately (you can find their contact information here).

Postscript: to learn more about the Elgindy/Royer case, check out his excellent report from the series American Greed.

Posted in Featured Stories, Our Captured Federal Regulator the SEC, The Deep Capture CampaignComments (74)

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