ARE MONITARY PAYMENTS SUFFICIENT TO PREVENT A REPETITION?

The Commission brought two more actions in a series of civil and criminal cases arising out of the payments made by a brokerage firm to obtain municipal bond underwriting and interest rate swap agreement business in Jefferson County, Alabama. The criminal case is resolved. Two of the Commission’s actions are on-going, while an administrative proceeding is settled. That settlement with the securities firm raises a critical question about the adequacy of the relief.

The first is a settled administrative proceeding captioned In the Matter of J.P. Morgan Securities Inc., Adm. Proc. File No. 3-13673 (Filed Nov. 4, 2009). This action alleges that, over a two year period beginning in 2002, the securities firm, through former managing directors Charles LeCroy ad Douglas MacFaddin, paid more than $8.2 million at the direction of local county commissioners essentially to obtain business.

The payments were made to close friends of the county commissioners who either worked at, or owned, local broker dealers. The individuals who received the payments had no official role in the transactions and typically performed few if any services. These fees, in many instances, dwarfed those paid to others involved in the deals such as the lawyers and bankers who advised the county and worked extensively on the transactions. In taped telephone conversations Messrs. LeCroy and MacFaddin referred to the payments as “payoffs,” “giving away free money” or “the price of doing business.”

In return for the payoffs, the county commissioners were instrumental in directing the offering and swap business to J.P. Morgan Securities. In the offerings, not only did the firm fail to disclose the payments made to direct the business to it, but the “payoffs” were incorporated into higher swap interest rates charged to the county thereby increasing the transaction costs for the government and the taxpayers. The Order for Proceedings states that J.P. Morgan Securities willfully violated Section 17(a)(2) and 17(2)(3) of the Securities Act as well as Section 15B(c)(1) of the Exchange Act and MSRB Rule G-17.

To settle the case, the securities firm agreed to make a $50 million payment to Jefferson county and to terminate all obligations of the county to make any payments to J.P. Morgan Chase Bank under the swap agreements. In addition, the firm consented to the entry of a cease and desist order, a censure and to pay a penalty of $25 million which will be placed in a Fair Fund.

A second case was brought against Messrs. LeCroy and MacFaddin, SEC v. LeCroy, Civil Action No. CV – 09-U/B 2238-S (N.D. Ala. Filed Nov. 4, 2009). The complaint in this action is based on the same conduct detailed in the J.P. Morgan Securities action. The complaint however, alleges violations of Section 17(a) of the Securities Act and Sections 10(b) and 15B(c)(1) of the Exchange Act as well as violations of rules of the Municipal Securities Rulemaking Board. See also Litig. Rel. 21280 (Nov. 4, 2008). This case is currently in litigation.

Previously, the SEC brought an action based on essentially the same conduct against certain local officials, discussed here. SEC v. Langford, Civil Action No. cv-08-B-0761-S (N.D. Ala. April 30, 2008). That action is pending. The defendants in that action were also charged in a criminal case, discussed here, U.S. v. Langford, Case No. 2:08-CR-00245 (N.D. Ala. Filed Dec. 1, 2008). Defendants Albert LaPierre and William Blount have pleaded guilty and agreed to pay certain forfeitures. Mr. Langford was convicted on 60 counts of bribery, mail fraud, wire fraud and tax evasion. The three defendants are awaiting sentencing.

In these cases, the taxpayers were the victims of greedy local officials who obtained millions of dollars for the friends and a broker hungry for business. The settlement in the administrative proceeding against the broker should help local taxpayers recoup their losses. It does not however, provide any significant assurance against a replication of the conduct in the future.

A key point of a Commission action is not only to discover and halt violations, but to ensure that they do not reoccur. While the payment to the county and the penalty have, respectively, a remedial impact in the nature of restitution and a punitive, deterrent effect neither assures against future repetition.

The conduct here, at its core, is a simple bribery scheme using millions of dollars of money belonging to the securities firm. The repeated bribes over a two year period raise a critical question regarding the adequacy of the firm’s compliance procedures and its controls. Yet, no new procedures are being instituted. No safeguards have been undertaken to prevent a reoccurrence. To ensure against a future repetition of this kind of conduct appropriate procedures should have been included in the settlement.

MADOFF ACCOUNTANT PLEADS GUILTY, IS RELEASED ON BAIL

David Friehling, auditor through his CPA firm of Bernard L. Madoff Investment Securities LLC and its predecessor, pleaded guilty to a nine-count criminal information and agreed to certain forfeitures. Mr. Friehling also entered into a cooperation agreement with the government. Comments at the time of the plea suggest he will implicate others in the fraud, although he apparently denied knowing about the Ponzi scheme. The court agreed to his release on bond. U.S. v. Friehling, Case No. 1:09-mj-00729 (S.D.N.Y. Filed July 17, 2009).

The nine-count information, filed on Tuesday, charged Mr. Friehling with one count of securities fraud, one count of investment adviser fraud, four counts of making false statements to the SEC and three counts of obstructing the administration of the internal revenue laws. Essentially, the information alleges that Mr. Friehling, a CPA practicing as a sole practitioner through Friehling & Horowitz, CPAs, from at least the 1990s through 2008 represented that he conducted audits of the Madoff firm in accord with generally accepted auditing standards when in fact he did not. Among other things, Mr. Friehling, according to the information: failed to conduct independent verification of the assets; failed to review material sources of revenue including commissions; failed to examine a bank account through which billions of dollars of client funds flowed; failed to verify liabilities related to the Madoff client accounts; and failed to verify the purchase and custody of securities by the firm.

Mr. Friehling also falsely represented that the financial statements of the Madoff firm had been prepared in accordance with generally accepted accounting principles. In fact, they were not because, among other things, Mr. Friehling did not meet the required independence standards. He and/or his wife had an investment account at the Madoff firm. At the end of each year between 1995 and 2007, that account had an equity balance of at least $500,000. Mr. Friehling also filed false reports with the SEC.

At the Tuesday hearing, Mr. Friehling pleaded guilty to each of the counts in the information. Some reports indicate that during the hearing he denied knowing that Bernard Madoff conducted a Ponzi scheme, although that allegation is not specifically contained in the information. He reportedly was asked by the court at one point who else was involved. The question was not answered at the request of the government.

As part of the plea, the defendant agreed to forfeit approximately $3.1 million. That represents the total amount of compensation he received from Madoff along with the sums he and his family withdrew from his investment account. He also agreed to forfeit certain properties traceable to the scheme. As part of the plea arrangement, Mr. Friehling entered into a cooperation agreement with the government. Following the plea, the court directed his release on a $2.5 million bond.

In the parallel SEC action, Mr. Friehling consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the Securities Act, the Exchange Act and from aiding and abetting violations of certain provisions of the Investment Advisers Act. The resolution of all monetary issues has been deferred. SEC v. Friehling, Case No. 09 CV 2467 (S.D.N.Y. Filed March 18, 2009); See also Litig. Rel. 21274 (Nov. 3, 2009).