PONZI SCHEME HALTED AFTER MORE THAN A DECADE

In the wake of the market crisis, Ponzi scheme cases continue to be a staple of SEC enforcement. It seems the turmoil in the markets in recent times is exposing the schemes. SEC Chairman Schapiro cited these actions last week in discussing significant cases the division is bringing. Speech by SEC Chairman: Keynote Address at the Compliance and Legal Society of the Securities Industry and Financial Markets Association 2010 Annual Seminar, May 6, 2010. Likewise, criminal prosecutors are also bringing an increasing number of Ponzi scheme cases.

Last week, a scheme which had been going on for over a decade came to an end when Gregory Cronin pleaded guilty to a two count information charging wire and securities fraud based on his scheme. U.S. v. Cronin, Case No. 1:10CR154 (E.D. Va. Filed May 7, 2010). According to the agreed Statement of Facts filed with the plea, Mr. Cronin raised over $6.7 million from individuals who where were largely friends and former clients from the time he was employed as a retail broker for a large bank. Mr. Cronin solicited investors to place their money in his firm, Investment Advisors, Inc., obtaining discretionary trading authority. Frequently he encouraged potential investors to refinance their homes to obtain cash to invest. Many clients gave Mr. Cronin the funds in their retirement accounts.

Typically, each month investors would receive a statement showing that their funds had been invested in an individual account in stocks such as Coca-Cola, Duke Energy and Apple Computer. The statements showed clients that their investment was increasing. In fact the statements were false. Client funds were pooled in a single bank account and used to trade options. The trading had losses, not profits. When clients insisted on withdrawing funds, Mr. Cronin used cash obtained from other investors to pay them.

The scheme began to unravel in June 2009 when the Virginia Corporation Commission interviewed defendant Cronin. During the discussion he falsely told the officials that his trading business “had wound down” and that he no longer had any clients or records. By September 2009, Mr. Cronin tried unsuccessfully to borrow funds from one of his investors, falsely claiming he needed the money to cover a short position in his personal account. About two weeks later he admitted his scheme to Postal Inspectors and turned over his computer records. Sentencing is scheduled for July 23, 2010.

REGULATORY REFORM AND ORGANIZATIONAL CULTURE

The market crisis has spawned repeated calls for regulatory reform. Many argue that regulation has been lax. Others contend that while some new regulation may be necessary, additional study should be given to the origins and causes of the market crisis before any action is taken. Many business leaders and organizations agree that Congress needs to craft new and updated rules for the financial road. Yet, a host of lobbyists have descended on Capital Hill, cajoling members of Congress to vote for or against various proposals or to just make a small change in language of a particular provision for the benefit of their client.

To date all of this has spawned at lest three pending proposals. One is a House bill which purports to be comprehensive regulatory reform, addressing the root causes of the market crisis. Another is the Dodd bill, crafted by the Senate Finance Committee under the Chairmanship of Senator Christopher Dodd. This bill is also intended to address the key causes of the market crisis. A third is the Lincoln Bill, which emerged from the Senate Agricultural Committee chaired by Senator Blanche Lincoln. Virtually every day there are headlines and news stories of bipartisan agreements, amendments and disputes regarding these bills. Whether any of these bills will become law or, more importantly, if any will prevent another market crisis, is at best unclear.

One lesson of the market crisis is that there are regulatory gaps and inadequacies which must be addressed by Congress. Another lesson which should be equally evident is that more laws are not the whole answer to preventing another calamity. Statutes like the federal securities laws, which were designed to bring a new ethics to the marketplace during the market crisis of the 1930’s, are at best a beginning, not the end. In many ways they are the safety net for the system, setting the minimal standards for conduct, dealing and interacting in the market place. Those laws, however well crafted and intended, are not a substitute for a culture of fair dealing and ethical practices that must be the bedrock of every market participant from Wall Street investment banks and broker dealers to public companies operating with the Main Street’s money raised in the capital markets.

The question of how an organization does business and interacts in the marketplace begins with proper guiding principles from its top and must flow down through all of its operations. FINRA Chairman and CEO Rick Ketchum, in his recent remarks at the SIFMA Compliance & Legal Division’s Annual Seminar on May 7, 2010, addressed the question of how an organization operates in the context of a Wall Street investment bank and broker noting: “when a firm develops a corporate trading strategy, whether as a result of risk management reviews or otherwise, there needs to be a careful rethinking of compliance controls. Leave to the side for the moment any carefully crafted arguments on legal responsibility – the business intersection of proprietary trading, market making, agency and banking is an accident waiting to happen. It poses the risk of faulty disclosure, unsuitable recommendations or a host of other, at least reputational, exposures. While each fact situation may be different, some things are clear: these decisions should not be made without the participation of legal and compliance officers so that there is someone there to ask the simple question ‘What is the impact on our customers?’ It is for that reason that I have underlined again and again the importance of compliance and legal participation in risk management committee deliberations, as well as senior staff meetings.” Remarks available here.

Mr. Ketchum’s remarks should be applied not just to the investment banks and broker dealers to whom they were addressed, but to all who obtain money in the capital markets and rely on the public’s trust for their operations. It is not sufficient that those operations be “legally defensible,” although it is clear that compliance and legal personnel should participate in key meetings and the development of important strategy as Mr. Ketchum indicates. The critical question should be about the impact of a strategy on the customers of the organization and the markets in which it operates. Perhaps the real test for a strategy should be whether the organization would like to be known for the particular approach if it is published on the front page of a newspaper, headlined on the evening news or streamed across the internet. Congress can and should study the causes of the market crisis and pass appropriate legislation. Avoiding another market crisis, however, begins closer to home: It starts in every board room and executive suite from Wall Street to Main Street with a commitment to a culture of fair and ethical dealing.