Curried Wealth Building
Finding an Edge

If you want help with your finances, give me a call at 703-791-3243.
May 1, 2010
Issue 94  -  Deep Capture

I'm going to write about a subject that very few people know about.  I've written a little about it, the term is deep capture.  This refers to the "capturing" of the regulatory agencies to the point that they don't go after the bad guys.  This unfortunately describes our current situation.  There is basically a revolving door from the agencies mandated to enforce the laws in our financial markets to the players in the market.  The main regulatory agency in stocks is the Securities and Exchange Commission (SEC).  What do they do?  Here is their own description:

The Investor's Advocate:
How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation

Wow, that sounds good.  There's one simple problem:  they haven't done #1 or #2.  Did they protect investors from Bernie Madoff?  Did they protect investors in Enron?  How much integrity does Goldman Sachs have?  Arthur Anderson?  No, they haven't really done a stellar job.  They have the authority, what's going on?  Corruption, that's what.  I've referred to corruption as the #1 growth industry in our government and the SEC is the poster child.  Almost every government agency has a 2 year ban on working for entities that they regulate.  The one exception is the SEC.  This has created a feeder system.  Go to work for the SEC and then move on over to Wall Street....right 3-10 times the salary.  Sweet deal if you can get it.
 So let me ask you this:  If you KNEW you could multiply your salary many fold in a short time by just going along and looking the other way, what incentive would you have to crack heads on Wall Street?  None.  Let's put it this way.  It's no secret to those going to work at the SEC.  Pay your dues and then get paid.  Stinks to high heaven.  The SEC is a captured agency.  Deep implies the capturing is done at the highest levels.  This deep capturing means the authorities have no teeth.  Maybe that's why they have so much time to watch porn.  This has been going on since the 1930s.  It is the culture.  Totally ingrained.  How else could you explain this blatantly illegal behavior:
Insiders Sold Shares As SEC Probed Firm
Five senior executives of Goldman Sachs Group Inc., including the firm's co-general counsel, sold $65.4 million worth of stock after the firm received notice of possible fraud charges, which later drove its stock down 13%.
Sales by three of the five Goldman insiders occurred at prices higher than the stock's current level. The stock sales by co-general counsel Esta Stecher, vice chairmen Michael Evans and Michael Sherwood, principal accounting officer Sarah Smith and board member John Bryan occurred between October 2009 and February 2010. It was the most active spate of insider selling in three years, according to in ...
How can someone say that Goldman is concerned about getting caught if they are selling stocks when they know an investigation is coming?  The stock fell about 10% on Friday which is HUGE for a major bank in one day.  The closing price was about $145 a share. You can check the vulnerability of a stock by looking at their options.  Go to Yahoo and enter in a stock symbol.  On the left hand side select options.  Now look at the prices under the "calls" section.  Look at the line where the strike price is closest to the current price.  Usually the price of these options will be under a dollar because it is likely that they will not be worth much when they expire.  The higher the price in this row, the more volatile the stock is likely to be.  Goldman options were selling for over $7 on Friday!  That is amazing.  This means people are expecting the price to rise $7 more dollars in three weeks.  That's very rare.  Goldman could be in big trouble.  The people selling the options, at the very least, are counting on huge volatility.  Just as a comparison, IBM which has a similar price per share, has the nearest priced options going for about a $1.  Could get crazy next week. 
Goldman works for the Fed, secretly, but they will be taken down if someone views that as a necessity.  Someone else will fill the void. 
The term deep capture is actually the name of a blog which has been investigating the malfeasance for years.  Here is blog post put up recently further explaining the SEC culture: 

The SEC and its culture of regulatory capture

Posted on 29 April 2010 by Judd Bagley

Perspective is a funny thing. The full taxpayer cost of the S&L bailout came to an enormous, inflation-adjusted tab of around $255-billion; and yet, in the shadow of the latest spate of bank bailout checks written by Congress, that doesn’t seem like much. Similarly, the $60-billion Madoff fiasco tends to make the many Ponzi scheme busts that followed seem quaint by comparison, including the $7-billion scam allegedly carried out by Robert Allen Stanford’s firm.

Just to make sure everybody agrees that $7-billion is a lot of money – keep in mind it exceeds the GNP of 40% of the nations on earth. Imagine putting a match to all the goods and services produced in one year by the people of Laos or Mongolia. Stanford is accused of doing that, and more. But because it’s just a tenth of the wealth destroyed by Madoff, Stanford may forever be regarded a Ponzi also-ran.

But dig a little deeper and you’ll find the Stanford case is the bigger outrage by far, not so much for the scam itself, but for the shocking behavior of the regulators tasked with preventing it. Where Madoff was enabled by SEC bureaucratic incompetence, Stanford was empowered by overt SEC indifference.

That’s right – indifference. Unlike Meghan Cheung, the former head of enforcement at the SEC’s New York branch, who didn’t know how to determine whether Madoff was running a Ponzi scheme, her counterpart in Fort Worth spent years swimming in evidence of Stanford’s scam, but simply preferred not to do anything about it.

The evidence, if you can stomach it, is oozing out of the report recently submitted by SEC Inspector General extraordinaire David Kotz. In it, we learn that SEC examiners spotted the red flags as early as 1997, and spent eight years lobbying then-chief of Fort Worth’s enforcement division, Spencer Barasch, to investigate. Barasch repeatedly declined, even as evidence of the Stanford scam – together with the size of the scam itself – grew exponentially.

The first referral by SEC examiners was sent to Barasch in 1998. According to the testimony of Julie Preuitt, who helped author the request, Barasch declined to investigate after discussing the matter with Stanford’s legal counsel at the time, former SEC Fort Worth District Administrator Wayne Secore.

According to the report:

Barasch told Preuitt “he asked Wayne Secore if there was a case there and Wayne Secore said that there wasn’t. So he was satisfied with that and decided not to pursue it further.”

Obviously, Barasch denies this, and such a claim would be difficult to believe were it not for the well-documented facts that follow.

Barasch finally left the SEC for a spot as partner in the law firm of Andrews Kurth in 2005, shortly after putting the kibosh on a third attempt by SEC examiners to investigate Stanford. Barasch’s replacement accepted a similar recommendation later that year, but the resulting inquiry was mismanaged and did not produce an enforcement case until February 2009, after the Commission’s hand was forced by Madoff’s admission two months earlier.

But it was what happened after Barasch’s departure from the SEC that casts his earlier actions in a much harsher light. As the investigation discovered:

[Barasch], who played a significant role in multiple decisions over the years to quash investigations of Stanford, sought to represent Stanford on three separate occasions after he left the Commission, and in fact represented Stanford briefly in 2006 before he was informed by the SEC Ethics Office that it was improper to do so.

The final of Barasch’s three attempts to represent Stanford was by far the most brazen, not to mention instructive. It happened in February 2009, immediately after the SEC filed suit against Stanford. Like the two before it, the third was also denied. When asked to justify the renewed request, Barasch replied,

“Every lawyer in Texas and beyond is going to get rich over this case. Okay? And I hated being on the sidelines.”

In email, veritas.

Not only was Barasch apparently numb to the definition of “ethical conflict,” he seems to have used it as a business development tool, at least that’s the impression left by an email not included in the Kotz report but acquired by the Dallas Morning News. According to the email, after Mark Cuban was sued by the SEC’s Fort Worth office for insider trading in 2008, Barasch told an associate of Cuban’s,

“I am friends with and helped promote two of the guys who signed the Complaint against Mark. Someone should tell Mark to look at my profile on my firm website, my SEC press releases, and advise Mark to add me to his defense team.”

It’s safe to say that Barasch plays the heavy in the IG’s report, but read it carefully, and you’ll find that he’s not the real villain. Instead, that role is played subtly but consistently by the broader SEC Enforcement Division’s flawed culture.

As the report stated,

We found that the Fort Worth Enforcement program’s decisions not to undertake a full and thorough investigation of Stanford were due, at least in part, to Enforcement’s perception that the Stanford case was difficult, novel and not the type favored by the Commission. The former head of the Fort Worth office told the OIG that regional offices were “heavily judged” by the number of cases they brought and that it was very important for the Fort Worth office to bring a high number of cases…The former head of the Examination program in Fort Worth testified that Enforcement leadership in Fort Worth “was pretty upfront” with the Enforcement staff about the pressure to produce numbers and communicated to the Enforcement staff, “I want numbers. I want these things done quick.” He also testified that this pressure for numbers incentivized the Enforcement staff to focus on “easier cases” – “quick hits.”

And these instructions were predictably manifest in the handling of the Stanford case, as evidenced by the reaction to an anonymous Stanford insider’s letter, first sent to the NASD, denouncing Stanford as a Ponzi scheme. The letter was forwarded to the SEC where Barasch saw and ignored it, saying,

“Rather than spend a lot of resources on something that could end up being something that we could not bring, the decision was made to not go forward at that time, or at least to not spend the significant resources and wait and see if something else would come up.”

The report also cites a former Fort Worth office administrator who says Barasch and others in his group had been subjected to criticism from high-level SEC staff in Washington DC for “bringing too many Temporary Restraining Order, Ponzi, and prime bank cases.”

Accordingly, Fort Worth was admonished to avoid investigating “mainstream” cases in favor of simple accounting fraud.

Now, let’s take a step back to see what insights into the SEC’s enforcement paradigm might be gleaned from what we’ve learned so far.

  1. Given his actions both prior to and after leaving the Commission, I suspect Spencer Barasch’s approach to regulating Stanford – and presumably other entities – was heavily influenced by a desire to maximize his eventual private sector opportunities. This is further evidence that the significance of regulatory capture and the revolving door ethic in the minds of SEC enforcement officials cannot be overstated.
  2. Whereas “Ponzi and prime bank cases” most often apply to investing institutions, while accounting fraud charges are most often leveled against public companies, I suspect the high-level mandate to prefer the latter over the former to be the root of the SEC’s long-suspected anti-issuer/pro-institutional investor bias – or at the very least, further evidence of it.
  3. This apparent anti-issuer bias, paired with the report’s well-documented evidence of the SEC’s preference of case quantity over quality, offers additional support for the widely-held belief that cases against public companies are seen as low-hanging (and career-protecting) fruit in the eyes of Enforcement Division staffers.

If my conclusions are correct, then the Stanford outrage is not really about Spencer Barasch, but the SEC’s flawed enforcement culture, from Washington DC on down. I further suspect this culture to be a key factor in explaining the SEC’s role as enabler of the stock manipulation schemes extensively documented here on Deep Capture.

But don’t take my word for it. Instead, consider the words of then-Director of the SEC’s Division of Enforcement, Linda Chatman Thomsen, responding to a question posed by a member of the audience following her keynote address at the US Chamber of Commerce’s 2008 Capital Markets Summit.

Audience member: “You spent a lot of time talking about insider trading and penny stock fraud, but you failed to mention an issue that’s of great concern to the Chamber, and that is naked short selling and the unsettled trades that can result from that. How can the Commission claim that it is serious about enforcement when millions of trades fail to settle every day and companies remain on Reg SHO Threshold Lists for years and years?”

Thomsen: “As to naked short selling, and more generally market manipulation generally, it is an area we are focused on. We have seen fewer cases in that arena because, often times, this is not necessarily with respect to naked shorts, but shorting or market manipulation more generally, because often the components of something that might look to be manipulative are all legal trades as you point out. So it’s a hard case to bring, which is not to say that it isn’t something that we don’t investigate, because we do. So I hear and understand the frustration of many on the subject of short selling generally. When we hear complaints about short selling—and, frankly, it is both short and naked short, it is a combination of both—we routinely hear from companies who’ve come in, who worry that they’re being shorted in an illegal way. We routinely take all that information in and look into it.

“And often times, as I think many defense counsel would be happy to tell you, when we dig in, what we find is that some of the information that has caused people to be shorting is actually true as to the company, and we may very well be confronted with two issues, one on the company and its disclosure side as well as on the trading side. But they’re very difficult cases, which is not to say that we aren’t focused on them and interested in them and indeed this new focus that we have on some smaller companies and smaller issuers will wrap some of those concerns into their focus as well.”

Thomsen’s answer needs to be examined from two angles: what she said and what she (meaning, her division) actually did.

What Thomsen said, was that when it comes to illegal, manipulative naked short selling, “it’s a hard case to bring,” and that it often it turns out the targeted company deserved to have its stock manipulated. But don’t worry…the SEC Division of Enforcement cares and regularly investigates complaints of illegal, manipulative short selling.

What Thomsen’s division actually did was quite different. We know this thanks to another outstanding report by SEC Inspector General David Kotz relating to the Commission’s handling of complaints of illegal, manipulative naked short selling between January 2007 and June 2008. What Kotz discovered was that of the more than 5,000 complaints received by the Division of Enforcement during that time, not one resulted in an investigation.

Kotz further found that while robust methods exist for dealing with complaints relating to “spam driven manipulations, unregistered online offerings and insider trading” (again, infractions typically committed by issuers), no written policies existed for dealing with complaints of illegal naked short selling. This “[has] the effect of naked short selling complaints being treated differently than other types of complaints.”

And in this case, “differently” meant “not at all.” This attitude closely mirrors that of the SEC’s Division of Enforcement as described in the Stanford report.

In my opinion, the best thing to happen to the SEC in many years is the arrival of Inspector General David Kotz. The second best thing is the February 2009 departure of Linda Thomsen. In the months following the arrival of Thomsen’s successor, Robert Khuzami, many encouraging developments have been observed, including two enforcement cases brought against manipulative naked short sellers, the permanent adoption of regulations greatly reducing instances of such manipulation, and the recent case brought against Goldman Sachs (NYSE:GS). Each of these represents an important departure from the SEC’s long-standing anti-issuer/pro-bank approach to regulation.

These positive developments notwithstanding, the dysfunctional culture at the SEC’s Division of Enforcement was undoubtedly a long time in the making. As a result, it will require a long time to root out. Unfortunately, we don’t have a long time. Investor confidence in the fundamental fairness of our capital markets must be restored now, not as long as it takes the old guard’s institutional memory to fade away. Having read the Stanford report, the only practical solution I see is a new beginning. Congress needs to sunset the SEC on an immovable — and ideally not too distant — date certain and instruct the Department of Justice to have a replacement ready to begin work the next day.

The next best solution would be to disband the SEC entirely, and send big, red warning letters to all potential market participants, giving them fair warning that they’re on their own.

These may seem like desperate measures, but I suspect you’ll agree these are becoming increasingly desperate times.

In case you didn't read it, the gist is that an SEC lawyer turned down a referral to look into a hedge fund.  He declined on numerous occasions. Eventually when they were finally investigated, the same lawyer was trying to get the hedge fund to hire him, to DEFEND them, in a private sector position.  You just can't make this up.  The SEC is a joke and has no loyalty to their true customers, you and me. 
I have talked about naked short selling (not as fun as it sounds) and it's disastrous effect on the markets.  Basically you sell stock you don't have, and are never going to get, in a blatant attempt to the drive the price of a stock into oblivion.  Totally illegal.  Here is the chairwoman of the SEC demonstrating her incompetence, or more probably her complicity in the whole sordid affair:
"anybody who was manipulating the market or spreading false rumors was potentially breaking securities law.  "
Potentially???????????  How could doing those things NOT be breaking the law?  I mean, my god, she is in charge of enforcing securities laws and she says this?
When asked about whether this went on with Lehman or Bear Stearns she "couldn't" comment because the case was ongoing.  ONGOING?????  This almost brought down the whole system and it's been 18 months and we have nothing??  We're still "looking."  This is just further proof that this is agency is captured.  NO ONE is that incompetent. 
So who watches out for us then?  The main watchdogs SHOULD be the media.  How are they doing on this?  They rarely talk about this topic.  They're too busy watching every 1 point move in the DOW.  Yeah, why don't you "explain" to me why the dow is down 4 points.  Like that's possible.  They distract you with this nonsense.  Hey why don't we have another interview with the "best investor ever", Warren Buffet.  He's just like you and me right?  Well.....not really: (from GATA)
Don't Ever Buy Into the Warren Buffett Myth

He's not a down-home simple guy who lives in the original home he had before he made his fortune.  It's well-known that he has at least one mistress and he has expensive real estate in several glamour locations, including Sun Valley and Santa Fe.

Follow his money and sphere of influence. Don't forget he has a big stake in Goldman Sachs and he recently expressed full support for the Company and it's antics. He also controls Nebraska Senator Ben Nelson: 

Anyway, WSJ reports that while the Democrats are making real progress on derivatives reform, the bill could contain a big pro-Berkshire loophole. And of course, the loophole was placed by Nebraska Senator Ben Nelson. Here's the nut of it: The provision, sought by Berkshire and pushed by Nebraska Sen. Ben Nelson in the Senate Agriculture Committee, would largely exempt existing derivatives contracts from the proposed rules. Previously, the legislation could have allowed regulators to require that companies such as Nebraska-based Berkshire put aside large sums to cover potential losses. The change thus would aid Berkshire, which has a $63 billion derivatives portfolio, according to Barclays Capital.
Here's the link from  The Buffet Rule

If this provision remains intact, it will enable Buffett's Berkshire Hathaway to escape expensing up front the massive cost of potential derivatives losses embedded throughout the Berkshire empire. Kick the can down the road at the expense of shareholders who might otherwise sell the stock in anticipation of lower reported earnings OR new buyers of the stock who get lured in by GAAP earnings that are essentially fictitious.

Lest we forget, Buffett also owns 10% of Wells Fargo, which is defiantly overstating the value of its toxic real estate-related assets, is sitting on a powder keg of subprime pay-option ARM mortgages (which currently have a 45% default rate, but you wouldn't know that from looking at WFC's balance sheet valuations) and has not even come close addressing the reality of the commercial real estate to which its exposed.

Just remember, there's rules for Warren Buffett and then there's rules for the rest of us. Just like in a Banana Republic. Buffett said it himself a couple years ago: the U.S. will become a country of serfs (and he'll be King). Oh ya, his frumpy "sack suits" designed to look inexpensive are actually very expensive Italian suits tailored to give the look he's known for. 

Bread and circuses, to keep you busy.  Not noticing that you are being robbed blind.  Ole Warren has bought off legislators?  Who would've thunk it.  With CNBC at the helm, not you. 
How about the paragon of virtue, the International Monetary Fund.  They are there to "rescue" third world countries, right?  They are the angels of finance right?  Not so much:

IMF corruption exposed

October 27th, 2009 |  

EDITOR'S NOTE: The following report by the BBC is one more evidence that the IMF and World Bank are corrupted organizations that are causing havoc in 3rd world countries such as Ethiopia by fueling brutal dictatorships with hundreds of millions of dollars.

Senegal admits IMF 'money gift'

(BBC) — Senegal has confirmed it gave money to an International Monetary Fund (IMF) official earlier this month, after previously denying the allegations.

Alex Segura was given almost $200,000 (£122,000) at the end of his three-year posting – money which the IMF says was paid back as quickly as it could be.

Prime Minister Souleymane Ndene Ndiaye said it was a goodbye present — part of an African tradition.

But opposition activists have condemned what they regard as a corrupt payment.

The fund said in a statement Mr Segura was given the present after a dinner with President Abdoulaye Wade, but did not realise the gift was money until he was about to leave the country for Barcelona.

"With Mr Segura worried about missing his flight, and concerned that there was no place to leave the money safely in Senegal, he decided to take the money aboard the plane," Reuters quoted the IMF as saying.

The cash was handed over to Senegal's ambassador in Spain.

Government 'exposed'

The BBC's Hamadou Tidiane Sy, in Dakar, says the affair has sparked anger and outrage in Senegal.

He says Senegalese want to know why an IMF official was allowed to leave the country with so much money, and they also want to see whether anyone will be punished.

Anti-corruption campaigner Mamadou Mbodj said the case should be referred to the country's High Court of Justice.

"It is unacceptable in a poor country like ours to use the taxpayers' money to reward international civil servants who are already highly paid for their jobs", he told the BBC.

Aissata Tall Sall, spokeswoman for the Socialist Party, said the government had "exposed its true nature to the rest of the world".

She called for international sanctions and said it was unacceptable for the IMF and government to consider the issue closed.

The president has not commented on the affair, but Mr Ndiaye admitted the gift was given, while denying corruption.

"We in Africa have a tradition – when someone visits you, you give him a gift at departure," he told local media.

These are the guys claiming the high ground?  Oh, and they are supposedly holding a good chunk of gold, including some from the U.S.  They are ALWAYS threatening to sell it to raise "money".  (funny how the announcement is always when gold is flying)  I wonder what they are REALLY doing with that gold?  Wonder what would happen if we asked them?  We don't have to wonder:  (from Business Insider)

Five Questions About Gold The IMF Refuses To Answer

You'll recall that a few weeks ago, we interviewed the IMF on why it had blocked investor Eric Sprott's attempt to buy gold from the fund. We then spoke with Eric Sprott and the Gold Anti-Trust Action Committee, better known as GATA for their take on the matter.

Along the way, both GATA and Sprott suggested we ask the IMF some questions that the fund has avoided answering in the past. So we did. They were:

  • What are the incentives for the IMF not to sell gold on the open market or to investors, be it institutional or retail?
  • What are the designated depositories for gold?
  • Did gold physically change hands with the banks you have sold to so far or was the transaction basically bookkeeping stuff (the IMF still holds the physical gold in this case)?
  • Are there available records on the actual serial numbers of bullion? How is the gold at the IMF tracked and accounted for?
  • When the IMF says it will "phase out" the sal of available gold, could you be more specific? What amount of gold in regard to what amount of time.
  • Does IMF support a need for total transparency in the sale of gold despite the effects it could have on various markets?

The official response from Alistair Thomson, the IMF's media guy, was:

"I looked through your message; we don’t have anything more for you on this."

Interesting, considering the IMF refused to answer similar questions posed by GATA and Sprott. Some are perfectly reasonable questions too, like did gold physically change hands? What does the term "phase out" actually mean?

Certainly this unwillingness is only fodder for skeptical gold folks out there.

Does this confirm the fact that this gold is merely a sham, to manipulate things?  I believe so.  Why won't they answer these questions?  It's not THEIR gold after all.  Why aren't the member countries, like the United States, making them answer the questions?  They aren't THAT tough, are they?  What are the actual serial numbers of the gold they have is a question you refuse to answer?  This is a GIANT red light flashing to buy gold.  Make sure you have yours.  No...I mean it.  YOU need to have some physical gold and silver.  No more thinking about it.  Just get started.
A quick note on my biggest holding Gold Resources Corp  (GORO).  They announced the following this week:
May 15, 2010 Gold Resource Corporation to present at the Global Chinese Financial Forum in Los Angeles, CA.
This is a presentation to 200 wealthy Chinese investors.  There will only be 5 companies presenting.  This will almost surely send the stock price up.  It may only be a temporary bump.  However, they may be holding back some news to jump start the presentation and send the price higher, possibly permanently.  In the mean time, the price of the stock may fall, giving a good buy opportunity.  The company has an incentive to have the stock at least stay flat until the presentation.  (legal disclaimer: This is NOT investing advice)
I'm also watching the stock market very closely.  If the Goldman Sachs issue expands, look out below.  The market could get crushed.  I haven't sold any of my index funds, but I may this week if things get worse. 
I'll close this week with a video that documents something that had never been done.  Taking a picture of a giant redwood.  These trees are simply awesome.  Have a great week!