Tuesday, September 10, 2013

Victims Twice Over: The Stanford Financial Fraud

Victims Twice Over: The Stanford Financial Fraud

Although the Bernard Madoff fraud may be the largest of all time, the Stanford Financial fraud takes honors when it comes to the pain and inanity inflicted by the aftermath.  In both instances, investors lost huge chunks of their savings in what they thought were “safe” investments.  I am writing about Stanford because after more than four years, the victims of the Stanford fraud are about to receive a paltry sum representing 1% of their losses.  You’re probably thinking that this is the last of a series of payments.  No, this is the first payment in this $7 billion saga.
One-Off Acquisition (1999)
The crux of the fraud involved Stanford Financial’s sale of certificate of deposits by its Antiguan bank to clients scattered across the planet.  The money flowed into the bank and then either disappeared into a flurry of bad loans, paid off earlier depositors, or financed R. Allen’s Stanford’s life style.  The victims were lured by the bank’s promise to pay a substantially higher rate of interest than similar instruments in the victim’s home countries.  While the CDs did not enjoy FDIC protection in the U.S., a seemingly reputable financial institution was offering them.  Moreover, for a period of time Stanford dutifully paid off its investors as the CDs matured.  While the Stanford fraud is easy to understand and a lot less intricate than Mr. Madoff’s transgressions, the recovery phase has been a second nightmare.

I went back through news accounts, victim websites, and court filings to get some sense of the second nightmare.  Frankly, my brief summary doesn’t do justice to the twists and turns that have confronted the Stanford claimants.

When Stanford was closed down, its clients lost access to their accounts as well as the value of their investment in the Stanford CDs.  Receivers were appointed in several countries to try to recover on behalf of victims.   The second nightmare began when investors discovered that the court-appointed receiver wasn’t about to given them quick access to their accounts.  For months on end, Stanford’s clients filed paperwork and ran into one delay after the other before they regained control of their remaining assets.

The receivers immediately got into a heated war over control of the remaining Stanford assets.  The biggest and costliest battle was waged between the American receiver and his Antiguan counterpart.   The American represented the biggest pool of investors, and the Antiguan laid claim to the bank at the center of the fraud.  Of course, the cost for waging this dispute was paid from recovery proceeds.   No matter who had claim to the assets, it was soon clear there were relatively few assets in relation to the $7 billion fraud.

As has been the case in the Madoff fraud, investors directed their attention to third-parties in order to perhaps find a deep pocket capable of paying damages.  In the Madoff saga investors have had some notable successes.  However, the Stanford victims have had no such luck and have been greatly frustrated in the process.

It turns out that the SEC knew about Stanford’s questionable practices long before the firm collapsed.  A report by the SEC Inspector General concluded that the agency was aware of the Ponzi scheme as early as 1997 and did nothing about it.[1]  When investors attempted to sue the SEC, the claim was thrown out under the Federal Tort Claims Act, which bars claims against the Federal Government for fraud or deceit.

After Congress pressured the SEC to do something on behalf of the victims, the SEC sought to have the claims covered by the Securities Investment Protection Corporation (SIPC).  The SIPC protects brokerage accounts when a broker-dealer fails.   The SEC wound up suing the SIPC after it refused to extend coverage.  A Federal District Court ruled that the losses on the CD were generated by Stanford’s foreign bank and not its domestic brokerage operation and therefore not covered by insurance.  A court of appeals ruling is pending on the matter.

Meanwhile the US receiver has settled his difference with his Antiguan counter-part.  He’s got suits against various individuals for claims of about $700 million, and continues to collect dribs and drabs from various Stanford assets.  Since the receiver went into business in 2009, he’s managed to collect $230 million, while spending $119 million.  In other words, over half of the money recovered on behalf of victims has gone to pay lawyers, accountants, and other professionals, which only adds to the nightmare.

I’ve been searching for lessons in this terrible tale, and can’t find too many.  Perhaps investors should have been more vigilant in the first place, since the yields on Stanford’s CDs were so high.  On the other hand, the Stanford CDs had been paying interest and redeemed for more than decade.  I suppose some of the ugliness of the recovery process could probably be eliminated in the hands of a more adept receiver.  However, given the scale of Stanford’s fraud, it’s hard to imagine a hugely better recovery.

The misfeasance of the SEC stands out.  The SEC Inspector General’s report chronicles an agency that was too close to the business it was supposed to regulate.  However, in the 1990s and the first part of this century, that’s how our politicians and the public wanted our regulators to behave.  The SEC was supposed to help facilitate business instead of regulating it.  In the past six months there are some signs that the SEC is finally changing.  Clearly, it’s too late for the victims of Stanford Financial.

[1] http://www.sec.gov/news/studies/2010/oig-526.pdf

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