Fraud on the Street

The Securities and Exchange Commission announced Monday it had begun an inquiry into two dozen financial companies to determine whether they followed accounting practices similar to those recently disclosed in an investigation of Lehman Brothers.

Where on earth has the SEC been?It’s now clear Lehman Brothers’ balance sheet was bogus before the bank collapsed in 2008, catapulting the Street and the world into the worst financial crisis since 1929. The Lehman bankruptcy examiner’s recent report details what just about everyone on the Street has known since the firm imploded – that Lehman defrauded its investors. Even Hank Paulson, in his recent memoir, referred to Lehman’s balance sheet as bogus.

In order to look like it could borrow $30 for every dollar of its own money, Lehman shifted liabilities off its books at the end of each quarter. Its CPA, Ernst and Young, approved of this fraud against the advice of its own whistle blower, whom Ernst and Young fired.

Lehman’s practices couldn’t have been all that different from those of every other big bank on the Street. After all, they were all competing for the same business, and using many of the same techniques. Lehman was just the first to go under, causing a financial run that led George W. to warn “this sucker could go down” unless the federal government came up with hundreds of billions to bail out the others.

In other words, the TARP covered the other bankers’ assets and asses.

We now know, for example, Goldman Sachs helped Greece hide its public debt and then placed financial bets that Greece would default, using credit-default swaps to avoid risking its own capital. It’s the same tactic Goldman used for (and against) American International Group (AIG): Hide the ball, and then bet against the ball and fob off the risk to investors and taxpayers, using derivatives to remove the risky tactics from the balance sheets. Even today no one knows the fair value of the complex derivatives underlying these and related maneuvers, which is exactly the point.

Congress is now struggling to come up with legislation to stop this from happening again. And the Street is struggling to stop Congress. As of now, the Street’s political payoffs seem to be working. Proposed legislation still allows secret derivative trading in foreign-exchange swaps (similar to what Goldman used to help Greece hide its debt) and in transactions between big banks and many of their corporate clients (as with AIG).

But wait. We already have a law designed to stop this sort of fraud. It’s called the Sarbanes-Oxley Act of 2002.

Think back to the corporate looting scandals that came to light almost a decade ago when the balance sheets of Enron, WorldCom, and others were shown to be fake, causing their investors to lose their shirts. Nearly every major investment bank played a part in the fraud — not only advising the companies but also urging investors to buy their stocks when the banks’ own analysts privately described them as junk.

Sarbanes-Oxley – Sarbox, as it’s come to be known – was designed to stop this. It requires CEOs and other senior executives to take personal responsibility for the accuracy and completeness of their companies’ financial reports and to set up internal controls to assure the accuracy and completeness of the reports. If they don’t, they’re subject to fines and criminal penalties.

Sarbox is directly relevant to the off-the-balance-sheet derivative games the Street played and continues to play. No bank CEO can faithfully attest to the accuracy and completeness of its financial reports when derivatives guarantee that the reports are incomplete and deceptive.

So where has the SEC been?

robert_reich.jpgI was on a panel a few weeks ago with a former chair of the Securities and Exchange Commission who was asked why the commission has so far failed to enforce Sarbox against Wall Street. He had no response except to mumble that legislation is meaningless unless adequately enforced. Exactly.

Bottom line: While financial reform is needed, there’s no reason to wait for it. Sarbox is already there. And even if financial reform is enacted without loopholes, there’s no reason to think it will be enforced if laws already on the books, such as Sarbox, aren’t.

(adapted from my column in The American Prospect)

by Robert Reich

This article first appeared on Robert Reich’s Blog. Republished with permission


  1. tm says

    “Congress is now struggling to come up with legislation to stop this from happening again. ”

    The first step should be to extend the death penalty to corporate fraud.

  2. Elaine says

    I think Hank Paulson was the one who should have saw this coming long before it did & probably did but just not wanting to do his job. His biggest mistake was to make all the banks that did not need a bail out take one so no one would know who the bad ones were. The bad ones should have been left to fail just like Lehman did. Let the stronger ones survive & maybe some of them could have saved a few of the bad ones but that would have been a big risk. What he did was wrong & gave Obama an opening to jump into to take more power & pass more stimulus & borrow more money & spend more money & cause us to be in the position we are in now. I do not think he knew what he was doing to the country allowing Obama to take over the way he did. Nothing can be done about it now until we vote in November provided we do not have interference at the polls as we did in 2008. I am concerned that the new companies that were once Acorn & SEIU & AFL-CIO & the Black Panthers are going to try to interfere at the polls as before & may cause problems. We can only hope that all turns out well. But it is the responsibility of Californians to get rid of Pelosi, Boxer, Waxman & some of the other really bad Congressmen & Senators they have just like it is Nevada’s responsibility to get rid of Reid & others that forced all of this mess on us. Here in my state we have got several to get rid of also. We have all got to stand together to take back our Constitution & our democracy & get us away from socialism.

  3. garry walsh says

    Maybe, just maybe,a bankster bone or two will be thrown to the mob: so freaking what. If lawmakers and lawmen were real serious about justice a lot of assets could be recovered. That isnt going to happen when you govern by auction and profit mostly by deception and war. I am investing in pitchfork futures because somebody real smart once said “once the secrets of an age are known, the age comes to an end”. Janice Joplin said it another way ” when u got nothin u got nothin to lose” Once the American people figure out whats goin on watch out. I have faith in the cahones and basic decency of the common folk . To the streets folks!


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