Securities Law Blog

Another brick in the Madoff scam crumbles under further investigation by the Securities and Exchange Commission (SEC). On February 25, 2010, the former Director of Operations at Bernard L. Madoff Investment Securities, LLC (BMIS), Daniel Bonventre, was charged for his involvement in the multi-billion dollar fraud.

At BMIS, Bonventre oversaw the firm’s accounting and securities clearing functions for about the last thirty years. The SEC’s complaint, filed in the U.S. District Court for the Southern District of New York, made several allegations about Bonventre’s role in the scam.

According to the SEC complaint, Bonventre allegedly falsified financial reports to investors to avoid disclosing the firm’s massive liabilities. BMIS financial reports were allegedly doctored by Bonventre to inappropriately state how investor funds were being used and maintained.

The SEC alleges that Bonventre was aware that billions of investor funds were not being used to purchase securities on behalf of investors, and worked alongside Madoff and others to disguise the information. When BMIS came under review, Bonventre and others allegedly produced reams of false reports and data filled with “serial misrepresentations.”

George S. Canellos, Director of the SEC’s Regional New York Office said, “A fraud of this magnitude requires a coordinated effort. Bonventre played an essential part by creating bogus financial records to give BMIS the appearance of legitimacy, when in fact the firm lost money and could not have survived without the fraud.”

To hide that BMIS was consistently operating at a significant loss, the firm allegedly used over $750 million in investor funds to artificially improve reported revenue and income.

Finally the SEC alleges that the former Director of Operations made an estimated $1.9 million in illicit personal profits through fake backdated trades in his own investor accounts at BMIS. One such trade was backdated by twelve years.

If convicted on all charges, Bonventre, 63, faces up to 77 years in prison. The SEC is also seeking to impose financial penalties and disgorgement of all ill-gotten gains.
The charges against Bonventre mark the SEC’s seventh enforcement action concerning the Madoff scam since its collapse in December 2008. Previous actions where parties have pleaded guilty to criminal charges include Madoff and BMIS, DiPascali, and auditors David G. Friehling and David G. Friehling & Horowitz CPAs, P.C. Certain feeder funds have also been charged with committing securities fraud, and two computer programmers at Madoff’s firm were charged for their role in concealing the scheme.

The Securities and Exchange Commission (SEC) charged State Street Bank and Trust Company on February 4, 2010 with misleading its investors in the Limited Duration Bond Fund. State Street created The Limited Duration Bond Fund (the “Fund”) in February 2002, and marketed it to investors as an alternative to a money market fund, claiming to have better sector diversification.

In 2006 and early 2007, State Street increased the investors’ exposure to subprime mortgages, while investors remained unaware of the extent to which their investments were tied to the money-losing loans. The Fund continued to be marketed to prospective investors without disclosing the extent of the fund’s concentration in subprime investments, according to the SEC complaint.

When the market meltdown began happening in July 2007, State Street provided selected investors with more complete information about the Fund, while allegedly keeping others in the dark. The informed investors are said to include clients of State Street’s internal advisory groups, who paid more for consulting services. According to the Complaint, these investors were informed by late July to exit the fund, while others were encouraged to stay and continue to invest. State Street began selling the fund’s most liquid holdings in order to meet the redemption demands of the more informed investors. The Fund was left with mostly illiquid holdings and cost investors millions of dollars.

Neither admitting or denying guilt, State Street agreed to settle the SEC’s charges by paying $313 million to allegedly misled investors who lost money during the meltdown. Making up the $313 million is a $50 million penalty, $8.3 million in disgorgement and prejudgment interest, and $255 million to investors. Prior to the SEC’s recent charges, State Street has already agreed to pay nearly $350 million to settle private lawsuits.

I have always been a strong believer that Boards need to tread lightly in matters of investments—there are potential fiduciary duty breaches everywhere. Were the investments prudent? Were they held too long? Were they sold do early? Did you take enough risk? Did you take too little risk? A recent NY Times article detailed a new study that examines Madoff fraud losses and suggests that a bigger Board may help prevent account losses.

According to the New York Times, an inquiry into corruption at the New York State pension fund continued to broaden nationwide when a top consultant to pension funds around the country was charged with a fraud-related felony late last week by the office of the New York Attorney General.Skip to next paragraph

The consultant, Saul Meyer of Aldus Equity, a Dallas-based firm, was also charged with violations of securities laws by the Securities and Exchange Commission as part of what the agency called “a multimillion-dollar kickback scheme involving New York’s largest pension fund.” The commission also charged Aldus Equity with multiple securities violations.

Mr. Meyer, 38, is a founder of Aldus, which has advised several of the nation’s largest pension funds, including those overseen by New York State and the city of Los Angeles. Mr. Meyer surrendered to the authorities in New York and pleaded not guilty to the fraud-related felony, a violation of the Martin Act, a sweeping state securities statute, on Thursday in Manhattan Criminal Court. A judge ordered him released on $200,000 bail.

In a teleconference on Thursday, Mr. Cuomo said his investigation, which is continuing, had uncovered what amounts to a conspiracy involving politicians, professional investors and consultants to defraud public pension funds in New York and other states by paying millions of dollars in kickbacks in exchange for access to the funds. Investment firms reap lucrative fees by managing portions of the funds.

“I learned years ago that it’s far easier for a prosecutor to file a complaint than to prevail at a trial,” said Paul L. Shechtman, Mr. Meyer’s lawyer. “Time and the evidence will show that Saul Meyer did nothing wrong.”

In a statement, a lawyer for Aldus, Matthew D. Orwig, accused the S.E.C. of conducting a “trial by news release” and called its action “appalling and careless.”

Aldus is accused of helping Daniel Hevesi, former New York Comptroller Alan Hevesi’s son, profit from a deal in New Mexico at the same time that the New York comptroller’s office, then run by his father, agreed to increase by $200 million the amount of pension money overseen by Aldus.

Laura A. Brevetti, a lawyer for Daniel Hevesi, said on Thursday that her client did not have “any knowledge of a so-called quid pro quo arrangement for his benefit.” Bradley D. Simon, a lawyer for Alan Hevesi, said his client did not engage “in a quid pro quo to benefit his son.”

Hank Morris, a former political consultant to Alan Hevesi, also received money as part of deals in New Mexico and California. Mr. Morris was accused last month in an indictment of demanding millions of dollars from investment firms in exchange for access to the New York State pension fund. He has pleaded not guilty.

“We are purposefully and aggressively looking to cooperate with other enforcement agencies across the country,” Attorney General Cuomo said. “This is sort of like when you pull a thread on the sweater and that one thread starts to unravel the entire fabric.”

“We’re pulling threads and it turns out the other end of the thread is in New Mexico or Connecticut or Illinois or in California,” he said.

In court filings, the S.E.C. has described a range of improper transactions undertaken in connection with an investment pool run by Aldus for the New York State pension fund. Among other things, Aldus agreed to split fees with Mr. Morris as part of its advisory deal with the pension fund, the filings said.

Mr. Hevesi, who resigned as comptroller in late 2006 after pleading guilty to an unrelated felony, has not been charged in the case.

According to published reports on Bloomberg, FINRA, supervising 344 investor arbitration cases over auction-rate bonds, skirted losses from auction rate securities by selling its holdings months before the market collapsed.

FINRA, responsible for educating and protecting investors, owned as much as $862.2 million of the debt before exiting the market in the spring of 2007, less than six months before auctions began to fail. Investors who were sold the auction rate securities as money-market alternatives say FINRA, a non-profit corporation owned by banks that oversees 5,000 brokerage firms and 659,000 brokers, failed to protect them. The market froze in February 2008 when banks, which had supported the debt for two decades through periodic dealer-run auctions, stopped buying bonds that investors didn’t want as losses from subprime mortgages spread.

Auction-rate securities (ARS) are long-term notes and preferred stock with interest rates reset through sales every seven, 28 or 35 days. Auctions failed when banks, beset by mounting losses on bonds tied to subprime mortgages, stopped buying bonds that went unsold. Borrowers were forced to pay rates of more than 20 percent and investors got stuck with unwanted securities.

Dozens of auctions continue to fail daily, according to data compiled by Bloomberg.

FINRA issued its first guidance for investors caught in the debt on March 31, 2008, more than a month after the failure rate rose to about 80 percent.

FINRA, known as the National Association of Securities Dealers until its 2007 merger with the regulatory unit of the New York Stock Exchange, invested in auction-rate securities with funds from the $1.6 billion sale of the NASDAQ electronic trading system starting in 2000.