SEC enforcement chief wants to catch investment scammers in the act

Personal Finance

When it comes to securities fraud, 2009 was either the best of times or the worst. Both arguments are made in the statistics.

Last year, the Securities and Exchange Commission, the nation’s top investment regulator:

* Sought 71 temporary restraining orders to halt misconduct and prevent further harm to investors. That was up 82% from 2008.


* Doubled the number of formal investigations of securities violations.

* Ordered wrongdoers to disgorge some $2.1 billion in ill-gotten gains, up 170% from the previous year.

* Asked courts for 82 asset freezes to preserve money owed to victimized investors, up 78% from the year before.

For Robert Khuzami, who is completing his first year as the SEC’s director of enforcement, those numbers represent a regulatory coup. The agency has never caught as many crooks, ordered as much money returned to investors or slammed as many bank accounts shut.

What’s not so positive is that the numbers also reflect that millions of investors lost billions of dollars before the crooks were caught. As the $65-billion Bernard L. Madoff scam illustrates, you can take some comfort in knowing that Madoff’s 150-year prison term will keep him from scamming investors again, but his past victims will be lucky to recover a few pennies on the dollars they lost.

That has Khuzami pursuing a new tack. Last month he kicked off a whistle-blower initiative intended to catch the crooks red-handed -- hopefully before they’ve done too much damage and when they still have assets to seize. He’s also pressing for legislation that would provide big economic incentives for securities tattletales.

The SEC’s new whistle-blower program, aimed directly at people involved in perpetrating the scams, provides escalating levels of protection for people who participate in fraudulent schemes but now want to turn in their bosses and co-conspirators.

The program includes “cooperation agreements,” which promise that the SEC will take a whistle-blower’s help into consideration when taking enforcement action and, in some cases, exempt the whistle-blower from SEC suits entirely and provide legal help if the Justice Department were to launch its own criminal case.

Also, Khuzami has lent his support to a legislative effort to add whistle-blower payments and protections to U.S. securities laws.

If the proposal becomes law, someone who provided pivotal information that allowed regulators to catch a felon such as Madoff could collect up to 30% of the amount regulators later recovered from the scam as a reward.

A similar provision was added to tax laws four years ago, and the IRS reports that it has significantly boosted the number of multimillion-dollar prosecutions of tax cheats.

Both laws are modeled after the nation’s False Claims Act, says Stephen Kohn, executive director of the National Whistleblower Center in Washington, which has returned billions of dollars to federal coffers through prosecutions of fraud against the government.

“Whistle-blower laws provide a powerful incentive for people to come forward,” Kohn said. “The U.S. government has collected billions and billions of dollars as the result of the False Claims Act.”

Khuzami considers the SEC’s whistle-blower program a game-changer for the simple reason that many financial crimes are so complicated that it’s tough to understand the wrongdoing unless you know the lengths to which the criminals have gone to cover their tracks.

“People who engage in a lot of white-collar crimes are often planning their defenses at the same time as they are planning their offense,” Khuzami said.

People who illegally trade based on nonpublic information, for example, often collect research reports in advance to create a paper trail that would indicate they bought the stocks for valid and public reasons, he added.

“To strip that away and expose it for [the fabricated alibi] that it is is much easier with an insider,” Khuzami said. “When an insider can tell a jury what happened and how it’s really powerful.”

However, the success of Khuzami’s new whistle-blower effort may well rest on the shoulders of Bradley Birkenfeld, a former international banker who is in federal prison even though he turned in his bosses at Swiss banking giant UBS, leading to one of the largest IRS settlements in history.

Birkenfeld’s supporters say that his prison term will discourage whistle-blowers everywhere from stepping forward, and they are seeking a presidential pardon for him. They say that in return for his extraordinary cooperation with the government, Birkenfeld remains the only banker involved in the largest illegal tax scheme in history to receive a long prison sentence.

“Being a whistle-blower is never easy,” Kohn said.

The Justice Department sought prison time for Birkenfeld, saying he turned in his superiors but did not disclose his own role in helping one of his clients. But Kohn says the department “botched” the Birkenfeld case.

“They never treated him as a whistle-blower, and it’s probably going to cost the government billions of dollars because the Swiss are now refusing to cooperate,” he said. “Birkenfeld has had a chilling effect on whistle-blowers.”

Khuzami had no role in the Birkenfeld case, but the SEC may be experiencing some of the after-effects. He admits his fledgling program hasn’t yet produced many tips. He’s still hopeful for the future.

“Cooperators’ testimony allows us to act more quickly -- find out where the bank accounts are located and increase our chance of returning more money to investors,” he said. “And the earlier you shut down a case, the less victims there are. Tomorrow’s victims will not materialize.”