Fall of oil exec Roger Parker marked by risky bets gone bad

originally appeared in The Denver Post:

Roger Parker appeared to have it all in 2007. He lived in a historic, $9 million mansion in Cherry Hills Village amid Denver's business and sporting elite. He golfed with John Elway. He traveled by private jet to gamble in Las Vegas and golf in Palm Springs.
Also that year, Parker completed the deal of his career. The chief executive of Denver-based Delta Petroleum sold a $684 million, one-third stake in the growing company to Tracinda Corp., owned by billionaire investor Kirk Kerkorian.

The transaction would be Parker's undoing, marking the start of a remarkable downfall. It played out, friends say, as a close business associate discovered that Parker, then married, was having an affair with his wife.
Parker and Delta struggled with risky bets gone bad. Tracinda forced Parker out after about a year and eventually took Delta into bankruptcy. It pursued Parker for more than $7 million from an unpaid loan but recently found just $46 in his retirement account and $10,000 in his brokerage account.

On Nov. 27, the U.S. Securities and Exchange Commission accused Parker of tipping off his close friend and another, as-yet-unidentified friend ahead of the Tracinda deal, allowing them to reap hundreds of thousands of dollars in ill-gotten gains. His lifestyle included use of private charter jet services as well as many other exclusive memberships.
Two Cherry Hills homes — one Parker bought in 2004 for $9 million and the one it replaced, recently signed over to his ex-wife — are for sale.
An attorney for Parker did not respond to requests for comment for this story. He has not yet responded to the SEC's claims.

Interviews with friends, associates and businessmen, as well as scores of public documents, paint a picture of Parker, 51, as ambitious and aggressive, someone who set out early on a path toward multimillion-dollar success and social prominence.
He achieved both — with the help of a network of well-placed friends — but he took big risks along the way, spent lavishly and seldom settled for second-best.
Roger was a guy who thinks it all works out in spades, according to Delta's former chief operating officer.  At one point, he speculated aloud he would be worth $200 million someday.

Fast success
Parker was a standout student at the University of Colorado business-school program in mineral land management. It trained students to be the property-acquisition brains behind the geologic science that identified potentially drillable resources.
But the 1980s, with the petroleum industry tanking, wasn't the best time to aspire to be an oilman.
There were no jobs, recruiting was down 80 percent, and the only ones likely to find a job after the collapse were those with experience, or new grads, according to an associate who graduated with Parker in 1983. But Roger got involved from the start. While we were all in school, he was getting a feel for the business, getting connections and experience. Parker found fast success from hard work.

Only a couple years out of school, he had the big house, all the trappings of success, according to one source.
That happened at Ampet Inc., a small oil-and-gas company formed by Parker mentor and a family friend, a Breckenridge attorney, and his lawyer father, Parker's parents were investors in the business.
The younger Parker and the junior partner would remain business associates for years, beginning with Parker's seat as executive vice president of Ampet while still a student at CU, records show.
While Parker worked at Ampet, his business partner and an associate formed Delta Petroleum in 1984. Parker was first listed on Delta documents as secretary in 1987.

Golf friendships
Two months later, Parker's father, was nominated to the U.S. District Court bench in New Mexico by President Ronald Reagan.
The elder Parker eventually served as federal chief judge in New Mexico until 2003. Along the way, he invested in oil and gas — including Delta — and as of 2010 was drawing royalties on several Colorado wells, some in the range of $500,000 to $1 million, according to financial-disclosure records required of all federal judges.
Roger Parker's relationships reach deep into Denver's business community and stretch across years.

Boisterous in laughter and quick with a joke, Parker was often found hanging with pals at Elway's, in part because of a friendship with the former Broncos quarterback. Both exceptional golfers, Elway and Parker sometimes partnered in charity events, friends said.
Efforts to reach Elway through the Denver Broncos were unsuccessful.
One of Parker's closest friends is a CU graduate in mineral land management with Parker.
The two are avid golfers — with memberships at Cherry Hills and Castle Pines, among others — and big boosters of CU's athletic program, forming the elite Buff Club Cabinet with others including Van Gilder.
The CU graduate has found a level of success that eluded his friend. He recently sold his Cordillera Energy Partners III for $2.8 billion to the company where he started, Apache Corp. Efforts to reach the college friend for comment were unsuccessful.

Drive for status
Parker, twice divorced, enjoyed living large, primarily through houses, golf-club memberships and jets, friends say.
His drive for status was evident in a years-long pursuit of a home at the very pinnacle of Denver society.
Parker sold his first Cherry Hills house and moved into a two-story Tudor he built in 2001 next to the Cherry Hills Country Club. He borrowed $1.6 million to build it and borrowed another $9 million on it over the years. But friends said he was disappointed with the outcome.
In 2004, Parker bought a $9 million mansion from old-money oilman's family along the exclusive Cherry Hills Park Drive. Next door lived the Broncos head coach, and across the street was their legendary money manager.
But Parker was unable to sell the Tudor home, and it remains on the market. The mansion he bought from the oil family — one of the oldest in that area — also is for sale.
Parker acquired a quarter interest in use of a Citation 10 jet, and he sold half of that to Delta.

On a golf trip to Palm Springs, Parker and friends stopped in Las Vegas — the Bellagio and Venetian were among his favorite haunts — to play the tables. Parker believed he could break the house in blackjack, one associate said.
Parker isn't flashy, most comfortable wearing shorts and tennis shoes, driving an SUV, listening to Aerosmith and drinking rum and Coke, friends said.

Parker often does business with friends. One of those is Denver power broker and Parker's personal and business attorney. Earlier this year, Parker pledged 100,000 shares in Prospect Global Energy as collateral to his attorney's law firm for personal legal help, state corporation filings show. At the time, the shares were worth $1 million. Today, they're valued at $167,000.

His attorney who is not representing Parker in the SEC's insider-trading case, would not comment for this story.
One of the attoney's sons, is vice chairman and co-founder of the Denver company, which mines potash.
A Prospect investor who founded Hexagon Investments in 1992, also is a friend of Parker's. He would eventually loan $24.7 million into Parker's latest venture, Recovery Energy, according to financial filings. Efforts to reach the investor for comment were unsuccessful.

Lucrative introduction
Parker was introduced to Kerkorian by a former chauffeur who entered the oil-and-gas business after marrying the former Denver Post owner. The chauffeur, now a Las Vegas resident, had done business with Delta as far back as 2003.
For the introduction — and the resulting sale of a 35 percent ownership share of the Denver company — Davis landed about $5 million worth of Delta shares. Kerkorian would allege later in a settled lawsuit that Parker had secretly arranged contracts and business arrangements for Davis as part of the deal.
Tracinda bought in at $19 a share — Parker had pushed off an initial $17 bid and pressed for more — on New Year's Eve 2007. The $684 million purchase pushed the company stock up 19 percent in one day. It would eventually hit $24.78 from $15.51, when the Tracinda deal was announced.

The SEC alleges in its civil suit that in the months and days before the Tracinda investment was firm and made public, he sent dozens of text messages about it to his business associate. Insiders said Parker didn't even tell some of his closest board members and company executives about the impending deal.
In a related case, his business associate was indicted on criminal insider-trading charges that he allegedly made about $86,000 on the information. He has pleaded not guilty. The SEC alleges that another unnamed individual who is friends with him and Parker racked up a $730,000 payday on Delta stock.
The government has not accused Parker of profiting from the information.
Delta and Parker had encountered the SEC before. In 2006 and 2007 — prior to the Tracinda deal — the government investigated alleged backdating of stock options that were awarded to Parker and other executives. The SEC later dropped its inquiry, and a pair of shareholder suits alleging the practice were settled.

Margin call
Following the merger, it didn't take long before Parker's business plan — a no-hedge, keep-drilling approach — would weigh on Delta's books and, eventually, its stock price.
Several company insiders say Parker's steadfast refusal to hedge some of the company's natural-gas and oil assets against a potential price drop was its most critical undoing. Typically, energy companies hedge by agreeing to sell a portion of their future production at a set price or range.

Delta's former COO and chief geologist, said Delta could have hedged through 2015 but didn't. We'd still be around today if it had.
When shares in Delta dropped below $4 in November 2008, it triggered a margin call on Parker's brokerage account because he had pledged shares as collateral for loans.
Tracinda loaned Parker $7.5 million to cover the shortfall. It said in legal filings it wanted Parker to pay attention to Delta instead of his failing personal finances.
By January 2009, the situation was, in one insider's viewpoint, desperate. He was the eternal optimist of gas prices coming right back, the insider said.  They didn't.

By May 2009, Kerkorian had had enough. Three board members asked Parker to resign as chairman and CEO. Parker couldn't get along with new co-chairman Daniel Taylor, a Kerkorian board appointee.
Parker left with a severance payday of about $7 million.

New venture
Parker wasn't unemployed for long.
With the help of friends, he staged a comeback through a new venture, Recovery Energy.
While Reiman was the money lender, the oil-and-gas properties that made up Recovery's inventory came from Davis. Van Gilder provided the office space.
Parker paid for much of it with shares in the new company, a tactic he had used before.
Filings show the company's production and revenues followed a downward trend. Revenues in 2010 were $9.76 million but only $8.36 million in 2011. Oil and gas production in the second quarter of 2012 was down 24 percent from 2011.
Interest expenses in 2011 almost equaled the value of the oil and gas the company produced.

Parker engaged in an unusual practice with his Recovery shares that may have been intended to land a bigger payday or ward off a creditor such as Tracinda.
Normally, executives try to obtain the shares they are granted as quickly as possible, a process known as vesting.  Parker, however, amended his employment agreement 14 times over more than two years to push back the date when his Recovery shares would vest and come into his possession.

Tracinda in late August won a judgment for the $7.5 million loan — now $7.7 million — against Parker, who argued he'd been shorted about $5 million in an effort to sell the last of his Delta stock in 2009.

Tracinda has been following Parker with garnishment orders to collect — first on his pension account and then his securities account. Total garnered: $10,745.
It followed with a garnishment order at Recovery for Parker's salary, roughly $21,000 a month, and is making a grab at about 1.3 million of Parker's Recovery shares.
Parker resigned from Recovery on Nov. 14, just ahead of another garnishment effort by Tracinda. SEC notices show his business partner began selling Recovery stock heavily just after.
Two weeks later, the SEC named Parker a co-defendant in its insider-trading lawsuit against another associate.
Friends said he left town on a trip when the case was about to be made public.

SEC is Agency Most Affected by Financial Reform

Washington Post

The financial regulation law signed by President Obama on Wednesday will arguably affect no federal agency more than it does the Securities and Exchange Commission.

The SEC is required to issue 95 new regulations governing a wide swath of the financial sector, dozens more than the Federal Reserve, the new Consumer Financial Protection Bureau or other federal agencies. The SEC is also slated to complete 17 one-time studies and five new ongoing reports, according to a tally by the law firm Davis Polk & Wardwell.

The SEC will serve on the new Financial Stability Oversight Council, a new interagency body meant to spot emerging risks to the overall financial system. It will have to write rules to supervise the multibillion-dollar market of derivatives linked to stocks and bonds. It will begin examining the activities of hedge funds and private equity firms and tighten oversight of credit-rating agencies. And it will do studies of short selling and whether brokerage and investment firms must meet higher standards.

Perhaps only the Office of Thrift Supervision can compete with the SEC in terms of the new law's impact. But in contrast to the SEC, which is gaining so many new responsibilities, OTS, which regulated home lenders, is being abolished.

Indeed, the SEC is coming out of the financial regulatory overhaul far stronger than many observers of the agency might have anticipated. The SEC was the object of much criticism -- on Capitol Hill, Wall Street and elsewhere -- for multiple regulatory failures, from oversight of investment banks to the Ponzi scheme orchestrated by Bernard Madoff.

"There was a point in time when things were not looking good for the SEC. People were asking whether it should be merged with another agency," said Marc S. Gerber, a securities lawyer at Skadden Arps. "But with the leadership led by Mary Schapiro, they were able to right the ship and get the SEC on course and improve their standing in Congress, so they were able to get these new responsibilities."

More tasks for agency

Before the financial reform law, the SEC already had a full plate. It is working to implement or finalize nearly 20 new regulations covering areas ranging from money market funds to high-speed electronic trading. It is also conducting numerous investigations growing out of the financial crisis and is in the early stages of implementing many internal reforms in its enforcement and examination divisions.

The agency's new tasks are just as onerous. Schapiro said at a congressional hearing Tuesday that the SEC will have to hire 800 new employees.

"The act requires the SEC to promulgate a large number of new rules, create five new offices, and conduct multiple studies, many within one year," Schapiro told Congress in prepared testimony. "The importance and complexity of the rules coupled both with their timing and high volume and the rule writing agenda currently pending will make the upcoming rule writing process both logistically challenging and extremely labor intensive."

SEC officials say they will look to write rules and conduct studies as fast as they can with the schedule largely dictated by the new law.

Some of the new rules the SEC will implement on its own. Others will require coordination with other agencies. For example, the SEC must work with the Commodity Futures Trading Commission to write rules for derivatives. The agency must work with the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. to write rules requiring that banks that issue securities to the secondary market hold 5 percent of the investment on their own balance sheets -- a "risk retention" measure.

While the new law imposes many new responsibilities on the SEC, it also makes the agency's job easier in several ways. One is offering more explicit support for some of the more controversial rulemaking efforts the SEC had already launched.

For example, the SEC has proposed rules that would make it easier for shareholders to join together to nominate directors to sit on the boards of public companies. But business interests generally oppose "proxy access" and have threatened to sue if the SEC implements the rules.

The legislation, which makes clear that the agency has the power to write rules granting this power to shareholders, makes the threat of lawsuit less ominous. "For a number of years people have questioned whether the SEC has the authority to adopt proxy access," Gerber said. "That question has been answered."

New enforcement powers

The law also gives the agency's enforcement division new powers to conduct investigations and bring lawsuits against companies and people accused of committing financial wrongdoing. It will be easier for the SEC to serve lawsuits and subpoenas and to bring cases in a more favorable and less expensive regulatory court. The agency will also have a new ability to reward whistleblowers who provide information that's essential to a case.

The law gives the agency plenty of new financial support -- but not as much as the agency wanted. It doubles the agency's budget over five years and also creates a reserve fund the agency can use to plan long-term expenditures such as technology. But the agency wasn't given the power to fund itself through industry fees, as it had wanted.

Commodity Manipulation May Be Easier to Prove With U.S. Financial Overhaul‏

Bloomberg News

Traders will face new rules aimed at making it easier for regulators to prove manipulation in markets for commodities such as oil, wheat and natural gas under the financial overhaul awaiting President Barack Obama’s signature.

The regulations, written in part by Senator Maria Cantwell, a Democrat from Washington state, attempt to relieve the Commodity Futures Trading Commission of the burden of proving a trader intended to manipulate prices. Instead, the CFTC will have to show the trading was “reckless.”

“It will make it easier for the CFTC to bring cases and get people to settle, because people will be reluctant to go to court,” said Geoffrey Aronow, former director of enforcement at the commission and a partner at the Washington law firm Bingham McCutchen LLP.

Proving manipulation has challenged courts and lawmakers since the early attempts to regulate U.S. commodity markets in the 1920s. The financial overhaul of the $615 trillion derivatives market, approved by the U.S. Senate last week and the House on June 30, redraws rules that have been determined for decades by a patchwork of case law.

The legislation will allow the CFTC to better police manipulation, while also expanding its jurisdiction to the over- the-counter derivatives market, said Michael Greenberger, a former director of trading and markets and now a professor at the University of Maryland law school in Baltimore.

Lower Standard

“The standard of proof is lower,” Greenberger said. “If you can’t police for manipulation, you’ve effectively got one hand tied behind your back. The Cantwell amendment unties the hand of the CFTC.”

Derivatives are contracts whose value is derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates or weather. Futures are traded on regulated exchanges, while over-the- counter contracts are privately negotiated.

The financial overhaul will push most of the off-exchange contracts to be processed, or cleared, through third-party clearinghouses and traded on exchanges or similar systems. All trades will have to be reported to trade repositories, which will allow regulators a view of the overall risk in the market.

“The problem I’ve got with it is you have no guidance for your traders,” said Jerry Markham, a professor at Florida International University law school in Miami and an expert witness. “Traders have to be aggressive. This is trading, not tiddlywinks.”

Under current law, manipulation cases hinge on a four-prong test that begins with proving that prices were “artificial,” or outside the bounds of normal supply and demand, Markham said. Then the government must prove that the accused had the ability to cause an artificial price, took actions to cause it and intended it. Proving intent typically requires evidence such as traders’ e-mails or taped telephone calls, he said.

‘Artificial’ Prices

Proving manipulation in court is tough because the statute provides little definition, including how to measure an “artificial” price and establish intent, said Craig Pirrong, director of the Global Energy Markets Institute at the University of Houston, who has written essays on the subject and served as an expert witness.

Confusion has existed since the early days of regulation, Pirrong said. He quoted a 1928 hearing where cotton trader William Clayton said manipulation seems to mean any market move “that does not suit the gentleman who is speaking at the moment.”

In 2008, the year after BP Plc paid a record $303 million to settle a CFTC claim that it cornered the propane market, the four BP traders who were individually charged in the case won a dismissal, in part because U.S. District Judge Gray Miller in Houston found that the law they were accused of violating was too vague to be enforceable.

‘Confusing’ Regime

“The court is sympathetic to the government’s desire to discourage the types of behavior alleged here, but its ability to do so is currently limited by a confusing and incomplete statutory common-law regime,” Miller wrote in his decision,

The U.S. Justice Department has appealed the case.

In addition to the anti-manipulation rules introduced by Cantwell, the law contains provisions that allow the CFTC to police trading practices with oddball names such as “spoofing” and “banging the close,” and contains a measure that Commission Chairman Gary Gensler has dubbed “The Eddie Murphy Rule.”

The rule is named for the 1983 movie Trading Places, which starred Murphy and Dan Akroyd. The plot centers on two brothers who plot to get an orange crop forecast and corner the market for orange juice. Murphy and Akroyd beat them to it, substitute a forgery, and make a fortune while the scheming brothers go bust. The provision bans trading using non-public information misappropriated from a government source, such as crop forecasts or fuel stockpile reports.

Canceling Trades

“Spoofing” is a practice where a trader enters a bid or offer with the intent of canceling it before the trade is carried out.

The legislation also targets any activity that shows a “reckless disregard” for “orderly” trading in the closing period, during which the day’s settlement prices are determined. The provision targets a practice known as “smashing” or “banging” the close, where traders attempt to bully the day’s settlement price by buying or selling large volumes just before the close.

“It’s going to be very much like the standard for pornography,” said Gary DeWaal, general counsel for Newedge USA LLC, the world’s largest futures broker. “The CFTC is going to say, we know orderly when we see it. And that’s going to be a bone of contention.”

SEC Approves 'Circuit Breaker'

The Wall Street Journal

Trading exchanges as early as Friday will implement rules designed to tame the volatility of individual stocks by temporarily halting trading during dramatic price changes, even as market participants are bracing for stiffer rules.

Members of the Securities and Exchange Commission signed off on the stock market "circuit breaker" Thursday, the agency said.

The New York Stock Exchange said it will begin a phased rollout on Friday. BATS Global Markets and Direct Edge also have said they expect to begin implementation Friday.

The rule will be in effect on a pilot basis for six months.

The cross-market trading pause was proposed last month in response to the May 6 "flash crash" that saw the Dow Jones Industrial Average plummet almost 1,000 points before partially recovering.

All exchanges will halt trading for five minutes in an individual stock when its price moves 10% or more, up or down, in the previous five minutes. The pause is designed to give traders time to catch their breath and assess whether a stock's price change stems from a real shift in value or an unrelated market hiccup.

"These new rules will ensure that all markets pause simultaneously and provide time for buyers and sellers to trade at rational prices," said SEC Chairman Mary Schapiro.

The SEC considers the stock-by-stock circuit-breaker rule to be the first step of several to curb damage caused by unusual market fluctuations like those seen May 6. Regulators haven't pinpointed a single cause for the incident and are saying it was caused by a confluence of events.

The financial industry generally supports the circuit breaker, but most observers and regulators agree that it alone won't stop another flash crash from occurring.

Right now, the circuit breaker applies only to stocks contained in Standard & Poor's 500-stock index. It doesn't cover smaller cap stocks or index-based products such as exchange-traded funds, which were some of the stocks most dramatically affected on May 6.

"It is my hope to rapidly expand the program to thousands of additional publicly traded companies," Ms. Schapiro said.

In a letter to the SEC, Rep. Melissa Bean (D., Ill.) said, "I am concerned that by limiting the rules to the issuers in the S&P 500, other issuers will be vulnerable to continued market volatility."

The Issuer Advisory Group suggested that regulators include an "opt-in" provision that would permit non-S&P 500 companies to elect to participate.

Other people commenting about the rule are concerned about the market disruptions outside of the 9:45 a.m. to 3:45 p.m. EDT window when the circuit breaker would be in effect. TD Ameritrade Inc. said 10% to 15% of its trades on any given day are placed overnight to be executed at market open, leaving those stocks vulnerable for 15 minutes.

As a next step, the SEC is looking to ban "stub quotes," which are placeholder prices that tend to be far from an actual market price. Normally, those trades won't get executed. But investigators believe that on May 6 some trades were executed unintentionally at stub-quote prices.

The SEC also is working with exchanges to create a unified and predictable policy for breaking erroneous trades.

Regulators and exchanges have said they are dissatisfied with the decision to cancel hundreds of trades that occurred during the height of market volatility on May 6. After the flash crash, the exchanges decided to cancel all trades executed at prices that were more than 60% above or below those printed before 2:40 p.m.

The SEC is eyeing certain types of buy and sell orders for further regulation. Ms. Schapiro has identified two of these types: market orders (orders to buy or sell at market price without regard to fluctuations) and stop-loss orders (orders to sell when a stock falls to a certain price). Investigators of the flash crash believe those types of orders could have accelerated the market drop.

Regulators also will be keeping an eye on different exchanges' rules to curb market volatility. NYSE Euronext has a protocol that halts trading in stocks under certain circumstances. Nasdaq OMX Group Inc. last week announced a similar system that it says is designed to complement the stock-by-stock circuit-breaker rule.

Knight Capital Group Inc. said in a letter to the SEC that the NYSE and Nasdaq protocols, combined with SEC rules on market pauses, "could all be triggered during volatile market periods, creating a great deal of confusion and uncertainty."

The NYSE will undergo a phased rollout of the circuit-breaker pilot program, with the circuit breakers for some stocks starting Friday and the remainder being added early next week, according to Raymond Pellecchia Jr., vice president of corporate communications at NYSE Euronext.

By Wednesday, the circuit breakers will be functioning for all affected stocks, he said.

This weekend, the NYSE will provide scripted halt messages during a testing period that will allow member firms to ensure they receive them properly. The exchange hosted a similar testing session last weekend as well. Mr. Pellecchia said firms can participate in the testing remotely, and so it won't necessarily require traders to be on the floor on a weekend.

SEC Porn Investigation Yields Dozens

The Washington Post

 

Dozens of Securities and Exchange Commission staffers used government computers to access and download explicit images and many of the incidents have occurred since the global financial meltdown began, according to a new watchdog investigation.

The SEC inspector general conducted 33 probes of employees, 31 of which occurred in the last two and a half years, according to a summary of the cases requested by Sen. Charles E. Grassley (R-Iowa) that first surfaced Thursday evening.

Several of employees held senior positions, earning between $99,300 and $222,418 per year, the inspector general's summary said. Three of the incidents occurred this year, ten in 2009, 16 in 2008, two in 2007 and one each in 2006 and 2005.

In one instance, a regional office staff account admitted viewing pornography on his office computer and on his SEC-issued laptop while on official government travel. Another staff account received nearly 1,800 access denials for pornography Web sites in a two-week period and had more than 600 images saved on her laptop’s hard drive, the report said.

A senior attorney at SEC headquarters in Washington admitted he sometimes spent as much as eight hours viewing pornography from his office computer, according to the report. The attorney’s computer ran out of space for the downloaded images, so he started storing them on CDs and DVDs that he stored in his office.

Rep. Darrell Issa (R-Calif.), ranking Republican on the House Oversight and Government Reform Committee, said it was “nothing short of disturbing that high-ranking officials within the SEC were spending more time looking at pornography than taking action to help stave off the events that brought our nation's economy to the brink of collapse."

"This stunning report should make everyone question the wisdom of moving forward with plans to give regulators like the SEC even more widespread authority," Issa said in a subtle jab at ongoing financial reform efforts.

Grassley’s decision to release the summary comes as SEC investigators have filed a fraud case against Wall Street powerhouse Goldman Sachs. But a spokeswoman cautioned against reading too much into the timing.

"The IG findings that Grassley released underscore the importance of good IG work," said Grassley spokeswoman Jill Kozeny.

The behavior exposed in the watchdog report violates government ethics rules, but illegal pornography access by federal workers is nothing new:

• A senior executive at the National Science Foundation spent at least 331 days looking at pornography on his government computer and chatting online with nude or partially clad women without being detected. The problems reportedly were so pervasive they diverted the agency's watchdog from its main mission.

• National Park Service employee John A. Latschar, who oversaw the Gettysburg National Military Park, used his office computer over a two-year period to search for and view more than 3,400 sexually explicit images. He was later reassigned to an unspecified desk job.

• Alex Kozinski, chief judge of the U.S. 9th Circuit Court of Appeals, established a Web site that featured sexually explicit photos and video. He later acknowledged posting images, defended the content as "funny" (no, really) and said he thought the site was for his private storage. All of this while he was presiding over an obscenity trial. He later took the site down.

Ex-SEC Chief Cox says SEC could bring Lehman Case

Reuters

A bankruptcy examiner's report showing that Lehman Brothers may have filed misleading financial reports could lead to U.S. Securities and Exchange Commission charges, the former head of the SEC said on Tuesday.

Christopher Cox, who was chairman of the SEC when Lehman declared bankruptcy in September 2008, also said that neither the SEC or the Federal Reserve was aware that Lehman used so-called "Repo 105" transactions to artificially reduce its apparent leverage, as alleged in the report.

"The examiner's report of evidence that Lehman filed misleading financial reports and failed to disclose material accounting information... may provide the basis for SEC law enforcement action in that case," Cox said in testimony prepared for the U.S. House of Representative's Financial Services Committee.

Cox did not clarify whether he believes the SEC may be able to charge the firm or individuals.

Former Lehman Chief Executive Richard Fuld said in prepared remarks for the same hearing that he only learned of the firm's use of Repo 105, a controversial accounting technique, a year after the investment bank filed for bankruptcy.

The committee is exploring the public policy implications of investment bank Lehman's failure and the findings of the bankruptcy examiner.

Cox, whose agency was the primary supervisor for Lehman and other investment banks, did not appear in person, but submitted eight pages of testimony.

He said international bank capital standards at the time were not adequate to protect Lehman and other firms from shocks to the financial system.

Cox said he is concerned new stricter capital and liquidity rules are not yet in place.

"In my view, it remains a matter of the utmost urgency, in particular for commercial bank holding companies, whose ranks now include not only such large and systemically important entities such as Citigroup and Bank of America, but also the nation's largest investment banks," he said.

He also said that in the final days before Lehman filed for bankruptcy, it was still not clear to top government officials and Wall Street executives whether there would be federal support for Lehman.

"The lack of such clarity may have contributed to the demise of Lehman in September 2008," Cox said.

Lehman Examiner to Testify That S.E.C. Sat on Its Hands

NY Times

From left, Securities and Exchange Commission Chair Mary L. Schapiro, Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Timothy F. Geithner testified before the House Financial Services Committee on Tuesday. 

 

The court-appointed examiner who dissected the Lehman Brothers bankruptcy is expected to criticize the Securities and Exchange Commission on Tuesday for its decision to “stand by idly” as the investment bank veered toward collapse.

The S.E.C. knew that Lehman did not have adequate liquidity and had exceeded its own limits on risk-taking but in essence did nothing, the examiner, Anton R. Valukas, will say in testimony released in advance by the House Financial Services Committee.

One of the most damning findings in Mr. Valukas’s 2,209-page report last month — that Lehman used accounting gimmicks to hide the extent of its indebtedness — was not known to the S.E.C. He wrote: “I saw nothing in my investigation to suggest that the S.E.C. asked even the most fundamental questions that might have uncovered this practice early on, before Lehman escalated it to a $50 billion issue.”

Prepared testimony of Richard S. Fuld Jr., Lehman’s chief executive, says that he had no knowledge of the accounting maneuvers, known at the firm as Repo 105 transactions. “I have absolutely no recollection whatsoever of hearing anything about Repo 105 transactions while I was C.E.O. of Lehman,” his statement says. “Nor do I have any recollection of seeing documents that related to Repo 105 transactions.”

The committee, which is examining the implications of Mr. Valukas’s report, has also summoned Treasury Secretary Timothy F. Geithner to testify, and Ben S. Bernanke, the Federal Reserve chairman. Mary L. Schapiro, who took over the S.E.C. in January 2009, has also been called.

But the testimony of Mr. Valukas is likely to be the high point of the hearing. His statement says there was no way of knowing whether the S.E.C. could have saved Lehman from a failure in September 2008 that caused the credit markets to seize up and threatened a wider catastrophe.

“But what is clear is that had the government acted sooner on what it did or should have known, there would have been more opportunities for a soft landing,” it says. “The markets might have been spared the turmoil of Lehman’s abrupt failure.”

Mr. Valukas wrote, “The S.E.C.’s role was not to simply absorb and acquiesce to Lehman’s decisions; the S.E.C.’s role was to supervise and regulate to protect investors and the markets.”

Both the Federal Reserve and the Treasury Department grew increasingly concerned about Lehman’s survival after the near collapse of Bear Stearns in March 2008, but both entities deferred to the S.E.C. as Lehman’s presumed regulator.

The S.E.C. chairman at the time, Christopher Cox, told Mr. Valukas that he believed that the agency’s jurisdiction “was limited to Lehman’s broker-dealer subsidiary and that it was not the regulator of Lehman itself.”

All five big investment banks — Lehman, Bear, Goldman Sachs, Morgan Stanley and Merrill Lynch — had voluntarily submitted to an S.E.C. regulatory program from 2004 to 2008. But Mr. Valukas said it was pretty much toothless.

“The S.E.C. made a few recommendations or directions here and there, but in general it simply collected data; it did not direct action, it did not regulate,” he wrote in his testimony.

Mr. Bernanke’s testimony states that “the Federal Reserve was not aware that Lehman was using so-called Repo 105 transactions to manage its balance sheet,” but adds that knowledge of the gimmicks would not have changed its view that “the capital and liquidity of the firm were seriously deficient.”

The statement notes that the Fed placed two examiners on site to monitor Lehman’s financial condition after it began taking part in an emergency lending program the Fed created in March 2008. “Beyond gathering information, however, these employees had no authority to regulate Lehman’s disclosures, capital, risk management, or other business activities,” it says.

Dodd's New Plan for Finance Rules Aims to Give More Muscle to Fed

The Wall Street Journal

WASHINGTON—The political battle over rewriting the rules of Wall Street will intensify Monday afternoon when Senate Banking Committee Chairman Christopher Dodd is expected to introduce legislation tougher on financial companies than was expected just a few weeks ago.

The shift follows a push from the Obama administration, which sees a political advantage in pushing legislation taking aim at Wall Street. Mr. Dodd's bill would allow the Fed to examine any bank-holding company with more than $50 billion in assets, and large financial companies that aren't banks could be lassoed into the Fed's supervisory orbit. This came after Treasury officials pushed Mr. Dodd to bring more companies under the Fed's purview.



Any financial company, from small payday lenders to huge megabanks, would have to abide by new rules written by an autonomous Fed division that would be given the job of protecting consumers. This division would also be able to sanction any bank with more than $10 billion of assets for violations of consumer rules. Other industries could face enforcement if regulators decide to expand the division's powers. This is a departure from a more-constrained setup Republicans thought they had secured in recent talks.

The bill would now give the government more power to crack down on risky practices or certain types of lending.

In other highlights, under the proposed legislation the government would have power to seize and dismantle failing financial companies; complex financial instruments such as derivatives would face more scrutiny; shareholders would have more say in the way publicly traded companies operate; and the government would have more tools to force banks to reduce their risk.

Mr. Dodd has courted Republican support for months and said Sunday in an interview he still hoped to pass a bill with broad support. But he also appeared emboldened, and called Republican efforts to delay a vote "totally unrealistic and wrong." He suggested Republicans who wanted to make changes to the bill would have to "back up their commitment with the votes."

He dismissed arguments from some in the banking sector that have said more regulations would constrain credit. He called this a "Chicken Little" argument, calling it alarmist and arguing that financial crises are what dry up credit.

With Mr. Dodd intent on moving quickly, the banking industry will have limited time to try to shape the bill. "The industry will be subject to these new rules for the next 50 years or so, so this is a major moment in the history of the financial-services industry," said Scott Talbott, a senior vice president at the Financial Services Roundtable, a trade group representing large financial companies.

The Dodd bill comes nearly 18 months after the height of the financial crisis in 2008. Whether it can quickly gain traction could help determine the fate of the Obama administration's yearlong effort to rein in banks.

"There's no question that Treasury is pushing left, and that's what I would expect at this point," said Sen. Bob Corker (R., Tenn.), who negotiated for weeks with Mr. Dodd on parts of the bill.

The biggest winner in Mr. Dodd's bill appears to be the central bank. It would police previously unregulated sectors of the economy and would have a new division to write consumer-protection policy. The biggest losers appear to be large financial companies, who would face a muscular, centralized regulatory architecture for perhaps the first time in U.S. history.

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Bill's Highlights

Dodd's proposal touches on several areas. Key points:

    * Consumers: A consumer-protection division would be created within the Federal Reserve, with the ability to write new rules governing the way companies offer financial products such as mortgages and credit cards. It would have authority over any bank with more than $10 billion of assets, and certain nonbank lenders.

    * Banks: The Fed would oversee bank holding companies with more than $50 billion of assets. Regulators would have the discretion to force banks to reduce their risk or halt certain speculative trading practices.

    * Failing companies: The government would be able to seize and break up large failing financial companies. Big companies would have to pay into a $50 billion fund to finance the dissolution of a failing firm.

    * Systemic risk: A new council of regulators would be created to monitor broader risks to the economy. The council could strongly urge individual agencies to take specific actions to curb risk.

    * Corporate governance: The Securities and Exchange Commission would have authority to write rules giving proxy access to shareholders who own a certain amount of stock. Shareholders would have a nonbinding vote on compensation packages for top executives.

    * Hedge funds: Large funds would have to register with the government.
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Democrats opted last week to forge ahead and introduce a bill without Republican support. Central parts of the bill—especially consumer protection and the role of the Fed—could precipitate a clash, making the bill's prospects cloudy. Democrats believe they can rally public support, with many people still angry at the banking industry in the wake of the financial crisis.

"It would be great to find a bipartisan solution, but if we can't, we have to be true to the policy of ending the malpractice on Wall Street," said Sen. Jeff Merkley (D., Ore.), a member of Mr. Dodd's committee.

Mr. Dodd hopes he can begin holding votes in his committee starting next week. The legislation could come to the Senate floor by late April.

The House of Representatives passed its version in December. Any differences would have to be reconciled with a potential Senate version.

Republicans have said they wanted new market rules. They have blamed the White House for forcing Democrats to push ahead before a bipartisan deal could be struck. The party has not spelled out a strategy for responding to Mr. Dodd's bill, and it's possible Republicans could try to filibuster it, with Democrats one shy of the 60 Senate votes they need to end debate. On Friday, the 10 Republicans on the Senate Banking Committee urged Democrats to slow the process down.

Mr. Dodd's bill is expected to more closely align with the White House's initial proposal, after diverging from it during weeks of negotiations with Republicans. Mr. Dodd, in an earlier proposal, had cut the Fed out of bank supervision. After aggressive lobbying by Treasury Secretary Timothy Geithner and Fed officials, Mr. Dodd agreed to expand the Fed's scope to allow it to monitor any large financial companies.

How I Got the Goods on Madoff, and Why No One Would Listen

Business Week / By Harry Markopolos, with Frank Casey, Neil Chelo, Gaytri Kachroo, and Michael Ocrant

Harry Markopolos and his ad hoc team of sleuths spent eight years trying to expose Bernie Madoff as a fraud—but the SEC turned a deaf ear. His new book tells the sad tale

"I'm a quant," writes Harry Markopolos. "I look at numbers the way other people read books." That ability allowed him to smell a rat in 1999 when he encountered the remarkable returns claimed for a secretive hedge fund run by Bernard Madoff, a renowned Wall Street broker-dealer. Markopolos and two colleagues at asset manager Rampart Investment began looking into Madoff's operation. They soon concluded he couldn't produce those results legally.

The following excerpt describes Markopolos' 2002 trip to Europe with Thierry de la Villehuchet, a French aristocrat who ran Access International, a New York firm that funneled money to Madoff. Markopolos already suspected Madoff was running a giant Ponzi scheme. As he and de la Villehuchet try to market an options-based trading product, Markopolos begins to understand the true dimension of Madoff's crime. On Dec. 23, 2008, less than two weeks after Madoff confessed to FBI agents, de la Villehuchet committed suicide.

We had 20 meetings in three countries in 10 days. It was a whirlwind tour of Europe. We met with various hedge funds and funds of funds. The meetings eventually ran together in my memory, but it seemed like each office or conference room was more luxurious than the previous one. The floors were covered with plush Persian carpets; the walls were done in rich walnut and cherry woods, and hung on many of them were oil paintings; we were served only with sterling silver, and the fixtures were gold. These rooms had been decorated to impress clients, to show them that money didn't matter—which they apparently believed was an effective means of convincing clients to give them their money.

We met with many of the leading investment banks and private banks of Europe. The system there is quite different than here, as wealthy investors use private banks to conduct their business. I went to a meeting with members of the L'Oréal family. At JPMorgan (JPM) I met with a member of the Givenchy family, who spent considerable time complaining about the Hermès family, who apparently were suing his family over an investment that had soured. At lunch one day with Prince Michel of Yugoslavia we sat at a table near Marc Rich, the disgraced financier whom Bill Clinton had so controversially pardoned. All these people knew each other. In Geneva, we were supposed to meet with Philippe Junot, the playboy who had been married to Princess Caroline of Monaco, but he canceled, I was told, because he thought my strategy was too risky, and he preferred to stay with Madoff.

EUROPEAN EXPOSURE

Thierry began every one of our 20 meetings the same way: "Harry is just like Madoff. It's an option-based derivative strategy, only he offers a higher risk and a higher return. But it's different enough from Madoff that you should have him in your portfolio. If you have Madoff and you want some diversification, this will do it."

And every time he said it I got furious. What I wanted to shout out loud was that I was offering higher returns than Madoff because my returns were real and his were not. And I was a lot lower risk, because at most I was going to lose only 50% of their money while with Bernie they were going down a full load.

But I didn't. Instead I smiled and explained how this strategy worked. After that we would drill down to the details. I'd go through my pitch book. Then they would ask the usual range of questions: What are your risk controls? What are your trading rules? What is the frequency of the bad events that can hurt you?

It was the potential risk that scared them. I told them that way less than 1 percent of events could hurt the product, although admittedly should it happen it could be catastrophic. I was honest: "You could lose half your money very quickly."

The only fund that asked what I thought were the right questions about my due diligence was Société Générale. The people I met with there knew their derivative math. They told me, "We like your risk controls.

Harry Markopolos and his ad hoc team of sleuths spent eight years trying to expose Bernie Madoff as a fraud—but the SEC turned a deaf ear. His new book tells the sad tale

You're the only guy who's ever come in here and specified what we can lose. But that risk is too high for us." Ironically, we found out in January 2008 that they actually weren't such good risk managers, as an employee named Jérôme Kerviel defrauded them of more than $7 billion by executing a series of elaborate, off-the-books transactions that circumvented the bank's internal controls.

These meetings generally lasted about 90 minutes, and Thierry would end each one the same way: "When can I have your answer? When shall I call you to find out how much you'd like to invest?" It was never "if you want to invest," always "how much." He was a master salesman.

While the objective of this trip was to introduce my product to these fund managers, it also turned out to be an extremely educational trip for me. I came back with a lot more knowledge about Bernie Madoff than I had expected—and what I learned changed my life.

My team had absolutely no concept of how big Madoff was in Europe. We assumed several European funds and funds of funds had invested with him, but we never appreciated the number of funds or the size of their investments. It became clear to me during this trip for the first time that Madoff presented a clear and present danger to the American capital markets—and to the reputation of the Securities & Exchange Commission (SEC). While obviously I had lost confidence in the SEC, I also knew that investors around the world believed that it offered them a great level of protection and that their money was safe. That was one reason they invested here. When they discovered that wasn't true, that confidence in the integrity of the American markets that led people to invest in them was going to be badly shaken. When Madoff went down, and that was inevitable, the American financial system was going to take a worldwide beating to its reputation. A primary reason to invest in the United States would have disappeared.

Of the 20 meetings we had, the managers from 14 of those funds told me they believed in Bernie. Listening to them, I got the feeling it wasn't so much an investment as it was some sort of financial cult. What was almost frightening was the fact that every one of those 14 funds thought that they had a special relationship with him and theirs was the only fund from which he was continuing to take new money. At first I thought the only reason they would admit to me, someone they didn't know at all, that Madoff was managing their money was because they trusted Thierry, but then I began to understand that they were telling me this to impress me. The message was practically the same in every one of those 14 meetings: "We have a special relationship with Mr. Madoff. He's closed to new investors and he takes money only from us."

When I heard that said the first time I accepted it. When I heard it the second time I began to get suspicious. And when I heard it 14 times in less than two weeks, I knew it was a Ponzi scheme. I didn't say anything about the fact that I heard the same claim of exclusivity from several other funds. If I had, or if I had tried to warn anyone, they would have responded by dumping on me. Who was I to attack their god?

"HE'S NOT A FRAUD"

What I did wonder about was what was going on in Thierry's mind. He heard these 14 fund managers bragging, literally bragging about this special access, just like I did, and he knew it was a lie just like I did. But we never discussed it. Like Frank [Frank Casey, one of Markopolos' colleagues], I had previously tried to warn him. Before we'd left for Europe I'd told him, in these precise words, "You know Madoff is a fraud, don't you?"

And just as he had done when Frank told him, Thierry became extremely defensive. "Oh no, that's not possible," he'd replied. "He's one of the most respected financiers in the world. We check every trade ticket. We have them faxed. We put them in a journal. He's not a fraud."

I had considered asking to see those trade tickets, knowing I could use them to prove to Thierry I was right, but I didn't.

I was afraid that if I asked to see them he would think I was using them to reverse engineer Madoff, and I knew he wouldn't let me kill his golden goose.

I cared about Thierry and I wanted to save him. After it had become clear that Thierry wouldn't listen to me, I called Access's director of research, who was a bright guy and understood derivative math, and told him that I had compiled a substantial amount of evidence proving Madoff was a fraud. "I get into the office at 6:30 in the morning," I'd told him. "If you'll come over half an hour early before tomorrow's scheduled meeting, I can prove to you mathematically that Madoff is a fraud."

He never showed up. And then I got it. He didn't want to know. Thierry didn't want to know. They were committed to Madoff; without him they didn't exist. It was their access to Bernie Madoff that allowed Access International to prosper. So when Thierry heard each of these funds claim an exclusive relationship, there was nothing he could do about it. It changed nothing. I also felt absolutely no obligation to tell any of the 14 asset managers that Madoff was a fraud. I had no personal relationship with any of them, and I certainly didn't want Bernie Madoff to know we were tracking him. Like Access, these funds needed Bernie to survive; they didn't need me. Where would their loyalty be? And what would happen to me when Madoff found out I had warned them?

I did appreciate the fact that they were trapped. They had to have Madoff to compete. No one had a risk-return ratio like Bernie. If you didn't have him in your portfolio, your returns paled in comparison to those competitors who did. If you were a private banker and a client told you someone he knew had invested with Madoff and was getting 12% annually with ultralow volatility, what choice do you have? You're going to either get Madoff for that client or lose the client to a banker who has him. And Madoff not only made it easy; he made it lucrative. He allowed the feeder funds to earn higher fees than anyone else and always returned a profit.

That was the reason so many European funds gave their millions to him. It was after these meetings that I strongly suspected Madoff was even bigger in Europe than he was in the U.S. I estimated the minimum amount of money Bernie had taken out of Europe was $10 billion and in retrospect even that probably was low.

Once I realized how much money he had taken out of Europe—and was continuing to take—there was no longer any doubt in my mind that he wasn't front-running [that is, using his knowledge of transactions moving through his brokerage to trade ahead of them for his hedge fund clients]. This was a Ponzi scheme.

FEEDING THE MONSTER

For a Ponzi scheme to continue to survive you have to bring in new money faster than it is flowing out, because you're robbing Peter to pay Paul. The more Pauls you have to pay, the more Peters you need to find. It's a ravenous monster that needs to be continuously fed. It never stops devouring cash.

But it became clear to me that the Europeans believed he was front-running—and they took great comfort in it. They thought it was phenomenal because it meant the returns were real and high and consistent and that they were the beneficiaries of it. They certainly didn't object to it; there was a real sense of entitlement on this level. To them, the fact that he had a seemingly successful broker-dealer arm was tremendously reassuring, because it gave him plenty of opportunity to steal from his brokerage clients and pass the returns on to them. They never bothered to look a little deeper to see if he was cheating other clients—like them, for example. What they didn't understand was that a great crook cheats everybody. They thought they were too respectable, too important to be cheated. Madoff was useful to them, so they used him.

They were attracted to Bernie like moths to a flame.

Just like the Americans, they knew. They knew. Several people admitted to me, "Well, of course we don't believe he is really using split-strike conversions. We think he has access to order flow."

It was said with a proverbial wink and a nod—we know what he's doing. And if the American Madoff got caught, well, c'est la vie. They believed that the worst that could happen was that he could get caught and go to prison for a long, long time; but they would get to keep their ill-gotten returns and would get their principals back because they were offshore investors and the U.S. courts have no legal hold on them.

But for me, the most chilling discovery of this trip was the fact that many of these funds were operating offshore. It was not something that was spoken about; it was just something I picked up in conversation. Offshore funds are known as tax havens, places for people to quietly hide money so governments won't know about it. They're particularly popular in nations with high tax brackets, like France. While offshore funds certainly can be legitimate, to me it indicated that at least some of these funds were handling dirty money.

An offshore fund allows investors from a high-tax jurisdiction to pretend their income is coming from a low- or no-tax jurisdiction. While I have no direct knowledge, I definitely don't believe that all income from offshore tax havens is eventually declared to the proper government. But what was more frightening to me was the fact that offshore investments are used by some very dangerous people to launder a lot of money. It is common knowledge that offshore funds are used by members of organized crime and the drug cartels that have billions of dollars and no legitimate place to invest them.

For me, that suddenly added a frightening new perspective. It wasn't just the people in these luxurious offices who were going to be destroyed when Madoff went down; it also was some of the worst people in the world. I was pretty certain the Russian mafia had to be investing through one of those funds. I didn't know about the Latin American drug cartels, but I knew they went offshore and were probably into Madoff in a big way. Obviously Bernie had to be worried about a lot more than going to jail. These were men who had their own way of dealing with people who zero out their accounts. Maybe Bernie was close to being a billionaire—we had no idea how much of the money he was keeping for himself—but we knew that even he couldn't afford that.

Philadelphia, Where Rogue Traders Dare Not Tread

Reuters

An office building that sits atop an upscale shopping mall in downtown Philadelphia is not the sort of place that would ordinarily strike fear into the hearts of bad guys on Wall Street.

But that is home turf for the little-known regulator who has built a better mousetrap: an increasingly sophisticated computer database which is already helping the U.S. Securities and Exchange Commission catch insider traders.

Last month, Daniel Hawke, an energetic, guitar-playing 46-year-old lawyer, was named head of a new task force charged with cracking down on a variety of market abuses.

Even before the promotion, Hawke, who remains director of the SEC's Philadelphia office, cast a surprisingly long shadow over the financial industry from his perch a two-hour or so drive from the canyons of Wall Street.

A few weeks after hedge fund billionaire Raj Rajaratnam was arrested in New York last October in the most significant insider trading investigation in two decades, Hawke and his team of lawyers were busy working to reel in the next big catch.

In mid-November, his crew handed out more than a dozen subpoenas to hedge funds and Wall Street investment firms seeking information about trading activity in shares of several drug manufacturers and consumer products companies that were buyout targets in 2006 and 2007.

Hawke, who has more than a decade of regulatory work under his belt, won't discuss the details of the subpoenas or the nature of the ongoing investigation.

But the flurry of activity last fall is indicative of the new, aggressive approach Hawke said he and his team are using to unearth cases of insider trading. And in the months to come, Wall Street firms and hedge funds likely will receive more of these regulatory calling cards from Philadelphia.

"Our focus is on conducting trader-based investigations, rather than going security by security," said Hawke, who has run the Philadelphia office since 2006 and will now also serve as director of the new market abuse unit.

The goal, he said was to discover "hard-to-detect frauds."

CYBER SLEUTHS

Much of the initial detective work that Hawke's group is doing relies heavily on computers. The team cross-checks trading data on dozens of stocks with personal information about individual traders, such as where they went to business school or where they used to work.

Hawke said his investigators are looking for patterns of "behavior by traders across multiple securities" and seeing if there are any common relationships or associations between those traders.

His stock sleuths then try to determine whether those traders who are wheeling-and-dealing in the same group of securities are doing so because they are simply smarter and luckier than other investors, or have benefited from improper access to confidential information.

Looking for connections and past associations among traders at hedge funds and Wall Street firms may not sound like an entirely novel way to conduct an investigation. But it is a marked departure from the way insider trading investigations tended to get going at the SEC.

Historically, the agency has pursued such cases only after being tipped off by an informant or receiving a referral from a market surveillance team at a particular exchange about unusual trading in some stock.

"Our goal is to be better masters of our own destiny by making the most informed decision about what conduct to investigate," said SEC Enforcement Chief Robert Khuzami, in a recent interview. "And one way to accomplish that is to have the broadest and deepest information about what is going on in the markets."

Even the sprawling Galleon Management insider trading investigation, which has led to criminal charges filed against Rajaratnam and 21 others, began with a tip from an exchange and the help of an informant. Federal prosecutors didn't begin placing wiretaps on some of the defendants' cell phones until well after the SEC began gathering evidence of potential wrongful trading by Galleon co-founder Rajaratnam and others.

"A decade ago there wasn't a whole lot of computer assistance when it came to matching up names or matching up employers," said Bruce Carton, a former SEC senior counsel and now editor of Securities Docket, an online securities law blog. "That's extremely helpful."

PHILADELPHIA STORY

This newly elevated status for Hawke's crew may come as a surprise to some on Wall Street, where the SEC's Philadelphia office is often seen as playing second fiddle in regulatory matters to New York and Washington, D.C.

After all, the Galleon case has been almost entirely a New York and Washington operation. And while Hawke's office has jurisdiction over firms operating in five mid Atlantic states and the nation's capital, no one could confuse Philadelphia's Market Street district with Wall Street.

Four years ago, security was so lax at the building where Hawke works that a group of self-styled anarchists stormed the entryway of the SEC's offices and staged a protest.

But tapping Hawke to oversee the SEC's new market abuse task force is a way for the agency's bosses to acknowledge that the Philadelphia office has come up with innovative ways to investigate insider trading.

The agency is giving Hawke the authority to pull in SEC lawyers across the nation. Indeed, his deputy in the market abuse unit is Sanjay Wadhwa, who is currently the assistant regional director of the SEC's New York office.

Hawke began briefing the agency's top brass about his computer-assisted forensic work in late 2007. During a meeting with then SEC Enforcement Chief Linda Thomsen and others, he explained how his team had begun compiling trading records kept by Wall Street market makers on dozens of stocks that were buyout targets. He told his superiors they were looking for common trading patterns to begin an initial inquiry.

A year ago, Hawke's strategy of combing through these so-called "blue sheet" trading records scored its first big success. The Philadelphia office, in tandem with federal prosecutors in New York, filed civil and criminal charges against seven people in conjunction with an insider trading scheme that reaped more than $11 million in profits. The case arose from an analysis of trading patterns in stocks of several companies involved in buyouts in which UBS kept coming-up as one of the deal advisors.

Federal prosecutors got a big break in that investigation when one of the defendants, former UBS investment banker Nicos Stephanou, pleaded guilty and agreed to testify against his alleged co-conspirators. Stephanou is charged with providing some of the defendants with confidential information about the impending buyouts of supermarket chain Albertsons and construction materials manufacturer ElkCorp.

In his cooperation agreement, Stephanou also admitted providing some of his co-conspirators with confidential deal information as far back as 1997. Before the arrests in Galleon, the Stephanou case was one of the bigger insider trading busts by prosecutors and securities regulators in recent memory.

LONG ARM OF THE SEC

Over the years, Hawke, a Washington native, whose father John was a former U.S. Comptroller of the Currency, has earned a reputation for taking on complex cases. He joined the SEC in 1999, after walking away from a lucrative job as a partner with a Washington law firm.

One of his first assignments was a case that led to the SEC filing administrative charges in the summer of 2001 against the now defunct accounting firm Arthur Andersen, which the agency accused of producing faulty audits of trash hauling giant Waste Management Inc. A few months later, Arthur Anderson would again be in the news for its improper audits of Enron.

But it is in insider trading cases where Hawke has shined. And he's not shied away from taking on cases where defendants accused of wrongful trading live in far flung places.

In the Stephanou case, for instance, some of the defendants come from Cyprus and Greece. In 2005, he uncovered a scheme by traders in Estonia to get illegal access to corporate press releases distributed by Business Wire before the potential market-moving information was released to the public.

"Dan has a long history pursuing investigations that have a market abuse angle," said Scott Friestad, an associate director in the SEC's Washington, D.C. office, who supervised Hawke before he moved to the Philadelphia office. "He has been involved in bringing a number of cases that are ground-breaking in some fashion."

Hawke has also had his share of setbacks. For example, in 2008, a federal judge tossed out a case Hawke's office had filed against a hedge fund manager it had accused of insider trading.

Right now, the Philadelphia office is embroiled in a pitched legal battle with suspended Blackstone Group investment banker Ramesh Chakrapani, one of the defendants in the Stephanou case. In an unusual procedural move, Hawke's office wants to dismiss its insider trading case against Chakrapani but retain the right to refile the case at a later date. But a lawyer for Chakrapani, in a bid to clear his client's name, has asked a federal judge to dismiss the SEC action with prejudice -- meaning the agency can't come back and charge the banker again.

A ruling in the matter is pending.

And some, even inside the SEC, question whether Hawke's approach is of much use for developing investigative leads beyond cases in which traders are getting access to confidential buyout-related information.

Hawke is cognizant of those criticisms. He said his proactive approach doesn't necessarily trump tips or informants. The Estonian case, he pointed out, began with a tip from Seattle-area trader and well-known regulatory gadfly Yolanda Holtzee about an unusual spike in trading in a stock.

Rather, he said, computer-assisted probes are intended as a "starting point" for investigations. They help regulators get a better view of what traders are doing in the markets, he said.

Hawke, whose office overlooks the historic building where Thomas Jefferson penned the Declaration of Independence, also said he hopes to send a stern warning to would-be scofflaws that the SEC is on the watch and won't be waiting for informants to come forward to expose wrongdoing.

Former K-Mart Chief Found Liable For Misleading Investors
Story from Bloomberg

Kmart Corp. former Chief Executive Officer Charles Conaway was found liable by a federal jury for misleading investors about the company’s cash crisis in the months before its 2002 bankruptcy.

The U.S. Securities and Exchange Commission, which seeks to bar Conaway from ever serving as an officer of a publicly traded company, sued him in 2005, alleging he duped investors in a third-quarter 2001 securities filing and during a Nov. 27, 2001, conference call.

The case was “a matter of credibility and accountability,” Alan Lieberman, an SEC lawyer, said after today’s verdict. “This jury held Mr. Conaway accountable for his own conduct.”

The jury of five men and five women delivered the verdict near the end of the first full day of deliberations in the trial in federal court in Ann Arbor, Michigan. U.S. Magistrate Judge Steven Pepe will determine what penalty to impose.

Conaway’s attorney, Scott Lassar said he was “very disappointed in the verdict.” Conaway plans to appeal, said Lassar.

‘Dodged Information’

Conaway “dodged inconvenient information,” Lieberman told jurors in closing arguments last week. “He knew when to deny and blame others and say ‘Nobody ever told me.’”

Kmart filed for bankruptcy protection on Jan. 22, 2002, after fourth-quarter sales fell, the surety bonds market evaporated and some suppliers halted shipments. Conaway was fired two months later. Kmart subsequently shed 599 stores and fired about 57,000 workers.

The SEC alleged that Conaway hid the fact the company was short of cash and had a program to delay payments to vendors. Lassar said in his closing argument that the regulator’s case against his client is “ridiculous.”

“There was no liquidity crisis at Kmart” at the time, Lassar argued.

Conaway claimed in testimony last week that he wasn’t involved in preparing the quarterly report. He said he was focused on saving the struggling retailer before the bankruptcy.

“Liquidity was in excellent shape,” Conaway testified. “Better shape than in prior years.” Kmart had caught up by the third quarter, he said. “It wasn’t an issue.”

Bankruptcy Exit

The company exited bankruptcy in May 2003. Kmart Holding Corp. later bought Sears, Roebuck & Co., creating Sears Holdings Corp., based in Hoffman Estates, Illinois.

The government alleged that Kmart began delaying payments to vendors to ease a cash crunch caused by an “extraordinary” $850 million inventory purchase by Kmart’s chief operating officer, without the knowledge of other top Kmart managers, in the summer of 2001.

After delivering the verdict, three jurors who declined to give their names agreed that the videotaped testimony of former Kmart chief financial officer Jeffrey Boyer was particularly important in their verdict against Conaway.

Boyer testified that he was fired after telling Conaway about liquidity problems at the company. The conversation came before Conaway’s November 2001 conference call with analysts, Boyer testified.

The case is Securities and Exchange Commission v. Conaway, 05-cv-40263, U.S. District Court, Eastern District of Michigan (Ann Arbor).