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TMFPostOfTheDay (< 20)

Why Isn't Sarbanes-Oxley Enforced?



December 06, 2011 – Comments (5)

Board: Macro Economics

Author: WatchingTheHerd

The December 4 edition of 60 Minutes aired a two-segment summary of two absolute smoking gun cases of fraudulent business practices at CountryWide and Citi that

a) were detected by the auditing and financial control teams within the firm
b) were reported to executive management as required under SEC regulations and SOX
c) resulted in suspicious termination of employment or material changes in employment responsibilities of those doing the whistleblowing
d) failed to stop CEOs and CFOs from signing quarterly financial statements certifiying the use of adequate financial controls

In the case of CountryWide, its SVP of auditing was notified of issues with loans issued in its Boston office, dispatched a team to the office in off-hours and salvaged documents from recycling bins which proved loan officers were cutting out customer signatures from documents and pasting them on forged documents then photocopying the pasted versions for use as "final" documents. By the end of the mortgage boom, nearly thirty three percent of Countrywide's loans were going bad, sometimes within a handful of months of origination. The SVP reporting the problem was promoted when BoA bought CountryWide but was let go a day before she was to provide information to the SEC

In the case of Citi, a senior executive overseeing audits of mortgage backed securities sold by Citi found glaring performance problems with the mortgages being bundled together in the MBS being sold. Nearly sixty percent of the securities were defaulting. Yet, the papers accompanying the MBS offering stated the underlying securities in question substantially complied with Citi's own internal guidelines for mortgage loans (they DIDN'T). The senior executive wrote emails and issued weekly reports citing the concerns regarding the particular MBS issue and the larger problem with the financial controls in place. Finally, a letter was written to the executive team AND Citi board member Robert Rubin stating that Ciit's financial controls were NOT adequate and that the company had material financial losses lurking which were not reflected on its books and financial statements. Despite the warnings, Citi's CEO signed a quarterly SOX statement eight days later.


Besides the obvious problem posed by a corrupt / incompetent / lazy SEC and Department of Justice, an interview with a key prosecutor in the DoJ seems to point out a larger problem. The pat answer provided when asked why no prosecutions in what appear to be obvious cases of criminal activity have been pursued seems to be: These cases are very hard to prove because one not only has to prove mis-representations were made but that those charged actually intended to make the fraudulent representations.

I think we can all join together to ask in unison: WHAT THE #)@%!

By definition, if you are operating a lending operation that is originating mortgages with a THIRTY THREE PERCENT or SIXTY PERCENT default rate and you know that and that figure is NOT being disclosed to your shareholders or other customers who are buying securities from you, you are committing a fraud. The purpose of Sarbanes-Oxley was to explicitly put executives on notice that the bar for the accuracy of financial reports was being raised and to REMIND them of that higher standard EVERY QUARTER.

"Adequate controls" in the financial world should be equated to the idea of a civil or mechanical engineer being charged with criminal negligence for failure to meet a duty of care in designing a bridge or building that winds up collapsing and killing people. If you are operating a bank that cannot stop lending operations that are producing default rates above a few percent, you are operating a criminally negligent financial institution. If you continue to operate such an institution and have those default rates in front of you and fail to report those default rates to your shareholders, bondholders or customers purchasing securities from you, you are perpetrating a criminal fraud.


5 Comments – Post Your Own

#1) On December 06, 2011 at 11:04 AM, awallejr (28.16) wrote:

I have said for years, that "they got away with it."  The SEC is a simple joke.  I keep urging to appoint Eliot Spitzer in charge of it all. 

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#2) On December 06, 2011 at 12:28 PM, OneLegged (< 20) wrote:

This is allowed because the government is too busy running guns and laundering money for Mexican drug cartels to pay any attention.

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#3) On December 06, 2011 at 12:44 PM, DJDynamicNC (38.75) wrote:

Regulatory capture.

When you claim that corporations have human rights, and that dollars are equivalent to free speech, then the companies with the most dollars get the most say. And when you say that corporations can spend an unlimited amount on electioneering, well... it should be no surprise then that the government regulatory agencies can be captured by the industries they are supposed to be watching.

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#4) On December 06, 2011 at 12:45 PM, outoffocus (23.91) wrote:

Seems like most regulations put into place these days do nothing to actually solve the problem.  They only serve to make compliance more expensive and running a business less fun.

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#5) On December 06, 2011 at 3:37 PM, leohaas (30.01) wrote:

This one is simple to answer: it is because enforcement of regulations is severely underfunded. That's the way the lobbyists who have the politicians (of both parties) at the b@lls want it!

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