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Author: WatchingTheHerd Big red star, 1000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 461146  
Subject: 60 Minutes: SOX Sucks Date: 12/4/2011 8:12 PM
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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 explicity 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.


WTH
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Author: jaagu Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 381103 of 461146
Subject: Re: 60 Minutes: SOX Sucks Date: 12/5/2011 3:00 AM
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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.

WTH

=============================================

Citicorp is also fradulent in another area - Judge Rakoff rejected a $285 million settlement between Citigroup and the SEC which shows the following:

According to the SEC, Citigroup stuffed a $1 billion mortgage fund that it sold to investors in 2007 with securities that it believed would fail so that it could bet against its customers and profit when values declined. The fraud, the agency said, was in Citigroup’s falsely telling investors that an independent party was choosing the portfolio’s investments. Citigroup made $160 million from the deal and investors lost $700 million.

http://www.nytimes.com/2011/11/29/business/judge-rejects-sec...

jaagu

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Author: LEDfan Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 381118 of 461146
Subject: Re: 60 Minutes: SOX Sucks Date: 12/5/2011 11:17 AM
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Between this thread by WTH and this thread, http://boards.fool.com/mf-global-quotmissing-customer-fundsq...

It is pretty clear that some serious crime busting is needed. If the feds won't do it, LET THE STATE ATTY GENERALS AT THEM!

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Author: albaby1 Big gold star, 5000 posts Top Favorite Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 381121 of 461146
Subject: Re: 60 Minutes: SOX Sucks Date: 12/5/2011 12:02 PM
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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.

At the risk of stepping into yet another discussion about this, the above statement is partially incorrect. While such practices might constitute a fraud under particular factual circumstances, they are not fraud by definition.

As a very general matter, fraud involves the intentional affirmative misrepresentation of a material fact. Absent either: i) an affirmative obligation to disclose a default rate; ii) or an affirmative representation of a particular default rate associated with a particular batch of mortgages being bundled in a security, then the fact that the default rate is really high would not constitute a fraud. Generally speaking, in commercial transactions between sophisticated parties, there is no affirmative duty to disclose anything at all. So whether fraud occurred is going to be dependent on the specifics of the affirmative representations, rather than a "by definition" thing.

There are affirmative duties to disclose various material financial facts to shareholders, so that might be fraudulent - but again, it depends on how much of the risk of default was being borne by the institution itself vs. being borne by other parties (ie. the folks buying the securities). Again, a factual matter - not a "by definition" matter.

Albaby

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Author: steve203 Big funky green star, 20000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 381122 of 461146
Subject: Re: 60 Minutes: SOX Sucks Date: 12/5/2011 12:31 PM
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If the feds won't do it, LET THE STATE ATTY GENERALS AT THEM!

What amazes me about the various state AG suits, is that, in every case of a company not domiciled in the state filing suit, the company does not make a motion for dismissal based on "interstate commerce" being exclusivily under Federal control, thus the company is out of the state's jurisdiction.

Recall, several years ago, when some states passed airline passenger "bill of rights", the FAA stepped in to declare that the moment the people boarded the plane, they were under Federal jurisdiction, not the state's, even if the plane was still sitting on the ground, so the state did not have jurisdiciton over what happened on the plane.

Steve

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Author: WatchingTheHerd Big red star, 1000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 381142 of 461146
Subject: Re: 60 Minutes: SOX Sucks Date: 12/5/2011 7:37 PM
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Albaby writes: At the risk of stepping into yet another discussion about this, the above statement is partially incorrect. While such practices might constitute a fraud under particular factual circumstances, they are not fraud by definition.

As a very general matter, fraud involves the intentional affirmative misrepresentation of a material fact. Absent either: i) an affirmative obligation to disclose a default rate; ii) or an affirmative representation of a particular default rate associated with a particular batch of mortgages being bundled in a security, then the fact that the default rate is really high would not constitute a fraud. Generally speaking, in commercial transactions between sophisticated parties, there is no affirmative duty to disclose anything at all. So whether fraud occurred is going to be dependent on the specifics of the affirmative representations, rather than a "by definition" thing.


=========================

I recapped his response because logically and legally I agree with it, but because of the special intent of the Sarbanes-Oxley reporting requirements, that intent would seem to negate this normally winning argument over the legalese of the defintion of "fraud." (Again, I'm not arguing with Albaby and he's not really arguing either...)

The SOX rules were enacted to

1) ensure publicly traded firms created viable financial control systems
2) ensure publicly traded firms created protected reporting processes for suspect processes and behavior
3) require POSITIVE affirmation by CEO/CFO personnel that they had read the firm's financial reports
4) require POSITIVE affirmation by CEO/CFO types that they were UNAWARE of any concerns about the integrity of said reports and the systems that produced them

In both of these particular cases, the execs signing SOX compliance affirmations were given repeated WRITTEN documentation of concerns raised not by mere grunts somewhere in the company trying to stir the **** but by senior execs specifically charged with managing the firm's audit systems and financial reports.

In both of these cases, the firms filed "normal" SOX affirmations with their quarterly reports AFTER being given written notice of MAJOR financially material and MAJOR criminally material concerns about their business processes and accounting systems.

In both of these cases, the employer took punitive measures against the employee reporting the information -- also a violation of law. In the BoA case, the employee eventually won a wrongful termination lawsuit and over $1,000,000 in back pay. In the Citi case, the employee wasn't "terminated" but was literally divested of his subordinates and told to work from home, never to co-mingle with other employees again.

Are banks currently required to disclose their default rates on mortgages originated by the firm? Maybe not. Are banks currently required to disclose default rates on securities sold by the firm to its customers? Maybe not. In the case of Citi though, the prospectus issued by Citi for a MBS offering stated in writing that default rates of the mortgages underlying the security were "substantially the same" as mortgages it originated as a major retail lender. One can debate what the likely default rate is for mortgages issued by a top 5 bank -- maybe 5 percent? 10 percent? 20 percent even, given a really bad economy?

No reasonable investor -- sophisticated or not -- would expect a 60 percent default rate on a pool of mortgages. When Citi issued the prospectus stating the mortgages in its MBS deal were substantially the same as its own mortgages, it was making a written representation of quality it knew to be false.

The behavior of CountryWide might be arguably more iffy from a legal standpoint but not very iffy. CountryWide issued fianncial reports quarter after quarter reflecting profits from skyrocketing volume for mortgage originations but did not reflect any loan loss reserves that would have given a moderately informed investor a hint that the volume was achieved by taking on additional risk. CountryWide had volumes of internal data confirming EXACTLY how bad the loans were it was issuing. In the Bethany McLean/ Joe Nocera book All the Devils Are Here, they cite info showing that the firm was carrying $2.8 billion in "leftovers" from loans otherwise securitized away to other parties -- 15 percent of its equity - but did not disclose it to investors. They also added $32.7 billion worth of pay option ARMs on its books -- at full value. Here's what the CEO said in written emails at the time:

We have no way, with any reasonable certainty, to assess the real risk of hodling these loans on our balance sheet... The bottom line is that we are flying blind on how these loans will perform in a stressed environment. -- page 230

You can consult CountryWide's quarterly statements for 2006 and 2007 and it's reasonably assured that the words "flying blind" don't appear anywhere in the CEO summary or auditor's notes to the financial statements.

These are exactly the types of scenarios for which SOX was written. If we are truly at a point where a court of law must recreate the chemical reactions in the synapses of the brain cells of the defendents to somehow "prove" they INTENDED to commit fraud despite mountains of written correspondence proving they knew one thing and representated another, there isn't a fraud statute left on the books worth enforcing and the market will devolve into a high-speed, electronic Wild West race to meltdown.


WTH

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