In a Sunday op-ed piece in the NY Times, Michael Lewis and David Einhart argue that the revolving door of SEC enforcement attorneys to high-paying Wall Street jobs is a deterrent to the SEC working hard to penalize serious corporate and management malfeasance.  They state:

[A]nything the S.E.C. does to roil the markets, or reduce the share price of any given company, also roils the careers of the people who run the S.E.C. Thus it seldom penalizes serious corporate and management malfeasance — out of some misguided notion that to do so would cause stock prices to fall, shareholders to suffer and confidence to be undermined. Preserving confidence, even when that confidence is false, has been near the top of the S.E.C.’s agenda.

IT’S not hard to see why the S.E.C. behaves as it does. If you work for the enforcement division of the S.E.C. you probably know in the back of your mind, and in the front too, that if you maintain good relations with Wall Street you might soon be paid huge sums of money to be employed by it.

In a second op-ed, they add that the answer to this problem is “perfectly obvious:”

Close the revolving door between the S.E.C. and Wall Street. At every turn we keep coming back to an enormous barrier to reform: Wall Street’s political influence. Its influence over the S.E.C. is further compromised by its ability to enrich the people who work for it. Realistically, there is only so much that can be done to fix the problem, but one measure is obvious: forbid regulators, for some meaningful amount of time after they have left the S.E.C., from accepting high-paying jobs with Wall Street firms.

I disagree with this “obvious” reform.  In my experience at the SEC, the incentives seemed to be the opposite of what the authors describe.  That is, there was a common desire among the go-getters at the SEC’s Division of Enforcement to try to get on the big, high-profile, high-impact cases so as to build one’s credentials and resume.  If you look at the press releases for people hired out of the SEC to the private sector, they invariably state something like, “Mr. Jones played a significant role in the case against WorldCom.”  They do not say, “Mr. Jones successfully did nothing in his 5 years at the SEC and did not roil the markets.”

In addition, at least anecdotally it strikes me that far more SEC Enforcement lawyers go on to private careers with law firms, not to Wall Street (although some of the recent heads of Enforcement heads have gone on to Wall Street).  Law firms also value high-impact resumes for their own marketing purposes.

I am not alone in this opinion, it appears.  Today I saw a post on the excellent Conglomerate blog stating something similar:

They say that the SEC falls down on the job because of the revolving door between government and Wall Street. Ho hum, and maybe true in a sense that few SEC officials want to abolish financial intermediaries and most hope that the markets will prosper. But revolving door conspiracy theorists should imagine the results of an empirical study on the career prospectors of white collar crime prosecutors. We could check this if we wanted, but I suspect that financial crimes prosecutors who bring big cases against big defendants make much more money when they go into private practice than do prosecutors who bring no cases against no defendants. The revolving door would suggest otherwise, but would you, an ambitious young bureaucrat who secretly really wants to make money rather have been put on the Enron team or the Dynegy team? I’d recommend the former.

So, to me, the reform proposed in the NY Times op-ed will not have much impact, if any, and will arguably deter the most ambitious and talented SEC prospects who do not want to be locked-out of the private sector for “some meaningful amount of time” from joining the SEC at all.

Judging from the countless “out of the office” email replies I’ve received over the past two weeks, I think it is safe to say that the holiday-friendly calendar this year has allowed many to take a well-deserved break after a sometimes trying year.  For those of you who have been in and out of the office (mostly out) over the last two weeks of December, here are the 10 things you need to know to get caught up:

12/22: SEC filed a settled enforcement action against UnitedHealth, and stated in its Litigation Release that it chose not to seek a fraud injunction against the company or a financial penalty based on the “extraordinary” cooperation of UnitedHealth.  The SEC provided a detailed outline of the steps the company took, which should be helpful guidance to issuers and encourage cooperation in the future.

12/22: On December 22, Phyllis Molchatsky, a 61-year-old retiree from Valley Cottage, NY, who lost nearly $2 million investing with Bernard Madoff, filed a claim against the SEC.  Her administrative claim alleges that the SEC was negligent in failing to detect alleged Madoff’s alleged fraud, the WSJ reports, and seeks $1.7 million in damages.  Legal experts such as Professor Erwin Chemerinsky say that they do not see a viable suit for money damages against the United States (including the SEC) because of the doctrine of sovereign immunity.

12/24: Although Congress and many others have criticized the SEC for its passivity in the face of the financial crisis, SEC Chairman Christopher Cox stated that, to the contrary, the SEC’s “calmness” has been a “signal achievement:”

“What we have done in this current turmoil is stay calm, which has been our greatest contribution — not being impulsive, not changing the rules willy-nilly, but going through a very professional and orderly process that takes into account unintended consequences and gives ample notice to market participants,” Cox said. This caution, he added, “has really been a signal achievement for the SEC.”

12/25: The NY Times reported that according to new research data, there were 133 prosecutions for securities fraud in the first 11 months of this fiscal year, down from 437 cases in 2000 and from a high of 513 cases in 2002.  In addition, at the SEC, agency investigations that led to DOJ prosecutions for securities fraud dropped from 69 in 2000 to just 9 in 2007, a decline of 87 percent.

12/26: With the number of class actions against Bernard Madoff rising daily, Kevin LaCroix of the D&O Diary introduced “The List: Madoff Investor and Feeder Fund Litigation,” a table of all of the Madoff-related lawsuits that have been filed to date.

12/29: Securities Docket launched its new “Securities Litigation and Enforcement Channel,” and announced two upcoming webcasts to kick things off:

• Jan. 6, 2 pm Eastern: “The 2008 Year in Review–Securities Litigation and Enforcement”
  This webcast will provide a review of the most important developments in 2008, and a look ahead to 2009.  Panelists include several of the leading bloggers in the securities litigation and SEC enforcement world, including Walter Olson (Point of Law; Overlawyered), Kevin LaCroix (The D&O Diary); Tom Gorman (SEC Actions), and Francine McKenna (re: the Auditors).  And me.
• Jan. 14, 2 pm Eastern: “Madoff Litigation–Can the Lost Billions be Recovered? How?”
  This webcast will address the key questions arising from Bernard Madoff’s alleged $50 billion scheme, such as how much money has been lost? Where did it go? What avenues of possible recovery exist and what are the chances of success? Who is entitled to recover? Panelists are Gerald Silk of Bernstein Litowitz Berger & Grossman LLP; Brad Friedman of Milberg LLP; and Dr. Fred Dunbar of NERA Economic Consulting.

To attend either of these free webcasts, please sign up here: http://www.securitiesdocket.com/webcasts

12/30: The SEC announced that after 14 years of service, Susan G. Markel, Chief Accountant for the Division of Enforcement, will leave the agency in January to become a Managing Director in the Corporate Investigations practice of AlixPartners LLP, a global business advisory firm.

12/31: Bernard Madoff provided the SEC with a list of his personal assets, meeting the court-ordered deadline of Dec. 31.  The SEC confirmed receipt of the list on Wednesday, but it declined to reveal details or make the documents available to journalists. According to a subsequent report, the list provided on December 31 hasn’t revealed any major sources of additional cash.

12/31: The stock market closed with the following year-end numbers:

• DJIA down 33.84%, the worst since 1931, third-worst in history;
• S&P 500 down 38.49%, the worst since 1937; and
• The Nasdaq Composite Index down 40.54%, the worst in history.

1/2: The SEC is reportedly pursuing at least one new Ponzi scheme case in which investors may have been cheated out of as much as $1 billion.

So that’s it, you are now completely caught up.  Thank you for reading Enforcement Action in 2008, and here’s wishing all of you a great and prosperous 2009!

The House Committee on Financial Services has scheduled a Full Committee Meeting for Monday, January 5, 2009, at 2:00 p.m., to hear testimony on “Assessing the Madoff Ponzi and the Need for Regulatory Reform.”  The names of the witnesses are not yet listed on the Committee’s website, but TPMMuckraker reports that according to a press release today, Rep. Paul Kanjorski will call the following witnesses before the House Financial Services committee:

- Mr. H. David Kotz, Inspector General, U.S. Securities and Exchange Commission
- Mr. Stephen P. Harbeck, President, Securities Investor Protection Corporation
- Mr. Harry Markopolos, an independent financial fraud investigator for institutional investors and others seeking forensic accounting expertise, as well as a Chartered - Financial Analyst and Certified Fraud Examiner
- Mr. Allan Goldstein, a retiree and investor with Bernard L. Madoff Investment Securities
- Ms. Tamar Frankel, Professor of Law and Michaels Faculty Research Scholar, Boston University School of Law
- Mr. Leon Metzger, adjunct faculty member at Columbia University, Cornell University, New York University, and Yale University

H. David Kotz, of course, is the SEC’s IG, who on Dec. 16 was asked by SEC Chairman Cox to launch “a full and immediate review of the past allegations regarding Mr. Madoff and his firm and the reasons they were not found credible [by SEC investigators]…. The review will also cover the internal policies at the SEC governing when allegations such as those in this case should be raised to the Commission level, whether those policies were followed, and whether improvements to those policies are necessary. The investigation should also include all staff contact and relationships with the Madoff family and firm, and their impact, if any, on decisions by staff regarding the firm.”

Markopolis is a securities executive who commenced a long-running campaign back in 1999 to have the SEC investigate Madoff.  In 2005, he wrote to the SEC that “Bernie Madoff’s returns aren’t real and if they are real, then they would almost certainly have been generated by front-running customer order flow from the broker-dealer arm of Madoff Investment Securities.”

Harbeck, the head of SIPC, has for several weeks now been reviewing the records of Madoff’s business, and recently stated that his review shows that “we do not seem to be dealing with a traditional Ponzi scheme alone.” He said that “this seems to be something of a hybrid,” and added that the potential losses could be far greater than anyone first thought.

Enforcement Action readers are invited to attend what promises to be a great webcast — a review of the most important developments in 2008, and a look ahead to 2009. This free webcast is scheduled for January 6, 2008, at 2 pm Eastern, and is the first of many to come on the new “Securities Litigation and Enforcement Channel.”

The webcast will feature several of the leading bloggers in the securities litigation and SEC enforcement world — Walter Olson (Point of Law; Overlawyered), Kevin LaCroix (The D&O Diary); Tom Gorman (SEC Actions), Francine McKenna (re: the Auditors) and Lyle Roberts (The 10b-5 Daily).  And me, too.

Please join us by signing up below for the free January 6th webcast.   Once you have signed up for this or any other webcast on the Securities Litigation and Enforcement Channel, you can attend all future webcasts with just a “one-click” sign-up.

On Thursday of last week, the SEC filed a insider trading lawsuit against a ring of seven individuals, including Matthew Devlin.  According to the SEC, for over four years Devlin secretly obtained, traded on, and shared with friends inside information from his unknowing wife, who had access to the information because she handled PR for companies entering into mergers and acquisitions.

The familial betrayal alleged by the SEC in the Devlin case is shocking, but hardly novel, unfortunately.  Indeed, there has been a long series of such cases through the years.  Here are my picks for the SEC’s Top 5 Familial Betrayal Cases, sorted by my all-new, color-coded “Familial Betrayal Advisory System.”

#5. SEC v. Melton (April 2007) — Betrayal Level: Low (”Someday We’ll Laugh About It”)

The SEC sued Gary Melton, the husband of an Amgen vice president, for insider trading in the stock of Abgenix, Inc. The SEC alleged that in early November 2005, Melton and his wife discussed the publicly announced favorable results of a clinical trial for an antibody jointly developed by Amgen and Abgenix. At the time, Melton commented to his wife that he might purchase some Abgenix stock, to which his wife said nothing.  A month later Melton’s wife learned through her employment at Amgen that Amgen was about to announce that it was acquiring Abgenix, and she specifically instructed Melton not to purchase Abgenix stock.

Despite his wife’s admonition, Melton promptly purchased 2,050 shares of Abgenix stock prior to the acquisition, and later liquidated his Abgenix stock for a profit of $15,252.

4.  SEC v. Rocklage (January 2005) — Betrayal Level: Guarded (”Counseling Required”)

The SEC sued Patricia Rocklage (the wife of the CEO of Cubist Pharmaceuticals), her brother, and others for insider trading in Cubist securities.  According to the SEC, on December 31, 2001, Rocklage’s husband informed her of the negative results of a clinical trial involving one of Cubist’s most important products, Cidecin.  However, unbeknownst to her husband, Ms. Rocklage had a “pre-existing understanding with her brother whereby she would give him a ‘wink and a nod’” if she ever became aware of any bad news about Cubist that might affect its stock price.  Ms. Rocklage told her husband that she intended to signal her brother to sell his Cubist stock, and her husband urged her not to do so.  The SEC alleged that “notwithstanding her husband’s entreaties, by no later than the morning of January 2, 2002, Ms. Rocklage provided ‘a wink and a nod’” to her brother, who promptly sold all of his 5,583 shares, avoiding a loss of nearly $100,000 when Cubist stock plummeted.

3.  SEC v. Edelman (January 2006) — Betrayal Level: Elevated (”Clothes Thrown Out Window”)

The SEC sued Lee Edelman for insider trading in the securities of Metron Technologies shortly before the August 2004 announcement that it was being acquired by Applied Materials. According to the SEC, Edelman learned about the acquisition negotiations while living with his girlfriend, an associate at a prominent New York law firm retained by Applied Materials. Edelman saw his attorney girlfriend working in their apartment, reviewing deal documents and discussing the transaction on the phone with colleagues, and used this information to secretly begin acquiring Metron shares.

The SEC alleged that several days later, Edelman’s girlfriend directly told him that she was working on an acquisition of Metron, but cautioned him that he could not use the information for any purpose. Edelman agreed not to misuse the information. Unbeknownst to his girlfriend and despite their agreement, Edelman continued acquiring Metron shares, ultimately making profits of $23,000. As a final kicker, it was later reported that a few weeks after he betrayed his girlfriend, Edelman broke up with her, to boot.

2.  SEC v. Stummer (April 2008) — Betrayal Level: High (”Restraining Order”)

The SEC brought an insider trading case against Michael Stummer for insider trading in the common stock of Ryan’s Restaurant Group. According to the SEC, on July 21, 2006, Stummer and his family arrived at the New York home of his brother-in-law for an annual weekend gathering. At this time, his brother-in-law served as director of a private equity firm advising a company on the acquisition of Ryan’s Restaurant Group. During the weekend visit, Stummer snuck into the brother-in-law’s bedroom office and secretly accessed his bedroom office computer. He then correctly guessed his brother-in-law’s password, gained access to the private equity firm’s computer network, and read several confidential and nonpublic emails relating to the Ryan transaction. The SEC alleges that Stummer used the information he obtained to buy 5,500 shares of Ryan’s over the next several days, ultimately realizing a profit of $22,351.17 after the acquisition was announced.

Stummer was subsequently featured in an article in Portfolio, which dubbed him the “Brother-in-Law from Hell” and asked:

What’s the worst thing your brother in law could possibly do at a big family gathering? Get drunk and hit on your spouse? Insult your mother? Break a family heirloom?

How about hack into your home computer, discover confidential information about a private equity deal you’re running, and trade on it illegally?

1.  SEC v. Devlin (December 2008) — Betrayal Level: Severe (”Hell Hath No Fury”)

As discussed above, the SEC sued Matthew Devlin last week for trading on and tipping his clients and friends with confidential, nonpublic information about 13 impending corporate transactions that allegedly led to $4.8 million in illegal profits. According to the SEC, Devlin obtained the information from his wife, a partner in the New York City office of an international public relations firm (Brunswick Group) that was working on the deals. The betrayal allegedly began just four months after the two got married in 2003, and went on for more than four years. Devlin’s wife, who just had a baby three weeks ago, reportedly had no idea that her husband was doing this and is “devastated beyond words.”

The SEC alleged that because the information from his wife was so valuable, Devlin and his friends, including co-defendant Jamil Bouchareb, dubbed Ms. Devlin the “Golden Goose.”  At one point, Devlin reportedly told Bouchareb, whose girlfriend Maria Checa was once a Playboy Playmate (and who is also named in the complaint as a relief defendant), “[your girlfriend] may be amazing at some things, but none of them are like the golden goose.”

How about this stroke of brilliance from Credit Suisse?

Bloomberg reports today that Credit Suisse Group AG’s investment bank will use about $5 billion of its most illiquid loans and bonds to pay senior executives’ employees’ year-end bonuses. The bank will reportedly use leveraged loans and commercial mortgage-backed debt, among the securities blamed for spawning the current financial crisis.

Bloomberg reports that the new policy “applies only to managing directors and directors, the two most senior ranks at the Zurich-based company, according to a memo sent to employees today”

Dirk Hoffman-Becking, an analyst at Sanford C. Bernstein Ltd. in London, stated that “It’s monstrously clever.” “From a shareholders’ perspective it’s great because you’ve got rid of some of the assets and regulators will be pleased because you’ve organized a risk transfer.”

For employees, “there’s some upside in there and if the alternative is nothing, it’s a lot better than nothing,” Hoffman-Becking said.

Read the Bloomberg article (via Clusterstock)

Spurred by the recent insanity arrests events involving Marc Dreier and Bernard Madoff, I set out yesterday to create a Mount Rushmore of Securities Fraud in a post (click here) over at Securities Docket.  After much deliberation, I went with:

1. Marc Dreier
2. Bernard Madoff
3. David Pajcin and Eugene Plotkin; and
4. Lohmus Haavel & Viisemann (Lohmus) and two of its employees, Oliver Peek and Kristjan Lepik

You can read the post at Securities Docket for my reasoning, but I’m pretty comfortable with nos. 1, 2 and 3.  I think I can be persuaded to change #4, although the “Estonian Spider Hackers” from Lohmus are a personal favorite of mine.

Please weigh in below in the comments: Who do you think should be on the Mount Rushmore of Securities Fraud?

In the summer of 2001, General Electric (GE) acquired Heller Financial.  Before the deal was publicly announced, Pequot Capital Management Arthur Samberg directed the purchase of “a little over a million shares” of Heller Financial stock and also directed Pequot to short shares of GE during the same time period. Just after the acquisition was announced, Samberg sold the Heller stock and covered the GE short position, resulting in approximately $18 million in profits over a period of a few weeks.

These trades set in motion an SEC insider trading investigation in 2003, but also a series of related, follow-on investigations that has grown to be truly beyond belief and which continues to this day.  In short, these trades have so far led to:

• an investigation by the SEC’s Division of Enforcement.
• an investigation by the SEC’s Inspector General of the investigation by the SEC’s Division of Enforcement.
• an investigation and 108-page report by the Senate Finance and Judiciary Committees of the investigation by the SEC’s Inspector General of the investigation by the SEC’s Division of Enforcement.
• a complete re-investigation and 191-page report by the SEC’s Inspector General of the investigation by the SEC’s Division of Enforcement.
• a brief “re-re-investigation” and 15-page report by an SEC Initiating Official of the SEC’s Inspector General’s disciplinary recommendations flowing from his re-investigation of the investigation by the SEC’s Division of Enforcement.
• a new investigation commenced in December 2008 by the Senate Finance and Judiciary Committees of reported new evidence emerging in the Pequot insider trading matter.
• an FBI investigation commenced in December 2008 based on the reported new evidence.

The excruciating chronology and details of these investigations are as follows:

November 2003: SEC’s Division of Enforcement opens informal inquiry into potential securities law violations by Pequot Capital Management,

September 2004: New SEC employee Gary Aguirre assigned to case.

January 2005: SEC issues formal order of investigation, issues subpoenas for documents and witness testimony.  Individual Pequot employees represented by six different law firms.

March 2005.  SEC issues a second subpoena for documents; “among over 90 that the SEC issued in the Pequot investigation.”

April-May 2005: Pequot begins producing approximately 80,000 electronic records and 300,000 pages per week to SEC, until a discovery dispute waylays production.

September 1, 2005: Aguirre fired.

October 2005: SEC’s Inspector General Walter Stachnik opens initial investigation regarding Aguirre’s claims that John Mack, CEO of Morgan Stanley, given preferential treatment in Pequot investigation.

November 2005: After interviewing six SEC employees, Stachnik investigation closed.

April 2006: Senate Finance and Judiciary Committees commence investigation into Aguirre’s allegations of lax enforcement in Pequot case.  Senate committees hold three separate hearings related to these matters in June, September and December 2006.  In addition, Senate Finance and Judiciary Committees interview and/or take testimony of at least 14 separate individuals.

July 2006: SEC’s Inspector General Stachnik reopens his investigation of alleged irregularities in Pequot investigation at request of Chairman Cox.

November 30, 2006. SEC’s Division of Enforcement closes its Pequot investigation, takes no action.

August 2007: Senate Finance and Judiciary Committees issue 108-page final report (with additional 599 pages of exhibits) finding that SEC’s IG Stachnik failed to conduct a serious, credible investigation of Aguirre’s claims.

August 2007: SEC IG Stachnik resigns.

December 2007: H. David Kotz named new SEC IG,

January 2008: Kotz personally takes over re-investigation of Aguirre/Pequot matter.  In connection with re-investigation, Kotz and his office:

• take Aguirre’s testimony on five seprate occasions and had telephone discussions with Aguirre on at least 13 other occasions
• interview 28 individuals with knowledge of Aguirre/Pequot matter
• take sworn testimony of 26 individuals
• review countless documents and emails from all key individuals

October 2008: IG Kotz issues 191-page report finding that there is evidence “rais[ing] serious questions about the impartiality and fairness” of the SEC’s investigation of possible insider trading at Pequot Capital Management, recommends disciplinary action against Enforcement officials.

November 2008: Initiating Official Brenda Murray, re-opens record, re-examines facts and solicits new statements from SEC Enforcement officials.  She then issues a 15-page report rejecting IG Kotz’s recommendations of discipline, and finds record does not support any disciplinary or performance-action.

December 2008: New evidence emerges that Pequot secretly began to pay $2.1 million to a key witness in the case in 2007. Senate Finance and Judiciary Committees asks Pequot’s chairman to provide records related to the payments, and the FBI is now reportedly looking into the matter.

Will this case and its investigations of investigations of investigations ever end?

The SEC announced today (click here) that it has finalized settlements with Citigroup Global Markets, Inc. and UBS Securities LLC and UBS Financial Services, Inc. that will provide nearly $30 billion to tens of thousands of customers who invested in auction rate securities before the market for those securities froze in February. The SEC stated that the settlements “resolve the SEC’s charges that both firms misled investors regarding the liquidity risks associated with auction rate securities that they underwrote, marketed and sold.” In mid-February 2008, according to the complaints, Citi and UBS decided to stop supporting the ARS market, leaving tens of thousands of Citi and UBS customers holding tens of billions of dollars in illiquid ARS.

SEC Chairman Christopher Cox stated that “Today’s settlements are the largest in SEC history, and represent the largest return of customer money in the agency’s 75 years.”  The SEC said the settlements will restore approximately $7 billion in liquidity to Citi customers who invested in ARS, and $22.7 billion to UBS customers who invested in ARS.

Read that last part again: $22 billion! What does that even mean? Is UBS stroking a check or a series of checks in the amount of $22 billion? It turns out that the answer is no, and that UBS does not expect its cost to be even 5% of that amount.  In a press release from August 2008 (click here), when UBS first announced its settlement with the SEC and state regulators, UBS stated that:

The full cost of the proposed settlement, taking into account the projected redemption
patterns of clients, the difference between the purchase prices and the current market
value of client ARS holdings, and the regulatory fine related to the settlements, is
estimated to be in the range of USD 900 million on a pre-tax basis, to be booked in the
second quarter results. This includes reimbursements to all clients for losses incurred from sales of ARS holdings between Feb. 13 and Aug. 8, 2008.

This $900 million estimate includes $150 million in fines paid to state regulators, meaning that UBS estimates the total cost to it under the SEC settlement to be $750 million.

How does the number get from $22 billion to an expected total cost of $750 million?  I spoke today with UBS spokeperson Karina Byrne, who explained that the far lower expected cost is the result of several factors:

• Only a percentage of those eligible to participate and receive funds in the settlement from UBS will elect to do so.
• Nearly half of UBS payments need not be made until the middle of 2010, by which time the ARS market may have improved.
• Many of the ARS that UBS is offering to repurchase maintain a significant percentage of their market value, meaning that the net cost to UBS is only a fraction of par value.

The $750 million is a pre-tax number, as well, meaning that the total cost may be even less if it can be used as a tax deduction.  Ms. Byrne also explained that UBS will pay for the settlement via “a combination of standard financing solutions involving short and long term debt financing, as well as more specialized structured solutions.”

An SEC spokesperson confirmed to me that the SEC considers the amounts of today’s settlements to be the larger $22.7 billion (UBS) and $7 billion (Citigroup) figures in its press release.

Last month I wrote here that although there are virtually no “repeatable” ways to legally trade and profit off of inside information, every once in a while a scenario or idea emerges that puts that proposition to the test.  I cited two examples: (1) the recent assertion that some people have early access to, and can trade in advance on, releases on PR newswire services, and (2) Mark Cuban’s Sharesleuth.com business model, which involved him hiring a business reporter to conduct investigations to “identify suspect companies,” Cuban selling short based on the findings, and then Sharesleuth.com publishing reports showing all of the damning evidence (and the stock price of the company involved falling).

Yesterday I found what appears to be example number three of what I call “legal insider trading,” and it falls under the Sharesleuth.com model.  Barry Minkow, former boy-wonder CEO of ZZZZ Best and convicted securities fraudster who spent seven years in prison, now runs a company called Fraud Discovery Institute which seems to specialize in ferreting out executives at public companies who inflate or flat-out lie about their academic credentials.  According to a recent WSJ article (here), Minkow’s company has flagged no fewer than 11 executives for inflated academic credentials.

The reason Minkow’s FDI is of note for this post, however, is its “for profit” business model that it discloses right up front.  As FDI states in its Privacy Policy and Disclaimer,

Barry Minkow almost always holds a position in securities reported on, or profiled by, FDI websites.  Neither FDI nor Mr. Minkow will report when a position is initiated or covered. Each investor must make that decision based on his/her judgment of the market.   We always insist that anyone who relies on our reports, independently corroborate our findings before making any decisions.

Like Sharesleuth.com, Minkow attempts to identify what he believes will be market-moving information about public company executives’ credentials and integrity, sells short on that information pre-publication, and then publishes that information expecting or at least hoping that it will push the price of the executive’s company’s stock down, allowing him to profit.