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The SEC Flacks Paint Lehman's Looters as the Victims of a "Political" SEC

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I have been a senior official in an agency in which the enforcement head followed Cannelos' practice of arrogating to the enforcement attorney the client's right to define its interpretation of its rules.  Our enforcement head asserted that this action meant the enforcement attorney was uniquely virtuous for refusing to act against the senior officers leading the most notorious S&L control frauds.  The enforcement head was particularly proud about refusing to bring an enforcement action that the supervisory client requested against Charles Keating's frauds.  The results were disastrous and played a critical role in producing the worst losses of any S&L failure during the debacle.  It was only after the enforcement head's monopoly on bringing enforcement actions was broken by delegating authority to the regions' enforcement counsel that the Office of Thrift Supervision (OTS) made enormous strides in bringing effective enforcement actions.

It is disgraceful that the SEC enforcement team has been leaking to the NYT reporters the false claim (under their own account of the facts) that they bravely resisted "SEC Chair Mary Schapiro['s] "political pressure [to] bring a case [where] the evidence was lacking.'"  Cannelos and his teams were not brave martyrs for "justice" and Schapiro was not exerting "political pressure" to force them to bring an abusive suit motivated by the Obama administration's (non-existent) desire to punish Lehman's looters for their politics.  Under the facts found by Cannelos, the SEC's experts on materiality and fraud concluded that Lehman's officers had engaged in a very large fraud that was material to investors.  Schapiro and the SEC's experts on materiality believed that Cannelos was wrong about materiality and that it was improper for him to override the client's interpretation of "material."  Schapiro's and the SEC's experts' positions were not "political."  They were substantive, and they were correct.  Cannelos was in the wrong and he compounded his failure by making false claims that those who disagreed with him were "political" and "unethical."

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Let me be clear that the ultimate responsibility for the SEC fiasco lies with Schapiro.  She was appointed to head the SEC by Obama for his traditional reason -- she was an abject failure as the leader of securities industry's self-regulatory body that took no effective action against the epidemics of accounting control fraud that devastated that industry and our Nation.  Ultimately, Schapiro deferred to "Canellos's team, which was closest to the evidence" rather than appoint a competent team and team leader to investigate Lehman's looters.  The issue as to "materiality," however was not "close[ness] to the evidence" but the analysis of whether only the direction of the (dishonestly) reported trend in the leverage ratio (v. the actual leverage ratio) was "material" to investors.  The experts on that issue were the "senior accountants and the head of the S.E.C. unit that oversaw corporate disclosures" and they understood correctly that the actual leverage ratio was material to investors.

Schapiro lacked the courage to replace an enforcement attorney who arrogated to himself the clients decision and who would have attacked Schapiro had he been replaced as unethical and political.  The reporters claim:  "Ms. Schapiro did not override [Cannelos'] judgment after S.E.C. officials cautioned her that it could be unethical for a political appointee like herself to do so."  But the relevant question was not overriding Cannelos' judgment -- it was Cannelos who was overriding the judgment of the client.  That was contrary to the ethical obligations of an attorney, including an enforcement attorney unless the client was pressing a bad faith interpretation of "material."  Allowing Cannelos to override his client's (eminently correct) interpretation of "material" was a dereliction of duty on the part of Schapiro and her head of enforcement.  The SEC was so weak under Schapiro because she was such a weak leader.

Cannelos was so out of control in his devotion to Lehman's looters' cause that he was insubordinate.

"But at a 2011 meeting of senior S.E.C. officials, Lorin L. Reisner, then the No. 2 enforcement official, suggested preparing a draft of potential charges so the agency could have a concrete document to review. Mr. Canellos's team balked, officials who attended the meeting said.

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Mr. Canellos, the officials said, instead proposed that the S.E.C. publish a report that would publicly explain the decision to forgo charges. Ms. Schapiro and other S.E.C. officials rejected that option, concerned that Mr. Canellos's first draft was too sympathetic to Lehman."

It was a perfectly reasonable and normal "suggest[ion]" by Cannelos' boss that Cannelos' team prepare a draft of potential charges against Lehman's officers.  When your boss makes a "suggest[ion]" of this nature you prepare the document.  There is no "ethical" issue in providing your superior with the strongest notice of charges you believe is supported by the evidence.  Cannelos' real problem was that had he drafted such a notice of charges it would have been obvious that the evidence did support a finding of materiality under the agency's interpretation of materiality.  The limited nature of his draft would also reveal how little about Lehman's far larger frauds Cannelos' team had actually investigated.

Instead, Cannelos had already begun drafting the propaganda that has now become the NYT article.  He wanted the SEC to publicly endorse his defense of Lehman's officers' fraudulent conduct as immaterial.  Note that this would set a terrible precedent that was contrary to the agency's much broader interpretation of "materiality" -- a precedent that would allow many frauds to escape sanction and impair deterrence.  No enforcement lawyer whose concern was the agency, rather than his personal reputation, would make such a self-serving suggestion.  Naturally, after Cannelos caused the SEC to allow Lehman's controlling officers to escape all accountability for growing obscenely wealthy by committing widespread fraud and arrogated to Cannelos the interpretation of an accounting provision where an attorney's duty is to represent the client's position rather than his own he was promoted for his failures and now co-leads the SEC's exceptionally weak enforcement effort.

The SEC leakers and the NYT reporters almost have to be admired for their audacity.  Admittedly, the SEC enforcement staff, as my first column explained in detail, has nothing to be brag about in their entire response to the fraud epidemics that drove the crisis and caused the worst epidemic of securities fraud in history.  Not a single elite banker who led a control fraud has had his fraud proceeds removed by the SEC.  Not a single elite banker who became immensely wealthy by leading a control fraud has even had to personally pay a non-trivial portion of his fraud proceeds to the SEC.  In this long list of failures Lehman stands out as a glaring failure.  Lehman was destroyed by widespread looting that made it senior officers exceptionally wealthy.  Lehman's failure triggered the global financial crisis.  The SEC allowed Lehman's securities frauds to continue for many years when it was not only reviewing Lehman's securities filings but also serving as Lehman's "consolidated supervision" authority.  The SEC compounded its total failure as Lehman's supervisor through a total failure as an enforcer of the securities laws and its supervisory rules even after Lehman's control fraud caused its failure.  The mortgage fraud crisis represents the worst enforcement failure by the SEC in its history.

Cannelos and the SEC flacks now have the chutzpah to try to spin one of the SEC's worst enforcement failures into a morality play in which Cannelos is the hero precisely because he refused to hold Lehman's looters accountable for their violations and allowed them to walk away wealthy with the proceeds of numerous insider fraud schemes.  The villain becomes Ms. Schapiro who is reimagined as a would-be unethical official who tried to sue the poor, innocent Lehman officers for "political" reasons but was blocked from doing so by Cannelos' selfless valor and dedication to "justice."  It is an odd form of "justice" in which the most elite frauds became wealthy by scams that caused a $11 trillion loss to American households and cost over 10 million Americans their jobs and avoid all accountability for their frauds.  But that is Cannelos' definition of "justice" and the NYT reporters are so credulous that they have become the propagandists for Cannelos and Lehman's looters.

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William K Black , J.D., Ph.D. is Associate Professor of Law and Economics at the University of Missouri-Kansas City. Bill Black has testified before the Senate Agricultural Committee on the regulation of financial derivatives and House (more...)

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