The FBI’s investigation into alleged false investment performance at the $67 billion Pennsylvania Public School Employees’ Retirement System may suggest law enforcement is finally focused upon public pension shenanigans. That’s not likely.
If you want to understand how pension looters and high-level investment scammers frequently escape prosecution, begin with studying the legal and regulatory structure of the money management industry. Successful scammers know: (1) which laws or regulations they can skirt, or break; (2) who, i.e., which agencies may come after them for their bad behavior; and (3) the limitations of different regulators and law enforcement.
A “security” is a broad term that includes many types of investments, such as municipal bonds, corporate stock and bonds, bank notes, investment contracts and more. Securities fraud occurs when someone involved with one of these investments lies, cheats, or steals in an attempt to gain a financial advantage.
The U.S. Securities and Exchange Commission is an independent agency of the federal government which holds primary responsibility, i.e., jurisdiction, for enforcing the federal securities laws, proposing securities rules, and regulating the securities industry, which is the nation’s stock and options exchanges, as well as the money management industry.
The bad news (for scammers): if they engage in securities fraud the SEC may come after them.
The SEC can bring a civil action in a U.S. District Court, or an administrative proceeding which is heard by an independent administrative law judge. At worst, the thief will receive a fine, a black mark on his record and a suspension or ban from the securities industry.
The good news (for scammers): Most SEC cases end up with out-of-court settlements in which the scammer pays a fine or endures a temporary suspension without admitting guilt. Firms and individuals who accept such settlements typically publicly state they did nothing wrong and claim they settled just to get the cases behind them and to save legal costs.
More good news (for scammers): the SEC does not have criminal authority and the fines and penalties it seeks rarely represent more than a fraction, say 10-20%, of the amount stolen. Steal a million, pay a $100,000 fine ten years later when you get caught—long after you bought and enjoyed that ski chalet.
As I write in my book, How To Steal A Lot of Money—Legally, they Go to Vail, Not to Jail.
True, the SEC may refer cases to state and federal prosecutors, like the Federal Bureau of Investigation, for criminal prosecution. But savvy scammers needn’t lose any sleep over that.
It has often been said the SEC has no teeth and its bark is worse than its bite. Further, the agency has long been accused of being effectively captured by—and subservient to—the industry it is supposed to be objectively regulating. Experts have opined that the SEC is a prime candidate for “regulatory capture” for two reasons:
“First, the lawyers (the majority of SEC professional staff) who work in the regulation writing divisions often find their best, and best by a wide margin, post-SEC employment opportunities working for the regulatees, and must change fields completely if they go elsewhere. Second, the inherent complexity of the institutions of the securities industry and its regulatory apparatus create substantial fixed costs that purveyors of influence must conquer in order to be effective. These two factors make for powerful forces that push the SEC in the direction of rule changes that help rather than hurt the powerful incumbents of the securities industry.”
Revolving door + complexity = regulatory capture.
As a former SEC attorney who has worked with the agency for over three decades, I have witnessed countless examples of the SEC failing to take effective action to combat fraud in the securities industry. Regulatory capture is a reality, which is bad for investors but great for scammers.
In addition to federal regulators and statutes, each state also has its own laws about securities fraud and its own state securities commission. While any securities fraud might be punishable under either state or federal law, such crimes are most often prosecuted as federal crimes. The state securities regulators pay their employees a whole lot less than the SEC and, as a result, their staffs are generally far less knowledgeable. Scammers worry least about the state regulators.
Only a small fraction of all securities fraud cases are handled as criminal cases and even when criminal convictions are obtained, prison sentences for these non-violent, white-collar crimes are not common. SEC civil fines often match or exceed those imposed in criminal cases, so prosecutors feel there is little to gain from the extra effort it takes to bring criminal cases.
A criminal case requires proof beyond a reasonable doubt, while proof in a civil case requires only a preponderance of the evidence. Unlike your typical thief, investment scammers often can afford teams of lawyers, many of whom are former prosecutors or regulators (revolving door guys and gals) skilled at finding the holes in the prosecutors’ cases.
3 Hallmarks of High-Level Investment Fraud
· Nobody ever admits guilt.
· Nobody ever goes to jail.
· Nobody ever pays back all the money they have stolen.
Also, securities fraud cases are often extremely complex and difficult to explain to juries. Juries have trouble understanding investment scamming cases and most U.S. Attorneys’ offices don’t have expertise in such matters. The U.S. Attorney in New York City is the only one in the country with a standing securities fraud team.
In my experience, law enforcement—including the FBI, often doesn’t understand investment scamming cases and, for this reason, fails to recognize criminal activity or prosecute these cases.
Investment fraud criminal cases—which require additional effort to prove guilt B.A.R.D., as well as an understanding of complex financial concepts—almost never happen. The more complex the fraud, the more difficult to prove criminal intent and the less likely prosecutors and juries will be able to understand.
Whether you know it or not, the criminal fraud convictions you read about are the most straightforward and seemingly stupid. It’s not that all fraudsters are idiots—the masterminds you never hear of, never get caught.
You may have heard of the K.I.S.S. principle. KISS is an acronym for “keep it simple, stupid,” a design principle supposedly originated by the U.S. Navy in 1960. The KISS principle states that simplicity should be a key goal in design, and unnecessary complexity should be avoided.
To be a successful scammer, follow a non-KISS approach: devise intentionally overly-complex schemes—schemes which can even be painstakingly disclosed in sales materials provided to investors—but which neither investors nor regulators/law enforcement will be able understand or prosecute.
Non-KISS principle: Intentionally overly-complex financial schemes are less likely to be prosecuted.
It may be surprising to learn that police and law enforcement officers get defrauded by investment scammers—all the time.
Their great instincts—“radar”—when it comes to spotting seedy criminal activity, involving drug dealers, prostitutes, pimps and thugs, completely fail them when judging socially prominent, well-educated, well-spoken, well-groomed, white collar investment con-men. Cops trust, respect and even envy these seemingly prosperous pillars of the community wholeheartedly. Even law enforcement realizes it’s got a problem—that’s why I have been asked to talk to FBI agents and others in law enforcement about how to protect themselves from investment scammers.
In my speeches, I like to show cops in the audience two pictures—one of a young man dressed thuggishly and another of a mature stockbroker dressed in a designer suit, starched white dress shirt and tie.
Who poses a greater threat to your financial well-being, I ask them to consider. Who is more likely to get access to the greatest chunk of your wealth and run with it?
In conclusion, pension looting and high level investment scamming falls within a law enforcement blind spot. Law enforcement training and instincts are generally not helpful when it comes to rooting out investment fraud. Further, lack of sophistication in investment matters also makes it difficult for law enforcement to respond appropriately to investment wrongdoing.
For example, in the law enforcement mindset, if a criminal misappropriates $5 million from a client but 7 years later (promptly, after being confronted regarding the wrongful taking) agrees to repay the money, there is no crime worth prosecuting because the victim has been “made whole.” He got all his money back, right?
From an investment perspective, however, with 10% compounding, money doubles every 7 years. So, over the 7 year period, the criminal has stolen and the victim has lost $5 million. That’s a lot of money—well worth prosecuting, in my opinion.
Bottomline: Law enforcement, including the FBI, generally neither “get” nor are effective prosecuting high level investment scammers. Scammers know this and even brazenly target law enforcement as potential victims.
So, if you are a participant in a public pension, or a taxpayer that contributes to one, and believe the FBI has finally awaken to widespread public pension looting, think again.