First Bernard Madoff. Now Sir Allen Stanford. Stanford, the colorful sponsor of cricket, polo, tennis and sailing events relished his access to the rich and famous. Both men enjoyed near unrestricted access to those who regulated them. Although the allegations against each are very different, the search for potential sources of liability and economic recovery for victims point in a very sobering direction - that is, at those who recommended the investments.
In late February, the court-appointed trustee in the Madoff case declared there was no evidence of the purchase of any securities for Madoff clients in the past 13 years. What the FBI wrote in a Criminal Complaint was Madoff's own admission - a Ponzi scheme. So the investors searching for sources of recovery and imposition of liability, in anticipation of a small recovery pool through the trustee and receiver, are turning to those who either advised to invest with Madoff or collected funds and in turn invested them with Madoff. In short, the recovery targets are and will continue to be the investment funds, whether "feeder funds," hedge funds (including funds of funds) and other entities.
The Stanford matter is different. The charges are best described as classic securities fraud, making materially false and misleading statements in connection with the sale of securities. The certificates of deposit were not backed by liquid securities, as represented; rather, the SEC alleges that illiquid assets, such as investments in real estate and start-up companies, backed the instruments. Of possibly greater significance should be that the Stanford "companies," including those subject to the freeze order, are the Houston-based broker/dealer and investment adviser Stanford Group Company. The registered representatives and investment advisors affiliated with this domestic broker/dealer and investment advisor were selling these certificates of deposits to U.S. investors. Their personal assets, held with the broker/dealer, are covered by the freeze order. So, they too are victims. But, if the Stanford receiver cannot or does not make whole the investors, where will they turn? The answer is not to institutions or "feeder funds." Instead, it will be the broker and advisor who recommended the investment, those same industry professionals whose assets are presently frozen.
If that thought does not cause the heart to skip a beat, consider further the significance of the Feb. 26 arrest of Stanford's chief investment officer. The criminal complaint charges obstruction of the SEC investigation by lying to the SEC. It's the "Martha Stewart charge," but using a Sarbanes-Oxley Act authored statute. The choice for the CIO is not exactly a brain-teaser - plead to the five-year felony for obstruction and cooperate with the government or face an indictment that includes sweeping securities fraud charges with exposure to a 25-year sentence. Once the cooperation gates open, it is in her interest to provide as much information as possible. The investigation will not end with criminal charges against those at the top; the investigation will continue. That means, the Department of Justice, the SEC and FINRA will turn their attention to the brokers and advisers next. It's not a matter of if; the question is when. So too, the brokers and advisors will come well within the sites of the Receiver and injured investors.
For brokers and advisors in the Stanford mix, the next step is simple - lawyer up, don't wait. For all others in the industry, there are some quick and important steps to take. Check your errors and omissions insurance policy to determine the scope of coverage and whether it is sufficient for the challenges of 2009. Revisit the due diligence files on investments you recommended. Ensure that the files are complete and undertake immediately to preserve records. Document your communications, both with clients and about investments. Determine when you last examined whether a fund, for example, is adhering to its investment strategies and terms. And, confirm that all of your compliance procedures, including know-your-customer obligations, are up to date. These are just starting points, as each portfolio and business is different.
Jacob S. Frenkel is a partner in the law firm Shulman, Rogers, Gandal, Pordy & Ecker, P.A. in Rockville, Md. He is a former SEC Enforcement lawyer and former federal prosecutor who chairs his law firm's Securities Enforcement and White-Collar Criminal Practice Group.