Wall Street scourge Janet Tavakoli usually reserves her fire for big cheating firms, but the derivatives and structured finance expert saved a few rounds for the SEC as well in an interview Thursday on the government’s criminal indictment of SAC Capital on insider trading charges.
In an interview with ThinkAdvisor, a week after U.S. Attorney for the Southern District of New York Preet Bharara indicted the hedge fund and the SEC brought civil charges against founder Steven Cohen for failure to supervise, Tavakoli discerned a “lack of will” on the part of the SEC and described Bharara as the “motor” driving the case.
“It seems like the SEC has a habit of trial by email,” said Tavakoli, a frequent expert witness in cases involving financial complexity. “You have to be lucky for people to be incriminating themselves and providing evidence needed for successful prosecution.”
She urged the government securities enforcer to examine SAC’s business relationships, obtain trading records and not assume it has a slam-dunk case.
Not that there is a shortage of leads. Tavakoli points to the improbability that any firm could obtain such high average annual returns–in the neighborhood of 40% a decade ago and around 25% more recently–at a time when Treasuries are paying a pittance.
Add to that SAC’s reputation as Wall Street’s top commission generator and its unique fee structure–3% annual fees and 50% of profits, compared to the usual hedge fund 2% and 20% arrangement.
“The SEC should be asking what did [SAC] get in return [for its high commissions]?,” Tavakoli asks. She also thinks the SEC should be interested in how the firm generated consistently stratospheric returns. “You can’t create money out of thin air in equity markets,” she says, wondering if the name Madoff rings any bells.
And that leads to Tavakoli’s main point about the SEC, and her warning to financial advisors: the need for the federal agency to claw back unjust gains.
“As long as the SEC is so slow and lame about prosecution [the message is] you can enjoy the benefits of criminal activity for a long time–you are now enabling the less diligent, the less skeptical and in worst-case scenario silent co-conspirators to prosper.”
Tavakoli cites the vaunted revolving door between Washington and Wall Street, to which SEC personnel look for their next jobs–as a possible reason for lethargy in pursuing the SAC case, where allegations of insider trading have swirled for at least a decade. “The SEC itself should be investigated for not prosecuting alleged crimes during the financial crisis,” she says.
Tavakoli says the SEC should be asking if sophisticated investors like Blackstone, Morgan Stanley and HSBC were enabling a criminal enterprise by not being skeptical enough.
“We have gone so far beyond the pale about having appropriate outrage to the point where alleged criminal activity is the norm,” she worries, emphasizing that a government failure to actively claw back unjust gains implies that insider trading is a victimless crime, while rewarding bad actors and punishing those who do due diligence.
“Is it just too hard to calculate what the excess gains are? [The SEC is] enabling [cheating] managers intentionally or otherwise by putting their brains in neutral. They’re disadvantaging honest investors and honest managers who raise issues and are skeptical [who] tell investors: ‘The returns look great but we’re not going in because we have due dilligence questions.’ By punishing the diligent ones, you’d be creating an incentive for investors and managers to cheat,” she says.
That is why the expert in financial shenanigans warns the SEC not to simply “declare victory” should it collect a lot of cash in the case. The government needs to make cheaters and go-along money managers cough up any ill-gotten gains.
Her warning to financial advisors:
“Don’t do business with criminal enterprises or ones that look suspicious. Because the day will come when you get tapped on the shoulder for clawbacks. Companies that did business with Madoff got the tap.”
Check out this story about Tavakoli, Finding the Culprits of the Crisis, in Research magazine.