Seventeen years ago, U.S. Securities and Exchange Commission investigators “actually suspected” and failed to explore whether Bernard Madoff was “operating a Ponzi scheme” through his fundraiser Avellino & Bienes, a summary of the forthcoming repo

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By Lisa Brennan

Sept. 4 (Bloomberg) -- Seventeen years ago, U.S. Securities and Exchange Commission investigators “actually suspected” and failed to explore whether Bernard Madoff was “operating a Ponzi scheme” through his fundraiser Avellino & Bienes, a summary of the forthcoming report by Inspector General David Kotz said.

The 1992 SEC probe focused on accountants Frank Avellino and Michael Bienes, who had funneled investors to Madoff since the 1960s promising returns of between 13.5 percent and 20 percent a year. Within days of SEC questioning, Avellino -- then represented by Ira Sorkin of Dickstein Shapiro in New York, now the lawyer for Madoff in his criminal case -- agreed to return the $441 million they had raised to about 3,200 people.

While SEC examiners sought trade records from the Depository Trust Company, or DTC, which would have revealed fraud, the agency relied on records provided by Madoff, found nothing, and shut the case, the Kotz report summary said. It remains to be seen whether Kotz’s 450-page report, which may be released today, will name the SEC lawyers in the case.

The SEC lawyers who handled the case are now in private practice. Richard Walker, then head of the New York regional office, is Deutsche Bank AG general counsel. Kathryn Ashburgh, the lead lawyer on the case, works from her home in McLean, Virginia. Keith Miller, a senior lawyer in the New York office, is a partner at New York’s Paul, Hastings, Janofsky & Walker.

“According to the lead examiner, someone should have been aware of the fact that the money used to pay back Avellino & Bienes’ customers could have come from other investors, but there was no examination of where the money that was used to pay back the investors came from,” the Kotz report summary said.

Archived records from the 1992 case exposed numerous red flags at a time before Madoff’s Ponzi ties spread around the globe. For one, court-appointed auditors at Price Waterhouse were told by Avellino that he didn’t “commit figures to scrutiny.” The audit was cut short at the urging of Sorkin and Avellino, even though a federal judge questioned Avellino’s credibility.

With so many red flags, the failure of the SEC examiners to find the source for the money Avellino & Bienes used to pay back investors defied basic “common sense,” the Kotz report summary said. “The result was a missed opportunity to uncover Madoff’s Ponzi scheme 16 years before Madoff confessed.”

For Madoff’s criminal case, click here.

For David Scheer story on 1992 case, click here.

Ex-SEC Lawyer Says Kotz Needed to Focus on Bosses, WSJ Reports

Genevievette Walker-Lightfoot, a former lawyer with the U.S. Securities and Exchange Commission’s Office of Compliance Inspections and Examinations who investigated Bernard Madoff in 2004, said Inspector General David Kotz’s report summary puts too much onus on junior lawyers rather than top supervisors, the Wall Street Journal reported.

“It would have been more insightful to take a more holistic approach,” Walker-Lightfoot told the Journal. Referring to herself she said: “Here was someone who raised red flags and said, ‘We need to look into these things.’ But I wasn’t senior management so it wasn’t my call.”

Walker-Lightfoot, who warned her bosses about irregularities at Madoff’s firm in 2004, and was promptly transferred off the case, now works as a lawyer and risk- management specialist at the Federal Reserve in Washington.

She previously worked at the American Stock Exchange and said she understood the complicated trading strategies Madoff claimed he employed. She told Mark Donohue, then a compliance and inspections branch chief who still works at the SEC, and Eric Swanson, an assistant director under then director Lori Richards, there was something wrong with Madoff’s business, and gave Donohue a list of questions she sought to pursue, the Washington Post reported.

Shortly thereafter, Walker-Lightfoot was transferred off the Madoff case and told to focus on mutual funds, the Post said, citing agency documents and people familiar with the investigation. Swanson, the SEC compliance boss who reassigned Walker-Lightfoot, later married Shana Madoff, the daughter of Bernard Madoff’s brother, Peter.

The Kotz report summary said Swanson’s relationship didn’t influence the SEC’s conduct during its Madoff probes.

Barclays Repackaged Downgraded CDO into Top-Rated Securities

Barclays Capital repackaged a portion of a $1 billion collateralized debt obligation managed by Highland Capital Management LP into new securities with the highest credit ratings after they were downgraded in July.

“Repackaging is typically a regulatory maneuver,” said Gene Phillips, a director at PF2 Securities Evaluations Inc., an advisory firm in New York. “Some investors are also unable to hold securities that are rated below AAA.”

Barclays Capital is selling $77.25 million of securities backed by leveraged loans with AAA rankings from Standard & Poor’s and Moody’s Investors Service, said a person familiar with the offering who declined to be identified because the deal is private. The bank also created an $18.8 million piece rated AAA by S&P and a $250,000 unrated slice, according to the bond agreement.

Banks are turning downgraded securities into new investments with top credit ratings, seeking to create more valuable debt to sell or to restructure investors’ holdings. New York-based Barclays Capital is modeling the financing structure after so-called re-REMICs, which bundle mortgage bonds into new securities that may offer investors an additional layer of protection, or collateral, from downgrades.

“Critics of this practice have argued that it appears to be the creation of something from nothing -- in effect ‘alchemy,’” Moody’s analyst Leonid Mogunov wrote in an August report. “Such repackaging can in fact produce at least one class of notes more creditworthy than the underlying CLO tranche,” he wrote.

For more from Pierre Paulden, click here.

For Goldman, JPMorgan REMIC redos, click here.

Treasury Pick Owes at Least $10.5 Million on Investment Deals

Exemplifying the hurdles Wall Street executives may face when they agree to work for the government, Jeffrey Goldstein, the private-equity executive nominated as Treasury undersecretary, must pay at least $10.5 million to several investment partnerships, according to an ethics filing.

Goldstein has pledged $5 million to $25 million each for two funds run by his former firm, Hellman & Friedman LLC, and $500,000 to $1 million in another of its partnerships, according to the form, which only included ranges for the values. The money must be paid when requested by the fund manager, Goldstein wrote in the disclosure to the U.S. Office of Government Ethics.

Goldstein’s finances illustrate some of the potential obstacles going into government from the private sector. Without a complete severing of ties, he may need to recuse himself from policies affecting private equity, said Kenneth Gross, a partner at Skadden, Arps, Slate, Meagher & Flom.

“If he cannot extricate himself from those commitments, then he is not going to be able to regulate those entities, starting right now,” said Gross, who specializes in government ethics at the law firm in Washington. “The objective when you are going to a position regulating the industry you came from is to make as clean a break as you can.”

The investments are one of several links Goldstein has to the buyout industry, where he earned about $30 million in partnership income during the past 1 1/2 years, according to the disclosure. The nominee has agreed to divest his partnership in Hellman & Friedman for an amount to be determined, and it’s unclear whether he’ll be released from his capital commitments to the funds. Goldstein is also due a $5 million to $25 million performance bonus from the firm, the filing shows.

Goldstein has already begun work at the department as a counselor to Treasury Secretary Timothy Geithner while awaiting Senate confirmation as undersecretary for domestic finance.

Meg Reilly, a Treasury spokeswoman, said Goldstein will comply with all laws and has entered into an ethics agreement developed by Treasury Department lawyers in consultation with the Office of Government Ethics.

“Mr. Goldstein has agreed to comply with all financial conflict-of-interest rules, including divestitures where needed, and to a complete divestiture from Hellman & Friedman,” she said, declining to comment further. San Francisco-based Hellman & Friedman declined to comment through a spokesman.

For more from Robert Schmidt, click here.

RBS Told Not to Call Subordinated Bonds After Bailout

Royal Bank of Scotland Group Plc, the largest bank bailed out by the U.K., won’t call $1.6 billion of subordinated bonds after regulators objected to using state aid to pay holders of the lender’s lowest-rated securities.

The Financial Services Authority, the U.K.’s market regulator, told RBS not to redeem early four series of bonds after the European Commission stated Aug. 19 that banks shouldn’t use government money to repay equity and subordinated debt, the Edinburgh-based lender said in a statement today.

One of the four bonds, a 400 million-euro ($571 million) undated 6.625 percent note, plunged 17 cents on the euro to 69.5 cents today, according to price data compiled by Bloomberg. RBS is 70 percent-owned by the U.K. government after receiving a 20 billion-pound ($33 billion) bailout last year and putting 325 billion pounds of assets into a state insurance program.

“The concern is other U.K. banks could be forced to follow suit by the regulator,” credit analysts at BNP Paribas SA wrote in a note to investors.

The Commission is taking a tougher stance on banks rescued with government cash amid the deepest recession since World War II. Northern Rock Plc, the first lender nationalized by the U.K. in the credit crisis, said last month it would defer interest payments on eight subordinated bonds with an aggregate face value of about $2.74 billion.

For more, click here.

Lloyds Says European Commission Dealing With Cases Individually

Lloyds Banking Group Plc, the second-biggest U.K. bank bailed out by the government, said the European Commission is dealing with lenders on an “individual basis” after regulators stopped Royal Bank of Scotland Group Plc from calling $1.6 billion of subordinated bonds.

U.S. Treasury Seeks Global Accord on Bank Capital Before 2011

The U.S. Treasury Department said it wants a global agreement requiring banks to increase their capital cushions to be reached by the end of next year.

In a statement of principles issued yesterday in Washington, the department said that an accord on capital and liquidity rules should be reached by the end of 2010 and be in place by the end of 2012.

The rules must be “as uniform as possible across countries,” the statement said, “to better protect the safety and soundness of individual banking firms and the stability of the global financial system and economy.”

For more, click here.

Banks May Face Further Post-Crisis Capital Rules From U.K. FSA

Banks in March were promised a “revolution” in financial regulation by the chairman of the U.K. Financial Services Authority. Those proposals were only the first wave of attacks on banks’ business models, rather than an overnight coup.

Banks can expect by the end of the year further proposals in addition to feedback on ideas first floated by FSA Chairman Adair Turner in his March report, the agency said yesterday. In two interviews, he outlined ideas that may become proposals, including extending interim rules on how much capital banks should hold if international diktats are slow in coming.

For more, click here.

House Oversight Panel to Hold Hearings on SEC’s Madoff Failures

The House Committee on Oversight and Government Reform plans hearings on the U.S. Securities and Exchange Commission’s recruitment of investigators after a report faulted the agency for missing Bernard Madoff’s fraud.

“In light of the alarming findings related to the Bernard Madoff matter, I expect to convene hearings in the near future,” Chairman Edolphus Towns wrote in a letter to SEC Chairman Mary Schapiro yesterday.

For more, click here.

SEC, CFTC May Sharpen Their Rules on Market Manipulation

The heads of the Securities and Exchange Commission and Commodity Futures Trading Commission said they are weighing changes to margin requirements, insider-trading rules and new financial product approvals as part of efforts to coordinate oversight of the derivatives market.

The agencies will seek to close gaps in oversight, eliminate duplicative rules that allow for “regulatory arbitrage” and bring consistency to the supervision of similar products, firms and markets, CFTC Chairman Gary Gensler said yesterday at a joint meeting of the two agencies in Washington.

For more, click here.

Schumer Proposes Letting SEC Boost Its Budget by Keeping Fees

U.S. Senator Charles Schumer said the Securities and Exchange Commission should be permitted to put all of the fees and fines it collects toward efforts to battle crimes such as Bernard Madoff’s Ponzi scheme.

Schumer said yesterday he will propose a bill “fundamentally altering” the SEC’s funding when Congress returns from recess next week. The measure could substantially increase the agency’s budget, the New York Democrat said in a call with reporters, noting that its fiscal 2007 allocation was about $650 million less than the $1.5 billion it received in fees.

The difference between what the agency collects and the budget approved by the president and Congress “could be used to update the SEC’s out-of-date technological resources, to hire more experienced analysts and examiners, and keep those good ones that they have,” said Schumer, a member of the Senate Banking Committee.

For more, click here.

SEC May Send Staff to ‘Fraud College’ to Detect Future Madoffs

The Securities and Exchange Commission may create a “fraud college” to train staff in detecting market abuses after the agency failed to stop Bernard Madoff’s $65 billion Ponzi scheme, Chairman Mary Schapiro said.

“The fraud college concept is a great one,” Schapiro said yesterday at a joint meeting with the Commodity Futures Trading Commission in Washington. Coordinating fraud-detection training with the CFTC “would be particularly valuable,” she said.

For more, click here.

HSBC Expands Role to Fill Lehman Void as Hedge Fund Broker

HSBC Holdings Plc, Europe’s biggest bank, is seeking to expand its role as a broker to hedge funds after last year’s collapse of Lehman Brothers Holdings Inc.

“It’s a significant opportunity for a new revenue stream,” said Stuart Gulliver, HSBC’s investment banking chief, at a Nomura Holdings Inc. conference yesterday in London. “We’ve seen a number of hedge funds moving their accounts to HSBC because their main concern is getting their money back.”

About 700 clients of Lehman’s European division, including MKM Longboat Capital Advisors LLP and GLG Partners Inc., lost control of their assets when the parent company filed for bankruptcy. PricewaterhouseCoopers LLP, Lehman’s U.K. administrator, said last month it may be a decade before creditors receive all of the $9 billion they are owed.

“Post Lehman, the issue of counterparty risk became uppermost in the minds of fund managers and they were under pressure to move their money to where it is safest,” said Neil Wilson, editorial director of HedgeFund Intelligence, publisher of EuroHedge and other hedge fund publications. “The panic has subsided a bit, but there’s still a business opportunity.”

Lehman was the world’s ninth-largest prime broker in 2007, Sanford C. Bernstein & Co. analyst Brad Hintz estimated.

Goldman Sachs Group Inc. and Credit Suisse Group AG are Europe’s biggest prime brokers, according to April rankings by EuroHedge. HSBC didn’t rank in the top 11 firms, according to the survey. Prime brokers provide trading clearing, lending and other services to hedge fund clients.

For more, click here.

Fannie Shares Fall as Questions About Underlying Value Abound

Fannie Mae and Freddie Mac fell in New York trading after FBR Capital Market’s Paul Miller said the mortgage-finance companies have no “underlying value” to justify a more than tripling in their share prices this month.

“There is no fundamental value remaining in Fannie and Freddie, particularly since the government owns 80 percent of each company,” Miller, a banking analyst based in Arlington, Virginia, said in an Aug. 31 note to investors.

While the stock-market values of government-controlled companies like Fannie Mae have soared this summer, it’s debatable what those values are, Jonathan Weil reports.

Fannie’s market cap is either $1.5 billion or $7.8 billion, depending on which share count you use, Weil said. The larger share counts include warrants issued to the U.S. Treasury that would allow the government to buy 79.9 percent stakes in the companies’ common shares at a nominal cost. As of yet, those warrants haven’t been exercised, and so the shares haven’t been issued, Weil said.

That raises the question of why investors would pay anything to own any of Fannie’s common shares, when the firm in its disclosures, says that its common equity is worth less than zero, according to Weil.

Unlike other companies, the two government-backed mortgage financiers publish quarterly fair-value balance sheets showing estimates of the real-world values for all their assets and liabilities. At Fannie, Weil said, the number was negative $138.1 billion.

For more on Miller comments moving the market, click here.

For more from Weil, click here.

Company News, SEC Filings, Interviews

Credit Suisse in Preliminary Talks to Buy Mesirow Fund of Funds

Credit Suisse Group AG held preliminary talks with Chicago-based Mesirow Financial Holdings Inc. about buying its $11 billion business that invests clients’ cash in hedge funds, according to two people familiar with the discussions. Credit Suisse, based in Zurich, already manages almost $15 billion in its hedge fund of funds unit.

For more, click here.

Citigroup Gets Shareholder Approval to Convert Preferred Shares

Citigroup Inc., the third-largest U.S. bank by assets, said its common shareholders approved resolutions allowing the bank to finish its preferred share conversion and conduct a reverse stock split.

For more, click here.

Scor Amends JPMorgan Mortality Swap to Hedge Against Swine Flu

Scor SE, France’s largest reinsurer, renegotiated a contract with JPMorgan Chase & Co. to make cash more quickly available if needed for a surge in claims tied to a swine flu pandemic.

JPMorgan will pay as much as $75 million when an index tied to European and U.S. death rates climbs to between 105 percent and 110 percent. The earlier arrangement was for $100 million and 36 million euros to be paid when the index reached 125 percent, the Puteaux-based reinsurer said yesterday in a statement. The protection was renegotiated to guard against terrorism, pandemics and natural disasters, Scor said.

For more, click here.

N.Y. Public Pension Costs Rise 61%, Highest Since ‘05

New York state and most of its local governments face a 61 percent jump in pension costs to the highest rate in six years, as the public retirement fund rebuilds following investment losses.

The 2011 payments due in February will amount to 11.9 percent of the public employee payroll, up from 7.4 percent, Comptroller Thomas DiNapoli said. For police and firefighter pensions, a separate part of the $116.5 billion state fund, contributions will rise to 18.2 percent of pay, from 15.1 percent.

For more, click here.

Comings and Goings

Transatlantic Hires Goldman’s Cholnoky After Spinoff From AIG

Transatlantic Holdings Inc., the reinsurer spun off by American International Group Inc., hired former Goldman Sachs Group Inc. insurance analyst Thomas Cholnoky. He will serve as senior vice president of investor relations and report to Chief Financial Officer Steven Skalicky, the New York-based reinsurer said.

Ex-Lehman Trader Bedwick to Manage OGI Global Macro Hedge Fund

OGI Capital Partners Ltd., a Japanese hedge fund with 3.5 billion yen ($40 million) in assets, plans to almost double in size by starting a global macro hedge fund to be run by Allan Bedwick, a former proprietary trader at Lehman Brothers Holdings Inc.

The OGI Global Macro Fund will start this month with seed money from an overseas institutional investor of 3 billion yen and wager on stocks, bonds and currencies globally with a focus in Asia, said Naoya Takahashi, OGI’s head of fund management.

For more, click here.

Bank of America Rebrands Offices in New York, London Towers

Bank of America Corp., the largest U.S. bank by assets, is changing signs at its New York and London offices to reflect the acquisition of Merrill Lynch & Co. The Manhattan tower at One Bryant Park on 42nd Street will have a “Bank of America Merrill Lynch” sign added to the sky lobby, reception floor and video wall, the Charlotte, North Carolina-based bank said in a memo to the staff. The Merrill Lynch Financial Centre in London will be rebranded as the Bank of America Merrill Lynch Financial Centre, another memo said.

Bank of America has been trying to mesh the banking and brokerage cultures since it bought Merrill Lynch in January, vowing to keep the brokerage’s brand and iconic bull logo. By contrast, the company dropped the Countrywide Financial Corp. name after purchasing the California-based home lender, retiring it in favor of Bank of America Home Loans beginning in August.

London employees were told in one of the memos that the rebranding is the first part of a larger program that will affect other locations “as appropriate.” Spokeswoman Jessica Oppenheim, who confirmed the memos, said the corporate name remains Bank of America.

For more, click here.

International

Brown Joins Merkel, Sarkozy to Urge Rules on Bonuses

U.K. Prime Minister Gordon Brown joined German Chancellor Angela Merkel and French President Nicolas Sarkozy in calling for Group of 20 leaders to impose global rules on bonus payments awarded by banks.

Bonuses must have an “appropriate” relation to fixed salaries and be linked to banks’ performance, the leaders said. The G-20 “must transform these principles into binding rules” and back “sanctions” for banks that refuse to cooperate, they wrote in a letter to Swedish Prime Minister Fredrik Reinfeldt, who holds the European Union’s rotating presidency.

“It’s time to say that we are never going to go back to the old ways,” Brown told reporters in London yesterday.

For more, click here.

To contact the reporter responsible for this report: Lisa Brennan in New York at lbrennan1@bloomberg.net.

Last Updated: September 4, 2009 10:35 EDT