Flyover Country, photo by benjam1n

Two officers of Sentinel Management, a Chicago firm, were recently indicted in Chicago, Eric Bloom and Charles Mosley. The case was attributed to the phonyFinancial Fraud Enforcement Task Force, though the investigation was underway long before the alleged creation of that group. The case is typical of financial fraud enforcement today; there may be criminals in flyover country but ain’t no criminals on Wall Street.

Sentinel was in the business of investing idle funds held by investors and commodity brokers. Commodities brokers are required to segregate customer assets and are not allowed to use them for any purpose. Of course, that’s a crock, MF Global and now Peregrine Financial Group Inc. and who know how many more companies have stolen billions from their customers. Sentinel entered into agreements with a number of commodity brokers to hold and invest that money for customers in accordance with the CFTC’s rules applicable to commodity brokers.

Commodity brokers also have their own funds, house money, which they invest for their own benefit.

According to the indictment, Sentinel agreed to invest customer funds very conservatively, as required by the rules of the CFTC. It agreed to hold house money in pooled accounts that sought higher returns with higher risk. In both cases, Sentinel was paid a management fee. It sounds like a pretty good business model, but Bloom and Mosley wanted to increase the returns, presumably so they could collect larger management fees.

Beginning at least as early as 2004, they started buying low-quality collateralized debt obligations and other esoteric securities (CDOs) and financing the purchases with customer funds and lines of credit. The lines of credit were secured by a pooled group of collateral from all of the different funds managed by Sentinel, including those low-quality CDOs. The CDO market crashed in 2007, and Sentinel was forced into bankruptcy. About 70 clients lost more than $500 million.

And then, there’s this:

… Mosley received substantial personal benefits from Firm 1 and Firm 2 in the form of gifts, vacations, expensive tickets to sporting events, and parties.

Actually, that’s a weak description. The bankruptcy trustee for Sentinel, Frederick Grede, sued four individuals and three investment banks on grounds that sound exactly like the allegations concerning Firm 1 and Firm 2. The defendants moved to dismiss. The Court denied the bulk of the motion in a Memorandum Opinion and Order that gives a better account:

While at KBW, Defendants offered, and Mosleys [sic] accepted, tickets to professional sporting events and a Big 10 football game, expensive dinners, limousine rides, concert tickets, a trip to Florida including lodging, entertainment, limousine rides, and tickets to the Orange Bowl football game (in a luxury sky box), trips to strip clubs (lap dances included), and an expenses-paid trip to New York (hotel included). [After two of the brokers] moved to Cohen, the “gifts” continued, including more tickets to professional sporting events, expensive dinners, limousine rides, the purchase of $600 in Girl Scout Cookies from Mosley’s daughter, and an expenses-paid golf outing in Philadelphia. The complaint is also rife with offers of more event tickets, trips, and the use of vacation homes.

The Trustee identified three firms and four individuals in separate complaints containing similar allegations. The Trustee says that the bribes far exceeded the norms of the brokerage business in the “extent of the debauchery involved in many of the events.”

The Trustee alleges that the individuals knew or should have known all about the business of Sentinel, and knew that the securities they were dumping violated the promises made by Sentinel to its customers.

He also alleges among other things that the defendants lied about the quality of the CDOs, failed to provide copies of the offering materials, told Mosley that the securities were rated when they weren’t, and claimed that their firms would make a market in the CDOs, meaning that the firms would buy back the CDOs, when they knew that they couldn’t.

Two of the sued brokers joined Cohen and Company Securities in 2006, the same year Christopher Ricciardi joined Cohen. Ricciardi saw himself as the Grandfather of CDOs. The Wall Street Journal says he “helped turn Merrill into the Wal-Mart of the CDO industry”. At Cohen and Company, he formed 25 CDOs valued at more than $25 billion. It took a lot of selling to move that stuff in 2006-7, given the fear in the markets.

Other than the Trustee’s lawsuits, there is no evidence of any regulatory or enforcement activity directed at any of the Wall Streeters. We have many examples showing that lying and bribing people to buy crappy securities isn’t a problem. For example, JPMorgan Chase bribed officials in connection with the interest rate swaps that bankrupted Jefferson County, and paid off other brokers not to bid on the swaps.

Maybe prosecutors like Preet Bharara and the SEC/CFTC people just don’t believe their good neighbors on Wall Street acted with the requisite level of intent. It’s a parallel to the Bernie Madoff case, where despite years of hectoring from a whistleblower, the agencies and the prosecutors just wouldn’t investigate, because after all, he’s really respectable and he’s a big market maker on the NASDAQ, and was Chairman of the National Association of Securities Dealers.

Or, maybe it’s that everybody does it, so it’s just fine. Sort of like everybody manipulates LIBOR, so nobody gets indicted.

Or maybe the only prosecutors with backbones are in the heartland. Too bad they aren’t Co-Chairs of the Financial Fraud Enforcement Task Force instead of Eric Schneiderman. Maybe there would at least be a credible investigation.