Tuesday, September 27, 2011

SEC Counsel Criticized for Conflict of Interest

One would expect that the SEC, which brings actions against individuals or corporations based on their failure to disclose a material conflict of interest to the public, would be sensitive to conflicts of interest of its own employees.  Nonetheless, as a report released last week by SEC Inspector General H. David Kotz reveals, former SEC general counsel David M. Becker participated significantly in decisions relating to the distribution of SIPC funds relating to the Bernard Madoff case although he had a significant personal financial interest in the decisions.

Becker and two brothers in 2004 inherited and in 2009 liquidated $2 million in Madoff investment funds, $1.5 million of which were purported profits from the original investment.  Later in 2009, Becker was prominently involved in two substantial questions in which the SEC recommendations to the bankruptcy court, while not conclusive, would be expected to carry significant weight in the court, given the deference courts pay to administrative agency decisions.

One issue concerned what position the SEC would take as to what should be considered "net equity," the amount that customers can claim in a brokerage liquidation.  That question was essentially the same as what should be considered the "net equity" figure in a "clawback" action by the bankruptcy trustee, a decision in which Becker had a significant potential personal monetary interest, even though he and his family had not yet been sued (they were later).  Becker initially argued against the "money-in/money-out method" under which an investor could recover only the amount he invested and for the "last account statement method" under which an investor could recover the amount of the last - and fictitious - statement from Madoff.  The "last account statement method" would obviously have been beneficial to Becker in that it would have protected him in a "clawback" action by the Madoff bankruptcy trustee for the $1.5 million he and his brothers had received in Madoff "profits."

After consideration, Becker concluded that the last account statement method was unsupportable.  His position was in accord with that of the SEC, SIPC, the bankruptcy trustee, and ultimately the Second Circuit, In re Bernard Madoff Investment Securities, LLC, ___ F.3d ___ (2d Cir., August 16, 2011). Becker argued, however, contrary to the position of SIPC, for the "constant dollar approach" in which the recovery under the money-in/money-out method would be adjusted upward for inflation and lost real economic gain.  Under this approach, the bankruptcy trustee's potential clawback recovery from the Beckers would have been reduced by $138,500.

It is apparent, as any law student who has taken an ethics course would realize, and as the Inspector General determined, that Becker had a conflict of interest in the resolution of these questions.  Yet, the SEC's "ethics" officer, who reported to and was evaluated by Becker, saw no conflict.  The ethics officer, revealing a narrow view of conflict of interest, and an apparent misunderstanding of relevant securities law, found no conflict in part because there was "no direct and predictable effect" between the SEC's position and the trustee's clawback decision.

SEC Chairwoman Mary L. Schapiro was aware, to some extent, of Becker's Madoff financial interest, but she did not suggest he recuse himself.  She and Becker both contended before Congress last week that he had acted properly by reporting the conflict to her and others.  That defense, however, is limited and misplaced.

Reporting a conflict - especially if only to underlings and colleagues - is not sufficient.  Even public disclosure of Becker's personal interest - and it was not disclosed to the public, Congress, the courts, or four of the SEC's five commissioners - would not have cured the conflict.  Becker simply should have recused himself and not have participated at all in decisions as to the formulation of SEC policy relating to recovery of Madoff assets.

Schapiro was no doubt swayed by her respect for Becker's legal ability and integrity.  Becker, who has written that he did "not remember giving any consideration to how the various proposed outcomes would affect me," may well have believed that his personal interest would not affect his professional judgment.  In any case, his decision not to recuse himself and Schapiro's at least implicit condonation of this decision, demonstrate that the agency which polices conflicts of interest in the marketplace fails to appreciate them when they occur in its own house.

The Inspector General referred this matter to DOJ for consideration for criminal prosecution.  I do not suggest that Becker acted criminally with respect to 18 U.S.C. 208, the statute proscribing acts affecting a personal financial interest, or any other law.  He may well have lacked whatever scienter is required under the law based on his reporting to others or other acts or circumstances.  Not every improper act is criminal.

(goldman)

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