$300 million gold scam reveals regulatory lapse

May 29, 2014 05:48 AM

Despite the mountains of regulations that Washington prescribes each year, it seems that the agencies in charge of enforcement tend to prefer a pillow instead of a hammer.

As enforcement efforts fail, C-SPAN regularly programs lethargic legislators lecturing reckless regulators.

This month, C-SPAN featured findings of the Senate Special Committee on Aging, which is investigating a 13-year rap sheet of gold investment scams targeting Florida seniors.

The hearing exposed how the Commodity Futures Trading Commission, which is supposed to deter bad actors from engaging in commodity scams, has devolved into a toothless agency, one that needs more than just excuses about budget cuts and promises on future education efforts to justify its existence.

The two-hour event revealed that current CFTC regulatory efforts aren’t working.

And, more importantly, it revealed why.  

How not to prevent a scam

This hearing wasn’t about big ticket issues like the London Whale, shadow over-the-counter markets, or any other global problems that financial regulators has slept through since 2000.

These were telemarketing scams run from inside Florida boiler rooms and assailed by Congress for more than three decades.

These scams targeted seniors’ retirement accounts with false promises of an assured rise in commodity prices. In turn, scammers scrapped away as much as 38% of each invested dollar toward debilitating management fees that tore more than 10,000 American retirees from their last knuckle-guarded dollars.

Averse to another market downturn, seniors believed they had made a safe investment in hard assets. But, for an investor to break even, gold had to appreciate 25% over the “purchase” price as these scammers were really selling metals leveraged futures laden with abysmal transaction and bogus “storage” fees, with the majority of investors ultimately losing huge sums upon the inevitable margin call.

These scams are older than most of Generation Y.

Sen. Bill Nelson (D-FL) at one point even noted that Congress investigated such gold scams in 1983.

So why is this still happening?

The reason is simple.

Our watchdogs rely on the same tired efforts of deterrence and public awareness.

In fact, two Senate members appeared so detached from the motivations of bad market actors that they too regurgitated the need to double down on this failed strategy.

Sens. Susan Collins (R-ME) and Bill Nelson (D-FL) touted the importance of “consumer education” to prevent future scams. Nelson babbled how agency websites can provide future warnings to increase awareness of fraudsters, because, we all know that seniors spend their days reading the CFTC website.

Meanwhile, Collins promoted the placement of educational pamphlets in senior centers or emailing online newsletters to warn of scams. Of course, it will take the agency two years to choose which “subject line” to use and most seniors don’t read public pamphlets unless Wilford Brimley is on the cover.

The CFTC and other agencies have requested increases to budgets to promote consumer protection efforts and financial education – both tired exercises that have run their course – as a first line of defense.

Thankfully, Sen. Claire McCaskill (D-MO) drove a truck through such proposals and offered a blunter, more refreshing solution during the hearing. 

“The first line of defense is not consumer education,” she said. “The first line of defense is putting the crooks in prison.”

At least someone gets it.

A scammer apologizes

The hearing featured the testimony of a former scammer – or trader if you will – named Karl Spicer.

Spicer, who was deeply apologetic (in advance of his sentencing hearing) and warning others of telemarketing hijinks in the commodity markets, was convicted for his role in ripping off investors in a metals scam.

His testimony offered the purest rationale for why these scams continue 30 years later: the government agencies fail to instill the fear of God into these crooks. Without a fear of real consequences, criminals shift from scam to scam, and even if they are caught, they’re still undeterred and will continue swindling.

“With all due respect to the civil authorities, the people that I have encountered ... [they] don't really respect the civil authority bans," he said. "The gentleman I was with had a CFTC ban, he cooperated; he had a ban and he still went about doing business the very next day."

What’s worse, the scam companies work with lawyers to circumvent existing laws. These lawyers help scammers operate businesses under false names, deflect blame to subordinates, and detect Federal investigations, allowing them to shut down and quickly find a new scheme to enact.

Since 2001, these gold frauds have cost victims an estimated $300 million.

Failing enforcers

Enforcement hasn’t been something that the CFTC has done well. With revolving doors between enforcers and Wall Street, some have accused the CFTC of being a fox guarding a hen house.

That’s a fair comparison if the fox is blind, missing two legs, and its tail is stuck in the door. It has routinely missed deadlines for implementation of new policies on agricultural derivatives.

The agency missed or was late to the game on numerous failures and frauds including the MF Global debacle that created lasting damage to the industry it is charged to protect.

The first excuse, of course, is a lack of money. In an interview with Wall Street Journal in October 2013, former CFTC head David Meister explained that the agency was too “undersized” to properly police for the global futures and options markets. It has dropped Federal cases against JPMorgan traders and downright refused to investigate some banks over their violations of CFTC rules because it doesn’t have the resources.

But resource allocation is a matter of priorities and the CFTC has stubbornly chose to fervently pursue certain issues—position limits for one — of dubious value while crying poor. The agency has also used its overstretched investigative resources to prosecute minor technical violations of customer segregation rules by futures commission merchants dating back several years in what appeared to be an attempt to justify an unpopular rule change.

But budget cuts aren’t the only reason why enforcement has failed.

The CFTC and the Federal Trade Commission, which enforces laws against false marketing in commodity markets, have investigated and shut down companies. They have “enforced.”

But neither maintains criminal prosecution authority. And this bureaucracy’s biggest problem. Brother and sister agencies don’t play well together.

After an investigation, the CFTC must take new cases to lawyers at other agencies like the Justice Department, many of whom have worked with, golfed with, and dined with the defense lawyers representing the banks or other financial institutions.

In some cases, these Federal lawyers even once defended the accused.

And given that Federal lawyers are allowed to pick and choose which cases they want to pursue, McCaskill noted that many cases won’t reach a courtroom because of Washington’s hand-washing nature.

That doesn’t mean the agency can’t do more to allow local officials in Florida to handle these cases.

They just choose not to. Either they don’t trust state prosecutors or their pursuit for glory – read: ego – is getting in the way.

The pawns of Palm Beach

From the testimony, a major takeaway was that the CFTC has failed to get the local lawyers involved. And that’s pretty staggering. As McCaskill explained, state lawyers do not enjoy the luxury of picking and choosing its cases. To McCaskill, these cases are slam dunks, because local juries are likely to convict with strong evidence, and that alone would ensure a future trading ban against bad actors.

McCaskill called for the agency to “get into a meaningful partnership with local prosecutors.”

More regulatory power isn’t the answer, nor is tossing more money at the problem, as Washington is want to do. Instead, the CFTC and a number of other agencies need should enforce the existing laws and use the structural advantages of the state legal system to ensure a day in court.

While there is some truth to the notion that the fear of prosecution is less likely to pivot the career path of the serial scamster, it is also the case that the CFTC hasn’t been able to instill fear into low-level scammers ripping off average Americans. The kings of con rely upon pawns like Spicer to scale their frauds. (The Florida metals scams have victimized 9,100 investors since 2001) The reality is that jail would be an effective deterrent – one that would run these young, entry-level scammers away from finance. Former construction worker and first-time fraudster Spicer, when asked by McCaskill, admitted he would avoid not just commodities but the entire financial sector as a place of employment for the rest of his life after his conviction.

After all, if the CFTC can’t deter local gold scams, how will they ever prevent Too Big to Fail banks – and those members of Washington’s crony inner-circle – from ever playing by the rules?

You can watch the panel hearing by clicking here. It will direct you to the Senate.gov website. 

Hat tip to McCaskill—check her out at the 1:14 mark.

Image courtesy of Don Hankins 

About the Author

Jeff Joseph is the CEO of The Alpha Pages, the parent company of Modern Trader magazine.
E-mail him at jj@alphapages.com or find him on Twitter @alphapagesceo and @venturepopulist.