More On Legal & Compliancefrom The Advisor's Professional Library
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
- Trading Practices and Errors When SEC-registered investment advisors conduct annual audits of firm policies and procedures, they should pay close attention to trading practices. Though usually not required to, state-registered advisors should look at their trading practices and revise policies that do not fully protect clients.
With scandal engulfing Barclays and its manipulation of the LIBOR being called the largest market fraud in history (it affected $800 trillion in contracts), it got us wondering about other large schemes that harmed entire markets.
Throughout history, financial scams have roiled markets, but a con man has to be truly brazen to base his scheme on manipulating a market rather than a single company or stock.
With lawmakers already holding hearings on the LIBOR fiasco, it will be interesting to see if any of the players involved from Barclays, the British government or other banks will be brought before the bar of justice.
At AdvisorOne we’ve compiled a look at 5 of history's brazen crooks who defrauded markets. Don’t worry, justice caught up with the all of the perpetrators. Then again, that hasn’t stopped the next schemer from trying his hand at stealing a fortune.
5. Alves dos Reis Nearly Bankrupts a Nation
Cost: $1 million pounds in 1925 or 1% of Portgual’s GDP
Penalty: 20-year prison sentence
Plenty has been written about the size of Bernard Madoff’s scheme ($20 billion or so in principal lost, more if you count the fake balances shown to investors) but the world’s largest Ponzi scheme didn’t come close to toppling a currency.
That trick was nearly turned by Alves dos Reis and his counterfeiting scheme in Portugal in 1925. By all accounts, dos Reis had humble beginnings in Lisbon. Clearly he craved wealth and didn’t care how he attained it.
After avoiding serious jail time on a technicality for a scheme to take over a mining company, he set his sights higher. Through a series of shady deals he was able to flood the Portuguese market with 200,000, 500-ecudo notes. That amount represented 1% of the country’s GDP.
When things started to get hot, dos Reis tried to acquire controlling interest in the Bank of Portugal in a bid to avoid any serious inquiry. It didn’t work, and dos Reis was finally convicted in 1930 and sentenced to 20 years in prison. Released after 15 years, he was later nabbed for a coffee scheme in Angola, although he served no jail time. Forced back to his humble roots, he died in 1955.
The Portuguese currency recovered but not before overcoming doubts about its stability.
4. The Hunt Brothers Corner the Silver Market
Cost: $100 million in missed deliveries
Penalty: William and Nelson banned from trading, ordered to sell their silver holdings, fined $10 million each
In 1973, silver was trading at $2 an ounce. The Hunt brothers, William and Nelson, saw an opportunity and set about buying silver futures. A lot of silver futures. With the help of backers in Saudi Arabia, the brothers amassed 200 million ounces worth by 1980. They made $2 billion to $4 billion from their scheme.
The price had reached $50 an ounce, but the Hunts wanted more. They imagined a price of $200 or even $300. Alas, it wasn’t to be. Like many who tried to corner a market, they were foiled by regulators. The Commodities Exchange decided to stop the Hunts before they could reap their windfall.
A new regulation, Silver Rule 7, made it harder for one contract holder to control too much of the market. That led to March 27, 1980, when the Hunts were unable to deliver on a margin call worth $100 million. The day became forever known as Silver Thursday when the price collapsed by 50%.
After years of legal wrangling the Hunts were forced to divest and paid their hefty fine.
3. Yasuo Hamanaka Controls Copper
Cost: At least $1.8 billion
Penalty: 8 years in prison
Yasuo Hamanaka picked up an apt nickname as a trader of precious metals for the Japanese trading giant Sumitomo Corp.: “Mr. Copper.” In the early to mid-1990s, he was able to acquire 5% of the world’s supply in the precious metal.
That was enough to put him in a dominant position owing to the cost and difficulty of moving the metal from one country to another to cover shortages. He used his position to keep the price artificially high. Other traders knew he was the big man on the trading floor, but could never outflank him because Sumitomo’s deep pockets could get him out of any short position he’d find himself in. A lack of regulatory oversight didn’t hurt him, either.
It all came crashing down in 1995. More copper entered the market as China’s mining activity increased, causing the manipulated price to fall. Sumitomo was forced to take losses on futures contracts that totaled at least $1.8 billion.
In the end, Sumitomo removed Mr. Copper from his position and then denounced him as a rogue trader. He was convicted of forging the signatures of executives on documents and sentenced to eight years in prison. He was released in 2005, a year early.
2. Kenneth Lay’s Enron Drives Up Power Prices
Cost: $11 billion lost by shareholders
Penalty: Prison time for top execs, including CEO Ken Lay and COO/CEO Jeffrey Skilling; payment of $1.5 billion settlement to power companies
The layers of the Enron scandal were many and throtled investors, allied companies and even the California electricity market.
After years of fabulous profits and a stock price that rose 56% in 1999 alone, things started downward for the company. Unfortunately, it was revealed that a constant focus on the bottom line led the company, which had its start with the merger of two Texas natural-gas pipeline companies, to inflate the value of assets and cash flow while keeping liabilities off the books.
Another aspect of Enron’s wrongdoing involved manipulating prices in the California electricity market in 2000 and 2001. The company saw an opportunity when the Golden State deregulated its power market. By using techniques that included creating phony congestion on the state’s power grid and then falsely claiming to relieve it, Enron was able to drive prices up, costing residents tens of billions of dollars and increasing the company’s profits.
As the practices came to light, the company spiraled into bankruptcy, taking with it top executives (Kenneth Lay, who died less than two months after his trial in 2006, and Jeffrey Skilling, each serving as CEO, received 45 and 24 years in prison, respectively) among nearly two dozen people who were convicted of charges including fraud. The scandal even took down the accounting giant Arthur Andersen, which was effectively put out of business for its role in the scandal.
In 2005, Enron agreed to pay California and other Western states $1.52 billion to settle claims in the power manipulation case.
1. Charles Keating Jr.: Symbol of the S&L Meltdown
Cost: At least $153 billion across the S&L industry
Penalty: 5 years in prison
The U.S. Savings & Loan industry was going gangbusters in the 1980s. And Charles Keating Jr.’s Lincoln Savings & Loan in Phoenix was at the center of it all when it came crashing down late in the decade. Thrifts across the country had invested in junk bonds, which turned out to be a bad move.
When the investments went south, the investigations and congressional hearings began. Keating ended up in the middle. Evidence of his giving large donations to five U.S. senators, the so-called Keating Five, which included Sen. John McCain, R-Ariz., bolstered the idea that he paid the money to make sure his S&L was not shut down. For a time, it seemed to work, but then Keating’s luck ran out and the S&L was seized in 1989. Lincoln's failure alone cost the U.S. government over $3 billion and about 23,000 customers were left with nothing.
Congress created the Resolution Trust Corp. to clean up the mess left by the hundreds of S&Ls teetering on the edge of bankruptcy. The overall crash cost $153 billion to fix, with taxpayers forking over $124 billion and what was left of the S&L industry covering the rest.
Keating was sentenced to 12½ years for fraud, racketeering and other charges. He served five years before the convictions were thrown out in 1996 because a judge ruled that the jurors had been contaminated by learning of an earlier conviction. In 1999, he pleaded guilty to wire fraud charges and was sentenced to time served.
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