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Why The SEC Sued Me - And Why You Should Care |
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An atypically up-close-and-personal
perspective of the SEC,
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Plus, a brief recap of Bill Bonner's musings
from Friday...
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Eric Fry with a few quick words about today's special guest
essay...
Today we take a break from our typical Reckoning to bring you an atypical
Reckoning. Our colleague, Porter Stansberry provides an up-
close-and-personal perspective of the SEC - the government agency in
charge of safeguarding the financial markets and protecting the interests
of individual investors. Does this particular government agency actually
safeguard the markets and protect the interests of individual investors?
Let the reader decide.
Your editor's here at The Daily Reckoning will refrain from
commentary that might prejudice our readers. Nevertheless, we must admit
that we cannot escape the thought that Porter's experience reminds us of a
familiar children 's story: "My what big teeth you have, Grandma!" Read
on...
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Why The SEC Sued Me - And Why You Should Care
By Porter Stansberry
Baltimore, Maryland
The reason you might have heard about my Securities and Exchange
Commission (SEC) lawsuit is because I didn't settle the case.
When most people are sued by the SEC, they do their best to put the matter
behind them - as quickly and quietly as possible.
This normally involves paying a large fine and essentially promising "not
to do it again." If you pay the fine, the chances are good most people
will ignore the matter. You're not required to admit any guilt. Thus, the
damage to your reputation is largely mitigated and you can go on with your
life. That's why most people settle with the SEC when it comes to civil
(noncriminal) lawsuits.
But I didn't settle when they sued me.
Even when a settlement was offered to me for as little as $1 million, I
refused it. Instead, I've faced a lengthy court battle that's brought with
it tremendous risks to my reputation and legal bills amounting to almost
$3 million.
Why on Earth would I try to fight the "city hall" of the securities
industry?
Because I'm eager for the facts of my case to come to the public's
attention. I know when the facts of my case are accurately known by the
public, my subscribers will support my decision to fight the SEC. That's
why I've never tried to hide this matter from anyone.
Unfortunately, so far, almost none of the critical issues at stake in my
fight have been accurately reported. Worse, people who have no idea what
they're talking about continue to assume my case is another example of a
financial publisher acting scurrilously - front-running his subscribers or
ripping people off by promoting penny stocks that he's been paid to
endorse.
And so... at the risk of upsetting the judges who have to date refused to
believe a word I've said about the matter... I would like the opportunity
to tell you, my subscribers, exactly why I've refused to settle my case.
And why the matter is now pending before the U.S. Supreme Court.
I'd also like the opportunity to direct you to several reliable sources of
information about the matter, such as The New York Times and
The Wall Street Journal. Most of the things written about the case
elsewhere are patently false and misleading.
For example, most people don't know my battle with the SEC actually has
nothing to do with stock trading or actual securities fraud.
The truth is, there isn't any allegation that I ever owned the stock in
question - and there never has been.
Nor is there any allegation I've done anything at all that's directly
related to the purchase or the sale of any security. I didn't "front run"
my recommendation. I wasn't being paid by promoters to recommend a stock.
These things have all been said about the case - even by a few fellow
journalists. But in fact, I wasn't even accused of doing them by the SEC.
So what is this case about, if it's not about trading in securities?
My lawsuit with the SEC started as a fight over the First Amendment rights
of a publisher - me. It has continued because I refused to settle or
buckle under to the government. I maintain my writing was honest,
materially correct, and is certainly protected by the First Amendment of
the U.S. Constitution.
I claim a former unit of the Department of Energy - a unit that was sold
to investors in 1996 and is now known as USEC - was withholding material
information from the public. I believe it did so in order to reward
certain investors, including its bankers, its corporate insiders, and
members of the Department of Energy.
By revealing information about a major and long-pending agreement with
USEC's Russian supplier of uranium, I disrupted the opportunity insiders
had to accumulate shares at lower prices. In short, I ruined the party by
telling investors the agreement had been reached and would be announced in
a few days.
Because USEC was trading at a very distressed price (half of book value)
and was paying such a high dividend (yielding more than 8%), I believed
the stock would soar once this long-pending agreement was made public. In
my report, I explained why the agreement would turn USEC into a profitable
company by lowering the company's raw material costs dramatically. I
predicted the stock would double on the news.
And that's almost exactly what happened.
Based on what I'd learned from a company insider (the director of investor
relations), I wrote the agreement would be announced at a major nuclear
summit featuring presidents Bush and Putin on May 22, 2002. The insider
explained the details of the summit to me in advance, long before they
appeared in the newspaper and told me to "watch the stock on May 22." And
in fact, the long-awaited announcement came about a month later, on June
19, 2002. Keep in mind, this agreement had been pending for more than two
years. And yet, somehow, I was able to pinpoint almost to the day when it
would be announced to the public.
Did the stock soar? No, not exactly. It moved from around $8 to around
$11. That's roughly a 40% move in a few days. That's not bad. More
importantly though, following the new agreement with the Russian uranium
supplier, the stock traded all the way up to nearly $20 over the following
three years. In fact, by the time my case reached its first federal judge,
investors who followed my advice would have made more than 150% on the
investment, thanks to capital gains and big dividends. (The stock
eventually went to $25 during the uranium bubble of 2007.)
Yes... that's right. The SEC is suing me for a matter that involves a
stock that went from under $8 to nearly $25. That's more than a 200% gain.
You've got to be kidding, right? Nope.
But why?
Here's the heart of the matter.
I believe the company knew for certain its deal for cheap Russian uranium
would receive the required final approval of both the U.S. and Russian
governments at the summit. This approval was the only thing holding up the
deal. With this knowledge in hand, it would have been easy for the
company's insiders and other senior officials in the Department of Energy
to load up on the stock and profit once the news was announced to the
public.
And I wasn't the only analyst who was told when to expect the deal.
In the discovery process of our lawsuit, we found a notebook from USEC's
investment bank - Bank of America - where its analysts clearly indicated
May 22 was the expected announcement date.
But instead of pursuing the possibility USEC's managers and bankers were
withholding this material information, the SEC decided to attack me. Keep
this in mind: I didn't use this information for my own personal gain. I
didn't buy the stock. Or even just tell my friends to buy the stock. No,
instead I did my job. I published a report about what I'd learned and
offered to sell my report to any (and all) interested investors.
I also sent a copy of my report (and the accompanying sales letter) to my
source at USEC. He never asked me to change a single word of my report. He
had my cell phone number. He had my office number. He had my e-mail
address. If there was any legitimate problem with my report, all he had to
do was ask for a correction. He never did. Not even to this day.
I did all of the things any reputable journalist would do. I checked my
source's facts. Sure enough, a presidential summit was approaching. Sure
enough, there was a large pending contract. Sure enough, the new deal
would change the economics of the company in a dramatically positive way.
I sent a copy of my report to my source. And I offered it for sale to the
public. If anyone wasn't satisfied with the report, for any reason, I gave
him his money back.
Even today, looking back at the matter through the lens of time and
experience, I still think my USEC report was one of the great stories of
my career and I'm proud of the report I wrote. Are there things I would
have done differently? Yes. I would have made sure to have a recording of
my interview.
You see, even though I never owned a share of the company, even though I
had no incentive whatsoever to lie about the company, and even though
third parties who have looked at the facts of the case (like The New
York Times) agree my report on the matter was overwhelmingly
correct... the SEC decided to come after me and not the people who were
really defrauding the public.
Incredibly, the SEC sued me for securities fraud, saying I had lied about
what my source told me and that selling my report about USEC was
tantamount to brokering the stock. Specifically, the SEC claimed my source
didn't tell me to "watch the stock on May 22," which was the only part of
our conversation that I quoted.
Since I can't prove what my source said, you might assume I must be lying.
But if he didn't explain the timing of the deal to me, how could I have
known - within a month - exactly when the deal would close? The fact is,
until our discussion, I didn't know anything about the upcoming
presidential summit. It wasn't reported in The Wall Street Journal
until about a week after our discussion.
But... just for the sake of the argument... what if you assume I knew
about the summit from another source and I merely attributed it to the
company in order to claim I really had "inside" information? Why then,
even after I wrote the report and sent my source a copy, did he not demand
a retraction?
And if the company knew my report was false, why didn't it put out a press
release denying it? The NYSE rules require companies to put out press
releases anytime there's a material misstatement in the press.
The fact of the matter is, my report was overwhelmingly correct. And my
source couldn't deny my report because he didn't know whether or not I had
a recording of our conversation (which took place over the phone).
When the SEC came calling later in 2002, I expected it would be going
after the company for selective disclosure - a violation of SEC regulation
FD. And sure enough, it wanted all of my personal records to make sure I
wasn't front-running the stock, etc. But then, instead of shifting its
investigation to the company, it demanded to have the entire subscription
list of not just my publishing company, but also of our parent company,
Agora Inc.
It wasn't going after USEC for withholding material information; it was
going after us by intimidating our clients. And it didn't ask for just the
USEC report subscribers - it demanded every single name and address on our
entire database, including my parent company's database.
Rather than give in to this subpoena, we sued the SEC in federal court to
protect our subscribers' privacy. A well-established legal precedent
protects a publisher's subscriber lists. (What you decide to read is none
of the government's business.)
That's part of the story I'm sure you've never heard before: We sued the
SEC first. And we did so to protect our subscribers, the overwhelming
majority of whom never bought the USEC report in the first place.
I understand that you might reasonably wonder... How could any of this be
true? I mean, wouldn't you expect that as soon as the SEC knew I'd sent my
source a copy of the report, the matter would be closed? Or don't you
think as soon as it knew I wasn't trading the stock or front- running it,
the SEC would have simply left me alone?
Even after reading all of this, undoubtedly, a lot of people must think
I'm merely trying to muddy the waters because I'm guilty of front- running
the stock... or lying to investors. Why else would the government waste
its time on a newsletter writer?
I understand my story might be hard to believe - at first. The public
generally has confidence in our government. It will be hard for some
people to imagine the SEC would actually go after a journalist with the
intent of putting him out of business simply because it didn't like what
he was writing about.
But my story isn't unique.
At the same time the SEC was abusing its power by subjecting me to
interrogations, subpoenas, and crushing legal bills - all in violation of
the First Amendment - it was also going after many other legitimate market
participants - including David Einhorn, the well-regarded hedge- fund
manager (Greenlight Capital) for merely speaking about securities.
As with my case, the SEC came after Einhorn for speaking openly about
abuses taking place at a Washington-based business (Allied Capital), a
company that - like USEC - was heavily staffed with former government
officials, including Joan Sweeney, the company's chief operating officer,
who was a former senior member of the SEC's Division of Enforcement. Our
stories are eerily similar...
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THIS IS WHAT EINHORN WAS WARNING INVESTORS ABOUT, AS EARLY AS 2002. THE
SEC RESPONDED BY INVESTINGATING EINHORN.
Rather than investigating Einhorn's claim that Allied Capital was cooking
its books by using fraudulent accounting, the SEC instead began
investigating him, alleging securities fraud because of what he'd said
about Allied Capital during a presentation at an investment conference
that's held to benefit charities.
After several years of threats and abuses (like having his phone records
stolen), Einhorn was vindicated. The shares of Allied Capital collapsed as
the company was revealed as fraudulent. But even today, Joan Sweeney is
still with Allied Capital. The SEC has never been forced to fire any of
the agents who abused their power during the investigation of David
Einhorn.
To draw attention to the abuse he'd suffered, Einhorn decided to donate
all of the money he made from shorting Allied Capital to charity, and he
wrote an entire book about the situation called, Fooling Some of the
People All of the Time.
Says Einhorm about his experience:
Allied isn't the biggest, most egregious, or most audacious fraud I
have seen. In a sense it is a garden-variety fraud - dishonest business
dealings by dishonest management. So why all the fuss? The story I am
telling is one that has been surprising and unexpected - even to me. I
think it is important and needs to be told. This book reveals some serious
problems in the regulatory landscape that I am in a unique place to
discuss.
I care that the SEC and other regulators seem to have stopped enforcing
laws against corporate malfeasance. I care that company officials can lie
with impunity on public conference calls. And I have been appalled that
the government officials overseeing the lending programs that Allied has
defrauded are so indifferent and unwilling to act even when presented with
clear evidence of abuse. The overall lack of law enforcement is
startling...
If we are going to permit the retribution against the whistleblowers shown
in this story - defamation, investigation, invasion of privacy and so
forth - then we surrender public free speech. If we allow the people in
this story to operate outside the law, then we nourish a corrupt business
culture. Rather than turn a blind eye to the fraud I witnessed, I made a
decision to stand up and speak out despite the consequences. I hope my
story inspires regulators and government agencies to do the right thing.
I hope you'll remember most people don't do what I've done and what
Einhorn did.
Most people don't fight the SEC because they don't want their names in the
paper, they don't want the stigma of being investigated by the government,
etc.
Believe me, I can understand why. When the news of the SEC's investigation
of me leaked out, publishers around the world refused to do business with
me. Potential employees refused to come to work with me. Companies refused
to be interviewed by me. The lawsuit has made it vastly more difficult for
me to simply stay in business. Even today, every time a potential
subscriber stumbles across information about the lawsuit on the Internet
(and much of it is completely untrue) he's likely to cancel his
subscription or simply decide not to renew.
And think about this... the more people who simply refuse to write about
securities because of the threat of an SEC action or because they fear
retaliation from the businesses they write about, the less high- quality
information will be available to investors. The less information is
available, the more bad actors will take advantage of investors.
Whether you realize it or not, the SEC isn't trying to protect investors.
If it were, Bernie Madoff would have never happened. The SEC knew all
about Bernie Madoff - the SEC audited him regularly. Many people -
including Barron's - pointed their finger right at Madoff and
revealed his fraud. Still, the SEC did nothing.
The SEC knew all about Enron and WorldCom and the conflicts at the
investment banks during the Internet boom. The SEC knew all about GM's
debt load. It knew all about the problems with Fannie and Freddie. In
fact, it was the SEC that approved the huge increase to investment banks'
leverage in 2004 - a move that directly led to the financial crisis of
2008.
But... maybe you still trust the SEC. And if you do and you want to
believe Porter Stansberry is out to harm investors by publishing
independent reports on public companies - that come with a money-back
guarantee - there's probably very little I can do to change your mind.
On the other hand, if you ask any securities industry professional who
reads our newsletters, I have no doubt he will tell you our work is among
the best you can buy anywhere and is far superior to nearly all of the
research put out by the brokerage firms. I know this is true because
thousands of professionals are our clients and I have hundreds, if not
thousands, of testimonials from these readers.
The truth of this case is so simple to see. Just ask yourself two
questions:
1. How can the SEC accuse Porter of intentionally lying when Porter sent
his source his full report and the source never requested a retraction or
a correction to any of Porter's reporting?
2. Why would the SEC risk a constitutional battle with a bona fide
journalist over a report even The New York Times says was
basically correct? Why would the SEC want to shut down a business like
Stansberry & Associates Investment Research - which offers refunds to any
unsatisfied customers and whose analysts never trade in the securities
they recommend?
Don't you wonder why the SEC would target my business - which doesn't
manage money or broker stocks - while ignoring enormous ponzi schemes
going on in the businesses it supposedly regulates?
I can't prove it... but I don't think the government likes it very much
when I tell investors the truth about things like Fannie, Freddie, and
General Motors. I don't think the SEC wants the American people to know
the truth about our financial markets - or the state of our government's
finances. And I think the government is afraid of what will happen when
you find out the truth.
Whatever happens with my court case, I hope you'll know I did, and have
always done, my best to tell you the truth.
After all, unlike the government, the truth is my only weapon.
Regards,
Porter Stansberry
for The Daily Reckoning
Joel's Note: Even though the SEC rarely recognizes
fraudulent accounting and/or corrupt corporate governance before the fact,
professional short-sellers often do. And even though the SEC rarely
prosecutes the frauds it does discover, the financial markets ALWAYS
prosecute and punish corporate wrongdoing...eventually. In the chart
above, you can see very clearly when the market rendered its damning
judgment of Allied Capital. Although short-sellers are wrongly blamed for
subverting confidence in companies like Allied, the technique of short
selling is actually one of the best tools for keeping these guys in line.
Porter's S&A Short Report does exactly that - providing readers
with honest analyses and, therefore, opportunities to profit as these
companies' dirty laundry is brought into the unforgiving light of day. You
can learn more about this service right here:
The S&A Short Report
Our intrepid reckoner-in-chief, Bill Bonner, is en route to India today.
So, just in case you missed it, here is a recap of some of his musings
from last week...
"The US is insolvent," says a report from a hedge fund. As of the third
quarter of last year, the federal government had assets of $2.67 trillion
and total liabilities of $14.12 trillion.
That leaves a net negative position of more than $11 trillion. By the way,
this is projected to get a lot worse, fast. The feds are expected to
increase their debts by about $3 trillion more over the next 2 years.
Federal spending is out of control...the feds have lost control of their
own budget, let alone the economy.
Typically lenders look for what they call 'debt coverage' - debt compared
to revenue. If you take the US revenue as a whole, you find federal debt
currently equal to a bit more than 80% of GDP. But that number is going up
quickly. It will be over one hundred percent in just 2 or 3 years.
Well, so what? As long as you have the income to support it, you don't
worry, right? Well, let's look at it from that angle.
Hmmm... Doesn't look so good from that perspective either. The income tax
only generates 43% of the budget. The feds get a little more from
corporate and other taxes, but the deficit is enormous...from a third to a
half of all expenditures.
This is not looking good. Most of the deficits do not come as emergency
reactions to a financial crisis. Most of red ink is 'structural' - the
result of programs already in place before the crisis hit. They are hard
to curtail, since it requires major acts of political will to undo them.
So, they tend to continue.
Which means, the US needs to borrow huge amounts of money just to continue
drifting along in the style to which it has become accustomed. There is no
end in sight to the deficits...no practical way to reduce them...and no
way out of the debt whirlpool. Which means, financing them has got to be a
losing proposition for the lenders.
Nothing new in that...
Still, we drift...we wander...we float from one bank to the other...and
wonder when we will finally sink.
Regards,
Bill Bonner,
for The Daily Reckoning
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Here at The Daily Reckoning, we value your questions and
comments. If you would like to send us a few thoughts of your own, please
address them to your managing editor at
joel@dailyreckoning.com
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