Prosecution Fumbles

By Christopher Byron
New York Post
August 2, 2004

WHEN I was a little boy, my mother used to say to me, "Son, never go back for a second helping until you've eaten everything on your plate."

I think that's pretty good advice for Chairman William Donaldson of the U.S. Securities and Exchange Commission, who had scarcely settled into his job in February of 2003 when he dispatched the SEC's Enforcement Division, armed with an emergency court order from a federal judge in Miami, to seize and shut down a $1 billion penny-stock fraud factory known as the Lancer Fund.

But after the headline-grabbing pyrotechnics of the court-ordered seizure, the case has been left to languish for more than a year in the SEC's Miami district office, the victim of bureaucratic inertia, staff turnover, and a total lack of effective leadership from the head office in Washington.

This is no different from how the Department of Justice as been handling criminal cases on Wall Street. Typical example: the conspiracy and racketeering case that is now set for trial in October against a controversial short-seller named Amr Elgindy.

Prosecutors have been pursuing Elgindy for more than a decade. But in their zeal to get Elgindy, the lead prosecutor in the latest case, a fellow from Brooklyn named Kenneth Breen, did neither himself nor his case any favors when, on the basis of no known evidence, he announced in court at the time of Elgindy's arrest that the Egyptian-born stockbroker may have been tipped in advance of the terrorist attacks of 9/11, and that he had profited from that knowledge by some clever stock trades the day before the attacks.

The FBI subsequently disavowed the claim.

Such stunts are a way to grab a quick headline and appear to be in control in a time of crisis. But the headlines come only at the expense of serious long-term damage to the credibility of the government itself when the headlines fade away and all that remains is the bad aftertaste of grandstanding that led to no follow-through.

That's the problem Donaldson now faces, for even as he has allowed the Lancer case to languish in Miami, the SEC has geared up a whole new grandstanding effort at the expense of the hedge fund industry by requiring that all hedge funds now begin registering with the SEC as if they were nothing but mutual funds for the wealthy, which in many respects is really all that they are.

But why bother subjecting hedge funds to the same rules that govern the mutual fund industry when, if the Lancer case is any guide, violating those rules brings no punishment at all?

Of all the many hedge funds that have collapsed under the weight of fraud and mismanagement in recent years, none even comes close to matching the scofflaw attitude that governed life at Lancer, where the founder of the fund, a one-time stock analyst named Michael Lauer, raised nearly $700 million in cash from investors on a promise to put their money into a portfolio of carefully researched small-cap growth stocks.

Instead, Lauer filled the Lancer portfolios with worthless Over The Counter penny stocks, many issued by shell companies controlled by individuals connected with Organized Crime.

Had investors known that this was what he was actually doing with their money, it is doubtful that Lauer would have been able to raise more than a few million dollars before the money dried up and the Lancer house of cards collapsed.

But Lauer kept his activities secret. He did this by simply ignoring SEC rules that apply to all investors whether they are hedge funds or not. These rules require investors to file timely, accurate and up-to-date reports to the SEC every time they buy or sell stock in any company in which they already own or control 5 percent or more of the company's shares.

Failure to file such a form is itself a crime, and Lauer did so not once or twice but dozens of times, and arguably even hundreds of times, all to keep his investors in the dark regarding what he was doing with their money. As such, he headed an ongoing criminal enterprise in which crime itself was the key element of the business plan.

It would hardly have been difficult to build a case against him on this set of facts alone since the court-appointed receiver that took over the Lancer assets in July of 2003 has spent most of the last 13 months simply filing delinquent SEC forms — 13 of them, to date — in an effort to establish what stocks the funds legally own.

Two weeks ago the receiver, a team of lawyers from the Hunton & Williams law firm in Washington, D.C., filed its fourth quarterly report on its activities in liquidating the funds' assets. The report shows that of 49 portfolio companies held by the Lancer funds (nearly all of them penny stocks), only $5.7 million worth of stock has been able to be sold — this out of a stated portfolio value of more than $1.2 billion only months before the funds collapsed in the spring of 2003.

Additionally, the receiver was able to sell a Cessna aircraft that had been seized as one of the group's assets, as well as a Manhattan co-op that Lauer had lived in from time to time. For the moment, he currently resides at a home in Greenwich, but that too will likely eventually be sold.

Of the total cash of close to $700 million that investors poured into the funds, the receiver now thinks it will be lucky to recover 7 percent, and that number could itself turn out to be wildly optimistic. Where the rest of the money went, no one seems to have a clue. No one that is, but Lauer.

Yet the government hardly seems eager to get him to 'fess up. His passport has not been pulled, and sources in the case say he was traveling recently in Europe, looking to raise money to launch a whole new fund.

When I asked one of the top lawyers on the Hunton & Williams team why neither the Department of Justice nor the SEC had brought any kind of a case based on Lancer's failure to file these so-called Form 13D reports (the key violation that sent junk bond czar Michael Milken to prison for 10 years back at the start of the 1990s), he simply shrugged and said, "Hey, you're preaching to the choir. That case is a no-brainer. Why they haven't made it I just don't understand."

Because of this, an enormous opportunity to draw back the curtain on the global operations of a corrupt billion-dollar hedge fund, which snookered investors ranging from Britney Spears to the University of Montreal, has pretty much been squandered.

Officials at some of the major financial institutions on earth were obviously in on the swindle.

They ranged from accountants in the Curacao office of the PricewaterhouseCoopers accounting firm, which audited Lancer's books, to their counterparts at Bank of America Securities, which processed its trades, to those at Citco Fund Services, which served as administrator of the fund's chaotic books and records.

Bottom line: Expect no more than a weak and confusing civil suit, heading for trial in September at the earliest, in which Lauer is accused of rigging the market in a few of the penny stocks in his portfolio — a charge that will lead to nothing but weak civil penalties if he's found liable (which is by no means assured), and which will avoid opening the door to the entire world of criminality that the Lancer funds were part of.

So, why should anyone on Wall Street care — or even listen — when the SEC says it now plans to begin regulating the entire hedge fund industry? A year after he first served himself the helping of glop called the Lancer fund, Chairman Bill sits staring at his plate, and he still hasn't eaten a bite of what's on it. As my mother used to say...

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