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Thursday, February 19, 2009

Stanford Bank Fraud

Recently, Stanford Bank (no affiliation with the school) made headlines. It was shut down by SEC regulators.

I couldn't find any really good links describing the incident. Here is a summary of what I saw on the Communism Channel (CNBC) and various other sources.

Stanford Bank was dealing with a branch in Antigua, which is very loosely regulated. They were selling CDs with very high above-market yields. For example, they were selling 1 year CD of around 8% when current yields are 2%-3%.

Since the bank was in Antigua, they were not FDIC insured. They were not subject to Federal regulation. However, the CDs were sold to customers in the USA.

These CDs had very high sales commissions. For example, suppose the CD yielded 8%. The broker would get a commission of 3% (!), and the customer would get a return of 5%. For a 1 year CD, 5% is a very attractive yield.

The high commission places the broker in a conflict of interest position. This creates an incentive for the broker to look the other way, and assure the customer that the CD is safe. Via sovereign immunity, the broker is protected. Even if you invested in the CD and lost your money, it probably isn't possible to sue the broker who sold you the CD.

Normally, proceeds from CD sales are invested in relatively liquid and safe assets. The proceeds of these CDs were invested in illiquid assets, such as real estate and private equity. Borrowing at 8% to buy real estate is typically a good deal. Since there's no regulatory oversight, you can use huge leverage ratios. The difference between 8% and the actual return is profit for the scam operator.

This was not an explicit Ponzi scam like Bernard Madoff was running. It still is fraudulent, because the proceeds of the CD sales were invested in risky assets. It is likely that customers will only recover 10%-20% of the amount invested in the CD.

Scams like Bernard Madoff and Stanford bank are attractive due to a corrupt monetary system. If you invest in a money market account or bonds, you're guaranteed to be ripped off by inflation over time. If you invest in stocks, you risk losing your principal, as the recent stock market decline indicated. A stock investment doesn't outperform true inflation.

People are eager to protect their principal, while earning a decent return. This makes investment scams attractive. Brokers are paid high sales commissions, which gives them an incentive to look the other way. Via sovereign immunity, most of the participants in the scam are protected from personal liability. If you're an employee, "I was just following orders!" is normally a valid defense. If you have any financial knowledge at all, CDs that pay 6% more than their competition are suspicious. The brokers who sold those CDs should have known that fraud was occurring.

I saw another interesting bit. Most of the executives at Stanford bank were relatives of the owner. This allows the scam to be covered up, if all the relatives are dedicated to preserving it.

The individuals are always blamed, and not the corrupt system. Bernard Madoff is blamed. The owner of Stanford bank is blamed. The evil fnord is "These corrupt individuals got caught. Therefore, the system is fair."

Physical gold and silver stored in a safe place might be the only way to protect your savings.

1 comment:

James said...

I realize that you are getting your "facts" from a third party source but your information is almost completely inaccurate! Get the facts straight please or don't claim to know the truth. You should know that you can't depend on media outlets to do anything but report the sensational. Sometimes (read as often) they don't bother to cross check for accuracty.
I was a short term employee but I was there long enough to know the facts.

"They were selling CDs with very high above-market yields. For example, they were selling 1 year CD of around 8% when current yields are 2%-3%."
When local banks were paying 3.5% for a 1 yr CD, SIB was paying 5%. SIB rates did not move as often up or down as local or national banks but they were typically only 2.5-3%better than FDIC insured bank rates, when comparing like terms and amounts. Larger amounts of money certainly got better rates but you can get better yields than the published rates at local banks also in a larger CD.

"These CDs had very high sales commissions. For example, suppose the CD yielded 8%. The broker would get a commission of 3% (!)"
NOT EVEN CLOSE!
The 3% was paid to Stanford Group Company as a referral fee but the broker received only 50-100 bps (0.50-1.0%) depending on level of production. This was not an upfront commission but was instead paid out monthly over one year. As long as the CD stayed in the bank you continued to receive the "trailing commision"
(50-100 bps)based on the level of production for the past quarter. Some time ago, there was also a 1% upfront bonus for reps that were higher producers but most reps seldom achieved this level. This certainly provided an incentive to recommend the CD's, but bonuses are used in many parts of the financial services industry (sales of annuities, for example).

" . . . CDs that pay 6% more than their competition are suspicious. The brokers who sold those CDs should have known that fraud was occurring."
If there had been a difference of 6%, the brokers probably would have smelled a rat. But we had nearly 20 years of "audited" financial statements (there were audit letters included with each semi-annual statement)that showed SIB was solvent, liquid, and very well reserved. What about this would have made YOU suspicious?

I am not sure about the issue of relatives of Allen Stanford being in executive positions. My only knowledge of a relative was his Father being on the BOD. But maybe there were others also.

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