INTERVIEW: Whistleblowing is a duty if internal calls unheeded, U.S. bailout overseer tells compliance officers

By Guest Contributor
July 31, 2012

By Stuart Gittleman

NEW YORK, July 31 (Thomson Reuters Accelus) - Compliance officers have a duty to become whistleblowers if their concerns are not heeded internally, Neil Barofsky, the watchdog over the U.S. financial crisis bailout program, told Compliance Complete in an interview.

Exposing wrongdoing is the only way to eradicate a “cancer” of fraud that can endanger companies and the larger economy, said Barfosky, who also in the interview warned on dangers of a revolving door between financial regulators and Wall Street.

Barofsky was appointed Special Inspector General for the Troubled Asset Relief Program in the aftermath of the September 2008 financial crash by President George W. Bush and served from mid-December through March 2011, when he left to teach at New York University School of Law.

As SIGTARP, Barofsky and his colleagues were tasked with reporting on whether the relief program, or TARP, was using funds as Congress intended, and with preventing the misuse or theft of trillions of dollars of public funds.

Before coming to Washington D.C., Barofsky was a Manhattan federal prosecutor whose work resulted in the convictions of Columbian drug dealers, the men behind the Refco scam initial public offering, and mortgage fraudsters who preyed on homeowners who were desperately seeking to avoid foreclosure.

Barofsky wrote a just-published book, Bailout: an inside account of how Washington abandoned Main Street while rescuing Wall Street. He took time from appearing on talk shows, where he is being asked about working with Treasury Secretary Timothy Geithner, to discuss how financial service compliance officers can use what he learned in the crucible of governing during a financial crisis to protect their firms and customers – and themselves.

The following is an edited version of his conversation with Compliance Complete.

Compliance Complete: In the book you describe how the initial SIGTARP authorization made it difficult for your team to carry out its assignments. Congress created TARP, and SIGTARP, under extreme circumstances amid thoughts of the U.S. and global economies going off a cliff. If we need to do this again, what would you change?

Barofsky: SIGTARP initially lacked clear law-enforcement authority, but Congress ultimately gave us what we needed. We could have used more flexibility in hiring – like Treasury had – because of the difficulty of bringing the most dedicated and talented people to an agency with a short expected life span. But in the end we attracted great people, and I think it is generally appropriate to limit the authority of a limited-purpose inspector general.

You describe Geithner berating you over what he called the “fungibility” of money in response to your plan to track how banks used bailout funds. Based on your experience in prosecuting drug and financial fraud cases, can you effectively follow the money? Do the courts and FinCEN, the Financial Crimes Enforcement Network, a Treasury agency, buy his theory in terms of forfeiting criminal proceeds in money laundering allegations?

Barofsky: We never thought Geithner’s argument was legitimate but was just a maneuver to hide the ball and evade transparency. Prosecutors can’t follow particular dollar bills but they can follow the money to tell legitimate assets from illicit proceeds.

I think the insistence that money is money was indicative of taking the banks’ argument against reporting on their use of bailout funds at face value, parroting the Wall Street line, when he instead should have been highly skeptical.

SIGTARP eventually took before-and-after snapshots showing that banks were using the bailout to buy assets cheaply, strengthen their balance sheets and pay bonuses to reward failure and mediocrity, but not to help homeowners.

You describe foiling the plans of Colonial Bank and Taylor Bean & Whitaker executives to steal hundreds of millions of bailout bucks. What initial clues raised an alarm?

Barofsky: At first we thought it was insider trading because Colonial’s stock shot up after it announced it was getting bailout funds, and then dropped when it said the TARP approval was conditional. But the $300 million purported investment by Lee Farkas, Taylor Bean’s chief executive, in Colonial – his mortgage firm’s lender – smelled wrong.

We initially thought the so-called investment was a round-trip transaction, like what we had seen at Refco, and we got more suspicious when they started stonewalling us. Finally, when a whistle-blower said documents were being destroyed, we had no choice but to follow up. In the end, it was illegal, but not what we thought before we had the evidence.

What role did your team’s experience in investigating and prosecuting financial fraud play in this case and others like it?

Barofsky: Our experience made us both skeptical and confident, but in the right proportions. We didn’t take banks or the government at face value and we had been trained by – and had tried cases against – some of the best white collar defense lawyers in the country.

You describe what is often called “regulatory capture.” What can officials, particularly at the appointive level, do to improve their independence? What about the rank-and-file?

Barofsky: Regulatory capture is very difficult to eradicate. First, the people at the top have to recognize there is a problem, but Washington culture puts a premium on not acknowledging fault. Then they have to identify the sources of influence, and limit them. Finally, they have to change the incentive structure.

You describe working with law enforcement agents against some of the deadliest criminals ever. These agents do not go back and forth from the FBI or DEA to help drug cartels launder money or terrorists plan bombings, and then return to government service at a higher level. Should there be a revolving door for financial services regulatory careers?

Barofsky: The revolving door promotes regulatory capture in two ways. On the incentive side, people may think they should pull punches in order to advance their career, and on the influence side, the ideology that the industry you regulate is your client and is as important as its executives think it is gets pushed onto the agency staff.

The key is to support an aggressive approach to regulation over complacency. At the U.S. Attorney’s Office for the Southern District of New York, we were encouraged to think that bringing tough cases and winning them fairly is how careers are made. This approach doesn’t seem to exist in the regulatory world, but it could.

What other “compliance lessons learned” or better practices did you take with you from SIGTARP?

Barofsky: There is no easy answer. If working within the organization to prevent or stop fraud or misconduct does not work – if compliance officers are ignored or punished – they must blow the whistle. Otherwise, they may be cited for not doing their job, and in the worst-case scenario, their job may disappear, like it did at Colonial, Refco and Enron.

The financial crisis shows that fraud is an outlier in the business world but it can taint healthy firms and endanger the whole economy. Only by exposing wrongdoing can we do something about this cancer.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. <a href=”http://accelus.thomsonreuters.com/solut ions/regulatory-intelligence/compliance- complete/” target=_new”>Compliance Complete</a> provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)


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