“A long history in distress”: Senator Schumer in Rule 10b-5 stock fraud scheme?

by Kurt Schulzke on October 22, 2008

Many Americans think of stock fraud as a one-way street in which a seller tricks buyers by overstating the value of equity or debt. The reality is, fraud cuts both ways. Lying low is just as fraudulent as lying high. Senator Chuck Schumer (D-NY, pic right) should know. He is a member of the Senate Banking Committee and represents America’s financial capital.

Yet, evidence suggests that when Senator Schumer triggered the collapse of IndyMac Bancorp back in July, he may have been trying to manipulate downward the company’s value on behalf of campaign contributors who were looking to buy. If true, Schumer could be prosecuted or sued for securities fraud.

In 1942, the SEC caught wind of a company president who, angling for a controlling stake in the firm, induced existing shareholders to sell out cheaply by deliberately understating the company’s value. The SEC responded, in 1948, with SEC Rule 10b-5, now known as the 1934 Exchange Act’s “anti-fraud provision.” It applies equally to transactions in public and private company shares. The rule is relatively short yet expansive in scope:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

a. To employ any device, scheme, or artifice to defraud,
b. To make any untrue statement of a material fact, or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
c. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

In other words, anything that anyone intentionally does or says in “interstate commerce” — in the context of the purchase or sale of any “security” — to deceive or mislead anyone violates the law. Civil and criminal sanctions may be applied against violators.

Fast-forward 60 years to June 22, 2008. At that point in time, the WSJ reports that IndyMac Bancorp was in financial distress, searching for a capital infusion. Oaktree Capital Management, LP was performing “due diligence,” digging through IndyMac’s books to determine what price to offer, if any. Oaktree’s thing is buying companies on the cheap, shortly before or even after they go bankrupt. Chairman Howard Marks reportedly told the WSJ, “We’re bargain hunters. And we have a long history in distress.”

On June 22, Oaktree’s Managing Director, Skarden Baker, wrote an e-mail to Chairman Howard Marks that read, in part: “I am taking the view of doing enough here [at IndyMac] to jump in if it goes to receivership.” In other words, it would suit Oaktree just fine if IndyMac went under. Conveniently, Oaktree-affiliated investors have contributed $700K to Senate Democrats during Chuck Schumer’s four years in charge of the Senate Democrat Campaign Committee.

Four days later, on June 26, 2008, Senator Schumer — in a “highly unusual” move, publicized a letter he had written to bank regulators, raising doubts about IndyMac’s viability. That letter read, in part:

“I am concerned that IndyMac’s financial deterioration poses significant risks to both taxpayers and borrowers,” the senator wrote, warning that “the bank could face a failure if prescriptive measures are not taken quickly.”

Schumer’s publication of this letter triggered the very bankruptcy Oaktree was hoping for, according to this OTS press release:

The OTS has determined that the current institution, IndyMac Bank, is unlikely to be able to meet continued depositors’ demands in the normal course of business and is therefore in an unsafe and unsound condition. The immediate cause of the closing was a deposit run that began and continued after the public release of a June 26 letter to the OTS and the FDIC from Senator Charles Schumer of New York. The letter expressed concerns about IndyMac’s viability. In the following 11 business days, depositors withdrew more than $1.3 billion from their accounts.

Later, in August, 51 former IndyMac employees asked California AG Jerry Brown to investigate Schumer for violations of California’s banking laws. Predictably, Brown declined. It seems possible, however, that Schumer could be prosecuted or sued under Rule 10b-5. No word at this point on whether anyone is contemplating such a move. Either way, Schumer’s antics in relation to IndyMac shed new light on the phrase, “Loose lips sink ships.”

Parenthetically, small business owners may want to note that Rule 10b-5 applies to interstate communications in relation to the purchase or sale of private and public company securities. That is, even if a company is not an SEC registrant, the SEC’s anti-fraud provisions apply. They should also keep in mind that all companies must register with the SEC unless they fall under a specific exemption from registration.