John Scott Clark of Utah is being sued by the SEC for allegedly running a Ponzi scheme with the two online payday loan companies that he owns. Image from Wikimedia Commons.

The Securities and Exchange and Commission has slapped two online payday loans lending companies owned by a single man with fraud suits. John Scott Clark, of Utah, is being sued by the SEC for allegedly running a Ponzi scheme with two online financial services companies. He has allegedly bilked more than 120 investors out of millions.

SEC slaps online lending companies with fraud suit

The owner of two companies involved in lending payday loans online has been sued by the Securities and Exchange Commission for running a multimillion-dollar Ponzi scheme. The SEC sued John Scott Clark, of Cache County, Utah, for defrauding more than 120 investors over a period of five years in return for investing capital into two businesses that he owned, Impact Cash LLC and Impact Payment Systems LLC, according to the Salt Lake Tribune. Clark allegedly recruited investors by promising an average return of 80 percent in exchange for capital, which he allegedly said would be used to fund payday loans to reliable customers. Clark was allegedly recruiting investors from March of 2006 to September 2010 and was able to secure more than $47 million from the investors he convinced to join the operation, according to the Credit Union Times.

Clark accused of funding Mercedes habit with investor funds

Clark would gain the confidence of investors and allegedly use new investment funds to pay dividends to initial investors and fund his lifestyle, according to Deseret News. Clark supposedly purchased three Mercedes-Benz cars, a 1963 Chevrolet Corvette, installed a home theater system in his home that cost $25,000 and also purchased lavish home furnishings. Some of his investors were growing suspicious by 2009 and asked Clark to sell their stake in his companies and turn the proceeds over, which he refused to do. Eventually, the SEC became involved, slapping Clark with a lawsuit alleging five different violations of the Securities Act. A Federal judge has placed both Impact companies into receivership and frozen the same day loans lending companies, according to the Wall Street Journal.

One bad apple

Online payday lenders are thought by some to be a nest of vipers. That is far from the case, but transactions that are completed fairly and honestly do not go widely reported. Still, customers and investors should be careful who they deal with in financial matters. Organizations like the Better Business Bureau exist for a reason. An informed consumer will always be in a position to make a better decision, and something that sounds too good to be true usually is.

Sources

Salt Lake Tribune

Wall Street Journal

Deseret News

Credit Union Times

The 2012 budget could possibly strip financing from financial reform regulations. Image: Flickr / MoneyBlogNewz / CC-BY

The Commodity Futures Trading Commission and Securities and Exchange Commission are supposed to be the financial police officers of the economy. The 2010 Dodd-Frank Act was meant to increase the power of these agencies to protect consumers and keep an eye on Wall Street. The funding to carry out these tasks, however, is caught in the cross hairs of the Congressional budget fight.

Policing the financial system

The 2010 Dodd-Frank Act was intended to increase oversight of the financial system to prevent another collapse. Both agencies have requested increased funding in order to carry out these new responsibilities. In 2010, the Securities and Exchange Commission received $1.1 billion in funding. For fiscal year 2012, the two agencies have requested several hundred million more in funding in order to hire more than 1,000 new staffers.

Obama’s proposed increase in funding

In the initial 2012 budget President Obama proposed, the CFTC and SEC were set to receive additional funding, mostly from fees on the trades. The $583 trillion derivatives market would end up paying $117 million in per-trade fees each year in order to fund additional oversight. The federal government would also be responsible for an additional $300 million in oversight funding to the agencies.

Comprehensive budget strips funding

Though Obama’s proposed budget fully funds both regulatory agencies, the comprehensive budget Republicans have proposed not only strips that funding, it reduces funding of the agencies further. A House panel is scheduled to hold hearings on the cost of implementing Dodd-Frank regulations on March 30, but by then the budget could be set. If the current Republican-supported comprehensive budget bill passes, the CFTC would need to reduce its staff by more than 200, and the SEC would need to cap the number of experts hired. Legislators say the fear is that “overly strict implementation” of financial regulation will harm the ongoing economic recovery.

Sources

CNN Money
Wall Street Journal
Washington Independent
Reuters

Goldman Sachs said goodbye to a few bucks this fiscal quarter. Image from Flickr.

Goldman Sachs profits fell 86 percent in the second quarter compared to the first — the richest securities firm on Wall Street took a beating. The biggest reasons for the precipitous drop in revenue, most analysts say, are a big fat SEC fine and an even fatter British bonus tax. However, historically volatile markets also hurt the bank’s earnings.

Goldman Sachs profits withstand SEC fines and British bonus taxes

Tuesday Goldman Sachs announced that the bank’s profits were $613 million in the second quarter. Those numbers are down 86 percent from the first quarter and 84 percent from the second quarter of 2009. The Los Angeles Times reports the Goldman Sachs profits announcement came just a few days after it settled a lawsuit with the Securities and Exchange Commission. In a deal during the financial crisis, the SEC accused Goldman Sachs of fraud as it made money at its clients’ expense. In the Goldman Sachs fraud case, the bank escaped having to admit to a crime, but it coughed up a $550 million fine to sweep the case under the rug. The total amount was subtracted from the bank’s earnings for the second quarter. A $600 million British bonus tax levied on Goldman Sachs for its executives working in Britain also hit the bottom line.

Goldman Sachs went wrong direction in volatile market

Bloomberg reports that Goldman Sachs lost money because it bet on stock market volatility to ease just as it was surging. To illustrate, Bloomberg used the Chicago Board Choices Exchange Volatility Index, known as the VIX. The VIX is probably the most widely used measure of stock market volatility. The VIX, which started the second quarter at 17.47, rose as high as 45.79 on May 20 before ending the quarter at 34.54. The index, which methods the cost of using opportunities as insurance against declines within the Standard and Poor’s 500 Index, has averaged 20.38 over 20 years.

Goldman Sachs nevertheless pays out billions in bonuses

Even though Goldman Sachs profits fell in the second quarter, the bank nevertheless made tons of money. The Los Angeles times article said that though Goldman Sachs has come under fire before because of its massive employee bonuses, it didn’t let up in that department. In the second quarter, the bank dedicated $ 3.8 billion, or 43 percent of total revenues, to Goldman Sachs bonuses — the exact same percentage of revenue used for bonuses during the first quarter. And even as second quarter profits plunged, the bank hired 1,000 new employees.

More details about this topic at these websites

latimes.com

bloomberg.com

dailyfinance.com

Peer-to-peer money lending is confounding the standard definitions at the SEC. Image from Flickr.

The Securities and Exchange Commission has been in an extended debate with Prosper, one of the two largest peer to peer lending businesses. A new industry, the peer to peer lending model is a Silicon Valley startup that directly connects investors with borrowers, effectively cutting banks out of the lending equation. The SEC believes that these businesses should fall under their purview of regulations. However, one of the two largest p2p lenders is fighting that ruling.

The basics of p2p lending

Peer to peer lending is a business model that is not entirely unheard of. The basic idea is that investors get the option of investing a lot or a little money directly with the borrower. Borrowers posts their information, including credit score and desired loan amount. Investors can peruse these requests, and decide exactly where they want to put their money — and they can loan as little as $25. The two largest p2p lending facilitators are both Silicon Valley startups – prosper.com and lendingclub.com. These two companies report that, on average, investors get a return of 6 to 16 percent on their investments.

The regulation question for peer to peer lenders

The Securities and Exchange commission currently regulates the lending and investing that occurs on these peer to peer lending websites. The argument the SEC uses is that these online lenders are investment firms selling bonds – and therefore fall under the purview of the SEC. One lender, Prosper, is arguing that the business is instead a lender that should fall under regulation of a different agency — ideally, the new Consumer Financial Protection Agency.

The difference between bonds and loans

A bond, usually known as a corporate bond, is a type of investment usually used by corporations and companies. A bond is basically a promise to pay a certain amount of money later in exchange for an amount of money now. A bond can be traded, exchanged, insured and generally moved around financial markets without much trouble. Because of this liquidity, a bond usually has a very low interest rate – 5 percent or lower. A loan, on the other hand, is a contract between a borrower and a lender that cannot be easily exchanged or traded. Generally, loans are “sold” by individuals to a bank, while bonds are “sold” by corporations to individuals.

Where should p2p lending be categorized?

Peer to peer lending is a difficult industry to categorize. Relatively new in the financial market, these businesses offer loans directly from one individual to another. Because of this, these loans could be seen as bonds, but they could also be viewed as standard loans. Currently, the SEC regulates both the Lending Club and Prosper, though Prosper has chafed under this regulation. The company has spent a significant amount of money on lobbying for p2p lending to be categorized and separately regulated by the possible new Consumer Financial Protection Agency. At the same time, Prosper has spent over $5 million to come into compliance with SEC regulations. Either way, this is an industry that appears to only be growing – and is worth keeping an eye on.

The SEC today announced that Goldman Sachs would be prosecuted for their part in the mortgage crisis. Image from Flickr.

This morning, the Securities and Exchange Commission brought charges up against Goldman Sachs for fraud. The SEC alleges that Goldman Sachs defrauded investors by “misstating and omitting key facts.” The SEC suit against Goldman Sachs is an outgrowth of the investigation into the collapse of the U.S. housing market, urged on by unsecured loans at all levels of the financial system.

The SEC suit against Goldman Sachs

The downfall of the housing market and much of the associated U.S. economy is the “fault” of many different entities such as Goldman Sachs. Specifically, the SEC is alleging that Goldman Sachs had a cut-and-dry conflict of interest that they lied about. Specifically, Goldman Sachs allowed a hedge fund that was making bets on mortgages to have a say in the “quality” of those mortgages. Goldman Sachs then told investors that an independent third party had verified the quality of these investments.

Goldman Sachs responds to the SEC filing

At the same time that the Securities and Exchange Commission filed its  suit against Goldman Sachs, Goldman Sachs released a response. The response was all of one sentence:

The SEC’s charges are completely unfounded in law and fact, and we will vigorously contest them and defend the firm and its reputation.

The products Goldman Sachs was selling

The basis of the SEC filing against Goldman Sachs is a product called Collatoralized Debt Obligations, or CDO. A Collateralized Debt Obligation is simply a group of mortgages. Once a homeowner gets a mortgage, the bank bundled it up with lots of other mortgages, and sold that bundle. Because the homes acted as collateral, many banks and investment firms saw these CDO products as safe investments. The idea is that payments on the mortgages would continue to come in, and the investment firm would make money. What many banks – like Goldman Sachs – did not tell investors is that these mortgages were not all good. In fact, many of these home loans were practically payday loans – given with no credit check and no certainty that the mortgage would actually be paid.

The specifics of the Goldman Sachs CDO

The debt obligation that the SEC filing against Goldman Sachs is based on is the ABACUS CDO. Goldman Sachs bundled up all these bad mortgages, known as Residential Mortgage Backed Securities, or RMBS. Goldman Sachs then asked ACA Management LLC to analyze how risky the investment might be. What Goldman Sachs did not tell ACA Management or investors was that these mortgages had been selected by a group of people who had taken out a bet that the mortgages would fail. In other words, investors bet that the mortgages would fail, then selected mortgages they knew would fail. When Goldman Sachs sold these mortgages in groups, the company didn’t tell investors that huge bets had been taken out against the mortgages. To put it simply, Goldman Sachs knew that this was a bad investment and didn’t say a thing about it.

Find out more about the Goldman Sachs inside job

A great resource to find out more about how these financial products work and how some companies made billions of dollars off the housing collapse is the This American Life episode Inside Job

Sources

Securities and Exchange Commission
MarketWatch

Think this represents the average payday loan company CEO? Think again. Profitability is hardly out of sight, even if it has allowed the industry to grow. (Photo: flickr.com)

Infinite profits earned off the backs of the infinite suffering masses. If you take your news from the multi-colored, sugar-laden toothpaste tube that is the mainstream media, then you believe that the payday loan industry is reaping massive profits while those who crawl about on their bellies are drowning in six inches of debt. It’s such an affecting image that it resides in some nether-region beyond belief. In other words, don’t buy the hype.

Payday loan companies aren’t a charitable organization, to be sure. They profit from the service they offer to consumers, but as studies like “The Profitability of Payday Loans” by Paige Skiba of Vanderbilt University Law School and Jeremy Tobacman of Oxford University indicate, the profits derived from interest are very much in line with those taken by more “traditional” lending institutions.

Short-Term Liquidity Has its Price

That’s exactly what payday loans and similar forms of short term loans provide. Their convenient immediacy (sans an extensive battery of credit and background checks) presents a certain amount of risk for lenders, so price protection is understandable. Skiba and Tobacman use financial data from the Center for Research in Security Prices (CRSP) and SEC filings, as well as loan data from several major payday loan companies.

While the most expensive payday lenders charge what amounts to over 1,000 percent APR (somewhat moot; payday lenders typically charge 12 to 20 percent for two- to four-week loans), the authors find that “lenders’ firm-level returns differ little from typical financial returns.” The implication here is that on a per-loan and per-store basis, the payday loan industry experiences high costs that bite into their “profits.”

Methodology of the Study

The authors examine the CRSP and SEC numbers for seven First we summarize publicly available, firm-level profitability data from CRSP and SEC filings. They find average returns of 10 to 25 percent each year in profit. That’s on a per-firm level.

On the individual level, it is observed that loans are generally small, yielding a meager $49 in interest on average. Yet five percent loss ratios eat up more than one quarter of that interest. Net returns (interest minus defaults) amount “in expectation over all of the marginal borrower’s loans to only about $100,” find the authors. Payday lenders, then, would appear to exist in a highly competitive environment where per-loan and per-store costs are indeed large when compared with interest earnings.

Firm-Level Profits

According to the data, payday lenders have performed well on average, earning 10.1 percent profit. Yet because returns have been volatile, the Sharpe ratio (of excess return) is close to zero. Stock data has revealed little indication of excess dividends and SEC 10-K and 10-Q show only “moderate” return on equity, find the authors. Looking at the data of the payday loan firms involved in the study and comparing their returns against those of companies in the S&P 500, the authors once again find that there is “a profile of firm-level profits that fails to approach annualized payday loan interest rates.”

It should be noted that government regulation of the payday loan industry, particularly the September 2006 Talent-Nelson Amendment cap on lending to active-duty military, have impacted firm-level large risk premiums, to the point where the FDIC even released a report (http://www.fdic.gov/regulations/safety/payday/) suggesting that the “unusual risk” accepted by payday lenders justifies the interest and suggests ways payday loan companies can effectively handle this risk.

Individual-Level Profits

How does interest as high as 7,295 percent (the highest instance in the authors’ study) per year lead to only a 10 percent equity return? The authors look at individual-level data for payday loan origination, repayment and instances of customer defaults. The authors determine a mean payday loan size of $283 and median of $269. Eighteen percent interest leads to average revenue of $49 per payday loan, but once losses are taken into account, the story changes. The authors observed that approximately nine percent of post-dated collateral checks bounce. Collections were found to be pursued internally for 60 days, during which time the lenders collected on about half.

Credit standards tell an important tale as well. The better the short term loan applicant’s credit score, the greater revenues payday lenders derive. The authors find that “the intercept of the best-fitting line at the credit score threshold is $100.49. Thus, if the industry is competitive, the total economic costs of servicing the marginal borrower equal $100.49.”

Small Money, Big Default

Returns are astronomical in theory only. Stock returns are also observed to be modest for payday lenders. Store-level costs have to play a major role in this. A 2003 study by Jerry Robinson and John Wheeler estimated 40,000 employees in the payday lending industry. Their wages totaled $1.4 billion annually. They also found that total interest revenue for payday loans totaled $4.0 to $4.3 billion in 2002, indicating that employee salaries eat up a significant portion of that (about one-third).

A 2003 study by Michael Stegman and Robert Faris found that while the 2000 per-payday loan outlet profit in North Carolina was $57,999, the capital requirements for these outlets amount to at least $35,606. This doesn’t factor in wage costs, rent, marketing or administrative expenses, but it does include bounced-check fees, screening costs and loan losses.

You begin to see how expensive it is to operate a payday loan business. Flannery and Samolyk (2005) found that store costs and their revenues are related to store age, too. Start-up costs and establishing a clientele are difficult hurdles that have led newer entrants into the payday lending market to consider the online payday loan market.

A Cash Flow Example

Skiba and Tobacman present this hypothetical. Let’s say a payday loan store has $10,000 in capital at the beginning of the year. If risk is loan default risk is eliminated from the equation and 18 percent interest is earned every two weeks, the take would be $739,500 by year’s end. If annual wages amount to $30,000 (paid out every two weeks), that bill would be a large part of the $1,800 in interest income at the beginning of the year. At that time, the store would only early six percent on its capital. The year-end result would be an annual net of 2,150 percent, which is profitable but hardly extortionary.

So Someone Thinks Payday Lenders Should Only Charge by Cost?

Critics want a flat fee for payday loans – regardless of loan size – but the truth is that so many cost variables exist such as the cost of firms to originate payday loans that per-store differences in fees charged are necessary. Considering the explosive growth within the industry (200 stores observed in 1990 according to the authors vs. 30,000 in 2004), which came in no small part due to lobbying, there is both a consumer need for the product and an environment in which they can successfully exist on the subprime market.

Pricing behavior is largely regulated by oversight organizations like the Community Financial Services Association and the Online Lenders’ Association, but businesses that exist outside these member organizations may unfortunately set rates that are far beyond what is necessary. This is where government regulation can help rein in payday loan companies with the most excessive prices (even if this group may be in the minority of the industry), but excessive regulation is not desirable. Stifling market competition and limiting consumer choice are hardly a desirable alternative.

Every once in a while, I think that perhaps I should invest in the stock market. People make a lot of money doing that, or so I’ve heard. I always shy away from going through with it, though,  because I feel like I don’t know what I’m doing.

Today is one of those days when I’m glad I haven’t tried to participate in something I don’t fully understand. I could have been one of the Sky Capital investors who got bilked out of all their money. Check out this tidbit from Courthouse News Service:

Sky Capital and the six men who run it sold millions of dollars of securities in a fraudulent boiler scheme to investors who were restricted from selling the stock, which became worthless, the Securities Exchange Commission claims in Federal Court.

Beware aggressive salespeople

Any investors who were counting on being able to sell their stock and use the money might have to turn to paycheck loans instead. This is another example of why sometimes people shouldn’t trust fast-talking salespeople. If a person tries to sell you something and seems to be withholding information, use your money somewhere else.

The SEC claims the firm’s founder, president and CEO Ross Mandell, of Boca Raton, Fla., directed Sky Capital brokers to make material misrepresentations and omissions and use high-pressure sales tactics to push stock in two related companies – Sky Capital Holdings Ltd. and Sky Capital Enterprises, says Courthouse News Service.

Give me the names

Courthouse News Service also printed the names of each person named in the Federal Court case:

Also charged are COO Stephen Shea of Brooklyn, and four former registered representatives: Robert Grabowski of Staten Island, Adam Harrington Ruckdeschel of New York City, Michael Passaro of Boca Raton, and Arn Wilson of Dix Hills, N.Y.
The SEC seeks disgorgement, penalties and injunctions.

Who can we trust?

Image by Matthew Stubstad

It’s tough nowadays to distinguish a good idea from a bad scam. Con artists have come out of the woodwork as the economy has deteriorated. Scammers promise help getting out of debt or lower mortgage payments, charge fees upfront at then make off with the cash.

There isn’t one good answer for how to avoid scams. A few simple tips, though:

• If it seems too good to be true, it probably is.
• If you’re unsure about a financial decision, don’t give in to pressure.
• Be wary of financial services that charge fees up front. Most debt consolidators don’t charge you until they have already completed their jobs, and likewise with mortgage adjusters.

Scary stock market

The only tip that would have helped those who were defrauded by Sky Capital is not to give in to pressure. If a business people or sales people really have great, legitimate deals, they won’t feel the need to pressure you into buying from them. After all, if they’ve got a great thing going, they should be able to find lots of buyers, right?

It’s a sad fact that humans will lie, cheat and steal for money, but it’s true. Be careful with your money.