Corruption in general has a deleterious effect
on the readiness of economic agents to invest. In the long run, it leads to a
paralysis of economic life. But very often it is not that economic agents
themselves have had the bad experience of being cheated and ruined, they just
know that in this country, or in this part of the economy, or this building
scene, there is a high likelihood that you will get cheated and that free riders
can get away with it. Here again, reputation is absolutely essential, which is
why transparency is so important. Trust can only be engendered by transparency.
It's no coincidence that the name of the most influential non-governmental
organization dealing with corruption is Transparency International.
A Conversation with Karl Sigmund: When Rule of Law is
Not Working
https://www.edge.org/conversation/karl_sigmund-when-the-rule-of-law-is-not-working
Bankers bet with their bank's capital, not their own. If the bet goes right,
they get a huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by
Avital Louria Hahn, "Missing: How Poor Risk-Management Techniques
Contributed to the Subprime Mess," CFO Magazine, March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Fed is going to
bail out these crooks with taxpayer funds makes it all the worse.
The bourgeoisie can be termed as any group of people
who are discontented with what they have, but satisfied with what they are
Nicolás
Dávila
This
one on the report card business schools seemed too important to pass up.
I think it relates to the points Dr.
Brazil
made in the quotation that I placed
(with permission) in http://faculty.trinity.edu/rjensen/book05q1.htm#020805
(You have to scroll down some distance to find the
Brazil
quotation.)
Today's Bourgeoisie
Education molds not just individuals but also common assumptions and
conventional wisdom. And when it comes to the business world, our
universities - and especially their graduate business schools - are
powerful shapers of the culture.
History suggests it was
always this way. Even Isaac Newton, of gravity fame but who also held the
position of master of the mint, lost money in the South Sea Bubble. He got out,
thinking it was a bubble, then got back in when it kept going up. He lost a
small fortune in the process when it finally collapsed. Human greed, coupled
with hubris, hasn't changed in the four centuries for which we have some sense
of economic history.
Lawrence B. Lindsey, "Loosen Deposit
Insurance Rules To Prevent a Bank Run," The Wall Street Journal,
September 17, 2008 ---
http://online.wsj.com/article/SB122161066927045759.html?mod=djemEditorialPage
Jensen Comment
You can read about the South Sea Bubble in 1720 at
http://en.wikipedia.org/wiki/South_Sea_bubble
The South Sea Company was selling shares in itself and calling it income.
Mortgage Backed Securities are like boxes
of chocolates. Criminals on Wall Street and one particular U.S. Congressional
Committee stole a few chocolates from the boxes and replaced them with turds.
Their criminal buddies at Standard & Poors rated these boxes AAA Investment Grade
chocolates. These boxes were then sold all over the world to investors.
Eventually somebody bites into a turd and discovers the crime. Suddenly nobody
trusts American chocolates anymore worldwide. Hank Paulson now wants the
American taxpayers to buy up and hold all these boxes of turd-infested
chocolates for $700 billion dollars until the market for turds returns to
normal. Meanwhile, Hank's buddies, the Wall Street criminals who stole all the
good chocolates are not being investigated, arrested, or indicted. Momma always
said: '"Sniff the chocolates first Forrest." Things generally don't pass the
smell test if they came from Wall Street or from Washington DC.
Forrest Gump as quoted at
http://newsgroups.derkeiler.com/Archive/Rec/rec.sport.tennis/2008-10/msg02206.html
Forrest Gump's Momma
The Sleazy Subprime Mortgage Lending Companies Have a New (actually
renewed old) Scheme to Make Billions at Taxpayer Expense
As if they haven't done enough damage. Thousands of
subprime mortgage lenders and brokers—many of them the very sorts of firms that
helped create the current financial crisis—are going strong. Their new strategy:
taking advantage of a long-standing federal program designed to encourage
homeownership by insuring mortgages for buyers of modest means. You read that
correctly. Some of the same people who propelled us toward the housing market
calamity are now seeking to profit by exploiting billions in federally insured
mortgages. Washington, meanwhile, has vastly expanded the availability of such
taxpayer-backed loans as part of the emergency campaign to rescue the country's
swooning economy.
Chad Terhune and Robert Berner,
"FHA-Backed Loans: The New Subprime The same people whose reckless practices
triggered the global financial crisis are onto a similar scheme that could cost
taxpayers tons more," Business Week, November 19, 2008 ---
http://www.businessweek.com/magazine/content/08_48/b4110036448352.htm?link_position=link2
Jensen Comment
That's right. The greedy slime balls "Borne of Sleaze, Bribery, and Lies" are
resurfacing with Barney Frank's blessing ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
"Financial Reversals: Everything bad is good
again," by Jacob Sullum, Reason Magazine, November 19,
2008 ---
http://www.reason.com/news/show/130142.html
"Proposed new Bailout Plan," by Andreas Hippin, Bloomberg,
November 20, 2008 ---
http://www.wallstreetoasis.com/forums/proposed-new-bailout-plan
The Somali pirates, renegade Somalis known for
hijacking ships for ransom in the Gulf of Aden, are negotiating a purchase
of Citigroup.
The pirates would buy Citigroup with new debt and
their existing cash stockpiles, earned most recently from hijacking numerous
ships, including most recently a $200 million Saudi Arabian oil tanker. The
Somali pirates are offering up to $0.10 per share for Citigroup, pirate
spokesman Sugule Ali said earlier today. The negotiations have entered the
final stage, Ali said. ``You may not like our price, but we are not in the
business of paying for things. Be happy we are in the mood to offer the
shareholders anything," said Ali.
The pirates will finance part of the purchase by
selling new Pirate Ransom Backed Securities. The PRBS's are backed by the
cash flows from future ransom payments from hijackings in the Gulf of Aden.
Moody's and S&P have already issued their top
investment grade ratings for the PRBS's.
Head pirate, Ubu Kalid Shandu, said "we need a bank
so that we have a place to keep all of our ransom money. Thankfully, the
dislocations in the capital markets has allowed us to purchase Citigroup at
an attractive valuation and to take advantage of TARP capital to grow the
business even faster." Shandu added, "We don't call ourselves pirates. We
are coastguards and this will just allow us to guard our coasts better."
"New Michael Lewis Book on Financial World Will Be Published in March,"
by Julie Bosmanian, New York Times, January 14, 2014 ---
http://www.nytimes.com/2014/01/15/business/media/new-michael-lewis-book-on-financial-world-will-be-published-in-march.html?partner=socialflow&smid=tw-nytimesbusiness&_r=0
Michael Lewis, whose colorful reporting on
money and excess on Wall Street has made him one of the country’s most
popular business journalists, has written a new book on the financial world,
his publisher said on Tuesday.
The book, titled “Flash Boys,” will be released by
W.W. Norton & Company on March 31. A spokeswoman for Norton said the new
book “is squarely in the realm of Wall Street.”
Starling Lawrence, Mr. Lewis’s editor, said in a
statement: “Michael is brilliant at finding the perfect narrative line for
any subject. That’s what makes his books, no matter the topic, so indelibly
memorable.”
Mr. Lewis is the author of “Moneyball,” “Liar’s
Poker” and “The Big Short.”
Jensen Comment
His books are both humorous and well-researched.
Absolutely Must-See CBS Sixty Minutes Videos
You, your students, and the world in general really should repeatedly study the
following videos until they become perfectly clear!
Two of them are best watched after a bit of homework.
Video 1
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Then Watch Video 1 at
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals) ---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March 14. Both videos feature one of
my favorite authors of all time, Michael Lewis, who hhs been writing (humorously
with tongue in cheek) about Wall Street scandals since he was a bond salesman on
Wall Street in the 1980s. The other person featured on in these videos is a
one-eyed physician with Asperger Syndrome who made hundreds of millions of
dollars anticipating the collapse of the CDO markets while the shareholders of
companies like Merrill Lynch, AIG, Lehman Bros., and Bear Stearns got left
holding the empty bags.
"The End," by Michael Lewis December 2008 Issue The era that
defined Wall Street is finally, officially over. Michael Lewis, who chronicled
its excess in Liar’s Poker, returns to his old haunt to figure out what went
wrong.
http://faculty.trinity.edu/rjensen/2008Bailout.htm#TheEnd
Liars Poker II is called "The End"
The Not-Funny Punch Line is Not Until Page 9 of This Tongue in Cheek
Explanation of the Meltdown on Wall Street!
Now I asked
Gutfreund about his biggest decision. “Yes,” he said. “They—the
heads of the other Wall Street firms—all said what an awful thing it was
to go public (beg for a government
bailout) and how could you do such a
thing. But when the temptation arose, they all gave in to it.” He agreed
that the main effect of turning a partnership into a corporation was to
transfer the financial risk to the shareholders. “When things go wrong,
it’s their problem,” he said—and obviously not theirs alone. When a Wall
Street investment bank screwed up badly enough, its risks became the
problem of the U.S. government. “It’s laissez-faire until you get in
deep shit,” he said, with a half chuckle. He was out of the game.
This is a must read to understand what went wrong on Wall Street ---
especially the punch line!
"The End," by Michael Lewis December 2008 Issue The era that defined Wall
Street is finally, officially over. Michael Lewis, who chronicled its excess
in Liar’s Poker, returns to his old haunt to figure out what went wrong.
http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?tid=true
To this day, the willingness of a Wall Street
investment bank to pay me hundreds of thousands of dollars to dispense
investment advice to grownups remains a mystery to me. I was 24 years
old, with no experience of, or particular interest in, guessing which
stocks and bonds would rise and which would fall. The essential function
of Wall Street is to allocate capital—to decide who should get it and
who should not. Believe me when I tell you that I hadn’t the first clue.
I’d never taken an accounting course, never run
a business, never even had savings of my own to manage. I stumbled into
a job at Salomon Brothers in 1985 and stumbled out much richer three
years later, and even though I wrote a book about the experience, the
whole thing still strikes me as preposterous—which is one of the reasons
the money was so easy to walk away from. I figured the situation was
unsustainable. Sooner rather than later, someone was going to identify
me, along with a lot of people more or less like me, as a fraud. Sooner
rather than later, there would come a Great Reckoning when Wall Street
would wake up and hundreds if not thousands of young people like me, who
had no business making huge bets with other people’s money, would be
expelled from finance.
When I sat down to write my account of the
experience in 1989—Liar’s Poker, it was called—it was in the spirit of a
young man who thought he was getting out while the getting was good. I
was merely scribbling down a message on my way out and stuffing it into
a bottle for those who would pass through these parts in the far distant
future.
Unless some insider got all of this down on
paper, I figured, no future human would believe that it happened.
I thought I was writing a period piece about
the 1980s in America. Not for a moment did I suspect that the financial
1980s would last two full decades longer or that the difference in
degree between Wall Street and ordinary life would swell into a
difference in kind. I expected readers of the future to be outraged that
back in 1986, the C.E.O. of Salomon Brothers, John Gutfreund, was paid
$3.1 million; I expected them to gape in horror when I reported that one
of our traders, Howie Rubin, had moved to Merrill Lynch, where he lost
$250 million; I assumed they’d be shocked to learn that a Wall Street
C.E.O. had only the vaguest idea of the risks his traders were running.
What I didn’t expect was that any future reader would look on my
experience and say, “How quaint.”
I had no great agenda, apart from telling what
I took to be a remarkable tale, but if you got a few drinks in me and
then asked what effect I thought my book would have on the world, I
might have said something like, “I hope that college students trying to
figure out what to do with their lives will read it and decide that it’s
silly to phony it up and abandon their passions to become financiers.” I
hoped that some bright kid at, say, Ohio State University who really
wanted to be an oceanographer would read my book, spurn the offer from
Morgan Stanley, and set out to sea.
Somehow that message failed to come across. Six
months after Liar’s Poker was published, I was knee-deep in letters from
students at Ohio State who wanted to know if I had any other secrets to
share about Wall Street. They’d read my book as a how-to manual.
In the two decades since then, I had been
waiting for the end of Wall Street. The outrageous bonuses, the slender
returns to shareholders, the never-ending scandals, the bursting of the
internet bubble, the crisis following the collapse of Long-Term Capital
Management: Over and over again, the big Wall Street investment banks
would be, in some narrow way, discredited. Yet they just kept on
growing, along with the sums of money that they doled out to
26-year-olds to perform tasks of no obvious social utility. The
rebellion by American youth against the money culture never happened.
Why bother to overturn your parents’ world when you can buy it, slice it
up into tranches, and sell off the pieces?
At some point, I gave up waiting for the end.
There was no scandal or reversal, I assumed, that could sink the system.
The New Order The crash did more than wipe out
money. It also reordered the power on Wall Street. What a Swell Party A
pictorial timeline of some Wall Street highs and lows from 1985 to 2007.
Worst of Times Most economists predict a recovery late next year. Don’t
bet on it. Then came Meredith Whitney with news. Whitney was an obscure
analyst of financial firms for Oppenheimer Securities who, on October
31, 2007, ceased to be obscure. On that day, she predicted that
Citigroup had so mismanaged its affairs that it would need to slash its
dividend or go bust. It’s never entirely clear on any given day what
causes what in the stock market, but it was pretty obvious that on
October 31, Meredith Whitney caused the market in financial stocks to
crash. By the end of the trading day, a woman whom basically no one had
ever heard of had shaved $369 billion off the value of financial firms
in the market. Four days later, Citigroup’s C.E.O., Chuck Prince,
resigned. In January, Citigroup slashed its dividend.
From that moment, Whitney became E.F. Hutton:
When she spoke, people listened. Her message was clear. If you want to
know what these Wall Street firms are really worth, take a hard look at
the crappy assets they bought with huge sums of borrowed money, and
imagine what they’d fetch in a fire sale. The vast assemblages of highly
paid people inside the firms were essentially worth nothing. For better
than a year now, Whitney has responded to the claims by bankers and
brokers that they had put their problems behind them with this
write-down or that capital raise with a claim of her own: You’re wrong.
You’re still not facing up to how badly you have mismanaged your
business.
Rivals accused Whitney of being overrated;
bloggers accused her of being lucky. What she was, mainly, was right.
But it’s true that she was, in part, guessing. There was no way she
could have known what was going to happen to these Wall Street firms.
The C.E.O.’s themselves didn’t know.
Now, obviously, Meredith Whitney didn’t sink
Wall Street. She just expressed most clearly and loudly a view that was,
in retrospect, far more seditious to the financial order than, say,
Eliot Spitzer’s campaign against Wall Street corruption. If mere scandal
could have destroyed the big Wall Street investment banks, they’d have
vanished long ago. This woman wasn’t saying that Wall Street bankers
were corrupt. She was saying they were stupid. These people whose job it
was to allocate capital apparently didn’t even know how to manage their
own.
At some point, I could no longer contain
myself: I called Whitney. This was back in March, when Wall Street’s
fate still hung in the balance. I thought, If she’s right, then this
really could be the end of Wall Street as we’ve known it. I was curious
to see if she made sense but also to know where this young woman who was
crashing the stock market with her every utterance had come from.
It turned out that she made a great deal of
sense and that she’d arrived on Wall Street in 1993, from the Brown
University history department. “I got to New York, and I didn’t even
know research existed,” she says. She’d wound up at Oppenheimer and had
the most incredible piece of luck: to be trained by a man who helped her
establish not merely a career but a worldview. His name, she says, was
Steve Eisman.
Eisman had moved on, but they kept in touch.
“After I made the Citi call,” she says, “one of the best things that
happened was when Steve called and told me how proud he was of me.”
Having never heard of Eisman, I didn’t think
anything of this. But a few months later, I called Whitney again and
asked her, as I was asking others, whom she knew who had anticipated the
cataclysm and set themselves up to make a fortune from it. There’s a
long list of people who now say they saw it coming all along but a far
shorter one of people who actually did. Of those, even fewer had the
nerve to bet on their vision. It’s not easy to stand apart from mass
hysteria—to believe that most of what’s in the financial news is wrong
or distorted, to believe that most important financial people are either
lying or deluded—without actually being insane. A handful of people had
been inside the black box, understood how it worked, and bet on it
blowing up. Whitney rattled off a list with a half-dozen names on it. At
the top was Steve Eisman.
Steve Eisman entered finance about the time I
exited it. He’d grown up in New York City and gone to a Jewish day
school, the University of Pennsylvania, and Harvard Law School. In 1991,
he was a 30-year-old corporate lawyer. “I hated it,” he says. “I hated
being a lawyer. My parents worked as brokers at Oppenheimer. They
managed to finagle me a job. It’s not pretty, but that’s what happened.”
He was hired as a junior equity analyst, a
helpmate who didn’t actually offer his opinions. That changed in
December 1991, less than a year into his new job, when a subprime
mortgage lender called Ames Financial went public and no one at
Oppenheimer particularly cared to express an opinion about it. One of
Oppenheimer’s investment bankers stomped around the research department
looking for anyone who knew anything about the mortgage business.
Recalls Eisman: “I’m a junior analyst and just trying to figure out
which end is up, but I told him that as a lawyer I’d worked on a deal
for the Money Store.” He was promptly appointed the lead analyst for
Ames Financial. “What I didn’t tell him was that my job had been to
proofread the documents and that I hadn’t understood a word of the
fucking things.”
Ames Financial belonged to a category of firms
known as nonbank financial institutions. The category didn’t include
J.P. Morgan, but it did encompass many little-known companies that one
way or another were involved in the early-1990s boom in subprime
mortgage lending—the lower class of American finance.
The second company for which Eisman was given
sole responsibility was Lomas Financial, which had just emerged from
bankruptcy. “I put a sell rating on the thing because it was a piece of
shit,” Eisman says. “I didn’t know that you weren’t supposed to put a
sell rating on companies. I thought there were three boxes—buy, hold,
sell—and you could pick the one you thought you should.” He was
pressured generally to be a bit more upbeat, but upbeat wasn’t Steve
Eisman’s style. Upbeat and Eisman didn’t occupy the same planet. A hedge
fund manager who counts Eisman as a friend set out to explain him to me
but quit a minute into it. After describing how Eisman exposed various
important people as either liars or idiots, the hedge fund manager
started to laugh. “He’s sort of a prick in a way, but he’s smart and
honest and fearless.”
“A lot of people don’t get Steve,” Whitney
says. “But the people who get him love him.” Eisman stuck to his sell
rating on Lomas Financial, even after the company announced that
investors needn’t worry about its financial condition, as it had hedged
its market risk. “The single greatest line I ever wrote as an analyst,”
says Eisman, “was after Lomas said they were hedged.” He recited the
line from memory: “ ‘The Lomas Financial Corp. is a perfectly hedged
financial institution: It loses money in every conceivable interest-rate
environment.’ I enjoyed writing that sentence more than any sentence I
ever wrote.” A few months after he’d delivered that line in his report,
Lomas Financial returned to bankruptcy.
Continued in article
Michael Lewis, Liar's Poker: Playing the Money Markets (Coronet, 1999,
ISBN 0340767006)
Lewis writes in Partnoy’s earlier whistleblower
style with somewhat more intense and comic portrayals of the major
players in describing the double dealing and break down of integrity on
the trading floor of Salomon Brothers.
Reply from Tom Hood
Thanks Bob for the Michael Lewis article, “The End” – great explanation of
the mess we a re in and how we got here. Just found this one that does a
great job of summarizing the mess – visually
http://flowingdata.com/2008/11/25/visual-guide-to-the-financial-crisis/
Tom Hood, CPA.CITP, CEO & Executive Director, Maryland Association of CPAs
443-632-2301,
http://www.macpa.org
Check out our blogs for CPAs
http://www.cpasuvvess.com
http://www.newcpas.com
http://www.cpaisland.com
Financial WMDs (Credit Derivatives) on Sixty Minutes (CBS) on August 30,
2009 ---
http://www.cbsnews.com/video/watch/?id=5274961n&tag=contentBody;housing
The free download will only be available for a short while. I downloaded this
video (a little over 5 Mbs) using a free updated version of RealMedia ---
Click Here
http://www.real.com/dmm/superpass?pcode=cj&ocode=cj&cpath=aff&rsrc=1275588_10303897_SPLP
Steve Kroft examines the complicated financial instruments known as credit
default swaps and the central role they are playing in the unfolding economic
crisis. The interview features my hero Frank Partnoy. I don't know of
anybody who knows derivative securities contracts and frauds better than Frank
Partnoy, who once sold these derivatives in bucket shops. You can find links to
Partnoy's books and many, many quotations at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
For years I've used the term "bucket shop" in financial securities marketing
without realizing that the first bucket shops in the early 20th Century were
bought and sold only gambles on stock pricing moves, not the selling of any
financial securities. The analogy of a bucket shop would be a room full of
bookies selling bets on NFL playoff games.
See "Bucket Shop" at
http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)
Fraud and incompetence among credit rating
agencies ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
The New York Stock Exchange's report on the pay package given to its
former chairman, Dick Grasso, made clear the excessiveness of the
compensation and the ineffectiveness of the safety controls that
failed to stop it. What the report didn't provide, however, was an
answer to an obvious question: Why did nobody on the exchange's board
look at that astronomical sum and feel some personal responsibility to
find out what was happening? I can't read minds, but I think
it's fair to say that to some extent the players in this drama - as
well as those in the ones now being played out in courtrooms and
starring former executives of Tyco, WorldCom and HealthSouth - have
been shaped by the broader business culture they have worked in for so
long. And, as with any situation in which we are puzzled by how a
group of people can think in a seemingly odd way, it helps to look
back to how they were educated. Education
molds not just individuals but also common assumptions and
conventional wisdom. And when it comes to the business world, our
universities - and especially their graduate business schools - are
powerful shapers of the culture.
Robert J. Shiller, "How Wall Street Learns to Look the
Other Way," The New York Times, February 8, 2005 --- http://www.nytimes.com/2005/02/08/opinion/08shiller.html
Ending a bitter public
fight over whether former New York Stock Exchange Chief Executive Dick Grasso
was paid too much, a state appeals court ruled that Mr. Grasso can keep every
penny collected from his $187.5 million multiyear compensation package. The
3-to-1 ruling by the Appellate Division of the New York State Supreme Court was
a vindication for the relentless Mr. Grasso, who was ousted after details of his
lucrative pay were revealed in 2003.
Aaron Lucchetti, "Grasso Wins Court Fight, Can Keep NYSE Pay," The Wall
Street Journal, July 2, 2008; Page A1 ---
http://online.wsj.com/article/SB121492781324819635.html?mod=todays_us_page_one
Clinton's famously crude remark
And I hope that comes through in the book (Infectious
Greed). I am very critical of the tax law
changes that created the incentives for companies to pay executives with stock
options, which were made at the beginning of the Clinton Administration to
appease populist anti-corporation forces among his supporters by appearing to do
something about what, even then, was alleged to be excessive pay for corporate
executives. Not to mention his Administration's hands-off approach to Wall
Street (when Arthur Levitt headed the SEC).
There's that great story --- perhaps apocoryphal --- that I recount in the book
about Clinton's famously crude remark when he discovered that voters cared much
more about whether the stocks were going up than his economic program.
Frank Partnoy, Partnoy's Solutions, welling@weeden, October 21, 2005
Symptoms include "excessive and sometimes fraudulent risks
Add to the growing number of recently diagnosed
diseases in America the Icarus Syndrome. This malady, discovered by a law
professor, is said to affect corporations in particular. The symptoms include
"excessive and sometimes fraudulent risks." The disease has attacked
corporate America not only in our own scandal-plagued times but, it seems, since
about 1873. Icarus in the Boardroom (Oxford University Press, 250
pages, $25) is an attempt to alert public-health officials, so to speak, to the
dangers of this contagion. David Skeel, a professor of law at the University of
Pennsylvania, labels all sorts of apparently admirable traits --
"self-confidence, visionary insight, the ability to think outside the
box" -- as potential Icaran qualities, full of danger. They "may spur
entrepreneurs to take misguided risks," he writes, "in the belief that
everything they touch will eventually turn to gold." Fortunately, he offers
a number of cures, ranging from small doses of regulation to massive doses of
regulation. And little wonder. What is most interesting about "Icarus
in the Boardroom" is the vast divide it reveals -- between American lawyers
who study corporations and, well, everybody else. Following common sense and
economic logic, most people view corporate risk-taking and corporate fraud as
different things: Fraud involves lying; risk-taking does not. As in the case of
Enron and WorldCom, fraudulent executives often misstate how much risk their
investors will assume. For academic lawyers such as Mr. Skeel, however, it
seems that risk-taking and fraud are points on a continuum. Risk-taking quickly
fades into "excessive" risk-taking, which then morphs into fraud. Mr.
Skeel never says just how we are to distinguish acceptable risks from the
excessive and fraudulent kind. Apparently, though, lawmakers and regulators will
figure out a formula, for it falls to them, in Mr. Skeel's view, "to
prevent risk-taking that edges toward market manipulation or fraud."
Jonathan R. Macey, "A Risky Proposition," The Wall Street Journal,
March 15, 2005; Page D8 --- http://online.wsj.com/article/0,,SB111083993718979142,00.html?mod=todays_us_personal_journal
That some bankers have ended
up in prison is not a matter of scandal, but what is outrageous is the
fact that all the others are free.
Honoré
de Balzac
Two months ago, shortly before Japan
ordered Citigroup to close its private banking unit there for, among
other things, failing to guard against money laundering, Charles O.
Prince, the chief executive, commissioned an independent examination
of his bank's lapses. When he received the assessment in mid-October,
he got an eyeful.
"It's Cleanup Time at Citi," by Timothy L. O'Brien and
Landon Thomas, Jr., The New York Times, November 7, 2004 --- http://www.nytimes.com/2004/11/07/business/yourmoney/07citi.html
The Sleazy Subprime Mortgage Lending Companies Have a New (actually
renewed old) Scheme to Make Billions at Taxpayer Expense
As if they haven't done enough damage. Thousands of
subprime mortgage lenders and brokers—many of them the very sorts of firms that
helped create the current financial crisis—are going strong. Their new strategy:
taking advantage of a long-standing federal program designed to encourage
homeownership by insuring mortgages for buyers of modest means. You read that
correctly. Some of the same people who propelled us toward the housing market
calamity are now seeking to profit by exploiting billions in federally insured
mortgages. Washington, meanwhile, has vastly expanded the availability of such
taxpayer-backed loans as part of the emergency campaign to rescue the country's
swooning economy.
Chad Terhune and Robert Berner,
"FHA-Backed Loans: The New Subprime The same people whose reckless practices
triggered the global financial crisis are onto a similar scheme that could cost
taxpayers tons more," Business Week, November 19, 2008 ---
http://www.businessweek.com/magazine/content/08_48/b4110036448352.htm?link_position=link2
Jensen Comment
That's right. The greedy slime balls "Borne of Sleaze, Bribery, and Lies" are
resurfacing with Barney Frank's blessing ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
"Financial Reversals: Everything bad is good
again," by Jacob Sullum, Reason Magazine, November 19,
2008 ---
http://www.reason.com/news/show/130142.html
"Proposed new Bailout Plan," by Andreas Hippin, Bloomberg,
November 20, 2008 ---
http://www.wallstreetoasis.com/forums/proposed-new-bailout-plan
The Somali pirates, renegade Somalis known for
hijacking ships for ransom in the Gulf of Aden, are negotiating a purchase
of Citigroup.
The pirates would buy Citigroup with new debt and
their existing cash stockpiles, earned most recently from hijacking numerous
ships, including most recently a $200 million Saudi Arabian oil tanker. The
Somali pirates are offering up to $0.10 per share for Citigroup, pirate
spokesman Sugule Ali said earlier today. The negotiations have entered the
final stage, Ali said. ``You may not like our price, but we are not in the
business of paying for things. Be happy we are in the mood to offer the
shareholders anything," said Ali.
The pirates will finance part of the purchase by
selling new Pirate Ransom Backed Securities. The PRBS's are backed by the
cash flows from future ransom payments from hijackings in the Gulf of Aden.
Moody's and S&P have already issued their top
investment grade ratings for the PRBS's.
Head pirate, Ubu Kalid Shandu, said "we need a bank
so that we have a place to keep all of our ransom money. Thankfully, the
dislocations in the capital markets has allowed us to purchase Citigroup at
an attractive valuation and to take advantage of TARP capital to grow the
business even faster." Shandu added, "We don't call ourselves pirates. We
are coastguards and this will just allow us to guard our coasts better."
I'm suspicious that Andreas Hippin, in the above tidbit, was inspired by "The
End" by Michael Lewis
"The End," by Michael Lewis December 2008 Issue The era that defined Wall Street
is finally, officially over. Michael Lewis, who chronicled its excess in Liar’s
Poker, returns to his old haunt to figure out what went wrong.
http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?tid=true
Also see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#TheEnd
From the Financial Clippings Blog on October 22, 2008 ---
http://financeclippings.blogspot.com/
I
wrote earlier
that credit rating agencies seem to be run like protection rackets..
from
CNBC
In a hearing today before the House Oversight
Committee, the credit rating agencies are being portrayed as
profit-hungry institutions that would give any deal their blessing for
the right price.
Case in point: this instant message exchange between two unidentified
Standard & Poor's officials about a mortgage-backed security deal on
4/5/2007:
Official #1: Btw (by the way) that deal is ridiculous.
Official #2: I know right...model def (definitely) does not capture half
the risk.
Official #1: We should not be rating it.
Official #2: We rate every deal. It could be structured by cows and we
would rate it.
A former executive of Moody's says
conflicts of interest got in the way of rating agencies properly valuing
mortgage backed securities.
Former Managing Director Jerome Fons, who worked at Moody's until August
of 2007, says Moody's was focused on "maxmizing revenues," leading it to
make the firm more "issuer friendly."
Fraud and incompetence among credit rating
agencies ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
In the years after Enron, many chief
executives had been operating in a defensive crouch. Last year,
however, they switched to offense, yelping about the new securities
rules — way too strict and so time-consuming — and whining that
Eliot Spitzer and his meddlesome investigations could wreck the nation’s
economy. The United States Chamber of Commerce even sued the
Securities and Exchange Commission, hoping to overturn its new rule
requiring mutual fund chairmen to be independent. So as 2005
dawns, it is again time to grant the Augustus Melmotte Memorial
Prizes, named for the charlatan who parades through “The Way We Live
Now,” the novel by Anthony Trollope. Mr. Melmotte, who would fit
just fine into today’s business world, is a confidence man who takes
London by storm in the late 1800’s.
Gretchen Morgensen, "The Envelopes, Please," The New York
Times, January 1, 2005 --- http://www.nytimes.com/2005/01/01/business/yourmoney/02award.backup.html?oref=login
Bob Jensen's threads on corporate governance are at http://faculty.trinity.edu/rjensen/fraud001.htm#Governance
Who's Preying on Your Grandparents?
Back in February, Jose and Gloria Aquino
received a flier in the mail inviting them to a free seminar on one
of their favorite topics: protecting their financial assets. As
retirees, they were always on the lookout for safe investment
strategies as well as tips on how to make sure they didn't outlive
their savings. Besides, the flier promised a free lunch for anyone
attending the workshop, so what did they have to lose? Potentially
plenty, they would soon discover.
Gretchen Morgenson, "Who's Preying on Your Grandparents?" The New
York Times, May 15, 2005 ---
http://www.nytimes.com/2005/05/15/business/yourmoney/15vict.html?
Dilbert Cartoons on Market Manipulations
"Scott Adams Discovers Market Manipulation," by Barry Ritholtz, Ritholtz
Blog, March 2013 ---
http://www.ritholtz.com/blog/2013/03/scott-adams-manipulators/
Regular readers know I
am a fan of Scott Adams, creator of the comic
Dilbert
and occasional commentator on a variety of matters.
He has a somewhat odd
blog post up, titled,
Here Come the Market Manipulators. In it, he
makes two interesting suggestions: The first is to decry “market
manipulators,” who do what they do for fun and profit to the detriment of
the rest of us. The second is to say that these manipulators are likely to
cause “a 20% correction in 2013.”
Let’s quickly address
both of these issues: First off, have a look at the frequency of 20%
corrections in markets. According to
Fidelity (citing
research from Capital Research and Management Company), over the period
encompassing 1900-2010, has seen the following corrections occur:
Corrections During 1900 – 2010
5%: 3 times per year
10%: Once per year
20%: Once every 3.5
years
Note that Fido does not
specify which market, but given the dates we can assume it is the Dow
Industrials. (I’ll check on that later).
Note that US market’s have
not had a 20% correction since the lows in March 2009. I’ll pull up the
relevant data in the office, but a prior corrective action of 19% is the
closest we’ve come, followed by a ~16% and ~11%.
As to the manipulators of
the market, I can only say: Dude, where have you been the past 100 years
or so?
Yes, the market gets
manipulated. Whether its tax cuts or interest rate cuts or federal spending
or wars or QE or legislative rule changes to FASB or even the creation of
IRAs and 401ks, manipulation abounds.
In terms of the larger
investors who attract followers — I do not see the same evidence that Adams
sees. Sure, the market is often driven by large investors. Yes, many of
these people have others who follow them. We need only look at what Buffet,
Soros, Dalio, Icahn, Ackman, Einhorn and others have done to see widely
imitated stock trades. But that has shown itself to be a
bad idea, and I doubt anyone is making
much money attempting to do so. And, it hardly leads to the conclusion that
any more than the usual manipulation is going on.
Will be have a 20%
correction? I guarantee that eventually, we will. Indeed, we are even
overdue for it, postponed as it is by the Fed’s manipulation.
But I have strong
doubts it is going to be caused by a cabal manipulating markets for fun &
profit. It will occur because
that’s what markets do . . .
Previously:
Dilbert’s Unified Theory of Everything Financial’ (October 15th, 2006)
7 Suggestions for Scott Adams (November 27th, 2007)
Don’t Follow Wealthy Investors, Part 14 (February 17th, 2008)
"What’s Wrong with the Financial Services Industry?" by Barry Ritholtz,
Ritholtz Blog, February 21, 2013 ---
http://www.ritholtz.com/blog/2013/02/whats-wrong-with-the-financial-services-industry/
Jensen Comment
You can also see a Dilbert cartoon about making up data ---
http://faculty.trinity.edu/rjensen/Theory01.htm
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
How the Gatekeepers Failed in Their Responsibilities
to Protect the Public from Corporate and Banking Fraud
Brooksley Born, chair of the Commodity
Futures Trading Commission --- suggested that government should at
least study whether some regulation might make sense, a stampede of
lobbyists, members of Congress, and other regulators --- including
Alan Greenspan and Robert Rubin --- ran her over, admonishing her to
keep quiet. Derivatives tightened the connections among various
markets, creating enormous financial benefits and making global
transacting less costly --- no one denied that. But they also
raised the prospect of a system-wide breakdown. With each
crisis, a few more dominos fell, and regulators and market
participants increasingly expressed concerns about systematic risk ---
a term that described a financial-market epidemic. After
Long-Term Capital collapsed, even Alan Greenspan admitted that the
financial markets had been close to the brink.
Frank Partnoy, Infectious Greed (Henry Holt and Company, 2004,
Page 229)
Throughout 1994 and 1995, Brickell (the
banking industry's pit bull in Washington) and Levitt (Head of the
SEC) worked to protect the finance industry from new
legislation. In early 1994, lobbyists waited for investors to
calm down from the shock of how much money-fund managers and corporate
treasures had lost gambling on interest rates. When legislation
was introduced, Brickell fought it and Levitt gave speeches saying the
financial industry should police itself. The issues were
complicated, and the public --- once angered by the various scandals
--- ultimately lost interest. Instead of new derivatives
regulation, Congress, various federal agencies, and even the Supreme
Court created new legal rules that insulated Wall Street from
liability and enabled financial firms to regulate
themselves. Under the influence of Levitt and Brickell,
regulators essentially left the abuses of the 1990s to what Justice
Cardozo had called the "morals of the market place."
Frank Partnoy, Infectious Greed (Henry Holt and
Company, 2004, Page 143)
In God, but not our financial advisor, we
trust!
Declining trust has spurred some 25% of the affluent investors
surveyed to move a portion of their assets out of their
financial-services firms in the past two years, according to a study
by Spectrem Group, a Chicago research and consulting firm. A litany of
complaints, including poor investment performance, conflicts of
interest, hidden fees and financial scandals, prompted wealthy
investors to move their business elsewhere.
Rachel Emma Silverman, "Wealthy Lose Trust in
Advisers," The Wall Street Journal, February 2, 2005, Page
D2 --- http://online.wsj.com/article/0,,SB110730662305243216,00.html?mod=todays_us_personal_journal
One of the world's most widely known and
respected economists, Henry Kaufman is almost single-handedly
responsible for founding the spectator sport known as "Fed
watching." He began a 26-year career at Salomon Brothers in 1962,
when he was probably the only Wall Street employee with a doctorate.
There he built one of the most prestigious securities research
departments and became a senior partner and vice chairman. In the last
30 years, he has been one of the most vocal critics of insufficient
financial oversight and regulation, and his pronouncements and
prognostications have often moved markets. We interviewed Dr. Kaufman
in his New York office, where he heads his own international economic
consulting firm.
Wall Street Wisdom ---
http://www.amazon.com/exec/obidos/tg/feature/-/41979/102-2649781-5248131
Question
What is the SEC's new NMS?
In the best possible marketplace, all buyers see
the prices asked by all sellers and all sellers see the prices offered by all
buyers -- and little guys are treated the same as big ones. The result:
competition that insures the most efficient interplay of supply and demand. In
theory, it sounds great. And indeed, this is the idea behind the Security and
Exchange Commission's push for an integrated stock market called the National
Market System, or NMS. But could the best intentions backfire? Wharton finance
professor Marshall E. Blume answers that question in a new research paper
titled, "Competition and Fragmentation in the Equity Markets: The Effect of
Regulation NMS."
"Will the SEC's National Market System Stifle the Innovation It Hopes to
Promote?" Wharton Business School at the University of Pennsylvania,
Knowledge@Wharton, April 4, 2007 ---
Click Here
"Psychology Of Fraud: Why Good People Do Bad
Things (with cartoons)," by Chana Joffe-Walt and Alix Spiegel, NPR, May
1, 2012 ---
http://www.npr.org/2012/05/01/151764534/psychology-of-fraud-why-good-people-do-bad-things
Thank you Jim McKinney for the heads up.
Jensen Comment
This was a very good broadcast. I've tracked fraud for years --
http://faculty.trinity.edu/rjensen/Fraud.htm
One of the most important aspects of fraud
psychology is the follow-the-herd-mentally when those around you are both
committing fraud and getting away with it. My best illustrations here are
tracked in my extensive timeline of derivative financial instruments frauds ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Another key ingredient of some large frauds is
that white collar crime pays big even if you get caught ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
For some fraud is a disease like pedophilia in
that the worst of the worst just seem to not be able to help themselves.
Recidivism: is very high after being released from prison.---
http://www.springerlink.com/content/w125216287260u28/
Question
"U.S. Securities Law: Does 'High Intensity' Enforcement Pay Off?"
Knowledge@Wharton, May 30, 2007 ---
Click Here
Strong enforcement is critical to
obtaining good governance and adding value to corporations, and investors
stand to gain from it.
. . .
In the U.K., the FSA budget for
enforcement is between 12.5% and 13% of its total budget, which Coffee said
is consistent with many other countries. The SEC spends around 40% of its
overall budget on enforcement, and Australia spends even more -- nearly 47%
in 2005. Coffee also noted that the SEC has 1,200 attorneys working full
time for the agency. The FSA, he said, maintains a "skeletal" legal staff
and outsources cases when necessary. In Britain and many other countries,
regulators place more emphasis on negotiating settlements to avoid formal
enforcement actions. "They don't like to keep a legal enforcement staff
because they see enforcement as a last-ditch effort."
. . .
In the wake of corporate scandals
in the U.S., criminal enforcement is the "ultimate deterrence," Coffee said.
Citing research from cases between 1978 and 2004, he noted that some 755
individuals and 40 firms were indicted for "financial misrepresentation,"
which he said is just a small subset of securities violations. In all,
1,230.7 years of incarceration and 397.5 years of probation were imposed,
with an average sentence of 4.2 years.
Continued in article
Importance of Internal Controls Even Among
the "Good Folks"
April 3, 2011 Message from Jim McKinney
On today’s
NPR Program, This American Life, there was an interesting story today about
how a young untrained person was put in-charge of The Kennedy Center gift
shop and learned the importance of internal controls. The shrinkage was in
the 40% range initially. The main point was, here are these basically good
people volunteering time, and yet many of them were stealing cash and
merchandise because there were no internal controls.
http://www.thisamericanlife.org/radio-archives/episode/431/see-no-evil
Jim McKinney, Ph.D.,
C.P.A.
Tyser Teaching Fellow
Accounting and Information Assurance
Robert H. Smith School of Business
4333G Van Munching Hall
University of Maryland
College Park, MD 20742-1815
http://www.rhsmith.umd.edu
There's a shelf of financial bestsellers whose
titles now sound absurd: Ravi Batra's The Great Depression of 1990; James
Glassman's Dow 36,000; Harry Figgie's Bankruptcy 1995: The Coming Collapse of
America and How to Stop It. There’s BusinessWeek’s 1979 description of "the
death of equities as a near permanent condition,
Michael Lewis, "The Evolution of an
Investor," Blaine-Lourd Profile, December 2007 ---
http://www.portfolio.com/executives/features/2007/11/19/Blaine-Lourd-Profile#page3
As quoted by Jim Mahar in his Finance Professor Blog at
http://financeprofessorblog.blogspot.com/
As a group, professional money managers control more
than 90 percent of the U.S. stock market. By definition, the money they invest
yields returns equal to those of the market as a whole, minus whatever fees
investors pay them for their services. This simple math, you might think, would
lead investors to pay professional money managers less and less. Instead, they
pay them more and more...Nobody knows which stock is going to go up. Nobody
knows what the market as a whole is going to do, not even Warren Buffett. A
handful of people with amazing track records isn’t evidence that people can game
the market. Nobody knows which company will prove a good long-term investment.
Even Buffett’s genius lies more in running businesses than in picking stocks.
But in the investing world, that is ignored. Wall Street, with its army of
brokers, analysts, and advisers funneling trillions of dollars into mutual
funds, hedge funds, and private equity funds, is an elaborate fraud.
Michael Lewis, "The Evolution of an
Investor," Blaine-Lourd Profile, December 2007 ---
http://www.portfolio.com/executives/features/2007/11/19/Blaine-Lourd-Profile#page3
As quoted by Jim Mahar in his Finance Professor Blog at
http://financeprofessorblog.blogspot.com/
A second paper in this series will examine the
theoretical justifications for the importance of the stock market as perhaps the
central financial institution in the United States.
"Who Needs the Stock Market? Part I: The Empirical
Evidence," by Lawrence E. Mitchell George Washington University - Law School,
SSRN, October 30, 2008 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1292403
Data on historical
and current corporate finance trends drawn from a variety of sources present
a paradox. External equity has never played a significant role in financing
industrial enterprises in the United States. The only American industry that
has relied heavily upon external financing is the finance industry itself.
Yet it is commonly accepted among legal scholars and economists that the
stock market plays a valuable role in American economic life, and a recent,
large body of macroeconomic work on economic development links the growth of
financial institutions (including, in the U.S, the stock market) to growth
in real economic output. How can this be the case if external equity as
represented by the stock market plays an insignificant role in financing
productivity? This paradox has been largely ignored in the legal and
economic literature.
This paper surveys
the history of American corporate finance, presents original and secondary
data demonstrating the paradox, and raises questions regarding the structure
of American capital markets, the appropriate rights of stockholders, the
desirable regulatory structure (whether the stock market should be regulated
by the Securities and Exchange Commission or the Commodities Futures Trading
Commission, for example), and the overall relationship between finance and
growth.
The answers to
these questions are particularly pressing in light of a dramatic increase in
stock market volatility since the turn of the century creating distorted
incentives for long-term corporate management, especially trenchant in light
of the recent global financial collapse.
A second paper in
this series will examine the theoretical justifications for the importance
of the stock market as perhaps the central financial institution in the
United States.
Shocking 25 Minute Video
A Rigged Trading System: "The odds are better in Las Vegas than on Wall Street"
This is the same fraud as the one committed by Max in the Broadway show called
The Producers (watch the Bloomberg video of how the fraud works)
Max sold over 100% of the shares in his play.
A fraudulent market manipulation contributed to the Wall Street meltdown
Phantom Shares and Market Manipulation (Bloomberg News
video on naked short selling) ---
http://video.google.com/videoplay?docid=4490541725797746038
Labor Unions Want Less Financial Disclosure and
accountability
From day one of the Obama era, union
leaders want the lights dimmed on how they spend their mandatory member dues.
The AFL-CIO's representative on the Obama transition team for Labor is Deborah
Greenfield, and we're told her first inspection stop was the Office of
Labor-Management Standards, or OLMS, which monitors union compliance with
federal law. Ms. Greenfield declined to comment, citing Obama transition rules,
but her mission is clear enough. The AFL-CIO's formal "recommendations" to the
Obama team call for the realignment of "the allocation of budgetary resources"
from OLMS to other Labor agencies. The Secretary should "temporarily stay all
financial reporting regulations that have not gone into effect," and "revise or
rescind the onerous and unreasonable new requirements," such as the LM-2 and T-1
reporting forms. The explicit goal is to "restore the Department of Labor to its
mission and role of advocating for, protecting and advancing the interests of
workers." In other words, while transparency is fine for business, unions are
demanding a pass for themselves.
"Quantum of Solis Big labor wants Obama to dilute union disclosure rules,"
The Wall Street Journal, December 21, 2008 ---
http://online.wsj.com/article/SB122990431323225179.html?mod=djemEditorialPage
I’m not going to hold
my breath waiting for Porter to give some evidence of contrition about his
mission to Tripoli. Sir Howard Davies may have resigned as director of the LSE
(“The short point is that I am responsible for the school’s reputation and that
has suffered”), but being a Harvard professor apparently means never having to
say you’re sorry. Perhaps instead the university will find some way to rein in
on its professors’ more self-serving ambitions.
David Warsh, "A Recent Exercise in Nation-Building by Some Harvard
Boys," EconomicPrincipals.com, March 27, 2011 ---
http://www.economicprincipals.com/issues/2011.03.27/1248.html
Thank you Robert Walker for the heads up.
It was worth a smile at
breakfast that morning in February 2006, a scrap of social currency to take
out into the world. Michael Porter, the Harvard Business School management
guru, had grown famous offering competitive strategies to firms, regions,
whole nations. Earlier he had taken on the problems of inner cities, health
care and climate change. Now he was about to tackle perhaps the hardest
problem of all (that is, after the United States’ wars in Afghanistan and
Iraq).
He had become adviser to
Moammar Khadafy’s Libya.
There at the bottom of
the front page of the Financial Times was a
story that no one else had that day, or any other
– a scoop. It turned out that Porter and his friend Daniel Yergin and the
consulting firms which they had respectively co-founded and founded, Monitor
Group and Cambridge Energy Research Associates, had been working for a year
on a plan to diversify the Libyan economy away from its heavy dependence on
oil. Their teams had conducted more than 2,000 interviews with “small- and
medium-scale entrepreneurs as well as Libyan and foreign business leaders.”
(Both men are better-known as celebrated authors: Porter for
Competitive Strategy: Techniques for Analyzing Industries and Competitors
and The Competitive Advantage of Nations, Yergin for The Prize: the
Epic Quest for Oil, Money and Power and The Commanding Heights: the
Battle for the World Economy.)
The next day Porter
would
present the 200-page
document they had prepared in a ceremony in Tripoli. Khadafy himself might
attend. The FT had seen a copy of the report, which envisaged a
glorious future under the consultants’ plan. If all went well, it said, then
by 2019 – the 50th anniversary of the military coup that brought Col.
Khadafy to power – Libya would have “one of the fastest rates of business
formation in the world,” making it a regional leader contributing to the
“wealth and stability of surrounding nations.”
. . .
We now know that
Khadafy’s son bribed his way into his PhD from the London School of
Economics (LSE); that Monitor Group had been paid to help him write his
dissertation there (much of which apparently turns out to have been
plagiarized, anyway); that the Libyan government
was paying Monitor $250,000 a month for its services; that, according to
The New York Times, Libya’s sovereign wealth fund today owns a portion
of Pearson PLC, the conglomerate that publishes the Financial Times
and The Economist; that the whole deal quietly fell apart two years
later.
Sir Howard Davies resigned
earlier this month as director of the LSE after it was disclosed he had
accepted a ₤1.5 million donation in 2009 from a charity controlled by Saif
Khadafy.
It turns out that
Monitor also proposed to write a book boosting Khadafy as “one of the most
recognizable individuals on the planet,” promised to generate positive
press, and to bring still more prominent academics, policymakers and
journalists to Libya, according to Farah Stockman of The Boston Globe.
She did a banner job of pursuing the details she found in
A Proposal For Expanding the Dialogue Surrounding the Ideas of Moammar
Khadafy, a proposal from Mark Fuller in 2007 that
a Libyan opposition group posted on the Web.
Among those enlisted
were Sir Anthony Giddens, former director of the LSE; Francis Fukuyama, then
of Johns Hopkins University; Benjamin Barber, of Rutgers University
(emeritus); Nicholas Negroponte, founder of MIT’s Media Lab; Robert Putnam
and Joseph Nye, both former deans of Harvard’s Kennedy School of
Government. Nye received a fee and wrote a
broadly sympathetic account of his three-hour
visit with Khadafy for The New Republic. He also told the Globe’s
Stockman he had commented on a chapter of Saif’s doctoral dissertation.
(When The New Republic scolded Nye earlier this month, after
Mother Jones magazine
disclosed the fee, Nye replied that his original
manuscript implied that he had been employed as a consultant by Monitor, but
that the phrase had been edited out).
. . .
I’m not going to hold my
breath waiting for Porter to give some evidence of contrition about his
mission to Tripoli. Sir Howard Davies may have resigned as director of the
LSE (“The short point is that I am responsible for the school’s reputation
and that has suffered”), but being a Harvard professor apparently means
never having to say you’re sorry. Perhaps instead the university will find
some way to rein in on its professors’ more self-serving ambitions.
New Book --- Yeah Right!
Harvard Business Review on Making Smart Decisions ---
Click Here
http://hbr.org/product/harvard-business-review-on-making-smart-decisions/an/10323-PDF-ENG?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date
New Book --- Yeah Right!
Jensen Comment
In Chile the
Chicago Boys rebuilt a nation with honor. I Libya the
Harvard Boys were apparently less honorable.
And look what a desert swamp we're mired in now!
. . . being a Harvard
professor apparently means never having to say you’re sorry
The entire year 2006 ethics flap about climbers not rendering aid to a
supposedly dying climber on Mt. Everest was preceded by a great 1983 real world
case called the Parable of the Sadhu from the Harvard Business School ---
Click Here
The Parable of the Sadhu was and still is widely used in ethics
courses, especially regarding issues of situational ethics and group versus
individual ethics. The author Bowen H. McCoy was the managing director of the
investment banking firm Morgan Stanley & Co. After returning to New York, McCoy
was conscious stricken about leaving a dying religious man during an Everest climb. The
climbers at that time shed some clothes to keep the dying man warm. But climbers
from various nations (U.S., Switzerland, and Japan) actually moved on and did not help the man down to shelter
because they all felt that he was going to die in any case. Also, the weather
was such that the climbers could not complete their climbing goal if they delayed to
carry the dying man to shelter.
McCoy wrote the following after returning to New York:
We do not know if the sadhu lived or died. For many
of the following days and evenings Stephen and I discussed and debated our
behavior toward the sadhu. Stephen is a committed Quaker with deep moral
vision. He said, "I feel that what happened with the Sadhu is a good example
of the breakdown between the individual ethic and the corporate ethic. No
one person was willing to assume ultimate responsibility for the sadhu. Each
was willing to do his bit just so long as it was not too inconvenient. When
it got to be a bother everyone just passed the buck to someone else and took
off . . . "
. . .
Despite my arguments, I feel and continue to feel
guilt about the sadhu. I had literally walked through a classic moral
dilemma without fully thinking through the consequences. My excuses for my
actions include a high adrenaline flow, super-ordinate goal, and a
once-in-a-lifetime opportunity --- factors in the usual corporate situation,
especially when one is under stress.
Real moral dilemmas are ambiguous and many of us
hike right through them, unaware that they exist. When, usually after the
fact, someone makes an issue of them, we tend to resent his or her bringing
it up. Often, when the full import of what we have done (or not done) falls
on us, we dig into a defensive position from which it is very difficult to
emerge. In rare circumstances we may contemplate what we have done from
inside a prison.
Had we mountaineers have been free of physical and
mental stress caused by the effort and the high altitude, we might have
treated the sadhu differently. Yet isn't stress the real test of personal
and corporate values? The instant decisions executives make under pressure
reveal the most about personal and corporate character.
Among the many questions that occur to me when
pondering my experience are: What are the practical limits of moral
imagination and vision? Is there a collective or institutional ethic beyond
the ethics of the individual? At what level of effor or commitment can one
discharge one's ethical responsibilities?
Continued in this 1983 Harvard Business School Case.
Jensen Comment
I might add that this 1983 case was written before the breakdown in ethics
during the 1990s high tech bubble in which investment banking, executive
compensation, corporate governance, and corporate ethics in general sometimes
become Congress to the core ---
http://faculty.trinity.edu/rjensen/FraudCongress.htm
********************
You can read more about the 2006 repeat of the dilemma at
"Everest pioneer appalled that climber was left to die," by Steve McMorran,
Seattle Times, May 25, 2006 ---
http://seattletimes.nwsource.com/html/nationworld/2003017177_everest25.html
May 28, 2006 reply from Andrew Priest [a.priest@ECU.EDU.AU]
Hi Bob
And you can contrast this action and the 2006 with
the help given to Lincoln Hall again this year (events still going on).
Lincoln was left on the mountain, assumed dead. He was not and is lower down
the mountain and doing okay. Details at <
http://www.mounteverest.net/news.php?id=3315>
and more details at
<
http://www.mounteverest.net/news.php?id=3311> .
Compassion and caring wins out every time in my
view over selfishness.
Andrew
"Remarks by Chairman Alan Greenspan Before a conference
sponsored by the Office of the Comptroller of the Currency,
Washington, D.C. October 14, 1999 --- http://federalreserve.gov/boarddocs/speeches/1999/19991014.htm
Measuring Financial Risk in the
Twenty-first Century
During a financial crisis, risk aversion
rises dramatically, and deliberate trading strategies are replaced
by rising fear-induced disengagement. Yield spreads on relatively
risky assets widen dramatically. In the more extreme manifestation,
the inability to differentiate among degrees of risk drives trading
strategies to ever-more-liquid instruments that permit investors to
immediately reverse decisions at minimum cost should that be
required. As a consequence, even among riskless assets, such as U.S.
Treasury securities, liquidity premiums rise sharply as investors
seek the heavily traded "on-the-run" issues--a behavior
that was so evident last fall.
As I have indicated on previous occasions,
history tells us that sharp reversals in confidence occur abruptly,
most often with little advance notice. These reversals can be
self-reinforcing processes that can compress sizable adjustments
into a very short period. Panic reactions in the market are
characterized by dramatic shifts in behavior that are intended to
minimize short-term losses. Claims on far-distant future values are
discounted to insignificance. What is so intriguing, as I noted
earlier, is that this type of behavior has characterized human
interaction with little appreciable change over the generations.
Whether Dutch tulip bulbs or Russian equities, the market price
patterns remain much the same.
We can readily describe this process, but,
to date, economists have been unable to anticipate sharp reversals
in confidence. Collapsing confidence is generally described as a
bursting bubble, an event incontrovertibly evident only in
retrospect. To anticipate a bubble about to burst requires the
forecast of a plunge in the prices of assets previously set by the
judgments of millions of investors, many of whom are highly
knowledgeable about the prospects for the specific investments that
make up our broad price indexes of stocks and other assets.
Nevertheless, if episodic recurrences of
ruptured confidence are integral to the way our economy and our
financial markets work now and in the future, the implications for
risk measurement and risk management are significant.
Probability distributions estimated
largely, or exclusively, over cycles that do not include periods of
panic will underestimate the likelihood of extreme price movements
because they fail to capture a secondary peak at the extreme
negative tail that reflects the probability of occurrence of a
panic. Furthermore, joint distributions estimated over periods that
do not include panics will underestimate correlations between asset
returns during panics. Under these circumstances, fear and
disengagement on the part of investors holding net long positions
often lead to simultaneous declines in the values of private
obligations, as investors no longer realistically differentiate
among degrees of risk and liquidity, and to increases in the values
of riskless government securities. Consequently, the benefits of
portfolio diversification will tend to be overestimated when the
rare panic periods are not taken into account.
The uncertainties inherent in valuations of
assets and the potential for abrupt changes in perceptions of those
uncertainties clearly must be adjudged by risk managers at banks and
other financial intermediaries. At a minimum, risk managers need to
stress test the assumptions underlying their models and set aside
somewhat higher contingency resources--reserves or capital--to cover
the losses that will inevitably emerge from time to time when
investors suffer a loss of confidence. These reserves will appear
almost all the time to be a suboptimal use of capital. So do fire
insurance premiums.
The above is only a quotation from the speech.
UNEQUAL
TREATMENT: Congress to the Core
"Playing
Favorites: Why Alan Greenspan's Fed lets banks off easy on
corporate fraud," by Ronald Fink, CFO Magazine, April
2004, pp. 46-54 --- http://www.cfo.com/article/1,5309,12866||M|886,00.html
The module below is not in
the above online version of the above article. However, it is on
Page 51 of the printed version.
UNEQUAL
TREATMENT
IF
THE FEDERAL RESERVE BOARD AND THE SECURITIES AND EXCHANGE
Commission
pursue the same agenda, why were Merrill Lynch & Co. and the
Canadian Imperial Bank of Commerce (CIBC) treated so differently by
the Corporate Fraud Task Force--a team with representatives from the
SEC, the FBI, and the Department of Justice (DoJ) set up to
prosecute perpetrators of Enron's fraud--than were Citigroup and J.
P. Morgan Chase & Co.? After all, all four banks did much
the same thing.
Under
settlements signed with the SEC last July, Citigroup and Chase were
fined a mere $101 million (including $19 million for its actions
relating to a similar fraud involving Dynegy) and $135 million,
respectively, which amounts to no more than a week of either's most
recent annual earnings. And they agreed, in effect, to cease
and desist from doing other structured-finance deals that mislead
investors. That contrasts sharply with the punishment meted
out by the DoJ to Merrill and CIBC, each of which not only paid $80
million in fines, but also agreed to have their activities monitored
by a supervising committee that reports to the DoJ. Even more
striking, CIBC agreed to exit not only the structured-finance
business but also the plain-vanilla commercial--paper conduit trade
for three years. No regulatory agency involved in the
settlements would comment on the cases, though the SEC's settlement
with Citigroup took note of the bank's cooperation in the
investigation.
But Brad S.
Karp, an attorney with the New York firm Paul, Weiss, Rifkind,
Wharton & Garrison LLP, suggested recently that the terms of the
SEC settlement with its client, Citigroup, reflected a lack of
knowledge or intent on the bank's part. As Karp noted more
than once at a February conference on legal issues and compliance
facing bond-market participants, the SEC's settlement with Citigroup
was ex scienter, a Latin legal phrase meaning "without
knowledge."
However,
the SEC's administrative order to Citigroup cited at least 13
instances where the bank was anything but in the dark about its
involvement in Enron's fraud.
As Richard
H. Walker, former director of the SEC's enforcement division and now
general counsel of Deutsche Bank's Corporate and Investment Bank,
puts it, all the banks involved in Enron's fraud "had
knowledge" of it. Yet Walker isn't surprised by their
disparate treatment at the hands of regulators. "The SEC
does things its way," he says, "and the Fed does them
another." *Ronald Fink and Tim Reason
The just don't get it! Chartered Jets, a
Wedding At Versailles and Fast Cars To Help Forget Bad Times.
As financial companies start to pay out big
bonuses for 2003, lavish spending by Wall Streeters is showing signs
of a comeback. Chartered jets and hot wheels head a list of
indulgences sparked by the recent bull market.
Gregory Zuckerman and Cassell Bryan-Low, "With the
Market Up, Wall Street High Life Bounces Back, Too," The Wall
Street Journal, February 4, 2004 --- http://online.wsj.com/article/0,,SB107584886617919763,00.html?mod=home%5Fpage%5Fone%5Fus
Scandals Are a Hot Topic in College Courses --- http://www.smartpros.com/x42201.xml
Most of us enter the investment business for the
same sanity-destroying reasons a woman becomes a prostitute: It avoids the
menace of hard work, is a group activity that requires little in the way of
intellect, and is a practical means of manking money for those with no special
talent for anything else.
Richard New, The Wall Street Jungle (as quoted by Frank Partnoy in
FIASCO: The Inside Story of a Wall Street Trader.)
Behind every great fortune there lies a great crime.
Honore de Balzac (as quoted by Frank Partnoy in FIASCO: The Inside
Story of a Wall Street Trader.)
But for Freddie Mac, the other pillar of
the colossal U.S. mortgage market, Freddie Mac's restatement has only
caused headaches and has even raised new questions about the quality
of financial reporting.
Patrick Barta, "Restatement by Freddie Mac Puts Fannie on the
Spot," The Wall Street Journal, January 12, 2004, Page C1.
The problem is the companies'
(Freddie
Mac versus Fannie Mae) business and financial
statements have become so complex that they are effectively "unanalyzable"
says James Bianco, president of Bianco Research,
a Chicago-based fixed-income research firm that has been critical of
Fannie and Freddie in the past. He says the same is becoming
true of other large financial institutions, particularly those that,
like Fannie and Freddie, use large volumes of derivatives, which are
investment contracts that can be used by companies to offset risk from
interest rate shifts.
Ibid
The Timeline of the Recent History of Fannie Mae Scandals
2002-2008 ---
http://faculty.trinity.edu/rjensen/caseans/000index.htm#FannieMae
"Fannie Mayhem: A History," The Wall Street Journal,
July 14, 2008
So what's a little business deal among
friends? It's trouble, if the friends are college or
college-foundation trustees who benefit personally from the decisions
they make on behalf of the institutions they serve.
Julianne Basinger, "Boars Crack Down on Members' Insider
Benefits," The Chronicle of Higher Education, February 6.
2004, Page A1.
Mutual-fund investors sent a record $14
billion in net assets to exchange-traded funds last month as they
sought escape from the recent share-trading scandal.
Aaron Lucchetti, The Wall Street Journal, January 23, 2004 --- http://online.wsj.com/article/0,,SB107482213730209735,00.html?mod=mkts_main_news_hs_h
S. Scott Voynich, Chair of the American
Institute of Certified Public Accountants, has stated that further
changes were necessary to regain the confidence of American investors.
Voynich was the keynote speaker at the Institute’s 2003 AICPA
National Conference on Current SEC Developments .
http://accountingeducation.com/news/news4675.html
Nothing wrong with overcharging, so long
as everyone else is doing it, right?
Gretchen Morgenson"The Mutual Fund Scandal's Next
Chapter," The New York Times, December 7, 2003
(See below)
Are you
disgusted enough with mutual funds to raise a stink? So far,
savers don't seem nearly as outraged as they were about Enron--yet
deceptive funds and sneaky "financial advisers" have swiped
more money, from more people, than all the corporate scandals
combined. The House of
Representatives just passed a reform bill, but in the Senate, the
going looks tough. Your
legislators are scooping up money from the mutual-fund lobby, which
hopes to head off any major change.
To counter the lobby,
Congress needs angry protest calls from voters like you.
Jane Bryant Quinn (See Below)
One the one
hand, eliminating the middleman would result in lower costs, increased
sales, and greater consumer satisfaction; on the other hand,
we're the middleman.
New Yorker Cartoon, Page 29, The New Yorker Book of Business
Cartoons
In the context of the recent mutual fund scandals, financial advisors
have become those middlemen.
Boyer had also
asked Kmart's auditors at PricewaterhouseCoopers in several cases to
look into various accounting issues and was unsatisfied with the
firm's work, according to the lawsuit.
"Fired From Kmart, Ex-CFO Is Key Figure in
Lawsuits," SmartPros (See below)
"I believe
this (mutual fund rip-off) is the worst
scandal we've seen in 50 years, and I can't say I saw it coming,"
said Arthur Levitt, the former chairman of the Securities and Exchange
Commission for nearly eight years under the Clinton administration.
"I probably worried about funds less than insider trading,
accounting issues and fair disclosure to investors" by public
companies.
Stephen Labaton --- http://faculty.trinity.edu/rjensen/fraud.htm#Cleland
Illegal
or unfair trading isn't hard for directors (or the SEC)
to spot, says New York Attorney General Eliot Spitzer, who brought the
first of these scandals to light. They just have to compare
their funds' total sales with total redemptions. When the two
are about the same, skimming might be going on. I asked Lipper,
a fund-tracking service, to list the larger funds where redemptions
reached 90 to 110 percent of sales. It found 229, some looking
obviously churned.
Jane Bryant Quinn --- http://faculty.trinity.edu/rjensen/fraud.htm#Cleland
One thing your
can count on: When you invest, a lot of the people you trust are
going to cheat. Billions of investor dollars whirl through the
system. It's all too easy for insiders to stick their hands into
that current and grab. We're not talking about a bad apple here
and there. Cheating runs through Wall Street's very seams ---
even in the sainted mutual funds.
Jane Bryant Quinn --- http://faculty.trinity.edu/rjensen/fraud.htm#Cleland
But Wall Street's Lobbyists Still Have a
Firm Grip Where it Counts
While Representative Baker pushes his bill in
the House, the Senate is not expected to take up a measure before next
year. Some lawmakers have filed bills, but Senator Richard Shelby, the
Alabama Republican who heads the Senate banking committee, has said he
is not convinced of the need for new laws.
Stephen Labaton, "S.E.C. Offers Plan for Tightening Grip on
Mutual Funds," The New York Times, November 19, 2003 --- http://www.nytimes.com/2003/11/19/business/19sec.html
You can read more about SEC Chairman
William H. Donaldson's defense of his quick and some say marshmallow
punishment of mutual fund cheaters at
http://faculty.trinity.edu/rjensen/fraud.htm#Cleland
What makes this such a
big scandal is that the savings of half the households in the U.S. are
at stake here. The tragedy is that now that the scandal is
surfacing in the media and in state courts, the SEC is only wrist
slapping mutual funds. This
is along with the continued wrist slapping of investment banking
(e.g., why is Merrill Lynch still in existence after frauds dating
back to
Orange
County
?) is the real evidence of industry power over regulators.
Sarbanes-Oxley won’t do it!
It’s still Congress to the core in
Washington
DC
as long as industries have regulators in their well-financed pockets
--- http://faculty.trinity.edu/rjensen/fraud.htm#Cleland
New
York State Attorney General Eliott Spitzer's charges of improper
trading practices by several leading mutual fund families are another
blow to public trust in financial institutions. Mutual funds have been
the place you would advise the most unsophisticated investors to go:
Mutual funds were designed for grandpa and grandma, and repeatedly
recommended to them by all kinds of benevolent authorities. Thus
scandals in the mutual fund sector are potentially much more damaging
to public trust in our financial institutions than are scandals in
other sectors -- such as the one playing out in the New York Stock
Exchange right now.
See Robert Shiller's article below.
If
you don't know jewelry, know your jeweler.
Warren Buffett,
Lowly
investors who lost their retirement accounts following the advice of
Citigroup's Jack Grubman or followed the "research" of some
other firm that was bought and paid for by favored clients can only
burn with shame and disbelief. Restore investor confidence in Wall
Street? Not likely for baby boomers, who've already been publicly
fleeced in broad daylight. Wall Street will have to wait for another
generation of innocents to prey upon.
Richard Dooling, The New York Times, May 4, 2003
Mr. Quattrone's rise shows
how some who were on the inside during the tech boom piled up huge
fortunes in part through special access, unavailable to other
investors, to the machinery of that era's frenzied stock market. But
now he faces a crunch. The steep yearlong downturn in tech stocks has
hurt the profits of his technology group. And in recent weeks, the
group he heads has come under scrutiny in connection with a federal
probe into whether some investment-bank employees awarded shares of
hot IPOs in exchange for unusually high commissions, and whether those
commissions amounted to kickbacks.
Susan Pulliam and Randall Smith, The Wall Street Journal, May
3, 2003 --- http://online.wsj.com/article/0,,SB988836228231147483,00.html?mod=2_1040_1
The Investment Banker Who Got Away to Start Another Day
The (Frank Quattrone)
deal marks the end of a sorry chapter in American business
history. While high-profile white-collar crime persists, the dramatic criminal
cases that were launched just after the dotcom economy fizzled are now mostly
completed. The icons of massive, turn-of-the-century corporate fraud--Ken Lay
and Jeff Skilling of Enron, Bernie Ebbers of WorldCom, Dennis Kozlowski and Mark
Swartz of Tyco--are convicted and, in Lay's case, dead. Even Martha Stewart has
served time. And many, if not most, of the cases the feds brought against
smaller fish--to help assuage a share-owning public that had been scammed by
phony accounting and overhyped stock--are resolved. The government claims that
since mid-2002 it has won more than 1,000 corporate-fraud convictions, including
those of more than 100 CEOs and presidents.
Barbara Kiviat, "The One Who Got Away: The decision to abandon a
high-profile case against a dotcom poster boy marks the end of a sorry era,"
Time Magazine, August 27, 2006 ---
Click Here
Cleaning Up Corporate Japan
Is Japan Inc. finally moving toward more
responsible corporate governance? After last week's arrest of Yoshiaki
Tsutsumi, owner of the country's major railway, hotel and resort
conglomerate Seibu group, there's at least reason to believe that the
government is finally demanding more accountability from its corporate
leaders. Mr. Tsutsumi, former chairman of Seibu railway and its
holding company, Kokudo, was arrested on Thursday on charges of
insider trading and falsification of documents. While his guilt of
these charges is still to be determined, the Japanese press has not
held back from criticizing the politically influential Mr. Tsutsumi
and his business empire, portraying them as powerful symbols of
corporate Japan's lack of transparency and disregard for shareholder
interests.
"Cleaning Up Corporate Japan," The Wall Street Journal,
March 10, 2005 --- http://online.wsj.com/article/0,,SB111040748350775119,00.html?mod=opinion&ojcontent=otep
Hi Milt,
I think the problem in the investment banking industry that spilled
over into accounting, banking, mutual funds, securities dealers, and
large corporations is truly "infectious greed." When
deregulations came 8n 1995, executives watched as investment bankers
became filthy rich and many, certainly not all, decided to join in the
fun.
What is important in Parnoy's latest book is a greater explanation
of "how" it was done.
And yes, I think that many would do it again even if they knew they
would get caught. See http://faculty.trinity.edu/rjensen/fraudconclusion.htm#CrimePays
Many of the perpetrators in the 1990s are now sitting in places like
London and Switzerland enjoying a very nice life with no longer having
to work. Many of them will gladly sacrifice pride for wealth, which is
something that I gather would never appeal to you.
As for Nixon, I think his years in public office drove him to
pathological paranoia. He was driven more by fear than greed. I think
he wanted to go down in history as a great statesman, and he feared
his enemies were out keep him from realizing his dream.
Bob Jensen
-----Original Message-----
From: MILT COHEN [mailto:uncmlt@juno.com]
Sent: Sunday, April 25, 2004 9:06 AM
To: Jensen, Robert
Subject: comment on your comments
Hi Bob
I read your comments on various books
written on securities fraud and related "fun & games"
with investors per Cheryl Dunn's request --- http://faculty.trinity.edu/rjensen/Fraud.htm#Quotations
Just a couple of comments from my view. I
read one of the books you wrote on - namely Liar's Poker and I also
read a book on Michael Milkens dealings during his days at Drexel,
his downfall along with Drexel's, and how others of that era that
were involved in those dealings.
It seems to me that most of these books get
muddled down into the same expose type of writing and/or reporting.
It's like, wow! Is that what really happened? Or, I guess I forgot
about that. Each book seems to be a primer for the next
"hero" who wlll take investors and accountants for another
fleecing. And make lawyers rich.
My question to you (and you may have the
same feeling I have) is why are there so many fraudulent happenings
in the security arena? One would think that with jail sentences and
monetary fines being given (even Martha Stewart), people's
reputations driven into a ditch - perhaps forever (notwithstanding
Michael Milken's good deeds in medicine and education) is the wealth
obtained so worthy of being convicted of being a thief? Does anyone
have that answer? Is it all worth it just to get out of jury duty?
Back in history when I was an under grad back in the 1950s the big
defalcation (as it was titled) was the McKesson Robbins inventory
cover-up of the 1930s. The next one that comes to my mind was the
Equity Funding matter of the 1960-1970 era that centered on the
fraud of writing nonexistent life insurance contracts that brought
attention to the firm of Seidman & Seidman (I had a friend
working for them during that era).
After Equity Funding, the fraud circuit was
quiet for awhile, but in the last fifteen or so years, it seems we
experience one hit after another (like airplanes in a flight plan at
LAX) - all centering on the oversight of audits that have gone on
for years or even decades. The latest being the B of A involvement
with the Italian dairy company. (how a bank account could be
overlooked or confirmed when it didn't exist is beyond me). My
conclusion after 45 years in this "game" is that it all
relates back to Richard Nixon. Nixon in his day depicted the worst
of fraud and lying in the matter of Watergate. (He also was depicted
as a less than ethical politician here in California. The name
"tricky Dick" didn't come from nowhere). Anyway, he showed
the populace that anyone can "get away with it". Fast
forward to Bill Clinton and we have another example of not telling
the truth. (only he has the definition of sex?) So what can our kids
and students think as they trudge through college. If ethics is not
emphasized in class (and I assume it is not a major topic these or
any other days) and ethical actions are not depicted in real life as
well as in movies and TV (look at Ormirosa's actions on the Donald
Trump show) how can we expect that these financial frauds will not
be a continual event? Perhaps the next reality show should be
centered on financial fraud. It might bring in bigger ratings than
Trump's show did. (And Trump is such an icon of ethical behavior in
business dealings too - (that's a joke)).
Anyway, I just thought I'd share my
feelings on your thoughts and comments on current readings and
topical events.
Sincerely,
Milt Cohen Chatsworth, Ca.
Hi Again Milt,
The entire body of agency theory that evolved in the past three
decades is built upon the underlying assumption that managers' utility
functions are also in the best interest of the prosperity of
corporations and shareholders. Agency theory falls apart when managers
like Fastow, Kozwalski, Waksal, etc. are willing to loot the company
and/or rob shareholders for personal gain even if they know they will
get caught and spend some relaxing time in Club Fed --- http://faculty.trinity.edu/rjensen/fraudconclusion.htm#CrimePays
We always hope that dastardly managers are few and far between such
that your assumptions and agency theory still hold water. What we saw
in the late 1990s, however, was that highly infectious greed that
commenced to sicken entire industries such as investment banking,
energy traders, stock brokers, and securities dealers after Federal
regulations were eliminated in 1995 --- http://faculty.trinity.edu/rjensen/FraudCongress.htm
Sadly, the auditing profession was not immune to infectious greed
as consulting opportunities exploded in auditing clients. We would
hope that integrity is being restored in the auditing profession, but
the scandals in tax shelter marketing and client billing cheating
since the Sarbanes-Oxley legislation have further eroded the
credibility of auditing firms --- http://faculty.trinity.edu/rjensen/Fraud.htm#others
See "ACCOUNTING PROFESSIONALISM: THEY JUST DON'T GET IT"
--- http://aaahq.org/AM2003/WyattSpeech.pdf
Bob Jensen
-----Original Message-----
From: MILT COHEN [mailto:uncmlt@juno.com]
Sent: Sunday, April 25, 2004 2:31 PM To: Jensen, Robert
Subject: Re: comment on your comments
You may be precisely correct in your
conclusion, but one would like to think that the greedy bunch
wouldn't want to ruin the 'game" for everyone else. That old
story about killing the goose that lays the golden eggs is
happening. Another story about the bar owner watching a new
bartender steal every other drink that is sold. Finally when the
bartender pockets two in a row, the owners calls him over and asks,
"aren't we partners on that one?" I mean, in order for
investors to part with money the thieves have to let others make a
few bucks just to sweeten the pot, or the game is over, in my view.
The flip side is that with new laws and the emphasis on accountant's
trust, many students will opt out of accounting and just head for
the finance sign. I tutored a student last year who was trying to
understand Intermediate Accounting. He said he did well in the
Principle course. His last remark to me was that if he blows the
mid-term he'll drop the course and take up Finance just to keep his
grade average. So much for tenacity and commitment.
Sincerely Milt Cohen
March 13, 2009 message from Zafar Khan
Why was Sarbanes-Oxley enacted?
Zafar Khan, Ph.D.
Professor
Eastern Michigan University
March 14, 2009 reply from Bob Jensen
Hi Zafar,
Sarbanes (SOX) was enacted to keep
investors from abandoning the U.S. stock market after enormous scandals
like Enron, WorldCom, and other huge scandals that revealed CPA audits
themselves were becoming both substandard and non-profitable ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm
To make money, auditing firms themselves
were profiting from irresponsible audit cost cutting and non-audit
consulting that compromised their auditing independence. Inside
corporations, internal controls for responsible financial reporting had
broken down or never existed in the first place.
Sarbanes forced auditors to become more
independent and also made it possible to double or triple audit fees,
thereby restoring auditing to profitable services rather than services
that lost money for auditing firms trying to be responsible auditors.
SOX also created the PCAOB that got
serious about reviewing auditor performance (including fining Deloitte a
million dollars). Many of the large and smaller CPA firms failed the
PCAOB tests early on and soon cleaned up their audit practices with the
PCAOB breathing down their backs.
Among other things SOX increased
government funding for the SEC and the FASB (which before SOX received
no taxpayer funding). This, in turn, made the FASB less dependent upon
sales of publications. The FASB then made many publications free
electronically, most notably free distribution of standards and
interpretations. The IASB, sadly, still depends upon publication revenue
such that IFRS are not free unless you play games like download the
equivalent Hong Kong accounting standards.
See
http://en.wikipedia.org/wiki/Sarbanes_and_Oxley
A variety of complex factors
created the conditions and culture in which a series of large
corporate frauds occurred between 2000-2002. The spectacular,
highly-publicized frauds at Enron (see
Enron scandal), WorldCom, and Tyco exposed significant problems
with conflicts of interest and incentive compensation practices. The
analysis of their complex and contentious root causes contributed to
the passage of SOX in 2002. In a 2004 interview, Senator Paul
Sarbanes stated:
|
The Senate Banking Committee
undertook a series of hearings on the problems in the
markets that had led to a loss of hundreds and hundreds of
billions, indeed trillions of dollars in market value. The
hearings set out to lay the foundation for legislation. We
scheduled 10 hearings over a six-week period, during which
we brought in some of the best people in the country to
testify...The hearings produced remarkable consensus on the
nature of the problems: inadequate oversight of accountants,
lack of auditor independence, weak corporate governance
procedures, stock analysts' conflict of interests,
inadequate disclosure provisions, and grossly inadequate
funding of the Securities and Exchange Commission. |
|
-
Auditor conflicts of interest:
Prior to SOX, auditing firms, the primary financial "watchdogs"
for investors, were self-regulated. They also performed
significant non-audit or consulting work for the companies they
audited. Many of these consulting agreements were far more
lucrative than the auditing engagement. This presented at least
the appearance of a conflict of interest. For example,
challenging the company's accounting approach might damage a
client relationship, conceivably placing a significant
consulting arrangement at risk, damaging the auditing firm's
bottom line.
-
Boardroom failures: Boards of
Directors, specifically Audit Committees, are charged with
establishing oversight mechanisms for financial reporting in
U.S. corporations on the behalf of investors. These scandals
identified Board members who either did not exercise their
responsibilities or did not have the expertise to understand the
complexities of the businesses. In many cases, Audit Committee
members were not truly independent of management.
-
Securities analysts' conflicts of interest:
The roles of securities analysts, who make buy and sell
recommendations on company stocks and bonds, and investment
bankers, who help provide companies loans or handle mergers and
acquisitions, provide opportunities for conflicts. Similar to
the auditor conflict, issuing a buy or sell recommendation on a
stock while providing lucrative investment banking services
creates at least the appearance of a conflict of interest.
-
Inadequate funding of the SEC:
The SEC budget has steadily increased to nearly double the
pre-SOX level.
In the interview cited above, Sarbanes
indicated that enforcement and rule-making are more effective
post-SOX.
-
Banking practices: Lending to
a firm sends signals to investors regarding the firm's risk. In
the case of Enron, several major banks provided large loans to
the company without understanding, or while ignoring, the risks
of the company. Investors of these banks and their clients were
hurt by such bad loans, resulting in large settlement payments
by the banks. Others interpreted the willingness of banks to
lend money to the company as an indication of its health and
integrity, and were led to invest in Enron as a result. These
investors were hurt as well.
-
Internet bubble: Investors
had been stung in 2000 by the sharp declines in technology
stocks and to a lesser extent, by declines in the overall
market. Certain
mutual fund managers were alleged to have advocated the
purchasing of particular technology stocks, while quietly
selling them. The losses sustained also helped create a general
anger among investors.
-
Executive compensation: Stock
option and bonus practices, combined with volatility in stock
prices for even small earnings "misses," resulted in pressures
to manage earnings. Stock options were not treated as
compensation expense by companies, encouraging this form of
compensation. With a large stock-based bonus at risk, managers
were pressured to meet their targets.
Pay Me More and More and More
Sadly, SOX did not attack the root problems that led to the subsequent
subprime lending scandals. These root problems included
pay-for-performance compensation plans that motivated mortgage brokers,
real estate appraisers, banks, and investment banks to screw both
shareholders and home owners.
Pass the Trash
Added to this was Congressional pressure on Fannie Mae and Freddie Mack
to buy hopeless mortgages that had almost no chance of being repaid.
Banks commenced a practice of passing the trash to Freddie, Fannie, and
Wall Street investment banks that, in turn, passed the trash to their
customers in CDOs that were intended to diversify the bad loan risks
(but failed to do so when the real estate bubble burst).
SOX has worked in countless ways, but
not all ways
There are countless success stories where SOX led to better internal
controls and better auditing with more substantive testing in place of
lousy analytical reviews. However, SOX did almost nothing to prevent
fraud in the mortgage brokering and banking sectors.
You can read more about subprime sleaze at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
You can read more about auditing
professionalism at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Professionalism
Fiduciaries turned into whores
One of the most sad things for me is the way that CPA auditing firms
failed to signal the public that banks were filling up on toxic loans.
Equally unprofessional were the credit rating agencies like Standard and
Poors and Moody’s that in essence became Wall Street’s whores.
Why regulations fail and
succeed in the turning of the carousel
The main problem with government
regulations on industry is that industry eventually runs the regulators
(e.g., the Federal Reserve, SEC, FDA, FAA, FCC, etc.) until some
enormous scandals force the regulators to use the powers entrusted to
them. Then we get new regulations that industry eventually figures out
how to circumvent. Then we wait for more huge scandals. And so the
carousel goes round and round.
Socialism bypasses the regulation
process by owning and running the industries. Then the abuses really
begin
The
inherent vice of capitalism is the unequal sharing of the blessings. The
inherent blessing of socialism is the equal sharing of misery.
Winston Churchill
May 14, 2009 reply from Zafar Khan
[zkhan@EMICH.EDU]
Hi Bob, one can always depend upon you to
set the record straight. Otherwise, some might continue to believe that this
(SOX) was another gratuitous government intervention to disrupt the smooth
functioning of our self correcting financial markets.
I also read in a recent post that the
government should not do anything about executive compensation despite the
obscene abuse of power by the executives of public companies who have
enriched themselves while running their companies into the ground because
the market will in the end sort it out. My humble response to that is dream
on.
Zafar Khan, Ph.D.
Professor
Eastern Michigan University
March 15, 2009 reply from Bob Jensen
Hi again Zafar,
After the fall of Andersen you would've
thought CPA auditors would've "self corrected" without having SOX since
their reputations had hit bottom.
In 2003 a former professor of accounting
at the University of Illinois and long-time executive partner with
Andersen told accounting professors that the CPA firm executives "still
didn't get it." This is probably why we needed SOX and the PCAOB to help
them "get it." Art Wyatt’s plenary session speech at the 2003 American
Accounting Association annual meetings is at
http://aaahq.org/AM2003/WyattSpeech.pdf
Art is also a former AAA President and a member of the Accounting Hall
of Fame. His opinions have a lot of clout in both the CPA profession and
academe.
From “Topics for Class Debate” at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
This might be a good topic of debate for an ethics and/or fraud course.
The topic is essentially the problem of regulating and/or punishing many
for the egregious actions of a few. The best example is the major
accounting firm of Andersen in which 84,000 mostly ethical and highly
professional employees lost their jobs when the firm's leadership
repeatedly failed to take action to prevent corrupt and/or incompetent
audits of a small number audit partners. Clearly the firm's management
failed and deserves to be fired and/or jailed for obstruction of justice
and failure to protect the public in general and 83,900 Andersen
employees. A former
Andersen executive partner,
Art Wyatt, contends that Andersen's leadership did not get the message
and that leadership in today's leading CPA firms is still not (just
before SOX) getting the message ---
http://aaahq.org/AM2003/WyattSpeech.pdf
Bob Jensen's threads on auditing professionalism are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Professionalism
"8 Accused of Kickbacks, Fraud at Wall Street
Brokerage Firms," SmartPros, May 23, 2008 ---
http://accounting.smartpros.com/x61954.xml
"Eliot Spitzer's Case Book," by Elizabeth Weinstein, The Wall
Street Journal, April 28, 2005
Eliot Spitzer is a man on the hunt. From mutual
funds to music, executive compensation to counterfeit drugs, the New York
attorney general has pursued investigations of alleged misdeeds in half a
dozen industries.
Though sometimes criticized for focusing too
closely on Wall Street -- and on his own bid for New York state governor in
2006 -- Mr. Spitzer's probes have led to stricter controls on Wall Street
research and spurred other attorneys general to action. His landmark
investigations have zeroed in on high-profile executives, most recently
Maurice Greenberg at insurer American International Group.
Last year alone, the New York attorney general's office recovered a record
$2.38 billion earmarked for restitution to individual shareholders and other
consumers. Mr. Spitzer's office, which has an annual budget of $214 million,
has added nearly 50 lawyers to its staff of more than 500 attorneys since
1999.
Here is an overview of key investigations:
Investment Banking Stock research
Probe launched: 2001
At issue: Misleading information in analysts' public research reports
An investigation into the stock research issued by Merrill Lynch & Co.'s
Internet group, whose star analyst was Henry Blodget, showed that some
analysts harbored different opinions privately from those they expressed in
their public research reports. The investigation spawned a wide-ranging
probe over nearly two years into the procedures at many firms. Ultimately,
10 of the largest securities firms
agreed to pay $1.4 billion to settle charges that
they routinely issued misleading stock research to curry favor with
corporate clients during the stock-market bubble of the late 1990s. The
firms consented to the charges without admitting or denying wrongdoing. The
$1.4 billion settlement was among the highest ever imposed by securities
regulators, and both Mr. Blodget and Jack Grubman of Salomon Smith Barney
were banned from the securities business.
Investment Banking - IPOs
Probe launched: 2001
At issue: Unfair allocations of shares in initial public offerings
Mr. Spitzer's office also charged that several big Wall Street firms
improperly doled out coveted shares in initial public offerings to corporate
executives in a bid to win banking business. Two companies, Citigroup Inc.'s
Citigroup Global Markets unit, formerly Salomon Smith Barney, and Credit
Suisse Group's Credit Suisse First Boston, settled these charges as part of
the $1.4 billion pact with securities firms and did so without admitting or
denying wrongdoing. In a related probe, former star CSFB banker Frank
Quattrone was
convicted of obstruction of justice for impeding
and investigation of CSFB's IPO allocations.
Insurance - Improper transactions
Probe launched: 2003
At issue: Whether several AIG business deals were designed to manipulate its
financial statements
In 2003, the Securities and Exchange Commission and Mr. Spitzer's office
looked into insurance transactions that American International Group Inc.
conducted with two firms, cellphone distributor Brightpoint Inc. and PNC
Financial Services Group Inc. AIG paid $126 million in a settlement without
admitting or denying guilt. Later, both the SEC and Mr. Spitzer's office
scrutinized a deal struck between AIG and Berkshire Hathaway's General
Reinsurance unit in 2000 to determine if the deal was aimed at making the
giant insurer's reserves look healthier than they were. Longtime Chairman
Maurice R. "Hank" Greenberg
retired from the company, and in late March, AIG
admitted to a broad range of improper accounting.
Other AIG executives were forced out, including chief financial officer
Howard Smith. Meanwhile, Berkshire chief Warren Buffett this week told
investigators that he
didn't know details about the contentious
transaction. Mr. Greenberg also was deposed and repeatedly invoked his
constitutional right against self incrimination.
Insurance - Broker fees
Probe launched: 2004
At issue: Whether fees paid by insurance companies to insurance brokers and
consultants posed a conflict of interest
Mr. Spitzer and other state attorneys general as well as insurance
regulators in New York and Illinois alleged that insurance companies
routinely paid fees to brokers and consultants who advised employers on
where to buy policies for workers, a potential conflict of interest. Mr.
Spitzer accused several insurance brokers of accepting undisclosed
commissions and, in the case of Marsh & McLennan, of bid-rigging --
soliciting fake bids from insurers to help steer business to favored
providers. In February 2005, Marsh
agreed to pay $850 million in restitution to
clients of its Marsh Inc. insurance brokerage firm who allegedly were
cheated by Marsh brokers. Marsh neither admitted nor denied wrongdoing.
The investigations shook up an insurance dynasty. Marsh was run by Jeffrey
W. Greenberg, the eldest son of AIG's former head Maurice Greenberg, before
he was ousted as a result of the probe. Another insurance firm included in
the probe, Ace Ltd., is run by Evan Greenberg, Jeffrey's younger brother.
Meanwhile, Aon Corp.
reached a $190 million settlement without
admitting or denying wrongdoing, and earlier this month, insurance broker
Willis Group Holdings Ltd.
said it would pay $51 million and change its
business practices to end an investigation by attorneys general in New York
and Minnesota. Willis admitted no wrongdoing or liability.
NYSE - Executive Compensation
Probe launched: 2004
At issue: Whether then-New York Stock Exchange Chairman Dick Grasso's
compensation was excessive
Mr. Spitzer sued Mr. Grasso, the NYSE and the Wall Street executive who
headed its compensation committee for what Mr. Spitzer claimed was a pay
package so huge that it violated the state law governing not-for-profit
groups. Mr. Spitzer said the compensation -- valued at nearly $200 million
-- came about as a result of Mr. Grasso's intimidation of the exchange's
board of directors. Mr. Grasso, who denied there was anything improper about
his pay, was
forced to resign from the Big Board in September
2003 following a public outcry over his compensation. The lawsuit, which is
still in progress, led to new governance oversight at the Big Board.
Retail
Probe launched: 2004
At issue: Antitrust violations by retailers
Mr. Spitzer claimed that Federated Department Stores Inc. and May Department
Stores Co. conspired to pressure housewares makers Lenox Inc., a unit of
Brown-Forman Corp. and Waterford Wedgwood PLC's U.S. unit to pull out as
planned anchors of Bed Bath & Beyond Inc.'s new tableware department. The
case was settled in August when the four companies agreed to pay a total of
$2.9 million in civil penalties but admit no wrongdoing. Later, Mr. Spitzer
charged James M. Zimmerman, Federated's retired
chairman, with perjury, alleging that he lied under oath to conceal evidence
of possible antitrust violations. Mr. Zimmerman has pleaded not guilty.
Music
Probe launched: 2004
At issue: Payments by music companies middlemen aimed at securing better
airplay for the labels' artists
Mr. Spitzer's
investigation, which is continuing, centers around independent promoters
-- middlemen between record companies and radio
stations -- whom music labels pay to help them secure better airplay for
their music releases. Broadcasters are prohibited from taking goods or cash
for playing songs on their stations. The independent-promotion system has
been viewed as a way around laws against payola -- undisclosed cash payments
to individuals in exchange for airplay. Last fall, Mr. Spitzer requested
information from Warner Music Group, EMI Group PLC, Vivendi Universal SA's
Universal Music Group, and Sony Corp. and Bertelsmann AG's Sony BMG Music
Entertainment. Warner Music received an additional subpoena
last week.
Marketing
Probe launched: 2004
At issue: Software secretly installed on home computers to put ads on
screens
After a six-month investigation into Internet marketer Intermix Media Inc.,
Mr. Spitzer in April 2005
filed suit, claiming the company installed a wide
range of advertising software on home computers nationwide. The software,
known as "spyware" or "adware," prompts nuisance pop-up advertising on
computer screens, setting users up for PC slowdowns and crashes. The
programs sometimes don't come with "un-install" applications and can't be
removed by most computers' add/remove function. Mr. Spitzer said the suit is
designed to combat the practice of redirecting of home computer users to
unwanted Web sites, the adding of unnecessary toolbar items and the delivery
of unwanted ads that pop up on computer screens. The civil suit accuses
Intermix of violating state General Business Law provisions against false
advertising and deceptive business practices, and also of trespass under New
York common law. Intermix has said it doesn't "promote or condone spyware"
and has ceased distribution of the software at issue, which it says was
introduced under prior leadership.
Health Care
Probe launched: 2005
At issue: Covert sales of counterfeit drugs
Mr. Spitzer's office has
sent subpoenas to three big drug wholesalers
--
Cardinal Health Inc., Amerisource Bergen Corp. and McKesson Corp. -- related
to the companies' purchase of drugs on the secondary market. Although few
details about the probe have emerged, some industry analysts have said that
the subpoenas are likely connected to sales transactions involving
counterfeit products. Counterfeit drugs are those sold under a product name
without proper authorization -- they can include drugs without the active
ingredient, with an insufficient quantity of the active ingredient, with the
wrong active ingredient, or with fake packaging. The investigation focuses
on the secondary market, where the wholesalers buy drugs from each other,
often at lower prices, and counterfeit drugs are hard to track. It isn't
clear whether the wholesalers are the focus of a probe or just sources of
information.
How Grasso Got Greener: Grasso Took Fifth In SEC Testimony
An official in the office of New York state's attorney
general yesterday said former New York Stock Exchange Chief Executive Dick
Grasso last year declined to answer certain questions during a deposition by the
Securities and Exchange Commission regarding that regulator's probe of trading
firms at the Big Board. Avi Schick, a lawyer working for Attorney General Eliot
Spitzer, made that assertion during a pretrial hearing in New York state court
for a civil lawsuit claiming that Mr. Grasso's $187.5 million pay package as Big
Board chief was excessive under New York law covering not-for-profits. (The NYSE
has since become a public company, NYSE Group Inc.) The disclosure could be
useful to Mr. Spitzer in the compensation case if he can use it to suggest that
Mr. Grasso was an inadequate market regulator.
Chad Bray, "Grasso Took Fifth In SEC Testimony, Spitzer Aide Says," The Wall
Street Journal, March 17, 2006; Page C3 ---
Click Here
Ending a bitter public
fight over whether former New York Stock Exchange Chief Executive Dick Grasso
was paid too much, a state appeals court ruled that Mr. Grasso can keep every
penny collected from his $187.5 million multiyear compensation package. The
3-to-1 ruling by the Appellate Division of the New York State Supreme Court was
a vindication for the relentless Mr. Grasso, who was ousted after details of his
lucrative pay were revealed in 2003.
Aaron Lucchetti, "Grasso Wins Court Fight, Can Keep NYSE Pay," The Wall
Street Journal, July 2, 2008; Page A1 ---
http://online.wsj.com/article/SB121492781324819635.html?mod=todays_us_page_one
Can You Train Business School Students To Be
Ethical?
The way we’re doing it now doesn’t work. We need a new way
Question
What is the main temptation of white collar criminals?
Answer from
http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm#01
Jane Bryant Quinn once said something to the effect that, when corporate
executives and bankers see billions of loose dollars swirling above there heads,
it's just too tempting to hold up both hands and pocket a few millions,
especially when colleagues around them have their hands in the air. I tell my
students that it's possible to buy an "A" grade in my courses but none of them
can possibly afford it. The point is that, being human, most of us are
vulnerable to some temptations in a weak moment. Fortunately, none of you
reading this have oak barrels of highly-aged whiskey in your cellars, the
world's most beautiful women/men lined up outside your bedroom door, and
billions of loose dollars swirling about like autumn leaves in a tornado.
Most corporate criminals that regret their actions later confess that the
temptations went beyond what they could resist. What amazes me in this era,
however, is how they want to steal more and more after they already have $100
million stashed. Why do they want more than they could possibly need?
"Can You Train Business School Students To Be
Ethical? The way we’re doing it now doesn’t work. We need a new way," by Ray
Fisman and Adam Galinsky, Slate, September 4, 2012 ---
http://www.slate.com/articles/business/the_dismal_science/2012/09/business_school_and_ethics_can_we_train_mbas_to_do_the_right_thing_.html
A few years ago,
Israeli game theorist
Ariel Rubinstein got the idea of examining how
the tools of economic science affected the judgment and empathy of his
undergraduate students at Tel Aviv University. He made each student the
CEO of a struggling hypothetical company, and tasked them with deciding
how many employees to lay off. Some students were given an algebraic
equation that expressed profits as a function of the number of employees
on the payroll. Others were given a table listing the number of
employees in one column and corresponding profits in the other. Simply
presenting the layoff/profits data in a different format had a
surprisingly strong effect on students’ choices—fewer than half of the
“table” students chose to fire as many workers as was necessary to
maximize profits, whereas three quarters of the “equation” students
chose the profit-maximizing level of pink slips. Why? The “equation”
group simply “solved” the company’s problem of profit maximization,
without thinking about the consequences for the employees they were
firing.
Rubinstein’s
classroom experiment serves as one lesson in the pitfalls of the
scientific method: It often seems to distract us from considering the
full implications of our calculations. The point isn’t that it’s
necessarily immoral to fire an employee—Milton Friedman famously
claimed that the
sole purpose of a company is indeed to maximize profits—but
rather that the students who were encouraged to think of the decision to
fire someone as an algebra problem didn’t seem to think about the
employees at all.
The experiment is
indicative of the challenge faced by business schools, which devote
themselves to teaching management as a science, without always
acknowledging that every business decision has societal repercussions. A
new generation of psychologists is now thinking about how to create
ethical leaders in business and in other professions, based on the
notion that good people often do bad things unconsciously. It may
transform not just education in the professions, but the way we think
about encouraging people to do the right thing in general.
At present, the
ethics curriculum at business schools can best be described as an
unsuccessful work-in-progress. It’s not that business schools are
turning Mother Teresas into
Jeffrey Skillings (Harvard Business School,
class of ’79),
despite some claims to that effect. It’s easy
to come up with examples of rogue MBA graduates who have lied, cheated,
and stolen their ways to fortunes (recently convicted
Raj Rajaratnam is a graduate of the University
of Pennsylvania’s Wharton School of Business; his partner in crime,
Rajat Gupta, is a
Harvard Business School alum). But a huge number of companies are run by
business school grads, and for every Gupta and Rajaratnam there are
scores of others who run their companies in perfectly legal anonymity.
And of course, there are the many ethical missteps by non-MBA business
leaders—Bernie Madoff was educated as a lawyer; Enron’s Ken Lay had a
Ph.D. in economics.
In actuality,
the picture suggested by the data is that
business schools have no impact whatsoever on the likelihood that
someone will cook the books or otherwise commit fraud. MBA programs are
thus damned by faint praise: “We do not turn our students into
criminals,” would hardly make for an effective recruiting slogan.
If it’s too much to expect
MBA programs to turn out Mother Teresas, is there anything that business
schools can do to make tomorrow’s business leaders more likely
to do the right thing? If so, it’s probably not by trying to teach them
right from wrong—moral epiphanies are a scarce commodity by age 25, when
most students start enrolling in MBA programs. Yet this is how business
schools have taught ethics for most of their histories. They’ve often
quarantined ethics into the beginning or end of the MBA education. When
Ray began his MBA classes at Harvard Business School in 1994, the ethics
course took place before the instruction in the “science of management”
in disciplines like statistics, accounting, and marketing. The idea was
to provide an ethical foundation that would allow students to integrate
the information and lessons from the practical courses with a broader
societal perspective. Students in these classes read philosophical
treatises, tackle moral dilemmas, and study moral exemplars such as
Johnson & Johnson CEO James Burke, who took responsibility for and
provided a quick response to the series of deaths from tampered Tylenol
pills in the 1980s.
It’s a mistake to assume
that MBA students only seek to maximize profits—there may be eye-rolling
at some of the content of ethics curricula, but not at the idea that
ethics has a place in business. Yet once the pre-term ethics instruction
is out of the way, it is forgotten, replaced by more tangible and easier
to grasp matters like balance sheets and factory design. Students get
too distracted by the numbers to think very much about the social
reverberations—and in some cases legal consequences—of employing
accounting conventions to minimize tax burden or firing workers in the
process of reorganizing the factory floor.
Business schools are
starting to recognize that ethics can’t be cordoned off from the rest of
a business student’s education. The most promising approach, in our
view, doesn’t even try to give students a deeper personal sense of
mission or social purpose – it’s likely that no amount of indoctrination
could have kept Jeff Skilling from blowing up Enron. Instead, it helps
students to appreciate the unconscious ethical lapses that we commit
every day without even realizing it and to think about how to minimize
them. If finance and marketing can be taught as a science, then perhaps
so too can ethics.
These ethical
failures don’t occur at random – countless experiments in psychology and
economics labs and out in the world have documented the circumstances
that make us most likely to ignore moral concerns – what social
psychologists Max Bazerman and Ann Tenbrusel call our moral
blind spots. These result from numerous
biases that exacerbate the sort of distraction from ethical consequences
illustrated by the Rubinstein experiment. A classic
sequence of studies illustrate how readily
these blind spots can occur in something as seemingly straightforward as
flipping a fair coin to determine rewards. Imagine that you are in
charge of splitting a pair of tasks between yourself and another person.
One job is fun and with a potential payoff of $30; the other tedious and
without financial reward. Presumably, you’d agree that flipping a coin
is a fair way of deciding—most subjects do. However, when sent off to
flip the coin in private, about 90 percent of subjects come back
claiming that their coin flip came up assigning them to the fun task,
rather than the 50 percent that one would expect with a fair coin. Some
people end up ignoring the coin; more interestingly, others respond to
an unfavorable first flip by seeing it as “just practice” or deciding to
make it two out of three. That is, they find a way of temporarily
adjusting their sense of fairness to obtain a favorable outcome.
Jensen Comment
I've always thought that the most important factors affecting ethics were early
home life (past) and behavior others in the work place (current). I'm a believer
in relative ethics where bad behavior is affected by need (such as being swamped
in debt) and opportunity (weak internal controls at work). I've never been
a believer in the effectiveness of teaching ethics in college, although this is
no reason not to teach ethics in college. It's just that the ethics mindset was
deeply affected before coming to college (e.g. being street smart in high
school) and after coming to college (where pressures and temptations to cheat
become realities).
An example of the follow-the-herd ethics
mentality.
If Coach C of the New Orleans Saints NFL football team offered Player X serious
money to intentionally and permanently injure Quarterback Q of an opposing team,
Player X might've refused until he witnessed Players W, Y, and Z being paid to
do the same thing. I think this is exactly what happened when several
players on the defensive team of the New Orleans Saints intentionally injured
quarterbacks for money.
New Orleans Saints bounty scandal ---
http://en.wikipedia.org/wiki/New_Orleans_Saints_bounty_scandal
Question
What is the main temptation of white collar criminals?
Answer from
http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm#01
Jane Bryant Quinn once said something to the effect that, when corporate
executives and bankers see billions of loose dollars swirling above there heads,
it's just too tempting to hold up both hands and pocket a few millions,
especially when colleagues around them have their hands in the air. I tell my
students that it's possible to buy an "A" grade in my courses but none of them
can possibly afford it. The point is that, being human, most of us are
vulnerable to some temptations in a weak moment. Fortunately, none of you
reading this have oak barrels of highly-aged whiskey in your cellars, the
world's most beautiful women/men lined up outside your bedroom door, and
billions of loose dollars swirling about like autumn leaves in a tornado.
Most corporate criminals that regret their actions later confess that the
temptations went beyond what they could resist. What amazes me in this era,
however, is how they want to steal more and more after they already have $100
million stashed. Why do they want more than they could possibly need?
See Bob Jensen's "Rotten to the Core" document at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
The exact quotation from Jane Bryant Quinn at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#MutualFunds
Why white collar crime pays big time even if
you know you will eventually be caught ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
Bob Jensen's threads on professionalism and
ethics ---
http://faculty.trinity.edu/rjensen/Fraud001c.htm
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
September 5, 2012 reply from Paul Williams
Bob,
This is the wrong question
because business schools across all disciplines contained therein are
trapped in the intellectual box of "methodological individualism." In every
business discipline we take as a given that the "business" is not a
construction of human law and, thus of human foible, but is a construction
of nature that can be reduced to the actions of individual persons. Vivian
Walsh (Rationality Allocation, and Reproduction) critiques the neoclassical
economic premise that agent = person. Thus far we have failed in our
reductionist enterprise to reduce the corporation to the actions of other
entities -- persons (in spite of principal/agent theorists claims).
Ontologically corporations don't exist -- the world is comprised only of
individual human beings. But a classic study of the corporation (Diane
Rothbard Margolis, The Managers: Corporate Life in America) shows the
conflicted nature of people embedded in a corporate environment where the
values they must subscribe to in their jobs are at variance with their
values as independent persons. The corporate "being" has values of its own.
Business school faculty, particularly accountics "scientists," commit the
same error as the neoclassical economists, which Walsh describes thusly:
"...if neo-classical theory
is to invest its concept of rational agent with the penumbra of moral
seriousness derivable from links to the Scottish moral philosophers and,
beyond them, to the concept of rationality which forms part of the
conceptual scheme underlying our ordinary language, then it must finally
abandon its claim to be a 'value-free` science in the sense of logical
empiricism (p. 15)." Business, as an intellectual enterprise conducted
within business schools, neglects entirely "ethics" as a serious topic of
study and as a problem of institutional design. It is only a problem of
unethical persons (which, at sometime or another, includes every human being
on earth). If one takes seriously the Kantian proposition that, to be
rationally ethical beings, humans must conduct themselves so as to treat
always other humans not merely as means, but also always as ends in
themselves, then business organization is, by design, unethical. Thus, when
the Israeli students had to confront employees "face-to-face" rather than as
variables in a profit equation, it was much harder for them to treat those
employees as simply disposable means to an end for a being that is merely a
legal fiction. One thing we simply do not treat seriously enough as a worthy
intellectual activity is the serious scrutiny of the values that lay
conveniently hidden beneath the equations we produce. What thoughtful person
could possibly subscribe to the notion that the purpose of life is to
relentlessly increase shareholder wealth? Increasing shareholder value is a
value judgment, pure and simple. And it may not be a particularly good one.
Why would we be surprised that some individuals conclude that "stealing"
from them (they, like the employees without names in the employment
experiment, are ciphers) is not something that one need be wracked with
guilt about. If the best we can do is prattle endlessly on about the "tone
at the top" (do people who take ethics seriously get to the top?), then the
intellectual seriousness which ethics is afforded within business schools is
extremely low. Until we start to appreciate that the business narrative is
essentially an ethical one, not a technical one, then we will continue to
rue the bad apples and ignore how we might built a better barrel.
Paul
September 5, 2012 reply from Bob Jensen
Hi Paul,
Do you think the ethics in government is in better shape, especially given
the much longer and more widespread history of global government corruption
throughout time? I don't think ethics in government is better than ethics in
business from a historical perspective or a current perspective where
business manipulates government toward its own ends with bribes, campaign
contributions, and promises of windfall enormous job benefits for government
officials who retire and join industry?
Government corruption is the name of the game in nearly all nations,
beginning with Russia, China, Africa, South America, and down the list.
Political corruption in the U.S. is relatively low from a global
perspective.
See the attached graph from
http://en.wikipedia.org/wiki/Corruption_%28political%29
Respectfully,
Bob Jensen
"Why Are Some Sectors (Ahem, Finance) So Scandal-Plagued?" by Ben W.
Heineman, Jr., Harvard Business Review Blog, January 10, 2013 ---
Click Here
http://blogs.hbr.org/cs/2013/01/scandals_plague_sectors_not_ju.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
The trouble with crony capitalism isn't capitalism. It's the cronies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#CronyCapitalism
Subprime: Borne of Greed, Sleaze, Bribery, and Lies (including the credit
rating agencies) ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
History of
Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Club Fed Why the government goes easy on corporate crime.---
https://newrepublic.com/article/144969/club-fed-why-government-goes-easy-federal-crime
Corporate Crime Pays Even When You Know You're Going to Be Caught ---
http://faculty.trinity.edu/rjensen//FraudConclusion.htm#CrimePays
"Speed Traders Play Defense Against Michael
Lewis’s Flash Boys," by Matthew Philips, Bloomberg Businessweek,
March 31, 2014 ---
http://www.businessweek.com/articles/2014-03-31/speed-traders-play-defense-to-michael-lewiss-flash-boys?campaign_id=DN033114
In Sunday night’s
60 Minutes interview about
his new book on high-frequency trading—Flash Boys—author Michael
Lewis got right to the point. After a brief lead-in reminding us that
despite the strongest bull market in years, American stock ownership is at a
record low, reporter Steve Kroft asked Lewis for the headline: “Stock
market’s rigged,” Lewis said nonchalantly. By whom? “A combination of stock
exchanges, big Wall Street banks, and high-frequency traders.”
Flash Boys
was published today. Digital versions went live at midnight, so presumably
thousands of speed traders and industry players spent the night plowing
through it. Although the book was announced last year, it’s been shrouded in
secrecy. Its publisher, W. W. Norton,
posted some excerpts briefly
online before taking them down.
Despite a lack of concrete details, word
started getting around a few months ago that Lewis had spent a lot of time
with some of the HFT industry’s most vehement critics, such as
Joe Saluzzi
at Themis Trading. The 60 Minutes
interview only confirmed what many people had suspected for months:
Flash Boys is an unequivocal attack on computerized speed trading.
In the interview, Lewis adhered to the
usual assaults: High-frequency traders have an unfair advantage; they
manipulate markets; they get in front of bigger, slower investors and drive
up the prices they pay to buy a stock. They are, in Lewis’s view, the
consummate middlemen extracting unnecessary rents from a class of everyday
investors who have never been at a bigger disadvantage. This has essentially
been the nut of the
HFT debate over the past five years.
Continued article
The Flash Boys book ---
http://www.amazon.com/s/ref=nb_sb_ss_i_1_7?url=search-alias%3Dstripbooks&field-keywords=flash%20boys%20michael%20lewis&sprefix=Flash+B%2Cstripbooks%2C236
The Kindle Edition is only $9.18
The three segments on the March 30, 2014 hour of
CBS Sixty Minutes were exceptional. The most important to me was an interview
with Michael Lewis on how the big banks and other operators physically laid very
high speed cable between stock exchanges to skim the cream off purchase an sales
of individuals, mutual funds, and pension funds. The sad part is that the
trading laws have a loop hole allowing this type of ripoff.
The fascinating features of this show and a new
book by Michael Lewis include how the skimming operation was detected and how a
new stock exchange was formed to block the skimmers.
Try the revised links below. These are
examples of links that will soon vaporize. They can be used in class
under the Fair Use safe harbor but only for a very short time until you
or your library purchases these and other Sixty Minutes videos.
But the transcripts will are available from CBS
and can be used for free on into the future. Click on the upper menu choice
"Episodes" for links to the transcripts.
Note the revised video links. a menu should appear
to the left that can lead to the other videos currently available for free
(temporarily).
The three segments on the March 30, 2014 hour
of CBS Sixty Minutes were exceptional. The most important to me was an
interview with Michael Lewis on how the big banks and other operators
physically laid very high speed cable between stock exchanges to skim the
cream off purchase an sales of individuals, mutual funds, and pension funds.
The sad part is that the trading laws have a loop hole allowing this type of
ripoff.The fascinating features of
this show and a new book by Michael Lewis include how the skimming operation
was detected and how a new stock exchange was formed to block the skimmers.
Free access to the video is very limited, so
take advantage of the following link now:
Lewis explains how the stock market is rigged ---
http://www.cbsnews.com/videos/is-the-us-stock-market-rigged/
The big question remaining is why it is
taking the SEC so long to put an end to this type of skimming?
"2009 Securities Litigation Study," by
PricewaterhouseCoopers (PwC), May 6, 2010 ---
http://snipurl.com/pwc050610
Summary:
The financial crisis continued to dominate the litigation landscape in 2009
- although to a lesser degree than in 2008, according to the annual PwC
Securities Litigation Study. Governments worldwide remained focused on
regulatory overhaul, stimulus plans and investigations into the "who, what,
when, where, why, and how" of alleged wrongdoings related to the crisis.
This is an annual PwC study.
Bob Jensen's threads on securities frauds ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's threads on auditing firm
litigation ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"The Man Who Busted the ‘Banksters’," Smithsonian, November 29,
2011 ---
http://blogs.smithsonianmag.com/history/2011/11/the-man-who-busted-the-%E2%80%98banksters%E2%80%99/
Three years removed from the stock market crash of
1929, America was in the throes of the Great Depression, with no recovery on
the horizon. As President Herbert Hoover reluctantly campaigned for a second
term, his motorcades and trains were pelted with rotten vegetables and eggs
as he toured a hostile land where shanty towns erected by the homeless had
sprung up. They were called “Hoovervilles,” creating the shameful images
that would define his presidency. Millions of Americans had lost their jobs,
and one in four Americans lost their life savings. Farmers were in ruin, 40
percent of the country’s banks had failed, and industrial stocks had lost 80
percent of their value.
With unemployment hovering at nearly 25 percent in
1932, Hoover was swept out of office in a landslide, and the newly elected
president, Franklin Delano Roosevelt, promised Americans relief. Roosevelt
had decried “the ruthless manipulation of professional gamblers and the
corporate system” that allowed “a few powerful interests to make industrial
cannon fodder of the lives of half the population.” He made it plain that he
would go after the “economic nobles,” and a bank panic on the day of his
inauguration, in March 1933, gave him just the mandate he sought to attack
the economic crisis in his “First 100 Days” campaign. “There must be an end
to a conduct in banking and in business which too often has given to a
sacred trust the likeness of callous and wrongdoing,” he said.
Ferdinand Pecora was an an unlikely answer to what
ailed America at the time. He was a slight, soft-spoken son of Italian
immigrants, and he wore a wide-brimmed fedora and often had a cigar dangling
from his lips. Forced to drop out of school in his teens because his father
was injured in a work-related accident, Pecora ultimately landed a job as a
law clerk and attended New York Law School, passed the New York bar and
became one of just a handful of first-generation Italian lawyers in the
city. In 1918, he became an assistant district attorney. Over the next
decade, he built a reputation as an honest and tenacious prosecutor,
shutting down more than 100 “bucket shops”—illegal brokerage houses where
bets were made on the rise and fall prices of stocks and commodity futures
outside of the regulated market. His introduction to the world of fraudulent
financial dealings would serve him well.
Just months before Hoover left office, Pecora was
appointed chief counsel to the U.S. Senate’s Committee on Banking and
Currency. Assigned to probe the causes of the 1929 crash, he led what became
known as the “Pecora commission,” making front-page news when he called
Charles Mitchell, the head of the largest bank in America, National City
Bank (now Citibank), as his first witness. “Sunshine Charley” strode into
the hearings with a good deal of contempt for both Pecora and his
commission. Though shareholders had taken staggering losses on bank stocks,
Mitchell admitted that he and his top officers had set aside millions of
dollars from the bank in interest-free loans to themselves. Mitchell also
revealed that despite making more than $1 million in bonuses in 1929, he had
paid no taxes due to losses incurred from the sale of diminished National
City stock—to his wife. Pecora revealed that National City had hidden bad
loans by packaging them into securities and pawning them off to unwitting
investors. By the time Mitchell’s testimony made the newspapers, he had been
disgraced, his career had been ruined, and he would soon be forced into a
million-dollar settlement of civil charges of tax evasion. “Mitchell,” said
Senator Carter Glass of Virginia, “more than any 50 men is responsible for
this stock crash.”
The public was just beginning to get a taste for
the retribution that Pecora was dishing out. In June 1933, his image
appeared on the cover of Time magazine, seated at a Senate table, a cigar in
his mouth. Pecora’s hearings had coined a new phrase, “banksters” for the
finance “gangsters” who had imperiled the nation’s economy, and while the
bankers and financiers complained that the theatrics of the Pecora
commission would destroy confidence in the U.S. banking system, Senator
Burton Wheeler of Montana said, “The best way to restore confidence in our
banks is to take these crooked presidents out of the banks and treat them
the same as [we] treated Al Capone.”
President Roosevelt urged Pecora to keep the heat
on. If banks were worried about the hearings destroying confidence,
Roosevelt said, they “should have thought of that when they did the things
that are being exposed now.” Roosevelt even suggested that Pecora call none
other than the financier J.P. Morgan Jr. to testify. When Morgan arrived at
the Senate Caucus Room, surrounded by hot lights, microphones and dozens of
reporters, Senator Glass described the atmosphere as a “circus, and the only
things lacking now are peanuts and colored lemonade.”
Continued in article
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's American History of Fraud ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
A New Teaching Module for Ethics Courses: Channel Checking and
Trading
Question
When should channel checking (e.g., traders bribing employees of trade channel
suppliers and distributors) and channel trading (e.g., trading by Minnie Pearl
in a supplier's Accounts Receivable Department in securities or derivative
securities of customers)?
"Who’s Checking Your Channel?" by Bruce
Carton, Securities Docket, December 8, 2010
Two months ago I declared
September 2010 “Insider Trading Month” for the Securities and Exchange
Commission’s sudden burst of enforcement activity on that front. Then came
November, and boy, did enforcement go off the charts.
The extraordinary activity
of prosecutors and regulators that month set Wall Street traders abuzz, but
compliance officers and other executives at public companies should also
take careful notice. And what’s so different about the latest round of
insider-trading cases? Investigators are focusing on the flow of
supply-chain information. That includes a lot more people than the gossipy
traders working in lower Manhattan.
On November 20, reports
circulated that both the Justice Department and the SEC were preparing
insider-trading cases against a long list of Wall Street entities:
consultants, investment bankers, hedge fund and mutual fund traders, and
analysts. According to the Wall Street Journal, the charges would allege “a
culture of pervasive insider trading in U.S. financial markets, including
new ways non-public information is passed to traders through experts tied to
specific industries or companies.” Two days later, the FBI raided the
offices of three hedge funds as part of the investigation, with more raids
expected.
Portions of the
investigation are fairly standard—hedge funds tipped off to pending merger
deals, for example; that’s nothing new under the sun. But another wrinkle
has equity research analysts on red alert. Regulators are now thought to be
probing whether an analyst practice commonly known as “channel checking”
constitutes illegal insider trading. If so, the public companies whose
information is in play could soon be pulled into the whirlwind.
One company where channel
checks have reportedly now become a widely used and highly relied-upon
source of information for traders is Apple.
In a channel check, analysts
try to glean information about a company’s production via interviews with
the company’s suppliers, distributors, contract manufacturers, and sometimes
even current company employees. The goal is to piece together a better
picture of the company’s performance. Apple, always secretive about its
products, is an example of a company where channel checking is reportedly
common. Indeed, analyst reports based on channel checks routinely cause
Apple stock to dip or surge.
As supply-chain expert
Pradheep Sampath of GXS noted on his blog, these interviews typically occur
without the target company’s permission or participation. Sampath adds that:
Data collected from these
sources is seemingly innocuous when viewed separately. When pieced together
however, these data points from a company’s supply chain can deliver
startling insights into revenue and future earnings of a company—much in
advance of such information becoming publicly available. This practice
becomes more pronounced for companies such as Apple that are extremely
guarded and secretive about information they make publicly available.
Reasons abound to question
whether the Justice Department or the SEC will ever decide to bring a
channel-checking case. First, the information gleaned from any one
individual in the channel is unlikely to be material by itself. For example,
the maker of screens for Apple’s iPhones may reveal that sales of those
screens to Apple ticked up in December. But given that Apple has so many
revenue streams and just as many channels for those streams, this one detail
from our screen-maker is not likely to be material by itself.
Only when that information
is pieced together with many other pieces of information to build a “mosaic”
does a larger picture emerge that might arguably be material information
about the company. This is, in effect, what equity research analysts are
paid to do. But as the U.S. Supreme Court stated in the SEC’s ultimately
unsuccessful insider-trading case against research analyst Raymond Dirks,
analysts play an important role in preserving a healthy market, and imposing
“an inhibiting influence” on that role may not be desirable.
Nonetheless, if prosecutors
are now scrutinizing analysts’ practices of gathering information from a
public company’s supply chain—which have a long, established history—that
presents an important opportunity for public companies to re-examine their
own policies and procedures concerning how such information is tracked and
controlled. Here are some questions that public companies will want to
consider:
1. Are analysts interested
in, and attempting to obtain, information from our supply-chain?
If not, then channel checks
may be more of a back-burner issue for you. If yes, press on.
2. As part of our agreements
with suppliers, distributors, and manufacturers, do we have confidentiality
or non-disclosure agreements (NDAs) in place?
Implicit in any enforcement
action or prosecution that might result from the ongoing channel-check probe
is the idea that the information in question is confidential and a company’s
suppliers should not be sharing it. Suppliers speaking to Apple analysts,
for example, may well be violating NDA agreements with Apple and allowing
analysts to access confidential information. That doesn’t differ much from
committing insider trading by obtaining information from inside the company
itself.
If the SEC and prosecutors
now view supply-chain information as material, non-public information that
can support an insider-trading case, then companies should take a fresh look
at how they try to prevent the misuse of such information.
Jacob Frenkel, a former SEC
enforcement attorney now with law firm Shulman, Rogers, Gandal, Pordy &
Ecker, says that weak corporate controls over supply chains has been a
looming issue and was bound to become a compliance headache sooner or later.
Frenkel says companies should adopt rules governing the conduct of their
business partners, including what information they may share.
3. If we do have
confidentiality agreements or NDAs in place with suppliers, distributors,
and manufacturers, are they being violated? And are we seeking to enforce
them?
To continue the Apple
example: If traders routinely receive and act upon analyst reports based on
supply chain interviews about the company, one wonders whether any NDAs with
suppliers are in place or enforced. (Regulators would certainly be wondering
about it.) For the record, Apple told the Wall Street Journal that the
company does not release that type of information about its production, and
declined to comment further.
Consider this hypothetical:
Company X’s supply-chain
information is material and non-public, meaning Company X or a “person
acting on its behalf” could not selectively disclose it to one analyst under
Regulation FD without making a public disclosure of that same information;
Company X is fully aware that its suppliers are providing supply-chain
information regularly to select analysts; and Company X either (a) does not
impose an NDA on its suppliers, or (b) does impose an NDA but never enforces
it. Is the supplier’s disclosure of information to select analysts, with
Company X’s knowledge, a “back door” violation of Regulation FD (or at least
the spirit of Regulation FD)?
4. Are we permitting current
company employees to hold discussions with analysts or traders as industry
“consultants”?
Law professor Peter Henning
noted in a recent article that many employees are providing information as
consultants do so openly, and “it may even be that these consultants were
authorized by corporate employers—or it was at least tolerated as a cost of
keeping talented employees.” Given the risk that an employee/consultant may
end up talking about the company, however, Henning says it is an
“interesting issue” why a company would allow one of its employees to
consult in this fashion.
Given the SEC’s intense
focus on insider trading, there is certainly more to come on this front, so
keep an eye on developments in the coming months. And keep an ear to the
ground for those whispers from your suppliers, distributors, and contract
manufacturers.
Originally
published in Compliance Week. Reprinted with
permission. © 2010 Haymarket Media, Inc. All Rights
Reserved. Compliance Week can be found at
http://www.complianceweek.com.
Jensen Comment
If it is not illegal to pay Joe on the loading dock for information, this can
get terribly complicated. Joe might seek work on the loading dock for the sole
purpose of eliciting bribes from traders and hedge fund managers. Suppose Joe
gets paid by Trader A to slip information on the types of components being
shipped to an iPad assembly plant such as information that iPad is shipping in
millions of USB ports. Further suppose Trader B then pays Joe to slip Trader A
false information such as falsely claiming iPad is shipping in millions of USB
ports.
As another scenario suppose that Minnie Pearl in the Accounting Department of
a USB port manufacturer works in the Accounts Receivable Department. She sees a
lot of her employer's billings go out to the iPad plant --- I think you get the
picture of how Minnie Pearl donned a new straw hat, moved to Nashville, and
bought an expensive acreage that once belonged to another woman named Minnie
Pearl.
The fraud hazards in channel probing are indeed complicated and very
difficult to regulate.
Bob Jensen threads on dirty rotten frauds are
at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"The Triumph of Propaganda," by Nemo Almen, American Thinker,
January 2, 2011 ---
http://www.americanthinker.com/2011/01/the_triumph_of_propaganda.html
Does anyone
remember what happened on Christmas Eve last year? In one of the most
expensive Christmas presents ever, the government
removed the $400 billion limit on their Fannie and
Freddie guaranty. This act increased taxpayer liabilities by
six trillion dollars; however, the news was lost
in the holiday cheer. This is one instance in a broader campaign to
manipulate the public perception, gradually depriving us of independent
thought.
Consider another example: what news story broke on April 16, 2010? Most of
us would say the SEC's
lawsuit against Goldman Sachs. Goldman is the
market leader in "ripping the client's face off," in this instance creating
a worst-of-the-worst pool of securities so Paulson & Co could bet against
it. Many applauded the SEC for this action. Never mind that singling out
one vice president (the "Fabulous Fab") and one instance of fraud is like
charging Al Capone with tax evasion. The dog was wagged.
Very
few caught the real news that day, namely the damning
complicity of the SEC in the Stanford Ponzi
scheme. Clearly, Stanford was the bigger story, costing thousands of
investors
billions of dollars while Goldman later settled
for half a
billion. Worse, the SEC knew about Stanford since
1997, but instead of shutting it down, people left the SEC to
work
for Stanford. This story should have caused
widespread outrage and reform of the SEC; instead it was buried in the back
pages and lost to the public eye.
Lest we
think the timing of these was mere coincidence, the Goldman lawsuit was
settled on July 15, 2010, the same day the financial reform package
passed. The government threw Goldman to the
wolves in order to hide its own shame. When the government had its desired
financial reforms, it let Goldman settle. These examples demonstrate a
clear pattern of manipulation. Unfortunately, our propaganda problem runs
far deeper than lawsuits and Ponzi schemes.
Here is a
more important question: which companies own half of all
subprime and
Alt-A (liar loan) bonds? Paul Krugman writes that
these companies were "mainly out of the picture during the housing bubble's
most feverish period, from 2004 to 2006. As a result, the agencies played
only a minor role in the epidemic of bad lending."[iii] This phrase is
stupefying. How can a pair of companies comprise half of a market and yet
have no major influence in it? Subprime formed the core of the financial
crisis, and Fannie and Freddie (the "agencies") formed the core of the
subprime market. They were not "out of the picture" during the subprime
explosion, they were the picture. The fact that a respectable Nobel
prize-winner flatly denies this is extremely disturbing.
Amazingly, any attempt to hold the government accountable for its role in
the subprime meltdown is dismissed as right-wing
propaganda. This dismissal is left-wing
propaganda. It was the government that initiated securitization as a tool
to dispose of
RTC assets. Bill Clinton ducks all
responsibility, ignoring how his administration imposed arbitrary
quotas on any banks looking to merge as Attorney
General Janet Reno "threatened legal action against lenders whose racial
statistics raised her suspicions."[iv] Greenspan fueled the rise of
subprime derivatives by lowering rates,[v] lowering reserves,[vi] and
beating down reasonable
opposition. And at the center of it all were
Fannie and Freddie
bribing officials, committing
fraud,
dominating private-sector
competition, and expanding to a
six-trillion-dollar debacle. The fact that these facts are dismissed as
propaganda shows just how divorced from reality our ‘news' has become. Yes,
half of all economists are employed by the
government, but this is no reason to flout one's
professional responsibility. As a nation we need to consider all the facts,
not just those that are politically expedient.
Continued in article
Nemo Almen is the author of
The Last Dodo: The Great Recession and our Modern-Day Struggle for Survival.
"The Stanford Sentence SEC examiners first
flagged Stanford way back in the 1990s," The Wall Street Journal,
June 15, 2012 ---
http://professional.wsj.com/article/SB10001424052702303734204577466672525877312.html?mg=reno64-wsj#mod=djemEditorialPage_t
Convicted Ponzi schemer R. Allen Stanford was
sentenced Thursday to 110 years in federal prison for his $7 billion fraud.
Stanford victimized thousands of individual investors to fund a lifestyle of
private jets and island vacation homes. Now the question is whether there will
be anything left at all for these victims once authorities in jurisdictions
around the world finish sifting through the wreckage.
Stanford "stole more than millions. He stole our
lives as we knew them," said victim Angela Shaw, according to Reuters.
Certificates of deposit issued by a Stanford bank in Antigua promised sky-high
returns but succeeded only in destroying the savings of middle-class retirees.
More than three years after U.S. law enforcement shut down the Stanford outfit,
victims have recovered nothing.
A receiver appointed by a federal court, Ralph
Janvey, has collected $220 million from the remains of Stanford's businesses but
has already used up close to $60 million in fees for himself and other lawyers,
accountants and professionals, plus another $52 million to wind down the
Stanford operation.
And then there's the Securities and Exchange
Commission, which didn't charge Stanford for years even after its own examiners
raised red flags as early as the 1990s. The SEC has lately pursued a bizarre
attempt at blame-shifting, trying to get the Securities Investor Protection
Corporation to cover investor losses. Even the SEC must know that SIPC doesn't
guarantee paper issued by banks in Antigua—or anywhere else for that matter.
SEC enforcers should instead focus on catching the
next Allen Stanford. Careful investors should expect that they won't.
"Victims Of A $7 Billion Ponzi Scheme Are Still Penniless 5 Years Later,"
by Scott Cohn, CNBC via Business Insider, February 18, 2014
http://www.businessinsider.com/victims-allen-stanford-ponzi-scheme-still-penniless-2014-2
Five years after learning they were victims of a $7
billion Ponzi scheme, investors in the Stanford Financial Group say they
feel abandoned, even though their losses rival those in the Madoff scam that
was revealed two months earlier.Unlike the
Madoff case, in which a court-appointed trustee has said he is well on his
way to recovering all of the investors' principal—estimated at $17.5
billion—Stanford victims have recovered less than one penny on the dollar
since the Securities and Exchange Commission sued the firm and a court
placed it in receivership on Feb. 17, 2009.
"I do have to say the Stanford victims do feel like
the stepchildren in the Ponzi world," said Angela Shaw Kogutt, who estimates
her family lost $4.5 million in the scam. Shaw heads the Stanford Victims
Coalition, which has been trying for years to drum up support in Washington.
Some 28,000 investors—10 times the number of direct
investors in the Madoff case—bought certificates of deposit from Stanford
International Bank in Antigua, which was owned by Texas financier R. Allen
Stanford. Stanford's U.S. sales force had promised the investors—many of
them retired oil workers—that the CDs were at least as safe as instruments
from a U.S. bank. But a jury later found most of the clients' money financed
Stanford's lavish lifestyle instead of the high-grade securities and real
estate it was supposed to.
Stanford, who portrayed himself as a self-made
billionaire, exuded the American Dream. He claimed to have built his global
financial empire from a family insurance business in his rural hometown of
Mexia, Texas. A generous contributor to politicians of all stripes, Stanford
effectively took over the financial sector in Antigua while nurturing rumors
of his unique connections.
But asked directly by CNBC in 2009 about
suggestions he was a government informant, Stanford demurred.
"You talkin' about the CIA?" he asked. "I'm not
gonna talk about that."
On the eve of the fifth anniversary of the scandal,
Dallas attorney Ralph Janvey, appointed by a federal judge to head the
receivership and round up assets for the victims, said he feels the victims'
pain.
"Even though my team and I have worked hard and
made much progress over the last five years, the process of unwinding the
fraud and the pace of recovering money have been frustratingly slow," Janvey
wrote in an
open letter to "all those affected by the Stanford
fraud."
In the Stanford case, progress is relative.
Last April, Janvey won court approval to begin
distributing $55 million to some investors. In the letter, he said $25
million has already been distributed, another $5.5 million could be paid
this month and another $18 million in Stanford assets from Canada could be
distributed this year as well.
Continued in article
"The 11 Most Shocking Insider Trading
Scandals Of The Past 25 Years," Business Insider, November 4, 2010
---
http://www.businessinsider.com/biggest-insider-trading-scandals-2010-11#ixzz14WznUXEr
1986: Ivan Boesky, Dennis Levine and the
fall of Drexel Burnham Lambert
2001: Martha Stewart and ImClone (I think
this is less about what she did than who she was)
2001: Art Samberg's Illegal Microsoft Trades
2001: Rene Rivkin Convicted For Insider
Trading That Netted Him Only $346
2005: Joseph Nacchio and Qwest
Communications
2006: Livedoor and Murakami, The Enron Of
Japan
2007: Mitchel Guttenberg, David Tavdy and
Erik Franklin
2007: Randi and Christopher Collotta
2009: The Galleon Mess
2010: Some Very Wily Brothers - Charles and
Sam Wyly And An Alleged $550 M Scheme
2010: Insider Trading By French Doc Might
Have Helped FrontPoint Avoid Huge Losses
American
History of Fraud ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
"The Difficulty of Proving Financial Crimes,"
by Peter J. Henning, DealBook, December 13, 2010 ---
http://blogs.law.harvard.edu/corpgov/2010/12/20/why-do-cfos-become-involved-in-material-accounting-manipulations/
The prosecution revolved
around the recognition of revenue from Network Associates’ sales of computer
security products to a distributor through what is called “sell-in”
accounting rather than the “sell-through” method. Leaving aside the
accounting minutiae, prosecutors asserted that Mr. Goyal chose “sell-in”
accounting as a means to overstate revenue from the sales and did not
disclose complete information to the company’s auditors about agreements
with the distributor that could affect the amount of revenue generated from
the transactions.
The line between aggressive
accounting and fraud is a thin one, involving the application of unclear
rules that require judgment calls that may turn out to be incorrect in
hindsight. While Mr. Goyal was responsible as the chief financial officer
for adopting an accounting method that likely enhanced Network Associates’
revenue, the problem with the securities fraud theory was that prosecutors
did not introduce evidence that the “sell-in” method was improper under
Generally Accepted Accounting Principles. And even if it was, the court
pointed out lack of evidence that that this accounting method had a
“material” impact on Network Associates’ revenue, which must be shown to
prove fraud.
A more significant problem
for prosecutors was the absence of concrete proof that Mr. Goyal intended to
defraud or that he sought to mislead the auditors. The Court of Appeals for
the Ninth Circuit found that the “government’s failure to offer any evidence
supporting even an inference of willful and knowing deception undermines its
case.”
The court rejected the
proposition that an executive’s knowledge of accounting and desire to meet
corporate revenue targets can be sufficient to establish the intent to
commit a crime. The court stated, “If simply understanding accounting rules
or optimizing a company’s performance were enough to establish scienter,
then any action by a company’s chief financial officer that a juror could
conclude in hindsight was false or misleading could subject him to fraud
liability without regard to intent to deceive. That cannot be.”
The court further explained
that an executive’s compensation tied to the company’s performance does not
prove fraud, stating that such “a general financial incentive merely
reinforces Goyal’s preexisting duty to maximize NAI’s performance, and his
seeking to meet expectations cannot be inherently probative of fraud.”
Don’t be surprised to see
the court’s statements about the limitations on corporate expertise and
financial incentives as proof of intent quoted with regularity by defense
lawyers for corporate executives being investigated for their conduct
related to the financial meltdown. The opinion makes the point that just
being at the scene of financial problems alone is not enough to show
criminal intent.
If the Justice Department
decides to try to hold senior corporate executives responsible for suspected
financial chicanery or misleading statements that contributed to the
financial meltdown, the charges are likely to be similar to those brought
against Mr. Goyal, requiring proof of intent to defraud and to mislead
investors, auditors, or the S.E.C.
The intent element of the
crime is usually a matter of piecing together different tidbits of evidence,
such as e-mails, internal memorandums, public statements and the
recollection of participants who attended meetings. Connecting all those
dots is not an easy task, as prosecutors learned in the case against two
former Bear Stearns hedge fund managers when e-mails proved to be at best
equivocal evidence of their intent to mislead investors, resulting in an
acquittal on all counts.
The collapse of Lehman
Brothers raises issues about whether prosecutors could show criminal conduct
by its executives. The bankruptcy examiner’s report highlighted the firm’s
use of the so-called “Repo 105” transactions to make its balance sheet look
healthier than it was each quarter, which could be the basis for criminal
charges. But the appeals court opinion highlights how great the challenge
would be to establish a Lehman executive’s knowledge of improper accounting
or the falsity of statements because just arguing that a chief executive or
chief financial officer had to be aware of the impact of the transactions
would not be enough to prove the case.
The same problems with
proving a criminal case apply to other companies brought down during the
financial crisis, like Fannie Mae, Freddie Mac and American International
Group. Many of the decisions that led to these companies’ downfall were at
least arguably judgment calls made with no intent to defraud, short-sighted
as they might have been. Disclosures to regulators and auditors, and public
statements to shareholders, are rarely couched in definitive terms, so
proving that a statement was in fact false can be difficult, and then
showing knowledge of its falsity even more daunting.
In a concurring opinion in
the Goyal case, Chief Judge Alex Kozinski bemoaned the use of the criminal
law for this type of conduct, stating that this prosecution was “one of a
string of recent cases in which courts have found that federal prosecutors
overreached by trying to stretch criminal law beyond its proper bounds.”
Despite the public’s desire
to see some corporate executives sent to jail for their role in the
financial meltdown, the courts will hold the government to the requirement
of proof beyond a reasonable doubt and not simply allow the cry for
retribution to lead to convictions based on high compensation and presiding
over a company that sustained significant losses.
Continued in article
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Absolutely Must-See CBS Sixty Minutes Videos
You, your students, and the world in general really should repeatedly study the
following videos until they become perfectly clear!
Two of them are best watched after a bit of homework.
Video 1
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Then Watch Video 1 at
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of
the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals)
---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March
14. Both videos feature one of my favorite authors of all time, Michael Lewis,
who hhs been writing (humorously with tongue in cheek) about Wall Street
scandals since he was a bond salesman on Wall Street in the 1980s. The other
person featured on in these videos is a one-eyed physician with Asperger
Syndrome who made hundreds of millions of dollars anticipating the collapse of
the CDO markets while the shareholders of companies like Merrill Lynch, AIG,
Lehman Bros., and Bear Stearns got left holding the empty bags.
The major lessons of videos 2 and 3 went over
the head of my wife. I think that viewers need to do a bit of homework in order
to fully appreciate those videos. Here's what I recommend before viewing Videos
2 and 3 if you've not been following details of the 2008 Wall Street collapse
closely:
This is not
necessary to Videos 2 and 3, but to really appreciate what suckered the Wall
Street Banks into spreading the poison, you should read about how they all
used the same risk diversification mathematical function --- David Li's
Gaussian Copula Function:
Can
the 2008
investment banking failure be traced to a math error?
Recipe for
Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For
five years, Li's formula, known as a
Gaussian copula function, looked
like an unambiguously positive breakthrough, a piece of financial technology
that allowed hugely complex risks to be modeled with more ease and accuracy
than ever before. With his brilliant spark of mathematical legerdemain, Li
made it possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His
method was adopted by everybody from bond investors and Wall Street banks to
ratings agencies and regulators. And it became so deeply entrenched—and was
making people so much money—that warnings about its limitations were largely
ignored.
Then the model fell
apart." The article goes on to show that correlations are at the heart of
the problem.
"The
reason that ratings agencies and investors felt so safe with the triple-A
tranches was that they believed there was no way hundreds of homeowners
would all default on their loans at the same time. One person might lose his
job, another might fall ill. But those are individual calamities that don't
affect the mortgage pool much as a whole: Everybody else is still making
their payments on time.
But not
all calamities are individual, and tranching still hadn't solved all the
problems of mortgage-pool risk. Some things, like falling house prices,
affect a large number of people at once. If home values in your neighborhood
decline and you lose some of your equity, there's a good chance your
neighbors will lose theirs as well. If, as a result, you default on your
mortgage, there's a higher probability they will default, too. That's called
correlation—the degree to which one variable moves in line with another—and
measuring it is an important part of determining how risky mortgage bonds
are."
I would highly
recommend reading the entire thing that gets much more involved with the
actual formula etc.
The “math error” might
truly be have been an error or it might have simply been a gamble with what
was perceived as miniscule odds of total market failure. Something similar
happened in the case of the trillion-dollar disastrous 1993 collapse of Long
Term Capital Management formed by Nobel Prize winning economists and their
doctoral students who took similar gambles that ignored the “miniscule odds”
of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question
is whether the failure is ignorance in model building or risk taking using
the model?
- You should understand how the Wall Street
Banks used the big credit rating agencies to give AAA ratings to sell CDO
bonds that should've instead been rated as junk bonds. Michael Lewis in
Video 2 seems to think the credit rating agencies were just naive and were
manipulated by the Wall Street bankers. I'm more inclined to think the CRAs
were knowingly and greedily part of the frauds ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
CRA ---
http://en.wikipedia.org/wiki/Credit_rating_agency
- You should also understand what a credit
default swap (CDS) is and how Video 2 above keeps calling it unregulated
credit "insurance." Essentially, this is how some banks, particularly
Goldman Sachs was "insuring" against the value collapse of the poisoned CDOs
they were creating and selling. The "insurance" company brokering the AIG
credit default swaps was AIG.
CDS ---
http://en.wikipedia.org/wiki/Credit_default_swap
Here's how they worked ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
- Understand how some Wall Street Banks were
better connected in the Treasury Department and Federal Reserve than other
banks. In particular, Goldman Sachs alumni were practically in charge while
Hank
Paulson (former Goldman Sachs CEO) was U.S. Treasury Secretary. Why did
Paulson save Goldman Sachs and let others watch their shareholders get wiped
out like Lehman Bros., Bear Stearns, Merrill Lynch, etc.? Understand why
saving Goldman Sachs with TARP money entailed saving AIG since saving AIG
was crucial to paying off the CDS insurance.
- For the above three videos it is not
necessary to understand the lack of professionalism (at best) among the bank
auditors that never provided any warning that thousands of banks that failed
had badly underestimated bad debts and overvalued poisoned loan portfolios.
The above videos do not get into the failings of the CPA auditors in this
regard, but you can read about these failings at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
For more on the inside track of all of this I
highly recommend Janet Tavakili's great book entitled Dear Mr. Buffett
(Wiley, 2009). Videos 1-3 will help you understand some of the technicalities in
her fantastic and very depressing book.
Here are some of the take-aways from the three
CBS videos above:
- The root cause of the 2008 meltdown of Wall
Street was really the failings on Main Street where the poison was first
added to mortgages by Main Street brokers who were willing to broker
mortgages (including re-financings) that were bound to be defaulted. Note
that the problem was not just in brokering mortgages for poor people
(Barney's Rubble). Poisoned mortgages were also being written for higher
income people who were borrowing beyond their means for those four-car
garage dream houses with swimming pools and marble floors. In other words
the root cause was the ability to broker a poisoned mortgage and then sell
it to Freddie Mack, Fannie Mae, and the Wall Street Banks.
- The next cause of the 2008 meltdown was
David Li's risk diversification formula that all the Wall Street banks were
using on the theory that default risk of mortgage investments could be
diversified by crumbling mortgage cookies into crumbs that were reassembled
into thousands of CDOs (each CDO having only a small crumble of each
mortgage's poison). With the blessings of credit rating agencies, these CDO
bonds were then sold as AAA-rated when in fact they were worse than junk.
- Videos 2 and 3 above stress how the
underlying cause of allowing a one-eyed physician with Asperger Syndrome
make hundreds of millions dollars by detecting the collapse of the CDO
values way in advance of the Wall Street pros is that the Wall Street pros
were paid not to look for the CDO risks. And the bank CDO sellers who
perhaps did understand the risks were willing to screw their eimployers
(such as Lehman, Bear Stearnes, etc.) because it was so easy to steal
hundreds of millions from these employers who were even willing and still
are willing to pay them bonuses in spite of their thefts.
- After the government bailed them out, the
Wall Street banks that survived because of the government's bailout are
still paying out billions in bonuses. One of my favorite quotes in Video 2
goes something like:
"If Goldman does not pay its best people billions in bonuses they will quit
and go to JP Morgan, and if JP Morgan does not pay its best people billions
in bonuses they will quit and go to Goldman." Meanwhile the taxpayers got
screwed out of nearly a trillion dollars.
- Video 2 leaves us with the impression that
Wall Street is no longer a value-added part of U.S. economy. The TARP in
reality is truly the Greatest Swindle in the
History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Meanwhile the surviving swindlers and their credit rating agencies and their
auditors are still thriving as if nothing has happened. Opps! I forgot that
the credit rating agencies and auditing firms still have some multi-billion
shareholder lawsuits pending that do threaten their survival. But a lot of
big swindlers still have their yachts thanks to Hank and Ben and Tim.
I highly recommend the outstanding and often
humorous books of both Michael Lewis and Frank Partnoy.
My timeline of these books and the scandals they write about can be found at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Related CBS Sixty Minutes videos are as
follows:
I also recommend watching all the David
Walker videos on YouTube.
Watch them and weep.
Oil and Water Must Read: Economists
versus Criminologists
:"Why the ‘Experts’ Failed to See How Financial Fraud Collapsed the Economy,"
by "James K. Galbraith, Big Picture, June 2, 2010 ---
http://www.ritholtz.com/blog/2010/06/james-k-galbraith-why-the-experts-failed-to-see-how-financial-fraud-collapsed-the-economy/
The following is the text of a James K.
Galbraith’s written statement to members of the Senate Judiciary Committee
delivered this May. Original
PDF text is here.
Chairman Specter, Ranking
Member Graham, Members of the Subcommittee, as a former member of the
congressional staff it is a pleasure to submit this statement for your
record.
I write to you from a
disgraced profession. Economic theory, as widely taught since the 1980s,
failed miserably to understand the forces behind the financial crisis.
Concepts including “rational expectations,” “market discipline,” and the
“efficient markets hypothesis” led economists to argue that speculation
would stabilize prices, that sellers would act to protect their reputations,
that caveat emptor could be relied on, and that widespread fraud therefore
could not occur. Not all economists believed this – but most did.
Thus the study of financial
fraud received little attention. Practically no research institutes exist;
collaboration between economists and criminologists is rare; in the leading
departments there are few specialists and very few students. Economists have
soft- pedaled the role of fraud in every crisis they examined, including the
Savings & Loan debacle, the Russian transition, the Asian meltdown and the
dot.com bubble. They continue to do so now. At a conference sponsored by the
Levy Economics Institute in New York on April 17, the closest a former Under
Secretary of the Treasury, Peter Fisher, got to this question was to use the
word “naughtiness.” This was on the day that the SEC charged Goldman Sachs
with fraud.
There are exceptions. A
famous 1993 article entitled “Looting: Bankruptcy for Profit,” by George
Akerlof and Paul Romer, drew exceptionally on the experience of regulators
who understood fraud. The criminologist-economist William K. Black of the
University of Missouri-Kansas City is our leading systematic analyst of the
relationship between financial crime and financial crisis. Black points out
that accounting fraud is a sure thing when you can control the institution
engaging in it: “the best way to rob a bank is to own one.” The experience
of the Savings and Loan crisis was of businesses taken over for the explicit
purpose of stripping them, of bleeding them dry. This was established in
court: there were over one thousand felony convictions in the wake of that
debacle. Other useful chronicles of modern financial fraud include James
Stewart’s Den of Thieves on the Boesky-Milken era and Kurt Eichenwald’s
Conspiracy of Fools, on the Enron scandal. Yet a large gap between this
history and formal analysis remains.
Formal analysis tells us
that control frauds follow certain patterns. They grow rapidly, reporting
high profitability, certified by top accounting firms. They pay exceedingly
well. At the same time, they radically lower standards, building new
businesses in markets previously considered too risky for honest business.
In the financial sector, this takes the form of relaxed – no, gutted –
underwriting, combined with the capacity to pass the bad penny to the
greater fool. In California in the 1980s, Charles Keating realized that an
S&L charter was a “license to steal.” In the 2000s, sub-prime mortgage
origination was much the same thing. Given a license to steal, thieves get
busy. And because their performance seems so good, they quickly come to
dominate their markets; the bad players driving out the good.
The complexity of the
mortgage finance sector before the crisis highlights another characteristic
marker of fraud. In the system that developed, the original mortgage
documents lay buried – where they remain – in the records of the loan
originators, many of them since defunct or taken over. Those records, if
examined, would reveal the extent of missing documentation, of abusive
practices, and of fraud. So far, we have only very limited evidence on this,
notably a 2007 Fitch Ratings study of a very small sample of highly-rated
RMBS, which found “fraud, abuse or missing documentation in virtually every
file.” An efforts a year ago by Representative Doggett to persuade Secretary
Geithner to examine and report thoroughly on the extent of fraud in the
underlying mortgage records received an epic run-around.
When sub-prime mortgages
were bundled and securitized, the ratings agencies failed to examine the
underlying loan quality. Instead they substituted statistical models, in
order to generate ratings that would make the resulting RMBS acceptable to
investors. When one assumes that prices will always rise, it follows that a
loan secured by the asset can always be refinanced; therefore the actual
condition of the borrower does not matter. That projection is, of course,
only as good as the underlying assumption, but in this perversely-designed
marketplace those who paid for ratings had no reason to care about the
quality of assumptions. Meanwhile, mortgage originators now had a formula
for extending loans to the worst borrowers they could find, secure that in
this reverse Lake Wobegon no child would be deemed below average even though
they all were. Credit quality collapsed because the system was designed for
it to collapse.
A third element in the toxic
brew was a simulacrum of “insurance,” provided by the market in credit
default swaps. These are doomsday instruments in a precise sense: they
generate cash-flow for the issuer until the credit event occurs. If the
event is large enough, the issuer then fails, at which point the government
faces blackmail: it must either step in or the system will collapse. CDS
spread the consequences of a housing-price downturn through the entire
financial sector, across the globe. They also provided the means to short
the market in residential mortgage-backed securities, so that the largest
players could turn tail and bet against the instruments they had previously
been selling, just before the house of cards crashed.
Latter-day financial
economics is blind to all of this. It necessarily treats stocks, bonds,
options, derivatives and so forth as securities whose properties can be
accepted largely at face value, and quantified in terms of return and risk.
That quantification permits the calculation of price, using standard
formulae. But everything in the formulae depends on the instruments being as
they are represented to be. For if they are not, then what formula could
possibly apply?
An older strand of
institutional economics understood that a security is a contract in law. It
can only be as good as the legal system that stands behind it. Some fraud is
inevitable, but in a functioning system it must be rare. It must be
considered – and rightly – a minor problem. If fraud – or even the
perception of fraud – comes to dominate the system, then there is no
foundation for a market in the securities. They become trash. And more
deeply, so do the institutions responsible for creating, rating and selling
them. Including, so long as it fails to respond with appropriate force, the
legal system itself.
Control frauds always fail
in the end. But the failure of the firm does not mean the fraud fails: the
perpetrators often walk away rich. At some point, this requires subverting,
suborning or defeating the law. This is where crime and politics intersect.
At its heart, therefore, the financial crisis was a breakdown in the rule of
law in America.
Ask yourselves: is it
possible for mortgage originators, ratings agencies, underwriters, insurers
and supervising agencies NOT to have known that the system of housing
finance had become infested with fraud? Every statistical indicator of
fraudulent practice – growth and profitability – suggests otherwise. Every
examination of the record so far suggests otherwise. The very language in
use: “liars’ loans,” “ninja loans,” “neutron loans,” and “toxic waste,”
tells you that people knew. I have also heard the expression, “IBG,YBG;” the
meaning of that bit of code was: “I’ll be gone, you’ll be gone.”
If doubt remains,
investigation into the internal communications of the firms and agencies in
question can clear it up. Emails are revealing. The government already
possesses critical documentary trails — those of AIG, Fannie Mae and Freddie
Mac, the Treasury Department and the Federal Reserve. Those documents should
be investigated, in full, by competent authority and also released, as
appropriate, to the public. For instance, did AIG knowingly issue CDS
against instruments that Goldman had designed on behalf of Mr. John Paulson
to fail? If so, why? Or again: Did Fannie Mae and Freddie Mac appreciate the
poor quality of the RMBS they were acquiring? Did they do so under pressure
from Mr. Henry Paulson? If so, did Secretary Paulson know? And if he did,
why did he act as he did? In a recent paper, Thomas Ferguson and Robert
Johnson argue that the “Paulson Put” was intended to delay an inevitable
crisis past the election. Does the internal record support this view?
Let us suppose that the
investigation that you are about to begin confirms the existence of
pervasive fraud, involving millions of mortgages, thousands of appraisers,
underwriters, analysts, and the executives of the companies in which they
worked, as well as public officials who assisted by turning a Nelson’s Eye.
What is the appropriate response?
Some appear to believe that
“confidence in the banks” can be rebuilt by a new round of good economic
news, by rising stock prices, by the reassurances of high officials – and by
not looking too closely at the underlying evidence of fraud, abuse,
deception and deceit. As you pursue your investigations, you will undermine,
and I believe you may destroy, that illusion.
But you have to act. The
true alternative is a failure extending over time from the economic to the
political system. Just as too few predicted the financial crisis, it may be
that too few are today speaking frankly about where a failure to deal with
the aftermath may lead.
In this situation, let me
suggest, the country faces an existential threat. Either the legal system
must do its work. Or the market system cannot be restored. There must be a
thorough, transparent, effective, radical cleaning of the financial sector
and also of those public officials who failed the public trust. The
financiers must be made to feel, in their bones, the power of the law. And
the public, which lives by the law, must see very clearly and unambiguously
that this is the case.
Thank you.
~~~
James K. Galbraith is the author of
The Predator State: How Conservatives Abandoned the Free Market and Why
Liberals Should Too, and of a new preface to The Great Crash, 1929, by
John Kenneth Galbraith. He teaches at The University of Texas at Austin
Bob Jensen's threads on the subprime sleaze
is at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
The
Greatest Swindle in the History of the World
Paulson and Geithner Lied Big Time
"The
Ugly AIG Post-Mortem: The TARP Inspector General's report has a lot more to say
about the rating agencies than it does about Goldman Sachs," by Holman
Jenkins, The Wall Street Journal, November 24m 2009 ---
Click Here
A year later, the myrmidons of the media have gotten around to the question of
why, after the government took over AIG, it paid 100 cents on the dollar to
honor the collateral demands of AIG's subprime insurance counterparties.
By all means, read TARP Inspector General Neil Barofsky's report on the AIG
bailout—but read it honestly.
It does not say AIG's bailout was a "backdoor bailout" of Goldman Sachs. It does
not say the Fed was remiss in failing to require Goldman and other
counterparties to settle AIG claims for pennies on the dollar.
It does not for a moment doubt the veracity of officials who say their concern
was to stem a systemic panic that might have done lasting damage to the U.S.
standard of living.
To be sure, Mr. Barofsky has some criticisms to offer, but the biggest floats
inchoate between the lines of a widely overlooked section headed "lessons
learned," which focuses on the credit rating agencies. The section notes not
only the role of the rating agencies, with their "inherently conflicted business
model," in authoring the subprime mess in the first place—but also the role of
their credit downgrades in tipping AIG into a liquidity crisis, in undermining
the Fed's first attempt at an AIG rescue, and in the decision of government
officials "not to pursue a more aggressive negotiating policy to seek
concessions from" AIG's counterparties.
Though not quite spelling it out, Mr. Barofsky here brushes close to the last
great unanswered question about the AIG bailout. Namely: With the government now
standing behind AIG, why not just tell Goldman et al. to waive their collateral
demands since they now had the world's best IOU—Uncle Sam's?
Congress might not technically have put its full faith and credit behind AIG,
but if banks agreed to accept this argument, and Treasury and Fed insisted on
it, and the SEC upheld it, the rating agencies would likely have gone along. No
cash would have had to change hands at all.
This didn't happen, let's guess, because the officials—Hank Paulson, Tim
Geithner and Ben Bernanke—were reluctant to invent legal and policy authority
out of whole cloth to overrule the ratings agencies—lo, the same considerations
that also figured in their reluctance to dictate unilateral haircuts to holders
of AIG subprime insurance.
Of course, the thinking now is that these officials, in bailing out AIG, woulda,
shoulda, coulda used their political clout to force such haircuts, but quailed
when the banks, evil Goldman most of all, insisted on 100 cents on the dollar.
This story, in its gross simplification, is certainly wrong. Goldman and others
weren't in the business of voluntarily relinquishing valuable claims. But the
reality is, in the heat of the crisis, they would have acceded to any terms the
government dictated. Washington's game at the time, however, wasn't to
nickel-and-dime the visible cash transfers to AIG. It was playing for bigger
stakes—stopping a panic by asserting the government's bottomless resources to
uphold the IOUs of financial institutions.
What's more, if successful, these efforts were certain to cause the
AIG-guaranteed securities to rebound in value—as they have. Money has already
flowed back to AIG and the Fed (which bought some of the subprime securities to
dissolve the AIG insurance agreements) and is likely to continue to do so for
the simple reason that the underlying payment streams are intact.
Never mind: The preoccupation with the Goldman payments amounts to a misguided
kind of cash literalism. For the taxpayer has assumed much huger liabilities to
keep homeowners in their homes, to keep mortgage payments flowing to investors,
to fatten the earnings of financial firms, etc., etc. These liabilities dwarf
the AIG collateral calls, inevitably benefit Goldman and other firms, and
represent the real cost of our failure to create a financial system in which
investors (a category that includes a lot more than just Goldman) live and die
by the risks they voluntarily take without taxpayers standing behind them.
No, Moody's and S&P are not the cause of this policy failure—yet Mr. Barofsky's
half-articulated choice to focus on them is profound. For the role the agencies
have come to play in our financial system amounts to a direct, if feckless and
weak, attempt to contain the incentives that flow from the government's
guaranteeing of so many kinds of private liabilities, from the pension system
and bank deposits to housing loans and student loans.
The rating agencies' role as gatekeepers to these guarantees is, and was,
corrupting, but the solution surely is to pare back the guarantees themselves.
Overreliance on rating agencies, with their "inherently conflicted business
model," was ultimately a product of too much government interference in the
allocation of credit in the first place.
The Mother
of Future Lawsuits Directly Against Credit Rating Agencies and I, ndirectly
Against Auditing Firms
It has
been shown how Moody's and some other credit rating agencies sold AAA ratings
for securities and tranches that did not deserve such ratings ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
Also see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
My friend
Larry sent me the following link indicating that a lawsuit in Ohio may shake up
the credit rating fraudsters.
Will 49 other states and thousands of pension funds follow suit?
Already facing a spate of private lawsuits, the
legal troubles of the country’s largest credit rating agencies deepened on
Friday when the attorney general of Ohio sued
Moody’s Investors Service,
Standard & Poor’s and
Fitch, claiming that they had cost state
retirement and pension funds some $457 million by approving high-risk Wall
Street securities that went bust in the financial collapse.
http://www.nytimes.com/2009/11/21/business/21ratings.html?em
Jensen
Comment
The credit raters will rely heavily on the claim that they relied on the
external auditors who, in turn, are being sued for playing along with fraudulent
banks that grossly underestimated loan loss reserves on poisoned subprime loan
portfolios and poisoned tranches sold to investors ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Bad things happen in court where three or more parties start blaming each other
for billions of dollars of losses that in many cases led to total bank failures
and the wiping out of all the shareholders in those banks, including the pension
funds that invested in those banks. A real test is the massive lawsuit against
Deloitte's auditors in the huge Washington Mutual (WaMu) shareholder lawsuit.
"Ohio Sues
Rating Firms for Losses in Funds," by David Segal, The New York Times,
November 20m 2009 ---
Click Here
Already facing a spate of private lawsuits, the legal troubles of the country’s
largest credit rating agencies deepened on Friday when the attorney general of
Ohio sued Moody’s Investors Service, Standard & Poor’s and Fitch, claiming that
they had cost state retirement and pension funds some $457 million by approving
high-risk Wall Street securities that went bust in the financial collapse.
Already facing a spate of private lawsuits, the legal troubles of the country’s
largest credit rating agencies deepened on Friday when the attorney general of
Ohio sued Moody’s Investors Service, Standard & Poor’s and Fitch, claiming that
they had cost state retirement and pension funds some $457 million by approving
high-risk Wall Street securities that went bust in the financial collapse.
The case could test whether the agencies’ ratings are constitutionally protected
as a form of free speech.
The lawsuit asserts that Moody’s, Standard & Poor’s and Fitch were in league
with the banks and other issuers, helping to create an assortment of exotic
financial instruments that led to a disastrous bubble in the housing market.
“We believe that the credit rating agencies, in exchange for fees, departed from
their objective, neutral role as arbiters,” the attorney general, Richard
Cordray, said at a news conference. “At minimum, they were aiding and abetting
misconduct by issuers.”
He accused the companies of selling their integrity to the highest bidder.
Steven Weiss, a spokesman for McGraw-Hill, which owns S.& P., said that the
lawsuit had no merit and that the company would vigorously defend itself.
“A recent Securities and Exchange Commission examination of our business
practices found no evidence that decisions about rating methodologies or models
were based on attracting market share,” he said.
Michael Adler, a spokesman for Moody’s, also disputed the claims. “It is
unfortunate that the state attorney general, rather than engaging in an
objective review and constructive dialogue regarding credit ratings, instead
appears to be seeking new scapegoats for investment losses incurred during an
unprecedented global market disruption,” he said.
A spokesman for Fitch said the company would not comment because it had not seen
the lawsuit.
The litigation adds to a growing stack of lawsuits against the three largest
credit rating agencies, which together command an 85 percent share of the
market. Since the credit crisis began last year, dozens of investors have sought
to recover billions of dollars from worthless or nearly worthless bonds on which
the rating agencies had conferred their highest grades.
One of those groups is largest pension fund in the country, the California
Public Employees Retirement System, which filed a lawsuit in state court in
California in July, claiming that “wildly inaccurate ratings” had led to roughly
$1 billion in losses.
And more litigation is likely. As part of a broader financial reform, Congress
is considering provisions that make it easier for plaintiffs to sue rating
agencies. And the Ohio attorney general’s action raises the possibility of
similar filings from other states. California’s attorney general, Jerry Brown,
said in September that his office was investigating the rating agencies, with an
eye toward determining “how these agencies could get it so wrong and whether
they violated California law in the process.”
As a group, the attorneys general have proved formidable opponents, most notably
in the landmark litigation and multibillion-dollar settlement against tobacco
makers in 1998.
To date, however, the rating agencies are undefeated in court, and aside from
one modest settlement in a case 10 years ago, no one has forced them to hand
over any money. Moody’s, S.& P. and Fitch have successfully argued that their
ratings are essentially opinions about the future, and therefore subject to
First Amendment protections identical to those of journalists.
But that was before billions of dollars in triple-A rated bonds went bad in the
financial crisis that started last year, and before Congress extracted a number
of internal e-mail messages from the companies, suggesting that employees were
aware they were giving their blessing to bonds that were all but doomed. In one
of those messages, an S.& P. analyst said that a deal “could be structured by
cows and we’d rate it.”
Recent cases, like the suit filed Friday, are founded on the premise that the
companies were aware that investments they said were sturdy were dangerously
unsafe. And if analysts knew that they were overstating the quality of the
products they rated, and did so because it was a path to profits, the ratings
could forfeit First Amendment protections, legal experts say.
“If they hold themselves out to the marketplace as objective when in fact they
are influenced by the fees they are receiving, then they are perpetrating a
falsehood on the marketplace,” said Rodney A. Smolla, dean of the Washington and
Lee University School of Law. “The First Amendment doesn’t extend to the
deliberate manipulation of financial markets.”
The 73-page complaint, filed on behalf of Ohio Police and Fire Pension Fund, the
Ohio Public Employees Retirement System and other groups, claims that in recent
years the rating agencies abandoned their role as impartial referees as they
began binging on fees from deals involving mortgage-backed securities.
At the root of the problem, according to the complaint, is the business model of
rating agencies, which are paid by the issuers of the securities they are paid
to appraise. The lawsuit, and many critics of the companies, have described that
arrangement as a glaring conflict of interest.
“Given that the rating agencies did not receive their full fees for a deal
unless the deal was completed and the requested rating was provided,” the
attorney general’s suit maintains, “they had an acute financial incentive to
relax their stated standards of ‘integrity’ and ‘objectivity’ to placate their
clients.”
To complicate problems in the system of incentives, the lawsuit states, the
methodologies used by the rating agencies were outdated and flawed. By the time
those flaws were obvious, nearly half a billion dollars in pension and
retirement funds had evaporated in Ohio, revealing the bonds to be “high-risk
securities that both issuers and rating agencies knew to be little more than a
house of cards,” the complaint states.
"Rating
agencies lose free-speech claim," by Jonathon Stempel, Reuters,
September 3, 2009 ---
http://www.reuters.com/article/GCA-CreditCrisis/idUSTRE5824KN20090903
There are two superpowers in the world today in my opinion. There’s the United
States and there’s Moody’s Bond Rating Service. The United States can destroy
you by dropping bombs, and Moody’s can destroy you by down grading your bonds.
And believe me, it’s not clear sometimes who’s more powerful. The most that we
can safely assert about the evolutionary process underlying market equilibrium
is that harmful heuristics, like harmful mutations in nature, will die out.
Martin Miller, Debt and Taxes as quoted by Frank Partnoy, "The Siskel and Ebert
of Financial Matters: Two Thumbs Down for Credit Reporting Agencies,"
Washington University Law Quarterly, Volume 77, No. 3, 1999 ---
http://faculty.trinity.edu/rjensen/FraudCongressPartnoyWULawReview.htm
Credit rating agencies gave AAA ratings to mortgage-backed securities that
didn't deserve them. "These ratings not only gave false comfort to investors,
but also skewed the computer risk models and regulatory capital computations,"
Cox said in written testimony.
SEC Chairman Christopher Cox as quoted on October 23, 2008 at
http://www.nytimes.com/external/idg/2008/10/23/23idg-Greenspan-Bad.html
"How
Moody's sold its ratings - and sold out investors," by Kevin G. Hall,
McClatchy Newspapers, October 18, 2009 ---
http://www.mcclatchydc.com/homepage/story/77244.html
Paulson
and Geithner Lied Big Time: The
Greatest Swindle in the History of the World
What was their real motive in the greatest fraud conspiracy in the history of
the world?
Bombshell: In 2008 and early 2009, Treasury Secretary leaders
Paulson and
Geithner told the media and Congress that
AIG needed a global bailout due to not having cash reserves to meet credit
default swap (systematic risk) obligations and insurance policy payoffs. On
November 19, 2009 in Congressional testimony Geithner now admits that all this
was a pack of lies. However, he refuses to resign as requested by some Senators.
"AIG and
Systemic Risk Geithner says credit-default swaps weren't the problem, after
all," Editors of The Wall Street Journal, November 20, 2009 ---
Click Here
TARP Inspector General Neil Barofsky keeps committing flagrant acts of
political transparency, which if nothing else ought to inform the debate
going forward over financial reform. In his latest bombshell, the IG
discloses that the New York Federal Reserve did not believe that AIG's
credit-default swap (CDS) counterparties posed a systemic financial risk.
Hello?
For the last year, the entire Beltway theory of the financial panic has been
based on the claim that the "opaque," unregulated CDS market had forced the
Fed to take over AIG and pay off its counterparties, lest the system
collapse. Yet we now learn from Mr. Barofsky that saving the counterparties
was not the reason for the bailout.
In the fall of 2008 the New York Fed drove a baby-soft bargain with AIG's
credit-default-swap counterparties. The Fed's taxpayer-funded vehicle,
Maiden Lane III, bought out the counterparties' mortgage-backed securities
at 100 cents on the dollar, effectively canceling out the CDS contracts.
This was miles above what those assets could have fetched in the market at
that time, if they could have been sold at all.
The New York Fed president at the time was none other than Timothy Geithner,
the current Treasury Secretary, and Mr. Geithner now tells Mr. Barofsky that
in deciding to make the counterparties whole, "the financial condition of
the counterparties was not a relevant factor."
This is startling. In April we noted in these columns that Goldman Sachs, a
major AIG counterparty, would certainly have suffered from an AIG failure.
And in his latest report, Mr. Barofsky comes to the same conclusion. But if
Mr. Geithner now says the AIG bailout wasn't driven by a need to rescue CDS
counterparties, then what was the point? Why pay Goldman and even foreign
banks like Societe Generale billions of tax dollars to make them whole?
Both Treasury and the Fed say they think it would have been inappropriate
for the government to muscle counterparties to accept haircuts, though the
New York Fed tried to persuade them to accept less than par. Regulators say
that having taxpayers buy out the counterparties improved AIG's liquidity
position, but why was it important to keep AIG liquid if not to protect some
class of creditors?
Yesterday, Mr. Geithner introduced a new explanation, which is that AIG
might not have been able to pay claims to its insurance policy holders: "AIG
was providing a range of insurance products to households across the
country. And if AIG had defaulted, you would have seen a downgrade leading
to the liquidation and failure of a set of insurance contracts that touched
Americans across this country and, of course, savers around the world."
Yet, if there is one thing that all observers seemed to agree on last year,
it was that AIG's money to pay policyholders was segregated and safe inside
the regulated insurance subsidiaries. If the real systemic danger was the
condition of these highly regulated subsidiaries—where there was no CDS
trading—then the Beltway narrative implodes.
Interestingly, in Treasury's official response to the Barofsky report,
Assistant Secretary Herbert Allison explains why the department acted to
prevent an AIG bankruptcy. He mentions the "global scope of AIG, its
importance to the American retirement system, and its presence in the
commercial paper and other financial markets." He does not mention CDS.
All of this would seem to be relevant to the financial reform that Treasury
wants to plow through Congress. For example, if AIG's CDS contracts were not
the systemic risk, then what is the argument for restructuring the
derivatives market? After Lehman's failure, CDS contracts were quickly
settled according to the industry protocol. Despite fears of systemic risk,
none of the large banks, either acting as a counterparty to Lehman or as a
buyer of CDS on Lehman itself, turned out to have major exposure.
More broadly, lawmakers now have an opportunity to dig deeper into the
nature of moral hazard and the restoration of a healthy financial system.
Barney Frank and Chris Dodd are pushing to give regulators "resolution
authority" for struggling firms. Under both of their bills, this would mean
unlimited ability to spend unlimited taxpayer sums to prevent an unlimited
universe of firms from failing.
Americans know that's not the answer, but what is the best solution to the
too-big-to-fail problem? And how exactly does one measure systemic risk? To
answer these questions, it's essential that we first learn the lessons of
2008. This is where reports like Mr. Barofsky's are valuable, telling us
things that the government doesn't want us to know.
In remarks Tuesday that were interpreted as a veiled response to Mr.
Barofsky's report, Mr. Geithner said, "It's a great strength of our country,
that you're going to have the chance for a range of people to look back at
every decision made in every stage in this crisis, and look at the quality
of judgments made and evaluate them with the benefit of hindsight." He
added, "Now, you're going to see a lot of conviction in this, a lot of
strong views—a lot of it untainted by experience."
Mr. Geithner has a point about Monday-morning quarterbacking. He and others
had to make difficult choices in the autumn of 2008 with incomplete
information and often with little time to think, much less to reflect. But
that was last year. The task now is to learn the lessons of that crisis and
minimize the moral hazard so we can reduce the chances that the panic and
bailout happen again.
This means a more complete explanation from Mr. Geithner of what really
drove his decisions last year, how he now defines systemic risk, and why he
wants unlimited power to bail out creditors—before Congress grants the
executive branch unlimited resolution authority that could lead to bailouts
ad infinitum.
Jensen
Comment
One of the first teller of lies was the highly respected Gretchen Morgenson of
The New York Times who was repeating the lies told to her and Congress by
the Treasury and the Fed. This was when I first believed that the problem at AIG
was failing to have capital reserves to meet CDS obligations. I really believed
Morgenson's lies in 2008 ---
http://www.nytimes.com/2008/09/21/business/21gret.html
Here's
what I wrote in 2008 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Credit Default Swap (CDS)
This is an insurance policy that essentially "guarantees" that if a CDO goes bad
due to having turds mixed in with the chocolates, the "counterparty" who
purchased the CDO will recover the value fraudulently invested in turds. On
September 30, 2008 Gretchen Morgenson of The New York Times aptly
explained that the huge CDO underwriter of CDOs was the insurance firm called
AIG. She also explained that the first $85 billion given in bailout money by
Hank Paulson to AIG was to pay the counterparties to CDS swaps. She also
explained that, unlike its casualty insurance operations, AIG had no capital
reserves for paying the counterparties for the the turds they purchased from
Wall Street investment banks.
"Your
Money at Work, Fixing Others’ Mistakes," by Gretchen Morgenson, The New York
Times, September 20, 2008 ---
http://www.nytimes.com/2008/09/21/business/21gret.html
Also see "A.I.G., Where Taxpayers’ Dollars Go to Die," The New York Times,
March 7, 2009 ---
http://www.nytimes.com/2009/03/08/business/08gret.html
What Ms.
Morgenson failed to explain, when Paulson eventually gave over $100 billion for
AIG's obligations to counterparties in CDS contracts, was who were the
counterparties who received those bailout funds. It turns out that most of them
were wealthy Arabs and some Asians who we were getting bailed out while Paulson
was telling shareholders of WaMu, Lehman Brothers, and Merrill Lynch to eat
their turds.
You tube
had a lot of videos about a CDS. Go to YouTube and read in the phrase "credit
default swap" ---
http://www.youtube.com/results?search_query=Credit+Default+Swaps&search_type=&aq=f
In particular note this video by Paddy Hirsch ---
http://www.youtube.com/watch?v=kaui9e_4vXU
Paddy has some other YouTube videos about the financial crisis.
Bob
Jensen’s threads on accounting for credit default swaps are under the C-Terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
The
Greatest Swindle in the History of the World
"The
Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print
Bob
Jensen's threads on why the infamous "Bailout" won't work ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#BailoutStupidity
Bob Jensen's
"Rotten to the Core" threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"Going Concern Audit Opinions: Why So Few
Warning Flares?" by Francine McKenna, re: The Auditors, September 18,
2009 ---
http://retheauditors.com/2009/09/18/going-concern-audit-opinions-why-so-few-warning-flares/
Lehman Brothers. Bear
Stearns. Washington Mutual. AIG. Countrywide. New Century. American Home
Mortgage. Citigroup. Merrill Lynch. GE Capital. Fannie Mae. Freddie Mac.
Fortis. Royal Bank of Scotland. Lloyds TSB. HBOS. Northern Rock.
When each of the
notorious “financial crisis” institutions collapsed, were bailed
out/nationalized by their governments or were acquired/rescued by
“healthier” institutions, they were all carrying in their wallets
non-qualified, clean opinions on their financial statements from their
auditors. In none of the cases had the auditors warned shareholders and the
markets that there was “ a substantial doubt about the company’s ability to
continue as a going concern for a reasonable period of time, not to exceed
one year beyond the date of the financial statements being audited.”
Continued in a very good article by Francine
(she talks with some major players)
http://retheauditors.com/2009/09/18/going-concern-audit-opinions-why-so-few-warning-flares/
Francine maintains an outstanding auditing
blog at
http://retheauditors.com/
Bob Jensen's threads on "Where Were the
Auditors?" ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Some auditing firms are now being hauled into
court in bank shareholder and pension fund lawsuits ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Auditors
"Countrywide (now part of Bank of America) Pays $108 Million to Settle
Fees Complaint." by Edward Wyatt, The New York Times, June 7, 2010 ---
http://www.nytimes.com/2010/06/08/business/08ftc.html?hp
The Federal Trade Commission announced Monday that
two Countrywide mortgage servicing companies had agreed to pay $108 million
to settle charges that they collected excessive fees from financially
troubled homeowners.
The $108 million payment is one of the largest
overall judgments in the commission’s history and resolves its largest
mortgage servicing case. The money will go to more than 200,000 homeowners
whose loans were serviced by Countrywide before July 2008, when it was
acquired by Bank of America.
Jon Leibowitz, the chairman of the Federal Trade
Commission, said that Countrywide’s loan servicing operation charged
excessive fees to homeowners who were behind on their mortgage payments, in
some cases asserting that customers were in default when they were not.
The fees, which were billed as the cost of services
like property inspections and lawn mowing, were grossly inflated after
Countrywide created subsidiaries to hire vendors to supply the services,
increasing the cost several-fold in the process, the commission said.
In addition, the commission said that Countrywide
at times imposed a new round of fees on homeowners who had recently emerged
from bankruptcy protection, sometimes threatening the consumers with a new
foreclosure.
“Countrywide profited from making risky loans to
homeowners during the boom years, and then profited again when the loans
failed,” Mr. Leibowitz said.
The $108 million settlement represents the agency’s
estimate of consumer losses, but does not include a penalty, which the
commission is not allowed to impose.
Clifford J. White III, the director of the
executive office for the United States Trustees Program, which enforces
bankruptcy laws for the Department of Justice, said that the commission’s
settlement “will help prevent future harm to homeowners in dire financial
straits who legitimately seek bankruptcy protection.”
The settlement bars Countrywide from making false
representations about amounts owed by homeowners, from charging fees for
services that are not authorized by loan agreements, and from charging
unreasonable amounts for work.
In addition, the settlement requires Countrywide to
establish internal procedures and an independent third party to verify that
bills and claims filed in bankruptcy court are valid.
“Now more than ever, companies that service
consumers’ mortgages need to do so in an honest and fair way,” Mr. Leibowitz
said.
The F.T.C. has not yet established how much will be
paid to each consumer, in part, Mr. Leibowitz said, because Countrywide’s
record keeping was “abysmal.” About $35 million of the $108 million total
was charged to homeowners already in bankruptcy proceedings, with the
remainder charged to customers whom Countrywide said were in default on
their mortgages.
Jensen Comment
I think Countrywide got off too easy. The evil Countrywide brokered mortgages to
borrowers that had no hope of paying back the debt and then charged they
excessive fees when they got behind in their payments.
Bob Jensen's threads on the sleaze of Countrywide are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Federal securities class action
lawsuits increased 19 percent in 2008, with almost half involving firms in the
financial services sector according to the annual report prepared by the
Stanford Law School Securities Class Action Clearinghouse in cooperation with
Cornerstone Research ---
http://securities.stanford.edu/scac_press/20080106_YIR08_Press_Release.pdf
Especially note the 2008 Year in Review link at
http://securities.stanford.edu/clearinghouse_research/2008_YIR/20080106.pdf
Simoleon Sense
Reviews Janet Tavakoli’s Dear Mr. Buffett ---
http://www.simoleonsense.com/simoleon-sense-reviews-janet-tavakolis-dear-mr-buffett/
What’s The Book (Dear Mr. Buffett) About
Dear Mr. Buffett,
chronicles the agency problems, poor regulations, and participants which led to
the current financial crisis. Janet accomplishes this herculean task by
capitalizing on her experiences with derivatives, Wall St, and her relationship
with Warren Buffett. One wonders how she managed to pack so much material in
such few pages!
Unlike many books which only analyze past events, Dear Mr.
Buffett, offers proactive advice for improving financial markets. Janet is
clearly very concerned about protecting individual rights, promoting honesty,
and enhancing financial integrity. This is exactly the kind of character we
should require of our financial leaders.
Business week once called Janet the Cassandra of Credit
Derivatives. Without a doubt Janet should have been listened to. I’m confident
that from now on she will be.
Closing thoughts
Rather than a complicated book on financial esoterica, Janet has
created a simple guide to understanding the current crisis. This book is a must
read for all students of finance, economics, and business. If you haven’t read
this book, please do so.
Warning –This book is likely to infuriate you, and that’s a good
thing!
Janet provides indicting evidence and citizens may be tempted to
initiate vigilante like witch trials. Please
consult with your doctor before taking this financial medication.
Continued in article
September 1, 2009 reply from Rick Lillie
[rlillie@CSUSB.EDU]
Hi Bob,
I am reading Dear Mr.
Buffett, What an Investor Learns 1,269 Miles from Wall Street, by Janet
Tavakoli. I am just about finished with the book. I am thinking about giving
a copy of the book to students who perform well in my upper-level financial
reporting classes.
I agree with the reviewer’s
comments about Tavakoli’s book. Her explanations are clear and concise and
do not require expertise in finance or financial derivatives in order to
understand what she (or Warren Buffet) says. She explains the underlying
problems of the financial meltdown with ease. Tavakoli does not blow you
over with “finance BS.” She does in print what Steve Kroft does in the 60
Minutes story.
Tavakoli delivers a unique
perspective throughout the book. She looks through the eyes of Warren
Buffett and explains issues as Buffett sees them, while peppering the
discussion with her experience and perspective.
The reviewer is correct.
Tavakoli lets the finance world, along with accountants, attorneys, bankers,
Congress, and regulators, have it with both barrels!
Tavakoli’s book is the
highlight of my summer reading.
Best wishes,
Rick Lillie
Rick Lillie, MAS, Ed.D., CPA
Assistant Professor of Accounting Coordinator - Master of Science in
Accountancy (MSA) Program Department of Accounting and Finance College of
Business and Public Administration CSU San Bernardino 5500 University Pkwy,
JB-547 San Bernardino, CA. 92407-2397
Telephone Numbers: San
Bernardino Campus: (909) 537-5726 Palm Desert Campus: (760) 341-2883, Ext.
78158
For technical details see the following book:
Structured Finance and Collateralized Debt Obligations: New Developments in
Cash and Synthetic Securitization (Wiley Finance) by Janet M. Tavakoli
(2008)
FBI Arrest in What Appears to Be the World's Largest Case Involving
Insider Information
More and more keeps coming out, including revelations of wiretapping
"8 trades the insiders allegedly made The government's case against the
Galleon crew includes transactions in companies like Google, AMD, Hilton and
Sun," by Michael Copeland, Fortune, October 19, 2009 ---
Click Here
http://money.cnn.com/2009/10/19/markets/insider_trading_arrests.fortune/?postversion=2009101912
The government's case in what it is calling the
largest insider trading case involving a U.S. hedge fund contains a detailed
list of trades involving household-name companies.
Investigators have pieced together a case that
alleges more than $25 million in illegal gains based on trading in 2006-09
on companies including Advanced Micro Devices (AMD, Fortune 500), Akamai (AKAM),
Clearwire (CLWR), Google (GOOG, Fortune 500), Hilton, Polycom (PLCM) and Sun
Microsystems (JAVA, Fortune 500), among others.
The six people charged include hedge fund
billionaire Raj Rajaratnam, founder of Galleon Group; Robert Moffat, IBM's
(IBM, Fortune 500) top hardware executive and an oft-discussed CEO
candidate; Mark Curland and Danielle Chiesi, executives of the hedge fund
New Castle Partners; Anil Kumar, a director at consulting firm McKinsey &
Co.; and Rajiv Goel, an executive in Intel's treasury department.
Just what did they allegedly do? Using information
gleaned from wiretapped conversations between the accused and others, along
with the statements of an apparent informant, SEC investigators have pieced
together a series of episodes alleging to show how the defendants used
inside information and well-timed trades to turn million-dollar profits.
Those charged have yet to enter pleas in the case.
Jim Waldman, a lawyer for Rajaratman, told the Wall Street Journal that the
hedge fund chief "is innocent. We're going to fight the charges." Lawyers
for some of the other accused said their clients are shocked by the charges
and deny wrongdoing.
What follows is a condensed account of eight major
trades the suspects made and the inside information they capitalized on,
according to the the SEC investigation and complaint. At the center of some
of the trades is an unnamed "Tipper A," a person who gathered a great deal
of information on companies for Rajaratnam, and whose identity presumably
will be made public as the case unfolds in court.
Polycom beats the Street
On Jan. 10, 2006, the
unnamed source identified in the SEC's complaint as "Tipper A" told
Galleon's Rajaratnam that, based on information received from a Polycom
insider, revenues at the video-conferencing company for the fourth-quarter
of 2005 were about to beat Wall Street estimates. Polycom was set to
announce its earnings more than two weeks later.
Rajaratnam sent an
instant message to his trader instructing him to "buy 60 [thousand shares]
PLCM" for certain Galleon Tech funds. All told, from Jan. 10 through Jan.
25, the date of the Polycom earnings release, Rajaratnam and Galleon bought
245,000 shares of Polycom and 500 Polycom call-option contracts. Polycom did
beat the Street, and collectively, the Galleon Tech funds made over $570,000
in connection with their Polycom trades based on Tipper A's tip.
The same scenario was
repeated for Polycom's first-quarter 2006 earnings, the complaint says.
Galleon made $165,000 on the information. Tipper A made $22,000.
The Hilton takeover
Tipper A allegedly
obtained confidential information in advance of a July 3, 2007, announcement
that a private equity group would be buying Hilton for $47.50 per share, a
premium of $11.45 over the July 3 closing price. Tipper A obtained the
information from an analyst who, at the time, was working at Moody's, a
rating agency that was evaluating Hilton's debt in connection with the
planned buyout. Tipper A bought call option contracts based on the
information, and passed on the tip to Rajaratnam.
On July 3, Rajaratnam and
Galleon bought 400,000 shares of Hilton in the Galleon Tech funds. That
evening, the Hilton transaction was announced. Tipper A sold all of the
Hilton call option contracts for a profit of more than $630,000, the
complaint says. To compensate the source for the Hilton tip, Tipper A paid
the source $10,000. The Galleon Tech funds sold their Hilton shares after
the July 3 announcement for a profit of more than $4 million.
Google Misses
Around July 10, 2007, a
PR consultant to Google allegedly told Tipper A that Google's second-quarter
earnings per share would be down about 25 cents. The Street had estimated
yet another strong quarter for the search giant, which was scheduled to
report earnings July 19.
Two days later Tipper A
bought put options in Google and passed along details of the pending Google
miss to Rajaratnam. He and Galleon began buying Google put options for the
Galleon Tech funds, and continued buying them through July 19. In addition,
Galleon funds bought other options betting on a fall in Google shares and
sold short Google stock beginning July 17.
On July 19, Google
announced its earnings results, disclosing that its earnings-per-share was
indeed 25 cents lower than the prior quarter. Google's share price fell from
over $548 per share to almost $520 per share. The Galleon Tech funds'
profits from the Google tip were almost $8 million. Tipper A sold all of the
put options the day after the July 19 announcement for a profit of over
$500,000.
Trading in Intel
Rajaratnam allegedly tapped former Wharton classmate
and Intel executive Rajiv Goel just before Intel's (INTL)
scheduled fourth-quarter 2006 earnings announcement to get inside
information on the world's largest chipmaker. On Jan. 8, 2007, Rajaratnam
contacted Intel's Goel. The next day, Rajaratnam bought 1 million shares of
Intel at $21.08 per share. On Jan, 11, he bought 500,000 more at $21.65 per
share.
Goel and Rajaratnam
communicated again multiple times over the Martin Luther King Day weekend
that followed. On Tuesday, Jan. 16, the day the markets reopened, Rajaratnam
reversed course, selling the Galleon Tech funds' entire 1.5 million share
long position in Intel at $22.03 per share, and making a profit of a little
over $1 million
Later that day, after the
markets closed, Intel released its fourth-quarter 2006 earnings. Although
the company's earnings beat analysts' projections, its guidance was below
expectations. Intel's stock price fell nearly 5% on the news, but Rajaratnam
was already out of the stock.
According to Intel
officials, Goel has been placed on administrative leave pending the court
case.
Clearwire Gets a Partner
In early February 2008, Goel allegedly tipped
Rajaratnam that there was a pending joint venture between wireless broadband
company Clearwire and Sprint (S,
Fortune 500). Intel
was a huge shareholder in Clearwire. Over the next three months, Galleon
Tech funds bought and sold Clearwire shares on three occasions. Each time,
the Galleon Tech funds traded in advance of news reports relating to the
deal between Clearwire and Sprint, and shortly after calls between Goel and
Rajaratnam. Overall, the Galleon Tech funds realized gains of about $780,000
on their Clearwire trading between February and May 2008. On May 8, the
joint venture between Sprint and Clearwire was publicly announced.
As payback for Goel's
tips, Rajaratnam (or someone acting on his behalf) executed trades in Goel's
personal brokerage account based on inside information concerning Hilton and
PeopleSupport (the government notes that a Galleon director sits on the
PeopleSupport's board of directors though no charges of wrongdoing have been
brought against that person), which resulted in nearly $250,000 in profits
for Goel.
Shorting Akamai
Another hedge fund
executive, New Castle's Danielle Chiesi, is an acquaintance of Rajaratnam.
When an Akamai executive told her that the Internet infrastructure company
would trend lower in the company's second-quarter 2008 guidance to
investors, the government claims she passed along the information to
Rajaratnam. The consensus among Akamai's management was that Akamai's stock
price would decline in the wake of the lowered guidance scheduled for July
30.
Chiesi and the Akamai
source spoke multiple times between July 2 and July 24. Chiesi told what she
had learned from the Akamai source to her colleague at New Castle, Mark
Kurland. On July 25, several New Castle funds took short positions in Akamai
shares. The positions grew through July 30. Rajaratnam's Galleon funds also
built up a short position during the same period.
In its second-quarter
2008 earnings announcement on July 30, Akamai's results disappointed
investors. The stock fell nearly 20% following the announcement. New Castle
made $2.4 million. The Galleon Tech funds took home more than $3.2 million.
IBM knows Sun
In January 2009, IBM was conducting due diligence on Sun Microsystems in
preparation for an offer to buy it (Sun was ultimately bought by Oracle (ORCL,
Fortune 500)).
As part of that process, Sun opened its books to IBM, providing its
second-quarter 2009 results in advance of the scheduled Jan. 27
announcement.
Because much of Sun's
business is hardware, IBM's top hardware executive Robert Moffat was
involved in the evaluation of Sun. Moffat allegedly had access to Sun's
earnings results. He and Chiesi were also friends and contacted each other
repeatedly during January 2009. The frequency of contact between the two
increased just prior to the Sun earnings release, investigators say.
On Jan. 26, New Castle
began acquiring a substantial long position in Sun. On Jan. 27, after the
market close, Sun reported earnings that exceeded Wall Street's estimates,
posting a two-cent per-share profit when analysts had expected a loss. Sun
shares soared 21% on the news. New Castle made almost $1 million.
AMD gets out of manufacturing
On June 1, 2008, McKinsey
& Co. began advising Advanced Micro Devices over its negotiations with two
Abu Dhabi sovereign entities. One, a joint venture with the Abu Dhabi
government, Advanced Technology Investment Co., would take over AMD's chip
manufacturing. The other, an Abu Dhabi sovereign wealth fund, Mubadala
Investment Co., would provide a large investment in AMD (in the end, it
would total $314 million). According to the SEC, Anil Kumar was one of the
McKinsey team briefed on the negotiations. Kumar also knew Rajaratnam.
On Aug. 14, Kumar learned
that the two deals were finally getting done. The next day he told
Rajaratnam, investigators say. Almost immediately, Rajaratnam and Galleon
increased their long position in AMD by buying more than 2.5 million shares
in Galleon funds and continuing to build their long position until just
before the announcement of the AMD transactions. Rajaratnam and Galleon
bought 4 million AMD shares on Sept. 25 and 26, and 1.65 million more on
Oct. 3. On Oct. 8, the deals were announced publicly. AMD's stock price
increased by about 25%. All told, the value of Galleon's entire position in
AMD increased approximately $9.5 million in Oct. 6-7.
However, the allegedly ill-gotten gain was wiped out by the financial crisis
of the time. Because the Galleon Tech funds had accumulated much of their
AMD position beginning in August, before the crisis sent stock prices,
including AMD's, tumbling in September and October, the funds lost money on
the overall trade
The Deep Shah Insiders Leak at Moody's: What $10,000 Bought
Leaks such as this are probably impossible to stop
What disturbs me is that the Blackstone Group would exploit investors based up
such leaks
"Moody's Analysts Are Warned to Keep Secrets," by Serena Ing, The Wall
Street Journal, October 20, 2009 ---
http://online.wsj.com/article/SB125599951161895543.html?mod=article-outset-box
"Billionaire among 6 nabbed in inside trading
case Wall Street wake-up call: Hedge fund boss, 5 others charged in $25M-plus
insider trading case," by Larry Neumeister and Candice Choi, Yahoo
News, October 16, 2009 ---
Click Here
One of America's wealthiest
men was among six hedge fund managers and corporate executives arrested
Friday in a hedge fund insider trading case that authorities say generated
more than $25 million in illegal profits and was a wake-up call for Wall
Street.
Raj Rajaratnam, a portfolio
manager for Galleon Group, a hedge fund with up to $7 billion in assets
under management, was accused of conspiring with others to use insider
information to trade securities in several publicly traded companies,
including Google Inc.
U.S. Magistrate Judge
Douglas F. Eaton set bail at $100 million to be secured by $20 million in
collateral despite a request by prosecutors to deny bail. He also ordered
Rajaratnam, who has both U.S. and Sri Lankan citizenship, to stay within 110
miles of New York City.
U.S. Attorney Preet Bharara
told a news conference it was the largest hedge fund case ever prosecuted
and marked the first use of court-authorized wiretaps to capture
conversations by suspects in an insider trading case.
He said the case should
cause financial professionals considering insider trades in the future to
wonder whether law enforcement is listening.
"Greed is not good," Bharara
said. "This case should be a wake-up call for Wall Street."
Joseph Demarest Jr., the
head of the New York FBI office, said it was clear that "the $20 million in
illicit profits come at the expense of the average public investor."
The Securities and Exchange
Commission, which brought separate civil charges, said the scheme generated
more than $25 million in illegal profits.
Robert Khuzami, director of
enforcement at the SEC, said the charges show Rajaratnam's "secret of
success was not genius trading strategies."
"He is not the master of the
universe. He is a master of the Rolodex," Khuzami said.
Galleon Group LLP said in a
statement it was shocked to learn of Rajaratnam's arrest at his apartment.
"We had no knowledge of the investigation before it was made public and we
intend to cooperate fully with the relevant authorities," the statement
said.
The firm added that Galleon
"continues to operate and is highly liquid."
Rajaratnam, 52, was ranked
No. 559 by Forbes magazine this year among the world's wealthiest
billionaires, with a $1.3 billion net worth.
According to the Federal
Election Commission, he is a generous contributor to Democratic candidates
and causes. The FEC said he made over $87,000 in contributions to President
Barack Obama's campaign, the Democratic National Committee and various
campaigns on behalf of Hillary Rodham Clinton, U.S. Sen. Charles Schumer and
New Jersey U.S. Sen. Robert Menendez in the past five years. The Center for
Responsive Politics, a watchdog group, said he has given a total of $118,000
since 2004 -- all but one contribution, for $5,000, to Democrats.
The Associated Press has
learned that even before his arrest, Rajaratnam was under scrutiny for
helping bankroll Sri Lankan militants notorious for suicide bombings.
Papers filed in U.S.
District Court in Brooklyn allege that Rajaratnam worked closely with a
phony charity that channeled funds to the Tamil Tiger terrorist
organization. Those papers refer to him only as "Individual B." But U.S. law
enforcement and government officials familiar with the case have confirmed
that the individual is Rajaratnam.
At an initial court
appearance in U.S. District Court in Manhattan, Assistant U.S. Attorney Josh
Klein sought detention for Rajaratnam, saying there was "a grave concern
about flight risk" given Rajaratnam's wealth and his frequent travels around
the world.
His lawyer, Jim Walden,
called his client a "citizen of the world," who has made more than $20
million in charitable donations in the last five years and had risen from
humble beginnings in the finance profession to oversee hedge funds
responsible for nearly $8 billion.
Walden promised "there's a
lot more to this case" and his client was ready to prepare for it from home.
Rajaratnam lives in a $10 million condominium with his wife of 20 years,
their three children and two elderly parents. Walden noted that many of his
employees were in court ready to sign a bail package on his behalf.
Rajaratnam -- born in Sri
Lanka and a graduate of University of Pennsylvania's Wharton School of
Business -- has been described as a savvy manager of billions of dollars in
technology and health care hedge funds at Galleon, which he started in 1996.
The firm is based in New York City with offices in California, China, Taiwan
and India. He lives in New York.
According to a criminal
complaint filed in U.S. District Court in Manhattan, Rajaratnam obtained
insider information and then caused the Galleon Technology Funds to execute
trades that earned a profit of more than $12.7 million between January 2006
and July 2007. Other schemes garnered millions more and continued into this
year, authorities said.
Bharara said the defendants
benefited from tips about the earnings, earnings guidance and acquisition
plans of various companies. Sometimes, those who provided tips received
financial benefits and sometimes they just traded tips for more inside
information, he added.
The timing of the arrests
might be explained by a footnote in the complaint against Rajaratnam. In it,
an FBI agent said he had learned that Rajaratnam had been warned to be
careful and that Rajaratnam, in response, had said that a former employee of
the Galleon Group was likely to be wearing a "wire."
The agent said he learned
from federal authorities that Rajaratnam had a ticket to fly from Kennedy
International Airport to London on Friday and to return to New York from
Geneva, Switzerland next Thursday.
Also charged in the scheme
are Rajiv Goel, 51, of Los Altos, Calif., a director of strategic
investments at Intel Capital, the investment arm of Intel Corp., Anil Kumar,
51, of Santa Clara, Calif., a director at McKinsey & Co. Inc., a global
management consulting firm, and Robert Moffat, 53, of Ridgefield, Conn.,
senior vice president and group executive at International Business Machines
Corp.'s Systems and Technology Group.
The others charged in the
case were identified as Danielle Chiesi, 43, of New York City, and Mark
Kurland, 60, also of New York City.
According to court papers,
Chiesi worked for New Castle, the equity hedge fund group of Bear Stearns
Asset Management Inc. that had assets worth about $1 billion under
management. Kurland is a top executive at New Castle.
Kumar's lawyer, Isabelle
Kirshner, said of her client: "He's distraught." He was freed on $5 million
bail, secured in part by his $2.5 million California home.
Kerry Lawrence, an attorney
representing Moffat, said: "He's shocked by the charges."
Bail for Kurland was set at
$3 million while bail for Moffat and Chiesi was set at $2 million each.
Lawyers for Moffat and Chiesi said their clients will plead not guilty. The
law firm representing Kurland did not immediately return a phone call for
comment.
A message left at Goel's
residence was not immediately returned. He was released on bail after an
appearance in California.
A criminal complaint filed
in the case shows that an unidentified person involved in the insider
trading scheme began cooperating and authorities obtained wiretaps of
conversations between the defendants.
In one conversation about a
pending deal that was described in a criminal complaint, Chiesi is quoted as
saying: "I'm dead if this leaks. I really am. ... and my career is over.
I'll be like Martha (expletive) Stewart."
Stewart, the homemaking
maven, was convicted in 2004 of lying to the government about the sale of
her shares in a friend's company whose stock plummeted after a negative
public announcement. She served five months in prison and five months of
home confinement.
Prosecutors charged those
arrested Friday with conspiracy and securities fraud.
A separate criminal
complaint in the case said Chiesi and Moffat conspired to engage in insider
trading in the securities of International Business Machines Corp.
According to another
criminal complaint in the case, Chiesi and Rajaratnam were heard on a
government wiretap of a Sept. 26, 2008, phone conversation discussing
whether Chiesi's friend Moffat should move from IBM to a different
technology company to aid the scheme.
"Put him in some company
where we can trade well," Rajaratnam was quoted in the court papers as
saying.
The complaint said Chiesi
replied: "I know, I know. I'm thinking that too. Or just keep him at IBM,
you know, because this guy is giving me more information. ... I'd like to
keep him at IBM right now because that's a very powerful place for him. For
us, too."
According to the court
papers, Rajaratnam replied: "Only if he becomes CEO." And Chiesi was quoted
as replying: "Well, not really. I mean, come on. ... you know, we nailed
it."
Continued in article
"Arrest of Hedge Fund Chief Unsettles the
Industry," by Michael J. de la Merced and Zachery Kouwe, The New York Times,
October 18, 2009 ---
http://www.nytimes.com/2009/10/19/business/19insider.html?_r=1
The firm made no secret that
its investors included technology executives. Among them was Anil Kumar, a
McKinsey director who did consulting work for Advanced Micro Devices and was
charged in the scheme. Another defendant, Rajiv Goel, is an Intel executive
who is accused of leaking information about the chip maker’s earnings and an
investment in Clearwire.
Prosecutors also say that a
Galleon executive on the board of PeopleSupport, an outsourcing company,
regularly tipped off Mr. Rajaratnam about merger negotiations with a
subsidiary of Essar Group of India. Regulatory filings by PeopleSupport last
year identified the director as Krish Panu, a former technology executive.
He was not charged on Friday.
Galleon has previously
been accused of wrongdoing by regulators. In 2005, it paid more than $2
million to settle an S.E.C. lawsuit claiming it had conducted an illegal
form of short-selling.
Bob Jensen's fraud updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Question
Do you ever get the feeling while we debate accounting theory and standards that
we're just fiddling while investors burn?
"Is stock market still a chump's game? Small
investors won't have a fair shot until a presumption of integrity is restored.
It's not clear that Obama's proposed remedy will resolve the conflicts," by
Eliot Spitzer, Microsoft News, August 19, 2009 ---
http://articles.moneycentral.msn.com/Investing/Extra/is-stock-market-still-a-chumps-game.aspx
Link forwarded by Steve Markoff
[smarkoff@KIMSTARR.ORG]
One of America's great
accomplishments in the last half-century was the so-called "democratization"
of the financial markets.
No longer just for the upper
crust, investing became a way for the burgeoning middle class to accumulate
wealth. Mutual funds exploded in size and number, 401k plans made savings
and investing easy, and the excitement of participating in the growth of our
economy gripped an ever larger percentage of the population.
Despite a backdrop of
doubters -- those who knowingly asserted that outperforming the average was
an impossibility for the small investor -- there was a growing consensus
that the rules were sufficient to protect the mom-and-pop investor from the
sharks that swam in the water.
That sense of fair play in
the market has been virtually destroyed by the bubble burstings and market
drops of the past few years.
Recent rebounds
notwithstanding, most people now are asking whether the system is
fundamentally rigged. It's not just that they have an understandable
aversion to losing their life savings when the market crashes; it's that
each of the scandals and crises has a common pattern: The small investor was
taken advantage of by the piranhas that hide in the rapidly moving currents.
And underlying this pattern is
a simple theme: conflicts of interest that violated the duty the market
players had to their supposed clients.
It is no wonder that
cynicism and anger have replaced what had been the joy of participation in
the capital markets.
Take a quick run through a
few of the scandals:
-
Analysts at major
investment banks promote stocks they know to be worthless, misleading
the investors who rely on their advice yet helping their
investment-banking colleagues generate fees and woo clients.
-
Ratings agencies slap AAA
ratings on debt they know to be dicey in order to appease the issuers --
who happen to pay the fees of the agencies, violating the rating
agency's duty to provide the marketplace with honest evaluations.
-
Executives receive outsized
and grotesque compensation packages -- the result of the perverted
recommendations of compensation consultants whose other business depends
upon the goodwill of the very CEOs whose pay they are opining upon, thus
violating the consultants' duty to the shareholders of the companies for
whom they are supposedly working.
-
Mutual funds charge
exorbitant fees that investors have to absorb -- fees that dramatically
reduce any possibility of outperforming the market and that are set by
captive boards of captive management companies, not one of which has
been replaced for inadequate performance, violating their duty to guard
the interests of the fund investors for whom they supposedly work.
-
"High-speed trading"
produces not only the reality of a two-tiered market but also the
probability of front-running -- that is, illegally trading on
information not yet widely known -- that eats into the possible profits
of the retail clients supposedly being served by these very same market
players, violating the obligation of the banks to get their clients
"best execution" without stepping between their customers and the best
available price.
-
AIG (AIG,
news,
msgs) is bailed out, costing taxpayers
tens of billions of dollars, even though (as we later learned) the big
guys knew that AIG was going down and were able to hedge and cover their
positions. Smaller investors are left holding the stock, and all of us
are left picking up the tab.
The unifying theme is
apparent: Access to information and advice, the very lifeblood of a level
playing field, is not where it needs to be. The small investor still doesn't
have a fair shot.
While there have been
case-specific remedies, the aggregate effect of all the scandals is still to
deny the market the most essential of ingredients: the presumption of
integrity.
The issue confronting those
who wish to solve this problem is that there really is no simple fix.
Bob Jensen's threads on the economic crisis
are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Alpha Return on Investment ---
http://en.wikipedia.org/wiki/Alpha_(investment)
What the professional investors don't tell
you ---
I downloaded this video ---
http://www.cs.trinity.edu/~rjensen/temp/FinancialRounds.flv
From the Financial Rounds Blog on September 4,
2009 ---
http://financialrounds.blogspot.com/
When I teach
investments, there's always a section on market efficiency. A key point I
try to make is that any test of market efficiency suffers from the "joint
hypothesis" problem - that the test is not tests market efficiency, but also
assumes that you have the correct model for measuring the benchmark
risk-adjusted return.
In other words, you can't say that you have "alpha" (an abnormal return)
without correcting for risk.
Falkenblog makes exactly this point:
In my book
Finding Alpha I describe these strategies, as
they are built on the fact that alpha is a residual return, a
risk-adjusted return, and as 'risk' is not definable, this gives people
a lot of degrees of freedom. Further, it has long been the case that
successful people are good at doing one thing while saying they are
doing another.
Even better, he's got a pretty
good video on the topic (it also touches on other topics). Enjoy.
You can watch the video under September 4, 2009
at
http://financialrounds.blogspot.com/
I downloaded this video ---
http://www.cs.trinity.edu/~rjensen/temp/FinancialRounds.flv
Bob Jensen's threads on Return on Investment
(ROI) are at
http://faculty.trinity.edu/rjensen/roi.htm
Bob Jensen's threads on market efficiency (EMH)
are at
http://faculty.trinity.edu/rjensen/theory01.htm#EMH
Bob Jensen's investment helpers are at
http://faculty.trinity.edu/rjensen/Bookbob1.htm#InvestmentHelpers
Instead of adding more regulating
agencies, I think we should simply make the FBI tougher on crime and the IRS
tougher on cheats
Our Main Financial Regulating Agency:
The SEC Screw Everybody Commission
One of the biggest regulation failures in history is the way the SEC failed to
seriously investigate Bernie Madoff's fund even after being warned by Wall
Street experts across six years before Bernie himself disclosed that he was
running a $65 billion Ponzi fund.
CBS Sixty Minutes on June 14, 2009 ran a
rerun that is devastatingly critical of the SEC. If you’ve not seen it, it may
still be available for free (for a short time only) at
http://www.cbsnews.com/video/watch/?id=5088137n&tag=contentMain;cbsCarousel
The title of the video is “The Man Who Would Be King.”
Between 2002 and 2008 Harry Markopolos
repeatedly told (with indisputable proof) the Securities and Exchange Commission
that Bernie Madoff's investment fund was a fraud. Markopolos was ignored and, as
a result, investors lost more and more billions of dollars. Steve Kroft reports.
Markoplos makes the SEC look truly
incompetent or outright conspiratorial in fraud.
I'm really surprised that the SEC
survived after Chris Cox messed it up so many things so badly.
As Far as Regulations Go
An annual
report issued by the Competitive Enterprise Institute (CEI) shows that the U.S.
government imposed $1.17 trillion in new regulatory costs in 2008. That almost
equals the $1.2 trillion generated by individual income taxes, and amounts to
$3,849 for every American citizen. According the 2009 edition of Ten Thousand
Commandments: An Annual Snapshot of the Federal Regulatory State, the government
issued 3,830 new rules last year, and The Federal Register, where such rules are
listed, ballooned to a record 79,435 pages. “The costs of federal regulations
too often exceed the benefits, yet these regulations receive little official
scrutiny from Congress,” said CEI Vice President Clyde Wayne Crews, Jr., who
wrote the report. “The U.S. economy lost value in 2008 for the first time since
1990,” Crews said. “Meanwhile, our federal government imposed a $1.17 trillion
‘hidden tax’ on Americans beyond the $3 trillion officially budgeted” through
the regulations.
Adam Brickley, "Government Implemented Thousands of New Regulations
Costing $1.17 Trillion in 2008," CNS News, June 12, 2009 ---
http://www.cnsnews.com/public/content/article.aspx?RsrcID=49487
Jensen Comment
I’m a long-time believer that industries being regulated end up controlling the
regulating agencies. The records of Alan Greenspan (FED) and the SEC from Arthur
Levitt to Chris Cox do absolutely nothing to change my belief ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
How do industries leverage the
regulatory agencies?
The primary control mechanism is to have high paying jobs waiting in industry
for regulators who play ball while they are still employed by the government. It
happens time and time again in the FPC, EPA, FDA, FAA, FTC, SEC, etc. Because so
many people work for the FBI and IRS, it's a little harder for industry to
manage those bureaucrats. Also the FBI and the IRS tend to focus on the worst of
the worst offenders whereas other agencies often deal with top management of the
largest companies in America.
Being Honest About Being
Dishonest
Democrats openly admit that most of the stimulus money is going to counties that
voted for Obama
A new study released by USA Today also finds that
counties that voted for Obama received about twice as much stimulus money per
capita as those that voted for McCain. "The stimulus bill is designed to help
those who have been hurt by the economic downturn.... Do you see disparity out
there in where the money is going? Certainly," a Democratic congressional
staffer knowledgeable about the process told FOXNews.com.
John Lott, "ANALYSIS: States Hit
Hardest by Recession Get Least Stimulus Money," Fox News, July 19,
2009---
http://www.foxnews.com/story/0,2933,533841,00.html
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll,
The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print
The legislation's guidelines for crafting the
rescue plan were clear: the TARP should protect home values and consumer
savings, help citizens keep their homes and create jobs. Above all, with the
government poised to invest hundreds of billions of taxpayer dollars in
various financial institutions, the legislation urged the bailout's
architects to maximize returns to the American people.
That $700 billion bailout has since
grown into a more than $12 trillion commitment by
the US government and the Federal Reserve. About
$1.1 trillion
of that is taxpayer money--the TARP money and an additional $400 billion
rescue of mortgage companies Fannie Mae and Freddie Mac. The TARP now
includes twelve separate programs, and recipients range from megabanks like
Citigroup and JPMorgan Chase to automakers Chrysler and General Motors.
Seven months in, the bailout's impact is
unclear. The Treasury Department has used the
recent "stress test" results it applied to
nineteen of the nation's largest banks to suggest that the worst might be
over; yet the
International Monetary Fund, as well as economists
like New York University professor and economist Nouriel Roubini and New
York Times columnist Paul Krugman
predict greater losses in US markets, rising unemployment and
generally tougher economic times ahead.
What cannot be disputed, however, is the
financial bailout's biggest loser: the American taxpayer. The US government,
led by the Treasury Department, has done little, if anything, to maximize
returns on its trillion-dollar, taxpayer-funded investment. So far, the
bailout has favored rescued financial institutions by
subsidizing their
losses to the tune of $356 billion,
shying away from much-needed management changes and--with the exception of
the automakers--letting companies take taxpayer money without a coherent
plan for how they might return to viability.
The bailout's perks have been no less
favorable for private investors who are now picking over the economy's
still-smoking rubble at the taxpayers' expense. The newer bailout programs
rolled out by Treasury Secretary Timothy Geithner give private equity firms,
hedge funds and other private investors significant leverage to buy "toxic"
or distressed assets, while leaving taxpayers stuck with the lion's share of
the risk and potential losses.
Given the lack of transparency and
accountability, don't expect taxpayers to be able to object too much. After
all, remarkably little is known about how TARP recipients have used the
government aid received. Nonetheless, recent government
reports,
Congressional testimony and
commentaries offer those patient enough to pore over hundreds of pages of
material glimpses of just how Wall Street friendly the bailout actually is.
Here, then, based on the most definitive data and analyses available, are
six of the most blatant and alarming ways taxpayers have been scammed by the
government's $1.1-trillion, publicly funded bailout.
1. By
overpaying for its TARP investments, the Treasury Department provided
bailout recipients with generous subsidies at the taxpayer's expense.
When the Treasury Department ditched its
initial plan to buy up "toxic" assets and instead invest directly in
financial institutions, then-Treasury Secretary Henry Paulson Jr. assured
Americans that they'd get a fair deal. "This is an investment, not an
expenditure, and there is no reason to expect this program will cost
taxpayers anything," he
said in October 2008.
Yet the Congressional Oversight Panel
(COP), a five-person group tasked with ensuring that the Treasury Department
acts in the public's best interest, concluded in its
monthly report for February that
the department had significantly overpaid by tens of billions of dollars for
its investments. For the ten largest TARP investments made in 2008, totaling
$184.2 billion, Treasury received on average only $66 worth of assets for
every $100 invested. Based on that shortfall, the panel calculated that
Treasury had received only $176 billion in assets for its $254 billion
investment, leaving a $78 billion hole in taxpayer pockets.
Not all investors subsidized the
struggling banks so heavily while investing in them. The COP report notes
that private investors received much closer to fair market value in
investments made at the time of the early TARP transactions. When, for
instance,
Berkshire Hathaway invested $5 billion in Goldman Sachs
in September, the Omaha-based company received
securities worth $110 for each $100 invested. And when
Mitsubishi invested in Morgan Stanley
that same month, it received securities worth
$91 for every $100 invested.
As of May 15, according to the
Ethisphere TARP Index, which
tracks the government's bailout investments, its various investments had
depreciated in value by almost $147.7 billion. In other words, TARP's losses
come out to almost $1,300 per American taxpaying household.
2. As the
government has no real oversight over bailout funds, taxpayers remain in the
dark about how their money has been used and if it has made any difference.
While the Treasury Department can make
TARP recipients report on just how they spend their government bailout
funds, it has chosen not to do so. As a result, it's unclear whether
institutions receiving such funds are using that money to increase
lending--which would, in turn, boost the economy--or merely to fill in holes
in their balance sheets.
Neil M. Barofsky, the special inspector
general for TARP, summed the situation up this way in his office's April
quarterly report to Congress: "The American people have a right to know how
their tax dollars are being used, particularly as billions of dollars are
going to institutions for which banking is certainly not part of the
institution's core business and may be little more than a way to gain access
to the low-cost capital provided under TARP."
This lack of transparency makes the
bailout process highly susceptible to fraud and corruption.
Barofsky's report stated that twenty separate
criminal investigations were already underway involving corporate fraud,
insider trading and public corruption. He also
told the Financial Times
that his office was investigating whether banks manipulated their books to
secure bailout funds. "I hope we don't find a single bank that's cooked its
books to try to get money, but I don't think that's going to be the case."
Economist Dean Baker, co-director of the
Center for Economic and Policy Research in Washington, suggested to
TomDispatch in an interview that the opaque and complicated nature of the
bailout may not be entirely unintentional, given the difficulties it raises
for anyone wanting to follow the trail of taxpayer dollars from the
government to the banks. "[Government officials] see this all as a Three
Card Monte, moving everything around really quickly so the public won't
understand that this really is an elaborate way to subsidize the banks,"
Baker says, adding that the public "won't realize we gave money away to some
of the richest people."
3. The
bailout's newer programs heavily favor the private sector, giving investors
an opportunity to earn lucrative profits and leaving taxpayers with most of
the risk.
Under Treasury Secretary Geithner, the
Treasury Department has greatly expanded the financial bailout to troubling
new programs like the Public-Private Investment Program (PPIP) and the Term
Asset-Backed-Securities Loan Facility (TALF). The PPIP, for example,
encourages private investors to buy "toxic" or risky assets on the books of
struggling banks. Doing so, we're told, will get banks lending again because
the burdensome assets won't weigh them down. Unfortunately, the incentives
the Treasury Department is offering to get private investors to participate
are so generous that the government--and, by extension, American
taxpayers--are left with all the downside.
Joseph Stiglitz, the Nobel-prize winning
economist,
described the PPIP program in a
New York Times op-ed this way:
Consider an asset that
has a 50-50 chance of being worth either zero or $200 in a year's time. The
average "value" of the asset is $100. Ignoring interest, this is what the
asset would sell for in a competitive market. It is what the asset is
'worth.' Under the plan by Treasury Secretary Timothy Geithner, the
government would provide about 92 percent of the money to buy the asset but
would stand to receive only 50 percent of any gains, and would absorb almost
all of the losses. Some partnership!
Assume that one of the
public-private partnerships the Treasury has promised to create is willing
to pay $150 for the asset. That's 50 percent more than its true value, and
the bank is more than happy to sell. So the private partner puts up $12, and
the government supplies the rest--$12 in "equity" plus $126 in the form of a
guaranteed loan.
If, in a year's time,
it turns out that the true value of the asset is zero, the private partner
loses the $12, and the government loses $138. If the true value is $200, the
government and the private partner split the $74 that's left over after
paying back the $126 loan. In that rosy scenario, the private partner more
than triples his $12 investment. But the taxpayer, having risked $138, gains
a mere $37."
Worse still, the PPIP can be easily
manipulated for private gain. As economist
Jeffrey Sachs has described it, a
bank with worthless toxic assets on its books could actually set up its
own public-private fund to bid on those assets. Since no true bidder
would pay for a worthless asset, the bank's public-private fund would win
the bid, essentially using government money for the purchase. All the
public-private fund would then have to do is quietly declare bankruptcy and
disappear, leaving the bank to make off with the government money it
received. With the PPIP deals set to begin in the coming months, time will
tell whether private investors actually take advantage of the program's
flaws in this fashion.
The Treasury Department's TALF program
offers equally enticing possibilities for potential bailout profiteers,
providing investors with a chance to double, triple or even quadruple their
investments. And like the PPIP, if the deal goes bad, taxpayers absorb most
of the losses. "It beats any financing that the private sector could ever
come up with," a
Wall Street trader commented
in a recent Fortune magazine story. "I almost want to say it is
irresponsible."
4. The
government has no coherent plan for returning failing financial institutions
to profitability and maximizing returns on taxpayers' investments.
Compare the treatment of the auto industry
and the financial sector, and a troubling double standard emerges. As a
condition for taking bailout aid, the government required Chrysler and
General Motors to present
detailed plans on how the
companies would return to profitability. Yet the Treasury Department
attached minimal conditions to the billions injected into the largest
bailed-out financial institutions. Moreover, neither Geithner nor Lawrence
Summers, one of President Barack Obama's top economic advisors, nor the
president himself has articulated any substantive plan or vision for how the
bailout will help these institutions recover and, hopefully, maximize
taxpayers' investment returns.
The Congressional Oversight Panel
highlighted the absence of such a comprehensive plan in its
January report. Three months into
the bailout, the Treasury Department "has not yet explained its strategy,"
the report stated. "Treasury has identified its goals and announced its
programs, but it has not yet explained how the programs chosen constitute a
coherent plan to achieve those goals."
Today, the department's endgame for the
bailout still remains vague. Thomas Hoenig, president of the Federal Reserve
Bank of Kansas City,
wrote in the Financial Times
in May that the government's response to the financial meltdown has been "ad
hoc, resulting in inequitable outcomes among firms, creditors, and
investors." Rather than perpetually prop up banks with endless taxpayer
funds, Hoenig suggests, the government should allow banks to fail. Only
then, he believes, can crippled financial institutions and systems be fixed.
"Because we still have far to go in this crisis, there remains time to
define a clear process for resolving large institutional failure. Without
one, the consequences will involve a series of short-term events and far
more uncertainty for the global economy in the long run."
The healthier and more profitable bailout
recipients are once financial markets rebound, the more taxpayers will earn
on their investments. Without a plan, however, banks may limp back to
viability while taxpayers lose their investments or even absorb further
losses.
5. The
bailout's focus on Wall Street mega-banks ignores smaller banks serving
millions of American taxpayers that face an equally uncertain future.
The government may not have a long-term
strategy for its trillion-dollar bailout, but its guiding principle, however
misguided, is clear: what's good for Wall Street will be best for the rest
of the country.
On the day the mega-bank stress tests were
officially released, another set of stress-test results came out to much
less fanfare. In its
quarterly report on the health of individual banks and the banking industry
as a whole, Institutional Risk
Analytics (IRA), a respected financial services organization, found that the
stress levels among more than 7,500 FDIC-reporting banks nationwide had
risen dramatically. For 1,575 of the banks, net incomes had turned negative
due to decreased lending and less risk-taking.
The conclusion IRA drew was telling: "Our
overall observation is that US policy makers may very well have been
distracted by focusing on 19 large stress test banks designed to save Wall
Street and the world's central bank bondholders, this while a trend is
emerging of a going concern viability crash taking shape under the radar."
The report concluded with a question: "Has the time come to shift the policy
focus away from the things that we love, namely big zombie banks, to tackle
things that are truly hurting us?"
6. The bailout
encourages the very behaviors that created the economic crisis in the first
place instead of overhauling our broken financial system and helping the
individuals most affected by the crisis.
As Joseph Stiglitz explained in the New
York Times, one major cause of the economic crisis was bank
overleveraging. "Using relatively little capital of their own," he wrote,
banks "borrowed heavily to buy extremely risky real estate assets. In the
process, they used overly complex instruments like collateralized debt
obligations." Financial institutions engaged in overleveraging in pursuit of
the lucrative profits such deals promised--even if those profits came with
staggering levels of risk.
Sound familiar? It should, because in the
PPIP and TALF bailout programs the Treasury Department has essentially
replicated the very over-leveraged, risky, complex system that got us into
this mess in the first place: in other words, the government hopes to repair
our financial system by using the flawed practices that caused this crisis.
Then there are the institutions deemed
"too big to fail." These financial giants--among them AIG, Citigroup and
Bank of America-- have been kept afloat by billions of dollars in bottomless
bailout aid. Yet reinforcing the notion that any institution is "too big to
fail" is dangerous to the economy. When a company like AIG grows so large
that it becomes "too big to fail," the risk it carries is systemic, meaning
failure could drag down the entire economy. The government should force "too
big to fail" institutions to slim down to a safer, more modest size;
instead, the Treasury Department continues to subsidize these financial
giants, reinforcing their place in our economy.
Of even greater concern is the message the
bailout sends to banks and lenders--namely, that the risky investments that
crippled the economy are fair game in the future. After all, if banks fail
and teeter at the edge of collapse, the government promises to be there with
a taxpayer-funded, potentially profitable safety net.
The handling of the bailout makes at least
one thing clear, however. It's not your health that the government is
focused on, it's theirs-- the very banks and lenders whose convoluted
financial systems provided the underpinnings for staggering salaries and
bonuses, while bringing our economy to the brink of another Great
Depression.
Bob Jensen's threads how your money was put to word
(fraudulently) to pay for the mistakes of the so-called professionals of finance
---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Bob Jensen's threads on why the infamous "Bailout" won't
work ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#BailoutStupidity
"SEC Charges Four With Fraud," by
Kathy Shwiff, The Wall Street Journal, July 15, 2009 ---
http://online.wsj.com/article/SB124751046687234157.html#mod=todays_us_money_and_investing
The Securities and Exchange
Commission charged Seattle securities lawyer David Otto, three other
individuals and two companies with conducting a fraudulent "pump-and-dump"
scheme in which they secretly unloaded more than $1 million in "penny
stocks" of a company touting a nonexistent antiaging product.
The complaint says the
defendants violated antifraud and other provisions of federal securities
laws. The SEC is seeking disgorgement and financial penalties.
The agency said misleading
news releases and Web profiles touting beverages and nutritional supplements
pushed the stock price of Seattle-based MitoPharm up more than four times to
above $2.30 although MitoPharm's products were in the developmental stage.
Two key products didn't exist, according to the complaint.
The SEC said Mr. Otto sold
his shares for more than $1 million while Houston-based stock promoter
Charles Bingham generated proceeds of $300,000 before heavy selling caused
the price to fall to a nickel by November 2007.
The SEC's complaint, filed
in federal court in Seattle, charges Mr. Otto, associate Todd Van Siclen of
Seattle, Mr. Bingham and his company, Wall Street PR Inc., along with
MitoPharm and its chief executive, Pak Peter Cheung of Vancouver.
Mr. Otto's attorney,
Jeff Coopersmith said Mr. Otto committed no intentional violation of
securities law. Mr. Bingham's attorney, Ronald Kaufman, said his client is
as much a victim as any other shareholder. Mr. Bingham said his firm lost
money on the work it did for MitoPharm, adding he had no way of knowing the
products, which were being manufactured in China, weren't as described. The
other defendants couldn't be reached for comment.
Bob Jensen's threads on securities frauds are
at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#SecuritiesFraud
"Insider Trading Inside the SEC," by Joe
Weisenthal, Business Insider, May 15, 2009 ---
http://www.businessinsider.com/insider-trading-at-the-sec-2009-5
Kotz, who told Congress last year he was examining
whether frequent trades by the pair broke agency
rules, referred the case to the U.S. Attorney’s
Office in Washington after finding evidence the bets
might amount to insider trading, he wrote in the
March 3 report released by Senator
Charles Grassley.
Both lawyers still work for the agency and denied
improper conduct.
The report faults the agency for inadequately
monitoring trades by employees and relying on an
“honor system.” The lawyers frequently discussed
stocks at work, traded in at least one company under
investigation and didn’t properly disclose some
transactions, it says. One lawyer made 247 trades in
the two years ending January 2008, and the other
made 14.
ead the whole thing >
Question
What are hedge funds, especially after Bernie Madoff made them so famous?
When people ask me this question, my initial
response is that a hedge fund no longer necessarily has anything to do with
financial risk hedging. Rather a hedge fund is merely a "private" investment
"club" that does not offer shares to the general public largely because it would
then subject itself to more SEC, stock exchange, and other regulators. Having
said this, it's pretty darn easy for anybody with sufficient funds to get into
such a "private" club. Minimum investments range from $10,000 to $1,000,000 or
higher.
Since Bernie Madoff made hedge funds so famous,
the public tends to think that a hedge fund is dangerous, fraudulent, and a back
street operation that does not play be the rules. Certainly hedge funds emerged
in part to avoid being regulated. Sometimes they are risky due to high leverage,
but some funds skillfully hedge to manage risk and are
much safer than mutual funds. For example, some hedge funds have shrewd
hedging strategies to control risk in interest rate and/or foreign currency
trading.
Most hedge funds are not fraudulent. In general,
however, it's "buyer beware" for hedge fund investors.
I would never invest in a hedge fund that is not
audited by a very reliable CPA auditing firm. Not all CPA auditing firms are
reliable (Bernie Madoff proved you can engage a fraudulent auditor operating out
of a one-room office). Hence, the first step in evaluating a hedge fund is to
investigate its auditor. The first step in evaluating an auditor is to determine
if the auditing firm is wealthy enough to be a serious third party in law suits
if the hedge fund goes belly up.
But the recent multimillion losses of Carnegie
Mellon, the University of Pittsburgh, and other university endowment funds that
invested in a verry fraudulent hedge fund purportedly audited by Deloitte
suggests that the size and reputation of the auditing firm is not, by itself,
sufficient protection against a criminal hedge fund (that was supposedly given a
clean opinion by Deloitte in financial reports circulated to the victims of the
fraud).
When learning about hedge funds, you may want to
begin at
http://en.wikipedia.org/wiki/Hedge_Fund
"What is a hedge fund and how is it different
from a mutual fund?" by Andy Samuels, Business and Finance 101
Examiner, June 10, 2009 ---
Click Here
Jim Mahar pointed out this link.
Having migrated away from
their namesake, hedge funds no longer focus primarily on “hedging”
(attempting to reduce risk) because hedge funds are now focused almost
blindly on one thing: returns.
Having been referred
to as “mutual funds for the super rich” by
investopedia.com, hedge funds are very similar to
mutual funds in that they pool money together from many investors. Hedge
funds, like
mutual funds, are also managed by a financial
professionals, but differ because they are geared toward wealthier
individuals.
Hedge funds, unlike
mutual funds, employ a wider array of ivesting techniques, which are
considered more aggresive. For example, hedge funds often use
leverage to amplify their returns (or losses if
things go wrong).
The other key
difference between hedge funds and mutual funds is the amount of regulation
involved. Hedge funds are relatively unregulated because investors in hedge
funds are assumed to be more sophisticated investors, who can both afford
and understand the potential losses. In fact, U.S. laws require that the
majority of investors in the fund are
accredited.
Most hedge funds draw in investors because of
the trustworthy reputations of the executives of the fund. Word-of-mouth praise
and affiliations are often the key to success. Bernie Madoff succeed in luring
customers based on two leading factors: (1) His esteemed reputation on
Wall Street and (2) His highly regarded connections in the Jewish community
where he drew in most of his victims.
A Bit of History
German Chancellor's Call for Global Regulations to Curb Hedge Funds
Germany and the United States are parting company
again, this time over Chancellor Gerhard Schröder's call for international
regulations to govern hedge funds. Treasury Secretary John W. Snow, speaking
here Thursday at the end of a five-country European tour, said the United
States opposed "heavy-handed" curbs on markets. He said that he was not
familiar with the German proposals, but left little doubt about how
Washington would react. "I think we ought to be very careful about
heavy-handed regulation of markets because it stymies financial innovation,"
Mr. Snow said after a news conference here to sum up his visit. Noting that
the Securities and Exchange Commission has proposed that hedge funds be
required to register themselves, he said he preferred the "light touch
rather than the heavy regulatory burden."
Mark Landler, "U.S. Balks at German Chancellor's Call for Global Regulations
to Curb Hedge Funds," The New York Times, June 17, 2005 ---
http://www.nytimes.com/2005/06/17/business/worldbusiness/17hedge.html?
An investing balloon that will one day burst
The numbers are mind-boggling: 15 years ago,
hedge funds managed less than $40 billion. Today, the figure is
approaching $1 trillion. By contrast, assets in mutual funds grew at an
impressive but much slower rate, to $8.1 trillion from $1 trillion, during
the same period. The number of hedge fund firms has also grown - to 3,307
last year, up 74 percent from 1,903 in 1999. During the same period, the
number of funds created - a manager can start more than one fund at a time
- has surged 209 percent, with 1,406 funds introduced in 2004, according
to Hedge Fund Research, based in Chicago.
Jenny Anderson and Riva D. Atlas, "If I Only Had a Hedge Fund,"
The New York Times, The New York Times, March 27, 2005 ---
http://www.nytimes.com/2005/03/27/business/yourmoney/27hedge.html
Jensen Comment: The name "hedge fund" seems to imply that
risk is hedged. Nothing could be further from the case. Hedge
funds do not have to hedge risks, Hedge funds should instead be
called private investment clubs. If structured in a certain way they
can avoid SEC oversight.
Remember how the Russian
space program worked in the 1960s? The only flights that got publicized
were the successful ones. Hedge funds are like that. The ones asking
for your money have terrific records. You don't hear about the ones that
blew up. That fact should strongly color your view of hedge funds with
terrific records.
Forbes, January 13, 2005 ---
http://snipurl.com/ForbesJan_13
US hedge funds prior to 2005 were exempted from
Securities and Exchange Commission reporting requirements, as well as from
regulatory restrictions concerning leverage or trading strategies. They
now must register with the SEC except under an enormous loophole for funds
that cannot liquidate in less than two years.
The Loophole: Locked-up
funds don't require oversight. That means more risk for investors.
"Hedge Funds Find an Escape Hatch," Business Week,
December 27, 2004, Page 51 ---
Securities
& Exchange Commission Chairman William H. Donaldson recently
accomplished a major feat when he got the agency to pass a controversial
rule forcing hedge fund advisers to register by 2006. Unfortunately,
just weeks after the SEC announced the new rule on Dec. 2, many hedge
fund managers have already figured out a simple way to bypass it.
The easy out is
right on page 23 of the new SEC rule: Any fund that requires investors
to commit their money for more than two years does not have to register
with the SEC. The SEC created that escape hatch to benefit
private-equity firms and venture capitalists, which typically make
long-term investments and have been involved in few SEC enforcement
actions. By contrast, hedge funds, some of which have recently been
charged with defrauding investors, typically have allowed investors to
remove their money at the end of every quarter. Now many are considering
taking advantage of the loophole by locking up customers' money for
years.
Bob Jensen's threads on frauds are linked at
http://faculty.trinity.edu/rjensen/fraud.htm
In particular see
http://faculty.trinity.edu/rjensen/fraud001.htm
Video 1: "Nobelist Daniel Kahneman On Behavioral Economics (Awesome)!"
Simoleon Sense, June 5, 2009 ---
http://www.simoleonsense.com/video-nobelist-daniel-kahneman-on-behavioral-economics-awesome/
Introduction (Via Fora.Tv)
Nobel
Prize-winning psychologist Daniel Kahneman addresses the
Georgetown class of 2009 about the merits of behavioral
economics.
He deconstructs the assumption that people always act
rationally, and explains how to promote rational
decisions in an irrational world.
Topics Covered:
1. The
Economic Definition Of Rationality
2.
Emphasis on Rationality in Modern Economic Theory
3. Examples of Irrational Behavior (watch this part)
4. How
to encourage rational decisions
Speaker Background (Via Fora.Tv)
Daniel
Kahneman - Daniel Kahneman is Eugene Higgins Professor
of Psychology and Professor of Public Affairs Emeritus
at Princeton University. He was educated at The Hebrew
University in Jerusalem and obtained his PhD in
Berkeley. He taught at The Hebrew University, at the
University of British Columbia and at Berkeley, and
joined the Princeton faculty in 1994, retiring in 2007.
He is best known for his contributions, with his late
colleague Amos Tversky, to the psychology of judgment
and decision making, which inspired the development of
behavioral economics in general, and of behavioral
finance in particular. This work earned Kahneman the
Nobel Prize in Economics in 2002 and many other honors
Video 2: Nancy Etcoff is part of a new
vanguard of cognitive researchers asking: What makes us happy? Why do we like
beautiful things? And how on earth did we evolve that way?
Simoleon Sense, June 10, 2009
http://www.simoleonsense.com/science-of-happiness/
"Must Read: Why People Fall Victim To Scams,"
Simoleon Sense, March 18, 2009 ---
http://www.simoleonsense.com/must-read-why-people-fall-victim-to-scams/
The paper is at
http://www.oft.gov.uk/shared_oft/reports/consumer_protection/oft1070.pdf
A fraudulent market manipulation contributed to
the Wall Street meltdown
Phantom Shares and Market Manipulation (Bloomberg News
video on naked short selling) ---
http://video.google.com/videoplay?docid=4490541725797746038
Securities Fraud ---
http://en.wikipedia.org/wiki/Securities_fraud
Securities fraud, also
known as investment fraud, is a practice in which
investors are deceived and manipulated, resulting in losses.[1]
Generally speaking, securities fraud consists of deceptive
practices in the stock and commodity markets, and occurs
when investors are enticed to part with their money based on
untrue statements.
Securities fraud frequently includes theft of
capital from investors and misstatements on a public
company's financial reports. The term also encompasses a
wide range of other actions, including insider trading.
Sometimes the losses caused
by securities fraud are difficult to quantify, but real. For
example, insider trading is believed to raise the cost of
capital for securities issuers, thus decreasing overall
economic growth.
This
white collar crime has become increasingly frequent as
the
Internet and
World Wide Web are giving criminals greater access to
prey. The trading volume in the
United States
securities and commodities markets, having grown
dramatically in the 1990s, has led to an increase in
fraud and misconduct by
investors,
executives,
shareholders, and other market participants.
Securities regulators and other prominent groups
estimate civil securities fraud totals approximately $40
billion per year. Fraudulent schemes perpetrated in the
securities and commodities markets can ultimately have a
devastating impact on the viability and operation of these
markets.
According to the
FBI, securities fraud includes false information on a
company's financial statement and
Securities and Exchange Commission (SEC) filings; lying
to corporate auditors; insider trading; stock manipulation
schemes, and embezzlement by stockbrokers.
Overview ---
http://en.wikipedia.org/wiki/Securities_fraud
-
1
Types of securities fraud
-
1.1
Internet fraud
-
1.2
Insider trading
-
1.3
Microcap fraud
-
1.4
Accountant fraud
-
1.5
Boiler rooms
-
2
Pervasiveness of
securities fraud
-
3
Characteristics of victims
and perpetrators
-
4
Other effects of
securities fraud
-
5
Related subjects
-
6
See also
-
7
References
|
The Way Financial
Media Fraud Works
Video from YouTube
(not sure how long it will be online)
http://www.youtube.com/watch?v=dwUXx4DR0wo
From Jim Mahar's Blog on March 152, 2009 ---
http://financeprofessorblog.blogspot.com/
While
there was much hype in the days leading
up to the show, the actual interview was
pretty good. Jon Stewart vs Jim Cramer.
Here is the
link from The DailyShow
for the entire
episode.
It is also available (at least
temporarily) on
YouTube
Jon Stewart vs Jim
Cramer Interview Fight on Daily Show
---
http://www.youtube.com/watch?v=LceizefhP4k
Some talking
points:
* Stewart's main point seems to be that
while Cramer and CNBC claim to be
looking out for investors, in actuality
they are are nothing more than
entertainment at best and accomplices at
worst.
* It is interesting to see the
discussion on Short Selling and the way
that Cramer (and by inference other
hedge fund managers) essentially lied to
drive the price down. I would have to
think the SEC might be interested in
this.
* Stewart maintains that the financial
media plays a role in governance. They
dropped the ball.
* Cramer was good in admitting that
success (year after year of 30% returns)
changes our view and we forget that
things go wrong.
* Line of the day from Stewart: "We are
both snake oil salesmen, but I let
people know I sell snake oil.:
* Line of the day from Cramer: "No one
should be spared in this environment."
The whole interview (unedited) is also
available. Here is the 3rd part:
Video
from YouTube (not sure how long it will
be online)
http://www.youtube.com/watch?v=dwUXx4DR0wo
Bernard Madoff, former Nasdaq Stock Market chairman and
founder of Bernard L. Madoff Investment Securities LLC, was arrested and charged
with securities fraud Thursday in what federal prosecutors called a Ponzi scheme
that could involve losses of more than $50 billion.
It is bigger than Enron, bigger than Boesky and bigger than
Tyco
"Madoff Scandal: 'Biggest Story of the Year'," Seeking
Alpha, December 12, 2008 ---
http://seekingalpha.com/article/110402-madoff-scandal-biggest-story-of-the-year?source=wildcard
According to
RealMoney.com columnist Doug Kass,
general partner and investment manager of hedge fund Seabreeze Partners
Short LP and Seabreeze Partners Short Offshore Fund, Ltd., today's
late-breaking report of an alleged massive fraud at a well known investment
firm could be "the biggest story of the year." In his view,
it is bigger than
Enron, bigger than Boesky and bigger than Tyco.
It attacks at the core of investor confidence -- because, if true,
and this could happen ... investors might think that almost anything
imaginable could happen to the money they have entrusted to their fiduciaries.
Here are some excerpts
from the Bloomberg report, entitled
"Madoff Charged in $50 Billion Fraud at Advisory Firm":
Bernard Madoff,
founder and president of Bernard Madoff Investment Securities, a
market-maker for hedge funds and banks, was charged by federal
prosecutors in a $50 billion fraud at his advisory business.
Madoff, 70, was
arrested today at 8:30 a.m. by the FBI and appeared before U.S.
Magistrate Judge Douglas Eaton in Manhattan federal court. Charged
in a criminal complaint with a single count of securities fraud, he
was granted release on a $10 million bond guaranteed by his wife and
secured by his apartment. Madoff’s wife was present in the
courtroom.
"It’s all just
one big lie," Madoff told his employees on Dec. 10, according to a
statement by prosecutors. The firm, Madoff allegedly said, is
"basically, a giant Ponzi scheme." He was also sued by the
Securities and Exchange Commission.
Madoff’s New
York-based firm was the 23rd largest market maker on Nasdaq in
October, handling a daily average of about 50 million shares a day,
exchange data show. The firm specialized in handling orders from
online brokers in some of the largest U.S. companies, including
General Electric Co (GE). and Citigroup Inc. (C).
...
SEC Complaint
The SEC in its
complaint, also filed today in Manhattan federal court, accused
Madoff of a "multi-billion dollar Ponzi scheme that he perpetrated
on advisory clients of his firm."
The SEC said it’s
seeking emergency relief for investors, including an asset freeze
and the appointment of a receiver for the firm. Ira Sorkin, another
defense lawyer for Madoff, couldn’t be immediately reached for
comment.
...
Madoff, who owned
more than 75 percent of his firm, and his brother Peter are the only
two individuals listed on regulatory records as "direct owners and
executive officers."
Peter Madoff was
a board member of the St. Louis brokerage firm A.G. Edwards Inc.
from 2001 through last year, when it was sold to Wachovia Corp (WB).
$17.1 Billion
The Madoff firm
had about $17.1 billion in assets under management as of Nov. 17,
according to NASD records. At least 50 percent of its clients were
hedge funds, and others included banks and wealthy individuals,
according to the records.
...
Madoff’s Web site
advertises the "high ethical standards" of the firm.
"In an era of
faceless organizations owned by other equally faceless
organizations, Bernard L. Madoff Investment Securities LLC harks
back to an earlier era in the financial world: The owner’s name is
on the door," according to the Web site. "Clients know that Bernard
Madoff has a personal interest in maintaining the unblemished record
of value, fair-dealing, and high ethical standards that has always
been the firm’s hallmark."
...
"These guys were
one of the original, if not the original, third market makers," said
Joseph Saluzzi, the co-head of equity trading at Themis Trading LLC
in Chatham, New Jersey. "They had a great business and they were
good with their clients. They were around for a long time. He’s a
well-respected guy in the industry."
The case is U.S.
v. Madoff, 08-MAG-02735, U.S. District Court for the Southern
District of New York (Manhattan)
Continued in article
And here is the
SEC press release
Also see
http://lawprofessors.typepad.com/securities/
What was the auditing firm of Bernard Madoff
Investment Securities, the auditor who gave a clean opinion, that's been
insolvent for years?
Apparently, Mr Madoff said the business had been
insolvent for years and, from having $17 billion of assets under management at
the beginning of 2008, the SEC said: “It appears that virtually all assets of
the advisory business are gone”. It has now emerged that Friehling & Horowitz,
the auditor that signed off the annual financial statement for the investment
advisory business for 2006, is under investigation by the district attorney in
New York’s Rockland County, a northern suburb of New York City.
"The $50bn scam: How Bernard Madoff allegedly cheated investors," London
Times, December 15, 2008 ---
http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article5345751.ece
It was at the Manhattan
apartment that Mr Madoff apparently confessed that the business was in fact
a “giant Ponzi scheme” and that the firm had been insolvent for years.
To cap it all, Mr Madoff
told his sons he was going to give himself up, but only after giving out the
$200 - $300 million money he had left to “employees, family and friends”.
All the company’s remaining
assets have now been frozen in the hope of repaying some of the companies,
individuals and charities that have been unfortunate enough to invest in the
business.
However, with the fraud
believed to exceed $50 billion, whatever recompense investors could receive
will be a drop in the ocean.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Where were the auditors?
What surprised me is the size of this alleged fraud
"This is huge," said David Rosenfeld,
associate regional director of the SEC's New York Regional Office.
"This is a truly egregious fraud of immense proportions."
"Carnegie Mellon and Pitt Accuse 2 Investment Managers of
$114-Million Fraud," by Scott Carlson, Chronicle of Higher Education,
February 26, 2009 ---
Click Here
The University of Pittsburgh and
Carnegie Mellon University are suing two investment managers who
allegedly took $114-million from the institutions and spent it on
cars, horses, houses for their wives, and even teddy bears.
The two managers, Paul Greenwood and
Stephen Walsh, are said to have taken a total of more than
$500-million from the universities and other investors through their
company, Westridge Capital Management, and they have also been
charged with fraud by the Federal Bureau of Investigation. The
universities named several associates of Mr. Greenwood and Mr. Walsh
in the lawsuit.
According to the complaint, the
universities became alarmed after the National Futures Association,
a nonprofit organization that investigates member firms, tried to
audit Mr. Greenwood and Mr. Walsh’s company. The association
determined that that Mr. Greenwood and Mr. Walsh had taken hundreds
of millions in loans from the investment funds. On February 12 the
association suspended their membership after repeatedly trying, and
failing, to contact them.
That step spurred the universities
to try to locate their money. On February 18 they contacted the
Securities and Exchange Commission and sought an investigation.
According to their lawsuit, Carnegie Mellon had invested $49-million
and the University of Pittsburgh had invested $65-million.
Today’s
Pittsburgh Post-Gazette
listed some of the things that Mr.
Greenwood and Mr. Walsh had purchased with their investors’ money:
rare books, Steiff teddy bears at up to $80,000 each, a horse farm,
cars, and a $3-million residence for Mr. Walsh’s ex-wife.
Mr. Greenwood and Mr. Walsh were
also handling money for retirement funds for teachers and public
employees in Iowa, North Dakota, and Sacramento County, California.
In the Post-Gazette, David Rosenfeld, an associate regional
director of the SEC’s New York Regional
Office, said the case represented “a truly egregious fraud of
immense proportions.”
Mr. Walsh, it appears, had ties to
another university as well. He is a member of the foundation board
at the State University of New York at Buffalo, from which he
graduated in 1966 with a political-science degree. In a written
statement, officials at Buffalo said that he had not been an active
board member for the past two years and that foundation policy
forbade investing university money with any member of the board. |
"Pitt, CMU money managers arrested in fraud FBI says they
misappropriated $500 million for lavish lifestyles," by Jonathon Silver,
Pittsburgh Post-Gazette, February 26, 2009 ---
http://www.post-gazette.com/pg/09057/951834-85.stm
Two East Coast investment managers sued
for fraud by the University of Pittsburgh and Carnegie Mellon University
misappropriated more than $500 million of investors' money to hide losses
and fund a lavish lifestyle that included purchases of $80,000 collectible
teddy bears, horses and rare books, federal authorities said yesterday.
As Pitt and Carnegie Mellon were busy
trying to learn whether they will be able to recover any of their combined
$114 million in investments through Westridge Capital Management, the FBI
yesterday arrested the corporations' managers.
Paul Greenwood, 61, of North Salem, N.Y.,
and Stephen Walsh, 64, of Sands Point, N.Y., were charged in Manhattan -- by
the same office prosecuting the Bernard L. Madoff fraud case -- with
securities fraud, wire fraud and conspiracy.
Both men also were sued in civil court by
the U.S. Securities and Exchange Commission and the Commodity Futures
Trading Commission, which alleged that the partners misappropriated more
than $553 million and "fraudulently solicited" $1.3 billion from investors
since 1996.
The Accused
Paul Greenwood and Stephen Walsh are
accused of misappropriating millions from investors. Here is a look at some
of their biggest personal purchases:
• HOME: Mr. Greenwood, a horse
breeder, owned a horse farm in North Salem, N.Y., an affluent community
that counts David Letterman as a resident.
• BEARS: Mr. Greenwood owns as many as
1,350 Steiff toys, including teddy bears costing as much as $80,000.
• DIVORCE: Mr. Walsh bought his
ex-wife a $3 million condominium as part of their divorce settlement.
"This is huge," said David Rosenfeld,
associate regional director of the SEC's New York Regional Office. "This is
a truly egregious fraud of immense proportions."
Lawyers for the defendants either could
not be reached or had no comment.
Mr. Greenwood and Mr. Walsh, longtime
associates and former co-owners of the New York Islanders hockey team, ran
Westridge Capital Management and a number of affiliated funds and entities.
As late as this month, the partners
appeared to be doing well. Mr. Greenwood told Pitt's assistant treasurer
Jan. 21 that they had $2.8 billion under management -- though that number is
now in question. And on Feb. 2, Pitt sent $5 million to be invested.
But in the course of less than three
weeks, Westridge's mammoth portfolio imploded in what federal authorities
called an investment scam meant to cover up trading losses and fund
extravagant purchases by the partners.
An audit launched Feb. 5 by the National
Futures Association proved key to uncovering the alleged deceit and
apparently became the linchpin of the case federal prosecutors are building.
That audit came about in an indirect way.
The association, a self-policing membership body, had taken action against a
New York financier. That led to a man named Jack Reynolds, a manager of the
Westridge Capital Management Fund in which CMU invested $49 million; and Mr.
Reynolds led to Westridge.
"We just said we better take a look at
Jack Reynolds and see what's happening, and that led us to Westridge and WCM,
so it was a domino effect," said Larry Dyekman, an association spokesman.
"We're just not sure we have the full picture yet."
Mr. Reynolds has not been charged by
federal authorities, but he is named as a defendant in the lawsuit that was
filed last week by Pitt and CMU.
"Greenwood and Walsh refused to answer any
of our questions about where the money was or how much there was," Mr.
Dyekman continued.
"This is still an ongoing investigation,
and we can't really say at this point with any finality how much has been
lost."
The federal criminal complaint traces the
alleged illegal activity to at least 1996.
FBI Special Agent James C. Barnacle Jr.
said Mr. Greenwood and Mr. Walsh used "manipulative and deceptive devices,"
lied and withheld information as part of a scheme to defraud investors and
enrich themselves.
The complaint refers to a public
state-sponsored university called "Investor 1" whose details match those
given by Pitt in its lawsuit.
The SEC's Mr. Rosenfeld said the fraud
hinged not so much on the partners' investment strategy but on the fact that
they are believed to have simply spent other people's money on themselves.
"They took it. They promised the investors
it would be invested. And instead of doing that they misappropriated it for
their own use," Mr. Rosenfeld said.
Not only do federal authorities believe
Mr. Greenwood and Mr. Walsh used new investors' funds to cover up prior
losses in a classic Ponzi scheme, they used more than $160 million for
personal expenses including:
• Rare books bought at auction;
• Steiff teddy bears purchased for up to
$80,000 at auction houses including Sotheby's;
• A horse farm;
• Cars;
• A residence for Mr. Walsh's ex-wife,
Janet Walsh, 53, of Florida, for at least $3 million;
• Money for Ms. Walsh and Mr. Greenwood's
wife, Robin Greenwood, 57, both of whom are defendants in the SEC suit. More
than $2 million was allegedly wired to their personal accounts by an unnamed
employee of the partners.
"Defendants treated investor money -- some
of which came from a public pension fund -- as their own piggy bank to
lavish themselves with expensive gifts," said Stephen J. Obie, the Commodity
Futures Trading Commission's acting director of enforcement.
It is not clear how Pitt and CMU got
involved with Mr. Greenwood and Mr. Walsh. But there is at least one
connection involving academia. The commission suit said Mr. Walsh
represented to potential investors that he was a member of the University at
Buffalo Foundation board and served on its investment committee.
Mr. Walsh is a 1966 graduate of the State
University of New York at Buffalo where he majored in political science.
He was a trustee of the University at
Buffalo Foundation, but the foundation did not have any investments in
Westridge or related firms.
Universities, charitable organizations,
retirement and pension funds are among the investors who have done business
with Mr. Greenwood and Mr. Walsh.
Among those investors are the Sacramento
County Employees' Retirement System, the Iowa Public Employees' Retirement
System and the North Dakota Retirement and Investment Office, which handles
$4 billion in investments for teachers and public employees.
The North Dakota fund received about $20
million back from Westridge Capital Management, but has an undetermined
amount still out in the market, said Steve Cochrane, executive director.
Mr. Cochrane said Westridge Capital was
cooperative in returning what money it could by closing out their position
and sending them the money.
"I dealt with them exclusively all these
years," Mr. Cochrane said.
"They always seemed to be upfront and
honest. I think they're as stunned and as victimized as we are, is my
guess."
He said Westridge Capital had done an
excellent job over the years.
The November financial statement indicated
that the one-year return from Westridge Capital was a negative 11.87
percent, but the five-year annualized rate of return was a positive 8.36
percent.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's Rotten to the Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bernard Madoff's Gangster Family Seems to Have Been Overlooked by
Investors
"Pretty v. Ugly at the University," University Diaries Blog, Inside Higher
Ed, February 24, 2009 ---
http://www.insidehighered.com/blogs/university_diaries
Bernard Madoff is a
classic Mafia-style gangster. He comes from gangsters - his mother was a
crook. Investigators are looking into his
father-in-law. A lot of his friends and investors
are crooks. He was born a crook, has always been a crook.
"The FBI believes
Madoff may never have properly invested any of the money entrusted to him,"
writes Stephen Foley in
The Independent. That's <em>never</em>. Madoff is
in his seventies.
Psychopathically evil,
Madoff makes an exception - again, Mafia-style - for his closest family and
friends. His last act before turning himself in was writing big checks to
the inner circle.
Tomorrow,
Harry Markopolos will tell Congress how easy it
was, ten years ago, for him to prove that Madoff was a crook, and how
difficult it was for him to convince the SEC, or anyone else, of this
obvious truth.
An ugly story, isn't
it.... Ugh. Let us turn to the verdant paths of Brandeis University, and
walk to the door of
its art museum, where
pretty canvases hang on the walls and rekindle our sense of the beauty of
the world and the goodness of mankind.
Yet all of this beauty will
soon be shuttered, because that ugly world is all over Brandeis. It's all
over a number of other universities, too -- Yeshiva, Bard, NYU, all the
schools who loved charitable Bernie Madoff and his charitable friends.
Madoff, after all, was a
philanthropist.
Not that he, as the word
suggests, loves people. He hates people.
But he (and
benefactors like
Carl Shapiro, his closest business associate) gave
lots of money to pretty places like universities, places that stand for
love, not hate, and beauty, not ugliness. Why did he do that?
For the same reason many
other crooks do it. To get their names on buildings, and, much more
importantly, to launder their images. Madoff's been cleaning himself up for
public consumption all his life, and there's nothing like gifts to
universities to do oneself up <em>real</em> good.
University Diaries has
covered, over the years, many amusing stories of universities using the
latest in stone-blasting technology to get the names of crooks off of
buildings the crooks endowed. At any given time, some university in this
country is using power tools on its walls in a desperate effort to
dissociate itself from scum. Here's
the latest case. One of the most amusing was
Dennis Kozlowski at Seton Hall.
Even if it doesn't
call for power tools, the problem of taking crooks' money can be just as
troublesome, as with the University of Missouri-Columbia's
Kenneth L. Lay Chair in International Economics.
Sometimes things call for
quick-action internet prowess. Recall how, deep in the pre-exposure night,
Yeshiva University deleted from its webpages the once-sainted names of
Bernard Madoff and his partner, Ezra Merkin.
Our wretched economy will
continue to reveal the reputation-laundering enterprise some of our
universities have been running.
Just as every Madoff
associate or victim claims to be a deceived innocent, so these campuses will
tell us they never suspected a thing.
The farce would be fun to
watch if it weren't so incredibly destructive.
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's threads on security frauds are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"Argentina Has a Bond It Wants to Sell You:
Deadbeat nations should be kept out of U.S. capital markets," by Mark Shapiro
and Nancy Soderberg, The Wall Street Journal, February 27, 2009 ---
http://online.wsj.com/article/SB123569777717089081.html?mod=djemEditorialPage
In 2001, Argentina defaulted on $81
billion in sovereign bonds. Four years later it presented a unilateral,
nonnegotiable restructuring plan worth about 25 cents on the dollar. When
half of its foreign lenders said "no thanks," Buenos Aires repudiated their
claims.
Since Argentina had earlier agreed to
waive sovereign immunity and accept the jurisdiction and judgments of New
York courts, more than 160 lawsuits were filed. But the governments of
Nestor Kirchner and of his wife and successor, Christina Fernandez, have
ignored numerous court judgments. Judge Thomas Griesa has repeatedly
condemned their conduct, noting in 2005 that "I have not heard one single
word from the [Argentine] Republic except ways to avoid paying those
judgments." Nothing has changed since then.
If Argentina gets away with its misdeeds
-- offering terrible terms for restructuring its debt and then repudiating
its obligations to those who object -- the likelihood of additional defaults
could increase substantially. If that occurs, it would inflict another
serious blow to a global financial system in crisis.
Already, Buenos Aires's scofflaw behavior
is being imitated. Citing Argentina's example, Ecuador recently defaulted on
sovereign debts issued in the U.S., though it has the means to meet its
obligations. The default drove down the market price of the bonds. The
Correa government then entered the American secondary market with a massive
repurchase program, scooping up much of its own debt at a very steep
discount.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's Rotten to the Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Question
Is the history of Arthur Levitt Jr. at the SEC so pure?
He does charge out at $900 per hour ---
http://en.wikipedia.org/wiki/Arthur_Levitt
When he was Director of the SEC, Arthur Levitt
and his Chief SEC Accountant gave the large auditing firms considerable trouble
(unlike SEC Chairman Harvey Pitt). But to my knowledge Levitt was pretty much
hands off on free-wheeling Wall Street financial institutions and is now
probably given too much credence in terms of cleaning up the mess after Chris
Cox was the disastrous head of the SEC ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#SEC
Leavitt was easily duped by his close friend
Bernie Madoff, probably not separating church and state when Levitt was head of
the SEC and Madoff was committing fraud (for over 28 years of phony stock trades
in his investment fund that Levitt, Pitt, and Cox left unregulated to the point
of not even requiring audits by registered auditing firms).
From The Wall Street Journal Accounting
Weekly Review on January 23, 2009
Good and Bad Ideas on How to Thwart
Another Madoff
by Kevin Rosenberg, Paul L
Comstock, Eunice Bet-Mansour, Ph.D., and Porter Landreth
The Wall Street Journal
Jan 10, 2009
Click here to view the full article
on WSJ.com
TOPICS: Auditing, Fraudulent Financial Reporting, SEC,
Securities and Exchange Commission
SUMMARY: These letters to the editor express a range of
opinions on another op-ed piece by Arthur Levitt Jr., former
Chairman of the SEC. In Levitt's January 5 Op-Ed piece, he
stated that he "never saw an instance where credible information
about misconduct was not followed up by the agency."
CLASSROOM APPLICATION: Understanding the role of the SEC and
the skill set needed to fulfill its mission are the primary uses
of this article.
QUESTIONS:
1. (Introductory) Who is Arthur Levitt? Summarize his
recent opinion-page piece that led to these letters in response.
2. (Introductory) What concerns the CPA, Kevin
Rosenberg, who describes the types of audit and accounting firms
associated with recent financial reporting frauds and failures?
3. (Advanced) One op-ed writer, Paul L. Comstock,
argues that "the SEC can only do so much to protect without
paralyzing our capital markets." But does Eunice Bet-Mansour,
Ph.D., necessarily call for a greater quantity of regulatory
steps to avoid another Ponzi scheme or fraud such as that
committed by Mr. Madoff?
4. (Advanced) What level of skill set does Dr. Bet-Mansour
say is needed among SEC staffers? What level of education
provides this analytical skill set? In your answer, consider the
level of education held by Harry Markopoulos.
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
How the SEC Can Prevent More
Madoffs
by Arthur Levitt, Jr.
Jan 05, 2009
Online Exclusive
|
Bob Jensen's threads on fraud are at
http://faculty.trinity.edu/rjensen/fraud001.htm
Bob Jensen's Rotten to the Core threads are
at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Madoff Chasers Dug for Years, to No Avail
by Kara
Scannell
Jan 05, 2009
Click here to view the full article on WSJ.com
TOPICS: Auditing,
Fraudulent Financial Reporting, SEC, Securities and Exchange
Commission
SUMMARY: "I
think the reality is the [SEC] enforcement program needs some
systematic review at this point, and it is not a review which
should start with judgments," said, Joel Seligman, president of
the University of Rochester, in the related article. "You want
to know what went wrong." The main article describes a series of
detailed investigations into Madoff investment management
practices that failed to uncover the biggest Ponzi scheme in
history.
CLASSROOM
APPLICATION: Auditing classes can use the article to discuss
fraud investigations versus overall financial statement audits,
evidential matter, and the importance of overall financial
statement analysis to assess reasonability of reported results.
QUESTIONS:
1. (Introductory) What auditing expertise is needed by
Securities and Exchange Commission staff members to properly
perform their functions related to the matter of Bernard L.
Madoff Securities Investment LLC?
2. (Introductory) Author of the lead article Kara
Scannell writes that "regulatory gaps abound in the paper trail
generated by the SEC's scrutiny of Bernard L. Madoff Investment
Securities." What were the regulatory gaps?
3. (Introductory) What reasonableness test was used by
Harry Markopolous to make the assessment that "Madoff Securities
is the world's largest Ponzi Scheme," as he wrote in a letter to
the SEC. Did the SEC follow up on this accusation?
4. (Advanced) One accusation by an outsider that the
SEC did specifically pursue, according to the article, was to
determine whether Mr. Madoff was "front-running" for favored
clients. Design an audit test to assess that question, including
in your answer a definition of the term.
5. (Advanced) Review the audit test drafted in answer
to question 4. Is it likely that your test would uncover the
type of fraud Madoff committed? Why or why not?
6. (Advanced) What audit steps did the SEC undertake in
its review of January 2005 customer accounts, according to the
article? What audit steps did they possibly overlook? How might
these steps have uncovered fraud?
7. (Introductory) In 1992, the SEC's enforcement
division sued two Florida accountants for selling unregistered
investment securities managed by Madoff. "With no investors
found to be harmed, the SEC concluded there was no fraud." Why
were the investors not shown to be harmed?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED
ARTICLES:
SEC Nominee to Face Tough Questions at Confirmation Hearing
by Sarah N. Lynch
Jan 07, 2009
Online Exclusive
|
"Madoff Chasers Dug for Years, to No Avail: Regulators
Probed at Least 8 Times Over 16 Years; Congress Starts Review of SEC Today," by
Kara Scannell, The Wall Street Journal, January 5, 2008 ---
http://online.wsj.com/article/SB123111743915052731.html?mod=djem_jiewr_AC
Bernard L. Madoff Investment Securities
LLC was examined at least eight times in 16 years by the Securities and
Exchange Commission and other regulators, who often came armed with
suspicions.
SEC officials followed up on emails from a
New York hedge fund that described Bernard Madoff's business practices as
"highly unusual." The Financial Industry Regulatory Authority, the
industry-run watchdog for brokerage firms, reported in 2007 that parts of
the firm appeared to have no customers.
Mr. Madoff was interviewed at least twice
by the SEC. But regulators never came close to uncovering the alleged $50
billion Ponzi scheme that investigators now believe began in the 1970s.
The serial regulatory failures will be on
display Monday when Congress holds a hearing to probe why the alleged fraud
went undetected. Among the key witnesses is SEC Inspector General David Kotz,
who was asked last month by the agency's chairman, Christopher Cox, to
investigate the mess.
The situation is even more awkward because
SEC examiners seemed to be looking in the right places, yet still were
unable to unmask the alleged scheme. For example, investigators were led
astray by concerns that Mr. Madoff, now under house arrest, was placing
orders for favored clients ahead of others to get a better price, a practice
known as "front running." Front running isn't thought to have played a role
in the firm's collapse.
Concern that the SEC lacks the expertise
to keep up with fraudsters is the latest criticism of the agency, which saw
the Wall Street investment banks it oversees get pummeled or vanish
altogether in 2008. With Congress likely to take a hard look at how to
structure oversight of financial markets, the SEC is struggling to maintain
its clout.
The failure to stop Mr. Madoff also is an
embarrassment for Mary Schapiro, the Finra chief who has been nominated by
President-elect Barack Obama as the next SEC chairman. Finra was involved in
several investigations of Mr. Madoff's firm, concluding in 2007 that it
violated technical rules and failed to report certain transactions in a
timely way.
Ms. Schapiro declined to comment. Mr. Cox
has previously acknowledged mistakes by the SEC. The agency declined to
comment.
Regulatory gaps abound in the paper trail
generated by the SEC's scrutiny of Bernard L. Madoff Investment Securities,
according to a review of the documents. Many of the details haven't been
reported previously.
For years, Mr. Madoff told regulators he
wasn't running an investment-advisory business. By saying he instead managed
accounts for hedge funds, Mr. Madoff was able to avoid regular reviews of
his advisory business.
In 1992, Mr. Madoff had a brush with the
SEC's enforcement division, which had sued two Florida accountants for
selling unregistered securities that paid returns of 13.5% to 20%. The SEC
believed at the time it had uncovered a $440 million fraud.
"We went into this thinking it could be a
major catastrophe," Richard Walker, then-chief of the SEC's New York office,
told The Wall Street Journal at the time.
The SEC probe turned up money that had
been managed by Mr. Madoff. He said he didn't know the money had been raised
illegally.
With no investors found to be harmed, the
SEC concluded there was no fraud. But the scheme indicated Mr. Madoff was
managing money on behalf of other people.
In 1999 and 2000, the SEC sent examiners
into Mr. Madoff's firm to review its trading practices. SEC officials
worried the firm wasn't properly displaying orders to others in the market,
violating a trading rule. In response, Mr. Madoff outlined new procedures to
address the findings.
Continued in article
A Tale of Four Investors
Forwarded by Dennis Beresford
Four investors made different
investment decisions 10 years ago. Investor one was extremely risk
averse so he put $1 million in a safe deposit box. Today he still
has $1 million. Investor two was a bit less risk averse so she
bought $1 million of 6% Fanny Mae Preferred. She put the $15,000
she received in dividends each quarter in a safe deposit box. After
receiving 40 dividends, she recently sold her investment for $20,000
so she now has $620,000 in her safe deposit box. Investor three was
less risk averse so he bought and held a $1 million well diversified
U.S. stock portfolio which he recently sold for $1 million, putting
the $1 million in his safe deposit box. Investor four had a friend
who knew someone who was able to invest her $1 million with Bernie
Madoff. Like clockwork, she received a $10,000 check each and every
month for 120 months. She cashed all the checks, putting the money
in her safe deposit box. She was outraged to learn that she will no
longer receive her monthly checks. Even worse, she lost all her
principal. She only has $1,200,000 in her safe deposit box. She
hopes the government will bail her out.
Lawrence D. Brown J. Mack Robinson Distinguished Professor of Accounting Georgia State University December 18, 2008
Robert Edward Rubin (born August 29, 1938)
is Director and Senior Counselor of Citigroup where he was the architect of
Citigroup's strategy of taking on more risk in debt markets, which by the end of
2008 led the firm to the brink of collapse and an eventual government rescue
[1]. From November to December 2007, he served temporarily as Chairman of
Citigroup.[2][3] From 1999 to present, he earned $115 million in pay at
Citigroup[4]. He served as the 70th United States Secretary of the Treasury
during both the first and second Clinton administrations.
Wikipedia ---
http://en.wikipedia.org/wiki/Robert_Rubin
A new Citigroup scandal is engulfing
Robert Rubin and his former disciple Chuck Prince for their roles in an alleged
Ponzi-style scheme that's now choking world banking. Director Rubin and ousted
CEO Prince - and their lieutenants over the past five years - are named in a
federal lawsuit for an alleged complex cover-up of toxic securities that spread
across the globe, wiping out trillions of dollars in their destructive paths.
Paul Tharp, "'PONZI SCHEME' AT CITI SUIT SLAMS RUBIN," The New York Post,
December 5, 2008 ---
http://www.nypost.com/seven/12042008/business/ponzi_scheme_at_citi_142511.htm
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Why Madoff's Hedge Fund Could Be Audited by Non-registered
Auditors
We all know that Bernie Madoff's brokerage firm was
audited by an obscure 3-person accounting firm that is not registered with the
Public Company Accounting Oversight Board. This was permitted because the SEC
exempted privately owned brokerage firms from the SOX requirement that firms are
audited by registered accountants. Floyd Norris reports, in today's NY Times,
that the SEC has now quietly rescinded that exemption. As a result, firms that
audit broker-dealers for fiscal years that end December 2008 or later will have
to be registered. However, under another SOX provision, PCAOB is allowed to
inspect only audits of publicly held companies. NYTimes,
Oversight for Auditor of Madoff.
"Why an Obscure Accounting Firm Could Audit Madoff's Records," Securities Law
Professor Blog, January 9, 2008 ---
http://lawprofessors.typepad.com/securities/
"SEC Goes After Another
Ponzi Scheme," Securities Law Professor Blog,
January 8, 2009 ---
http://lawprofessors.typepad.com/securities/
Another Ponzi scheme -- is the SEC seeking
atonement for failure to uncover the Madoff fraud?
The SEC announced today that it has filed
an emergency civil enforcement action to
halt an ongoing affinity fraud and Ponzi scheme orchestrated by
Buffalo-based Gen-See Capital
Corporation a/k/a Gen Unlimited ("Gen-See") and its owner and president,
Richard S. Piccoli. According to the Commission's complaint, the defendants
have raised millions of dollars from investors by promising steady,
"guaranteed" returns, ranging from 7.1% to 8.3% per annum, and no fees or
commissions. In November 2008 alone, the defendants raised over $500,000
from investors. The defendants have relied heavily on advertisements in
newsletters published by churches and dioceses. The complaint further
alleges that the defendants told investors that their money was invested in
"high quality" residential mortgages that the defendants were able to
purchase at a discount. The defendants did not invest the funds as promised,
but instead used new investor funds to make payments to earlier investors.
In addition, the complaint alleges that Gen-See's offering and sale of
securities to the public was not registered with the Commission.
The Commission seeks, among other
emergency relief, a temporary restraining order (i) enjoining the defendants
from future violations of the federal securities laws; (ii) freezing the
defendants' assets; (iii) directing the defendants to provide verified
accountings; and (iv) prohibiting the destruction, concealment or alteration
of documents. In addition to this emergency relief, the Commission seeks
preliminary and permanent injunctive relief and civil money penalties
against the defendants as well as disgorgement by the defendants of their
ill-gotten gains plus prejudgment interest.
"SEC Takes Action to Halt
Ponzi Scheme,"
Securities Law Professor Blog, January 7, 2009 ---
http://lawprofessors.typepad.com/securities/
The SEC filed an emergency action to halt
an estimated $50 million Ponzi scheme conducted by Joseph S.
Forte (“Forte”) and Joseph Forte,
L.P. (“Forte LP”), of Broomall, Pennsylvania. According to the Commission’s
complaint, from at least February 1995 to the present, Forte has been
operating a Ponzi scheme in which he fraudulently obtained approximately $50
million from as many as 80 investors through the sale of securities in the
form of limited partnership interests. The federal district court for the
Eastern District of Pennsylvania issued an order granting a preliminary
injunction, freezing assets, compelling an accounting, and imposing other
emergency relief. Without admitting or denying the allegations in the
Commission’s complaint, Forte and Forte LP consented to the entry of the
order.
The Commission’s complaint alleges that in
late December 2008, Forte admitted to federal authorities that from at least
1995 through December 2008, he had been conducting a Ponzi scheme. Forte,
who has never been registered with the Commission in any capacity, told
investors that he would invest the limited partnership funds in a securities
futures trading account in the name of Forte LP that would trade in futures
contracts, including S&P 500 stock index futures (“trading program”). Forte
has admitted that he misrepresented and falsified Forte LP’s trading
performance from the very first quarter. From 1995 through September 30,
2008, the defendants reported to investors annual returns ranging from
18.52% to as high as 37.96%. However, from January 1998 through October
2008, the Forte LP trading account had net trading losses of approximately
$3.3 million.
Greenspan's Disastrous Agency Problem
In political science and economics, the principal-agent problem or agency
dilemma treats the difficulties that arise under conditions of incomplete and
asymmetric information when a principal hires an agent. Various mechanisms may
be used to try to align the interests of the agent with those of the principal,
such as piece rates/commissions, profit sharing, efficiency wages, performance
measurement (including financial statements), the agent posting a bond, or fear
of firing. The principal-agent problem is found in most employer/employee
relationships, for example, when stockholders hire top executives of
corporations. Numerous studies in political science have noted the problems
inherent in the delegation of legislative authority to bureaucratic agencies.
The implementation of legislation (such as laws and executive directives) is
open to bureaucratic interpretation, creating opportunities and incentives for
the bureaucrat-as-agent to deviate from the intentions or preferences of the
legislators. Variance in the intensity of legislative oversight also serves to
increase principal-agent problems in implementing legislative preferences.
Wikipedia ---
http://en.wikipedia.org/wiki/Agency_theory
Not only have individual
financial institutions become less vulnerable to shocks from underlying risk
factors, but also the financial system as a whole has become more resilient.
Alan Greenspan in 2004 as quoted by Peter S.
Goodman, Taking a Good Look at the Greenspan Legacy," The New York Times,
October 8, 2008 ---
http://www.nytimes.com/2008/10/09/business/economy/09greenspan.html?em
The problem is not that the
contracts failed, he says. Rather, the people using them got greedy. A lack
of integrity spawned the crisis, he argued in a speech a week ago at
Georgetown University, intimating that those peddling derivatives were not
as reliable as “the pharmacist who fills the prescription ordered by our
physician.”
But others hold a starkly
different view of how global markets unwound, and the role that Mr.
Greenspan played in setting up this unrest.
“Clearly, derivatives are a
centerpiece of the crisis, and he was the leading proponent of the
deregulation of derivatives,” said Frank Partnoy, a law professor at the
University of San Diego and an expert on financial regulation.
The derivatives market is
$531 trillion, up from $106 trillion in 2002 and a relative pittance just
two decades ago. Theoretically intended to limit risk and ward off financial
problems, the contracts instead have stoked uncertainty and actually spread
risk amid doubts about how companies value them.
If Mr. Greenspan had acted
differently during his tenure as Federal Reserve chairman from 1987 to 2006,
many economists say, the current crisis might have been averted or muted.
Over the years, Mr. Greenspan
helped enable an ambitious American experiment in letting market forces run
free. Now, the nation is confronting the consequences.
Derivatives were created to
soften — or in the argot of Wall Street, “hedge” — investment losses. For
example, some of the contracts protect debt holders against losses on
mortgage securities. (Their name comes from the fact that their value
“derives” from underlying assets like stocks, bonds and commodities.) Many
individuals own a common derivative: the insurance contract on their homes.
On a grander scale, such
contracts allow financial services firms and corporations to take more
complex risks that they might otherwise avoid — for example, issuing more
mortgages or corporate debt. And the contracts can be traded, further
limiting risk but also increasing the number of parties exposed if problems
occur.
Throughout the 1990s, some
argued that derivatives had become so vast, intertwined and inscrutable that
they required federal oversight to protect the financial system. In meetings
with federal officials, celebrated appearances on Capitol Hill and heavily
attended speeches, Mr. Greenspan banked on the good will of Wall Street to
self-regulate as he fended off restrictions.
Ever since housing began to
collapse, Mr. Greenspan’s record has been up for revision. Economists from
across the ideological spectrum have criticized his decision to let the
nation’s real estate market continue to boom with cheap credit, courtesy of
low interest rates, rather than snuffing out price increases with higher
rates. Others have criticized Mr. Greenspan for not disciplining
institutions that lent indiscriminately.
But whatever history ends up
saying about those decisions, Mr. Greenspan’s legacy may ultimately rest on
a more deeply embedded and much less scrutinized phenomenon: the spectacular
boom and calamitous bust in derivatives trading.
Bob Jensen's timeline of derivatives
scandals and the evolution of accounting standards for accounting for
derivatives financial instruments can be found at
http://faculty.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds
"‘I made a mistake,’ admits
Greenspan," by Alan Beattie and James Politi, Financial Times, October
23, 2008 ---
http://www.ft.com/cms/s/0/aee9e3a2-a11f-11dd-82fd-000077b07658.html?nclick_check=1
“I made a
mistake in presuming that the self-interest of organisations, specifically
banks and others, was such that they were best capable of protecting their
own shareholders,” he said.
In the second of two days of
tense hearings on Capitol Hill, Henry Waxman, chairman of the House of
Representatives, clashed with current and former regulators and with
Republicans on his own committee over blame for the financial crisis.
Mr Waxman said Mr Greenspan’s
Federal Reserve – along with the Securities and Exchange Commission and the
US Treasury – had propagated “the prevailing attitude in Washington... that
the market always knows best.”
Mr Waxman blamed the Fed for
failing to curb aggressive lending practices, the SEC for allowing credit
rating agencies to operate under lax standards and the Treasury for opposing
“responsible oversight” of financial derivatives.
Christopher Cox, chairman of
the Securities and Exchange Commission, defended himself, saying that
virtually no one had foreseen the meltdown of the mortgage market, or the
inadequacy of banking capital standards in preventing the collapse of
institutions such as Bear Stearns.
Mr Waxman accused the SEC
chairman of being wise after the event. “Mr Cox has come in with a long list
of regulations he wants... But the reality is, Mr Cox, you weren’t doing
that beforehand.”
Mr Cox blamed the fact that
congressional responsibility was divided between the banking and financial
services committees, which regulate banking, insurance and securities, and
the agriculture committees, which regulate futures.
“This jurisdictional split
threatens to for ever stand in the way of rationalising the regulation of
these products and markets,” he said.
Mr Greenspan accepted that
the crisis had “found a flaw” in his thinking but said that the kind of
heavy regulation that could have prevented the crisis would have damaged US
economic growth. He described the past two decades as a “period of euphoria”
that encouraged participants in the financial markets to misprice
securities.
He had wrongly assumed that
lending institutions would carry out proper surveillance of their
counterparties, he said. “I had been going for 40 years with considerable
evidence that it was working very well”.
Continued in the article
Jensen Comment
In other words, he assumed the agency theory model that corporate employees, as
agents of their owners and creditors, would act hand and hand in the best
interest for themselves and their investors. But agency theory has a flaw in
that it does not understand Peter Pan.
Peter Pan, the manager of Countrywide Financial on Main Street, thought he had
little to lose by selling a fraudulent mortgage to Wall Street. Foreclosures
would be Wall Street’s problems and not his local bank’s problems. And he got
his nice little commission on the sale of the Emma Nobody’s mortgage for
$180,000 on a house worth less than $100,000 in foreclosure. And foreclosure was
almost certain in Emma’s case, because she only makes $12,000 waitressing at the
Country Café. So what if Peter Pan fudged her income a mite in the loan
application along with the fudged home appraisal value? Let Wall Street or Fat
Fannie or Foolish Freddie worry about Emma after closing the pre-approved
mortgage sale deal. The ultimate loss, so thinks Peter Pan, will be spread over
millions of wealthy shareholders of Wall Street investment banks. Peter Pan is
more concerned with his own conventional mortgage on his precious house just two
blocks south of Main Street. This is what happens when risk is
spread even farther than Tinkerbell can fly!
Also see how corporate executives cooked the books ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
The Saturday Night Live Skit on the Bailout ---
http://patdollard.com/2008/10/it-is-here-the-banned-snl-skit-cannot-hide-from-louie/
Bankers (Men in Black)
bet with their
bank's capital, not their own. If the bet goes right, they get a
huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby.
Council on Foreign Relations, as quoted by Avital Louria Hahn,
"Missing: How Poor Risk-Management Techniques Contributed to
the Subprime Mess," CFO
Magazine, March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Jensen Comment
Now that the Government is going to bail out these speculators with
taxpayer funds makes it all the worse. I received an email
message claiming that if you had purchased $1,000 of AIG
stock one year ago, you would have $42 left; with Lehman, you
would have $6.60 left; with Fannie or Freddie, you would have
less than $5 left. But if you had purchased $1,000 worth of beer
one year ago, drank all of the beer, then turned in the cans for
the aluminum recycling REFUND, you would have had $214. Based on
the above, the best current investment advice is to drink
heavily and recycle. It's called the 401-Keg. Why let others
gamble your money away when you can piss it away on your own? |
Selling New
Equity to Pay Dividends: Reminds Me About the South Sea Bubble of
1720 ---
http://en.wikipedia.org/wiki/South_Sea_bubble
"Fooling Some
People All the Time"
"Melting into
Air: Before the financial system went bust, it went postmodern," by
John Lanchester, The New Yorker, November 10, 2008 ---
http://www.newyorker.com/arts/critics/atlarge/2008/11/10/081110crat_atlarge_lanchester
This is also why the
financial masters of the universe tend not to write books. If you have been
proved—proved—right, why bother? If you need to tell it, you can’t truly
know it. The story of David Einhorn and Allied Capital is an example of a
moneyman who believed, with absolute certainty, that he was in the right,
who said so, and who then watched the world fail to react to his irrefutable
demonstration of his own rightness. This drove him so crazy that he did what
was, for a hedge-fund manager, a bizarre thing: he wrote a book about it.
The story began on May
15, 2002, when Einhorn, who runs a hedge fund called Greenlight Capital,
made a speech for a children’s-cancer charity in Hackensack, New Jersey. The
charity holds an annual fund-raiser at which investment luminaries give
advice on specific shares. Einhorn was one of eleven speakers that day, but
his speech had a twist: he recommended shorting—betting against—a firm
called Allied Capital. Allied is a “business development company,” which
invests in companies in their early stages. Einhorn found things not to like
in Allied’s accounting practices—in particular, its way of assessing the
value of its investments. The mark-to-market
accounting that Einhorn favored is based on the
price an asset would fetch if it were sold today, but many of Allied’s
investments were in small startups that had, in effect, no market to which
they could be marked. In Einhorn’s view, Allied’s way of pricing its
holdings amounted to “the you-have-got-to-be-kidding-me method of
accounting.” At the same time, Allied was
issuing new equity, and, according to Einhorn,
the revenue from this could be used to fund the dividend payments that were
keeping Allied’s investors happy. To Einhorn,
this looked like a potential Ponzi scheme.
The next day, Allied’s stock
dipped more than twenty per cent, and a storm of controversy and
counter-accusations began to rage. “Those engaging in the current
misinformation campaign against Allied Capital are cynically trying to take
advantage of the current post-Enron environment by tarring a great and
honest company like Allied Capital with the broad brush of a Big Lie,”
Allied’s C.E.O. said. Einhorn would be the first to admit that he wanted
Allied’s stock to drop, which might make his motives seem impure to the
general reader, but not to him. The function of hedge funds is, by his
account, to expose faulty companies and make money in the process. Joseph
Schumpeter described capitalism as “creative destruction”: hedge funds are
destructive agents, predators targeting the weak and infirm. As Einhorn
might see it, people like him are especially necessary because so many
others have been asleep at the wheel. His book about his five-year battle
with Allied, “Fooling Some of the People All of the Time” (Wiley;
$29.95), depicts analysts, financial journalists, and the S.E.C. as being
culpably complacent. The S.E.C. spent three years investigating Allied. It
found that Allied violated accounting guidelines, but noted that the company
had since made improvements. There were no penalties. Einhorn calls the
S.E.C. judgment “the lightest of taps on the wrist with the softest of
feathers.” He deeply minds this, not least because the complacency of the
watchdogs prevents him from being proved right on a reasonable schedule: if
they had seen things his way, Allied’s stock price would have promptly
collapsed and his short selling would be hugely profitable. As it was,
Greenlight shorted Allied at $26.25, only to spend the next years watching
the stock drift sideways and upward; eventually, in January of 2007, it hit
thirty-three dollars.
All this has a great
deal of resonance now, because, on May 21st of this year, at the same
charity event, Einhorn announced that Greenlight had shorted another stock,
on the ground of the company’s exposure to financial derivatives based on
dangerous subprime loans. The company was Lehman Brothers. There was little
delay in Einhorn’s being proved right about that one: the toppling company
shook the entire financial system. A global
cascade of bank implosions ensued—Wachovia, Washington Mutual, and the
Icelandic banking system being merely some of the highlights to date—and a
global bailout of the entire system had to be put in train.
The short sellers were proved right, and also came to
be seen as culprits; so was mark-to-market accounting, since it caused
sudden, cataclysmic drops in the book value of companies whose holdings had
become illiquid. It is therefore the perfect moment for a short-selling
advocate of marking to market to publish his account. One can only speculate
whether Einhorn would have written his book if he had known what was going
to happen next. (One of the things that have happened is that, on September
30th, Ciena Capital, an Allied portfolio company to whose fraudulent lending
Einhorn dedicates many pages, went into bankruptcy; this coincided with a
collapse in the value of Allied stock—finally!—to a price of around six
dollars a share.) Given the esteem with which Einhorn’s profession is
regarded these days, it’s a little as if the assassin of Archduke Franz
Ferdinand had taken the outbreak of the First World War as the timely moment
to publish a book advocating bomb-throwing—and the book had turned out to be
unexpectedly persuasive.
SEC = Suckers Endup Cheated
David Albrecht, Bowling Green University"
The Performance of the
SEC is shameful: In 2005 the SEC was warned that Madoff was
running a Ponzi scheme
Due-diligence firms use the fees collected from their clients to
hire professionals to meticulously review hedge firms for signs of
deceit. One such firm is Aksia LLC. After painstakingly
investigating the operations of Madoff's operation, they found
several red flags. A brief summary of some of the red flags
uncovered by Aksia can be found here. Shockingly,
Aksia even
uncovered a letter to the SEC dating from 2005 which claimed that
Madoff was running a Ponzi scheme.
As a result of
its investigation, Aksia advised all of its clients not to invest
their money in Madoff's hedge fund. This is a perfect case study
showing that the SEC is incapable of protecting investors as well as
free-market institutions can. The SEC is becoming increasingly
irrelevant and people are beginning to take notice. It failed to
save investors from the house of cards made up of mortgage-backed
securities, credit default swaps, and collateralized debt
obligations that resulted from the housing bubble. Now it has failed
to protect thousands more individuals and charities from something
as simple and old as a Ponzi scheme!
Briggs Armstrong, "Madoff
and the Failure of the SEC," Ludwig Von Mises Institutue, December
18, 2008 ---
http://mises.org/story/3260
The chairman
of the Securities and Exchange Commission, a longtime proponent of deregulation,
acknowledged on Friday that failures in a voluntary supervision program for Wall
Street’s largest investment banks had contributed to the global financial
crisis, and he abruptly shut the program down. The S.E.C.’s oversight
responsibilities will largely shift to the Federal Reserve, though the
commission will continue to oversee the brokerage units of investment banks.
Also Friday, the S.E.C.’s inspector general released a report strongly
criticizing the agency’s performance in monitoring Bear Stearns before it
collapsed in March. Christopher Cox, the commission chairman, said he agreed
that the oversight program was “fundamentally flawed from the beginning.” “The
last six months have made it abundantly clear that voluntary regulation does not
work,” he said in a statement. The program “was fundamentally flawed from the
beginning, because investment banks could opt in or out of supervision
voluntarily. The fact that investment bank holding companies could withdraw from
this voluntary supervision at their discretion diminished the perceived mandate”
of the program, and “weakened its effectiveness,” he added.
"S.E.C. Concedes Oversight Flaws Fueled Collapse," by Stephen Labaton, The
New York Times, September 26, 2008 ---
http://www.nytimes.com/2008/09/27/business/27sec.html?_r=1&hp&oref=slogin
Bernard Madoff, former Nasdaq Stock Market chairman and
founder of Bernard L. Madoff Investment Securities LLC, was arrested and charged
with securities fraud Thursday in what federal prosecutors called a Ponzi scheme
that could involve losses of more than $50 billion.
It is bigger than Enron, bigger than Boesky and bigger than
Tyco
"Madoff Scandal: 'Biggest Story of the Year'," Seeking Alpha,
December 12, 2008 ---
http://seekingalpha.com/article/110402-madoff-scandal-biggest-story-of-the-year?source=wildcard
According to
RealMoney.com columnist Doug Kass,
general partner and investment manager of hedge fund Seabreeze
Partners Short LP and Seabreeze Partners Short Offshore Fund,
Ltd., today's late-breaking report of an alleged massive fraud
at a well known investment firm could be "the biggest story of
the year." In his view,
it is bigger
than Enron, bigger than Boesky and bigger than Tyco.
It attacks at the core of investor confidence --
because, if true, and this could happen ... investors
might think that almost anything imaginable could happen
to the money they have entrusted to their fiduciaries.
Here are some excerpts
from the Bloomberg report, entitled
"Madoff Charged in $50 Billion Fraud at Advisory Firm":
Bernard Madoff,
founder and president of Bernard Madoff Investment
Securities, a market-maker for hedge funds and banks,
was charged by federal prosecutors in a $50 billion
fraud at his advisory business.
Madoff, 70,
was arrested today at 8:30 a.m. by the FBI and appeared
before U.S. Magistrate Judge Douglas Eaton in Manhattan
federal court. Charged in a criminal complaint with a
single count of securities fraud, he was granted release
on a $10 million bond guaranteed by his wife and secured
by his apartment. Madoff’s wife was present in the
courtroom.
"It’s all just
one big lie," Madoff told his employees on Dec. 10,
according to a statement by prosecutors. The firm,
Madoff allegedly said, is "basically, a giant Ponzi
scheme." He was also sued by the Securities and Exchange
Commission.
Madoff’s New
York-based firm was the 23rd largest market maker on
Nasdaq in October, handling a daily average of about 50
million shares a day, exchange data show. The firm
specialized in handling orders from online brokers in
some of the largest U.S. companies, including General
Electric Co (GE). and Citigroup Inc. (C).
...
SEC Complaint
The SEC in its
complaint, also filed today in Manhattan federal court,
accused Madoff of a "multi-billion dollar Ponzi scheme
that he perpetrated on advisory clients of his firm."
The SEC said
it’s seeking emergency relief for investors, including
an asset freeze and the appointment of a receiver for
the firm. Ira Sorkin, another defense lawyer for Madoff,
couldn’t be immediately reached for comment.
...
Madoff, who
owned more than 75 percent of his firm, and his brother
Peter are the only two individuals listed on regulatory
records as "direct owners and executive officers."
Peter Madoff
was a board member of the St. Louis brokerage firm A.G.
Edwards Inc. from 2001 through last year, when it was
sold to Wachovia Corp (WB).
$17.1 Billion
The Madoff
firm had about $17.1 billion in assets under management
as of Nov. 17, according to NASD records. At least 50
percent of its clients were hedge funds, and others
included banks and wealthy individuals, according to the
records.
...
Madoff’s Web
site advertises the "high ethical standards" of the
firm.
"In an era of
faceless organizations owned by other equally faceless
organizations, Bernard L. Madoff Investment Securities
LLC harks back to an earlier era in the financial world:
The owner’s name is on the door," according to the Web
site. "Clients know that Bernard Madoff has a personal
interest in maintaining the unblemished record of value,
fair-dealing, and high ethical standards that has always
been the firm’s hallmark."
...
"These guys
were one of the original, if not the original, third
market makers," said Joseph Saluzzi, the co-head of
equity trading at Themis Trading LLC in Chatham, New
Jersey. "They had a great business and they were good
with their clients. They were around for a long time.
He’s a well-respected guy in the industry."
The case is
U.S. v. Madoff, 08-MAG-02735, U.S. District Court for
the Southern District of New York (Manhattan)
Continued in article
And here is the
SEC press release:
What was the auditing firm of Bernard Madoff Investment
Securities, the auditor who gave a clean opinion, that's been
insolvent for years?
Apparently, Mr Madoff said the business had
been insolvent for years and, from having $17 billion of assets
under management at the beginning of 2008, the SEC said: “It appears
that virtually all assets of the advisory business are gone”. It has
now emerged that Friehling & Horowitz,
the auditor that signed off the annual financial statement for the
investment advisory business for 2006, is under investigation by the
district attorney in New York’s Rockland County, a northern suburb
of New York City.
"The $50bn scam: How Bernard Madoff allegedly cheated investors," London
Times, December 15, 2008 ---
http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article5345751.ece
It was at the Manhattan apartment that
Mr Madoff apparently confessed that the business was in fact a
“giant Ponzi scheme” and that the firm had been insolvent for
years.
To cap it all, Mr Madoff told his sons
he was going to give himself up, but only after giving out the
$200 - $300 million money he had left to “employees, family and
friends”.
All the company’s remaining assets have
now been frozen in the hope of repaying some of the companies,
individuals and charities that have been unfortunate enough to
invest in the business.
However, with the fraud believed to
exceed $50 billion, whatever recompense investors could receive
will be a drop in the ocean.
"Bernie Madoff's Victims: The List (as known thus far) ,"
by Henry Blodget, Clusterstock, December 14, 2008 ---
http://clusterstock.alleyinsider.com/2008/12/bernie-madoff-hosed-client-list
Jensen Question
How could such sophisticated investors be so naive? At a minimum,
investors should consider whether the auditing firm has deep
pockets. Bernie's auditors,
Friehling & Horowitz,
probably do not have any pockets at all in order to streamline for
speed while fleeing the scene.
"Madoff's auditor... doesn't audit? The three-person firm that
apparently certified Madoff's books has been telling a key
accounting industry group for years that it doesn't conduct audits,"
by Alyssa Abkowitz, CNN, December 18, 2008 ---
http://money.cnn.com/2008/12/17/news/companies/madoff.auditor.fortune/index.htm?postversion=2008121808
The three-person auditing firm that
apparently certified the books of Bernard Madoff Investment
Securities, the shuttered home of an alleged multibillion-dollar
Ponzi scheme, is drawing new scrutiny.
Already under investigation by local
prosecutors for its potential role in the scandal, the firm,
Friehling & Horowitz, is now also being investigated by the
American Institute of Certified Public Accountants, the
prestigious body that sets U.S. auditing standards for private
companies.
The problem: The auditing firm has been
telling the AICPA for 15 years that it doesn't conduct audits.
The AICPA, which has more than 350,000
individual members, monitors most firms that audit private
companies. (Public-company auditors are overseen, as the name
suggests, by the Public Company Accounting Oversight Board,
which was created in 2003 in response to accounting scandals
involving WorldCom and Enron.)
Some 33,000 firms enroll in the AICPA's
peer review program, in which experienced auditors assess each
firm's audit quality every year. Forty-four states require
accountants to undergo reviews to maintain their licenses to
practice.
Friehling & Horowitz is enrolled in the
program but hasn't submitted to a review since 1993, says AICPA
spokesman Bill Roberts. That's because the firm has been
informing the AICPA -- every year, in writing -- for 15 years
that it doesn't perform audits.
Meanwhile, Friehling & Horowitz has
reportedly done just that for Madoff. For example, the firm's
name and signature appears on the "statement of financial
condition" for Madoff Securities dated Oct. 31, 2006. "The plain
fact is that this group hasn't submitted for peer review and
appears to have done an audit," Roberts says. AICPA has now
launched an "ethics investigation," he says.
As it happens, New York is one of only
six states that does not require accounting firms to be
peer-reviewed. But on the heels of the Madoff revelations, on
Tuesday, the New York State senate passed legislation that
requires such a process. (The bill now awaits Gov. David
Paterson's signature.) "We've not been regulated in the fashion
we should've inside the state," says David Moynihan,
president-elect of the New York State Society of Certified
Public Accountants.
David Friehling, the only active
accountant at Friehling & Horowitz, according to the AICPA,
might seem like an odd person to flout the institute's rules. He
has been active in affiliated groups: Friehling is the immediate
past president of the Rockland County chapter of the New York
State Society of Certified Public Accountants and sits on the
chapter's executive board.
Friehling, who didn't return calls
seeking comment, is rarely seen at his office, according to
press reports. The 49-year-old, whose firm is based 30 miles
north of Manhattan in New City, N.Y., operates out of a
13-by-18-foot office in a small plaza.
A woman who works nearby told Bloomberg
News that a man who dresses casually and drives a Lexus appears
periodically at Friehling & Horowitz's office for about 10 to 15
minutes at a stretch and then leaves. (State automobile records
indicate that Friehling owns a Lexus RX.) The Rockland County
District Attorney's Office has opened an investigation to see if
the firm committed any state crimes.
People who know Friehling, through the
state accounting chapter and through the Jewish Community Center
in Rockland County (where he's a board member) were reluctant to
discuss him. Most members of both boards wouldn't comment except
to say they were surprised by Friehling's connection to Madoff.
"He's nothing but the nicest guy in the
world," says David Kirschtel, chief executive of JCC Rockland.
"I've never had any negative dealings with him."
From The Wall Street Journal Accounting Weekly Review on
December 19, 2008
SEC to Probe Its Ties to Madoffs
by Aaron
Lucchetti, Kara Scannell and Amir Efrati
The Wall Street Journal
Dec 17, 2008
Click here to view the full article on WSJ.com
TOPICS: Accounting,
Auditing, SEC, Securities and Exchange Commission
SUMMARY: "Bernard
Madoff was trying to raise funds for his investment empire as
recently as early this month, as redemptions were about to
prompt an unraveling of an apparent $50 billion investment
scam....According to a criminal complaint [filed] Dec.
11,...clients during the first week of December had requested
about $7 billion of assets from their accounts...[and] Mr.
Madoff...was struggling to meet those obligations....The sharp
downturn in stocks this year may have sealed the firm's demise,
since it hurt the ability for Mr. Madoff to keep recruiting new
clients." Madoff's sons, Andrew and Mark Madoff, contacted the
FBI through their attorney to after allegedly being told by
their father that the family business "was a giant Ponzi scheme"
totaling $50 billion. The SEC has made "an extraordinary
admission that [it] was aware of numerous red flags raised about
Bernard L. Madoff Investment Securities LLC but failed to take
them seriously enough."
CLASSROOM
APPLICATION: Financial reporting and auditing classes may
use this case for discussing ethics and audit procedures.
QUESTIONS:
1. (Introductory) What is a Ponzi scheme? Why would
recent market losses lead to the collapse of such a fraud?
2. (Introductory) How did Bernard L. Madoff attract
investors to his scheme?
3. (Advanced) What "red flags" did the SEC and others
miss that would have brought down the fraud earlier? You may use
related articles to help answer this question.
4. (Advanced) What should records of a legitimate
investment advisory firm show? How would you envision "a phony
set of records used to cover up [the] alleged $50 billion fraud"
would appear?
5. (Advanced) What audit steps are designed to identify
frauds, such as the one Mr. Madoff has allegedly perpetrated?
Why might such audit procedures fail to uncover fraud?
6. (Introductory) What is the role of the U.S. SEC? How
does this fraud reflect on the SEC's performance of its role in
the U.S. financial system?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED
ARTICLES:
Fairfield Group forced to Confront Its Madoff Ties
by Carrick Mollenkamp, Cassell Bryan-Low and Thomas Catan
Dec 17, 2008
Page: A10
Impact on Jewish Charities is Catastrophic
by Eleanor Laise and Dennis K. Berman
Dec 16, 2008
Online Exclusive
|
"SEC to Probe Its Ties to Madoffs ," by Aaron Lucchetti, Kara Scannell and
Amir Efrati, The Wall Street Journal, December 17, 2008 ---
http://online.wsj.com/article/SB122947343148212337.html?mod=djem_jiewr_AC
The Securities and Exchange Commission will examine
the relationship between a former official at the agency and a niece of
financier Bernard L. Madoff, after the SEC's chief admitted "apparent
multiple failures" to oversee the firm at the center of an alleged $50
billion Ponzi scheme.
In an extraordinary admission that the SEC was
aware of numerous red flags raised about Bernard L. Madoff Investment
Securities LLC, but failed to take them seriously enough, SEC Chairman
Christopher Cox ordered a review of the agency's oversight of the New York
securities-trading and investment-management firm.
The review will include whether relationships between SEC officials and Mr.
Madoff or his family members had any impact on the agency's oversight.
"I am gravely concerned" by the agency's regulation
of the firm, Mr. Cox said.
Mr. Madoff's niece, Shana Madoff, married a former
SEC attorney named Eric Swanson last year. Mr. Swanson worked at the SEC for
10 years, including as a senior inspections and examination official, before
leaving in 2006. Ms. Madoff is a compliance lawyer at the securities firm.
Among Mr. Swanson's duties was supervising the
SEC's inspection program in charge of trading oversight at stock exchanges
and electronic-trading platforms, according to a press release from Bats
Trading Inc., an electronic stock exchange that hired Mr. Swanson as general
counsel earlier this year.
Neither person is named in the SEC statement as a
target of the probe, which is being led by the agency's inspector general,
David Kotz. But Mr. Kotz said in an interview that he intended to examine
the relationship between Mr. Madoff's niece and Mr. Swanson.
In a statement Tuesday night, a spokesman for Mr.
Swanson acknowledged that "the compliance team he helped supervise made an
inquiry about Bernard Madoff's securities operation," without being more
specific. He said the couple began dating in 2006, and were married in 2007.
A second representative of Mr. Swanson said the
romantic relationship with Ms. Madoff began "years after" the regulatory
scrutiny in which Mr. Swanson was involved. Mr. Swanson will "fully
cooperate" with the SEC investigation, the representative said.
Ms. Madoff couldn't be reached for comment.
Mr. Cox's statements represent a strong rebuke of
an agency already facing criticism of its response to the credit crisis. Mr.
Cox said an initial review of SEC oversight of Mr. Madoff's firm found that
"credible and specific allegations" made as far back as 1999 "were
repeatedly brought to the attention of SEC staff, but were never recommended
to the Commission for action."
Mr. Cox wasn't specific about the past claims that
were inadequately investigated. But around 2000, Harry Markopolos, at the
time an executive at a rival firm to Mr. Madoff's, contacted the SEC with
suspicions about Mr. Madoff's business. "Madoff Securities is the world's
largest Ponzi scheme," Mr. Markopolos wrote in a letter to the agency. Mr.
Markopolos pursued his accusations for years, dealing with the SEC's
regional offices in New York and Boston, according to documents reviewed by
The Wall Street Journal.
In 2005, the SEC's inspections division in New York
examined Mr. Madoff's business operations, concluding there was a violation
of technical trading rules, according to the SEC. The agency's enforcement
staff in New York completed an investigation in 2007 without recommending
action.
Late Tuesday, Lori Richards, director of the SEC's
inspection and examinations division, detailed Mr. Swanson's role in
oversight of Mr. Madoff's firm, saying he was a member of a team that looked
at the securities-trading business in 1999 and 2004. "He did not participate
in the 2005 exam," she said.
Ms. Richards added that the SEC "has very strict
rules prohibiting SEC staff from participating in matters involving firms
where they have a personal interest. Subsequently, Mr. Swanson did not work
on any other examination matters involving the Madoff firm before leaving
the agency."
Mr. Cox's criticisms of the agency came as
investigators searching the offices of Mr. Madoff's firm in New York City
discovered what they described as phony sets of records used to cover up its
alleged $50 billion fraud, even as it became clear that Mr. Madoff was
trying to attract new investors as recently as early December.
Those potential investors included the Pritzkers,
one of America's wealthiest families, people familiar with the matter say.
Mr. Madoff's efforts didn't result in an investment from the family.
Meantime, a financial firm with ties to Mr. Madoff
is being drawn into the probe by regulators. The Massachusetts Secretary of
State has subpoenaed Cohmad Securities Corp., which was closely affiliated
with Mr. Madoff and advisers who helped bring investors to his business.
No one answered calls placed to two phone numbers
for Cohmad in New York on Tuesday.
Investigators, hunkered down in the 17th-floor
office where they believe Mr. Madoff carried out what he allegedly described
to his sons as a $50 billion fraud, have found what appear to be "falsified
records," according to Stephen Harbeck of Securities Investor Protection
Corp., the securities-industry nonprofit group helping to oversee the firm's
liquidation. These include a set of books that doesn't accurately reflect
the assets held by the firm, he said.
"Some customer statements do not reflect securities
in the firm's possession," Mr. Harbeck said.
The firm's records are in disarray, and the company
has officially ceased operations, Mr. Harbeck said. According to Mr. Cox,
Mr. Madoff "kept several sets of books and false documents, and provided
false information involving his advisory activities to investors and to
regulators."
The alleged scam is widely expected to cause
billions of dollars in losses for banks, hedge funds, well-known investors
and charities around the world, some of whom have been wiped out. Investors
and other affected parties have disclosed combined exposure of more than $25
billion.
Continued in article
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Heavy Insider
Trading ---
http://investing.businessweek.com/research/stocks/ownership/ownership.asp?symbol=ALD
Allied's
independent auditor is KPMG
KPMG has a lot of problems
with litigation ---
http://faculty.trinity.edu/rjensen/fraud001.htm
Bob Jensen's
threads on the collapse of the Banking System are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's
threads on fraud are at
http://faculty.trinity.edu/rjensen/Fraud.htm
Also see Fraud Rotten at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's
threads on accounting theory are at
http://faculty.trinity.edu/rjensen/theory01.htm
Also see the theory of fair value accounting at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
History of Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
Bob Jensen's threads on earnings management and creative
accounting to cook the books ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
Keeping Score on the SEC in 2008
"The SEC in 2008: A Very Good Year? A terrific one, the
commission says, tallying a fiscal-year record in insider-trading cases, and the
second-highest number of enforcement cases overall. But what would John McCain
say?" by Stephen Taub and Roy Harris, CFO.com, October 22, 2008 ---
http://www.cfo.com/article.cfm/12465408/c_12469997
It was a great year for Securities and
Exchange Commission enforcement, according to the SEC. In a fiscal-year-end
summary, it notes, for example, that it brought the highest number ever of
insider trading cases.
And altogether, it took the second-highest
number of enforcement actions in agency history.
"The SEC's role in policing the markets
and protecting investors has never been more critical," said Linda Chatman
Thomsen, director of the SEC's Division of Enforcement. "The dedicated
enforcement staff has been working around the clock to investigate and
punish wrongdoing."
The celebration of these records and
near-records, however, comes during a time of widespread charges of what
critics call lax policing by the regulator. They question its performance
before the powderkeg of subprime mortgage lending, amid loose standards
within major financial institutions, exploded into the worst global
financial crisis since the Great Depression. Just a month ago, Republican
presidential candidate John McCain promoted the replacement of SEC Chairman
Christopher Cox, while many legislators have supported folding the SEC and
other agencies into one larger, more encompassing financial regulator.
But this day, at least, was one for the
SEC proudly to recount the 671 enforcement actions it took during the most
recent fiscal year. And it made special note of how insider trading cases
jumped more than 25 percent over the previous year.
Among those trading cases, the SEC seemed
to prize most highly the charges against former Dow Jones board member David
Li, and three other Hong Kong residents, in a $24-million insider-trading
enforcement action, along with the charging of the former chairman and CEO
of a division of Enron Corp. with illegally selling hundreds of thousands of
shares of Enron stock based on nonpublic information.
Market manipulation cases surged more than
45 percent. They included charges against a Wall Street short seller for
spreading false rumors, and charging 10 insiders or promoters of publicly
traded companies who made stock sales in exchange for illegal kickbacks.
Among the major fraud cases, the SEC sued
two Bear Stearns hedge fund managers for fraudulently misleading investors
about the financial state of the firm's two largest hedge funds. The
regulator also charged five former employees of the City of San Diego for
failing to disclose to the investing public buying the city's municipal
bonds that there were funding problems with its pension and retiree health
care obligations and those liabilities had placed the city in serious
financial jeopardy.
Illegal stock-option backdating was also a
big focus of the agency in 2008. The SEC charged eight public companies and
27 executives with providing false information to investors based on
improper accounting for backdated stock option grants.
The SEC said that another growth area
involved cases against U.S. companies that use corporate funds to bribe
foreign officials, an activity precluded by the Foreign Corrupt Practices
Act. In 2008, the SEC filed 15 FCPA cases. Since January 2006, the SEC has
brought 38 FCPA enforcement actions — more than were brought in all prior
years combined since FCPA became law in 1977.
Bob Jensen's threads on creative
accounting are at
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
Also see
http://faculty.trinity.edu/rjensen//theory/00overview/AccountingTricks.htm
Peter, Paul, and Barney: An Essay on 2008 U.S. Government Bailouts of Private
Companies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Timeline of Financial Scandals, Auditing
Failures, and the Evolution of International Accounting Standards ----
http://faculty.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds
White Collar Fraud Site ---
http://www.whitecollarfraud.com/
Note the column of links on the left.
Online Searching for Law, Accounting, and Finance ---
http://securities.stanford.edu/
Stanford University Law School Securities Class Action Clearinghouse
---
http://securities.stanford.edu/
Securities Law Archives ---
http://www.bespacific.com/mt/archives/cat_securities_law.html
Securities and Exchange Commission ---
http://en.wikipedia.org/wiki/U.S._Securities_and_Exchange_Commission
Accounting Fraud ---
http://faculty.trinity.edu/rjensen/Fraud.htm
Question
Why are so many Ivy League alumni behind bars?
From Bloomberg.com July 3, 2008 ---
http://www.bloomberg.com/apps/news?pid=20601103&sid=awkNQpGwkfkU&refer=us
No matter which prison former Refco Inc.
Chief Executive Officer Phillip Bennett serves the 16-year sentence he
received today in Manhattan federal court, chances are he will be the only
one there with a master's degree from Cambridge University in England.
The head of what was once the biggest
independent U.S. futures broker, Bennett also was ordered to forfeit $2.4
billion in assets for what prosecutors said was ``among the very worst''
white-collar crimes. He faced a possible life sentence after pleading guilty
to bank fraud and money laundering.
Bennett, 60, joins at least a dozen other
wealthy corporate executives with degrees from elite institutions such as
Harvard University and the University of Pennsylvania's Wharton School
who've been incarcerated for white-collar crimes this decade. Exceptional
intelligence, self-confidence and feeling special, common among those
educated at such schools, can turn into deviousness, arrogance and
entitlement, said Tom Donaldson, a professor of ethics and law at Wharton in
Philadelphia.
``If the devil exists, he no doubt has a
high IQ and an Ivy League degree,'' Donaldson said. ``It's clear that having
an educational pedigree is no prophylactic against greed and bad behavior.''
Imprisoned executives with Ivy League
degrees include Jeffrey Skilling, 54, former CEO of Enron Corp. (Harvard
Business School); Timothy Rigas, 52, former chief financial officer of
Adelphia Communications Corp. (Wharton); and William Sorin, 59, former
general counsel of New York-based Comverse Technology Inc. (Harvard Law
School).
Elite Schools
Some of these convicted executives have
multiple degrees. Conrad Black, the former CEO of Chicago-based Hollinger
International Inc., now serving a 6 1/2-year sentence for stealing $6.1
million from the company, has two bachelor's degrees from Carleton
University, a master's degree from McGill University and a law degree from
Laval University, all in Canada.
``There is a correlation between going to
an elite school and ending up as a CEO,'' said Edwin Hartman, a professor of
business ethics at New York University's Stern School of Business. ``Look at
the list of the heads of the 400 elite companies. They certainly didn't go
to no-name state schools.''
A top-level education may also cultivate
arrogance, said Maurice Schweitzer, who teaches information management at
Wharton.
`They Feel Special'
``We tell our students at premier
institutions that they are special, and they certainly feel special,''
Schweitzer said. ``We have famous faculty and great resources. They are
surrounded by accomplished peers, and recruiters flock to them.''
Massachusetts-based Harvard University
spokeswoman Rebecca Rollins said the school didn't have an immediate
comment.
Wrongdoing in the executive suite is more
about character flaws than alma maters, said Andrew Weissmann, a former
federal prosecutor who led the U.S. Justice Department task force that
investigated the collapse of Enron.
``Just because you went to a good school
doesn't mean you have a good moral compass,'' Weissmann said.
Moreover, some of the executives convicted
since the Sarbanes-Oxley Act was passed in 2002 in response to corporate
corruption didn't attend elite schools. HealthSouth Corp. founder Richard
Scrushy, 55, sentenced to almost 7 years in prison for bribery, has a
bachelor's degree from the University of Alabama in Birmingham. Former Tyco
International Ltd. CEO L. Dennis Kozlowski, convicted of stealing $137
million from the company and in prison for 8 1/3 to 25 years, has a
bachelor's degree from Seton Hall University.
Risk Takers
Executives with top educations may end up
trading their pin stripes for prison jumpsuits because they're driven to
excel.
``People who succeed in corporate America
are risk-takers,'' said Anthony Barkow, a former federal prosecutor and
Harvard Law School graduate who is now a New York University Law School
professor. ``They're smart, confident and sometimes even arrogant. That's
what it takes to succeed. Risk-takers get closer to the line and sometimes
cross it.''
Graduates from top-tier universities may
feel so special, they think law doesn't apply to them, Wharton's Schweitzer
said.
``We encourage our students to explore and
think outside the box,'' Schweitzer said. ``In general, this approach is
very constructive, but it may prompt people to be less likely to recognize
an ethical dilemma.''
Morgenthau's Warning
Current and former prosecutors who've
handled white-collar cases said the defendants' most common trait was
avarice.
``It doesn't matter if you graduated from
the best schools in the world and had every privilege accorded to you or
not,'' said Campbell, a member of the Enron Task Force with degrees from
Yale University and the University of Chicago School of Law. ``Greed is a
strong motivation, and it can cause you to make mistakes.''
Robert Morgenthau, the Manhattan District
Attorney who is a graduate of Amherst College and Yale Law School, issued
this warning:
``No matter what your position is in life
or where you went to school, if you commit a crime in our jurisdiction,
we'll be happy to prosecute you.''
Question
What are do so many executives cheat in recent years?
Answer
See Question 1 and Answer 1 at
http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's "Congress to the Core" threads are at
http://faculty.trinity.edu/rjensen/FraudCongress.htm
"Merrill Lynch Settlement With SEC Worth Up
to $7B," SmartPros, August 25, 2008 ---
http://accounting.smartpros.com/x62971.xml
Federal regulators said
Friday that investors who bought risky auction-rate securities from Merrill
Lynch & Co. before the market for those bonds collapsed will be able to
recover up to $7 billion under a new agreement.
The largest U.S. brokerage
will buy back the securities from thousands of investors under a settlement
with the Securities and Exchange Commission, New York Attorney General
Andrew Cuomo and other state regulators over its role in selling the
high-risk bonds to retail investors. Under that deal, announced Thursday,
Merrill agreed to hasten its voluntary buyback plan by repurchasing $10
billion to $12 billion of the securities from investors by Jan. 2.
Merrill also agreed to pay a
$125 million fine in a separate accord with state regulators.
The $330 billion market for
auction-rate securities collapsed in mid-February.
The SEC's estimate of a $7
billion recovery is based on its projection of the eventual amount of the
bonds that will be cashed in by the affected investors, who bought them
before Feb. 13. The $10 billion to $12 billion is the total amount that
Merrill is committing to buy back. The firm has to offer redemptions to all
investors, though not all may cash in the securities.
The SEC said the new
agreement will enable retail investors, small businesses and charities who
purchased the securities from Merrill "to restore their losses and
liquidity."
New York-based Merrill
neither admitted nor denied wrongdoing in agreeing to the federal
settlement, which is subject to approval by SEC commissioners.
The firm wasn't fined under
the accord, but the SEC said Merrill "faces the prospect" of a penalty after
completing its obligations under the agreement. The amount of the penalty,
if any, would take into account the extent of Merrill's misconduct in
marketing and selling auction-rate securities, and an assessment of whether
it fulfilled its obligations, the SEC said.
"Merrill Lynch's conduct
harmed tens of thousands of investors who will have the opportunity to get
their money back through this agreement," Linda Thomsen, the agency's
enforcement director, said in a statement. "We will continue to aggressively
investigate wrongdoing in the marketing and sale of auction-rate
securities."
Merrill, Goldman Sachs Group
Inc. and Deutsche Bank on Thursday brought to eight the number of global
banks that have settled a five-month investigation into claims they misled
customers into believing the securities were safe.
The auction-rate securities
market involved investors buying and selling instruments that resembled
regular corporate debt, except the interest rates were reset at regular
auctions - some as frequently as once a week. A number of companies and
retail clients invested in the securities because, thanks to the regular
auctions, they could treat their holdings as liquid, almost like cash.
Major issuers included
companies that financed student loans and municipal agencies like the Port
Authority of New York and New Jersey. When big banks ceased backstopping the
auctions with supporting bids because of concerns about credit exposure, the
bustling market collapsed. That left some issuers paying double-digit
interest rates because of the terms under which they issued the securities.
Regulators have been
investigating the collapse in the market to determine who was responsible
for its demise and whether banks knowingly misrepresented the safety of the
securities when selling them to investors.
Jensen Comment
It's unbelievable how many huge frauds there are in which Merrill Lynch has been
an active participant. For example, do a word search for "Merrill" in this
document that you are reading now.
"Market and Political/Regulatory Perspectives on the Recent Accounting
Scandals," by Ray Ball at the University of Chicago, SSRN, September 17,
2008 --- (free download) ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1272804
Not surprisingly, the recent accounting
scandals look different when viewed from the perspectives of the
political/regulatory process and of the market for corporate governance and
financial reporting. We do not have the opportunity to observe a world in
which either market or political/regulatory processes operate independently,
and the events are recent and not well-researched, so untangling their
separate effects is somewhat conjectural. This paper offers conjectures on
issues such as: What caused the scandalous behavior? Why was there such a
rash of accounting scandals at one time? Who killed Arthur Andersen – the
SEC, or the market? Did fraudulent accounting kill Enron, or just keep it
alive for too long? What is the social cost of financial reporting fraud?
Does the US in fact operate a “principles-based” or a “rules-based”
accounting system? Was there market failure? Or was there regulatory
failure? Or both? Was the Sarbanes-Oxley Act a political and regulatory
over-reaction?
Jensen Comment
Although Professor Ball is best known for empirical research of capital markets
data, the above article is best described as a commentary of his personal
opinion. On many issues I agree with him, but on some issues I disagree.
Would market forces have killed Enron even if there was no criminal case
for document destruction?
Ray Ball (opinion with no supporting
evidence)
I conclude that market forces, left to their
own devices, would have closed Andersen.
Bob Jensen (agrees completely with
supporting evidence)
I don't think there's any doubt that Andersen would've folded due
to market forces of a succession of failed audits for which it did not
change its fundamental behavior and questions of auditor independence after
losing a succession of failed audit lawsuits prior to Enron. For example, it
continued to hire hire the in-charge auditor of Waste Management even after
his felony conviction.
When the Securities and Exchange Commission
found evidence in e-mail messages that a senior partner at Andersen had
participated in the fraud at Waste Management, Andersen did not fire him.
Instead, it put him to work revising the firm's document-retention policy.
Unsurprisingly, the new policy emphasized the need to destroy documents and
did not specify that should stop if an S.E.C. investigation was threatened.
It was that policy David Duncan, the Andersen partner in charge of Enron
audits, claimed to be following when he shredded Andersen's reputation.
Floyd Norris, "Will Big Four Audit Firms Survive in a World of Unlimited
Liability?," The New York Times, September 10, 2004
Although Ray Ball does not cite the empirical evidence, there is empirical
evidence that ultimately, due to a succession of incompetent or fraudulent
audits, having Andersen as an auditor raised a client's cost of capital.
"The Demise of Arthur Andersen," by Clifford F. Thies, Ludwig Von Mises
Institute, April 12, 2002 ---
http://www.mises.org/fullstory.asp?control=932&FS=The+Demise+of+Arthur+Andersen
From Yahoo.com, Andrew and I downloaded
the daily adjusted closing prices of the stocks of these companies (the
adjustment taking into account splits and dividends). I then constructed
portfolios based on an equal dollar investment in the stocks of each of
the companies and tracked the performance of the two portfolios from
August 1, 2001, to March 1, 2002. Indexes of the values of these
portfolios are juxtaposed in Figure 1.
From August 1, 2001, to November 30,
2001, the values of the two portfolios are very highly correlated. In
particular, the values of the two portfolios fell following the
September 11 terrorist attack on our country and then quickly recovered.
You would expect a very high correlation in the values of truly matched
portfolios. Then, two deviations stand out.
In early December 2001, a wedge
temporarily opened up between the values of the two portfolios. This
followed the SEC subpoena. Then, in early February, a second and
persistent wedge opened. This followed the news of the coming DOJ
indictment. It appears that an
Andersen signature (relative to a "Final Four" signature) costs a
company 6 percent of its market capitalization.
No wonder corporate clients--including several of the companies that
were in the Andersen-audited portfolio Andrew and I constructed--are
leaving Andersen.
Prior to the demise of Arthur Andersen,
the Big 5 firms seemed to have a "lock" on reputation. It is possible
that these firms may have felt free to trade on their names in search of
additional sources of revenue. If that is what happened at Andersen, it
was a big mistake. In a free market, nobody has a lock on anything.
Every day that you don’t earn your reputation afresh by serving your
customers well is a day you risk losing your reputation. And, in a
service-oriented economy, losing your reputation is the kiss of death.
Did (undetected) fraudulent accounting keep Enron alive too long?
Ray Ball
It is difficult to escape the conclusion
that market forces caused Enron’s bankruptcy, for the simple reason that it
had invested enormous sums and by 2000 was not generating profits.
Conversely, its accounting transgressions kept the company alive for some
period (perhaps one or two years) longer than would have occurred if it had
reported its true profitability. The welfare loss arose from keeping an
unprofitable company alive longer than optimal, and wasting capital and
labor that were better used elsewhere.
Bob Jensen (disagrees with the power
of GAAP in the case of Enron)
I think Ray Ball is attributing too much to financial reports of
past transactions. Even if Enron's financial reports were "true" in terms of
conformance with GAAP, the market may well have kept Enron alive because of
profit potential of some of the huge, albeit presently losing, ventures. The
counter example here is the more legitimate reporting losses in Amazon.com
for almost its entire history and the willingness of investors to "bet on
the come" of Amazon's ventures in spite of the reported losses in
conformance with GAAP. Furthermore, Enron's executives were so skilled at
sales pitches, I think Enron might've actually kept going much, much longer
if it conformed to GAAP and simply pitched its sweet-sounding ventures and
political connections in Washington DC. Enron was primarily brought down by
fraud that commenced to appear in the media and the pending lawsuits that
formed overhead due to the fraud.
Who killed Enron – the SEC or the market?
Ray Ball
It is difficult to escape the conclusion that
market forces caused Enron’s bankruptcy, for the simple reason that it had
invested enormous sums and by 2000 was not generating profits. Conversely,
its accounting transgressions kept the company alive for some period
(perhaps one or two years) longer than would have occurred if it had
reported its true profitability. The welfare loss arose from keeping an
unprofitable company alive longer than optimal, and wasting capital and
labor that were better used elsewhere.
Bob Jensen (disagrees because losing
divisions could've been dropped in favor of continued operations of highly
profitable divisions)
What Ray does not seek out is the first tip of the demise of Enron.
The single event that commenced Enron's dominos to fall has to be the
reporting of illegal related party transactions by a Wall Street Journal
Reporter. Once these became known, the SEC had to act and commenced a
chain of events from which Enron could not possibly survive in terms of
lawsuits and market reactions with lawsuit risks that bore down on the
market prices of Enron shares.
After John Emshwiller's WSJ report, determining whether the market or
the SEC brought down Enron is a chicken versus egg question!
Eichenwald states the following on pp. 490-492 in Conspiracy of Fools ---
http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm#22
It was section
eight, called "Related Party Transactions," that got John
Emshwiller's juices flowing.
After being
assigned to follow the Skilling resignation, Emshwiller had put in a
request for an interview, then scrounged up a copy of Enron's most
recent SEC filing in search of any nuggets.
What he found
startled him. Words about some partnerships run by an unidentified
"senior officer." Arcane stuff, maybe, but the numbers were huge.
Enron reported more than $240 million in revenues in the first six
months of the year from its dealings with them.
One fact struck
Emshwiller in particular. This anonymous senior officer, the filing
said, had just sold his financial interest in the partnerships.
Now, it said, the partnerships were no longer related to Enron.
The senior
officer had just sold his interest, Skilling had just resigned. The
connection seemed obvious.
Could Enron have
actually allowed Jeff Skilling to run partnerships that were doing
massive business with the company? Now that, Emshwiller
thought, would be a great story.
Emshwiller was
back on the phone with Mark Palmer. With no better explanation for
Skilling's resignation, he said, the Journal was going to dig
through everything it could find. Right now he was focusing on
these partnerships. Were those run by Skilling?
"No, that's not
Skilling," Palmer replied, almost nonchalantly. "That's Andy
Fastow."
A pause. "Who's
Andy Fastow?" Emshwiller asked.
The message was
slipped to Skilling later that day. A Journal reporter was
pushing for an explanation of his departure and now was rooting
around, looking for anything he could find. Probably best just to
give the paper a call.
Emshwiller was
at his desk when the phone rang.
"Hi," a soft
voice said. "It's Jeff Skilling."
It was a
startling moment. Emshwiller had been on the hunt, and suddenly the
quarry just walked in and lay down on the floor, waiting for him to
fire. So he did: why was Skilling quitting his job?
"It's all pretty
mundane," Skilling replied. He'd worked hard and accomplished a lot
but now had the freedom to move on. His voice was distant, almost
depressed.
He and been
ruminating about it for a while, Skilling went on, but had wanted to
stay on at the company until the California situation eased up.
Then, he took the conversation in a new direction.
"The stock price
has been very disappointing to me," Skilling said. "The stock is
less than half of what it was six months ago. I put a lot of
pressure on myself. I felt I must not be communicating well
enough."
Skilling rambled
as Emshwiller took it down. India. California. Expense cuts. The
good shape of Enron.
"Had the stock
price not done what it did..." He paused. "I don't think I would
have felt the pressure to leave if the stock price had stayed up."
What?
Had Emshwiller heard that right? Was all this stuff about "personal
reasons" out the window? Had Skilling thrown in the towel because
of the stock price?
"What was that,
Mr. Skilling?" Emshwiller asked.
The employees at
Enron owned lots of shares, Skilling said. They were worried,
always asking him about the direction of the price. He found it
very frustrating.
"Are you saying
that you don't think you would have quit if the stock price had
stayed up?"
Skilling was
silent for several seconds.
"I guess so," he
finally mumbled.
Minutes later,
Emshwiller burst into his boss's office. "You're not gong to
believe what Skilling just told me!"
|
What are the incentives to commit fraud?
Ray Ball
My view, based on mainly anecdotal experience,
is that non-financial motives are more powerful than is commonly believed,
and sometimes are the dominant reason for committing accounting fraud. An
important motivator seems to be maintaining the esteem of one’s
peers,ranging from co-workers to the public at large. Enron executives
reportedly were celebrities in Houston, and in important places like the
White House.
Bob Jensen (disagrees as to level of
importance of non-financial motives except in isolated instances such as
possibly Ken Lay)
Although there are instances where non-financial motives may have
been powerful, I believe that they generally pale when compared to the
financial reasons for committing all types of financial fraud, including
accounting fraud ---
http://faculty.trinity.edu/rjensen/FraudCongress.htm
Was Sarbanes-Oxley Necessary?
Ray Ball (who is generally critical of the
need for Sarbanes-Oxley relative to market forces without such regulation
and fraud penalties)
Markets need rules, and rely on trust. U.S.
financial markets historically had very effective rules by world standards,
the rules were broken, and there were immense consequences for the
transgressors.
Bob Jensen (strongly disagrees)
One need only look how the market-based system worldwide moved in
cycles of being Congress to the core among the major corporations, investment
banks, insurance companies, and credit rating companies ---
http://faculty.trinity.edu/rjensen/FraudCongress.htm
After getting caught these firms simply moved on to new schemes
without fear of market forces.
Nowhere is the wild west of market-based fraud more evident than in the
timeline history of derivative financial instruments frauds ---
http://faculty.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds
Frank Partnoy,
Page 283 of a Postscript entitled "The Return"
F.I.A.S.C.O. : The Inside Story of a Wall Street Trader by Frank
Partnoy - 283 pages (February 1999) Penguin USA (Paper); ISBN:
0140278796
Perhaps we don'
think we deserve a better chance. We play the lottery in record
numbers, despite the 50 percent cut (taken by the government). We
flock to riverboat casinos, despite substantial odds against
winning. Legal and illegal gambling are growing just as fast as the
financial markets, Las Vegas is our top tourist destination in the
U.S., narrowly edging out Atlantic City. Are the financial markets
any different? In sum, has our culture become so infused with the
gambling instinct that we would afford investors only that bill of
rights given a slot machine player: the right to pull the handle,
their right to pick a different machine, the right to leave the
casino, abut not the right to a fair game.
|
Infectious
Greed: How Deceit and Risk Corrupted the Financial Markets
(Henry Holt and Company, 2003, Page 17, ISBN 0-8050-7510-0)
In February 1985, the
United States Financial Accounting Standards Board
(FASB)
--- the private group that established
most accounting standards (in the U.S.) --- asked whether banks
should begin including swaps on their balance sheets, the financial
statements that recorded their assets and liabilities . . .since the
early 1980s banks had not included swaps as assets or liabilities .
. . the banks' argument was deeply flawed. The right to receive
money on a swap was a valuable asset, and the obligation to pay
money on a swap was a costly liability.
But bankers knew that
the fluctuations in their swaps (swap value volatility) would worry
their shareholders, and they were determined to keep swaps off their
balance sheets (including mere disclosures as footnotes), FASB's
inquiry about banks' treating swaps as off-balance-sheet --- a term
that would become widespread during the 1991s --- mobilized and
unified the banks, which until that point had been competing
aggressively and not cooperating much on regulatory issues. All
banks strongly opposed disclosing more information about their
swaps, and so they threw down their swords and banded together a
serveral high-level meetings. |
Infectious
Greed: How Deceit and Risk Corrupted the Financial Markets
(Henry Holt and Company, 2003, Page 77, ISBN 0-8050-7510-0)
The process of
transferring receivables to a new company and issuing new bonds
became known as
securitization,
which became a major part of the
structured finance industry . . . One of the most significant
innovations in structured finance was a deal called the
Collateralized Bond Obligation,
or CBO. CBOs are one of the threads that
run through the past fifteen years of financial markets, ranging
from Michael Milken to First Boston to Enron and WorldCom. CBOs
would mutate into various types of
credit derivatives ---
financial instruments tied to the creditworthiness of companies ---
which would play and important role in the aftermath of the collapse
of numerous companies in 2001and 2002.
. . .
In simple terms, here
is how a CBO works. A bank transfers a portfolio of junk bonds to a
Special Purpose Entity,
typically a newly created company, partnership, or trust domiciled
in a balmy tax haven, such as the Cayman Islands. This entity then
issues several securities, backed by bonds, effectively splitting
the junk bonds into pieces. Investors (hopefully) buy the pieces.
. . .
The first CBO was
TriCapital Ltc., a $420 million deal sold in July 1988. There were
about $900 million CBOs in 1988, and almost $ $3 billion in 1989.
Notwithstanding the bad press junk bonds had been getting, analysts
from all three of the credit-rating agencies began pushing CBOs.
Ther were very profitable for the rating agencies, which received
fees for rating the various pieces.
. . .
With the various
types of structured-finance deals, a trend began of companies using
Special Purpose Entities
(SPEs)
to hide risks. From an accounting perspective, the key question was
whether a company that owned particular financial assets needed to
disclose those assets in its financial statements even after it
transferred them to an SPE. Just as derivatives dealers had argued
that swaps should not be included in their balance sheets,
financial companies began arguing that their
interest in SPEs did not need to be disclosed
. . . In 1991. the acting chief accountant of the SEC, concerned
that companies might abuse this accounting standard, wrote a letter
saying the outside investment had to be at least three percent
(a requirement that helped implode Enron and its auditor
Andersen because the three percent investments were phony): |
Infectious
Greed: How Deceit and Risk Corrupted the Financial Markets
(Henry Holt and Company, 2003, Page 229, ISBN 0-8050-7510-0)
Third, financial
derivatives were now everywhere --- and largely unregulated.
Increasingly, parties were using financial engineering to take
advantage of the differences in legal rules among jurisdictions, or
to take new risks in new markets. In 1994, The Economist
magazine noted, "Some financial innovation is driven by wealthy
firms and individuals seeking ways of escaping from the regulatory
machinery that governs established financial markets." With such
innovation, the regulators' grip on financial markets loosened
during the mid-to-late 1990s . . . After Long-Term Capital
(Management) collapsed, even Alan Greenspan admitted that financial
markets had been close to the brink.
The decade was
peppered with financial debacles, but these faded quickly from
memory even as they increased in size and complexity. The billion
dollar-plus scandals included some colorful characters (Robert
Citron of Orange County, Nick Leeson of Barings, and John Meriwether
of Long-Term Capital Management), but even as each new scandal
outdid the others in previously unimaginable ways, the markets
merely hic-coughed and then started going up again. It didn't seem
that anything serious was wrong, and their ability to shake off a
scandal made markets seem even more under control.
Frank Portnoy, Infectious Greed (Henry Holt and Company,
2003, Page 2, ISBN 0-8050-7510-0). |
Société Générale Tradung Fraud in France
From The Wall Street Journal Accounting Weekly Review on October 14,
2010
Rogue French Trader Sentenced to 3 Years
by: David Gauthier-Villars
Oct 06, 2010
Click here to view the full article on WSJ.com
TOPICS: Banking, Internal Auditing, Internal Controls, International
Auditing
SUMMARY: Judge Dominique Plauthe heard the case against Jérôme Kerviel, the
French bank trader who amassed €4.9 billion in losses, equal to $7.2
billion, by making huge unauthorized trades that he hid for months until
discovery in January 2008. Many had expected that Société Générale would
have taken some of the blame for these losses. The bank "...itself
acknowledged in 2008 that it didn't have the right control systems in place
to correctly surpervise Mr. Kerviel." His lawyers argued "...that Société
Générale turned a blind eye on his illicit behavior as long as he was making
money." But Judge Plauthe "pointed his finger entirely at Mr. Kerviel,
calling him 'the unique mastermind, initiator and operator of a fraudulent
system.'"Mr. Kerviel has been sentenced to three years in prison and ordered
to repay his former employer the €4.9 billion-a sum impossible for him to
ever repay. Société Générale has said it will not ask Mr. Kerviel "...to
give up salary, savings, or assets...[but] would, however, seek any revenue
'derived from the fraud,' including money Mr,. Kerviel made on his book
'Caught in a Downward Spiral'."
CLASSROOM APPLICATION: This case illustrates the need for tight internal
controls to prevent unauthorized activity causing substantial losses. It
also makes clear that it is difficult to detect fraud when a perpetrator is
intent on covering it
QUESTIONS:
1. (Introductory) How did a lone trader wrack up huge losses for the French
bank Société Générale?
2. (Introductory) How did M. Kerviel cover up his activities?
3. (Advanced) What types of controls are designed to detect the steps that
M. Kerviel took to commit unauthorized trading?
4. (Advanced) Why would a bank be concerned about the fact that it "missed a
€ 1.4 billion gain" as well as the huge losses?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
French Bank Rocked by Rogue Trader
by David Gauthier-Villars, Carrick Mollenkamp and Alistair MacDonald
Jan 25, 2008
Page: A1
"Rogue French Trader Sentenced to 3 Years Kerviel Is Ordered to Repay Société
Générale $6.7 Billion," by by: David Gauthier-Villars, The Wall Street
Journal, October 6, 2010 ---
http://online.wsj.com/article/SB10001424052748703726404575533392217262322.html?mod=djem_jiewr_AC_domainid
A French court sentenced former Société Générale
trader Jérôme Kerviel to three years in prison for his role in one of the
world's biggest-ever trading scandals and ordered him to repay his former
employer €4.9 billion ($6.71 billion)—a sum it would take him 180,000 years
to pay at his current salary.
Mr. Kerviel's lawyer announced he is filing an
appeal that will likely take another 18 months to work through the courts.
Societe Generale's attorney said the bank would not actually expect the
former trader—who now works for a computer-consulting firm—to reimburse the
money or force him to give up his current paycheck or home.
Still, the ruling is a welcome development for
France's second-largest bank, as it lays the entire blame of the 2008
trading debacle on Mr. Kerviel. For years, the low-level trader managed to
hide risky trading, at one time making an unauthorized bet of €50 billion.
Throughout the trial, Mr. Kerviel and his lawyers
argued that Société Générale turned a blind eye on his illicit behavior as
long as he was making money. Société Générale itself acknowledged in 2008
that it didn't have the right control systems in place to correctly
supervise Mr. Kerviel. For this lack of oversight, the bank has already paid
€4 million in fines to France's banking regulator.
Though Société Générale wasn't a defendant in the
trial, many had expected the court to pin some of the responsibility on the
bank.
Judge Dominique Pauthe, however, pointed his finger
entirely at Mr. Kerviel, calling him "the unique mastermind, initiator and
operator of a fraudulent system."
In convicting Mr. Kerviel of breach of trust,
forgery, and unauthorized computer use, the judge also handed Mr. Kerviel a
lifetime trading ban. The prison sentence handed to Mr Kerviel is for five
years, of which two years were suspended.
As the judge read the ruling before a packed court,
Mr. Kerviel sat impassive. "Jerome is disgusted," his lawyer, Olivier
Metzner later told reporters.
"This ruling says the bank is responsible of
nothing and that Jerome Kerviel is responsible for the excesses of the
banking system."
For Société Générale, the ruling is likely to help
bank executives' efforts to draw a line under the scandal and clean up its
image. The bank's management team has changed since the scandal, and new
control systems have been introduced to its trading floors.
The bank's lawyer, Jean Veil, said that even if the
verdict were to be upheld on appeal, Société Générale wouldn't ask Mr.
Kerviel to give up salary, savings or assets. The bank would, however, seek
any revenue "derived from the fraud," including money Mr. Kerviel made on
his book "Caught in a Downward Spiral," which chronicles the affair, Mr.
Veil said. Mr. Kerviel sold about 50,000 copies of his book at €19.90
apiece, according to his French publisher Flammarion.
Outside the courtroom, many French analysts and
politicians criticized the verdict, saying Mr. Kerviel had been made a
scapegoat at a time when the banking system is trying to atone for its role
in the global financial crisis.
"Mr. Kerviel only did what he was paid for:
speculate," Pierre Laurent, head of France's Communist Party said in a
statement. "He was a cog in a machine and his guilt cannot be detached from
the whole system."
In January 2008, Société Générale shocked world
markets when it disclosed it had suffered a net loss of €4.9 billion after
unwinding a series of wild bets placed by Mr. Kerviel. As the probe got
under way, Mr. Kerviel immediately acknowledged to engaging in years of
unauthorized trades, but said that he was just trying to make money for the
bank.
Over the years, Mr. Kerviel had been able to defeat
multiple layers of control at the bank using apparently simple techniques:
He fabricated emails, promised bottles of champagne to back-office
supervisors and gave evasive answers when questioned about anomalies in his
trading books.
During the trial, Mr. Kerviel argued that the vague
nature of his answers should have alerted supervisors. But the court said
Mr. Kerviel couldn't blame others.
Continued in article
Jensen Comment
This is a blatant illustration of how lightly white collar criminals are let off
relative to other criminals. It seems to me that, aside from violent crimes,
punishments should be doled out on the basis of the amount stolen ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
Jérôme Kerviel's duties included arbitraging equity derivatives and equity
cash prices and commenced a crescendo of fake trades. This is an interesting
fraud case to study, but I doubt whether auditors themselves can be credited
with discovery of the fraud. It is a case of poor internal controls, but there
are all sorts of suggestions that the bank was actually using Kerviel to cover
its own massive losses. Kerviel did not personally profit from his fraud,
although he may have been anticipating a bonus due to his "profitable"
fake-trade arbitraging.
Société Générale ---
http://en.wikipedia.org/wiki/Soci%C3%A9t%C3%A9_G%C3%A9n%C3%A9rale
On January 24, 2008, the bank announced that a
single futures trader at the bank had fraudulently lost the bank €4.9billion
(an equivalent of $7.2billionUS), the largest such loss in history.
The company did not name the trader,
but other sources identified him as
Jérôme Kerviel, a
relatively junior
futures
trader who allegedly
orchestrated a series of bogus transactions that spiraled out of control
amid turbulent markets in 2007 and early 2008.
Partly due to the loss, that same day two
credit rating agencies reduced the bank's long
term debt ratings: from AA to AA- by Fitch; and from Aa1/B
to Aa2/B- by Moody's (B and B- indicate the bank's
financial strength ratings).
Executives said the trader acted alone and that he
may not have benefited directly from the fraudulent deals. The bank
announced it will be immediately seeking 5.5 billion euros in financing. On
the eve and afternoon of January 25, 2008, Police raided the Paris
headquarters of Société Générale and Kerviel's apartment in the western
suburb of
Neuilly, to seize his computer files. French
presidential aide Raymond Soubie stated that Kerviel dealt with $73.3
billion (more than the bank's
market capitalization of $52.6 billion). Three
union officials of Société Générale employees said Kerviel had family
problems.
On January 26, 2008, the Paris prosecutors'
office stated that Jerome Kerviel, 31, in Paris, "is not on the run. He will
be questioned at the appropriate time, as soon as the police have analysed
documents provided by Société Générale." Kerviel was placed under custody
but he can be detained for 24 hours (under French law, with 24 hour
extension upon prosecutors' request). Spiegel-Online stated that he may have
lost 2.8 billion dollars on 140,000 contracts earlier negotiated due to DAX
falling 600 points.
The alleged fraud was much larger than the
transactions by Nick Leeson that brought down
Barings Bank
Main article:
January 2008 Société Générale trading loss incident
Other notable trading losses
April 10 message from Jagdish Gangolly
[gangolly@GMAIL.COM]
Francine,
1. In France, accountants and
auditors are regulated by different ministries; accountants by Ministry of
Finance, and auditors by the Ministry of Justice. Only auditors can perform
statutory audits. All auditors are accountants, but not necessarily the
other way round.
I am not sure there is a
fundamental difference when it comes to apportionment of blame and so on,
except that the ominous and heavy hand of the state pervades in France; even
the codes assigned to the items in the national chart of accounts is
specified in French law (in the so called Accounting Plan).
2. I do not think the
accountants/auditors were involved in the Societe Generale case. The
unauthorised trades were detected and the positions closed all within two
days or so. Unfortunately us US taxpayers were left holding the bag in the
long run; we paid $11 billion for the credit default swaps to SG.
Jagdish
--
Jagdish S. Gangolly
Department of Informatics
College of Computing & Information
State University of New York at Albany
Harriman Campus, Building 7A, Suite 220
Albany, NY 12222
Phone: 518-956-8251, Fax: 518-956-8247
April 11, 2010 reply from Francine McKenna
[retheauditors@GMAIL.COM]
Societe Generale was not
resolved that quickly. In the MF Global "rogue trading scandal" the
positions were closed overnights because the trades were in wheat which is
exchange traded and cleared by the CME. Societe General trader was working
with primarily non-exchange traded derivatives. They did not see it right
away and counterparties who could complain about margin calls did not exist.
The banks internal audit group
was ignored (like AIG) and the auditors gave a bank that had poor internal
controls and the ability for any controls to be overridden easily, a clean
bill of health.
Thanks for further
clarification of the French approach. I did not know they had accountants
and auditors but that makes it seem even more like the barristers and
solicitors division...
http://retheauditors.com/2008/10/14/what-the-auditors-saw-an-update-on-societe-generale/
http://retheauditors.com/2008/03/03/mf-global-socgen-and-rogue-traders-dont-fall-for-the-simple-answers/
April 11, 2010 reply from Tom Selling
[tom.selling@GROVESITE.COM]
To refresh memories, the auditors (two Big Four
firms) of Société Générale were involved in the aftermath, by exploiting a
questionable loophole in IFRS. Société Générale chose to lump Kerviel's 2008
trading losses in 2007's income statement, thus netting the losses of the
later year with his gains of the previous year. There is no disputing that
the losses occurred in 2008, yet the company's position is that application
of specific IFRS rules (very simply, marking derivatives to market) would,
for reasons unstated, result in a failure of the financial statements to
present a "true and fair view."
See Floyd Norris’s column in NYT:
http://www.nytimes.com/2008/03/07/business/07norris.html?ref=business
Best,
Tom
Bob Jensen's threads on brokerage trading frauds are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Remember when the 2007/2008 severe economic collapse was caused by "street
events":
Fraud on Main Street
Issuance of "poison" mortgages (many
subprime)
that lenders knew could never be repaid by borrowers.
Lenders didn't care about loan defaults because they sold the poison mortgages
to suckers like Fannie and Freddie.
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
For low income borrowers the Federal Government forced Fannie and Freddie to buy
up the poisoned mortgages ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
Math Error on Wall Street
Issuance of CDO portfolio bonds laced with a portion of
healthy mortgages and a portion of poisoned mortgages.
The math error is based on an assumption that risk of poison can be diversified
and diluted using a risk diversification formula.
The risk diversification formula is called the
Gaussian copula function
The formula made a fatal assumption that loan defaults would be random events
and not correlated.
When the real estate bubble burst, home values plunged and loan defaults became
correlated and enormous.
Fraud on Wall Street
All the happenings on Wall Street were not merely innocent
math errors
Banks and investment banks were selling CDO bonds that they knew were
overvalued.
Credit rating agencies knew they were giving AAA high credit ratings to bonds
that would collapse.
The banking industry used powerful friends in government to pass its default
losses on to taxpayers.
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
History
(Long Term
Capital Management and CDO Gaussian Coppola failures)
Repeats Itself in Over a Billion Lost in MF Global
"Models
(formulas) Behaving Badly Led to MF’s Global Collapse – People Too,"
by Aaron Task, Yahoo Finance, November 21, 2011 ---
http://finance.yahoo.com/blogs/daily-ticker/models-behaving-badly-led-mf-global-collapse-people-174954374.html
"The entire system has been utterly destroyed by
the MF Global collapse," Ann Barnhardt, founder and CEO of Barnhardt Capital
Management, declared last week in a letter to clients.
Whether that's hyperbole or not is a matter of
opinion, but MF Global's collapse — and the inability of investigators to
find about $1.2 billion in "missing" customer funds, which is twice the
amount previously thought — has only further undermined confidence among
investors and market participants alike.
Emanuel Derman, a professor at Columbia University
and former Goldman Sachs managing director, says
MF Global was undone by
an over-reliance on short-term funding, which dried up as revelations of its
leveraged bets on European sovereign debt came to light.
In the accompanying video, Derman says MF Global
was much more like Long Term Capital Management than Goldman Sachs, where he
worked on the risk committee for then-CEO John Corzine.
A widely respected expert on risk management,
Derman is the author of a new book
Models. Behaving. Badly: Why Confusing Illusion with Reality Can Lead to
Disaster, on Wall Street and in Life.
As discussed in the accompanying video, Derman says
the "idolatry" of financial models puts Wall Street firms — if not the
entire banking system — at risk of catastrophe. MF Global was an extreme
example of what can happen when the models — and the people who run them --
behave badly, but if Barnhardt is even a little bit right, expect more
casualties to emerge.
Jensen Comment
MF Global's auditor (PwC) will now be ensnared, as seems appropriate in this
case, the massive lawsuits that are certain to take place in the future ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
"Does the use
of Financial Derivatives Affect Earnings Management Decisions?"
by Jan Barton, The Accounting Review, January 2001, pp. 1-26.
I present evidence
consistent with managers using derivatives and discretionary
accruals as partial substitutes for smoothing earnings. Using
1994-1996 data for a sample of Fortune 500 firms, I estimate a set
of simultaneous equations that captures managers' incentives to
maintain a desired level of earnings volatility through hedging and
accrual management. These incentives include increasing managerial
compensation and wealth, reducing corporate taxes and debt financing
costs, avoiding underinvestment and earnings surprises, and
mitigating volatility caused by low diversification. After
controlling for such incentives, I find significant negative
association between derivatives' notional amounts and proxies for
the magnitude of discretionary accruals.
|
Frank Partnoy introduces Chapter 7 of Infectious
Greed as follows:
Pages
187-188
The
regulatory changes of 1994-95 sent three messages to
corporate CEOs. First, you are not likely to be
punished for "massaging" your firm's accounting
numbers. Prosecutors rarely go after financial fraud
and, even when they do, the typical punishment is a
small fine; almost no one goes to prison. Moreover,
even a fraudulent scheme could be recast as mere
earnings management--the practice of smoothing a
company's earnings--which most executives did, and
regarded as perfectly legal.
Second, you
should use new financial instruments--including options,
swaps, and other derivatives--to increase your own pay
and to avoid costly regulation. If complex derivatives
are too much for you to handle--as they were for many
CEOs during the years immediately following the 1994
losses--you should at least pay yourself in stock
options, which don't need to be disclosed as an expense
and have a greater upside than cash bonuses or stock.
Third, you
don't need to worry about whether accountants or
securities analysts will tell investors about any hidden
losses or excessive options pay. Now that Congress and
the Supreme Court have insulated accounting firms and
investment banks from liability--with the Central Bank
decision and the Private Securities Litigation Reform
Act--they will be much more willing to look the other
way. If you pay them enough in fees, they might even be
willing to help.
Of course,
not every corporate executive heeded these messages.
For example, Warren Buffett argued that managers should
ensure that their companies' share prices were accurate,
not try to inflate prices artificially, and he
criticized the use of stock options as compensation.
Having been a major shareholder of Salomon Brothers,
Buffett also criticized accounting and securities firms
for conflicts of interest.
But for
every Warren Buffett, there were many less scrupulous
CEOs. This chapter considers four of them: Walter
Forbes of CUC International, Dean Buntrock of Waste
Management, Al Dunlap of Sunbeam, and Martin Grass of
Rite Aid. They are not all well-known among investors,
but their stories capture the changes in CEO behavior
during the mid-1990s. Unlike the "rocket scientists" at
Bankers Trust, First Boston, and Salomon Brothers, these
four had undistinguished backgrounds and little training
in mathematics or finance. Instead, they were
hardworking, hard-driving men who ran companies that met
basic consumer needs: they sold clothes, barbecue
grills, and prescription medicine, and cleaned up
garbage. They certainly didn't buy swaps linked to
LIBOR-squared.
|
|
I do agree with Ray Ball that regulation in and of itself is not panacea
when either preventing or detecting fraud.
"Greater
Regulation of Financial Markets?" by Richard Posner, The
Becker-Posner Blog, April 28, 2008 ---
http://www.becker-posner-blog.com/
Re-Regulate Financial Markets?--Posner's Comment I no longer believe
that deregulation has been a complete, an unqualified, success. As I
indicated in my posting of last week, deregulation of the airline
industry appears to be a factor in the serious deterioration of
service, which I believe has imposed substantial costs on travelers,
particularly but not only business travelers; and the partial
deregulation of electricity supply may have been a factor in the
western energy crisis of 2000 to 2001 and the ensuing Enron debacle.
The deregulation of trucking, natural gas, and pipelines has, in
contrast, probably been an unqualified success, and likewise the
deregulation of the long-distance telecommunications and
telecommunications terminal equipment markets, achieved by a
combination of deregulatory moves by the Federal Communications
Commission beginning in 1968 and the government antitrust suit that
culminated in the breakup of AT&T in 1983.
Although
one must be tentative in evaluating current events, I suspect that
the deregulation (though again partial) of banking has been a factor
in the current credit crisis. The reason is related to Becker's very
sensible suggestion that, given the moral hazard created by
government bailouts of failing financial institutions, a tighter
ceiling should be placed on the risks that banks are permitted to
take. Because of federal deposit insurance, banks are able to borrow
at low rates and depositors (the lenders) have no incentive to
monitor what the banks do with their money. This encourages risk
taking that is excessive from an overall social standpoint and was
the major factor in the savings and loan collapse of the 1980s.
Deregulation, by removing a variety of restrictions on permitted
banking activities, has allowed commercial banks to engage in
riskier activities than they previously had been allowed to engage
in, such as investing in derivatives and in subprime mortgages, and
thus deregulation helped to bring on the current credit crunch. At
the same time, investment banks such as Bear Sterns have been
allowed to engage in what is functionally commercial banking; their
lenders do not have deposit insurance--but their lenders are banks
that for the reason stated above are happy to make risky loans.
The
Federal Deposit Insurance Reform Act of 2005 required the FDIC to
base deposit insurance premiums on an assessment of the riskiness of
each banking institution, and last year the Commission issued
regulations implementing the statutory directive. But, as far as I
can judge, the risk-assessed premiums vary within a very narrow band
and are not based on an in-depth assessment of the individual bank’s
riskiness.
Now it
is tempting to think that deregulation has nothing to do with this,
that the problem is that the banks mistakenly believed that their
lending was not risky. I am skeptical. I do not think that bubbles
are primarily due to avoidable error. I think they are due to
inherent uncertainty about when the bubble will burst. You don't
want to sell (or lend, in the case of banks) when the bubble is
still growing, because then you may be leaving a lot of money on the
table. There were warnings about an impending collapse of housing
prices years ago, but anyone who heeded them lost a great deal of
money before his ship came in. (Remember how Warren Buffett was
criticized in the late 1990s for missing out on the high-tech stock
boom.) I suspect that the commercial and investment banks and hedge
funds were engaged in rational risk taking, but that (except in the
case of the smaller hedge funds--the largest, judging from the
bailout of Long-Term Capital Management in 1998, are also considered
by federal regulators too large to be permitted to go broke) they
took excessive risks because of the moral hazard created by deposit
insurance and bailout prospects.
Perhaps
what the savings and loan and now the broader financial-industry
crises reveal is the danger of partial deregulation. Full
deregulation would entail eliminating both government deposit
insurance (especially insurance that is not experience-rated or
otherwise proportioned to risk) and bailouts. Partial deregulation
can create the worst of all possible worlds, as the western energy
crisis may also illustrate, by encouraging firms to take risks
secure in the knowledge that the downside risk is truncated.
There has I
think been a tendency of recent Administrations, both Republican and
Democratic but especially the former, not to take regulation very
seriously.
This tendency expresses itself in deep cuts in staff and in the
appointment of regulatory administrators who are either political
hacks or are ideologically opposed to regulation. (I have long
thought it troublesome that Alan Greenspan was a follower of Ayn
Rand.) This would be fine if zero regulation were the social
desideratum, but it is not. The correct approach is to carve down
regulation to the optimal level but then finance and staff and
enforce the remaining regulatory duties competently and in good
faith. Judging by the number of scandals in recent years involving
the regulation of health, safety, and the environment, this is not
being done. And to these examples should probably be added the weak
regulation of questionable mortgage practices and of rating
agencies' conflicts of interest and, more basically, a failure to
appreciate the gravity of the moral hazard problem in the financial
industry. |
If auditors and their clients do not take there professional and ethical
responsibilities more seriously then neither market forces nor regulators will
prevent frauds from increasingly undermining our prized capital markets.
Bob Jensen's Congress to the Core threads are at
http://faculty.trinity.edu/rjensen/FraudCongress.htm
Bob Jensen's Fraud Conclusions are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm
The Most Criminal Class Writes the Laws
Question
Trading of insider information is against U.S. law for every segment of society
except for one privileged segment that legally exploits investors for personal
gains by trading on insider information. What is that privileged segment of U.S.
society legally trades on inside information for personal gains?
Hints:
Congress is our only native criminal class.
Mark Twain ---
http://en.wikipedia.org/wiki/Mark_Twain
We
hang the petty thieves and appoint the great ones to public office.
Attributed to Aesop
Congress is our only native criminal class.
Mark Twain ---
http://en.wikipedia.org/wiki/Mark_Twain
We
hang the petty thieves and appoint the great ones to public office.
Attributed to Aesop
Why People Elect Crooks: They flaunt their rough edges as proof that
they will fight for the people. And because many have experience subverting the
system, they deliver ---
http://www.wsj.com/articles/why-people-elect-crooks-1485303029?mod=djemMER
List of Federal Political Scandals ---
https://en.wikipedia.org/wiki/List_of_federal_political_scandals_in_the_United_States
Corruption in the United States ---
https://en.wikipedia.org/wiki/Corruption_in_the_United_States
"Who is Telling the Truth? The Fact Wars" as written on the
Cover of Time Magazine
Jensen Comment
Both U.S. presidential candidates are spending tends of millions of dollars to
spread lies and deceptions.
Both are alleged Christian gentlemen, a faith where big lies are sins
jeopardizing the immortal soul.
The race boils down to the sad fact that the biggest Christian liar will win the
race for the presidency in November 2012.
"Who is Telling the Truth? The Fact Wars: ," as written on
the Cover of Time Magazine
"Blue Truth-Red Truth: Both candidates say White House hopefuls should
talk straight with voters. Here's why neither man is ready to take his own
advice ,"
by Michael Scherer (and Alex Altma), Time Magazine Cover Story, October
15, 2012, pp. 24-30 ---
http://www.cs.trinity.edu/~rjensen/temp/PresidentialCampaignLies2012.htm
Bob Jensen's threads on Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
What Affects Our Trust in Government?
http://daily.jstor.org/what-affects-our-trust-in-government/
Jensen Comment
One thing that affects are trust in government is lenient prison sentences for
enormous white-collar fraudsters in both the public and private sectors
---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays i
Crime pays as long as the
crime is massive in rewards.
Another thing that affects our trust in government is the coziness of the
private and public sector such as when government bureaucrats are given fabulous
incentives to bail out of government jobs into high paying jobs in the
industries they preciously regulated. Generals hope to become defense contractor
executives. FDA regulators hope to become executives in the pharmaceutical
industry. SEC, FBI, and Department of Justice employees hope to get plush jobs
and offices in big accounting and law firms. It did take long before industries
eventually owned the government agencies that regulated and investigated those
industries. What government agency is truly independent and highly respected?
Another thing that affects our trust in government is when current or former
bureaucrats and legislators are given $250,000 or more for a short speech. That
must be some inspirational/informative speech! Yeah right!
Our legislators are not trusted by the public for good reason. They are
trusted even less when they leave office to become high-paid lobbyists.
How many mayors and governors went to prison when the loot they stashed can't
be found? Three recent governors of Illinois, for example, went to prison.
Don't expect them to be clerking at convenience stores when they're released.
Can you become a mayor of most of the USA's major cities without doing
under-the-table business with corrupt municipal labor unions?
The bigger the government program the bigger the piñata for fraud! Exhibit A
is the Department of Defense. Exhibit B is Medicare. Exhibit C is Medicaid. And
on and on and on.
Private sector fraud goes hand-in-hand with public sector fraud.
Name some of our government servants who became multimillionaires even though
they were always on the public payroll? LBJ is not an exception. He's the rule.
The real world is not a Disney movie victory of of goodness over evil.
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
From the Scout Report on October 12, 2012
A report calls on Italy to address widespread government corruption
Italy needs anti-corruption authority: Transparency International
http://www.chicagotribune.com/news/sns-rt-us-italy-corruptionbre8941bb-20121005,0,988805.story
Italy: open letter to Prime Minister Monti
http://www.transparency.org/news/feature/italy_open_letter_to_prime_minister_monti
European Commission: Italy ---
http://cordis.europa.eu/italy/
Italy and the European Union ---
http://www.brookings.edu/research/books/2011/italyandtheeuropeanunion
Reporters Without Borders Press Freedom Index 2011-2012 ---
http://en.rsf.org/press-freedom-index-2011-2012,1043.html
Transparency International ---
http://www.transparency.org/
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Meanwhile Congress passed a law against its members profiting from insider
trading. However, the law is a joke since each member's family can still profit
legally from insider trading
The Wonk (Professor) Who Slays Washington
Insider trading is an asymmetry of information between a buyer and a seller
where one party can exploit relevant information that is withheld from the other
party to the trade. It typically refers to a situation where only one party has
access to secret information while the other party has access to only
information released to the public. Financial markets and real estate markets
are usually very efficient in that public information is impounded pricing the
instant information is made public. Markets are highly inefficient if traders
are allowed to trade on private information, which is why the SEC and Justice
Department track corporate insider trades very closely in an attempt to punish
those that violate the law. For example, the former
wife of a partner in the auditing firm Deloitte & Touche was recently sentenced
to 11 months exploiting inside information extracted from him about her
husband's clients. He apparently did was not aware she was using this inside
information illegally.
In another recent case, hedge fund manager Raj Rajaratnam was sentenced to 11
years for insider trading.
Even more commonly traders who are damaged by insiders typically win enormous
lawsuits later on for themselves and their attorneys, including enormous
punitive damages. You can read more about insider trading at
http://en.wikipedia.org/wiki/Insider_trading
Corporate executives like Bill Gates often announce future buying and selling
of shares of their companies years in advance to avoid even a hint of scandal
about exploiting current insider information that arises in the meantime. More
resources of the SEC are spent in tracking possible insider information trades
than any other activity of the SEC. Efforts are made to track trades of
executive family and friends and whistle blowing is generously rewarded.
Question
Trading on insider information is against U.S. law for every segment of society
except for one privileged segment that legally exploits investors for personal
gains by trading on insider information. What is that privileged segment of
U.S. society legally trades on inside information for personal gains?
Hints:
Congress is our only native criminal class.
Mark Twain ---
http://en.wikipedia.org/wiki/Mark_Twain
We hang the petty thieves and appoint the great ones to public office.
Attributed to Aesop
Answer (Please share this with your students):
Over the years I've been a loyal viewer of the top news show on television ---
CBS Sixty Minutes
On November 13, 2011 the show entitled "Insider"
is the most depressing segment I've ever watched on television ---
http://www.cbsnews.com/video/watch/?id=7387951n&tag=contentMain;contentBody#ixzz1dfeq66Ok
Also see
http://financeprofessorblog.blogspot.com/2011/11/congress-trading-stock-on-inside.html
Jensen Comment
- It came as no surprise that many (most?) members of the U.S. House of
Representatives and the U.S. Senate that writes the laws of the land made it
illegal for to trade in financial and real estate market by profiting
personally on insider information not yet available, including pending
legislation that they will decide, wrote themselves out of the law making
it legal for them to personally profit from trading on insider information.
What came as a surprise is how leaders at the very top of Congress make
millions trading on inside information with impunity and well as immunity.
- The Congressional leader that comes off the worst in this Sixty
Minutes "Insider" segment is former House Speaker and current Minority
leader
Nancy Pelosi.
When confronted with specific facts on how she and her husband made some of
their insider trading millions she fired back at reporter Steve Kroft with
an evil glint saying what is tantamount to: "How dare you question me
about insider trades that are perfectly legal for members of Congress. Who
are you to question my ethics about exploiting our insider trading
privileges. Back off Steve or else!" Her manner can be extremely scary.
Other Democratic Party members of Congress come off almost as bad in terms
of insider trading for personal gain.
- Current Speaker of the House,
John
Boehner, is more subtle. He denies making any of his personal portfolio
investment decisions and denies communicating with the person he hires to
make such decision. However, that trust investor mysteriously makes money
for Rep. Boehner using insider information obtained mysteriously. Other
Republican members of Congress some off even worse in terms of insider
trading.
- Members of Congress on powerful committees regularly make insider
profits on legislation currently being written into the law that is still
being held secret from the public. One of my heroes, former Senator
Judd Gregg,
is no longer my hero.
- Everybody knows that influence peddling in Congress by lobbyists, many
of them being former members of Congress, is a dirty business of showering
gifts on current members of Congress. What is made clear, however, is that
these lobbyists are personally getting something in return from friendly
members of Congress who pass along insider information to lobbyists. The
lobbyists, in turn, peddle this insider information back to the private
sector, such as hedge fund managers, for a commission. Moral of story:
Voters do not stop insider trading by a member of Congress by voting him
or her out of office if they become peddlers of insider information
obtained, as lobbyists, from their old friends still in the Congress.
- Five out of 435 members of the House of Representatives are seeking to
sponsor a bill to make it illegal for representatives and senators to profit
from trading on inside information. The Sixty Minutes show demonstrates how
Nancy Pelosi, John Boehner, and other House leaders have buried that effort
so deep in the bowels of the legislative process that there's no chance in
hell of stopping insider trading by members of Congress. Insider trading is
a privilege that attracts unethical people to run for Congress.
Watch the "Insider" Video Now While
It's Still Free ---
http://www.cbsnews.com/video/watch/?id=7387951n&tag=contentMain;contentBody
"They have legislated themselves as untouchable as a
political class . . . "
"The Wonk (Professor) Who Slays Washington," by Peter J. Boyer,
Newsweek Magazine, November 21, 2011, pp. 32-37 ---
http://www.thedailybeast.com/newsweek/2011/11/13/peter-schweizer-s-new-book-blasts-congressional-corruption.html
"Treasury's Fannie Mae Heist: The government asked investors to
shore up the two mortgage giants. Now those investors are being stiffed," by
Theodore B. Olson, The Wall Street Journal, July 23, 2013 ---
http://online.wsj.com/article/SB10001424127887323309404578617451897504308.html?mod=djemEditorialPage_h
The federal government currently is seizing the
substantial profits of the government-chartered mortgage firms, Fannie Mae
FNMA -4.35% and Freddie Mac, FMCC -1.36% taking for itself the property and
potential gains of private investors the government induced to help prop up
these companies. This conduct is intolerable.
Earlier this month I filed a lawsuit to stop it,
now known as Perry Capital v. Lew, and other lawsuits challenging the
government's authority to demolish private investment are stacking up.
Perhaps it's time for the government to change course.
When the nationwide mortgage crisis first took hold
in 2007 and 2008, Fannie and Freddie shored up their balance sheets with
some $33 billion in private capital, much of it from community banks, which
federal regulators encouraged to invest in the companies. As the crisis
deepened, the government determined that Fannie and Freddie also needed
substantial assistance from taxpayers. Congress passed the Housing and
Economic Recovery Act of 2008, and under that law the government ultimately
plowed $187 billion into the companies.
Taxpayers should get their investment back, but
once they do, so should the private investors who first came to Fannie and
Freddie's aid. The government's scheme to wipe out these investors is bad
policy and a plain violation of the law that respects private,
investment-backed expectations and our constitutional protection of property
rights.
When the government intervened in Fannie and
Freddie in 2008, it faced a choice: It could place the companies into a
receivership and liquidate them, or it could operate them in a
conservatorship and manage them back to financial health. Conservatorship,
the government agreed, offered the best chance of stabilizing the mortgage
market while repaying the taxpayers for their investment.
Today, Fannie and Freddie are back. Last quarter,
Fannie announced a quarterly profit of over $8 billion; Freddie made $7
billion.
Rather than allow private investors to share in
these profits, the federal government unilaterally decided to seize every
dollar for itself. Last summer the government changed the terms of its
investment from a fixed annual dividend of 10%—a healthy return in this
market—to a dividend of nearly every dollar of the companies' net worth for
as long as they remain in operation.
So, at the end of last month, Fannie and Freddie
sent a whopping $66 billion to the Treasury as a dividend. None of this
money went to pay down the government's investment. Whatever amount of money
the government takes out of Fannie and Freddie, the amount owed to the
government is never to be reduced, meaning there can never be any recovery
for private investors.
It's a splendid deal for the government: The
president's budget estimates, over the next 10 years, that the government
will recover $51 billion more than it invested in the companies—and that's
on top of tens of billions in dividends the government took out of the
companies from 2008-12. But it's a complete destruction of the investments
of private shareholders.
That is unlawful for at least three reasons. First,
the government's authority to revise its investments in Fannie and Freddie
expired more than three years ago. Its change in the payment structure was
utterly lawless.
Second, the Housing and Economic Recovery Act
expressly requires the government to consider how its actions affect private
ownership of the companies. The government has evidently given no attention
to that requirement.
Third, that same law requires the government,
operating Fannie and Freddie as a conservator, to safeguard their assets,
but the government's new dividend scheme conserves nothing. In fact, the
government has acknowledged it intends to facilitate the companies' ultimate
liquidation. That is the opposite of conservatorship and it violates
virtually every limitation that Congress imposed on the government's
authority to intervene in Fannie and Freddie.
Some have suggested that this illegal extinction of
private investment is justified by the extraordinary levels of support that
taxpayers provided to Fannie and Freddie during the financial crisis.
Certain recent legislative proposals even purport retroactively to legalize
the government's cash-grab in the name of ensuring the taxpayers are repaid.
But the companies' return to profitability means that taxpayers likely will
be repaid in full, with interest, by the end of next year.
In these circumstances the right thing to do is to
permit the companies to pay down what they owe to the government's
investment so that private investors also might have the opportunity to earn
returns on theirs. Yet, the "right thing" here is not just what the law
requires. It may benefit the taxpayers as well. If Fannie and Freddie ever
return to private ownership, the government has rights to 80% of the
companies' common stock.
The government's recent cash grab squanders that
opportunity, but it threatens even more serious harms. The United States has
the most liquid securities markets in the world only because of its strong
commitment to the rule of law and respect for private property. The
government's actions here are an affront to those commitments.
Mr. Olson, a former U.S. solicitor general, is a partner at Gibson,
Dunn & Crutcher.
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Countrywide gave home-loan discounts to Washington officials," by
Jonaton Strong, Roll Call, July 5, 2012 ---
http://www.rollcall.com/news/countrywide_offered_discounted_loans_to_members_report_says-215901-1.html?pos=hln
Jensen Comment
This is a major reason why Senator Chris Dodd (Chairman of the Senate Banking
Committee) did not seek re-election after the news of his loan discount was
revealed to the public ---
http://en.wikipedia.org/wiki/Chris_Dodd
Countrywide Financial loan controversy Further
information: Countrywide financial political loan scandal
In his role as chairman of the Senate Banking Committee Dodd proposed a
program in June 2008 that would assist troubled sub-prime mortgage lenders
such as Countrywide Financial in the wake of the United States housing
bubble's collapse.[28] Condé Nast Portfolio reported allegations that in
2003 Dodd had refinanced the mortgages on his homes in Washington, D.C. and
Connecticut through Countrywide Financial and had received favorable terms
due to being placed in the "Friends of Angelo" VIP program, so named for
Countrywide CEO Angelo Mozilo. Dodd received mortgages from Countrywide at
allegedly below-market rates on his Washington, D.C. and Connecticut
homes.[28] Dodd had not disclosed the below-market mortgages in any of six
financial disclosure statements he filed with the Senate or Office of
Government Ethics since obtaining the mortgages in 2003.[29]
Dodd's press secretary said "The Dodds received a
competitive rate on their loans", and that they "did not seek or anticipate
any special treatment, and they were not aware of any", then declined
further comment.[30] The Hartford Courant reported Dodd had taken "a major
credibility hit" from the scandal.[31] At the same time, the Chairman of the
Senate Budget Committee Kent Conrad and the head of Fannie Mae Jim Johnson
received mortgages on favorable terms due to their association with
Countrywide CEO Angelo Mozilo.[32] The Wall Street Journal, The Washington
Post, and two Connecticut papers have demanded further disclosure from Dodd
regarding the Mozilo loans.[33][34][35][36]
On June 17, 2008, Dodd met twice with reporters and
gave accounts of his mortgages with Countrywide. He admitted to reporters in
Washington, D.C. that he knew as of 2003 that he was in a VIP program, but
claimed it was due to being a longtime Countrywide customer, not due to his
political position. He omitted this detail in a press availability to
Connecticut media.[37]
On July 30, 2009, Dodd responded to news reports
about his mortgages by releasing information from the Wall Street Journal
showing that both mortgages he received were in line with those being
offered to general public in fall 2003 in terms of points and interest
rate.[38]
On August 7, 2009, a Senate ethics panel issued its
decision on the controversy. The Select Committee on Ethics said it found
"no credible evidence" that Dodd knowingly sought out a special loan or
treatment because of his position, but the panel also said in an open letter
to Mr. Dodd that the lawmaker should have questioned why he was being put in
the "Friends of Angelo" VIP program at Countrywide: "Once you became aware
that your loans were in fact being handled through a program with the name 'V.I.P.,'
that should have raised red flags for you."[39]
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
The Wonk (Professor) Who Slays Washington
Insider trading is an asymmetry of information between a buyer and a seller
where one party can exploit relevant information that is withheld from the other
party to the trade. It typically refers to a situation where only one party has
access to secret information while the other party has access to only
information released to the public. Financial markets and real estate markets
are usually very efficient in that public information is impounded pricing the
instant information is made public. Markets are highly inefficient if traders
are allowed to trade on private information, which is why the SEC and Justice
Department track corporate insider trades very closely in an attempt to punish
those that violate the law. For example, the former
wife of a partner in the auditing firm Deloitte & Touche was recently sentenced
to 11 months exploiting inside information extracted from him about her
husband's clients. He apparently did was not aware she was using this inside
information illegally.
In another recent case, hedge fund manager Raj Rajaratnam was sentenced to 11
years for insider trading.
Even more commonly traders who are damaged by insiders typically win enormous
lawsuits later on for themselves and their attorneys, including enormous
punitive damages. You can read more about insider trading at
http://en.wikipedia.org/wiki/Insider_trading
Corporate executives like Bill Gates often announce future buying and selling
of shares of their companies years in advance to avoid even a hint of scandal
about exploiting current insider information that arises in the meantime. More
resources of the SEC are spent in tracking possible insider information trades
than any other activity of the SEC. Efforts are made to track trades of
executive family and friends and whistle blowing is generously rewarded.
Question
Trading on insider information is against U.S. law for every segment of society
except for one privileged segment that legally exploits investors for personal
gains by trading on insider information. What is that privileged segment of
U.S. society legally trades on inside information for personal gains?
Hints:
Congress is our only native criminal class.
Mark Twain ---
http://en.wikipedia.org/wiki/Mark_Twain
We hang the petty thieves and appoint the great ones to public office.
Attributed to Aesop
Answer (Please share this with your students):
Over the years I've been a loyal viewer of the top news show on television ---
CBS Sixty Minutes
On November 13, 2011 the show entitled "Insider"
is the most depressing segment I've ever watched on television ---
http://www.cbsnews.com/video/watch/?id=7387951n&tag=contentMain;contentBody#ixzz1dfeq66Ok
Also see
http://financeprofessorblog.blogspot.com/2011/11/congress-trading-stock-on-inside.html
Jensen Comment
- It came as no surprise that many (most?) members of the U.S. House of
Representatives and the U.S. Senate that writes the laws of the land made it
illegal for to trade in financial and real estate market by profiting
personally on insider information not yet available, including pending
legislation that they will decide, wrote themselves out of the law making
it legal for them to personally profit from trading on insider information.
What came as a surprise is how leaders at the very top of Congress make
millions trading on inside information with impunity and well as immunity.
- The Congressional leader that comes off the worst in this Sixty
Minutes "Insider" segment is former House Speaker and current Minority
leader
Nancy Pelosi.
When confronted with specific facts on how she and her husband made some of
their insider trading millions she fired back at reporter Steve Kroft with
an evil glint saying what is tantamount to: "How dare you question me
about insider trades that are perfectly legal for members of Congress. Who
are you to question my ethics about exploiting our insider trading
privileges. Back off Steve or else!" Her manner can be extremely scary.
Other Democratic Party members of Congress come off almost as bad in terms
of insider trading for personal gain.
- Current Speaker of the House,
John
Boehner, is more subtle. He denies making any of his personal portfolio
investment decisions and denies communicating with the person he hires to
make such decision. However, that trust investor mysteriously makes money
for Rep. Boehner using insider information obtained mysteriously. Other
Republican members of Congress some off even worse in terms of insider
trading.
- Members of Congress on powerful committees regularly make insider
profits on legislation currently being written into the law that is still
being held secret from the public. One of my heroes, former Senator
Judd Gregg,
is no longer my hero.
- Everybody knows that influence peddling in Congress by lobbyists, many
of them being former members of Congress, is a dirty business of showering
gifts on current members of Congress. What is made clear, however, is that
these lobbyists are personally getting something in return from friendly
members of Congress who pass along insider information to lobbyists. The
lobbyists, in turn, peddle this insider information back to the private
sector, such as hedge fund managers, for a commission. Moral of story:
Voters do not stop insider trading by a member of Congress by voting him
or her out of office if they become peddlers of insider information
obtained, as lobbyists, from their old friends still in the Congress.
- Five out of 435 members of the House of Representatives are seeking to
sponsor a bill to make it illegal for representatives and senators to profit
from trading on inside information. The Sixty Minutes show demonstrates how
Nancy Pelosi, John Boehner, and other House leaders have buried that effort
so deep in the bowels of the legislative process that there's no chance in
hell of stopping insider trading by members of Congress. Insider trading is
a privilege that attracts unethical people to run for Congress.
Watch the "Insider" Video Now While
It's Still Free ---
http://www.cbsnews.com/video/watch/?id=7387951n&tag=contentMain;contentBody
"They have legislated themselves as untouchable as a
political class . . . "
"The Wonk (Professor) Who Slays Washington," by Peter J. Boyer,
Newsweek Magazine, November 21, 2011, pp. 32-37 ---
http://www.thedailybeast.com/newsweek/2011/11/13/peter-schweizer-s-new-book-blasts-congressional-corruption.html
In the Spring of 2010, a bespectacled, middle-aged
policy wonk named Peter Schweizer fired up his laptop and began a
months-long odyssey into a forbidding maze of public databases, hunting for
the financial secrets of Washington’s most powerful politicians. Schweizer
had been struck by the fact that members of Congress are free to buy and
sell stocks in companies whose fate can be profoundly influenced, or even
determined, by Washington policy, and he wondered, do these ultimate
insiders act on what they know? Yes, Schweizer found, they certainly seem
to. Schweizer’s research revealed that some of Congress’s most prominent
members are in a position to routinely engage in what amounts to a legal
form of insider trading, profiting from investment activity that, he says,
“would send the rest of us to prison.”
Schweizer, who is 47, lives
in Tallahassee with his wife and children (“New York or D.C. would be
too distracting—I’d never get any writing done”) and commutes regularly
to Stanford, where he is the William J. Casey research fellow at the
Hoover Institution. His circle of friends includes some bare-knuckle
combatants in the partisan frays (such as conservative media impresario
Andrew Breitbart), but Schweizer himself comes across more as a bookish
researcher than the right-wing hit man liberal critics see. Indeed, he
sounds somewhat surprised, if gratified, to have attracted attention
with his findings. “To me, it’s troubling that a fellow at Stanford who
lives in Florida had to dig this up.”
It was in his Tallahassee
office that Schweizer began what he thought was a promising research
project: combing through congressional financial-disclosure records
dating back to 2000 to see what kinds of investments legislators were
making. He quickly learned that Capitol Hill has quite a few market
players. He narrowed his search to a dozen or so members—the leaders of
both houses, as well as members of key committees—and focused on trades
that coincided with big policy initiatives of the sort that could move
markets.
While examining trades made
around the time of the 2003 Medicare overhaul, Schweizer experienced what he
calls his “Holy crap!” moment. The legislation, which created a new
prescription-drug entitlement, promised to be a huge boon to the
pharmaceutical industry—and to savvy investors in the Capitol. Among those
with special insight on the issue was Massachusetts Sen. John Kerry,
chairman of the health subcommittee of the Senate’s powerful Finance
Committee. Kerry is one of the wealthiest members of the Senate and heavily
invested in the stock market. As the final version of the drug program
neared approval—one that didn’t include limits on the price of drugs—brokers
for Kerry and his wife were busy trading in Big Pharma. Schweizer found that
they completed 111 stock transactions of pharmaceutical companies in 2003,
103 of which were buys.
“They were all great picks,”
Schweizer notes. The Kerrys’ capital gains on the transactions were at least
$500,000, and as high as $2 million (such information is necessarily
imprecise, as the disclosure rules allow members to report their gains in
wide ranges). It was instructive to Schweizer that Kerry didn’t try to shape
legislation to benefit his portfolio; the apparent key to success was the
shaping of trades that anticipated the effect of government policy.
Continued in article
Jensen Questions
If all these transactions were only by chance profitable, why is it that the
representatives, senators, and their trust investors always profited and never
lost in dealings connected to inside information?
More importantly why did representatives and senators who write the laws
have to write themselves in as exempt from insider trading laws?
Why aren't national leaders like Nancy Pelosi, John Kerry, and John
Boehner who vigorously deny inside trading actively seeking to overturn laws
that exempt representatives and senators from insider trading lawsuits? Why do
they still hold themselves above their own law?
Why have representatives and senators buried reform legislation concerning
their insider trading exemption so deep in the legislative process that there's
zero hop of reforming themselves against abuses of insider trading and
exploitation of other investors?
Watch the "Insider" Video Now While
It's Still Free ---
http://www.cbsnews.com/video/watch/?id=7387951n&tag=contentMain;contentBody
THIS IS HOW YOU FIX CONGRESS!!!!!
If you agree with the above, pass it on.
Warren Buffett, in a recent interview with CNBC, offers one of the best
quotes about the debt ceiling:"I could end the deficit in 5 minutes," he
told CNBC. "You just pass a law that says that anytime there is a deficit of
more than 3% of GDP, all sitting members of Congress are ineligible for
re-election. The 26th amendment (granting the right to vote for 18
year-olds) took only 3 months & 8 days to be ratified! Why? Simple! The
people demanded it. That was in1971...before computers, e-mail, cell phones,
etc. Of the 27 amendments to the Constitution, seven (7) took 1 year or less
to become the law of the land...all because of public pressure.Warren Buffet
is asking each addressee to forward this email to a minimum oftwenty people
on their address list; in turn ask each of those to do likewise. In three
days, most people in The United States of America will have the message.
This is one idea that really should be passed around.*Congressional Reform
Act of 2011......
1. No Tenure / No Pension. A Congressman collects a salary while in office
and receives no pay when they are out of office.
2.. Congress (past, present & future) participates in Social Security. All
funds in the Congressional retirement fund move to the Social Security
system immediately. All future funds flow into the Social Security
system,and Congress participates with the American people. It may not be
used for any other purpose..
3. Congress can purchase their own retirement plan, just as all Americans
do...
4. Congress will no longer vote themselves a pay raise. Congressional pay
will rise by the lower of CPI or 3%.
5. Congress loses their current health care insurance and participates in
the same health care plan as the American people.
6. Congress must equally abide by all laws they impose on the American
people..
7. All contracts with past and present Congressmen are void effective
1/1/12. The American people did not make this contract with Congressmen.
Congressmen made all these contracts for themselves. Serving in Congress is
an honor,not a career. The Founding Fathers envisioned citizen legislators,
so ours should serve their term(s), then go home and back to work.
If each person contacts a minimum of twenty people then it will only take
three days for most people (in the U.S.) to receive the message. Maybe it is
time.
PLEASE PASS THIS ON
Holman Jenkins of The Wall Street Journal contends that in total
representatives and senators do not perform better (possibly even worse) than
average investors in the stock market ---
http://online.wsj.com/article/SB10001424052970204190504577039834018364566.html?mod=djemEditorialPage_t
What he does not mention is that opportunities to trade on inside information is
generally infrequent and often limited to a few members of a particular
legislative committee receiving insider testimony or preparing to release
committee recommendations to the legislature.
Jenkins misses the entire point of insider trading. If it was a daily event
in the public or private sector it would be squashed even harder than it is now
being squashed, because rampant insider trading would drive the public away from
the financial and real estate markets. The trading markets survive this cancer
because it is relatively infrequent when it does take place among corporate
executives (illegally) or our legislators (legally).
Feeling
cynical?
They say that patriotism is the last refuge
To which a scoundrel clings.
Steal a little and they throw you in jail,
Steal a lot and they make you king.
There's only one step down from here, baby,
It's called the land of permanent bliss.
What's a sweetheart like you doin' in a dump like this?
Lyrics of a Bob Dylan song forwarded by Amian Gadal
[DGADAL@CI.SANTA-BARBARA.CA.US] |
If the law passes in its current form, insider
trading by Congress will not become illegal.
"Congress's Phony Insider-Trading Reform: The denizens of Capitol Hill
are remarkable investors. A new law meant to curb abuses would only make their
shenanigans easier," by Jonathan Macey, The Wall Street Journal,
December 13, 2011 ---
http://online.wsj.com/article/SB10001424052970203413304577088881987346976.html?mod=djemEditorialPage_t
Members of Congress already get better health
insurance and retirement benefits than other Americans. They are about to
get better insider trading laws as well.
Several academic studies show that the investment
portfolios of congressmen and senators consistently outperform stock indices
like the Dow and the S&P 500, as well as the portfolios of virtually all
professional investors. Congressmen do better to an extent that is
statistically significant, according to studies including a 2004 article
about "abnormal" Senate returns by Alan J. Ziobrowski, Ping Cheng, James W.
Boyd and Brigitte J. Ziobrowski in the Journal of Financial and Qualitative
Analysis. The authors published a similar study of the House this year.
Democrats' portfolios outperform the market by a
whopping 9%. Republicans do well, though not quite as well. And the trading
is widespread, although a higher percentage of senators than representatives
trade—which is not surprising because senators outperform the market by an
astonishing 12% on an annual basis.
These results are not due to luck or the financial
acumen of elected officials. They can be explained only by insider trading
based on the nonpublic information that politicians obtain in the course of
their official duties.
Strangely, while insider trading by corporate
insiders has long been the white collar crime equivalent of a major felony,
the Securities and Exchange Commission has determined that insider trading
laws do not apply to members of Congress or their staff. That is because,
according to the SEC at least, these public officials do not owe the same
legal duty of confidentiality that makes insider trading illegal by
nonpoliticians.
The embarrassing inconsistency was ignored for
years. All of this changed on Nov. 13, 2011, after insider trading on
Capitol Hill was the focus of CBS's "60 Minutes." The previously moribund
"Stop Trading on Congressional Knowledge Act" (H.R. 1148), first introduced
in 2006, was pulled off the shelf and reintroduced. The bill suddenly had
more than 140 sponsors, up from a mere nine before the show.
The "Stock" Act, as it is called, would make it
illegal for members of Congress and staff to buy or sell securities based on
certain nonpublic information. It would toughen disclosure obligations by
requiring congressmen and their staffers to report securities trades of more
than $1,000 to the clerk of the House (or the secretary of the Senate)
within 90 days. And it would bring the new cottage industry in Washington,
the so-called political intelligence consultants used by hedge funds, under
the same rules that govern lobbyists. These political intelligence
consultants are hired by professional investors to pry information out of
Congress and staffers to guide trading decisions.
Publicly, House members echo bill sponsor Rep.
Louise Slaughter (D., N.Y) in saying things like: "We want to remove any
current ambiguity" about whether insider trading rules apply to Congress. Or
as co-sponsor Rep. Timothy Walz (D., Minn.) put it: "We are trying to set
the bar higher for members of Congress."
On closer examination, it appears that what
Congress really wants is to keep making the big bucks that come from trading
on inside information but to trick those outside of the Beltway into
believing they are doing something about this corruption. For one thing, the
rules proposed for Capitol Hill are not like those that apply to the rest of
us. Ours are so broad and vague that prosecutors enjoy almost unfettered
discretion in deciding when and whom to prosecute.
Congress's rules would be clear and precise. And
not too broad; in fact they are too narrow. For example, the proposed rules
in the Stock bill are directed only at information related to pending
legislation. It would appear that inside information obtained by a
congressman during a regulatory briefing, or in another context unrelated to
pending legislation, would not be covered.
At a Dec. 6 House hearing, SEC enforcement chief
Robert Khuzami opined that any new rules for Congress should not apply to
ordinary citizens. He worried that legislators might "narrow current law and
thereby make it more difficult to bring future insider trading actions
against individuals outside of Congress."
This don't-rock-the-boat approach serves the
interests of the SEC because it maximizes the commission's power and
discretion, but it's not the best approach. The sensible thing to do would
be to rationalize the rules by creating a clear definition of what
constitutes insider trading, and then apply those rules to everyone on and
outside Capitol Hill.
If the law passes in its current form, insider
trading by Congress will not become illegal. I predict such trading will
increase because the rules of the game will be clearer. Most significantly,
the rule proposed for Congress would not involve the same murky inquiry into
whether a trader owed or breached a "fiduciary duty" to the source of the
information that required that he refrain from trading.
Continued in article
Bob Jensen's threads on Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Can You Train Business School Students To Be Ethical?
The way we’re doing it now doesn’t work. We need a new way
Question
What is the main temptation of white collar criminals?
Answer from
http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm#01
Jane Bryant Quinn once said something to the effect that, when corporate
executives and bankers see billions of loose dollars swirling above there heads,
it's just too tempting to hold up both hands and pocket a few millions,
especially when colleagues around them have their hands in the air. I tell my
students that it's possible to buy an "A" grade in my courses but none of them
can possibly afford it. The point is that, being human, most of us are
vulnerable to some temptations in a weak moment. Fortunately, none of you
reading this have oak barrels of highly-aged whiskey in your cellars, the
world's most beautiful women/men lined up outside your bedroom door, and
billions of loose dollars swirling about like autumn leaves in a tornado.
Most corporate criminals that regret their actions later confess that the
temptations went beyond what they could resist. What amazes me in this era,
however, is how they want to steal more and more after they already have $100
million stashed. Why do they want more than they could possibly need?
"Can You Train Business School Students To Be Ethical? The way we’re doing
it now doesn’t work. We need a new way," by Ray Fisman and Adam Galinsky,
Slate, September 4, 2012 ---
http://www.slate.com/articles/business/the_dismal_science/2012/09/business_school_and_ethics_can_we_train_mbas_to_do_the_right_thing_.html
A few years ago,
Israeli game theorist
Ariel Rubinstein got the idea of examining how
the tools of economic science affected the judgment and empathy of his
undergraduate students at Tel Aviv University. He made each student the
CEO of a struggling hypothetical company, and tasked them with deciding
how many employees to lay off. Some students were given an algebraic
equation that expressed profits as a function of the number of employees
on the payroll. Others were given a table listing the number of
employees in one column and corresponding profits in the other. Simply
presenting the layoff/profits data in a different format had a
surprisingly strong effect on students’ choices—fewer than half of the
“table” students chose to fire as many workers as was necessary to
maximize profits, whereas three quarters of the “equation” students
chose the profit-maximizing level of pink slips. Why? The “equation”
group simply “solved” the company’s problem of profit maximization,
without thinking about the consequences for the employees they were
firing.
Rubinstein’s
classroom experiment serves as one lesson in the pitfalls of the
scientific method: It often seems to distract us from considering the
full implications of our calculations. The point isn’t that it’s
necessarily immoral to fire an employee—Milton Friedman famously
claimed that the
sole purpose of a company is indeed to maximize profits—but
rather that the students who were encouraged to think of the decision to
fire someone as an algebra problem didn’t seem to think about the
employees at all.
The experiment is
indicative of the challenge faced by business schools, which devote
themselves to teaching management as a science, without always
acknowledging that every business decision has societal repercussions. A
new generation of psychologists is now thinking about how to create
ethical leaders in business and in other professions, based on the
notion that good people often do bad things unconsciously. It may
transform not just education in the professions, but the way we think
about encouraging people to do the right thing in general.
At present, the
ethics curriculum at business schools can best be described as an
unsuccessful work-in-progress. It’s not that business schools are
turning Mother Teresas into
Jeffrey Skillings (Harvard Business School,
class of ’79),
despite some claims to that effect. It’s easy
to come up with examples of rogue MBA graduates who have lied, cheated,
and stolen their ways to fortunes (recently convicted
Raj Rajaratnam is a graduate of the University
of Pennsylvania’s Wharton School of Business; his partner in crime,
Rajat Gupta, is a
Harvard Business School alum). But a huge number of companies are run by
business school grads, and for every Gupta and Rajaratnam there are
scores of others who run their companies in perfectly legal anonymity.
And of course, there are the many ethical missteps by non-MBA business
leaders—Bernie Madoff was educated as a lawyer; Enron’s Ken Lay had a
Ph.D. in economics.
In actuality,
the picture suggested by the data is that
business schools have no impact whatsoever on the likelihood that
someone will cook the books or otherwise commit fraud. MBA programs are
thus damned by faint praise: “We do not turn our students into
criminals,” would hardly make for an effective recruiting slogan.
If it’s too much to expect
MBA programs to turn out Mother Teresas, is there anything that business
schools can do to make tomorrow’s business leaders more likely
to do the right thing? If so, it’s probably not by trying to teach them
right from wrong—moral epiphanies are a scarce commodity by age 25, when
most students start enrolling in MBA programs. Yet this is how business
schools have taught ethics for most of their histories. They’ve often
quarantined ethics into the beginning or end of the MBA education. When
Ray began his MBA classes at Harvard Business School in 1994, the ethics
course took place before the instruction in the “science of management”
in disciplines like statistics, accounting, and marketing. The idea was
to provide an ethical foundation that would allow students to integrate
the information and lessons from the practical courses with a broader
societal perspective. Students in these classes read philosophical
treatises, tackle moral dilemmas, and study moral exemplars such as
Johnson & Johnson CEO James Burke, who took responsibility for and
provided a quick response to the series of deaths from tampered Tylenol
pills in the 1980s.
It’s a mistake to assume
that MBA students only seek to maximize profits—there may be eye-rolling
at some of the content of ethics curricula, but not at the idea that
ethics has a place in business. Yet once the pre-term ethics instruction
is out of the way, it is forgotten, replaced by more tangible and easier
to grasp matters like balance sheets and factory design. Students get
too distracted by the numbers to think very much about the social
reverberations—and in some cases legal consequences—of employing
accounting conventions to minimize tax burden or firing workers in the
process of reorganizing the factory floor.
Business schools are
starting to recognize that ethics can’t be cordoned off from the rest of
a business student’s education. The most promising approach, in our
view, doesn’t even try to give students a deeper personal sense of
mission or social purpose – it’s likely that no amount of indoctrination
could have kept Jeff Skilling from blowing up Enron. Instead, it helps
students to appreciate the unconscious ethical lapses that we commit
every day without even realizing it and to think about how to minimize
them. If finance and marketing can be taught as a science, then perhaps
so too can ethics.
These ethical
failures don’t occur at random – countless experiments in psychology and
economics labs and out in the world have documented the circumstances
that make us most likely to ignore moral concerns – what social
psychologists Max Bazerman and Ann Tenbrusel call our moral
blind spots. These result from numerous
biases that exacerbate the sort of distraction from ethical consequences
illustrated by the Rubinstein experiment. A classic
sequence of studies illustrate how readily
these blind spots can occur in something as seemingly straightforward as
flipping a fair coin to determine rewards. Imagine that you are in
charge of splitting a pair of tasks between yourself and another person.
One job is fun and with a potential payoff of $30; the other tedious and
without financial reward. Presumably, you’d agree that flipping a coin
is a fair way of deciding—most subjects do. However, when sent off to
flip the coin in private, about 90 percent of subjects come back
claiming that their coin flip came up assigning them to the fun task,
rather than the 50 percent that one would expect with a fair coin. Some
people end up ignoring the coin; more interestingly, others respond to
an unfavorable first flip by seeing it as “just practice” or deciding to
make it two out of three. That is, they find a way of temporarily
adjusting their sense of fairness to obtain a favorable outcome.
Jensen Comment
I've always thought that the most important factors affecting ethics were early
home life (past) and behavior others in the work place (current). I'm a believer
in relative ethics where bad behavior is affected by need (such as being swamped
in debt) and opportunity (weak internal controls at work). I've never been
a believer in the effectiveness of teaching ethics in college, although this is
no reason not to teach ethics in college. It's just that the ethics mindset was
deeply affected before coming to college (e.g. being street smart in high
school) and after coming to college (where pressures and temptations to cheat
become realities).
An example of the follow-the-herd ethics mentality.
If Coach C of the New Orleans Saints NFL football team offered Player X serious
money to intentionally and permanently injure Quarterback Q of an opposing team,
Player X might've refused until he witnessed Players W, Y, and Z being paid to
do the same thing. I think this is exactly what happened when several
players on the defensive team of the New Orleans Saints intentionally injured
quarterbacks for money.
New Orleans Saints bounty scandal ---
http://en.wikipedia.org/wiki/New_Orleans_Saints_bounty_scandal
Question
What is the main temptation of white collar criminals?
Answer from
http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm#01
Jane Bryant Quinn once said something to the effect that, when corporate
executives and bankers see billions of loose dollars swirling above there heads,
it's just too tempting to hold up both hands and pocket a few millions,
especially when colleagues around them have their hands in the air. I tell my
students that it's possible to buy an "A" grade in my courses but none of them
can possibly afford it. The point is that, being human, most of us are
vulnerable to some temptations in a weak moment. Fortunately, none of you
reading this have oak barrels of highly-aged whiskey in your cellars, the
world's most beautiful women/men lined up outside your bedroom door, and
billions of loose dollars swirling about like autumn leaves in a tornado.
Most corporate criminals that regret their actions later confess that the
temptations went beyond what they could resist. What amazes me in this era,
however, is how they want to steal more and more after they already have $100
million stashed. Why do they want more than they could possibly need?
See Bob Jensen's "Rotten to the Core" document at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
The exact quotation from Jane Bryant Quinn at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#MutualFunds
Why white collar crime pays big time even if you know you will eventually
be caught ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
Bob Jensen's threads on professionalism and ethics ---
http://faculty.trinity.edu/rjensen/Fraud001c.htm
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
September 5, 2012 reply from Paul Williams
Bob,
This is the wrong question because business schools
across all disciplines contained therein are trapped in the intellectual box
of "methodological individualism." In every business discipline we take as a
given that the "business" is not a construction of human law and, thus of
human foible, but is a construction of nature that can be reduced to the
actions of individual persons. Vivian Walsh (Rationality Allocation, and
Reproduction) critiques the neoclassical economic premise that agent =
person. Thus far we have failed in our reductionist enterprise to reduce the
corporation to the actions of other entities -- persons (in spite of
principal/agent theorists claims). Ontologically corporations don't exist --
the world is comprised only of individual human beings. But a classic study
of the corporation (Diane Rothbard Margolis, The Managers: Corporate Life in
America) shows the conflicted nature of people embedded in a corporate
environment where the values they must subscribe to in their jobs are at
variance with their values as independent persons. The corporate "being" has
values of its own. Business school faculty, particularly accountics
"scientists," commit the same error as the neoclassical economists, which
Walsh describes thusly:
"...if neo-classical theory is to invest its
concept of rational agent with the penumbra of moral seriousness derivable
from links to the Scottish moral philosophers and, beyond them, to the
concept of rationality which forms part of the conceptual scheme underlying
our ordinary language, then it must finally abandon its claim to be a
'value-free` science in the sense of logical empiricism (p. 15)." Business,
as an intellectual enterprise conducted within business schools, neglects
entirely "ethics" as a serious topic of study and as a problem of
institutional design. It is only a problem of unethical persons (which, at
sometime or another, includes every human being on earth). If one takes
seriously the Kantian proposition that, to be rationally ethical beings,
humans must conduct themselves so as to treat always other humans not merely
as means, but also always as ends in themselves, then business organization
is, by design, unethical. Thus, when the Israeli students had to confront
employees "face-to-face" rather than as variables in a profit equation, it
was much harder for them to treat those employees as simply disposable means
to an end for a being that is merely a legal fiction. One thing we simply do
not treat seriously enough as a worthy intellectual activity is the serious
scrutiny of the values that lay conveniently hidden beneath the equations we
produce. What thoughtful person could possibly subscribe to the notion that
the purpose of life is to relentlessly increase shareholder wealth?
Increasing shareholder value is a value judgment, pure and simple. And it
may not be a particularly good one. Why would we be surprised that some
individuals conclude that "stealing" from them (they, like the employees
without names in the employment experiment, are ciphers) is not something
that one need be wracked with guilt about. If the best we can do is prattle
endlessly on about the "tone at the top" (do people who take ethics
seriously get to the top?), then the intellectual seriousness which ethics
is afforded within business schools is extremely low. Until we start to
appreciate that the business narrative is essentially an ethical one, not a
technical one, then we will continue to rue the bad apples and ignore how we
might built a better barrel.
Paul
September 5, 2012 reply from Bob Jensen
Hi Paul,
Do you think the ethics in government is in better shape, especially given
the much longer and more widespread history of global government corruption
throughout time? I don't think ethics in government is better than ethics in
business from a historical perspective or a current perspective where
business manipulates government toward its own ends with bribes, campaign
contributions, and promises of windfall enormous job benefits for government
officials who retire and join industry?
Government corruption is the name of the game in nearly all nations,
beginning with Russia, China, Africa, South America, and down the list.
Political corruption in the U.S. is relatively low from a global
perspective.
See the attached graph from
http://en.wikipedia.org/wiki/Corruption_%28political%29
Respectfully,
Bob Jensen
Question
How does capitalism possibly reduce as well as increase corruption in
government?
Answer
I think it's because some of the more onerous types of governmental corruption,
particularly outright bribery and extortion, are enormous frictions on having
capitalism succeed.. If capitalism is to work at all, some of the most onerous
types of political corruption have to be greatly reduced. Russian never realized
this, and hence Russia remains one of the most violently corrupt and least
successful "capitalist" nations on the planet.
"Mohammed Ibrahim: The Philanthropist of Honest Government Africa's
cellphone billionaire, Mohammed Ibrahim, is offering a rich payoff for African
leaders who don't take payoffs. He says it'll do for development what foreign
aid never has," The Wall Street Journal, September 7, 2012 ---
http://professional.wsj.com/article/SB10000872396390444318104577587641175010510.html?mod=djemEditorialPage_t&mg=reno64-wsj
Jensen Comment
What struck me in the above how political corruption tends to be lower in many
nations that rely more on capitalism and market distributions. Note in
particular the tiny blue strip of Chile in that map. At one time Chile was one
of the most corrupt nations of the world. Then some students of the Chicago
School are given credit for making Chile literally the most capitalist nation in
South America as well as the world in general (of course not without lingering
inequality problems).- ---
http://en.wikipedia.org/wiki/Chicago_Boys
Chile has the best credit standing in Latin America.
Also note how non-capitalist nations that are wealthy in resources such as
Russia, Saudi Arabia, and Veneszuela are the most corrupt in the world.
The real test over the next 50 years will be China. China is a very corrupt
nation, especially at the local levels of government. It will be interesting to
see if the continued rise in capitalism can work a miracle somewhat like that in
Chile ---
http://en.wikipedia.org/wiki/Chile#Economic_policies
This does not tell college graduates something that they don't already know:
Temporary and Low Wages
"Majority of New Jobs Pay Low Wages, Study Finds," by Catherine Rampell,
The New York Times, August 30, 2012 ---
http://www.nytimes.com/2012/08/31/business/majority-of-new-jobs-pay-low-wages-study-finds.html?_r=1
While a majority of jobs lost during the downturn
were in the middle range of wages, a majority of those added during the
recovery have been low paying, according to a new report from the National
Employment Law Project.
The disappearance of midwage, midskill jobs is part
of a longer-term trend that some refer to as a hollowing out of the work
force, though it has probably been accelerated by government layoffs.
“The overarching message here is we don’t just have
a jobs deficit; we have a ‘good jobs’ deficit,” said Annette Bernhardt, the
report’s author and a policy co-director at the National Employment Law
Project, a liberal research and advocacy group.
The report looked at 366 occupations tracked by the
Labor Department and clumped them into three equal groups by wage, with each
representing a third of American employment in 2008. The middle third —
occupations in fields like construction, manufacturing and information, with
median hourly wages of $13.84 to $21.13 — accounted for 60 percent of job
losses from the beginning of 2008 to early 2010.
The job market has turned around since then, but
those fields have represented only 22 percent of total job growth.
Higher-wage occupations — those with a median wage of $21.14 to $54.55 —
represented 19 percent of job losses when employment was falling, and 20
percent of job gains when employment began growing again.
Lower-wage occupations, with median hourly wages of
$7.69 to $13.83, accounted for 21 percent of job losses during the
retraction.
Continued in article
"Charles G. Koch: Corporate Cronyism Harms America:
When businesses feed at the federal trough, they threaten public support for
business and free markets," by Charles G. Koch, The Wall Street Journal,
September 9, 2012 ---
http://professional.wsj.com/article/SB10000872396390443847404577629841476562610.html?mod=djemEditorialPage_t&mg=reno-wsj
"We didn't build this business—somebody else did."
So reads a sign outside a small roadside craft
store in Utah. The message is clearly tongue-in-cheek. But if it hung next
to the corporate offices of some of our nation's big financial institutions
or auto makers, there would be no irony in the message at all.
It shouldn't surprise us that the role of American
business is increasingly vilified or viewed with skepticism. In a Rasmussen
poll conducted this year, 68% of voters said they "believe government and
big business work together against the rest of us."
Businesses have failed to make the case that
government policy—not business greed—has caused many of our current
problems. To understand the dreadful condition of our economy, look no
further than mandates such as the Fannie Mae and Freddie Mac "affordable
housing" quotas, directives such as the Community Reinvestment Act, and the
Federal Reserve's artificial, below-market interest-rate policy.
Far too many businesses have been all too eager to
lobby for maintaining and increasing subsidies and mandates paid by
taxpayers and consumers. This growing partnership between business and
government is a destructive force, undermining not just our economy and our
political system, but the very foundations of our culture.
With partisan rhetoric on the rise this election
season, it's important to remind ourselves of what the role of business in a
free society really is—and even more important, what it is not.
The role of business is to provide products and
services that make people's lives better—while using fewer resources—and to
act lawfully and with integrity. Businesses that do this through voluntary
exchanges not only benefit through increased profits, they bring better and
more competitively priced goods and services to market. This creates a
win-win situation for customers and companies alike.
Only societies with a system of economic freedom
create widespread prosperity. Studies show that the poorest people in the
most-free societies are 10 times better off than the poorest in the
least-free. Free societies also bring about greatly improved outcomes in
life expectancy, literacy, health, the environment and other important
dimensions.
So why isn't economic freedom the "default setting"
for our economy? What upsets this productive state of affairs? Trouble
begins whenever businesses take their eyes off the needs and wants of
consumers—and instead cast longing glances on government and the favors it
can bestow. When currying favor with Washington is seen as a much easier way
to make money, businesses inevitably begin to compete with rivals in
securing government largess, rather than in winning customers.
We have a term for this kind of collusion between
business and government. It used to be known as rent-seeking. Now we call it
cronyism. Rampant cronyism threatens the economic foundations that have made
this the most prosperous country in the world.
We are on dangerous terrain when government picks
winners and losers in the economy by subsidizing favored products and
industries. There are now businesses and entire industries that exist solely
as a result of federal patronage. Profiting from government instead of
earning profits in the economy, such businesses can continue to succeed even
if they are squandering resources and making products that people wouldn't
ordinarily buy.
Because they have the advantage of an uneven
playing field, crony businesses can drive their legitimate competitors out
of business. But in the longer run, they are unsustainable and unable to
compete internationally (unless, of course, the government handouts are big
enough). At least the Solyndra boondoggle ended when it went out of
business.
By subsidizing and mandating politically favored
products in the energy sector (solar, wind and biofuels, some of which
benefit Koch Industries), the government is pushing up energy prices for all
of us—five times as much in the case of wind-generated electricity. And by
putting resources to less-efficient use, cronyism actually kills jobs rather
than creating them. Put simply, cronyism is remaking American business to be
more like government. It is taking our most productive sectors and making
them some of our least.
The effects on government are equally
distorting—and corrupting. Instead of protecting our liberty and property,
government officials are determining where to send resources based on the
political influence of their cronies. In the process, government gains even
more power and the ranks of bureaucrats continue to swell.
Subsidies and mandates are just two of the
privileges that government can bestow on politically connected friends.
Others include grants, loans, tax credits, favorable regulations, bailouts,
loan guarantees, targeted tax breaks and no-bid contracts. Government can
also grant monopoly status, barriers to entry and protection from foreign
competition.
Whatever form these privileges take, Americans are
rightly suspicious of the cronyism that substitutes political influence for
free markets. According to Rasmussen, two-thirds of the electorate are
convinced that crony connections explain most government contracts—and that
federal money will be wasted "if the government provides funding for a
project that private investors refuse to back." Some 71% think "private
sector companies and investors are better than government officials at
determining the long-term benefits and potential of new technologies." Only
11% believe "government officials have a better eye for future value."
Continued in article
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Video: Fora.Tv on Institutional Corruption & The Economy Of Influence
---
http://www.simoleonsense.com/video-foratv-on-institutional-corruption-the-economy-of-influence/
Why single out capitalism for immorality and ethics misbehavior?
Making capitalism ethical is a tough task – and
possibly a hopeless one.
Prem Sikka (see below)
The
global code of conduct of Ernst & Young, another
global accountancy firm, claims that "no client or external relationship is
more important than the ethics, integrity and reputation of Ernst & Young".
Partners and former partners of the firm have also been found
guilty of promoting tax evasion.
Prem Sikka (see below)
Jensen Comment
Yeah right Prem, as if making the public sector and socialism ethical is an
easier task. The least ethical nations where bribery, crime, and immorality are
the worst are likely to be the more government (dictator) controlled and lower
on the capitalism scale. And in the so-called capitalist nations, the lowest
ethics are more apt to be found in the public sector that works hand in hand
with bribes from large and small businesses.
Rotten Fraud in General ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Rotten Fraud in the Public Sector (The Most Criminal Class Writes the Laws) ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#Lawmakers
We hang the petty thieves and appoint the great ones to public office.
Aesop
Congress is our only native criminal class.
Mark Twain ---
http://en.wikipedia.org/wiki/Mark_Twain
Why should
members of Congress be allowed to profit from insider trading?
Amid broad congressional concern about ethics scandals, some lawmakers are
poised to expand the battle for reform: They want to enact legislation that
would prohibit members of Congress and their aides from trading stocks based on
nonpublic information gathered on Capitol Hill. Two Democrat lawmakers plan to
introduce today a bill that would block trading on such inside information.
Current securities law and congressional ethics rules don't prohibit lawmakers
or their staff members from buying and selling securities based on information
learned in the halls of Congress.
Brody Mullins, "Bill Seeks to Ban Insider Trading By Lawmakers and Their Aides,"
The Wall Street Journal, March 28, 2006; Page A1 ---
http://online.wsj.com/article/SB114351554851509761.html?mod=todays_us_page_one
The
Culture of Corruption Runs Deep and Wide in Both U.S. Political Parties: Few if
any are uncorrupted
Committee members have shown no appetite for
taking up all those cases and are considering an amnesty for reporting
violations, although not for serious matters such as accepting a trip from a
lobbyist, which House rules forbid. The data firm PoliticalMoneyLine calculates
that members of Congress have received more than $18 million in travel from
private organizations in the past five years, with Democrats taking 3,458 trips
and Republicans taking 2,666. . . But of course, there are those who deem the
American People dumb as stones and will approach this bi-partisan scandal
accordingly. Enter Democrat Leader Nancy Pelosi, complete with talking points
for her minion, that are sure to come back and bite her .... “House Minority
Leader Nancy Pelosi (D-Calif.) filed delinquent reports Friday for three trips
she accepted from outside sponsors that were worth $8,580 and occurred as long
as seven years ago, according to copies of the documents.
Bob Parks, "Will Nancy Pelosi's Words Come Back to Bite Her?" The National
Ledger, January 6, 2006 ---
http://www.nationalledger.com/artman/publish/article_27262498.shtml
And when
they aren't stealing directly, lawmakers are caving in to lobbying crooks
Drivers can send their thank-you notes to Capitol
Hill, which created the conditions for this mess last summer with its latest
energy bill. That legislation contained a sop to Midwest corn farmers in the
form of a huge new ethanol mandate that began this year and requires drivers to
consume 7.5 billion gallons a year by 2012. At the same time, Congress refused
to include liability protection for producers of MTBE, a rival oxygen
fuel-additive that has become a tort lawyer target. So MTBE makers are pulling
out, ethanol makers can't make up the difference quickly enough, and gas
supplies are getting squeezed.
"The Gasoline Follies," The Wall Street Journal, March 28, 2006; Page
A20 ---
Click Here
Once again, the power of pork to sustain incumbents gets its best demonstration
in the person of John Murtha (D-PA). The acknowledged king of earmarks in the
House gains the attention of the New York Times editorial board today, which
notes the cozy and lucrative relationship between more than two dozen
contractors in Murtha's district and the hundreds of millions of dollars in pork
he provided them. It also highlights what roughly amounts to a commission on the
sale of Murtha's power as an appropriator: Mr. Murtha led all House members this
year, securing $162 million in district favors, according to the watchdog group
Taxpayers for Common Sense. ... In 1991, Mr. Murtha used a $5 million earmark to
create the National Defense Center for Environmental Excellence in Johnstown to
develop anti-pollution technology for the military. Since then, it has garnered
more than $670 million in contracts and earmarks. Meanwhile it is managed by
another contractor Mr. Murtha helped create, Concurrent Technologies, a research
operation that somehow was allowed to be set up as a tax-exempt charity,
according to The Washington Post. Thanks to Mr. Murtha, Concurrent has boomed;
the annual salary for its top three executives averages $462,000.
Edward Morrissey, Captain's Quarters, January 14, 2008 ---
http://www.captainsquartersblog.com/mt/archives/016617.php
Oh, and don't
forget Fannie Mae and Freddie Mac, those two government-sponsored mortgage
giants that engineered the 2008 subprime mortgage fiasco and are now on the
public dole. The Fed kept them afloat by buying over a trillion dollars of their
paper. Now, part of the Treasury's borrowing from the public covers their
continuing large losses.
George Melloan, "Hard Knocks From Easy Money: The Federal Reserve
is feeding big government and harming middle-class savers," The Wall Street
Journal, July 6, 2010 ---
http://online.wsj.com/article/SB10001424052748704103904575337282033232118.html?mod=djemEditorialPage_t
"What Caused the Bubble? Mission accomplished: Phil Angelides succeeds in
not upsetting the politicians," by Holman W, Jenkins, Jr., The Wall
Street Journal, January 29. 2011 ---
http://online.wsj.com/article/SB10001424052748704268104576108000415603970.html#mod=djemEditorialPage_t
The 2008 financial crisis happened because no one
prevented it. Those who might have stopped it didn't. They are to blame.
Greedy bankers, incompetent managers and
inattentive regulators created the greatest financial breakdown in nearly a
century. Doesn't that make you feel better? After all, how likely is it that
some human beings will be greedy at exactly the same time others are
incompetent and still others are inattentive?
Oh wait.
You could almost defend the Financial Crisis
Inquiry Commission's (FCIC) new report if the question had been who, in
hindsight, might have prevented the crisis. Alas, the answer is always going
to be the Fed, which has the power to stop just about any macro trend in the
financial markets if it really wants to. But the commission was asked to
explain why the bubble happened. In that sense, its report doesn't seem even
to know what a proper answer might look like, as if presented with the
question "What is 2 + 2?" and responding "Toledo" or "feral cat."
The dissenters at least propose answers that might
be answers. Peter Wallison focuses on U.S. housing policy, a diagnosis that
has the advantage of being actionable.
The other dissent, by Keith Hennessey, Bill Thomas
and Douglas Holtz-Eakin, sees 10 causal factors, but emphasizes the
pan-global nature of the housing bubble, which it attributes to ungovernable
global capital flows.
That is also true, but less actionable.
Let's try our hand at an answer that, like Mr.
Wallison's, attempts to be useful.
The Fed will make errors. International capital
flows will sometimes be disruptive. Speculators will be attracted to hot
markets. Bubbles will be a feature of financial life: Building a bunch of
new houses is not necessarily a bad idea; only when too many others do the
same does it become a bad idea. On that point, not the least of the
commission's failings was its persistent mistaking of effects for causes,
such as when banks finally began treating their mortgage portfolios as hot
potatoes to be got rid of.
If all that can't be changed, what can? How about
the incentives that invited various parties to shovel capital into housing
without worrying about the consequences?
The central banks of China, Russia and various
Asian and Arab nations knew nothing about U.S. housing. They poured hundreds
of billions into it only because Fannie and Freddie were perceived as
federally guaranteed and paid a slightly higher yield than U.S. Treasury
bonds. (And one of the first U.S. actions in the crisis was to assure China
it wouldn't lose money.)
Borrowers in most states are allowed to walk away
from their mortgages, surrendering only their downpayments (if any) while
dumping their soured housing bets on a bank. Change that even slightly and
mortgage brokers and home builders would find it a lot harder to coax people
into more house than they can afford.
Mortgage middlemen who don't have "skin in the
game" and feckless rating agencies have also been routine targets of blame.
But both are basically ticket punchers for large institutions that should
have and would have been assessing their own risk, except that their own
creditors, including depositors, judged them "too big to fail," creating a
milieu where they could prosper without being either transparent or
cautious. We haven't even tried to fix this, say by requiring banks to take
on a class of debtholder who would agree to be converted to equity in a
bailout. Then there'd be at least one sophisticated marketplace demanding
assurance that a bank is being run in a safe and sound manner. (Sadly, the
commission's report only reinforces the notion that regulators are
responsible for keeping your money safe, not you.)
The FCIC Chairman Phil Angelides is not stupid, but
he is a politician. His report contains tidbits that will be useful to
historians and economists. But it's also a report that "explains" poorly.
His highly calculated sound bite, peddled from one interview to the next,
that the crisis was "avoidable" is worthless, a nonrevelation. Everything
that happens could be said to happen because somebody didn't prevent it. So
what? Saying so is saying nothing.
Mr. Angelides has gone around trying to convince
audiences that the commission's finding was hard hitting. It wasn't. It was
soft hitting. More than any other goal, it strives mainly to say nothing
that would actually be inconvenient to Barack Obama, Harry Reid, Barney
Frank or even most Republicans in Congress. In that, it succeeded.
Jensen Comment
And then the subprime crisis was followed by the biggest swindle in the history
of the world ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
At this point time in 2011 there's only marginal benefit in identifying all
the groups like credit agencies and CPA audit firms that violated
professionalism leading up to the subprime crisis. The credit agencies,
auditors, Wall Street investment banks, Fannie Mae, and Freddie Mack were all
just hogs feeding on the trough of bad and good loans originating on Main
Streets of every town in the United States.
If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks There Would've Been No Poison to Feed Upon
by the Hogs With Their Noses in the Trough Up to and Including Wall Street and
Fannie and Freddie.
If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks All Would've Been Avoided
The most interesting question in my mind is what might've prevented the poison (uncollectability)
in the real estate loans from being concocted in the first place. What
might've prevented it was for those that approved the loans (Main Street banks
and mortgage companies in towns throughout the United States) to have to bear
all or a big share of the losses when borrowers they approved defaulted.
Instead those lenders that approved the loans easily passed those loans up
the system without any responsibility for their reckless approval of the
loans in the first place. It's easy to blame Barney Frank for making it
easier for poor people to borrow more than they could ever repay. But the fact
of the matter is that the original lenders like Countrywide were approving
subprime mortgages to high income people that also could not afford their
payments once the higher prime rates kicked in under terms of the subprime
contracts. If lenders like Countrywide had to bear a major share of the bad debt
losses the lenders themselves would've been more responsible about only
approving mortgages that had a high probability of not going into default.
Instead Countrywide and the other Main Street lenders got off scott free until
the real estate bubble finally burst.
And why would a high income couple refinance a fixed rate mortgage with a
risky subprime mortgage that they could not afford when the higher rates kicked
in down the road? The answer is that the hot real estate market before the crash
made that couple greedy. They believed that if they took out a subprime loan
with a very low rate of interest temporarily that they could turn over their
home for a relatively huge profit and then upgrade to a much nicer mansion on
the hill from the profits earned prior to when the subprime rates kicked into
higher rates.
When the real estate bubble burst this couple got left holding the bag and
received foreclosure notices on the homes that they had gambled away. And the
Wall Street investment banks, Fannie, and Freddie got stuck with all the poison
that the Main Street banks and mortgage companies had recklessly approved
without any risk of recourse for their recklessness.
If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks There Would've Been No Poison to Feed Upon
by the Hogs With Their Noses in the Trough Up to and Including Wall Street and
Fannie and Freddie.
Bob Jensen's threads on this entire mess are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"Washington’s Financial Disaster," by Frank Partnoy, The New York
Times, January 29, 2011 ---
http://www.nytimes.com/2011/01/30/opinion/30partnoy.html?_r=1&nl=todaysheadlines&emc=tha212
THE long-awaited Financial Crisis Inquiry
Commission report, finally published on Thursday, was supposed to be the
economic equivalent of the 9/11 commission report. But instead of a lucid
narrative explaining what happened when the economy imploded in 2008, why,
and who was to blame, the report is a confusing and contradictory mess, part
rehash, part mishmash, as impenetrable as the collateralized debt
obligations at the core of the crisis.
The main reason so much time, money and ink were
wasted — politics — is apparent just from eyeballing the report, or really
the three reports. There is a 410-page volume signed by the commission’s six
Democrats, a leaner 10-pronged dissent from three of the four Republicans,
and a nearly 100-page dissent-from-the-dissent filed by Peter J. Wallison, a
fellow at the American Enterprise Institute. The primary volume contains
familiar vignettes on topics like deregulation, excess pay and poor risk
management, and is infused with populist rhetoric and an anti-Wall Street
tone. The dissent, which explores such root causes as the housing bubble and
excess debt, is less lively. And then there is Mr. Wallison’s screed against
the government’s subsidizing of mortgage loans.
These documents resemble not an investigative
trilogy but a left-leaning essay collection, a right-leaning PowerPoint
presentation and a colorful far-right magazine. And the confusion only
continued during a press conference on Thursday in which the commissioners
had little to show and nothing to tell. There was certainly no Richard
Feynman dipping an O ring in ice water to show how the space shuttle
Challenger went down.
That we ended up with a political split is not
entirely surprising, given the structure and composition of the commission.
Congress shackled it by requiring bipartisan approval for subpoenas, yet
also appointed strongly partisan figures. It was only a matter of time
before the group fractured. When Republicans proposed removing the term
“Wall Street” from the report, saying it was too pejorative and imprecise,
the peace ended. And the public is still without a full factual account.
For example, most experts say credit ratings and
derivatives were central to the crisis. Yet on these issues, the reports are
like three blind men feeling different parts of an elephant. The Democrats
focused on the credit rating agencies’ conflicts of interest; the
Republicans blamed investors for not looking beyond ratings. The Democrats
stressed the dangers of deregulated shadow markets; the Republicans blamed
contagion, the risk that the failure of one derivatives counterparty could
cause the other banks to topple. Mr. Wallison played down both topics. None
of these ideas is new. All are incomplete.
Another problem was the commission’s sprawling,
ambiguous mission. Congress required that it study 22 topics, but
appropriated just $8 million for the job. The pressure to cover this wide
turf was intense and led to infighting and resignations. The 19 hearings
themselves were unfocused, more theater than investigation.
In the end, the commission was the opposite of
Ferdinand Pecora’s famous Congressional investigation in 1933. Pecora’s
10-day inquisition of banking leaders was supposed to be this commission’s
exemplar. But Pecora, a former assistant district attorney from New York,
was backed by new evidence of widespread fraud and insider dealings,
shocking documents that the public had never seen or imagined. His fierce
cross-examination of Charles E. Mitchell, the head of National City Bank,
Citigroup’s predecessor, put a face on the crisis.
This commission’s investigation was spiritless and
sometimes plain wrong. Richard Fuld, the former head of Lehman Brothers, was
thrown softballs, like “Can you talk a bit about the risk management
practices at Lehman Brothers, and why you didn’t see this coming?” Other
bankers were scolded, as when Phil Angelides, the commission’s chairman,
admonished Lloyd Blankfein, the chief executive of Goldman Sachs, for
practices akin to “selling a car with faulty brakes and then buying an
insurance policy on the buyer of those cars.” But he couldn’t back up this
rebuke with new evidence.
The report then oversteps the facts in its
demonization of Goldman, claiming that Goldman “retained” $2.9 billion of
the A.I.G. bailout money as “proprietary trades.” Few dispute that Goldman,
on behalf of its clients, took both sides of trades and benefited from the
A.I.G. bailout. But a Goldman spokesman told me that the report’s assertion
was false and that these trades were neither proprietary nor a windfall. The
commission’s staff apparently didn’t consider Goldman’s losing trades with
other clients, because they were focused only on deals with A.I.G. If they
wanted to tar Mr. Blankfein, they should have gotten their facts right.
Lawmakers would have been wiser to listen to
Senator Richard Shelby of Alabama, who in early 2009 proposed a bipartisan
investigation by the banking committee. That way seasoned prosecutors could
have issued subpoenas, cross-examined witnesses and developed cases.
Instead, a few months later, Congress opted for this commission, the last
act of which was to coyly recommend a few cases to prosecutors, who already
have been accumulating evidence the commissioners have never seen.
There is still hope. Few people remember that the
early investigations of the 1929 crash also failed due to political battles
and ambiguous missions. Ferdinand Pecora was Congress’s fourth chief
counsel, not its first, and he did not complete his work until five years
after the crisis. Congress should try again.
Frank Partnoy is a law professor at the University of San Diego and the
author of “The Match King: Ivar Kreuger, the Financial Genius Behind a
Century of Wall Street Scandals.”
Jensen Comment
Professor Partnoy is one of my all-time fraud fighting heroes. He was at one
time an insider in marketing Wall Street financial instrument derivatives
products and, while he was one of the bad guys, became conscience-stricken about
how the bad guys work. Although his many books are somewhat repetitive, his
books are among the best in exposing how the Wall Street investment banks are
rotten to the core.
Frank Partnoy has been a a strong advocate of regulation of the derivatives
markets even before Enron's energy trading scams came to light. His testimony
before the U.S. Senate about Enron's infamous Footnote 16 ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm#Senator
I quote Professor Partnoy's books frequently in my Timeline of Derivative
Financial Instruments Frauds ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
"Senators Get
Donor $8 Million Earmark," Judicial Watch, June 8, 2010 ---
http://www.judicialwatch.org/blog/2010/jun/senators-get-donor-8-million-earmark
In yet another example of
lawmakers unscrupulously funneling tax dollars to their political
supporters, New Jersey’s two U.S. Senators steered a multi million-dollar
earmark to enhance a campaign donor’s luxury condominium development.
Democrats Frank Lautenberg and Robert Menendez
allocated $8 million for a public walkway and park space adjacent to
upscale, waterfront condos built by a developer whose executives have
donated generously to their political campaigns. The veteran legislators
have received about $100,000 in contributions from the developer, according
to federal election records cited in a news report this week.
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"The Triumph of Propaganda," by Nemo Almen, American Thinker,
January 2, 2011 ---
http://www.americanthinker.com/2011/01/the_triumph_of_propaganda.html
Does anyone
remember what happened on Christmas Eve last year? In one of the most
expensive Christmas presents ever, the government
removed the $400 billion limit on their Fannie and
Freddie guaranty. This act increased taxpayer liabilities by
six trillion dollars; however, the news was lost
in the holiday cheer. This is one instance in a broader campaign to
manipulate the public perception, gradually depriving us of independent
thought.
Consider another example: what news story broke on April 16, 2010? Most of
us would say the SEC's
lawsuit against Goldman Sachs. Goldman is the
market leader in "ripping the client's face off," in this instance creating
a worst-of-the-worst pool of securities so Paulson & Co could bet against
it. Many applauded the SEC for this action. Never mind that singling out
one vice president (the "Fabulous Fab") and one instance of fraud is like
charging Al Capone with tax evasion. The dog was wagged.
Very
few caught the real news that day, namely the damning
complicity of the SEC in the Stanford Ponzi
scheme. Clearly, Stanford was the bigger story, costing thousands of
investors
billions of dollars while Goldman later settled
for half a
billion. Worse, the SEC knew about Stanford since
1997, but instead of shutting it down, people left the SEC to
work
for Stanford. This story should have caused
widespread outrage and reform of the SEC; instead it was buried in the back
pages and lost to the public eye.
Lest we
think the timing of these was mere coincidence, the Goldman lawsuit was
settled on July 15, 2010, the same day the financial reform package
passed. The government threw Goldman to the
wolves in order to hide its own shame. When the government had its desired
financial reforms, it let Goldman settle. These examples demonstrate a
clear pattern of manipulation. Unfortunately, our propaganda problem runs
far deeper than lawsuits and Ponzi schemes.
Here is a
more important question: which companies own half of all
subprime and
Alt-A (liar loan) bonds? Paul Krugman writes that
these companies were "mainly out of the picture during the housing bubble's
most feverish period, from 2004 to 2006. As a result, the agencies played
only a minor role in the epidemic of bad lending."[iii] This phrase is
stupefying. How can a pair of companies comprise half of a market and yet
have no major influence in it? Subprime formed the core of the financial
crisis, and Fannie and Freddie (the "agencies") formed the core of the
subprime market. They were not "out of the picture" during the subprime
explosion, they were the picture. The fact that a respectable Nobel
prize-winner flatly denies this is extremely disturbing.
Amazingly, any attempt to hold the government accountable for its role in
the subprime meltdown is dismissed as right-wing
propaganda. This dismissal is left-wing
propaganda. It was the government that initiated securitization as a tool
to dispose of
RTC assets. Bill Clinton ducks all
responsibility, ignoring how his administration imposed arbitrary
quotas on any banks looking to merge as Attorney
General Janet Reno "threatened legal action against lenders whose racial
statistics raised her suspicions."[iv] Greenspan fueled the rise of
subprime derivatives by lowering rates,[v] lowering reserves,[vi] and
beating down reasonable
opposition. And at the center of it all were
Fannie and Freddie
bribing officials, committing
fraud,
dominating private-sector
competition, and expanding to a
six-trillion-dollar debacle. The fact that these facts are dismissed as
propaganda shows just how divorced from reality our ‘news' has become. Yes,
half of all economists are employed by the
government, but this is no reason to flout one's
professional responsibility. As a nation we need to consider all the facts,
not just those that are politically expedient.
Continued in article
Nemo Almen is the author of
The Last Dodo: The Great Recession and our Modern-Day Struggle for Survival.
"The Difficulty of Proving Financial Crimes," by Peter J. Henning,
DealBook, December 13, 2010 ---
http://blogs.law.harvard.edu/corpgov/2010/12/20/why-do-cfos-become-involved-in-material-accounting-manipulations/
The prosecution revolved around the recognition of
revenue from Network Associates’ sales of computer security products to a
distributor through what is called “sell-in” accounting rather than the
“sell-through” method. Leaving aside the accounting minutiae, prosecutors
asserted that Mr. Goyal chose “sell-in” accounting as a means to overstate
revenue from the sales and did not disclose complete information to the
company’s auditors about agreements with the distributor that could affect
the amount of revenue generated from the transactions.
The line between aggressive accounting and fraud is
a thin one, involving the application of unclear rules that require judgment
calls that may turn out to be incorrect in hindsight. While Mr. Goyal was
responsible as the chief financial officer for adopting an accounting method
that likely enhanced Network Associates’ revenue, the problem with the
securities fraud theory was that prosecutors did not introduce evidence that
the “sell-in” method was improper under Generally Accepted Accounting
Principles. And even if it was, the court pointed out lack of evidence that
that this accounting method had a “material” impact on Network Associates’
revenue, which must be shown to prove fraud.
A more significant problem for prosecutors was the
absence of concrete proof that Mr. Goyal intended to defraud or that he
sought to mislead the auditors. The Court of Appeals for the Ninth Circuit
found that the “government’s failure to offer any evidence supporting even
an inference of willful and knowing deception undermines its case.”
The court rejected the proposition that an
executive’s knowledge of accounting and desire to meet corporate revenue
targets can be sufficient to establish the intent to commit a crime. The
court stated, “If simply understanding accounting rules or optimizing a
company’s performance were enough to establish scienter, then any action by
a company’s chief financial officer that a juror could conclude in hindsight
was false or misleading could subject him to fraud liability without regard
to intent to deceive. That cannot be.”
The court further explained that an executive’s
compensation tied to the company’s performance does not prove fraud, stating
that such “a general financial incentive merely reinforces Goyal’s
preexisting duty to maximize NAI’s performance, and his seeking to meet
expectations cannot be inherently probative of fraud.”
Don’t be surprised to see the court’s statements
about the limitations on corporate expertise and financial incentives as
proof of intent quoted with regularity by defense lawyers for corporate
executives being investigated for their conduct related to the financial
meltdown. The opinion makes the point that just being at the scene of
financial problems alone is not enough to show criminal intent.
If the Justice Department decides to try to hold
senior corporate executives responsible for suspected financial chicanery or
misleading statements that contributed to the financial meltdown, the
charges are likely to be similar to those brought against Mr. Goyal,
requiring proof of intent to defraud and to mislead investors, auditors, or
the S.E.C.
The intent element of the crime is usually a matter
of piecing together different tidbits of evidence, such as e-mails, internal
memorandums, public statements and the recollection of participants who
attended meetings. Connecting all those dots is not an easy task, as
prosecutors learned in the case against two former Bear Stearns hedge fund
managers when e-mails proved to be at best equivocal evidence of their
intent to mislead investors, resulting in an acquittal on all counts.
The collapse of Lehman Brothers raises issues about
whether prosecutors could show criminal conduct by its executives. The
bankruptcy examiner’s report highlighted the firm’s use of the so-called
“Repo 105” transactions to make its balance sheet look healthier than it was
each quarter, which could be the basis for criminal charges. But the appeals
court opinion highlights how great the challenge would be to establish a
Lehman executive’s knowledge of improper accounting or the falsity of
statements because just arguing that a chief executive or chief financial
officer had to be aware of the impact of the transactions would not be
enough to prove the case.
The same problems with proving a criminal case
apply to other companies brought down during the financial crisis, like
Fannie Mae, Freddie Mac and American International Group. Many of the
decisions that led to these companies’ downfall were at least arguably
judgment calls made with no intent to defraud, short-sighted as they might
have been. Disclosures to regulators and auditors, and public statements to
shareholders, are rarely couched in definitive terms, so proving that a
statement was in fact false can be difficult, and then showing knowledge of
its falsity even more daunting.
In a concurring opinion in the Goyal case, Chief
Judge Alex Kozinski bemoaned the use of the criminal law for this type of
conduct, stating that this prosecution was “one of a string of recent cases
in which courts have found that federal prosecutors overreached by trying to
stretch criminal law beyond its proper bounds.”
Despite the public’s desire to see some corporate
executives sent to jail for their role in the financial meltdown, the courts
will hold the government to the requirement of proof beyond a reasonable
doubt and not simply allow the cry for retribution to lead to convictions
based on high compensation and presiding over a company that sustained
significant losses.
Continued in article
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Great Public Sector Reform Speech ---
http://njn.net/television/webcast/ontherecord.html
"Tax Havens Devastating To National Sovereignty," Southwerk,
January 13, 2011 ---
http://southwerk.wordpress.com/2011/01/13/tax-haven-devastating-to-national-economies/
Thank you Nadine Sabai for the heads up.
The blog post is
a review of the book,
Nicholas Shaxson’s -
Treasure Islands: Uncovering the Damage of Offshore Banking and Tax
Havens
Tax havens are the ultimate source of strength
for our global elites. Just as European nobles once consolidated their
unaccountable powers in fortified castles, to better subjugate and extract
tribute from the surrounding peasantry, so financial capital has coalesced
in their modern equivalent today: the tax havens. In these fortified nodes
of secret, unaccountable political and economic power, financial and
criminal interests have come together to capture local political systems and
turn the havens into their own private law-making factories, protected
against outside interference by the world’s most powerful countries – most
especially Britain. Treasure Islands will, for the first time, show the
blood and guts of just how they do it.
The nations of the world are harmed by the evasion
of their laws and taxes made possible by tax havens. The tax money is
important but more important is the ability to threaten governments to force
actions that multinational corporations such as investment banks wish done.
These escape routes transform the merely
powerful into the untouchable. “Don’t tax or regulate us or we will flee
offshore!” the financiers cry, and elected politicians around the world
crawl on their bellies and capitulate. And so tax havens lead a global race
to the bottom to offer deeper secrecy, ever laxer financial regulations, and
ever more sophisticated tax loopholes. They have become the silent battering
rams of financial deregulation, forcing countries to remove financial
regulations, to cut taxes and restraints on the wealthy, and to shift all
the risks, costs and taxes onto the backs of the rest of us. In the process
democracy unravels and the offshore system pushes ever further onshore. The
world’s two most important tax havens today are United States and Britain.
But the world is not without means to
remedy the situation. In the late 1700′s piracy flourished because nations
found it advantageous to use them against their enemies. Pirates often
employed as privateers fattened the treasury of the nations hiring them and
did harm to their enemies.
But over time, it became obvious that the
benefits of piracy were outweighed by the faults.
So, nations by treaty and policy ran the
pirates out of business.
The United States in concert with the
European Union, China and other nations could by agreement make this kind of
tax haven impossible to maintain or at the very least difficult.
It has been a daunting task to motivate the
government of the United States to act against the interests of these larger
corporations particularly the financial ones, but the future of this nation
may well depend on those tax dollars and enforcing the national interest.
James Pilant
I wish to thank
homophilosophicus for calling my attention to
Thriven’s Blog.
Video: Air Pelosi Scandal
The Disgraceful Personal Spending of House Speaker, CNN ---
http://www.youtube.com/watch_popup?v=A6_xgKWzhRw
"Judicial Watch Announces List of Washington's "Ten Most Wanted Corrupt
Politicians" for 2009," Judicial Watch ---
http://www.judicialwatch.org/news/2009/dec/judicial-watch-announces-list-washington-s-ten-most-wanted-corrupt-politicians-2009
Rep. Nancy Pelosi (D-CA): At the
heart of the corruption problem in Washington is a sense of entitlement.
Politicians believe laws and rules (even the U.S. Constitution) apply to the
rest of us but not to them. Case in point: House Speaker Nancy Pelosi and
her excessive and
boorish demands for military travel. Judicial
Watch obtained documents from the Pentagon in 2008 that suggest Pelosi has
been treating the Air Force like her own personal airline. These documents,
obtained through the Freedom of Information Act, include internal Pentagon
email correspondence detailing attempts by Pentagon staff to accommodate
Pelosi's numerous requests for military escorts and military aircraft as
well as the speaker's 11th hour cancellations and changes. House Speaker
Nancy Pelosi also came under fire in April 2009, when she claimed she was
never briefed about the CIA's use of the waterboarding technique during
terrorism investigations. The CIA produced a report documenting a briefing
with Pelosi on September 4, 2002, that suggests otherwise. Judicial Watch
also obtained documents, including a
CIA Inspector General report, which further
confirmed that Congress was fully briefed on the enhanced interrogation
techniques. Aside from her own personal transgressions, Nancy Pelosi has
ignored serious incidents of corruption within her own party, including many
of the individuals on this list. (See Rangel, Murtha, Jesse Jackson, Jr.,
etc.)
At the end of
every year, Judicial Watch publishes a top
ten list of the most corrupt politicians in
Washington, D.C.
|
The motto of Judicial Watch is "Because no one
is above the law". To this end, Judicial Watch uses the open records or freedom
of information laws and other tools to investigate and uncover misconduct by
government officials and litigation to hold to account politicians and public
officials who engage in corrupt activities.
Judicial Watch ---
http://www.judicialwatch.org/
Air Pelosi
Scandal
In March
2009, Judicial Watch received documents from
the Department of Defense detailing Nancy
Pelosi's abuse of a system which provided
military aircraft for the transportation of
the Speaker of the House. The documents,
which were acquired through the Freedom of
Information Act (FOIA), detail the attempts
by DOD staff to accommodate Pelosi's
numerous requests for military escorts and
military aircraft as well as the speaker's
last minute cancellations and changes.
Press
Releases
Documents
|
"A Low, Dishonest Decade: The press and
politicians were asleep at the switch.," The Wall Street Journal,
December 22, 2009 ---
http://online.wsj.com/article/SB10001424052748703478704574612013922050326.html?mod=djemEditorialPage
Stock-market indices are not
much good as yardsticks of social progress, but as another low, dishonest
decade expires let us note that, on 2000s first day of trading, the Dow
Jones Industrial Average closed at 11357 while the Nasdaq Composite Index
stood at 4131, both substantially higher than where they are today. The
Nasdaq went on to hit 5000 before collapsing with the dot-com bubble, the
first great Wall Street disaster of this unhappy decade. The Dow got north
of 14000 before the real-estate bubble imploded.
And it was supposed to have
been such an awesome time, too! Back in the late '90s, in the crescendo of
the Internet boom, pundit and publicist alike assured us that the future was
to be a democratized, prosperous place. Hierarchies would collapse, they
told us; the individual was to be empowered; freed-up markets were to be the
common man's best buddy.
Such clever hopes they were.
As a reasonable anticipation of what was to come they meant nothing. But
they served to unify the decade's disasters, many of which came to us
festooned with the flags of this bogus idealism.
Before "Enron" became
synonymous with shattered 401(k)s and man-made electrical shortages, the
public knew it as a champion of electricity deregulation—a freedom fighter!
It was supposed to be that most exalted of corporate creatures, a "market
maker"; its "capacity for revolution" was hymned by management theorists;
and its TV commercials depicted its operations as an extension of humanity's
quest for emancipation.
Similarly, both Bank of
America and Citibank, before being recognized as "too big to fail," had
populist histories of which their admirers made much. Citibank's long
struggle against the Glass-Steagall Act was even supposed to be evidence of
its hostility to banking's aristocratic culture, an amusing image to
recollect when reading about the $100 million pay reportedly pocketed by one
Citi trader in 2008.
The Jack Abramoff lobbying
scandal showed us the same dynamics at work in Washington. Here was an
apparent believer in markets, working to keep garment factories in Saipan
humming without federal interference and saluted for it in an op-ed in the
Saipan Tribune as "Our freedom fighter in D.C."
But the preposterous
populism is only one part of the equation; just as important was our failure
to see through the ruse, to understand how our country was being disfigured.
Ensuring that the public
failed to get it was the common theme of at least three of the decade's
signature foul-ups: the hyping of various Internet stock issues by Wall
Street analysts, the accounting scandals of 2002, and the triple-A ratings
given to mortgage-backed securities.
The grand, overarching theme
of the Bush administration—the big idea that informed so many of its sordid
episodes—was the same anti-supervisory impulse applied to the public sector:
regulators sabotaged and their agencies turned over to the regulated.
The public was left to read
the headlines and ponder the unthinkable: Could our leaders really have
pushed us into an unnecessary war? Is the republic really dividing itself
into an immensely wealthy class of Wall Street bonus-winners and everybody
else? And surely nobody outside of the movies really has the political clout
to write themselves a $700 billion bailout.
What made the oughts so
awful, above all, was the failure of our critical faculties. The problem was
not so much that newspapers were dying, to mention one of the lesser
catastrophes of these awful times, but that newspapers failed to do their
job in the first place, to scrutinize the myths of the day in a way that
might have prevented catastrophes like the financial crisis or the Iraq war.
The folly went beyond the
media, though. Recently I came across a 2005 pamphlet written by historian
Rick Perlstein berating the big thinkers of the Democratic Party for their
poll-driven failure to stick to their party's historic theme of economic
populism. I was struck by the evidence Mr. Perlstein adduced in the course
of his argument. As he tells the story, leading Democratic pollsters found
plenty of evidence that the American public distrusts corporate power; and
yet they regularly advised Democrats to steer in the opposite direction, to
distance themselves from what one pollster called "outdated appeals to class
grievances and attacks upon corporate perfidy."
This was not a party that
was well-prepared for the job of iconoclasm that has befallen it. And as the
new bunch muddle onward—bailing out the large banks but (still) not
subjecting them to new regulatory oversight, passing a health-care reform
that seems (among other, better things) to guarantee private insurers
eternal profits—one fears they are merely presenting their own ample
backsides to an embittered electorate for kicking.
Before reading this module you may want to read about Governmental
Accounting at
http://en.wikipedia.org/wiki/Governmental_accounting
"Don't Like the Numbers? Change 'Em If a CEO issued the kind of distorted
figures put out by politicians and scientists, he'd wind up in prison," by
Stanford Economics Professor Michael J. Boskin, The Wall Street Journal,
January 14, 2010 ---
http://online.wsj.com/article/SB10001424052748704586504574654261655183416.html?mod=djemEditorialPage
Politicians and scientists who don't like what their data show lately have
simply taken to changing the numbers. They believe that their end—socialism,
global climate regulation, health-care legislation, repudiating debt
commitments, la gloire française—justifies throwing out even minimum standards
of accuracy. It appears that no numbers are immune: not GDP, not inflation, not
budget, not job or cost estimates, and certainly not temperature. A CEO or CFO
issuing such massaged numbers would land in jail.
The late
economist Paul Samuelson called the national income accounts that measure real
GDP and inflation "one of the greatest achievements of the twentieth century."
Yet politicians from Europe to South America are now clamoring for alternatives
that make them look better.
A
commission appointed by French President Nicolas Sarkozy suggests heavily
weighting "stability" indicators such as "security" and "equality" when
calculating GDP. And voilà!—France outperforms the U.S., despite the fact that
its per capita income is 30% lower. Nobel laureate Ed Prescott called this
disparity the difference between "prosperity and depression" in a 2002 paper—and
attributed it entirely to France's higher taxes.
With
Venezuela in recession by conventional GDP measures, President Hugo Chávez
declared the GDP to be a capitalist plot. He wants a new, socialist-friendly way
to measure the economy. Maybe East Germans were better off than their cousins in
the West when the Berlin Wall fell; starving North Koreans are really better off
than their relatives in South Korea; the 300 million Chinese lifted out of
abject poverty in the last three decades were better off under Mao; and all
those Cubans risking their lives fleeing to Florida on dinky boats are loco.
In
Argentina, President Néstor Kirchner didn't like the political and budget hits
from high inflation. After a politicized personnel purge in 2002, he changed the
inflation measures. Conveniently, the new numbers showed lower inflation and
therefore lower interest payments on the government's inflation-linked bonds.
Investor and public confidence in the objectivity of the inflation statistics
evaporated. His wife and successor Cristina Kirchner is now trying to grab the
central bank's reserves to pay for the country's debt.
America
has not been immune from this dangerous numbers game. Every president is guilty
of spinning unpleasant statistics. President Richard Nixon even thought there
was a conspiracy against him at the Bureau of Labor Statistics. But President
Barack Obama has taken it to a new level. His laudable attempt at transparency
in counting the number of jobs "created or saved" by the stimulus bill has
degenerated into farce and was just junked this week.
The
administration has introduced the new notion of "jobs saved" to take credit
where none was ever taken before. It seems continually to confuse gross and net
numbers. For example, it misses the jobs lost or diverted by the fiscal
stimulus. And along with the congressional leadership it hypes the number of
"green jobs" likely to be created from the explosion of spending, subsidies,
loans and mandates, while ignoring the job losses caused by its taxes, debt,
regulations and diktats.
The
president and his advisers—their credibility already reeling from exaggeration
(the stimulus bill will limit unemployment to 8%) and reneged campaign promises
(we'll go through the budget "line-by-line")—consistently imply that their new
proposed regulation is a free lunch. When the radical attempt to regulate energy
and the environment with the deeply flawed cap-and-trade bill is confronted with
economic reality, instead of honestly debating the trade-offs they confidently
pronounce that it boosts the economy. They refuse to admit that it simply boosts
favored sectors and firms at the expense of everyone else.
Rabid
environmentalists have descended into a separate reality where only green
counts. It's gotten so bad that the head of the California Air Resources Board,
Mary Nichols, announced this past fall that costly new carbon regulations would
boost the economy shortly after she was told by eight of the state's most
respected economists that they were certain these new rules would damage the
economy. The next day, her own economic consultant, Harvard's Robert Stavis,
denounced her statement as a blatant distortion.
Scientists are expected to make sure their findings are replicable, to make the
data available, and to encourage the search for new theories and data that may
overturn the current consensus. This is what Galileo, Darwin and Einstein—among
the most celebrated scientists of all time—did. But some climate researchers,
most notably at the University of East Anglia, attempted to hide or delete
temperature data when that data didn't show recent rapid warming. They quietly
suppressed and replaced the numbers, and then attempted to squelch publication
of studies coming to different conclusions.
The
Obama administration claims a dubious "Keynesian" multiplier of 1.5 to feed the
Democrats' thirst for big spending. The administration's idea is that virtually
all their spending creates jobs for unemployed people and that additional rounds
of spending create still more—raising income by $1.50 for each dollar of
government spending. Economists differ on such multipliers, with many leading
figures pegging them at well under 1.0 as the government spending in part
replaces private spending and jobs. But all agree that every dollar of spending
requires a present value of a dollar of future taxes, which distorts decisions
to work, save, and invest and raises the cost of the dollar of spending to well
over a dollar. Thus, only spending with large societal benefits is justified, a
criterion unlikely to be met by much current spending (perusing the projects on
recovery.gov doesn't inspire confidence).
Even
more blatant is the numbers game being used to justify health-insurance reform
legislation, which claims to greatly expand coverage, decrease health-insurance
costs, and reduce the deficit. That magic flows easily from counting 10 years of
dubious Medicare "savings" and tax hikes, but only six years of spending;
assuming large cuts in doctor reimbursements that later will be cancelled; and
making the states (other than Sen. Ben Nelson's Nebraska) pay a big share of the
cost by expanding Medicaid eligibility. The Medicare "savings" and payroll tax
hikes are counted twice—first to help pay for expanded coverage, and then to
claim to extend the life of Medicare.
One
piece of good news: The public isn't believing much of this out-of-control spin.
Large majorities believe the health-care legislation will raise their insurance
costs and increase the budget deficit. Most Americans are highly skeptical of
the claims of climate extremists. And they have a more realistic reaction to the
extraordinary deterioration in our public finances than do the president and
Congress.
As a
society and as individuals, we need to make difficult, even wrenching choices,
often with grave consequences. To base those decisions on highly misleading,
biased, and even manufactured numbers is not just wrong, but dangerous.
Squandering their credibility with these numbers games will only make it more
difficult for our elected leaders to enlist support for difficult decisions from
a public increasingly inclined to disbelieve them.
Mr. Boskin is a
professor of economics at Stanford University and a senior fellow at the Hoover
Institution. He chaired the Council of Economic Advisers under President George
H.W. Bush
Bob Jensen's threads on The Sad State of Governmental Accounting and
Accountability ---
http://faculty.trinity.edu/rjensen/theory01.htm#GovernmentalAccounting
University of Illinois at Chicago Report
on Massive Political Corruption in Chicago
"Chicago Is a 'Dark Pool Of Political Corruption'," Judicial Watch,
February 22, 2010 ---
http://www.judicialwatch.org/blog/2010/feb/dark-pool-political-corruption-chicago
A major U.S. city long known
as a hotbed of pay-to-play politics infested with clout and patronage has
seen nearly 150 employees, politicians and contractors get convicted of
corruption in the last five decades.
Chicago has long been
distinguished for its pandemic of public corruption, but actual cumulative
figures have never been offered like this. The astounding information is
featured in a
lengthy report published by one of Illinois’s
biggest public universities.
Cook County, the
nation’s second largest, has been a
“dark pool of political corruption” for more than
a century, according to the informative study conducted by the University of
Illinois at Chicago, the city’s largest public college. The report offers a
detailed history of corruption in the Windy City beginning in 1869 when
county commissioners were imprisoned for rigging a contract to paint City
Hall.
It’s downhill from there,
with a plethora of political scandals that include 31 Chicago alderman
convicted of crimes in the last 36 years and more than 140 convicted since
1970. The scams involve bribes, payoffs, padded contracts, ghost employees
and whole sale subversion of the judicial system, according to the report.
Elected officials at
the highest levels of city, county and state government—including prominent
judges—were the perpetrators and they worked in various government locales,
including the assessor’s office, the county sheriff, treasurer and the
President’s Office of Employment and Training. The last to fall was renowned
political bully Isaac Carothers, who just a few
weeks ago pleaded guilty to federal bribery and tax charges.
In the last few years alone
several dozen officials have been convicted and more than 30 indicted for
taking bribes, shaking down companies for political contributions and
rigging hiring. Among the convictions were fraud, violating court orders
against using politics as a basis for hiring city workers and the
disappearance of 840 truckloads of asphalt earmarked for city jobs.
A few months ago the
city’s largest newspaper revealed that Chicago aldermen keep a
secret, taxpayer-funded pot of cash (about $1.3
million) to pay family members, campaign workers and political allies for a
variety of questionable jobs. The covert account has been utilized for
decades by Chicago lawmakers but has escaped public scrutiny because it’s
kept under wraps.
Judicial Watch has
extensively investigated Chicago corruption, most recently the
conflicted ties of top White House officials to
the city, including Barack and Michelle Obama as well as top administration
officials like Chief of Staff Rahm Emanual and Senior Advisor David Axelrod.
In November Judicial Watch
sued Chicago Mayor Richard Daley's office to
obtain records related to the president’s failed bid to bring the Olympics
to the city.
Bob Jensen's threads on the sad state of
governmental accounting are at
http://faculty.trinity.edu/rjensen/theory01.htm#GovernmentalAccounting
Bob Jensen's threads on political
corruption are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#Lawmakers
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/fraudUpdates.htm
"How to Guard Against Stimulus Fraud:
Based on past experience, thieves may rip off the taxpayers for $100 billion,"
by Daniel J. Castleman, The Wall Street Journal, January 13, 2010 ---
http://online.wsj.com/article/SB10001424052748703948504574648331267709784.html#mod=djemEditorialPage
The Obama administration—and
state and local governments—should brace themselves for fraud on an Olympic
scale as hundreds of billions of taxpayer dollars continue to pour into job
creation efforts.
Where there are government
handouts, fraud, waste and abuse are rarely far behind. The sheer scale of
the first and expected second stimulus packages combined with the
multitiered distribution channel—from Washington to the states to community
agencies to contractors and finally to workers—are simply irresistible
catnip to con men and thieves.
There are already warning
signs. The Department of Energy's inspector general said in a report in
December that staffing shortages and other internal weaknesses all but
guarantee that at least some of the agency's $37 billion economic-stimulus
funds will be misused. A tenfold increase in funding for an obscure federal
program that installs insulation in homes has state attorneys general
quietly admitting there is little hope of keeping track of the money.
While I was in charge of
investigations at the Manhattan District Attorney's office, we brought case
after case where kickbacks, bid-rigging, false invoicing schemes and
outright theft routinely amounted to a tenth of the contract value. This was
true in industries as diverse as the maintenance of luxury co-ops and
condos, interior construction and renovation of office buildings, court
construction projects, dormitory construction projects, even the
distribution of copy paper. In one insurance fraud case, the schemers
actually referred to themselves as the "Ten Percenters."
Based on past experience,
the cost of fraud involving federal government stimulus outlays of more than
$850 billion and climbing could easily reach $100 billion. Who will prevent
this? Probably no one, particularly at the state and local level.
New York, for instance, has
an aggressive inspector general's office, with experienced and dedicated
professionals. But, it is already woefully understaffed—with a head count of
only 62 people—to police the state's already existing agencies and programs.
There is simply no way that office can effectively scrutinize the influx of
$31 billion in state stimulus money.
There is a solution however,
which is to set aside a small percentage of the money distributed to fund
fraud prevention and detection programs. This will ensure that states and
municipalities can protect projects from fraud without tapping already
thinly stretched resources.
Meaningful fraud prevention,
detection and investigation can be funded by setting aside no more than 2%
of the stimulus money received. For example, if a county is to receive $50
million for an infrastructure project, $1 million should be set aside to
fund antifraud efforts; if it costs less, the remainder can be returned to
the project's budget.
While the most obvious
option might be to simply pump the fraud prevention funds into pre-existing
law enforcement agencies, that would be a mistake. Government agencies take
too long to staff up and rarely staff down.
A better idea is to tap the
former government prosecutors, regulators and detectives with experience in
fraud investigations now working in the private sector. If these resources
can be harnessed, effective watchdog programs can be put in place in a
timely manner. Competition between private-sector bidders will also lower
the cost.
Some might object to
providing a "windfall" to private companies. Any such concern is misplaced.
One should not look at the 2% spent, but rather the 8% potentially saved.
Moreover, consider the alternative: law enforcement agencies swamped trying
to stem the tide of corruption on a shoestring and a prayer.
There will always be
individuals who will rip off money meant for public projects. In the
aftermath of the 9/11 attacks, and Hurricane Katrina hundreds of people were
prosecuted for trying to steal relief funds. But the stimulus funding
represents the kind of payday even the most ambitious fraudster could never
have imagined
To avoid a stimulus
fraud Olympics that will be impossible to clean up, it is better to spend a
little now to save a lot later. The savings could put honest people to work
and fraudsters out of business.
Mr. Castleman, a former chief assistant
Manhattan district attorney, is a managing director at FTI Consulting.
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's
threads on The Sad State of Governmental Accounting and Accountability ---
http://faculty.trinity.edu/rjensen/theory01.htm#GovernmentalAccounting
The Most Criminal
Class is Writing the Laws ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#Lawmakers
William D. Eggers is the Global Director of
Deloitte's Public Sector research program. John O'Leary is a Research Fellow at
the Ash Institute of the Harvard Kennedy School. Their new book is
If We Can Put a Man on the Moon: Getting Big Things Done in Government
(Harvard Business Press, 2009).
"Why the Success of "Obama Care"
Could Be
Riskier Than Failure," by William D. Eggers and John O'Leary, Harvard
Business School Blog, December 23, 2009 ---
http://blogs.hbr.org/cs/2009/12/why_the_success_of_obama_care.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE
When President Obama
launched his
health reform effort, more than anything he wanted
to avoid the mistakes of the
1993-1994 attempt at health care reform. His
advisors have said repeatedly over these past months that they want
something passed.
Now it appears they will get
their wish. It's certainly true that one way "Obama Care" could fail — the
one everybody has been worrying about — is by never being passed into law.
Another way it can fail, however, is if a poorly designed bill passes and
then wreaks havoc during implementation. Indeed, this sort of design and
execution failure could do greater lasting damage to the goals of health
care reform than mere failure to pass a bill.
The Obama
administration, and all reform-minded public agencies and organizations,
would do well to avoid some of the mistakes of 2004, when an all-Republican
Congress and White House rammed through a
Medicare prescription drug benefit. The messy,
ill-considered implementation of what in essence was a massive giveaway
program generated huge initial ill-will among seniors, the very group the
benefit was designed to serve.
Ultimately, the GOP's
Medicare prescription drug reform stands as a model for achieving short-term
legislative success that creates an implementation nightmare. In more
general terms, those pushing for change saw official approval as the finish
line rather than, more accurately, as the starting line.
Here are some of the key risks that the 2004 Congress should have had in
mind in their push to get Medicare reform done — and which should be
front-of-mind for change-leaders now:
The risk of ramming
it through. The process by which Medicare Part D became legislative
reality wasn't pretty. It involved low-balled cost estimates, an
unprecedented all-night vote, and high-pressure tactics from Republicans to
sway votes that cost Tom DeLay an ethics rebuke. With all the high-stakes
political gamesmanship, any actual review of the proposed policy for "implementability"
was minimal to non-existent. A related lesson as the Democrats now drive
health care and other reforms through Congress: political memory rarely
fades. Cut-throat tactics lead inexorably to future in-kind retribution.
Public leaders must stop the vicious cycle in which avenging political
battle scars trumps practical lessons learned from prior missteps of
execution.
Forgetting who
you're designing the reform for. Seniors were totally
confused by their new "benefit." "This whole program is so complicated that
I've stayed awake thinking, 'How can a brain come up with anything like
this?'" lamented a seventy-nine-year old, retired business manager.
Americans do not normally lie awake pondering the design of a federal
program. But the Medicare prescription drug program was something special.
"I have a PhD, and it's too complicated to suit me," said a
seventy-three-year old retired, chemist.
Giving the nation's elderly
voters apoplexy was not what Republicans had intended. But lawmakers had
designed the legislation primarily to curry favor with other "stakeholders"
— big pharmaceutical firms, health plans, employers, rural hospitals, and
senior advocates such as the AARP — instead of designing it to work in the
real world for the "end consumer" of the reform, i.e. everyday senior
citizens.
The number of plans the
typical senior had to sort through depended on where he or she lived. In
Colorado, retirees faced a choice of 55 plans from 24 companies. Residents
of Pennsylvania selected from 66 plans.
"The program is so
poorly designed and is creating so much confusion that it's having a
negative effect on most beneficiaries," said one pharmacist. "It's making
people cynical about the whole process — the new program, the government's
help."
Unrealistic
timeline and scale. "No company would ever launch countrywide a new
product to 40 million people all at once," explained Kathleen Harrington,
the Bush political appointee at the
Centers for Medicare and Medicaid Services who led
the launch of Medicare Part D. "No one would ever say that you have to get
all of the platforms, all of the systems developed for this and working
within six months." Nobody except Congress, who in fact tried to do this,
giving scant consideration to implementation challenges and the inherent
difficulty in changing a well-established system.
The launch from
hell. The computer system cobbled together to support the new
benefit crashed the very first day coverage took effect. System errors
slapped seniors with excessive charges or denied them their drugs
altogether. Computer glitches generated calls to the telephone hotlines,
which quickly became overloaded.
While eventually the
program was turned around thanks to some heroic efforts by senior federal
executives, the days and weeks following the January 2006 opening of benefit
enrollment were
a disaster — caused primarily by a dysfunctional
design process and lack of an implementation mindset.
Lessons learned.
Both Medicare Part D, as well as what we have seen of the current,
huge effort toward health care reform, highlight why government has such a
hard time dealing with complex problems. But the basic truth is simple:
ultimately, to be successful, a health reform bill has to do two things — it
has to pass through Congress, and it has to actually work in the real world.
These two considerations
often work against each other. For political reasons, artificial deadlines
are introduced. To appease interest groups, regulations are altered, or
goodies buried in the bill. These measures are almost always taken to secure
passage, but with little (or not enough) thought given to how they might
hinder implementation.
Given the problems
that arose in the comparatively simple launch of a new drug benefit to
seniors, policymakers should be examining every risk inherent in
implementing any serious overhaul of one-seventh of our economy. The
legislative process needs to produce health care reform that can work in the
real world or the backlash from a failed implementation will be furious.
William D. Eggers is the Global Director of Deloitte's Public Sector
research program. John O'Leary is a Research Fellow at the Ash Institute of
the Harvard Kennedy School. Their new book is
If We Can Put a Man on the Moon: Getting Big Things Done in Government
(Harvard Business Press, 2009).
Bob Jensen's threads on health care are at
http://faculty.trinity.edu/rjensen/Health.htm
"Public Policy as Public Corruption," by
Michael Gerson, Townhall, December 23, 2009 ---
http://townhall.com/columnists/MichaelGerson/2009/12/23/public_policy_as_public_corruption
"Several Democrats, including some closed allied to Speaker Nancy Pelosi, are
the subject of ethics complaints," by Holly Bailey, Newsweek Magazine,
October 3, 2009 ---
http://www.newsweek.com/id/216687
Nancy Pelosi likes to brag that she's
"drained the swamp" when it comes to corruption in the House, but ethics
problems could come back to haunt Democrats in 2010. Democrats are currently
the subject of 12 of the 16 complaints pending before the House ethics
committee. Two of the lawmakers under scrutiny—Reps. Jack Murtha and Charlie
Rangel—have close ties to Pelosi, who has come under criticism for not
asking them to resign their committee posts. Murtha, chairman of a key
defense-appropriations subcommittee, is is not formally under investigation
but the ethics committee is reviewing political contributions he and other
House lawmakers received from lobbying firm whose clients received millions
of dollars in Defense earmarks. Rangel, chairman of the Ways and Means
Committee, is facing scrutiny for not fully disclosing assets. The ethics
committee is also looking into ties between Rangel and a developer who
leased rent-controlled apartments to the congressman, and whether Rangel
improperly used his House office to raise funds for a public policy
institute in his name. Rangel and Murtha deny any wrongdoing. (Another
lawmaker under investigation: Rep. Jesse Jackson Jr., who, according to the
committee, "may have offered to raise funds" for then–Illinois governor Rod
Blagojevich in exchange for the president's Senate seat—a charge Jackson
denies. The panel deferred its probe at the request of the Justice
Department, which is conducting its own inquiry.)
Pelosi has said little about Rangel's
ethics problems, or those involving other Democrats; a Pelosi spokesman,
Brendan Daly, e-mails NEWSWEEK, "The speaker has said that [Rangel] should
not step aside while the independent, bipartisan ethics committee is
investigating."
But watchdog groups, not to mention
Republicans, are calling Pelosi hypocritical (as if
they weren't equally hypocritical)
since Democrats won back control of the House by, in part, trashing the
GOP's ethics lapses. Republicans already plan to use the ethics issue
against Democrats in 2010. Though Rangel and Murtha aren't as known as Tom
DeLay, the GOP poster boy for scandal in 2006, the party aims to change
that: this week the House GOP plans to introduce a resolution calling on
Rangel to resign his committee post.
Pelosi "promised to run the most ethical
Congress in history," says Ken Spain, a spokesman for the National
Republican Congressional Committee,
"and instead of cracking down on corruption, she
promotes it (to garner votes in Congress)."
Daly responds, "Since Democrats
took control of Congress, we have strengthened the ethics process." (Daly
has some magnificent ocean front property for sale in Arizona.)
"Can morality be brought to market?" by Prem Sikka, The Guardian,
October 7, 2009 ---
http://www.guardian.co.uk/commentisfree/2009/oct/07/bae-business-ethics-morality-markets
The
BAE bribery scandal has once again brought
discussions of business ethics to the fore. Politicians also claim to be
interested in promoting
morality in markets, but have not explained how
this can be achieved.
There is no shortage of
companies wrapping themselves in claims of ethical conduct to disarm
critics. BAE boasts a global
code of conduct, which claims that "its leaders
will act ethically, promote ethical conduct both within the company and in
the markets in which we operate". In the light of the revelations about the
way the company secured its business contracts, such claims must be doubted.
BAE is not alone. There is
a huge gap between corporate talk and action, and a few illustrations would
help to highlight this gap. KPMG is one of the world's biggest accountancy
firms. Its
global code of conduct states that the firm is
committed to "acting lawfully and ethically, and encouraging this behaviour
in the marketplace … maintaining independence and objectivity, and avoiding
conflicts of interest". Yet the firm created an extensive organisational
structure to devise
tax avoidance and tax evasion schemes. Former
managers have been
found guilty of tax evasion and the firm was fined
$456m for "criminal
wrongdoing".
The
global code of conduct of Ernst & Young, another
global accountancy firm, claims that "no client or external relationship is
more important than the ethics, integrity and reputation of Ernst & Young".
Partners and former partners of the firm have also been found
guilty of promoting tax evasion.
UBS, a leading bank, has
been fined $780m by the US authorities for
facilitating tax evasion, but it told the world
that "UBS upholds the law, respects regulations and behaves in a principled
way. UBS is self-aware and has the courage to face the truth. UBS maintains
the highest ethical standards."
British Airways paid a
fine of £270m after admitting
price fixing on fuel surcharges on its long-haul
flights while its
code of conduct promised that it would behave
responsibly and ethically towards its customers.
These are just a tiny sample that shows that
corporations say one thing but do something completely different. This
hypocrisy is manufactured by corporate culture, and unless that process is
changed there is no prospect of securing moral corporations or markets.
The key issue is that companies cannot buck the
systemic pressures to produce ever higher profits. Capitalism is not
accompanied by any moral guidance on how high these profits have to be, but
shareholders always demand more. Markets do not ask any questions about the
quality of profits or the human consequences of ever-rising returns. Behind
a wall of secrecy, company directors devise plans to fleece taxpayers and
customers to increase profits, and are rewarded through profit-related
remuneration schemes. The social system provides incentives for unethical
behaviour.
Within companies, daily routines encourage
employees to prioritise profit-making even if that is unethical. For
example, tax departments within major accountancy firms operate as profit
centres. The performance of their employees is assessed at regular
intervals, and those generating profits are rewarded with salary increases
and career advancements. In time, the routines of devising tax avoidance
schemes and other financial dodges become firmly established norms, and
employees are desensitised to the consequences.
With increasing public scepticism, and pressure
from consumer groups and non-governmental organisations (NGOs), companies
manage their image by publishing high-sounding statements. Ethics itself has
become big business, and armies of consultants and advisers are available
for hire to enable companies to manage their image. No questions are raised
about the internal culture or the economic incentives for misbehaviour. It
is far cheaper for companies to publish glossy brochures than to pay taxes
or improve customer and public welfare. The payment of fines has become just
another business cost.
Making capitalism ethical is a tough task – and
possibly a hopeless one. Any policy for
encouraging ethical corporate conduct has to change the nature of capitalism
and corporations so that companies are run for the benefit of all
stakeholders, rather than just shareholders. Pressures to change corporate
culture could be facilitated by closing down persistently offending
companies, imposing personal penalties on offending executives and offering
bounties to whistleblowers.
Some Great Role Models --- Ha! Ha!
"Dozens in Congress under ethics inquiry:
AN ACCIDENTAL DISCLOSURE Document was found on file-sharing network," by
Ellen Nakashima and Paul Kane, The Washington Post, October 30, 2009 ---
Click Here
The report appears
to have been inadvertently placed on a publicly accessible computer network,
and it was provided to The Washington Post by a source not connected to the
congressional investigations. The committee said Thursday night that the
document was released by a low-level staffer.
The ethics
committee is one of the most secretive panels in Congress, and its members
and staff members sign oaths not to disclose any activities related to its
past or present investigations. Watchdog groups have accused the committee
of not actively pursuing inquiries; the newly disclosed document indicates
the panel is conducting far more investigations than it had revealed.
Shortly after 6
p.m. Thursday, the committee chairman, Zoe Lofgren (D-Calif.), interrupted a
series of House votes to alert lawmakers about the breach. She cautioned
that some of the panel's activities are preliminary and not a conclusive
sign of inappropriate behavior.
"No inference
should be made as to any member," she said.
Rep. Jo Bonner
(Ala.), the committee's ranking Republican, said the breach was an isolated
incident.
The 22-page
"Committee on Standards Weekly Summary Report" gives brief summaries of
ethics panel investigations of the conduct of 19 lawmakers and a few staff
members. It also outlines the work of the new Office of Congressional
Ethics, a quasi-independent body that initiates investigations and provides
recommendations to the ethics committee. The document indicated that the
office was reviewing the activities of 14 other lawmakers. Some were under
review by both ethics bodies.
A broader inquiry
Ethics committee
investigations are not uncommon. Most result in private letters that either
exonerate or reprimand a member. In some rare instances, the censure is more
severe.
Many of the broad
outlines of the cases cited in the July document are known -- the committee
announced over the summer that it was reviewing lawmakers with connections
to the now-closed PMA Group, a lobbying firm. But the document indicates
that the inquiry was broader than initially believed. It included a review
of seven lawmakers on the House Appropriations defense subcommittee who have
steered federal money to the firm's clients and have also received large
campaign contributions.
The document also
disclosed that:
-- Ethics committee
staff members have interviewed House Ways and Means Chairman Charles B.
Rangel (D-N.Y.) about one element of the complex investigation of his
personal finances, as well as the lawmaker's top aide and his son. Rangel
said he spoke with ethics committee staff members regarding a conference
that he and four other members of the Congressional Black Caucus attended
last November in St. Martin. The trip initially was said to be sponsored by
a nonprofit foundation run by a newspaper. But the three-day event, at a
luxury resort, was underwritten by major corporations such as Citigroup,
Pfizer and AT&T. Rules passed in 2007, shortly after Democrats reclaimed the
majority following a wave of corruption cases against Republicans, bar
private companies from paying for congressional travel.
Rangel said he has
not discussed other parts of the investigation of his finances with the
committee. "I'm waiting for that, anxiously," he said.
The Justice
Department has told the ethics panel to suspend a probe of Rep. Alan B.
Mollohan (D-W.Va.), whose personal finances federal investigators began
reviewing in early 2006 after complaints from a conservative group that he
was not fully revealing his real estate holdings. There has been no public
action on that inquiry for several years. But the department's request in
early July to the committee suggests that the case continues to draw the
attention of federal investigators, who often ask that the House and Senate
ethics panels refrain from taking action against members whom the department
is already investigating.
Mollohan said that
he was not aware of any ongoing interest by the Justice Department in his
case and that he and his attorneys have not heard from federal
investigators. "The answer is no," he said.
-- The committee on
June 9 authorized issuance of subpoenas to the Justice Department, the
National Security Agency and the FBI for "certain intercepted
communications" regarding Rep. Jane Harman (D-Calif.). As was reported
earlier this year, Harman was heard in a 2005 conversation agreeing to an
Israeli operative's request to try to obtain leniency for two pro-Israel
lobbyists in exchange for the agent's help in lobbying House Speaker Nancy
Pelosi (D-Calif.) to name her chairman of the intelligence committee. The
department, a former U.S. official said, declined to respond to the
subpoena.
Harman said that
the ethics committee has not contacted her and that she has no knowledge
that the subpoena was ever issued. "I don't believe that's true," she said.
"As far as I'm concerned, this smear has been over for three years."
In June 2009, a
Justice Department official wrote in a letter to an attorney for Harman that
she was "neither a subject nor a target" of a criminal investigation.
Because of the
secretive nature of the ethics committee, it was difficult to assess the
current status of the investigations cited in the July document. The panel
said Thursday, however, that it is ending a probe of Rep. Sam Graves (R-Mo.)
after finding no ethical violations, and that it is investigating the
financial connections of two California Democrats.
The committee did
not detail the two newly disclosed investigations. However, according to the
July document, Rep. Maxine Waters, a high-ranking member of the House
Financial Services Committee, came under scrutiny because of activities
involving OneUnited Bank of Massachusetts, in which her husband owns at
least $250,000 in stock.
Waters arranged a
September 2008 meeting at the Treasury Department where OneUnited executives
asked for government money. In December, Treasury selected OneUnited as an
early participant in the bank bailout program, injecting $12.1 million.
The other, Rep.
Laura Richardson, may have failed to mention property, income and
liabilities on financial disclosure forms.
File-sharing
The committee's
review of investigations became available on file-sharing networks because
of a junior staff member's use of the software while working from home,
Lofgren and Bonner said in a statement issued Thursday night. The staffer
was fired, a congressional aide said.
The committee "is
taking all appropriate steps to deal with this issue," they said, noting
that neither the committee nor the House's information systems were breached
in any way.
"Peer-to-peer"
technology has previously caused inadvertent breaches of sensitive
financial, defense-related and personal data from government and commercial
networks, and it is prohibited on House networks.
House
administration rules require that if a lawmaker or staff member takes work
home, "all users of House sensitive information must protect the
confidentiality of sensitive information" from unauthorized disclosure.
Leo Wise, chief
counsel for the Office of Congressional Ethics, declined to comment, citing
office policy against confirming or denying the existence of investigations.
A Justice Department spokeswoman also declined to comment, citing a similar
policy.
The Most Criminal Class Writes the Laws ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#Lawmakers
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
This is the way most fraud arises on Wall
Street and it does not take even a high school education to understand how it
works
"Former RNC Finance Chair pleads guilty to $1 million bribery," by Mark
Hemingway, Washington Examiner, December 4, 2009 ---
http://www.washingtonexaminer.com/opinion/blogs/beltway-confidential/Former-RNC-Finance-Chair-pleads-guilty-to-1-million-bribery-78554297.html
Elliott Broidy, the former
Finance Chairman of the Republican National Committee, plead guilty
yesterday to offering $1 million bribes to officials with New York state's
pension funds. In return, Broidy got a $250 million investement in the Wall
Street firm he worked for:
Broidy, who also
resigned as chairman of Markstone Capital Partners, the private equity
firm, admitted that he had paid for luxury trips to hotels in Israel and
Italy for pension staffers and their relatives -- including first-class
flights and a helicopter tour. Broidy funneled the money through
charities and submitted false receipts to the state comptroller's office
to cover his tracks.
The California
financier, who was the GOP finance chairman in 2008, also paid thousands
of dollars toward rent and other expenses for former "Mod Squad" star
Peggy Lipton, who was dating a high-ranking New York pension official at
the time.
Broidy now faces up to four
years in jail and has to return some $18 million. Since the scandal with New
York's pension fund broke, it has so far led to five guilty pleas and $100
million in public funds have been returned. However, Pro-Publica -- which
has been doggedly covering the story -- notes that nothing has been done to
prevent future corruption:
The system that allowed
corruption to flourish in New York, where $110 billion in retirement
savings are controlled by a sole trustee with no board oversight, is
still in place.
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Are there any truly honest local, state, and
Federal officials ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#Lawmakers
"Obama Administration Steers Lucrative No-Bid Contract for Afghan Work to
Dem Donor," Free Republic, January 25, 2010 ---
http://www.freerepublic.com/focus/f-news/2436733/posts
Despite President Obama's long history of
criticizing the Bush administration for "sweetheart deals" with favored
contractors, the Obama administration this month awarded a $25 million
federal contract for work in Afghanistan to a company owned by a Democratic
campaign contributor without entertaining competitive bids, Fox News has
learned. The contract, awarded on Jan. 4 to Checchi & Company Consulting,
Inc., a Washington-based firm owned by economist and Democratic donor
Vincent V. Checchi, will pay the firm $24,673,427 to provide "rule of law
stabilization services" in war-torn Afghanistan.
"Big government's business cronies," by
John Stossel, WorldNetDaily, February 3, 2010 ---
http://www.wnd.com/index.php?fa=PAGE.view&pageId=123960
Many window-making
companies struggle because of the recession's effect on home building. But
one little window company, Serious Materials, is "booming,"
says Fortune. "On a roll," according to Inc.
magazine, which put Serious' CEO on its cover, with a story titled:
"How to Build a Great Company."
The
Minnesota Freedom Foundation tells me that this
same little window company also gets serious attention from the most visible
people in America.
Vice President Joe Biden
appeared at the opening of one of its plants. CEO Kevin Surace thanked him
for his "unwavering support." "Without you and the recovery ("stimulus")
act, this would not have been possible," Surace said.
Biden returned the
compliment: "You are not just churning out windows; you are making some of
the most energy-efficient windows in the world. I would argue the most
energy-efficient windows in the world."
Gee, other
window-makers say their windows are just as
energy
efficient,
but the vice president didn't visit them.
Biden laid it on pretty
thick for Serious Materials: "This is a story of how a new economy
predicated on innovation and efficiency is not only helping us today but
inspiring a better tomorrow."
Serious doesn't just
have the vice president in his corner. It's got President Obama himself.
Milton Friedman's classic "Capitalism and Freedom" explains how individual
liberty can only thrive when accompanied by economic liberty
Company board member Paul
Holland had the rare of honor of introducing Obama at a "green energy"
event. Obama then said: "Serious Materials just reopened ... a manufacturing
plant outside of Pittsburgh. These workers will now have a new mission:
producing some of the most energy-efficient windows in the world."
How many companies get
endorsed by the president of the United States?
When the CEO said that
opening his factory wouldn't have been possible without the Obama
administration, he may have known something we didn't. Last month, Obama
announced a new set of tax credits for so-called green companies. One window
company was on the list: Serious Materials. This must be one very special
company.
But wait, it gets even more
interesting.
On my Fox
Business
Network
show on
"crony capitalism," I displayed a picture of
administration officials and so-called "energy leaders" taken at the U.S.
Department of Energy. Standing front and center was Cathy Zoi, who oversees
$16.8 billion in stimulus
funds,
much of it for weatherization programs that benefit Serious.
The interesting twist is
that Zoi happens to be the wife of Robin Roy, who happens to be vice
president of "policy" at Serious Windows.
Of all the window companies
in America, maybe it's a coincidence that the one that gets presidential and
vice presidential attention and a special tax credit is one whose company
executives give thousands of dollars to the Obama campaign and where the
policy officer spends nights at home with the Energy Department's
weatherization boss.
Or maybe not.
There may be nothing illegal
about this. Zoi did disclose her marriage and said she would recuse herself
from any matter that had a predictable effect on her financial interests.
But it sure looks funny to
me, and it's odd that the liberal media have so much interest in this one
company. Rachel Maddow of MSNBC, usually not a big promoter of corporate
growth, gushed about how Serious Materials is an example of how the
"stimulus" is working.
When we asked the company
about all this, a spokeswoman said, "We don't comment on the personal lives
of our employees." Later she called to say that my story is "full of lies."
But she wouldn't say what
those lies are.
On its website, Serious
Materials says it did not get a taxpayer subsidy. But that's just playing
with terms. What it got was a tax credit, an opportunity that its
competitors did not get: to keep money it would have paid in taxes. Let's
not be misled. Government is as manipulative with selective tax credits as
it is with cash subsidies. It would be more efficient to cut taxes across
the board. Why should there be favoritism?
Because politicians
like it. Big, complicated government gives them opportunities to do favors
for their friends.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/fraudUpdates.htm
The
Greatest Swindle in the History of the World
Paulson and Geithner Lied Big Time
"The
Ugly AIG Post-Mortem: The TARP Inspector General's report has a lot more to say
about the rating agencies than it does about Goldman Sachs," by Holman
Jenkins, The Wall Street Journal, November 24m 2009 ---
Click Here
A year later, the myrmidons of the media have gotten around to the question of
why, after the government took over AIG, it paid 100 cents on the dollar to
honor the collateral demands of AIG's subprime insurance counterparties.
By all means, read TARP Inspector General Neil Barofsky's report on the AIG
bailout—but read it honestly.
It does not say AIG's bailout was a "backdoor bailout" of Goldman Sachs. It does
not say the Fed was remiss in failing to require Goldman and other
counterparties to settle AIG claims for pennies on the dollar.
It does not for a moment doubt the veracity of officials who say their concern
was to stem a systemic panic that might have done lasting damage to the U.S.
standard of living.
To be sure, Mr. Barofsky has some criticisms to offer, but the biggest floats
inchoate between the lines of a widely overlooked section headed "lessons
learned," which focuses on the credit rating agencies. The section notes not
only the role of the rating agencies, with their "inherently conflicted business
model," in authoring the subprime mess in the first place—but also the role of
their credit downgrades in tipping AIG into a liquidity crisis, in undermining
the Fed's first attempt at an AIG rescue, and in the decision of government
officials "not to pursue a more aggressive negotiating policy to seek
concessions from" AIG's counterparties.
Though not quite spelling it out, Mr. Barofsky here brushes close to the last
great unanswered question about the AIG bailout. Namely: With the government now
standing behind AIG, why not just tell Goldman et al. to waive their collateral
demands since they now had the world's best IOU—Uncle Sam's?
Congress might not technically have put its full faith and credit behind AIG,
but if banks agreed to accept this argument, and Treasury and Fed insisted on
it, and the SEC upheld it, the rating agencies would likely have gone along. No
cash would have had to change hands at all.
This didn't happen, let's guess, because the officials—Hank Paulson, Tim
Geithner and Ben Bernanke—were reluctant to invent legal and policy authority
out of whole cloth to overrule the ratings agencies—lo, the same considerations
that also figured in their reluctance to dictate unilateral haircuts to holders
of AIG subprime insurance.
Of course, the thinking now is that these officials, in bailing out AIG, woulda,
shoulda, coulda used their political clout to force such haircuts, but quailed
when the banks, evil Goldman most of all, insisted on 100 cents on the dollar.
This story, in its gross simplification, is certainly wrong. Goldman and others
weren't in the business of voluntarily relinquishing valuable claims. But the
reality is, in the heat of the crisis, they would have acceded to any terms the
government dictated. Washington's game at the time, however, wasn't to
nickel-and-dime the visible cash transfers to AIG. It was playing for bigger
stakes—stopping a panic by asserting the government's bottomless resources to
uphold the IOUs of financial institutions.
What's more, if successful, these efforts were certain to cause the
AIG-guaranteed securities to rebound in value—as they have. Money has already
flowed back to AIG and the Fed (which bought some of the subprime securities to
dissolve the AIG insurance agreements) and is likely to continue to do so for
the simple reason that the underlying payment streams are intact.
Never mind: The preoccupation with the Goldman payments amounts to a misguided
kind of cash literalism. For the taxpayer has assumed much huger liabilities to
keep homeowners in their homes, to keep mortgage payments flowing to investors,
to fatten the earnings of financial firms, etc., etc. These liabilities dwarf
the AIG collateral calls, inevitably benefit Goldman and other firms, and
represent the real cost of our failure to create a financial system in which
investors (a category that includes a lot more than just Goldman) live and die
by the risks they voluntarily take without taxpayers standing behind them.
No, Moody's and S&P are not the cause of this policy failure—yet Mr. Barofsky's
half-articulated choice to focus on them is profound. For the role the agencies
have come to play in our financial system amounts to a direct, if feckless and
weak, attempt to contain the incentives that flow from the government's
guaranteeing of so many kinds of private liabilities, from the pension system
and bank deposits to housing loans and student loans.
The rating agencies' role as gatekeepers to these guarantees is, and was,
corrupting, but the solution surely is to pare back the guarantees themselves.
Overreliance on rating agencies, with their "inherently conflicted business
model," was ultimately a product of too much government interference in the
allocation of credit in the first place.
The Mother
of Future Lawsuits Directly Against Credit Rating Agencies and I, ndirectly
Against Auditing Firms
It has
been shown how Moody's and some other credit rating agencies sold AAA ratings
for securities and tranches that did not deserve such ratings ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
Also see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
My friend
Larry sent me the following link indicating that a lawsuit in Ohio may shake up
the credit rating fraudsters.
Will 49 other states and thousands of pension funds follow suit?
Already facing a spate of private lawsuits, the
legal troubles of the country’s largest credit rating agencies deepened on
Friday when the attorney general of Ohio sued
Moody’s Investors Service,
Standard & Poor’s and
Fitch, claiming that they had cost state
retirement and pension funds some $457 million by approving high-risk Wall
Street securities that went bust in the financial collapse.
http://www.nytimes.com/2009/11/21/business/21ratings.html?em
Jensen
Comment
The credit raters will rely heavily on the claim that they relied on the
external auditors who, in turn, are being sued for playing along with fraudulent
banks that grossly underestimated loan loss reserves on poisoned subprime loan
portfolios and poisoned tranches sold to investors ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Bad things happen in court where three or more parties start blaming each other
for billions of dollars of losses that in many cases led to total bank failures
and the wiping out of all the shareholders in those banks, including the pension
funds that invested in those banks. A real test is the massive lawsuit against
Deloitte's auditors in the huge Washington Mutual (WaMu) shareholder lawsuit.
"Ohio Sues
Rating Firms for Losses in Funds," by David Segal, The New York Times,
November 20m 2009 ---
Click Here
Already facing a spate of private lawsuits, the legal troubles of the country’s
largest credit rating agencies deepened on Friday when the attorney general of
Ohio sued Moody’s Investors Service, Standard & Poor’s and Fitch, claiming that
they had cost state retirement and pension funds some $457 million by approving
high-risk Wall Street securities that went bust in the financial collapse.
Already facing a spate of private lawsuits, the legal troubles of the country’s
largest credit rating agencies deepened on Friday when the attorney general of
Ohio sued Moody’s Investors Service, Standard & Poor’s and Fitch, claiming that
they had cost state retirement and pension funds some $457 million by approving
high-risk Wall Street securities that went bust in the financial collapse.
The case could test whether the agencies’ ratings are constitutionally protected
as a form of free speech.
The lawsuit asserts that Moody’s, Standard & Poor’s and Fitch were in league
with the banks and other issuers, helping to create an assortment of exotic
financial instruments that led to a disastrous bubble in the housing market.
“We believe that the credit rating agencies, in exchange for fees, departed from
their objective, neutral role as arbiters,” the attorney general, Richard
Cordray, said at a news conference. “At minimum, they were aiding and abetting
misconduct by issuers.”
He accused the companies of selling their integrity to the highest bidder.
Steven Weiss, a spokesman for McGraw-Hill, which owns S.& P., said that the
lawsuit had no merit and that the company would vigorously defend itself.
“A recent Securities and Exchange Commission examination of our business
practices found no evidence that decisions about rating methodologies or models
were based on attracting market share,” he said.
Michael Adler, a spokesman for Moody’s, also disputed the claims. “It is
unfortunate that the state attorney general, rather than engaging in an
objective review and constructive dialogue regarding credit ratings, instead
appears to be seeking new scapegoats for investment losses incurred during an
unprecedented global market disruption,” he said.
A spokesman for Fitch said the company would not comment because it had not seen
the lawsuit.
The litigation adds to a growing stack of lawsuits against the three largest
credit rating agencies, which together command an 85 percent share of the
market. Since the credit crisis began last year, dozens of investors have sought
to recover billions of dollars from worthless or nearly worthless bonds on which
the rating agencies had conferred their highest grades.
One of those groups is largest pension fund in the country, the California
Public Employees Retirement System, which filed a lawsuit in state court in
California in July, claiming that “wildly inaccurate ratings” had led to roughly
$1 billion in losses.
And more litigation is likely. As part of a broader financial reform, Congress
is considering provisions that make it easier for plaintiffs to sue rating
agencies. And the Ohio attorney general’s action raises the possibility of
similar filings from other states. California’s attorney general, Jerry Brown,
said in September that his office was investigating the rating agencies, with an
eye toward determining “how these agencies could get it so wrong and whether
they violated California law in the process.”
As a group, the attorneys general have proved formidable opponents, most notably
in the landmark litigation and multibillion-dollar settlement against tobacco
makers in 1998.
To date, however, the rating agencies are undefeated in court, and aside from
one modest settlement in a case 10 years ago, no one has forced them to hand
over any money. Moody’s, S.& P. and Fitch have successfully argued that their
ratings are essentially opinions about the future, and therefore subject to
First Amendment protections identical to those of journalists.
But that was before billions of dollars in triple-A rated bonds went bad in the
financial crisis that started last year, and before Congress extracted a number
of internal e-mail messages from the companies, suggesting that employees were
aware they were giving their blessing to bonds that were all but doomed. In one
of those messages, an S.& P. analyst said that a deal “could be structured by
cows and we’d rate it.”
Recent cases, like the suit filed Friday, are founded on the premise that the
companies were aware that investments they said were sturdy were dangerously
unsafe. And if analysts knew that they were overstating the quality of the
products they rated, and did so because it was a path to profits, the ratings
could forfeit First Amendment protections, legal experts say.
“If they hold themselves out to the marketplace as objective when in fact they
are influenced by the fees they are receiving, then they are perpetrating a
falsehood on the marketplace,” said Rodney A. Smolla, dean of the Washington and
Lee University School of Law. “The First Amendment doesn’t extend to the
deliberate manipulation of financial markets.”
The 73-page complaint, filed on behalf of Ohio Police and Fire Pension Fund, the
Ohio Public Employees Retirement System and other groups, claims that in recent
years the rating agencies abandoned their role as impartial referees as they
began binging on fees from deals involving mortgage-backed securities.
At the root of the problem, according to the complaint, is the business model of
rating agencies, which are paid by the issuers of the securities they are paid
to appraise. The lawsuit, and many critics of the companies, have described that
arrangement as a glaring conflict of interest.
“Given that the rating agencies did not receive their full fees for a deal
unless the deal was completed and the requested rating was provided,” the
attorney general’s suit maintains, “they had an acute financial incentive to
relax their stated standards of ‘integrity’ and ‘objectivity’ to placate their
clients.”
To complicate problems in the system of incentives, the lawsuit states, the
methodologies used by the rating agencies were outdated and flawed. By the time
those flaws were obvious, nearly half a billion dollars in pension and
retirement funds had evaporated in Ohio, revealing the bonds to be “high-risk
securities that both issuers and rating agencies knew to be little more than a
house of cards,” the complaint states.
"Rating
agencies lose free-speech claim," by Jonathon Stempel, Reuters,
September 3, 2009 ---
http://www.reuters.com/article/GCA-CreditCrisis/idUSTRE5824KN20090903
There are two superpowers in the world today in my opinion. There’s the United
States and there’s Moody’s Bond Rating Service. The United States can destroy
you by dropping bombs, and Moody’s can destroy you by down grading your bonds.
And believe me, it’s not clear sometimes who’s more powerful. The most that we
can safely assert about the evolutionary process underlying market equilibrium
is that harmful heuristics, like harmful mutations in nature, will die out.
Martin Miller, Debt and Taxes as quoted by Frank Partnoy, "The Siskel and Ebert
of Financial Matters: Two Thumbs Down for Credit Reporting Agencies,"
Washington University Law Quarterly, Volume 77, No. 3, 1999 ---
http://faculty.trinity.edu/rjensen/FraudCongressPartnoyWULawReview.htm
Credit rating agencies gave AAA ratings to mortgage-backed securities that
didn't deserve them. "These ratings not only gave false comfort to investors,
but also skewed the computer risk models and regulatory capital computations,"
Cox said in written testimony.
SEC Chairman Christopher Cox as quoted on October 23, 2008 at
http://www.nytimes.com/external/idg/2008/10/23/23idg-Greenspan-Bad.html
"How
Moody's sold its ratings - and sold out investors," by Kevin G. Hall,
McClatchy Newspapers, October 18, 2009 ---
http://www.mcclatchydc.com/homepage/story/77244.html
Paulson
and Geithner Lied Big Time: The
Greatest Swindle in the History of the World
What was their real motive in the greatest fraud conspiracy in the history of
the world?
Bombshell: In 2008 and early 2009, Treasury Secretary leaders
Paulson and
Geithner told the media and Congress that
AIG needed a global bailout due to not having cash reserves to meet credit
default swap (systematic risk) obligations and insurance policy payoffs. On
November 19, 2009 in Congressional testimony Geithner now admits that all this
was a pack of lies. However, he refuses to resign as requested by some Senators.
"AIG and
Systemic Risk Geithner says credit-default swaps weren't the problem, after
all," Editors of The Wall Street Journal, November 20, 2009 ---
Click Here
TARP Inspector General Neil Barofsky keeps committing flagrant acts of
political transparency, which if nothing else ought to inform the debate
going forward over financial reform. In his latest bombshell, the IG
discloses that the New York Federal Reserve did not believe that AIG's
credit-default swap (CDS) counterparties posed a systemic financial risk.
Hello?
For the last year, the entire Beltway theory of the financial panic has been
based on the claim that the "opaque," unregulated CDS market had forced the
Fed to take over AIG and pay off its counterparties, lest the system
collapse. Yet we now learn from Mr. Barofsky that saving the counterparties
was not the reason for the bailout.
In the fall of 2008 the New York Fed drove a baby-soft bargain with AIG's
credit-default-swap counterparties. The Fed's taxpayer-funded vehicle,
Maiden Lane III, bought out the counterparties' mortgage-backed securities
at 100 cents on the dollar, effectively canceling out the CDS contracts.
This was miles above what those assets could have fetched in the market at
that time, if they could have been sold at all.
The New York Fed president at the time was none other than Timothy Geithner,
the current Treasury Secretary, and Mr. Geithner now tells Mr. Barofsky that
in deciding to make the counterparties whole, "the financial condition of
the counterparties was not a relevant factor."
This is startling. In April we noted in these columns that Goldman Sachs, a
major AIG counterparty, would certainly have suffered from an AIG failure.
And in his latest report, Mr. Barofsky comes to the same conclusion. But if
Mr. Geithner now says the AIG bailout wasn't driven by a need to rescue CDS
counterparties, then what was the point? Why pay Goldman and even foreign
banks like Societe Generale billions of tax dollars to make them whole?
Both Treasury and the Fed say they think it would have been inappropriate
for the government to muscle counterparties to accept haircuts, though the
New York Fed tried to persuade them to accept less than par. Regulators say
that having taxpayers buy out the counterparties improved AIG's liquidity
position, but why was it important to keep AIG liquid if not to protect some
class of creditors?
Yesterday, Mr. Geithner introduced a new explanation, which is that AIG
might not have been able to pay claims to its insurance policy holders: "AIG
was providing a range of insurance products to households across the
country. And if AIG had defaulted, you would have seen a downgrade leading
to the liquidation and failure of a set of insurance contracts that touched
Americans across this country and, of course, savers around the world."
Yet, if there is one thing that all observers seemed to agree on last year,
it was that AIG's money to pay policyholders was segregated and safe inside
the regulated insurance subsidiaries. If the real systemic danger was the
condition of these highly regulated subsidiaries—where there was no CDS
trading—then the Beltway narrative implodes.
Interestingly, in Treasury's official response to the Barofsky report,
Assistant Secretary Herbert Allison explains why the department acted to
prevent an AIG bankruptcy. He mentions the "global scope of AIG, its
importance to the American retirement system, and its presence in the
commercial paper and other financial markets." He does not mention CDS.
All of this would seem to be relevant to the financial reform that Treasury
wants to plow through Congress. For example, if AIG's CDS contracts were not
the systemic risk, then what is the argument for restructuring the
derivatives market? After Lehman's failure, CDS contracts were quickly
settled according to the industry protocol. Despite fears of systemic risk,
none of the large banks, either acting as a counterparty to Lehman or as a
buyer of CDS on Lehman itself, turned out to have major exposure.
More broadly, lawmakers now have an opportunity to dig deeper into the
nature of moral hazard and the restoration of a healthy financial system.
Barney Frank and Chris Dodd are pushing to give regulators "resolution
authority" for struggling firms. Under both of their bills, this would mean
unlimited ability to spend unlimited taxpayer sums to prevent an unlimited
universe of firms from failing.
Americans know that's not the answer, but what is the best solution to the
too-big-to-fail problem? And how exactly does one measure systemic risk? To
answer these questions, it's essential that we first learn the lessons of
2008. This is where reports like Mr. Barofsky's are valuable, telling us
things that the government doesn't want us to know.
In remarks Tuesday that were interpreted as a veiled response to Mr.
Barofsky's report, Mr. Geithner said, "It's a great strength of our country,
that you're going to have the chance for a range of people to look back at
every decision made in every stage in this crisis, and look at the quality
of judgments made and evaluate them with the benefit of hindsight." He
added, "Now, you're going to see a lot of conviction in this, a lot of
strong views—a lot of it untainted by experience."
Mr. Geithner has a point about Monday-morning quarterbacking. He and others
had to make difficult choices in the autumn of 2008 with incomplete
information and often with little time to think, much less to reflect. But
that was last year. The task now is to learn the lessons of that crisis and
minimize the moral hazard so we can reduce the chances that the panic and
bailout happen again.
This means a more complete explanation from Mr. Geithner of what really
drove his decisions last year, how he now defines systemic risk, and why he
wants unlimited power to bail out creditors—before Congress grants the
executive branch unlimited resolution authority that could lead to bailouts
ad infinitum.
Jensen
Comment
One of the first teller of lies was the highly respected Gretchen Morgenson of
The New York Times who was repeating the lies told to her and Congress by
the Treasury and the Fed. This was when I first believed that the problem at AIG
was failing to have capital reserves to meet CDS obligations. I really believed
Morgenson's lies in 2008 ---
http://www.nytimes.com/2008/09/21/business/21gret.html
Here's
what I wrote in 2008 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Credit Default Swap (CDS)
This is an insurance policy that essentially "guarantees" that if a CDO goes bad
due to having turds mixed in with the chocolates, the "counterparty" who
purchased the CDO will recover the value fraudulently invested in turds. On
September 30, 2008 Gretchen Morgenson of The New York Times aptly
explained that the huge CDO underwriter of CDOs was the insurance firm called
AIG. She also explained that the first $85 billion given in bailout money by
Hank Paulson to AIG was to pay the counterparties to CDS swaps. She also
explained that, unlike its casualty insurance operations, AIG had no capital
reserves for paying the counterparties for the the turds they purchased from
Wall Street investment banks.
"Your
Money at Work, Fixing Others’ Mistakes," by Gretchen Morgenson, The New York
Times, September 20, 2008 ---
http://www.nytimes.com/2008/09/21/business/21gret.html
Also see "A.I.G., Where Taxpayers’ Dollars Go to Die," The New York Times,
March 7, 2009 ---
http://www.nytimes.com/2009/03/08/business/08gret.html
What Ms.
Morgenson failed to explain, when Paulson eventually gave over $100 billion for
AIG's obligations to counterparties in CDS contracts, was who were the
counterparties who received those bailout funds. It turns out that most of them
were wealthy Arabs and some Asians who we were getting bailed out while Paulson
was telling shareholders of WaMu, Lehman Brothers, and Merrill Lynch to eat
their turds.
You tube
had a lot of videos about a CDS. Go to YouTube and read in the phrase "credit
default swap" ---
http://www.youtube.com/results?search_query=Credit+Default+Swaps&search_type=&aq=f
In particular note this video by Paddy Hirsch ---
http://www.youtube.com/watch?v=kaui9e_4vXU
Paddy has some other YouTube videos about the financial crisis.
Bob
Jensen’s threads on accounting for credit default swaps are under the C-Terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
The
Greatest Swindle in the History of the World
"The
Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print
Bob
Jensen's threads on why the infamous "Bailout" won't work ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#BailoutStupidity
More on the unfunded entitlements that Congress simply added to Social
Security and Medicare hemorrhages
This may well affect payroll tax increases in the future
"Determining which employees are disabled under the new ADA regulations,"
AccountingWeb, November 19, 2009 ---
http://www.accountingweb.com/topic/cfo/determining-which-employees-are-disabled-under-new-ada-regulations
Wading into the depths of the Americans
with Disabilities Act of 1990 to determine who is disabled and who is not
has never been a simple task for employers or their employees. On January 1,
2009 amendments to the Act took effect but the new amendments left many
unanswered questions. Now, as instructed by Congress, the U.S. Equal
Employment Commission has proposed rules designed to bring some clarity to
both employers and employees.
Whether that actually occurs remains to be
seen, but it is imperative for companies to become familiar with the
proposed rules, which represent some significant departures from the past.
Why? Consider several scenarios and try to determine in which cases an
employee is considered disabled and must be offered a reasonable
accommodation:
A: An employee with post-traumatic stress
disorder; B: An employee with cancer who is currently in remission; C: An
employee with asthma that they treat with an inhaler; or D: An employee who
wears contact lenses.
According to the EEOC's proposed rules,
the answers are yes, yes, yes, and no. The rules are still being debated,
but employers must make sure they understand which impairments may qualify
as a disability, which may not and how to determine what falls into either
category.
The Revised ADA Regulations
When the ADA Amendments Act of 2008 (ADAAA)
took effect at the beginning of 2009, it brought some significant changes to
the way that disabilities could be interpreted, even though it made few
changes to the definition of a disability.
Under the ADAAA, a disability remains "an
impairment that substantially limits one or more major life activities, a
record of such an impairment, or being regarded as having such an
impairment."
However, the new law made several
important changes, which have spurred the EEOC's proposed rules. Those
changes include:
Expanding the definition of major life
activities to include walking, reading, and many major bodily functions,
such as the immune system, normal cell growth, digestive, bowel, bladder,
neurological, brain, respiratory, circulatory, endocrine, and reproductive
functions. Ordering employers to not consider mitigating measures other than
regular eyeglasses or contact lenses when determining whether an individual
has a disability. Clarifying that an impairment that is episodic or in
remission is a disability if it would substantially limit a major life
activity when the impairment is active – that is, employees are disabled
even if they are not showing symptoms of their disease, if the disease would
qualify as a disability when the employee is experiencing symptoms.
The EEOC Weighs In
When the law was passed, the EEOC was
directed to evaluate how employers should interpret the changes in the ADAAA,
employees, and job applicants. In September, the commission did so when it
issued its Notice of Proposed Rulemaking. According to the commission, the
proposed rules – like the amended ADA – are meant to offer broad coverage to
disabled individuals to the maximum extent allowed. The intent of the EEOC
seems clear – the issue should be less about whether an employee or job
applicant has a disability and more about whether discrimination has
occurred.
The EEOC has also included a specific
laundry list of impairments that "consistently meet" the definition of a
disability – a list that is far more extensive than in the past. There are
several other important aspects of the proposed rules, which are still being
debated. Those aspects include:
Along with the list of impairments that
consistently meet the definition of a disability, the proposed rules include
examples of impairments that require more analysis to determine whether they
are, in fact, disabilities, since these impairments may cause more
difficulties for some than others. Impairments that are episodic or in
remission, including epilepsy, cancer, and many kinds of psychiatric
impairments, are disabilities if they would "substantially limit" major life
activities when active. "Major life activities" include caring for oneself,
performing manual tasks, seeing, hearing, eating, sleeping, walking,
standing, sitting, reaching, lifting, bending, speaking, breathing,
learning, reading, concentrating, thinking, communicating, interacting with
others, and working.
Three of these – reaching, interacting
with others, and sitting – are seen for the first time in the proposed rules
and are not listed in the ADAAA. This is not an exhaustive list, according
to the commission.
The proposed rules also include a
specific, non-exhaustive list of major bodily functions that constitute
major life activities, including several – special sense organs and skin,
genitourinary, cardiovascular, hemic, lymphatic, and musculoskeletal – that
are new under the EEOC proposed rules.
· The proposed rules change the definition
of "substantially limits." Under the new regulations, a person is regarded
as disabled if an impairment substantially limits his or her ability to
perform a major life activity compared to what "most people in the general
population" could perform. This is a change from the old regulations, which
define a disability as one that substantially limits how a person can
perform a major life activity compared to "average person in the general
population" can perform an activity.
According to the EEOC, an impairment
doesn't need to prevent or severely restrict an individual from performing a
major life activity. Those tests were too demanding, according to the
proposed rules. Now, employers should rely on a common-sense assessment,
based on how an employee's or applicant's ability to perform a major life
function compares with most people in the general population.
In good news for employers, the proposed
rules do say that temporary, non-chronic impairments that do not last long
and that leave little or no residual effects are usually not considered
disabilities. Prior factors for considering whether an impairment is
substantially limiting, such as the nature, severity and duration of the
impairment, as well as long-term and permanent effects, have been removed.
According to the EEOC, at most, an extra
one million workers may consider themselves to be disabled under the
proposed rules. While that may not seem like many to the commission,
businesses must prepare themselves.
Education and communication are the most
important steps employers can take to prevent discriminations lawsuits from
those claiming disabilities. Employers must educate themselves about the
proposed rules and how those may change when they are ultimately approved.
Employers must also educate their
employees about changes to the ADA and the EEOC's interpretation of the act.
Human resources personnel, managers, and supervisors should be trained to
respond to employees who seek a reasonable accommodation to their
impairment. Employees should receive training, so they know the correct
channels to go through if they believe an impairment qualifies as a
disability. Formalized training, with employee sign-offs, can help to
protect employers from discrimination claims.
They should be working with legal counsel
to update all of their training manuals and employee handbooks, in light of
the new regulations and proposed rules.
With the shift to a broader definition of
disability, employers must brace for the possibility of an increasing number
of claims. They must also work to ensure that they are not inadvertently
discriminating against anyone who now qualifies as disabled.
Bob Jensen's threads on unfunded entitlements ---
http://faculty.trinity.edu/rjensen/entitlements.htm
"Pay-to-Play Torts Pension middlemen get
investigated; lawyers get a pass," The Wall Street Journal, October
31, 2009 ---
http://online.wsj.com/article/SB10001424052748704107204574473310387443816.html?mod=djemEditorialPage
Pay-to-play schemes
involving public officials and the pension funds they oversee are finally
getting the hard look they deserve. Some 36 states are investigating how
financial brokers and other middlemen have used kickbacks and campaign
contributions to gain access to retirement funds. Now if only plaintiffs law
firms would get the same scrutiny.
Like investment funds,
class-action law firms hire intermediaries to help win state business. But
the more common practice is for plaintiffs lawyers to make campaign
contributions to public officials with the goal of being selected by those
same officials to represent the pension fund in securities litigation.
These enormous state funds
are among the world's largest institutional investors, and they frequently
sue companies on behalf of shareholders. The role of pension funds in such
suits became all the more important after the securities-law reform of 1995
that limited the ability of some plaintiffs to file shareholder lawsuits. So
plaintiffs law firms have worked especially hard to turn these pension funds
into business partners in their pursuit of class action riches.
The law firms typically
agree to take the cases on a contingency basis that means no fees up front
but a huge share (30% or more) of any settlement or jury verdict. However,
attorneys suing on the government's behalf are supposed to be neutral actors
whose goal is justice, not lining their own pockets. When for-profit lawyers
are involved with a contingency fee at the end of the lawsuit rainbow, the
incentives shift toward settling to get a big payday.
This month, the New York
Daily News reported that the lawyers representing New York state's $116.5
billion pension fund have received more than a half-billion dollars in
contingency fees over the past decade. Meanwhile, state Comptroller Thomas
DiNapoli, the fund's sole trustee, "has raked in more than $200,000 in
campaign cash from law firms looking to represent the state's pension fund
in big-money suits," the paper reported. Attorneys from one Manhattan firm,
Labaton Sucharow, gave Mr. DiNapoli $47,500 in December 2008, only months
after he chose the firm as lead counsel in a class action suit against
Countrywide Financial. Mr. DiNapoli's office says firms that give money
don't get preferential treatment.
The Empire State is hardly
unusual. Labaton Sucharow has given more than $58,000 to Massachusetts State
Treasurer Timothy Cahill, who recently announced his gubernatorial bid. The
Labaton firm is representing state and county pension funds in more than a
dozen security class action lawsuits.
The Louisiana State
Employees' Retirement System is among the most litigious in the nation. John
Kennedy, the state treasurer who helps decide when Louisiana's major pension
funds should bring a law suit, has received tens of thousands of dollars in
political donations from Bernstein Litowitz, which has offices in New York,
New Orleans and San Diego and was the country's top-grossing securities
class-action firm in 2008. The law firm has represented Louisiana's public
pension funds at least 13 times since 2004, and its partners donated nearly
$30,000 to Mr. Kennedy's two most recent campaigns, even though he ran
unopposed both times.
In Mississippi, the state
attorney general determines when the public employees retirement fund should
bring a securities class action and which outside firms will represent the
fund. Would you be shocked to learn that AG Jim Hood has frequently chosen
law firms that have donated to his campaigns?
Mr. Hood is also partial to
Bernstein Litowitz. On February 21, 2006, he chose the firm to represent the
Mississippi Public Employees Retirement Fund in a securities class action
against Delphi Corporation—just days after receiving $25,000 in donations
from Bernstein Litowitz attorneys. The suit was eventually settled, and the
lawyers on the case received $40.5 million in fees. Mr. Hood's campaign
would appear to deserve a raise.
Back in New York, Attorney
General Andrew Cuomo has garnered banner headlines and much praise for his
pay-to-play pension fund probe that has already led to four guilty pleas by
investors and politicians. Good for him. Yet when asked about pursuing the
trial bar for similar behavior, his office says it has no jurisdiction to go
after law firms in class action suits. He could at least turn down their
campaign money, however.
Mr. Cuomo's campaign happens
to have received $200,000 from securities law firms. Perhaps it's merely a
coincidence that the expected candidate for governor in 2010 doesn't want to
investigate his funders. Mr. Cuomo recently proposed legislation that puts
restrictions on campaign donations from investment firms seeking pension
business. His proposal does not seek the same restrictions on securities law
firms. Perhaps that's another coincidence.
If Mr. Cuomo won't
investigate pay-to-play torts on his own, then someone else should
investigate Mr. Cuomo's relationship with these pay-to-play law firms.
Once again, the power of pork to sustain incumbents
gets its best demonstration in the person of John Murtha (D-PA). The
acknowledged king of earmarks in the House gains the attention of the New York
Times editorial board today, which notes the cozy and lucrative relationship
between more than two dozen contractors in Murtha's district and the hundreds of
millions of dollars in pork he provided them. It also highlights what roughly
amounts to a commission on the sale of Murtha's power as an appropriator: Mr.
Murtha led all House members this year, securing $162 million in district
favors, according to the watchdog group Taxpayers for Common Sense. ... In 1991,
Mr. Murtha used a $5 million earmark to create the National Defense Center for
Environmental Excellence in Johnstown to develop anti-pollution technology for
the military. Since then, it has garnered more than $670 million in contracts
and earmarks. Meanwhile it is managed by another contractor Mr. Murtha helped
create, Concurrent Technologies, a research operation that somehow was allowed
to be set up as a tax-exempt charity, according to The Washington Post. Thanks
to Mr. Murtha, Concurrent has boomed; the annual salary for its top three
executives averages $462,000.
Edward Morrissey, Captain's Quarters, January 14, 2008 ---
http://www.captainsquartersblog.com/mt/archives/016617.php
Many Colleges Turn
Their Ears Toward Congress
Higher education leaders
have long had a love-hate
relationship with earmarks.
On the one hand, they’re
regularly derided by critics
as fostering the waste of
tax dollars and encouraging
a sometimes secretive
circumvention of peer review
in ways that do not
necessarily produce the best
science. But the fact
remains that colleges and
the research initiatives
they house have been among
the key recipients of the
dollars, which some argue
level the research playing
field for less-prestigious
institutions. Public
university presidents
regularly pass through
Washington to lobby their
members of Congress for the
grants; on Monday alone, two
who met with Inside Higher
Ed’s editors boasted that
that was a primary reason
for their visits to town.
Although many members of
Congress defend the grants
as a way for them to reward
constituents who do good
work but are disadvantaged
for a variety of reasons in
traditional competitions for
funds, the grants have come
under increasing scrutiny
from budget hawks and “good
government” types who see
the earmarks as wasteful.
Congress has made several
changes in law and policy
aimed at improving
disclosure of the grants,
with the goal of
embarrassing lawmakers into
providing fewer of them. But
that strategy appears to
have failed miserably so
far; in its 2008 spending
bills, Congress funded
11,000 noncompetitive
projects worth $14 billion —
half the amount delivered in
2007, but about 1,000 more
grants than awarded that
year.
Doug Lederman, 'Bush on
Earmarks: Tough Words,
Little Meaning," Inside
Higher Ed, January 29,
2008 ---
http://www.insidehighered.com/news/2008/01/29/bush
A company owned by a nephew of Rep. John Murtha
received $4 million from the Defense Department last year for engineering and
warehouse services, The Washington Post reported Tuesday. Murtha, D-Pa., is
chairman of the House Appropriations defense subcommittee. Murtech Inc., based
on Glen Burnie, Md., is owned by the congressman's nephew Robert C. Murtha Jr.,
who told the Post the company provides "necessary logistical support" to
Pentagon testing programs, "and that's about as far as I feel comfortable
going." The Post reported that the Pentagon rewarded contracts to Murtech
without competition.
"Murtha's Nephew Got Millions in Gov't Contracts," Fox News,
May 5, 2009 ---
http://www.foxnews.com/politics/2009/05/05/murthas-nephew-got-millions-defense-contracts/
"The Myth of Regulation," by J. Edward Ketz, SmartPros, October
2009 ---
http://accounting.smartpros.com/x67705.xml
Mark Twain remarked that
"There is no distinctively native American criminal class except Congress." He
was wrong. He should have included presidents and the SEC.
On August 4 the SEC
accused General Electric of accounting fraud (Litigation
Release No. 21166), but it chose not to disclose
who committed the frauds and it did not punish the criminals. Instead, the SEC
fined the victims—the shareholders—$50 million. Worse, the SEC protracted the
so-called investigation so long that even if the felons were indicted, the case
likely would get tossed out of court because of the statute of limitations.
This is just one example of many injustices by the SEC during the last decade
that reveals how this agency has supported the efforts of some managers and
directors to defraud the investing public.
I infer that Congress and
recent presidents have approved these activities, for Congress, Bush, and Obama
have done nothing to improve matters. They have given the appearance of caring,
but thwarted any real, effective measures.
Congress enacted Sarbanes-Oxley and President Bush signed the legislation. But
Sarbanes-Oxley did little to dampen the activities of criminally-minded managers
and directors. This was because it did so little to improve enforcement
activities. Sarbanes-Oxley merely required a variety of studies and increased
penalties and required auditors to report on the firm’s internal controls. But
these actions have not lessened securities fraud or accounting shenanigans.
More recently President
Obama claims to fight the problems that caused the financial crisis by
advocating a new agency. “The Consumer Financial Protection Agency will have
the power to ensure that consumers get information that is clear and concise,
and to prevent the worst kinds of abuses.” Many business writers have critiqued
this proposal for a variety of reasons. I agree with them, but I think there is
a deeper problem and that is the myth of regulation.
What Obama is really
trying to do is give American voters the impression that he is in charge, that
he cares about them, and that he is improving matters so that the chances of
another financial meltdown is infinitesimal. It is political legerdemain.
As long as managers have
perverse incentives to cheat investors and as long as the SEC goes after only
the little guys and ignores managers at Enron, WorldCom, Madoff Investments
Securities, and GE, nothing is going to change. If the Congress and if the
President want to improve matters—and I have no idea if they really do—then they
must change the set of incentives and disincentives. To effect real change, the
system must punish managers and directors who lie and steal and cover it up with
scandalous financial reporting.
More regulation might
make society feel better, but that just is an indication that most Americans
have little understanding of economics. They will continue to lose in the stock
markets until they insist elected officials do something substantive.
My fear is that Democrats
will rally around Obama while Republicans vilify him, similar to the previous
administration when Republicans rallied around Bush and Democrats denigrated
him. There is too much partisanship in this country and not enough rational
analysis. Americans need to understand that both presidents have failed us by
supporting new legislation and by crippling better enforcement. (For whatever
it is worth, this is one of the reasons I am an Independent.)
Jensen Comment
The problem of regulation is that the industries being regulated end up owning
the regulators until the next big scandal makes headlines. Bob Jensen's threads
on the need for better regulation and enforcement are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
The Sorry State of Democratic Party Leadership in
Combating Earmark Fraud and Pork
Democratic Earmark Fraud Nancy Pelosi Does Not Want Investigated
"Pelosi's Pork Problem: The PMA scandal could make
Abramoff look like a piker," The Wall Street Journal, June 5, 2009
---
http://online.wsj.com/article/SB124416236598887387.html
Picture a freight train roaring down the
tracks. Picture House Speaker Nancy Pelosi positioning her party on the
rails. Picture a growing stream of nervous souls diving for the weeds.
Picture all this, and you've got a sense of the Democrats'
earmark-corruption problem.
This particular choo-choo has the name
John Murtha emblazoned on the side, and with each chug is proving that those
who ignore history are doomed to repeat it. Republicans got tossed in 2006
in part for failing to police the earmarks at the center of the Jack
Abramoff and other corruption scandals. Mrs. Pelosi is today leaving her
members exposed to an earmark mess that might make Abramoff look junior
varsity.
Federal investigators are deep into a
criminal investigation of PMA Group, a now-defunct lobby shop founded by a
former aide to Mr. Murtha, Pennsylvania's 18-term star appropriator. The
suspicion is that some members of Congress may have peddled lucrative
earmarks to PMA clients in exchange for campaign contributions. To get a
sense of this probe's scope, consider that last year alone more than 100
members secured earmarks for PMA clients.
Mr. Murtha, who in the past two years
alone directed $78 million to PMA companies, has so far not been accused of
wrongdoing and has proclaimed his innocence. The feds, for their part, are
picking up speed. Federal agents have raided PMA, as well as a defense
contractor to which Mr. Murtha had directed earmarks, Kuchera Defense
Systems. By last week, Mr. Murtha's fellow defense appropriator and
PMA-earmarker, Indiana Rep. Peter Visclosky, had disclosed he'd received
subpoenas in connection with PMA, while the Navy said it had suspended
Kuchera from doing business with it because of "alleged fraud."
The result is growing dissent among
Democrats, on full display this week. On one side is Mrs. Pelosi, who has
demanded her party protect Mr. Murtha, a man hugely responsible for her
ascent. One the other side are younger, first- and second-term Democrats who
won their seats off GOP scandals and who have no interest in sacrificing
them at the back-scratching altar.
Republican Rep. Jeff Flake this week gave
notice he was introducing his ninth resolution calling for an ethics
committee investigation into PMA. This scourge of earmarks worries that,
since the 1990s, some lawmakers have been "refining" earmarking, moving
beyond "bring home the bacon" pork for districts and instead viewing
earmarks as "fund-raising tools" -- a way to deliver money to companies that
produce campaign cash. "We've crossed a line," he tells me. "And we in
Congress need to understand that this is why Justice is interested."
His resolutions are forcing members to
take sides, and with each vote he's peeled off a few more of Mrs. Pelosi's
caucus. His first resolution, in February, got support from 17 Democrats.
These were folks like California's Jerry McNerney, who spent his 2006
campaign lashing his GOP rival to Abramoff. And New Hampshire's Paul Hodes,
who in the same year criticized his opponent for failing to return campaign
donations from former House Majority Leader Tom DeLay.
By last month's Flake resolution, 29
Democrats had jumped on board. Welcome Mike Quigley, newly elected in
Illinois after a campaign focused on Rod Blagojevich. Welcome, too, New
York's Scott Murphy, who in March squeaked out a special-election victory
after attacking his opponent on ethics. Some Democrats have fretted that
even lining up with Mr. Flake won't provide adequate cover from a possible
Murtha train wreck. In April, Mr. Hodes and Arizona Rep. Gabrielle Giffords
debuted a bill to ban lawmakers from taking contributions from companies on
whose behalf they've requested earmarks.
Mrs. Pelosi has relentlessly fought to
tamp down this uprising. In April, she recruited the former top Democrat on
the ethics committee, Howard Berman, to lecture members in a closed-door
meeting as to why they should continue to oppose Mr. Flake. In May, as the
House prepared for another vote, Mrs. Pelosi's assistant, Rep. Chris Van
Hollen, sent an email to staffers warning "Don't Be a Flake" and making
clear defections would not be viewed charitably.
But the news of the Visclosky subpoena,
and the possibility of another Flake vote, this week threatened a mass
revolt. Majority Leader Steny Hoyer pre-empted Mr. Flake with his own
resolution calling on the ethics committee merely to disclose whether it is
already looking at PMA. Democrats then watered this down further by
referring the resolution to committee, where it can be buried. Many of the
GOP's biggest earmarkers, in particular Alaska's Don Young and Florida's
Bill Young, went along with this charade, proving Republicans have yet to
exorcise their own earmark demons.
As political cover goes this is pretty
scant, and Democrats are in control. If and when this train derails, the
exposure could be huge. For Mr. Flake, it's all a bit mindboggling. "This is
a well-trodden path of denial that we Republicans already walked down.
Democrats are now walking down that path. Philosophically, it's nuts."
From The Wall Street Journal Accounting Weekly Review on July 10, 2009
Public Pensions Cook the Books
by Andrew G.
Biggs
The Wall Street Journal
Jul 06, 2009
Click here to view the full article on WSJ.com
TOPICS: Advanced
Financial Accounting, Financial Accounting Standards Board, Governmental
Accounting, Market-Value Approach, Pension Accounting
SUMMARY: As
Mr. Biggs, a resident scholar at the American Enterprise Institute, puts it,
"public employee pension plans are plagued by overgenerous benefits, chronic
underfunding, and now trillion dollar stock-market losses. Based on their
preferred accounting methods...these plans are underfunded nationally by
around $310 billion. [But] the numbers are worse using market valuation
methods...which discount benefit liabilities at lower interest rates...."
CLASSROOM APPLICATION: Introducing
the importance of interest rate assumptions, and the accounting itself, for
pension plans can be accomplished with this article.
QUESTIONS:
1. (Introductory)
Summarize the accounting for pension plans, including the process for
determining pension liabilities, the funded status of a pension plan,
pension expense, the use of a discount rate, the use of an expected rate of
return. You may base your answer on the process used by corporations rather
than governmental entities.
2. (Advanced)
Based on the discussion in the article, what is the difference between
accounting for pension plans by U.S. corporations following FASB
requirements and governmental entities following GASB guidance?
3. (Introductory)
What did the administrators of the Montana Public Employees' Retirement
Board and the Montana Teachers' Retirement System include in their
advertisements to hire new actuaries?
4. (Advanced)
What is the concern with using the "expected return" on plan assets as the
rate to discount future benefits rather than using a low, risk free rate of
return for this calculation? In your answer, comment on the author's
statement that "future benefits are considered to be riskless" and the
impact that assessment should have on the choice of a discount rate.
5. (Advanced)
What is the response by public pension officers regarding differences
between their plans and those of corporate entities? How do they argue this
leads to differences in required accounting? Do you agree or disagree with
this position? Support your assessment.
Reviewed By: Judy Beckman, University of Rhode Island
"Public Pensions Cook the Books: Some plans want to hide the truth
from taxpayers," by Andrew Biggs, The Wall Street Journal, July 6,
2009 ---
http://online.wsj.com/article/SB124683573382697889.html
Here's a dilemma: You manage a public employee
pension plan and your actuary tells you it is significantly underfunded. You
don't want to raise contributions. Cutting benefits is out of the question.
To be honest, you'd really rather not even admit there's a problem, lest
taxpayers get upset.
What to do? For the administrators of two Montana
pension plans, the answer is obvious: Get a new actuary. Or at least that's
the essence of the managers' recent solicitations for actuarial services,
which warn that actuaries who favor reporting the full market value of
pension liabilities probably shouldn't bother applying.
Public employee pension plans are plagued by
overgenerous benefits, chronic underfunding, and now trillion dollar
stock-market losses. Based on their preferred accounting methods -- which
discount future liabilities based on high but uncertain returns projected
for investments -- these plans are underfunded nationally by around $310
billion.
The numbers are worse using market valuation
methods (the methods private-sector plans must use), which discount benefit
liabilities at lower interest rates to reflect the chance that the expected
returns won't be realized. Using that method, University of Chicago
economists Robert Novy-Marx and Joshua Rauh calculate that, even prior to
the market collapse, public pensions were actually short by nearly $2
trillion. That's nearly $87,000 per plan participant. With employee benefits
guaranteed by law and sometimes even by state constitutions, it's likely
these gargantuan shortfalls will have to be borne by unsuspecting taxpayers.
Some public pension administrators have a strategy,
though: Keep taxpayers unsuspecting. The Montana Public Employees'
Retirement Board and the Montana Teachers' Retirement System declare in a
recent solicitation for actuarial services that "If the Primary Actuary or
the Actuarial Firm supports [market valuation] for public pension plans,
their proposal may be disqualified from further consideration."
Scott Miller, legal counsel of the Montana Public
Employees Board, was more straightforward: "The point is we aren't
interested in bringing in an actuary to pressure the board to adopt market
value of liabilities theory."
While corporate pension funds are required by law
to use low, risk-adjusted discount rates to calculate the market value of
their liabilities, public employee pensions are not. However, financial
economists are united in believing that market-based techniques for valuing
private sector investments should also be applied to public pensions.
Because the power of compound interest is so
strong, discounting future benefit costs using a pension plan's high
expected return rather than a low riskless return can significantly reduce
the plan's measured funding shortfall. But it does so only by ignoring risk.
The expected return implies only the "expectation" -- meaning, at least a
50% chance, not a guarantee -- that the plan's assets will be sufficient to
meet its liabilities. But when future benefits are considered to be riskless
by plan participants and have been ruled to be so by state courts, a 51%
chance that the returns will actually be there when they are needed hardly
constitutes full funding.
Public pension administrators argue that government
plans fundamentally differ from private sector pensions, since the
government cannot go out of business. Even so, the only true advantage
public pensions have over private plans is the ability to raise taxes. But
as the Congressional Budget Office has pointed out in 2004, "The government
does not have a capacity to bear risk on its own" -- rather, government
merely redistributes risk between taxpayers and beneficiaries, present and
future.
Market valuation makes the costs of these potential
tax increases explicit, while the public pension administrators' approach,
which obscures the possibility that the investment returns won't achieve
their goals, leaves taxpayers in the dark.
For these reasons, the Public Interest Committee of
the American Academy of Actuaries recently stated, "it is in the public
interest for retirement plans to disclose consistent measures of the
economic value of plan assets and liabilities in order to provide the
benefits promised by plan sponsors."
Nevertheless, the National Association of State
Retirement Administrators, an umbrella group representing government
employee pension funds, effectively wants other public plans to take the
same low road that the two Montana plans want to take. It argues against
reporting the market valuation of pension shortfalls. But the association's
objections seem less against market valuation itself than against the fact
that higher reported underfunding "could encourage public sector plan
sponsors to abandon their traditional pension plans in lieu of defined
contribution plans."
The Government Accounting Standards Board, which
sets guidelines for public pension reporting, does not currently call for
reporting the market value of public pension liabilities. The board
announced last year a review of its position regarding market valuation but
says the review may not be completed until 2013.
This is too long for state taxpayers to wait to
find out how many trillions they owe.
A Sickening Lobbying Effort for Off-Balance-Sheet Financing in IFRS
The International Accounting Standards Board is working
quickly to produce some updated and clarified guidance on how to account for
financial assets and liabilities. The financial meltdown renewed attention on
this matter, as well as the use of special-purpose entities to hold financial
assets, a device that generally gets them off balance sheets. There is still
disagreement on how big of a role off-balance-sheet accounting played in
starting the financial crisis, but banks appear to be against changes that would
bring about greater disclosure of assets and liabilities.
Peter Williams, "Peter Williams Accounting: Off balance – the future of
off-balance sheet transactions," Personal Computer World, July 3, 2009
---
http://www.pcw.co.uk/financial-director/comment/2245360/balance-4729409
A working paper on fair value accounting from Columbia University ---
http://www4.gsb.columbia.edu/publicoffering/post/731291/Behind+the+Mark-to-Market+Change#
Bob Jensen's threads on the never-ending OBSF wars ---
http://faculty.trinity.edu/rjensen/theory01.htm#OBSF2
"Controlled by the corporations: Before we can deal with a financial
crisis manufactured in boardrooms, we must curb corporate power over our
legislators," by Prem Sikka, The Guardian, January 8, 2008 ---
http://www.guardian.co.uk/commentisfree/2009/jan/08/financial-crisis-regulation
As we enter the second year of the financial crisis
manufactured in corporate boardrooms, there is hardly any sign of major
reforms. Short-selling of securities was considered to be a major blot on
the financial landscape, but is apparently OK now. The blinkered Financial
Services Authority (FSA) is still wielding its blunt regulatory instruments.
The corporate-controlled Financial Reporting Council (FRC), which did not
monitor the accounts of any bank and had no idea of their off balance sheet
accounting games, is still in place.
The real problem is the nature of neoliberal
democracy. Corporate interests have become central to domestic and foreign
policymaking. With minimum public scrutiny, legislation demanded by
corporate interests is enacted. Legislators are available for hire through
consultancies and are only too willing to do their bidding. Little attention
is paid to the long-term issues, or even consequences for the people, or the
economy.
Continued in article
"Why Congress Won't Investigate Wall Street: Republicans and
Democrats would find themselves in the hot seat," by Thomas Frank, The
Wall Street Journal, April 29, 2009 ---
http://online.wsj.com/article/SB124096712823366501.html
The famous Pecora Commission of 1933 and 1934 was
one of the most successful congressional investigations of all time, an
instance when oversight worked exactly as it should. The subject was the
massively corrupt investment practices of the 1920s. In the course of its
investigation, the Senate Banking Committee, which brought on as its counsel
a former New York assistant district attorney named Ferdinand Pecora, heard
testimony from the lords of finance that cemented public suspicion of Wall
Street. Along the way, the investigations formed the rationale for the
Glass-Steagall Act, the Securities Exchange Act, and other financial
regulations of the Roosevelt era.
A new round of regulation is clearly in order these
days, and a Pecora-style investigation seems like a good way to jolt the
Obama administration into action. After all, the financial revelations of
today bear a striking resemblance to those of 1933. In his own account of
his investigation, Pecora described bond issues that were almost certainly
worthless, but which 1920s bankers sold to uncomprehending investors anyway.
He told of the bonuses which the bankers thereby won for themselves. He also
told of the lucrative gifts banks gave to lawmakers from both political
parties. And then he told of the banking industry's indignation at being
made to account for itself. It regarded the outraged public, in Pecora's
shorthand, as a "howling mob."
The idea of a new Pecora investigation is catching
on, particularly, but not exclusively, on the left.
It's probably not going to happen, though, in the
comprehensive way that it should. The reason is that understanding our
problems, this time around, would require our political leaders to examine
themselves.
The crisis today is not solely one of bank
misbehavior. This is also about the failure of the regulators -- the Wall
Street policemen who dozed peacefully as the crime of the century went off
beneath the window.
We have all heard the official explanation for this
failure, that "the structure of our regulatory system is unnecessarily
complex and fragmented," in the soothing words of Treasury Secretary Tim
Geithner. But no proper Pecora would be satisfied with such piffle. The
system was not only complex, it was compromised and corrupted and thoroughly
rotten even in the spots where its mandate was simple.
After all, we have for decades been on a national
crusade to slash red tape and stifle regulators. Over the years, federal
agencies have been defunded, their workers have grown dispirited, their
managers, drawn in many cases from antiregulatory organizations, have seemed
to care far more about industry than the public.
Consider in this connection the 2003 photograph,
rapidly becoming an icon of the Bush years, in which James Gilleran, then
the director of the Office of Thrift Supervision (it regulates savings and
loan associations) can be seen in the company of several jolly bank industry
lobbyists, holding a chainsaw to a pile of rule books. The picture not only
tells us more about our current fix than would a thousand pages about
overlapping jurisdictions; it also reminds us why we may never solve the
problem of regulatory failure. To do so, we would have to examine the
apparent subversion of the regulatory system by the last administration. And
that topic is supposedly off limits, since going there would open the door
to endless partisan feuding.
But it's not only Republicans who would feel the
sting of embarrassment. Launching Pecora II would automatically raise this
question: Whatever happened to the reforms put in place after the first
go-round?
Now a different picture comes to mind. It's Bill
Clinton in November of 1999, surrounded by legislators of both parties,
giving a shout-out to his brilliant Treasury Secretary Larry Summers, and
signing the measure that overturned Glass-Steagall's separation of
investment from commercial banking. Mr. Clinton is confident about what he
is doing. He knows the lessons of history, he talks glibly about "the new
information-age global economy" that was the idol of deep thinkers
everywhere in those days. "[T]he Glass-Steagall law is no longer appropriate
to the economy in which we live," he says. "It worked pretty well for the
industrial economy, which was highly organized, much more centralized, and
much more nationalized than the one in which we operate today. But the world
is very different."
It turns out the world hadn't changed much after
all. But the Democratic Party sure had. And while today's chastened
Democrats might be ready to reregulate the banks, they are no more willing
to scrutinize the bad ideas of the Clinton years than Republicans are the
bad ideas of the Bush years.
"We may now need to be reminded what Wall Street
was like before Uncle Sam stationed a policeman at its corner," Pecora wrote
in 1939, "lest, in time to come, some attempt be made to abolish that post."
Well, the time did come. The attempt was made. And
we could use that reminder today.
Broken Promises and
Pork Binges
The Democratic majority came
to power in January
promising to do a better job
on earmarks. They appeared
to preserve our reforms and
even take them a bit
further. I commended
Democrats publicly for this
action. Unfortunately, the
leadership reversed course.
Desperate to advance their
agenda, they began trading
earmarks for votes, dangling
taxpayer-funded goodies in
front of wavering members to
win their support for
leadership priorities.
John
Boehner,
"Pork Barrel Stonewall,"
The Wall Street Journal,
September 27, 2007 ---
http://online.wsj.com/article/SB119085546436140827.html
"Earmarks Again Eat
Into the Amount Available
for Merit-Based Research,
Analysis Finds," by
Jeffrey Brainard,
Chronicle of Higher
Education, January 9,
2008 ---
http://chronicle.com/daily/2008/01/1161n.htm
After a one-year
moratorium for most
earmarks, Congress
resumed directing
noncompetitive grants
for scientific research
to favored constituents,
including universities,
this year, a new
analysis says.
Spending for nondefense
research fell by about
one-third in the 2008
fiscal year, compared
with 2006, but the
earmarked money
nevertheless ate into
sums available for
traditional,
merit-reviewed grants,
the
analysis
by
the American Association
for the Advancement of
Science found.
In
all, Congress earmarked
$4.5-billion for 2,526
research projects in
appropriations bills for
2008, according to the
AAAS. Legislators
approved the measures in
November and December,
and President Bush
signed them.
More important,
lawmakers increased
spending for earmarks in
federal
research-and-development
programs by a greater
amount than they added
to the programs for all
purposes, the AAAS
reported. That will
result in a net decrease
in money available for
nonearmarked research
grants, which federal
agencies typically
distributed based on
merit and competition.
For example, Congress
added $2.1-billion to
the Pentagon's overall
request for basic and
applied research and for
early technology
development, but
lawmakers also specified
an even-larger amount,
$2.2-billion, for
earmarked projects in
those same accounts.
For nondefense research
projects, Congress
showed restraint in
earmarking, providing
only $939-million in the
2008 fiscal year, which
began in October. That
was down from about
$1.5-billion in 2006 and
appeared to reflect a
pledge by Congressional
Democrats to reduce the
total number of
earmarks.
For the Pentagon, total
spending on research
earmarks of all kinds
reached $3.5-billion,
much higher than the
$911-million tallied by
the AAAS in 2007.
(Pentagon earmarks were
among the only kind
financed by Congress
that year.) However, the
apparent increase was
largely the result of an
accounting change: For
2008, Congress mandated
increased disclosure of
earmarks, a change that
especially affected the
tally of Pentagon
earmarks, said Kei
Koizumi, director of the
association's R&D Budget
and Policy Program.
Adjusting for that
change, the total number
of Defense Department
earmarks appears to have
fallen in 2008, he said.
As
in past years, lawmakers
avoided earmarking
budgets for the National
Institutes of Health and
the National Science
Foundation, the two
principal sources of
federal funds for
academic research. The
Departments of Energy
and Agriculture were the
most heavily earmarked
domestic research
agencies. After being
earmark-free for the
first years of its
existence, the
Department of Homeland
Security got $82-million
in
research-and-development
earmarks for 2008.
The AAAS did not report
how much of the
earmarked research money
will go to colleges, but
academic institutions
have traditionally
gotten most of it. Some
research earmarks go to
corporations and federal
laboratories. In
addition, many colleges
obtain earmarks for
nonresearch projects,
like renovating
dormitories and
classroom buildings, but
the AAAS does not track
that spending.
Academic earmarks more
than quadrupled from
1996 to 2003,
The Chronicle
found.
The practice is
controversial because
some critics see it as
circumventing peer
review and supporting
projects of dubious
quality. Supporters call
earmarks the only way to
finance some types of
worthy projects not
otherwise supported by
the federal government.
When
Jeff Flake was elected to
Congress in 2000 from
Arizona’s Sixth
Congressional District with
the hope of “effectively
advanc[ing] the principles
of limited government,
economic freedom, and
individual responsibility,”
he was a relatively unknown
entity outside Arizona. Some
may have dismissed the
Arizona newbie as just
another congressman out of a
435-member body, but that
would have been a big
mistake.Over his seven years
in the House, the
mild-mannered contrarian has
become the bane of porkers
everywhere. To the chagrin
of his congressional
colleagues, the Arizona
representative has made a
career out of targeting some
of Congress’s most
outrageous pork projects by
introducing amendments to
eliminate those projects
from congressional spending
bills. In 2006, Flake
introduced nineteen
amendments, putting each
member of Congress on record
either in favor or in
opposition to spending
taxpayer dollars on such
crucial projects as the
National Grape and Wine
Initiative,
a
swimming pool in
California, and
hydroponic tomato production
in
Ohio.
Pat Toomey,
"Make It Flake! An
appropriating move,"
National Review, January
17, 2008 ---
Click Here
Jensen Comment
Jeff Flake is a thorn in
Majority Speaker Nancy
Pelosi's side as she agrees
to earmarks in order to
grease legislation through
the House. It's really hard
to manage a bunch of thieves
without giving them
something to steal.
"Audit: More Bad Accounting in Veterans Health Care," AccountingWeb,
January 23, 2009 ---
http://accounting.smartpros.com/x65142.xml
Two years after a politically embarrassing $1
billion shortfall that imperiled veterans health care, the Veterans Affairs
Department is still lowballing budget estimates to Congress to keep its
spending down, government investigators say.
The report by the Government Accountability Office,
set to be released Friday, highlights the Bush administration's problems in
planning for the treatment of veterans that President Barack Obama has
pledged to fix. It found the VA's long-term budget plan for the
rehabilitation of veterans in nursing homes, hospices and community centers
to be flawed, failing to account for tens of thousands of patients and
understating costs by millions of dollars.
In its strategic plan covering 2007 to 2013, the VA
inflated the number of veterans it would treat at hospices and community
centers based on a questionably low budget, the investigators concluded. At
the same time, they said, the VA didn't account for roughly 25,000 - or
nearly three-quarters - of its patients who receive treatment at nursing
homes operated by the VA and state governments each year.
"VA's use, without explanation, of cost assumptions
and a workload projection that appear unrealistic raises questions about
both the reliability of VA's spending estimates and the extent to which VA
is closing previously identified gaps in noninstitutional long-term care
services," according to the 34-page draft report obtained by The Associated
Press.
The VA did not immediately respond to a request for
comment.
In the report, the VA acknowledged problems in its
plan for long-term care, which accounts annually for more than $4 billion,
or 12 percent of its total health care spending. In many cases, officials
told the GAO they put in lower estimates in order to be "conservative" in
their appropriations requests to Congress and to "stay within anticipated
budgetary constraints."
As to the 25,000 nursing home patients unaccounted
for, the VA explained it was usual clinical practice to provide short-term
care of 90 days or less following hospitalization in a VA medical center,
such as for those who had a stroke, to ensure patients are medically stable.
But the VA had chosen not to budget for them because the government is not
legally required to provide the care except in serious cases.
The GAO noted the VA was in the process of putting
together an updated strategic plan. Retired Gen. Eric K. Shinseki, who was
sworn in Wednesday as VA secretary, has promised to submit "credible and
adequate" budget requests to Congress.
"VA supports GAO's overarching conclusion that the
long-term care strategic planning and budgeting justification process should
be clarified," wrote outgoing VA Secretary James Peake in a response dated
Jan. 5. He said the department would put together an action plan within 60
days of the report's release.
The report comes amid an expected surge in demand
from veterans for long-term rehabilitative and other care over the next
several years. Roughly 40 percent of the veteran population is age 65 or
older, compared to about 13 percent of the general population, with the
number of elderly veterans expected to increase through 2014.
In 2005, the VA stunned Congress by suddenly
announcing it faced a $1 billion shortfall after failing to take into
account the additional cost of caring for veterans injured in Iraq and
Afghanistan. The admission, which came months after the department insisted
it was operating within its means and did not need additional money, drew
harsh criticism from both parties.
The GAO later determined the VA repeatedly
miscalculated - if not deliberately misled taxpayers - with questionable
methods used to justify Bush administration cuts to health care amid the
burgeoning Iraq war. In Friday's report, the GAO said it had found similarly
unrealistic assumptions and projections in the VA's more recent budget
estimates submitted in August 2007.
Continued in article
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Question
How did a grandmother help build the corruption case against the Democratic
Party political machine in Illinois?
"Secret Tapes Helped Build Graft Cases In Illinois: Hospital CEO
Reported Shakedown, Wore Wire," by Carrie Johnson and Kimberly Kindy, The
Washington Post, December 22, 2008 ---
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/21/AR2008122102334.html?hpid=topnews
The wide-ranging public corruption probe that led
to the arrest of Illinois Gov. Rod Blagojevich got its first big break when
a grandmother of six walked into a breakfast meeting with shakedown artists
wearing an FBI wire.
Pamela Meyer Davis had been trying to win approval
from a state health planning board for an expansion of Edward Hospital, the
facility she runs in a Chicago suburb, but she realized that the only way to
prevail was to retain a politically connected construction company and a
specific investment house. Instead of succumbing to those demands, she went
to the FBI and U.S. Attorney Patrick J. Fitzgerald in late 2003 and agreed
to secretly record conversations about the project.
Her tapes led investigators down a twisted path of
corruption that over five years has ensnared a collection of
behind-the-scenes figures in Illinois government, including Joseph Cari Jr.,
a former Democratic National Committee member, and disgraced businessman
Antoin "Tony" Rezko.
On Dec. 9, that path wound up at the governor's
doorstep. Another set of wiretaps suggested that Blagojevich was seeking to
capitalize on the chance to fill the Senate seat just vacated by
President-elect Barack Obama.
Many of the developments in Operation Board Games
never attracted national headlines. They involved expert tactics in which
prosecutors used threats of prosecution or prison time to flip bit players
in a tangle of elaborate schemes that Fitzgerald has called pay-to-play "on
steroids."
But now, Fitzgerald's patient strategy has led to
uncomfortable questions not only for Blagojevich but also for the powerful
players who privately negotiated with him, unaware that their conversations
were being monitored. Democratic Rep. Jesse L. Jackson Jr. faces queries
about his interest in the Senate seat, and key players in the Obama
presidential transition team -- White House Chief of Staff-designate Rahm
Emanuel and adviser Valerie Jarrett -- are being asked about their contacts
with the governor on the important appointment.
Pamela Meyer Davis had been trying to win approval
from a state health planning board for an expansion of Edward Hospital, the
facility she runs in a Chicago suburb, but she realized that the only way to
prevail was to retain a politically connected construction company and a
specific investment house. Instead of succumbing to those demands, she went
to the FBI and U.S. Attorney Patrick J. Fitzgerald in late 2003 and agreed
to secretly record conversations about the project.
Her tapes led investigators down a twisted path of
corruption that over five years has ensnared a collection of
behind-the-scenes figures in Illinois government, including Joseph Cari Jr.,
a former Democratic National Committee member, and disgraced businessman
Antoin "Tony" Rezko.
On Dec. 9, that path wound up at the governor's
doorstep. Another set of wiretaps suggested that Blagojevich was seeking to
capitalize on the chance to fill the Senate seat just vacated by
President-elect Barack Obama.
Many of the developments in Operation Board Games
never attracted national headlines. They involved expert tactics in which
prosecutors used threats of prosecution or prison time to flip bit players
in a tangle of elaborate schemes that Fitzgerald has called pay-to-play "on
steroids."
But now, Fitzgerald's patient strategy has led to
uncomfortable questions not only for Blagojevich but also for the powerful
players who privately negotiated with him, unaware that their conversations
were being monitored. Democratic Rep. Jesse L. Jackson Jr. faces queries
about his interest in the Senate seat, and key players in the Obama
presidential transition team -- White House Chief of Staff-designate Rahm
Emanuel and adviser Valerie Jarrett -- are being asked about their contacts
with the governor on the important appointment.
Continued in article
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bankers bet with their bank's capital, not
their own. If the bet goes right, they get a huge bonus; if it
misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as
quoted by Avital Louria Hahn, "Missing: How Poor Risk-Management
Techniques Contributed to the Subprime Mess," CFO Magazine,
March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Fed
is going to bail out these crooks with taxpayer funds makes it all
the worse.
The bourgeoisie can be termed as any group of people who are
discontented with what they have, but satisfied with what they are
Nicolás Dávila |
Oh, and don't
forget Fannie Mae and Freddie Mac, those two government-sponsored mortgage
giants that engineered the 2008 subprime mortgage fiasco and are now on the
public dole. The Fed kept them afloat by buying over a trillion dollars of their
paper. Now, part of the Treasury's borrowing from the public covers their
continuing large losses.
George Melloan, "Hard Knocks
From Easy Money: The Federal Reserve is feeding big government and harming
middle-class savers," The Wall Street Journal, July 6, 2010 ---
http://online.wsj.com/article/SB10001424052748704103904575337282033232118.html?mod=djemEditorialPage_t
The Treasury Department on Sunday seized control of the quasi-public
mortgage finance giants, Fannie Mae and Freddie Mac, and announced a four-part
rescue plan that included an open-ended guarantee to provide as much capital as
they need to stave off insolvency.
"U.S. Unveils Takeover of Two Mortgage Giants," by Edmund L. Andrews, The
New York Times, Septembr 7, 2008 ---
http://www.nytimes.com/2008/09/08/business/08fannie.html?hp
At a news conference on Sunday morning, the
Treasury secretary Henry M. Paulson Jr. also announced that he had dismissed
the chief executives of both companies and replaced them with two long-time
financial executives. Herbert M. Allison, the former chairman of TIAA-CREF,
the huge pension fund for teachers, will take over Fannie Mae and succeed
Daniel H. Mudd. At Freddie Mac, David M. Moffett, currently a senior adviser
at the Carlyle Group, the large private equity firm, will succeed Richard F.
Syron. Mr. Mudd and Mr. Syron, however, will stay on temporarily to help
with the transition.
“Fannie Mae and Freddie Mac are so large and so
interwoven in our financial system that a failure of either of them would
cause great turmoil in our financial markets here at home and around the
globe,” Mr. Paulson said. “This turmoil would directly and negatively impact
household wealth: from family budgets, to home values, to savings for
college and retirement. A failure would affect the ability of Americans to
get home loans, auto loans and other consumer credit and business finance.
And a failure would be harmful to economic growth and job creation.”
Mr. Paulson refused to say how much capital the
government might eventually have to provide, or what the ultimate cost to
taxpayers might be.
The companies are likely to need tens of billions
of dollars over the next year, but the ultimate cost to taxpayers will
largely depend on how fast the housing and mortgage markets recover.
Fannie and Freddie have each agreed to issue $1
billion of senior preferred stock to the United States; it will pay an
annual interest rate of at least 10 percent. In return, the government is
committing up to $100 billion to each company to cover future losses. The
government also receives warrants that would allow it to buy up to 80
percent of each company’s common stock at a nominal price, or less than $1 a
share.
Beginning in 2010, the companies must also pay the
Treasury a quarterly fee — the amount to be determined — for any financial
support provided under the agreement.
Standard & Poor’s, the bond rating agency, said
Sunday that the government’s AAA/A-1+ sovereign credit rating would not be
affected by the takeover.
Mr. Paulson’s plan begins with a pledge to provide
additional cash by buying a new series of preferred shares that would offer
dividends and be senior to both the existing preferred shares and the common
stock that investors already hold.
The two companies would be allowed to “modestly
increase” the size of their existing investment portfolios until the end of
2009, which means they will be allowed to use some of their new
taxpayer-supplied capital to buy and hold new mortgages in investment
portfolios.
But in a strong indication of Mr. Paulson’s
long-term desire to wind down the companies’ portfolios, drastically shrink
the role of both Fannie and Freddie and perhaps eliminate their unique
status altogether, the plan calls for the companies to start reducing their
investment portfolios by 10 percent a year, beginning in 2010.
The investment portfolios now total just over $1.4
trillion, and the plan calls for that to eventually shrink to $250 billion
each, or $500 billion total.
“Government support needs to be either explicit or
nonexistent, and structured to resolve the conflict between public and
private purposes,” Mr. Paulson said. “We will make a grave error if we don’t
use this time out to permanently address the structural issues presented by
the G.S.E.’s,” he added, a reference to the companies as
government-sponsored enterprises.
Critics have long argued that Fannie and Freddie
were taking advantage of the widespread assumption that the federal
government would bail them out if they got into trouble. Administration
officials as well as the Federal Reserve have argued that the two companies
used those implicit guarantees to borrow money at below-market rates and
lend money at above-market returns, and that they had become what amounted
to gigantic hedge funds operating with only a sliver of capital to protect
them from unexpected surprises.
Continued in article
IN OTHER words, foreseeing
that wealthy individuals would be reluctant to lend their money to the poor as
the seventh year approached, the Bible commanded them to lend it anyway. Yet
Hillel, seeing that the wealthy were disregarding this injunction and depriving
the poor of badly needed loans, changed the biblical law to ensure that money
would be lent by providing a way of recovering it.This was a watershed in the
evolution of Judaism. The biblical law of debt-cancellation is motivated by a
deep concern, which runs through the
Mosaic code (also see
Halakhah) and the prophets, for the poor, who are to be periodically
forgiven by their creditors in order to prevent their becoming hopelessly mired
in debt. One could not imagine a more Utopian piece of social legislation. But
this, as Hillel the Elder realized, was precisely the problem with it:
the regulation was having the paradoxical consequence of
only making life for the poor harder by preventing them from borrowing at all.
Herbert Gintis, Commentary, Jul/Aug2008, Vol. 126 Issue 1, pp. 4-6
Bob Jensen's threads on financial scandals and
regulation are at
http://faculty.trinity.edu/rjensen/FraudCongress.htm
Question
Is transfer pricing still the main tax dodge inside developing nations?
"Not paying their dues Global companies are evading tax in the developing
world. The money lost could go towards alleviating poverty and saving lives," by
Prem Sikka, The Guardian, May 12, 2008 ---
http://commentisfree.guardian.co.uk/prem_sikka_/2008/05/not_paying_their_dues.html
The tax avoidance industry is the mafia of our
times. It makes huge profits for itself and its clients, but inflicts
hardship, misery, squalor and early death on many innocent people.
A new report by Christian Aid,
Death and Taxes, highlights the human consequences
of the tax-dodging industry. Developing countries are estimated to lose
$160bn of tax revenues a year from tax evasion, mainly by giant
multinational corporations. This is more than one-and-a-half times the
combined aid budget of the rich world. Add tax avoidance perpetrated through
complex structures, tax holidays, low royalty rates for mineral extraction
and a variety of tax avoidance schemes and a figure of $500bn a year is
sucked out of developing countries. Imagine what this money could do to
improve the quality of life for millions of people.
The $160bn of illegal activity alone could provide
decent healthcare and save lives in developing countries. Around 1,000
children under the age of five die each day from poverty and disease. This
massive tax evasion condemns 350,000 children a year to an early death.
Christian Aid estimates that tax evasion will have been responsible for the
early death of some 5.6 million children between 2000 and 2015, equivalent
to the entire population of Denmark.
. . .
Developing countries have been systematically
stripped
(pdf) of their wealth and taxes.
China has found that almost 90% of foreign-funded
enterprises are making money under the table. Some of their businesses
involve smuggling. But, most commonly, they use transfer pricing to dodge
tax payments. Authorities say that
tax evasion through transfer pricing accounts for
60% of total tax evasion by multinational companies. Due to lack of tax
revenues many developing countries can't develop the infrastructure to catch
the evaders.
Bob Jensen's threads on
higher education
controversies are at
http://faculty.trinity.edu/rjensen/HigherEdControversies.htm
Question
This is some of the best material ever for legal-writer John Grisham ---
http://en.wikipedia.org/wiki/John_Grisham
But will he have the courage to venture into this ethical snakepit?
"Lawsuit, Inc.," The Wall Street Journal,
February 25, 2008; Page A14 ---
http://online.wsj.com/article/SB120389878913889385.html
Should state Attorneys
General be able to outsource their legal work to for-profit tort lawyers,
who then funnel a share of their winnings back to the AGs? That's become a
sleazy practice in many states, and it is finally coming under scrutiny --
notably in Mississippi, home of Dickie Scruggs, Attorney General Jim Hood,
and other legal pillars.
The Mississippi Senate
recently passed a bill requiring Mr. Hood to pursue competitive bidding
before signing contracts of more than $500,000 with private lawyers. The
legislation also requires a review board to examine contracts, and limits
contingency fees to $1 million. Mr. Hood is trying to block the law in the
state House, and no wonder considering how sweet this business has been for
him and his legal pals.
We've recently examined
documents from the AG's office detailing which law firms he has retained. We
then cross-referenced those names with campaign finance records. The results
show that some of Mr. Hood's largest campaign donors are the very firms to
which he's awarded the most lucrative state contracts.
The documents show Mr. Hood
has retained at least 27 firms as outside counsel to pursue at least 20
state lawsuits over five years. The law firms are thus able to employ the
full power of the state on their behalf, while Mr. Hood can multiply the
number of targets.
Those targets are invariably
deep corporate pockets: Eli Lilly, State Farm, Coca-Cola, Merck, Boston
Scientific, Vioxx and others. The vast majority of the legal contracts were
awarded on a contingency fee basis, meaning the law firm is entitled to a
big percentage of any money that it can wring from defendants. The amounts
can be rich, such as the $14 million payout that lawyer Joey Langston shared
with the Lundy, Davis firm in an MCI/WorldCom settlement.
These firms are only too
happy to return the favor to Mr. Hood via campaign contributions. Campaign
finance records show that these 27 law firms -- or partners in those firms
-- made $543,000 in itemized campaign contributions to Mr. Hood over the
past two election cycles.
The firm of Pittman,
Germany, Roberts & Welsh was hired by Mr. Hood on a contingency basis to
prosecute State Farm. According to finance documents, partner Crymes Pittman
donated $68,570 to Mr. Hood's campaign, and other Pittman partners chipped
in $33,500 more.
Partners in the Langston Law
Firm gave more than $130,000 to elect Mr. Hood, having been retained to sue
Eli Lilly. Lead partner Joey Langston has separately pleaded guilty to
conspiracy to corruptly influence a judge.
Among others: The Wolf
Popper firm from New York was retained to pursue Sonus Networks, a
telecommunications firm; Wolf Popper and its partners gave $27,500 to Mr.
Hood's campaign. Bernstein, Litowitz sued at least four different companies
for the AG, and the firm and its partners chipped in $41,500. Partners at
Schiffren, Barroway went after Coca-Cola and Viacom, and donated $37,500.
Then there are the law firms
that have piggybacked their class action suits on Mr. Hood's state
prosecutions. Mr. Scruggs and his Katrina litigation partners realized a
nearly $80 million windfall after Mr. Hood used his powers to pressure State
Farm into settling both the state and Scruggs suits. Mr. Scruggs gave
$33,000 to Mr. Hood in the 2007 election cycle. (Mr. Scruggs and his son
Zach have been indicted in an unrelated bribery case, and claim to be
innocent.) David Nutt, a partner in Mr. Scruggs's Katrina litigation, also
gave $25,500 to Mr. Hood's campaign last year.
The Mississippi AG has also
benefited from the national network of trial lawyers and its ability to
funnel money into the state. We've examined finance records of the
Democratic Attorneys General Association, a so-called 527 group that helps
elect liberal prosecutors. In 2007, law firms that have benefited from Mr.
Hood gave the organization $572,000, and in turn the group wrote campaign
checks in 2007 to Mr. Hood for $550,000. Guess who supplied no less than
$400,000 to the group? Messrs. Scruggs and Langston.
Add all of this up, and in
2007 alone Mr. Hood received some $790,000 from partners and law firms that
have benefited financially from his office. That is more than half of all of
Mr. Hood's itemized contributions for 2007.
This kind of quid pro quo is
legal in Mississippi and most other states. However, if this kind of
sweetheart arrangement existed between a public official and business
interests, you can bet Mr. Hood would be screaming about corruption. Yet Mr.
Hood and his trial bar partners are fighting even Mississippi's modest
attempt to require more transparency in their contracts. The AG says it's
all part of a plot to undermine his attempts to "recoup the taxpayers' money
from corporate wrongdoers."
The real issue is the way
this AG-tort bar mutual financial interest creates perverse incentives that
skew the cause of justice. A decision to prosecute is an awesome power, and
it ought to be motivated by evidence and the law, not by the profit motives
of private tort lawyers and the campaign needs of an ambitious Attorney
General. Government is supposed to act on behalf of the public interest, not
for the personal profit of trial lawyers. The tort bar-AG cabal deserves to
be exposed nationwide.
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
The Most Criminal Class Writes the Laws ---
http://online.wsj.com/article/SB120389878913889385.html
"The Government Is Wasting Your Tax Dollars! How Uncle Sam spends nearly
$1 trillion of your money each year," by Ryan Grim with Joseph K. Vetter,
Readers Digest, January 2008, pp. 86-99 ---
http://www.rd.com/content/the-government-is-wasting-your-tax-dollars/4/
1. Taxes:
Cheating Shows. The Internal Revenue Service estimates that the annual net
tax gap—the difference between what's owed and what's collected—is $290
billion, more than double the average yearly sum spent on the wars in Iraq
and Afghanistan.
About $59 billion of that figure results from the
underreporting and underpayment of employment taxes. Our broken system of
immigration is another concern, with nearly eight million undocumented
workers having a less-than-stellar relationship with the IRS. Getting more
of them on the books could certainly help narrow that tax gap.
Going after the deadbeats would seem like an
obvious move. Unfortunately, the IRS doesn't have the resources to
adequately pursue big offenders and their high-powered tax attorneys. "The
IRS is outgunned," says Walker, "especially when dealing with multinational
corporations with offshore headquarters."
Another group that costs taxpayers billions: hedge
fund and private equity managers. Many of these moguls make vast "incomes"
yet pay taxes on a portion of those earnings at the paltry 15 percent
capital gains rate, instead of the higher income tax rate. By some
estimates, this loophole costs taxpayers more than $2.5 billion a year.
Oil companies are getting a nice deal too. The
country hands them more than $2 billion a year in tax breaks. Says Walker,
"Some of the sweetheart deals that were negotiated for drilling rights on
public lands don't pass the straight-face test, especially given current
crude oil prices." And Big Oil isn't alone. Citizens for Tax Justice
estimates that corporations reap more than $123 billion a year in special
tax breaks. Cut this in half and we could save about $60 billion.
The Tab* Tax Shortfall: $290 billion (uncollected
taxes) + $2.5 billion (undertaxed high rollers) + $60 billion (unwarranted
tax breaks) Starting Tab: $352.5 billion
2. Healthy Fixes.
Medicare and Medicaid, which cover elderly and low-income patients
respectively, eat up a growing portion of the federal budget. Investigations
by Sen. Tom Coburn (R-OK) point to as much as $60 billion a year in fraud,
waste and overpayments between the two programs. And Coburn is likely
underestimating the problem.
The U.S. spends more than $400 per person on health
care administration costs and insurance -- six times more than other
industrialized nations.
That's because a 2003 Dartmouth Medical School
study found that up to 30 percent of the $2 trillion spent in this country
on medical care each year—including what's spent on Medicare and Medicaid—is
wasted. And with the combined tab for those programs rising to some $665
billion this year, cutting costs by a conservative 15 percent could save
taxpayers about $100 billion. Yet, rather than moving to trim fat, the
government continues such questionable practices as paying private insurance
companies that offer Medicare Advantage plans an average of 12 percent more
per patient than traditional Medicare fee-for-service. Congress is trying to
close this loophole, and doing so could save $15 billion per year, on
average, according to the Congressional Budget Office.
Another money-wasting bright idea was to create a
giant class of middlemen: Private bureaucrats who administer the Medicare
drug program are monitored by federal bureaucrats—and the public pays for
both. An October report by the House Committee on Oversight and Government
Reform estimated that this setup costs the government $10 billion per year
in unnecessary administrative expenses and higher drug prices.
The Tab* Wasteful Health Spending: $60 billion
(fraud, waste, overpayments) + $100 billion (modest 15 percent cost
reduction) + $15 billion (closing the 12 percent loophole) + $10 billion
(unnecessary Medicare administrative and drug costs) Total $185 billion
Running Tab: $352.5 billion +$185 billion = $537.5 billion
3. Military Mad Money.
You'd think it would be hard to simply lose massive amounts of money, but
given the lack of transparency and accountability, it's no wonder that eight
of the Department of Defense's functions, including weapons procurement,
have been deemed high risk by the GAO. That means there's a high probability
that money—"tens of billions," according to Walker—will go missing or be
otherwise wasted.
The DOD routinely hands out no-bid and cost-plus
contracts, under which contractors get reimbursed for their costs plus a
certain percentage of the contract figure. Such deals don't help hold down
spending in the annual military budget of about $500 billion. That sum is
roughly equal to the combined defense spending of the rest of the world's
countries. It's also comparable, adjusted for inflation, with our largest
Cold War-era defense budget. Maybe that's why billions of dollars are still
being spent on high-cost weapons designed to counter Cold War-era threats,
even though today's enemy is armed with cell phones and IEDs. (And that $500
billion doesn't include the billions to be spent this year in Iraq and
Afghanistan. Those funds demand scrutiny, too, according to Sen. Amy
Klobuchar, D-MN, who says, "One in six federal tax dollars sent to rebuild
Iraq has been wasted.")
Meanwhile, the Pentagon admits it simply can't
account for more than $1 trillion. Little wonder, since the DOD hasn't been
fully audited in years. Hoping to change that, Brian Riedl of the Heritage
Foundation is pushing Congress to add audit provisions to the next defense
budget.
If wasteful spending equaling 10 percent of all
spending were rooted out, that would free up some $50 billion. And if
Congress cut spending on unnecessary weapons and cracked down harder on
fraud, we could save tens of billions more.
The Tab* Wasteful military spending: $100 billion
(waste, fraud, unnecessary weapons) Running Tab: $537.5 billion + $100
billion = $637.5 billion
4. Bad Seeds.
The controversial U.S. farm subsidy program, part of which pays farmers not
to grow crops, has become a giant welfare program for the rich, one that
cost taxpayers nearly $20 billion last year.
Two of the best-known offenders: Kenneth Lay, the
now-deceased Enron CEO, who got $23,326 for conservation land in Missouri
from 1995 to 2005, and mogul Ted Turner, who got $590,823 for farms in four
states during the same period. A Cato Institute study found that in 2005,
two-thirds of the subsidies went to the richest 10 percent of recipients,
many of whom live in New York City. Not only do these "farmers" get money
straight from the government, they also often get local tax breaks, since
their property is zoned as agricultural land. The subsidies raise prices for
consumers, hurt third world farmers who can't compete, and are attacked in
international courts as unfair trade.
The Tab* Wasteful farm subsidies: $20 billion
Running Tab: $637.5 billion + $20 billion = $657.5 billion
5. Capital Waste.
While there's plenty of ongoing annual operating waste, there's also a
special kind of profligacy—call it capital waste—that pops up year after
year. This is shoddy spending on big-ticket items that don't pan out. While
what's being bought changes from year to year, you can be sure there will
always be some costly items that aren't worth what the government pays for
them.
Take this recent example: Since September 11, 2001,
Congress has spent more than $4 billion to upgrade the Coast Guard's fleet.
Today the service has fewer ships than it did before that money was spent,
what 60 Minutes called "a fiasco that has set new standards for
incompetence." Then there's the Future Imagery Architecture spy satellite
program. As The New York Times recently reported, the technology flopped and
the program was killed—but not before costing $4 billion. Or consider the
FBI's infamous Trilogy computer upgrade: Its final stage was scrapped after
a $170 million investment. Or the almost $1 billion the Federal Emergency
Management Agency has wasted on unusable housing. The list goes on.
The Tab* Wasteful Capital Spending: $30 billion
Running Tab: $657.5 billion + $30 billion = $687.5 billion
6. Fraud and Stupidity.
Sen. Chuck Grassley (R-IA) wants the Social Security Administration to
better monitor the veracity of people drawing disability payments from its
$100 billion pot. By one estimate, roughly $1 billion is wasted each year in
overpayments to people who work and earn more than the program's rules
allow.
The federal Food Stamp Program gets ripped off too.
Studies have shown that almost 5 percent, or more than $1 billion, of the
payments made to people in the $30 billion program are in excess of what
they should receive.
One person received $105,000 in excess disability
payments over seven years.
There are plenty of other examples. Senator Coburn
estimates that the feds own unused properties worth $18 billion and pay out
billions more annually to maintain them. Guess it's simpler for bureaucrats
to keep paying for the property than to go to the trouble of selling it.
The Tab* General Fraud and Stupidity: $2 billion
(disability and food stamp overpayment) Running Tab: $687.5 billion + $2
billion = $689.5 billion
7. Pork Sausage.
Congress doled out $29 billion in so-called earmarks—aka funds for
legislators' pet projects—in 2006, according to Citizens Against Government
Waste. That's three times the amount spent in 1999. Congress loves to deride
this kind of spending, but lawmakers won't hesitate to turn around and drop
$500,000 on a ballpark in Billings, Montana.
The most infamous earmark is surely the "bridge to
nowhere"—a span that would have connected Ketchikan, Alaska, to nearby
Gravina Island—at a cost of more than $220 million. After Hurricane Katrina
struck New Orleans, Senator Coburn tried to redirect that money to repair
the city's Twin Span Bridge. He failed when lawmakers on both sides of the
aisle got behind the Alaska pork. (That money is now going to other projects
in Alaska.) Meanwhile, this kind of spending continues at a time when our
country's crumbling infrastructure—the bursting dams, exploding water pipes
and collapsing bridges—could really use some investment. Cutting two-thirds
of the $29 billion would be a good start.
The Tab* Pork Barrel Spending: $20 billion Running
Tab: $689.5 billion + $20 billion = $709.5 billion
8. Welfare Kings.
Corporate welfare is an easy thing for politicians to bark at, but it seems
it's hard to bite the hand that feeds you. How else to explain why corporate
welfare is on the rise? A Cato Institute report found that in 2006,
corporations received $92 billion (including some in the form of those farm
subsidies) to do what they do anyway—research, market and develop products.
The recipients included plenty of names from the Fortune 500, among them
IBM, GE, Xerox, Dow Chemical, Ford Motor Company, DuPont and Johnson &
Johnson.
The Tab* Corporate Welfare: $50 billion Running
Tab: $709.5 billion + $50 billion = $759.5 billion
9. Been There,
Done That. The Rural Electrification Administration, created during the New
Deal, was an example of government at its finest—stepping in to do something
the private sector couldn't. Today, renamed the Rural Utilities Service,
it's an example of a government that doesn't know how to end a program. "We
established an entity to electrify rural America. Mission accomplished. But
the entity's still there," says Walker. "We ought to celebrate success and
get out of the business."
In a 2007 analysis, the Heritage Foundation found
that hundreds of programs overlap to accomplish just a few goals. Ending
programs that have met their goals and eliminating redundant programs could
comfortably save taxpayers $30 billion a year.
The Tab* Obsolete, Redundant Programs: $30 billion
Running Tab: $759.5 billion + $30 billion = $789.5 billion
10. Living on Credit.
Here's the capper: Years of wasteful spending have put us in such a deep
hole, we must squander even more to pay the interest on that debt. In 2007,
the federal government carried a debt of $9 trillion and blew $252 billion
in interest. Yes, we understand the federal government needs to carry a
small debt for the Federal Reserve Bank to operate. But "small" isn't how we
would describe three times the nation's annual budget. We need to stop
paying so much in interest (and we think cutting $194 billion is a good
target). Instead we're digging ourselves deeper: Congress had to raise the
federal debt limit last September from $8.965 trillion to almost $10
trillion or the country would have been at legal risk of default. If that's
not a wake-up call to get spending under control, we don't know what is.
The Tab* Interest on National Debt: $194 billion
Final Tab: $789.5 billion + $194 billion = $983.5 billion
What YOU Can Do Many believe our system is
inherently broken. We think it can be fixed. As citizens and voters, we have
to set a new agenda before the Presidential election. There are three things
we need in order to prevent wasteful spending, according to the GAO's David
Walker:
• Incentives for people to do the right thing.
• Transparency so we can tell if they've done
the right thing.
• Accountability if they do the wrong thing.
Two out of three won't solve our problems.
So how do we make it happen? Demand it of our
elected officials. If they fail to listen, then we turn them out of office.
With its approval rating hovering around 11 percent in some polls, Congress
might just start paying attention.
Start by writing to your Representatives. Talk to
your family, friends and neighbors, and share this article. It's in
everybody's interest.
"Taxpayers distrustful of government
financial reporting," AccountingWeb, February 22, 2008 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=104680
The federal government is
failing to meet the financial reporting needs of taxpayers, falling short of
expectations, and creating a problem with trust, according to survey
findings released by the Association of Government Accountants (AGA). The
survey, Public Attitudes to Government Accountability and Transparency 2008,
measured attitudes and opinions towards government financial management and
accountability to taxpayers. The survey established an expectations gap
between what taxpayers expect and what they get, finding that the public at
large overwhelmingly believes that government has the obligation to report
and explain how it generates and spends its money, but that that it is
failing to meet expectations in any area included in the survey.
The survey further found
that taxpayers consider governments at the federal, state, and local levels
to be significantly under-delivering in terms of practicing open, honest
spending. Across all levels of government, those surveyed held "being open
and honest in spending practices" vitally important, but felt that
government performance was poor in this area. Those surveyed also considered
government performance to be poor in terms of being "responsible to the
public for its spending." This is compounded by perceived poor performance
in providing understandable and timely financial management information.
The survey shows:
The American public is most
dissatisfied with government financial management information disseminated
by the federal government. Seventy-two percent say that it is extremely or
very important to receive this information from the federal government, but
only 5 percent are extremely or very satisfied with what they receive.
Seventy-three percent of
Americans believe that it is extremely or very important for the federal
government to be open and honest in its spending practices, yet only 5
percent say they are meeting these expectations.
Seventy-one percent of
those who receive financial management information from the government or
believe it is important to receive it, say they would use the information to
influence their vote.
Relmond Van Daniker,
Executive Director at AGA, said, "We commissioned this survey to shed some
light on the way the public perceives those issues relating to government
financial accountability and transparency that are important to our members.
Nobody is pretending that the figures are a shock, but we are glad to have
established a benchmark against which we can track progress in years to
come."
He continued, "AGA members
working in government at all levels are in the very forefront of the fight
to increase levels of government accountability and transparency. We believe
that the traditional methods of communicating government financial
information -- through reams of audited financial statements that have
little relevance to the taxpayer -- must be supplemented by government
financial reporting that expresses complex financial details in an
understandable form. Our members are committed to taking these concepts
forward."
Justin Greeves, who led the
team at Harris Interactive that fielded the survey for the AGA, said, "The
survey results include some extremely stark, unambiguous findings. Public
levels of dissatisfaction and distrust of government spending practices came
through loud and clear, across every geography, demographic group, and
political ideology. Worthy of special note, perhaps, is a 67 percentage
point gap between what taxpayers expect from government and what they
receive. These are significant findings that I hope government and the
public find useful."
This survey was conducted
online within the United States by Harris Interactive on behalf of the
Association of Government Accountants between January 4 and 8, 2008 among
1,652 adults aged 18 or over. Results were weighted as needed for age, sex,
race/ethnicity, education, region, and household income. Propensity score
weighting was also used to adjust for respondents' propensity to be online.
No estimates of theoretical sampling error can be calculated.
You can read the
Survey
Report, including a full methodology and associated commentary.
Report on the Transparency International Global Corruption Barometer 2007 ---
http://www.transparency.org/content/download/27256/410704/file/GCB_2007_report_en_02-12-2007.pdf
E XECUTIVE
SUMMARY
– GLOBAL
CORRUPTION
BAROMETER
2007...................2
P AYING
BRIBES AROUND THE WORLD CONTINUES TO BE ALL TOO COMMON
......3
Figure 1. Demands for bribery, by
region 3
Table 1. Countries most affected by
bribery 4
Figure 2. Experience of bribery
worldwide, selected services 5
Table 2. Percentage of respondents
reporting that they paid a bribe to obtain a service 5
Figure 3. Experience with bribery, by
service 6
Figure 4. Selected Services:
Percentage of respondents who paid a bribe, by region 7
Figure 5. Comparing Bribery: 2006 and
2007 8
C ORRUPTION
IN KEY INSTITUTIONS: POLITICAL
PARTIES AND THE
LEGISLATURE VIEWED AS MOST CORRUPT ............................................................8
Figure 6. Perceived levels of
corruption in key institutions, worldwide 9
Figure 7. Perceived levels of
corruption in key institutions, comparing 2004 and 2007 10
E XPERIENCE
V.
PERCEPTIONS OF CORRUPTION
–
DO THEY ALIGN?...................10
Figure 8. Corruption Perceptions Index v. citizens’
experience with bribery 11
L EVELS
OF CORRUPTION EXPECTED TO RISE OVER THE NEXT THREE YEARS....11
Figure 9. Corruption will get worse,
worldwide 11
Figure 10. Expectations about the
future: Comparing 2003 and 2007 12
P UBLIC
SCEPTICISM OF GOVERNMENT EFFORTS TO FIGHT CORRUPTION
–
IN
MOST PLACES
.......................................................................................................13
Table 3. How effectively is government fighting corruption?
The country view 13
C ONCLUSIONS
......................................................................................................13
A PPENDIX
1: THE
GLOBAL
CORRUPTION
BAROMETER
2007 QUESTIONNAIRE15
A PPENDIX
2: THE
GLOBAL
CORRUPTION
BAROMETER
– ABOUT
THE SURVEY17
A PPENDIX
3: REGIONAL
GROUPINGS..................................................................20
G LOBAL
CORRUPTION
BAROMETER
2007..........................................................20
A PPENDIX
4: COUNTRY
TABLES..........................................................................21
Table 4.1: Respondents who paid a
bribe to obtain services 21
Table 4.2: Corruption’s impact on
different sectors and institutions 22
Table 4.3: Views of corruption in the
future 23
Table 4.4: Respondents' evaluation of their
government's efforts to fight corruption 24
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Accountant and Auditor Scandals
"10 Worst Corporate Accounting Scandals,"
by Barry Ritholtz, Ritholtz Blog, March 7, 2013 ---
http://www.ritholtz.com/blog/2013/03/worst-corp-scandals/#more-90147
Jensen Comment
Barry is a financial analyst with a political science background. As an
accounting professor I claim that he missed some of the biggest accounting
scandals even if we leave out the really big scandals before 1950 (e.g, leave
out the South Sea Scandal of monumental proportion).
There are really two tacks that one can take in
the definition of "Corporate Accounting Scandals." One is the size of the
"theft" resulting from accountant and/or auditor negligence. Barry probably had
this in mind, but he missed a few such as the Franklin Raines earnings
management scandal at Fannie Mae.
The other tack is gross accountant and/or audit
negligence even when the size of the theft is somewhat smaller for a worse
crime. For example, there was enormous accountant and/or auditor negligence when
pilfered $53 million from Dixon, Illinois ---
"Rita
Crundwell, Ill. financial officer (Dixon, Illinois horse enthusiast) who
allegedly stole $53 million, sentenced to 19.5 years in prison," by Casey Glynn, CBS News, February 14, 2013 ---
http://www.cbsnews.com/8301-504083_162-57569411-504083/rita-crundwell-ill-financial-officer-who-allegedly-stole-$53-million-sentenced-to-19.5-years-in-prison/
There are many such thefts by accountants that are bad as it gets even if the
amounts they stole is are not in the record books.
Here are some examples of accounting examples
Barry should've also considered::
When KPMG Got Fired
Fannie Mae may have conducted the worst earnings management scheme in the
history of accounting.
. . . flexibility
also gave Fannie the ability to manipulate earnings to hit -- within
pennies -- target numbers for executive bonuses. Ofheo details an
example from 1998, the year the Russian financial crisis sent interest
rates tumbling. Lower rates caused a lot of mortgage holders to prepay
their existing home mortgages. And Fannie was suddenly facing an
estimated expense of $400 million.
Well, in its wisdom, Fannie decided to recognize only $200 million,
deferring the other half. That allowed Fannie's executives -- whose
bonus plan is linked to earnings-per-share -- to meet the target for
maximum bonus payouts. The target EPS for maximum payout was $3.23 and
Fannie reported exactly . . . $3.2309. This bull's-eye was worth $1.932
million to then-CEO James Johnson, $1.19 million to then-CEO-designate
Franklin Raines, and $779,625 to then-Vice Chairman Jamie Gorelick.
That same year Fannie installed software that allowed management to
produce multiple scenarios under different assumptions that, according
to a Fannie executive, "strengthens the earnings management that is
necessary when dealing with a volatile book of business." Over the
years, Fannie designed and added software that allowed it to assess the
impact of recognizing income or expense on securities and loans. This
practice fits with a Fannie corporate culture that the report says
considered volatility "artificial" and measures of precision "spurious."
This disturbing culture was apparent in Fannie's manipulation of its
derivative accounting. Fannie runs a giant derivative book in an attempt
to hedge its massive exposure to interest-rate risk. Derivatives must be
marked-to-market, carried on the balance sheet at fair value. The
problem is that changes in fair-value can cause some nasty volatility in
earnings.
So, Fannie decided to classify a huge amount of its derivatives as
hedging transactions, thereby avoiding any impact on earnings. (And we
mean huge: In December 2003, Fan's derivatives had a notional value of
$1.04 trillion of which only a notional $43 million was not classified
in hedging relationships.) This misapplication continued when Fannie
closed out positions. The company did not record the fair-value changes
in earnings, but only in Accumulated Other Comprehensive Income (AOCI)
where losses can be amortized over a long period.
Fannie had some $12.2 billion in deferred losses in the AOCI balance at
year-end 2003. If this amount must be reclassified into retained
earnings, it might punish Fannie's earnings for various periods over the
past three years, leaving its capital well below what is required by
regulators.
In all, the Ofheo report notes, "The misapplications of GAAP are not
limited occurrences, but appear to be pervasive . . . [and] raise
serious doubts as to the validity of previously reported financial
results, as well as adequacy of regulatory capital, management
supervision and overall safety and soundness. . . ." In an agreement
reached with Ofheo last week, Fannie promised to change the methods
involved in both the cookie-jar and derivative accounting and to change
its compensation "to avoid any inappropriate incentives."
But we don't think this goes nearly far enough for a company whose
executives have for years derided anyone who raised a doubt about either
its accounting or its growing risk profile. At a minimum these
executives are not the sort anyone would want running the U.S. Treasury
under John Kerry. With the Justice Department already starting a
criminal probe, we find it hard to comprehend that the Fannie board
still believes that investors can trust its management team.
Fannie Mae isn't an ordinary company and this isn't a run-of-the-mill
accounting scandal. The U.S. government had no financial stake in the
failure of Enron or WorldCom. But because of Fannie's implicit subsidy
from the federal government, taxpayers are on the hook if its capital
cushion is insufficient to absorb big losses. Private profit, public
risk. That's quite a confidence game -- and it's time to call it.
Wikipedia has a listing of major
accounting scandals that I don't think Barry looked at when listing his "10
Worst Corporate Accounting Scandals" ---
http://en.wikipedia.org/wiki/Accounting_fraud#List_of_major_accounting_scandals
One of the largest settlements/fines paid by an
accounting firm arose when KPMG confessed to selling over $2 billion in
fraudulent tax shelters. The firms cash settlement with the IRS was over $400
million, which was a small amount compared to the actual damages.
The February 19, 2004 Frontline worldwide
broadcast is going to greatly sadden the already sad face of KPMG. As a former
KPMG Professor of Accounting at Florida State University, it also saddens me
that the primary focus of the Frontline broadcast was on the bogus tax
shelters marketed by KPMG over the past few years. All the other large firms
were selling such shelters to some extent, but when their tactics were exposed
the others quickly apologized and promised to abandon sales of such shelters.
KPMG stonewalled and lied to a much greater extent in part because their
illegality went much deeper. The video can now be viewed online for free from
http://www.pbs.org/wgbh/pages/frontline/shows/tax/view/
My summary of the highlights is as
follows:
-
These illegal acts added an enormous
amount of revenue to KPMG, over $1 billion dollars of fraud.
American investigators have discovered that KPMG
marketed a tax shelter to investors that generated more than $1bn (£591m) in
unlawful benefits in less than a year.
David Harding, Financial Director ---
http://www.financialdirector.co.uk/News/1135558
-
While KPMG and all the other large
firms were desperately promising the public and the SEC that they were
changing their ethics and professionalism in the wake of the Andersen melt
down and their own publicized scandals, there were signs that none of the
firms, and especially KPMG, just were not getting it. See former executive
partner Art Wyatt's August 3, 2004 speech entitled "ACCOUNTING
PROFESSIONALISM: THEY JUST DON'T GET IT" ---
http://aaahq.org/AM2003/WyattSpeech.pdf
-
KPMG's illegal acts in not
registering the bogus tax shelters was deliberate with the strategy that if
the firm got caught by the IRS the penalties were only about 10% of the
profits in those shelters such that the illegality was approved all the way
to the top executives of KPMG.
Former Partner's
Memo Says Fees Reaped From Sales of Tax Shelter Far Outweigh Potential
Penalties
KPMG LLP in
1998 decided not to register a new tax-sheltering strategy for wealthy
individuals after a tax partner in a memo determined the potential
penalties were vastly lower than the potential fees.
The shelter,
which was designed to minimize taxes owed on large capital gains such as
from the sale of stock or a business, was widely marketed and has come
under the scrutiny of the Internal Revenue Service. It was during the
late 1990s that sales of tax shelters boomed as large accounting firms
like KPMG and other advisers stepped up their marketing efforts.
Gregg W. Ritchie, then a KPMG LLP tax partner who now works for a Los
Angeles-based investment firm, presented the cost-benefit analysis about
marketing one of the firm's tax-shelter strategies, dubbed OPIS, in a
three-page memorandum to a senior tax partner at the accounting firm in
May 1998. By his calculations, the firm would reap fees of $360,000 per
shelter sold and potentially pay only penalties of $31,000 if
discovered, according to the internal note.
Mr. Ritchie recommended that KPMG avoid registering the strategy with
the IRS, and avoid potential scrutiny, even though he assumed the firm
would conclude it met the agency's definition of a tax shelter and
therefore should be registered. The memo, which was reviewed by The Wall
Street Journal, stated that, "The rewards of a successful marketing of
the OPIS product [and the competitive disadvantages which may result
from registration] far exceed the financial exposure to penalties that
may arise."
The directive, addressed to Jeffrey N. Stein, a former head of tax
service and now the firm's deputy chairman, is becoming a headache
itself for KPMG, which currently is under IRS scrutiny for the sale of
OPIS and other questionable tax strategies. The memo is expected to play
a role at a hearing Tuesday by the Senate's Permanent Subcommittee on
Investigations, which has been reviewing the role of KPMG and other
professionals in the mass marketing of abusive tax shelters. A second
day of hearings, planned for Thursday, will explore the role of lawyers,
bankers and other advisers.
Richard Smith, KPMG's current head of tax services, said Mr. Ritchie's
note "reflects an internal debate back and forth" about complex issues
regarding IRS regulations. And the firm's ultimate decision not to
register the shelter "was made based on an analysis of the law. It
wasn't made on the basis of the size of the penalties" compared with
fees. Mr. Ritchie, who left KPMG in 1998, declined to comment. Mr. Stein
couldn't be reached for comment Sunday.
KPMG, in a statement Friday, said it has made "substantial improvements
and changes in KPMG's tax practices, policies and procedures over the
past three years to respond to the evolving nature of both the tax laws
and regulations, and the needs of our clients. The tax strategies that
will be discussed at the subcommittee hearing represent an earlier time
at KPMG and a far different regulatory and marketplace environment. None
of the strategies -- nor anything like these tax strategies -- is
currently being offered by KPMG."
Continued in the article.
-
KPMG would probably still be selling
the bogus tax shelters if a KPMG whistle blower named Mike Hamersley had not
called attention to the highly secretive bogus tax shelter sales team at
KPMG. His recent and highly damaging testimony to KPMG is available at
http://finance.senate.gov/hearings/testimony/2003test/102103mhtest.pdf
This is really, really bad for the image of professionalism that KPMG tries
to portray on their happy face side of the firm. KPMG is now under criminal
investigation by the U.S. Department of Justice.
-
The reason that KPMG and the other large accounting firms did
and can continue to sell illegal tax shelters at the margin is that they
have poured millions into an expensive lobby team in Washington DC that has
been highly successful in blocking Senator Grassley's proposed legislation
that would make all tax shelters illegal if the sheltering strategy served
no economic purpose other than to cheat on taxes. Your large accounting
firms in conjunction with the world's largest banks continue to block this
legislation. If the
accounting firms wanted to really improve their professionalism image they
would announce that they have shifted their lobbying efforts to supporting
Senator Grassley's proposed cleanup legislation. But to do so would put
these firms at odds with their largest clients who are the primary
benefactors of abusive tax shelters.
And KPMG's negligent audits of
Countrywide Financial may have resulted in the largest economic damage ever for
an auditing firm.
"Settling For Silence: KPMG Closes The Books On New Century And Countrywide,"
by Francine McKenna, re:TheAuditors, August 18, 2010 ---
http://retheauditors.com/2010/08/18/settling-for-silence-kpmg-closes-the-books-on-new-century-and-countrywide/
And if we move beyond accounting per
se, the recent LIBOR scandals are bigger than all of his "10 Worst" combined ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Private Equity Crooks
"Keep Private Equity Away From Our Banks,"
by Andy Stern, The Wall Street Journal, July 7, 2008; Page A13 ---
http://online.wsj.com/article/SB121538911268431155.html?mod=djemEditorialPage
Private-equity firms have
made a lavish living on making big bets when no one is looking. Unlike banks
and thrifts – which are regulated, transparent and generally publicly owned
enterprises – private-equity firms operate in secret, virtually free from
regulation. They use tax loopholes around carried interest – and deduct
interest payments on the debt they use for buyouts – to extract huge profits
from the companies they buy. Private-equity profits are built on big risks,
and taking advantage of lax regulation – the very problems that led to the
subprime and credit crises.
Shareholders are also paying
the price for private-equity investments in banks. Texas Pacific Group's (TPG)
recent investment in Washington Mutual (WaMu) massively diluted shareholder
stakes by handing 50.2% of the company to TPG and its partners. While the
deal – crafted in secret without shareholder input or approval – has already
put $50 million in transaction fees in the pocket of TPG, WaMu shareholders
have seen their stock value fall to $5.38 a share, the lowest level in 16
years (a nearly 90% drop in the last year alone).
Continued in article
The Vultures Feeding on Insolvency
"All aboard the insolvency gravy train: Insolvency practitioners are
making vast sums out of the recession ... and leaving creditors with pennies,"
by Prem Sikka, The Guardian, October 23, 2009 ---
http://www.guardian.co.uk/commentisfree/2009/oct/23/insolvency-administration-industry-fees
"Insolvent abuse: Insolvency practitioners often charge huge fees,
leaving less money for the creditors. It's time this industry was properly
regulated," by Prem Sikka, The Guardian, April 14, 2008 ---
http://commentisfree.guardian.co.uk/prem_sikka_/2008/04/insolvent_abuse.html
The current economic turmoil is expected to lead to
a steep rise in business and personal bankruptcies. Millions of innocent
people will lose their jobs, homes, savings, pensions and investments. The
bad news for millions is a boon for corporate undertakers, also known as
insolvency practitioners, who are poorly regulated, lack effective public
accountability and indulge in predatory practices.
Following the
Insolvency Act 1986, all UK personal and business
insolvencies must be handled by just 1,600
insolvency practitioners
belonging to law and accountancy trade associations. They are regulated by
no fewer than seven self-interested groups rather than by any independent
regulator, leaving plenty of scope for duplication, waste and buck-passing.
Over half of all insolvency practitioners work for
the
big
four accountancy firms. Within accountancy firms,
insolvency work is treated as a profit centre and employees are under
constant pressure to generate new business. Capitalism provides its own
victims, but profitable opportunities are also manufactured by
practitioners.
MPs have highlighted a longstanding insolvency
tactic. As many companies have seasonal cash flows
they rely upon bank loans and overdrafts to provide working capital. Unlike
banks in many other countries, UK banks do not become closely involved in
the oversight of the client companies. Instead, they periodically send in
accountants to report on the financial health of the borrowing company. If
accountants say all is well, they receive a one-off fee. If accountants say
all is not well and then persuade the bank to nominate them as the
administrators, receivers or liquidators, they can collect fees for many
years to come. Many a company has been
unnecessarily (pdf) put into liquidation and
thousands of jobs have been lost through such ploys. There is a clear
conflict of interests and in the words of the MP Austin Mitchell, it is "a
...
scandal that should have been dealt with". Major
accountancy firms charge up to £600 an hour for insolvency work.
Most insolvency practitioners are appointed by
secured creditors, usually banks. Generally, they owe a duty of care only to
the party appointing them and not to any other stakeholder. A creditors'
committee is supposed to supervise the work of liquidators, but most
creditors are too busy searching for other business and thus cannot spare
the time to supervise the practitioners. In practice, the creditors'
committee is dominated by the insolvency practitioner and the secured
creditors.
Insolvency practitioners have the first claim on
the assets and cash of the bankrupt business or individuals. They need to be
paid before anyone else. Inevitably, only asset-rich companies become
bankrupt otherwise insolvency practitioners will not be able to collect
their fees. As fees paid to insolvency practitioners are related to the time
taken to finalise insolvency, they have economic incentives to prolong the
cases.
Following frauds by the late Robert Maxwell,
Maxwell Communications Corporation entered
receivership and then liquidation in December 1991. The insolvency has not
yet been finalised but some £92m in fees has been collected by accountants
and lawyers. One tranche of Maxwell assets was sold for £1,672,500, but
insolvency practitioners charged fees of £1,628,572, leaving £43,928 for
creditors.
The Bank of Credit and Commerce International
(BCCI)
went into liquidation in July 1991 and the UK
liquidators and their advisers have so far charged £282m in fees. The final
bill may well be around £500m. The BCCI liquidator also paid £75.3m to Bank
of England to cover the costs of a 12 year legal battle. The case was
described by the judge as built "not even on sand
but rather on air" and as "a grotesque and cynical
operation". Courts, the furniture chain, went into
administration in November 2004 and by January 2008, its administrators had
collected
£23.7m in fees, charging up £600 an hour for its
labour. In October 2006,
Lexi Holdings, a property finance firm, went into
administration and by November 2007, the insolvency practitioners had raised
£12.6m through the sale of assets, but charged over £5m in fees. In November
2006, Farepak, the Christmas hamper business, collapsed and savers have been
told that they might be able to recover five pence in the pound, but by
September 2007, insolvency practitioners and their advisers racked up fees
of over £1.2m. The longevity of liquidation processes reduces the amounts
available to creditors.
In January 2008, a
Minister told parliament that 4,921 company
administrations or liquidations began between 10 and fifteen years ago and
had still not been finalised. Some 12,571 began more than 15 years ago but
had still not been finalised. Yet ever keen to appease big accountancy
firms, ministers have not launched an investigation into the efficiency,
accountability and performance of the insolvency industry.
The insolvency industry is out of control. It lacks
independent regulation, independent complaints investigation procedures and
an independent ombudsman to adjudicate on disputes between practitioners and
other stakeholders. The practitioners owe a duty of care to all stakeholders
and must be forced to make public all relevant information in their
possession. One hopes that with the deepening economic gloom parliamentary
committees will examine the role of this industry in the loss of jobs, homes
and savings.
Question
What is the most profit ever made by a speculator on Wall Street?
April 16, 2008 message from David Albrecht
[albrecht@PROFALBRECHT.COM]
April 16, 2008
Wall Street Winners Get Billion-Dollar Paydays
By JENNY ANDERSON
Hedge fund managers, those masters of a secretive, sometimes volatile
financial universe, are making money on a scale that once seemed
unimaginable, even in Wall Street’s rarefied realms.
One manager, John Paulson, made $3.7 billion last year. He reaped that
bounty, probably the richest in Wall Street history, by betting against
certain mortgages and complex financial products that held them.
Mr. Paulson, the founder of Paulson & Company, was not the only big winner.
The hedge fund managers James H. Simons and George Soros each earned almost
$3 billion last year, according to an annual ranking of top hedge fund
earners by Institutional Investor’s Alpha magazine, which comes out
Wednesday.
Hedge fund managers have redefined notions of wealth in recent years. And
the richest among them are redefining those notions once again.
Their unprecedented and growing affluence underscores the gaping inequality
between the millions of Americans facing stagnating wages and rising home
foreclosures and an agile financial elite that seems to thrive in good times
and bad. Such profits may also prompt more calls for regulation of the
industry.
Even on Wall Street, where money is the ultimate measure of success, the
size of the winnings makes some uneasy. “There is nothing wrong with it
it’s not illegal,” said William H. Gross, the chief investment officer of
the bond fund Pimco. “But it’s ugly.”
The richest hedge fund managers keep getting richer fast. To make it into
the top 25 of Alpha’s list, the industry standard for hedge fund pay, a
manager needed to earn at least $360 million last year, more than 18 times
the amount in 2002. The median American family, by contrast, earned $60,500
last year.
Combined, the top 50 hedge fund managers last year earned $29 billion. That
figure represents the managers’ own pay and excludes the compensation of
their employees. Five of the top 10, including Mr. Simons and Mr. Soros,
were also at the top of the list for 2006. To compile its ranking, Alpha
examined the funds’ returns and the fees that they charge investors, and
then calculated the managers’ pay.
Continued at:
http://www.nytimes.com/2008/04/16/business/16wall.html
"U.S. Expected to Charge Executive Tied to
Galleon Case," by Azam Ahmed, Peter Lattman, and Ben Protess, The New
York Times, October 25, 2011 ---
http://dealbook.nytimes.com/2011/10/25/gupta-faces-criminal-charges/?nl=todaysheadlines&emc=tha2
Federal prosecutors are
expected to file criminal charges on Wednesday against Rajat K. Gupta, the
most prominent business executive ensnared in an aggressive insider trading
investigation, according to people briefed on the case.
The case against Mr. Gupta,
62, who is expected to surrender to F.B.I. agents on Wednesday, would extend
the reach of the government’s inquiry into America’s most prestigious
corporate boardrooms. Most of the defendants charged with insider trading
over the last two years have plied their trade exclusively on Wall Street.
The charges would also mean
a stunning fall from grace of a trusted adviser to political leaders and
chief executives of the world’s most celebrated companies.
A former director of Goldman
Sachs and Procter & Gamble and the longtime head of McKinsey & Company, the
elite consulting firm, Mr. Gupta has been under investigation over whether
he leaked corporate secrets to Raj Rajaratnam, the hedge fund manager who
was sentenced this month to 11 years in prison for trading on illegal stock
tips.
While there has been no
indication yet that Mr. Gupta profited directly from the information he
passed to Mr. Rajaratnam, securities laws prohibit company insiders from
divulging corporate secrets to those who then profit from them.
The case against Mr. Gupta,
who lives in Westport, Conn., would tie up a major loose end in the
long-running investigation of Mr. Rajaratnam’s hedge fund, the Galleon
Group. Yet federal authorities continue their campaign to ferret out insider
trading on multiple fronts. This month, for example, a Denver-based hedge
fund manager and a chemist at the Food and Drug Administration pleaded
guilty to such charges.
A spokeswoman for the United
States attorney in Manhattan declined to comment.
Gary P. Naftalis, a lawyer
for Mr. Gupta, said in a statement: “The facts demonstrate that Mr. Gupta is
an innocent man and that he acted with honesty and integrity.”
Mr. Gupta, in his role at
the helm of McKinsey, was a trusted adviser to business leaders including
Jeffrey R. Immelt, of General Electric, and Henry R. Kravis, of the private
equity firm Kohlberg Kravis Roberts & Company. A native of Kolkata, India,
and a graduate of the Harvard Business School, Mr. Gupta has also been a
philanthropist, serving as a senior adviser to the Bill & Melinda Gates
Foundation. Mr. Gupta also served as a special adviser to the United
Nations.
His name emerged just a week
before Mr. Rajaratnam’s trial in March, when the Securities and Exchange
Commission filed an administrative proceeding against him. The agency
accused Mr. Gupta of passing confidential information about Goldman Sachs
and Procter & Gamble to Mr. Rajaratnam, who then traded on the news.
The details were explosive.
Authorities said Mr. Gupta gave Mr. Rajaratnam advanced word of Warren E.
Buffett’s $5 billion investment in Goldman Sachs during the darkest days of
the financial crisis in addition to other sensitive information affecting
the company’s share price.
At the time, federal
prosecutors named Mr. Gupta a co-conspirator of Mr. Rajaratnam, but they
never charged him. Still, his presence loomed large at Mr. Rajaratnam’s
trial. Lloyd C. Blankfein, the chief executive of Goldman, testified about
Mr. Gupta’s role on the board and the secrets he was privy to, including
earnings details and the bank’s strategic deliberations.
The legal odyssey leading to
charges against Mr. Gupta could serve as a case study in law school criminal
procedure class. He fought the S.E.C.’s civil action, which would have been
heard before an administrative judge. Mr. Gupta argued that the proceeding
denied him of his constitutional right to a jury trial and treated him
differently than the other Mr. Rajaratnam-related defendants, all of whom
the agency sued in federal court.
Mr. Gupta prevailed, and the
S.E.C. dropped its case in August, but it maintained the right to bring an
action in federal court. The agency is expected to file a new, parallel
civil case against Mr. Gupta as well. It is unclear what has changed since
the S.E.C. dropped its case in August.
An S.E.C. spokesman declined
to comment.
Continued in article
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Insolvent Vultures Feeding on
Creditors and Taxpayers
"Insolvency: a licence to print money: Chapter 11 is
not all it's cracked up," by Prim Sikka, "The Guardian," July 17,
2008 ---
http://www.guardian.co.uk/commentisfree/2008/jul/17/conservatives
David Cameron
wants to reform insolvency procedures. Rather than
scrutinising the UK's existing practices, he wants to import the US
practices, particularly "Chapter 11" of the
US Bankruptcy Code. Chapter 11 has some merits. It
gives distressed companies breathing space to reorganise their financial
affairs, protect some jobs and forestall bankruptcy, but it also has
unexpected outcomes.
WorldCom was one of the biggest US
corporate frauds of recent years. The company's reporting of fictitious
profits exerted pressure on its competitors and destroyed several of them.
The fraud resulted in loss of jobs, savings, investments and pensions.
WorldCom also avoided billions of dollars in
taxes.
In 2002, WorldCom filed for Chapter 11 bankruptcy, secured new finance and
in 2004 re-emerged as MCI. The revamping generated millions of dollars in
fees for accountants and lawyers. As part of the bankruptcy processes,
creditors agreed to forego some of the amounts due to them. With lower
interest charges and depreciation on its assets, WorldCom has been able to
portray itself as a sound company. The same advantages are not available to
those companies who did not indulge in fraudulent activities.
WorldCom's survival is of little
consolation to those who tried to compete honestly with the original entity.
Those who originally supported the company now find that their financial
interests are less well protected than the new backers.
Chapter 11 proceedings have increasingly
been used by companies for "strategic bankruptcies" – in other words, they
have used the law to avoid leasing agreements, employee rights, tax
payments, damages awarded against them by courts and even to defeat
unwelcome takeover bids.
Airlines have
frequently resorted to Chapter 11 processes to reconstruct their affairs and
avoid making debt repayments. One
book
highlights how Continental Airlines used the process to cut labour costs. A
company facing asbestos related claims declared itself insolvent to avoid
paying compensation to victims.
Cameron's interest in Chapter 11 may well
be a publicity stunt. At the height of the last recession, the then
Conservative government could have introduced Chapter 11 reforms, but it did
not - as shown by parliamentary
replies from ministers. The
Conservatives also opposed making the fees charged by insolvency
practitioners more transparent, and even the idea of a bankruptcy court that
might have adjudicated on disputes between insolvency practitioners and
stakeholders.
The UK's woeful current insolvency laws
allow viable businesses to be placed into liquidation. The process typically
begins with the bank, usually a secured creditor, sending accountants to
review the financial health of a debtor company. If the accountants conclude
that all is well, they stand to receive a one-off fee from the bank.
However, if they raise doubts and then persuade the bank to appoint the same
accounting firm as receivers or liquidators, they could be collecting fees
for years to come. There is an inevitable
conflict of interests and many good businesses
have been placed into liquidation. Some years ago, Royal Bank of Scotland
declared that it would not award receiverships to any accounting firm which
had previously acted as reporting accountants for the client in question. It
subsequently reported a 60%
reduction in the number of
business recommended for receivership and liquidations.
Insolvency is a licence to print money.
Practitioners are paid before any creditor and can charge more than
£600 for an hour's work. They do not owe a "duty
of care" to all stakeholders affected by their practices, and that provides
plenty of incentives to prolong insolvencies. Both
Maxwell Communication Corporation plc (looted by
Robert Maxwell) and the Bank of Credit and Commerce International (BCCI)
began liquidation proceedings in 1991. Neither has
been finalised, but MCC plc has generated £88m in fees for the insolvency
practitioners and BCCI's liquidators have collected over £400m. Nor are
these cases unusual. Almost 5,000 companies where the administration or
liquidation process began
between 10 and fifteen years ago , and 12,571
companies where the administration or liquidation process began
more than 15 years ago are not
finalised.
David Cameron could advance his new-found
interest in business insolvencies by commissioning an independent
investigation into the insolvency industry. Currently,
seven buck-passing and ineffective
regulators regulate around 1,600 licensed practitioners. Theses should be
replaced by one independent regulator who owes a duty of care to all
stakeholders. Reporting accountants should not be allowed to become
receivers and liquidators. There should be an independent complaints
investigations procedure, and an ombudsman should adjudicate on disputes.
These modest reforms could save many businesses from vultures. Is the Tory
leader willing to take on big accounting firms and open a new chapter in
saving jobs?
Mutual Fund,
Hedge Fund,
and Insurance Company Scandals
So where was
Levitt before Spitzer did his job? While heading up the SEC.
Levitt always seemed willing to take on the CPA firms, but he treaded
lightly (really did very little) while the financial industry on Wall
Street ripped off investors bigtime. It never ceases to amaze me
how Levitt capitalizes on his failures.
Forget Enron, WorldCom or mutual funds. The
crisis enveloping the insurance industry is "the scandal of the
decade, without a question" and "dwarfs anything we've seen
thus far."
Arthur Levitt as quoted by SmartPros, October 25, 2004 --- http://www.smartpros.com/x45590.xml
Bob Jensen's threads on insurance frauds are at http://faculty.trinity.edu/rjensen/fraudCongress.htm#MutualFunds
Democratic
Presidential Candidate John Kerry refers to the Mutual Fund Industry
as "Organized Crime."
"John Kerry’s 19 Year Record On Investor Issues," American
Shareholders' Association --- http://www.americanshareholders.com/news/asakerryreport03-22-04.pdf
Three Bank of America
Corp. brokerage units agreed to pay $375 million to settle market timing
charges, the U.S. Securities and Exchange Commission said Wednesday. The SEC
charged that Banc of America Capital Management LLC, BACAP Distributors LLC, and
Banc of America Securities LLC entered into "improper and undisclosed
agreements" that let favored large investors engage in rapid short-term,
market timing and late trading in Nations Funds mutual funds. Separately,
Bank of America's Fleet mutual fund unit agreed to pay $140 million to settle
market timing charges, while five former executives were individually charged
with market timing violations, the SEC said.
"Bank of America to Settle Mutual Fund Charges," The New York Times,
February 9, 2005 --- http://www.nytimes.com/2005/02/09/business/09WIRE-BOFA.html
Washington's insurance commissioner is seeking
millions of dollars from accounting firm Ernst & Young for its alleged
neglect in overseeing finances at Metropolitan Mortgage &
Securities.
Washington State Sues E&Y Over Met Mortgage Woes," AccounitngWeb,
October 19m 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99940
One thing your
can count on: When you invst, a lot of the people you trust are
going to cheat. Billions of investor dollars whirl through the
system. It's all too easy for insiders to stick their hands into
that current and grab. We're not talking about a bad apple here
and there. Cheating runs through
Wall Street's very seams --- even in
the sainted mutual funds.
Jane Bryant Quinn. "Mutual Funds' Greed Machine, Newsweek,
November 24, 2003, Page 45
"I believe this
(mutual
fund rip-off) is the worst scandal we've seen in 50 years,
and I can't say I saw it coming," said
Arthur Levitt, the former chairman of the Securities and Exchange Commission for
nearly eight years under the Clinton administration. "I probably worried
about funds less than insider trading, accounting issues and fair disclosure to
investors" by public companies.
Stephen Labaton (see below)
One Person's Claim Can Dramatically Increase a
Firm's Employee Health Insurance
Such are the challenges for smaller businesses in
Kansas and the many other states where laws permit insurers to raise health
premiums substantially for small employers when one worker incurs significant
medical bills. And it is why, as state legislatures, Congress and presidential
candidates of all stripes debate the growing problem of Americans without health
insurance, the struggles of small businesses — which employ about 40 percent of
the nation’s work force — are likely to become a central issue. Small-business
employees are one of the fastest-growing segments of the nation’s 44 million
uninsured; they now represent at least 20 percent of the total, according to
federal census data. And even modest-size employers like Varney’s that say they
remain committed to providing benefits find themselves wondering how long they
can continue.
"Small Businesses’ Premiums Soar After Illness," The New York Times, May
6, 2007 ---
http://www.nytimes.com/2007/05/05/business/05insure.html
Mutual Funds Watchdog Site
Featured (Positively) in USA Today on July 3, 2006, Page 3B ---
http://www.fundalarm.com/
FundAlarm is a free, non-commercial Website. Our
view of the mutual fund industry is slightly off-center. We help you decide
when it's time to sell a fund, instead of when it's time to buy. The mutual
fund industry is full of broken promises, arrogance, greed, hypocrisy -- the
list goes on. We try to shine a light in the darker corners, and poke holes
in balloons that could use some poking.
A close-up look at the IT infrastructure
behind the Madoff affair
December 17, 2009 message from Scott Bonacker
[lister@BONACKERS.COM]
There is an article in the
new Bank Technology News that might be of interest to anyone teaching
internal controls or fraud detection. Or if you're just curious.
http://www.americanbanker.com/btn_issues/22_12/the-it-secrets-1004419-1.html
"Special Feature The IT
Secrets from the Liar's Lair Two years ago, IT executive Bob McMahon
wondered why his highly-profitable employer, Bernard L. Madoff Investment
Services, didn't replace antiquated systems with more modern and efficient
off-the-shelf technology. On Dec. 11, 2008, when Madoff was arrested, he got
his answer.A close-up look at the IT infrastructure behind the Madoff
affair."
Scott Bonacker CPA
Springfield, MO
"The IT Secrets from the Liar's Lair," by John
Dodge, Bank Technology News, December 2009 ---
http://www.americanbanker.com/btn_issues/22_12/the-it-secrets-1004419-1.html
Two years ago, IT
executive Bob McMahon wondered why his highly-profitable employer, Bernard
L. Madoff Investment Services, didn't replace antiquated systems with more
modern and efficient off-the-shelf technology. The Madoff systems were
expensive to maintain and made it difficult to grow the business by
expanding into new classes of securities. McMahon's job: To organize and
document projects that would create custom technology for the firm's trading
operations.
On Dec. 11, 2008,
he got his answer.
That day, Bernie
Madoff was arrested and charged with stealing tens of billions of his
clients' money over decades. McMahon realized if "technologists" had
replaced the proprietary systems with more modern and open computers, they
would have invariably found the absence of data on countless stock trades
that supposedly took place. In a sense, the preservation of old computer
technology helped Madoff successfully go undetected for years until his
massive Ponzi scheme collapsed that day.
Over the past six
weeks, Securities Industry News, a sister publication of Bank Technology
News, has dug into and beyond the court records to construct an extensive
picture of how Madoff actually operated: The systems and technology he and
underlings used to create - or fake - the most detailed set of customer
accounts underlying a fraud in the history of the securities industry.
Included are
details of a declaration filed Oct. 16 on behalf of the court-appointed
trustee, Irving Picard, investigating the case, and information filed in
court when two IT employees were arrested in mid-November. The documents,
and subsequent interviews, describe how the real and the fake trading floors
worked, and why the securities investors believed they owned are never going
to be declared "missing." The answer: Because they never existed in the
first place.
LEGITIMATE AND
ILLEGITIMATE
"I asked myself how
Bernie could have hidden and maintained this for so long. A lot of it was
because he had proprietary and legacy systems. And he relied on IT people he
hired and paid," to not upset the status quo, says McMahon.
As a project
manager, he always felt like an odd duck at Bernard L. Madoff Investment
Services (BLMIS), an outfit which seemed to lack standards and procedures
routine at former employers of his such as the International Securities
Exchange and CheckFree Investment Services (now Fiserv, Inc.). Little was
documented and the company seemed to be overwhelmed keeping the older
systems from breaking down.
"I immediately
recognized there was massive institutional chaos in the way the place was
managed. No one found value in participating in project management meetings
or in writing things down. There was no documentation," says McMahon, today
an operational performance consultant for Standard & Poors.
McMahon lasted less
than a year at Madoff's firm. He was hired in February 2007, by long-time
BLMIS chief information officer Elizabeth Weintraub. She died in September
of that year. Differences over updating the systems and formalizing
procedures with Weintraub's two successors led to his dismissal the
following January, by McMahon's account.
Nader Ibrahim, who
was on the support desk from 2000 to 2003, confirmed that the atmosphere in
the BLMIS IT department was often tense and unusual.
"We did not have
titles, which was definitely suspicious to me. We all knew who each other
worked for, but nobody knew what the other person was doing," he said.
"Everything was on a need-to-know basis. There was a lot of secrecy."
But the real secret
about Madoff's purported trading for thousands of investment advisory
clients, investigators say, is that it never happened.
To be fair, it's
not as if Madoff didn't have a real trading floor. Madoff's legitimate
market-making business was located on the 19th floor of 885 Third Ave., in
New York, using one IBM Application System/400 computer, known within the
firm as "House 5.'' BLMIS' information technology operation was located on
the 18th floor, where McMahon had his cube and was supposed to organize and
document projects involving custom technology for the trading operation.
What was on the
17th floor? The fake trading floor where a second IBM AS/400 known
internally as "House 17" processed historical price information on
securities allegedly bought for clients. The end result was phony trade
confirmations and wholly manufactured-but official-looking-statements for
4,903 investment advisory clients.
OPEN AND CLOSED
Madoff's legitimate
traders used a mix of green-screen and "M2" Windows-based desktop computers.
These ran in-house trading software referred to as MISS, which McMahon
recalled standing for something like "Madoff Investment Systems and
Services." The internally-named and developed M2s ran MISS as a Windows
application and were used by younger traders who wanted familiar software
instead of the rigid green screen system, developed around 1985, where only
text appeared on screen and instructions were in almost cryptic codes
entered into command lines.
Support for House 5
was almost like that of a large investment bank's support of its trading
operations. Nothing was too good, in theory, for the Madoff trading
operation on the 19th floor. Even if it was not necessary.
"Madoff did not buy
anything off the shelf. The IT team was doing proprietary software
development. Maybe J.P. Morgan Chase needs all this heavy technology, but a
hedge fund with 120 people doesn't have to be in systems development," says
McMahon, adding that a similarly-sized firm might have a half dozen IT
people. Both McMahon and Ibrahim pegged the number of people actively
supporting technology at BLMIS at between 40 and 50.
But large staff and
support for House 5 has not thrown off investigators. Court-appointed
trustee Irving Picard, who is charged with liquidating Madoff's remaining
assets, has instead focused on "House 17,'' where the daily administration
of the Ponzi scheme was executed.
Picard hired an
investigator, Joseph Looby, an accounting forensics expert who probably
knows the most about the technology that aided Madoff in stealing client
funds other than former members of Madoff's staff. Looby is an expert in
electronic fraud and senior managing partner with FTI Consulting Inc. in New
York.
Looby's 20-page
declaration on Picard's behalf with the U.S. Bankruptcy Court for Southern
District of New York on Oct. 16 amounts to the deepest examination yet of
the foundational technology behind Madoff's fraud. The declaration seeks to
deny paying Madoff's victims based on their last statements, dated Nov. 30,
2008, because the values stated were based on investments that were
allegedly never bought or sold (see graphic at right).
Reached in his
Times Square office, Looby, like Picard, said he could not elaborate on his
examination of "House 17. But in the declaration, he reported that "House 5"
supported Madoff's market-making operation and was networked to third
parties outside the firm that would logically support a trading operation.
One, for example, was the depository and clearing firm Depository Trust &
Clearing Corp. (DTCC).
"[House 5] was an
AS/400, consistent with a legitimate securities trading business," Looby
wrote. In the declaration, he often compares House 5's legitimacy to House
17's illegitimacy.
House 17, for
reasons that are now obvious, was shut off to anyone but Madoff's former
chief finance officer and right-hand-man Frank DiPascali Jr. as well as his
alleged accomplices. That list now includes Jerome O'Hara, 46, and George
Perez, 43, who have both been charged in civil and criminal complaints with
helping DiPascali create the phoney statements that supported the Ponzi
scheme. O'Hara and Perez face 30 years in prison and more than $5 million in
fines if convicted. DiPascali sits in a New York jail awaiting sentencing
after pleading guilty to 10 felony counts on Aug. 11. He faces 125 years and
his sentencing is scheduled for May 2010. In the interim, investigators are
hoping to get his cooperation to implicate others.
"They want to
squeeze him for more than what he's giving now so he can avoid 125 years in
prison," says Erin Arvedlund, author of "Too Good to be True: The Rise and
Fall of Bernie Madoff." The former reporter for Barron's in a widely-cited
2001 story challenged Madoff's implausible if not impossible returns and
asked why hundreds of millions in uncollected commissions were left on the
table. It appears now there were no trades made, from which to derive
commissions. "[House 17] was a closed system, separate and distinct from any
computer system utilized by the other BLMIS business units; consistent with
one designed to mass produce fictitious customer statements," according to
Looby's declaration. House 17's expressed purpose was to maintain phony
records and crank out millions of phony IRS 1099s on capital gains and
dividends, trade confirmations, management reports and customer statements.
"The AS/400 was like a giant Selectric typewriter. When you're making up
numbers like that, you're using your computer as a typewriter," says
computer consultant Judith Hurwitz, president of Hurwitz & Associates in
Newton, Mass.
ON THE HOUSE
House 17 held 4,659
active accounts overseen by DiPascali where Madoff purportedly executed a
"split strike conversion" strategy on large cap stocks. In basic terms, it's
a "collar," putting a floor and a ceiling on returns. A floor on potential
losses is created by purchasing a put on a stock. The sale of a call then
puts a ceiling on the returns. The "split" in "strike" prices is considered
a "vacation trade.'' The trader doesn't worry about what happens until the
expiration dates on the put or call options arrive.
The strategy was
allegedly applied for the thousands of customers on "baskets" of large cap
stocks. According to the faked BLMIS statements, these accounts typically
yielded 11 to 17 percent returns annually.
Another 244
"non-split strike" accounts produced phony returns in excess of 100 percent
and were managed by BLMIS employees other than DiPascali.
The "non-split
strike" accounts included many "long time" Madoff customers and feeder funds
such as those operated by Stanley Chais or Jeffry Picower and against whom
Picard has filed civil suits to reclaim billions in profits alleged to be
illegal. Picower of Palm Beach was found dead in his pool Oct. 25. Chais
maintains he's innocent.
In the declaration,
Looby repeatedly asserts that no securities were ever bought for BLMIS
investment advisory customers. Proceeds sent in by clients for that purpose
were "instead primarily used to make distributions to or payments on behalf
of, other investors as well as withdrawals and payments to Madoff family
members and employees," the declaration states.
Here's how it
worked: BLMIS employees fed the AS/400 constantly with stock data, enough to
support trades that would satisfy the expectations promised to Madoff's
thousands of eventual victims. To support the fantasy returns, so-called
"baskets" of S&P100 stocks would be bought and sold, on behalf of clients.
Looby did not specify the typical size of a basket, but they were
proportional to the proceeds a client had remitted to BLMIS. "If a basket
was $400,000 and a customer had $800,000 available, two baskets of
securities and options would be purportedly "purchased" for the account,"
Looby wrote. The types of stocks can be seen in a Madoff statement. Proceeds
from purported basket sales existed only on "House 17" and on the paper it
put out, which indicated the funds were put into safe U.S. Treasury bonds.
Meanwhile, funds remitted by clients were being diverted to a JPMorgan Chase
& Co. bank account known as "703."
The complaints
against O'Hara and Perez add further rich detail to how Madoff and his
accomplices used aging but extensive computer technology to maintain the
fraud. They also seem to confirm what common sense suggests about such a
massive and enduring fraud: Madoff and DiPascali had to have technical help.
"O'Hara and Perez
wrote programs that generated many thousands of pages of fake trade
blotters, stock records, Depository Trust Corp. reports and other phantom
books and records to substantiate nonexistent trading. They assigned names
to many of these programs that began with "SPCL," which is short for
"special," according to an SEC press announcement about the civil complaint.
The "special"
programs were found on backup tapes, according to an official close to the
investigation and who asked not to be identified. He added that the pair has
not been cooperating with authorities. The evidence in the complaints is
from BLMIS computers and documents, according to the source.
Among 10 fraudulent
functions detailed in the criminal complaint, the special programs altered
trade details by using "algorithms that produced false and random results;"
created "false and fraudulent execution reports;" and "generated false and
fraudulent commission reports." The criminal complaint also charges the pair
with helping Madoff and DiPascali create misleading reports between 2004-08
to throw off SEC investigators and a European accounting firm hired by a
Madoff client.
In 2006, O'Hara and
Perez cashed out their BLMIS accounts worth "hundreds of thousands of
dollars" and told Madoff they would no longer "generate any more fabricated
books and records." O'Hara's handwritten notes from the encounter allegedly
say "I won't lie any longer."
However, the
"crisis of conscience" did not stop them from asking for a 25 per cent bump
in salary and a $60,000 bonus to keep quiet, the complaints allege.
"DiPascali then
managed to convince O'Hara and Perez to modify computer programs to he and
other 17th floor employees could create the necessary reports," according to
the SEC complaint. The reference to "other 17th floor employees" suggests
that O'Hara and Perez will not be the last to be charged.
A sharp eye could
have detected that funds weren't where they were supposed to be: 2008
customer statements showed funds in a "Fidelity Spartan U.S. Treasury Money
Market Fund" that hadn't been offered since 2005. The fabulous returns had
lulled BLMIS clients to sleep. While some trading data was input by hand,
DiPascali cleverly used "essentially a mail merge program" to replicate the
same stock trading information across multiple accounts, according to the
declaration.
Stocks in a basket
were "priced" after the market closed (i.e., with the knowledge of the prior
published price history). Customer statements were then fabricated by BLMIS
staff on House 17 which appeared to outsiders to keep track of customer
investments and funds in a manner typical of any investment advisor. "BLMIS
staff confirmed it, the system facilitated it and consistent returns could
not have been achieved without it," Looby's declaration states.
Indeed, the
customer statements had been perfected as an instrument in the deception.
Madoff investor Ronnie Sue Ambrosino, a former computer analyst who
ironically had worked on an AS/400, told Securities Industry News that she
never suspected a thing. After all, the Securities and Exchange Commission
had given Madoff a clean bill of health on several occasions since 1992 by
not digging deeply into his operations or just plain neglect.
"The statements
were always perfect, neat and immaculately presented. They came on time and
everything was like clockwork," says Ambrosino, 56, a victim and now
activist representing a group of about 400 Madoff investors. She bristles
when the AS/400 is called old or outdated. "I know the 400 and it's a pretty
powerful machine." It was powerful enough to convince investors that
whatever proceeds they sent to Madoff were being invested in the stocks
cited on their statements. "Key punch operators were provided with the
relevant basket information that they manually entered into House 17. The
basket trade was then routinely replicated in selected BLMIS split strike
customer accounts automatically and proportionally according to each
customer's purported net equity," Looby's declaration says.
The situation was
largely the same for non-split strike clients except that the purported
trades were in single equities, not baskets. "Thousands of documents
including customer statements, IA (investment advisory) staff notes, account
folders and programs in the AS/400 were reviewed, and these documents
confirm the fact that such statements were prepared on an account-by-account
basis (i.e. not basket trading)," Looby wrote.
Looby verified that
trades between 2002 and 2008 were phantom by cross-checking with various
clearing houses such as DTCC, Clearstream Banking S.A. in Luxembourg, the
Chicago Board of Options Exchange (CBOE) and four other clearing firms. He
also compared the cleared trades on the AS/400 "House 5" and "99.9 percent"
of the fake trades on "House 17" did not match. The only connection he found
is what looked like a small portion of a single client's trades, which were
directed by the client and recorded on House 5.
Madoff employees
monitored the "baskets" for split strike accounts in an Excel spreadsheet to
make sure "the prices chosen after-the-fact obtained returns that were
neither too high or low."
However, such
monitoring was far from perfect. Looby cited several examples where daily
trading volumes at BLMIS exceeded the entire daily volume for several
stocks.
For instance,
Madoff reported the purchase of 17.8 million shares of Exxon Mobil on Oct.
16, 2002. This amounted to 131 percent of the company's trading volume for
that day. BLMIS's actual Exxon Mobil holdings that October were verified by
the DTCC at 5,730 shares. Similar discrepancies for Amgen, Microsoft and
Hewlett Packard were found on Nov. 30, 2008, the date for the final batch of
BLMIS customer statements, as it turned out.
BLMIS data for
options puts and calls was even more blatantly unreal. On Oct. 11, 2002,
Looby found that BLMIS "applied an imaginary basket to 279 accounts with a
volume of 82,959 OEX (S&P 100 options) calls and 82,959 puts." That amounted
to 13 times the OEX volume at the CBOE that day.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's Rotten to the Core threads are
at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"SEC Proposes Changes for 'Dark Pools',"
SmartPros, October 21, 2009 ---
http://accounting.smartpros.com/x67909.xml
Federal regulators are
proposing tighter oversight for so-called "dark pools," trading systems that
don't publicly provide price quotes and compete with major stock exchanges.
The Securities and Exchange
Commission voted Wednesday to propose new rules that would require more
stock quotes in the "dark pool" systems to be publicly displayed. The
changes could be adopted sometime after a 90-day public comment period.
The alternative trading
systems, private networks matching buyers and sellers of large blocks of
stocks, have grown explosively in recent years and now account for an
estimated 7.2 percent of all share volume. SEC officials have identified
them as a potential emerging risk to markets and investors.
The SEC initiative is the
latest action by the agency seeking to bring tighter oversight to the
markets amid questions about transparency and fairness on Wall Street. The
SEC has floated a proposal restricting short-selling - or betting against a
stock - in down markets.
Last month, the agency
proposed banning "flash orders," which give traders a split-second edge in
buying or selling stocks. A flash order refers to certain members of
exchanges - often large institutions - buying and selling information about
ongoing stock trades milliseconds before that information is made public.
Institutional investors like
pension funds may use dark pools to sell big blocks of stock away from the
public scrutiny of an exchange like the New York Stock Exchange or Nasdaq
Stock Market that could drive the share price lower.
"Given the growth of dark
pools, this lack of transparency could create a two-tiered market that
deprives the public of information about stock prices," SEC Chairman Mary
Schapiro said before the vote at the agency's public meeting.
Republican Commissioners
Kathleen Casey and Troy Paredes, while voting to put out the proposed new
rules for public comment, cautioned against rushing to overly broad
regulation that could have a negative impact on market innovation and
competition.
Dark pools might decide to
maintain stock trading at levels below those that trigger required public
display under the proposed rules, Paredes said. "Darker dark pools" could be
worse than the current situation, he suggested.
When investors place an
order to buy or sell a stock on an exchange, the order is normally displayed
for the public to view. With some dark pools, investors can signal their
interest in buying or selling a stock but that indication of interest is
communicated only to a group of market participants.
That means investors who
operate within the dark pool have access to information about potential
trades which other investors using public quotes do not, the SEC says.
The SEC proposal would
require indications of interest to be treated like other stock quotes and
subject to the same disclosure rules.
Continued in article
Bob Jensen's threads on mutual fund and index
fund and insurance company scandals are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#MutualFunds
The Deep Shah Insiders Leak at Moody's:
What $10,000 Bought
Leaks such as this are probably impossible to stop
What disturbs me is that the Blackstone Group would exploit investors based up
such leaks
"Moody's Analysts Are Warned to Keep Secrets,"
by Serena Ing, The Wall Street Journal, October 20, 2009 ---
http://online.wsj.com/article/SB125599951161895543.html?mod=article-outset-box
From their first
day at Moody's Investors Service, junior analysts are warned against sharing
confidential information with outsiders. They are even told not to mention
company names in the elevators at the credit-rating firm's Lower Manhattan
headquarters.
Federal prosecutors
now allege that a former junior analyst, identified by a person familiar
with the matter as Deep Shah, breached that trust in July 2007 when he
passed on inside information about Blackstone Group's pending $26 billion
takeover of Hilton Hotels.
Mr. Shah and other
employees of the ratings firm, owned by publicly traded Moody's Corp., had
advance notice about the takeover as part of a standing practice to prebrief
credit analysts about planned deals. Prosecutors allege that the junior
analyst shared the Hilton information with an unidentified third party, who
in turn passed the tip to Galleon Group's Raj Rajaratnam. The tip enabled
Mr. Rajaratnam to reap $4 million in profits from trading Hilton shares, a
federal complaint alleges.
While Mr. Shah's
role in the alleged insider-trading affair is small, his link to the third
party -- now a key cooperating witness in the probe -- could shed light on
how investigators uncovered the trading ring. Unusual trading in Hilton's
shares was one of the first events that attracted scrutiny from regulators
in 2007. The same cooperating witness was friends with an executive at
Polycom Inc. and also passed on information about Google Inc.
The complaint said
the cooperating witness arranged to pay $10,000 to the Moody's associate
analyst, a title that describes staffers who aren't considered full analysts
but assist them in analyzing data. Mr. Shah hasn't been charged with a
crime. It isn't known if he is under investigation or if he will face
charges.
Mr. Shah couldn't
be reached for comment. A Moody's spokesman declined to comment on the
alleged role of Mr. Shah. He reiterated the company's statement last week,
saying that the alleged wrongdoing by one of its employees "would be an
egregious violation" of the rating firm's policies.
Moody's has drawn
flak in the past year for inaccurate credit ratings on mortgage securities
and has had to battle recent accusations from a former employee that it
still issues inflated ratings on complex securities. Throughout the
financial crisis, however, Moody's credit ratings on corporate bonds have
largely conformed to expectations.
Still, critics say
the Hilton incident may raise questions about whether ratings firms should
be privy to inside information. Companies often inform rating analysts about
mergers, acquisitions or other transactions ahead of time, to let analysts
digest and analyze the information and announce rating actions soon after
the deals become public.
Like law firms and
investment banks, credit-rating agencies have policies and controls to limit
the number of people privy to inside information. "But you can't watch
everyone all the time, and if someone is determined to violate the law they
will do so," said Scott McCleskey, a former Moody's compliance officer who
is now U.S. managing editor of Complinet Inc.
Mr. Shah, who is in
his mid-20s, left Moody's more than a year ago and is believed to have
returned to his home country of India, according to former colleagues. One
ex-colleague described him as "mellow."
He joined the
ratings firm in an entry-level position, and worked with analysts who rated
companies in the technology, lodging and gaming sectors, according to
Moody's reports that listed Mr. Shah's name from 2005 to early 2008.
According to the
U.S. attorney's complaint, Hilton executives contacted a Moody's lead
analyst by phone on the afternoon of July 2, the day before Blackstone Group
announced it would acquire Hilton. The complaint said that, shortly
afterward, an associate analyst "involved" in the rating called the
unidentified third party three times from a cellphone with information that
Hilton was to be taken private. The information was passed to Mr. Rajaratnam
who traded Hilton's stock, according to the complaint.
As an associate
analyst, Mr. Shah would have been paid roughly $90,000 in annual salary,
plus a bonus that could reach $30,000, according to former Moody's
employees.
Bob Jensen's fraud updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Former top executive of American
International Group Inc. plundered an AIG retirement program of billions of
dollars
"AIG lawyer tells jury that Greenberg plundered
retirement program after being forced out," by Madlen Read, Newser,
June 15, 2009 ---
Click Here
The former top executive of
American International Group Inc. plundered an AIG retirement program of
billions of dollars because he was angry at being forced out of the company,
a lawyer for AIG told jurors Monday at the start of a civil trial.
Attorney Theodore Wells told
the jury in Manhattan that former AIG Chief Executive Officer Maurice "Hank"
Greenberg improperly took $4.3 billion in stock from the company in 2005,
after he was ousted by the company amid investigations of accounting
irregularities.
"Hank Greenberg was mad. He
was angry," Wells said in U.S. District Court of the emotional state of the
man who, over a 35-year-career, built AIG from a small company into the
world's largest insurance company.
Wells said that Greenberg,
within weeks of being forced out in mid-2005, gave the go-ahead for tens of
millions of shares to be sold from a trust fund. The fund was set up to
provide incentive bonuses to a select group of AIG management and highly
compensated employees that they would receive upon their retirement.
Greenberg, 84, has contended
through his lawyers that he had the right to sell the shares because they
were owned by Starr International, a privately held company he controlled.
Starr International was
named after Cornelius Vander Starr, who created a worldwide network of
insurance companies in the early 1900s.
AIG maintains that Starr and
Greenberg, his protege and successor, decided in the late 1960s to organize
the various companies under one holding company, AIG.
Starr International remained
a private company and its shareholders decided in 1970 that the amount that
its shares of AIG were worth above book value of about $110 million should
be used to compensate AIG employees, AIG has said.
The embattled insurer is
trying to reclaim the money from Starr it says was wrongly pocketed through
stock sales by Greenberg.
Minority Interests: Lambs being led to
slaughter?
From The Wall Street Journal Accounting
Weekly Review on June 11, 2009
Investors Missing the Jewel in
Crown
by Martin Peers
The Wall Street Journal
Jun 06, 2009
Click here to view the full article on WSJ.com
http://online.wsj.com/article/SB124425049774290141.html?mod=djem_jiewr_AC
TOPICS: Advanced
Financial Accounting, Consolidations, Debt, Financial Accounting, Financial
Analysis
SUMMARY: The
article assesses the situation of two companies associated with financial
difficulties: Crown Media, 67% owned by Hallmark Cards, and Clear Channel
Outdoor, 89% owned by Clear Channel Media. In the latter case, the entity in
financial difficulty is the owner company. Questions ask students to look at
a quarterly filing by Crown Media, to consider the situation facing
noncontrolling interest shareholders, and to understand the use of earnings
multiplier analysis for pricing a security.
CLASSROOM APPLICATION: The
article is good for introducing the interrelationships between affiliated
entities when covering consolidations. It also covers alternative
calculations of, and analytical use of, a P/E ratio.
QUESTIONS:
1. (Introductory)
Access the Crown Media 10-Q filing for the quarter ended March 31, 2009 at
http://www.sec.gov/Archives/edgar/data/1103837/000110383709000008/mainform5709.htm
Alternatively, click on the live link to Crown Media in the WSJ article,
click on SEC Filings in the left hand column, then choose the 10-Q filing
made on May 7, 2009. Describe the company's financial position and results
of operations.
2. (Advanced)
Crown Media's majority shareholder is Hallmark Cards "which also happens to
be its primary lender to the tune of a billion dollars...." Where is this
debt shown in the balance sheet? How is it described in the footnotes? When
is it coming due?
3. (Advanced)
What has Hallmark Cards proposed to do about the debt owed by Crown Media?
What impact will this transaction have on the minority Crown Shareholders?
4. (Advanced)
Do you think the noncontrolling interest shareholders in Crown Media can do
anything to stop Hallmark Cards from unilaterally implementing whatever
changes it desires? Support your answer.
5. (Introductory)
Refer to the description of Clear Channel Outdoor. How is the company's
share price assessed? In your answer, define the term "price-earnings ratio"
or P/E ratio and explain the two ways in which this is measured.
6. (Advanced)
What does the author mean when he writes that "anyone buying Outdoor stock
should remember that" the existence of a majority shareholder with
significant debt holdings also could pose problems for an investment?
Reviewed
By: Judy Beckman, University of Rhode Island
"Investors Missing the Jewel in Crown," by
Martin Peers, The Wall Street Journal, June 5, 2009 ---
http://online.wsj.com/article/SB124425049774290141.html?mod=djem_jiewr_AC
Investing in a company
controlled by its primary lender can be hazardous. Just ask shareholders in
Crown Media.
Owner of the Hallmark TV
channel, Crown is 67%-owned by Hallmark Cards, which also happens to be its
primary lender to the tune of a billion dollars. With the debt due next
year, Hallmark on May 28 proposed swapping about half of its debt for
equity, which would massively dilute the public shareholders. Crown's stock,
long supported by hope that the channel would get scooped up by a big media
company, is down 36% since then.
Helping feed outrage among
some shareholders was the fact that the swap proposal comes as the Hallmark
Channel was making inroads with advertisers. Profits were on the horizon.
Clear Channel Outdoor holds
parallels. The billboard company owes $2.5 billion to Clear Channel Media,
its 89% shareholder, a fraught situation for Outdoor's public holders.
In this case, of course, the
parent is in financial distress. Hence the significance of Outdoor's
contemplation of refinancing options, which could lead to the loan being
repaid. The hope among some investors is that events conspire to prevent
that, forcing the parent into bankruptcy and putting Outdoor up for auction.
That could bail out
shareholders. At $6.36 a share at Friday's close, Outdoor's enterprise value
is roughly 9.8 times projected 2009 earnings before interest, taxes,
depreciation and amortization, below Lamar Advertising's 10.9 times
multiple. Using 2010 projections and an equivalent multiple implies a share
price above $10.
But as Crown showed, the
interests of a majority shareholder who doubles as a lender don't
necessarily coincide with minority holders. Anyone buying Outdoor stock
should remember that.
Bob Jensen's threads on accounting theory are
at
http://faculty.trinity.edu/rjensen/theory01.htm
Bob Jensen's threads on corporate governance
are at
http://faculty.trinity.edu/rjensen/fraud001.htm#Governance
Question
What is closet indexing in mutual fund investing? Does this sound like a rip
off?
We've used this space to
draw attention to an under-appreciated problem in financial services: big,
diversified mutual funds that behave more like their underlying benchmarks than
true instruments of "active management." Click
here for an
August post that links to a couple other items we've written on this topic.) In
the March issue of the
Exchange-Traded Funds Report
(subscription required), we ran across an intriguing passage in the edited
transcript of a roundtable discussion of the ETF marketplaceTo summarize . . .
Using ETFs to equitize assets can be a perfectly sensible periodic/short-term
tactic. But as ever in this business, we prefer more transparency to less, and
thus less subterfuge to more. If managers are using ETFs in their active
portfolios, they should freely acknowledge as much, explain their
decision-making, and be accountable for their results. Anything less is a breach
of managers' fiduciary duty to fund shareholders
"Closet Indexing By Mutual Funds: Worse Than We Thought?" Seeking Alpha,
April 9, 2008 ---
Click Here
But Keenan's remarks reveal a couple
serious -- and potentially related -- problems:
(1) reporting-period manipulation designed
to conceal the fact that managers are equitizing assets using ETFs and
(2) the cynical
laziness of earning market returns and layering on active-management fees.
Investors never seem to grow weary of being screwed by mutual
fund executives
The Securities and Exchange Commission has launched
an investigation of 27 mutual-fund companies that the agency says have accepted
kickbacks totaling hundreds of millions of dollars in recent years. The
investigation centers on alleged arrangements in which independent contractors
agreed to pay rebates to mutual-fund companies in order to win lucrative
contracts for jobs like producing shareholder reports and prospectuses. The
probe stems from a $21.4 million settlement the SEC reached last month with
Bisys Fund Services Inc., an administrative-services provider owned by Bisys
Group Inc.
Tom Lauricella, "SEC Probes Mutual-Fund Firms After Settlement in Kickback
Case," The Wall Street Journal, Page A1, October 26, 2006 ---
http://online.wsj.com/article/SB116183087038004278.html?mod=todays_us_page_one
Question
Why are mutual funds still Congress to the core?
"The Soft Dollar Scandal," by Benn Steil, The Wall Street
Journal, June 19, 2006; Page A15 ---
http://online.wsj.com/article/SB115068121938383835.html?mod=opinion&ojcontent=otep
The SEC will shortly issue its
long-awaited final "interpretive release" on a brokerage industry practice
that would make Tony Soprano blush. Known as "soft dollars," the practice
involves a broker charging a fund manager commission fees five to 10 times
the market rate for a trade execution, in return for which the broker kicks
back a substantial portion in the form of "investment-related services" to
the manager. Magazines, online services, accounting services, proxy
services, office administration, computers, monitors, printers, cables,
software, network support, maintenance agreements, entrance fees for resort
conferences -- all these things are bought through brokers with soft
dollars. And in one of the industry's loveliest ironies, fund managers even
pay inflated commissions in return for trading cost measurement services
which invariably tell them that their brokers cost too much.
Why do the fund managers do it? Why
don't they buy items directly from their suppliers, and then choose brokers
on the basis of lowest trading cost? The reason is clear. If the fund
manager buys items directly from the suppliers, he pays with his firm's
cash. If he buys them through brokers when executing trades, however, the
law, or the SEC, lets him use his clients' cash.
How widespread is the practice? Some
95% of institutional brokers receive soft dollars, about a third of which
were found by the SEC in the late 1990s to be providing illegal services to
fund managers, well outside the scope of "investment-related." Surveys find
that fund managers routinely choose brokers based on criteria having nothing
to do with trade execution.
How much does this practice cost
investors? My own analysis suggests that the cost in bad trading alone
amounts to about 70 basis points a year, or about 14 times the estimated
cost of the market timing abuses that dominated headlines in 2004.
The Senate Banking Committee held
hearings on soft dollars in March 2004. Chairman Richard Shelby indicated at
the time that the SEC would "get more than a nudge" to eliminate clear
abuses, defined as services which could not reasonably be held to constitute
"research." So what has our champion of investor rights decided to do for
us? Punt the ball back to Congress. In its initial guidance last October,
expected to be substantially reiterated in the forthcoming final verdict,
the commission's long-awaited crack down amounted to little more than a
memorandum to fund managers instructing them to read the law, cut out a few
egregious abuses (office furniture is a no-no, though resort conferences are
still fine), and pay only "reasonable" commissions.
How does the "reasonable" commission
regime work in practice? Put simply, the higher the price tag on the
soft-dollar goodies, the more trading the fund manager does with the broker
to acquire them, which is clearly antithetical to investor protection.
To his credit, freshman SEC Chairman
Christopher Cox issued a thoughtful statement in advance of last October's
guidance, diplomatically describing soft dollars as an "anachronism" --
referring to the politics of unfixing fixed commissions 30 years ago, and
Congress's insertion of the Section 28(e) safe harbor into the Exchange Act,
allowing client trading commissions to pay for research. But it was under
the SEC's watch that the safe harbor ballooned into a safe coastal resort,
in which client-financed commission payments have become so generous that a
broker for one of the nation's largest fund management companies made the
headlines in 2003 by thanking the funds' traders with a lavish
dwarf-chucking bachelor party. It is therefore time for Congress and the SEC
to stop punting the ball back and forth, and for Congress finally to abolish
the "anachronism."
As a Wall Street Journal reader in
good standing, I'm not calling for more rules and market intervention. Quite
the opposite. It is in the nature of a government-sanctioned kickback scheme
that serial interventions by regulators will be required to pacify the
fleeced. This is a simple property rights issue, and treating it sensibly as
such would require less government intervention in the future.
The solution is simple. If a fund
manager wants to buy $10,000 worth of research, let him write a check to the
provider. That's how you and I would buy it -- we wouldn't expect to get it
by making a thousand phone calls through Verizon at 10 times the normal
price. There is a legitimate debate over whether the cost of research should
be charged to the fund manager, which would then recoup it transparently
through the management fee, or deducted directly from the clients' assets.
The first option was recommended by
former Gartmore chairman Paul Myners in his famous 2001 report to the U.K.
Treasury. The second would, in any case, be a dramatic improvement on the
status quo. If the government did not force funds to buy research through
brokers in order to pass the cost on to clients, the SEC's "best execution"
requirements, meaningless in a soft-dollar environment, would actually
become part of a fund manager's DNA. No longer forced to choose between soft
dollars for his firm or good trades for his client, he will finally have an
incentive to seek out value-for-money in both research and trading, as it
will benefit both his firm and his client.
What do mutual fund traders think? At
a November conference, I surveyed 35 of them anonymously. The majority, 46%,
said that fund managers should buy independent research with "hard dollars,"
out of their own assets rather than those of the investors; 37% backed
option two above, paying the providers directly rather than through
commissions, which the SEC currently prohibits. A mere 17% supported the
status quo, soft dollars. The problem is that fund managers have no
incentive to move away from soft dollars while their competitors are legally
using them to inflate profits.
So who actually loses from Congress
correcting its mistake? Brokers. But shed no tears for them. Middlemen
always lose when kickback schemes are ended.
Mr. Steil is director of international economics at
the Council on Foreign Relations.
Question
Should you advise someone to purchase long term care insurance?
"A Conversation With Barry Goldwater: Are You Recommending
Long-Term Care Insurance?" AccountingWeb, April 20, 2007 ---http://www.accountingweb.com/cgi-bin/item.cgi?id=103435
Who is the largest payer of long-term care assistance?
It’s the general public who fund long-term care from personal savings and
through public assistance programs. But the numbers bear out that CPAs and
advisors are doing a poor job of referring their clients to asset protection
long-term care programs. Why is this?
Because of the way the U.S. healthcare system is
set up, a long-term care event could devastate family retirement savings.
Last year the long-term care insurers paid out $3.3 billion in claims but
that figure only equated to 6 percent of total claims paid – a percentage
that pales in comparison to the real costs born by the general public.
Twenty-seven percent, or $30 billion, of all long-term care expenses are
paid out of savings accounts, a major contributing reason for people going
into bankruptcy. Another $42 billion was paid by Medicaid, and Medicare paid
$15 billion.
In our litigious society, the reality of long-term
care insurance (LTCI) being treated as a fiduciary item has arrived.
Disgruntled beneficiaries whose inheritances have been depleted by the
expense their parents bore funding their long-term care experiences are
successfully arguing and receiving monetary judgments from advisors who are
not bringing up the subject of future liability planning. It is becoming a
question of fiduciary responsibility to recommend asset protection.
For example: It is projected that a 50-year-old
person today is going to spend more than $1 million a year upon needing
long-term care assistance when they are 85. Do you really want to make a
negative million dollar decision for your clients if they lose this amount
to the lack of asset protection? Are CPAs making these kinds of client
assessments or does the CPA really not care whether a client should self
insure the risk of a future long-term care event or transfer that risk to an
insurance company?
Statistic: Forty percent of those needing
long-term care (LTC) are under age 65.
Do CPAs recommend long-term care insurance? Tax and
audit professionals are focused on fee planning in their core competencies.
They make few financial planning referrals because their firm does not have
a team planning approach outside of their core business model. These CPAs
usually do not recommend LTCI. The CPA who is a multi-disciplinary advisor
is looking for programs of opportunity in a broader environment that
incorporates financial services and wealth management. This group usually
will have an in house expert or a very close strategic alliance with an
advanced planning insurance broker and will try to incorporate long-term
care planning into their practice. These CPAs do recommend LTCI and are
proactive inserting this item in their financial plan for clients.
Because women generally outlive men by an
average of seven years, they face a 50 percent greater likelihood than men
of entering a nursing home after age 65.
However, just 18 percent of women who responded to
a study on the financial literacy of women have talked with their spouse or
partner about long-term care insurance. Most women do not want to be a
burden on their children. Yet about three-quarters of respondents have not
had serious discussions with their children about long-term care insurance.
How does the CPA connect with the aging baby boomer
client on matters of long-term care and asset protection planning when 71
percent of all caregivers are women who are related to the in need relative?
Advisors are not connecting with women and long-term care at all! We believe
there is reluctance among CPAs to discuss transferring risk to insurance
companies because somehow it is an uncomfortable conversation to have. But
the numbers are compelling and advisors need to sit up and take notice.
To plan for a future liability in combination with
a plan for retirement income is the kind of creative planning clients are
expecting. CPA advisors should know and should be making their clients aware
that it is not the decision of the client to buy LTC insurance, it is the
decision of the carrier whether they will offer the client a contract. When
we surveyed our clients with the question, “Would you think it to be a good
idea that we do future liability planning alongside of future income
planning so that if you need medical or assistance to live in your home in
the future, that expense would not come out of your retirement savings
account?” When you say it with inflection, it is not as long a sentence as
it appears and it is a very responsible question for an advisor to ask. The
overwhelming response from our clients was extremely favorable with the most
common reasonable accompanying question being “How much does it cost?” In
other words, how much of my $20k 401k contribution am I going to be spending
in order to protect it? The direct response is; “Based on information
analyzed as to costs associated with a long-term care event, you can spend
$3k per year for 20 years based on your age and risk factor probabilities or
you can spend between $50k-$250k annually, for an average of five years, on
your care? Which program can you best afford to fund?” When you consider the
potential spend down of assets, you begin to understand the fiduciary
aspects associated with prudent advice when the client is told to self
insures these kinds of risk.
On the other hand, high net worth clients will not
pay for something without recognizing its perceived value. If I can fund
future liability events from cash flow, why should I spend money on
insurance I do not need? Here is the question for our high net worth
clients; “Do you have an asset protection plan in place that covers the
downside risk of investment loss due to a future medical liability or
long-term care event?” That question enables me to have the conversation
about long-term care insurance with high net worth people. And these facts
bear me out.
If the client has a $5 million investment portfolio
returning 9 percent per year, his/her income from investments is projected
to be $450,000 before taxes. If a future liability occurred and the cost of
an assistance related liability was $150,000, the cost to the client would
be $150,000 plus the loss of investment income at 9 percent. The total loss
of principal plus interest for one year is $163,500, for three years the
cost is $490,500. This is not how high net worth people plan, they do not
leave these kinds of gaps that can effectuate loss. To transfer the risk,
the cost is $6,000 for this married couple in their mid-50’s. If we do the
math correctly, they would have to pay premiums for 25 years to equal one
year’s cost for care. Their premiums would never exceed the cost of two
years worth of care. No matter what one does with his or her money, the cost
for care is always going to be the same, $163,000 is always going to be
greater then $6,000, high net worth or not.
It is our clients call to make, but if we connect
our recommendations to the larger picture of asset protection, our message
for risk transference becomes more powerful. From the financial data
presented, Americans are paying 94 percent of the costs associated with
long-term care expenses either in the form of public assistance or from
savings. The majority of caretakers are our mothers, wives and daughters.
These are alarming figures moving forward and given medical inflation
outpacing other inflationary indices, CPAs should be aware of their
fiduciary responsibility to make relationships with long-term care insurance
specialists so their clients can be better served in this area of asset
protection and they will be protected from litigious beneficiaries.
About Barry Goldwater
Barry Goldwater is the Principal of the Financial Resource Group and a
20-year veteran of the insurance industry. He focuses not only on working
with the business and affluent clients of CPAs and attorneys, but also in
helping CPA's form and develop a business model to include financial
services. He can be reached at 617-527-9736,or at
barry@frg-creative.com. His web sites are
http://www.frg-creative.com or
www.goldwaterfinancial.net
Jensen Comment
It is important to note that the above author is with the insurance industry. In
my opinion, elder care insurance is not a good deal for many people. For one
thing it is very expensive and adds another "middle man" to profit from elder
care. Second, reasonably wealthy people who can afford long-term care expected
costs (adjusted for probabilities and family health history) may find insuring
for long term care to be a bad deal that cuts into cash flow they might enjoy in
earlier years of their lives. Similarly people with limited means who are likely
to qualify for Medicaid benefits may find it a bad deal. Also read the fine
print of a contract. Insurance companies have a way of limiting their own risk
exposures, especially risks of rising eldercare costs.
Another risk is that your so-called financial advisor may be
receiving some sort of kickback for helping to get clients to take out elder
care insurance. This is an expensive cash flow item that requires high integrity
financial advising.
February 7, 2008 question from Miklos A. Vasarhelyi
[miklosv@ANDROMEDA.RUTGERS.EDU]
Does anyone understand what this is?
miklos
Jensen Comment
Miklos forwarded interactive graphics video link on monoline insurance ---
Click Here
February 7, 2008 reply from J. S. Gangolly
[gangolly@CSC.ALBANY.EDU]
Miklos,
Buyers of bonds can insure against default
risks by buying policies from monoline insurance companies who service
exclusively the capital markets. To protect against default by the monoline
on its policy, you buy a credit swap on it from another monoline insurance
company (which would be obligated to either buy the bonds at face value or
to pay the difference between that and the recovery value in case of
default).
When such trades take place, the buyer of
the bonds (usually investment banks) have theoretically transferred the risk
in bonds, and so can account for the bundle of transactions and recognise
"profits".
Apparently, these trades have been very
lucrative for banks and so have taken the profits in such transactions over
the entire life of the bonds at the consummations of such transactions.
The problem with such accounting for
profits is that, if the monoline insurance companies are downgraded, the
risk on the bonds reverts to the holder (bank), who must reverse the
profits.
The usual culprits in these fancy
transactions are investment banks. It is difficult to account for the
"profits" because the bonuses paid to the traders on such transactions might
have been paid years ago.
What a wonderful fiction we accountants
have created wheere profits are not what they seem. Alice in Wonderland
pales by comparison.
I should have stuck with my first intended
profession (actuary).
Regards,
Jagdish
February 7, 2008 reply from Paul Williams
[Paul_Williams@NCSU.EDU]
Jagdish,
Thank you for explaining this. The fault
is not entirely ours. Deregulated finance entrepreneurs have invented these
complex transactions, which, frankly, can't be accounted for (part of the
motivation for their design is precisely because they can't be accounted
for). In theory the probability that a bond issuer will default is not
altered by these arrangements.
All they do is shift the risk many degrees
removed from where it originated. An interesting empirical issue is whether
the probability of default does change in the presence of these risk
shifting transactions. How does it alter the monitoring of debtors by their
creditors when their creditors may not even know they are their creditors?
Do these risk shifting arrangements change
the risk? Anyone out there know of any literature that addresses the issue?
February 7, 2008 reply from Bob Jensen
Hi Miklos, Jagdish, Paul, and others,
Actually there’s a very good module (one of the best) on
the history of monoline insurance in Wikipedia ---
http://en.wikipedia.org/wiki/Monolines There are excellent
references as to when (belatedly) and why monoline insurance companies have
been put under review by credit rating agencies.
Credit rating agencies placed the other monoline insurers
under review [16]. Credit default swap markets quoted rates for default
protection more typical for less than investment grade credits. [17]
Structured credit issuance ceased, and many municipal bond issuers spurned
bond insurance, as the market was no longer willing to pay the traditional
premium for monoline-backed paper[18]. New players such as Warren Buffett's
Berkshire Hathaway Assurance entered the market[19]. The illiquidity of the
over-the-counter market in default insurance is illustrated by Berkshire
taking four years (2003-06) to unwind 26,000 undesirable swap positions in
calm market conditions, losing $400m in the process. By January 2008, many
municipal and institutional bonds were trading at prices as if they were
uninsured, effectively discounting monoline insurance completely. The slow
reaction of the ratings agencies in formalising this situation echoed their
slow downgrading of sub-prime mortgage debt a year earlier. Commentators
such as investor David Einhorn [20] have criticized rating agencies for
being slow to act, and even giving monolines undeserved ratings that allowed
them to be paid to bless bonds with these ratings, even when the bonds were
issued by credits superior to their own.
It has been particularly problematic for investors in
municipal bonds.
Bob Jensen
Just Another in a Long Line of Prudential Rip-Offs
Prudential to Cough Up $600 million to settle charges of Improper Mutual Fund
Trading
"Brokerage unit admits criminal wrongdoing, DOJ says," by Alistair Barr &
Robert Schroeder, MarketWatch, August 29, 2006 ---
http://www.the-catbird-seat.net/Prudential.htm
Prudential Financial Inc.'s brokerage unit agreed
on Monday to pay $600 million to settle charges that former employees
defrauded mutual fund investors by helping clients rapidly trade funds.
The payment -- the largest market-timing settlement
involving a single firm -- ends civil and criminal probes and allegations by
the Department of Justice, the Securities and Exchange Commission and
several other regulators including New York Attorney General Eliot Spitzer.
Prudential Equity Group, a subsidiary of Prudential
Financial (PRU) admitted criminal wrongdoing as part of its agreement with
the Justice Department. Prudential Equity Group was formerly known as
Prudential Securities.
Prudential will pay $270 million to victims of the
fraud, a $300 million criminal penalty to the U.S. government, a $25 million
fine to the U.S. Postal Inspection Service and a $5 million civil penalty to
the state of Massachusetts, according to the Justice Department.
"Prudential to Pay Fine in Trading," by Landen Thomas Jr., The New York
Times, August 29, 2006 ---
Click Here
Prudential Financial, the life insurance company,
agreed yesterday to pay with federal and state regulators that one of
its units engaged in inappropriate mutual fund trading.
The payment, the second-largest levied against a
financial institution over the practice, may bring to a close a three-year
investigation into the improper trading of mutual funds that has ensnared
some of the largest names on Wall Street and the mutual fund industry.
The settlement with the Justice Department, which
covers trades totaling more than $2.5 billion made from 1999 to 2000, is
also the first in the market timing scandal in which an institution has
admitted to criminal wrongdoing.
Such a concession by Prudential, part of a deferred
prosecution agreement that will last five years, underscores the extent to
which the improper trading practices were not only widespread at Prudential
Securities, but also condoned by its top executives, despite repeated
complaints from the mutual fund companies.
How Bear Stearns Got Greener
The strong earnings increase was also clouded by
details of long-expected regulatory charges unveiled yesterday showing how three
separate Bear units aided improper mutual-fund trading -- in some cases
intentionally and despite thousands of complaints from the funds. Bear settled
the charges by the Securities and Exchange Commission and the New York Stock
Exchange, without admitting or denying wrongdoing, by agreeing to pay $250
million -- including $160 million in disgorgement of gains and a $90 million
fine.
Randall Smith and Tom Lauricella, "Bear Stearns to Pay $250 Million Fine; Net
Rises 36%," The Wall Street Journal, March 17, 2006; Page C3 ---
http://online.wsj.com/article/SB114210497174995838.html?mod=todays_us_money_and_investing
Yawn! Another week and another multimillion dollar fine
paid by Merrill Lynch. So what's new?
Merrill Lynch & Co. will pay a $10 million fine for
failing to deliver prospectuses to customers in mutual-fund transactions, as
well as other supervisory and operational lapses, New York Stock Exchange
regulators said. The Big Board officials said the brokerage firm failed to
deliver prospectuses from October 2002 to March 2004 with respect to 64,000
transactions related to sales of registered, open-ended mutual-fund securities.
The firm also failed to deliver prospectuses between January 2004 and July 2004
in 900 transactions in 275 accounts related to auction-rate preferred stocks,
they said.
Chad Bray, "Merrill Fined $10 Million by NYSE," The Wall Street Journal,
August 16, 2005; Page C13 ---
http://online.wsj.com/article/0,,SB112414156768313701,00.html?mod=todays_us_money_and_investing
Jensen Comment: Sometimes it seems that there are almost
no securities frauds in which Merrill Lynch is not somehow involved. Just
search for "Merrill" in this document.
Yawn! Another Merrill Lynch fine, this time in the U.K.
FSA fines Merrill Lynch £150,000 for transaction
reporting failures The Financial Services Authority has fined Merrill Lynch
International £150,000 for failing to accurately report certain transactions to
the FSA and previously the Securities and Futures Authority. Accurate
transaction reports are critical to the FSA's ability to maintain confidence in
the financial markets and reduce financial crime.
Rachel Rutherford, Association of International Accountants Accountancy E-news,
August 11, 2006
Just another day on the Merrill Lynch fraud beat
Merrill Lynch & Co. was fined a total of $13.5
million by regulators for failing to supervise four brokers in New Jersey who
helped a hedge fund rapidly trade in and out of mutual funds and variable
annuity investment accounts to the detriment of other investors. Three
brokers in Merrill's Fort Lee office and one with lesser responsibility in
another New Jersey branch allegedly helped hedge fund Millennium Partners LP
rapidly trade in and out of 521 mutual funds and 40 variable annuity accounts
despite policies at Merrill and some of the funds to discourage such trading,
known as market timing, the regulators said. Merrill fired three of the brokers
in October 2003.
Jed Horowitz, "Merrill Fined In Market-Timing Case: Firm to Pay $13.5
Million; 4 Accused of Rapid Trading To Aid Millennium Partners," The
Wall Street Journal, March 9, 2005; Page C15 --- http://online.wsj.com/article/0,,SB111029865794273529,00.html?mod=todays_us_money_and_investing
Bucking a
spate of previous rulings favorable to the securities industry, arbitrators
ordered Merrill
Lynch & Co. to pay a Florida couple more than $1 million for failing to
disclose that its analysts had conflicts of interest in recommending stocks.
Jed Horowitz, "Merrill Ordered to Pay 2 Clients Over Analyst Conflicts on
Stocks," The Wall Street Journal, March 1, 2005; Page C3 --- http://online.wsj.com/article/0,,SB110962110354266151,00.html?mod=todays_us_money_and_investing
Jensen Comment: Merrill Lynch has one of the worst fraud records on Wall
Street. Eliot Spitzer once claimed he had enough smoking guns to bring
down Merrill Lynch if he chose to do so.
You can read more by searching for
"Merrill" in this document
Please try to understand this math
Investors who are content to pay the average
fee for their mutual fund might be surprised to learn that most
investors are actually paying quite a bit less. The average
annual fee, expressed as a percentage of fund assets, for the 10,585
open-end stock funds tracked by Lipper Inc. is 1.573%. But the
dollar-weighted average fee -- or what the average investor is
actually paying -- is a mere 0.936%, according to Lipper. There
is a significant difference because the vast majority of mutual funds
aren't the multibillion-dollar portfolios that dominate media
coverage, but smaller portfolios that generally have higher so-called
expense ratios.
Daisy Maxey, "How to Look at Mutual-Fund Fees," The Wall
Street Journal, February 7, 2005, Page R1 --- http://online.wsj.com/article/0,,SB110773891359147341,00.html?mod=todays_us_the_journal_report
Try
This Out for Mutual Fund Conflict of Interest: Guess the Stance
Taken by Fidelity's Board With Respect to Expensing of Corporate (read
that Intel) Failure to Expense Employee Stock Options?
But while Fidelity funds hold almost 3
percent of Intel's shares for clients, Intel is also a big customer of
Fidelity, creating the potential for a conflict at the fund giant.
Fidelity is the recordkeeper for Intel's 401(k) plan, which held eight
Fidelity funds worth $1 billion at the end of 2003.
Gretchen Morgenson, "A Door Opens The View Is Ugly Mutual
Fund Board Voting," The New York Times, September
12, 2004.
Bob Jensen's threads on the mutual fund scandals are at http://faculty.trinity.edu/rjensen/fraudCongress.htm#MutualFunds
Improper
share trading at Putnam shortchanged investors by over $100 million,
about 10 times a prior estimate, a consultant found.
John Hechinger, "Putnam May Owe $100 Million: Independent
Consultant Finds Improper Trading Cost Investors More Than Previously
Believed," The Wall Street Journal, February 2, 2005 --- http://online.wsj.com/article/0,,SB110728870444542645,00.html?mod=home_whats_news_us
Question
Are you paying too much for mutual fund experts who are "closet indexers"
collect big fees for doing little more than basing their stock picks on the
market index?
"Professors Shine a Light Into 'Closet Indexes': Measurement May Help
Investors See How Much of Their Holdings Are Actively Managed -- And Not," by
Tom Lauricella, The Wall Street Journal, August 18, 2006; Page C1---
http://online.wsj.com/article/SB115586769681639076.html?mod=todays_us_money_and_investing
Are your mutual-fund managers earning their keep?
A complaint lodged against many managers of funds
that invest in stocks is that they collect big fees for doing little more
than basing their stock picks on the market index -- say, the Standard &
Poor's 500-stock index -- against which their fund's performance is
measured. There's even a term for this behavior: closet indexing.
For investors, there hasn't been an easy way to
tell if a fund falls into this category. Now a pair of Yale University
professors have developed a simple way of measuring to what degree a fund's
holdings are actively managed, as opposed to passively mirroring an index.
It also turns out that -- at least according to the research -- this measure
could be a useful predictor of fund performance.
The new measure, created by Antti Petajisto and
Martijn Cremers from the Yale School of Management, takes a simple approach.
Called the "active share" of a portfolio, it matches the holdings reported
by a fund in Securities and Exchange Commission filings against the
components of an index, and then measures the percentage of overlap. For
example, if General Electric and Exxon Mobil each account for 4% of an
index, and a fund had a portfolio exactly mirroring the index except it had
8% in GE and nothing in Exxon, its active share would be 4%. The more a
portfolio differs from an index, the higher the active share percentage.
The study found that the average fund using the S&P
500 as a benchmark (generally, funds investing in large-company stocks) has
an average active-share percentage of 66%. In other words, the average
large-company stock fund had a portfolio that was 66% different than the
benchmark and the rest essentially mirrored the index.
The study, which examined data from 1980 through
the end of 2003, found an increase in funds that could be described as
closet indexing during the 1990s, a period of major growth in the
mutual-fund industry. Closet index funds (generally, those with active share
falling into the 20% to 60% range) contained about 30% of all assets in
2003, up from virtually no assets in the 1980s.
One reason investors should care: Actively managed
funds charge higher fees, on average, than index funds. After all, the idea
is that you're paying a premium for the talents of a skilled stock picker --
not just someone who is mirroring a stock index.
But the study found that funds charged similar
fees, regardless of their active-share reading. Funds with an active share
of 70% or higher have expense ratios averaging roughly 1.57%. However,
closet-index funds with an active share of 40% to 50% charged an average of
1.31%. Portfolios with an active share of 30% or 40% charged an average of
1.13%. (Index funds in the study charged on average 0.55%, though many are
substantially cheaper.)
According to the study, active-share percentages
are a good predictor of performance. Funds registering the highest active
share beat their benchmark index by an average of 1.39 percentage points per
year, while those in the lowest active-share group produced returns that, on
average, fell short of their benchmark by 1.41 percentage points. This makes
sense, argues Mr. Petajisto, one of the study's authors. Once fees are
subtracted, a fund hugging an index is going be hard-pressed to provide
investors with returns that top the index.
In addition, the study found that, in general,
funds with higher active-share readings tend to repeat top performance.
"It's consistent with the idea that the most active funds are likely to have
more skilled managers," Mr. Petajisto says.
Mr. Petajisto suggests investors compare a fund's
active share against the fees they're paying. "If a closet indexer has 30%
active share but only charges 0.30% [a fee not much more than most index
funds], it may still be a reasonably good deal," he says.
The classic example of a mutual fund accused of
being a closet indexer is Fidelity Investment's giant Magellan. In the early
1980s, Magellan's active share under famed manager Peter Lynch ranged
between 70% and 90% -- a time when the fund earned its reputation by being a
strong-performing, invest-anywhere portfolio. However, the active share
declined later in the decade, to the mid 50%, coinciding with massive growth
in the fund. By the mid-1990s, when Robert Stansky took the helm, the fund's
active share started plunging to extremely low readings in the 30% range, a
time when Magellan was widely criticized for being a closet index fund.
During this time Magellan's performance suffered and the fund consistently
landed in the bottom half of its peer group.
When Harry Lange took over the controls at Magellan
late last year, the fund's active share rebounded from 41% in September 2005
to 66% in December. "When Lange replaced Stansky, the fund became
significantly more active within only a few months," Mr. Petajisto notes.
A commonly voiced concern of fund industry
observers is whether, as was the case with Magellan, mutual funds are more
likely to become closet indexers as they grow in size. The Yale study did
find that for funds investing in large-company stocks, active-share readings
tend to decline after assets top $1 billion. "That doesn't mean a fund
necessary always has to become an extreme closet indexer," Mr. Petajisto
says.
For example, the $19 billion Legg Mason Value
Trust, run by William Miller, had an active-share reading of 85% for 2005
and the $36 billion Fidelity Low Priced Stock Fund, which compares itself to
the Russell 2000 index of small company stocks, has an active-share reading
of 90%.
When making any investment, investors should
consider a wide variety of factors and active share is no different.
However, it can raise questions about whether funds are living up to the
claim of being actively managed. For example, the $3.6 billion Thrivent
Large Cap Stock fund tells investors that it employs an "individual,
bottom-up approach to stock selection" focusing on "corporate fundamentals."
However, its active share percentage is just 38%.
Thrivent didn't respond to a request for comment.
At Calamos Investments, active share points to
possible differences between two funds that the firm says use similar
investment strategies. Calamos Growth, which sports a top long-term
performance record, clocks in among the most actively management funds with
an active share percentage of 89%. But Calamos Blue Chip, which tells
investors it uses "intense research" to pick stocks, posts an active share
rating of just 40%. Meanwhile, investors in Calamos Blue Chip are charged
expenses of 1.46%, far more than the 1.16% in fees levied on the average
large-cap blend fund, according to Morningstar Inc. (Investors also pay a
commission to purchase the fund).
In a statement, Chief Investment Officer Nick
Calamos said, "The Blue Chip Fund is not an index product....It is
big-company, blue-chip biased and more sector-constrained than the Growth
Fund."
At the other extreme, funds with active-share
readings above 95% include managers with top long-term track records built
through years of building eclectic portfolios. Among them are CGM Focus
Fund, Brandywine Blue Fund and Longleaf Partners funds.
In these hard times, how many going concern
doubts will force auditors to shift from going concern GAAP to exit value GAAP
with going concern doubts expressed in the audit opinions? Also will broken
markets for toxic securities, how will exit values be estimated?
From The Wall Street Journal's Accounting Weekly Review on December
12, 2008
AIG Faces $10 Billion in Losses on Bad Bets
by Serena Ng, Carrick
mollenkamp, and Michael Siconolfi
The Wall Street Journal
Dec 10, 2008
Click here to view the full article on WSJ.com ---
http://online.wsj.com/article/SB122887203792493481.html?mod=djem_jiewr_AC
TOPICS: Accounting,
Derivatives, Disclosure, Financial Accounting
SUMMARY: While the
article states that AIG faces a potential additional $10 billion in losses
on speculative derivatives, the figure actually represents the underlying
notional amount of the derivative. AIG responded to the front page article.
Their response is listed as a related article. It references disclosure
explaining the $10 billion underlying notional amount on page 117 of the
10-Q for the quarter ended September 30, 2008.
CLASSROOM APPLICATION: The
article covers issues related to complex derivative transactions.
QUESTIONS:
1. (Introductory) With respect to derivative securities, what is an
underlying notional amount? Give an example of a notional amount in the
context of a specific derivative security.
2. (Advanced) The headline of the article says that AIG faces $10
billion losses on trades. AIG responded in the related article to say that
the $10 billion is an underlying notional amount on derivative securities.
Is it possible that AIG will face an additional $10 billion in payments
related to this amount?
3. (Introductory) What is the difference between using derivative
securities to speculate and using them for hedging? In your answer, define
these two terms.
4. (Advanced) "The $10 billion...stems from...AIG's exposure to
speculative investments...which were essentially bets on the performance of
bundles of derivatives linked to subprime mortgages, commercial real-estate
bonds and corporate bonds." Based on the description in the article, why are
these speculative investments not "covered" by the government bailout
assistance given to AIG?
5. (Advanced) In the related article, AIG refers to disclosures on
page 117 of its 10-Q filing for the quarter ended September 30, 2008. Refer
to the disclosures on that page. What events cause AIG to incur losses and
cash payments to counterparties on these securities? Does this description
change your answer to question 2?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
AIG Responds to Wall Street Journal Story
by WSJBlog
Dec 10, 2008
Online Exclusive
"AIG Faces $10 Billion in Losses on Bad Bets," The Wall Street
Journal, by Serena Ng,
Carrick mollenkamp, and Michael Siconolfi, The Wall Street Journal, December 10,
2008 ---
http://online.wsj.com/article/SB122887203792493481.html?mod=djem_jiewr_AC
American International Group Inc. owes
Wall Street's biggest firms about $10 billion for speculative trades that
have soured, according to people familiar with the matter, underscoring the
challenges the insurer faces as it seeks to recover under a U.S. government
rescue plan.
The details of the trades go beyond what
AIG has explained to investors about the nature of its risk-taking
operations, which led to the firm's near-collapse in September. In the past,
AIG has said that its trades involved helping financial institutions and
counterparties insure their securities holdings. The speculative trades,
engineered by the insurer's financial-products unit, represent the first
sign that AIG may have been gambling with its own capital.
The soured trades and the amount lost on
them haven't been explicitly detailed before. In a recent quarterly filing,
AIG does note exposure to speculative bets without going into detail. An AIG
spokesman characterizes the trades not as speculative bets but as "credit
protection instruments." He said that exposure has been fully disclosed and
amounts to less than $10 billion of AIG's $71.6 billion exposure to
derivative contracts on debt pools known as collateralized debt obligations
as of Sept. 30.
AIG's financial-products unit, operating
more like a Wall Street trading firm than a conservative insurer selling
protection against defaults on seemingly low-risk securities, put billions
of dollars of the company's money at risk through speculative bets on the
direction of pools of mortgage assets and corporate debt. AIG now finds
itself in a position of having to raise funds to pay off its partners.
The fresh $10 billion bill is particularly
challenging because the terms of the current $150 billion rescue package for
AIG don't cover those debts. The structure of the soured deals raises
questions about how the insurer will raise the funds to pay the debts. The
Federal Reserve, which lent AIG billions of dollars to stay afloat, has no
immediate plans to help AIG pay off the speculative trades.
The outstanding $10 billion bill is in
addition to the tens of billions of taxpayer money that AIG has paid out
over the past 16 months in collateral to Goldman Sachs Group Inc. and other
trading partners on trades called credit-default swaps. These instruments
required AIG to insure trading partners, known on Wall Street as
counterparties, against any losses in their holdings of securities backed by
pools of mortgages and other assets. With the value of those mortgage
holdings plunging in the past year and increasing the risk of default, AIG
has been required to put up additional collateral -- often cash payments.
AIG's problem: The rescue plan calls for a
company funded largely by the Federal Reserve to buy about $65 billion in
troubled CDO securities underlying the credit-default swaps that AIG had
written, so as to free AIG from its obligations under those contracts. But
there are no actual securities backing the speculative positions that the
insurer is losing money on. Instead, these bets were made on the performance
of pools of mortgage assets and corporate debt, and AIG now finds itself in
a position of having to raise funds to pay off its partners because those
assets have fallen significantly in value.
The Fed first stepped in to rescue AIG in
mid-September with an $85 billion loan when the collateral demands from
banks and losses from other investments threatened to send the firm into
bankruptcy court. A bankruptcy filing would have created losses and problems
for financial institutions and policyholders all over the world that were
relying AIG to insure them against the unexpected.
By November, AIG had used up a large chunk
of the government money it had borrowed to meet counterparties' collateral
calls and began to look like it would have difficulty repaying the loan. On
Nov. 10 the government stepped in again with a revised bailout package. This
time, the Treasury said it would pump $40 billion of capital into AIG in
exchange for interest payments and proceeds of any asset sales, while the
Fed agreed to lend as much as $30 billion to finance the purchases of
AIG-insured CDOs at market prices.
The $10 billion in other IOUs stems from
market wagers that weren't contracts to protect securities held by banks or
other investors against default. Rather, they are from AIG's exposures to
speculative investments, which were essentially bets on the performance of
bundles of derivatives linked to subprime mortgages, commercial real-estate
bonds and corporate bonds.
These bets aren't covered by the pool to
buy troubled securities, and many of these bets have lost value during the
past few weeks, triggering more collateral calls from its counterparties.
Some of AIG's speculative bets were tied to a group of collateralized debt
obligations named "Abacus," created by Goldman Sachs.
The Abacus deals were investment
portfolios designed to track the values of derivatives linked to billions of
dollars in residential mortgage debt. In what amounted to a side bet on the
value of these holdings, AIG agreed to pay Goldman if the mortgage debt
declined in value and would receive money if it rose.
As part of the revamped bailout package,
the Fed and AIG formed a new company, Maiden Lane III, to purchase CDOs with
a principal value of $65 billion on which AIG had written
credit-default-swap protection. These CDOs currently are worth less than
half their original values and had been responsible for the bulk of AIG's
troubles and collateral payments through early November.
Fed officials believed that purchasing the
underlying securities from AIG's counterparties would relieve the insurer of
the financial stress if it had to continue making collateral payments. The
plan has resulted in banks in North America and Europe emerging as winners:
They have kept the collateral they previously received from AIG and received
the rest of the securities' value in the form of cash from Maiden Lane III.
The government's rescue of AIG helped
prevent many of its policyholders and counterparties from incurring
immediate losses on those traditional insurance contracts. It also has been
a double boon to banks and financial institutions that specifically bought
protection on now shaky mortgage securities and are effectively being made
whole on those positions by AIG and the Federal Reserve.
Some $19 billion of those payouts were
made to two dozen counterparties just between the time AIG first received
federal government assistance in mid-September and early November when the
government had to step in again, according to a confidential document and
people familiar with the matter. Nearly three-quarters of that went to
French bank Société Générale SA, Goldman, Deutsche Bank AG, Crédit Agricole
SA's Calyon investment-banking unit, and Merrill Lynch & Co. Société
Générale, Calyon and Merrill declined to comment. A Goldman spokesman says
the firm's exposure to AIG is "immaterial" and its positions are supported
by collateral.
As of Nov. 25, Maiden Lane III had
acquired CDOs with an original value of $46.1 billion from AIG's
counterparties and had entered into agreements to purchase $7.4 billion
more. It is still in talks over $11.2 billion.
Bob Jensen's threads on the AIG bailout of 2008 ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#MutualFunds
A billion here, a billion there --- PS the debits are on the
left
The American International Group, the
embattled insurance giant, said last night that an in-depth
examination of its operations had turned up additional accounting
improprieties going back to 2000 that would reduce its net worth by
$2.7 billion, or $1 billion more than it had previously estimated.
Gretchen Morgenson, "Giant Insurer Finds $1 Billion More in Flaws,
The New York Times, May 2, 2005 ---
http://www.nytimes.com/2005/05/02/business/02aig.html?
Bob Jensen's updates on fraud in general are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Jury Finds Former Insurance Executives Guilty," The
New York Times, February 25, 2008 ---
http://www.nytimes.com/aponline/us/AP-CT-GenRe-AIGTrial.html
A Connecticut jury found five former
insurance company executives guilty Monday of a scheme to manipulate the
financial statements of the world's largest insurance company.
The verdict came in the seventh day of
jury deliberations following a month long trial in federal court.
The defendants, four former executives of
General Re Corp. and a former executive of American International Group
Inc., sat stone-faced as the verdict was read. They were accused of
inflating AIG's (NYSE:AIG) reserves through reinsurance deals by $500
million in 2000 and 2001 to artificially boost its stock price.
The defendants were former General Re CEO
Ronald Ferguson; former General Re Senior Vice President Christopher P.
Garand; former General Re Chief Financial Officer Elizabeth Monrad; and
Robert Graham, a General Re senior vice president and assistant general
counsel from about 1986 through October 2005.
Also charged was Christian Milton, AIG's
vice president of reinsurance from about April 1982 until March 2005.
Ferguson, Monrad, Milton and Graham each
face up to 230 years in prison and a fine of up to $46 million. Garand faces
up to 160 years in prison and a fine of up to $29.5 million.
"This is a very sad day, not only for Ron
Ferguson, but for our criminal justice system," Clifford Schoenberg,
Ferguson's personal attorney, said in a statement distributed at U.S.
District Court in Hartford. "I and the rest of Ron's legal team will not
rest until we see him -- and justice -- vindicated."
Reinsurance policies are backups purchased
by insurance companies to completely or partly insure the risk they have
assumed for their customers.
Prosecutors said AIG Chief Executive
Maurice "Hank" Greenberg was an unindicted coconspirator in the case.
Greenberg has not been charged and has denied any wrongdoing, but
allegations of accounting irregularities, including the General Re
transactions, led to his resignation in 2005.
Continued in article
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Buffett Won’t Be Witness in Fraud Trial
Defense lawyers rested their case at the fraud trial of General Reinsurance
executives accused of helping the American International Group mislead
investors, without jurors hearing from the billionaire investor Warren E.
Buffett. Closing arguments are scheduled for Monday, and the case is expected to
go to the jury shortly after that. Mr. Buffett’s holding company, Berkshire
Hathaway, owns General Re. In the case, four former executives from General
Reinsurance and one from A.I.G. are accused of conspiring on a transaction that
let A.I.G. inflate loss reserves by $500 million in 2000 and 2001. Lawyers for
two defendants presented character witnesses on Thursday.
"Buffett Won’t Be Witness in Fraud Trial," Bloomberg News via The New
York Times, February 8, 2008 ---
http://www.nytimes.com/2008/02/08/business/08genre.html?_r=1&ref=business&oref=slogin
Accounting Fraud Can Cost Billions
AIG is close to a deal involving a payment of at least
$1.5 billion to resolve accounting fraud and other allegations with federal and
state authorities. The expected agreement could be the largest finance-industry
regulatory settlement with a single company in U.S. history.
Kara Scannell and Ian McDonald, "AIG Close to Deal To Settle Charges, Pay $1.5
Billion," The Wall Street Journal, February 6, 2006; Page C1 ---
http://online.wsj.com/article/SB113919423276365730.html?mod=todays_us_money_and_investing
HANK GREENBERG IS BEING investigated by
U.S. prosecutors as to whether the AIG chairman manipulated the
insurer's share price in 2001 to save money on its deal for American
General. AIG said that it reached tentative settlements with the
Justice Department and SEC over transactions that allegedly helped
clients commit accounting fraud.
Kate Kelly and Kara Scannell, "Hank Greenberg Probed By U.S. Over
Stock Deal," The Wall Street Journal, November 24, 2004,
Page C1 ---
http://online.wsj.com/article/0,,SB110126378958082699,00.html?mod=home_whats_news_us
"AIG Probes Bring First Charges: New York Suit Accuses Insurer,
Greenberg and Ex-Finance Chief Of Manipulating Firm's Results," by Ian McDonald
and Theo Francis, The Wall Street Journal, May 27, 2005; Page C1 ---
http://online.wsj.com/article/0,,SB111712238633844135,00.html?mod=todays_us_money_and_investing
In the first formal charges to come
In the first formal charges to come from the probes
of American International Group Inc.'s accounting, New York state
authorities sued AIG, former Chairman Maurice R. "Hank" Greenberg and the
insurance company's former chief financial officer, painting a picture of
widespread accounting gimmickry aimed at duping regulators and investors.
New York State Attorney General Eliot Spitzer and
the New York State Insurance Department alleged that AIG engaged in "sham
transactions," hid losses and created false income. On one occasion, Mr.
Greenberg even laughed at a joke about one of the alleged maneuvers, the
civil lawsuit says.
The goal, the suit contends, was to exaggerate the
strength of the company's core underwriting business, propping up the price
of one of the nation's most widely held stocks.
AIG shares rose 3% yesterday after the lawsuit was
announced, as investors saw that the charges were civil, not criminal,
though a criminal investigation of individuals continues. AIG is the world's
biggest publicly traded seller of property-casualty insurance to companies
and is the largest life insurer in the U.S., as measured by premiums.
Continued in article
Bye bye Hank!
At the helm of American International Group Inc.,
Maurice Greenberg was under mounting pressure. Regulators were applying
increasing heat over a transaction AIG did with a unit of Warren Buffett's
Berkshire Hathaway Inc., a deal they considered possibly misleading to AIG
investors. Mr. Greenberg, known as Hank, resisted the pressure with the
same tenacity he displayed in nearly four decades running what has become the
world's largest insurer. But then, in the past week, came the tipping point. The
regulators -- relying on nearly 1,000 pages of e-mails and phone-call records --
gave AIG's independent directors an analysis providing new details of the deal
and Mr. Greenberg's role in it. And some of that was in conflict with or missing
from his statements on the matter.
Monica Langley and Theo Francis, "How Investigations of AIG Led To
Retirement of Longtime CEO: Spitzer's and SEC's Close Look At Big Trove of
Documents Put Pressure on the Chief Greenberg: 'I'll Get Going Now'," The
Wall Street Journal, March 15, 2005; Page A1 --- http://online.wsj.com/article/0,,SB111084108330679173,00.html?mod=todays_us_page_one
Bye bye again Hank!
Maurice R. "Hank" Greenberg, the insurance industry's
most powerful figure for decades, decided to retire as nonexecutive chairman of
American International Group Inc., succumbing to mounting law-enforcement
scrutiny of the company he built.
Deborah Solomon and Ian McDonald, "Finally, an AIG Without Hank:
Retirement Ends Last Top Role At the Company Greenberg Built And Comes Amid
Investigations, The Wall Street Journal, March 29, 2005; Page C1 ---
http://online.wsj.com/article/0,,SB111206560939091696,00.html?mod=home_whats_news_us
How did AIG use insurance contracts to sell accounting fraud?
Steven Gluckstern and Michael Palm figured
out how to minimize insurers' risk and give customers an accounting
edge and a tax break: Multiyear contracts in which the premiums
covered most if not all of the potential losses -- but refunded much
of the unclaimed money at the end of the contract. Buyers loved
the policies because they could offset losses with loan-like proceeds
without disclosing liabilities that would muddy their bottom lines.
And the premiums were tax deductible. Such policies became among
the industry's hottest products. Now, two decades later, they are the
focus of multiple state and federal investigations into companies
suspected of using them to manipulate earnings. And this week, those
probes helped topple Mr. Greenberg as chief executive, although he
will remain chairman. His company sold one policy later declared a
sham by federal authorities and itself bought another -- now the focus
of intense scrutiny -- from Berkshire Hathaway Inc., where Messrs.
Gluckstern and Palm got their start. "If used improperly,
these contracts can enable a company to conceal the bottom-line impact
of a loss and thus misrepresent its financial results," says the
Securities and Exchange Commission's Mark Schonfeld, who is overseeing
the agency's probe of such policies as the head of its Northeast
office.
Ianthe Jeanne Dugan and Theo Francis, "How a Hot Insurance
Product Burned AIG: An Unlikely Duo's New Approach Called
'Finite Risk Insurance' Was a Hit -- Until Inquiries Began," The
Wall Street Journal, March 15, 2005; Page C1 --- http://online.wsj.com/article/0,,SB111084339061279243,00.html?mod=todays_us_money_and_investing
AIG Expected to Pay $1 Billion-Plus to Settle Probes
AIG is expected to pay more than $1 billion to settle
state and federal civil-fraud charges alleging the giant insurer used improper
accounting to polish its earnings. Former CEO Hank Greenberg is not included in
the accord.
Ian McDonald and Monica Langley, "AIG Expected to Pay $1 Billion-Plus to Settle
Probes: Huge Penalty Would Resolve Fraud Case Against Insurer But Wouldn't
Cover Ex-CEO," The Wall Street Journal, January 13, 2006; Page A1 ---
http://online.wsj.com/article/SB113712355453045791.html?mod=todays_us_page_one
The latest huge Enron-type scandal: Where was the external auditor,
PwC, when all this was going on?
Among AIG's admissions: It used insurers in Bermuda and
Barbados that were secretly under its control to bolster its financial results,
including shifting some liabilities off its books. Amid the wave of financial
scandals that have toppled corporate executives in recent years, AIG's woes
stand out. Unlike Enron, WorldCom and HealthSouth -- all highfliers that rose to
prominence in the 1990s -- AIG has been a solid blue-chip for decades. Its stock
is in the Dow Jones Industrial Average, and its longtime chief, Maurice R.
"Hank" Greenberg, was a globe-trotting icon of American business. Civil and
criminal probes already have forced the departure of the 79-year-old Mr.
Greenberg after nearly four decades at AIG's helm. Investigators are closely
examining the actions of Mr. Greenberg and several other top AIG officials who
have quit or been ousted in recent days, including its former chief financial
officer; the architect of its offshore operations in Bermuda; and its
reinsurance operations chief. In addition, the Securities and Exchange
Commission could eventually bring civil-fraud charges against the company or
executives.
Ian McDonald, Theo Francis, and Deborah Solomon, "AIG Admits 'Improper'
Accounting : Broad Range of Problems Could Cut $1.77 Billion Of Insurer's
Net Worth A Widening Criminal Probe," The Wall Street Journal, March 31,
2005; Page A1---
http://online.wsj.com/article/0,,SB111218569681893050,00.html?mod=todays_us_page_one
Underwriting losses: AIG said it improperly
characterized losses on insurance policies -- known as underwriting losses
-- as another type of loss, through a series of transactions with Capco
Reinsurance Co. of Barbados. It said Capco should have been treated as a
subsidiary of AIG, a change that will force AIG to restate $200 million of
the other losses as underwriting losses from its auto-warranty business. AIG
long has prided itself on having among the lowest underwriting losses in the
industry -- a closely watched figure.
• Investment income: Through a string of
transactions with unnamed outside companies, AIG said it booked a total of
$300 million in gains on its bond portfolio from 2001 through 2003 without
actually selling the bonds. If it had waited to book the income until it
sold the bonds, the income would have come later and been counted as
"realized capital gains." That category of income is sometimes treated
suspiciously by investors because insurance companies have considerable
discretion over when they sell securities in their portfolio.
• Bad debts: The company suggested that money owed
to AIG by other companies for property-casualty insurance policies might not
be collectible. The company said that could result in an after-tax charge of
$300 million.
• Commission costs: Potential problems with AIG's
accounting for the up-front commissions it pays to insurance agents and
similar items might force it to take an after-tax charge of up to $370
million, the company said.
• Compensation costs: AIG also will begin recording
an expense on its books for compensation paid to its employees by Starr
International, the private company run by current and former executives.
Starr has spent tens of millions of dollars on a deferred-compensation
program for a hand-picked group of AIG employees in recent years.
The probe that spurred the AIG admissions stemmed
from a broader investigation of "nontraditional insurance," an industry
niche that had grown rapidly in the 1990s. In particular, regulators have
been concerned about a product called "finite-risk reinsurance."
Reinsurance is a decades-old business that sells
insurance to insurance companies to cover bigger-than-expected claims,
thereby spreading the losses for policies they sell to individuals and
companies. Finite-risk reinsurance blends elements of insurance and loans.
Regulators had become concerned that some insurers
were using the policies to improperly bolster their financial results. Their
concern: For a contract to count as insurance, it has to transfer risk to
the insurer selling the policy. Some finite-risk policies appeared to be
more akin to loans than insurance policies -- yet the buyers used favorable
insurance accounting.
In December, the SEC opened a broad probe into at
least 12 insurance and reinsurance companies, including General Re, ACE
Ltd., Chubb Corp. and Swiss Reinsurance Co. All four companies have said
they are cooperating with the inquiry.
Key to the inquiry is how the finite-risk
transactions were structured and treated on the financial statements of the
companies or their clients, these people said. Following the SEC request for
information, General Re lawyers combed through their finite-risk insurance
deals and turned up roughly a dozen transactions where it wasn't clear that
enough risk had been transferred to treat them as insurance. Among those
deals was the AIG deal. General Re lawyers quickly alerted the SEC and the
New York attorney general's office, which resulted in the current probe.
The catalogue of problems AIG unveiled yesterday
was detailed to law-enforcement and regulatory authorities in meetings with
the company's outside lawyers in recent days. The company also has fired
three senior executives for refusing to cooperate with investigators,
including former chief financial officer Howard I. Smith and Michael Murphy,
a Bermuda-based AIG executive.
Given its level of cooperation so far, the company
almost certainly will be able to reach a civil settlement with authorities,
people familiar with the probes said. One of these people compared AIG's
cooperation to the approach taken by Michael Cherkasky, the chief executive
of Marsh & McLennan Cos. After Mr. Spitzer accused Marsh's insurance
brokerage of bid-rigging, its board forced out then-CEO Jeffrey Greenberg,
Mr. Greenberg's son and a former AIG executive. Mr. Cherkasky, the head of
Marsh's investigative unit, became the new chief.
When he came in, a criminal indictment of the
company remained a possibility. But Mr. Cherkasky cleaned house among the
company's high ranks, then made sure the firm's internal investigation and
cooperation with regulators were the top priority. He often personally
participated in talks with regulators.
Bob Jensen's threads on PwC woes are at
http://faculty.trinity.edu/rjensen/fraud001.htm#PwC
Earnings Management Deception
The 1999 bulletin also said that if accounting
practices were intentionally misleading "to impart a sense of increased earnings
power, a form of earnings management, then by definition amounts involved would
be considered material." AIG hinted some errors may have been intentional,
saying that certain transactions "appear to have been structured for the sole or
primary purpose of accomplishing a desired accounting result."
Jonathan Weil, "AIG's Admission Puts the Spotlight On Auditor PWC," The Wall
Street Journal, April 1, 2005 ---
http://online.wsj.com/article/0,,SB111231915138095083,00.html?mod=home_whats_news_us
Bob Jensen's threads on earnings management are at
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#Manipulation
"Insurer's Filings Had Accounting Clues," By Jonathan Weil and Theo Francis,
The Wall Street Journal, April 11, 2005, Page C1 ---
http://online.wsj.com/article/0,,SB111318484816103175,00.html?mod=todays_us_money_and_investing
It might have taken an eagle eye and extensive
knowledge of accounting rules to spot the no-expense treatment as a
potential problem. But unlike most of the accounting issues AIG disclosed
March 30 -- involving complex insurance contracts, derivative financial
instruments and offshore reinsurance dealings -- the information about the
stock plan was out there for anybody to see. AIG now says it will change its
policy to treat such payments as expenses -- though it has stopped short of
saying the original accounting was wrong.
Here is why AIG's prior accounting treatment looks
questionable to some accounting specialists: Under the accounting rules for
stock compensation, if a principal stockholder of a company establishes a
stock plan to pay that company's employees, the company must account for the
payments as an expense on its own income statement.
The rules define a principal stockholder as one
that either owns 10% or more of a company's common stock or has the ability
to exert significant influence over a company's affairs, directly or
indirectly.
AIG spokesman Chris Winans declined to clarify
whether AIG believes the prior accounting treatment was improper. He said
AIG will provide further details when it files its 2004 annual report this
month.
The history of the rules governing such stock plans
dates to a June 1973 pronouncement by the now-defunct Accounting Principles
Board. David Norr, a board member at the time, recalled that it was
responding to a move by Ray Kroc, McDonald's Corp.'s founder, to distribute
portions of his own stock to the burger chain's employees.
The accounting board noted the difficulty for
outsiders of establishing whether a principal stockholder's intent is to
satisfy his generous nature or attempt to increase his investment's value.
If the latter, it said, "the corporation is implicitly benefiting from the
plan by retention of, and possibly improved performance by, the employee,"
in which case "the benefits to a principal stockholder and to the
corporation are generally impossible to separate."
Continued in the article
Flashback on AIG Fraud (forwarded to me by Miklos
Vasarhelyi
[miklosv@andromeda.rutgers.edu]
American International Group Inc. agreed to pay a $10
million fine to settle Securities and Exchange Commission allegations that the
insurance company participated in an accounting fraud at Brightpoint Inc. The
SEC also alleged that New York-based American International, the world's largest
insurer by market value, failed to cooperate with its investigation. The SEC
charged Brightpoint with accounting fraud in a scheme to conceal losses by using
an AIG insurance policy. "AIG worked hand-in-hand with Brightpoint personnel to
custom-design a purported insurance policy that allowed Brightpoint to overstate
its earnings by a staggering 61 percent," said Wayne M. Carlin, director of
SEC's Northeast Regional Office in New York. Carlin said the transaction
amounted to a "round-trip" of cash from Brightpoint to AIG and back to
Brightpoint. In the past year, the SEC also has charged energy companies, such
as Reliant Resources Inc. and Reliant Energy Inc., in "round-trip" arrangements
that misled investors.
Reuters, "AIG Pays $10 Million Fine in Brightpoint Accounting Fraud," The New
York Times, September 11, 2003
You can read more about round tripping at
http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm#RoundTripping
I have a longer quotation on this article at the above link. You can also
read about Enron's round trips to the plate.
Over the last two weeks we have
been flooded with revelations of problems with AIG accounting, in particular,
some "round trip like" transactions between AIG and Berkshire's General Re: that
will reduce AIG's net worth by 2% max according to AIG. However, a much deeper
issue came to light that has widely been ignored by the press and maybe by the
regulators and the FASB. AIG had extensive dealings with offshore companies
which were also owned or controlled by AIG or its executives. These companies
paid compensation to the executives that was not included in AIG's 10Ks. As IAG
and / or its executives including Mr. Grenberg controlled for example Richmond
and Union Reinsurance a Barbados based company the relationship was not
arms-length... consequently it is possible that the deals included substantial
"extra fat" for rich payments for these same executives in the privately held
companies... This arrangement makes it feel very much like Mr. Fastow's Enron
SPEs. As I have argued many times, any privately held company or partnership
that does extensive business with publicly held companies should be subject to
the same onus of disclosure of public companies... consequently the distinction
is very murky and like some European countries most companies publicly or
privately held including partnerships, LLPs and LLCs should have SEC-like
disclosure requirements.
April 3, 2005 message from Miklos Vasarhelyi
[miklosv@andromeda.rutgers.edu]
From The Wall Street Journal Weekly
Accounting Review on April 1, 2005
TITLE: AIG's Mistakes Over Accounting May Be in Billions
REPORTER: Monica Langley and Ian McDonald
DATE: Mar 25, 2005 PAGE: A1 LINK:
http://online.wsj.com/article/0,,SB111170837700789265,00.html
TOPICS: Accounting Changes and Error Corrections, Advanced Financial Accounting,
Regulation, Reserves, Revenue Recognition, Auditing, Consolidation
SUMMARY: AIG "disclosed the initial findings of its internal investigation in
a conference call Tuesday evening that its lawyers initiated with authorities
from the New York Insurance Department, the New York Atotrney General and the
Securities and Exchange Commission. The internal investigation has focused on
questionable deals over the past five years..." undertaken with reinsurers.
QUESTIONS:
1.) What is re-insurance? What is the purpose of undertaking a re-insurance
contract?
2.) What is the revenue recognition issue at the heart of this investigation
into AIG's accounting practices? What accounting standard (or standards)
establishes required practice in this area?
3.) What consolidation issue also is being questioned in this investigation?
What accounting standard (or standards) addresses requirements for these
practices?
4.) How must auditors assess the propriety of transactions described in this
article? List and explain all procedures you think might be necessary.
5.) Do you think auditors face a risk of not uncovering problematic
practices, even systemic ones, covering a period of five years and relating to
multiple accounting areas? Support your answer, then explain what audit
practices must be used to address this risk.
6.) Refer to the related article. AIG "is considering hiring forensic
accountants to work with them..." What is a forensic accountant? How might such
an accountant's work be used in this investigation?
7.) Again refer to the related article. "AIG hasn't yet determined whether to
restate past years' earnings or take a charge against current earnings,
according to one person familiar with the matter." Is there a choice between
these two methods of handling any problems uncovered by this investigation?
Explain, supporting your answer with reference to the accounting literature and
the nature of the issues discussed in these articles.
8.) Again refer to the related article. "AIG continues to 'believe that the
matters subject to review are unlikely to result in significant changes to the
company's financial position,' meaning shareholders' equity..." Define the terms
"financial position" and "shareholders' equity". Would you use the terms
interchangeably? How are they related? How is shareholders' equity particularly
of concern in the insurance industry, as in the banking industry?
Reviewed By: Judy Beckman, University of Rhode Island
--- RELATED ARTICLES ---
TITLE: SEC Subpoenas Senior Executives In Probe at AIG
REPORTER: Monica Langley, Deborah Solomon, Theo Francis and Ian McDonald
PAGE: A1
ISSUE: Mar 28, 2005
LINK:
http://online.wsj.com/article/0,,SB111198187755390721,00.html
A quote from Katherine
After months of government investigations of
financial-engineering products in the insurance industry, the nation's
accounting rule makers said they will consider tightening standards that govern
how companies account for their dealings with insurance companies. The Financial
Accounting Standards Board yesterday voted unanimously to add a project to its
agenda aimed at clarifying when contracts structured as insurance policies
actually transfer risk from the policies' buyers, and when they don't. The
FASB's decision is an acknowledgment that the current accounting rules for the
insurance industry in many respects are porous. "We've got a specific problem
that's been brought to our attention in which there are allegations that the
accounting is not representationally faithful and not comparable," said
Katherine Schipper, a member of the FASB, the private-sector body that sets
generally accepted accounting principles. "So we need to craft a solution that
addresses that specific set of allegations."
Diya Gullapalli, "FASB Weighs Its Finite-Risk Rules: Accounting Body to
Start By Defining 'Insurance Risk'; Changes Could Take Years, The Wall Street
Journal, April 7, 2005; Page C3
After months of government investigations of
financial-engineering products in the insurance industry, the nation's
accounting rule makers said they will consider tightening standards that
govern how companies account for their dealings with insurance companies.
The Financial Accounting Standards Board yesterday
voted unanimously to add a project to its agenda aimed at clarifying when
contracts structured as insurance policies actually transfer risk from the
policies' buyers, and when they don't. The FASB's decision is an
acknowledgment that the current accounting rules for the insurance industry
in many respects are porous.
"We've got a specific problem that's been brought
to our attention in which there are allegations that the accounting is not
representationally faithful and not comparable," said Katherine Schipper, a
member of the FASB, the private-sector body that sets generally accepted
accounting principles. "So we need to craft a solution that addresses that
specific set of allegations."
In recent years, many companies are believed to
have used structured insurance-industry products to burnish their financial
statements. The FASB's current standards don't define even basic concepts
like "insurance contract" and "insurance risk." FASB members said that
defining those terms will be their first order of business as they tackle
the project. For years, the lack of clarity over what qualifies for
insurance accounting, combined with lax public-disclosure requirements, made
it fairly easy for companies to interpret the rules aggressively without
fear of attracting scrutiny by outside investors.
The accounting for "finite-risk" reinsurance
policies is at the heart of regulators' investigations at a host of
insurance companies, including American International Group Inc. and MBIA
Inc. These nontraditional insurance products blend elements of insurance and
financing. To qualify for more-favorable insurance accounting, policies must
transfer sufficient risk of loss to a seller from a buyer. Regulators have
contended that, in some cases, finite-risk policies appear more akin to
loans.
FASB members debated several approaches yesterday.
Possibilities include enhancing disclosure rules, issuing new guidance in a
question-and-answer format, and amending one of the key standards on risk
transfer in reinsurance contracts, known as Financial Accounting Standard
113. Formally amending FAS 113 could require months or years of work,
however.
The subject of risk transfer also is under review
by the National Association of Insurance Commissioners, whose members are
the insurance industry's chief regulators. In addition, the London-based
International Accounting Standards Board and the U.S. Securities and
Exchange Commission's staff are considering issuing new guidance on
accounting for finite-risk reinsurance. With the IASB also in the kitchen,
Michael Crooch, an FASB board member, wonders if the FASB's work on the
matter will be "seen at least across the pond as the FASB meddling or
getting ahead of them."
The least likely scenario would be for the FASB to
adopt what, until recently, had been a widely used rule of thumb in the
accounting and insurance industries for determining when risk is transferred
to an insurer. This held that risk is transferred when there is a 10% chance
of a 10% loss by an insurer or reinsurer. That industry guidepost --
developed largely because of the FASB's lack of guidance on the subject --
today is being frowned upon because of its arbitrariness and its openness to
abuse.
Large auditing firms are trying to stay on top of
finite-risk reinsurance rules, as well. On its internal Web site, for
example, PricewaterhouseCoopers LLP, which is AIG's outside auditor,
recently posted a 20-page summary for personnel and clients on accounting
issues surrounding these products. And at Grant Thornton LLP, the nation's
fifth-largest accounting firm, Chief Executive Ed Nusbaum said: "We're more
on the lookout for insurance transactions with these accounting issues."
Audio broadcasts of FASB meetings are available to listeners for FREE via the
Internet. Meetings also are available via your telephone on a pay-to-listen
basis (see below). To access an FASB meeting for FREE via the Internet, click
the link below to begin listening on your computer ---
http://www.trz.cc/fasb/live.html
April 7, 2005 reply from
escribne@nmsu.edu
Bob,
This looks relevant to your quote from Katherine Schipper.
Ed
"Accounting for the Abuses at AIG," Insurance
and Pensions at the Wharton School of Business," ---
http://knowledge.wharton.upenn.edu/index.cfm?fa=viewfeature&id=1180
Improper Use of Finite Policies
But in practice, finite policies have
sometimes been used improperly. In 2000 and
2001, AIG's Greenberg asked General Re to do
an unusual deal involving a bundle of finite
contracts General Re had written for
clients. AIG took over the obligation to pay
up to $500 million in claims on the
contracts. At the same time, General Re
passed to AIG $500 million in premiums the
clients had paid. AIG paid General Re a $5
million fee for moving these contracts to
AIG's books.
Last year, General Re reported the deal to
investigators who were questioning a number
of reinsurers about finite policies. This
deal carried a red flag because it was
backwards: Typically, it would be AIG
seeking a finite policy to shift risk to
General Re. Because the $500 million in
premiums had to be paid back to General Re,
AIG seemed to be losing money on the deal,
not making it. So why had Greenberg asked to
take over those contracts?
In accounting for the deal, AIG tallied the
premiums as $500 million in revenue and
applied that amount to its reserve funds
used to pay potential claims. This helped
satisfy shareholders who had been concerned
AIG did not have enough in reserve.
The issue in this deal, as in many finite
insurance contracts, is whether AIG was
providing insurance coverage or receiving a
loan. To be insurance, AIG would have to
assume a risk of loss. An industry rule of
thumb known as "10/10" says the insurer
should face, at a minimum, a 10% chance of
losing 10% of the policy amount for the
contract to be considered insurance.
In the absence of that degree of risk, the
premiums transferred from General Re to AIG,
and repayable later, would be a loan. AIG
would then not be able to count the $500
million in premiums as additional reserves,
as it had.
On March 30, AIG directors announced that:
"Based on its review to date, AIG has
concluded that the General Re transaction
documentation was improper and, in light of
the lack of evidence of risk transfer, these
transactions should not have been recorded
as insurance."
As a result, the company said it would
reduce its reserve figure by $250 million
and show that liabilities had increased by
$245 million. However, it added, these
changes would have "virtually no impact" on
the company's financial condition. Bottom
line: The AIG-General Re deal was an
accounting gimmick to make AIG's reserves
look healthier than they were -- an apparent
effort to deceive regulators, analysts and
shareholders.
More Cases of Questionable Accounting
The directors then surprised observers by
announcing they had uncovered a number of
additional cases of questionable accounting.
The most serious involved reinsurance
contracts AIG had taken with a Barbados
reinsurer, Union Excess, allowing AIG's risk
to pass to the other company and off AIG's
books. AIG found that Union did business
exclusively with AIG subsidiaries, and that
Union was partially owned by Starr
International Company Inc. (SICO), a large
AIG shareholder controlled by a board made
up of current and former AIG managers.
Hence, the AIG statement said, SICO could be
viewed as an AIG unit, or "consolidated
entity," and SICO's risks were therefore
actually AIG's. As a result, AIG had to
reduce its shareholders' equity by $1.1
billion.
Another case involved a Bermuda insurer,
Richmond Insurance Company, that the
directors found to be secretly controlled by
AIG. A third concerned Capco Reinsurance
Company, another Barbados insurer, and
"involved an improper structure created to
recharacterize underwriting losses as
capital losses," the directors said. Fixing
this meant listing Capco as a consolidated
entity and converting $200 million in
capital losses to underwriting losses.
Yet another case involved $300 million in
income AIG improperly claimed for selling
outside investors covered calls on bonds in
AIG's portfolio. Covered calls are supposed
to give their owners the option to buy bonds
at a set price for a given period, but AIG
used other derivatives transactions to
assure it could retain the bonds.
The directors also stated that certain debts
owed to AIG might be unrecoverable,
resulting in after-tax charges of $300
million. And they noted that the company was
revising accounting for deferred acquisition
costs and other expenses involving some AIG
subsidiaries, resulting in as much as $370
million in corrections.
Some of the revelations seemed eerily
similar to ones raised in the Enron case,
which included use of little known offshore
subsidiaries to hide liabilities, although
the scale of the abuse so far appears to be
far smaller at AIG.
The scandal highlights one of the dilemmas
of American accounting, says
Catherine M. Schrand, professor of
accounting at Wharton. "We have
one-size-fits-all accounting for firms in
this country. If the standard-setters try to
make it too specific and take out all the
gray areas, then they would have a problem
creating financial statements that are
relevant."
The degree of risk assumed by a company that
takes out a finite insurance policy is
difficult to measure, so it may not be
absolutely clear, even to the most well
intentioned accountant, whether the policy
should be counted as insurance or a loan.
Companies like AIG are so big, and their
accounting so complex, that it's impossible
to write regulations to prevent all abuse,
Strand suggests. "They will just find
another way to do it.... Flexibility gives
companies the opportunity to make their
financial statements better. But it also
gives them the opportunity to abuse the
rules."
his article is continued at
http://knowledge.wharton.upenn.edu/index.cfm?fa=viewfeature&id=1180
|
|
|
|
From The Wall Street Journal's Accounting Weekly Review on April 8,
2005
TITLE: SEC Brings New Federal Oversight to Insurance Industry with Probes
REPORTER: Deborah Solomon
DATE: Apr 01, 2005
PAGE: A1
LINK:
http://online.wsj.com/article/0,,SB111230901945894804,00.html
TOPICS: Insurance Industry, Regulation, Securities and Exchange Commission,
Accounting
SUMMARY: "The Securities and Exchange Commission [SEC], using its power as an
enforcer of accounting rules, is asserting for the first time in 60 years a key
role for federal oversight of the insurance industry."
QUESTIONS:
1.) Why is the insurance industry regulated? Why is it regulated primarily by
the states as opposed to the federal government?
2.) What accounting measures are used to regulate the insurance industry?
List those that are mentioned in the article and any that you know of from
experience or reading.
3.) How might improper transactions be undertaken to "dress up" the
accounting information that is used in the regulatory process over the insurance
industry? As one example, specifically comment on the product referred to in the
article as "thinly disguised loans". (Hint: you may refer to the related article
to help with this answer.)
4.) How has the SEC used its regulatory control over accounting issues to
effect change in industries over which it has little jurisdiction, such as the
insurance industry?
Reviewed By: Judy Beckman, University of Rhode Island
--- RELATED ARTICLES ---
TITLE: AIG Admits 'Improper' Accounting
REPORTER: Ian McDonald, Deborah Solomon, and Theo Francis
PAGE: A1
ISSUE: Mar 31, 2005
LINK:
http://online.wsj.com/article/0,,SB111218569681893050,00.html
February 18, 2005 message from Joanne Tweed [ibridges@san.rr.com]
America's seniors are being cheated of their life's
savings by securities Broker/Dealers.
SENIORS AGAINST SECURITIES FRAUD http://seniorsagainstsecuritiesfraud.com
offers supportive educational links and solutions. Please consider linking.
Most Sincerely,
Joanne Tweed
Contingent Payment Schemes in the Insurance Industry
A new study found widespread uses of so-called contingent
payments to insurance agents for steering customers to certain insurers or for
selling policies that generate lower levels of claims. A new study found
widespread use of payments to insurance agents who steer customers to certain
home and auto insurers, generating the same potential conflicts as those alleged
by New York Attorney General Eliot Spitzer in the commercial-insurance arena.
Judith Burns, "Insurance Agents Steer Consumers To Favored
Companies, Study Says," The Wall Street Journal, January 27, 2005,
Page D1 --- http://online.wsj.com/article/0,,SB110678244395337299,00.html?mod=todays_us_personal_journal
"Survey Shows Consumers are Unaware of Increase in Fake Insurance,"
AccountingWeb, December 22, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100252
At this time of year, there is no room in the
budget for purchases that do not deliver value. Yet, the General
Accounting Office reports the number of fake insurance policies sold
to consumers is on the rise, resulting in $252 million in unpaid
health insurance claims alone.
According to a survey released today, conducted by the National
Association of Insurance Commissioners (NAIC), most of the public
(74 percent) is unaware of the rise in fake insurance sales and the
need for increased vigilance when purchasing insurance.
The survey also revealed that most Americans feel the information
available from their state insurance department could be helpful in
avoiding fake insurance (83 percent), but only 8 percent of adults
surveyed said they have contacted their state insurance department
to confirm the validity of an insurance provider before making a
purchase.
As part of the United States' fight against the rise in fake
insurance, the NAIC has launched a nationwide awareness campaign
that encourages consumers to "Stop. Call. Confirm." before
buying insurance.
"In the area of fake health insurance alone, the General
Accounting Office reported 144 fake health insurers nationwide sold
bogus policies to more than 200,000 policyholders between 2000 and
2002," said Diane Koken, NAIC president and commissioner of the
Pennsylvania Department of Insurance. "This is simply
unacceptable."
According to most states' laws, with very few exceptions, no
insurance product can be sold by individual agents, brokers, or
companies without the approval of the state insurance department.
Fake insurance is any insurance plan intended to defraud consumers
or businesses.
Everyone is at risk
"Fake insurance can touch anyone at any time with potentially
disastrous results," said Koken. "Frequent targets of
unauthorized health insurance plans are older adults and small
businesses or associations looking to reduce health insurance
costs."
Fake insurance is attractive because it is typically less expensive
than legal policies. But that is because a fake policy does not
provide sufficient - if any - coverage.
As a result of fake insurance policies, honest people and businesses
are swindled, health is endangered, premiums stay high, and goods
and services cost more.
Protecting yourself is easy
The NAIC recommends, if not absolutely sure you are dealing with a
reputable, licensed insurance provider, look for three warning signs
of fake insurance:
- Aggressive marketing and a
high-pressure, "you must sign today" sales approach
with lots of fine print and disclaimers
- Premiums that are 15 percent or more
under the average price for comparable insurance products on the
market
- Few coverage limitations
How can you protect yourself against fake
insurance? The NAIC urges you to STOP ... CALL ... and CONFIRM
before buying insurance:
- STOP before signing anything or writing
a check
- CALL your state insurance department;
contact information is available at www.naic.org
- CONFIRM the company is legitimate and
licensed to do business in your state
"If consumers will stop, call, and
confirm before they buy insurance, they may save themselves the pain
of unpaid claims," said Koken. "They also can help us
track down and take action against the con artists who sell fake
insurance."
Bob Jensen's threads on medial and drug company frauds are at
http://faculty.trinity.edu/rjensen/FraudReporting.htm#PhysiciansAndDrugCompanies
One of the most unethical things stock brokers and investment
advisors can do is to steer naive customers into mutual funds that pay
the brokers kickbacks rather than suitable funds for the investors.
The well known and widespread brokerage firm of Edward Jones & Co.
to pay $75 million to settle charges that it
steered investors to funds without disclosing it received payments.
The
sad part is that many people who want mutual funds can get straight
forward information from reputable mutual funds like Vanguard and
avoid having to pay a financial advisor anything and avoid the risk of
unethical advice from that advisor.
"Edward Jones Agrees to Settle Host of Charges," by Laura
Johannes and John Hechinger, and Deborah Solomon, The Wall Street
Journal, December 21, 200r, Page C1 ---
http://online.wsj.com/article/0,,SB110356207980304862,00.html?mod=home_whats_news_us
Edward D. Jones & Co.
agreed to pay $75 million to settle regulatory charges that it
steered investors to seven "preferred" mutual-fund groups,
without telling the investors that the firm received hundreds of
millions of dollars in compensation from those funds.
The settlement, tentatively
agreed to by the Securities and Exchange Commission, the National
Association of Securities Dealers and the New York Stock Exchange,
represents the largest regulatory settlement to date involving
revenue sharing at a brokerage house, an industry practice in which
mutual-fund companies pay brokerage houses to induce them to push
their products.
Even so, California Attorney
General Bill Lockyer called the settlement "inadequate"
given payments from the funds that he said totaled about $300
million since January 2000, and declined to join it and filed a
civil lawsuit against Edward D. Jones yesterday in Sacramento County
Superior Court.
Mr. Lockyer called Edward D.
Jones "the most egregious example we have reviewed so far"
of secret revenue-sharing arrangements. California's suit, if it
reaches trial, could seek repayment of the entire amount the
brokerage house received, plus the "hundreds of millions"
lost by investors who were sold inferior funds, Mr. Lockyer said.
Edward D. Jones, of St.
Louis, has nearly 10,000 sales offices nationally, comprising the
largest network of brokerage outlets in the U.S. Its revenue-sharing
practices were the subject of a page-one
article in The Wall Street Journal in January. In a statement
yesterday, the company said it will "take immediate steps to
revise customer communications and disclosures." Edward D.
Jones said it has neither admitted nor denied the regulators'
claims. The company added it "intends to vigorously defend
itself" against the charges brought by the California attorney
general.
Continued in article
Not so much fidelity at Fidelity
"2 more leave Fidelity amid probe Traders depart as SEC examines gifts
by brokers," by Andrew Caffrey, The Boston Globe, January 21, 2005
--- http://www.boston.com/business/articles/2005/01/21/2_more_leave_fidelity_amid_probe/
Fidelity spokeswoman Anne Crowley also
declined to say whether the company has taken additional
disciplinary action beyond those it disclosed last month, when it
fined or sanctioned 14 traders and said two others left after its
own internal inquiry revealed violations of its gifts policies.
Among the employees Fidelity has fined is
the prominent head of its stock-trading operation, Scott DeSano,
according to attorneys involved in the case and news accounts.
DeSano remains in his position.
Fidelity is the subject of a wide-ranging
probe by securities regulators, one that has subpoenaed scores of
brokers and traders in Boston's financial community. According to
lawyers and others involved in the case, investigators are trying to
determine if the gift-giving, which included fancy dinners,
expensive wines, and trips to out-of-state golf courses and sporting
matches, were the partying antics of a close, macho trader culture,
or whether the Fidelity traders had in effect, a "pay to
play" system, in which brokers who wanted a piece of the fund
company's prodigious trading volume had to pony up presents.
Continued in article
"Citigroup Warns of S.E.C. Action," Reuters, The New York Times,
January 22, 2005 --- http://www.nytimes.com/2005/01/22/business/22sec.html?oref=login
The S.E.C. may take action against
Citigroup Asset Management; Citicorp Trust Bank; Thomas W. Jones,
the former chief executive of the asset management unit; and three
other people, one of whom is still with the unit.
Citigroup said the commission took issue
with actions related to its creation and operation of an internal
transfer agent unit serving more than 20 closed-end funds that the
company managed
Continued in article
Surprise! Surprise!
"Claim Says Morgan Stanley Got
Kickbacks to Push Some Products," by Susanne Craig and Ian
McDonald, The Wall Street Journal, January 7, 2004, Page C3 ---
http://online.wsj.com/article/0,,SB110505182475219324,00.html?mod=home_whats_news_us
A new arbitration
claim asserts that Wall Street firm Morgan Stanley received hidden
incentives from several big insurance companies to push certain
variable annuities and other investment products.
"Rather than
placing the interests of their customers first -- as it is required
to do -- Morgan Stanley put its interests first by acting in a
manner that was designed to maximize the kickbacks it received under
[a] distribution agreement," lawyer Ron Marron alleges in a
complaint filed on behalf of a client he says bought two variable
annuities from Hartford Financial Services Group Inc. that performed
poorly and were unsuitable for the client's needs. He says Morgan
was motivated to sell his client this product because of undisclosed
payments the firm was getting.
A Morgan Stanley
spokesman said the complaint is "wholly without merit. We're
confident that the compensation arrangements covering these products
have been appropriately disclosed." He said there is language
in prospectuses that the firm believes constitutes disclosure.
Hartford declined to comment.
This latest
arbitration filing is believed to be among the first that zeroes in
on alleged abuses in the sale of variable annuities, which are part
insurance, part investment. The buyer, or contract-holder, invests
money among various mutual-fund-like portfolios in tax-deferred
accounts. The "insurance" consists of a stream of income
the buyer receives from the account in retirement and a so-called
death benefit paid to the contract holder's heirs. There is more
than $1 trillion invested in variable annuities, according to the
National Association for Variable Annuities.
The potential
conflict of interest from brokers' hidden financial incentives to
sell some investments over others has been an issue for some time.
To get a spot on brokerages' preferred lists of mutual funds, for
example, many fund firms strike "revenue sharing" deals by
which a fund company pays brokerage firms a percentage of the sales
the brokers bring in, on top of the commissions that investors pay.
For mutual-fund
firms, these deals are a way to stand out from the ocean of choices
available. Brokerages say these fees help cover the costs of
marketing funds, but critics say they give broker incentives to sell
funds that are more profitable for the firm and not necessarily the
best choice for a given client.
Such arrangements are
legal as long as they are properly disclosed. Late in 2003, Morgan
Stanley paid $50 million to settle civil charges levied the by
Securities and Exchange Commission that the firm failed to tell
clients that it paid brokers more if they sold funds offered by 14
firms whose extra payments earned them a spot on the firm's
preferred list of funds.
Mr. Marron's claim
about variable annuities, filed in late December with the National
Association of Securities Dealers, alleges, among other things, that
Morgan Stanley entered into secret "distribution
agreements" with various insurance companies through which
Morgan Stanley got money for steering its clients into certain
insurance products. The NASD said yesterday it is aware of the claim
and it is looking into the matter.
"'Safer' Mutual Funds Look Sorry," Ian McDonald, The
Wall Street Journal, January 28, 2005 --- http://online.wsj.com/article/0,,SB110686375437638485,00.html?mod=todays_us_money_and_investing
Money is leaking out of what are known as
principal-protected mutual funds, as investors learn the perils of
playing it safe. These funds' cautious investment style and steep
fees have left their returns lagging far behind stock funds.
Continued in the article
The
SEC is assessing whether fund managers are pocketing rebates on
stock-trading commissions that should go back to investors.
"SEC
Examines Rebates Paid To Large Funds ," by Susan Pulliam and
Gregory Zuckerman, The Wall Street Journal, January 6, 2005, Page C1
--- http://online.wsj.com/article/0,,SB110496678233318071,00.html?mod=home_whats_news_us
T he
Securities and Exchange Commission has launched a broad examination
of whether managers of big mutual funds and hedge funds are
pocketing rebates on stock-trading commissions that should be
directed back to investors, people familiar with the matter say.
The move is
the latest in a series of efforts by federal regulators to stamp out
possible improper payments received by favored Wall Street clients
for trading business.
At issue
are commissions that these large investors pay to Wall Street firms
to execute stock trades. Typically, the funds pay commissions
totaling as much as five cents a share. But part of these
commissions -- two cents or so -- sometimes is sent back to
money-management firms in the form of rebates, depending on how much
business they generate for the Wall Street firms, and how much they
pay for services such as stock research, among other things.
This
practice isn't improper if it is disclosed and the rebates benefit
fund holders. The SEC is seeking to find out whether some money
managers, including hedge-fund managers, have used any kinds of
rebates to enrich themselves or their firms, or to pay for items
that don't benefit fund holders, the people say.
"It's
something that's talked about in the business. Some hedge funds
don't put that rebate back into their funds, but rather keep it for
themselves," says David Moody, a lawyer at Purrington Moody LLP
in New York who represents hedge funds. "If a rebate is going
to the fund manager, and not the fund, that is a big deal. It's not
the fund manager's money."
The issue
is significant for fund holders, particularly in an era of slimmer
gains in the stock market. Money managers pay huge commissions to
Wall Street. Last year, hedge funds alone paid at least $3 billion
in commissions, estimates Richard Strauss, an analyst at Deutsche
Bank. Though it is unclear how much of these commissions were
rebated, even a sliver going into the pockets of fund managers could
amount to large sums of money lost by investors.
The
examination into rebate practices is part of a broader effort by
regulators to curb abuses relating to how Wall Street rewards
privileged clients. The National Association of Securities Dealers
and the SEC recently launched an investigation into gifts and
business entertainment awarded by Wall Street to its best clients.
That investigation has led to disciplinary actions by firms against
14 trading employees at mutual-fund companies and elsewhere.
Meanwhile, the SEC's enforcement chief, Stephen Cutler, and Lori
Richards, head of examinations at the SEC, long have been interested
in the issue of trading commissions paid by money managers,
particularly hedge funds.
Commission
rebates are the latest in a string of longstanding industry
practices now under regulatory scrutiny. On the heels of sweeping
investigations by New York Attorney General Eliot Spitzer, the SEC
has begun to open broad investigations into entire industries when
evidence of problems surface, even if they initially appear
isolated. Last year, as part of this initiative, the SEC began
looking at oil-company reserve accounting after problems surfaced at
Royal Dutch/Shell Group.
Continued
in article
"Fidelity's antitiming fees anger big clients," by Andrew
Caffrey, The Boston Globe, January 20, 2005 --- http://www.boston.com/business/articles/2005/01/20/fidelitys_antitiming_fees_anger_big_clients/
More than 130 of Fidelity's 350 funds have
redemption fees. The costs vary from 0.25 percent to 2 percent per
transaction. The new rules impose the fees when an investors buy
into, and then sells out of, a fund within a certain time period,
which can range from 30 to 90 days. The Fidelity policy comes as the
Securities and Exchange Commission debates imposing a short-term
trading fee rule throughout the industry.
The SEC proposal, and Fidelity's policies,
are intended to curb the kind of rapid trading in and out of mutual
funds that scandalized the industry in 2003 and 2004. Savvy traders
such as hedge funds targeted international funds and other mutual
funds that had extreme volatility or inefficiency in the pricing of
the funds' holdings. In some cases, traders used retirement funds
for these strategies because some did not have policies restricting
frequent trades.
Such frequent exchanges drives up a fund's
trading expenses -- costs that Fidelity said are paid for by other
long-term shareholders in the fund. Fidelity said it is only fair
that those other shareholders be reimbursed by investors whose
short-term trading drives up a fund's costs.
Continued in article
"The Mutual Fund Trading
Scandals," by Brian Carroll, Journal of Accountancy,
pp. 32-37 --- http://www.aicpa.org/pubs/jofa/dec2004/carroll.htm
EXECUTIVE
SUMMARY |
SINCE THE FIRST MAJOR MARKET-TIMING and
late-trading scandal broke, a barrage of federal
and state enforcement actions against funds has
followed.
LATE-TRADING IS ILLEGAL UNDER FEDERAL
securities laws and some state statutes. It
occurs when a mutual fund or intermediary
permits an investor to purchase fund shares
after the day’s net asset value is calculated,
as though the purchase order were placed earlier
in the day.
THE SEC HAS ADOPTED A NEW RULE requiring
a fund to disclose in its prospectus and
statement of additional information its
market-timing risks; policies and procedures
adopted, if any, by the board of directors,
aimed at deterring market-timing; and any
arrangement that permits it.
THE SEC HAS PROPOSED A NEW RULE that
generally would require all mutual fund trades
to be placed by a “hard 4 p.m.” Eastern time
deadline.
IN CONTRAST TO LATE-TRADING, MARKET-TIMING
is not illegal per se. Problems arise, however,
when the timing of trades violates the
disclosures in the prospectus. This can cause so
many buys and sells that the costs escalate and
the fund is disrupted, to the detriment of its
long-term shareholders.
|
Brian
Carroll, CPA, is special counsel with the U.S.
Securities and Exchange Commission in
Philadelphia. He also is an adjunct professor at
Rutgers University School of Law in Camden, New
Jersey.
The U.S. Securities and
Exchange Commission disclaims responsibility for
any private publication or statement of any
commission employee or commissioner. This
article expresses the author’s views and does
not necessarily reflect those of the commission,
the commissioners or other members of the staff.
|
|
Bob Jensen's threads on proposed reforms are at http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm
From 'Smart Stops on the Web', Journal of Accountancy, December 2004,
Page 29 --- http://www.aicpa.org/pubs/jofa/dec2004/news_web.htm
SMART
STOPS ON THE WEB |
Back to Basics
mutualfunds.about.com
CPAs looking for a refresher course on mutual
funds will find articles such as “Determining Your Mutual
Fund’s ‘Cost Basis’” and “Avoiding Internet
Investment Scams.” Users can sign up for a free 10-day
online course on the basics of mutual fund investing or a
mutual fund newsletter. Other resources include links to
broker ratings of funds, financial calculators and glossaries.
The Fund Finder
www.mutualfundsnet.com
CPAs looking for investment information for
their clients will want to bookmark this Web site. In addition
to free mutual fund sponsor searches in categories such as
socially responsible corporate and government mutual funds,
users can find information about investment conferences and
links to breaking industry news. CPA broker-dealers can add
their resumes to the database or check job postings from
listed companies.
For Fund Facts
www.mfea.com
Investment advisers looking to educate their
clients on mutual fund options will find detailed information
on topics including taxes and fund risk at this stop on the
Web. Users can find explanations of the differences among
mutual funds and a glossary of investment terms or search for
funds, create model portfolios or use calculators for college,
retirement and tax-savings plans.
The Kids and College section of this Web stop links to
sites that offer investment resources for money-minded
children, such as calculators to help them decide how much
allowance to save for major purchases and a dictionary of
basic investment terms.
Satisfy Your Need to Know
www.ici.org
Here visitors can find free statistics on
money market mutual fund assets or reports on the latest
industry developments, such as “SEC changes SRO Procedures
for Filing Rule Changes.” Other sections include A Guide to
Understanding Mutual Funds, Frequently Asked Questions and a
news archive dating back to 1995.
Keep Track of the Market
www.123jump.com
Users can register for free to keep tabs on
their mutual funds at this e-stop, which offers general
business, current and archived earnings news, as well as
QuoteStream to see how your picks measure up on the Nasdaq,
NYSE and S&P 500 stock index. Visitors also can get two
daily e-mail newsletters, Earnings Ticker and
Ticker AM—Business News Update.
|
Bob Jensen's helpers for investors are at http://faculty.trinity.edu/rjensen/bookbob1.htm#Finance
A warning from Herb XXXXX about variable annuity pushes from mutual funds and
banks! I recommended that he look at
From The Wall Street Journal Accounting Weekly Review on October 8,
2004
TITLE: How Not to Outlive Your Savings
REPORTER: David Wessel
DATE: Sep 30, 2004
PAGE: D1
LINK: http://online.wsj.com/article/0,,SB109650287519832031,00.html
TOPICS: Accounting, Financial Literacy
SUMMARY: David Wessel discusses the benefits of insurance annuity
contracts. Questions focus general definitions of annuities for use in
teaching time value of money topics.
December 13, 2004 message from Herb XXXXX
The common practice of providing mutual
funds inside variable group annuity "wrappers" where the
401 (k) pays the mutual fund and the insurance fees -- on top of 401
(k) administration) is a costly way to go, without tax justification
for the cost, and probably shifts costs to unsuspecting employees.
I will read the article. I will also let
you know if I learn anything specific.
Again, Thank you.
Herb
AIG said it would pay $126 million and unveil four years of
transactions to a reviewer under a tentative accounting settlement.
Theo Francis, "AIG to Pay $126 Million in Deals With Federal
Prosecutors, SEC," The Wall Street Journal, November 26,
2004, Page C3 --- http://online.wsj.com/article/0,,SB110130661333082996,00.html?mod=home_whats_news_us
Under terms paralleling those
of other recent financial-sector settlements, American
International Group Inc. said its tentative pacts with federal
prosecutors and securities regulators will cost it $126 million and
require it to unveil four years' of transactions to an outside
reviewer.
AIG said Wednesday that it
expects a subsidiary to pay an $80 million "penalty" to
the Justice Department to settle criminal inquiries into the New
York insurer's dealings with PNC
Financial Services Group Inc. and Brightpoint
Inc. In addition, AIG would pay $46 million into a
disgorgement-of-fees fund at the Securities and Exchange Commission
to settle that agency's civil inquiry into the PNC transactions.
An "independent
consultant" agreed upon by both agencies and AIG will
"review certain transactions entered into between 2000 and
2004" to determine if the buyers used them to violate
accounting rules or "obtain a specified accounting or reporting
result," the insurer said. AIG also must establish a
"transaction review committee," overseen by the reviewer.
The terms disclosed by AIG are similar to those reported in The Wall
Street Journal on Wednesday.
Consumers End Up Paying More, State Attorney General Testifies;
Guilty Pleas Grow in Manhattan
"Spitzer Decries Lax Regulation Over Insurance," by
Deborah Solomon and Ian McDonald, The Wall Street Journal,
November 17, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110062060600975508,00.html?mod=us_business_whats_news
New York Attorney General
Eliot Spitzer told federal lawmakers that Congress needs to look
into the insurance industry's "Pandora's box" of problems,
saying that lack of federal oversight and disclosure has padded
consumers' insurance costs.
While Mr. Spitzer was
testifying on Capitol Hill, two more low-level insurance executives
in New York surrendered to police and made their way to a courthouse
in lower Manhattan, where they pleaded guilty to criminal charges
for their roles in alleged bid-rigging and steering.
Five individuals have pleaded
guilty as part of the probe kicked off Oct. 14 by Mr. Spitzer's
civil suit against Marsh
& McLennan Cos.' Marsh Inc. insurance-brokerage unit. In it,
he alleged that Marsh brokers cheated clients by rigging bids for
insurance contracts and steering business to insurers that paid
Marsh millions of dollars in so-called contingent-fee commissions,
which Mr. Spitzer likened to kickbacks.
As the number of guilty pleas
rises, it is likely that the scope of the insurance probe and the
profile of individuals charged will grow. Following a traditional
prosecutorial pattern, regulators are accepting guilty pleas from
lower-level employees in return for their cooperation in
strengthening cases against companies and higher-ranking
individuals, according to people familiar with the investigation.
Mr. Spitzer and Connecticut
Attorney General Richard Blumenthal, who also is probing
insurance-industry abuses, told a Senate governmental affairs
subcommittee that many of the conflicts now being uncovered stem
from regulatory "gaps" that let the industry escape tough
oversight.
"It is clear that the
federal government's hands-off policy with regard to insurance,
combined with uneven state regulation, has not entirely
worked," Mr. Spitzer said. "Many state regulators have not
been sufficiently aggressive in terms of supervising this
industry."
For its part, the National
Association of Insurance Commissioners proposed requiring better
disclosure of brokers' compensation, coordinating state
investigations and regulatory efforts, and establishing an online
fraud-reporting system. The group coordinates insurance regulation
among the states.
Mr. Spitzer said his probe
has turned up widespread evidence of undisclosed payments between
insurers and insurance brokers. A new conflict, he said, involves
insurers who made loans and gave company stock to individual brokers
who steered business their way. He declined to discuss which
companies engaged in the practice, which could be improper if it was
undisclosed and if it influenced a broker's decision about where to
steer business.
A person familiar with the
inquiry said the biggest brokers don't appear to have provided such
loans. However, smaller brokers borrowed significant amounts, with
interest on the loans forgiven as the broker directed business to
the lending insurers, this person said, declining to name the
brokers.
In New York, Zurich
Financial Services underwriters John Keenan and Edward Coughlin
pleaded guilty to a misdemeanor violation of New York state
antitrust law. Both face a maximum of one year in state prison and
are cooperating with Mr. Spitzer's probe. Attorneys for Messrs.
Keenan and Coughlin declined to comment.
They admitted to providing
phony so-called B bids for insurance contracts at the request of
Marsh brokers from August 2002 through September 2004. These fake
bids helped ensure that a company favored by Marsh would get the
contact. They worked in the Specialty Excess Casualty unit at Zurich
American Insurance Co., a unit of Zurich Financial Services, the
fourth-largest player in the U.S. property-and-casualty insurance
market.
Mr. Coughlin's felony
complaint cites an e-mail in which Marsh insurance broker Nicole
Michaels writes "please email me a B quote" in bidding for
a particular contract. It also cites an e-mail in which another
Marsh employee, Edward Keane, advises Ms. Michaels to ask Zurich for
a bid at a price between two existing bids. The complaint also notes
an e-mail from Mr. Coughlin to his boss, Jim Spiegel, that
references training material with subsections headed "How Marsh
Global Broking Works" and "B Quotes."
Continued in the article
"Spitzer says insurers inflated cost of benefits," by
Ellen Kelleher, The New York Times, November 12, 2004
Some of the biggest insurers in the US,
including MetLife and Prudential, colluded to inflate the cost of
employees benefits coverage, according to a suit filed on Friday by
Eliot Spitzer.
The New York attorney-general alleges that
the insurers paid higher commissions to a broker, San Diego-based
Universal Life Resources, in exchange for business from companies
including Viacom, Marriott, Colgate Palmolive and United Parcel
Service.
ULR also allegedly received hefty fees from
insurers for “communications services”, such as printing
informational materials and other activities.
Combined, these payments last year
accounted for more than $17m of ULR's total revenues of $25.3m.
The civil lawsuit is the second legal
action filed by Mr Spitzer in his widening investigation into
alleged corruption in the insurance industry.
Continued in the article
"Marsh's Settlement ($850 settlement for insurance
bid-rigging) Looks Likely Eligible For a Tax Deduction," by Ian McDonald, The
Wall Street Journal, February 7, 2005 --- http://online.wsj.com/article/0,,SB110773270240547175,00.html?mod=home_whats_news_us
MARSH'S CEO IS EXPECTED to resign as the insurance-brokerage
firm faces bid-rigging and civil fraud charges. The full board is set to meet
this morning to discuss, and possibly approve, a new chief executive to succeed
Jeffrey Greenberg, as well as corporate safeguards aimed at preventing improper
behavior.
"Marsh's Chief Is
Expected To Step Down," by Monica Langley and Ian McDonald, The
Wall Street Journal, October 25, 2004, Page C1 --- http://online.wsj.com/article/0,,SB109865866975754136,00.html?mod=home_whats_news_us
Marsh & McLennan Cos.
Chairman and Chief Executive Officer Jeffrey W. Greenberg, bowing to
pressure from regulators and investors, is expected to resign this
morning, people familiar with the situation say.
The full board of the world's
largest insurance-brokerage company also is set to meet this morning
to discuss -- and possibly approve -- a new chief executive, as well
as corporate safeguards aimed at preventing improper behavior at the
company.
The climactic meeting follows
days of marathon conference calls by the board's 10 outside
directors, including one call yesterday, aimed at resolving a crisis
that began more than a week ago when New York Attorney General Eliot
Spitzer brought bid-rigging and civil fraud charges against the New
York company. In unveiling his suit, Mr. Spitzer all but set Mr.
Greenberg's departure as a condition of any settlement. Big
investors added to the pressure late last week, calling for the
ouster of the 53-year-old Mr. Greenberg.
Since then, Marsh
& McLennan has suspended several employees and replaced the
head of its insurance-brokerage unit. But its shares have fallen 42%
through Friday, hacking billions of dollars off the company's value.
On Friday, Marsh shares jumped nearly 8% to $26.79 on reports that
Mr. Greenberg was about to resign, giving the board a glimpse of how
receptive Wall Street would be to his ouster.
"They have to get a new
manager to replace Greenberg," said Jim Huguet, manager of the
Great Companies Fund, in which he had owned Marsh shares for more
than two years before selling the position last week.
Mr. Spitzer was informed of
the meeting, but wasn't told who might succeed Mr. Greenberg. In
addition to management changes, Mr. Spitzer wants Marsh to overhaul
its systems of compliance with laws and regulations. "Where was
Marsh's compliance office?" the attorney general had asked
Marsh officials when reviewing the alleged bid-rigging and steering
of business to insurance companies that paid it high commissions
that Mr. Spitzer calls kickbacks. When Marsh's general counsel asked
what Mr. Spitzer's investigators had found, Mr. Spitzer retorted
that the company should have uncovered the problems itself.
The 10 outside directors on
the 16-member Marsh board have complained about being caught
flat-footed and blame management for not apprising them of the
gravity of Mr. Spitzer's investigation, people close to the
situation say.
Lewis W. Bernard, a retired
Morgan Stanley executive and a Marsh board member, has taken a
leading role, and his experience in the securities business has been
useful in dealing with investigators. Because Mr. Bernard comes from
the highly regulated securities industry where compliance officers
are standard, his advice to his colleagues has been useful, said a
person close to the situation.
In recent days, Marsh
effectively has been without leadership. The outside directors, in
daily meetings and conference calls, have focused entirely on the
crisis. While Mr. Greenberg has come to the office since the scandal
broke, he largely was shut out of decision-making, people familiar
with the situation said. Operations at the global company are
largely in the hands of the firm's lower layers of management, even
as many are paralyzed over whether they will lose their jobs in the
house-cleaning that is likely to follow.
"We are working very
hard on the problems," said Marsh director Oscar Fanjul, who
didn't want to comment further for the sake of "order and
discipline."
Mr. Greenberg decided to
resign because "he doesn't want to be part of the
problem," according to a person close to the situation.
"He's putting the company's interest above his own."
Mr. Greenberg is a member of
an insurance family dynasty headed by his father, Maurice
"Hank" Greenberg, who is chairman and chief executive of
American International Group Inc. But the Marsh CEO has no
employment contract or severance agreement in place, according to
the company's most recent proxy filings with the Securities and
Exchange Commission.
Mr. Greenberg's exit package
was being negotiated over the weekend. Last year, he was paid more
than $5 million in salary, bonuses and other cash compensation,
according to recent regulatory filings. He also received more than
$9 million of restricted Marsh shares that don't vest for a decade,
in addition to 500,000 options to buy Marsh shares at $42.99, well
above their current price.
Mr. Greenberg had no comment,
according to his attorney, Richard Beattie.
How Mr. Greenberg's expected
departure is presented and the wording of any settlement with Mr.
Spitzer are key because of the near certainty of civil litigation
over the allegedly corrupt practices, said a person close to the
company, which is bracing for lawsuits from shareholders and
customers.
In their hunt for a new
leader, the directors have a limited pool of insiders to choose from
because it still is unclear how far up the corporate ladder
knowledge of the bid-rigging and steering of customers to certain
insurance companies went. The only executive who has been elevated
during the crisis is Michael G. Cherkasky, formerly head of Kroll
Inc., the investigative firm Marsh acquired in July, who took over
Marsh's insurance brokerage unit the day after Mr. Spitzer's suit
was filed. Mr. Cherkasky was Mr. Spitzer's boss for a time in the
Manhattan district attorney's office.
Among those hit by the drop
in Marsh's stock price are company employees. At the start of the
year, they held more than 27.4 million Marsh shares, 5.2% of those
outstanding, through a stock investment plan, according to
regulatory filings. The company has encouraged employees to buy its
shares by matching those purchases with company stock. Effective
today, the company will lift remaining restrictions on employees'
ability to sell that stock and choose another investment, a
spokesman said.
Revenue
Sharing by Your Broker is a Kickback
By Any Other Name
About half of the
brokerages targeted in the SEC probe paid individual brokers more for
selling the shares of selected, revenue sharing funds or one of the
brokerages' own funds than for selling other funds' shares, the SEC
said.
"SEC: Brokerages
often get paid to push mutual funds By Christine Dugas, USA TODAY,
January 13, 2004 --- http://www.usatoday.com/money/perfi/funds/2004-01-13-fund-sales-abuses_x.htm
SEC: Brokerages often get paid to push
mutual funds By Christine Dugas, USA TODAY Brokerage firms routinely
receive payments from mutual fund companies to tout their funds, and
only about half of them disclose the arrangement, the Securities and
Exchange Commission said Tuesday. An examination of 15 brokerage
firms found that in return for so-called revenue-sharing payments,
13 of the firms appear to have favored those funds.
"I'm glad to see that the SEC is
highlighting what the rest of us already knew was going on,"
says Gary Gensler, co-author of The Great Mutual Fund Trap.
The payments range from 0.05% of sales to
0.4% of sales and from zero to 0.25% of assets held for a year or
more, the SEC said.
Continued in the article
Always
ask your broker or investment advisor about kickbacks!
Better yet, buy into honest mutual funds directly and leave your
broker out of the picture.
"SEC to Sever a Tie
Linking Mutual Funds, Brokerage Firms," by Karen Damato and
Deborah Solomon, The Wall Street Journal, August 10, 2004, Page
C1 --- http://online.wsj.com/article/0,,SB109277224166993831,00.html?mod=home_whats_news_us
The Securities and Exchange
Commission today (August 18, 2004)
is
expected to ban a type of arrangement that mutual-fund companies
long have used to gain favored status for their products at
brokerage firms.
The agency will no longer
allow fund-management companies to channel their funds'
securities-trading orders and the associated commissions to
brokerage firms as compensation for selling and prominently placing
their fund shares, according to people familiar with the matter.
Still, the crackdown on
what is known as "directed brokerage" isn't likely to
alter the underlying environment in which hundreds of fund
companies, all competing for "shelf space" at the
brokerage firms favored by individual investors, feel obliged to pay
for that access in one way or another. "If they can't pay
through directed brokerage, then they will pay another way,"
predicts Cynthia Mayer, a fund-industry analyst at Merrill Lynch.
Regulatory scrutiny has led a
number of fund managers to curtail their use of directed brokerage
in recent months, and fund firms already may be making increased
direct payments to brokerage firms, according to analysts including
Ms. Mayer and her Merrill colleague Guy Moszkowski.
SEC officials, who declined
to speak publicly because of today's vote, acknowledge that banning
directed brokerage might lead to an increase in direct payments,
known as "revenue sharing." But they say direct payments
are preferable because they come from the fund adviser's pocket and
not from assets owned by fund shareholders.
Properly disclosed
revenue-sharing arrangements "present more manageable
conflicts" for funds and brokerage firms than
directed-brokerage deals, the SEC said in proposing the ban in
February.
At the same time, the agency
is investigating whether a number of fund companies are adequately
disclosing these payments, which can include sponsoring seminars or
other events for brokers, and fund-company executives privately
complain that the rules on this practice are in flux as well.
It is legal for fund
companies to consider the level of fund-share sales at a brokerage
firm in allocating their trades as long as that consideration is
disclosed to fund investors and the investors aren't disadvantaged.
Continued in the article
"Bank One Settles
Allegations Over Improper Fund Trading," The Wall Street
Journal, June 29, 2004 --- http://online.wsj.com/article/0,,SB108854358741950719,00.html?mod=us_business_whats_news
A unit of Bank
One Corp. agreed to a $90 million settlement of allegations by
the New York attorney general's office and the Securities and
Exchange Commission that it allowed a hedge fund to make improper
mutual-fund trades.
The settlement Tuesday by
Banc One Investment Advisors Corp., which comes days before the
Chicago bank merges with J.P.
Morgan Chase & Co., makes the Bank One unit the last to
settle charges related to market-timing abuses of the original four
firms mentioned in New York Attorney General Eliot Spitzer's
September complaint against hedge fund Canary Capital Partners.
Banc One Advisors said in a
news release that it will return $50 million -- $40 million in a
civil fine and $10 million in disgorgement -- to eligible
shareholders as part of the settlement. The firm also agreed to
reduce fees by $40 million over five years.
"Soon after we first
learned of these investigations, we committed to cooperate with
regulators, make restitution to shareholders, and review and change
our policies," David J. Kundert, chief executive of Banc One
Investment Advisors, said in a prepared statement, adding that
procedures are now in place to "prevent a recurrence of similar
issues in the future."
Mark Beeson, the former chief
executive of the Banc One fund unit, was ordered to pay a civil fine
of $100,000. He is also barred from the fund industry for two years
and prohibited from acting as a director or officer for a mutual
fund or investment adviser for three years, the SEC said in a news
release.
Stephen Cutler, director of
the SEC's division of enforcement, said Mr. Beeson "blatantly
disregarded the well-being" of long-term fund shareholders by
allowing Canary Capital to market time the One Group family of
funds, and by providing Canary confidential information on fund
portfolio holdings.
The mutual-fund scandal, in
which fund companies profited by allowing a few sophisticated
traders to buy and sell shares in ways that hurt the returns of
regular investors, has implicated as many as 20 fund companies and
involved millions of investors. So far, mutual-fund companies have
agreed to settlements totaling more than $2 billion, with most of
that money pegged to be returned to investors.
The scandal encompasses both
market timing -- rapid buying and selling of fund shares to exploit
inefficiencies in fund-share pricing -- and late trading, which is
illegal. Late traders buy or sell fund shares after the market's 4
p.m. close, while using the price determined at the close. Market
timing, while not illegal, often violates a fund's stated rules.
Bob Jensen's threads on the mutual funds scandals
are at
http://faculty.trinity.edu/rjensen/FraudCongress.htm#MutualFunds
"Spitzer Inquiry Expands to Employee-Benefit Insurers,"
by Joseph B. Treaster, The New York Times, June 12, 2004 --- http://www.nytimes.com/2004/06/12/business/12insure.html
Three big insurance companies, Aetna, Cigna
and MetLife, said yesterday that they had received subpoenas from
the New York attorney general as an investigation widened into the
field of employee benefits - health, disability and group life
insurance.
Hartford, which operates a substantial
business in group life and disability insurance as well as in
commercial and personal lines of insurance, said late Thursday that
it, too, had received a subpoena.
Until now, the insurance investigations by
the attorney general, Eliot Spitzer, have centered on potential
conflicts of interest among commercial insurance brokers and
suspected improper sales and trading of variable annuities, which
are a combination of insurance and mutual funds.
Investigators have been concerned that
payments from insurance companies to the brokers for exceeding sales
goals and keeping down claims costs may undermine the brokers'
loyalty to their customers - the American corporations that pay them
fees and commissions to arrange coverage.
Industry executives said similar fees,
often referred to as contingency payments, were widely paid to
brokers and consultants by the employee benefits companies.
"It's no surprise that Mr. Spitzer is
pursuing these contingency payments in the employee benefits
area," said Terry Havens, the chief executive of Havensure, a
small employee benefits consulting firm in Cincinnati.
"Employers will likely be surprised to find out that their
intermediaries - brokers and consultants - are negotiating financial
agreements for themselves that raise the cost of corporate
insurance."
None of the employee benefits insurers
would discuss the investigations, and a spokesman for Mr. Spitzer
did not return a call.
Several insurance brokers disclosed in late
April that they had received subpoenas from Mr. Spitzer, including
Marsh and Aon, the two largest in the world, and Willis Group
Holdings. In mid-May, the Chubb Group, a leader in commercial
insurance, said that it, too, had received a subpoena for documents
dealing with compensation to brokers. Hartford said in late May that
it had received instructions from the New York Department of
Insurance not to destroy any documents related to its dealings with
brokers. The brokers have also refused to discuss the
investigations.
Industry executives said that most of the
midsize and smaller companies in the country bought health insurance
and other employee benefits through the big insurance brokers. But
many of the biggest corporations rely, instead, on consulting firms
that specialize in employee benefits and often work for negotiated
fees, they said.
Executives said they thought that the
consultants often received payments on both ends of transactions
just as the brokers have acknowledged they do. But so far none of
the consulting firms have reported receiving subpoenas.
Tom Beauregard, a senior executive at
Hewitt Associates, one of the nation's largest consultants on
employee benefits, said that his firm received payments exclusively
from its clients except in cases where the client negotiated for an
insurance company to share the costs of the consultant. When clients
ask for those kinds of payments, he said, they are fully disclosed
and included in estimates of all companies bidding for the coverage.
The question of disclosure has been at the
heart of Mr. Spitzer's investigations of the brokers so far. The
brokers often report on Web sites and in regulatory documents that
they receive compensation from the insurance companies. But the
corporate insurance buyers, known as risk managers, say the brokers
do not routinely disclose the details of the payments.
Risk managers - who often feel dependent on
brokers to get coverage, which since the Sept. 11, 2001, attacks has
been costly and scarce - say they do not press for details. But even
when the risk managers raise questions, some of them say, the
brokers can be evasive.
Joe Conway, a spokesman for Towers Perrin,
another big consultant on employee benefits, said that compensation
agreements at his firm were reached in advance by clients and that
the full amount of the compensation was disclosed.
Mr. Havens, who has been an employee
benefits consultant for 25 years, said that in addition to bonuses
for exceeding sales goals, some brokers and consultants receive
extra payments from insurers for the many employees who buy life
insurance or disability insurance to supplement the coverage
provided by their companies. The cost of these payments, which often
average $10 to $15 for each employee, are passed on directly to the
employees, he said, increasing the price of the coverage they buy.
In the employee benefits field, Mr. Havens
said, the sales bonuses and the extra payments for individual
employees are in many cases done without the knowledge of the
employers or the employees.
"The employers and the employees don't
know the payments are in there," Mr. Havens said. "At the
initiative of the brokers, the insurers provide a quote with the
costs of these payment included."
Mr. Havens said his practice was to report
to clients all payments he receives from all sources. But he said he
had lost business to some brokers and consultants who, as a result
of hidden payments from insurers, were willing to charge clients
less for their services.
"Carriers have complained to me that
they have to make these payments," Mr. Havens said. "They
don't think they are appropriate. But if they don't pay, they don't
get to play in the game. They don't get the business."
Brokers and consultants began demanding
payments from the insurance companies about 10 years ago when they
began to receive complaints from clients that their fees and
commissions were too high, Mr. Havens said. While the amount that
consultants and brokers received stayed at 1 percent to 5 percent of
the premium, Mr. Havens said, the visible portion that employers
paid to them declined.
"SEC Charges Fund Firm, Executives With Fraud," SmartPros,
May 10, 2--4 --- http://www.smartpros.com/x43542.xml
May 10, 2004 (USA TODAY) — Federal
regulators on Thursday accused mutual fund firm Pimco Advisors Fund
Management, its CEO and a former executive of cutting a secret
market-timing deal that involved more than $4 billion in trades.
--------------------------------------------------------------------------------
The Securities and Exchange Commission
filed civil fraud charges against the firm, an adviser to Pimco
funds; its CEO, Stephen Treadway; affiliates Pimco Advisors
Distributors and PEA Capital; and former PEA Capital CEO Kenneth
Corba.
Pimco, a unit of German financial services
firm Allianz, is the USA's fifth-largest mutual fund manager.
In its complaint, the SEC alleges that
Pimco defrauded investors by making an arrangement that favored
hedge fund Canary Capital Partners by allowing it to market time
certain funds in return for making long-term ''sticky'' investments
in other funds.
According to the SEC, Treadway approved the
arrangement in early 2002 but did not disclose it to the board of
trustees until about last September.
Market timing involves frequent trading to
exploit ''stale'' prices, typically due to time zone differences. It
is legal but might violate a fund's rules. It lets market timers
profit at the expense of other investors.
In a statement, PEA Capital took issue with
the charges, saying the firm did not violate the rules of its fund
prospectuses because they did not prohibit market timing outright.
The prospectuses only barred it if it was determined to hurt
shareholders. The company said only one fund was affected by the
market-timing activity, and in February, it paid $1.6 million to
compensate the fund.
Corba ''adamantly denies all of the
allegations of wrongdoing,'' lawyer Jim Rehnquist said. PEA Capital
said the charges against Treadway are ''inappropriate.''
The SEC lawsuit generally echoes a lawsuit
filed by New Jersey regulators in February. However, the SEC did not
name Pimco's well-known bond fund unit.
''We conducted a thorough investigation and
brought charges we believe are supported by the evidence,'' said
Michele Wein Layne, the SEC's assistant regional director of
enforcement. The complaint notes that in March 2002 the bond funds
asked for a halt in the market-timing activity.
It is significant that the SEC complaint
named Treadway because he is chairman of the board of trustees for
Pimco funds, and as such, he had a duty to look out for fund
investors, says Mercer Bullard, who heads Fund Democracy, an
investor advocacy group.
The SEC is considering requiring fund
boards to be headed by independent directors. Rep. Michael Oxley,
R-Ohio, House Financial Services Committee chairman, called the
charges against Treadway a ''textbook example of why we need
independent chairmen.''
"SEC May Police
Fair-Value Pricing," by Tom Lauricella, The Wall Street
Journal, April 26, 2004 ---
http://online.wsj.com/article/0,,SB108292923140792834,00.html?mod=home%5Fwhats%5Fnews%5Fus
Agency Is Weighing Move To Take Disciplinary Action Against Errant
Fund Firms
The Securities and Exchange
Commission for the first time is weighing bringing disciplinary
actions against mutual-fund companies that have failed to use
so-called fair-value pricing for portfolio holdings with out-of-date
market prices, agency officials said.
The SEC investigations into
fair-value pricing practices at an undisclosed number of fund
companies are still in the preliminary stages, the officials
cautioned. But any resulting disciplinary efforts would open another
front in the SEC's expanded scrutiny of the fund industry and signal
that the agency is attaching greater importance to fair-value
techniques in the wake of the share-trading scandal.
Fair-valuation practices
involve using estimates to set the value of portfolio holdings when
the securities' closing market prices become out of date because of
later developments. Such mispricing is particularly an issue for
U.S. mutual funds holding foreign stocks whose closing values are
hours old by the time the funds calculate their share prices at the
end of trading for U.S. markets. Funds using such out-of-date prices
have been targets of market timers, who are short-term traders who
profit by rapidly buying and selling fund shares to the detriment of
long-term fund investors.
The SEC approved fair-value
techniques in 1981 and strongly recommended funds use them, but the
agency never directly required funds to adopt such pricing methods.
However, under other SEC rules, funds have an obligation to make
sure their share prices are as accurate as possible after events
such as major swings in U.S. markets after the close of overseas
stock trading.
As a result, agency officials
said the SEC investigation is focusing on whether funds in such
circumstances violated their obligations to set the most accurate
share prices possible if they didn't consider using fair-value
techniques.
Some experts think the probe
will result in disciplinary charges if a fund didn't consider using
fair-value practices. "It wouldn't surprise me to see them
bring a case," says Barry Barbarsh, a former top SEC official
now at Shearman & Sterling. The notion that the SEC has wanted
funds to make greater use of fair-value techniques "has been
out there for a while," he said.
The prospect of new
allegations is an added headache for the fund industry that has been
enveloped in scandal for seven months because of share-trading
abuses as well as cases involving the misuse of investors' money in
promoting the sales of funds. Fund companies have already been hit
with $1.7 billion in fines and numerous top executives have lost
their jobs.
While substituting estimates
for market prices can be controversial, the SEC has long held that
the practice is preferable to using outdated market prices in
setting portfolio values. In 1997, Fidelity Investments drew
criticism from some investors when it used fair-value pricing on
some of its international stock funds during the turmoil of the
Asian financial crisis. The SEC backed Fidelity's actions, but the
practice still hasn't been widely adopted throughout the industry,
often because fund officials worry that using fair-value pricing
could open the door to lawsuits.
But the SEC, in an April 2001
letter to the Investment Company Institute, the fund industry's main
trade group, spelled out that funds had an obligation to set
internal policies covering fair-value pricing. Specifically, the SEC
said that "funds should continuously monitor for events that
might necessitate the use of fair-value prices."
Since disclosures of
widespread market timing in the fund industry, fair-value pricing
has received added attention. Many observers contend that employing
fair-value techniques is the best method for combating outdated
prices exploited by fund market timers.
Continued in the article
"Mutual-Fund Indictment Against Broker Reveals 'Startling'
Phone Dialogue," by Christopher Oster and Carrick Mollenkamp, The
Wall Street Journal, April 6, 2004, Page C1 --- http://online.wsj.com/article/0,,SB108118385501774428,00.html?mod=home_whats_news_us
New York Attorney General Eliot Spitzer
unsealed a criminal indictment against former Bank of America Corp.
broker Theodore Sihpol that included previously unreleased
recordings of phone conversations that Mr. Spitzer said show Mr.
Sihpol and a New Jersey hedge fund scheming to make illegal
mutual-fund trades.
Mr. Spitzer called the phone conversations
"startling" and said evidence in this and other cases in
the works will show market-timers and late-traders were fully aware
what they were doing was taboo, if not illegal. More such details
will emerge as other cases progress, the attorney general said.
"Similar types of subterfuge were employed" in other
fund-trading cases, said Mr. Spitzer.
Also yesterday, a top executive at Janus
Capital Group Inc., Lars O. Soderberg, was placed on leave in
connection with the ongoing mutual-fund-trading investigations.
Mr. Spitzer and the
Securities and Exchange Commission filed criminal and civil charges
against Mr. Sihpol, formerly a broker in Banc of America Securities'
private client group, in September. Yesterday's unsealed criminal
indictment lists 40 counts, including grand larceny, fraud and
violation of business law. The felonies are punishable by as much as
25 years in prison. Mr. Sihpol, who has denied the charges, was
dismissed by the bank after the investigation became public.
Banc of America Securities is
a unit of Bank of America, which declined to comment on the
indictment. Last month, Bank of America, based in Charlotte, N.C.,
settled with the attorney general and the SEC for its role in the
mutual-fund scandal and agreed to fee reductions, disgorgements,
restitution and fines totaling $675 million for the bank and
soon-to-be-acquired FleetBoston Financial Corp.
Mr. Spitzer said that he was
able to reach a settlement with Bank of America because the bank
didn't have knowledge of the type of conversations Mr. Sihpol
allegedly had with fund traders and detailed in the indictment.
While a few fund companies have settled with regulators, several
criminal cases are being pursued, and dozens of fund companies and
Wall Street firms have confirmed receiving subpoenas from regulators
related to fund trading.
Mr. Sihpol's attorney, Evan
Stewart, of Brown Raysman in New York, said the recorded statements
"represented in the indictment represent a small fragment of
the taped materials that exist. The attorney general's office has
yet to make available to the defendant a complete record of those
materials. Any tape recordings can be selectively taken out of
context and presented in a particular fashion. These do not change
Mr. Sihpol's position that he did not engage in criminal
wrongdoing."
Three phone conversations
between Mr. Sihpol and an unidentified representative of the hedge
fund are detailed in a transcript in the grand jury indictment. Two
of the conversations appear to show Mr. Sihpol and a representative
of the hedge fund, Canary Capital Partners LLC, negotiating the
timing of the hedge fund's trading. At first, Canary says it wants
to submit its trades at 6 p.m. Eastern time, according to the
transcript. At Mr. Sihpol's request, Canary agrees to make the
trades by 5 p.m.
Both Mr. Sihpol and Canary
said that tickets showing the time of the trades, however, would
show they were made before 4 p.m., the indictment shows. In the
second conversation, Canary's representative says he can send
through a slate of prospective trades by 2 or 2:30 in the afternoon,
which could be processed after 4 p.m. if Canary approves the trades.
If not, Mr. Sihpol was to "put them in the garbage."
After-hours trading allows an
investor to take advantage of news that comes out after the stock
market closes -- information that isn't available to investors who
buy or sell before 4 p.m. It is illegal.
In an interview, Mr. Spitzer
called the Canary arrangement disappointing and criminal. "The
notion that documents were being time-stamped to create the
possibility of being put through or not put through is brazen,"
Mr. Spitzer said. He declined to say who from Canary was speaking to
Mr. Sihpol.
In March 2003, Canary was
using software provided by the bank to place trades on its own, with
time-stamped tickets no longer necessary. But Mr. Sihpol, in a
conversation with a Canary representative, wanted to make sure the
two sides had their stories straight, according to Mr. Spitzer.
"I'm sure you know the
right answer, but it came up today in conversation," Mr. Sihpol
said in that conversation, according to the indictment transcript.
"You guys make all the investment decisions before 4 o'clock,
correct?"
The Canary representative
replied, "Absolutely" and asked Mr. Sihpol why the issue
surfaced. Referring to the software system that allowed Canary to
trade funds until 5:30 -- after the normal 4 p.m. cutoff for fund
trades -- Mr. Sihpol said another bank employee had concerns about
Canary having access to the system. The employee worried, Mr. Sihpol
said, about the possibility of Canary being audited.
As for Mr. Soderberg of Janus,
the Denver fund company -- one of the original companies implicated
in the fund-trading scandal that erupted last summer -- had said in
November that the "few employees central" to the decision
to accept money from timers had left the company.
Yesterday, however, Janus
said that Mr. Soderberg, head of the company's institutional
business, had agreed to take a leave of absence and that Janus would
"continue to evaluate [Mr.] Soderberg's future role with the
Company, in light of the ongoing investigations of the mutual fund
industry and related regulatory matters."
Continued in the article
The bill says: "Three
practices — soft dollar arrangements, revenue sharing, and directed
brokerage — ought not clutter any mutual fund prospectus.
"Tough Senate Bill Would End
Three Mutual Fund Practices," AccountingWeb, February 11,
2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=98699
Three U.S. senators on Monday unveiled the
Mutual Fund Reform Act of 2004 (MFRA), which would ban three
questionable, but legal, practices that bill sponsors say hurt
investors and create conflicts of interest. The bill, sponsored by
Sens. Peter Fitzgerald, R-Ill., Carl Levin, D-Mich., and Susan
Collins, R-Maine, is considered the toughest to date on the $7.4
trillion mutual fund industry, United Press International reported.
The bill says: "Three practices —
soft dollar arrangements, revenue sharing, and directed brokerage
— ought not clutter any mutual fund prospectus. And neither funds
nor fund advisers should be spending time and money crafting
elaborate disclosures and justifications of ultimately indefensible
practices. By simply prohibiting these practices, MFRA vastly
simplifies the disclosure regime, and benefits all
stakeholders."
The MFRA is one of four bills that have
been introduced in the Senate in the past few months. The House
passed its own mutual fund bill in November.
The bill also calls for a method of
identifying anonymous investors who use intermediaries to conduct
transactions in omnibus accounts. The bill says that funds need to
be able to trace individual investors who violate fund trading
rules.
Market timing and late trading practices
have also been under fire in the mutual fund industry scandal, and
the MFRA seeks a no-excuses 4 p.m. trading deadline. More than 20
mutual fund companies are under investigation for allegedly allowing
improper trading.
The bill also targets what is known as the
12b-1 law, which allows brokers to charge investors annually for
advertising and marketing costs. Over time these "distribution
fees," have morphed into "disguised loads," the bill
states.
"What happens when fund advisers use
their own profits — instead of tapping directly into investors'
money — for distribution expenses? Distribution expenses become
very reasonable," the bill says.
Other proposed changes include: requiring
funds to disclose all costs in an understandable way, making it
easier to replace fund directors, protecting whistleblowers,
mandating that the SEC approve any new costs the industry wants to
impose, and starting several studies on other preventative measures.
On Monday, the day the bill was introduced,
Franklin Resources, the biggest publicly traded U.S. mutual fund
manager, said the SEC plans to pursue charges against the company
and two executives over trading practices.
"Why a Brokerage
Giant Pushes Some Mediocre Mutual Funds," by Laura Johannes and
John Hechinger, The Wall Street Journal, January 9, 2004, Page
A1.
Like many who bought poorly
performing Putnam mutual funds in recent years, Nancy Wessels lost
big. One of her investments, Putnam Vista fund, dropped 40% from
when she bought it in April 2000, near the stock-market peak, until
she sold it in May 2002. That performance was worse than 80% of
similar stock funds.
What the 80-year-old widow's
broker, Edward D. Jones & Co., never told her was that it had a
strong incentive to sell Putnam funds instead of rivals that
performed better. Jones receives hefty payments -- one estimate tops
$100 million a year -- from Putnam and six other fund companies in
exchange for favoring those companies' funds at Jones's 8,131 U.S.
sales offices, the largest brokerage network in the nation.
When training its brokers in
fund sales, Jones gives them information almost exclusively about
the seven "preferred" fund companies, according to former
Jones brokers. Bonuses for brokers depend in part on selling the
preferred funds, and Jones generally discourages contact between
brokers and sales representatives from rival funds. But while
revenue sharing and related incentives are familiar to industry
insiders, Jones typically doesn't tell customers about any of these
arrangements.
The situation "gives you
the feeling of being violated," says Mrs. Wessels's son,
DuWayne, a Waterloo, Iowa, real-estate broker. He says he found out
about the fund-company payments to Jones from his mother's new
broker when the son moved her $300,000 account to another firm in
2002.
Jones, whose storefront
offices are common across much of the country, is one of the
nation's largest distributors of mutual funds, with 5.3 million
individual customers who hold more that $115 billion in fund shares.
The firm has earned respect for its advocacy of conservative,
buy-and-hold investing, and it hasn't been tarnished by the scandals
sweeping the mutual fund and brokerage industries.
But Jones, based in St.
Louis, is also among the nation's leading practitioners of a
little-understood fund-sales practice now under scrutiny by federal
securities regulators. In the industry it's known by the bland name
of "revenue sharing": Fund companies give brokers a cut of
their management fees to induce them to sell their products. Critics
call it "pay to play."
Continued in
the article
Apart from the breach of fiduciary
responsibility in which many fund mangers help there big customers
steal from their little customers, most funds charge customers much
more than the value added for services.
The Wall Street Journal, December 11, 2003, Page C1 --- http://online.wsj.com/article/0,,SB10710996418574900,00.html?mod=mkts_main_news_hs_h
And Fees Vary Dramatically |
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Among
the 25 largest fund firms, the three whose stock funds have
the |
highest
expense ratios and the three that have the lowest expense |
stock
funds. |
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|
|
|
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Alliance |
1.69% |
|
|
|
|
|
Federated |
1.53% |
|
|
|
|
|
AIM |
1.50% |
|
|
|
|
|
Fidelity |
0.82% |
|
|
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|
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American |
0.79% |
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Vanguard |
0.28% |
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|
What is also sad is the added fee that financial
advisors/brokers charge just to get into mutual funds when for most
investors who want diversification in various risk categories, the
funds themselves probably provide sufficient information for free.
Most of the funds like Vanguard now provide check books with their
funds such that deducting is as simple as writing a check and
depositing is as simple as filling out a deposit slip.
TIAA/CREF
Educators can read more about TIAA/CREF mutual funds at http://www.tiaa-cref.org/mfs/
TIAA/CREF charges 0.31% according
to http://www.tiaa-cref.org/charts/mf-expense.html
I could not find any information at the above
Website about whether TIAA/CREF offers check writing features like
Vanguard.
And the untarnished
winners are: Fidelity, Vanguard and the American Funds
Stock mutual funds took
in more money in the past three months than in any period since 2000,
despite the trading scandal. The upshot: The worst mess in the
history of mutual funds has become a marketing opportunity for those
firms still untarnished. As cash leaves implicated firms, fund
executives at major firms say their salespeople are working fervently
to attract money from investors who are eager to stay invested as the
stock market is again pushing strongly higher.
"Flight to Quality Benefits Three Fund Firms," by Ian
McDonald, The Wall Street Journal, December 12, 2003 ---
http://online.wsj.com/article/0,,SB107118601050112500,00.html?mod=home_whats_news_us
Financial planner Joseph
Lyons recently moved client assets out of a Putnam Investments
mutual fund whose manager allegedly made improper trades in its
shares. Mr. Lyons didn't move it out of the stock market. He chose
another stock mutual fund, managed by Morgan
Stanley.
Like many others, he wants to
avoid funds tainted by the sprawling mutual-fund trading scandal
that erupted in early September, but he isn't giving up on stocks.
It's hard to resist a market that seemingly keeps going up.
Enthusiasm for stocks pushed the Dow Jones Industrial Average
through the 10000 mark Thursday, the highest level in 18 months.
After a family discussion of
the issues, 43-year-old Mr. Lyons, who works with investment firm
Linsco Private Ledger, in Walnut Creek, Calif., shifted his wife's
retirement holdings from several Putnam Investment funds to some
Fidelity Investments portfolios. He's out to protect his clients' --
and his family's -- interests.
"As long as the stock
market is doing well, people will keep investing," says Steve
Henningsen, a financial adviser with the Wealth Conservancy in
Boulder, Colo. "It's kind of weird this scandal hasn't chased
people from funds."
Although many irate
individuals and institutions have unloaded holdings of funds run by
Putnam Investments, which has settled federal charges in the matter,
and Strong Capital Management, which is under investigation but
hasn't been charged with any wrongdoing, and other firms implicated
in the scandal, money flowing into the fund industry as a whole has
been surprisingly robust. From the start of September through the
end of last month, stock mutual funds took in more than $63 billion,
their highest three-month intake since early 2000 when stock prices
peaked, according to flow-tracker AMG Data Services. This money has
helped fuel the stock market's rise.
A staggering 55% of it has
gone to the country's three largest fund firms as measured by
assets: Fidelity Investments, Vanguard Group and American Funds.
Even though the three fund groups together hold more than $1.8
trillion of the industry's $7 trillion in assets, new money is
coming into Fidelity, Vanguard and American at a markedly faster
pace than usual. From 1998 to the start of this year, the three
firms took in a little more than a third of the industry's
stock-fund flows.
While new disclosures
continue to emerge almost daily in the investigations, Fidelity,
Vanguard and the American Funds family run by Capital Research &
Management have avoided allegations of wrongdoing in the scandal to
date. And while many other firms also have a clean bill of health so
far, it appears the industry's Big Three in particular are
benefiting from a drastic flight to quality in the fund world.
"These firms can portray
themselves as being good money managers who put the customer
first," says Charles Bevis, research editor at Boston fund
consultants Financial Research. "They have a very persuasive
message that other firms will have a hard time delivering to
customers."
Some observers find
investors' reaction to the scandal news heartening. Rather than give
overriding importance to the latest short-term investment returns,
they appear to be casting their lot with companies that look to be
more concerned about their current customers than prospective ones.
"Maybe fund investors aren't so dopey after all," says
Russ Kinnel, director of fund research at Morningstar.
The upshot: The worst mess
in the history of mutual funds has become a marketing opportunity
for those firms still untarnished. As cash leaves implicated firms,
fund executives at major firms say their salespeople are working
fervently to attract money from investors who are eager to stay
invested as the stock market is again pushing strongly higher.
Chances Are That Your
Mutual Funds Screwed You While the SEC Knowingly Looked the Other Way
All
the corporate scandals pale in the face of the mutual fund scandals. It’s
time that all of us help spread the word or else the mutual fund lobby
will continue to allow insiders to fleece investors from all over the
world.
Below you will find out how you may have been
cheated. Hopefully, you
will be angry enough to contact your local Senators as well as
Senators
Enzi, Grassley, Gregg, and Shelby in particular --- http://www.senate.gov/general/contact_information/senators_cfm.cfm
Senator
Shelby is an enormous problem!
While Representative Baker pushes his
bill in the House, the Senate is not expected to take up a measure
before next year. Some lawmakers have filed bills, but Senator Richard
Shelby, the
Alabama
Republican who heads the Senate banking
committee, has said he is not convinced of the need for new laws.
Stephen Labaton, "S.E.C. Offers Plan for Tightening Grip on
Mutual Funds," The New York Times,
November 19, 2003
---
http://www.nytimes.com/2003/11/19/business/19sec.html
"FIGHTING
THE FUND CHEATS," by Jane Bryant Quinn, Newsweek Magazine,
December 8, 2003, Page44.
Why you don't know
can cost you. A guide to what money managers hide.
Are you disgusted enough with
mutual funds to raise a stink? So far, savers don't seem
nearly as outraged as they were about Enron--yet
deceptive funds and sneaky "financial advisers" have
swiped more money, from more people, than all the corporate scandals
combined. The House
of Representatives just passed a reform bill, but in the Senate, the
going looks tough. Your
legislators are scooping up money from the mutual-fund lobby, which
hopes to head off any major change.
To counter the lobby,
Congress needs angry protest calls from voters like you.
At least the regulators are now
tailing the fund frauds that flourished right under their noses.
This week, the Securities and Exchange Commission is adopting new
rules to push funds toward obeying the current laws (they don't
now), as well as making it harder for them to let big investors skim
off profits. In a few weeks, the NASD (formerly the National
Association of Securities Dealers) will bring enforcement actions
against brokerage firms that grossly overcharged investors.
New York Attorney General Eliot Spitzer, who turned over the rock
that exposed these worms, says he's likely to bring a lawsuit a
week, through January, against devious mutual funds--and promises
"a lot of criminal cases across the nation."
Here's how funds cheat:
THEY MAY PAY BROKERAGE
FIRMS TO GET ON A 'PREFERRED LIST': The brokers sell from that
list, whether the funds are good or not.
THEY MAY PAY 'SOFT DOLLARS':
That means paying the brokerage firms more than necessary to buy and
sell securities. In return, the funds get stock return, the
funds get stock research, which could be useful. They might
also get "free" computers or services that, by law, should
be disclosed as part of the expense ratio. You pay soft-dollar
costs without ever knowing it.
THEY DON'T DISCLOSE ALL YOUR
COSTS: The prospectus shows you the upfront sales charge, if
any, and the "expense ratio," which covers operating
costs. But it doesn't reveal brokerage costs or soft dollars.
Vanguard founder John Bogle estimates that expenses on taxable funds
run 2 to 3 percent. Add 0.4 percent more for brokerage costs.
All together, that's about 25 percent of the stock market's
long-term, 10.4 percent return.
THEIR BOARD OF DIRECTORS HIDE:
You don't even know how to contact the board with a complaint.
The whistle-blowers who outed the deceptive funds didn't go to the
boards, they went to state regulators instead.
Reforms needed: The amount your
fund pays in brokerage commissions and soft dollars should be
disclosed. Boards of directors, who are supposed to represent
you, should put their names and a contact point into the annual
report. Morningstar managing director Don Phillips thinks they
should write a yearly shareholder letter saying what they did.
BROKERS DON'T GIVE YOU REQUIRED
DISCOUNTS ON SALES COMMISSIONS: If you buy A shares with a
front-end load, and invest a large amount--say, more than $25,000 or
$50,000 from an IRA rollover--you're entitled to a lower sales
charge. Where the discount kicks in is called a
"breakpoint"--but tons of investors aren't getting the
discounts they deserve. The NASD has ordered the firms to
contact clients and repay overcharges.
Some brokers sell large investors
B shares, which have no breakpoints, hence no discount--and you also
pay higher annual fees. If A shares would have been cheaper,
tell your broker to redo the buy. Calculating breakpoints is
more complicated than I've shown here. For details, go to
nasd.com and look for its informational Investor Alerts.
THEY CHARGE YOU DOUBLE LOADS:
Few investors (and brokers) know that if you're switched from one
load fund to another, you usually don't have to pay the load a
second time. The rules apply even if you buy from a different
broker. Planner Rick Sabo of Money Concepts in Gibsonia, Pa.,
got $1,250 back for a client just by asking the new fund for a fix.
Reforms needed: Brokers should
disclose how much the funds pay them to make a sale. Costs
should be shown in dollars and cents (something Vanguard has started
with its funds). "The best thing that could come out of
this mess is full fee disclosure on one piece of paper," says
Mary Schapiro, vice chair of the NASD.
Mutual funds are still your best
investment. To avoid crooked tactics, buy no-loads with low
yearly expenses (under 0.9 percent for U.S. equity funds; under 0.6
percent for bond funds). You want seasoned money managers who
trade infrequently and with long-term performance in line with that
of their peers.
Should you sell the mutual funds
in trouble with the law? Pause, if you'll pay big redemption
charge or taxes. But if the fund's fees are high, its
performance mediocre and its managers cheaters, dump it for the
skunk it is.
"Alliance Capital
Offers Annual-Fee Cut as Part Of Proposed Settlement," by Tom
Lauricella et al, The Wall Street Journal, December 11, 2003,
Page C1 --- http://online.wsj.com/article/0,,SB10710996418574900,00.html?mod=mkts_main_news_hs_h
As part of a proposed
settlement with the New York attorney general's office, Alliance
Capital Management Holding LP, one of the nation's largest
publicly traded mutual-fund companies, has offered to cut the annual
fees it charges investors for managing its mutual funds.
The settlement would be
unprecedented because Alliance isn't being accused of levying
excessive fees. Rather, the negotiations involve settling the
separate issue of whether Alliance allowed improper trading in its
funds at the expense of ordinary fund holders. The talks, which
still could unravel, come amid a burgeoning government investigation
of trading practices in the mutual-fund industry.
But the Securities and
Exchange Commission, which also is in settlement talks with
Alliance, is taking a different tack. Any change in fees, agency
officials argue, should be handled through new regulatory rules,
rather than through enforcement actions. SEC Chairman William
Donaldson recently lambasted New York Attorney General Eliot
Spitzer's push to link lower fees with charges of improper trading,
saying it is "improper to try to piggyback the fee-disclosure
issue on an unrelated matter."
Continued in the article.
Make Day Traders Act
Rationally Rather Than Regulate Hedge Funds
A groundbreaking study by Stefan Nagel, assistant professor of finance
at the Stanford GSB, finds that hedge funds not only failed to create
a stabilizing force during the technology bubble of 1998-2000 but
instead profitably rode the bubble --- http://www.gsb.stanford.edu/news/research/finance_hedgefunds_techbubble.shtml
Question
How did one of the most clever rip offs work?
Answer
Pilgrim did it with derivatives in index funds such that when
investors lost, Pilgrim won. When investors won, Pilgrim did not
lose. This was one of the more complicated and clever ways of
ripping off investors that will continue unless Congress bans
"The Mutual
Fund Scandal Unfair Fight," by Allan Sloan, Newsweek Magazine,
December 8, 2003, pp. 43-46.
It's a tale
of how insiders can grow fat from their stake in a fund even as
regular investors are being stripped to the bone. It turns out
that Pilgrim made rich profits from investing in his PBHG Growth
Fund while shareholders lost big. PBHG Growth dropped 65
percent from March of 2000 through November of 2001, the period
covered in suits filed by New York Attorney General Eliot Spitzer
and the Securities and Exchange Commission. That's a loss of
45 percent a year. But during that same period, according to
NEWSWEEK'S calculations based on information in the suits, Pilgrim
made 49 percent a year on his stake in PBHG Growth. His
profit: $3.9 million.
How can
this be? Unlike regular sucker investors, Pilgrim owned his
stake by investing through an outsider: a hedge fund called
Appalachian Trail. Appalachian profited by betting against
Growth. NEWSEEK has learned that Appalachian, which regulators
say bought and sold Growth a total of 240 times during this period,
made most or all of its profit by betting that the value of the
fund's stock portfolio would fall. Regular investors, by
contrast, profited only if Growth's investments increased in value.
Pilgrim, as the fund's manager, had a legal and moral fiduciary
obligation to look after his investors' money and place their
interests ahead of his own. But instead, he seems to have
profited from his investors' misfortune. It's as if a captain
ran his ship into an iceberg, however inadvertently, then jumped
into a private lifeboat and collected on his passengers' life
insurance policies. Pilgrim's lawyer had no comment on the
regulators' suits or on NEWSWEEK'S analysis. His defense,
people involved in the case say, will apparently be that he was a
passive investor in Appalachian and didn't help it bet against
Growth.
The Pilgrim
story is part of the almost daily revelations about mutual-fund
misdeeds that are driving home a message we can no longer ignore:
even when we hire professional managers to look after our money and
give us a diversified portfolio, we can get
(read that most likely will be)
eaten alive.
We thought mutual funds were boring but safe, compared with
individual stocks. Now we're finding out that many funds
weren't trustworthy.
A
Kickback By Any Other Name is a ____________!
"Why a Brokerage
Giant Pushes Some Mediocre Mutual Funds," by Laura Johannes and
John Hechinger, The Wall Street Journal, January 9, 2004, Page
A1.
Like many who bought poorly
performing Putnam mutual funds in recent years, Nancy Wessels lost
big. One of her investments, Putnam Vista fund, dropped 40% from
when she bought it in April 2000, near the stock-market peak, until
she sold it in May 2002. That performance was worse than 80% of
similar stock funds.
What the 80-year-old widow's
broker, Edward D. Jones & Co., never told her was that it had a
strong incentive to sell Putnam funds instead of rivals that
performed better. Jones receives hefty payments -- one estimate tops
$100 million a year -- from Putnam and six other fund companies in
exchange for favoring those companies' funds at Jones's 8,131 U.S.
sales offices, the largest brokerage network in the nation.
When training its brokers in
fund sales, Jones gives them information almost exclusively about
the seven "preferred" fund companies, according to former
Jones brokers. Bonuses for brokers depend in part on selling the
preferred funds, and Jones generally discourages contact between
brokers and sales representatives from rival funds. But while
revenue sharing and related incentives are familiar to industry
insiders, Jones typically doesn't tell customers about any of these
arrangements.
The situation "gives you
the feeling of being violated," says Mrs. Wessels's son,
DuWayne, a Waterloo, Iowa, real-estate broker. He says he found out
about the fund-company payments to Jones from his mother's new
broker when the son moved her $300,000 account to another firm in
2002.
Jones, whose storefront
offices are common across much of the country, is one of the
nation's largest distributors of mutual funds, with 5.3 million
individual customers who hold more that $115 billion in fund shares.
The firm has earned respect for its advocacy of conservative,
buy-and-hold investing, and it hasn't been tarnished by the scandals
sweeping the mutual fund and brokerage industries.
But Jones, based in St.
Louis, is also among the nation's leading practitioners of a
little-understood fund-sales practice now under scrutiny by federal
securities regulators. In the industry it's known by the bland name
of "revenue sharing": Fund companies give brokers a cut of
their management fees to induce them to sell their products. Critics
call it "pay to play."
Continued in the article
January 14, 2003 Update
A rule proposed by the SEC on January 14, 2004 would change that.
Brokers would be required to tell investors about any payments,
compensation or other incentives they receive from fund companies,
including whether they were paid more to sell a certain fund.
Conflicts would have to be disclosed before the sale is completed,
with a more detailed account of costs and conflicts in a subsequent
confirmation statement. If adopted, investors would get a document
showing the amount they paid for a fund, the amount their broker was
paid and how the fund compares with industry averages based on fees,
sales loads and brokerage commissions.
"Our Ethical
Erosion," by Arthur Levitt, Jr. and Richard C. Breeden, The
Wall Street Journal, December 3, 2003, Page A16 ---
http://online.wsj.com/article/0,,SB107041653779113800,00.html?mod=opinion%5Fmain%5Fcommentaries
From the neighborhood flea
market to the New York Stock Exchange, markets rely, more than
anything else, on trust. Market participants must trust -- and be
able to verify -- that the goods offered are what they are supposed
to be; that their offer is being considered without prejudice; that
their orders are being processed fairly; and that the market isn't
rigged to their disadvantage.
Since Enron filed for
bankruptcy two years ago this week, it has become clear that
investors' trust was taken for granted and abused not just in one
company or one sector, but across the breadth of our market system.
High standards of integrity and character seem to have slipped to
dangerous lows at many firms.
Recently, investors have
learned that this ethical erosion also has infected the mutual-fund
industry, apparently to a widespread degree. For 95 million
mutual-fund investors, mutual funds represent the best vehicle for
these individuals to access our markets and to build wealth to send
their children to college, buy a new home and save for retirement.
Yet, the mutual-fund industry has taken advantage of the
attractiveness of mutual funds to ordinary investors:
• Investors
are misled into buying funds based on past performance, even where
that record actually may be very poor.
• Investors are left
in the dark about the level of most fees, and about the effect
that fees, expenses, sales loads and trading costs have on their
actual investment returns.
• Fund directors
either are stretched too thin, or are otherwise uninterested or
unable to exercise effective oversight.
• Most shockingly,
fund management in many instances has offered pricing and trading
prerogatives to hedge funds and other large investors, with some
sponsors indirectly sharing in the profits from improper trading
practices. Deals of this kind, at best, turn individual investors
into second-class citizens, and, at worst, into sheep to be
fleeced. Apparently, $80 billion in annual fees is enough to
induce a bad case of ethical myopia.
The time has come for a real
clean-up. Cosmetic policy changes and compliance reviews or image
campaigns won't do it. The mutual fund industry's reach and its
importance to the livelihoods of millions of Americans demand not
just singular enforcement actions, but a much broader overhaul of
the industry itself. Anything less than swift, comprehensive action
risks causing long-term damage to an investment vehicle that is
important to the industry, to our markets, and to our economy as a
whole.
First, we need a coordinated
effort by the state attorneys general and the SEC to expose illegal
activity and to prosecute it vigorously. The New York attorney
general has performed an outstanding public service with his success
in the Canary Capital case and in exposing other wrongdoing. But the
strength of our markets rests on a national system, not on piecemeal
state standards. For the future, investors need both state and
federal authorities to work together in a genuine partnership to
root out abusive practices, as part of a coherent and effective
national effort.
Second, through legislation
and regulation, Congress and the SEC should underscore the simple
but critical fact that fund sponsors and directors alike have a
fiduciary duty to fund investors. Fund companies are not selling
soap, but a relationship based on millions of investors trusting
these companies with their savings. Duties of care and loyalty are
as essential in the fund industry as they are in the rest of
corporate America. The first loyalty of fund-company management and
directors must be to the task of enhancing the returns of ordinary
fund investors, not the profitability of the fund sponsor.
Third, the SEC needs to
intensify its dealings with the fund industry and improve its own
capacity to be an effective overseer. It must act quickly to stop
late trading, seriously curb market timing and clean up other shady
practices. Today the Commission is scheduled to begin that process.
More generally, fund managers must understand that the time for
compliance reviews is before, not after, improper conduct occurs.
For the worst offenders, sanctions need to imperil the flow of fees,
and fund sponsors who believe they are above ethical concerns should
see the regulatory roof cave in. When it comes to the mutual fund
industry, more than a few heads need to be cracked, and the
Commission shouldn't be afraid to do it.
The SEC is not waiting for a
legislative prod to adopt better rules to curb market timing. If
exchange limits, minimum redemption blackouts, or significant
redemption fees are not adequate to stop these practices cold the
agency can find other devices to allow after-hours real time
pricing. The bottom line is that where a fund tells investors that
they do not allow market timing, the SEC should insist that they
make good on that promise.
Fourth, we must make the
oversight of independent directors an effective check on mutual-
fund abuses. The SEC should require fund companies to have an
independent chairman without ties to the fund sponsor. That is one
of the best ways to improve accountability for management practices.
The SEC should also act to assure independence and competence among
fund directors. Too many independent directors aren't really
independent. Many directors are stretched far too thin and have
served far too long.
Independent fund
directorships are not supposed to be sinecures for those who won't
challenge powerful fund sponsors. All fund boards should have term
limits, and independent directors should have professional resources
to help them develop their own independent information on
fund-management performance and other issues. The SEC should
increase the number of independent directors to all but one; and
require that boards justify to their bosses -- the shareholders --
the choice of investment adviser and fees charged.
In egregious cases, fund
sponsors could be required to appoint to their boards an investor
ombudsman; or they could lose their ability to participate in
nominating new fund directors or to renew advisory contracts for a
defined period of time. Fund sponsors should take seriously the need
to adopt meaningful governance reforms within their own
organizations, not merely cosmetic trifles.
Fifth, mutual-fund companies
need to show leadership in reforming themselves. Reforms may be
encouraged by regulatory action, but ultimately only mutual-fund
companies themselves will win back investors' trust. We need them to
be a steady and loud voice for meaningful, pragmatic change. To that
end, mutual-fund companies should end misleading hype and
proactively ban deceptive performance advertising. Advertising
should fully reflect the effect of direct and indirect fees and
taxes on fund performance, as well as periods of poor and good
performance.
Finally, mutual-fund
companies also need to help clean up the brokerage system through
which more than 80% of investors purchase their shares. Revenue
sharing, sales contests and higher commissions for selling
home-grown funds all damage investor interests and have no place in
the industry. If they exist at all, "soft dollars" should
be disclosed so that investors have a clear understanding of the
relationships their mutual-fund companies and brokers have, and they
should inure solely to the benefit of fund investors, not sponsors.
Furthermore, Congress should consider revisiting the safe harbor it
granted soft-dollar arrangements shortly after it abolished fixed
brokerage commissions in 1975.
For years, mutual funds
boasted that they were investors' best friends. For the health of
the markets and our economy, it's time for them to prove it.
The primer below should have been entitled
"The Mutual Fund Scandal for Dummies." It is the best
explanation of what really happened and how mutual funds versus index
funds really work.
A
Primer on the Mutual-Fund Scandal --- www.businessweek.com:/print/bwdaily/dnflash/sep2003/nf20030922_7646.htm?db
Stanford University faculty member Eric Zitzewitz, "found
evidence of market timing and late trading across many fund families
he studied."
BusinessWeek Online, September 22, 2003
When
it comes to financial scandal, the mutual-fund industry had always
seemed above the fray. No longer. On Sept. 3, New York Attorney
General Eliot Spitzer kicked off an industry wide probe with
allegations that four prominent fund outfits allowed a hedge fund to
trade in and out of mutual funds in ways that benefited the parent
companies at the expense of their long-term shareholders.
By Sept. 16, Spitzer's office and the Securities & Exchange
Commission had filed criminal and civil charges against a former
Bank of America (BAC
) broker who allegedly facilitated illegal trading in mutual funds.
More fund companies are being subpoenaed for information about their
trading, and more state and federal regulators are joining the
growing investigation. It's all but certain that more fund firms
will be drawn into the deepening scandal.
Yet this major crisis for the fund industry has failed to inspire
much fury from investors, and it has done little to halt a rising
stock market. Maybe a partial explanation is that the fund companies
allegedly did wrong, and why it hurt shareholders, is difficult to
understand. For anyone who has read widespread coverage of the topic
but wanted to scream, "Explain what the heck is going on,"
we provide the following discussion:
Let's start at the beginning. How is a mutual fund set up?
A mutual fund is like any other public company. It has a board of
directors and shareholders. Its business is investing -- in stocks,
bonds, real estate, or other assets -- using whatever strategy is
set out in its prospectus, with money from individual investors. Its
strategy could be to buy, say, small, fast-growing U.S. companies or
to purchase the debt of firms across Europe.
A fund's board hires a portfolio manager as well as an outside firm
to market and distribute the fund to investors. But funds can become
big quickly, and the larger ones operate a bit differently. A
fund-management company (think Fidelity or Vanguard) sets up dozens
of funds, markets them to investors, hires the portfolio managers,
and handles the administrative duties. It makes a profit collecting
fees (usually a percentage of assets under management) from the
funds it manages.
A fund company typically has in place the same board of directors
(including some independent members) for its funds. The board of
directors should be on the lookout for abusive practices by the fund
company, but directors often have too many funds to oversee and may
be too aligned with the company's portfolio managers to provide much
oversight.
This case concerns mutual-fund trading. Does it involve the
portfolio managers?
No, that's not what this case is about. Portfolio managers buy and
sell securities for their funds. But the alleged improper trading
has to do with outside investors buying and selling a fund's shares.
Spitzer's complaint actually concerns the activity of one firm,
Canary Capital Partners, but he alleges the same activity is far
more widespread.
Portfolio managers, who are usually compensated based on their
funds' performance and frequently have their own money invested in
their funds, are usually shareholders' greatest defenders against
trading practices that hurt long-term results.
How are mutual funds traded?
Funds can be bought and sold all day. However, unlike stocks, which
are priced throughout the trading day, mutual funds are only priced
once a day, usually at 4 p.m. Eastern Time. At that point the funds'
price, or Net Asset Value (NAV), is determined by adding up the
worth of the securities the fund owns, plus any cash it holds, and
dividing that by the number of shares outstanding.
Buy a fund at 2 p.m. and you'll pay a NAV that is determined two
hours later. Buy a fund at 5 p.m. and you'll pay a price that won't
be set until 4 p.m. the following day. According to Spitzer's
complaint, Canary Capital Partners, a hedge fund, took advantage of
the way fund prices are set to effectively pick the pockets of
long-term shareholders.
What's a hedge fund?
A hedge fund is like a mutual fund in that it buys and sells
securities, is run by a portfolio manager, and tries to make money
for its investors. But hedge funds have a very different structure
(they are actually set up as partnerships) and are almost entirely
unregulated, mostly because they manage money for sophisticated high
net-worth individuals or companies, and have different rules
governing when and how investors can liquidate their positions.
Hedge-fund managers are compensated based on a percentage of profits
(often 20%), so they have a major incentive to take risks, which
they often do. Selling stocks short (a way to bet they will fall in
price), piling on complex financial security derivatives, and using
borrowed money to leverage returns are common strategies.
So exactly what did Canary Capital allegedly do?
According to Spitzer's complaint, Canary (which settled charges,
paid $40 million in fines, but didn't admit or deny guilt), had two
strategies (Spitzer called them "schemes") for making
money trading in mutual funds. The easiest to understand, the most
serious, and clearly illegal is "late trading." The other
strategy, "market timing" is far more common and not
illegal, although clearly unethical.
How does late trading work?
The rule of "forward pricing" prohibits orders placed
after 4 p.m. from receiving that day's price. But Canary allegedly
established relationships with a few financial firms, including Bank
of America, so that orders placed after 4 p.m. would still get that
day's price. In return for getting to trade late, Canary placed
large investments in other Bank of America funds, effectively
compensating the company for the privilege of trading late.
The late-trading ability would have allowed Canary to take advantage
of events that occurred after the market closed -- events that would
affect the prices of securities held in a fund's portfolio when the
market opened the next day.
I could use an example.
Here's a hypothetical, simplified one: Let's say the Imaginary Stock
mutual fund has 5% of its assets invested in the stock of XYZ Co.
After the close, XYZ announces earnings that exceed analysts'
expectations. XYZ closed at 4 p.m. at $40 a share but most likely,
its price will soar the next day.
The late trader buys the Imaginary Stock mutual fund at 6 p.m. after
the news is announced, paying an NAV of $15 (that was calculated
using the $40 share price of XYZ). The next day, when XYZ closes at
$50, it helps push the fund's NAV to $15.50. The late trader sells
the shares and pockets the gain. Spitzer says late trading is like
"betting today on yesterday's horse races." You already
know the outcome before you place your winning bet.
How do they turn this into real money? It sounds like small
potatoes.
If you did this dozens of times a year in hundreds of funds
investing millions of dollars at a time, it would add up.
What about market-timing? How does that work?
This strategy takes advantage of prices that are already outdated,
or "stale," when a fund's NAV is set. Most often the
strategy is carried out using international funds, in which prices
are stale because the securities closed earlier in a different time
zone.
Could you give an example?
Well, let's take the Imaginary International Stock mutual fund. One
day, U.S. markets get a huge boost thanks to positive economic news
and the benchmark Standard & Poor's 500 rises 5%. The
market-timer steps in and buys shares of the international fund at
an NAV of $15 at 4 p.m., knowing that about 75% of the time,
international markets will follow what happened in the U.S. the
previous trading day. Predictably, most of the time, the
international fund rises in price the next day and closes at an NAV
of $15.05. The market-timer then sells the shares, pocketing the
gain.
If market timing isn't illegal, why would Spitzer investigate the
industry for it?
Market timing (and late trading, for that matter) add to a fund's
costs, which are paid by shareholders. This kind of trading activity
also either dilutes long-term profits or magnifies losses depending
on whether the trader is betting the fund will go up or go down.
(For a more detailed example of how market-timing works, see BW
Online, 12/11/02, "How
Arbs Can Burn Fund Investors").
Most funds have a stated policy in place (included in the
prospectus) of prohibiting market-timing. They impose redemption
fees on investors that hold a fund less than 180 days. And many
prospectuses give fund companies the right to kick market-timers out
of the fund.
Yet Spitzer alleges that fund companies such as Janus (JNS
) and Strong got to reap extra management fees by allowing Canary to
do market-timing trades in return for Canary placing large deposits
of "sticky" assets (funds that are going to stay in one
place for a while) in other funds. That would put it in violation of
its fiduciary duty to act in its shareholders' best interests and
mean it has not conformed to policies laid out in its prospectus.
Spitzer offers this analogy: "Allowing timing is like a casino
saying that it prohibits loaded dice, but then allowing favored
gamblers to use loaded dice, in return for a piece of the
action." Janus, Strong, and the other companies named in
Spitzer's complaint have promised to cooperate with him and are
conducting their own internal investigations of trading practices.
Several firms have promised to make restitution to shareholders if
they find such deals cost shareholders money.
But wouldn't this amount to tiny losses for the shareholders in
the fund?
That depends on how many traders might have used these strategies.
Spitzer believes these practices are widespread and his
investigation is widening to include many more fund companies.
Eric Zitzewitz, an assistant professor of economics at Stanford, has
found evidence of market timing and late trading across many fund
families he studied. His research shows that an investor with
$10,000 in an international fund would have lost an average of $110
to market timers in 2001 and $5 a year to after-market traders.
Average losses in 2003 appear to be at roughly the same level, he
says. That may not sound like much, but in a three-year bear market,
when the average investor was losing hundreds if not thousands of
dollars on investments, it's adding the insult of abused trust to
the injury of heavy losses.
What's likely to happen next?
Spitzer and other securities regulators are likely to announce the
alleged involvement of more fund companies. If individual investors
believe fund companies abused their trust, they are likely to call
for more regulation and stiff penalties. Potentially they could pull
their money out of funds en masse, forcing portfolio managers to
liquidate stocks to fund redemptions. That could be very disruptive
to financial markets.
Another possibility is that the stock market continues to rise on
the back of a stronger economy and a jump in corporate profits. Fund
investors might be willing to ignore past losses due to illegal and
unethical trading practices because they're pleased with the current
gains their funds are providing. For now, that's clearly what the
embattled mutual-fund industry hopes will happen.
An Ethics Dilemma for Professors
Question
Should a research professor ethically exploit his research discoveries
at the expense of others?
Answers
Since I have long fantasized over this dilemma, let me note that there
are two levels of ethical dilemma.
Level
1:
A professor makes a discovery and then earns millions on it before
disclosing the discovery. This
seems to me to be blatantly unethical if it entails any type of
illegal or highly unethical exploitation. However, if the
activity itself is perfectly legal, then it is not blatantly
unethical. What Professor Zitzewitz (see below) did was legal for
him but not necessarily legal or ethical for his broker or other fund
managers who had fiduciary responsibilities to protect portfolios of
clients.
Level
2:
A professor makes a discovery and simultaneously discloses that
discovery while making millions exploiting an inefficient legal/market
system that has not yet caught up with the research findings.
The
Stanford
University
assistant professor of
business in question actually was simultaneously warning the world
that the mutual fund industry was ripping off the public for over $5
billion while he himself exploited his discovery by adding millions to
his own personal portfolio using his discovery.
Level 2 is a real gray zone, especially if the world is just
ignoring his efforts to disclose his research findings.
I recommended the above Stanford Professor Zitzewitz primer on the
mutual fund scandal --- www.businessweek.com:/print/bwdaily/dnflash/sep2003/nf20030922_7646.htm?db
I still recommend this primer!
Here's the saddening rest of the story.
"Prof. Zitzewitz Has Good Timing And Bad Timing," by
Randall Smith, The Wall Street Journal, December 9, 2003
---
The Stanford University business-school
professor who shot to fame by warning how much aggressive
mutual-fund traders using market-timing strategies cost long-term
investors put his money where his mouth is.
In a widely cited research paper published
last year, Eric Zitzewitz estimated that such trading costs
long-term investors $5 billion annually and criticized mutual funds
for allowing it. Yet Mr. Zitzewitz engaged in extensive timing
trades himself during a three-month period this summer, according to
people familiar with the trading.
Mr. Zitzewitz's study also concluded that
investors can earn 35% to 70% annually pursuing such trading
strategies in overseas mutual funds. In reality, he earned profits
of more than $500,000, somewhat less than his best-case scenario, by
trading with as much as $19.5 million in assets, which included
funds from his wife and another academic, the same people said.
Timing trades aim to exploit stale prices
of certain funds, such as foreign stock funds, which contain
securities whose prices are set in overseas markets that close many
hours before those in the U.S., and thus may not reflect the impact
of later market-moving developments.
In a statement, Mr. Zitzewitz said,
"The trading I did was based on a known pricing anomaly and was
legal: No trades were placed after 4 p.m. and there were of course
no quid-pro-quo arrangements with mutual funds." While he
acknowledged that he has been critical of mutual funds that allow
stale prices, he noted that he has no "fiduciary, regulatory or
legislative role overseeing mutual fund pricing," and thus his
trading wasn't a conflict of interest.
Although Mr. Zitzewitz's
trades didn't necessarily violate any rules, they resulted in
disciplinary action against his broker at UBS
AG for alleged violation of the firm's policies against such
rapid-fire fund trading. UBS fired two brokers and suspended nine
others last month for alleged violations of the guidelines, which
were put in place in December 2001.
However, Mr. Zitzewitz wasn't
aware of the UBS policy at the time, one of the people said. And he
quickly halted the activity in early September, once regulators
launched a crackdown on improper mutual-fund trading. A spokeswoman
for UBS said in a statement, "As a matter of policy, we do not
comment on client accounts."
The 32-year-old assistant
professor of strategic management, who is teaching at the Columbia
Business School in Manhattan on a one-year leave from Stanford, was
thrust into the spotlight in September by New York Attorney General
Eliot Spitzer. After Mr. Spitzer cited the academic's cost estimates
in his original complaint against Canary Capital Partners LLC, Mr.
Zitzewitz was quoted in several newspaper stories and testified on
the subject before a House subcommittee in November.
He isn't the first academic
to test his theory in the marketplace: Two finance professors from
Georgia universities who researched market-timing strategies and
reached conclusions similar to those of Mr. Zitzewitz have said they
took advantage of price discrepancies in international stock funds.
Those academics traded in their own retirement accounts.
Still, Mr. Zitzewitz's
efforts to profit from such trading flew in the face of the critical
tone he took in describing mutual funds which allowed it. The title
of his October 2002 paper was "Who Cares About Shareholders?
Arbitrage-Proofing Mutual Funds."
And the introduction said in
part, "Despite the fact that this arbitrage opportunity has
been understood by the industry for 20 years and heavily exploited
since at least 1998, the fund industry was still taking only limited
action to protect its long-term shareholders as of mid-2002."
In his congressional testimony, he said funds may have "dragged
their feet" on the issue to help "favored customers."
While timing trades aren't by
themselves illegal, regulators have charged some fund families with
civil violations for allegedly making illegal "quid pro
quo" arrangements to allow certain investors to make timing
trades against the funds' stated policies. However, they aren't
considered as serious a violation as a late trade, which aims to
exploit events that occur after the funds are priced as of 4 p.m.
There isn't any indication that Mr. Zitzewitz made any late trades
or quid pro quo arrangements.
In his October 2002 research
paper, Mr. Zitzewitz estimated that timing trades alone cost other
investors in foreign stock funds 1.14 percentage points in annual
returns in 2001. On a long-term basis, such a drag on performance
could amount to roughly 10% of investors' expected returns from such
funds. Mr. Zitzewitz estimated that cost had risen from 0.56
percentage point in 1998-99.
As recounted in his paper,
Mr. Zitzewitz and other academics had taken their concerns about
mutual funds' lack of response to the stale-price issue to the SEC.
The paper described the SEC as failing to act aggressively to
require funds to update stale prices, and cited mutual-fund industry
pressure as one of the possible reasons.
In mid-2003, just three
months before Mr. Spitzer first announced he was taking action
against the practice, Mr. Zitzewitz launched his trading effort.
Ironically, Mr. Spitzer's lead investigator had contacted Mr.
Zitzewitz around July in an effort to learn more about the subject.
Nothing wrong with overcharging, so long
as everyone else is doing it, right?
"The Mutual Fund Scandal's Next Chapter," by Gretchen
Morgenson, The New York Times, December 7, 2003 --- http://www.nytimes.com/2003/12/07/business/yourmoney/07watc.html
IT'S hard to know where the ever-amazing
mutual fund scandal will take investors next. But here is a clue.
Regulators are setting their sights on two new areas: funds that
fail to price their portfolios properly each day and those charging
excessive fees.
Funds with stale pricing - net asset values
that do not reflect market reality - are coming under scrutiny.
"We are going to make sure that funds are priced properly even
without any indication that there has been abusive market
timing," said Stephen M. Cutler, director of enforcement at the
Securities and Exchange Commission.
Of particular interest are corporate or
municipal bond funds whose net asset values stay mysteriously inert
even as the United States Treasury market is gyrating wildly.
Investors in funds whose net asset values have not reacted to major
moves may be paying or receiving the wrong prices. Moreover, stale
prices in bond funds provide fine opportunities for market timers
who jump in and out of funds to take advantage of out-of-whack
prices.
A case in point is what occurred in the
Treasury market last August. During the first week of the month,
Treasury securities maturing in five years yielded between 3.1
percent and 3.22 percent. The following week, however, Treasuries
fell and their yields moved sharply higher. By Aug. 15, yields on
the 5-year Treasury had jumped to 3.4 percent.
What happens in the United States Treasury
market ripples through other parts of the fixed-income world,
affecting prices in corporate, mortgage-backed and municipal
securities. Yet some bond funds appeared to be oddly impervious to
the August moves. Consider, for example, the Franklin AGE High
Income fund, which invests in speculative-grade debt. From Aug. 8
through Aug. 18, while the yields on Treasuries went from 3.18
percent to 3.4 percent, the Franklin fund's net asset value, the
price at which it is bought and sold, was constant at $1.87, except
for one day when it hit $1.88. And the week of Sept. 8, when
Treasury yields fell from 3.34 percent to 3.14 percent, the Franklin
fund's net asset value stood still at $1.95.
Here's another anomaly. For three weeks
beginning on Aug. 4, the net asset value of the Quaker Intermediate
Municipal Bond fund, which also invests in high-yield debt, remained
at $4.91.
A Franklin spokesman declined to comment on
why the fund did not move; he would say only that it was being
priced correctly. A Quaker spokesman did not return a call seeking
comment.
On the fees front, Mr. Cutler said his
staff was looking closely at stock index funds that levy fees a lot
higher than lower-cost funds like those offered by Vanguard Funds.
The Vanguard 500 Index fund has an expense ratio of 0.18 percent, or
18 basis points.
While the S.E.C. is not in the business of
legislating mutual fund fees, Mr. Cutler said the commission is
interested in hearing how fund boards justify agreeing to pay higher
fees to an adviser for what is essentially fund management on
autopilot.
Consider the MainStay Equity Index fund,
whose investment adviser is New York Life Investment Management. Its
expense ratio is an astonishing 1.02 percent annually. Slightly less
egregious but still expensive is the Northern Stock Index fund,which
charges 0.55 percent annually.
A MainStay spokesman did not return a call
seeking comment.
Lloyd Wennlund, a spokesman for Northern
Trust, manager of the Northern Index Fund, said that it charges
shareholders a fee at or below the median expense ratio of similar
funds. The median expense ratio for Standard & Poor's index
funds, he said, is 57.5 basis points. "We are higher than a
Vanguard, sure," he said, "but our goal is to provide
value to shareholders at a price that is at or below median
pricing."
Nothing wrong with overcharging, so long
as everyone else is doing it, right?
But Wall Street's Lobbyists Still Have a
Firm Grip Where it Counts
While Representative Baker pushes his bill in
the House, the Senate is not expected to take up a measure before next
year. Some lawmakers have filed bills, but Senator Richard Shelby, the
Alabama Republican who heads the Senate banking committee, has said he
is not convinced of the need for new laws.
Stephen Labaton, "S.E.C. Offers Plan for Tightening Grip on
Mutual Funds," The New York Times, November 19, 2003 ---
http://www.nytimes.com/2003/11/19/business/19sec.html
Illegal
or unfair trading isn't hard for directors (or the SEC) to spot, says
New York Attorney General Eliot Spitzer, who brought the first of
these scandals to light. They just have to compare their funds'
total sales with total redemptions. When the two are about the
same, skimming might be going on. I asked Lipper, a
fund-tracking service, to list the larger funds where redemptions
reached 90 to 110 percent of sales. It found 229, some looking
obviously churned.
Jane Bryant Quinn. "Mutual Funds' Greed Machine, Newsweek,
November 24, 2003, Page 45
Churning refers to the practice of
creating two classes of investors by a surprisingly large number of
mutual funds. The favored
traders buy fund shares at “stale prices” that are a few hours old
and lower than “fresh prices.”
They then sell to collect
a “rigged profit.” The
SEC was aware this was going on and allowed it to continue. Why?
What makes the mutual funds scandal such
a big deal is that the savings of half the households in the
U.S.
are at stake here. There
are, however, over six hundred such funds and some have been
responsible.
The tragedy is that now that the scandal is
surfacing in the media and in state courts, the SEC is only wrist
slapping mutual funds. This
is along with the continued wrist slapping of investment banking
(e.g., why is Merrill Lynch still in existence after frauds dating
back to Orange
County?) is the real evidence of industry power over regulators.
Sarbanes-Oxley won’t do it!
It’s still Congress to the core in
Washington
DC
as long as industries have regulators in their well-financed pockets
--- http://faculty.trinity.edu/rjensen/fraud.htm#Cleland
As an example, see what comes of the Senate Hearings on
stock option accounting. The
Senate is where industries take their last-ditch, high-lobby stances
--- http://banking.senate.gov/index.cfm?Fuseaction=Hearings.Detail&HearingID=76
November 14, 2003 Update:
See the lobbying is already paying off --- for Senators
"Senator Urges Caution On Accounting Reform," SmartPros,
November 14, 2003 --- http://www.smartpros.com/x41354.xml
"S.E.C.'s Oversight of Mutual Funds Is Said to Be Lax,"
by Stephen Labaton, The New York Times, November 16, 2003 ---
http://www.nytimes.com/2003/11/16/business/16FUND.html
The Securities and Exchange Commission
failed for years to police the mutual fund industry effectively
because it was captive to the industry when writing new regulations,
was preoccupied by other problems on Wall Street and was severely
short of staff and money, current and former officials say.
"I believe this
is the worst scandal we've seen in 50 years, and I can't say I saw
it coming," said Arthur
Levitt, the former chairman of the Securities and Exchange
Commission for nearly eight years under the Clinton administration.
"I probably worried about funds less than insider trading,
accounting issues and fair disclosure to investors" by public
companies
Continued in the article.
The
more or less unmentioned scandal in the current mutual fund mess is
the scandal of overcharging by many mutual funds. NBC mentioned this
morning that many of the funds have been charging investors more than
they are returning to investors.
If
your fund is charging more than 1%, you should probably investigate
why, and you may not get a straight answer from your broker of fund
advisor.
"SEC knew about dicey
fund pricing: Agency warned of problem for nearly six years, but
did little," by John W. Schoen, MSNBC, September 11, 2003 --- http://www.msnbc.com/news/965075.asp
The
Securities and Exchange Commission has known for nearly six years
about the sloppy pricing of mutual fund shares that one study
estimates is costing individual investors as much as $5 billion a
year, but the agency has initiated only a handful of low-profile
enforcement actions, a review of SEC statements and documents by
MSNBC.com has found.
FOLLOWING
last week’s complaint against four fund companies by New York
Attorney General Eliot Spitzer, the SEC announced that it would
investigate mutual fund pricing practices which have been estimated
to have cost tens of millions of long-term investors billions of
dollars. Spitzer’s investigation found that at least four mutual
fund companies — including Janus, Banc One, Strong and Bank of
America’s NationsFunds — made secret deals with a hedge fund
that allowed it to make rapid fire trades in fund shares at the
expense of individual investors who hold the funds for the long
haul.
Continued
in the article
In
spite of recent, criticisms of the
SEC, the SEC has a great site to look at for starters along with a
cost calculator --- http://www.sec.gov/investor/tools/mfcc/mfcc-int.htm
You
might want to check out http://dir.yahoo.com/Business_and_Economy/Finance_and_Investment/Mutual_Funds/
I
also recommend that you read Ric Edelman’s piece at http://www.ricedelman.com/planning/investing/loadfund_1.asp
This is somewhat dated, but it is a concise summary of how mutual
funds get money from you. I
think you can do better than the 1.5% low end that he talks about,
e.g., see Vanguard at http://www.vanguard.com/
Time
Magazine on November 17, 2003, Page 56 suggests shifting savings
into low cost mutual funds "like Vanguard, Fidelity or T. Rowe
Price." Of course consideration must be given to the tax
consequences if withdrawal values exceed your "cost basis."
Your present fund must disclose both the current value and the cost
basis.
"Market Timing Takes
Toll On Money-Market Funds," by Allicon Bisbey Colter, The
Wall Street Journal, December 3, 2003 ---
http://online.wsj.com/article/0,,SB107050110825510000,00.html?mod=mkts%5Fmain%5Fnews%5Fhs%5Fh
Stock- and bond-fund managers
weren't the only ones grappling with the effects of market timing at
Invesco Funds Group. Managers of the firm's money-market funds,
which invest in short-term debt instruments, also had to contend
with large sums flowing in and out of their portfolios.
Investors who entered into
special arrangements to make frequent, short-term purchases of
Invesco stock and bond funds agreed to park their assets in the
firm's money-market funds between transactions, allowing the firm to
collect big management fees.
The arrangement was lucrative
for Invesco, a unit of Amvescap
PLC, which was able to attract some $900 million of assets from
market timers by mid-2002. But it created havoc for portfolio
managers, who were forced to keep more money in cash, undercutting
the funds' performance, and generating higher trading costs and
additional taxes for long-term investors.
Money-market-fund managers
faced many of the same issues. In a Jan. 15 memorandum to Invesco
President and Chief Executive Raymond Cunningham, the firm's
compliance chief, James Lummanick, noted that timing activity at the
firm was so massive that it hurt the returns of the Invesco
money-market funds by forcing managers to invest in highly liquid
investments to accommodate the large volume of inflows and outflows.
The kinds of instruments
money-market funds invest in, such as commercial paper, banker's
acceptances, repurchase agreements, government securities and
certificates of deposit are all relatively liquid compared to most
stocks and long-term bonds. But generally speaking, the most liquid
securities, such as money that is lent overnight, pay the lowest
interest rates. So keeping large sums in ultra-safe or ultra-short
term debt would tend to undercut the performance of a money-market
fund.
Mr. Lummanick noted in his
memo to Mr. Cunningham that the firm's money-market funds were often
forced to keep 50% of their total assets in overnight repurchase
agreements, which currently yield around 1%.
Of course, the other kinds of
securities money-market funds invest in don't offer much of a pickup
in yields, and so long-term investors aren't necessarily giving up
much in the way of performance when a manager keeps large sums in
overnight repos.
By comparison, stock-fund
managers who keep large sums of money in cash potentially sacrifice
much bigger returns in a rising equity market.
Andrew Clark, a senior
research analyst at fund tracker Lipper, notes that most
money-market funds commit in their prospectuses to invest in
securities with an average maturity of no more than 90 days. But
even if they were to invest in a security with a maturity of two
years, it might not yield much more than 2%.
He said long-term investors
in money-market funds used by market timers to park their cash
"probably get dinged more on trading costs than anything
else."
Still, giving up even a small
amount of return can mean the difference between making money and
losing money in the current low interest-rate environment, where
many money-market funds struggle to generate big enough returns to
cover their management fees. Some firms have been waiving fees on
money-market funds in order to keep their returns in positive
territory.
The seven-day yield on the
average taxable money-market fund was just 0.53% in the week ended
Tuesday, according to iMoneynet. That is just 0.03 percentage point
shy of the all-time low yield of 0.5% for these funds reached on
Aug. 26.
IMoneynet Managing editor
Peter Crane said moving large sums of money in and out of
money-market funds can undercut performance in subtle ways. In
addition to compelling managers to keep more money in highly liquid
securities, it can force them to pay higher prices than they might
otherwise have paid.
That is because the money
markets are much more active in the early morning, when most
managers complete the day's transactions, than in the afternoon.
"As the day goes on, yields drop," Mr. Crane said.
"You've got to almost pay people to take your money late in the
day."
He said fund managers often
know their customer base well enough to plan ahead. In fact,
managers of money-market funds that cater to institutional investors
will often turn new money away late in the day. But managers of
retail money-market funds may not have the luxury of turning away
last-minute inflows from market timers.
Question
What does yield burning mean?
Answer
"IRS Examines
Derivatives Schemes." by John Connor, The Wall Street Journal,
December 4, 2003 --- http://online.wsj.com/article/0,,SB107049507430505200,00.html?mod=mkts_main_news_hs_h
The Internal Revenue Service
is investigating the use of derivatives to implement suspected
"yield-burning" schemes in the municipal-bond market.
In addition, the agency is
seeing instances of apparent bid-rigging of derivatives, a senior
IRS muni-enforcement official said.
The IRS several years ago
joined with the Securities and Exchange Commission and the Justice
Department in taking enforcement action against many Wall Street and
regional brokerage firms for alleged yield-burning abuses --
slapping excessive markups on Treasury securities used in escrow
accounts created in connection with muni advance refunding
transactions. These deals were done in the early 1990s.
The new crop of transactions
under scrutiny seem to be from 1998 forward, IRS officials said. The
SEC also is investigating some of these transactions, according to
people familiar with the matter.
A common denominator in these
more recent transactions is the use of derivatives -- financial
contracts whose value is designed to track the value of stocks,
bonds, currencies, commodities or some other benchmark -- to divert
arbitrage profits to investment bankers and lawyers, said Mark
Scott, director of the IRS's tax-exempt bond program.
Arbitrage is generally barred
in the muni market, where it is earned by investing tax-exempt bond
proceeds in higher-yielding instruments. Arbitrage profits are
supposed to be rebated to the Treasury Department. Yield-burning is
a form of arbitrage abuse.
The IRS's Mr. Scott said it's
not yet clear how pervasive the new, derivatives-related abuses are.
But he said, "We are finding more problems than I
expected." He said the agency's investigation is expanding.
One specific concern involves
the use of put options in advance-refunding escrow accounts. A put
option is a provision in a bond contract under which the investor
has the right -- on specified dates after required notification --
to return the securities to the issuer or trustee at a predetermined
price.
"Recent examinations
involving advance-refunding bonds with put options in the escrow
highlight increasing concerns about the use of derivative-type
products as a more-sophisticated yield-burning or general abusive
arbitrage scheme," said Charles Anderson, manager of the IRS's
tax-exempt-bond field operations. "In the case of a put-option
escrow, there is simply no reasonable need for the purchase of a put
in an escrow that is already sufficient for defeasance of earlier
bonds." He said that "any time people can sell products
paid for with money normally rebatable to Uncle Sam, you will see
the sharks circling."
Messrs. Scott and Anderson
declined to comment on specific cases or securities firms or law
firms.
The IRS settled at least one
put-option escrow case recently and is inviting parties involved in
similar deals to come forward and seek settlements through the
agency's voluntary closing agreement program.
Bob Jensen's threads on derivatives are at http://faculty.trinity.edu/rjensen/caseans/000index.htm
"Investors
First," by William H. Donaldson, The Wall Street Journal,
November 18, 2003, Page A20 ---
Among its many roles, the
Securities and Exchange Commission has two critical missions. The
first is to protect investors, and the second is to punish those who
violate our securities laws. Last week's partial settlement of the
SEC's fraud case against the Putnam mutual-fund complex does both.
It offers immediate and significant protections for Putnam's current
mutual-fund investors, serving as an important first step. Moreover,
by its terms, it enhances our ability to obtain meaningful financial
sanctions against alleged wrongdoing at Putnam, and leaves the door
open for further inquiry and regulatory action.
Despite its merits, the
settlement has provoked considerable discussion, and some criticism.
Unfortunately, the criticism is misguided and misinformed, and it
obscures the settlement's fundamental significance.
By acting quickly, the SEC
required Putnam to agree to terms that produce immediate and lasting
benefits for investors currently holding Putnam funds. First, we put
in place a process for Putnam to make full restitution for investor
losses associated with Putnam's misconduct. Second, we required
Putnam to admit its violations for purposes of seeking a penalty and
other monetary relief. Third, we forced immediate, tangible reforms
at Putnam to protect investors from this day forward. These reforms
are already being put into place, and they are working to protect
Putnam investors from the sort of misconduct we found in this case.
Among the important reforms
Putnam will implement is a requirement that Putnam employees who
invest in Putnam funds hold those investments for at least 90 days,
and in some cases for as long as one year -- putting an end to the
type of short-term trading we found at Putnam. On the corporate
governance front, Putnam fund boards of trustees will have
independent chairmen, at least 75% of the board members will be
independent, and all board actions will be approved by a majority of
the independent directors.
In addition, the fund boards
of trustees will have their own independent staff member who will
report to and assist the fund boards in monitoring Putnam's
compliance with the federal securities laws, its fiduciary duties to
shareholders, and its Code of Ethics. Putnam has also committed to
submit to an independent review of its policies and procedures
designed to prevent and detect problems in these critical areas --
now, and every other year.
This settlement is not the
end of the Commission's investigation of Putnam. We are also
continuing to examine the firm's actions and to pursue additional
remedies that may be appropriate, including penalties and other
monetary relief. If we turn up more evidence of illegal trading, or
any other prohibited activity, we will not hesitate to bring
additional enforcement actions against Putnam or any of its
employees. Indeed, our action in federal court charging two Putnam
portfolio managers with securities fraud is pending.
There are two specific
criticisms of the settlement that merit a response.
First, some have charged that
it was a mistake not to force the new management at Putnam to agree
that the old management had committed illegal acts. In fact, we took
the unusual step of requiring Putnam to admit to liability for the
purposes of determining the amount of any penalty to be imposed. We
made a decision, however, that it would be better to move quickly to
obtain real and practical protections for Putnam's investors, right
now, rather than to pursue a blanket legal admission from Putnam.
The SEC is hardly out of the mainstream in making such a decision.
All other federal agencies, and many state agencies (including that
of the New York attorney general), willingly and regularly forgo
blanket admissions in order to achieve meaningful and timely
resolutions of civil proceedings.
Second, some have criticized
the Putnam settlement because it does not address how fees are
charged and disclosed in the mutual fund industry. While this issue
is serious, the claim is spurious. The Putnam case is about
excessive short-term trading by at least six Putnam management
professionals and the failure of Putnam to detect and deter that
trading. The amount and disclosure of fees is not, and never has
been, a part of the Putnam case, and thus it would be wholly
improper to try to piggyback the fee-disclosure issue on an
unrelated matter
Continued in the article.
A Message from Eliot Spitzer, Attorney
General of New York , New York Times, November 17, 2003
With
two decisions in the last two weeks, the Bush administration has
sent its clearest message yet that it values corporate interests
over the interests of average Americans. In the Securities and
Exchange Commission
'
s settlement with Putnam Investments, the public comes away
short-changed. In the Environmental Protection Agency
'
s decision to forgo enforcement of the Clean Air Act, the public
comes away completely empty-handed.
The
95 million Americans who invest in mutual funds paid more than $70
billion in fees in 2002. These fees
went to an industry that did not take seriously its responsibility
to safeguard investors
'
money. Investors are now rightly
concerned about whether those mutual funds that breached their
fiduciary duties will be required to refund the exorbitant fees they
took, and what mechanism will be put in place to ensure that the
fees charged in the future are fair.
Unfortunately,
the S.E.C.
'
s deal with Putnam does not provide a satisfactory answer to these
questions. Instead, it raises new questions.
The
commission
'
s first failure is one of oversight. The mutual fund investigation
began when an informant approached our office with evidence of
illegal trading practices. Tipsters also approached the commission,
which is supposed to be the nation
'
s primary securities markets regulator, but the commission simply
did not act on the information.
The
commission
'
s second failure was acting in haste to settle with Putnam even
though the investigation is barely 10 weeks old and is yielding new
and important information each day. Whether the commission
recognizes it or not, the first settlement in a complex
investigation always sets the tone for what follows. In this case,
the bar is set too low.
The
Putnam agreement does contain a useful provision mandating that the
funds
'
board of directors be more independent of the management companies
that run its day-to-day operations. It also talks of fines and
restitution, but leaves for another day the determination of the
amount Putnam should pay.
Most
important, the agreement does not address the manner in which the
fees charged to investors are calculated. Nor does it require the
fund to inform investors exactly how much they are being charged —
or even provide a structure that will create market pressure to
reduce those fees. Finally, there is no discussion of civil or
criminal sanctions for the managers who acted improperly by engaging
in or permitting market timing and late trading.
S.E.C.
officials are now saying that they may be interested in additional
reforms. But by settling so quickly,
they have lost leverage in obtaining further measures to protect
investors. After reviewing this
agreement, I can say with certainty that any resolution with my
office will require concessions from the industry that go far beyond
what the commission obtained from Putnam.
It
is not surprising that the commission would sanction a deal that
ignores consumers and is unsatisfactory to state regulators. Just
look at the Bush administration
'
s decision to abandon pending enforcement actions and investigations
of Clear Air Act violations.
Even
supporters of the Bush administration
'
s environmental policy were stunned when the E.P.A. announced that
it was closing pending investigations into more than 100 power
plants and factories for violating the Clean Air Act — and
dropping 13 cases in which it had already made a determination that
the law had been violated.
Regulators
may disagree about what our environmental laws should look like. But
we should all be able to agree that companies that violated
then-existing pollution laws should be punished.
Those
environmental laws were enacted to protect a public that was
concerned about its health and safety. By letting companies that
violated the Clean Air Act off the hook, the Environmental
Protection Agency has effectively issued an industry-wide pardon.
This will only embolden polluters to continue practices that harm
the environment.
My
office had worked with the agency to investigate polluters, and will
continue to do so when possible. But today a bipartisan coalition of
14 state attorneys general will sue the agency to halt the
implementation of weaker standards. In addition, we will continue to
press the lawsuits that have been filed. We have also requested the
E.P.A. records for the cases that have been dropped, and will file
lawsuits if they are warranted by the facts.
Similarly,
my office — while committed to working with the Securities and
Exchange Commission in our investigation of the mutual fund industry
— will not be party to settlements that fail to protect the
interests of investors and let the industry off with little more
than a slap on the wrist.
The
public expects and deserves the protection that effective government
oversight provides. Until the Bush administration shows it is
willing to do the job, however, it appears the public will have to
rely on state regulators and lawmakers to protect its interests.
Eliot Spitzer is attorney
general of New York
"State regulators blast SEC funds
deal," MSNBC, November 14, 2003 --- http://www.msnbc.com/news/993660.asp?0dm=C11JB
In the widening probe
of mutual fund trading fraud, the fault line between the Securities &
Exchange Commission and two state attorneys general widened Friday, after
federal regulators blessed a partial settlement with Putnam Investments that
state regulators said let the mutual fund giant off too easy. Meanwhile, the
scandal spread to Charles Schwab, which said it had found some of its traders
had placed “late trades” that allowed them to profit at the expense of
Schwab fund customers.
THE SEC scrambled
Friday to counter criticisms that its regulators have done too little, too late
to clean up the $7 trillion mutual fund industry, which manages savings and
retirement investments for half of all U.S. households. CNBC reported that the
SEC will announce a “major enforcement action” in the scandal as soon as
Monday. Sources say the action will target Morgan Stanley. At issue are payments
Morgan Stanley allegedly received from mutual fund companies to sell their funds
to Morgan Stanley’s customers. The customers were apparently never told about
the payments. So a customer might be steered into a specific fund by his broker,
not knowing that Morgan Stanley was being paid to market the fund. A source says
the action will involve a significant amount of money.
PLAYING
CATCH-UP
But the SEC has been
playing catch-up in the mutual fund trading scandal since New York Attorney
General Eliot Spitzer leveled his first round of charges three months ago in a
widening probe that has uncovered fraudulent mutual-fund trading practices
throughout the industry. The SEC had been aware of the problem for nearly six
years, issuing warnings to the industry to clean up its act as far back as 1997.
But, until Spitzer moved, federal regulators failed to take significant action
against the well-heeled mutual fund industry to stop the practices.
Continued in the article.
"Is the Mutual Fund Issue Abuses, or Is It Fees?" by
Floyd Norris, The New York Times, November 19, 2003 ---
http://www.nytimes.com/2003/11/19/business/19place.html
The coming battle over mutual fund
regulation may well end up focusing not on trading abuses, which are
now the subject of regulatory action, but on the fees and costs that
funds charge investors.
Much may hinge on who will make the
decisions on how the rules will change.
William H. Donaldson, the chairman of the
Securities and Exchange Commission, yesterday laid firm claim to
mutual fund turf, and in the process voiced disapproval of the
possibility that state regulators like Eliot Spitzer, the New York
attorney general, might try to set new rules.
If Mr. Donaldson gets his way, the likely
results will be a lowering of fees and more disclosure of what
investors are paying.
That probably will reduce the profitability
of the fund industry while increasing the returns for those who
invest in the funds.
It is not clear if Mr. Spitzer will be
content to offer suggestions and criticisms, while deferring to the
S.E.C. in the end, or whether he will try to mandate reforms through
negotiated settlements of civil, or even criminal charges, brought
against mutual fund companies.
Nor is it clear whether Congress will be
content to let the S.E.C. act, or whether legislation will be passed
regarding fees.
In testimony before the Senate Banking
Committee yesterday, Mr. Donaldson indicated that the commission
would bring more disciplinary actions over the issue of payment for
"shelf space,'' in which funds pay brokerage firms to push
their funds. That was part of the case against Morgan
Stanley that was settled with the S.E.C. on Monday.
"Morgan Stanley's customers did not
know about these special shelf-space payments, nor in many cases did
they know that the payments were coming out of the very funds into
which these investors were putting their savings," Mr.
Donaldson told the Senate committee.
He added that the S.E.C. was now
investigating such payments at 15 brokerage firms "to determine
exactly what payments are being made by funds, the form of those
payments, the shelf space benefits that broker-dealers provide, and
most importantly, just what these firms tell their investors about
these practices." He said the commission was also "looking
very closely at the mutual fund companies themselves," hinting
they might face suits over the same payments.
The issue of fund fees, particularly their
disclosure, had been pending at the S.E.C. for some time, with an
expectation that new rules would be developed. But until the Morgan
Stanley action the commission had not taken disciplinary action.
The fee issue was inserted into the debate
over trading abuses by Mr. Spitzer, who criticized the commission
for reaching a partial settlement with Putnam Investments without
doing anything about fees.
In an Op-Ed article that appeared in The New
York Times on Monday, Mr. Spitzer denounced the "exorbitant
fees" that Putnam charged and said the settlement "does
not address the manner in which the fees charged to investors are
calculated.''
"Nor," he added, "does it
require the fund to inform investors exactly how much they are being
charged - or even provide a structure that will create market
pressure to reduce those fees."
Mr. Donaldson responded to that argument in
his own op-ed article, published in The Wall Street Journal
yesterday, in which he said Putnam's violations did not involve
fees.
"Those lacking rule-making authority
seem to want to shoehorn the consideration of the fee-disclosure
issues into the settlement of lawsuits about other subjects,"
Mr. Donaldson wrote. "But we should not use the threat of civil
or criminal prosecution to extract concessions that have nothing to
do with the alleged violations of the law."
Mr. Spitzer, in an interview yesterday,
said Mr. Donaldson was taking too narrow a view in separating
excessive fees from trading abuses. "They really should be
viewed as a set of issues that are woven together by the common
thread of failed mutual fund governance," he said. The S.E.C.'s
solution, Mr. Donaldson indicated in his testimony, is likely to be
much better disclosure of fees and other costs. He promised S.E.C.
action next month to require better disclosure of costs in
confirmation statements sent to investors when they buy fund shares,
but set no date for consideration of actions on other cost-related
issues, like the use of "soft-dollar" commissions to buy
services or the practice of using commissions to "facilitate
the sale and distribution of fund shares."
Better disclosure would probably cause some
money to move to lower-cost funds, but it is worth noting that
institutional investors, who presumably understand what they are
doing, in recent years have put much more money into hedge funds,
where fees are very high, in hopes of earning higher returns. Even
well-informed individuals might make similar choices among mutual
funds.
Continued in the article.
$50 Million is Peanuts at Morgan Stanley
"Morgan Stanley to
Settle With SEC," by Deborah Solomon and Tom Lauriciell, The Wall
Street Journal, November 17, 2003 --- http://online.wsj.com/article/0,,SB106902376181774100,00.html?mod=mkts_main_news_hs_h
Morgan
Stanley is expected to pay a $50
million civil penalty as part of an agreement with the Securities
and Exchange Commission to settle charges relating to the way the
firm sold mutual funds, according to people familiar with the
matter.
In charges likely to be
announced Monday, the SEC plans to accuse Morgan Stanley of
conflicts of interest in the selling of funds to investors,
including directing investors to certain funds based on commissions
the firm received. Morgan also is expected to say it will change
some of its business practices as part of the settlement.
The charges against Morgan
Stanley -- which have been expected -- are likely to be only the
first in a series of SEC moves stemming from its probe into
mutual-fund sales practices. The SEC is examining more than 15
brokerage firms, and is looking in part at how brokers are
compensated for selling funds. The agency also has been examining
whether some fund companies agreed to direct orders for
stock-and-bond trading to brokerage houses that in turn agreed to
promote sales of the fund companies' products, according to people
familiar with the probe.
(See related article.)
Continued in the article.
"Morgan Stanley
Settles, But Woes Linger," by Tom Lauricella, The Wall Street
Journal, November 18, 2003 ---
http://online.wsj.com/article/0,,SB106908566324425800,00.html?mod=2%5F1050%5F1
Alleging significant
wrongdoing in how a major Wall Street firm has sold mutual funds to
investors, the Securities and Exchange Commission charged Morgan
Stanley with a companywide failure to tell clients that it paid
its brokers more to sell certain mutual funds that were more
profitable to the firm.
In addition, in a case that
was expected, the SEC said Morgan Stanley often failed to tell
clients important information about the purchase of certain types of
mutual-fund shares that would, in some circumstances, end up costing
the investors more in fees while giving Morgan Stanley brokers a
bigger commission payment.
Morgan Stanley settled the
civil charges without admitting or denying wrongdoing. It will pay
$50 million, which will be put aside to reimburse Morgan Stanley
clients affected by the sales practices. Morgan Stanley will also
have to take steps to accommodate clients who were put into
inappropriate fund-share classes.
"Few things are more
important to investors than receiving unbiased advice from their
investment professionals -- or knowing that what they're getting may
not be unbiased," Stephen Cutler, director of the SEC's
enforcement division said at a news conference announcing the
charges. "In plain and simple terms, Morgan Stanley's customers
were not informed of the extent to which Morgan Stanley was
motivated to sell them a particular fund."
Continued in the article.
"The funds stank anyway:
Several funds tagged by market timers or late traders were long-term
underperformers."
by Jeanne Sahadi, CNN Money, November 7, 2003 --- http://money.cnn.com/2003/11/07/funds/fundsfire_fundperformance/index.htm
If you own one of the mutual funds alleged to have
been market-timed or late traded, why not channel your anger productively and
realize what the scandal really has brought to light: That a lot of the funds
implicated so far haven't been a great place for your money anyway.
At least judging by long-term performances.
To date, 39 funds have been identified either by
regulators or a fund family as being targets of market timers or late traders.
(Track the funds here.)
There are plenty of others, though.
In fact, the SEC has said as many as half of fund
companies have had market-timing arrangements. And in cases where firms such
as Prudential had brokers that were alleged to have facilitated improper
trades, they had access to a broad group of funds.
Using Morningstar data, we looked at the three-,
five- and 10-year performance records of the 39 funds that have been named to
see how their performance compared with that of their peers.
We found that 15 of the funds ranked in the bottom
half of their categories for two to three of those periods. And of those 15
funds, eight ranked in the bottom quarter for at least one of those periods.
One of the worst
offenders was OneGroup LargeCap Value (OLVAX),
which ranked in the 96th percentile of its category on a three-year basis; in
the 76th percentile over five years; and in the 77th percentile over 10 years.
Other funds that were
bottom performers for all three periods: Janus Enterprise (JAENX)
(which took above-average risk and delivered three-year returns that were
nearly 12 percentage points below its category average); Nations Value (NVLEX);
OneGroup Diversified Equity (PAVGX)
; OneGroup Diversified Midcap (PECAX),
and OneGroup Equity Income (OIEIX).
Alger SmallCap (ALSAX),
meanwhile, which doesn't have a 10-year record yet, ranked in the 98th
percentile of its peers over five years, with a return that fell more than 13
percentage points below its category average.
By contrast, only seven of the 39 funds ranked in the
top half of their categories for two to three of the time periods measured. Of
those, only four ranked in the top quarter for more than one time period.
The best performer in
these respects was Putnam International Equity (POVSX),
which was the only fund to have ranked in the top half of its category for all
three periods. It ranked in the 47th percentile of its category over three
years; in the 8th percentile over five years; and in the 2nd percentile over a
10-year time horizon.
"Actions by Bear
Stearns, SchwabBroaden Mutual-Fund Scandal," by Randall Smith, The
Wall Street Journal, November 17, 2003 ---
http://online.wsj.com/article/0,,SB106881837539468700,00.html?mod=home_whats_news_us
The mutual-fund trading
scandals continue to spread, with Bear
Stearns Cos., one of Wall Street's top trading operations, and Charles
Schwab Corp., a familiar name among Main Street investors, the
latest to discover possible improprieties.
Bear Stearns, a big financial
company that processes trades for dozens of other brokerage firms,
quietly fired four brokers and two assistants last week in an action
related to mutual-fund trading activity. Charles Schwab, which
popularized mutual-fund investment through a pioneering
"supermarket" of funds, disclosed it had found a
"limited number of instances" of questionable trading as
well as other issues at its U.S. Trust Co. unit.
The involvement of Bear
Stearns and Schwab underlines how big brokerage firms are now being
drawn into the mutual-fund trading scandals, which once centered
mainly on fund-management companies and a handful of aggressive
hedge funds. Morgan
Stanley, another big Wall Street firm, is expected to announce a
$50 million settlement with the Securities and Exchange Commission
related to the way the company sold mutual funds to individual
investors, according to people familiar with the matter. In all,
more than a dozen financial companies face allegations related to
misconduct in selling or trading mutual funds.
Question
If you are into a mutual
fund, what questions should
you ask your broker or
advisor?
Answer:
Colleen Sayther provides a rather nice set of questions to ask your broker or
advisor in the November 13, 2003 FEI Express newsletter at http://www.fei.org/newsletters/feixp/
Non-members of the FEI can register for free access.
THE
SEC BLASTED the
Big Board for failing to police its floor-trading firms. According to
a confidential report, about 2.2 billion shares were improperly traded
over the past three years, costing investors more than $150 million. The
SEC is examining if Grasso engaged in "influence
trading" by pressuring an NYSE floor firm to buy more AIG shares.
The Wall Street Journal, November 3, 2003 ---
http://online.wsj.com/article/0,,SB10678146664412100,00.html?mod=home_whats_news_us
The Quattrone trial provoked some soul searching in Silicon Valley, as the
proceedings revealed unflattering details of the cowboy culture that
predominated during the tech bubble.
"Quattrone Case Aired '90s Excesses," by Ann Grimes, The
Wall Street Journal, October 27, 2003 --- http://online.wsj.com/article/0,,SB10671934043114400,00.html?mod=technology%255Ffeatured%255Fstories%255Fhs
Silicon Valley breathed a sigh of relief
when a federal judge declared a mistrial Friday in a trial of one of
its own, former top Credit Suisse First Boston investment banker
Frank Quattrone, on charges of obstruction of justice and witness
tampering.
But Silicon Valley's entrepreneurs, bankers
and venture capitalists might not want to break out the bubbly so
fast.
While Mr. Quattrone's fate hinged narrowly
on whether he intended for his staff nearly three years ago to
destroy documents amid two government investigations and a
grand-jury inquiry into the Credit Suisse Group unit's allocations
of initial public offerings of stock, the backdrop included the
excesses of the late 1990s tech-stock bubble. And the picture that
emerged of Silicon Valley during the trial was of a cowboy culture,
with insiders known as "Friends of Frank" receiving
lucrative allocations of the hottest IPOs.
"The practices that were revealed are,
frankly, not very flattering," says Charles M. Elson, director
of the John L. Weinberg Center for Corporate Governance at the
University of Delaware. While "the Valley always has been
viewed very positively -- the innovation, the exuberant spirit"
-- what emerged from the trial, he says, is a "tarnished
version" of a group "that acted in economic
self-interest."
Few here dispute that the homegrown
scandal, following other corporate trials, has turned an
uncomfortable spotlight on this codependent community of
entrepreneurs, investment bankers, analysts, lawyers and venture
capitalists. As a result, self-examination about how things get done
here -- which began with the tech meltdown itself and gained steam
with the postbubble inquiries into the IPO-allocation practices --
has reintensified.
"We, as board members and investors,
need to be more proactive in addressing a myriad of topics,
including diversity, governance, corporate performance and impact on
the communities that we serve," says Jim Breyer, a general
partner at Accel Partners in Palo Alto, Calif.
Now, amid signs of revived tech-sector
investing including new initial public offerings, that mindset will
be put to the test.
Mr. Quattrone's trial posed an
"obvious challenge to the Silicon Valley culture of
friendships, networking and partnerships," says Kirk O. Hanson,
a business professor and director of the Markkula Center for Applied
Ethics at Santa Clara University. That culture, widely viewed as the
valley's unique strength, also is its weakness, he says, especially
when "an extra portion of the wealth created is directed to
insiders."
To be sure, some things have changed in the
valley. As part of Wall Street's $1.4 billion settlement this past
spring over too-bullish stock analysis, securities regulators
formally banned "spinning," under which securities firms
allocate coveted IPO shares to the personal accounts of corporate
executives to induce them to direct their companies'
investment-banking business to the firms.
Entrepreneurs report that venture
capitalists are checking the books more thoroughly before investing
in start-ups. These days, many founders are required to reach
specific milestones -- either in product development or new
customers -- before more money is handed over. The mantra among
entrepreneurs and investors is that they are building "real
companies," not just quick-exit, get-rich entities to be
flipped onto an unwitting public. At search engine Google Inc.,
Chief Executive Eric Schmidt says the Santa Clara, Calif., company
wants to send a message: "Product does matter." Google
executives have said they would like to offer shares as widely as
possible, people close to the situation said last week. One
possibility there: the "Dutch auction" system, whereby
market bids, not bankers, determine an offering price. The Financial
Times reported last week that Google is considering an online
auction of its shares.
Continued in the article.
The mutual-fund scandal is spreading, as it becomes clear that
players throughout the $7 trillion industry face scrutiny for improper
practices that are turning out to be surprisingly common.
"For Staid Mutual-Fund Industry, Growing Probe Signals Shake-Up:
Investigators Find Indications Of Widespread Abuses Hurting Small
Investors," by Tom Lauricella, The Wall Street Journal,
October 20, 2003 ---
http://online.wsj.com/article/0,,SB106659857633625700,00.html?mod=todays%255Fus%255Fpageone%255Fhs
The mutual-fund scandal is
spreading, as it becomes clear that players throughout the $7
trillion industry could face scrutiny for improper practices that
are turning out to be surprisingly common.
On Thursday, Massachusetts
securities regulators signaled that they are investigating whether
employees at three big mutual-fund companies -- Fidelity
Investments, Morgan
Stanley and Franklin
Resources Inc. -- helped brokers get around prohibitions on
short-term trading in their funds. The same day, state prosecutors
in New York who have spearheaded a growing criminal investigation of
the fund business, notched their first conviction of a mutual-fund
executive: a former senior official with Fred Alger Management Inc.,
who pleaded guilty to obstructing the probe (See
article).
New York Attorney General
Eliot Spitzer, having earlier forced changes in the way analysts at
brokerage firms operate, now says he intends to use the mutual-fund
investigation to clean up another part of the financial world that
has favored large clients at the expense of smaller ones, including
millions of workers and retirees. The Securities and Exchange
Commission, scrambling to keep up with him, as it did during the
investigation of Wall Street analysts, is now filing civil suits of
its own and is considering possible new rules aimed at preventing
misbehavior in mutual-fund trading.
Industry heads have begun to
roll. Top mutual-fund executives at Bank
of America Corp. and Bank
One Corp. have lost their jobs because of allegations of
questionable rapid trading at those firms. Alliance
Capital Management Holdings LP suspended a veteran portfolio
manager who ran one of the country's largest technology-stock funds.
The widening debacle -- which
could shake investor confidence and lead to significant changes in
mutual-fund rules -- is rooted in a paradox that has dogged the
industry since its birth nearly 80 years ago. The central attraction
of mutual funds is that they offer the opportunity to buy shares in
a single investment that reflects the composite value of dozens, or
even hundreds, of individual securities
Continued in the Article
Investment Banking, Banking, Brokerage, and Security Analysis
That some bankers have
ended up in prison is not a matter of scandal, but what is outrageous is the
fact that all the others are free.
Honoré de Balzac
Bankers bet with their bank's capital, not
their own. If the bet goes right, they get a huge bonus; if it
misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital
Louria Hahn, "Missing: How Poor Risk-Management Techniques
Contributed to the Subprime Mess," CFO Magazine, March 2008,
Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Government bailed out these crooks with taxpayer funds
makes it all the worse.
Wall Street
Remains Congress to the Core
The boom in corporate mergers is
creating concern that illicit trading ahead of deal announcements is
becoming a systemic problem. It is against the law to trade on
inside information about an imminent merger, of course. But an
analysis of the nation’s biggest mergers over the last 12 months
indicates that the securities of 41 percent of the companies
receiving buyout bids exhibited abnormal and suspicious trading in
the days and weeks before those deals became public. For those who
bought shares during these periods of unusual trading, quick gains
of as much as 40 percent were possible.
Gretchen Morgenson, "Whispers of Mergers Set Off Suspicious
Trading," The New York Times, August 27, 2006 ---
Click Here |
From the CFO Journal's Morning Ledger on May 26,
2016
Bankers rarely do time
The Wall
Street Journal examined 156 criminal and civil cases brought by the Justice
Department, Securities and Exchange Commission and Commodity Futures Trading
Commission against 10 of the largest Wall Street banks since 2009. In 81% of
those cases, individual employees were neither identified nor charged. A
total of 47 bank employees were charged in relation to the cases. One was a
boardroom-level executive, the Journal’s analysis found. The analysis shows
not only the rarity of proceedings brought against individual bank
employees, but also the difficulty authorities have had winning cases they
do bring.
"Why Are Some Sectors (Ahem, Finance) So Scandal-Plagued?" by Ben W.
Heineman, Jr., Harvard Business Review Blog, January 10, 2013 ---
Click Here
http://blogs.hbr.org/cs/2013/01/scandals_plague_sectors_not_ju.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date
Jensen Comment
The Big Banks and Wall Street in general will not learn until people are sent to
jail. Until then the fines are just company money.
From the CFO Journal's Morning Ledger on May 21,
2015
Banks to pay $5.6 billion in probes
http://www.wsj.com/articles/global-banks-to-pay-5-6-billion-in-penalties-in-fx-libor-probe-1432130400?mod=djemCFO_h
The five big banks will plead guilty to criminal
charges to resolve a U.S. investigation into whether traders colluded to
move foreign-currency rates for their own benefit. Four of the banks, Barclays PLC, Citigroup
Inc., J.P. Morgan Chase & Co. and Royal
Bank of Scotland Group PLC, pleaded guilty
on
Wednesday to conspiring to manipulate prices in the $500
billion-a-day market for U.S. dollars and euros, authorities said. The fifth
bank, UBS AG, received immunity in the antitrust case but
pleaded guilty to manipulating the London interbank offered rate, or Libor.
It will pay a fine for violating an earlier accord meant to resolve those
allegations of misconduct.
From the CFO Journal's Morning Ledger on May 21,
2015
Barclays fined for alleged manipulation of ISDAfix.
Barclays PLC was
fined $115 million by the Commodity Futures Trading Commission, which said
in a statement that Barclays’s U.S. traders attempted to manipulate the U.S.
dollar iteration of ISDAfix, or the International Swaps and Derivatives
Association Fix, between 2007 and 2012. A group of other financial
institutions including interdealer broker ICAP PLC have
said they are under investigation for alleged manipulation of the ISDAfix
rate.
Insider Trading ---
https://en.wikipedia.org/wiki/Insider_trading
"How the Feds Pulled Off the Biggest Insider-Trading Investigation in U.S.
History." by Patricia Hurtado & Michael Keller, Bloomberg, June 1,
2016 ---
http://www.bloomberg.com/graphics/2016-insider-trading/?cmpid=BBD060116_BIZ&utm_medium=email&utm_source=newsletter&utm_campaign=
For more than seven years, the U.S. government has
relentlessly prosecuted Wall Street traders who used inside information to
rake in hundreds of millions of dollars in profits.
Federal prosecutors in New York have racked up 91
convictions and collected almost $2 billion in fines. In the latest action
on May 19, the government looked beyond Wall Street, accusing a legendary
Las Vegas gambler of profiting from insider tips.
Here's a by-the-numbers look at what happens when
the Feds get serious about insider trading.
The suspects worked in what prosecutors described
as rings — loose and sometimes overlapping groups of insiders, traders, and
facilitators.
This arrangement, however, was also their undoing.
Adopting tactics used against mobsters and narcoterrorists, the FBI
infiltrated these rings using wiretaps and informants to work their way
further up the chain.
Continued in article
Bob Jensen's
Fraud Updates
---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's Rotten to
the Core Threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
They say that
patriotism is the last refuge
To which a scoundrel clings.
Steal a little and they throw you in jail,
Steal a lot and they make you king.
There's only one step down from here, baby,
It's called the land of permanent bliss.
What's a sweetheart like you doin' in a dump like this?
Lyrics of a Bob Dylan song forwarded by Amian Gadal
[DGADAL@CI.SANTA-BARBARA.CA.US]
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
The trouble with crony capitalism isn't capitalism. It's the cronies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#CronyCapitalism
Subprime: Borne of Greed, Sleaze, Bribery, and Lies (including the credit
rating agencies) ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
History of
Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Imagine the outrage for such death sentences in
the USA --- It will never happen!
Two Vietnam bank executives sentenced to death
in bank fraud ---
Click Here
http://www.fcpablog.com/blog/2014/4/4/two-vietnam-execs-sentenced-to-death-in-bank-fraud.html?cm_em=rjensen@trinity.edu&cm_mmc=AICPA-_-CheetahMail-_-globalcpa_041614_AIAPR1134-_-APR1
The End of Banking
by Jonathon McMillan
ZeroOne Economics ZMBH
2014
http://www.endofbanking.org/the-author/
What is it about? ---
http://www.endofbanking.org/book/
The End of Banking explains why a financial system
without banking is both desirable and possible in the digital age.
- The first part of the book presents the
functions and the mechanics of traditional banking. It discusses how a
delicate balance of government guarantees and banking regulation kept
the flaws of banking under control in the industrial age.
- The second part explains how the digital
revolution unsettled this balance. The rise of shadow banking is
explained, and it is shown how an unsustainable boom in the shadow
banking sector led to a banking panic: the financial crisis of 2007-08.
- The third part shows that the digital
revolution has played a dual role. Information technology not only
undermined the effectiveness of current banking regulation, but it also
rendered banking redundant. An innovative blueprint for a modern
financial system is presented and the implications of the end of banking
are discussed.
Table of contents
List of Illustrations
List of Acronyms
Preface
Introduction
PART ONE – BANKING IN THE INDUSTRIAL AGE
1. The Need for Banking
2. The Mechanics of Traditional Banking
3. The Problems with Banking
PART TWO – BANKING IN THE DIGITAL AGE
4. Banking Is Not Limited to Banks
5. The Mechanics of Shadow Banking
6. The Financial Crisis of 2007–08
7. The Financial System after 2008
PART THREE – A FINANCIAL SYSTEM FOR THE DIGITAL AGE
8. Banking Is No Longer Needed
9. Accounting for the Future: End Banking
10. The Role of the Public Sector
11. The Big Picture
Quotation from
http://www.endofbanking.org/the-author/
. . .
What happened in the financial services industry is
the opposite of what happened in many other service industries, for example,
accommodation, catering, or transportation. Just think of how simple renting
a room, choosing a restaurant or taking a taxi ride have become with
innovative companies such as AirBnB, Yelp or Uber. Innovation has made life
much easier and services much more transparent.
Not so in the financial sector: Innovation made the
financial system much more complex, opaque, inefficient, and fragile.
Continued in article
From the CFO Journal's Morning
Ledger on August 19, 2015
J.P. Morgan expected to settle with SEC on investment-steering case
http://www.wsj.com/articles/j-p-morgan-expected-to-settle-with-sec-on-investment-steering-case-1439924418?mod=djemCFO_h
J.P. Morgan Chase & Co. is in advanced talks
with the Securities and Exchange Commission to pay more than $150 million to
resolve allegations it inappropriately steered private-banking clients to
its own investment products without proper disclosures. The WSJ’s Emily
Glazer and Jean Eaglesham report that the settlement could be announced
within the next few weeks, according to people familiar with the matter.
From the CFO Journal's Morning
Ledger on August 19, 2015
Citigroup to return $4.5 million more in fee overcharges
http://www.reuters.com/article/2015/08/19/us-citigroup-nyag-fees-idUSKCN0QO04320150819?mod=djemCFO_h
Citigroup Global Markets Inc (CGMI), a unit of
Citigroup Inc. struck an agreement with the New York attorney general to
return $4.5 million in account management fees charged on some 15,000 frozen
accounts,
Reuters reports. More than $20 million will be
refunded to Citi customers for overcharges in an investigation initiated by
New York Attorney General Eric Schneiderman. In October, CGMI agreed return
some $16 million to more than 31,000 customers who paid higher advisory fees
than negotiated.
Jensen Comment
Paying fines for unethical or illegal acts is now just a cost of doing business
for big banks. Nothing is shocking about bank bad behavior these days.
Efficient Market Hypothesis (EMH) ---
http://faculty.trinity.edu/rjensen/Theory01.htm#EMH
"Why Those Guys Won the Economics Nobels," by Justin Fox, Harvard
Business Review Blog, April 2, 2014 ---
http://blogs.hbr.org/2014/04/why-those-guys-won-the-economics-nobels/
Jensen Comment 1
They won their Nobel Prizes on the assumption of the speed and fairness to which
stock markets react under the Efficient Market Hypothesis (EMH). In the recent
furor raised by Michael Lewis regarding high speed robot traders allegedly
skimming profits it will be interesting to see how Fama, Shiller, and Hansen
react to defend High Speed Trading in theory --- I assume they will come
to the defense of HSP for the sake of the EMH.
The may wait for the FBI and SEC findings, however, before they defend the
HSP as currently implemented and maligned by Machael Lewis.
Jensen Comment 2
When I had almost no money, while in college, I was a very, very small
time call options investor and sometimes went to a brokerage firm to watch the
NYSE trading prices flashing by on an electronic ribbon. In those days those
were the up-to-the-moment trading prices. Now they're misleading phony prices
that are skimmed by higher-speed robots that beat your orders in microseconds to
13 public exchanges armed with your bid or ask price just to steal some of your
money. Thank you Michael Lewis and the clever detectives you write about who
discovered how these high speed robots are ripping off investors --- no thanks
to the obsolete SEC.
In simple terms here's how the high speed robots
work using an analogy form one of the detectives described in 60 Minutes
segment. If you want to buy four online tickets for an event a robot detects
your order for four tickets costing at an unknown cost not to exceed $25
apiece.. Your order is immediately filled for only two tickets at $20 apiece.
The robot buys the adjoining two tickets for $20 apiece and makes them available
for $25 apiece. In the completed transaction you pay $90 for the four tickets.
High speed skimming ripoffs on the stock exchanges don't work exactly like that,
but the robots sneak ahead of your orders in microseconds to skim part or all of
your ultimate purchase or sale of stocks and bonds.
There is some debate as to whether this is
illegal "stealing," but let's say that the future of keeping investors in the
stock market means that the government and the stock exchange managers will
have to put an end to this practice or investors will abandon the market in
droves or go to a new stock exchange that is electronically blocking these robot
ripoffs.
By All Means Watch the CBS 60 Minutes Interview
With Michael Lewis (links shown below)
"Book Review: 'Flash Boys' by Michael Lewis High-frequency traders use
dedicated data cables and specialized algorithms to trade milliseconds ahead of
the rest of the market.," by Philip Delves Broughton, The Wall Street
Journal, March 31, 2014 ---
http://online.wsj.com/news/articles/SB10001424052702304432604579473281278352644?mod=djemMER_h&mg=reno64-wsj
Back in the day, if an investor wanted to buy or
sell a stock, he would call a broker, who would find a way to execute the
trade as efficiently as possible by talking to other human beings. The
arrival of computerized exchanges slowly eliminated people from the process.
Instead, bids and offers were matched by servers. The shouting men in
colorful jackets on the exchange floors became irrelevant. In theory, this
meant that the cost of trading fell and that the markets became more
efficient. But the effects of technology are rarely so simple.
In 2002, 85% of all U.S. stock-market trading
happened on the New York Stock Exchange and the rest mostly on the Nasdaq.
NDAQ +0.60% By early 2008, there were 13 different public exchanges, most
just stacks of computer servers in heavily guarded buildings in northern New
Jersey. Now, if you place an order for 1,000 shares of Microsoft, MSFT
+0.32% it pings from exchange to exchange claiming a few shares at each
stop, seeking the best price until the order is completed. But the moment
that it hits the first exchange, the HFTs see it, and they race ahead to the
other exchanges, buy the stock you want, and sell it back to you for
fractionally more than you hoped to pay. All in a matter of milliseconds,
millions of times a day to millions of investors—your grandmother and
hedge-fund titans alike. These tiny but profitable trades, Mr. Lewis writes,
add up to big profits for firms like Getco and Citadel. He cannot put a hard
number on the size of the industry, suggesting only that many billions are
involved.
If this sounds like the old Wall Street scam of
front-running the market, that's because it is. Except, in this case, it is
entirely legal. Indeed, Mr. Lewis suggests, the strategies of high-frequency
traders were the unintended consequence of well-intentioned regulation. Back
in 2005 the SEC, in an effort to ensure greater fairness for investors,
changed a key rule. Once, brokers had to perform the "best execution" for
their clients. This meant taking into account factors such as timing and
likelihood of completing the transaction, as well as price. Now they have to
find the "best price," as determined by regulators' own creaky computers,
scanning the bids and offers available on the various exchanges. But traders
could do the same analysis more quickly using their own networks, and make
trades in the milliseconds between an investor placing an order, the SEC
establishing the best price and the broker executing the trade.
A decade later, the HFTs do such big business that
they have begun to influence the operations of the exchanges that depend on
them. The exchanges take fees from the HFTs for access to the flow of
orders, as do investment banks that run their own private exchanges, called
"dark pools." Exchanges bend their rules to the bidding of the
high-frequency traders: The HFTs wanted an extra decimal place added to
stock prices, for instance, so they could mop up every thousandth of a penny
in price fluctuations; the exchanges obliged. "By the summer of 2013,"
writes Mr. Lewis, "the world's financial markets were designed to maximize
the number of collisions between ordinary investors and high-frequency
traders—at the expense of ordinary investors."
"Flash Boys" is not as larky as "Liar's Poker"
(1989), Mr. Lewis's memoir of working at Salomon Brothers during the lead-up
to the 1987 crash, or as accessible as "The Big Short" (2010), his
jaw-dropping take on the subprime meltdown. It may end up more important to
public debate about Wall Street than either, however, in exposing what one
of his central characters calls the "Pandora's box of ridiculousness" that
financial exchanges have become.
Mr. Lewis wants to argue, though, that the markets
are not just ridiculous, but rigged. The heroes of this book are clear: Mr.
Katsuyama eventually assembles a team of talented misfits to create an HFT-proofed
exchange called IEX, where a price is a price is a price. It's backed by
leading hedge funds and banks (and Jim Clark, the co-founder of Netscape and
the subject of Mr. Lewis's 1999 book, "The New New Thing"). Mr. Lewis gives
the reader extensive insight into how his heroes see the market, but the
alleged villains of the piece—HFTs themselves—are all but silent in their
own defense. "Flash Boys" is a decidedly one-sided book.
Yet there are reasonable arguments to be made that
the frenetic trading by HFTs leads to greater liquidity and more efficient
pricing. Or, God forbid, that they are not nearly so harmful to investors'
returns as Mr. Lewis makes out. Their rise has coincided with a historic
bull market. It is not hard to imagine a different book by Michael Lewis,
one celebrating HFTs as revolutionary outsiders, a cadre of innovative
engineers and computer scientists (many of them immigrants), rising from the
rubble of 2008 and making fools of a plodding financial system. "Flash Boys"
makes no claim to be a balanced account of financial innovation: It is a
polemic, and a very well-written one. Behind its outrage, however, lies
nostalgia for a prelapsarian Wall Street of trust and plain dealing, which
is a total mirage.
Mr. Delves Broughton's latest book is "The Art of the Sale: Learning
From the Masters About the Business of Life."
"Speed Traders Play Defense Against Michael
Lewis’s Flash Boys," by Matthew Philips, Bloomberg Businessweek,
March 31, 2014 ---
http://www.businessweek.com/articles/2014-03-31/speed-traders-play-defense-to-michael-lewiss-flash-boys?campaign_id=DN033114
In Sunday night’s
60 Minutes interview about his new book
on high-frequency trading—Flash Boys—author Michael Lewis got right
to the point. After a brief lead-in reminding us that despite the strongest
bull market in years, American stock ownership is at a record low, reporter
Steve Kroft asked Lewis for the headline: “Stock market’s rigged,” Lewis
said nonchalantly. By whom? “A combination of stock exchanges, big Wall
Street banks, and high-frequency traders.”
Flash Boys was published today. Digital
versions went live at midnight, so presumably thousands of speed traders and
industry players spent the night plowing through it. Although the book was
announced last year, it’s been shrouded in secrecy. Its publisher,
W. W. Norton,
posted some excerpts briefly online before taking
them down.
Despite a lack of concrete details, word started
getting around a few months ago that Lewis had spent a lot of time with some
of the HFT industry’s most vehement critics, such as
Joe Saluzzi
at Themis Trading. The 60 Minutes interview
only confirmed what many people had suspected for months: Flash Boys
is an unequivocal attack on computerized speed trading.
In the interview, Lewis adhered to the usual
assaults: High-frequency traders have an unfair advantage; they manipulate
markets; they get in front of bigger, slower investors and drive up the
prices they pay to buy a stock. They are, in Lewis’s view, the consummate
middlemen extracting unnecessary rents from a class of everyday investors
who have never been at a bigger disadvantage. This has essentially been the
nut of the
HFT debate over the past five years.
Continued article
The Flash Boys book ---
http://www.amazon.com/s/ref=nb_sb_ss_i_1_7?url=search-alias%3Dstripbooks&field-keywords=flash%20boys%20michael%20lewis&sprefix=Flash+B%2Cstripbooks%2C236
The Kindle Edition is only $9.18
Jensen Comment 3
The three segments on the March 30, 2014 hour of
CBS Sixty Minutes were exceptional. The most important to me was an interview
with Michael Lewis on how the big banks and other operators physically laid very
high speed cable between stock exchanges to skim the cream off purchase an sales
of individuals, mutual funds, and pension funds. The sad part is that the
trading laws have a loop hole allowing this type of ripoff.
The fascinating features of this show and a new
book by Michael Lewis include how the skimming operation was detected and how a
new stock exchange was formed to block the skimmers.
Try the revised links below. These are
examples of links that will soon vaporize. They can be used in class
under the Fair Use safe harbor but only for a very short time until you
or your library purchases these and other Sixty Minutes videos.
But the transcripts will are available from CBS
and can be used for free on into the future. Click on the upper menu choice
"Episodes" for links to the transcripts.
Note the revised video links. a menu should appear
to the left that can lead to the other videos currently available for free
(temporarily).
The three segments on the March 30, 2014 hour
of CBS Sixty Minutes were exceptional. The most important to me was an
interview with Michael Lewis on how the big banks and other operators
physically laid very high speed cable between stock exchanges to skim the
cream off purchase an sales of individuals, mutual funds, and pension funds.
The sad part is that the trading laws have a loop hole allowing this type of
ripoff.The fascinating features of
this show and a new book by Michael Lewis include how the skimming operation
was detected and how a new stock exchange was formed to block the skimmers.
Free access to the video is very limited, so
take advantage of the following link now:
Lewis explains how the stock market is rigged ---
http://www.cbsnews.com/videos/is-the-us-stock-market-rigged/
Cliff Asness Explains How High-Frequency Trading Helps Us And Why
Everyone Else Is Making A Big Stink About It
http://www.businessinsider.com/cliff-asness-on-high-frequency-trading-2014-4#ixzz2xkXEzgt1
Jensen Comment
What Asness fails to mention is that high-frequency trading will be a
disaster if millions of investors and investment funds leave the HFT
exchanges in favor of other exchanges that ban high frequency trading the
HFT robots will be left making markets for one another without the trillions
of dollars of investors who are weary of being ripped off by HFT exchanges.
Time will tell, but it's great that alternatives will be available to
investors who fear the high speed robotic traders.
Department of Justice Investigating High
Speed Insider Trading
"Holder Says U.S. Is Investigating High-Speed Trading Attorney General
Says Practice Has 'Rightly Received Scrutiny From Regulators," by Andrew
Grossman and Devlin Barret, The Wall Street Journal, April 4, 2014
---
http://online.wsj.com/news/articles/SB10001424052702303532704579481232323439224?mg=reno64-wsj&url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB10001424052702303532704579481232323439224.html
The Justice
Department is investigating high-speed trading practices to determine
whether they violate insider-trading laws,
Attorney General Eric Holder told lawmakers Friday.
Mr. Holder said the
practice has "rightly received scrutiny from regulators."
"The department is
committed to ensuring the integrity of our financial markets," Mr.
Holder said in testimony about the Justice Department's budget before
the House Appropriations Committee. "We are determined to follow this
investigation wherever the facts and the law may lead."
The Federal Bureau of
Investigation said earlier this week that it is probing high-frequency
trading. New York Attorney General Eric Schneiderman, the Commodity
Futures Trading Commission and the Securities and Exchange Commission
are also looking into the practice.
Pressed by Rep. Jose
Serrano (D., N.Y.), Mr. Holder acknowledged authorities aren't yet sure
whether some types of high-frequency trading might violate federal law.
"I am really getting up
to speed on this,'' Mr. Holder said, to which Mr. Serrano replied, "we
all are.''
The attorney
general said the concern of federal prosecutors "is that people are
getting an inappropriate advantage, an information advantage...
Milliseconds can matter, so we're looking at this to try to determine if
any federal criminal laws have been broken.''
Jensen Comment 4
The big question remaining is why it is
taking the SEC so long to put an end to this type of skimming?
Bob Jensen's Rotten to the Core Threads
---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Gasparino (Fox News) Shreds Michael
Lewis, Says He's A 'Lefty' And 'Completely And Utterly Disingenuous'
http://www.businessinsider.com/gasparino-on-michael-lewis-2014-4#ixzz2xq53yeFp
Jensen Comment
Yeah right! Watch the naive Charlie Gasparino get shredded in the comments
to this naive article. Read the comments following the article if you can
overlook some of the foul language.
I don't think I want Charlie Gasparino to be
my investment adviser.
Charles Schwab Seems to Agree With Michael
Lewis
SCHWAB: High-Frequency Trading Is A
Growing Cancer That Must Be Addressed ---
http://www.businessinsider.com/schwab-on-high-frequency-trading-2014-4#ixzz2xq82daen
Brokerages Make Millions Selling Orders
To High Frequency Trading Firms
http://www.businessinsider.com/brokerages-make-millions-selling-orders-to-high-frequency-trading-firms-2014-4#ixzz2yIfG9qh5
In his book
'Flash Boys', Michael Lewis attempts to answer
the question — what happens to my trade once I hit 'execute' now that
high frequency trading firms are in the market?'
Here's one answer — your
broker sells you trade to a high frequency trading firm in a bundle with
a bunch of other trades.
At that point they're
just orders. The high frequency trading firm that buys this bundle pays
your broker a lot of money for the privilege of executing your order and
turning it into a trade.
This practice is called
'payment for order flow', and it's not new to the market. Bernie Madoff
used to do it by paying other brokers a penny per share. Then his firm
would use that to trade with a better understanding price. (This part of
his business was totally different than the Ponzi scheme)
Think about it: If you
know demand in the market, and you know when/how other people (i.e. the
orders you just bought) are trading, you can trade smarter and better
for yourself — sometimes by sacrificing the best price for the order you
bought.
In our HFT world,
payment for order flow has a new incarnation that HFT critics have been
railing about for years.
Now it looks like
regulators are going to start looking into the practice. Because of
that, says the
Wall Street Journal, stocks like Charles
Schwab, TD Ameritrade, and E*Trade got killed last week. E*Trade fell
10%, Schwab fell 5%, and TD Ameritrade fell 9.2%.
One look at Charles
Schwab's 2013 annual report and you can see why the bears came out in
full force on this news. In 2012 the brokerage took in $236 million from
"other revenue" sources. One of the sources was payment for order flow.
From the report:
Other revenue – net
decreased by $20 million, or 8%, in 2013 compared to 2012 primarily due
to a non-recurring gain of $70 million relating to a confidential
resolution of a vendor dispute in the second quarter of 2012 and
realized gains of $35 million from the sales of securities available for
sale in 2012, partially offset by an increase in order flow
revenue that Schwab began receiving in November 2012.
Other revenue – net
increased by $96 million, or 60%, in 2012 compared to 2011 primarily due
to a non-recurring gain of $70 million relating to a confidential
resolution of a vendor dispute mentioned above. In November 2012, the
Company began receiving additional order flow rebates from market venues
to which client orders are routed for execution. Order flow
revenue increased by $23 million due to this revenue and the inclusion
of a full year of optionsXpress’ order flow revenue.
Charles Schwab told the
WSJ that payment for order flow is "entirely different from the unfair
access and practices used by high-frequency trading outfits that put
investors at a disadvantage."
It also released a note
calling for the end of HFT saying that "traders are gaming the system,
reaping billions in the process and undermining investor confidence in
the fairness of the markets."
Yet at the same time,
payment for order flow gives HFT firms the ammo they need to do
everything that they do.
Bob Jensen's Rotten to the Core Threads
---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"Is High-Frequency Trading Insider
Trading?" by Matthew Philips, Bloomberg Businessweek, April 4,
2014 ---
http://www.businessweek.com/articles/2014-04-04/is-high-frequency-trading-insider-trading?campaign_id=DN040414
Watch the Video
Ever since Michael
Lewis went on 60 Minutes Sunday night to accuse high-frequency
traders of rigging the stock market, it has been hard to avoid the
debate over
HFT’s merits and evils. Some of it’s been
useful; most has been a lot of angry yelling. The peak of the frenzy
came on Tuesday afternoon in a heated segment on CNBC with IEX’s Brad
Katsuyama and BATS Chief Executive Officer William O’Brien.
To me, this debate is
just circling the ultimate question: Should high-frequency trading be
considered insider trading?
Classically defined, insider trading means
having access to material, non-public information before it reaches the
rest of the market; it’s like getting a heads-up about a merger before
it’s announced, or maybe a
phone call from a Goldman
Sachs (GS)
board member saying that Warren Buffett is about
to invest $5 billion in the bank. Over the past few years, federal
prosecutors have
collected a
number of big insider-trading convictions of
people who got early word about a piece of highly valuable information
and made a lot of money as a result.
To its most vehement
critics, high-frequency trading is not terribly dissimilar. The most
common accusation is that these traders get better information faster
than the rest of the market. They do this through three primary methods:
First, they put
computer servers next to those of the exchanges, cutting down the time
it takes for an order to travel from their computers to the exchanges’
electronic matching engines. Second, they use faster pathways—fiber-optic
cables, microwave towers, and yes,
even laser beams—to trade more quickly between
far-flung markets such as Chicago and New York.
Last, they pay
exchanges for proprietary data feeds. This is where it gets really
complicated. These proprietary feeds are different than the public,
consolidated data feed maintained by the public exchanges, called the
securities information processor, or the SIP. Though it’s now a piece of
software, the public feed is the modern-day equivalent of the ticker
tape that provided stock price data to brokers, traders, and media
outlets. It’s what feeds the stock quotes crawling along the bottom of
the screen on CNBC
(CMCSA)
Bloomberg TV, or on financial websites; when the
public feed
broke in August,
trading on NASDAQ stopped for 3 hours.
While the purpose of the
public feed is to ensure that everyone gets the same price information
at the same time, the playing field isn’t as level as it would seem
since exchanges sell proprietary feeds. And not just to HFT firms. Lots
of different types of investors buy proprietary market data from
exchanges. By law, prices must be entered into the SIP and the
proprietary feeds at the same time, but once the data leaves the
exchanges, the proprietary systems often process and transmit the
information faster. These feeds arrive sooner and contain more robust
information—including all prices being offered, not just the best ones.
From 2006 to 2012,
Nasdaq’s proprietary market data revenue more than doubled, to
$150 million. The money it earns from the public feed fell 21 percent
over roughly the same period. So while Nasdaq used to earn more money
from its public feed, it now makes more from proprietary ones.
Especially after the August outage, this has stirred a lot of complaints
from market players that the
SIP has been neglected in favor of prop feeds.
For its part, Nasdaq has been
lobbying the committee
that oversees the SIP to beef it up.
Speed traders spend a
lot of money for faster access to better information. This allows them
to react more quickly to news and, in some cases, jump in front of other
people’s orders by figuring out which way the market is going to move.
So is that insider trading?
New York Attorney
General Eric Schneiderman has called HFT “insider trading 2.0″ on a
number of
occasions. His office is looking into the
relationships between traders, brokers and exchanges and asking whether
it all needs to be reformed. The FBI spent the last year looking to
uncover manipulative trading practices among HFT firms; the federal
agency is
now asking speed traders to come forward as
whistleblowers.
U.S. laws dealing with
insider trading were first passed 80 years ago. Some restrict the way
corporate executives and board members can trade in and out of their
company’s shares. Others deal with the fair disclosure of important
information—which, when it comes to high-frequency trading, is what
we’re talking about here. These laws essentially require companies to
release material information, such as earnings, to everyone at the same
time. No playing favorites.
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
From the CFO Journal's Morning Ledger
on April 3, 2014
High-frequency trading book slows Virtu’s race to market
Executives
at Virtu Financial
Inc. underestimated the firestorm that would surround the release of
“Flash Boys,” Michael Lewis’s new book about high-frequency trading,
report WSJ’s Telis Demos and Bradley Hope.
Even though the firm was mentioned only in a footnote, the entire
industry has been hit by accusations of corruption, which has dragged on
the shares of comparable
companies. Still, Virtu officials are confident the controversy will
pass and plan to move ahead. The earliest roadshow is expected to take
place this month.
The Flash Boys book ---
http://www.amazon.com/s/ref=nb_sb_ss_i_1_7?url=search-alias%3Dstripbooks&field-keywords=flash%20boys%20michael%20lewis&sprefix=Flash+B%2Cstripbooks%2C236
The Kindle Edition is only $9.18
LIBOR Rate ---
http://en.wikipedia.org/wiki/Libor
The LIBOR Scandal Was Huge: What took the FDIC so long?
Among other things LIBOR was the underlying for over a trillion dollars worth of
interest rate swaps
"F.D.I.C. Sues 16 Big Banks Over Rigging of a Key Rate," The New
York Times, March 14, 2014 ---
http://www.nytimes.com/2014/03/15/business/fdic-sues-16-big-banks-over-rate-rigging.html?smid=tw-share&_r=1
The Federal Deposit Insurance Corporation has sued
16 big banks that set a crucial global interest rate, accusing them of fraud
and conspiring to keep the rate low to enrich themselves.
The banks, which include Bank of America, Citigroup
and JPMorgan Chase in the United States, are among the world’s largest.
The F.D.I.C. said it sought to recover losses that
the rate manipulation caused to 10 United States banks that failed during
the financial crisis and were taken over by the agency. The lawsuit was
filed on Friday in Federal District Court in Manhattan.
The banks are accused of rigging the London
interbank offered rate, known as Libor, from August 2007 to at least
mid-2011. The F.D.I.C. also sued a trade group, the British Bankers’
Association, that helps set Libor.
Danielle Romero-Apsilos, a Citigroup spokeswoman,
declined to comment on the suit. Spokesmen for Bank of America and JPMorgan
didn’t immediately return requests for comment.
Four of the banks, Britain’s Barclays and Royal
Bank of Scotland; Switzerland’s biggest bank, UBS; and Rabobank of the
Netherlands, have paid about $2.6 billion to settle regulators’ charges of
rigging Libor. The banks signed agreements with the Justice Department that
allow them to avoid criminal prosecution if they meet certain conditions.
The process of setting Libor came under scrutiny
after Barclays admitted in June 2012 that it had submitted false information
to keep the rate low. A number of cities and municipal agencies in the
United States have also filed suits.
"Dutch Rabobank fined $1 billion over Libor scandal, by Sara Web,
Reuters, October 29, 2013 ---
http://www.reuters.com/article/2013/10/29/us-rabobank-libor-idUSBRE99S0L520131029
"Barclays Manipulates LIBOR While Auditor PwC Snoozes," by Francine
McKenna, Forbes, July 2, 2012 ---
http://www.forbes.com/sites/francinemckenna/2012/07/02/barclays-manipulates-libor-while-auditor-pwc-snoozes/
From the CFO Journal's Morning Ledger on October 18, 2013
HSBC unit hit with record $2.46 billion judgement
A unit of British bank HSBC Holdings
was hit with a record $2.46 billion judgement
in a U.S. securities class action
lawsuit against a business formerly known as Household International,
Reuters reported. The suit was filed in 2002 and alleged Household
International, its chief executive, chief financial officer and head of
consumer lending made false and misleading statements that inflated the
company’s share price.
SAC
agrees to pay $1 billion in insider-trading case.
Hedge-fund group
SAC Capital Advisors
agreed in principle to pay a penalty exceeding $1
billion in a potential criminal settlement
with federal prosecutors that would be the largest ever for an
insider-trading case, the WSJ reported, citing people familiar with the
matter. The payment, is expected to be roughly $1.2 billion to $1.4 billion,
bringing the total SAC would pay the U.S. to almost $2 billion following a
penalty from the SEC earlier this year. SAC, run by Steven A. Cohen, didn’t
admit or deny wrongdoing.
Barclays, Citigroup, RBS
forex messages probed
An instant-message group involving senior traders at banks
including Barclays, Citigroup and Royal Bank of Scotland is being
scrutinized by regulators over
the
potential manipulation of the foreign-exchange market,
Bloomberg reported, citing four people with knowledge of the probe. Over a
period of at least three years, the dealers exchanged messages through
Bloomberg terminals outlining details of their positions and client orders
and made trades before key benchmarks were set.
WSJ ordered to not divulge
Libor names. UK prosecutors obtained a court order
prohibiting The Wall Street Journal
from publishing names of individuals
the government planned to implicate in a criminal-fraud case alleging a
scheme to manipulate benchmark interest rates. The order, which applies to
publication in England and Wales, also demanded that the Journal remove “any
existing Internet publication” divulging the details. It threatened the
newspaper’s European banking editor and “any third party” with penalties
including a fine, imprisonment and asset seizure.
Jensen Comment
If you believe that some bankers will go to jail for LIBOR cheating then
I've got a some ocean frontage Arizona for sale. White collar crime pays
even if you know you're going to be caught.
Bankers bet with their bank's capital, not their
own. If the bet goes right, they get a huge bonus; if it misfires, that's the
shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by
Avital Louria Hahn, "Missing: How Poor Risk-Management Techniques Contributed
to the Subprime Mess," CFO Magazine, March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Bob Jensen's Rotten to the Core Threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's threads on use of LIBOR in accounting for derivative
financial instruments and hedging activities ---
http://faculty.trinity.edu/rjensen/caseans/000index.htm
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"JPMorgan's $920 Million Admission of Guilt," by Nick Summers,
Blookmberg Businessweek, September 19, 2013 ---
http://www.businessweek.com/articles/2013-09-19/jpmorgans-920-million-admission-of-guilt
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Fraud at Bank of America: Subprime Mortgage Fraud Allegations Hit
Bank of America," by Steven Mintz, Ethics Sage, August 9, 2013 ---
http://www.ethicssage.com/2013/08/fraud-at-bank-of-america-.html
Bob Jensen's Fraud Updates ---
http://www.ethicssage.com/2013/08/fraud-at-bank-of-america-.html
"Merrill Settles With SEC Over Crisis-Era Bond Deals: Bank of
America Unit to Pay $131.8 Million Over Hedge Fund's Role in CDOs," by Jean
Eaglesham, The Wall Street Journal, December 12, 2013 ---
http://online.wsj.com/news/articles/SB10001424052702304477704579254391431487388?mod=djemCFO_h
The regulatory crackdown on the complex mortgage
securities that became a symbol of the financial crisis is almost complete.
On Thursday, Bank of America Corp. BAC +0.33%
agreed to pay $131.8 million to settle civil charges its Merrill Lynch unit
misled investors in two mortgage-bond deals.
The settlement took the total sanctions paid to the
Securities and Exchange Commission for alleged misconduct related to the
2008 meltdown to more than $3 billion.
But there won't be many deals like this after it.
The SEC has ruled out enforcement action against
prominent hedge-fund firms that helped banks create the complicated
mortgage-bond deals that the hedge-fund firms then bet against, reaping
profits on the wagers when the housing market collapsed.
One of those hedge-fund firms, Magnetar Capital
LLC, was involved in helping to create a number of deals that have been the
focus of SEC cases, including Thursday's action against Merrill Lynch. The
SEC said investors in the Merrill deals weren't warned that Magnetar had a
"significant influence" in selecting the assets.
Chicago-based Magnetar said Thursday that SEC
officials have told it they have concluded an investigation into the firm
and won't recommend any enforcement action. The Wall Street Journal reported
in August that SEC enforcement officials had decided not to recommend filing
civil charges against Magnetar. An SEC spokesman declined to comment on
future enforcement actions.
The settlement with Merrill comes toward the tail
end of the SEC's push to hold firms and executives to account for crisis
misconduct. The Justice Department, meanwhile, is revving up its
crisis-related efforts, with last month's landmark $13 billion civil
settlement with J.P. Morgan Chase JPM +0.43% & Co. related to
mortgage-backed securities that officials see as a roadmap for action
against other firms.
The SEC has taken crisis-related actions against
169 firms and individuals, according to the agency's website. Only a handful
of significant crisis cases remain in the pipeline at the SEC, according to
people close to the agency.
The deal with Merrill is the fifth SEC settlement
of more than $100 million with a Wall Street firm related to deals called
collateralized debt obligations.
CDOs are investments based on pools of risky
mortgages and other loans that were bundled up and sold in slices of
differing risk and returns.
The SEC's pacts over CDOs have brought in penalties
totaling more than $1.3 billion.
The five firms concerned in the biggest CDO
settlements—Citigroup Inc., Goldman Sachs Group Inc., J.P. Morgan, Merrill
and Mizuho Financial Group Inc.—neither admitted nor denied wrongdoing in
settling the allegations.
A Bank of America spokesman said the bank was
"pleased to resolve this matter which predated Bank of America's acquisition
of Merrill Lynch," which was announced in September 2008.
The SEC to date hasn't brought enforcement actions
against some big CDO issuers, such as Barclays PLC and Deutsche Bank AG
DBK.XE +0.50% , that it has investigated.
Representatives of Barclays and Deutsche Bank
declined to comment.
The SEC is running up against a legal deadline that
can make it more difficult to extract penalties in cases related to conduct
that is more than five years old. The agency is also looking to focus on new
areas under Chairman Mary Jo White, who took over the top job in April.
The allegations against Merrill related to two CDOs:
a $1.5 billion deal that the bank created in 2006 called Octans I CDO Ltd
and a $1.5 billion deal called Norma CDO I Ltd. created in 2007.
Merrill Lynch marketed the complex investments
"using misleading materials that portrayed an independent process" for
selecting assets for the deals in the best interests of long-term investors,
said George Canellos, a co-chief of enforcement at the SEC.
"Investors did not have the benefit of knowing that
a prominent hedge fund firm with its own interests was heavily involved
behind the scenes in selecting the underlying portfolios," he added.
The agency took enforcement action against the
firms that managed the assets underlying the two deals.
Two principals of NIR Capital Management LLC agreed
to pay a total of more than $472,000 and to temporarily leave the securities
industry to settle charges related to the Norma deal.
Continued in article
From the CFO Journal's Morning Ledger on October 28, 2013
J.P. Morgan settlement puts government in tight spot
Will the U.S. government have to refund
J.P. Morgan part
of the bank’s expected $13 billion payment over soured mortgage securities?
The question is the biggest stumbling block to completing the record
settlement between the bank and the Justice Department,
writes the WSJ’s Francesco Guerrera.
The crux of the issue is whether the government can go
after J.P. Morgan for (alleged) sins committed by others. And investors,
bankers and lawyers are watching the process closely, worried that it could
set a bad precedent for the relationship between buyers, regulators and
creditors in future deals for troubled banks.
"JPMorgan's $13 Billion Settlement: Jamie Dimon Is a Colossus No More,"
by Nick Summers, Bloomberg Businessweek, October 24, 2013 ---
http://www.businessweek.com/articles/2013-10-24/jpmorgans-13-billion-settlement-jamie-dimon-is-a-colossus-no-more
Thirteen billion dollars
requires some perspective. The record amount that
JPMorgan Chase (JPM)
has tentatively agreed to pay the
U.S. Department of Justice, to settle civil investigations into
mortgage-backed securities it sold in the runup to the 2008 financial
crisis, is equal to the gross domestic product of Namibia. It’s more
than the combined salaries of every athlete in every major U.S.
professional sport, with enough left over to buy every American a
stadium hotdog. More significantly to JPMorgan’s executives and
shareholders, $13 billion is equivalent to 61 percent of the bank’s
profits in all of 2012. Anticipating the settlement in early October,
the bank recorded its first quarterly loss under the leadership of Chief
Executive Officer Jamie Dimon.
That makes it real money, even for the
country’s biggest bank by assets. Despite this walloping, there’s reason
for the company to exhale. The most valuable thing Dimon, 57, gets out
of the deal with U.S. Attorney General Eric Holder is clarity. The
discussed agreement folds in settlements with a variety of federal and
state regulators, including the Federal Deposit Insurance Corp. and the
attorneys general of California and New York. JPMorgan negotiated a
similar tack in September, trading the gut punch of a huge headline
number—nearly $1 billion in penalties related to the 2012 London Whale
trading fiasco—for the chance to resolve four investigations in two
countries in one stroke. In both cases, the bank’s stock barely budged;
its shares have returned 25 percent this year, exactly in line with the
performance of Standard & Poor’s 500-stock index.
That JPMorgan is able to withstand
penalties and regulatory pressure that would cripple many of its
competitors attests both to the bank’s vast resources and the influence
of the man who leads it. The sight of Dimon arriving at the Justice
Department on Sept. 26 for a meeting with the attorney general
underscored Dimon’s extraordinary access to Washington
decision-makers—although the Wall Street chieftain did have to humble
himself by presenting his New York State driver license to a guard on
the street. As news of the settlement with Justice trickled out, the
admirers on Dimon’s gilded list rushed to his defense, arguing that he
struck the best deal he could. “If you’re a financial institution and
you’re threatened with criminal prosecution, you have no ability to
negotiate,”
Berkshire Hathaway (BRK/A)
Chairman Warren Buffett told
Bloomberg TV. “Basically, you’ve got to be like a wolf that bares its
throat, you know, when it gets to the end. You cannot win.”
The challenges facing Dimon and his
company are far from over. With the $13 billion payout, JPMorgan is
still the subject of a criminal probe into its mortgage-bond sales,
which could end in charges against the bank or its executives. And other
federal investigations—into suspected bribery in China, the bank’s role
in the Bernie Madoff Ponzi scheme, and more—are ongoing.
The ceaseless scrutiny has tarnished
Dimon’s public image, perhaps irreparably. Once seen as the white knight
of the financial crisis, he’s now the executive stuck paying the bill
for Wall Street’s misdeeds. And as the bank’s legal fights drag on, it’s
worth asking just how many more blows the famously pugnacious Dimon can
take.
Although the $13 billion settlement
would amount to the largest of its kind in the history of regulated
capitalism, it looks quite different broken into its component pieces.
While the relative amounts could shift, JPMorgan is expected to pay
fines of only $2 billion to $3 billion for misrepresenting the quality
of mortgage securities it sold during the subprime housing boom.
Overburdened homeowners would get $4 billion; another $4 billion would
go to the Federal Housing Finance Agency, which regulates
Freddie Mac (FMCC)
and
Fannie Mae (FNMA);
and about $3 billion would go to investors who lost money on the
securities, Bloomberg News reported.
JPMorgan will only pay fines (as
distinct from compensation to investors or homeowner relief) related to
its own actions—and not those of Bear Stearns or Washington Mutual, the
two troubled institutions the bank bought at discount-rack prices during
the crisis. Aside from shaving some unknown amount off the final
settlement, this proviso enhances Dimon’s reputation as the shrewdest
banker of that era. In 2008, with the backing of the U.S. Department of
the Treasury and the Federal Reserve, who saw JPMorgan as a port in a
storm, Dimon got the two properties for just $3.4 billion. Extending
JPMorgan’s retail reach overnight into Florida and California, Bear and
WaMu helped the bank become the largest in the U.S. by 2011. The
portions of the settlement attributable to their liabilities are almost
certainly outweighed by the profits they’ve brought and will continue to
bring.
Bob Jensen's threads on the subprime mortgage scandals ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's Rotten to the Core Threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Search for the word ?Merrill" to see the many rotten deals of Merrill Lynch.
Bloomberg reports JP Morgan has agreed to pay a $410 penalty over
allegations it manipulated U.S. electricity markets ---
http://www.businessinsider.com/jpmorgan-ferc-settlement-2013-7
Under the agreement, JPMVEC will pay a civil
penalty of $285 million to the U.S. Treasury and disgorge $125 million in
unjust profits. The first $124 million of the disgorged profits will go to
ratepayers in the California Independent System Operator (California ISO),
which operates the California electricity market. The other $1 million will
go to ratepayers in the Midcontinent Independent System Operator (MISO).
Jensen Comment
I thought some traders at Enron went to prison for doing the same thing in
California. Where are the handcuffs?
That some bankers have ended up in
prison is not a matter of scandal, but what is outrageous is the fact that all
the others are free.
Honoré de Balzac
Bob Jensen's threads on dirty rotten bankers ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"Banks find appalling new way to cheat homeowners," by David Dayen,
Salon, September 24, 2013 ---
http://www.salon.com/2013/09/24/banks_find_appalling_new_way_to_cheat_homeowners_partner/
A few months ago, Ceith and Louise
Sinclair of Altadena, California, were told that their home had been sold.
It was the first time they’d heard that it was for sale.
Their mortgage servicer, Nationstar, foreclosed on
them without their knowledge, and sold the house to an investment company.
If it wasn’t for the Sinclairs going to a local
ABC affiliate and describing their horror story,
they would have been thrown out on the street, despite never missing a
mortgage payment. It’s impossible to know how many homeowners who didn’t get
the media to pick up their tale have dealt with a similar catastrophe, and
eventually lost their home.
Continued in article
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
From the CFO Journal's Morning Ledger on September 25, 2013
J.P. Morgan offers $3 billion to end mortgage probes
J.P.
Morgan
has offered to pay about $3 billion as it seeks to
settle criminal and civil investigations by
federal and state prosecutors into its mortgage-backed-securities
activities, the WSJ reports. The Justice Department rejected that sum as
billions of dollars too low for the number of cases involved, but the
discussions have widened to include other investigations of J.P. Morgan, and
the final tally could be larger. The offer from the bank shows that its top
executives and board are weighing the time and effort needed to fight, as
well as the impact on the bank’s reputation and employee morale.
Jensen Comment
$3 billion sounds like a big number but it's pennies on the dollar. In
reality J.P. Morgan should have gone the way of Lehman Brothers ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Three billion one day and $11 billion the
next: When will we be talking real money?
From the CFO Journal's Morning Ledger on September 26, 2013
J.P. Morgan
discussing $11 billion settlement
J.P. Morgan is in
discussions to settle probes related to
mortgage-backed securities for $11 billion,
the WSJ reports. The amount being discussed would
include $7 billion in cash and $4 billion in relief to consumers. As large
as the potential settlement may be, two people familiar with the matter
cautioned that even if a deal is reached, it may not resolve one of the
biggest dangers for the bank: the potential for criminal charges stemming
from the mortgage-backed securities probe.
"Chase, Once Considered "The Good Bank," Is About to Pay Another Massive
Settlement," by Matt Taibbi, Rolling Stone, July 18, 2013 ---
http://www.rollingstone.com/politics/blogs/taibblog/chase-once-considered-the-good-bank-is-about-to-pay-another-massive-settlement-20130718
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Why We Didn’t Learn Enough From the Financial Crisis," by Justin Fox,
Harvard Business Review Blog, September 13, 2013 ---
Click Here
http://blogs.hbr.org/2013/09/why-we-didnt-learn-enough-from-the-financial-crisis/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+harvardbusiness+%28HBR.org%29&cm_ite=DailyAlert-091613+%281%29&cm_lm=sp%3Arjensen%40trinity.edu&cm_ven=Spop-Email
“Liquidate labor, liquidate stocks, liquidate real
estate,” Treasury Secretary Andrew Mellon
may or may not have told Herbert Hoover in the
early years of the Great Depression. “It will purge the rottenness out of of
the system.” This is what has since become known as the “Austrian” view
(although most of its modern proselytizers are American): economic actors
need to learn from their mistakes, “malinvestment”
must be punished, busts are needed to wring out the
excesses created during boom times.
Within the economic mainstream, there is some
sympathy for the idea that crisis interventions can create “moral hazard” by
bailing out the irresponsible. But the argument that financial crises should
be allowed to wreak their havoc unchecked has few if any adherents. As
Milton Friedman
put it in 1998:
I think the Austrian business-cycle theory has
done the world a great deal of harm. If you go back to the 1930s, … you
had the Austrians sitting in London, Hayek and Lionel Robbins, and
saying you just have to let the bottom drop out of the world. You’ve
just got to let it cure itself. You can’t do anything about it. You will
only make it worse. You have Rothbard saying it was a great mistake not
to let the whole banking system collapse. I think by encouraging that
kind of do-nothing policy both in Britain and in the United States, they
did harm.
When a financial crisis hit in 2008 that was
probably worse than anything the world had seen since the early 1930s, it
was this mainstream view that won out. The bailout of the big banks in late
2008, while hugely unpopular with the general populace, has garnered
near-unanimous support from the economics profession. In a paper eventually
published in the Journal of Financial Economics in 2010, the
University of Chicago’s Pietro Veronesi and Luigi Zingales — two economists
who aren’t generally big fans of government economic intervention —
concluded that even
without including the impossible-to-measure systemic benefits, the cash
infusions and guarantees orchestrated by Treasury Secretary Hank Paulson
created between $73 billion and $91 billion in economic value after costs.
The Federal Reserve’s subsequent (and continuing)
support of asset markets has been somewhat more controversial, but still
meets widespread approval among economists. More controversial yet have been
fiscal stimulus efforts like the
American Recovery and Reinvestment Act of 2009,
but the tide of economic opinion and evidence seems to have turned in their
favor too, with the
bulk of post-stimulus empirical studies showing a
positive effect and the former austerity advocates at the International
Monetary Fund
dramatically changing their tune starting late
last year.
In sum, the economic mainstream got its way, the
Austrians didn’t, and we all appear to be better off for it. It has been a
tough five years, but not nearly as tough as the early 1930s. And the
biggest economic policy mistake made was probably not the bailouts or the
deficit spending or the printing of money, but the failure to stop Lehman
Brothers from failing on Sept. 15, 2008.
Yet despite this record of relative success, most
the commentaries being published in the lead-up to the fifth anniversary of
that fateful day seem to focus instead on the opportunities missed.
Princeton economist
Alan Blinder’s op-ed piece in the Wall Street
Journal is a prime example of this. Blinder laments that the dangerous
financial-sector practices that precipitated the crisis have mostly been
left in place. Contrasting the tepid regulatory measures taken since 2008
with the remaking of the financial system that took place during and after
the Great Depression, he writes:
Far from being tamed, the financial beast has
gotten its mojo back — and is winning. The people have forgotten — and
are losing.
What Blinder and his kindred spirits (and I should
add that I am one of them) generally fail to discuss, though, is that one of
the main reasons the people have forgotten is because economic policy-makers
succeeded in averting anything quite as memorable as the wave after wave of
bank failures and widespread economic misery that swept the U.S. in the
early 1930s. By giving us a Great Recession in place of a Great Depression,
they made it much harder to assemble a political consensus for truly
dramatic change.
Continued in article
"We’re All Still Hostages to the Big Banks," by Anat R. Admati, The
New York Times, August 25, 2013 ---
Click Here
http://www.nytimes.com/2013/08/26/opinion/were-all-still-hostages-to-the-big-banks.html?utm_source=Stanford+Business+Re%3AThink&utm_campaign=6076b3a7fe-Re_Think_Twenty_Two9_9_2013&utm_medium=email&utm_term=0_0b5214e34b-6076b3a7fe-70265733&ct=t%28Re_Think_Twenty_Two9_9_2013%29&_r=0
NEARLY five years after the bankruptcy of Lehman
Brothers touched off a global financial crisis, we are no safer. Huge,
complex and opaque banks continue to take enormous risks that endanger the
economy. From Washington to Berlin, banking lobbyists have blocked essential
reforms at every turn. Their efforts at obfuscation and influence-buying are
no surprise. What’s shameful is how easily our leaders have caved in, and
how quickly the lessons of the crisis have been forgotten.
We will never have a safe and healthy global
financial system until banks are forced to rely much more on money from
their owners and shareholders to finance their loans and investments. Forget
all the jargon, and just focus on this simple rule.
Mindful, perhaps, of the coming five-year
anniversary, regulators have recently taken some actions along these lines.
In June, a committee of global banking regulators based in Basel,
Switzerland, proposed changes to how banks calculate their leverage ratios,
a measure of how much borrowed money they can use to conduct their business.
Last month, federal regulators proposed going
somewhat beyond the internationally agreed minimum known as Basel III, which
is being phased in. Last Monday, President Obama scolded regulators for
dragging their feet on implementing Dodd-Frank, the gargantuan 2010 law that
was supposed to prevent another crisis but in fact punted on most of the
tough decisions.
Don’t let the flurry of activity confuse you. The
regulations being proposed offer little to celebrate.
From Wall Street to the City of London comes the
same wailing: requiring banks to rely less on borrowing will hurt their
ability to lend to companies and individuals. These bankers falsely imply
that capital (unborrowed money) is idle cash set aside in a vault. In fact,
they want to keep placing new bets at the poker table — while putting
taxpayers at risk.
When we deposit money in a bank, we are making a
loan. JPMorgan Chase, America’s largest bank, had $2.4 trillion in assets as
of June 30, and debts of $2.2 trillion: $1.2 trillion in deposits and $1
trillion in other debt (owed to money market funds, other banks, bondholders
and the like). It was notable for surviving the crisis, but no bank that is
so heavily indebted can be considered truly safe.
The six largest American banks — the others are
Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley —
collectively owe about $8.7 trillion. Only a fraction of this is used to
make loans. JPMorgan Chase used some excess deposits to trade complex
derivatives in London — losing more than $6 billion last year in a
notoriously bad bet.
Risk, taken properly, is essential for innovation
and growth. But outside of banking, healthy corporations rarely carry debts
totaling more than 70 percent of their assets. Many thriving corporations
borrow very little.
Banks, by contrast, routinely have liabilities in
excess of 90 percent of their assets. JPMorgan Chase’s $2.2 trillion in debt
represented some 91 percent of its $2.4 trillion in assets. (Under
accounting conventions used in Europe, the figure would be around 94
percent.)
Basel III would permit banks to borrow up to 97
percent of their assets. The proposed regulations in the United States —
which Wall Street is fighting — would still allow even the largest bank
holding companies to borrow up to 95 percent (though how to measure bank
assets is often a matter of debate).
If equity (the bank’s own money) is only 5 percent
of assets, even a tiny loss of 2 percent of its assets could prompt, in
essence, a run on the bank. Creditors may refuse to renew their loans,
causing the bank to stop lending or to sell assets in a hurry. If too many
banks are distressed at once, a systemic crisis results.
Prudent banks would not lend to borrowers like
themselves unless the risks were borne by someone else. But insured
depositors, and creditors who expect to be paid by authorities if not by the
bank, agree to lend to banks at attractive terms, allowing them to enjoy the
upside of risks while others — you, the taxpayer — share the downside.
Implicit guarantees of government support
perversely encouraged banks to borrow, take risk and become “too big to
fail.” Recent scandals — JPMorgan’s $6 billion London trading loss, an HSBC
money laundering scandal that resulted in a $1.9 billion settlement, and
inappropriate sales of credit-card protection insurance that resulted, on
Thursday, in a $2 billion settlement by British banks — suggest that the
largest banks are also too big to manage, control and regulate.
NOTHING suggests that banks couldn’t do what they
do if they financed, for example, 30 percent of their assets with equity (unborrowed
funds) — a level considered perfectly normal, or even low, for healthy
corporations. Yet this simple idea is considered radical, even heretical, in
the hermetic bubble of banking.
Bankers and regulators want us to believe that the
banks’ high levels of borrowing are acceptable because banks are good at
managing their risks and regulators know how to measure them. The failures
of both were manifest in 2008, and yet regulators have ignored the lessons.
If banks could absorb much more of their losses,
regulators would need to worry less about risk measurements, because banks
would have better incentives to manage their risks and make appropriate
investment decisions. That’s why raising equity requirements substantially
is the single best step for making banking safer and healthier.
The transition to a better system could be managed
quickly. Companies commonly rely on their profits to grow and invest,
without needing to borrow. Banks should do the same.
Banks can also sell more shares to become stronger.
If a bank cannot persuade investors to buy its shares at any price because
its assets are too opaque, unsteady or overvalued, it fails a basic “stress
test,” suggesting it may be too weak without subsidies.
Ben S. Bernanke, chairman of the Federal Reserve,
has acknowledged that the “too big to fail” problem has not been solved, but
the Fed counterproductively allows most large banks to make payouts to their
shareholders, repeating some of the Fed’s most obvious mistakes in the
run-up to the crisis. Its stress tests fail to consider the collateral
damage of banks’ distress. They are a charade.
Dodd-Frank was supposed to spell the end to all
bailouts. It gave the Federal Deposit Insurance Corporation “resolution
authority” to seize and “wind down” banks, a kind of orderly liquidation —
no more panics. Don’t count on it. The F.D.I.C. does not have authority in
the scores of nations where global banks operate, and even the mere
possibility that banks would go into this untested “resolution authority”
would be disruptive to the markets.
The state of financial reform is grim in most other
nations.
Continued in article
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Bob Jensen's threads on the "Financial Crisis" and its bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
LIBOR ---
http://en.wikipedia.org/wiki/LIBOR
From the CFO Journal's Morning Ledger on June 21, 2013
Libor case ensnares
more banks
Employees of some of the world’s largest
financial institutions conspired with a former bank trader to rig benchmark
interest rates, British prosecutors alleged, a sign authorities have their
sights on an array of banks and brokerages. The U.K.’s Serious Fraud Office
charged former UBS and Citigroup trader Tom Hayes with eight counts of
“conspiring to defraud” in an attempt to manipulate Libor,
the WSJ reports. The
charges read in court
Thursday accuse Mr. Hayes of conspiring with
employees of eight banks and interdealer brokerage firms, as well as with
former colleagues at UBS and Citigroup. Mr. Hayes, who was charged with
similar offenses by the U.S. last December, hasn’t entered a plea in either
country.
"Dutch Rabobank fined $1 billion over Libor scandal, by Sara Web,
Reuters, October 29, 2013 ---
http://www.reuters.com/article/2013/10/29/us-rabobank-libor-idUSBRE99S0L520131029
"Libor Case Ensnares More Banks U.K. Prosecutors Allege Staff From J.P.
Morgan, Deutsche Bank and Others Tried to Fix Rates," by David Enrich,
The Wall Street Journal, June 20, 2013 ---
http://online.wsj.com/article/SB10001424127887323893504578556941091595054.html?mod=djemCFO_h
Employees of some of the world's largest financial
institutions conspired with a former bank trader to rig benchmark interest
rates, British prosecutors alleged Thursday, a sign authorities have their
sights on an array of banks and brokerages.
The U.K.'s Serious Fraud Office this week charged
former UBS AG UBSN.VX +0.43% and Citigroup Inc. C -3.40% trader Tom Hayes
with eight counts of "conspiring to defraud" in an alleged attempt to
manipulate the London interbank offered rate, or Libor. Mr. Hayes appeared
in a London court Thursday, where prosecutors for the first time detailed
their allegations against him, including a list of institutions whose
employees Mr. Hayes allegedly conspired with.
Mr. Hayes, who was charged with similar offenses by
the U.S. last December, hasn't entered a plea to either country's charges.
He wrote in a January text message to The Wall Street Journal that "this
goes much much higher than me."
The charges read in court Thursday accuse Mr. Hayes
of allegedly conspiring with employees of eight banks and interdealer
brokerage firms, as well as with former colleagues at UBS and Citigroup.
Each of the eight charges accused Mr. Hayes of "dishonestly seeking to
manipulate [Libor]…with the intention that the economic interests of others
would be prejudiced and/or to make personal gain for themselves or another."
The banks include New York-based J.P. Morgan Chase
JPM -2.04% & Co.; Germany's Deutsche Bank DBK.XE +0.78% AG; British banks
HSBC Holdings HSBA.LN +1.34% PLC and Royal Bank of Scotland Group RBS.LN
-3.06% PLC; and Dutch lender Rabobank Groep NV. Prosecutors alleged Mr.
Hayes also worked with employees of ICAP IAP.LN +4.74% PLC, Tullett Prebon
TLPR.LN -0.07% PLC and R.P. Martin Holdings Ltd., which are London-based
interdealer brokers that serve as middlemen between bank traders.
An ICAP spokeswoman said the firm has provided
information to British prosecutors and continues to cooperate. A Rabobank
spokesman said the bank continues to cooperate with investigators and is
likely to eventually reach a settlement. In a statement, Tullett said it is
"cooperating fully" with prosecutors' requests for information.
Representatives for the rest of the named institutions declined to comment.
The list of banks and brokerages named at
Thursday's court hearing underscores the breadth of institutions that remain
under government scrutiny. So far, only three banks—UBS, RBS and Barclays
BARC.LN +0.30% PLC—have reached settlements with U.S. and British
authorities. Authorities hope to hammer out settlements with additional
institutions, including Rabobank, in coming months, according to a person
familiar with the investigation.
The list that prosecutors read Thursday included at
least one institution that has said it wasn't involved in the Libor scandal.
After UBS settled rate-rigging allegations last December, Tullett Prebon
spokeswoman Charlotte Kirkham said the firm didn't help UBS manipulate rates
and that no Tullett employees had been disciplined in connection with Libor.
In April, Tullett said it stood by that statement.
In a statement Thursday, Tullett disclosed for the
first time that it has been asked to provide information to various
regulators and government agencies in connection with Libor investigations.
In addition to saying it is cooperating with the requests, the firm
reiterated it hasn't been informed that it or its brokers are under
investigation in relation to Libor. A spokesman declined to comment further.
The interdealer brokers' alleged involvement in
attempts to rig Libor has rocked the industry in recent months. Two R.P.
Martin employees were arrested along with Mr. Hayes in December but not
charged. The U.S. Justice Department and the Commodity Futures Trading
Commission also are investigating brokers as part of their Libor probes,
according to people familiar with those investigations.
Mr. Hayes, a 33-year-old British citizen, was a
derivatives trader in Tokyo from 2006 through 2010, the period during which
prosecutors allege he attempted to manipulate Libor. He is the only person
the Serious Fraud Office has charged in their nearly yearlong Libor
investigation, although an agency spokesman said this week that more arrests
and charges are possible.
Mr. Hayes, wearing beige trousers and an untucked,
navy dress shirt, didn't respond to the charges at court Thursday. Standing
behind a glass partition in the courtroom, he was mostly silent aside from
telling the judge his name, address and date of birth. At one point, the
judge asked him to take his hands out of his pockets.
Continued in article
Bigger than Enron and Rotten to the Core: The LIBOR Scandal
Bob Jensen's threads on the LIBOR Scandal ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"The Best Way to Reform Libor: Scrap It: The market, and not a
single private entity, should determine this crucial interest-rate benchmark,"
by Richard S. Grossman, The Wall Street Journal, July 24, 2013 ---
http://online.wsj.com/article/SB10001424127887324348504578606041056905794.html?mod=djemEditorialPage_h
The British have learned nothing from the recent
Libor scandal. One year after the news broke that banks were manipulating
this vitally important interest rate, an independent committee appointed by
the government has decided to hand over responsibility for Libor to NYSE
Euronext . This is madness.
The London interbank offered rate, which is
calculated by averaging banks' self-reported estimated cost of borrowing
funds from other banks, plays a crucial role in the world financial system.
It serves as a benchmark for some $800 trillion in transactions—everything
from complex derivatives transactions to relatively simple adjustable-rate
home mortgages.
Because so much money is riding on Libor, banks
have an incentive to alter submissions—up or down, depending on the
situation—to improve their bottom lines. Many in the financial community had
long known about Libor manipulation. As early as 2008, then-president of the
Federal Reserve Bank of New York Timothy Geithner warned the Bank of England
that Libor's credibility needed to be enhanced. E-mails between bankers that
have come to light since the scandal broke almost a year ago prove
conclusively that cheating was commonplace.
And yet, knowing of Libor's troubled past and its
potential to be tampered with, British authorities earlier this month
granted a contract to run the index to NYSE Euronext, a company that owns
the New York Stock Exchange, the London International Financial Futures and
Options Exchange, and a number of other stock, bond, and derivatives
exchanges. NYSE Euronext is scheduled to be taken over by
IntercontinentalExchange, a firm which owns even more derivatives markets.
In other words, the company that will be
responsible for making sure that Libor is set responsibly and fairly will be
in a position to profit like no one else from even the slightest movements
in Libor.
British authorities have searched for ways to
rescue Libor, perhaps in a bid to maintain London's prestige as a financial
center. Last autumn, Martin Wheatley, a British financial regulator, issued
a report suggesting a number of reforms to how Libor is set. He suggested
some sensible reforms, including reducing the number of rates and currencies
represented, and increasing the number of firms contributing to the index.
But these were the equivalent of hunting big game with a water pistol.
NYSE Euronext is, of course, confident in its
ability to clean up the mess. Its press release following the announcement
trumpeted the firm as "uniquely placed to restore the international
credibility of Libor." The company argues that it "will be able to leverage
NYSE Euronext's trusted brand, long regulatory experience and market-leading
technical ability to return confidence to the administration of Libor."
That's all well and good, but coming just five
years after the eruption of the worst crisis in the financial system since
the Great Depression, there is a much better way to fix Libor: Scrap it.
The British government should announce that, six
months from today, Libor will cease to exist. The British Bankers'
Association, which technically owns the interest-rate index, has been so
wounded by the scandal that it has been willing to follow the government's
lead and will no doubt agree.
And how will markets react? The way they always do.
They will adapt.
Financial firms will have six months to devise
alternative benchmarks for their floating rate products. Given the low
repute in which Libor—and the people responsible for it—are held, it would
be logical for one or more market-determined rates to take the place of
Libor.
A number of alternative benchmarks exist or could
be easily created. One often mentioned candidate is the GCF Repo index
published by the Depository Trust & Clearing Corp. This index is based on
actual repurchase agreement transactions, and is thus a better indicator of
the cost of funds than banks' internal estimates—even if those estimates
were unbiased. Another option might be some newly constructed index based on
credit-default swaps transactions, corporate bonds and commercial paper.
Either of these alternatives would remove the possibility of cheating by
making the benchmark dependent on observable, market-determined rates,
rather than the "estimates" of a dozen or so bankers.
For already existing contracts that rely on Libor,
the British Bankers' Association should define some market-determined rate,
in consultation with the government, as the official successor to Libor
starting six months from now.
Most people still put their faith—rightly, in my
view—in market-based economies, believing that they are more likely to
deliver a higher standard of living than any other economic system that the
world has ever known. Politicians need to be aware that the public's faith
in—and patience with—the market has its limits.
The incentive to game an benchmark rate such as
Libor is just too high to risk putting it in the hands of a single private
entity, however committed that entity may be to restoring its credibility.
Replacing Libor with a transparent, fair, market-based alternative is the
only sensible solution.
Mr. Grossman is professor of economics at Wesleyan University in
Connecticut and a visiting scholar at Harvard. His book, "WRONG: Nine
Economic Policy Disasters and What We Can Learn from Them," will be
published by Oxford University press in November.
Bigger Than Enron: Bob Jensen's Threads on the LIBOR Scandal ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Search for LIBOR
"Who's Manipulating Derivative Indexes and Why: How to think about
the Libor scandal and its astonishingly proliferating offspring," by Holman
W. Jenkins Jr., The Wall Street Journal, June 21, 2013 ---
http://online.wsj.com/article/SB10001424127887323893504578559282047415410.html?mod=djemEditorialPage_h
Is Ewan McGregor, who played Nick Leeson in the
movie about the Barings bank bust, available for a sequel? He would find an
oddly similar character in Tom Hayes, the former UBS UBSN.VX -1.93% and
Citibank employee charged in this week's latest financial scandal of the
century.
Let's try to sort it out. As with Libor, or the
London interbank offered rate, a benchmark for loans world-wide, allegations
are floating that traders manipulated other widely used benchmarks. Three
big banks—Barclays, BARC.LN -2.26% UBS and Royal Bank of Scotland RBS.LN
-7.24% —have already paid $2.5 billion in fines and penalties in the Libor
caper. Now the focus has turned to suspected manipulation of fuel-market
indexes, loan-market indexes in Japan and Singapore, and indexes used in
pricing interest-rate swaps.
Said Europe's Competition Commissioner Joaquin
Almunia last month: "Huge damages for consumers and users would have been
originated by this."
Well, maybe. A basic schematic would go like this:
Some enterprising soul decides it would be useful to publish a daily price
benchmark by surveying market participants about certain transactions that
don't take place on a central exchange. Somebody else decides it would be
useful to create tradable derivatives whose price would vary based on
changes in these benchmarks—that is, would let participants bet on how a
survey of themselves in the future will come out.
Libor involved questioning bank traders about the
pricing of loans—and Libor derivatives let these same traders bet on the
answers they would give in the future. The invitation here now seems rather
obvious. Mr. Hayes, a baby-faced yen-derivatives trader in Tokyo at the
time, is charged with orchestrating attempts to rig a similar Tokyo-based
benchmark called Tibor.
All this proves one thing: Financial professionals
can't be counted on to do the right thing when self-interest beckons so we
must turn power over to government officials who always do the right thing
regardless of self-interest.
Or maybe not. The Libor scandal broke only because
London banks, in cahoots with regulators, put out transparently fake reports
about their borrowing costs during the 2008 panic. That led to the discovery
of a long history of everyday manipulation of their Libor borrowing costs.
Traders now fessing up say they learned the practice from their predecessors
who learned it from their predecessors, and so on.
As they drain this swamp, investigators like to
allege enormous damage to the public by multiplying small discrepancies by
the number of transactions in the market. Treat these claims with
skepticism. Whatever the extent of mispricing in downstream transactions, it
is a smidgeon compared to the rake-off brokers used to earn in
pre-electronic days. It is a smidgeon compared to the margins that middlemen
could extract before published surveys were available to shed light on
transactions previously invisible to most market participants.
It is also a smidgeon compared to the margins that
would have to be built into prices if not for Libor hedges and other
risk-sharing inventions.
A kick in the pants has been delivered to
publishers of price indexes. They need to make their products more
manipulation-proof. Where markets are thin and surveys are the only way to
glean market intelligence, publishers already exercise a visible hand to
expel questionable or anomalous data. A further solution might be to poll a
larger number of traders and randomly exclude most of their answers so no
trader would have any certainty of influencing the index.
To understand why such opportunities exist in the
first place is to understand something about a generic condition of our
world, in which technology has drastically reduced transaction costs and
cheap money has vastly increased leverage available even to low-ranking bank
employees, magnifying the return to small bits of illicit or licit
information, including insider information.
Continued in article
Bigger than Enron and Rotten to the Core: The LIBOR Scandal
Bob Jensen's threads on the LIBOR Scandal ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Teaching Case
From The Wall Street Journal Accounting Weekly Review on June 14,
2013
CRU, After LIBOR Scandal, Audits Steel Prices Index
by:
John W. Miller
Jun 05, 2013
Click here to view the full article on WSJ.com
TOPICS: Assurance Services, Auditing, Auditing Services
SUMMARY: CRU Group compiles steel prices and issues a report every
Wednesday. "The compiler...said an auditor
will conduct on-site inspections of steel companies that provide pricing
data and will gather more information about how the prices are collected for
four major types of steel product, which go into four different indexes. The
move is believed to be a first by a commodity-price-index firm to audit
information provided to it."
CLASSROOM APPLICATION: The article may be used in an auditing or
other assurance services class to discuss non-audit services, audit planning
for a first-of-its-kind engagement, and determination of materiality in such
a setting.
QUESTIONS:
1. (Introductory) What does Commodity Research Unit Group (CRU) do?
Who uses the information that the group prepares?
2. (Advanced) What service has CRU hired KPMG LLP to conduct? Be
specific in stating a type of service to be provided and the type of report
that you think may be issued under U.S. assurance service requirements.
3. (Advanced) What is the significance for assurance work planning
of the fact that this engagement is apparently the first by a
commodity-price-index firm to audit information provided to it?
4. (Advanced) Suppose you are an audit manager planning an
engagement for KPMG to examine steel prices. What factors will you consider
in deciding on materiality of amounts to examine?
Reviewed By: Judy Beckman, University of Rhode Island
"CRU, After LIBOR Scandal, Audits Steel Prices Index," by John W. Miller,
The Wall Street Journal, June 5, 2013 ---
http://online.wsj.com/article/SB10001424127887324069104578527632400988350.html?mod=djem_jiewr_AC_domainid
A key price compiler in the global steel industry
said it will begin auditing its data providers, part of an effort to address
concerns about transparency in price indexes following the Libor rate-fixing
scandal.
The compiler, Commodity Research Ltd., said an
auditor will conduct on-site inspections of steel companies that provide
pricing data and will gather more information about how the prices are
collected for four major types of steel product, which go into four
different indexes. Much of these steel types are destined for the U.S
automotive market.
The move is believed to first by a
commodity-price-index firm to audit information provided to it. CRU, based
in London and Pittsburgh, has hired KPMG LLP to conduct the audits,
according to a person familiar with the matter. KPMG didn't respond to a
request for comment.
Glenn Cooney, London-based head of operations for
CRU Indices, which publishes price data on 75 commodities in metals, mining
and fertilizers, said it would look at auditing other data providers in
other sectors to bolster industry transparency.
Currently, CRU collects price and volume data on
spot transactions from steel producers and buyers, who submit their prices
voluntarily to a CRU website. CRU publishes an index price based on the
submissions every Wednesday.
CRU officials say they hope the move will lend it
added credibility at a time of concern about indexes. Three banks in Europe
have agreed to pay over $2 billion in settlement fees to U.S. and U.K.
regulators after they were caught manipulating the London interbank offered
rate, or Libor, the interest rate banks charge to borrow from each other.
Josh Spoores, a Pittsburgh-based steel analyst for CRU, said the company
started receiving more requests for improved transparency after the Libor
scandal.
The company also hopes it will be able to reassure
several major U.S. steel mills, which in April said they would no longer
link some contracts to CRU's steel indexes because they felt prices quoted
weren't an accurate reflection of the market. The steelmakers that stopped
using the indexes include ArcelorMittal, MT +3.34% U.S. Steel Corp. X +5.23%
and Nucor Corp. NUE +3.01%
Grant Davidson, general manager for sales at
ArcelorMittal's Dofasco mill in Canada, said big steel companies would
welcome more transparency. "We're for what's most accurately reflecting the
price in the market," he said.
Michael Steubing, vice president of global
procurement for Mauser USA LLC, which makes steel drums and barrels, said an
audited index would help guarantee that he can sell his product at a
competitive price. He sells barrels to big chemical companies that use CRU
to help determine how much they will pay for the barrels. "So we'd like that
(CRU) to be as accurate as possible," he said.
CRU, which is used by the Chicago Mercantile
Exchange and says its prices are used to settle steel contracts with an
annual global value of over $20 billion, faces more competition from Platts,
a division of McGraw Hill Financial Inc., MHFI +0.97% which two years ago
bought price compiler The Steel Index.
Joe Innace, Platts's editorial director for metals,
said Platts would continue its phone survey for its Platts industry
newsletter independently of The Steel Index and wouldn't use audits because
he said it has enough verifications, such as checking that prices match the
types and volumes of steel appropriate to the index, in place.
Steve Randall, who founded The Steel Index in 2006,
said it had no plans to audit data providers. "We run all our data through a
series of screenings," he said. He declined to provide details about the
screening procedure.
Continued in article
"NYSE Euronext to Take Over Libor British Authorities Started Looking for
New Owner Last Year," by David Enrich, Jacob Bunge, and Cassell Brian-Lo,
The Wall Street Journal, July 10, 2013 ---
http://online.wsj.com/article/SB10001424127887324507404578595243333548714.html?mod=djemCFO_h
Libor, the scandal-tarred benchmark owned by a British
banking organization, is being sold to
NYSE Euronext,
NYX -0.61% the
U.S. company that runs the New York Stock Exchange. The deal is the British
government's latest attempt to salvage Libor's integrity, after multiple
banks acknowledged trying to profit by rigging the rate.
While
Libor underpins trillions of dollars in financial contracts and generates
about £2 million a year in revenue, a person familiar with the deal said the
benchmark rate was sold to NYSE for a token £1—a sign of the heavy toll
inflicted by the rate-rigging scandal.
Libor:
What You Need to Know
What
it is:
Libor—the London interbank offered rate benchmark—is supposed to measure the
interest rates at which banks borrow from one another. It is based on data
reported daily by banks. Other interest rate indexes, like the Euribor (euro
interbank offered rate) and the Tibor (Tokyo interbank offered rate),
function in a similar way.
Why
it's important:
More than $800 trillion in securities and loans are linked to the Libor,
including $350 trillion in swaps and $10 trillion in loans, including auto
and home loans, according to the Commodity Futures Trading Commission. Even
small movements—or inaccuracies—in the Libor affect investment returns and
borrowing costs, for individuals, companies and professional investors.
MoneyBeat
The
deal means that the City of London will lose one of the institutions most
closely associated with its rise as a global financial hub in recent
decades. The new owner will be the institution that is most closely
associated with Wall Street.
For NYSE, the deal is part of a recent effort by
exchanges to take over benchmarks like Libor in the hopes of converting them
into new business opportunities in the derivatives markets. NYSE itself is
in the process of being acquired by
IntercontinentalExchange Inc.,
ICE -1.14% an
Atlanta-based company that is one of the world's largest operators of
derivatives exchanges. Libor and similar benchmarks are components of
interest-rate derivatives that are heavily traded on exchanges in the U.S.
and Europe.
British authorities last year started looking for a new owner for Libor,
after concluding that the British Bankers' Association shouldn't be
responsible for administering a key benchmark. After a competitive bidding
process, a government-appointed commission picked NYSE, which will formally
take over Libor early in 2014.
Sarah
Hogg, who headed the U.K. commission that ran the Libor sale process, said
Tuesday that handing the benchmark to NYSE "will play a vital role in
restoring the international credibility of Libor." While Libor's new parent
company will be American, the rate will be administered by a British
subsidiary that will be regulated by the U.K.'s Financial Conduct Authority.
The deal immediately encountered criticism. It is "far
from ideal," said
Bart Chilton, one
of the commissioners who runs U.S. regulator the Commodity Futures Trading
Commission. "Whenever there's a profit motive involved in setting [these
benchmarks], I get suspicious."
Mr.
Chilton, who added he would have preferred a "neutral third party" to take
over Libor, said it would be misleading to suggest the deal would resolve
all the problems that have bedeviled Libor. "I'm not swallowing that."
Some
British officials decried the loss of an important institution to a rival
financial center. Following the Libor sale, "the French and the Germans will
be rubbing their hands with glee at the prospect of stealing other financial
markets from the U.K.," said John Mann, a Labour Party lawmaker.
The
BBA launched Libor in the 1980s as a way for banks to set interest rates on
syndicated corporate loans. The rate is based on daily estimates by banks
about how much it would cost them to borrow from other banks. Libor
eventually morphed into a ubiquitous cog in the financial system, and today
serves as the basis for rates on everything from residential mortgages to
derivatives.
Doubts about Libor's reliability surfaced in 2008
after a series of Wall Street Journal articles highlighted apparent problems
with the rate. But governments and central banks balked at regulating Libor,
and the BBA failed to stop banks from continuing to skew the rate. Only last
summer, after Barclays BARC.LN +0.31% PLC admitted trying to rig Libor, did
British authorities launch a process to overhaul the benchmark.
Part of that process involved finding a new home
for Libor. In addition, following a U.K. regulatory panel's recommendation,
the BBA earlier this year phased out certain variations of Libor that were
especially vulnerable to manipulation. Also, the British government recently
made it a crime to rig Libor.
Martin Wheatley, head of the Financial Conduct
Authority, said he expects NYSE "to develop further the oversight and
governance of Libor." The chief executive of the NYSE Liffe derivatives
exchange, Finbarr Hutcheson, said the company would continue "the process of
restoring credibility, trust and integrity in Libor as a key global
benchmark."
At least initially, NYSE is expected to continue
the current process for calculating Libor, according to a U.K. Treasury
official. That will be supplemented by cross-checking those submissions
against market transactions, the official said.
The new owner plans to work with market
participants and regulators to "evolve how Libor is calculated" to bring it
in line with recommendations last year from another U.K. commission, the
official said.
Among other bidders for Libor were Thomson Reuters,
which currently compiles Libor every day on the BBA's behalf, and Markit, a
data provider specializing in derivatives, said people briefed on the
process.
NYSE plans to continue licensing Libor to other
parties for use in financial products, according to a person familiar with
the deal. The benchmark is expected to keep its current name.
Analysts said the deal will give NYSE bragging
rights as owner of a benchmark that is central to the market for a variety
of derivatives. Exchanges in recent years have gravitated toward derivatives
trading because the markets bring higher fees than trading in stocks.
But NYSE could face years of regulatory, legal and
political scrutiny as it tries to repair Libor's battered reputation.
Continued in article
R
"Everything Is Rigged: The Biggest Price-Fixing Scandal Ever:
The Illuminati were amateurs. The second huge financial scandal of the year
reveals the real international conspiracy: There's no price the big banks can't
fix," by Matt Taibbi, Rolling Stone, April 25, 2013 ---
http://www.rollingstone.com/politics/news/everything-is-rigged-the-biggest-financial-scandal-yet-20130425
Bob Jensen's LIBOR fraud threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Bob Jensen's threads on LIBOR are under the C-terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
Bob Jensen's threads on LIBOR and other derivative financial instruments
frauds (timeline) ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
This is so huge it's better to do a word search for LIBOR
"Everything Is Rigged: The Biggest Price-Fixing Scandal Ever:
The Illuminati were amateurs. The second huge financial scandal of the year
reveals the real international conspiracy: There's no price the big banks can't
fix," by Matt Taibbi, Rolling Stone, April 25, 2013 ---
http://www.rollingstone.com/politics/news/everything-is-rigged-the-biggest-financial-scandal-yet-20130425
Conspiracy theorists of the world, believers in the
hidden hands of the Rothschilds and the Masons and the Illuminati, we
skeptics owe you an apology. You were right. The players may be a little
different, but your basic premise is correct: The world is a rigged game. We
found this out in recent months, when a series of related corruption stories
spilled out of the financial sector, suggesting the world's largest banks
may be fixing the prices of, well, just about everything.
You may have heard of the Libor scandal, in which
at least three – and perhaps as many as 16 – of the name-brand
too-big-to-fail banks have been manipulating global interest rates, in the
process messing around with the prices of upward of $500 trillion (that's
trillion, with a "t") worth of financial instruments. When that sprawling
con burst into public view last year, it was easily the biggest financial
scandal in history – MIT professor Andrew Lo even said it "dwarfs by orders
of magnitude any financial scam in the history of markets."
That was bad enough, but now Libor may have a twin
brother. Word has leaked out that the London-based firm ICAP, the world's
largest broker of interest-rate swaps, is being investigated by American
authorities for behavior that sounds eerily reminiscent of the Libor mess.
Regulators are looking into whether or not a small group of brokers at ICAP
may have worked with up to 15 of the world's largest banks to manipulate
ISDAfix, a benchmark number used around the world to calculate the prices of
interest-rate swaps.
Interest-rate swaps are a tool used by big cities,
major corporations and sovereign governments to manage their debt, and the
scale of their use is almost unimaginably massive. It's about a $379
trillion market, meaning that any manipulation would affect a pile of assets
about 100 times the size of the United States federal budget.
It should surprise no one that among the players
implicated in this scheme to fix the prices of interest-rate swaps are the
same megabanks – including Barclays, UBS, Bank of America, JPMorgan Chase
and the Royal Bank of Scotland – that serve on the Libor panel that sets
global interest rates. In fact, in recent years many of these banks have
already paid multimillion-dollar settlements for anti-competitive
manipulation of one form or another (in addition to Libor, some were caught
up in an anti-competitive scheme,
detailed in Rolling Stone last year, to
rig municipal-debt service auctions). Though the jumble of financial
acronyms sounds like gibberish to the layperson, the fact that there may now
be price-fixing scandals involving both Libor and ISDAfix suggests a single,
giant mushrooming conspiracy of collusion and price-fixing hovering under
the ostensibly competitive veneer of Wall Street culture.
The Scam Wall Street Learned From the Mafia
Why? Because Libor already affects the prices of
interest-rate swaps, making this a manipulation-on-manipulation situation.
If the allegations prove to be right, that will mean that swap customers
have been paying for two different layers of price-fixing corruption. If you
can imagine paying 20 bucks for a crappy PB&J because some evil cabal of
agribusiness companies colluded to fix the prices of both peanuts and peanut
butter, you come close to grasping the lunacy of financial markets where
both interest rates and interest-rate swaps are being manipulated at the
same time, often by the same banks.
"It's a double conspiracy," says an amazed Michael
Greenberger, a former director of the trading and markets division at the
Commodity Futures Trading Commission and now a professor at the University
of Maryland. "It's the height of criminality."
The bad news didn't stop with swaps and interest
rates. In March, it also came out that two regulators – the CFTC here in the
U.S. and the Madrid-based International Organization of Securities
Commissions – were spurred by the Libor revelations to investigate the
possibility of collusive manipulation of gold and silver prices. "Given the
clubby manipulation efforts we saw in Libor benchmarks, I assume other
benchmarks – many other benchmarks – are legit areas of inquiry," CFTC
Commissioner Bart Chilton said.
But the biggest shock came out of a federal
courtroom at the end of March – though if you follow these matters closely,
it may not have been so shocking at all – when a landmark class-action civil
lawsuit against the banks for Libor-related offenses was dismissed. In that
case, a federal judge accepted the banker-defendants' incredible argument:
If cities and towns and other investors lost money because of Libor
manipulation, that was their own fault for ever thinking the banks were
competing in the first place.
"A farce," was one antitrust lawyer's response to
the eyebrow-raising dismissal.
"Incredible," says Sylvia Sokol, an attorney for
Constantine Cannon, a firm that specializes in antitrust cases.
All of these stories collectively pointed to the
same thing: These banks, which already possess enormous power just by virtue
of their financial holdings – in the United States, the top six banks, many
of them the same names you see on the Libor and ISDAfix panels, own assets
equivalent to 60 percent of the nation's GDP – are beginning to realize the
awesome possibilities for increased profit and political might that would
come with colluding instead of competing. Moreover, it's increasingly clear
that both the criminal justice system and the civil courts may be impotent
to stop them, even when they do get caught working together to game the
system.
If true, that would leave us living in an era of
undisguised, real-world conspiracy, in which the prices of currencies,
commodities like gold and silver, even interest rates and the value of money
itself, can be and may already have been dictated from above. And those who
are doing it can get away with it. Forget the Illuminati – this is the real
thing, and it's no secret. You can stare right at it, anytime you want.
Continued in article
Bob Jensen's Rotten to the Core threads on the banking industry ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
The biggest scandal in the history of the SEC is probably how it botched the
Bernie Madoff Ponzi scandal. But there are other areas in need of reform at the
SEC and reforms instigated by the SEC.
Teaching Case
From The Wall Street Journal Accounting Weekly Review on June 14, 2013
A Reform Beginning at the SEC
by:
WSJ Opinion Page Editors
Jun 05, 2013
Click here to view the full article on WSJ.com
TOPICS: Accounting For Investments, Banking, Cost-Basis Reporting,
Mark-to-Market, SEC, Securities and Exchange Commission
SUMMARY: Some money market mutual funds may be allowed to 'break
the buck' in their financial reports. "A unanimous commission voted to
propose floating share prices for...money-market funds catering to large
institutional investors and holding corporate debt...The idea is to
underline for investors that money-fund values can fluctuate, and a modest
decline is no reason to panic...." During the financial crisis, "after bad
bets on Lehman Brothers debt caused the underlying assets of one fund,
Reserve Primary, to slip below $1, institutional investors began fleeing
Reserve and other 'prime' funds that held corporate debt. The federal
government responded by slapping a temporary guarantee around the whole
industry. After the crisis, much of the fund industry still resisted
floating asset values." The article reports that the SEC proposal closely
tracks a plan proposed in 2012 by one who has taken a different stance from
the industry on this issue, Charles Schwab CEO Walt Bettinger.
CLASSROOM APPLICATION: The article may be used in a course on
banking or in any financial reporting class covering investments,
particularly in comparing amortized cost for bond investments instead of
fair market value. NOTE TO INSTRUCTOR: REMOVE THE FOLLOWING INFORMATION
PRIOR TO DISTRIBUTING TO STUDENTS AS IT ANSWERS SEVERAL QUESTIONS AND THE
PROPOSED GROUP ASSIGNMENT. Amortized cost is the accounting method allowed
for money market mutual funds in order to present their net asset values as
$1 per share. This presentation is labeled "accounting fiction" in the
article. Resources for the instructor from the SEC's web site: "Money Market
Mutual Fund Reform: Opening statement at the SEC Open Meeting" by Norm
Champ, Director, Division of Investment Management, U.S. SEC, 06/05/13,
available on the SEC web site at
http://www.sec.gov/news/speech/2013/spch060513nc.htm " Rule 2a-7
under the Investment Company Act allows money market mutual funds to
maintain this stable $1.00 share price by allowing them to use certain
pricing and valuation conventions. In return, the funds must adhere to
certain credit quality, maturity, liquidity, and diversification
requirements designed to reduce the likelihood of fluctuations in their
value." Rule 2a-7 excerpts, from the SEC web site at
http://www.sec.gov/rules/final/21837.txt "To maintain a stable
share price, most money funds use the amortized cost method of valuation
("amortized cost method") or the penny-rounding method of pricing
("penny-rounding method") permitted by rule 2a-7. The 1940 Act and
applicable rules generally require investment companies to calculate current
net asset value per share by valuing portfolio instruments at market value
or, if market quotations are not readily available, at fair value as
determined in good faith by, or under the direction of, the board of
directors. Rule 2a-7 exempts money funds from these provisions, but contains
conditions designed to minimize the deviation between a fund's stabilized
share price and the market value of its portfolio." NOTES: -[5]-A money fund
is required to disclose prominently on the cover page of its prospectus
that: (1) the shares of the fund are neither insured nor guaranteed by the
U.S. Government; and (2) there can be no assurance that the fund will be
able to maintain a stable net asset value of $1.00 per share. ... -[6]-Under
the amortized cost method, portfolio securities are valued by reference to
their acquisition cost as adjusted for amortization of premium or accretion
of discount. Paragraph(a)(1) of rule 2a-7, as amended. -[7]-Share price is
determined under the penny-rounding method by valuing securities at market
value, fair value or amortized cost and rounding the per share net asset
value to the nearest cent on a share value of a dollar, as opposed to the
nearest one tenth of one cent.
QUESTIONS:
1. (Advanced) What is a money market mutual fund?
2. (Advanced) How is a money market fund's net asset value
determined?
3. (Introductory) According to the article, what are investors'
perceptions of money market funds when their net asset values are presented
at a constant $1 per share?
4. (Introductory) What is the "accounting fiction" described in the
article?
5. (Advanced) How could accounting rules support presentation of $1
net asset values "even if the underlying assets of a fund were worth
slightly more or less"?
SMALL GROUP ASSIGNMENT:
Assign question 6 as an in class group activity, having the students search
the SEC web site to find the accounting requirements for money market mutual
funds. The results can then be used to lean into a comparison of amortized
cost and market value accounting methods for investments.
Reviewed By: Judy Beckman, University of Rhode Island
"A Reform Beginning at the SEC," by WSJ Opinion Page Editors, June 5, 2013
---
http://online.wsj.com/article/SB10001424127887323844804578527462489392582.html?mod=djem_jiewr_AC_domainid
Is the taxpayer safety net under American finance
finally, just possibly, starting to shrink? On Wednesday the Securities and
Exchange Commission took a step toward reform, even as it reminded taxpayers
how far it has to go to ensure that the 2008 rescue of money-market mutual
funds is never repeated.
A unanimous commission voted to propose floating
share prices for a large category of money-market funds. If commissioners
enact a final rule later this year, funds catering to large institutional
investors and holding corporate debt would be required to report accurate
prices in real time, just as in other securities markets. The idea is to
underline for investors that money-fund values can fluctuate, and a modest
decline is no reason to panic or call the Treasury Secretary for help.
For decades, SEC rules have allowed fund companies
to report fixed values of $1 per share, even if the underlying assets of a
fund were worth slightly more or less. This accounting fiction encouraged
investors to view their money funds as cash balances akin to guaranteed bank
deposits.
To further encourage the illusion of risk-free
investing, the SEC also required funds to invest only in assets rated highly
by the government-approved credit ratings agencies, including Standard &
Poor's, Moody's MCO +2.98% and Fitch. Come the financial crisis, investors
learned that the idea that money funds never "break the buck" (never lose
value) was a marketing slogan, not a federal law. After bad bets on Lehman
Brothers debt caused the underlying assets of one fund, Reserve Primary, to
slip below $1, institutional investors began fleeing Reserve and other
"prime" funds that held corporate debt. The federal government responded by
slapping a temporary guarantee around the whole industry.
After the crisis, much of the fund industry still
resisted floating asset values. But last year Charles Schwab CEO Walt
Bettinger broke with the industry by proposing in these pages to float the
prices of institutional prime funds—ground zero in the 2008 panic. This
week's SEC proposal closely tracks the Bettinger plan and is a significant
reform.
Even better would be a requirement for floating
asset values across the whole industry. It's true that funds holding
government debt, as opposed to corporate debt, often perform better in times
of market turbulence, but government debts can also cause such turbulence
(see Europe). And there is the regulatory challenge of ensuring that
institutions cannot simply split up their money-fund investments into
various accounts if the retail end of the market still promises fixed asset
values. But it's encouraging that at long last the SEC is moving toward
clarifying that money funds are investments that can lose value, and not
deposits backed by taxpayers.
More disappointing in the SEC's Wednesday proposal
is that, almost two years after a legal deadline, the agency still hasn't
removed from its money-fund rules its endorsements of credit-rating
agencies. Forcing funds and by extension their investors to buy only assets
deemed safe by the government's anointed credit judges was disastrous in
2008 and will be again if not reformed.
Continued in article
Teaching Case
From The Wall Street Journal Accounting Weekly Review on June 14,
2013
CRU, After LIBOR Scandal, Audits Steel Prices Index
by:
John W. Miller
Jun 05, 2013
Click here to view the full article on WSJ.com
TOPICS: Assurance Services, Auditing, Auditing Services
SUMMARY: CRU Group compiles steel prices and issues a report every
Wednesday. "The compiler...said an auditor
will conduct on-site inspections of steel companies that provide pricing
data and will gather more information about how the prices are collected for
four major types of steel product, which go into four different indexes. The
move is believed to be a first by a commodity-price-index firm to audit
information provided to it."
CLASSROOM APPLICATION: The article may be used in an auditing or
other assurance services class to discuss non-audit services, audit planning
for a first-of-its-kind engagement, and determination of materiality in such
a setting.
QUESTIONS:
1. (Introductory) What does Commodity Research Unit Group (CRU) do?
Who uses the information that the group prepares?
2. (Advanced) What service has CRU hired KPMG LLP to conduct? Be
specific in stating a type of service to be provided and the type of report
that you think may be issued under U.S. assurance service requirements.
3. (Advanced) What is the significance for assurance work planning
of the fact that this engagement is apparently the first by a
commodity-price-index firm to audit information provided to it?
4. (Advanced) Suppose you are an audit manager planning an
engagement for KPMG to examine steel prices. What factors will you consider
in deciding on materiality of amounts to examine?
Reviewed By: Judy Beckman, University of Rhode Island
"CRU, After LIBOR Scandal, Audits Steel Prices Index," by John W. Miller,
The Wall Street Journal, June 5, 2013 ---
http://online.wsj.com/article/SB10001424127887324069104578527632400988350.html?mod=djem_jiewr_AC_domainid
A key price compiler in the global steel industry
said it will begin auditing its data providers, part of an effort to address
concerns about transparency in price indexes following the Libor rate-fixing
scandal.
The compiler, Commodity Research Ltd., said an
auditor will conduct on-site inspections of steel companies that provide
pricing data and will gather more information about how the prices are
collected for four major types of steel product, which go into four
different indexes. Much of these steel types are destined for the U.S
automotive market.
The move is believed to first by a
commodity-price-index firm to audit information provided to it. CRU, based
in London and Pittsburgh, has hired KPMG LLP to conduct the audits,
according to a person familiar with the matter. KPMG didn't respond to a
request for comment.
Glenn Cooney, London-based head of operations for
CRU Indices, which publishes price data on 75 commodities in metals, mining
and fertilizers, said it would look at auditing other data providers in
other sectors to bolster industry transparency.
Currently, CRU collects price and volume data on
spot transactions from steel producers and buyers, who submit their prices
voluntarily to a CRU website. CRU publishes an index price based on the
submissions every Wednesday.
CRU officials say they hope the move will lend it
added credibility at a time of concern about indexes. Three banks in Europe
have agreed to pay over $2 billion in settlement fees to U.S. and U.K.
regulators after they were caught manipulating the London interbank offered
rate, or Libor, the interest rate banks charge to borrow from each other.
Josh Spoores, a Pittsburgh-based steel analyst for CRU, said the company
started receiving more requests for improved transparency after the Libor
scandal.
The company also hopes it will be able to reassure
several major U.S. steel mills, which in April said they would no longer
link some contracts to CRU's steel indexes because they felt prices quoted
weren't an accurate reflection of the market. The steelmakers that stopped
using the indexes include ArcelorMittal, MT +3.34% U.S. Steel Corp. X +5.23%
and Nucor Corp. NUE +3.01%
Grant Davidson, general manager for sales at
ArcelorMittal's Dofasco mill in Canada, said big steel companies would
welcome more transparency. "We're for what's most accurately reflecting the
price in the market," he said.
Michael Steubing, vice president of global
procurement for Mauser USA LLC, which makes steel drums and barrels, said an
audited index would help guarantee that he can sell his product at a
competitive price. He sells barrels to big chemical companies that use CRU
to help determine how much they will pay for the barrels. "So we'd like that
(CRU) to be as accurate as possible," he said.
CRU, which is used by the Chicago Mercantile
Exchange and says its prices are used to settle steel contracts with an
annual global value of over $20 billion, faces more competition from Platts,
a division of McGraw Hill Financial Inc., MHFI +0.97% which two years ago
bought price compiler The Steel Index.
Joe Innace, Platts's editorial director for metals,
said Platts would continue its phone survey for its Platts industry
newsletter independently of The Steel Index and wouldn't use audits because
he said it has enough verifications, such as checking that prices match the
types and volumes of steel appropriate to the index, in place.
Steve Randall, who founded The Steel Index in 2006,
said it had no plans to audit data providers. "We run all our data through a
series of screenings," he said. He declined to provide details about the
screening procedure.
Continued in article
"Everything Is Rigged: The Biggest Price-Fixing Scandal Ever:
The Illuminati were amateurs. The second huge financial scandal of the year
reveals the real international conspiracy: There's no price the big banks can't
fix," by Matt Taibbi, Rolling Stone, April 25, 2013 ---
http://www.rollingstone.com/politics/news/everything-is-rigged-the-biggest-financial-scandal-yet-20130425
Bob Jensen's LIBOR fraud threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Bob Jensen's threads on LIBOR are under the C-terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
Bob Jensen's threads on LIBOR and other derivative financial instruments
frauds (timeline) ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
This is so huge it's better to do a word search for LIBOR
Definition of Screwed:
avg mkt return ~12%, avg mutual fund ret ~9%, average investor ret ~ 2.6%.
Timing, selection, and costs destroy
Finance Professor Jim Mahar
"Romancing Alpha (α), Breaking Up with Beta (β)," by Barry Ritholtz,
Ritholtz, February 15, 2013 --- |
http://www.ritholtz.com/blog/2013/02/alpha-beta/
Since it is a Friday (following Valentine’s Day), I
want to step back from the usual market gyrations to discuss a broader
topic: The pursuit of Alpha, where it goes wrong, and the actual cost in
Beta.
For those of you unfamiliar with the Wall Street’s
Greek nomenclature, a quick (and oversimplified) primer: When we refer to
Beta (β), we are referencing a portfolio’s correlation to its benchmark
returns, both directionally and in terms of magnitude.
We use a scale of 0-1. Let’s say your benchmark is
the S&P500 — it has a β = 1. Something uncorrelated does what it does
regardless of what the SPX does, and its Beta is = 0. We can also use
negative numbers, so a Beta of minus 1 (-1) does the exact opposite of the
benchmark.
Beta measures how closely your investments perform
relative to your benchmark. If you were to do nothing else but buy that
benchmark index (i.e., S&P500), you will have captured Beta (for these
purposes, I am ignoring volatility).
The other Greek letter we want to mention is Alpha
(α). Alpha is the risk-adjusted return of active management for any
investment. The goal of active management is through a combination of
stock/sector selection, market timing, hedging, leverage, etc. is to beat
the market. This can be described as generating Alpha.
To oversimplify: Alpha is a measure of
out-performance over Beta.
Why bring this up today?
Over the past few months, I have been looking at an
inordinate number of portfolios and 401(k) plans that have all done pretty
poorly. I am not referring to any one quarter of even year, but rather, over
the long haul. There is an inherent selection bias built into this group —
well performing portfolios don’t have owners considering switching asset
managers. But even accounting for that bias, a hefty increase in the sheer
number of reviews leads me to wonder about just how widespread the
under-performance is.
One of the things that has become so obvious to me
over the past few years is how unsuccessful various players in the markets
have been in their pursuit of Alpha. We know that 80% or so of mutual fund
managers underperform their benchmarks each year. We have seen Morningstar
studies that show of the remaining 20%, factor in fees, and that number
drops to 1%.
The overall performance of the highest compensated
group of managers, the 2%+20% Hedge Fund community, has been similarly
awful, as they have underperformed for a decade or more.
Continued in article
"How the Banking System Is Destroying America," by Barry Ritholtz,
The Washington Blog, March 29, 2013 ---
http://www.ritholtz.com/blog/2013/03/how-the-banking-system-is-destroying-america/
. . .
The long-time Chairman of the House Banking and Currency Committee
(Charles McFadden) said on June 10, 1932:
Some people think that the Federal Reserve Banks are United States
Government institutions. They are private monopolies ….
And congressman Dennis Kucinich
said:
The Federal Reserve is no more federal than
Federal Express!
The Fed Is Owned By – And Is Enabling – The Worst
Behavior of the Big Banks
Most people now realize that the big banks have
become
little more than criminal enterprises.
No wonder a
stunning list of economists, financial experts and bankers are calling
for them to be broken up.
But the Federal Reserve is enabling the banks.
Indeed, the giant banks and the Fed are part of a malignant, symbiotic
relationship.
Specifically:
The corrupt, giant banks would never have
gotten so big and powerful on their own. In a free market, the
leaner banks with sounder business models would be growing,
while the giants who made reckless speculative
gambles would have gone bust. See
this,
this and
this.
It is the Federal Reserve,
Treasury and Congress who have
repeatedly bailed out the big banks,
ensured they make money at taxpayer expense,
exempted them from standard accounting practices
and the
criminal and fraud laws which govern the little guy,
encouraged insane amounts of leverage, and
enabled the too big to fail banks – through “moral hazard” – to become
even more reckless.
Indeed, the government made them big in the
first place. As I
noted in 2009:
As MIT economics professor and former IMF
chief economist Simon Johnson
points out today, the official White House
position is that:
(1) The government created the
mega-giants, and they are not the product of free market
competition
***
(3) Giant banks are good for the
economy
***
The [corrupt, captured government "regulators"]
and the giant banks are part of a single malignant, symbiotic
relationship.
Indeed, the Fed and their big bank owners form a
crony capitalist cartel that is
destroying the economy for most Americans. The Fed
has been
bailing out the giant banks while
shafting the little guy.
Fed boss Bernanke
falsely stated that the big banks receiving
bailout money were healthy, when they were not. They were insolvent. By
choosing the big banks over the little guy, the Fed is
dooming both.
No wonder
many top economists say that we should end – or
strip most of the powers from – the Federal Reserve.
Even
long-time Fed Chairman Alan Greenspan says that we
should end the Fed.
A Better Alternative
Conservative and liberal economists both point out
that the big banks are already state-sponsored institutions … so the
government should
create a little competition through
public banking.
State-owned public banks – like North Dakota has – would take the power
away from the big banks, and
give it back to the people … as the
Founding Fathers intended.
Even a 12-year old sees the wisdom of public
banking.
Jensen Comment
I disagree to Barry on the point that a better alternative would be to create
state-owned banks like North Dakota State Banks. I agree that we need many more
banks to create competition is banking since the big banks since the 1970s
bought up the competition when creating their own nationwide networks of branch
banks.
I would instead prefer to "trust bust" by breaking up the giant banks into
smaller banks, possibly by reverting to laws that do not allow interstate
banking. Let's go back to the good old days where a local boy, George Bailey,
manages each local bank.
Question
What is "force-placed" insurance?
"GSE Investigation Into Force-Placed Insurance (finally)," by Barry
Ritholtz, March 26, 2013 ---
http://www.ritholtz.com/blog/2013/03/force-placed-insurance-investigated/
Fannie & Freddie have finally begun to investigate
the self-dealing and often fraudulent practice of Force-Placed
Insurance. Both the New York State Insurance Regulator and the
Consumer Financial Protection Bureau have been way ahead of the GSEs on
this.
For those of you who may be unfamiliar with
Force-Placed Insurance, it is an optional bank insurance product that
sometimes gets forcibly jammed down the throats of home owners and mortgage
investors at grossly inflated prices. As Jeff Horowitz detailed in 2010
(Losses
from Force-Placed Insurance Are Beginning to Rankle Investors),
most of the fees, commissions and revenues from this
“product” went straight back to the banks holding the related mortgage,
typically to wholly owned subsidiaries.
It was an abusive practice, and in quite a few
instances, the additional costs actually tipped homeowners into foreclosure.
Here’s the
WSJ:
“The Federal Housing Finance Agency, which
regulates mortgage giants Fannie Mae (FNMA) and Freddie Mac (FMCC) plans
to file a notice Tuesday to ban lucrative fees and commissions paid by
insurers to banks on so-called force-placed insurance . . .
Forced policies have boomed in the wake of the
housing bust, as many homeowners struggled to keep up with mortgage
payments. Some borrowers may try to save money by dropping the original
standard coverage, only to be hit by policies with premiums that are
typically at least twice as expensive as voluntary insurance, and
sometimes cost as much as 10 times more. Nearly six million such
policies have been written since 2009, insurance industry data indicate.
Consumers are free at any point to replace a force-placed policy with
one of their own choosing.”
The Consumer Financial Protection Bureau has issued
new rules on this, but the real action seems to be
the variety of
civil suits from
investors; additionally, New York State just reached a settlement
with forced-placed insurer Assurant, including a
$14 million penalty, and a long list of practice changes (after the
jump). If it were up
to me, I would have insisted on profit disgorgement and jail time for the
CEO (But I am “unreasonable”).
Hopefully, this is the first of many . . .
LIBOR ---
http://en.wikipedia.org/wiki/LIBOR
"Libor Lies Revealed in Rigging of $300 Trillion Benchmark," by Liam
Vaughan & Gavin Finch, Bloomberg News, January 28, 2013 ---
http://www.bloomberg.com/news/2013-01-28/libor-lies-revealed-in-rigging-of-300-trillion-benchmark.html
Jensen Comment
Crime Pays: The good news for banksters is that they rarely, rarely,
rarely get sent to prison ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
"The LIBOR Mess: How Did It Happen -- and What Lies Ahead?"
Knowledge@Wharton, July 18, 2012 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=3056
Finance Professor Jim Mahar says Barclays really should be removing these
advertisements as soon as possible.
Barclays ---
http://en.wikipedia.org/wiki/Barclays#Rate-fixing_scandal
Rate-fixing scandal
In June 2012, as a result of an international investigation, Barclays
Bank was fined a total of £290 million (US$450 million) for attempting to
manipulate the daily settings of London Interbank Offered Rate (Libor)
and the Euro Interbank Offered Rate (Euribor).
The United States Department of Justice and Barclays officially agreed that
"the manipulation of the submissions affected the fixed rates on some
occasions".[94]
The bank was found to have made 'inappropriate submissions' of rates which
formed part of the Libor and Euribor setting processes, sometimes to make a
profit, and other times to make the bank look more secure during the
financial crisis.[95]
This happened between 2005 and 2009, as often as daily.[96]
The BBC said
revelations concerning the fraud were "greeted with almost universal
astonishment in the banking industry."[97]
The UK's
Financial Services Authority (FSA), which levied a fine of £59.5 million
($92.7 million), gave Barclays the biggest fine it had ever imposed in its
history.[96]
The FSA's director of enforcement described Barclays' behaviour as
"completely unacceptable", adding "Libor is an incredibly important
benchmark reference rate, and it is relied on for many, many hundreds of
thousands of contracts all over the world."[95]
The bank's chief executive
Bob Diamond decided to give up his bonus as a result of the fine.[98]
Liberal Democrat politician
Lord Oakeshott criticised Diamond, saying: "If he had any shame he would
go. If the Barclays board has any backbone, they'll sack him."[95]
The U.S. Department of Justice has also been involved, with "other financial
institutions and individuals" under investigation.[95]
On 2 July 2012, Marcus Agius resigned from the chairman position following
the interest rate rigging scandal.[99]
On 3 July 2012, Bob Diamond resigned with immediate effect, leaving Marcus
Agius to fill his post until a replacement is found.[100]
LIBOR ---
http://en.wikipedia.org/wiki/Libor
"How Barclays Rigged the Machine," by Rana Foroohar, Time Magazine,
July 23, 2012 ---
http://www.time.com/time/subscriber/article/0,33009,2119318,00.html
Ever wonder why surveys about very personal topics
(think sex and money) are done anonymously? Of course you don't, because
it's obvious that people wouldn't tell the truth if they were identified on
the record. That's a key point in understanding the latest scandal to hit
the banking industry, which comes, as ever, with much hand-wringing,
assorted apologies and a crazy-sounding acronym--this time, LIBOR. That's
short for the London interbank offered rate, the interest rate that banks
charge one another to borrow money. On June 27, Britain's Barclays bank
admitted that it had deliberately understated that rate for years.
LIBOR is a measure of banks' trust in their
solvency. And around the time of the financial crisis of 2008, Barclays'
rate was rising. If a bank revealed publicly that it could borrow only at
elevated rates, it would essentially be admitting that it--and perhaps the
financial system as a whole--was vulnerable. So Barclays gamed the system to
make the financial picture prettier than it was. The charade was possible
because LIBOR is calculated not on the basis of documented lending
transactions but on the banks' own estimates, which can be whatever bankers
decree. This Kafkaesque system is overseen for bizarre historical reasons by
an association of British bankers rather than any government body.
The LIBOR scandal has already claimed Barclays'
brash American CEO, Bob Diamond, a man infamous for taking huge bonuses
while his company's share price and profit were declining. Diamond resigned,
but his head may not be the only one to roll. As many as 20 of the world's
largest banks are being sued or investigated for manipulating over the
course of many years the interest rate to which $350 trillion worth of
derivatives contracts are pegged. Bank of England and former
British-government officials accused of colluding with Barclays to stem a
financial panic may also be caught up in the mess.
What's surprising is that individual consumers may
actually have benefited, at least financially, from the collusion. Not only
the central reference point for derivatives markets, LIBOR is also the rate
to which all sorts of loans--variable mortgage rates, student loans, even
car payments--may be pegged. To the extent that banks kept LIBOR
artificially low, all those other loan rates were marked down too. Unlike
the JPMorgan trading fiasco of a few weeks ago, which has resulted in a
multibillion-dollar loss, the only apparent red ink so far in the LIBOR
scandal is the $450 million in fines that Barclays will pay to the U.K. and
U.S. governments for rigging rates (though pension funds and insurance
companies on the short end of LIBOR-pegged financial transactions may have
lost a lot of money).
Either way, the truth is that LIBOR is a much, much
bigger deal than what happened at JPMorgan. Rather than one screwed-up trade
that was--whether you like it or not (and I don't)--most likely legal, it
represents a financial system that is still, four years after the crisis
began, opaque, insular and dangerously underregulated. "This is a very, very
significant event," says Gary Gensler, chairman of the U.S. Commodity
Futures Trading Commission (CFTC), which is one of the regulators
investigating the scandal. "LIBOR is the mother of all financial indices,
and it's at the heart of the consumer-lending markets. There have been
winners and losers on both sides [of the LIBOR deals], but collectively we
all lose if the market isn't perceived to be honest."
Continued in article
View from the Left
"Barclays and the Limits of Financial Reform," by Alexander Cockburn,
The Nation, July 30, 2012 ---
http://www.thenation.com/article/168834/barclays-and-limits-financial-reform
"Execs to Cash In Despite Market Woes: Even companies whose
investors received a negative return this year expect to fund at least
100% of formula-based annual bonus plans," David McCann, CFO.com,
December 9, 2011 ---
http://www3.cfo.com/article/2011/12/compensation_executive-bonus-larre-towers-watson-
Are companies in denial when it comes to
executives' annual bonuses for 2011? Judge for yourself.
Among 265 companies that participated in a
newly released Towers Watson survey, 42% said their shareholders'
total returns were lower this year than in 2010. No surprise there,
given the stock markets' flat performance in 2011.
Yet among those that reported declining
shareholder value, a majority (54%) said they expected their bonus
plan to be at least 100% funded, based on the plan's funding
formula. That wasn't much behind the 58% of all companies that
expected full or greater funding (see chart).
"It boggles the mind. How do you articulate
that to your investors?" asks Eric Larre, consulting director and
senior executive pay consultant at Towers Watson. Noting that stocks
performed excellently in 2010 while corporate earnings stagnated —
the opposite of what has happened this year — he adds, "How are you
going to say to them, 'We made more money than we did last year, but
you didn't'?"
In particular, companies would have to
convincingly explain that annual bonus plans are intended to
motivate executives to achieve targets for short-term, internal
financial metrics such as EBITDA, operating margin, or earnings per
share, and that long-term incentive programs — which generally rest
on stock-option or restricted-stock awards, giving executives, like
investors, an ownership stake in the company — are more germane to
investors.
But such arguments may hold little sway
with the average investor, who "doesn't bifurcate compensation that
discretely," says Larre. Rather, investors simply look at the pay
packages as displayed in the proxy statement to see how much top
executives were paid overall, and at how the stock performed.
Larre attributes much of the current,
seeming generosity to executives to complacence within corporate
boards. This year, the first in which public companies were required
to give shareholders an advisory ("say on pay") vote on
executive-compensation plans, 89% received a thumbs-up. But that
came on the heels of 2010, when the S&P 500 gained some 13% and
investors were relatively content with their returns. "They may not
be as content now," Larre observes. "I think the number of 'no'
say-on-pay votes will be larger during the 2012 proxy season."
Continued in article
Compounding the Felony
"Libor problems haven't been fixed, regulators say," by Ben Protess and
Mark Scott, The New York Times, July 17, 2012 ---
http://dealbook.nytimes.com/2012/07/17/after-barclays-scandal-regulators-say-rates-remain-flawed/?ref=business
Federal authorities cast further doubt on Tuesday
about the integrity of a key interest rate that is the subject of a growing
investigation into wrongdoing at big banks around the globe.
In Congressional testimony, the chairman of the
Federal Reserve and the head of the Commodity Futures Trading Commission
expressed concern that banks had manipulated interest rates for their own
gain. They also indicated that flaws in the system — which were highlighted
in a recent enforcement case against Barclays — persist.
“If these key benchmarks are not based on honest
submissions, we all lose,” Gary Gensler, head of the trading commission,
which led the investigation into Barclays, said in testimony before the
Senate Agriculture Committee.
In separate testimony before the Senate Banking
Committee, Ben S. Bernanke, the Federal Reserve chairman, said he lacked
“full confidence” in the accuracy of the rate-setting process.
The Fed faces questions itself over whether it
should have reined in the rate-manipulation scheme, which took place from at
least 2005 to 2010.
Documents released last week show that the New York
Fed was well aware of potential problems at Barclays in 2008. At a hearing
in London on Tuesday, British authorities said the New York Fed never told
them Barclays was breaking the law.
Continued in article
"Sandy Weill Still Doesn't Have the Answer The banker-government
consortium re-exposed in the Libor scandal won't be unwound from the top,"
by Holman W. Jenkins, Jr., The Wall Street Journal, July 27, 2012 ---
http://professional.wsj.com/article/SB10000872396390443931404577552913658228058.html?mg=reno64-wsj#mod=djemEditorialPage_t
Sandy Weill was impressive as a scrambler, a
dealmaker, a man who could catch a wave. He's come out of retirement now, a
decade after creating the Citigroup oligopolist, to catch a new wave,
declaring on CNBC that investment banking and commercial banking should be
re-separated.
He explains that bank bailouts and too big to fail
would no longer be necessary, without explaining how, since both bank
bailouts and too big to fail predated the repeal of Glass-Steagall.
Mr. Weill finds himself suddenly welcome in the
company of editorialists who, since the Libor scandal, have been renewing
their clamor for bankers to be imprisoned, if not executed. He's become
their new hero.
The inherent Stalinism of those who crave to put
bankers in jail for things that aren't crimes is not unlike that of the
original Stalinist—who understood that nothing of substance has to change if
you've got enough scapegoats. Likewise, Mr. Weill's proposal to restore
Glass-Steagall would also change nothing.
Even too big to fail is too small a phrase. Do not
interpret the following conspiratorially: The total coalescence of the
financial elite with the governing elite in our and other countries is a
natural pattern. It may be corrupting. It may be counterproductive. But it's
the natural outcome of the giant, almost inconceivable amounts of debt the
U.S. and other governments ask the financial system to market and hold on
their behalf.
If you owe the bank $1 million, the bank owns you.
If you owe $1 billion, you own the bank. If you owe several trillion, you
are the financial system. Libor is called a key underpinning of global
finance. But that's far more true of IOUs issued by the U.S. government and
its major counterparts. The global financial system is built on a mountain
of government debt, and in turn banks and their governments are bedfellows
of a highly incestuous order.
That's why, in every transcript and phone
memorandum that has come to light, in talking about Libor, regulators and
bankers talk to each other as if they were all just bankers talking amongst
themselves.
That's why, when a high British official suggested
that Barclays lowball its Libor submission during the financial crisis,
Barclays didn't hesitate because, as one banker testified to the British
Parliament, these were government instructions "at a time when governments
were tangibly calling the shots."
It's ironic to think that some who championed the
euro saw it as way to break free of rule by bankers. Europe's new monetary
authority would be focused on a producing a stable currency; Europe's
national governments would have no choice but to live within their means.
This experiment failed because the European Central
Bank quickly adopted policies designed to induce banks not to distinguish
between the debts of disciplined and undisciplined governments. That is, the
euro was immediately corrupted by the need to help governments keep
financing themselves.
Now the world is Europe. Under the current regime
of financial repression, banks and states are even more annexes of each
other. Notice Japan's central bank explicitly stating plans to erode the
value of the government's debt in the hands of Japanese savers. Notice the
European Central Bank again hinting at readiness to buy the debt of
countries no longer able to find voluntary buyers in the market. In the
U.S., how long before the Treasury issues a perpetual bond yielding zero
percent for direct sale to the Fed?
The banker-government consortium re-exposed in the
Libor scandal won't be unwound from the top, not when governments are more
dependent than ever on a captive financial system to give their debt the
illusion of viability. And yet there's still a possibility of unwinding it
from the bottom, by giving large numbers of bankers an incentive to get out
of the government-insured sector and go back to a world in which they live
by their own profits and losses.
The solution begins with deposit-insurance reform.
The FDIC would stop insuring deposits that are invested in anything other
than U.S. Treasury paper. The FDIC would be charged solely with seizing
these assets when a bank gets in trouble so the claims of insured depositors
can be satisfied. There'd be no call to bail out other creditors or
shareholders to minimize the cost to the deposit insurance fund.
Yes, the threat might be only semi-credible. But
such a law could be got through Congress and risk-averse lenders would
become less interested in holding uninsured credit against banks that are
too big to manage and too opaque to be viable without a government backstop.
Continued in article
That some bankers have ended up in
prison is not a matter of scandal, but what is outrageous is the fact that all
the others are free.
Honoré de Balzac
Bankers bet with their bank's capital, not their
own. If the bet goes right, they get a huge bonus; if it misfires, that's the
shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by
Avital Louria Hahn, "Missing: How Poor Risk-Management Techniques Contributed
to the Subprime Mess," CFO Magazine, March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Fed is going to bail
out these crooks with taxpayer funds makes it all the worse.
"Horribly Rotten, Comically Stupid: Even as they rigged LIBOR rates,
UBS bankers displayed a warped loyalty to their co-manipulators," CFO.com,
December 21, 2012 ---
http://www3.cfo.com/article/2012/12/capital-markets_ubs-libor-euribor-financial-service-authority-barclays
For any who doubted whether there was honour among
thieves, or indeed among investment bankers, solace may be found in the
details of a settlement between UBS, a Swiss bank, and regulators around the
world over a vast and troubling conspiracy by some of its employees to rig
LIBOR and EURIBOR, key market interest rates. Regulators in Britain and
Switzerland have argued that manipulation of interest rates that took place
over a long period of time, involved many employees at UBS and that,
according to Britain’s Financial Service Authority, was so “routine and
widespread” that “every LIBOR and EURIBOR submission, in currencies and
tenors in which UBS traded during the relevant period, was at risk of having
been improperly influenced to benefit derivatives trading positions.” In
these settlements UBS agreed to pay 1.4 billion Swiss Francs ($1.5 billion)
to British, American and Swiss regulators. CFO.com (http://s.tt/1xxaa)
Yet, even in the midst
of this wrongdoing there was evidence of a sense of honour, however
misplaced. One banker at UBS, in asking a broker to help manipulate
submissions, promised ample recompense:
"I will fucking do one humongous deal with you ...
Like a 50, 000 buck deal, whatever. I need you to keep it as low as
possible ... if you do that ... I’ll pay you, you know, 50,000 dollars,
100,000 dollars ... whatever you want ... I’m a man of my word."
Further hints emerge of the warped morality that
was held by some UBS employees and their conspirators at brokers and
rival banks. In one telling conversation an unnamed broker asks an
employee at another bank to submit a false bid at the request of a UBS
trader. Lest the good turn go unnoticed the broker reassures the banker
that he will pass on word of the manipulation to UBS.
Broker B: “Yeah, he will know mate. Definitely,
definitely, definitely”;
Panel Bank 1 submitter: “You know, scratch my back
yeah an all”
Broker B: “Yeah oh definitely, yeah, play the
rules.”
The interchanges published by the FSA also reveal
a comical stupidity among people who, if judged by their above-average
pay, ought to have been expected to display above-average insight and
intelligence. Sadly, they showed neither.
In one instance, two UBS employees, a manager and
a trader (who also submitted interest rates) discuss an article in the
Wall Street Journal raising doubt over the accuracy of bank’s LIBOR
submissions. “Great article in the WSJ today about the LIBOR problem”
says one. “Just reading it” his colleague replies.
Yet according to the FSA, some two hours later
they were happily conspiring to submit manipulated bids:
Trader-Submitter D: “mate any axe in [GBP] libors?”
Manager D: “higher pls”
Trader-Submitter D: “93?”
Manager D: “pls”
Trader-Submitter D: “[o]k”
In another moment of comical stupidity one
employee sends out a request on a public chat forum at the bank asking
the 58 participants if there are any requests for a manipulated rate.
Later, after being admonished to “BE CAREFUL DUDE” in a private note
from a manager, he replies “i agree we shouldnt ve been talking about
putting fixings for our positions on public chat (sic)”.
Apart from the salacious glimpse that these
settlements give into the foul-mouthed and matey culture (as well as
atrocious grammar) of investment banking trading desks, they also reveal
worrying suggestions that this conspiracy was bigger than previously
suspected. Information released by the FSA shows it involved not just
banks, as was previously known from a settlement earlier this year by
Barclays, but that it also involves the collusion of employees at
inter-broker dealers, the firms that stand between banks and help them
to trade with one another.
Regulators found that brokers at these firms
helped coordinate false submissions between banks, posted false rates
and estimates of where rates might go on their own trading screens, and
even posted spoof bids to mislead market participants as to the real
rate in the market.
The details in these settlements suggest that
lawyers representing clients in a clutch of class-action lawsuits in
America against banks including UBS will have a field day.
The first reason they are cheering is because UBS
didn’t simply submit false estimates of interest rates on its own.
According to the settlement documents, UBS tried and apparently
succeeded in some cases in getting other firms to collude in
manipulating rates. That collusion strengthens the case of civil
litigants in America who are arguing in court that banks worked together
to fix prices. It also undermines one of the defences filed by banks in
American courts that their submissions, although possibly incorrect in
some cases, were simply the individual acts of banks that happened by
chance to be acting in parallel. The latest settlements may also make it
easier for civil litigants to claim damages from UBS since the Swiss
regulator found that it had profited from its wrongdoing.
Continued in article
Bob Jensen's threads on interest rate swaps and LIBOR ---
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
Search for LIBOR or swap.
Timeline of Financial Scandals, Auditing
Failures, and the Evolution of International Accounting Standards ----
http://faculty.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds
Timeline of Financial Scandals, Auditing Failures, and the Evolution of
International Accounting Standards ----
http://faculty.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds
(to view on a new page)
Bob Jensen's threads on corporate governance are at
http://faculty.trinity.edu/rjensen/fraud001.htm#Governance
Timeline of Financial Scandals, Auditing
Failures, and the Evolution of International Accounting Standards ----
http://faculty.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds
"Lies, Damn Lies and Libor: Call it one more improvisation in 'too
big to fail' crisis management," by Holman W. Jenkins Jr., The Wall
Street Journal, July 6, 2012 ---
http://professional.wsj.com/article/SB10001424052702304141204577510490732163260.html?mod=djemEditorialPage_t&mg=reno64-wsj
Ignore the man behind the curtain, said the Wizard
of Oz. That advice doesn't pay in the latest scandal of the century, over
manipulation of Libor, or the London Interbank Offered Rate. The mess is one
more proof of the failing wizardry of the First World's monetary-cum-banking
arrangements.
Libor is a reference point for interest rates on
everything from auto loans and mortgages to commercial credit and complex
derivatives. Major world banks are accused of artificially suppressing their
claimed Libor rates during the 2007-08 financial crisis to hide an erosion
of trust in each other.
Did the Bank of England or other regulators
encourage and abet this manipulation of a global financial indicator?
We are talking about TBTF banks—too big to fail
banks. Banks that, by definition, become suspect only when creditors begin
to wonder if regulators might seize them and impose losses selectively on
creditors. Their overseers could not have failed to notice that interbank
liquidity was drying up and the banks nevertheless were reporting Libor
rates that suggested all was well. The now-famous nudging phone call from
the Bank of England's Paul Tucker to Barclays's Bob Diamond came many months
after Libor manipulation had already been aired in the press and in meetings
on both sides of the Atlantic. That call was meant to convey the British
establishment's concern about Barclays's too-high Libor submissions.
Let's not kid ourselves about something else:
Central banks everywhere at the time were fighting collapsing confidence by
cutting rates to stimulate retail lending. Their efforts would have been
thwarted if Libor flew up on panic about the solvency of the major banks.
Of all the questionably legal improvisations
regulators resorted to during the crisis, then, the Libor fudge appears to
be just one more. Regulators everywhere gamed their own capital standards to
keep banks afloat. The Fed's bailout of AIG, an insurance company, hardly
bears close examination. And who can forget J.P. Morgan's last-minute
decision to pay Bear Stearns shareholders $10 a share, rather than the $2
mandated by Treasury Secretary Hank Paulson, to avoid a legal test of the
Fed-orchestrated takeover? Even today, the European Central Bank continues
to extend its mandate in dubious ways to fight the euro crisis.
There has been little legal blowback from any of
this, but apparently there will be a great deal of blowback from the Libor
fudge. Barclays has paid $453 million in fines. Half its top management has
resigned. A dozen banks—including Credit Suisse, Deutsche Bank, Citigroup
and J.P. Morgan Chase—remain under investigation. Private litigants are
lining up even as officialdom seemingly intends to wash its hands of its own
role.
Yet the larger lesson isn't that bankers are moral
scum, badder than the rest of us. The Libor scandal is another testimony (as
if more were needed) of just how lacking in rational design most human
institutions inevitably are.
Libor was flawed by the assumption that the banks
setting it would always be seen as top-drawer credit risks. The Basel
capital-adequacy rules were flawed because they incentivized banks to
overproduce "safe" assets, like Greek bonds and U.S. mortgages. The ratings
process was flawed eight ways from Sunday, including the fact that many
fiduciaries, under law, were required to invest in securities blessed by the
rating agencies.
Some Barclays emails imply that traders, even
before the crisis, sought to influence the bank's Libor submissions for
profit-seeking reasons. This is puzzling and may amount to empty chest
thumping. Barclays's "submitters" wouldn't seem in a position to move Libor
in ways of great use to traders. Sixteen banks are polled to set Libor and
any outlying results are thrown out. Plus each bank's name and submission
are published daily. But let's ask: Instead of trying to manipulate Libor in
a crisis, what would have been a more straightforward way of dealing with
its exposed flaws, considering the many trillions in outstanding credit tied
to Libor?
Continued in article
Compounding the Felony
"Libor problems haven't been fixed, regulators say," by Ben Protess and
Mark Scott, The New York Times, July 17, 2012 ---
http://dealbook.nytimes.com/2012/07/17/after-barclays-scandal-regulators-say-rates-remain-flawed/?ref=business
Federal authorities cast further doubt on Tuesday
about the integrity of a key interest rate that is the subject of a growing
investigation into wrongdoing at big banks around the globe.
In Congressional testimony, the chairman of the
Federal Reserve and the head of the Commodity Futures Trading Commission
expressed concern that banks had manipulated interest rates for their own
gain. They also indicated that flaws in the system — which were highlighted
in a recent enforcement case against Barclays — persist.
“If these key benchmarks are not based on honest
submissions, we all lose,” Gary Gensler, head of the trading commission,
which led the investigation into Barclays, said in testimony before the
Senate Agriculture Committee.
In separate testimony before the Senate Banking
Committee, Ben S. Bernanke, the Federal Reserve chairman, said he lacked
“full confidence” in the accuracy of the rate-setting process.
The Fed faces questions itself over whether it
should have reined in the rate-manipulation scheme, which took place from at
least 2005 to 2010.
Documents released last week show that the New York
Fed was well aware of potential problems at Barclays in 2008. At a hearing
in London on Tuesday, British authorities said the New York Fed never told
them Barclays was breaking the law.
Continued in article
Bob Jensen's threads on corporate governance are at
http://faculty.trinity.edu/rjensen/fraud001.htm#Governance
Bob Jensen's threads on interest rate swaps and LIBOR ---
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
Search for LIBOR or swap.
"Gangster Bankers: Too Big to Jail: How
HSBC hooked up with drug traffickers and terrorists. And got away with it,"
by Matt Taibbi, Rolling Stone, February 14, 2013 ---
http://www.rollingstone.com/politics/news/gangster-bankers-too-big-to-jail-20130214
The deal was announced
quietly, just before the holidays, almost like the government was hoping
people were too busy hanging stockings by the fireplace to notice. Flooring
politicians, lawyers and investigators all over the world, the U.S. Justice
Department granted a total walk to executives of the British-based bank HSBC
for the largest drug-and-terrorism money-laundering case ever. Yes, they
issued a fine – $1.9 billion, or about five weeks' profit – but they didn't
extract so much as one dollar or one day in jail from any individual,
despite a decade of stupefying abuses.
People may have outrage
fatigue about Wall Street, and more stories about billionaire greedheads
getting away with more stealing often cease to amaze. But the HSBC case went
miles beyond the usual paper-pushing, keypad-punching sort-of crime,
committed by geeks in ties, normally associated with Wall Street. In this
case, the bank literally got away with murder – well, aiding and abetting
it, anyway.
Daily Beast: HSBC Report Should Result in Prosecutions, Not Just Fines, Say
Critics
For at least half a decade,
the storied British colonial banking power helped to wash hundreds of
millions of dollars for drug mobs, including Mexico's Sinaloa drug cartel,
suspected in tens of thousands of murders just in the past 10 years – people
so totally evil, jokes former New York Attorney General Eliot Spitzer, that
"they make the guys on Wall Street look good." The bank also moved money for
organizations linked to Al Qaeda and Hezbollah, and for Russian gangsters;
helped countries like Iran, the Sudan and North Korea evade sanctions; and,
in between helping murderers and terrorists and rogue states, aided
countless common tax cheats in hiding their cash.
"They violated every goddamn
law in the book," says Jack Blum, an attorney and former Senate investigator
who headed a major bribery investigation against Lockheed in the 1970s that
led to the passage of the Foreign Corrupt Practices Act. "They took every
imaginable form of illegal and illicit business."
That nobody from the bank
went to jail or paid a dollar in individual fines is nothing new in this era
of financial crisis. What is different about this settlement is that the
Justice Department, for the first time, admitted why it decided to go soft
on this particular kind of criminal. It was worried that anything more than
a wrist slap for HSBC might undermine the world economy. "Had the U.S.
authorities decided to press criminal charges," said Assistant Attorney
General Lanny Breuer at a press conference to announce the settlement, "HSBC
would almost certainly have lost its banking license in the U.S., the future
of the institution would have been under threat and the entire banking
system would have been destabilized."
It was the dawn of a new
era. In the years just after 9/11, even being breathed on by a suspected
terrorist could land you in extralegal detention for the rest of your life.
But now, when you're Too Big to Jail, you can cop to laundering terrorist
cash and violating the Trading With the Enemy Act, and not only will you not
be prosecuted for it, but the government will go out of its way to make sure
you won't lose your license. Some on the Hill put it to me this way: OK,
fine, no jail time, but they can't even pull their charter? Are you kidding?
But the Justice Department
wasn't finished handing out Christmas goodies. A little over a week later,
Breuer was back in front of the press, giving a cushy deal to another huge
international firm, the Swiss bank UBS, which had just admitted to a key
role in perhaps the biggest antitrust/price-fixing case in history, the
so-called LIBOR scandal, a massive interest-raterigging conspiracy
involving hundreds of trillions ("trillions," with a "t") of dollars in
financial products. While two minor players did face charges, Breuer and the
Justice Department worried aloud about global stability as they explained
why no criminal charges were being filed against the parent company.
"Our goal here," Breuer
said, "is not to destroy a major financial institution."
A reporter at the UBS
presser pointed out to Breuer that UBS had already been busted in 2009 in a
major tax-evasion case, and asked a sensible question. "This is a bank that
has broken the law before," the reporter said. "So why not be tougher?"
"I don't know what tougher
means," answered the assistant attorney general.
Also known as the Hong Kong
and Shanghai Banking Corporation, HSBC has always been associated with
drugs. Founded in 1865, HSBC became the major commercial bank in colonial
China after the conclusion of the Second Opium War. If you're rusty in your
history of Britain's various wars of Imperial Rape, the Second Opium War was
the one where Britain and other European powers basically slaughtered lots
of Chinese people until they agreed to legalize the dope trade (much like
they had done in the First Opium War, which ended in 1842).
A century and a half later,
it appears not much has changed. With its strong on-the-ground presence in
many of the various ex-colonial territories in Asia and Africa, and its rich
history of cross-cultural moral flexibility, HSBC has a very different
international footprint than other Too Big to Fail banks like Wells Fargo or
Bank of America. While the American banking behemoths mainly gorged
themselves on the toxic residential-mortgage trade that caused the 2008
financial bubble, HSBC took a slightly different path, turning itself into
the destination bank for domestic and international scoundrels of every
possible persuasion.
Three-time losers doing life
in California prisons for street felonies might be surprised to learn that
the no-jail settlement Lanny Breuer worked out for HSBC was already the
bank's third strike. In fact, as a mortifying 334-page report issued by the
Senate Permanent Subcommittee on Investigations last summer made plain, HSBC
ignored a truly awesome quantity of official warnings.
In April 2003, with 9/11
still fresh in the minds of American regulators, the Federal Reserve sent
HSBC's American subsidiary a cease-and-desist letter, ordering it to clean
up its act and make a better effort to keep criminals and terrorists from
opening accounts at its bank. One of the bank's bigger customers, for
instance, was Saudi Arabia's Al Rajhi bank, which had been linked by the CIA
and other government agencies to terrorism. According to a document cited in
a Senate report, one of the bank's founders, Sulaiman bin Abdul Aziz Al
Rajhi, was among 20 early financiers of Al Qaeda, a member of what Osama bin
Laden himself apparently called the "Golden Chain." In 2003, the CIA wrote a
confidential report about the bank, describing Al Rajhi as a "conduit for
extremist finance." In the report, details of which leaked to the public by
2007, the agency noted that Sulaiman Al Rajhi consciously worked to help
Islamic "charities" hide their true nature, ordering the bank's board to
"explore financial instruments that would allow the bank's charitable
contributions to avoid official Saudi scrutiny." (The bank has denied any
role in financing extremists.)
Continued in a long article
Bob Jensen's Rotten to the Core threads---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Teaching Case from The Wall Street Journal Weekly Accounting Review on
October 19, 2012
Broadway Show Was Duped, Prosecutors Say
by:
Chad Bray and Jennifer Maloney
Oct 15, 2012
Click here to view the full article on WSJ.com
TOPICS: Factoring, Fraud
SUMMARY: "In one of the biggest fraud accusations in Broadway
history, a former stockbroker was charged Monday with duping the producers
of "Rebecca: The Musical" into believing he had secured $4.5 million from a
group of overseas investors-all of whom he had invented, federal prosecutors
said....Mr. Hotton has been accused of...a separate alleged scheme to induce
companies to advance $3.7 million to buy a portion of the purported accounts
receivable for businesses run by Mr. Hotton and his wife...."
CLASSROOM APPLICATION: The article may be used in an accounting or
MBA class to discuss fraud and factoring accounts receivable.
QUESTIONS:
1. (Introductory) Summarize the fraud purportedly committed by Mr.
Mark Hotton. What financial benefit did Mr. Hotton receive? Who paid those
funds to Mr. Hotton?
2. (Advanced) What caution does this story give for Broadway shows
or other artistic endeavors looking for funding?
3. (Advanced) Define the term "factoring" of accounts receivable.
How did Mr. Hotton also allegedly try to use this business practice to
fraudulently obtain funds from others?
Reviewed By: Judy Beckman, University of Rhode Island
"Broadway Show Was Duped, Prosecutors Say," by
Chad Bray and Jennifer Maloney, The Wall Street Journal, October 19, 2012
---
http://professional.wsj.com/article/SB10000872396390443624204578058220817847906.html?mod=djem_jiewr_AC_domainid&mg=reno-wsj
In one of the biggest fraud
accusations in Broadway history, a former stockbroker was charged Monday
with duping the producers of "Rebecca: The Musical" into believing he had
secured $4.5 million from a group of overseas investors—all of whom he had
invented, federal prosecutors said.
Prosecutors alleged that
Mark Hotton, a 46-year-old living on Long Island outside New York City,
created four investors out of thin air, including an Australian named "Paul
Abrams" who, in a fantastical twist, was said to have contracted malaria on
what Mr. Hotton claimed was an African safari and died just as his wire
transfer of funds was due.
In return for lining up
these alleged investors as well as a fake $1.1 million loan, the show's
producers paid more than $60,000 to Mr. Hotton or entities he controlled,
prosecutors said.
Gerald Shargel, a lawyer for
Mr. Hotton, declined to comment Monday.
Mr. Hotton wove a complex
but sometimes sloppy web of deceit, using several fake email addresses and
website domains, according to court records. He used one email address for
communications from two different fictitious investors and later from
assistants supposedly working for Mr. Abrams, giving updates on the fake
investor's rapidly declining health.
Before Mr. Abrams's
purported demise, Mr. Hotton received an $18,000 advance from the show's
producers supposedly for taking the investor and his son on a safari,
prosecutors said.
"Rebecca," based on the 1938
novel by Daphne du Maurier, opened in Vienna in 2006, but suffered setbacks
as producers tried to bring it to Broadway, including a canceled production
in London last year and a postponement in New York this spring. It had been
slated to open on Broadway in November before it was postponed indefinitely
Sept. 30, after the money Mr. Hotton had promised failed to show up.
The criminal investigation
provides a backstage look into the secretive and sometimes murky
relationships behind the funding of Broadway's increasingly expensive shows.
"I think it's a wake-up call
to producers to be extra careful," said Steven Baruch, a longtime Broadway
producer who wasn't involved in "Rebecca." But, he added, "It's such a
unique piece of criminality that I don't think it scares substantial numbers
of people away."
Ronald G. Russo, an attorney
for lead "Rebecca" producer Ben Sprecher, said that when the producers first
met Mr. Hotton, they believed him to be legitimate because he held a Series
7 license, required to be a stockbroker. According to the Financial Industry
Regulatory Authority, which regulates the securities industry, he hasn't
held that license since May.
"I guess going forward, you
need to say, 'I want to meet this investor, I want to shake his hand, I want
to see his passport,' " Mr. Russo said.
According to court
documents, the show's producers reached out to Mr. Hotton in January after
they realized they were about $4 million short of the capital they needed to
open. The show had a budget of $12 million to $14 million.
Mr. Sprecher said he is
committed to opening "Rebecca" on Broadway. But other producers expressed
skepticism he will be able to find the investors he needs after having had
trouble locking them down so far.
Continued in article
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Disaster for Dodd Frank --- Lawyers are
Litigating
"Courts taking up opposition to Dodd-Frank,"
Dina ElBoghdady, The Washington Post, October 5, 2012 ---
Click Here
http://www.washingtonpost.com/business/economy/courts-taking-up-opposition-to-dodd-frank/2012/10/05/ebeb1874-0e27-11e2-bb5e-492c0d30bff6_story.html
After failing to scuttle the
landmark legislation in Congress, critics of the Dodd-Frank Act overhauling
financial regulations are trying to chisel away at it in the courts — with
some initial success.
Twice, federal regulators
have lost in court trying to defend the rules, which were put in place after
the 2008 financial crisis. On Friday, they were back in court again,
fighting for yet another regulation they say is linked to Dodd-Frank.
Each time, the challenge
came from a lawyer with a prominent legal pedigree: Eugene Scalia, son of
Supreme Court Justice Antonin Scalia.
The legal battles raise an
urgent question that’s likely to surface again and again about how much
deference the courts are willing to grant the agencies that police corporate
America.
“After all the lobbying in
Congress to tear down Dodd-Frank, there’s now a second stage in the war: the
courts,” said Donald Langevoort, a Georgetown Law securities professor. “The
judges seem more than willing to say that the rules adopted in the aftermath
of the financial crisis simply can’t be enforced because of procedural
defects.”
In the case Friday, a
federal judge heard a challenge to a rule that requires mutual funds that
invest in certain financial instruments to register with the Commodity
Futures Trading Commission. Last week, the same court struck down a
regulation designed to rein in speculative commodities trading. And about a
year ago, an appeals court blocked a rule that would have made it easier for
shareholders to oust members of corporate boards.
In each case, Scalia’s team
at Gibson, Dunn & Crutcher argued that the regulators failed to justify the
rules they crafted or fully consider their economic impact.
“The agencies gave reasons
that didn’t add up, contradicted themselves or failed to respond to
significant criticisms raised by the public,” Scalia said in an interview.
“Any one of those things is going to result in a rule getting thrown out by
any court at any time.”
In the case argued Friday,
the CFTC said that the financial overhaul bill gave it authority to set the
new rules for mutual funds. But the plaintiffs said the rule is unrelated to
the Dodd-Frank law, and that the agency is using that law “to change the
subject” because the regulation is neither necessary nor justified by
economic analysis.
Similar arguments prevailed
in the two cases decided by the courts so far.
In the commodities trading
decision last week, U.S. District Judge Robert L. Wilkins told the CFTC to
justify the need for a regulation that would limit how many contracts a
trader can obtain for the future delivery of 28 commodities, including
natural gas and oil. The rule also would have applied to certain financial
instruments known as swaps, a form of derivative.
The agency said it was
acting under a Dodd-Frank mandate designed to reduce excessive speculation
in the commodities market so that no one trader could control such a large
percentage of the market that it skews prices.
Continued in article
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"Should Some Bankers Be Prosecuted?" by
Jeff Madrick and Frank Partnoy, New York Review of Books, November 10,
2011 ---
http://www.nybooks.com/articles/archives/2011/nov/10/should-some-bankers-be-prosecuted/
Thank you Robert Walker for the heads up!
More than three years have
passed since the old-line investment bank Lehman Brothers stunned the
financial markets by filing for bankruptcy. Several federal government
programs have since tried to rescue the financial system: the $700 billion
Troubled Asset Relief Program, the Federal Reserve’s aggressive expansion of
credit, and President Obama’s additional $800 billion stimulus in 2009. But
it is now apparent that these programs were not sufficient to create the
conditions for a full economic recovery. Today, the unemployment rate
remains above 9 percent, and the annual rate of economic growth has slipped
to roughly 1 percent during the last six months. New crises afflict world
markets while the American economy may again slide into recession after only
a tepid recovery from the worst recession since the Great Depression.
n our article in the last
issue,1 we showed that, contrary to the claims of some analysts, the
federally regulated mortgage agencies, Fannie Mae and Freddie Mac, were not
central causes of the crisis. Rather, private financial firms on Wall Street
and around the country unambiguously and overwhelmingly created the
conditions that led to catastrophe. The risk of losses from the loans and
mortgages these firms routinely bought and sold, particularly the subprime
mortgages sold to low-income borrowers with poor credit, was significantly
greater than regulators realized and was often hidden from investors. Wall
Street bankers made personal fortunes all the while, in substantial part
based on profits from selling the same subprime mortgages in repackaged
securities to investors throughout the world.
Yet thus far, federal
agencies have launched few serious lawsuits against the major financial
firms that participated in the collapse, and not a single criminal charge
has been filed against anyone at a major bank. The federal government has
been far more active in rescuing bankers than prosecuting them.
In September 2011, the
Securities and Exchange Commission asserted that overall it had charged
seventy-three persons and entities with misconduct that led to or arose from
the financial crisis, including misleading investors and concealing risks.
But even the SEC’s highest- profile cases have let the defendants off
lightly, and did not lead to criminal prosecutions. In 2010, Angelo Mozilo,
the head of Countrywide Financial, the nation’s largest subprime mortgage
underwriter, settled SEC charges that he misled mortgage buyers by paying a
$22.5 million penalty and giving up $45 million of his gains. But Mozilo had
made $129 million the year before the crisis began, and nearly another $300
million in the years before that. He did not have to admit to any guilt.
The biggest SEC settlement
thus far, alleging that Goldman Sachs misled investors about a complex
mortgage product—telling investors to buy what had been conceived by some as
a losing proposition—was for $550 million, a record of which the SEC
boasted. But Goldman Sachs earned nearly $8.5 billion in 2010, the year of
the settlement. No high-level executives at Goldman were sued or fined, and
only one junior banker at Goldman was charged with fraud, in a civil case. A
similar suit against JPMorgan resulted in a $153.6 million fine, but no
criminal charges.
Although both the SEC and
the Financial Crisis Inquiry Commission, which investigated the financial
crisis, have referred their own investigations to the Department of Justice,
federal prosecutors have yet to bring a single case based on the private
decisions that were at the core of the financial crisis. In fact, the
Justice Department recently dropped the one broad criminal investigation it
was undertaking against the executives who ran Washington Mutual, one of the
nation’s largest and most aggressive mortgage originators. After hundreds of
interviews, the US attorney concluded that the evidence “does not meet the
exacting standards for criminal charges.” These standards require that
evidence of guilt is “beyond a reasonable doubt.”
This August, at last, a
federal regulator launched sweeping lawsuits alleging fraud by major
participants in the mortgage crisis. The Federal Housing Finance Agency sued
seventeen institutions, including major Wall Street and European banks, over
nearly $200 billion of allegedly deceitful sales of mortgage securities to
Fannie Mae and Freddie Mac, which it oversees. The banks will argue that
Fannie and Freddie were sophisticated investors who could hardly be fooled,
and it is unclear at this early stage how successful these suits will be.
Meanwhile, several state
attorneys general are demanding a settlement for abuses by the businesses
that administer mortgages and collect and distribute mortgage payments.
Negotiations are under way for what may turn out to be moderate settlements,
which would enable the defendants to avoid admitting guilt. But others,
particularly Eric Schneiderman, the New York State attorney general, are
more aggressively pursuing cases against Wall Street, including Goldman
Sachs and Morgan Stanley, and they may yet bring criminal charges.
Successful prosecutions of
individuals as well as their firms would surely have a deterrent effect on
Wall Street’s deceptive activities; they often carry jail terms as well as
financial penalties. Perhaps as important, the failure to bring strong
criminal cases also makes it difficult for most Americans to understand how
these crises occurred. Are they simply to conclude that Wall Street made
well- meaning if very big errors of judgment, as bankers claim, that were
rarely if ever illegal or even knowingly deceptive?
What is stopping
prosecution? Apparently not public opinion. A Pew Research Opinion survey
back in 2010 found that three quarters of Americans said that government
policies helped banks and financial institutions while two thirds said the
middle class and poor received little help. In mid-2011, half of those
surveyed by Pew said that Wall Street hurts the economy more than it helps
it.
Many argue that the
reluctance of prosecutors derives from the power and importance of bankers,
who remain significant political contributors and have built substantial
lobbying operations. Only 5 percent of congressional bills designed to
tighten financial regulations between 2000 and 2006 passed, while 16 percent
of those that loosened such regulations were approved, according to a study
by the International Monetary Fund.2 The IMF economists found that a major
reason was lobbying efforts. In 2009 and early 2010, financial firms spent
$1.3 billion to lobby Congress during the passage of the Dodd-Frank Act. The
financial reregulation legislation was weakened in such areas as derivatives
trading and shareholder rights, and is being further watered down.
Others claim federal
officials fear that punishing the banks too much will undermine the fragile
economic recovery. As one former Fannie official, now a private financial
consultant, recently told The New York Times, “I am afraid that we risk
pushing these guys off of a cliff and we’re going to have to bail out the
banks again.”
The responsibility for
reluctance, however, also lies with the prosecutors and the law itself. A
central problem is that proving financial fraud is much more difficult than
proving most other crimes, and prosecutors are often unwilling to try it.
Congress could fix this by amending federal fraud statutes to require, for
example, that prosecutors merely prove that bankers should have known rather
than actually did know they were deceiving their clients.
But even if Congress
does not, it is not too late for bold federal prosecutors to try to bring a
few successful cases. A handful of wins could create new precedents and
common law that would set a higher and clearer standard for Wall Street,
encourage more ethical practices, deter fraud—and arguably prevent
future crises.
Continued in article
"How Wall Street Fleeced the World: The
Searing New doc Inside Job Indicts the Bankers and Their
Washington Pals," by Mary Corliss and Richard Corliss, Time Magazine,
October 18, 2010 ---
http://www.time.com/time/magazine/article/0,9171,2024228,00.html
Like some malefactor being
grilled by Mike Wallace in his 60 Minutes prime, Glenn Hubbard, dean of
Columbia Business School, gets hot under the third-degree light of Charles
Ferguson's questioning in Inside Job. Hubbard, who helped design George W.
Bush's tax cuts on investment gains and stock dividends, finally snaps, "You
have three more minutes. Give it your best shot." But he has already shot
himself in the foot.
Frederic Mishkin, a former
Federal Reserve Board governor and for now an economics professor at
Columbia, begins stammering when Ferguson quizzes him about when the Fed
first became aware of the danger of subprime loans. "I don't know the
details... I'm not sure exactly... We had a whole group of people looking at
this." "Excuse me," Ferguson interrupts, "you can't be serious. If you would
have looked, you would have found things." (See the demise of Bernie
Madoff.)
Ferguson—whose
Oscar-nominated No End in Sight analyzed the Bush Administration's slipshod
planning of the Iraq occupation—did look at the Fed, the Wall Street solons
and the decisions made by White House administrations over the past 30
years, and he found plenty. Of the docufilms that have addressed the
worldwide financial collapse (Michael Moore's Capitalism: A Love Story,
Leslie and Andrew Cockburn's American Casino), this cogent, devastating
synopsis is the definitive indictment of the titans who swindled America and
of their pals in the federal government who enabled them.
With a Ph.D. in political
science from MIT, Ferguson is no knee-jerk anticapitalist. In the '90s, he
and a partner created a software company and sold it to Microsoft for $133
million. He is at ease talking with his moneyed peers and brings a calm tone
to the film (narrated by Matt Damon). Yet you detect a growing anger as
Ferguson digs beneath the rubble, and his fury is infectious. If you're not
enraged by the end of this movie, you haven't been paying attention. (See
"Protesting the Bailout.")
The seeds of the collapse
took decades to flower. By 2008, the financial landscape had become so
deregulated that homeowners and small investors had few laws to help them.
Inflating the banking bubble was a group effort—by billionaire CEOs with
their private jets, by agencies like Moody's and Standard & Poor's that kept
giving impeccable ratings to lousy financial products, by a Congress that
overturned consumer-protection laws and by Wall Street's fans in academe,
who can earn hundreds of thousands of dollars by writing papers favorable to
Big Business or sitting on the boards of firms like Goldman Sachs.
Who's Screwing Whom? In the
spasm of moral recrimination that followed the collapse, some blamed the
bright kids who passed up careers in science or medicine to make millions on
Wall Street and charged millions more on their expense accounts for cocaine
and prostitutes. After the savings-and-loan scandals of the late-'80s,
according to Inside Job, thousands of executives went to jail. This time,
with the economy bulking up on the steroids of derivatives and
credit-default swaps, the only person who has done any time is Kristin
Davis, the madam of a bordello patronized by Wall Streeters. Davis appears
in the film, as does disgraced ex--New York governor Eliot Spitzer; both
seem almost virtuous when compared with the big-money men. (See "The Case
Against Goldman Sachs.")
The larger message of both
No End in Sight and Inside Job is that American optimism, the engine for the
nation's expansion, can have tragic results. The conquest of Iraq? A slam
dunk. Gambling billions on risky mortgages? No worry—the housing market
always goes up. Ignoring darker, more prescient scenarios, the geniuses in
charge constructed faith-based policies that enriched their pals; they
stumbled toward a precipice, and the rest of us fell off.
The shell game continues.
Inside Job also details how, in Obama's White House, finance-industry
veterans devised a "recovery" that further enriched their cronies without
doing much for the average Joe. Want proof? Look at the financial industry's
fat profits of the past year and then at your bank account, your pension
plan, your own bottom line.
Video: Watch Columbia's Business School
Economist and Dean Hubbard rap his wrath for Ben Bernanke
The video
is a anti-Bernanke musical performance by the Dean of Columbia Business School
---
http://www.youtube.com/watch?v=3u2qRXb4xCU
Ben Bernanke (Chairman of the Federal Reserve and a great friend of big banks)
---
http://en.wikipedia.org/wiki/Ben_Bernanke
R. Glenn Hubbard (Dean of the Columbia Business School) ---
http://en.wikipedia.org/wiki/Glenn_Hubbard_(economics)
"Cheat
Sheet: What’s Happened to the Big Players in the Financial Crisis?" by
Braden Goyette, Publica, October 26, 2011 ---
http://www.propublica.org/article/cheat-sheet-whats-happened-to-the-big-players-in-the-financial-crisis
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
The greatest swindle in the history of the
world ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Bob Jensen's threads on how the banking
system is rotten to the core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"Woman Who Couldn’t Be Intimidated by
Citigroup Wins $31 Million," by Bob Ivry, Bloomberg News, May 31,
2012 ---
file:///C:/Documents and Settings/rjensen/My Documents/My Web Sites/images
Sherry Hunt never expected
to be a senior manager at a Wall Street bank. She was a country girl, raised
in rural Michigan by a dad who taught her to fish and a mom who showed her
how to find wild mushrooms. She listened to Marty Robbins and Buck Owens on
the radio and came to believe that God has a bigger plan, that everything
happens for a reason.
She got married at 16 and
didn’t go to college. After she had her first child at 17, she needed a job.
A friend helped her find one in 1975, processing home loans at a small bank
in Alaska. Over the next 30 years, Hunt moved up the ladder to
mortgage-banking positions in Indiana, Minnesota and Missouri, Bloomberg
Markets magazine reports in its July issue.
On her days off, when she
wasn’t fishing with her husband, Jonathan, she rode her horse, Cody, in Wild
West shows. She sometimes dressed up as the legendary cowgirl Annie Oakley,
firing blanks from a vintage rifle to entertain an audience. She liked the
mortgage business, liked that she was helping people buy houses.
In November 2004,
Hunt, now 55, joined
Citigroup (C) Inc. as a vice president in the
mortgage unit. It looked like a great career move. The housing market was
booming, and the New York- based bank, the
sixth-largest lender in the U.S. at the time, was responsible for 3.5
percent of all home loans. Hunt supervised 65 mortgage underwriters at
CitiMortgage Inc.’s sprawling headquarters in O’Fallon, Missouri, 45 minutes
west of St. Louis.
Avoiding Fraud
Hunt’s team was responsible
for protecting Citigroup from fraud and bad investments. She and her
colleagues inspected loans Citi wanted to buy from outside brokers and
lenders to see whether they met the bank’s standards. The mortgages had to
have properly signed paperwork, verifiable borrower income and realistic
appraisals.
Citi would vouch for the
quality of these loans when it sold them to investors or approved them for
government mortgage insurance.
Investor demand was so
strong for mortgages packaged into securities that Citigroup couldn’t
process them fast enough. The Citi stamp of approval told investors that the
bank would stand behind the mortgages if borrowers quit paying.
At the mortgage-processing
factory in O’Fallon, Hunt was working on an assembly line that helped
inflate a housing bubble whose implosion would shake the world. The O’Fallon
mortgage machinery was moving too fast to check every loan, Hunt says.
Phony Appraisals
By 2006, the bank was buying
mortgages from outside lenders with doctored tax forms, phony appraisals and
missing signatures, she says. It was Hunt’s job to identify these defects,
and she did, in regular reports to her bosses.
Executives buried her
findings, Hunt says, before, during and after the financial crisis, and even
into 2012.
In March 2011, more
than two years after Citigroup took $45 billion in bailouts from the U.S.
government and
billions more from the
Federal Reserve -- more in total than any other
U.S. bank -- Jeffery Polkinghorne, an O’Fallon
executive in charge of loan quality, asked Hunt and a colleague to stay in a
conference room after a meeting.
The encounter with
Polkinghorne was brief and tense, Hunt says. The number of loans classified
as defective would have to fall, he told them, or it would be “your asses on
the line.”
Hunt says it was clear what
Polkinghorne was asking -- and she wanted no part of it.
‘I Wouldn’t Play
Along’
“All a dishonest person had
to do was change the reports to make things look better than they were,”
Hunt says. “I wouldn’t play along.”
Instead, she took her
employer to court -- and won. In August 2011, five months after the meeting
with Polkinghorne, Hunt sued Citigroup in Manhattan federal court, accusing
its home-loan division of systematically violating U.S. mortgage
regulations.
The U.S.
Justice Department decided to join her suit in
January. Citigroup didn’t dispute any of Hunt’s facts; it didn’t mount a
defense in public or in court. On Feb. 15, 2012, the bank agreed to pay
$158.3 million to the U.S. government to settle the case.
Citigroup admitted approving
loans for government insurance that didn’t qualify under Federal Housing
Administration rules. Prosecutors kept open the possibility of bringing
criminal charges, without specifying targets.
‘Pure Myth’
Citigroup behaving
badly as late as 2012 shows how a big bank hasn’t yet absorbed the lessons
of the credit crisis despite billions of dollars in bailouts, says
Neil Barofsky, former special inspector general of
the Troubled Asset Relief Program.
“This case demonstrates that
the notion that the bailed-out banks have somehow found God and have
reformed their ways in the aftermath of the financial crisis is pure myth,”
he says.
As a reward for blowing the
whistle on her employer, Hunt, the country girl turned banker, got $31
million out of the settlement paid by Citigroup.
Hunt still remembers her
first impressions of CitiMortgage’s O’Fallon headquarters, a complex of
three concrete-and-glass buildings surrounded by manicured lawns and vast
parking lots. Inside are endless rows of cubicles where 3,800 employees
trade e-mails and conduct conference calls. Hunt says at first she felt like
a mouse in a maze.
“You only see people’s faces
when someone brings in doughnuts and the smell gets them peeking over the
tops of their cubicles,” she says.
Jean Charities
Over time, she came to
appreciate the camaraderie. Every month, workers conducted the so-called
Jean Charities. Employees contributed $20 for the privilege of wearing jeans
every day, with the money going to local nonprofit organizations. With so
many workers, it added up to $25,000 a month.
“Citi is full of wonderful
people, conscientious people,” Hunt says.
Those people worked on
different teams to process mortgages, all of them focused on keeping home
loans moving through the system. One team bought loans from brokers and
other lenders. Another team, called underwriters, made sure loan paperwork
was complete and the mortgages met the bank’s and the government’s
guidelines.
Yet another group did
spot-checks on loans already purchased. It was such a high-volume business
that one group’s assignment was simply to keep loans moving on the assembly
line.
Powerful Incentive
Still another unit
sold loans to
Fannie Mae,
Freddie Mac and Ginnie Mae, the
government-controlled companies that bundled them into securities for sale
to investors. Those were the types of securities that blew up in 2007,
igniting a global financial crisis.
Workers had a powerful
incentive to push mortgages through the process even if flaws were found:
compensation. The pay of CitiMortgage employees all the way up to the
division’s chief executive officer depended on a high percentage of approved
loans, the government’s complaint says.
By 2006, Hunt’s team was
processing $50 billion in loans that Citi-Mortgage bought from hundreds of
mortgage companies. Because her unit couldn’t possibly review them all, they
checked a sample.
When a mortgage wasn’t up to
federal standards -- which could be any error ranging from an unsigned
document to a false income statement or a hyped-up appraisal -- her team
labeled the loan as defective.
Missing
Documentation
In late 2007, Hunt’s group
estimated that about 60 percent of the mortgages Citigroup was buying and
selling were missing some form of documentation. Hunt says she took her
concerns to her boss, Richard Bowen III.
Bowen, 64, is a religious
man, a former Air Force Reserve Officer Training Corps cadet at Texas Tech
University in Lubbock with an attention to detail that befits his background
as a certified public accountant. When he saw the magnitude of the mortgage
defects, Bowen says he prayed for guidance.
In a Nov. 3, 2007,
e-mail, he alerted Citigroup executives, including
Robert Rubin, then chairman of Citigroup’s
executive committee and a former
Treasury secretary; Chief Financial Officer
Gary Crittenden; the bank’s senior risk officer;
and its chief auditor.
Bowen put the words “URGENT
-- READ IMMEDIATELY -- FINANCIAL ISSUES” in the subject line.
“The reason for this urgent
e-mail concerns breakdowns of internal controls and resulting significant
but possibly unrecognized financial losses existing within our
organization,” Bowen wrote. “We continue to be significantly out of
compliance.”
No Change
There were no
noticeable changes in the mortgage machinery as a result of
Bowen’s warning, Hunt says.
Just a week after
Bowen sent his e-mail, Sherry and Jonathan were driving their Toyota Camry
about 55 miles (89 kilometers) per hour on four-lane Providence Road in
Columbia,
Missouri, when a
driver in a Honda Civic hit them head-on. Sherry broke a foot and her
sternum. Jonathan broke an arm and his sternum.
Doctors used four bones
harvested from a cadaver and titanium screws to stabilize his neck.
“You come out of an
experience like that with a commitment to making the most of the time you
have and making the world a better place,” Sherry says.
Three months after the
accident, attorneys from
Paul, Weiss, Rifkind, Wharton & Garrison LLP, a
New York law firm representing Citigroup, interviewed Hunt. She had no idea
at the time that it was related to Bowen’s complaint, she says.
Home Computer
The lawyers’ questions made
her search her memory for details of loans and conversations with
colleagues, she says. She decided to take notes from that time forward on a
spreadsheet she kept on her home computer.
Bowen’s e-mail is now
part of the archive of the Financial Crisis Inquiry Commission, a panel
created by Congress in 2009. Citigroup’s
response to the
commission, FCIC records show, came from
Brad Karp, chairman of
Paul Weiss.
He said Citigroup had
reviewed Bowen’s issues, fired a supervisor and changed its underwriting
system, without providing specifics.
Continued in article
A CBS Sixty Minutes Blockbuster (December
4, 2011)
"Prosecuting Wall Street"
Free download for a short while
http://www.cbsnews.com/8301-18560_162-57336042/prosecuting-wall-street/?tag=pop;stories
Note that this episode features my hero Frank Partnoy
Key provisions of Sarbox with respect to the
Sixty Minutes revelations:
The act also covers issues such as
auditor independence,
corporate governance,
internal control assessment, and enhanced financial disclosure.
Sarbanes–Oxley Section 404: Assessment of
internal control ---
http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act#Sarbanes.E2.80.93Oxley_Section_404:_Assessment_of_internal_control
Both the corporate CEO and the external
auditing firm are to explicitly sign off on the following and are
subject (turns out to be a ha, ha joke) to huge fines and jail time for
egregious failure to do so:
- Assess both the
design and operating effectiveness of selected internal controls
related to significant accounts and relevant assertions, in the
context of material misstatement risks;
- Understand the flow
of transactions, including IT aspects, in sufficient detail to
identify points at which a misstatement could arise;
- Evaluate
company-level (entity-level) controls, which correspond to the
components of the
COSO framework;
- Perform a fraud
risk assessment;
- Evaluate
controls designed to
prevent or detect fraud, including management override of
controls;
- Evaluate
controls over the period-end
financial
reporting process;
- Scale the
assessment based on the size and complexity of the company;
- Rely on
management's work based on factors such as competency, objectivity,
and risk;
- Conclude on the
adequacy of internal control over financial reporting.
Most importantly as far as the CPA
auditing firms are concerned is that Sarbox gave those firms both a
responsibility to verify that internal controls were effective and the
authority to charge more (possibly twice as much) for each audit.
Whereas in the 1990s auditing was becoming less and less profitable,
Sarbox made the auditing industry quite prosperous after 2002.
There's a great gap between the theory of Sarbox
and its enforcement
In theory, the U.S. Justice Department
(including the FBI) is to enforce the provisions of Section 404 and subject
top corporate executives and audit firm partners to huge fines (personal
fines beyond corporate fines) and jail time for signing off on Section 404
provisions that they know to be false. But to date, there has not been one
indictment in enormous frauds where the Justice Department knows that
executives signed off on Section 404 with intentional lies.
In theory the SEC is to also enforce Section
404, but the SEC in Frank Partnoy's words is toothless. The SEC cannot send
anybody to jail. And the SEC has established what seems to be a policy of
fining white collar criminals less than 20% of the haul, thereby making
white collar crime profitable even if you get caught. Thus, white collar
criminals willingly pay their SEC fines and ride off into the sunset with a
life of luxury awaiting.
And thus we come to the December 4 Sixty
Minutes module that features two of the most egregious failures to enforce
Section 404:
The astonishing case of CitiBank
The astonishing case of Countrywide (now part of Bank of America)
The Astonishing Case of CitiBank
What makes the Sixty Minutes show most interesting are the whistle
blowing revelations by a former Citi Vice President in Charge of Fraud
Investigations
- What has to make the CitiBank revelations
the most embarrassing revelations on the Sixty Minutes blockbuster
emphasis that top CItiBank executives were not only informed by a Vice
President in Charge of Fraud Investigation of huge internal control
inadequacies, the outside U.S. government top accountant, the U.S.
Comptroller General, sent an official letter to CitiBank executives
notifying them of their Section 404 internal control failures.
- Eight days after receiving the official
warning from the government, the CEO of CitiBank flipped his middle finger
at the U.S. Comptroller General and signed off on Section 404 provisions
that he'd also been informed by his Vice President of Fraud and his Internal
Auditing Department were being violated.
http://www.bloomberg.com/news/2011-02-24/what-vikram-pandit-knew-and-when-he-knew-it-commentary-by-jonathan-weil.html
- What the Sixty Minutes show failed
to mention is that the external auditing firm of KPMG also flipped a bird at
the U.S. Comptroller General and signed off on the adequacy of its client's
internal controls.
- A few months thereafter CitiBank begged for
and got hundreds of billions in bailout money from the U.S. Government to
say afloat.
- The implication is that CitiBank and the
other Wall Street corporations are just to0 big to prosecute by the Justice
Department. The Justice Department official interviewed on the Sixty
Minutes show sounded like hollow brass wimpy taking hands off orders
from higher authorities in the Justice Department.
- The SEC worked out a settlement with
CitiBank, but the fine is such a joke that the judge in the case has to date
refused to accept the settlement. This is so typical of SEC hand slapping
settlements --- and the hand slaps are with a feather.
The astonishing case of Countrywide (now part of
Bank of America)
- Countrywide Financial before 2007 was the
largest issuer of mortgages on Main Streets throughout the nation and by
estimates of one of its own whistle blowing executives in charge of internal
fraud investigations over 60% of those mortgages were fraudulent.
- After Bank of America purchased the
bankrupt Countrywide, BofA top executives tried to buy off the Countrywide
executive in charge of fraud investigations to keep him from testifying.
When he refused BofA fired him.
- Whereas the Justice Department has not even
attempted to indict Countrywide executives and the Countrywide auditing firm
of Grant Thornton (later replaced by KPMG) to bring indictments for Section
404 violations, the FTC did work out an absurdly low settlement of $108
million for 450,000 borrowers paying "excessive fees" and the attorneys for
those borrowers ---
http://www.nytimes.com/2011/07/21/business/countrywide-to-pay-borrowers-108-million-in-settlement.html
This had nothing to do with the massive mortgage frauds committed by
Countrywide.
- Former Countrywide CEO Angelo Mozilo
settled the SEC’s Largest-Ever Financial Penalty ($22.5 million) Against a
Public Company's Senior Executive
http://sec.gov/news/press/2010/2010-197.htm
The CBS Sixty Minutes show estimated that this is less than 20% of what he
stole and leaves us with the impression that Mozilo deserves jail time but
will probably never be charged by the Justice Department.
I was disappointed in the CBS Sixty Minutes
show in that it completely ignored the complicity of the auditing firms to sign
off on the Section 404 violations of the big Wall Street banks and other huge
banks that failed. Washington Mutual was the largest bank in the world to ever
go bankrupt. Its auditor, Deloitte, settled with the SEC for Washington Mutual
for
$18.5 million. This isn't even a hand slap relative to the billions lost by
WaMu's investors and creditors.
No jail time is expected for any partners of
the negligent auditing firms. .KPMG settled for peanuts with Countrywide for
$24 million of negligence and New Century for
$45 million of negligence costing investors billions.
"Citigroup Finds Obeying the
Law Is Too Darn Hard: Jonathan Weil," by Jonothan Weil, Bloomberg
News, November 2 , 2011 ---
http://www.bloomberg.com/news/2011-11-02/citigroup-finds-obeying-the-law-is-too-darn-hard-jonathan-weil.html
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's threads on how white collar
crime pays even if you get caught ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
"Should Some Bankers Be Prosecuted?" by
Jeff Madrick and Frank Partnoy, New York Review of Books, November 10,
2011 ---
http://www.nybooks.com/articles/archives/2011/nov/10/should-some-bankers-be-prosecuted/
Thank you Robert Walker for the heads up!
"Not Much Illumination: JP Morgan, MF Global
& Man in the Middle, Jamie Dimon," by Francine McKenna, re:TheAuditors,
June 15, 2012 ---
http://retheauditors.com/2012/06/15/not-much-illumination-jp-morgan-mf-global-man-in-the-middle-jamie-dimon/
The more I write about
banks, auditors, legislators, regulators and the big money that passes
amongst them, the easier it is to see the connections between them all.
Jonathan Safran Foer
wrote a book in 2002 called Everything is Illuminated. According to
Wikipedia, the novel tells the story of…
“…a young American Jew
who journeys to Ukraine in search of Augustine, the woman who saved his
grandfather’s life during the Nazi liquidation of Trachimbrod, his
family shtetl. Armed with maps, cigarettes and many copies of an old
photograph of Augustine and his grandfather, Jonathan begins his
adventure with Ukrainian native and soon-to-be good friend, Alexander
“Alex” Perchov, who is Foer’s age and very fond of American pop culture,
albeit culture that is already out of date in the United States. Alex
studied English at his university, and even though his knowledge of the
language is not “first-rate”, he becomes the translator. Alex’s “blind”
grandfather and his “deranged seeing-eye bitch,” Sammy Davis, Jr., Jr.,
accompany them on their journey. Throughout the book, the meaning of
love is deeply examined.”
It’s widely believed
that the title of the book comes from a line in one of my all time favorite
novels The
Unbearable Lightness of Being by Milan
Kundera:
Continued in article
"Should Some Bankers Be Prosecuted?" by Jeff Madrick and Frank
Partnoy, New York Review of Books, November 10, 2011 ---
http://www.nybooks.com/articles/archives/2011/nov/10/should-some-bankers-be-prosecuted/
Thank you Robert Walker for the heads up!
More than three years have passed since the
old-line investment bank Lehman Brothers stunned the financial markets by
filing for bankruptcy. Several federal government programs have since tried
to rescue the financial system: the $700 billion Troubled Asset Relief
Program, the Federal Reserve’s aggressive expansion of credit, and President
Obama’s additional $800 billion stimulus in 2009. But it is now apparent
that these programs were not sufficient to create the conditions for a full
economic recovery. Today, the unemployment rate remains above 9 percent, and
the annual rate of economic growth has slipped to roughly 1 percent during
the last six months. New crises afflict world markets while the American
economy may again slide into recession after only a tepid recovery from the
worst recession since the Great Depression.
n our article in the last issue,1 we showed that,
contrary to the claims of some analysts, the federally regulated mortgage
agencies, Fannie Mae and Freddie Mac, were not central causes of the crisis.
Rather, private financial firms on Wall Street and around the country
unambiguously and overwhelmingly created the conditions that led to
catastrophe. The risk of losses from the loans and mortgages these firms
routinely bought and sold, particularly the subprime mortgages sold to
low-income borrowers with poor credit, was significantly greater than
regulators realized and was often hidden from investors. Wall Street bankers
made personal fortunes all the while, in substantial part based on profits
from selling the same subprime mortgages in repackaged securities to
investors throughout the world.
Yet thus far, federal agencies have launched few
serious lawsuits against the major financial firms that participated in the
collapse, and not a single criminal charge has been filed against anyone at
a major bank. The federal government has been far more active in rescuing
bankers than prosecuting them.
In September 2011, the Securities and Exchange
Commission asserted that overall it had charged seventy-three persons and
entities with misconduct that led to or arose from the financial crisis,
including misleading investors and concealing risks. But even the SEC’s
highest- profile cases have let the defendants off lightly, and did not lead
to criminal prosecutions. In 2010, Angelo Mozilo, the head of Countrywide
Financial, the nation’s largest subprime mortgage underwriter, settled SEC
charges that he misled mortgage buyers by paying a $22.5 million penalty and
giving up $45 million of his gains. But Mozilo had made $129 million the
year before the crisis began, and nearly another $300 million in the years
before that. He did not have to admit to any guilt.
The biggest SEC settlement thus far, alleging that
Goldman Sachs misled investors about a complex mortgage product—telling
investors to buy what had been conceived by some as a losing proposition—was
for $550 million, a record of which the SEC boasted. But Goldman Sachs
earned nearly $8.5 billion in 2010, the year of the settlement. No
high-level executives at Goldman were sued or fined, and only one junior
banker at Goldman was charged with fraud, in a civil case. A similar suit
against JPMorgan resulted in a $153.6 million fine, but no criminal charges.
Although both the SEC and the Financial Crisis
Inquiry Commission, which investigated the financial crisis, have referred
their own investigations to the Department of Justice, federal prosecutors
have yet to bring a single case based on the private decisions that were at
the core of the financial crisis. In fact, the Justice Department recently
dropped the one broad criminal investigation it was undertaking against the
executives who ran Washington Mutual, one of the nation’s largest and most
aggressive mortgage originators. After hundreds of interviews, the US
attorney concluded that the evidence “does not meet the exacting standards
for criminal charges.” These standards require that evidence of guilt is
“beyond a reasonable doubt.”
This August, at last, a federal regulator launched
sweeping lawsuits alleging fraud by major participants in the mortgage
crisis. The Federal Housing Finance Agency sued seventeen institutions,
including major Wall Street and European banks, over nearly $200 billion of
allegedly deceitful sales of mortgage securities to Fannie Mae and Freddie
Mac, which it oversees. The banks will argue that Fannie and Freddie were
sophisticated investors who could hardly be fooled, and it is unclear at
this early stage how successful these suits will be.
Meanwhile, several state attorneys general are
demanding a settlement for abuses by the businesses that administer
mortgages and collect and distribute mortgage payments. Negotiations are
under way for what may turn out to be moderate settlements, which would
enable the defendants to avoid admitting guilt. But others, particularly
Eric Schneiderman, the New York State attorney general, are more
aggressively pursuing cases against Wall Street, including Goldman Sachs and
Morgan Stanley, and they may yet bring criminal charges.
Successful prosecutions of individuals as well as
their firms would surely have a deterrent effect on Wall Street’s deceptive
activities; they often carry jail terms as well as financial penalties.
Perhaps as important, the failure to bring strong criminal cases also makes
it difficult for most Americans to understand how these crises occurred. Are
they simply to conclude that Wall Street made well- meaning if very big
errors of judgment, as bankers claim, that were rarely if ever illegal or
even knowingly deceptive?
What is stopping prosecution? Apparently not public
opinion. A Pew Research Opinion survey back in 2010 found that three
quarters of Americans said that government policies helped banks and
financial institutions while two thirds said the middle class and poor
received little help. In mid-2011, half of those surveyed by Pew said that
Wall Street hurts the economy more than it helps it.
Many argue that the reluctance of prosecutors
derives from the power and importance of bankers, who remain significant
political contributors and have built substantial lobbying operations. Only
5 percent of congressional bills designed to tighten financial regulations
between 2000 and 2006 passed, while 16 percent of those that loosened such
regulations were approved, according to a study by the International
Monetary Fund.2 The IMF economists found that a major reason was lobbying
efforts. In 2009 and early 2010, financial firms spent $1.3 billion to lobby
Congress during the passage of the Dodd-Frank Act. The financial
reregulation legislation was weakened in such areas as derivatives trading
and shareholder rights, and is being further watered down.
Others claim federal officials fear that punishing
the banks too much will undermine the fragile economic recovery. As one
former Fannie official, now a private financial consultant, recently told
The New York Times, “I am afraid that we risk pushing these guys off of a
cliff and we’re going to have to bail out the banks again.”
The responsibility for reluctance, however, also
lies with the prosecutors and the law itself. A central problem is that
proving financial fraud is much more difficult than proving most other
crimes, and prosecutors are often unwilling to try it. Congress could fix
this by amending federal fraud statutes to require, for example, that
prosecutors merely prove that bankers should have known rather than actually
did know they were deceiving their clients.
But even if Congress does not, it is not too late
for bold federal prosecutors to try to bring a few successful cases. A
handful of wins could create new precedents and common law that would set a
higher and clearer standard for Wall Street, encourage more ethical
practices, deter fraud—and arguably prevent future crises.
Continued in article
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
The greatest swindle in the history of the world ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Bob Jensen's threads on how the banking system is rotten to the core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Billings for Services Never Rendered
"SEC Charges Morgan Stanley Investment Management for Improper Fee
Arrangement," SEC, November 14, 2011 ---
http://sec.gov/news/press/2011/2011-244.htm
Morgan Stanley settled the charges for $3.3 million fine
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
What happened was an explosion of loans being made
outside of the regular banking system. It was largely the unregulated sector of
the lending industry and the underregulated and the lightly regulated that did
that.
Barney Frank
From The Economist, October 8-14, Page 12
America's Justice Department
and New York State's attorney general filed separate civil lawsuits against
BNY Mellon for allegedly defrauding clients by systematically using the
foreign exchange rate on transactions that best suited the bank.
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
The idea of a central
bank manipulating world markets packs an increasingly powerful emotional punch
with voters.
"Is there a shadowy plot behind gold?" by Gillian Tett, Financial Times,
October 21, 2011 ---
http://www.ft.com/intl/cms/s/2/90effa18-faa3-11e0-8fe7-00144feab49a.html?ftcamp=traffic/email/monthnl//memmkt#axzz1c1AAhDzo
Out there in the world
today, a cabal of western central bankers is secretly determined to
manipulate the world’s markets. They are doing this not via interest rates,
but by rigging gold prices. More specifically, they have kept bullion prices
artificially low in recent decades to ensure that our so-called fiat
currency system – that is, money created by central banks – continues to
work. For if the public ever knew the “real” price of gold, we would finally
understand that our currencies, such as the dollar, are a sham … hence the
need for that central bank plot.
Does this sound like the
ranting of a Tea Party activist? A Hollywood screenplay? Or could there be a
grain of truth in it? The question has been provoking hot debate among a
small tribe of investors in America for many years, particularly those
owning gold mining stocks. Right now it is also leaching into the more
mainstream American political world.
Continued in article
Jensen Comment
This is not a rant from an long-haired anarchist defecating in a NYC park, but
such a guy probably takes such market manipulation for granted. Such strange
things are happening with gold prices I'm a bit of a believer myself.
"Citigroup Finds Obeying the Law Is
Too Darn Hard: Jonathan Weil," by Jonothan Weil, Bloomberg News,
November 2 , 2011 ---
http://www.bloomberg.com/news/2011-11-02/citigroup-finds-obeying-the-law-is-too-darn-hard-jonathan-weil.html
Thank you David Albrecht for the heads up.
Five times since 2003 the
Securities and Exchange Commission has accused Citigroup Inc. (C)’s main
broker-dealer subsidiary of securities fraud. On each occasion the company’s
SEC settlements have followed a familiar pattern.
Citigroup neither admitted
nor denied the SEC’s claims. And the company consented to the entry of
either a court injunction or an SEC order barring it from committing the
same types of violations again. Those “obey-the-law” directives haven’t
meant much. The SEC keeps accusing Citigroup of breaking the same laws over
and over, without ever attempting to enforce the prior orders. The SEC’s
most recent complaint against Citigroup, filed last month, is no different.
Enough is enough. Hopefully
Jed Rakoff will soon agree.
Rakoff, the U.S. district
judge in New York who was assigned the newest Citigroup case, is
saber-rattling again, threatening to derail the SEC’s latest wrist-slap. The
big question is whether he has the guts to go through with it. Twice since
2009, Rakoff has put the SEC through the wringer over cozy corporate
settlements, only to give in to the agency later.
That the SEC went easy on
Citigroup again is obvious. The commission last month accused Citigroup of
marketing a $1 billion collateralized debt obligation to investors in 2007
without disclosing that its own traders picked many of the assets for the
deal and bet against them. The SEC’s complaint said Citigroup realized “at
least $160 million” in profits on the CDO, which was linked to subprime
mortgages. For this, Citigroup agreed to pay $285 million, including a $95
million fine -- a pittance compared with its $3.8 billion of earnings last
quarter. Looking Deliberate
On top of that, the agency
accused Citigroup of acting only negligently, though the facts in the SEC’s
complaint suggested deliberate misconduct. The SEC named just one individual
as a defendant, a low-level banker who clearly didn’t act alone. Plus, the
SEC’s case covered only one CDO, even though Citigroup sold many others like
it.
Here’s what makes the SEC’s
conduct doubly outrageous: The commission already had two cease-and-desist
orders in place against the same Citigroup unit, barring future violations
of the same section of the securities laws that the company now stands
accused of breaking again. One of those orders came in a 2005 settlement,
the other in a 2006 case. The SEC’s complaint last month didn’t mention
either order, as if the entire agency suffered from amnesia.
The SEC’s latest allegations
also could have triggered a violation of a court injunction that Citigroup
agreed to in 2003, as part of a $400 million settlement over allegedly
fraudulent analyst-research reports. Injunctions are more serious than SEC
orders, because violations can lead to contempt-of-court charges.
The SEC neatly avoided that
outcome simply by accusing Citigroup of violating a different fraud statute.
Not that the SEC ever took the prior injunction seriously. In December 2008,
the SEC for the second time accused Citigroup of breaking the same section
of the law covered by the 2003 injunction, over its sales of so-called
auction-rate securities. Instead of trying to enforce the existing court
order, the SEC got yet another one barring the same kinds of fraud
violations in the future.
It gets worse: Each time the
SEC settled those earlier fraud cases, Citigroup asked the agency for
waivers that would let it go about its business as usual. (This is standard
procedure for big securities firms.) The SEC granted those requests, saying
it did so based on the assumption that Citigroup would comply with the law
as ordered. Then, when the SEC kept accusing Citigroup of breaking the same
laws again, the agency granted more waivers, never revoking any of the old
ones. Legal Standard
Rakoff seems aware of the
problem, judging by the questions he sent the SEC and Citigroup last week.
Noting that the SEC is seeking a new injunction against future violations by
Citigroup, he asked: “What does the SEC do to maintain compliance?”
Additionally, he asked: “How many contempt proceedings against large
financial entities has the SEC brought in the past decade as a result of
violations of prior consent judgments?” We’ll see if the SEC finds any. A
hearing is set for Nov. 9.
The legal standard Rakoff
must apply is whether the proposed judgment is “fair, reasonable, adequate
and in the public interest.” Among Rakoff’s other questions: “Why should the
court impose a judgment in a case in which the SEC alleges a serious
securities fraud but the defendant neither admits nor denies wrongdoing?”
And this: “How can a securities fraud of this nature and magnitude be the
result simply of negligence?”
A Citigroup spokeswoman,
Shannon Bell, said, “Citi has entered into various settlements with the SEC
over the years, and there is no basis for any assertion that Citi has
violated the terms of any of those settlements.” I guess it depends on the
meaning of the words “settlement” and “violated.”
Rakoff gained fame in 2009
when he rejected an SEC proposal to fine Bank of America Corp. (BAC) $33
million for disclosure violations related to its $29.1 billion purchase of
Merrill Lynch & Co. Rakoff said the settlement punished Bank of America
shareholders for the actions of its executives, none of whom were named as
defendants.
Months later, though,
Rakoff approved a $150 million fine for the same infractions, on the
condition that the money would be redistributed to Bank of America
stockholders who supposedly were harmed. The stipulation was classic window
dressing. Even so, Rakoff became something of a folk hero, simply for daring
to question an SEC settlement. Most other judges are rubber stamps.
Continued in article
Bob Jensen's threads on Rotten to the Core
---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
“As I look at
the deficiencies cited in the letter, taken as a whole, it appears that
Citigroup had a material weakness with respect to valuing these financial
instruments,” said Ed Ketz, an accounting professor at Pennsylvania State
University, who reviewed the OCC’s letter to Pandit at my request. “It just
is overwhelming by the time you get to the end of it."
"How Did Citigroup’s Internal Controls
Cut the Mustard with KPMG?" by Caleb Newquist, Going Concern,
February 24, 2011 ---
http://goingconcern.com/2011/02/how-did-citigroups-internal-controls-cut-the-mustard-with-kpmg/#more-25882
Jonathan
Weil writes in his column today about Citigroup and their “acceptable
group of auditors,” (aka KPMG)
and he’s having trouble connecting the dots on a few things.
Specifically, how a love letter (it was sent on February 14, 2008, after
all)
sent by the Office of the Comptroller of the Currency
to Citigroup CEO Vikram Pandit:
The
gist of the
regulator’s findings: Citigroup’s
internal controls were a mess. So were its valuation methods for
subprime mortgage bonds, which had spawned record losses at the
bank. Among other things, “weaknesses were noted with model
documentation, validation and control group oversight,” the letter
said. The main valuation model Citigroup was using “is not in a
controlled environment.” In other words, the model wasn’t reliable.
Okay, so
the bank’s internal controls weren’t worth the paper they were printed
on. Ordinarily, one could reasonably expect management and perhaps
their auditors to be aware of such a fact and that they were handling
the situation accordingly. We said, “ordinarily”:
Eight
days later, on Feb. 22, Citigroup filed its
annual report to shareholders, in
which it said “management believes that, as of Dec. 31, 2007, the
company’s
internal control over financial
reporting is effective.” Pandit
certified
the report personally, including the
part about Citigroup’s internal controls. So did Citigroup’s chief
financial officer at the time,
Gary Crittenden.
The
annual report also included a Feb. 22 letter from KPMG LLP,
Citigroup’s outside auditor,
vouching
for the effectiveness of the company’s
financial-reporting controls. Nowhere did Citigroup or KPMG mention
any of the problems cited by the OCC. KPMG, which earned $88.1
million in fees from Citigroup for 2007, should have been aware of
them, too. The lead partner on KPMG’s Citigroup audit, William
O’Mara, was listed on the “cc” line of the OCC’s Feb. 14 letter.
Huh. There
has to be an explanation, right? It’s just one of the largest banks
on Earth audited by one of the largest audit firm on Earth.
You’d think these guys would be more than willing to stand by their
work. Funny thing – no one felt compelled to return JW’s calls. So, he
had no choice to piece it together himself:
[S]omehow
KPMG and Citigroup’s management decided they didn’t need to mention
any of those weaknesses or deficiencies. Maybe in their minds it was
all just a difference of opinion. Whatever their rationale, nine
months later Citigroup had taken a $45 billion taxpayer bailout,
[Ed. note: OH, right. That.] still sporting a balance sheet
that made it seem healthy.
Actually,
just kidding, he ran it by an expert:
“As I
look at the deficiencies cited in the letter, taken as a whole, it
appears that Citigroup had a material weakness with respect to
valuing these financial instruments,” said Ed Ketz, an accounting
professor at Pennsylvania State University, who reviewed the OCC’s
letter to Pandit at my request. “It just is overwhelming by the time
you get to the end of it."
"What Vikram Pandit Knew, and When
He Knew It: Jonathan Weil," by Jonathon Weil, Bloomberg News,
February 23, 2011 ---
http://www.bloomberg.com/news/2011-02-24/what-vikram-pandit-knew-and-when-he-knew-it-commentary-by-jonathan-weil.html
Yet somehow
KPMG and Citigroup’s management decided they didn’t need to mention any
of those weaknesses or deficiencies. Maybe in their minds it was all
just a difference of opinion. Whatever their rationale, nine months
later Citigroup had taken a $45 billion taxpayer bailout, still sporting
a balance sheet that made it seem healthy.
“As I look
at the deficiencies cited in the letter, taken as a whole, it appears
that Citigroup had a material weakness with respect to valuing these
financial instruments,” said Ed Ketz, an accounting professor at
Pennsylvania State University, who reviewed the OCC’s letter to Pandit
at my request. “It just is overwhelming by the time you get to the end
of it.”
One company
that did get a cautionary note from its auditor that same quarter was
American International Group Inc. In February 2008,
PricewaterhouseCoopers LLP warned of a material weakness related to
AIG’s valuations for credit-default swaps. So at least investors were
told AIG’s numbers might be off. That turned out to be a gross
understatement.
At
Citigroup, there was no such warning. The public deserves to know why.
Continued in article
Bob Jensen's threads on the good things and
not-so-good things done by KPMG are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
"MF Global : 99 Problems And Auditor
PwC Warned About None," by Francine McKenna, re:The Auditors,
October 28, 2011 ---
http://retheauditors.com/2011/10/28/mf-global-99-problems-and-pwc-warned-about-none-of-them/
Update October 31:
I’m putting updates over at Forbes.
My latest column is
up at American Banker, “Are Cozy Ties Muzzling S&P on MF Global
Downgrade?”
You may recall the
last time I wrote about MF Global. That story was about the “rogue”
trader that cost them $141 million. In the meantime we’ve seen
another “rogue” trader scandal and PwC has given MF Global clean
opinions on their financial statements and internal controls over
financial reporting since the firm went public in mid-2007.
I’m sure PwC thought
everything was peachy as recently as this past May when the annual
report came out for their year end March 30. Instead we’re seeing
another sudden, unexpected, calamitous, black-swan event that no one
could have predicted let alone warn investors about.
Right….
Also see
http://www.forbes.com/sites/francinemckenna/2011/10/30/mf-global-99-problems-and-auditor-pwc-warned-about-none/
Jensen Comment
I prefer "Yeah right!" to just plain "Right!"
MF Global also has some ocean front property for sale in Arizona that's
been attested to by PwC.
"MF Global Shares Halted; News
Pending," The Wall Street Journal, October 31, 2011 ---
http://blogs.wsj.com/deals/2011/10/31/mf-global-shares-halted-news-pending/
As stock markets
open in New York on Monday, MF Global shares remain halted. The only
news the company has released so far is a one-line press release
confirming the suspension from the Federal Reserve Bank of New York.
Pre-market trading
in MF Global Holdings has been halted since about 6 a.m. ET as news
is expected to be released about Jon Corzine’s ailing brokerage.
Meanwhile, the
global exchange and trading community is moving to lock-down mode on
MF Global as the U.S. broker continues efforts to forge a
restructuring that could include a sale and bankruptcy filing.
The U.S. clearing
unit of ICE said it is limiting MF Global to liquidation of
transactions, while the Singapore Exchange won’t enter into new
trades. Floor traders said Nymex has halted all MF Global-created
trading. Some MF traders are restricted from the entering the floor
of the Chicago Board of Trade, and the Federal Reserve Bank of New
York said it had suspended doing business with MF Global.
The New York Fed
said in its brief statement: “This suspension will continue until MF
Global establishes, to the satisfaction of the New York Fed, that MF
Global is fully capable of discharging the responsibilities set out
in the New York Fed’s policy…or until the New York Fed decides to
terminate MF Global’s status as a primary dealer.”
The Wall Street
Journal reported Sunday night that MF Global is working on a deal to
push its holding company into bankruptcy protection as soon as
Monday, and to sell its assets to Interactive Brokers Group in a
court-supervised auction.
Continued in article
Jensen Comment
Francine may be singing
'99 bottles of negligence on the wall, 99 bottles of negligence,
if one of the bottles should happen to fall, 98 bottles of negligence on
the wall, . . . "
"MF GLOBAL GOES BELLY UP, SO WHERE WAS THE
GOING CONCERN OPINION?" by Anthony H. Catanach Jr. and J. Edward Ketz,
Grumpy Old Accountants, November 1, 2011 ---
http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/368
Poor Jon Corzine! What a
pity his firm declared bankruptcy on Halloween. Because he no more tricks to
play, he will be receiving few treats.
Last week Francine McKenna
must have had premonition of what was to come, for she asked us whether PwC
should have issued a going concern opinion. Ok, maybe she was well connected
with all the movers and shakers and was on top of the news about the firm.
Or maybe she read the SEC filings. At any rate, she has discussed MF Global
in “Are Cozy Ties Muzzling S&P on MF Global Downgrade?” and “MF Global: 99
Problems and PwC Warned About None of Them.”
To answer the question, yes,
we do think PwC probably should have issued a going concern opinion. There
were plenty of breadcrumbs to reveal the cupboard was bare.
SAS No. 59 (AU section 341)
seems reasonably clear about the principles. It says in paragraph 2: “The
auditor has a responsibility to evaluate whether there is substantial doubt
about the entity’s ability to continue as a going concern for a reasonable
period of time, not to exceed one year beyond the date of the financial
statements being audited.” Paragraph 6 goes on to say the auditor should
consider such things as negative trends in key financial metrics,
indications of possible financial difficulties, and external matters that
have occurred.
We wonder what is meant by
this pronouncement and what evidence must be present to conclude that a
going concern opinion is appropriate. Might that include four years
(2008-2011) of massive losses, as occurred at MF Global? Might that include
severely negative free cash flows for three of the last four years? Might
that include an exposure to European sovereign debt that will lead to
greater future losses? Might that include several downgrades in the credit
ratings?
Unfortunately, our
experience with Big Four practice suggests a myopic and unreasonable focus
on the ability of the entity to pay its bills for the coming year is often
the primary criteria driving the opinion. Indeed, the number of going
concern opinions is decreasing when they likely should be increasing.
Continued in article
"MF Global: Where Is The Missing Money?"
by Francine McKenna, re:TheAuditors, November 10, 2011 ---
http://retheauditors.com/2011/11/10/mf-global-where-is-the-missing-money/
I put up a column on Tuesday
at Forbes.com that explains, in theory, what I think happened to MF Global’s
missing $600 million in customer assets. It’s hard to describe the reaction
to the story without jumping up and down and clapping. There’s so much
interest in the subject and so little information being provided by
mainstream media.
Here in Chicago, everyone is
mad and no one knows who has the answers.
MF Global’s auditor is
PricewaterhouseCoopers, who inherited the client when Man Financial, also a
client, spun off the brokerage firm in 2007.
Continued at Forbes Site
http://www.forbes.com/sites/francinemckenna/2011/11/09/mf-global-assets-have-left-the-building-how-when-where/
"MF Global : 99 Problems And Auditor
PwC Warned About None," by Francine McKenna, re:The Auditors, October
28, 2011 ---
http://retheauditors.com/2011/10/28/mf-global-99-problems-and-pwc-warned-about-none-of-them/
"MF GLOBAL GOES BELLY UP, SO WHERE
WAS THE GOING CONCERN OPINION?" by Anthony H. Catanach Jr. and J. Edward
Ketz, Grumpy Old Accountants, November 1, 2011 ---
http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/368
"Deloitte: MF Global’s Former Clients
Overstating Claims," by Michael Foster, Big Four Blog, November 13,
2011 ---
http://www.big4.com/deloitte/deloitte-mf-globals-former-clients-overstating-claims
Deloitte’s investigations of
claims against MF Global suggest that the defunct fund’s clients have
overstated their claims. According to Deloitte partner Chris Campbell, a
joint administrator of MF Global Australia, some clients of the brokerage
have claimed “significantly in excess” what the firm really owed them.
“If clients continue to do
that, there will be a shortfall in the full funds of those claims that are
valid, because there’s a finite amount of cash that needs to be split
between them all,” Campbell said of the claims.
In total, Deloitte believes
that clients are owed a total of $313 million. Deloitte also believes that
there is a total of $319 million in funds available for repaying clients.
If clients’ claims cannot be
reconciled with Deloitte’s investigation, an application to the Australian
Securities and Investments Commission and to a legal court may be necessary,
according to Campbell.
The $319 million available
for repayments consists of $167 million available to MF Global
counterparties and $155 million held for clients in segregated accounts. $55
million of the total relates to a derivative that helps traders profit from
price fluctuations in financial markets.
Deloitte was appointed as
the voluntary administrators of MF Global’s Australian operations.
Previously, clients were closed out of market positions when Deloitte began
the administration.
Bob Jensen's threads on PwC ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
Why didn't auditors question going concern
assumptions when thousands of banks failed?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Remember when the 2007/2008 severe economic
collapse was caused by "street events":
Fraud on Main Street
Issuance of "poison" mortgages (many
subprime)
that lenders knew could never be repaid by borrowers.
Lenders didn't care about loan defaults because they sold the poison mortgages
to suckers like Fannie and Freddie.
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
For low income borrowers the Federal Government forced Fannie and Freddie to buy
up the poisoned mortgages ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
Math Error on Wall Street
Issuance of CDO portfolio bonds laced with a portion of
healthy mortgages and a portion of poisoned mortgages.
The math error is based on an assumption that risk of poison can be diversified
and diluted using a risk diversification formula.
The risk diversification formula is called the
Gaussian copula function
The formula made a fatal assumption that loan defaults would be random events
and not correlated.
When the real estate bubble burst, home values plunged and loan defaults became
correlated and enormous.
Fraud on Wall
Street
All the happenings on Wall Street were not merely innocent
math errors
Banks and investment banks were selling CDO bonds that they knew were
overvalued.
Credit rating agencies knew they were giving AAA high credit ratings to bonds
that would collapse.
The banking industry used powerful friends in government to pass its default
losses on to taxpayers.
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Can the 2008 investment banking failure be
traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's
formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was
adopted by everybody from bond investors and Wall Street banks to
ratings agencies and regulators. And it became so deeply entrenched—and
was making people so much money—that warnings about its limitations were
largely ignored.
Then the model fell apart." The article goes
on to show that correlations are at the heart of the problem.
"The reason that ratings
agencies and investors felt so safe with the triple-A tranches was that
they believed there was no way hundreds of homeowners would all default
on their loans at the same time. One person might lose his job, another
might fall ill. But those are individual calamities that don't affect
the mortgage pool much as a whole: Everybody else is still making their
payments on time.
But not all calamities
are individual, and tranching still hadn't solved all the problems of
mortgage-pool risk. Some things, like falling house prices, affect a
large number of people at once. If home values in your neighborhood
decline and you lose some of your equity, there's a good chance your
neighbors will lose theirs as well. If, as a result, you default on your
mortgage, there's a higher probability they will default, too. That's
called correlation—the degree to which one variable moves in line with
another—and measuring it is an important part of determining how risky
mortgage bonds are."
I would highly recommend reading the entire
thing that gets much more involved with the
actual formula etc.
The “math error”
might truly be have been an error or it might have simply been a gamble with
what was perceived as miniscule odds of total market failure. Something similar
happened in the case of the trillion-dollar disastrous 1993 collapse of Long
Term Capital Management formed by Nobel Prize winning economists and their
doctoral students who took similar gambles that ignored the “miniscule odds” of
world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
History
(Long Term Capital Management
and CDO Gaussian Coppola failures)
Repeats Itself in Over a Billion Lost in MF Global
"Models
(formulas) Behaving Badly Led to MF’s Global Collapse – People Too," by
Aaron Task, Yahoo Finance, November 21, 2011 ---
http://finance.yahoo.com/blogs/daily-ticker/models-behaving-badly-led-mf-global-collapse-people-174954374.html
"The entire system has been
utterly destroyed by the MF Global collapse," Ann Barnhardt, founder and CEO
of Barnhardt Capital Management, declared last week in a letter to clients.
Whether that's hyperbole or
not is a matter of opinion, but MF Global's collapse — and the inability of
investigators to find about $1.2 billion in "missing" customer funds, which
is twice the amount previously thought — has only further undermined
confidence among investors and market participants alike.
Emanuel Derman, a
professor at Columbia University and former Goldman Sachs managing director,
says MF Global
was undone by an over-reliance on short-term funding, which dried up as
revelations of its leveraged bets on European sovereign debt came to light.
In the accompanying video,
Derman says MF Global was much more like Long Term Capital Management than
Goldman Sachs, where he worked on the risk committee for then-CEO John
Corzine.
A widely respected
expert on risk management, Derman is the author of a new book
Models. Behaving. Badly: Why Confusing Illusion with Reality Can Lead to
Disaster, on Wall Street and in Life.
As discussed in the
accompanying video, Derman says the "idolatry" of financial models puts Wall
Street firms — if not the entire banking system — at risk of catastrophe. MF
Global was an extreme example of what can happen when the models — and the
people who run them -- behave badly, but if Barnhardt is even a little bit
right, expect more casualties to emerge.
Jensen Comment
MF Global's auditor (PwC) will now be ensnared, as seems appropriate in this
case, the massive lawsuits that are certain to take place in the future ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
Collateralized Debt Obligation (CDO) ---
http://en.wikipedia.org/wiki/CDOs
"Sleight of hand: BofA moves dodgy Merrill
derivatives to bank," by Mark December, The New York Post, October
21, 2011 ---
http://www.nypost.com/p/news/business/sleight_of_hand_uy96iNSbW99JHMRnbxgvfL
A plan by beleaguered Bank
of America to foist trillions of dollars of funky Merrill Lynch derivatives
onto its depositors is raising eyebrows on Wall Street.
The rarely used move will
likely save the bank millions of dollars in collateral but could put
depositors’ cash behind the eight ball.
The move also brought to
light fissures between the nation’s top banking regulators, the Federal
Deposit Insurance Corp. and the Federal Reserve, in the wake of new
regulations meant to curb the free-wheeling habits that fostered the worst
crisis in a generation back in 2008.
At issue is BofA’s decision
to shift what sources say is some $55 trillion in derivatives at Merrill
Lynch to the retail bank unit, which houses trillions in deposits insured by
the FDIC.
Critics say the move
potentially imperils everyday depositors by placing their money and savings
at risk should BofA run into trouble.
Sources say that the
derivative transfers from Merrill to BofA’s bank subsidiary were sparked by
credit-rating downgrades to the bank holding company and are meant to help
BofA avoid having to fork over more money to post as collateral to its
derivative counterparties.
BofA officials who have
talked privately say the move was requested by its counterparties and
shouldn’t be perceived as problematic for the bank giant, sources said.
A BofA spokesman declined to
comment.
For weeks, BofA CEO Brian
Moynihan has been dogged about the health of one of the nation’s largest
banking franchises and its massive exposures to toxic debt after its shotgun
mergers with Merrill and Countrywide Financial during the credit crisis
three years ago.
Under Moynihan, BofA has
been attempting to right the bank’s ship and convince shareholders that the
firm is healthy and doesn’t need to raise fresh capital to backstop against
potential losses from faulty foreclosures and other mortgage-related
lawsuits.
In the third quarter, BofA
posted profit of $6.23 billion, or 56 cents a share, down 15 percent from
the same period a year ago.
The bank’s shares gained 1
percent yesterday, to $6.47. They are off 51 percent this year.
BofA’s third-quarter
performance comes as fears persist about the big bank’s ability to make
money amid stiff economic headwinds and a host of potential land mines that
could see it shelling out billions.
The derivatives transfer has
irked officials at the FDIC which, sources said, was informed of BofA’s plan
to shift the contracts to a retail deposit-taking entity just last week.
One source says that the
FDIC is in the process of reviewing the transfer and will relay its opinion
to the Federal Reserve.
But ultimately it’s the Fed
that has the final say on authorizing any transfers.
Neither the Fed nor
the FDIC would comment on BofA’s plans, which were first reported by
Bloomberg.
Continued in article
Jensen Comment
What is more bizarre is that BofA really did not want to buy Merrill Lynch at
any price in the 2008 Bailout after digging deeper into the financial records of
CDO-battered Merrill Lynch.. Then Treasury Secretary Hank Paulson for some
unknown reason did not want throw Merrill Lynch under the bus in the same manner
that he threw Bear Stearns under the bus. In my opinion, both of these giants
should have been ground up in the tires of the bus.
After the subprime collapse then BofA CEO, Ken
Lewis, most certainly did not want to use BofA money to stop the free fall of
Merrill Lynch. However, U.S. Treasury Secretary Hank Paulson resorted to
personal blackmail according to Ken Lewis.
"Bank Chief Tells of U.S. Pressure to Buy Merrill Lynch," by Louise Story
and Jo Becker, The New York Times, June 11. 2009 ---
http://www.nytimes.com/2009/06/12/business/12bank.html
Of course once BofA decided to concede to
Paulson's demands does not condone the alleged behavior of BofA executives or
Merrill Lynch executives in closing the deal.
"Ken Lewis BLASTS Merrill Lynch-Bank Of America Merger Lawsuit, Calls It
'Implausible'," by David B. Caruso, August 21, 2010 ---
http://www.huffingtonpost.com/2010/08/21/ken-lewis-blasts-merrill-_n_690215.html
Actually BofA was in great shape well into the
subprime mortgage crisis. BofA had been smart enough in 2007 to hold none of the
poisoned mortgages and CDOs that plagued most of the big banks and brokerage
houses like Merrill Lynch. But in a twist of fate BofA became drawn to the fire
sale pricing of big outfits like Countrywide and Merrill Lynch that were dying
from subprime poison. BofA just did not look these gift horses in the mouth
until it was too late to get them out of the BofA stables. There's no excuse for
the stupid purchase of Countrywide which left BofA will millions of defaulted
mortgages. There is purportedly an excuse for the purchase of Merrill Lynch. Ken
Lewis was a chicken sh*t. Ironically, he eventually lost his job anyway.
Now it appears that BofA wants to pass trillions
in Merrill Lynch CDO losses on to depositors who will pay for these losses in
nickels and dimes of daily bank charges for things like debit cards for the next
1,000 years. In reality, the counterparties to the CDO contracts should've
absorbed the loan loss poison, but Treasury Secretary Paulson and President
George Bush did not want to piss off the investors who finance U.S. Government
budget deficits --- especially our friends in Asia and the Middle East and large
banks like Goldman that had bought these poison-laced CDO bonds.
Ironically, it is now BofA depositors who will
now be paying off the bad debts that rightfully belonged to sovereign funds of
Asia and the Middle East as well as derivatives contract counterparties at
Goldman.
"U.S. Expected to Charge Executive Tied to
Galleon Case," by Azam Ahmed, Peter Lattman, and Ben Protess, The New
York Times, October 25, 2011 ---
http://dealbook.nytimes.com/2011/10/25/gupta-faces-criminal-charges/?nl=todaysheadlines&emc=tha2
Federal prosecutors are
expected to file criminal charges on Wednesday against Rajat K. Gupta, the
most prominent business executive ensnared in an aggressive insider trading
investigation, according to people briefed on the case.
The case against Mr. Gupta,
62, who is expected to surrender to F.B.I. agents on Wednesday, would extend
the reach of the government’s inquiry into America’s most prestigious
corporate boardrooms. Most of the defendants charged with insider trading
over the last two years have plied their trade exclusively on Wall Street.
The charges would also mean
a stunning fall from grace of a trusted adviser to political leaders and
chief executives of the world’s most celebrated companies.
A former director of Goldman
Sachs and Procter & Gamble and the longtime head of McKinsey & Company, the
elite consulting firm, Mr. Gupta has been under investigation over whether
he leaked corporate secrets to Raj Rajaratnam, the hedge fund manager who
was sentenced this month to 11 years in prison for trading on illegal stock
tips.
While there has been no
indication yet that Mr. Gupta profited directly from the information he
passed to Mr. Rajaratnam, securities laws prohibit company insiders from
divulging corporate secrets to those who then profit from them.
The case against Mr. Gupta,
who lives in Westport, Conn., would tie up a major loose end in the
long-running investigation of Mr. Rajaratnam’s hedge fund, the Galleon
Group. Yet federal authorities continue their campaign to ferret out insider
trading on multiple fronts. This month, for example, a Denver-based hedge
fund manager and a chemist at the Food and Drug Administration pleaded
guilty to such charges.
A spokeswoman for the United
States attorney in Manhattan declined to comment.
Gary P. Naftalis, a lawyer
for Mr. Gupta, said in a statement: “The facts demonstrate that Mr. Gupta is
an innocent man and that he acted with honesty and integrity.”
Mr. Gupta, in his role at
the helm of McKinsey, was a trusted adviser to business leaders including
Jeffrey R. Immelt, of General Electric, and Henry R. Kravis, of the private
equity firm Kohlberg Kravis Roberts & Company. A native of Kolkata, India,
and a graduate of the Harvard Business School, Mr. Gupta has also been a
philanthropist, serving as a senior adviser to the Bill & Melinda Gates
Foundation. Mr. Gupta also served as a special adviser to the United
Nations.
His name emerged just a week
before Mr. Rajaratnam’s trial in March, when the Securities and Exchange
Commission filed an administrative proceeding against him. The agency
accused Mr. Gupta of passing confidential information about Goldman Sachs
and Procter & Gamble to Mr. Rajaratnam, who then traded on the news.
The details were explosive.
Authorities said Mr. Gupta gave Mr. Rajaratnam advanced word of Warren E.
Buffett’s $5 billion investment in Goldman Sachs during the darkest days of
the financial crisis in addition to other sensitive information affecting
the company’s share price.
At the time, federal
prosecutors named Mr. Gupta a co-conspirator of Mr. Rajaratnam, but they
never charged him. Still, his presence loomed large at Mr. Rajaratnam’s
trial. Lloyd C. Blankfein, the chief executive of Goldman, testified about
Mr. Gupta’s role on the board and the secrets he was privy to, including
earnings details and the bank’s strategic deliberations.
The legal odyssey leading to
charges against Mr. Gupta could serve as a case study in law school criminal
procedure class. He fought the S.E.C.’s civil action, which would have been
heard before an administrative judge. Mr. Gupta argued that the proceeding
denied him of his constitutional right to a jury trial and treated him
differently than the other Mr. Rajaratnam-related defendants, all of whom
the agency sued in federal court.
Mr. Gupta prevailed, and the
S.E.C. dropped its case in August, but it maintained the right to bring an
action in federal court. The agency is expected to file a new, parallel
civil case against Mr. Gupta as well. It is unclear what has changed since
the S.E.C. dropped its case in August.
An S.E.C. spokesman declined
to comment.
Continued in article
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"Accused of Deception, Citi Agrees to Pay $285 Million," by Edward
Wyatt, The New York Times, October 19, 2011 ---
http://www.nytimes.com/2011/10/20/business/citigroup-to-pay-285-million-to-settle-sec-charges.html?hp
Citigroup agreed to pay $285 million to settle
charges that it misled investors in a $1 billion derivatives deal tied to
the United States housing market, then bet against investors as the housing
market began to show signs of distress, the Securities and Exchange
Commission said Wednesday.
The S.E.C. also brought charges against a Citigroup
employee who was responsible for structuring the transaction, and brought
and settled charges against the asset management unit of Credit Suisse and a
Credit Suisse employee who also had responsibility for the derivative
security.
¶ The S.E.C. said that the $285 million would be
returned to investors in the deal, a collateralized debt obligation known as
Class V Funding III. The commission said that Citigroup exercised
significant influence over the selection of $500 million of assets in the
deal’s portfolio.
¶ Citigroup then took a short position against
those mortgage-related assets, an investment in which Citigroup would profit
if the assets declined in value. The company did not disclose to the
investors to whom it sold the collateralized debt obligation that it had
helped to select the assets or that it was betting against them.
¶ The S.E.C. also charged Brian Stoker, the
Citigroup employee who was primarily responsible for putting together the
deal, and Samir H. Bhatt, a Credit Suisse portfolio manager who was
primarily responsible for the transaction. Credit Suisse served as the
collateral manager for the C.D.O. transaction.
¶ “The securities laws demand that investors
receive more care and candor than Citigroup provided to these C.D.O.
investors,” said Robert Khuzami, director of the S.E.C.’s division of
enforcement. “Investors were not informed that Citigroup had decided to bet
against them and had helped choose the assets that would determine who won
or lost.”
¶ Citigroup received fees of $34 million for
structuring and marketing the transaction and realized net profits of at
least $126 million from its short position. The $285 million settlement
includes $160 million in disgorgement plus $30 million in prejudgment
interest and a $95 million penalty, all of which will be returned to
investors.
¶ The companies and individuals who settled the
charges neither admitted nor denied the charges.
Continued in article
Bob Jensen's Timeline of Derivatives Frauds ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Bob Jensen's threads on the derivatives scandals in 2007 and 2008 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Commissioner slams SEC settlement,"
SmartPros, July 13, 2011 ---
http://accounting.smartpros.com/x72323.xml
One of the SEC's five
commissioners has taken the extraordinary step of publicly dissenting from
an enforcement action on the grounds that it was too weak.
Commissioner Luis A.
Aguilar said the Securities and Exchange Commission should have charged
a former Morgan Stanley trader with fraud in view of what he called "the
intentional nature of her conduct."
The dissent comes weeks
after the SEC took flak for negotiating a $153.6 million fine from J.P.
Morgan Chase in another enforcement case but taking no action against
any of the firm's employees or executives.
Under a settlement
announced Tuesday, the SEC alleged that former Morgan Stanley trader
Jennifer Kim and a colleague who previously settled with the agency had
executed at least 32 sham trades to mask the amount of risk they had
been incurring and to get around an internal restriction.
Their trading
contributed to millions of dollars of losses at the investment firm, the
SEC said.
Without admitting or
denying the SEC's findings, Kim agreed to pay a fine of $25,000.
Aguilar said the
settlement was "inadequate" and "fails to address what is in my view the
intentional nature of her conduct."
"The settlement should
have included charging Kim with violations of the antifraud provisions,"
Aguilar wrote.
Continued in article
Jensen Comment
Maybe Jennifer also did porn. SEC enforcers like porn (daily).---
http://abcnews.go.com/GMA/sec-pornography-employees-spent-hours-surfing-porn-sites/story?id=10452544
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
The Fed Audit
Socialist Bernie Sanders is probably my least favorite senator alongside Barbara
(mam) Boxer. But he does make some important revelations in the posting below.
The first ever GAO audit of the Federal Reserve
was conducted in early 2011 due to the Ron Paul, Alan Grayson Amendment to the
Dodd-Frank bill, which passed last year. Jim DeMint, a Republican Senator, and
Bernie Sanders, an independent Senator, led the charge for a Federal Reserve
audit in the Senate, but watered down the original language of the house bill
(HR1207), so that a complete audit would not be carried out. Ben Bernanke, Alan
Greenspan, and various other bankers vehemently opposed the audit and lied to
Congress about the effects an audit would have on markets. Nevertheless, the
results of the first audit in the Federal Reserve nearly 100 year history were
posted on Senator Sanders webpage in July.
The list of
institutions that received the most money from the Federal Reserve can be found
on page 131 of the GAO Audit and is as follows:
Citigroup: $2.5
trillion($2,500,000,000,000)
Morgan Stanley: $2.04 trillion ($2,040,000,000,000)
Merrill Lynch: $1.949 trillion ($1,949,000,000,000)
Bank of America : $1.344 trillion ($1,344,000,000,000)
Barclays PLC ( United Kingdom ): $868 billion* ($868,000,000,000)
Bear Sterns: $853 billion ($853,000,000,000)
Goldman Sachs: $814 billion ($814,000,000,000)
Royal Bank of Scotland (UK): $541 billion ($541,000,000,000)
JP Morgan Chase: $391 billion ($391,000,000,000)
Deutsche Bank ( Germany ): $354 billion ($354,000,000,000)
UBS ( Switzerland ): $287 billion ($287,000,000,000)
Credit Suisse ( Switzerland ): $262 billion ($262,000,000,000)
Lehman Brothers: $183 billion ($183,000,000,000)
Bank of Scotland ( United Kingdom ): $181 billion ($181,000,000,000)
BNP Paribas (France): $175 billion ($175,000,000,000)
"The Fed Audit," by Bernie Sanders, Independent
Senator from Vermont, July 21, 2011 ---
http://sanders.senate.gov/newsroom/news/?id=9e2a4ea8-6e73-4be2-a753-62060dcbb3c3
The first
top-to-bottom audit of the Federal Reserve uncovered eye-popping new details
about how the U.S. provided a whopping $16 trillion in secret loans to bail
out American and foreign banks and businesses during the worst economic
crisis since the Great Depression. An amendment by Sen. Bernie Sanders to
the Wall Street reform law passed one year ago this week directed the Government
Accountability Office to conduct the study. "As a
result of this audit, we now know that the Federal Reserve provided more
than $16 trillion in total financial assistance to some of the largest
financial institutions and corporations in the United States and throughout
the world," said Sanders. "This is a clear case of socialism for the rich
and rugged, you're-on-your-own individualism for everyone else."
Among the investigation's
key findings is that the Fed unilaterally provided trillions of dollars in
financial assistance to foreign banks and corporations from South Korea to
Scotland, according to the GAO report. "No agency of the United States
government should be allowed to bailout a foreign bank or corporation
without the direct approval of Congress and the president," Sanders said.
The non-partisan,
investigative arm of Congress also determined that the Fed lacks a
comprehensive system to deal with conflicts of interest, despite the serious
potential for abuse. In fact, according to the report, the Fed provided
conflict of interest waivers to employees and private contractors so they
could keep investments in the same financial institutions and corporations
that were given emergency loans.
For example, the CEO of JP
Morgan Chase served on the New York Fed's board of directors at the same
time that his bank received more than $390 billion in financial assistance
from the Fed. Moreover, JP Morgan Chase served as one of the clearing banks
for the Fed's emergency lending programs.
In another disturbing
finding, the GAO said that on Sept. 19, 2008, William Dudley, who is now the
New York Fed president, was granted a waiver to let him keep investments in
AIG and General Electric at the same time AIG and GE were given bailout
funds. One reason the Fed did not make Dudley sell his holdings, according
to the audit, was that it might have created the appearance of a conflict of
interest.
To Sanders, the conclusion
is simple. "No one who works for a firm receiving direct financial
assistance from the Fed should be allowed to sit on the Fed's board of
directors or be employed by the Fed," he said.
The investigation also
revealed that the Fed outsourced most of its emergency lending programs to
private contractors, many of which also were recipients of extremely
low-interest and then-secret loans.
The Fed outsourced virtually
all of the operations of their emergency lending programs to private
contractors like JP Morgan Chase, Morgan Stanley, and Wells Fargo. The same
firms also received trillions of dollars in Fed loans at near-zero interest
rates. Altogether some two-thirds of the contracts that the Fed awarded to
manage its emergency lending programs were no-bid contracts. Morgan Stanley
was given the largest no-bid contract worth $108.4 million to help manage
the Fed bailout of AIG.
A more detailed GAO
investigation into potential conflicts of interest at the Fed is due on Oct.
18, but Sanders said one thing already is abundantly clear. "The Federal
Reserve must be reformed to serve the needs of working families, not just
CEOs on Wall Street."
To read the GAO report, click here
http://sanders.senate.gov/imo/media/doc/GAO Fed Investigation.pdf
"Iran arrests 19 people in $2.6 billion bank
fraud described as nation’s biggest financial scam," The Washington Post,
September 19, 2011 ---
http://www.washingtonpost.com/world/middle-east/iran-arrests-19-people-in-26-billion-bank-fraud-described-as-nations-biggest-financial-scam/2011/09/19/gIQANmXNeK_story.html
Iran’s state prosecutor says
authorities have arrested 19 suspects in a $2.6 billion bank fraud described
as the biggest financial corruption scam in Iran’s history.
Several newspapers,
including the pro-reform Shargh daily, quote Gholam Hossein Mohseni Ejehei
as saying more people will be arrested.
Parliament summoned the
finance minister and the central bank governor to discuss the case on
Monday.
Officials say the fraud
involved the use of forged documents to get credit at one of Iran’s top
financial institutions to purchase assets including major state-owned
companies.
Continued in article
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
April 21, 2011 message from Francine
I am flattered that the authors chose to
close their paper with my thoughts from a recent Forbes article.
The Resignation of David Sokol:
Mountain or Molehill for Berkshire Hathaway? (PDF)
In 2011, David Sokol, CEO of Berkshire
Hathaway’s energy subsidiary, purchased $10 million of Lubrizol stock
days before recommending that Berkshire Hathaway acquire the firm. Did
Sokol’s actions reflect a broad governance failure for the firm?
Francine McKenna
Managing Editor
@ReTheAuditors on Twitter
"Traders Gone Rogue: A Greatest-Hits Album,"
by Thomas Kaplan, The New York Times, September 15, 2011 ---
http://dealbook.nytimes.com/2011/09/15/traders-gone-rogue-a-greatest-hits-album/
Traders run amok are often
sentenced to pay restitution, in addition to serving jail time or forgoing
any future dealings in the securities industry. But few have been held
responsible for an I.O.U. as large as the one a French court pinned on
Jérôme Kerviel on Tuesday: $6.7 billion.
That works out to the amount
his rogue trades ultimately cost Société Générale, The New York Times’s
Nicola Clark reports. But how does it equate to other famous (or infamous)
traders gone rogue through the years?
It depends how you look at
it, said William K. Black, a professor of economics and law at the
University of Missouri-Kansas City, who specializes in financial fraud.
“In terms of dollar losses
caused, he’s No. 1,” Professor Black told DealBook. “In terms of crushing
institutions, he’s not No. 1.”
That’s because Mr. Kerviel
did not actually bring down his firm, which other rogue traders have done.
While only four people in all of France would be rich enough to pay what Mr.
Kerviel’s owes in restitution — according to Forbes magazine’s list of the
world’s billionaires, at least — his bank lives on.
So, too, do several other
famous miscreant traders.
¶Indeed, while Mr. Kerviel
may have succeeded in amassing a fraud of historic magnitude, his rogue
counterparts have brought distinction (or shame) upon themselves in other
creative ways:.
¶¶ Creating fake identities.
John M. Rusnak pleaded guilty in 2002 to faking trades in order to hide
nearly $700 million in losses through rogue trades of Japanese yen for
Allfirst Financial, which was then a subsidiary of Allied Irish Banks.
¶Mr. Rusnak worked hard to
keep his wrongdoing a secret. At one point, in order to trick auditors, he
was said to have posed as a fictitious trader, David Russell, with whom he
supposedly had dealings. He pulled it off by renting a box at a Mail Boxes
Etc. on the Upper West Side in Manhattan; when bank auditors wanted to
verify his trades with the supposed Mr. Russell, Mr. Rusnak had them write
to that mailbox, where he then replied as if he were the fictitious trader.
¶Allied Irish Banks sold
Allfirst Financial to the M&T Bank Corporation of Buffalo shortly after the
scandal came to light. Mr. Rusnak, for his part, was released from federal
prison last year and has remained out of the headlines since then.
¶¶ Earning clever
nicknames.The Sumitomo Corporation of Japan in 1996 lost $2.6 billion
because of a rogue trader, Yasuo Hamanaka, the chief of the company’s copper
trading operations. Before his rogue trades became public, he had earned the
nickname “Mr. 5 Percent” — referring to the share of the world’s copper
market he was said to control.
¶Mr. Hamanaka pleaded guilty
to forgery and fraud and was jailed until 2005. Paying homage to what made
him famous, he told Bloomberg News upon his release that he was “amazed” at
how the price of copper had risen while he was incarcerated.
¶Making the best-seller
list. In the mid-1990s, Daiwa Bank lost more than $1 billion as a result of
a rogue New York-based bond trader, Toshihide Iguchi. Mr. Iguchi was
sentenced to four years in prison, which he told The Wall Street Journal was
less painful than the life of deceit he was living as a rogue trader trying
to cover his tracks.
¶While in prison, he wrote a
memoir, “The Confession,” that was widely read in Japan. But after settling
in Georgia upon his release, the only work Mr. Iguchi could find was a
$10-an-hour job at a furniture-building shop, so he eventually headed back
to Japan, where he opened an English school, The Journal reported in 2008.
¶But Mr. Kerviel’s case
brought back bad memories. Mr. Iguchi told The Journal that shortly after
the French trader was accused, he had nightmares about his own rogue
trading.
¶Going Hollywood. Nicholas
W. Leeson, a trader for the British investment bank Barings, managed to
topple his bank in 1995 as a result of his rogue trading. Based in
Singapore, Mr. Leeson lost more than $1 billion through ill-fated bets on
Japanese stock prices and interest rates.
¶Mr. Leeson pleaded guilty
in Singapore to fraud and forgery and served four years in prison. He is now
the chief executive of an Irish soccer club, Galway United.
¶But perhaps best of all,
Mr. Leeson managed to carve for himself a place in popular culture. He
commanded a reported $700,000 advance for a ghostwritten memoir, “Rogue
Trader” (1997), and more recently published a self-help book, “Back from the
Brink: Coping With Stress” (2005).
¶His first book was made
into a 1999 film starring Ewan McGregor. The film, like Mr. Leeson’s trading
practices, was widely panned.
Continued in article
Bob Jensen's threads on securities and trader
fraud ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"Why You Shouldn't Buy Those Quarterly
Earnings Surprises," The Wall Street Journal, July 2, 2011 ---
http://online.wsj.com/article/SB10001424052702303763404576419783497869132.html?mod=rss_IntelligentInvestor
Everyone loves surprises.
But perhaps you shouldn't get too excited over them.
This month, market
strategists, television commentators and other investing pundits will
bombard you with breathless updates on the percentage of companies in the
Standard & Poor's 500-stock index that have reported profits even higher
than what analysts expected—in Wall Street lingo, a "positive earnings
surprise."
The percentage of companies
that have beaten expectations often is cited as a barometer of corporate
profitability, an indicator of how well the economy as a whole is doing or a
predictor of where the stock market is going.
What goes unsaid, however,
is that these positive surprises are becoming so common they are nearly
universal. They are predetermined in a cynical tango-clinch between
companies and the analysts who cover them. And there is no reliable evidence
that the stock market as a whole will earn higher returns after periods with
more positive surprises.
In the first quarter of
2011, according to Bianco Research, 68% of the companies in the S&P 500
earned more than the consensus, or median, forecast by analysts.
What's more, that quarter
was the ninth in a row when at least two-thirds of the companies in the S&P
generated positive surprises—and the 50th consecutive quarter in which at
least half of the companies surpassed the consensus forecast of their
earnings.
Even in the depths of the
financial crisis, from the third quarter of 2008 through the first quarter
of 2009, between 59% and 66% of companies beat expectations, according to
Wharton Research Data Services, or WRDS.
In short, there isn't
anything surprising about earnings surprises. They aren't the exception;
they are the rule. "All the numbers are gamed at this point," says James A.
Bianco, president of Bianco Research.
With trading volumes down on
Wall Street and commission rates near record-low levels, brokerage firms are
starved for the revenue that stock trading used to provide. Since changes in
earnings forecasts encourage many investors to buy or sell, analysts have an
incentive to revise their predictions more often. But that hasn't made the
forecasts more accurate. On average, according to Denys Glushkov, research
director at WRDS, stock analysts are revising their earnings forecasts
nearly twice as frequently as they did a decade ago. And while the typical
forecast missed the mark by 1% in the 1990s, that margin of error has lately
been running at triple that rate.
What's going on here? In
what used to be called "lowballing" but now goes by the euphemism of
"guidance," an analyst will guesstimate what a company will earn over the
next year or calendar quarter. Then the company "walks down" the analyst's
forecast by providing a series of progressively lower targets until the
analyst's prediction falls slightly below where the actual number is likely
to come out.
Voila: The company gets to
announce earnings that are better than expected, while the analyst gets to
tell his investing clients that his estimate was pretty accurate and
conservative to boot.
According to a survey of 269
members by the National Investor Relations Institute, 90% provide guidance
in one form or another, most commonly on earnings and revenues over the
coming four quarters. No more than 5% offer any guidance on results further
than one year into the future.
Refusing to dance this
cynical tango isn't always easy. "If you cut back or eliminate guidance,
management needs to be prepared for the possibility of more volatility in
the stock price and a wider range in analysts' estimates," says Barbara
Gasper, head of investor relations at MasterCard, which doesn't give
short-term guidance. Instead, it provides three-year targets for sales and
profitability, leaving analysts at least partly on their own to form interim
forecasts of the company's earnings.
Somehow, the stock has
survived.
You might think that
positive earnings surprises would be good for future returns of the stock
market overall. Companies that report positive surprises still get a
short-term pop in their stock price, even though the smartest investors
realize the surprise is a staged event.
Continued in article
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Slippery People: Corporate Governance
at Berkshire Hathaway," by Francine McKenna, re:TheAuditors,
April 24, 2011 ---
http://retheauditors.com/2011/04/24/slippery-people-corporate-governance-at-berkshire-hathaway/
Warren Buffet
announced the sudden resignation of his heir apparent, David Sokol, on March
30, 2011. Berkshire Hathaway shareholders, fundamental style value investors,
law professors,
and the
business media have been talking about it ever since. However,
Buffett doesn’t want us to question him
further and
is not willing to say anything more…
I have
held back nothing in this statement. Therefore, if questioned about this
matter in the future, I will simply refer the questioner back to this
release.
The Berkshire
Hathaway Annual Meeting is typically a marathon of openness and
transparency. Buffet has been known to stay on stage at the revival-style
event, this year scheduled for April 30, for up to eight hours. But
Berkshire Hathaway has an Achilles heel. Buffett’s storied forthcoming
manner is not going to carry over to this case:
Alice Schroeder,
author
of “The Snowball: Warren Buffett and the Business of Life”: ORIGINALLY
I didn’t think Buffett was going to entertain questions on this subject
at the meeting. I think he’ll talk about it for maybe five or ten
minutes in a statement at the beginning of the meeting, much of which
time will be a recap of what happened. He could then cite litigation as
a reason for why he can’t have an open-ended discussion and take
questions.
I’ve written
several articles about this case because it fascinates me to see an iconic
figure stumble. Call it
schadenfreude.
Or just call it my natural cynicism. Either way, I’m gratified that my first
hunch – it’s not a case of insider trading but one of an agent/fiduciary
taking advantage of his trusted position to benefit himself first – has been
ratified.
On April 4: I
wrote,
The Gnome of Nebraska: Warren Buffett, Berkshire Hathaway, and Self-Dealing, for
Forbes:
When
asked by
CNBC
what he’d learned from the controversy over the transaction, Sokol
responded:
“Knowing
today what I know, what I would do differently is I just would never
have mentioned it to Warren, and just made my own investment and left it
alone…”
According
to Professor Macey, that’s called
“usurping a corporate opportunity,”
and it’s
a violation of an officer’s
duty of loyalty
to
a corporation.
On
April 11,
Professor Stephen Bainbridge reconsidered his and others’ idea that this was
an “insider trading” case. His reconsideration is based on, reportedly, an
email from his co-author Bill Klein.
Professor
Bainbridge doesn’t mention that I sent him an email on April 8 in response
to his March 30 post discussing the insider trading theory and drawing his
attention to my April 4th post at Forbes. I asked him to
consider the possibility that Sokol had “usurped a corporate opportunity”
and breached his fiduciary duty to Berkshire Hathaway. Bainbridge never
responded to me.
Bainbridge
does not expand on the agency, fiduciary duty, and usurpation theories until
April 20, after the shareholder derivative lawsuit is filed against Sokol
and the Berkshire board for breach of fiduciary duty. The suit also asks for
disgorgement of Sokol’s gain on his investment of Lubrizol stock.
In the
meantime, I wrote quite a few more more posts at Forbes and on this site,
including one about the lawsuit.
My posts and
links to my opinions were as follows:
April 4:
My first post
included this
quote:
So, what,
you might ask, is wrong with Sokol taking a little bit of the action
ahead of his typically successful dealmaking for Berkshire Hathaway?
After all, as he told CNBC,
Charlie Munger did it.
Jonathan R. Macey
of Yale,
in his 1991 article,
Agency Theory and the Criminal Liability of Corporations, tells us:
…[C]orporate
actors do not engage in criminal activity to benefit the firms for which
they work but to benefit themselves. In some, but not all cases, these
activities will benefit the firms for which the corporate actors work.
But the basic motivation for the behavior is self-interest.
Professor
Macey told me he doesn’t think this is an insider trading issue at all
unless Sokol failed to disclose his interests and his trading to
Berkshire, according to their policies.
I agree.
April 5:
I posted here at re: The Auditors about my April 4th
post at Forbes with some additional information including a link to Sokol’s
interview on CNBC:
Continued in article
"(Francine) McKenna Covers The Berkshire
Hathaway Annual Meeting," by Francine McKenna, re:TheAuditors, May 3,
2011 ---
http://retheauditors.com/2011/05/03/mckenna-covers-the-berkshire-hathaway-annual-meeting/
There are many ways
journalists, investors, and Warren Buffett himself refer to the Berkshire
Hathaway Annual Meeting, held in Omaha, Nebraska. These short-cuts and
sobriquets add a larger-than-life aspect to what is typically, for almost
any other public company, a rather perfunctory affair. Barring any
significant controversy, expected or unexpected, no one that doesn’t
absolutely have to show up at an annual meeting usually makes the trip.
I had the good fortune to
spend some time on Saturday with the New York Bureau Chief of The Economist
Matthew Bishop. He’s a UK native and co-author of the book “Philanthrocapitalism”.
This was also his first time at the “Woodstock for Capitalism.”
(That’s what Warren Buffet
calls the event in his Annual Letter to Shareholders but I think this
“Buffettism” is oxymoronic.)
Bishop told me that in the
UK there used to be much higher attendance at shareholder meetings, usually
for the banks. This reliable audience consisted mainly of retirees because
the companies served a lovely lunch in the City. When that stopped, most
budget-minded pensioners no longer attended.
Every once and a while
someone calls me a “gad-fly” with regard to audit industry reform. I don’t
much like that term because it makes a buzzing sound in my ears. When they
also mention fabled shareholders’ activist Evelyn Y. Davis in the same
breath, I warm to the label. You can still count on her to stir up a fuss at
an Annual Meeting.
Ms. Davis is a corporate
governance legend. Here’s her tombstone.
The Berkshire Hathaway
Annual Meeting draws a huge crowd because it features several hours of the
wit and wisdom of Berkshire Hathaway CEO and Chairman Warren Buffett and his
friend and Vice Chairman Charlie Munger. To say that Buffett, Munger, and
Berkshire Hathaway have a cult-like following would be a significant
understatement.
The atmosphere is a
“Buffett-a-palooza” – a term used across the board by major
media as well as bloggers.
Jeff Harding at
The Daily Capitalist: I like the fact that our
society elevates people like Buffett and Munger to celebrity status.
After all, we don’t have kings to adore. We Americans like and respect
money and we admire people who make money. Ask de Tocqueville
who was amazed at the audacity of poor people who thought they could
elevate themselves through diligence and hard work. We may love our
athletes and movie stars, but we listen to the ultra wealthy.
This year there was
more interest than ever in the Berkshire meeting because of the
Sokol affair.
The
Wall Street Journal, The
New York Times, The
Motley Fool, and assorted others such as
WalletPop Canada’s Neil Jain live-blogged
the meeting, which ran from 9:30am until 5:00pm. The most complete
transcript of the Q&A I’ve seen can be found here:
Notes from the Berkshire
Hathaway 2011 Annual Meeting, prepared by a
soon-to-be graduate who calls himself The Inoculated Investor.
Understand… The formal
Annual Meeting with a legal recording of the votes on resolutions in the
proxy, election of the slate of Board of Directors and confirmation of the
auditor – Deloitte – was conducted during the last half hour of the day. The
rest of the meeting was a Q&A session with Buffett and Munger, the two of
them alone on a bare stage in front of 40,000 people. It was an example of
high performance art, including Buffett playing straight man to Munger’s
snappy jokes until Munger finally nodded off about 4:30pm – or, more
accurately, carbo-crashed on stage, after munching constantly all day on
See’s peanut brittle.
I’ll let the New York Times’ Michael de la
Merced set the tone:
9:26 a.m. | Ladies and
gents, take your seats
It’s almost showtime. A
gravelly announcer – who sounds awfully similar to that guy from all the
movie trailers – tells of those who have gathered for “one gloriously
capitalistic weekend.” He further intones, “All roads led them to Omaha”
before the big finish: “You’ve arrived at the Berkshire Hathaway
shareholders meeting. The movie will begin in 10 minutes.”
Press were asked to
arrive and check in between 5:45am and 6:30am. Yes, three hours in advance
of the start time. It was a good thing, too, that I already had my press
pass.
Continued in article
Bob Jensen's threads on corporate
governance are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance
A parallel civil
complaint brought by the Securities and Exchange Commission said that Mr.
Goffer’s nickname among his fellow traders was “Octopussy” — a reference to the
James Bond movie — because his arms reached into so many sources of information.
Peter Lattman, "Zvi Goffer Found Guilty in Insider Trading Case," The
New York Times, June 13, 2011 ---
http://dealbook.nytimes.com/2011/06/13/zvi-goffer-found-guilty-in-insider-trading-case/
A federal jury in Manhattan
on Monday found Zvi Goffer and two co-conspirators guilty of insider
trading, the latest development in the government’s investigation into
insider trading at hedge funds.
Mr. Goffer, his brother
Emanuel Goffer and Michael A. Kimelman were convicted of participating in an
insider trading scheme that produced more than $20 million in illegal
profits.
The case was connected to
the prosecution of Raj Rajaratnam, the hedge-fund tycoon and co-founder of
the Galleon Group who was found guilty last month in the largest insider
trading case in a generation. Zvi Goffer, who sat in on much of Mr.
Rajaratnam’s trial, was employed by Galleon.
Continued in article
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"How a big US bank laundered billions from
Mexico's murderous drug gangs," by Ed Vulliamy, The Guardian, April
3, 2011 ---
http://www.guardian.co.uk/world/2011/apr/03/us-bank-mexico-drug-gangs
|Thank you Robert Walker for the heads up.
As the violence spread,
billions of dollars of cartel cash began to seep into the global financial
system. But a special investigation by the Observer reveals how the
increasingly frantic warnings of one London whistleblower were ignored
On 10 April 2006, a DC-9 jet
landed in the port city of Ciudad del Carmen, on the Gulf of Mexico, as the
sun was setting. Mexican soldiers, waiting to intercept it, found 128 cases
packed with 5.7 tons of cocaine, valued at $100m. But something else – more
important and far-reaching – was discovered in the paper trail behind the
purchase of the plane by the Sinaloa narco-trafficking cartel.
During a 22-month
investigation by agents from the US Drug Enforcement Administration, the
Internal Revenue Service and others, it emerged that the cocaine smugglers
had bought the plane with money they had laundered through one of the
biggest banks in the United States: Wachovia, now part of the giant Wells
Fargo.
The authorities uncovered
billions of dollars in wire transfers, traveller's cheques and cash
shipments through Mexican exchanges into Wachovia accounts. Wachovia was put
under immediate investigation for failing to maintain an effective
anti-money laundering programme. Of special significance was that the period
concerned began in 2004, which coincided with the first escalation of
violence along the US-Mexico border that ignited the current drugs war.
Criminal proceedings were
brought against Wachovia, though not against any individual, but the case
never came to court. In March 2010, Wachovia settled the biggest action
brought under the US bank secrecy act, through the US district court in
Miami. Now that the year's "deferred prosecution" has expired, the bank is
in effect in the clear. It paid federal authorities $110m in forfeiture, for
allowing transactions later proved to be connected to drug smuggling, and
incurred a $50m fine for failing to monitor cash used to ship 22 tons of
cocaine.
More shocking, and more
important, the bank was sanctioned for failing to apply the proper
anti-laundering strictures to the transfer of $378.4bn – a sum equivalent to
one-third of Mexico's gross national product – into dollar accounts from
so-called casas de cambio (CDCs) in Mexico, currency exchange houses with
which the bank did business.
"Wachovia's blatant
disregard for our banking laws gave international cocaine cartels a virtual
carte blanche to finance their operations," said Jeffrey Sloman, the federal
prosecutor. Yet the total fine was less than 2% of the bank's $12.3bn profit
for 2009. On 24 March 2010, Wells Fargo stock traded at $30.86 – up 1% on
the week of the court settlement.
Continued in article
Note that I've closed the March 31, 2011
edition of FraudUpdates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Forged mortgage paperwork mess: the next
housing shock and toxic mold threats?
I have written tens of thousands of tidbits over
the years. Aside from my tidbits on wars, deficits/entitlements, and
unemployment, I think my most depressing tidbits are on the corrupted real
estate deed registries of virtually all counties in the 50 states if America.
The major reason for this corruption is that, after the subprime bubble burst in
2008, megabanks and Wall Street brokerage houses lost track of mortgage
paperwork on millions of real estate parcels. These banks/brokerages then forged
new copies of the mortgages, often with fictitious names of bank officials where
the loans originated. When these properties were then foreclosed or otherwise
resold to new buyers, the forged mortgages became part of recorded deeds,
thereby corrupting the deed registries across the entire United States.
Watch the Video
"Mortgage paperwork mess: the next housing shock?" CBS Sixty Minutes,
April 3, 2011 ---
http://www.cbsnews.com/stories/2011/04/01/60minutes/main20049646.shtml
If there was a question
about whether we're headed for a second housing shock, that was settled last
week with news that home prices have fallen a sixth consecutive month.
Values are nearly back to levels of the Great Recession. One thing weighing
on the economy is the huge number of foreclosed houses.
Many are stuck on the market
for a reason you wouldn't expect: banks can't find the ownership documents.
Who really owns your mortgage?
Scott Pelley explains a bizarre aftershock of the U.S. financial
collapse: An epidemic of forged and missing mortgage documents.
It's bizarre but, it turns
out, Wall Street cut corners when it created those mortgage-backed
investments that triggered the financial collapse. Now that banks want to
evict people, they're unwinding these exotic investments to find, that
often, the legal documents behind the mortgages aren't there
Continued in article
Deed Registry ---
http://en.wikipedia.org/wiki/Registry_of_deeds
Mortgage ---
http://en.wikipedia.org/wiki/Mortgage_loan
Mortgage Backed Security ---
http://en.wikipedia.org/wiki/Mortgage-backed_security
Collateralized Debt Obligation (CDO) or
Structured Asset Backed Security (CABS) ---
http://en.wikipedia.org/wiki/Collateralized_debt_obligation
Registered deeds keep legal track over the years
of all real estate in the United States. Often the owners have taken out
mortgages that give lenders priority claims on the real estate ownership when
owners default on mortgage lending contracts. It's important to note that names
of mortgage investors, along with the property owners, are written into the
recorded deeds. Before a buyer purchases real estate the chronological records
of recorded deeds on the property are generally searched by legal experts who
then certify and sometimes insure that the buyer will have a clear title to the
purchased property.
If mortgages referenced in recorded deeds are
forged, the recorded deeds are thereby corrupted. Present owners accordingly do
not have clear titles to the purchased real estate. This includes John and Jane
Doe now living in their home at 123 Main Street. It also includes Fannie Mae,
Freddie Mack, Goldman Sachs, Bank of America, JP Morgan, and most of the other
megabanks inside and outside the United States. All are waiting for former
owners to file lawsuits claiming damages because of forged documents (including
lawsuits from owners who simply abandoned their houses because they could not
make the mortgage payments and those that got forced out by foreclosure
proceedings).
The FDIC claims that probably the only way out
of this mess is for the large banks and brokerages who in one way or another are
responsible for the document forgeries to pay tens of billions into a "clean up
fund" to be administered by the government to make claimants accept cash
settlements and relinquish their rights to sue over forged or missing documents.
This may be the only way to clear the titles to registered deeds, including the
deeds on millions of empty homes that now cannot be sold until the titles are
cleared of the forged recorded paperwork.
A Summary of How This Mess Came
About
1.
The main cause of this mess roots back to a time when banks and mortgage
companies that initially approve mortgage contracts commenced selling all their
mortgage investments to downstream investors like Fannie Mae, Freddie Mac, Bear
Stearns, Lehman Brothers, Merrill Lynch, and virtually all the large
international banks and Wall Street brokerages. Some like Bank of America did
not directly buy many of these downstream mortgages but later inherited millions
of mortgages such as when Bank of America bought the troubled Countrywide and JP
Morgan bought the troubled Wachovia as part of the TARP deals engineered by the
U.S. Treasury Department. It took until 2011 for the government to finally
mandate that original lenders must retain "some skin" in the mortgages sold
downstream (currently at least 5% of the financial risk skin). That was not the
case when the subprime bubble burst in 2008.
2.
Another leading cause was the common 1990s practice of issuing subprime interest
rate mortgages where interest in the early years was below prime rates with a
clause that higher rates would eventually kick in several years down the road.
Even current owners were tempted to abandon their fixed rate mortgages and
refinance with subprime mortgages with the intent of flipping their homes before
the higher rates kicked in with payments they could not afford. The plan was to
sell their houses at huge gains and move up the hill to bigger houses and better
neighborhoods. All of this was predicated on the assumption that the price
bubble in real estate would never burst. But in 2008 it did burst and millions
of home owners could no longer make their mortgage payments when the subprime
rates gave way to double-digit rates. Low income people defaulted in droves, but
higher income people also defaulted. Some very high income people bought
mansions on the hill at subprime rates hoping to turn those mansions over for
enormous profits as long as housing prices in America kept going up and up. CBS
Sixty Minutes captured the essence of what happened when the bubble burst.
CBS
Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards"
---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
3.
The eventual downstream owners of these risky subprime mortgages invented a way
of diversifying default risk by putting together and selling portfolios of
mortgages known as Collateralized Debt Obligation portfolios. Buyers included
many wealthy investors in the Middle East and Asia. Forest Gump describes a CDO
portfolio as a box of chocolates with mostly small pieces of good mortgages with
a few turds thrown in (small pieces of mortgages are likely to go into default
by owners who cannot afford their mortgage payments). Note that a CDO portfolio
does not 100% of any mortgage investment. Rather it contains like a 1% piece of
a mortgage spread over 100 CDO portfolios. This is important because this
slicing and dicing shredding of financial risk is where much of the original
paperwork got lost.
Mortgage Backed Securities are like boxes of
chocolates. Criminals (bankers and brokers)
on Wall Street and one particular U.S. Congressional Committee stole a few
chocolates from the boxes and replaced them with turds. Their criminal buddies
at Standard & Poors rated these boxes AAA Investment Grade chocolates. These
boxes were then sold all over the world to investors. Eventually somebody bites
into a turd and discovers the crime. Suddenly nobody trusts American chocolates
anymore worldwide. Hank Paulson now wants the American taxpayers to buy up and
hold all these boxes of turd-infested chocolates for $700 billion dollars until
the market for turds returns to normal. Meanwhile, Hank's buddies, the Wall
Street criminals who stole all the good chocolates are not being investigated,
arrested, or indicted. Momma always said: "Sniff the chocolates first Forrest."
Things generally don't pass the smell test if they came from Wall Street or from
Washington DC.
Forrest Gump as quoted at
http://newsgroups.derkeiler.com/Archive/Rec/rec.sport.tennis/2008-10/msg02206.html
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of
the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals)
---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March
14, 2010. Both videos feature one of my favorite authors of all time, Michael
Lewis, who hhs been writing (humorously with tongue in cheek) about Wall Street
scandals since he was a bond salesman on Wall Street in the 1980s. The other
person featured on in these videos is a one-eyed physician with Asperger
Syndrome who made hundreds of millions of dollars anticipating the collapse of
the CDO markets while the shareholders of companies like Merrill Lynch, AIG,
Lehman Bros., and Bear Stearns got left holding the empty bags.
4.
Financial WMDs (Credit Derivatives) on Sixty Minutes (CBS) on August 30, 2009
---
http://www.cbsnews.com/video/watch/?id=5274961n&tag=contentBody;housing
The free download will only be available for a short while. I downloaded this
video (a little over 5 Mbs) using a free updated version of RealMedia ---
Click Here
http://www.real.com/dmm/superpass?pcode=cj&ocode=cj&cpath=aff&rsrc=1275588_10303897_SPLP
Steve Kroft examines the complicated financial
instruments known as credit default swaps and the central role they are playing
in the unfolding economic crisis. The interview features my hero Frank
Partnoy. I don't know of anybody who knows derivative securities contracts
and frauds better than Frank Partnoy, who once sold these derivatives in bucket
shops. You can find links to Partnoy's books and many, many quotations at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
For years I've used the term "bucket shop" in
financial securities marketing without realizing that the first bucket shops in
the early 20th Century were bought and sold only gambles on stock pricing moves,
not the selling of any financial securities. The analogy of a bucket shop would
be a room full of bookies selling bets on NFL playoff games.
See "Bucket Shop" at
http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)
5.
So where does mortgage/deed forgeries enter into the picture.
It turns out that the Wall Street brokerage houses and megabanks that ended up
downstream with the mortgages and then sliced and diced them into new
securitization instruments called Mortgage Backed Obligation (MBO) portfolios
completely lost track of the millions original mortgage paper work that they
were shredding into millions of MBOs. Then when owners defaulted on their
original subprime mortgages the megabanks and brokerages, gasp, could not find
the original paperwork. Even worse, when responsible homeowners sold their homes
and wanted to pay off their mortgages the megabanks and brokerages also could
not find the original paperwork.
Horrors!
What's a megabank to do when new deeds have to be recorded and the current
recorded deeds/mortgages cannot be located. What the megabanks essentially
did was forge new paperwork. Not wanting to implicate their own employees in
this fraud they hired sleazy mortgage servicing companies who in turn hired high
school kids at minimum wage to forge up to 4,000 names per hour (including
forged notary public signatures). The megabanks now claim they did not know
these forgeries were taking place, but if you believe this I've got some ocean
front property in Arizona and the Brooklyn Bridge that I would like to sell to
those megabanks.
To see how all of this forgery really took place
watch the following:
Mortgage paperwork mess: the next housing
shock?" CBS Sixty Minutes, April 3, 2011 ---
http://www.cbsnews.com/stories/2011/04/01/60minutes/main20049646.shtml
If there was a question
about whether we're headed for a second housing shock, that was settled last
week with news that home prices have fallen a sixth consecutive month.
Values are nearly back to levels of the Great Recession. One thing weighing
on the economy is the huge number of foreclosed houses.
Many are stuck on the market
for a reason you wouldn't expect: banks can't find the ownership documents.
Who really owns your mortgage?
Scott Pelley explains a bizarre aftershock of the U.S. financial
collapse: An epidemic of forged and missing mortgage documents.
It's bizarre but, it turns
out, Wall Street cut corners when it created those mortgage-backed
investments that triggered the financial collapse. Now that banks want to
evict people, they're unwinding these exotic investments to find, that
often, the legal documents behind the mortgages aren't there
Continued in article
6.
So where does this leave us now and why is this so serious?
This leaves us with millions of corrupted deed
registries containing references to forged documents. Current owners do not have
clear titles to their properties, including megabanks holding corrupted titles
to vacant homes.
Currently 13% of all the houses in America are
vacant, including millions of double wides in mobile home parks and millions of
mansions in every county of the United States. Owners, including megabanks, of
these vacant houses do not have clear title do to forged documents. The houses
cannot be sold with corrupted titles such that they sit vacant year after year.
Mold takes hold in the walls and ceilings of
vacant homes that are not properly cooled and dehumidified in hot summer months
and warmed in frigid winter months. The mold spreads more and more until it
reaches toxic levels where real estate inspectors will not allow the homes to be
sold. The bull dozers have to push through those double wides and even those
mansions on the hill.
Now lawyers are hovering like vultures to
commence the lawsuits on behalf of former owners such as owners thrown out of
foreclosed houses and new owners who do not have clear titles to properties
purchased in good faith ---
http://wgroup.ning.com/
The FDIC is proposing a forged document cleanup
fund where the megabanks responsible for using forged paperwork put up tens of
billions of dollars into a fund to pay off the damaged former owners so that
titles can be cleared on millions of homes now having corrupted deeds on file
due to those forgeries. It's a little like how the BP fund in being administered
for oil spill damages to employees and businesses along the Gulf Coast, only the
forged mortgage fund has to be much, much, much larger.
What a mess!
"What Caused the Bubble? Mission accomplished: Phil Angelides succeeds in
not upsetting the politicians," by Holman W, Jenkins, Jr., The Wall
Street Journal, January 29. 2011 ---
http://online.wsj.com/article/SB10001424052748704268104576108000415603970.html#mod=djemEditorialPage_t
The 2008 financial crisis happened because no one
prevented it. Those who might have stopped it didn't. They are to blame.
Greedy bankers, incompetent managers and
inattentive regulators created the greatest financial breakdown in nearly a
century. Doesn't that make you feel better? After all, how likely is it that
some human beings will be greedy at exactly the same time others are
incompetent and still others are inattentive?
Oh wait.
You could almost defend the Financial Crisis
Inquiry Commission's (FCIC) new report if the question had been who, in
hindsight, might have prevented the crisis. Alas, the answer is always going
to be the Fed, which has the power to stop just about any macro trend in the
financial markets if it really wants to. But the commission was asked to
explain why the bubble happened. In that sense, its report doesn't seem even
to know what a proper answer might look like, as if presented with the
question "What is 2 + 2?" and responding "Toledo" or "feral cat."
The dissenters at least propose answers that might
be answers. Peter Wallison focuses on U.S. housing policy, a diagnosis that
has the advantage of being actionable.
The other dissent, by Keith Hennessey, Bill Thomas
and Douglas Holtz-Eakin, sees 10 causal factors, but emphasizes the
pan-global nature of the housing bubble, which it attributes to ungovernable
global capital flows.
That is also true, but less actionable.
Let's try our hand at an answer that, like Mr.
Wallison's, attempts to be useful.
The Fed will make errors. International capital
flows will sometimes be disruptive. Speculators will be attracted to hot
markets. Bubbles will be a feature of financial life: Building a bunch of
new houses is not necessarily a bad idea; only when too many others do the
same does it become a bad idea. On that point, not the least of the
commission's failings was its persistent mistaking of effects for causes,
such as when banks finally began treating their mortgage portfolios as hot
potatoes to be got rid of.
If all that can't be changed, what can? How about
the incentives that invited various parties to shovel capital into housing
without worrying about the consequences?
The central banks of China, Russia and various
Asian and Arab nations knew nothing about U.S. housing. They poured hundreds
of billions into it only because Fannie and Freddie were perceived as
federally guaranteed and paid a slightly higher yield than U.S. Treasury
bonds. (And one of the first U.S. actions in the crisis was to assure China
it wouldn't lose money.)
Borrowers in most states are allowed to walk away
from their mortgages, surrendering only their downpayments (if any) while
dumping their soured housing bets on a bank. Change that even slightly and
mortgage brokers and home builders would find it a lot harder to coax people
into more house than they can afford.
Mortgage middlemen who don't have "skin in the
game" and feckless rating agencies have also been routine targets of blame.
But both are basically ticket punchers for large institutions that should
have and would have been assessing their own risk, except that their own
creditors, including depositors, judged them "too big to fail," creating a
milieu where they could prosper without being either transparent or
cautious. We haven't even tried to fix this, say by requiring banks to take
on a class of debtholder who would agree to be converted to equity in a
bailout. Then there'd be at least one sophisticated marketplace demanding
assurance that a bank is being run in a safe and sound manner. (Sadly, the
commission's report only reinforces the notion that regulators are
responsible for keeping your money safe, not you.)
The FCIC Chairman Phil Angelides is not stupid, but
he is a politician. His report contains tidbits that will be useful to
historians and economists. But it's also a report that "explains" poorly.
His highly calculated sound bite, peddled from one interview to the next,
that the crisis was "avoidable" is worthless, a nonrevelation. Everything
that happens could be said to happen because somebody didn't prevent it. So
what? Saying so is saying nothing.
Mr. Angelides has gone around trying to convince
audiences that the commission's finding was hard hitting. It wasn't. It was
soft hitting. More than any other goal, it strives mainly to say nothing
that would actually be inconvenient to Barack Obama, Harry Reid, Barney
Frank or even most Republicans in Congress. In that, it succeeded.
Jensen Comment
And then the subprime crisis was followed by the biggest swindle in the history
of the world ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
At this point time in 2011 there's only marginal benefit in identifying all
the groups like credit agencies and CPA audit firms that violated
professionalism leading up to the subprime crisis. The credit agencies,
auditors, Wall Street investment banks, Fannie Mae, and Freddie Mack were all
just hogs feeding on the trough of bad and good loans originating on Main
Streets of every town in the United States.
If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks There Would've Been No Poison to Feed Upon
by the Hogs With Their Noses in the Trough Up to and Including Wall Street and
Fannie and Freddie.
If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks All Would've Been Avoided
The most interesting question in my mind is what might've prevented the poison (uncollectability)
in the real estate loans from being concocted in the first place. What
might've prevented it was for those that approved the loans (Main Street banks
and mortgage companies in towns throughout the United States) to have to bear
all or a big share of the losses when borrowers they approved defaulted.
Instead those lenders that approved the loans easily passed those loans up
the system without any responsibility for their reckless approval of the
loans in the first place. It's easy to blame Barney Frank for making it
easier for poor people to borrow more than they could ever repay. But the fact
of the matter is that the original lenders like Countrywide were approving
subprime mortgages to high income people that also could not afford their
payments once the higher prime rates kicked in under terms of the subprime
contracts. If lenders like Countrywide had to bear a major share of the bad debt
losses the lenders themselves would've been more responsible about only
approving mortgages that had a high probability of not going into default.
Instead Countrywide and the other Main Street lenders got off scott free until
the real estate bubble finally burst.
And why would a high income couple refinance a fixed rate mortgage with a
risky subprime mortgage that they could not afford when the higher rates kicked
in down the road? The answer is that the hot real estate market before the crash
made that couple greedy. They believed that if they took out a subprime loan
with a very low rate of interest temporarily that they could turn over their
home for a relatively huge profit and then upgrade to a much nicer mansion on
the hill from the profits earned prior to when the subprime rates kicked into
higher rates.
When the real estate bubble burst this couple got left holding the bag and
received foreclosure notices on the homes that they had gambled away. And the
Wall Street investment banks, Fannie, and Freddie got stuck with all the poison
that the Main Street banks and mortgage companies had recklessly approved
without any risk of recourse for their recklessness.
If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks There Would've Been No Poison to Feed Upon
by the Hogs With Their Noses in the Trough Up to and Including Wall Street and
Fannie and Freddie.
Bob Jensen's threads on this entire mess are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"Bribery and the Gathering Storm Over
Compliance," by Peter J. Henning, The New York Times (DealB%k), April
1, 2011 ---
http://dealbook.nytimes.com/2011/04/01/bribery-and-the-gathering-storm-over-compliance/
While insider trading cases
have been attracting much of the financial headlines, there is another issue
that will have a much greater impact on corporate bottom lines: bribery.
The British Ministry of
Justice has announced guidelines for the implementation of the far-reaching
Bribery Act of 2010, which goes into effect on July 1. Meanwhile, while the
Securities and Exchange Commission is set this month to announce rules
required by the Dodd-Frank Act to encourage whistleblowers to disclose
information about corporate misconduct, most likely including violations of
the Foreign Corrupt Practices Act.
The Bribery Act is sure to
drive up the costs of compliance programs for American companies doing
business in Britain, while the Dodd-Frank Act’s whistleblower provisions may
well render those programs superfluous, even though they will still be
required by the Sarbanes-Oxley Act.
The Foreign Corrupt
Practices Act prohibits individuals and companies from paying bribes to
foreign officials to obtain or retain business in the country. It also
requires corporations that file reports with the S.E.C. to maintain accurate
books and records in accordance with the accounting rules. The law, first
adopted in 1977, has grown in importance over the past decade as the Justice
Department, working with the S.E.C., has brought a number of cases against
multinational companies for corrupt payments, resulting in millions of
dollars of fines and penalties.
Britain’s Bribery Act is
broader in some respects than the Foreign Corrupt Practices Act, most
importantly applying to any type of bribery, not just payments to foreign
officials. The Bribery Act makes a company liable for the actions of those
“associated” with a “commercial organization,” including any employee or
agent who acts on its behalf, and the organization is strictly liable for
any failure to prevent the bribery.
For American companies, a
key facet of the Bribery Act is its application to any organization that
“carries on a business” in Britain. The Ministry of Justice’s guidance is
not particularly helpful on the scope of the law, noting that it would not
apply to foreign company that did not have a “demonstrable business
presence” in Britain, and that a company is not necessarily liable if it
lists its shares on a British exchange or maintains a subsidiary in the
country. Rather than explaining what the law does cover, the guidance simply
describes what might fall outside the Bribery Act, while noting that the
courts will finally decide the issue. This provides little clarity about the
scope of the law.
The Bribery Act provides a
defense for a company accused of a violation if it can show it had in place
“adequate procedures” to prevent an associated person from engaging in
bribery, something the Foreign Corrupt Practices Act does not recognize as a
basis to avoid liability. The Ministry of Justice outlined six principles
for preventing bribery that should guide companies in adopting or expanding
a compliance program to help establish a defense to a charge. The principles
focus on adequately assessing the risks of a violation and implementing a
sufficiently rigorous program of prevention and monitoring.
While almost every publicly
traded American company already has a compliance program in place, the
potentially broad scope of the Bribery Act is likely to require companies
doing any substantial amount of business in Britain to devote even greater
resources to preventing bribery of any type, not just that involving foreign
officials. Compliance is not cheap, of course, which means the lawyers,
accountants and outside consultants who specialize in this field will see an
uptick in business.
Continued in article
Bob Jensen's threads on whistleblowing are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing
"Inside The Mind of An Inside Trader," by
Francine McKenna, re:TheAuditors, March 5, 2011 ---
http://retheauditors.com/2011/03/05/inside-the-mind-of-an-inside-trader/
No Big 4 audit firms
or their partners have been named in the insider trading scandal surrounding
the now-defunct hedge fund Galleon Management. But the
SEC
has accused one of the most prominent businessmen
ever implicated in such crimes, Rajat Gupta, a former
McKinsey & Company Global Managing
Director.
Mark O’Connor, CEO of
Monadnock Research,
put together a research note for his subscribers that
gives us the details of the accusations. He also provides new insight into
why a guy like Gupta may have committed these alleged crimes.
Gupta is alleged to have
tipped Galleon’s Rajaratnam, a friend and business associate, providing
him with confidential information learned during board calls and in
other aspects of his duties on the Goldman and P&G boards. Gupta
reportedly made calls to Rajaratnam “within seconds” of leaving board
sessions where market-moving information was discussed.
The
complaint alleges that Rajaratnam then either
used the inside information on Goldman and P&G to execute trades on
behalf of some of Galleon’s hedge funds, or shared it with others at
Galleon, who then traded on it ahead of public disclosure. The SEC
claims the insider trading scheme generated more than $18 million in a
combination of illicit profits and loss avoidance.
The SEC also says that
Gupta was, at the time of the alleged disclosures of confidential
non-public information, a direct or indirect investor in at least some
of Galleon’s hedge funds, and had other business interests with
Rajaratnam.
Gupta, as a McKinsey
veteran, embodied the
“trusted advisor” consulting ethos and personified
the McKinsey “advisor to CEOs” business strategy and brand. The firm’s value
to its clients and its effectiveness as an advisor requires knowing their
secrets and holding them close to the vest.
Gupta was McKinsey
& Company’s worldwide Managing Director for 9 years from 1994 through
2003…Gupta, now 62, stepped down as a McKinsey partner in 2007, and has
since served as Managing Director Emeritus, according to his profile at
the
Indian School of Business (ISB).
Gupta was instrumental in co-founding ISB in 2001, and continues to
serve as its current Governing Board Chairman and Executive Board
Chairman. He is also a current or former board member (or trustee) of
AMR Corp., the parent of American Airlines; the Rockefeller Foundation;
the University of Chicago; Harman International Industries; Genpact
India; the World Economic Forum; the International Chamber of Commerce,
World Business Organization; New Silk Route and New Silk Route Private
Equity; and the Emergency Management and Research Institute. Galleon’s
Rajaratnam was also associated with the New Silk Route ventures, where
Gupta continues as Chairman. Rajaratnam is no longer associated with
those entities.
Several media commentators
have openly wondered whether the accusations against Gupta, and earlier
accusations in the same scandal against McKinsey senior partner and Gupta
protégé Anil Kumar, strike a deadly blow to McKinsey.
Will Rajat Gupta Destroy
McKinsey? John Carney, NetNet, March 2, 2011
McKinsey’s clients are
attracted by its reputation for excellence and discretion—and its
stellar network of alumni. Its consultants often refuse to even disclose
who their clients are.
If the charges against
Gupta prove true, it could be a mortal threat to the firm. Even if
there’s no evidence that confidentiality was breached while Gupta was at
the firm, being led by a man who would later leak insider information
would be devastating. If Gupta is shown to have engaged in similar
actions while he was at McKinsey, that could be the end for the Firm.
“At that point, I think
we go the way of Arthur Andersen,” another former McKinsey consultant
said, referring to the once-prestigious accounting company brought down
by its connections to Enron.
Loose Lips, Reuters BreakingViews, Robert
Cyran and Rob Cox, March 3, 2011
McKinsey’s reputation
rests on its ability to keep secrets. Consultancies, unlike investment
banks, don’t provide access to financial markets. All they offer is
counsel, which relies partly on confidences revealed by their clients.
According to McKinsey, “Our clients should never doubt that we will
treat any information they give us with absolute discretion.” The
allegations against Gupta make it hard for clients not to wonder.
It’s understandable that, in
the heat of this moment, some might naïvely compare the consequences of the
criminal indictment of an audit firm with civil charges against an
individual, albeit one who trades on – pun intended – his association with a
prestigious professional services firm.
It’s not the same thing.
Extrapolating Gupta’s
behavior to McKinsey as a whole is a stretch. I’m no McKinsey apologist but
one man, even a former Global Managing Director, does not make this firm.
On the contrary. The firm
made him and he’s the one whose currency is now worth less.
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Washington’s Financial Disaster," by
Frank Partnoy, The New York Times, January 29, 2011 ---
http://www.nytimes.com/2011/01/30/opinion/30partnoy.html?_r=1&nl=todaysheadlines&emc=tha212
THE long-awaited Financial
Crisis Inquiry Commission report, finally published on Thursday, was
supposed to be the economic equivalent of the 9/11 commission report. But
instead of a lucid narrative explaining what happened when the economy
imploded in 2008, why, and who was to blame, the report is a confusing and
contradictory mess, part rehash, part mishmash, as impenetrable as the
collateralized debt obligations at the core of the crisis.
The main reason so much
time, money and ink were wasted — politics — is apparent just from
eyeballing the report, or really the three reports. There is a 410-page
volume signed by the commission’s six Democrats, a leaner 10-pronged dissent
from three of the four Republicans, and a nearly 100-page
dissent-from-the-dissent filed by Peter J. Wallison, a fellow at the
American Enterprise Institute. The primary volume contains familiar
vignettes on topics like deregulation, excess pay and poor risk management,
and is infused with populist rhetoric and an anti-Wall Street tone. The
dissent, which explores such root causes as the housing bubble and excess
debt, is less lively. And then there is Mr. Wallison’s screed against the
government’s subsidizing of mortgage loans.
These documents resemble not
an investigative trilogy but a left-leaning essay collection, a
right-leaning PowerPoint presentation and a colorful far-right magazine. And
the confusion only continued during a press conference on Thursday in which
the commissioners had little to show and nothing to tell. There was
certainly no Richard Feynman dipping an O ring in ice water to show how the
space shuttle Challenger went down.
That we ended up with a
political split is not entirely surprising, given the structure and
composition of the commission. Congress shackled it by requiring bipartisan
approval for subpoenas, yet also appointed strongly partisan figures. It was
only a matter of time before the group fractured. When Republicans proposed
removing the term “Wall Street” from the report, saying it was too
pejorative and imprecise, the peace ended. And the public is still without a
full factual account.
For example, most experts
say credit ratings and derivatives were central to the crisis. Yet on these
issues, the reports are like three blind men feeling different parts of an
elephant. The Democrats focused on the credit rating agencies’ conflicts of
interest; the Republicans blamed investors for not looking beyond ratings.
The Democrats stressed the dangers of deregulated shadow markets; the
Republicans blamed contagion, the risk that the failure of one derivatives
counterparty could cause the other banks to topple. Mr. Wallison played down
both topics. None of these ideas is new. All are incomplete.
Another problem was the
commission’s sprawling, ambiguous mission. Congress required that it study
22 topics, but appropriated just $8 million for the job. The pressure to
cover this wide turf was intense and led to infighting and resignations. The
19 hearings themselves were unfocused, more theater than investigation.
In the end, the commission
was the opposite of Ferdinand Pecora’s famous Congressional investigation in
1933. Pecora’s 10-day inquisition of banking leaders was supposed to be this
commission’s exemplar. But Pecora, a former assistant district attorney from
New York, was backed by new evidence of widespread fraud and insider
dealings, shocking documents that the public had never seen or imagined. His
fierce cross-examination of Charles E. Mitchell, the head of National City
Bank, Citigroup’s predecessor, put a face on the crisis.
This commission’s
investigation was spiritless and sometimes plain wrong. Richard Fuld, the
former head of Lehman Brothers, was thrown softballs, like “Can you talk a
bit about the risk management practices at Lehman Brothers, and why you
didn’t see this coming?” Other bankers were scolded, as when Phil Angelides,
the commission’s chairman, admonished Lloyd Blankfein, the chief executive
of Goldman Sachs, for practices akin to “selling a car with faulty brakes
and then buying an insurance policy on the buyer of those cars.” But he
couldn’t back up this rebuke with new evidence.
The report then oversteps
the facts in its demonization of Goldman, claiming that Goldman “retained”
$2.9 billion of the A.I.G. bailout money as “proprietary trades.” Few
dispute that Goldman, on behalf of its clients, took both sides of trades
and benefited from the A.I.G. bailout. But a Goldman spokesman told me that
the report’s assertion was false and that these trades were neither
proprietary nor a windfall. The commission’s staff apparently didn’t
consider Goldman’s losing trades with other clients, because they were
focused only on deals with A.I.G. If they wanted to tar Mr. Blankfein, they
should have gotten their facts right.
Lawmakers would have been
wiser to listen to Senator Richard Shelby of Alabama, who in early 2009
proposed a bipartisan investigation by the banking committee. That way
seasoned prosecutors could have issued subpoenas, cross-examined witnesses
and developed cases. Instead, a few months later, Congress opted for this
commission, the last act of which was to coyly recommend a few cases to
prosecutors, who already have been accumulating evidence the commissioners
have never seen.
There is still hope. Few
people remember that the early investigations of the 1929 crash also failed
due to political battles and ambiguous missions. Ferdinand Pecora was
Congress’s fourth chief counsel, not its first, and he did not complete his
work until five years after the crisis. Congress should try again.
Frank Partnoy is a law professor at the
University of San Diego and the author of “The Match King: Ivar Kreuger, the
Financial Genius Behind a Century of Wall Street Scandals.”
Jensen Comment
Professor Partnoy is one of my all-time fraud fighting heroes. He was at one
time an insider in marketing Wall Street financial instrument derivatives
products and, while he was one of the bad guys, became conscience-stricken about
how the bad guys work. Although his many books are somewhat repetitive, his
books are among the best in exposing how the Wall Street investment banks are
rotten to the core.
Frank Partnoy has been a a strong advocate of
regulation of the derivatives markets even before Enron's energy trading scams
came to light. His testimony before the U.S. Senate about Enron's infamous
Footnote 16 ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm#Senator
I quote Professor Partnoy's books frequently in
my Timeline of Derivative Financial Instruments Frauds ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Harvard economist John Kenneth Galbraith said
something like "Ireland is a land of poets and has never produced one
economist." This is not an exact quotation but it captures the essence of what
this famous Harvard professor thought about Ireland's economic acumen.
Professor Galbraith did not live to see his
diagnosis turn into proof.
Michael Lewis is one of my favorite authors and
analysts. He's also a humorist who finds little funny about the current economic
crisis in Ireland.
"Michael Lewis: The Economic Crisis -When
Irish Eyes Are Crying," Vanity Fair via Simoleon Sense, February 2,
2011 ---
http://www.simoleonsense.com/michael-lewis-the-economic-crisis-when-irish-eyes-are-crying/
Even in an era when
capitalists went out of their way to destroy capitalism, the Irish bankers
set some kind of record for destruction. Theo Phanos, a London hedge-fund
manager with interests in Ireland, says that “Anglo Irish was probably the
world’s worst bank. Even worse than the Icelandic banks.”
…
Ireland’s financial disaster
shared some things with Iceland’s. It was created by the sort of men who
ignore their wives’ suggestions that maybe they should stop and ask for
directions, for instance. But while Icelandic males used foreign money to
conquer foreign places—trophy companies in Britain, chunks of
Scandinavia—the Irish male used foreign money to conquer Ireland. Left alone
in a dark room with a pile of money, the Irish decided what they really
wanted to do with it was to buy Ireland. From one another. An Irish
economist named Morgan Kelly, whose estimates of Irish bank losses have been
the most prescient, made a back-of-the-envelope calculation that puts the
losses of all Irish banks at roughly 106 billion euros. (Think $10
trillion.) At the rate money currently flows into the Irish treasury, Irish
bank losses alone would absorb every penny of Irish taxes for at least the
next three years.
….
In recognition of the
spectacular losses, the entire Irish economy has almost dutifully collapsed.
When you fly into Dublin you are traveling, for the first time in 15 years,
against the traffic. The Irish are once again leaving Ireland, along with
hordes of migrant workers. In late 2006, the unemployment rate stood at a
bit more than 4 percent; now it’s 14 percent and climbing toward rates not
experienced since the mid-1980s. Just a few years ago, Ireland was able to
borrow money more cheaply than Germany; now, if it can borrow at all, it
will be charged interest rates nearly 6 percent higher than Germany, another
echo of a distant past. The Irish budget deficit—which three years ago was a
surplus—is now 32 percent of its G.D.P., the highest by far in the history
of the Eurozone. One credit-analysis firm has judged Ireland the
third-most-likely country to default. Not quite as risky for the global
investor as Venezuela, but riskier than Iraq. Distinctly Third World, in any
case.
Continued in article
"Their Own Private Europe," by Paul Krugman, The New York Times,
January 27, 2011 ---
http://www.nytimes.com/2011/01/28/opinion/28krugman.html?_r=1&hp
Bob Jensen's threads on the bailout mess ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"Merrill Traded On Client Data: SEC," by
Jean Eaglesham, Dan Fitzpatrick, and Randall Smith, The Wall Street Journal,
January 26, 2011 ---
http://online.wsj.com/article/SB20001424052748704013604576104090997516476.html
On the fifth floor of
Merrill Lynch & Co.'s headquarters at the World Financial Center in lower
Manhattan, a small team of traders who bought and sold securities with the
firm's own money for two years were close enough to see the computer screens
of traders taking orders from clients and overhear their phone calls.
The Securities and Exchange
Commission said Tuesday that the proprietary-trading desk, which traded
electronic messages with its nearby counterparts, was illegally spoon-fed
information about what Merrill's clients were doing, and then copied an
unspecified number of trades between 2003 and 2005. Merrill also encouraged
market-making traders to generate and share "trading ideas" with the
proprietary-trading desk, according to the SEC.
Merrill, acquired by Bank of
America Corp. in 2009, agreed to pay $10 million to settle the accusations,
which also included charging institutional investors undisclosed trading
fees. Merrill neither admitted nor denied wrongdoing.
Such enforcement cases are
rare, and the Merrill settlement is likely to fuel longstanding suspicions
among many investors that Wall Street firms tap the continuous flow of
orders from customers for their own benefit. Securities firms are lobbying
U.S. regulators over the wording of the "Volcker rule," part of last year's
Dodd-Frank financial law that is expected to force banks to wind down or
sell their proprietary-trading desks.
In a statement, Bank of
America said the "matter involved issues from 2002 to 2007 at Merrill
Lynch." The proprietary-trading desk, which had one to three employees and
authority to trade more than $1 billion of Merrill's capital, was shut down
in 2005 "for business reasons" after the SEC began investigating, according
to people familiar with the situation.
The employees involved in
the trading no longer work at Bank of America, these people said.
Bank of America said Merrill
has "adopted a number of policy changes to ensure separation of proprietary
and other trading and to address the SEC's concerns."
Merrill Lynch also
voluntarily implemented enhanced training and supervision to improve the
principal-trading processes at the securities firm.
The SEC accused Merrill of
numerous regulatory breakdowns, ranging from supervision failures to
cheating customers.
"One of our goals in a case
like this is to make sure that the problems we find are fixed going
forward," said Scott Friestad, an associate director in the SEC's
enforcement division. The Merrill case is "one of the few times that the
[SEC] has ever charged a large Wall Street firm with misconduct involving
the activities of a proprietary-trading desk."
The traders involved in the
matter weren't identified in documents released by the SEC. People familiar
with the situation said the proprietary traders, who worked on what Merrill
called its Equity Strategy Desk, were led by Robert H. May.
Mr. May was among four
traders from Bank of America hired last week by boutique-trading firm First
New York Securities Inc.
Mr. May couldn't be reached
to comment. Neil Bloomgarden, who reported to Mr. May, now works at Morgan
Stanley. He and the firm declined to comment.
Bank of America hasn't
announced plans to shut down or sell its remaining proprietary-trading desk.
As a result of the
investigation, though, the company has physically separated such traders
from the rest of the trading floor. Merrill also separates client orders
from other trades to eliminate any mingling with positions taken by market
makers who buy and sell on behalf of clients.
The SEC cited four examples
in which Merrill traders on the proprietary-trading desk bought or sold
shares within minutes of a similar order for a customer, according to the
agency. Customers of Merrill were assured by the firm that information about
their orders would be kept confidential, and the company's code of ethics
requires employees to "not discuss the business affairs of any client with
any other person, except on a strict need-to-know-basis," the SEC said
Tuesday. The number of trades detailed by the SEC was small.
In September 2003, an
unidentified institutional client placed an order to sell about 40,000
shares of Teva Pharmaceutical Industries Ltd., according to the SEC filing.
Three minutes later, a market-making trader "sent an instant message to an
ESD trader informing him about the trade," the filing said. The proprietary
trader then sold 10,000 shares in the company for Merrill's own account.
"[I] always like to do what
the smart guys are doing," one Merrill proprietary trader wrote in an
electronic message, according to the SEC filing.
Continued in article
Ketz Me If You Can
"Triumph of Banking," by J. Edward Ketz, SmartPros, January 2011
---
http://accounting.smartpros.com/x71113.xml
My, how the year 2010 ended
with a bang! First, Attorney General Andrew Cuomo initiated a fraud suit
against Ernst & Young, and then the Financial Accounting Foundation named
Leslie Seidman as the chair of the FASB. These events culminate a return to
power and prestige for the investment banking industry, and we should salute
the triumph of banking.
Banks have not been so
fortunate during the previous five to ten years, when history was not so
kind to them. But the industry has fought back virulently both in direct and
covert ways. They employed the bully pulpit to argue the points they wished
to advance, they courted members of Congress and the White House, and they
issued innuendo after innuendo. And the battlefield shows their victory and
the spoils they have earned.
Recent troubles were in a
sense triggered by the CDO racketeering by the banking industry during the
last five to ten years, though I suppose I should be more genteel and call
it the collapse of the CDO business and the real estate market. More
accurately, the mayhem goes back at least to the days of Enron, when the
bankers had to minimize the damage caused by their enabling Lay and Skilling
and their underlings to commit accounting and securities frauds. Of course,
it included many other corporations, but part of the public relations battle
was to focus the dysfunctions exclusively on Enron, which allowed bankers
and corporate managers to claim it was just a few bad apples.
Even with Enron it was a
battle, but the industry mostly kept the casualties to a few fines and court
settlements. It is a minor miracle that the executives at Merrill Lynch
avoided prison, especially given the fraud involving the Nigerian barges.
More recently, when bankers
were at the verge of swallowing poison of their own making, they convinced
members of Congress and the White House that this was a societal problem,
thus it would be just and fair to rescue the banks from economic collapse
because it would help the common man. Amazingly the populace accepted such
drivel and Washington assisted them with massive bailouts. Such wealth
transfers from the middle class to the rich are unparalleled in history.
It is instructive that the
banking industry was able to convince many that the difficulties were
actually systemic problems. The beauty of this positioning is that it
absolved the banks from most of the blame for the catastrophe. Further, it
is important to notice that the bankers were able to push most of the
flotsam and jetsam onto Lehman Brothers alone, similar to their
interpretation of the events of 2001-2002. By focusing exclusively on Lehman
Brothers, the spokesmen for the banks could assert that the industry’s
contribution to the 2008 downfall was limited to a few bad apples at this
one institution.
But, the bankers really
showed their agility when public opinion opposed the granting of colossal
bonuses to top managers. The industry first got cheap loans from the
government as well as the ability to unload so-called “toxic” assets as the
idiots at the Fed paid top dollar for the junk. Then the industry quickly
paid off its debts to the federal government, so the poor executives could
enjoy the millions in bonuses.
Amid this posturing, some
politicians wanted to make sure the banks were solvent and devised stress
tests to evaluate the banks. The industry again displayed amazing dexterity
by manipulating the regulators so that they devised feeble stress tests that
Lehman Brothers could pass even after its bankruptcy. These felicitous
results calmed the public by relieving any fears that the banks were weak
and illiquid. Even if they were.
Bankers clamored against
fair value accounting, claiming that it was behind the 2008 collapse. That
this is untrue is hardly important. That the banks were gung ho in favor of
fair value accounting almost a decade ago when fair value gains added
substantially to the banks’ income statement seems a curiosity lost on many
observers. Bankers reversed their position only when the gains turned into
losses, and they have been zealously against fair value accounting ever
since. The work paid off when the FASB on April 2, 2009 caved in to the
demands of bankers and allowed them favorable treatments to minimize any
losses on their “toxic” assets.
And in this turmoil, it is
remarkable that banks have avoided any significant regulation of
derivatives. The CDOs that got us into this mess have been absolved by the
priests within the bank industry and their minions in Washington. Of course,
it helps to have the Treasury Secretary and the Fed Chairman in your back
pockets.
Continued in article
Jensen Comment
I join my friend Frank Partnoy in singing a loud chorus for more regulation of
derivatives ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Charles Ferguson via
MIT World (H/T
Jesse's Cafe Americain).
"Video: The Financial Crisis, the Recession, and the American Political Economy:
A Systemic Perspective," by Nadine Sabai, Sleight of Hand, January 13, 2011 ---
http://sleightfraud.blogspot.com/2011/01/video-financial-crisis-recession-and.html
Ferguson finds galling both
government apathy in regulating and in prosecuting high-end white collar
crime, but perceives the reason: a financial services industry that “as it
rapidly consolidated and concentrated became the dominant source not only of
corporate profits but campaign contributions and political funding in the
U.S.” Evidence for unrestrained financial power lies in the fact that the
government response to the crisis has been engineered by Wall Street
insiders intent on shoring up firms too big to fail. Ferguson cites as well
“corruption of the economics discipline,” the rising role of money in
politics, and the increasing concentration of wealth in the hands of a few.
The dominance of a single
industry constitutes a deep change and danger for America, believes
Ferguson. The nation “has evolved a political duopoly where two political
parties agree on things related to finance and money.” Without a political
structure immune to such influence, Ferguson sees little likelihood of
challenging the interests of the financial giants.
Bob Jensen's Rotten to the Core threads for
bankers are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
A Flaw in IFRS: Allowing Banks to Hide
Risks
"Bankers' bumper bonuses are the 'mistake' of flawed accounting rules,"
by Louise Armitstead, London Telegraph, January 13, 2011 ---
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8255590/Bankers-bumper-bonuses-are-the-mistake-of-flawed-accounting-rules.html
The House of Lords Economic
Affairs Committee, which is investigating the role of auditors in the
financial crisis, was told that the controversial International Financial
Accounting Standards (IFRS) had allowed banks to hide risks so that profits
and bonuses were inflated.
The devastating assessment
of the accounting rules was articulated for the first time by some of
Britain's biggest institutional investors.
Iain Richards, of Aviva
Investors, told the Lords that the IFRS system of auditing the banks had had
"a material cost to the taxpayer and to shareholders" because "as a result
dividend distributions have been made and bonuses have been paid that were
imprudent".
Mr Richards said: "The IFRS
(system) is extremely pro-cyclical; it facilitated and exacerbated the
credit bubble...There were some very clear risks inherent (in the
banks)...the risks were extremely material."
He told the Lords that
rather than highlighting the problems, the accounting standards allowed the
banks to look far more profitable than they were. The financial crisis
exposed the shortfall that had built up.
Mr Richards said: "The
double-digit billions pumped into the banks went to plug the gap created by
both bonus distribution and dividend distributions that were made just
preceding the crisis."
His assessment was backed by
fund management heavy weights giving evidence to the Lords including David
Pitt-Watson of Hermes; Guy Jubb of Standard Life Investments; and Robert
Talbut of Royal London Asset Management.
Mr Pitt Watson told the
Lords that "we as investors and society" need to see the re-introduction of
more principle-based accounting system that included prudential and on-going
assessments of risks. The "rules-based" IFRS system has been criticised for
not identifying bad loans until they fail.
He said that the lesson of
the crisis was that "rules encourage people to go round them." He added: "If
you have too much weight on rules not a professional over ride on that,
we'll give ourselves another problem."
The assessment backs that of
Tim Bush, the City veteran who wrote the Government in the summer warning
that IFRS amounted to a "regulatory fiasco" that had contributed to the
crisis and still posed a danger to the system now.
Stella Fearnley, professor
of accounting at Bournemouth University, said: "Since IFRS is supposed to
help investors to assess companies, I think that their obvious loss of
confidence is extremely important. There needs to be an immediate overhaul
of IFRS and the ASB which unleashed this defective system."
Jensen Question
Does anybody see something in this deal that does not screw taxpayers for the
benefit of big bankers?
Or is this just a sweetheart deal for the FDIC and its billionaire friends?
Or am I missing something here?
Dr. Wolff sent me a link to this video.
Video ---
http://www.youtube.com/user/fiercefreeleancer
I really was not aware of how this thing really
worked, so I found a link to the following document:
"FDIC's Sale of IndyMac to One West Bank -
Sweetheart deal or not?" by Dennis Norman, Real Estate Investors Daily, February
15, 2010 ---
http://realestateinvestordaily.com/market-information-news/fdics-sale-of-indymac-to-one-west-bank-sweetheart-deal-or-not/
Last week a friend
emailed me a link to a video titled “The
Indymac Slap in Our Face” that was
created by
Think Big Work Small. I watched the video which
gave a recap of the failure of Indymac bank back resulting in it’s seizure
by the FDIC in July, 2008, and the ultimate sale by the FDIC of Indymac Bank
to One West Bank in March, 2009.
According to the video,
One West Bank received a cushy, “sweetheart deal” and
implied it was related to the fact that the owners of One West Bank include
Goldman Sachs VP, Steven Mnuchin, billionaires George Soros and John
Paulsen, and that “it’s good to have friends in high places.” Here is a
recap of some of the “facts” of the deal they gave on the video:
- One West Bank paid the
FDIC 70 percent of the principal balance of all current residential
loans
- One West Bank paid the
FDIC 58 percent of the principal balance of all HELOC’s (Home Equity
Lines of Credit)
- The FDIC agreed to
cover 80 – 95 percent of One West’s loss on an Indymac loan as a result
of a short sale or foreclosure.
- The kicker is,
according to the video, is that the “loss” is
computed based upon the original loan amount and
not the amount One West paid for the loan.
On the video the hosts give
an example of an “actual scenario” showing how the
deal worked, below is a recap:
- One West Bank approved
a short-sale of $241,000 on one of the Indymac loans it purchased from
the FDIC (the total balance owed by the borrower at the time was
$485,200).
- Based upon the terms of
the loss sharing agreement, One West “lost” $244,200 on this
transaction, 80 percent of which ($195,360) was paid to One West by the
FDIC.
- So, One West received
$241,000 from the short sale and $195,360 from the FDIC for a total of
$436,360 on a loan they bought from the FDIC for $334,600, thereby
resulting in a profit of $101,760 on the loan to One West.
- One last kicker, the
video claims, in addition to making over $100,000 on the loan, since the
house was sold for less than what the borrower owed, One West also made
the borrower sign a promissory note for $75,000 of the short-fall.
Below is a link to the video
if you want to watch it for yourself.
ThinkBigWorkSmall.com Video ---
http://www.thinkbigworksmall.com/mypage/archive///
The video got me pretty
fired up like I imagine it did most people that saw it. Afterall, our
federal government is running up debt faster than ever before, the FDIC has
had to take over a record number of banks in the past year and now a
sweetheart deal for people that are “connected.” OK, I’ll admit it, I was a
little jealous….a 30 percent profit, guaranted by the FDIC?
And all I have to do is discourage borrowers from doing loan modifications
and force short-sales and foreclosures? Easier than taking candy from a
baby, huh?
Hmm….wait a minute
though, the skeptic in me (especially when it comes to anything distributed
via email) made me wonder if the video was accurate or was it
misunderstanding the facts, taking facts out of context or simply just
wrong? To the credit of
Think Big Work Small they did have links on their
site to the loss-sharing agreement they were referencing.
I went to the FDIC
website and found what I believe to be the original
Indymac sale agreement as well as the
loss sharing agreement with One West Bank as well
as a
supplemental information document on the sale the
FDIC published after the sale.
Following are some
highlights from the
FDIC “Fact Sheet” on the sale of IndyMac:
- The FDIC entered into a
letter of internt to sell New IndyMac to IMB HoldCo, LLC, a thrift
holding company controlled by IMB Management Holdings, LOP for
approximately $13.9 billion. IMB holdCo is owned by a consortium of
private equity investors led by Steven T. Mnuchin of Dune Capital
Management LP.
- The FDIC has
agreed to share losses on a portfolio of qualifying loans with
New IndyMac assuming the first 20 percent of losses,
after which the FDIC will share losses 80/20 for the
next 10 percent and 95/5 thereafter.
- Under a participation
structure on approximately $2 billion portfolio of construction and
other loans, the FDIC will receive a majority of all cash flows
generated.
- When the transaction is
closed, IMB HoldCo will put $1.3 billion in cash in New IndyMac to
capitalize it.
- In an overview of the
Consortium it does identify “Paulson & Co” as a member as well as “SSP
Offshore LLC”, which is managed by Soros Fund Management.
Just about the time I
finished researching everything for this article I received a
press release from the FDIC in response to the
video which stated “It is unfortunate but necessary to respond to the
blatantly false claims in a web video that
is being circulated about the loss-sharing agreement
between the FDIC and One West Bank.” The press release goes on to give these
“facts” about the deal:
- One West has “not been
paid one penny by the FDIC” in loss-share claims.
- The loss-shre agreement
is limited to 7 percent of the total assets that One West services.
- One West must first
take more than $2.5 billion in losses before it can make a loss-share
claim on owned assets.
- In order to be paid
through loss share, One West must have adhered to the Home
Affordable Modification Plan (HAMP).
The last paragraph starts
with “this video has no credibility.”
My Analysis
Before I get into this, I
need to point out that while I have reviewed the sale agreement between the
FDIC and One West as well as the loss-sharing agreement, watched the video
above and read the FDIC’s press release, this is complicated stuff and not
easy to understand. However, I think I have my arms around the deal somewhat
so the following is my best guess analysis of the IndyMac deal with regard
to the loss-sharing provision:
- The FDIC says the loss
sharing agreement only applies to 7 percent of the IndyMac Loans
serviced by One West. It appears there is $157.7 billion in loans
serviced, 7 percent of that amount is about $11 billion. So my guess is
the loss-share applies to about $11 billion worth of loans.
- One West agreed to a
“First Loss Amount” of 20 percent of the shared-loss loans. The
attachment for this was blank but the FDIC’s press release indicates
this amount is $2.5 Billion. If that is the case then the total amount
of loans the loss-share provision applies to is $12.5 billion.
Obviously there is a $1.5 billion discrepancy between my
calculation above and here (what’s $1.5 billion among friends?) but I’m
going to go with the $12.5 billion because the amount of loans serviced
I referenced may have been adusted at closing.
- One West purchased the
$12.5 billion in loans covered by the loss-sharing
agreement for less than $8.75 billion.
I say “less than” $8.75 billion as that is 70 percent of the loan amount
which represents the amount One-West paid for residential loans that
were current. The amount paid for current HELOC’s was only 58 percent
and the price for delinquent mortgages went as low as 55 percent and as
low as 37.75 percent for delinquent HELOC’s. Therefore I would assume
the actual price paid by One-West was less than the $8.75 billion.
- Once One West has
covered $2.5 billion in losses, then the FDIC starts covering 80
percent of the losses up to a threshold at which time the
FDIC covers 95 percent of the losses. Figuring out the
threshold was a little trickier…I see a reference to 30 percent of the
total loans covered by the loss-share so I’m going to use that which
works out to $3.75 billion.
Now let’s figure the
profit One West stands to make on the loans covered by the Loss-Share
agreement;
- If all the borrowers
would pay off their loans in full, not less than $3.75 billion
(not likely though that all borrowers will pay off in full).
- Let’s be real
pessimistic and look at the “worst-case” scenario: Lets
say 100 percent of the loans bought by One West (covered by the
loss-share) go bad and have to be short-sales or foreclosures at a loss.
For the sake of conversation lets say the losses equal 40 percent of the
loan amount, or $5 billion ($12.5 billion times 40 percent).
- One West would have
to cover the first $2.5 billion at which time the 80/20 rule would
kick in for the next $1.25 billion in losses resulting in One West
recovering $1.0 billion of those losses from the FDIC. Then for the
next $1.25 billion ($3.75 to $5 billion) One West would recover 95
percent of the loss fro the FDIC or $1.1875 billion.
- Recap: Of the
$12.5 billion in loans, under the scenario above, One West would
have realized $7.5 billion from foreclosures or short sales (60
percent of the debt) and would have recovered $2.1875 billion
from the FDIC of the $5 billion in losses, for a total
to One West of $9.6875 billion for loans they paid not
more than $8.75 billion for a profit of a little less
than $1 billion.
Keep in mind, my analysis
above is based somewhat on fact and some on speculation and my “profit”
scenario is based purely on speculation and pretty negative assumptions as
to loan losses. This coupled with the fact that, as I stated above, One West
probably bought the loans for less than I indicated, probably makes this a
better deal with more than the $1 billion profit at the end of the day.
So is is a sweetheart deal
or not? You be the judge…
One thing to keep in
mind is the investors only put $1.3 billion cash into the deal to
buy IndyMac, and they got a lot more than just the loans covered by the
loss-sharing agreement. I’m thinking it’s a pretty good deal and one
I probably would have jumped on…well, if I had $1.3 billion sitting
around doing nothing…
Jensen Question
Does anybody see something in this deal that does not screw taxpayers for the
benefit of big bankers?
Or is this just a sweetheart deal for the FDIC and its billionaire friends?
Or am I missing something here?
Bob Jensen
Unrelated reference
"Fed to Banks: Quit Stalling on Short Sales" ---
http://www.housingwatch.com/2010/01/13/fed-to-banks-quit-stalling-on-short-sales/
"Two Cheers for the New Bank Capital
Standards: Why do we still rely on the rating agencies, and why are we
still allowing Lehman Brothers levels of leverage," by Alan S. Blinder,
The Wall Street Journal, September 30, 2010 ---
http://online.wsj.com/article/SB10001424052748704523604575511813933977160.html#mod=djemEditorialPage_t
On Sept. 12 the heads of the
world's major central banks and bank-supervisory agencies met to bless what
is called "Basel III," the latest international agreement on bank capital
requirements. Should we be applauding or frowning upon this agreement? A
little of each.
The first big achievement,
and it is a big achievement, is that 27 countries, each with its own
disparate views and parochial interests, were able to agree at all—just 18
months after many of them were still fighting the last acute phase of the
financial crisis.
But what about the substance
of the agreement? What was it supposed to fix, and did it?
Remember, the essence of the
Basel accords is establishing a minimum ratio—of capital to risk-weighted
assets—and ratios have both numerators and denominators. It turns out that
defining the numerator, a bank's capital, is fraught with difficulties: What
counts and what doesn't? Most of the changes from Basel II to Basel III are
about the numerator: raising the amount of capital required and stiffening
the definition of what counts. Measuring assets is more straightforward, but
risk-weighting them is not, which is the essence of the denominator problem.
Before the crisis, at least
three major shortcomings of Basel II were apparent:
• Once you cut through the
complexities, Basel II actually reduced capital requirements relative to
Basel I. Even before the financial wreckage of 2007-2009, that looked like a
mistake. After the crisis, it looked absurd.
• In determining risk
weights for the denominator, Basel II assigned a major role to risk
assessments by credit rating agencies like Moody's and Standard & Poor's.
Once again, that looked dubious before the crisis and ludicrous thereafter.
• Basel II allowed the
largest—did someone say, the "most sophisticated"?—banks to use their own
internal models to measure risk. Let me repeat that: The biggest foxes were
allowed to assess the safety of the chicken coops—another serious
risk-weighting (denominator) problem.
Then along came the crisis,
revealing two more glaring weaknesses:
• One was the startling
extent to which some banks had used structured investment vehicles (SIVs)
and similar arrangements to avoid capital requirements by shifting assets
off balance sheet. This loophole cried out for plugging.
• The Basel Accords have
always focused on minimum capital requirements. But the crisis demonstrated
that, in a crunch, shortages of liquidity can be just as hazardous as
shortages of capital. Indeed, it was often hard to tell one from the other.
That made the need for minimum liquidity requirements apparent.
Those five issues should
have formed the core of the Basel III agenda. What was actually
accomplished? Let's go down the list.
First the good news: Capital
requirements will be raised substantially. Right now so-called Tier 1
capital must be at least 4% of risk-weighted assets and Tier 2 capital must
be at least 8%. The Basel II definition of Tier 1 capital includes some
things that are not common equity, such as some types of preferred stock;
and Tier 2 includes many more things, such as certain types of reserves and
subordinated debt. Basel III places the focus squarely where it belongs: on
common equity, which is undoubtedly real capital. And, after a long phase-in
period, it will raise the minimum common-equity requirement to 7%. Hooray
for both. But, folks, couldn't we have asked the world's bankers to comply
with the higher standard before 2019? Maybe if we said, "pretty please"?
Because of demonstrable
problems in assigning appropriate risk weights, Basel III also resurrects,
as a kind of backstop, the old-fashioned leverage ratio: Tier 1 capital
divided by total assets, with no risk weighting. Good idea. But, once again,
why must we wait until 2018 for full implementation? Furthermore, the chosen
capital requirement is only 3%—which you may know by its other name: 33-to-1
leverage. Isn't that about what Lehman Brothers had?
Second, while the Dodd-Frank
Act wisely removed most provisions in U.S. law that gave the rating agencies
special exalted status, Basel III did not. So the agencies that did so
poorly in rating mortgage-backed securities and collateralized debt
obligations will continue to play major roles in the risk-weighting process.
It gets worse. Didn't the
Basel Committee notice that the internal risk models of most of the world's
leading financial institutions led to disaster? Whether it was
gross-but-honest errors in assessing risk or self-serving behavior is an
important moral question, though not an important operational one. Either
way, letting banks grade themselves worked out about as well as letting
students grade themselves. Yet this grotesque shortcoming of Basel II
remains in place.
Fourth on the list is the
off-balance-sheet entities that caused the world so much grief. Here, some
technical improvements were made, thank goodness. For example, SIVs and the
like will be put back on banks' balance sheets for purposes of computing the
leverage ratio. But unfortunately not for the main risk-weighted capital
requirements.
Last, but not least, genuine
progress was made toward new minimum liquidity requirements. The technical
problems and novelty in defining liquidity proved to be formidable, as did
the opposition from the banking industry. So this job is not finished. But
the Basel Committee did at least institute a new liquidity requirement that
will become effective in 2015.
Beyond that, the committee
kicked most of the novel ideas down the road. For example, imposing higher
capital requirements on systemically-important institutions is left for the
future.
So let's applaud Basel III,
though one-handedly. More capital, better capital, a leverage ratio, and a
liquidity requirement are all important steps forward. But the unwarranted
reliance on rating agencies, the disgraceful internal risk models of banks,
and the disastrous SIVs should have been easy marks for reformers.
Should the U.S. adopt
the Basel III changes? Absolutely, with no hesitation. But work on Basel IV
should begin immediately.
Mr. Blinder, a professor of economics and
public affairs at Princeton University and vice chairman of the Promontory
Interfinancial Network, is a former vice chairman of the Federal Reserve
Board.
Bob Jensen's threads on the recent banking
scandals ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
The WSJ is often my best source when I look
for fraud reports and fraud warnings.
Although Paul Williams likes to put down the
Wall Street Journal, I like to give some credit where credit is due.
The WSJ is making money at a time when most other newspapers are failing, and
this allows the WSJ to afford some of the best reporters in the world, many of
whom pride themselves on their independence and integrity.
Here is an old example followed by a new
example.
Old Example
A dogged WSJ reporter deserves credit for the the first public arrow that
eventually brought down Enron's house of cards. If the WSJ was overly concerned
about the welfare of the largest corporations in the U.S., this reporter or his
employer would've buried this report.
A WSJ reporter was the first to uncover Enron's secret "Related Party
Transactions." What reporter was this and what are those transactions that
he/she investigated?
Answer ---
http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm#22
New Example
"By pushing professional cards to consumers who
otherwise wouldn't want them, card issuers can get around some of the provisions
of the Card Act," says Josh Frank, a senior researcher at the Center for
Responsible Lending, a consumer group.
"Beware That New Credit-Card Offer," by Jessica Silver-Greenberg, The Wall
Street Journal, August 28, 2010 ---
http://online.wsj.com/article/SB10001424052748704913704575454003924920386.html?mod=WSJ_hps_sections_personalfinance
Amid all the junk mail
pouring into your house in recent months, you might have noticed a
solicitation or two for a "professional card," otherwise known as a
small-business or corporate credit card.
If so, watch out. While
Capital One Financial Corp.'s World MasterCard, Citigroup Inc.'s Citibank
CitiBusiness/AAdvantage Mastercard and the others might look like typical
plastic, they are anything but.
Professional cards aren't
covered under the Credit Card Accountability and Responsibility and
Disclosure Act of 2009, or Card Act for short. Among other things, the law
prohibits issuers from controversial billing practices such as hair-trigger
interest rate increases, shortened payment cycles and inactivity fees—but it
doesn't apply to professional cards (see table).
Until recently professional
cards largely had been reserved for small-business owners or corporate
executives. But since the Card Act was passed in March 2009, companies have
been inundating ordinary consumers with applications. In the first quarter
of 2010, issuers mailed out 47 million professional offers, a 256% increase
from the same period last year, according to research firm Synovate.
The Card Act's strictures
have squeezed banks' profits and their ability to operate freely. By moving
cardholders out of protected consumer cards and into professional cards,
banks might recoup some of the revenue they have lost.
"By pushing
professional cards to consumers who otherwise wouldn't want them, card
issuers can get around some of the provisions of the Card Act," says Josh
Frank, a senior researcher at the Center for Responsible Lending, a consumer
group.
Several solicitations
from J.P. Morgan Chase & Co. have ended up in the mailbox of John and Gloria
Harrison, a retired military couple who live in Destrehan, La., outside New
Orleans. Mrs. Harrison says she gets an offer for an Ink From Chase card,
geared toward small businesses, almost every month. She says she finds this
puzzling because her husband retired in 1986 and doesn't own a business.
Bob Jensen's threads on The Dirty Secrets of
Credit Card Companies ---
http://faculty.trinity.edu/rjensen/FraudReporting.htm#FICO
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"Banks Bundled Bad Debt, Bet Against It and
Won," by Gretchen Morgenson and Louise Story, The New York Times,
December 23, 2009 ---
http://www.nytimes.com/2009/12/24/business/24trading.html?em
My friend Larry clued me in to this link.
In late October 2007, as the
financial markets were starting to come unglued, a Goldman Sachs trader,
Jonathan M. Egol, received very good news. At 37, he was named a managing
director at the firm.
Mr. Egol, a Princeton
graduate, had risen to prominence inside the bank by creating
mortgage-related securities, named Abacus, that were at first intended to
protect Goldman from investment losses if the housing market collapsed. As
the market soured, Goldman created even more of these securities, enabling
it to pocket huge profits.
Goldman’s own clients who
bought them, however, were less fortunate.
Pension funds and insurance
companies lost billions of dollars on securities that they believed were
solid investments, according to former Goldman employees with direct
knowledge of the deals who asked not to be identified because they have
confidentiality agreements with the firm.
Goldman was not the only
firm that peddled these complex securities — known as synthetic
collateralized debt obligations, or C.D.O.’s — and then made financial bets
against them, called selling short in Wall Street parlance. Others that
created similar securities and then bet they would fail, according to Wall
Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller
firms like Tricadia Inc., an investment company whose parent firm was
overseen by Lewis A. Sachs, who this year became a special counselor to
Treasury Secretary Timothy F. Geithner.
How these disastrously
performing securities were devised is now the subject of scrutiny by
investigators in Congress, at the Securities and Exchange Commission and at
the Financial Industry Regulatory Authority, Wall Street’s self-regulatory
organization, according to people briefed on the investigations. Those
involved with the inquiries declined to comment.
While the investigations are
in the early phases, authorities appear to be looking at whether securities
laws or rules of fair dealing were violated by firms that created and sold
these mortgage-linked debt instruments and then bet against the clients who
purchased them, people briefed on the matter say.
One focus of the inquiry is
whether the firms creating the securities purposely helped to select
especially risky mortgage-linked assets that would be most likely to crater,
setting their clients up to lose billions of dollars if the housing market
imploded.
Some securities packaged by
Goldman and Tricadia ended up being so vulnerable that they soured within
months of being created.
Goldman and other Wall
Street firms maintain there is nothing improper about synthetic C.D.O.’s,
saying that they typically employ many trading techniques to hedge
investments and protect against losses. They add that many prudent investors
often do the same. Goldman used these securities initially to offset any
potential losses stemming from its positive bets on mortgage securities.
But Goldman and other firms
eventually used the C.D.O.’s to place unusually large negative bets that
were not mainly for hedging purposes, and investors and industry experts say
that put the firms at odds with their own clients’ interests.
“The simultaneous selling of
securities to customers and shorting them because they believed they were
going to default is the most cynical use of credit information that I have
ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R
Consulting in New York. “When you buy protection against an event that you
have a hand in causing, you are buying fire insurance on someone else’s
house and then committing arson.”
Investment banks were not
alone in reaping rich rewards by placing trades against synthetic C.D.O.’s.
Some hedge funds also benefited, including Paulson & Company, according to
former Goldman workers and people at other banks familiar with that firm’s
trading.
Michael DuVally, a Goldman
Sachs spokesman, declined to make Mr. Egol available for comment. But Mr.
DuVally said many of the C.D.O.’s created by Wall Street were made to
satisfy client demand for such products, which the clients thought would
produce profits because they had an optimistic view of the housing market.
In addition, he said that clients knew Goldman might be betting against
mortgages linked to the securities, and that the buyers of synthetic
mortgage C.D.O.’s were large, sophisticated investors, he said.
The creation and sale of
synthetic C.D.O.’s helped make the financial crisis worse than it might
otherwise have been, effectively multiplying losses by providing more
securities to bet against. Some $8 billion in these securities remain on the
books at American International Group, the giant insurer rescued by the
government in September 2008.
From 2005 through 2007, at
least $108 billion in these securities was issued, according to Dealogic, a
financial data firm. And the actual volume was much higher because synthetic
C.D.O.’s and other customized trades are unregulated and often not reported
to any financial exchange or market.
Goldman Saw It Coming
Before the financial
crisis, many investors — large American and European banks, pension funds,
insurance companies and even some hedge funds — failed to recognize that
overextended borrowers would default on their mortgages, and they kept
increasing their investments in mortgage-related securities. As the mortgage
market collapsed, they suffered steep losses.
Continued in article
In my opinion, Bill Isaac is an ignorant
advocate of horrible and dangerous bank accounting
First of all he blamed the subprime collapse of thousands of banks on the FASB
requirements for fair value accounting (totally dumb) ---
http://faculty.trinity.edu/rjensen/2008bailout.htm#FairValue
Now he wants the FASB to continued to grossly
under estimate loan loss reserves (now that the FASB is finally trying to fix
the problem)
“AccountingWEB Exclusive: Former FDIC Chief says FASB proposal is
'irresponsible'," AccountingWeb, June 3, 2010 ---
http://www.accountingweb.com/topic/accounting-auditing/aw-exclusive-former-fdic-chief-says-fasb-proposal-irresponsible
Banks are notorious for underestimating loan
loss reserves and auditors are notorious for letting them get away with it ---
http://faculty.trinity.edu/rjensen/2008bailout.htm#AuditFirms
On May 26, 2010 the FASB issued an exposure
draft that would make it more difficult to enormously underestimate load losses.
International standards are expected to be changed accordingly.
On May 26, 2010, the FASB issued a proposed
Accounting Standards Update, Accounting for Financial Instruments and Revisions
to the Accounting for Derivative Instruments and Hedging Activities, setting out
its proposed comprehensive approach to financial instrument classification and
measurement, and impairment, and revisions to hedge accounting. Also, extensive
new presentation and disclosure requirements are proposed.
Here’s a “brief” from PwC on the new May 26 ED from the FASB ---
Click Here
http://cfodirect.pwc.com/CFODirectWeb/Controller.jpf?ContentCode=THUG-85UVWW&SecNavCode=MSRA-84YH44&ContentType=Content
PwC points out some of the major differences between these proposed FASB
revisions versus the IASB provisions.
Click Here to download the ED http://snipurl.com/fasb5-26-2010
"PwC May Have Overlooked Billions in Illegal
JP Morgan Transactions. Oopsie," by Adrenne Gonzalez, Going Concern,
June 10, 2010 ---
http://goingconcern.com/2010/06/pwc-may-have-overlooked-billions-in-illegal-jp-morgan-transactions-oopsie/
Now £15.7 billion may not
seem like much to you if you are, say, Bill Gates or Ben Bernanke but for
PwC UK, it may be the magic number that gets them into a whole steaming
shitpile of trouble.
UK regulators allege that
from 2002 – 2009, PwC client JP Morgan shuffled client money from its
futures and options business into its own accounts, which is obviously
illegal. Whether or not JP Morgan played with client money illegally is not
the issue here, the issue is: will PwC be liable for signing off on JPM’s
activities and failing to catch such significant shenanigans in a timely
manner?
PwC did not simply audit the
firm, they were hired to provide annual client reports that certified client
money was safe in the event of a problem with the bank. Obviously that
wasn’t the case.
The Financial Reporting
Council and the Institute of Chartered Accountants of England are
investigating the matter, and the Financial Services Authority has already
fined P-dubs £33.3 million for co-mingling client money and bank money.
That’s $48.8 million in Dirty Fed Notes if you are playing along at home.
Good luck with that,
PwC. We genuinely mean that.
Bob Jensen's threads on PwC are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
Where Were the Auditors?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Bob Jensen's Rotten to the Core threads on banks and brokerages ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"Guest Post – Fraud Girl: “Fraud by
Hindsight”- How Wall Street Firms [Legally] Get Away With Fraudulent Behavior!,"
Fraud Girl, Simoleon Sense, June 6, 2010 ---
Click Here
http://www.simoleonsense.com/guest-post-fraud-girl-%e2%80%9cfraud-by-hindsight%e2%80%9d-how-wall-street-firms-legally-get-away-with-fraudulent-behavior/
Last week we discussed the
credit rating agencies and their roles the financial crisis. These agencies
provided false ratings on credit they knew was faulty prior to the crisis.
In defense, these agencies (as well as Warren Buffet) said that they did not
foresee the crisis to be as severe as it was and therefore could not be
blamed for making mistakes in their predictions. This week’s post focuses on
foreseeability and the extent to which firms are liable for incorrect
predictions.
Like credit agencies,
Wall Street firms have been accused of knowing the dangers in the market
prior to its collapse. I came across this post (Black
Swans*, Fraud by hindsight, and Mortgage-Backed Securities)
via the Wall Street Law Blog that discusses how firms
could assert that they can’t be blamed for events they couldn’t foresee.
It’s a doctrine known as Fraud by Hindsight (“FBH”) where defendants claim
“that there is no fraud if the alleged deceit can only be discerned after
the fact”. This claim has been used in numerous securities fraud lawsuits
and surprisingly it has worked in the defendant’s favor on most occasions.
Many Wall Street firms say
they “could not foresee the collapse of the housing market, and therefore
any allegations of fraud are merely impermissible claims of fraud by
hindsight”. Was Wall Street able to foresee the housing market crash prior
to its collapse? According to the writers at WSL Blog, they did foresee it
saying, “From 1895 through 1996 home price appreciation very closely
corresponded to the rate of inflation (roughly 3% per year). From 1995
through 2006 alone – even after adjusting for inflation – housing prices
rose by more than 70%”. Wall Street must (or should) have foreseen a drastic
change in the market when rises in housing costs were so abnormal. By
claiming FBH, however, firms can inevitably “get away with murder”.
What exactly is FBH and how
is it used in court? The case below from Northwestern University Law Review
details the psychology and legalities behind FBH while attempting to show
how the FBH doctrine is being used as a means to dismiss cases rather than
to control the influence of Wall Street’s foreseeability claims.
Link Provided to Download "Fraud by
Hindsight" (Registration Required)
I’ve broken down the case
into two parts. The first part provides two theories on hindsight in
securities litigation: The Debiasing Hypothesis & The Case Management
Hypothesis. The Debiasing Hypothesis provides that FBH is being used in
court as a way to control the influence of ‘hindsight bias’. This bias says
that people “overstate the predictability of outcomes” and “tend to view
what has happened as having been inevitable but also view it as having
appeared ‘relatively inevitable’ before it happened”. The Debiasing
Hypothesis tries to prove that FBH aids judges in “weeding out” the biases
so that they can focus on the allegations at hand.
The Case Management
Hypothesis states that FBH is a claim used by judges to easily dismiss cases
that they deem too complicated or confusing. According to the analysis,
“…academics have complained that these [securities fraud] suits
settle without regard to merit and
do little to deter real fraud, operating instead as a needless tax on
capital raising. Federal judges, faced with overwhelming caseloads, must
allocate their limited resources. Securities lawsuits that are often
complex, lengthy, and perceived to be extortionate are
unlikely to be a high priority.
Judges might thus embrace any doctrine [i.e. FBH doctrine] that allows them
to dispose of these cases quickly” (782-783). The case attempts to prove
that FBH is primarily used for case management purposes rather than for
controlling hindsight bias.
The psychological aspects
behind hindsight bias are discussed thoroughly in this case. Here are a few
excerpts from the case regarding this bias:
(1)“Studies
show that judges are vulnerable to the bias, and that mere awareness of the
phenomenon does not ameliorate its influence on judgment. The failure
to develop a doctrine that addresses the underlying problem of judging in
hindsight means that the adverse consequences of the hindsight bias remain a
part of securities litigation. Judges are not accurately sorting fraud from
mistake, thereby undermining the system, even as they seek to improve it”
(777).
(2) “Judges assert that a
company’s announcement of bad results, by itself, does not mean that a prior
optimistic statement was fraudulent. This seems to be an effort to divert
attention away from the bad outcome and toward the circumstances that gave
rise to that outcome, which is exactly the problem that hindsight bias
raises. That is, if people
overweigh the fact of a bad outcome in hindsight, then the cure is to
reconstruct the situation as people saw it beforehand. Thus, the
development of the FBH doctrine suggests a judicial understanding of the
biasing effect of judging in hindsight and of a means to address the
problem” (781).
(3) “Once a bad event
occurs, the evaluation of a warning that was given earlier will be biased.
In terms of evaluating a decision-maker’s failure to heed a warning,
knowledge that the warned-of outcome occurred will increase the salience of
the warning in the evaluator’s mind and bias her in the direction of finding
fault with the failure to heed the warning. In effect, the hindsight bias
becomes an ‘I-told-you-so’ bias.” (793).
(4) “In foresight, managers
might reasonably believe that the contingency as too unlikely to merit
disclosure, whereas in hindsight it seems obvious a reasonable investor
would have wanted to know it. Likewise, as to warning a company actually
made, in foresight most investors might reasonably ignore them, whereas in
hindsight they seem profoundly important.
If defendants are allowed to defend
themselves by arguing that a reasonable investor would have attended closely
to these warnings, then the hindsight bias might benefit defendants”
(794).
Next week we’ll explore the
second part of the case and discuss the importance of utilizing FBH as a
means of deterring the hindsight bias. We’ll see how the case proves that
FBH is not being used for this purpose and is instead used as a mechanism to
dismiss cases that simply do not want to be heard.
See you next week…
-Fraud Girl
Bob Jensen's Rotten to the Core threads on
credit rating agencies ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
Bob Jensen's Fraud updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Questions
Why were expenses for the U.K. bank (Goldman) payroll tax recorded in the second
quarter of 2010 but considered to be particularly large and unusual in relation
to this quarter's income?
What accounting standard requires the treatment that was given to this item in
Goldman's financial reporting for this quarter?
From The Wall Street Journal Accounting
Weekly Review on July 23, 2010
Goldman Profit Magic Goes Missing
by: Susanne
Craig and Scott Patterson
Jul 21, 2010
Click here to view the full article on WSJ.com
Click here to view the video on WSJ.com
TOPICS: Contingent
Liabilities, Executive Compensation, Financial Accounting, Financial
Reporting, SEC, Securities and Exchange Commission
SUMMARY: This
article reports on the 2nd quarter 2010 effects of Goldman's settlement with
the SEC (more fully described in the related article) and the U.K. bank
payroll tax. Participants in the video related to this article state that it
is difficult to decide whether to include certain items in analyzing
Goldman's results for the second quarter of 2010. As well, the footnote
disclosure of the results for diluted earnings per share, common
shareholders' equity, and tangible common shareholders' equity exclude these
two amounts. The Form 8-K filing containing the earnings press release and
quarterly report for the 3 months ended June 30, 2010, is available directly
at
http://www.sec.gov/Archives/edgar/data/886982/000095012310066384/0000950123-10-066384-index.htm
CLASSROOM APPLICATION: The
article may be used to introduce conceptual framework issues in reporting
results of operations, particularly on quarterly reporting, in any financial
reporting or accounting theory class. Questions focus on the all-inclusive
nature of income statements and the quality of earnings.
QUESTIONS:
1. (Introductory)
What filing was made by Goldman Sachs on which this article and the related
video are based? To answer this question, click on the link to Goldman Sachs
in the online article, then click on SEC filings on the left hand side of
the page, then select the Form 8-K filing made on July 20, 2010.
2. (Advanced)
Why were expenses for the U.K. bank payroll tax recorded in the second
quarter of 2010 but considered to be particularly large and unusual in
relation to this quarter's income? What accounting standards requires the
treatment that was given to this item in Goldman's financial reporting for
this quarter?
3. (Advanced)
On April 16, 2010, the U.S. SEC announced is suit against Goldman Sachs and
was not resolved until after the June 30, 2010, end of the quarter. Why was
the expense for this settlement recorded in the second quarter of 2010? Cite
authoritative accounting and reporting literature requiring this treatment.
4. (Advanced)
Why might an analyst want to exclude both of the items above from
consideration in analyzing Goldman's results for the second quarter of 2010?
In your answer, comment on the persistence of earnings and define the
current operating performance approach to preparing an earnings statement.
5. (Advanced)
Define an all-inclusive approach to preparing an earnings statement. Why
might an analyst want to include one or both of these two items in analyzing
Goldman's results for the second quarter of 2010?
SMALL GROUP ASSIGNMENT:
This entire review may be used as an in class, small group based assignment.
As preparation, assign the main and related articles along with answering
question 1. Begin class with the video discussion of the Goldman Sachs
earnings release. Then assign the four questions numbered 2 through 5 as an
in class assignment, requiring access to the web, by four separate working
groups. All groups should be able to report out by the end of a one hour
class period.
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Goldman Settles Its Battle with SEC
by Susanne Craig and Kara Scannell
Jul 16, 2010
Page: A1
"Goldman Profit Magic Goes Missing," by: Susanne
Craig and Scott Patterson, The Wall Street Journal, July 21, 2010 ---
http://online.wsj.com/article/SB10001424052748703724104575378820317667494.html?mod=djem_jiewr_AC_domainid
When the financial markets
are topsy-turvy, Goldman Sachs Group Inc. has a knack for finding a way to
profit from the turbulence. That didn't happen in the second quarter.
Goldman reported an 82%
profit tumble, hurt by a surprisingly steep decline in revenue that included
a wrong-way bet on the stock market's volatility. The New York company
didn't disclose the size of the loss, which occurred in its
equity-derivatives business and is an unusually large blunder given
Goldman's reputation for prudent risk management.
In contrast, the huge hit to
Goldman's bottom line from the $550 million settlement announced last week
with the Securities and Exchange Commission plus $600 million set aside to
cover the new U.K. bonus tax caused barely a ripple among analysts and
investors.
Net income fell to $613
million, or 78 cents a share, down from $3.44 billion, or $5.59 a share, in
last year's second quarter, when Goldman earned more than it did in all of
2008. Net revenue shrank 36% to $8.84 billion from the year-earlier $13.76
billion. The latest quarter's net revenue and earnings were the smallest
since 2008's fourth quarter, while net income was the fourth-lowest since
Goldman went public in 1999.
Like J.P. Morgan Chase & Co.
and other financial firms that rely on trading revenue, Goldman was bruised
in the second quarter by worries about economic growth, toughened financial
regulation and Europe's sovereign-debt problems. Goldman Chief Financial
Officer David Viniar said many trading clients "lacked conviction" and "sat
on the sidelines."
Goldman, led by Chief
Executive Lloyd Blankfein, also reined in its own trading appetite, with the
firm's value-at-risk declining to an average of $136 million in the second
quarter from $161 million in the first quarter and $245 million in last
year's second quarter. Value-at-risk is a yardstick of how much in losses
could be suffered in one trading day.
But the firm made a costly
decision not to completely hedge bets made by customers that the market's
volatility would rise during the second quarter. "We were directionally
wrong," Mr. Viniar said.
Asked whether Goldman itself
made a mistake in the firm's view of turbulence in the market, Mr. Viniar
responded that Goldman "didn't hedge it fast enough."
One managing director on the
stock-derivatives desk that is responsible for the losses recently left
Goldman, and other employees in the unit are considering leaving, according
to people familiar with the situation. The departed managing director was a
salesman. Goldman declined to comment.
As a result of the losses,
"the most striking shortfall on the revenue line was equities trading, which
registered the lowest quarterly figure at least back to 2003 in our model,"
said Barclays Capital analyst Roger Freeman. Analysts surveyed by Thomson
Reuters had expected Goldman to report revenue of $8.94 billion.
Net revenue in the firm's
equities department, which includes the stock-derivatives desk, fell 62% to
$1.21 billion from $3.18 billion in last year's second quarter.
Fixed-income, currency and commodities-related net revenue, the biggest
profit engine at Goldman, slumped 35% to $4.4 billion from the year-earlier
$6.8 billion.
Excluding the impact of the
SEC settlement and U.K. bonus tax, Goldman said it earned $2.75 a share.
Goldman set aside $3.8
billion, or 43% of its net revenue in the latest quarter, to cover employee
compensation and benefits. So far this year, Goldman has set aside $9.3
billion, or $272,581 per employee, in total compensation and benefits, down
18% from $11.36 billion, or $364,135 per employee, in the first half of
2009.
The U.K. bonus tax imposes a
non-deductible 50% tax on financial companies that issue discretionary
bonuses of larger than £25,000, or about $40,000.
Mr. Viniar reiterated that
the SEC's civil-fraud lawsuit against Goldman, filed in April and settled
last week, didn't cause a noticeable client exodus, adding that firm still
ranks No. 1 in the high-profile business of advising companies on mergers
and acquisitions.
But some analysts remain
concerned that Goldman could face further accusations by the SEC. Last week,
the SEC said as part of its settlement announcement that the $550 million
deal "does not settle any other past, current or future SEC investigations
against the firm."
In a separate statement last
week, Goldman said it believed that "the SEC staff also has completed a
review of a number of other Goldman Sachs mortgage-related CDO transactions
and does not anticipate recommending any claims against Goldman Sachs or any
of its employees with respect to those transactions based on the materials
it has reviewed."
Mr. Viniar said Tuesday that
the SEC reviewed Goldman's statement before it was released. A spokesman for
the SEC declined to comment on Mr. Viniar's remarks.
The SEC is proceeding with
civil-fraud charges against Fabrice Tourre, the Goldman trader accused by
the SEC of being "principally responsible" for piecing together the
mortgage-bond deal at the center of the suit.
Mr. Tourre, who is on paid
leave from Goldman, denied in a court filing late Monday misleading
investors. Goldman is paying the legal costs of Mr. Tourre's defense. Mr.
Viniar described the case as "a separate suit against him, not against us,
so it's totally appropriate for him to have his own lawyer."
Judge Approves $550 Million SEC-Goldman
Settlement ---
http://online.wsj.com/article/SB10001424052748703724104575378820317667494.html?mod=djem_jiewr_AC_domainid
"How Many Times Did Sen. Levin Say 'Sh**ty Deal'? by Cindy Perman,
CNBC, April 28. 2010 ---
How Many Times Did Sen. Levin Say 'Sh**ty Deal'?
"Guest Post – Fraud Girl: “Fraud by
Hindsight”- How Wall Street Firms [Legally] Get Away With Fraudulent Behavior!
Part 2," by Fraud Girl, Simoleon Post, June 13, 2010 ---
Click Here
http://www.simoleonsense.com/guest-post-fraud-girl-%e2%80%9cfraud-by-hindsight%e2%80%9d-how-wall-street-firms-legally-get-away-with-fraudulent-behavior-part-2/
Last week we discussed the
first part of the “Fraud by Hindsight” study. As we learned, the FBH
doctrine is utilized in securities litigation cases. In learning about the
FBH doctrine we reviewed the Debiasing Hypothesis and the Case Management
Hypothesis. According to the Debiasing Hypothesis, FBH is used as a tool to
“weed out” hindsight bias in order to focus on legal issues at hand. The
Case Management Hypothesis, on the other hand declares that FBH is used to
dismiss securities fraud cases in order to facilitate judicial control over
them. This week we will strive to analyze how Fraud By Hindsight has
evolved, meaning, how the courts apply the doctrine (in real life), which
differs markedly from the doctrine’s theoretical meaning.
History
The first mention of FBH was
in 1978 with Judge Friendly in the case Denny v. Barber. The plaintiff in
this case claimed that the bank had “engaged in unsound lending practices,
maintained insufficient loan loss reserves, delayed writing off bad loans,
and undertook speculative investments” (796). Sound familiar? Anyway — the
plaintiff plead that the bank failed to disclose these problems in earlier
reports and instead issued reports with optimistic projections. Judge
Friendly claimed FBH stating that there were a number of “intervening
events” during that period (i.e. increasing prices in petroleum and the City
of New York’s financial crisis) that were outside the control of managers
and it was therefore insufficient to claim that the defendant should have
known better when out-of-the-ordinary incidents have occurred. The end
result of the case provided that “hindsight alone might not constitute a
sufficient demonstration that the defendants made some predictive decision
with knowledge of its falsity or something close to it” (797). Friendly
established that FBH is possible, but that in this case the underlying
circumstances did not justify a judgment against the bank.
The second relevant mention
of FBH was in 1990 with Judge Easterbrook in the case DiLeo v. Ernst &
Young. Like the prior case, DiLeo involved problems with loans where the
plaintiff plead that the bank and E&Y had known but failed to disclose that
a substantial portion of the bank’s loans were uncollectible. This case was
different, in that there were no “intervening events” that could have blind
sighted managers from issuing more accurate future projections. Still,
Easterbrook claimed FBH and said, “the fact that the loans turned out badly
does not mean that the defendant knew (or should have known) that this was
going to happen” (799-800). Easterbrook believed that the plaintiff must be
able to separate the true fraud from the underlying hindsight evidence in
order to prove their case.
Easterbrook’s articulation
of the FBH doctrine set the stage for all future securities class action
cases. As the authors state, the phrase was cited only about twice per year
before DiLeo but it increased to an average of twenty-seven times per year
afterwards. Unfortunately, the courts found Easterbrook’s perception of the
phrase to be more compelling. Instead of providing that the hindsight might
play a role determining if fraud has occurred, Easterbrook claimed that
there simply is no “fraud by hindsight”. This allows the courts to
adjudicate cases solely on complaint, therefore supporting the Case
Management Hypothesis.
The results of many tests
provided in this case proved that courts were using the doctrine as a means
to dismiss cases. Of all the tests, I found one to be most interesting: The
Stage of the Proceedings. The results of the test shows that “over 90
percent of FBH applications involve judgments on the pleadings” (814) stage
rather than at summary judgment. In the preliminary (pleading) stages, the
knowledge of information is not provided, meaning that it is less likely
that hindsight bias will affect their decisions. The more the judge delves
into the case, the more they are susceptible to the hindsight bias. If the
judge is utilizing the FBH doctrine mostly during the pleading stages where
hindsight bias is “weak”, then the Debiasing Hypothesis is not valid.
The authors point out the
problems with utilizing the FBH doctrine in this way:
“The problem, however, is
that the remedy is applied at the pleadings stage, not the summary judgment
stage. At the pleadings stage, a bad outcome truly is relevant to the
likelihood of fraud. At this stage, the Federal Rules do not ask the courts
to make a judgment on the merits, and hence the remedy of foreclosing
further litigation is inappropriate. By foreclosing further proceedings,
courts are not saying that they do not trust their own judgment, but that
they do not trust the process of civil discovery to identity whether fraud
occurred” (815).
Because cases are being
dismissed so early in the litigation process, courts are not allowing for
the discovery of fraud that may be apparent even though hindsight is a
factor in the case.
By gathering this and other
evidence, the case concludes that judges utilize FBH as a case management
tool. They cited that the development of the FBH doctrine could be described
as “naïve cynicism”. Though judges understand that hindsight bias must be
taken into consideration, they express the belief that the problem does not
affect their own judgment. The courts are relying on their own intuitions
and gathering the necessary facts to prove fraud by hindsight. The authors
note a paradox here saying, “Judges simultaneously claim that human judgment
cannot be trusted, and yet they rely on their own judgment”.
The problem is that the
naively cynical (FBH) approach has led to securities fraud cases to be
governed by moods. The authors say that “In the 1980s and 1990s, as concern
with frivolous securities litigation rose, courts and Congress simply made
it more difficult for plaintiffs to file suit. In the post-Enron era, this
skepticism about private enforcement of securities fraud might have abated
somewhat, leading to lesser pleading requirements” (825).
Recap & Implications
Overall the case proves that
the courts have not yet been able to establish a sensible mechanism for
sorting fraud from mistake. It therefore allows cases that really involve
fraud to potentially be dismissed. In cases since DiLeo, the win rate for
defendants in FBH cases is 70 percent, as compared with 47 percent in those
cases that did not mention it. The mere declaration of “Fraud by Hindsight”
gives the defendant an automatic advantage over the plaintiff. Now, the
defendant may in fact be innocent – but the current processes are not able
to determine who is or isn’t guilty. Remember, judges spend much of their
time in these cases separating the hindsight bias from the fraud. This task
can become very complex and time consuming.
In sum, the increasing use
of FBH has been beneficial for (1) judges because they don’t have to listen
to these complicated cases and (2) defendant’s because they are likely to
win the case by using the doctrine. The only ones who don’t benefit from
doctrine are the plaintiff’s who may truly have been victims of fraud. It is
crucial that the judiciary revise the way the FBH is interpreted in order to
protect the innocent and convict the guilty.
Have any ideas on how to fix
the FBH problem? Send me an email at fraudgirl @ simoleonsense.com.
See you next week.
- Fraud Girl
Click Here To Access The Original Fraud by Hindsight Case – Part II ---
http://www.scribd.com/doc/32994403/Fraud-by-Hindsight-Part-II
Bob Jensen's threads on fraud are at
http://faculty.trinity.edu/rjensen/Fraud.htm
Why must we worry about the hiring-away pipeline?
Credit Rating Agencies ----
http://en.wikipedia.org/wiki/Credit_rating_agency
A credit rating agency (CRA) is a
company that assigns
credit ratings for
issuers of certain types of
debt obligations as well as the debt instruments
themselves. In some cases, the servicers of the underlying
debt are also given ratings. In most cases, the
issuers of
securities are companies,
special purpose entities, state and local
governments,
non-profit organizations, or national governments
issuing debt-like securities (i.e.,
bonds) that can be traded on a
secondary market. A credit rating for an issuer
takes into consideration the issuer's
credit worthiness (i.e., its ability to pay back a
loan), and affects the
interest rate applied to the particular security
being issued. (In contrast to CRAs, a company that issues
credit scores for individual credit-worthiness is
generally called a
credit bureau or
consumer credit reporting agency.) The value of
such ratings has been widely questioned after the 2008 financial crisis. In
2003 the
Securities and Exchange Commission submitted a
report to Congress detailing plans to launch an investigation into the
anti-competitive practices of credit rating agencies and issues including
conflicts of interest.
Agencies that assign credit ratings for
corporations include:
How to Get AAA Ratings on Junk Bonds
- Pay cash under the table to credit rating agencies
- Promise a particular credit rating agency future multi-million
contracts for rating future issues of bonds
-
Hire away top-level credit rating agency
employees with insider information and great networks inside the credit
rating agencies
By now it is widely known that the big credit rating agencies (like Moody's,
Standard & Poor's, and Fitch) that rate bonds as AAA to BBB to Junk were
unethically selling AAA ratings to CDO mortgage-sliced bonds that should've been
rated Junk. Up to now I thought the credit rating agencies were merely selling
out for cash or to maintain "goodwill" with their best customers to giant Wall
Street banks and investment banks like Lehman Bros., AIG., Merrill Lynch, Bear
Stearns, Goldman Sachs, etc. ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
But it turns out that the credit rating agencies were also in that "hiring-away"
pipeline.
Wall
Street banks and nvestment banks were employing a questionable tactic used by
large clients of auditing firms. It is common for large clients to hire away the
lead auditors of their CPA auditing firms. This is a questionable practice,
although the intent in most instances (we hope) is to obtain accounting experts
rather than to influence the rigor of the audits themselves. The tactic is much
more common and much more sinister when corporations hire away top-level
government employees of regulating agencies like the FDA, FAA, FPC, EPA, etc.
This is a tactic used by industry to gain more control and influence over its
regulating agency. Current regulating government employees
who get too tough on industry will, thereby, be cutting off their chances of
getting future high compensation offers from the companies they now regulate.
The
investigations of credit rating agencies by the New York Attorney General and
current Senate hearings, however, are revealing that the hiring-away tactic was
employed by Wall Street Banks for more sinister purposes in order to get AAA
ratings on junk bonds. Top-level employees of the credit rating agencies were
lured away with enormous salary offers if they could use their insider networks
in the credit rating agencies so that higher credit ratings could be stamped on
junk bonds.
"Rating Agency Data Aided Wall Street in
Deals," The New York Times, April 24, 2010 ---
http://dealbook.blogs.nytimes.com/2010/04/24/rating-agency-data-aided-wall-street-in-deals/#more-214847
One of the mysteries of the financial crisis is how
mortgage investments that turned out to be so bad earned credit ratings that
made them look so good, The New York Times’s Gretchen Morgenson and Louise
Story
report. One answer is that Wall Street was given
access to the formulas behind those magic ratings —
and hired away some of the very people who had devised
them.
In essence, banks started with the answers and
worked backward, reverse-engineering top-flight ratings for investments that
were, in some cases, riskier than ratings suggested, according to former
agency employees.
Read More »
"Credit rating agencies
should not be dupes," Reuters, May 13, 2010 ---
http://www.reuters.com/article/idUSTRE64C4W320100513
THE PROFIT INCENTIVE
In fact, rating agencies sometimes discouraged
analysts from asking too many questions, critics have said.
In testimony last month before a Senate
subcommittee, Eric Kolchinsky, a former Moody's ratings analyst, claimed
that he was fired by the rating agency for being too harsh on a series of
deals and costing the company market share.
Rating agencies spent too much time looking for
profit and market share, instead of monitoring credit quality, said David
Reiss, a professor at Brooklyn Law School who has done extensive work on
subprime mortgage lending.
"It was incestuous -- banks and rating agencies had
a mutual profit motive, and if the agency didn't go along with a bank, it
would be punished."
The Senate amendment passed on Thursday aims to
prevent that dynamic in the future, by having a government clearinghouse
that assigns issuers to rating agencies instead of allowing issuers to
choose which agencies to work with.
For investigators to portray rating agencies as
victims is "far fetched," and what needs to be fixed runs deeper than banks
fooling ratings analysts, said Daniel Alpert, a banker at Westwood Capital.
"It's a structural problem," Alpert said.
Continued in article
Also see
http://blogs.reuters.com/reuters-dealzone/
Jensen Comment
CPA auditing firms have much to worry about these investigations and pending new
regulations of credit rating agencies.
Firstly, auditing firms are at the higher end
of the tort lawyer food chain. If credit rating agencies lose class action
lawsuits by investors, the credit rating agencies themselves will sue the bank
auditors who certified highly misleading financial statements that greatly
underestimated load losses. In fact, top level analysts are now claiming that
certified Wall Street Bank financial statement were pure fiction:
"Calpers
Sues Over Ratings of Securities," by Leslie Wayne, The New York Times,
July 14, 2009 ---
http://www.nytimes.com/2009/07/15/business/15calpers.html
Secondly, the CPA profession must begin to question the ethics of allowing
lead CPA auditors to become high-level executives of clients such as when a lead
Ernst & Young audit partner jumped ship to become the CFO of Lehman Bros. and as
CFO devised the questionable Repo 105 contracts that were then audited/reviewed
by Ernst & Yound auditors. Above you read that: "In
fact, rating agencies sometimes discouraged analysts from asking too many
questions, critics have said." We must also
worry that former auditors sometimes discourage current auditors from asking too
many questions.
http://retheauditors.com/2010/03/15/liberte-egalite-fraternite-lehman-brothers-troubles-for-ernst-young-threaten-the-big-4-fraternity/
Credit rating of CDO mortgage-sliced bonds
turned into fiction writing by hired away raters!
Frank Partnoy and Lynn Turner contend that Wall Street bank accounting is an
exercise in writing fiction:
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
At the height of the
mortgage boom, companies like Goldman offered
million-dollar pay packages to (credit agency)
workers like Mr. Yukawa who had been working at much lower pay at the rating
agencies, according to several former workers at the agencies.
In some cases, once
these (former credit agency) workers were at
the banks, they had dealings with their former colleagues at the agencies. In
the fall of 2007, when banks were hard-pressed to get mortgage deals done, the
Fitch analyst on a Goldman deal was a friend of Mr. Yukawa, according to two
people with knowledge of the situation.
"Prosecutors Ask if 8 Banks Duped Rating
Agencies," by Loise Story, The New York Times, May 12, 2010 ---
http://www.nytimes.com/2010/05/13/business/13street.html
The New York attorney
general has started an investigation of eight banks to determine whether
they provided misleading information to rating agencies in order to inflate
the grades of certain mortgage securities, according to two people with
knowledge of the investigation.
The investigation parallels
federal inquiries into the business practices of a broad range of financial
companies in the years before the collapse of the housing market.
Where those investigations
have focused on interactions between the banks and their clients who bought
mortgage securities, this one expands the scope of scrutiny to the interplay
between banks and the agencies that rate their securities.
The agencies
themselves have been widely criticized for overstating the quality of many
mortgage securities that ended up losing money once the housing market
collapsed. The inquiry by the attorney general of New York,
Andrew M. Cuomo,
suggests that he thinks the agencies may have been duped by one or more of
the targets of his investigation.
Those targets are
Goldman Sachs,
Morgan Stanley,
UBS,
Citigroup, Credit Suisse,
Deutsche Bank, Crédit Agricole and
Merrill Lynch, which is now owned by
Bank of America.
The companies that
rated the mortgage deals are
Standard & Poor’s,
Fitch Ratings and
Moody’s Investors Service. Investors used their
ratings to decide whether to buy mortgage securities.
Mr. Cuomo’s
investigation
follows an article in The New York Times that
described some of the techniques bankers used to get more positive
evaluations from the rating agencies.
Mr. Cuomo is also interested
in the revolving door of employees of the rating agencies who were hired by
bank mortgage desks to help create mortgage deals that got better ratings
than they deserved, said the people with knowledge of the investigation, who
were not authorized to discuss it publicly.
Contacted after subpoenas
were issued by Mr. Cuomo’s office notifying the banks of his investigation,
representatives for Morgan Stanley, Credit Suisse, UBS and Deutsche Bank
declined to comment. Other banks did not immediately respond to requests for
comment.
In response to questions for
the Times article in April, a Goldman Sachs spokesman, Samuel Robinson,
said: “Any suggestion that Goldman Sachs improperly influenced rating
agencies is without foundation. We relied on the independence of the ratings
agencies’ processes and the ratings they assigned.”
Goldman, which is
already under investigation by federal prosecutors, has been defending
itself against civil fraud accusations made in a complaint last month by the
Securities and Exchange Commission. The deal at
the heart of that complaint — called Abacus 2007-AC1 — was devised in part
by a former Fitch Ratings employee named Shin Yukawa, whom Goldman recruited
in 2005.
At the height of the
mortgage boom, companies like Goldman offered million-dollar pay packages to
workers like Mr. Yukawa who had been working at much lower pay at the rating
agencies, according to several former workers at the agencies.
Around the same time that
Mr. Yukawa left Fitch, three other analysts in his unit also joined
financial companies like Deutsche Bank.
In some cases, once these
workers were at the banks, they had dealings with their former colleagues at
the agencies. In the fall of 2007, when banks were hard-pressed to get
mortgage deals done, the Fitch analyst on a Goldman deal was a friend of Mr.
Yukawa, according to two people with knowledge of the situation.
Mr. Yukawa did not respond
to requests for comment. A Fitch spokesman said Thursday that the firm would
cooperate with Mr. Cuomo’s inquiry.
Wall Street played a
crucial role in the mortgage market’s path to collapse. Investment banks
bundled mortgage loans into securities and then often rebundled those
securities one or two more times. Those securities were given high ratings
and sold to investors, who have since lost billions of dollars on them.
. . .
At Goldman, there was even a
phrase for the way bankers put together mortgage securities. The practice
was known as “ratings arbitrage,” according to former workers. The idea was
to find ways to put the very worst bonds into a deal for a given rating. The
cheaper the bonds, the greater the profit to the bank.
The rating agencies may have
facilitated the banks’ actions by publishing their rating models on their
corporate Web sites. The agencies argued that being open about their models
offered transparency to investors.
But several former
agency workers said the practice put too much power in the bankers’ hands.
“The models were posted for bankers who develop C.D.O.’s to be able to
reverse engineer C.D.O.’s to a certain rating,” one former rating agency
employee said in an interview, referring to
collateralized debt obligations.
A central concern of
investors in these securities was the diversification of the deals’ loans.
If a C.D.O. was based on mostly similar bonds — like those holding mortgages
from one region — investors would view it as riskier than an instrument made
up of more diversified assets. Mr. Cuomo’s office plans to investigate
whether the bankers accurately portrayed the diversification of the mortgage
loans to the rating agencies.
Bob Jensen's Rotten to the Core threads on
banks and investment banks ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Bob Jensen's Rotten to the Core threads on
credit rating agencies ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
"Justice, SEC Investigate Morgan Stanley's
Mortgage Transactions," SmartPros, May 13, 2010 ---
http://accounting.smartpros.com/x69456.xml
The Justice Department and
the Securities and Exchange Commission are investigating Morgan Stanley as
part of a probe into whether Wall Street firms misled investors in selling
mortgage-related securities, according to federal law enforcement officials
and others familiar with the matter.
Since summer, the SEC has
been looking at how a number of banks packaged and marketed those
securities, according to sources familiar with the matter. The criminal
probe into Morgan Stanley, which came to light early Wednesday, is focused
on whether the bank accurately represented to investors its role in
mortgage-related deals it helped design but sometimes bet against, the
sources said.
The investigation into
Morgan, which is at a preliminary stage, is reminiscent of a federal
criminal probe into mortgage transactions at Goldman Sachs. The SEC sued
Goldman on civil fraud last month, alleging that the firm created and
marketed an investment, known as a synthetic collateralized debt obligation,
that was secretly designed to fail.
According to a source
familiar with Morgan Stanley's business, the bank bet against one CDO that
it also marketed to investors, a $160 million investment known as Baldwin.
The sources all spoke on the condition of anonymity because the inquiries
are at an early stage.
The Wall Street Journal
first reported the investigation on its Web site Wednesday morning, saying
that prosecutors were scrutinizing two mortgage-related deals named after
U.S. presidents James Buchanan and Andrew Jackson.
Sources could not
immediately confirm that those transactions are part of the probe, and it is
not clear what misrepresentations Morgan Stanley might have made to clients.
The firm made bets that the Buchanan and Jackson investments would lose
value but did not create the investments or play any role in marketing them,
according to a source familiar with Morgan Stanley's business.
"We have not been contacted
by the Justice Department about the transactions being raised by the Wall
Street Journal, and we have no knowledge of a Justice Department
investigation into these transactions," Mark Lake, a Morgan Stanley
spokesman, said Wednesday.
A source familiar with
Morgan Stanley's business said the firm has received some requests for
information from the SEC but not any broader subpoenas seeking documents or
depositions.
Citigroup and UBS created
the Buchanan and Jackson CDOs. The review of the deals might be focusing on
whether Citigroup and UBS properly told its clients that Morgan Stanley
would be betting against the investment.
Citigroup and UBS declined
to comment.
The SEC lawsuit against
Goldman claims the firm and an executive, Fabrice Tourre, committed fraud
when they sold clients a CDO linked to the value of home loans that was
secretly designed to fail.
A hedge fund, Paulson & Co.,
had helped Goldman create the CDO and planned to bet against it. But the SEC
claims that relationship was not disclosed to Goldman's clients, ACA
Financial Guaranty and the German bank IKB.
Continued in article
Bob Jensen's threads on the subprime sleaze
are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's threads on rotten to the core
banks ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"Forecast Perpetually Sunny, for Analysts,"
Alix Stuart, CFO.com, May 14, 2010 ---
http://www.cfo.com/article.cfm/14497484/c_14497718?f=home_todayinfinance
As many companies gear up
for growth, CFOs are perhaps more optimistic than they have been in a long
time. Few, however, are likely to be as optimistic as Wall Street analysts.
A recent study by consulting firm McKinsey & Co. finds that on average,
analysts' forecasts of annual earnings have been almost 100% too high, both
over the past 25 years and during shorter intervals that were sampled.
Since 1985, "actual earnings
growth surpassed forecasts in only two instances, both during the earnings
recovery following a recession," co-authors (and McKinsey consultants) Marc
Goedhart, Rishi Raj, and Abhishek Saxena write in the report; the two
instances were the periods 1991 to 1996 and 2003 to 2006. In general,
analysts "were slow to revise their forecasts to reflect new economic
conditions, and prone to making increasingly inaccurate forecasts when
economic growth declined."
Forecast inflation was the
subject of much scrutiny back in 2002, when evidence emerged that equity
analysts were pumping up certain stocks in order to generate
investment-banking business from those companies. Following the 2003 Global
Research Analyst Settlement between the Securities and Exchange Commission
and 10 Wall Street firms (and two analysts, Jack Grubman and Henry Blodget),
some researchers expected forecasts to move closer to reality, since some of
the possible perverse incentives for overly glowing reports had been
eliminated.
In fact, earnings and
analysts' five-year rolling average estimates do track fairly closely for
the years between 2001 and 2006. The authors, however, attribute the
coincidence of the two to "strong economic growth" between 2003 and 2006
rather than a more sober view of the markets. The margin of error widened
again in 2007 and 2008, they note, as the economy entered a recessionary
period. In general, the accuracy of estimates was higher during periods of
growth compared with those of decline.
Rodney Sullivan, who has
surveyed many research studies related to analyst behavior as head of
publications at the CFA Institute, says the results are no surprise. "One of
the things we've learned from behavioral finance is humans have a real
tendency to be optimistic and overconfident," he says. And while analysts
try to factor in the business cycle, "they tend to miss inflection points in
the economy, because it's very, very difficult" to forecast them, adds
Sullivan.
Indeed, "one reason analysts
are slow to update their forecasts is that they do in-depth research and
build complex forecasting models...[and] there is a trade-off between
accuracy and complexity," says Kenneth Posner, former managing director and
equity analyst at Morgan Stanley and author of a new book, Stalking the
Black Swan: Research and Decision-Making in a World of Extreme Volatility
(Columbia University Press, 2010).
Sullivan points to one
somewhat surprising factor that seems to have an influence on an analyst's
optimism: gender. In a study published last year in the CFA Institute's
Financial Analysts Journal, Emory University professors Clifton Green and
Narasimhan Jegadeesh and graduate student Yue Tang found that female
analysts consistently forecast earnings to be 0.5% lower, on average, than
male analysts. (Interestingly, the forecasts by women were also
statistically less accurate than those by men, with men's errors about 1.5%
smaller than women's).
Posner says that in order to
correct the problem, investment and research firms should track the accuracy
of analyst estimates, "so that analysts get specific feedback with which to
improve their forecasting process," something "the best shops already do."
The lesson for executives is
a slightly different one. "For executives, many of whom go to great lengths
to satisfy Wall Street's expectations in their financial reporting and
long-term strategic moves, this is a cautionary tale worth remembering,"
write the McKinsey consultants. Adds Posner: "There is a feedback effect
between the markets and [stock] fundamentals, but if a CFO or CEO tries
desperately to hit optimistic forecasts and then the stock goes up more,
they're on a path that ultimately leads to a fall."
For their part,
investors seem to be savvy enough to see through whatever window-dressing
may happen. "Except during the market bubble of 1999-2001, actual
price-to-earnings ratios have been 25 percent lower than implied P/E ratios
based on analyst forecasts," note the McKinsey consultants. As of November
2009, in fact, the actual forward P/E ratio of the S&P 500 was consistent
with long-term earnings growth of 5%, a "more reasonable assessment" than
the analysts' vision of the future, in the researchers' estimation.
"Your Guide to the Goldman Sachs Lawsuit,"
Yahoo News, April 20, 2010 ---
http://news.yahoo.com/s/usnews/20100420/ts_usnews/yourguidetothegoldmansachslawsuit
As the Securities and
Exchange Commission thrusts the Goldman Sachs case onto the national stage,
Americans are once again getting acquainted with the most controversial
members of the recession-era cast of characters: the subprime mortgage, the
"too big to fail" doctrine, the Wall Street bailout, and the housing bubble,
just to name a few.
But even as those themes hog
the limelight, two other recurring, albeit slightly more obscure,
characters--the matchmaker and the credit default swap--are also starting to
peek out from behind the glamorous SEC indictment. And as they do so, they
have the potential to reshape the contentious debate over Goldman's actions.
Matchmaker,
matchmaker. The Goldman product that the SEC is targeting is quite
complex. Known as ABACUS 2007-AC1, it is the result of years of evolution in
the synthetic investment market. But the underlying theory is quite simple.
Gary Kopff, a mortgage
expert and the president of Everest Management, uses the example of wheat.
"Two parties get together. One says, 'I think the price of wheat is going
up.' The other says, 'I think the price of wheat is going down,'" he
explains. "Neither party owns any wheat."
With the Goldman case, of
course, the big difference was that investors were instead betting on
mortgages. And since the investment products were synthetic, investors were
able to place bets on the direction of the housing market without actually
owning any physical mortgage bonds.
[See
How Strategic Defaults are Reshaping the Economy.]
In arranging these deals,
one of Goldman's roles was that of matchmaker. In other words, it was
Goldman's job to find some investors who thought that the housing market
would stay healthy and others who thought it would tank. Goldman would then
pair the two sides up in a transaction.
"Acting as a swaps dealer,
Goldman has a commodity. And in order for it to earn a fee for that
commodity going out into the marketplace, it has to put together the short
side and the long side. So it has to be simultaneously in possession of the
names of bona fide longs and shorts," says Kopff. Using a gambling metaphor,
he says, "In that sense, [Goldman] has a duel incentive. It wants some
people to go short and some people to go long because it's basically like
the house. It's making money as long as it pairs up the longs and shorts."
The question then becomes:
When should we blame the house? The most obvious answer is that the house
could be at fault when the deck is stacked against some of the betters.
In the Goldman case, this
issue is particularly relevant. Notably, the SEC is charging that Goldman
let hedge fund manager John
Paulson essentially hand pick mortgage bonds he thought were doomed
to fail. Goldman then created a vehicle where investors could get synthetic
exposure to those bonds.
Paulson, of course,
effectively shorted the housing market by betting against the bonds, but
there were also investors on the long side of the deal in question. The SEC
is alleging that Goldman, in its role as matchmaker, never told these
investors that the bonds they were getting exposure to were chosen because a
prominent manager thought they were poised to implode.
In fact, they were never
even made aware that Paulson was involved in the deal, according to the
lawsuit. Instead, according to the SEC, they were made to believe that ACA
Management, an independent third party, was behind the bond selection.
Legal issues aside, these
charges raise a number of pressing questions, particularly at a time when
Wall Street firms are under fire for what's perceived as a lack of corporate
responsibility.
"I think there is a very
large concern among American taxpayers that not only did
Wall Street cause this problem and not only did the American tax
payers have to bail Wall Street out, but now Wall Street is back and as
profitable as ever--if not more profitable--and is going back to using the
same old practices," says Michael Greenberger, a professor at the University
of Maryland School of Law.
At the moment, one thing is
clear: Goldman's own investors accurately predicted that the housing market
would crash, and they placed their bets accordingly. But what remains to be
seen is to what extent the investment bank encouraged some of its clients to
take the opposite position.
As a result, at least in the
court of public opinion, the Goldman case will be a key test of the
matchmaker defense. Put another way, was Goldman merely allowing clients who
had a bullish outlook toward the housing market to put money on that view?
After all, in order for markets to function, intelligent investors need to
disagree from time to time.
"In some ways, this is Wall
Street 101 in that there needs to be somebody on both sides of every deal.
So clearly you have a world full of smart financial firms, but still with
those firms often taking bets opposite of each other," says Kevin McPartland,
a senior analyst with the TABB Group, a financial-sector research and
advisory firm. "There's always going to be somebody that's looking in the
opposite direction."
But another possibility,
some say, is that Goldman was knowingly giving its clients bad advice by
actively prodding them into taking long positions rather than merely
presenting them with the option. "[Goldman is] cynically saying, 'We're not
making a recommendation on whether to buy or sell this.' But clearly they
are. They're creating the instrument and they're sending their salesmen
across the world to meet with institutional players," says Kopff. "To say
they're not taking on point of view on that almost belies reality."
From a legal standpoint, the
more pertinent question is: Did Goldman conceal the role of Paulson? And if
so, would the long investors in the deal in question still have taken the
same position had they known that Paulson picked the bonds with the goal of
effectively shorting them?
In answering the latter
question, the SEC points to the example of the German bank
IKB Deutsche Industriebank,
a Goldman client that took a long position in the Abacus deal that's the
subject of the lawsuit. "IKB would not have invested in the transaction had
it known that Paulson played a significant role in the collateral selection
process while intending to take a short position in ABACUS 2007-AC1," the
SEC says in the suit.
The 'naked' truth.
Another issue that could take center stage in the fallout from the Goldman
case is the validity of
credit default swaps, the complex deals that are often likened to
insurance policies.
With most forms of
insurance, people take out policies on items, such as houses and cars, that
they own. In some cases, credit default swaps work the same way. In other
words, investors can own mortgage bonds in the belief that they will
appreciate in value, but at the same time they can hold an insurance
policy--through these swaps--that will pay out in the event that borrowers
default. Used that way, these swaps allow investors to hedge their bets.
But there are also naked
swaps, which let people short investments without ever having to own them
directly. Using the insurance example, it would be the rough equivalent of a
person taking out an insurance policy on his neighbor's house under the
belief that the house would be struck by lightning.
That's what happened in the
Goldman deal, which was created using a package comprised of various credit
default swaps. Investors like Paulson were then able to take the short side
of the deal by buying insurance on the bonds referenced in the deal.
In turn, the long investors
were the insurers. They received regular payments, much in the same way
insurance providers do, from policyholders like Paulson. These payments were
much like the interest they would accumulate had they actually owned the
bonds outright. In exchange, they agreed to make large payouts to the short
investors should the bonds fail, which is exactly what happened.
During the downturn, Goldman
was hardly the only firm that allowed investors to employ these naked credit
default swaps. In fact, naked shorts are viewed by many as one of the prime
reasons why the housing collapse was so painful. "The naked CDS... wreaked
havoc on the market," says Greenberger.
That's because when these
shorts are part of synthetic deals, investors are not constrained by
physical supplies. Kopff uses the example of home insurance. In that
industry, people can only buy as many insurance policies as there are actual
houses.
"Once everyone's insured,
you've hit the maximum. There's no more insurance that can be written," he
says. "While that number can be exceedingly high, it is finite. When you
allow naked positions, you allow what doesn't exist in the hazard insurance
industry... Now you have someone saying, 'Listen, you've got a house over
there, and I'm going to bet that lightning hits it.' And then somebody else
comes in and says, 'Well, I'm going to bet that lightning doesn't hit it.'
And you can have as many bets as you want."
This, in turn, compounded
the losses that investors experienced when the housing market went under.
"Essentially, [investors] found people who would give them insurance on the
question of whether subprime mortgages would be paid," says Greenberger. "So
every time a subprime
mortgage collapsed, it wasn't just the real loss of the mortgage, but
it was the loss of all the betting that was done on whether the mortgage
would survive or not survive."
As the Goldman case
continues to attract attention, the debate about swaps is likely to
intensify. Importantly, this will happen right as Congress considers a
sweeping financial overhaul package, one which many would like to see take a
harder position on swaps and other similar deals.
Still, swaps do have ardent
defenders who argue that when used correctly, they can actually reduce the
riskiness of investors' portfolios. But as the Goldman case illustrates,
these defenders are pitted against an American public that is clamoring for
tighter regulations. Says Greenberger, "I think there's been a widespread
desire to see some accountability for this horrific crisis."
Goldman might get off the hook if it sends
enough free porn to the SEC ---
"GOP ramps up attacks on SEC over porn surfing," by Daniel Wagner, Yahoo News,
April 23, 2010 ---
http://news.yahoo.com/s/ap/20100423/ap_on_bi_ge/us_sec_porn
Bob Jensen's threads on banking and
investment banking frauds are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Accounting for Collateralized Debt
Obligations (CDOs)
As to CDOs in
VIEs, you might take a look at
http://www.mayerbrown.com/public_docs/cdo_heartland2004_FIN46R.pdf
Evergreen
Investment Management case at
http://www.sec.gov/litigation/admin/2009/34-60059.pdf
Bob Jensen's
threads on CDO accounting ---
http://faculty.trinity.edu/rjensen/theory01.htm#CDO
Bob Jensen's
threads on SPEs, SPVs, and VIEs ---
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
Accountants Claim Immorality is
Acceptable if It Fails to Pass the Materiality Test
Bedtime Lesson 1 for Children: Only Steal a Little Bit at Any One Time and Stay
Below Your Materiality Limit
Bedtime Lesson 2 for Children: The Materiality Limit is Higher for Thieves Who
Are Already Rich
Bedtime Lesson 3 Attributed to Prize Fighter Joe Lewis: Being Rich is Better
Than Being Poor
From The Wall Street Journal Accounting Weekly Review on April 23,
2010
Case Hinges on Vital Legal Concept
by: Ashby
Jones, Kara Scannel, and Susanne Craig
Apr 19, 2010
Click here to view the full article on WSJ.com
Click here to view the video on WSJ.com
TOPICS: Fraud,
Materiality, SEC, Securities and Exchange Commission
SUMMARY: The
Securities and Exchange Commission's civil case against Goldman Sachs Group
Inc. hinges in large part on the concept of materiality. The WSJ article
gives a casual definition of this concept. Students are asked to provide the
definition of the accounting concept of materiality and compare its use to
that described in this case. The related article is the main page article
with a clear graphic describing the transaction which led to the SEC case
again Goldman Sachs.
CLASSROOM APPLICATION: The
article is designed to expand students' understanding of the concept of
material beyond a numerical threshold for financial statement adjustments.
QUESTIONS:
1. (Introductory)
The WSJ article indicates that materiality is central to the case against
Goldman Sachs that was brought this week by the SEC. How is this concept
defined in the WSJ article?
2. (Introductory)
Also refer to the WSJ video of Ashby Jones discussing the legal issues
entitled SEC v. Goldman. How does he define this concept?
3. (Advanced)
Identify the accounting concept of materiality in the conceptual literature
behind U.S. GAAP or IFRS. Does this accounting definition differ from that
provided in the WSJ article? From the WSJ video of Ashby Jones discussing
the legal issues? Explain.
4. (Introductory)
Refer to the related print article and especially the graphic associated
with it, entitled "Middleman: How Goldman Sachs structured the deal under
scrutiny." Describe the transaction that has triggered the SEC's case
against Goldman Sachs.
5. (Introductory)
What was the potentially material fact that was kept from investors who
bought the Abacus CDO designed by ACA Management and sold by Goldman Sachs?
6. (Advanced)
Refer again to the accounting definition of materiality. How does this
example from outside accounting make it clear that the nature of a given
item may create materiality concerns as much as the dollar value of that
item?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Goldman Sachs Charged with Fraud
by Gregory Zuckerman, Susanne Craig and Serena Ng
Apr 17, 2010
Page: A1
SEC versus Goldman Sachs
"Will Wall Street (or the Rest of Us) Ever Learn?" by Bill Taylor,
Harvard Business Review Blog, April 19, 2010 ---
http://blogs.hbr.org/taylor/2010/04/will_wall_street_or_the_rest_o.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE
The SEC's decision to
file civil-fraud charges against Goldman Sachs
over one of the synthetic securities the investment bank issued during the
subprime-mortgage bubble has generated major headlines, roiled the stock
market, and otherwise created a flurry of shock and awe from Wall Street to
Washington, DC. What I find surprising, though, is how surprised people seem
to be by the charges. We still can't seem to come to terms with just how
badly so many "blue-chip" institutions behaved over the last few years, and
how easily so many high-profile executives got caught up in the speculative
frenzy to turn a quick buck (or, in this case, a quick billion).
I might have been surprised, too, had I not just
finished Michael Lewis's remarkable new book, The Big Short. This
account of the subprime-mortgage fiasco, the small band of eccentrics who
made billions betting against it, and the army of highly educated,
well-dressed, overpaid investment bankers who engaged in a march of folly to
the very end, left me angry, shaken, and depressed. It was as if I were
reading a bigger, badder account of all the financial booms and busts that
had come before--from the junk-bond craze to the LBO wave to the Internet
bubble.
As I read the last page and sighed, one question
nagged at me: How is it that so many allegedly brilliant people (just
ask the folks at Goldman, they'll tell you how smart they are)
never seem to learn? Why do the self-satisfied "lords of finance" keep
making the same self-inflicted mistakes, whether they are matters of bad
judgment, fraudulent conduct, or outright criminality?
I woke up the next morning, checked out The New
York Times, and saw a different version of the same story played out
yet again! A
front-page article
explored how the much-celebrated phenomenon of micro-lending, offering small
loans to individuals and entrepreneurs in the poorest countries as a way to
lift them from poverty, is facing a global backlash.
Muhammad Yunus, the Bangladeshi economist who won the Nobel Peace Prize in
2006 for his work in the field, was watching in
horror as powerful, hungry, often-reckless banks were rushing in to generate
big profits from an idea they either didn't understand or didn't care about.
"We created microcredit to fight the loan sharks; we didn't create
microcredit to encourage new loan sharks," Professor Yunus fumed.
"Microcredit should be seen as an opportunity to help people get out of
poverty in a business way, but not as an opportunity to make money out of
people."
I love innovation as much as the next
person--probably more so. But this makes me crazy! The story of finance over
the last 25 years has been the story of innovation run amok--and of our
systematic failure, as a society, as companies, as individual leaders, to
learn from mistakes we seem determined to keep making. It might be condo
loans in Miami, synthetic derivatives in London, or credits to yak herders
in Mongolia, but it's déjà vu all over again: good ideas gone disastrously
wrong, genuine steps forward that ultimately bring markets crashing down.
As I fumed once more, I thought back to some words
of wisdom from Warren Buffet, who continues to amaze with his common-sense
brilliance. Buffet
gave the best explanation of this phenomenon I've ever heard in an interview
with Charlie Rose. The PBS host, talking to the
billionaire about the same disaster Michael Lewis writes about, asked the
obvious question: "Should wise people have known better?" Of course, they
should have, Buffett replied, but there's a "natural progression" to how
good ideas go wrong. He called this progression the "three I's." First come
the innovators, who see opportunities that others don't. Then come the
imitators, who copy what the innovators have done. And then come the idiots,
whose avarice undoes the very innovations they are trying to use to get
rich.
The problem, in other words, isn't with innovation.
It's with the bad behavior that inevitably follows. So how do we as
individuals (not to mention as companies and societies) continue to embrace
the value-creating upside of creativity while guarding against the
value-destroying downsides of imitation and idiocy? It's not easy, which is
why so many of us fall prey to so many bad ideas. "People don't get smarter
about things that get as basic as greed," Warren Buffett told Rose. "You
can't stand to see your neighbor getting rich. You know you're smarter than
he is, but he's doing all these [crazy] things, and he's getting rich...so
pretty soon you start doing it."
That's some pretty straight shooting and a pretty
fair approximation of the delusional, foolish, and downright stupid behavior
that Michael Lewis chronicles in such detail. It's also a central challenge
for innovators everywhere. Sometimes, the most important form of leadership
is resisting an innovation that takes hold in your field when that
innovation, no matter how popular with your rivals, is at odds with your
values and long-term point of view. The most determined innovators are as
conservative as they are disruptive. They make big strategic bets for the
long term and don't hedge their bets when strategic fashions change.
Can you distinguish between genuine creativity and
mindless imitation? Are you prepared to walk away from ideas that promise to
make money, even if they make no sense? Do you have the discipline to keep
your head when so many around you are losing theirs? Those questions are
something to think about. The answers may be the difference between being an
innovator and an idiot.
Before reading below you may want to watch Francine McKenna in a NYT
interview ---
http://www.thedeal.com/video/inside-the-deal/goldman-sec-charges-to-spark-c.php
You might also want to read about swaps since Goldman brokered questionable
(from an ethics standpoint) swaps in this scandal ---
http://en.wikipedia.org/wiki/Swap_(finance)
"Goldman Sachs accused of fraud by US regulator SEC," BBC News,
April 16, 2010 ---
http://news.bbc.co.uk/2/hi/business/8625931.stm
Goldman Sachs, the Wall Street powerhouse, has been
accused of defrauding investors by America's financial regulator.
The Securities and Exchange Commission (SEC)
alleges that Goldman failed to disclose conflicts of interest.
The claims concern Goldman's marketing of sub-prime
mortgage investments just as the US housing market faltered.
Goldman rejected the SEC's allegations, saying that
it would "vigorously" defend its reputation.
News that the SEC was pressing civil fraud charges
against Goldman and one of its London-based vice presidents, Fabrice Tourre,
sent shares in the investment bank tumbling 12%.
The SEC says Goldman failed to disclose "vital
information" that one of its clients, Paulson & Co, helped choose which
securities were packaged into the mortgage portfolio.
These securities were sold to investors in 2007.
But Goldman did not disclose that Paulson, one of
the world's largest hedge funds, had bet that the value of the securities
would fall.
The SEC said: "Unbeknownst to investors, Paulson...
which was posed to benefit if the [securities] defaulted, played a
significant role in selecting which [securities] should make up the
portfolio."
"In sum, Goldman Sachs arranged a transaction at
Paulson's request in which Paulson heavily influenced the selection of the
portfolio to suit its economic interests," said the Commission.
Housing collapse
The whole building is about to collapse anytime
now... Only potential survivor, the fabulous Fabrice...
Email by Fabrice Tourre The SEC alleges that
investors in the mortgage securities, packaged into a vehicle called Abacus,
lost more than $1bn (£650m) in the US housing collapse.
Mr Tourre was principally behind the creation of
Abacus, which agreed its deal with Paulson in April 2007, the SEC said.
The Commission alleges that Mr Tourre knew the
market in mortgage-backed securities was about to be hit well before this
date.
The SEC's court document quotes an email from Mr
Tourre to a friend in January 2007. "More and more leverage in the system.
Only potential survivor, the fabulous Fab[rice Tourre]... standing in the
middle of all these complex, highly leveraged, exotic trades he created
without necessarily understanding all of the implications of those
monstrosities!!!"
Goldman denied any wrongdoing, saying in a brief
statement: "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 firm said that, rather than make money from the
deal, it lost $90m.
The two investors that lost the most money, German
bank IKB and ACA Capital Management, were two "sophisticated mortgage
investors" who knew the risk, Goldman said.
And nor was there any failure of disclosure,
because "market makers do not disclose the identities of a buyer to a seller
and vice versa."
Calls to Mr Tourre's office were referred to the
Goldman press office. Paulson has not been charged.
Asked why the SEC did not also pursue a case
against Paulson, Enforcement Director Robert Khuzami told reporters: "It was
Goldman that made the representations to investors. Paulson did not."
The firm's owner, John Paulson - no relation to
former US Treasury Secretary Henry Paulson - made billions of dollars
betting against sub-prime mortgage securities.
In a statement, Paulson & Co. said: "As the SEC
said at its press conference, Paulson is not the subject of this complaint,
made no misrepresentations and is not the subject of any charges."
'Regulation risk'
Goldman, arguably the world's most prestigious
investment bank, had escaped relatively unscathed from the global financial
meltdown.
This is the first time regulators have acted
against a Wall Street deal that allegedly helped investors take advantage of
the US housing market collapse.
The charges come as US lawmakers get tough on Wall
Street practices that helped cause the financial crisis. Among proposals
being considered by Congress is tougher rules for complex investments like
those involved in the alleged Goldman fraud.
Observers said the SEC's move dealt a blow to
Goldman's standing. "It undermines their brand," said Simon Johnson, a
professor at the Massachusetts Institute of Technology and a Goldman critic.
"It undermines their political clout."
Analyst Matt McCormick of Bahl & Gaynor said that
the allegation could "be a fulcrum to push for even tighter regulation".
"Goldman has a fight in front of it," he said.
"Goldman CDO case could be tip of iceberg,"
by Aaron Pressman and Joseph Giannone, Reuters, April 17, 2010 ---
http://in.reuters.com/article/businessNews/idINIndia-47771020100417
The case against Goldman Sachs Group Inc over a
2007 mortgage derivatives deal it set up for a hedge fund manager could be
just the start of Wall Street's legal troubles stemming from the subprime
meltdown.
The U.S. Securities and Exchange Commission charged
Goldman with fraud for failing to disclose to buyers of a collaterlized debt
obligation known as ABACUS that hedge fund manager John Paulson helped
select mortgage derivatives he was betting against for the deal. Goldman
denied any wrongdoing.
The practice of creating synthetic CDOs was not
uncommon in 2006 and 2007. At the tail end of the real estate bubble, some
savvy investors began to look for more ways to profit from the coming
calamity using derivatives.
Goldman shares plunged 13 percent on Friday and
shares of other financial firms that created CDOs also fell. Shares of
Deutsche Bank AG ended down 9 percent, Morgan Stanley 6 percent and Bank of
America, which owns Merrill Lynch, and Citigroup each declined 5 percent.
Merrill, Citigroup and Deutsche Bank were the top
three underwriters of CDO transactions in 2006 and 2007, according to data
from Thomson Reuters. But most of those deals included actual
mortgage-backed securities, not related derivatives like the ABACUS deal.
Hedge fund managers like Paulson typically wanted
to bet against so-called synthetic CDOs that used derivatives contracts in
place of actual securities. Those were less common.
The SEC's charges against Goldman are already
stirring up investors who lost big on the CDOs, according to well-known
plaintiffs lawyer Jake Zamansky.
"I've been contacted by Goldman customers to bring
lawsuits to recover their losses," Zamansky said. "It's going to go way
beyond ABACUS. Regulators and plaintiffs' lawyers are going to be looking at
other deals, to what kind of conflicts Goldman has."
An investigation by the online site ProPublica into
Chicago-based hedge fund Magnetar's 2007 bets against CDO-related debt also
turned up allegations of conflicts of interest against Deutsche Bank,
Merrill and JPMorgan Chase.
Magnetar has denied any wrongdoing. Deutsche Bank
declined to comment. Merrill and JPMorgan had no immediate comment.
The Magnetar deals have spawned at least one
lawsuit. Dutch bank Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., or
Rabobank for short, filed suit in June against Merrill Lynch over Magnetar's
involvement with a CDO called Norma.
"Merrill Lynch teamed up with one of its most
prized hedge fund clients -- an infamous short seller that had helped
Merrill Lynch create four other CDOs -- to create Norma as a tailor-made way
to bet against the mortgage-backed securities market," Rabobank said in its
complaint filed on June 12 in the Supreme Court of New York.
The two matters are unrelated and the claims today
are not only unfounded but were not included in the Rabobank lawsuit filed
nearly a year ago, said Merrill Lynch spokesman Bill Halldin.
Rabobank was a lender, not an investor, he added.
Regulators at the SEC and around the country said
they would be investigating other deals beyond ABACUS.
We are looking very closely at these products and
transactions," Robert Khuzami, head of the SEC's enforcement division, said.
"We are moving across the entire spectrum in determining whether there was
(fraud)."
Meanwhile, Connecticut Attorney General Richard
Blumenthal said in a statement his office had already begun a preliminary
review of the Goldman case.
"A key question is whether this case was an
isolated incident or part of a pattern of investment banks colluding with
hedge funds to purposely tank securities they created and sold to unwitting
investors," Connecticut Attorney General Richard Blumenthal said in a
statement.
"Goldman under investigation for its securities dealings,"
by Greg Gordon, McClatchy Newspapers, January 22, 2010 ---
http://www.mcclatchydc.com/251/story/82899.html
WASHINGTON — One of Congress' premier watchdog
panels is investigating Goldman Sachs' role in the subprime mortgage
meltdown, including how the firm sold securities backed by risky home loans
while it simultaneously bet that those bonds would lose value, people
familiar with the inquiry said Friday.
The investigation is part of a broader examination
by the Senate Permanent Subcommittee on Investigations into the roots of the
economic crisis and whether financial institutions behaved improperly, said
the individuals, who insisted upon anonymity because the matter is
sensitive.
Disclosure of the investigation comes amid a
darkening mood at the White House, in Congress and among the American public
over the long-term economic impact of the subprime crisis, prompting demands
to hold the culprits accountable.
It marks at least the third federal inquiry
touching on Goldman's dealings related to securities backed by risky home
mortgages.
The separate, congressionally appointed Financial
Crisis Inquiry Commission, which was created to investigate causes of the
crisis, began holding hearings Jan. 13 and took sworn testimony from
Goldman's top officer. In addition, the Securities and Exchange Commission,
which polices Wall Street, is investigating Goldman's exotic bets against
the housing market, using insurance-like contracts known as credit-default
swaps, in offshore deals, knowledgeable people have told McClatchy.
Goldman, the world's most prestigious investment
bank, has denied any improprieties and said that the use of "hedges," or
contrary bets, is a "cornerstone of prudent risk management."
Asked about the Senate inquiry late Friday, Goldman
spokesman Michael DuVally said only: "As a matter of policy, Goldman Sachs
does not comment on legal or regulatory matters."
A spokeswoman for the Senate subcommittee declined
to comment on the investigation, which was spawned by a four-part McClatchy
series published in November that detailed the Wall Street firm's role in
the debacle, which stemmed from subprime loans to millions of marginally
qualified borrowers.
The subcommittee, part of the Homeland Security and
Governmental Affairs Committee, is led by veteran Democratic Sen. Carl Levin
of Michigan, who said last year that his panel was "looking into some of the
causes and consequences of the financial crisis."
The panel has a history of conducting formal,
highly secretive investigations in which it typically issues subpoenas for
documents and witnesses, produces extensive reports and sometimes refers
evidence to the Justice Department for possible criminal prosecution.
It couldn't immediately be learned whether the
panel has subpoenaed Goldman executives or company records. However, the
subcommittee has issued at least one major subpoena seeking records related
to Seattle-based Washington Mutual, which collapsed in September 2008 after
being swamped by losses from its subprime lending. J.P. Morgan Chase then
purchased WaMu's banking assets.
Goldman was the only major Wall Street firm to
safely exit the subprime mortgage market. McClatchy reported, however, that
Goldman sold off more than $40 billion in securities backed by over 200,000
risky home loans in 2006 and 2007 without telling investors of its secret
bets on a sharp housing downturn, prompting some experts to question whether
it had crossed legal lines.
McClatchy also has reported that Goldman peddled
unregulated securities to foreign investors through the Cayman Islands, a
Caribbean tax haven, in some cases exaggerating the soundness of the
underlying home mortgages. In numerous deals, records indicate, the company
required investors to pay Goldman massive sums if bundles of risky mortgages
defaulted. Goldman has said its investors were fully informed of the risks.
Federal auditors found that Goldman placed $22
billion of its swap bets against subprime securities, including many it had
issued, with the giant insurer American International Group. In late 2008,
when the government bailed out AIG, Goldman received $13.9 billion.
Goldman's chairman and chief executive, Lloyd
Blankfein, appeared to acknowledge last week that the firm behaved
inappropriately when he was asked about the secret bets in sworn testimony
to the Financial Crisis Inquiry Commission.
Blankfein first said that the firm's contrary
trades were "the practice of a market maker," then added: "But the answer is
I do think that the behavior is improper, and we regret the result — the
consequence that people have lost money in it."
A day later, Goldman issued a statement denying
that Blankfein had admitted improper company behavior and said that his
ensuing answer stressed that the firm's conduct was "entirely appropriate."
Senate investigators were described as having pored
over Goldman's SEC filings in recent weeks.
Underscoring the breadth of the Senate
investigation is the disclosure by federal banking regulators in a recent
filing in the WaMu bankruptcy case.
In it, the Federal Deposit Insurance Corp. revealed
that the Senate subcommittee had served the agency with "a comprehensive
subpoena" for documents relating to WaMu, whose primary regulator was the
Office of Thrift Supervision.
The subcommittee's jurisdiction is "wide-ranging,"
the FDIC's lawyers wrote. "It covers, among other things, the study or
investigation of the compliance or noncompliance of corporations, companies,
or individual or other entities with the rules, regulations and laws
governing the various governmental agencies and their relationships with the
public." The subpoena, they said, "is correspondingly broad."
The Puget Sound Business Journal first reported on
the FDIC's disclosure.
Goldman's former chairman, Henry Paulson, served as
Treasury secretary during the bailouts that benefitted the firm and while
other Wall Street investment banks foundered because of their subprime
market exposure, its profits have soared.
In reporting a $13.4 billion profit for 2009 on
Thursday, the bank sought to quell a furor over its taxpayer-aided success
by scaling back employee bonuses. It also has limited bonuses for its 30
most senior executives to restricted stock that can't be sold for five years.
MORE FROM MCCLATCHY
Goldman Sachs: Low Road to High Finance
Justice Department eyes possible fraud on Wall Street
Goldman admits 'improper' actions in sales of securities
Goldman: Blankfein didn't say firm's practices were 'improper'
Facing frustrated voters, more senators oppose Bernanke
Obama moves to restrict banks, take on Wall Street
Check
out McClatchy's politics blog: Planet Washington
Bob Jensen's threads on subprime sleaze are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's threads on banking fraud are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
The Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Ah, the innocence of youth.
What really happened in the poisonous CDO markets?
I previously mentioned three CBS Sixty Minutes videos that are must-views for
understanding what happened in the CDO scandals. Two of those videos centered on
muckraker Michael Lewis. My friend, the Unknown Professor, who runs the
Financial Rounds Blog, recommended that readers examine the Senior Thesis of a
Harvard student.
"Michael Lewis’s ‘The Big Short’? Read the Harvard Thesis Instead," by Peter
Lattman, The Wall Street Journal, March 20, 2010 ---
http://blogs.wsj.com/deals/2010/03/15/michael-lewiss-the-big-short-read-the-harvard-thesis-instead/tab/article/
Deal Journal has yet to
read “The Big Short,” Michael Lewis’s yarn on the financial crisis that hit
stores today. We did, however, read his acknowledgments, where Lewis praises
“A.K. Barnett-Hart, a Harvard undergraduate who had just written a thesis about
the market for subprime mortgage-backed CDOs that remains more interesting than
any single piece of Wall Street research on the subject.”
While unsure if we can
stomach yet another book on the crisis, a killer thesis on the topic? Now that
piqued our curiosity. We tracked down Barnett-Hart, a 24-year-old financial
analyst at a large New York investment bank. She met us for coffee last week to
discuss her thesis, “The Story of the CDO Market Meltdown: An Empirical
Analysis.” Handed in a year ago this week at the depths of the market collapse,
the paper was awarded summa cum laude and won virtually every thesis honor,
including the Harvard Hoopes Prize for outstanding scholarly work.
Last October,
Barnett-Hart, already pulling all-nighters at the bank (we agreed to not name
her employer), received a call from Lewis, who had heard about her thesis from a
Harvard doctoral student. Lewis was blown away.
“It was a classic example
of the innocent going to Wall Street and asking the right questions,” said Mr.
Lewis, who in his 20s wrote “Liar’s Poker,” considered a defining book on Wall
Street culture. “Her thesis shows there were ways to discover things that
everyone should have wanted to know. That it took a 22-year-old Harvard student
to find them out is just outrageous.”
Barnett-Hart says she
wasn’t the most obvious candidate to produce such scholarship. She grew up in
Boulder, Colo., the daughter of a physics professor and full-time homemaker. A
gifted violinist, Barnett-Hart deferred admission at Harvard to attend
Juilliard, where she was accepted into a program studying the violin under
Itzhak Perlman. After a year, she headed to Cambridge, Mass., for a broader
education. There, with vague designs on being pre-Med, she randomly took “Ec
10,” the legendary introductory economics course taught by Martin Feldstein.
“I thought maybe this
would help me, like, learn to manage my money or something,” said Barnett-Hart,
digging into a granola parfait at Le Pain Quotidien. She enjoyed how the subject
mixed current events with history, got an A (natch) and declared economics her
concentration.
Barnett-Hart’s interest
in CDOs stemmed from a summer job at an investment bank in the summer of 2008
between junior and senior years. During a rotation on the mortgage
securitization desk, she noticed everyone was in a complete panic. “These CDOs
had contaminated everything,” she said. “The stock market was collapsing and
these securities were affecting the broader economy. At that moment I became
obsessed and decided I wanted to write about the financial crisis.”
Back at Harvard, against
the backdrop of the financial system’s near-total collapse, Barnett-Hart
approached professors with an idea of writing a thesis about CDOs and their role
in the crisis. “Everyone discouraged me because they said I’d never be able to
find the data,” she said. “I was urged to do something more narrow, more
focused, more knowable. That made me more determined.”
She emailed scores of
Harvard alumni. One pointed her toward LehmanLive, a comprehensive database on
CDOs. She received scores of other data leads. She began putting together charts
and visuals, holding off on analysis until she began to see patterns–how Merrill
Lynch and Citigroup were the top originators, how collateral became heavily
concentrated in subprime mortgages and other CDOs, how the credit ratings
procedures were flawed, etc.
“If you just randomly
start regressing everything, you can end up doing an unlimited amount of
regressions,” she said, rolling her eyes. She says nearly all the work was in
the research; once completed, she jammed out the paper in a couple of weeks.
“It’s an incredibly
impressive piece of work,” said Jeremy Stein, a Harvard economics professor who
included the thesis on a reading list for a course he’s teaching this semester
on the financial crisis. “She pulled together an enormous amount of information
in a way that’s both intelligent and accessible.”
Barnett-Hart’s thesis is
highly critical of Wall Street and “their irresponsible underwriting practices.”
So how is it that she can work for the very institutions that helped create the
notorious CDOs she wrote about?
“After writing my thesis,
it became clear to me that the culture at these investment banks needed to
change and that incentives needed to be realigned to reward more than just
short-term profit seeking,” she wrote in an email. “And how would Wall Street
ever change, I thought, if the people that work there do not change? What these
banks needed is for outsiders to come in with a fresh perspective, question the
way business was done, and bring a new appreciation for the true purpose of an
investment bank - providing necessary financial services, not creating
unnecessary products to bolster their own profits.”
Ah, the innocence of
youth.
The Senior Thesis
"The Story of the CDO Market Meltdown: An Empirical Analysis," by Anna
Katherine Barnett-Hart, Harvard University, March 19, 2010 ---
http://www.hks.harvard.edu/m-rcbg/students/dunlop/2009-CDOmeltdown.pdf
A former colleague and finance professor at Trinity
University recommends following up this Harvard student’s senior thesis with the
following:
Rene M. Stulz. 2010. Credit default swaps and the
credit crisis. J of Economic Perspectives, 24(1): 73-92 (not free) ---
http://www.aeaweb.org/jep/index.php
Absolutely Must-See CBS Sixty Minutes Videos
You, your students, and the world in general really should repeatedly study the
following videos until they become perfectly clear!
Two of them are best watched after a bit of homework.
Video 1
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Then Watch Video 1 at
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals) ---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March 14. Both videos feature one of
my favorite authors of all time, Michael Lewis, who hhs been writing (humorously
with tongue in cheek) about Wall Street scandals since he was a bond salesman on
Wall Street in the 1980s. The other person featured on in these videos is a
one-eyed physician with Asperger Syndrome who made hundreds of millions of
dollars anticipating the collapse of the CDO markets while the shareholders of
companies like Merrill Lynch, AIG, Lehman Bros., and Bear Stearns got left
holding the empty bags.
The major lessons of videos 2 and 3 went over the head of my wife. I think
that viewers need to do a bit of homework in order to fully appreciate those
videos. Here's what I recommend before viewing Videos 2 and 3 if you've not been
following details of the 2008 Wall Street collapse closely:
This is not necessary to Videos 2
and 3, but to really appreciate what suckered the Wall Street Banks into
spreading the poison, you should read about how they all used the same risk
diversification mathematical function --- David Li's Gaussian Copula Function:
Can the
2008 investment banking failure
be traced to a math error?
Recipe for Disaster: The
Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's
formula, known as a
Gaussian copula function, looked like an
unambiguously positive breakthrough, a piece of financial technology that
allowed hugely complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities, expanding
financial markets to unimaginable levels.
His method was adopted
by everybody from bond investors and Wall Street banks to ratings agencies and
regulators. And it became so deeply entrenched—and was making people so much
money—that warnings about its limitations were largely ignored.
Then the model fell apart." The
article goes on to show that correlations are at the heart of the problem.
"The reason that
ratings agencies and investors felt so safe with the triple-A tranches was that
they believed there was no way hundreds of homeowners would all default on their
loans at the same time. One person might lose his job, another might fall ill.
But those are individual calamities that don't affect the mortgage pool much as
a whole: Everybody else is still making their payments on time.
But not all calamities
are individual, and tranching still hadn't solved all the problems of
mortgage-pool risk. Some things, like falling house prices, affect a large
number of people at once. If home values in your neighborhood decline and you
lose some of your equity, there's a good chance your neighbors will lose theirs
as well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree to
which one variable moves in line with another—and measuring it is an important
part of determining how risky mortgage bonds are."
I would highly recommend reading the
entire thing that gets much more involved with the
actual formula etc.
The “math error” might truly be have
been an error or it might have simply been a gamble with what was perceived as
miniscule odds of total market failure. Something similar happened in the case
of the trillion-dollar disastrous 1993 collapse of Long Term Capital Management
formed by Nobel Prize winning economists and their doctoral students who took
similar gambles that ignored the “miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is
ignorance in model building or risk taking using the model?
Bob Jensen’s threads on the CDO and CDS scandals ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
That some bankers have ended up in
prison is not a matter of scandal, but what is outrageous is the fact that all
the others are free.
Honoré de Balzac
"Banks Bundled Bad Debt, Bet Against It and
Won," by Gretchen Morgenson and Louise Story, The New York Times,
December 23, 2009 ---
http://www.nytimes.com/2009/12/24/business/24trading.html?em
My friend Larry clued me in to this link.
In late October 2007, as the
financial markets were starting to come unglued, a Goldman Sachs trader,
Jonathan M. Egol, received very good news. At 37, he was named a managing
director at the firm.
Mr. Egol, a Princeton
graduate, had risen to prominence inside the bank by creating
mortgage-related securities, named Abacus, that were at first intended to
protect Goldman from investment losses if the housing market collapsed. As
the market soured, Goldman created even more of these securities, enabling
it to pocket huge profits.
Goldman’s own clients who
bought them, however, were less fortunate.
Pension funds and insurance
companies lost billions of dollars on securities that they believed were
solid investments, according to former Goldman employees with direct
knowledge of the deals who asked not to be identified because they have
confidentiality agreements with the firm.
Goldman was not the only
firm that peddled these complex securities — known as synthetic
collateralized debt obligations, or C.D.O.’s — and then made financial bets
against them, called selling short in Wall Street parlance. Others that
created similar securities and then bet they would fail, according to Wall
Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller
firms like Tricadia Inc., an investment company whose parent firm was
overseen by Lewis A. Sachs, who this year became a special counselor to
Treasury Secretary Timothy F. Geithner.
How these disastrously
performing securities were devised is now the subject of scrutiny by
investigators in Congress, at the Securities and Exchange Commission and at
the Financial Industry Regulatory Authority, Wall Street’s self-regulatory
organization, according to people briefed on the investigations. Those
involved with the inquiries declined to comment.
While the investigations are
in the early phases, authorities appear to be looking at whether securities
laws or rules of fair dealing were violated by firms that created and sold
these mortgage-linked debt instruments and then bet against the clients who
purchased them, people briefed on the matter say.
One focus of the inquiry is
whether the firms creating the securities purposely helped to select
especially risky mortgage-linked assets that would be most likely to crater,
setting their clients up to lose billions of dollars if the housing market
imploded.
Some securities packaged by
Goldman and Tricadia ended up being so vulnerable that they soured within
months of being created.
Goldman and other Wall
Street firms maintain there is nothing improper about synthetic C.D.O.’s,
saying that they typically employ many trading techniques to hedge
investments and protect against losses. They add that many prudent investors
often do the same. Goldman used these securities initially to offset any
potential losses stemming from its positive bets on mortgage securities.
But Goldman and other firms
eventually used the C.D.O.’s to place unusually large negative bets that
were not mainly for hedging purposes, and investors and industry experts say
that put the firms at odds with their own clients’ interests.
“The simultaneous selling of
securities to customers and shorting them because they believed they were
going to default is the most cynical use of credit information that I have
ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R
Consulting in New York. “When you buy protection against an event that you
have a hand in causing, you are buying fire insurance on someone else’s
house and then committing arson.”
Investment banks were not
alone in reaping rich rewards by placing trades against synthetic C.D.O.’s.
Some hedge funds also benefited, including Paulson & Company, according to
former Goldman workers and people at other banks familiar with that firm’s
trading.
Michael DuVally, a Goldman
Sachs spokesman, declined to make Mr. Egol available for comment. But Mr.
DuVally said many of the C.D.O.’s created by Wall Street were made to
satisfy client demand for such products, which the clients thought would
produce profits because they had an optimistic view of the housing market.
In addition, he said that clients knew Goldman might be betting against
mortgages linked to the securities, and that the buyers of synthetic
mortgage C.D.O.’s were large, sophisticated investors, he said.
The creation and sale of
synthetic C.D.O.’s helped make the financial crisis worse than it might
otherwise have been, effectively multiplying losses by providing more
securities to bet against. Some $8 billion in these securities remain on the
books at American International Group, the giant insurer rescued by the
government in September 2008.
From 2005 through 2007, at
least $108 billion in these securities was issued, according to Dealogic, a
financial data firm. And the actual volume was much higher because synthetic
C.D.O.’s and other customized trades are unregulated and often not reported
to any financial exchange or market.
Goldman Saw It Coming
Before the financial
crisis, many investors — large American and European banks, pension funds,
insurance companies and even some hedge funds — failed to recognize that
overextended borrowers would default on their mortgages, and they kept
increasing their investments in mortgage-related securities. As the mortgage
market collapsed, they suffered steep losses.
Continued in article
Bob Jensen's threads on banking and
investment banking frauds are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Accounting for Collateralized Debt
Obligations (CDOs)
As to CDOs in
VIEs, you might take a look at
http://www.mayerbrown.com/public_docs/cdo_heartland2004_FIN46R.pdf
Evergreen
Investment Management case at
http://www.sec.gov/litigation/admin/2009/34-60059.pdf
Bob Jensen's
threads on CDO accounting ---
http://faculty.trinity.edu/rjensen/theory01.htm#CDO
Bob Jensen's
threads on SPEs, SPVs, and VIEs ---
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
Forwarded by a good friend on February 21, 2010
From:
http://www.rollingstone.com/politics/story/32255149/wall_streets_bailout_hustle/
Rolling Stone
Wall Street's Bailout Hustle
Goldman Sachs and other big banks aren't just pocketing the trillions we
gave them to rescue the economy - they're re-creating the conditions for
another crash
MATT TAIBBI
Posted Feb 17, 2010 5:57 AM
On January 21st, Lloyd Blankfein left a peculiar voicemail message
on the work phones of his employees at Goldman Sachs. Fast becoming
America's pre-eminent Marvel Comics supervillain, the CEO used the call to
deploy his secret weapon: a pair of giant, nuclear-powered testicles. In his
message, Blankfein addressed his plan to pay out gigantic year-end bonuses
amid widespread controversy over Goldman's role in precipitating the global
financial crisis.
The bank had already set aside a tidy $16.2 billion for salaries and bonuses
— meaning that Goldman employees were each set to take home an average of
$498,246, a number roughly commensurate with what they received during the
bubble years. Still, the troops were worried: There were rumors that Dr.
Ballsachs, bowing to political pressure, might be forced to scale the number
back. After all, the country was broke, 14.8 million Americans were stranded
on the unemployment line, and Barack Obama and the Democrats were trying to
recover the populist high ground after their bitch-whipping in Massachusetts
by calling for a "bailout tax" on banks. Maybe this wasn't the right time
for Goldman to be throwing its annual Roman bonus orgy.
Not to worry, Blankfein reassured employees. "In a year that proved to have
no shortage of story lines," he said, "I believe very strongly that
performance is the ultimate narrative."
Translation: We made a shitload of money last year because we're so amazing
at our jobs, so fuck all those people who want us to reduce our bonuses.
Goldman wasn't alone. The nation's six largest banks — all committed to this
balls-out,
I drink
your milkshake! strategy of flagrantly gorging themselves as
America goes hungry — set aside a whopping $140 billion for executive
compensation last year, a sum only slightly less than the $164 billion they
paid themselves in the pre-crash year of 2007. In a gesture of
self-sacrifice, Blankfein himself took a humiliatingly low bonus of $9
million, less than the 2009 pay of elephantine New York Knicks washout Eddy
Curry. But in reality, not much had changed. "What is the state of our moral
being when Lloyd Blankfein taking a $9 million bonus is viewed as this great
act of contrition, when every penny of it was a direct transfer from the
taxpayer?" asks Eliot Spitzer, who tried to hold Wall Street accountable
during his own ill-fated stint as governor of New York.
Beyond a few such bleats of outrage, however, the huge payout was met, by
and large, with a collective sigh of resignation. Because beneath America's
populist veneer, on a more subtle strata of the national psyche, there
remains a strong temptation to not really give a shit. The rich, after all,
have always made way too much money; what's the difference if some fat cat
in New York pockets $20 million instead of $10 million?
The only reason such apathy exists, however, is because there's
still a widespread misunderstanding of how exactly Wall Street "earns" its
money, with emphasis on the quotation marks around "earns." The question everyone
should be asking, as one bailout recipient after another posts massive
profits — Goldman reported $13.4 billion in profits last year, after paying
out that $16.2 billion in bonuses and compensation — is this: In an economy
as horrible as ours, with every factory town between New York and Los
Angeles looking like those hollowed-out ghost ships we see on History
Channel documentaries like
Shipwrecks of the Great Lakes, where in the hell did Wall
Street's eye-popping profits come from, exactly? Did Goldman go from bailout
city to $13.4 billion in the black because, as Blankfein suggests, its
"performance" was just that awesome? A year and a half after they were
minutes away from bankruptcy, how are these assholes not only back on their
feet again, but hauling in bonuses at the same rate they were during the
bubble?
The answer to that question is basically twofold: They raped the taxpayer,
and they raped their clients.
The bottom line is that banks like Goldman have learned absolutely nothing
from the global economic meltdown. In fact,
they're back conniving and playing speculative long shots in force — only
this time with the full financial support of the U.S. government. In the
process, they're rapidly re-creating the conditions for another crash, with
the same actors once again playing the same crazy games of financial chicken
with the same toxic assets as before.
That's why this bonus business isn't merely a matter of getting upset about
whether or not Lloyd Blankfein buys himself one tropical island or two on
his next birthday. The reality is that the post-bailout era in which Goldman
thrived has turned out to be a chaotic frenzy of high-stakes con-artistry,
with taxpayers and clients bilked out of billions using a dizzying array of
old-school hustles that, but for their ponderous complexity, would have fit
well in slick grifter movies like
The Sting
and
Matchstick Men. There's even a term in con-man lingo for what
some of the banks are doing right now, with all their cosmetic gestures of
scaling back bonuses and giving to charities. In the grifter world, calming
down a mark so he doesn't call the cops is known as the "Cool Off."
To appreciate how all of these (sometimes brilliant) schemes work is to
understand the difference between earning money and taking scores, and to
realize that the profits these banks are posting don't so much represent
national growth and recovery, but something closer to the losses one would
report after a theft or a car crash. Many Americans instinctively understand
this to be true — but, much like when your wife does it with your 300-pound
plumber in the kids' playroom, knowing it and actually watching the whole
scene from start to finish are two very different things. In that spirit, a
brief history of the best 18 months of grifting this country has ever seen:
CON #1
THE SWOOP AND SQUAT
By
now, most people who have followed the financial crisis know that the
bailout of AIG was actually a bailout of AIG's "counterparties" — the big
banks like Goldman to whom the insurance giant owed billions when it went
belly up.
What is less understood is that the bailout of AIG counter-parties like
Goldman and Société Générale, a French bank, actually began
before the collapse of
AIG, before the Federal Reserve paid them so much as a dollar. Nor is it
understood that these counterparties actually accelerated the wreck of AIG
in what was, ironically, something very like the old insurance scam known as
"Swoop and Squat," in which a target car is trapped between two perpetrator
vehicles and wrecked, with the mark in the game being the target's insurance
company — in this case, the government.
This may sound far-fetched, but the financial crisis of 2008 was very much
caused by a perverse series of legal incentives that often made failed
investments worth more than thriving ones. Our economy was like a town where
everyone has juicy insurance policies on their neighbors' cars and houses.
In such a town, the driving will be suspiciously bad, and there will be a
lot of fires.
AIG was the ultimate example of this dynamic. At the height of the housing
boom, Goldman was selling billions in bundled mortgage-backed securities —
often toxic crap of the no-money-down, no-identification-needed variety of
home loan — to various institutional suckers like pensions and insurance
companies, who frequently thought they were buying investment-grade
instruments. At the same time, in a glaring example of the perverse
incentives that existed and still exist, Goldman was also betting
against
those same sorts of securities — a practice that one government investigator
compared to "selling a car with faulty brakes and then buying an insurance
policy on the buyer of those cars."
Goldman often "insured" some of this garbage with AIG, using a virtually
unregulated form of pseudo-insurance called credit-default swaps. Thanks in
large part to deregulation pushed by Bob Rubin, former chairman of Goldman,
and Treasury secretary under Bill Clinton, AIG wasn't required to actually
have the capital to pay off the deals.
As a result,
banks like Goldman bought more than $440 billion worth of this bogus
insurance from AIG, a huge blind bet that the taxpayer ended up having to
eat.
Thus, when the housing bubble went crazy, Goldman made money coming and
going. They made money selling the crap mortgages, and they made money by
collecting on the bogus insurance from AIG when the crap mortgages flopped.
Still, the trick for Goldman was: how to
collect
the insurance money. As AIG headed into a tailspin that fateful summer of
2008, it looked like the beleaguered firm wasn't going to have the money to
pay off the bogus insurance. So Goldman and other banks began demanding that
AIG provide them with cash collateral.
In the 15
months leading up to the collapse of AIG, Goldman received $5.9 billion in
collateral. Société Générale, a bank holding lots of mortgage-backed crap
originally underwritten by Goldman, received $5.5 billion. These
collateral demands squeezing AIG from two sides were the "Swoop and Squat"
that ultimately crashed the firm. "It put the company into a liquidity
crisis," says Eric Dinallo, who was intimately involved in the AIG bailout
as head of the New York State Insurance Department.
It was a brilliant move. When a company like AIG is about to die,
it isn't supposed to hand over big hunks of assets to a single creditor like
Goldman; it's supposed to equitably distribute whatever assets it has left
among all its creditors. Had AIG gone bankrupt, Goldman would have likely
lost much of the $5.9 billion that it pocketed as collateral. "Any
bankruptcy court that saw those collateral payments would have declined that
transaction as a fraudulent conveyance," says Barry Ritholtz, the author of
Bailout Nation. Instead, Goldman and the other counterparties
got their money out in advance — putting a torch to what was left of AIG.
Fans of the movie
Goodfellas will recall
Henry Hill and Tommy DeVito taking the same approach to the Bamboo Lounge
nightclub they'd been gouging. Roll the Ray Liotta narration:
"Finally,
when there's nothing left, when you can't borrow another buck . . . you bust
the joint out. You light a match."
And why not? After all, according to the terms of the bailout deal struck
when AIG was taken over by the state in September 2008, Goldman was paid 100
cents on the dollar on an additional $12.9 billion it was owed by AIG —
again, money it almost certainly would not have seen a fraction of had AIG
proceeded to a normal bankruptcy. Along with the collateral it pocketed,
that's $19 billion in pure cash that Goldman would not have "earned" without
massive state intervention. How's that $13.4 billion in 2009 profits looking
now? And that doesn't even include the
direct
bailouts of Goldman Sachs and other big banks, which began in earnest after
the collapse of AIG.
CON #2
THE DOLLAR STORE
In
the usual "DollarStore" or "Big Store" scam — popularized in movies like
The Sting
— a huge cast of con artists is hired to create a whole fake environment
into which the unsuspecting mark walks and gets robbed over and over again.
A warehouse is converted into a makeshift casino or off-track betting
parlor, the fool walks in with money, leaves without it.
The two key elements to the Dollar Store scam are the whiz-bang theatrical
redecorating job and the fact that everyone is in on it except the mark. In
this case, a pair of investment banks were dressed up to look like
commercial banks overnight, and it was the taxpayer who walked in and lost
his shirt, confused by the appearance of what looked like real Federal
Reserve officials minding the store.
Less than a week after the AIG bailout, Goldman and another investment bank,
Morgan Stanley, applied for, and received, federal permission to become bank
holding companies — a move that would make them eligible for much greater
federal support. The stock prices of both firms were cratering, and there
was talk that either or both might go the way of Lehman Brothers, another
once-mighty investment bank that just a week earlier had disappeared from
the face of the earth under the weight of its toxic assets.
By law, a five-day waiting period was required for such a conversion — but
the two banks got them overnight, with final approval actually coming only
five days after the AIG bailout.
Why did they need those federal bank charters? This question is the key to
understanding the entire bailout era — because this Dollar Store scam was
the big one. Institutions that were, in reality, high-risk gambling houses
were allowed to masquerade as conservative commercial banks. As a result of
this new designation, they were given access to a virtually endless tap of
"free money" by unsuspecting taxpayers. The $10 billion that Goldman
received under the better-known TARP bailout was chump change in comparison
to the smorgasbord of direct and indirect aid it qualified for as a
commercial bank.
When Goldman Sachs and Morgan Stanley got their federal bank charters, they
joined Bank of America, Citigroup, J.P. Morgan Chase and the other banking
titans who could go to the Fed and borrow massive amounts of money at
interest rates that, thanks to the aggressive rate-cutting policies of Fed
chief Ben Bernanke during the crisis, soon sank to zero percent. The ability
to go to the Fed and borrow big at next to no interest was what saved
Goldman, Morgan Stanley and other banks from death in the fall of 2008.
"They had no other way to raise capital at that moment, meaning they were on
the brink of insolvency," says Nomi Prins, a former managing director at
Goldman Sachs. "The Fed was the only shot."
In fact, the Fed became not just a source of emergency borrowing
that enabled Goldman and Morgan Stanley to stave off disaster — it became a
source of long-term guaranteed income. Borrowing at zero percent interest,
banks like Goldman now had virtually infinite ways to make money. In one of
the most common maneuvers, they simply took the money they borrowed from the
government at zero percent and lent it back to the government by buying
Treasury bills that paid interest of three or four percent. It was basically
a license to print money — no different than attaching an ATM to the side of
the Federal Reserve.
"You're borrowing at zero, putting it out there at two or three percent,
with hundreds of billions of dollars — man, you can make a lot of money that
way," says the manager of one prominent hedge fund. "It's free money." Which
goes a long way to explaining Goldman's enormous profits last year. But all
that free money was amplified by another scam:
CON #3
THE PIG IN THE POKE
At
one point or another, pretty much everyone who takes drugs has been burned
by this one, also known as the "Rocks in the Box" scam or, in its more
elaborate variations, the "Jamaican Switch." Someone sells you what looks
like an eightball of coke in a baggie, you get home and, you dumbass, it's
baby powder.
The scam's name comes from the Middle Ages, when some fool would be sold a
bound and gagged pig that he would see being put into a bag; he'd miss the
switch, then get home and find a tied-up cat in there instead. Hence the
expression "Don't let the cat out of the bag."
The "Pig in the Poke" scam is another key to the entire bailout era. After
the crash of the housing bubble — the largest asset bubble in history — the
economy was suddenly flooded with securities backed by failing or
near-failing home loans. In the cleanup phase after that bubble burst, the
whole game was to get taxpayers, clients and shareholders to buy these
worthless cats, but at pig prices.
One of the first times we saw the scam appear was in September 2008, right
around the time that AIG was imploding. That was when the Fed changed some
of its collateral rules, meaning banks that could once borrow only against
sound collateral, like Treasury bills or AAA-rated corporate bonds, could
now borrow against pretty much anything — including some of the
mortgage-backed sewage that got us into this mess in the first place. In
other words, banks that once had to show a real pig to borrow from the Fed
could now show up with a cat and get pig money. "All of a sudden, banks were
allowed to post absolute shit to the Fed's balance sheet," says the manager
of the prominent hedge fund.
The Fed spelled it out on September 14th, 2008, when it changed the
collateral rules for one of its first bailout facilities — the Primary
Dealer Credit Facility, or PDCF. The Fed's own write-up described the
changes: "With the Fed's action, all the kinds of collateral then in use . .
.
including non-investment-grade securities and equities . . .
became eligible for pledge in the PDCF."
Translation: We now accept cats.
The Pig in the Poke also came into play in April of last year, when Congress
pushed a little-known agency called the Financial Accounting Standards
Board, or FASB, to change the so-called "mark-to-market" accounting rules.
Until this rule change, banks had to assign a real-market price to all of
their assets. If they had a balance sheet full of securities they had bought
at $3 that were now only worth $1, they had to figure their year-end
accounting using that $1 value. In other words, if you were the dope who
bought a cat instead of a pig, you couldn't invite your shareholders to a
slate of pork dinners come year-end accounting time.
But last April, FASB changed all that. From now on, it
announced, banks could avoid reporting losses on some of their crappy cat
investments simply by declaring that they would "more likely than not" hold
on to them until they recovered their pig value. In short, the banks didn't
even have to
actually
hold on to the toxic shit they owned — they just had to
sort of
promise to hold on to it.
That's why the "profit" numbers of a lot of these banks are
really a joke. In many
cases, we have absolutely no idea how many cats are in their proverbial bag.
What they call "profits" might really be profits, only
minus undeclared millions
or billions in losses.
"They're hiding all this stuff from their shareholders," says Ritholtz, who
was disgusted that the banks lobbied for the rule changes. "Now, suddenly
banks that were happy to mark to market on the way up don't have to mark to
market on the way down."
CON #4
THE RUMANIAN BOX
One
of the great innovations of Victor Lustig, the legendary Depression-era con
man who wrote the famous "Ten Commandments for Con Men," was a thing called
the "Rumanian Box." This was a little machine that a mark would put a blank
piece of paper into, only to see real currency come out the other side. The
brilliant Lustig sold this Rumanian Box over and over again for vast sums —
but he's been outdone by the modern barons of Wall Street, who managed to
get themselves a real Rumanian Box.
How they accomplished this is a story that by itself highlights the
challenge of placing this era in any kind of historical context of known
financial crime. What the banks did was something that was never — and never
could have been — thought of before. They took so much money from the
government, and then did so little with it, that the state was forced to
start printing new cash to throw at them. Even the great Lustig in his
wildest, horniest dreams could never have dreamed up
this
one.
The setup: By early 2009, the banks had already replenished
themselves with billions if not trillions in bailout money. It wasn't just
the $700 billion in TARP cash, the free money provided by the Fed, and the
untold losses obscured by accounting tricks.
Another
new rule
allowed banks to collect interest on the cash they were required by law to
keep in reserve accounts at the Fed — meaning the state was now compensating
the banks simply for guaranteeing their own solvency. And a
new federal operation called the Temporary Liquidity Guarantee Program let
insolvent and near-insolvent banks dispense with their deservedly ruined
credit profiles and borrow on a clean slate, with FDIC backing. Goldman
borrowed $29 billion on the government's good name, J.P. Morgan Chase $38
billion, and Bank of America $44 billion. "TLGP," says Prins, the former
Goldman manager, "was a big one."
Collectively, all this largesse was worth trillions. The idea behind the
flood of money, from the government's standpoint, was to spark a national
recovery: We refill the banks' balance sheets, and they, in turn, start to
lend money again, recharging the economy and producing jobs. "The banks were
fast approaching insolvency," says Rep. Paul Kanjorski, a vocal critic of
Wall Street who nevertheless defends the initial decision to bail out the
banks. "It was vitally important that we recapitalize these institutions."
But here's the thing. Despite all these trillions in government rescues,
despite the Fed slashing interest rates down to nothing and showering the
banks with mountains of guarantees, Goldman and its friends had still not
jump-started lending again by the first quarter of 2009. That's where those
nuclear-powered balls of Lloyd Blankfein came into play, as Goldman and
other banks basically threatened to pick up their bailout billions and go
home if the government didn't fork over more cash — a
lot
more. "Even if the Fed could make interest rates negative, that wouldn't
necessarily help," warned Goldman's chief domestic economist, Jan Hatzius.
"We're in a deep recession mainly because the private sector, for a variety
of reasons, has decided to save a lot more."
Translation: You can lower interest rates all you want, but we're still not
fucking lending the bailout money to anyone in this economy. Until the
government agreed to hand over even more goodies, the banks opted to join
the rest of the "private sector" and "save" the taxpayer aid they had
received — in the form of bonuses and compensation.
The ploy worked. In March of last year, the Fed sharply expanded a radical
new program called quantitative easing, which effectively operated as a
real-live Rumanian Box. The government put stacks of paper in one side, and
out came $1.2 trillion "real" dollars.
The government used some of that freshly printed money to prop itself up by
purchasing Treasury bonds — a desperation move, since Washington's demand
for cash was so great post-Clusterfuck '08 that even the Chinese couldn't
buy U.S. debt fast enough to keep America afloat. But the Fed used most of
the new cash to buy mortgage-backed securities in an effort to spur home
lending — instantly creating a massive market for major banks.
And what did the banks do with the proceeds? Among other things,
they bought Treasury bonds, essentially lending the money back to the
government, at interest. The money that came out of the magic Rumanian Box
went from the government back to the government, with Wall Street stepping
into the circle just long enough to get paid. And
once quantitative easing ends, as it is scheduled to do in March, the flow
of money for home loans will once again grind to a halt.
The
Mortgage Bankers Association expects the number of new residential mortgages
to plunge by 40 percent this year.
CON #5
THE BIG MITT
All
of that Rumanian box paper was made even more valuable by running it through
the next stage of the grift. Michael Masters, one of the country's leading
experts on commodities trading, compares this part of the scam to the poker
game in the Bill Murray comedy
Stripes.
"It's like that scene where John Candy leans over to the guy who's new at
poker and says, 'Let me see your cards,' then starts giving him advice,"
Masters says. "He looks at the hand, and the guy has bad cards, and he's
like, 'Bluff me, come on! If it were me, I'd bet everything!' That's what
it's like. It's like they're looking at your cards as they give you advice."
In more ways than one can count, the economy in the bailout era turned into
a "Big Mitt," the con man's name for a
rigged poker game. Everybody was indeed looking at everyone else's cards, in many
cases with state sanction. Only taxpayers and clients were left out of the
loop.
At the same time the Fed and the Treasury were making massive, earthshaking
moves like quantitative easing and TARP, they were also consulting regularly
with
private advisory boards that include every major player on Wall Street.
The Treasury Borrowing Advisory Committee has a
J.P. Morgan executive as its chairman and a
Goldman
executive as its vice chairman, while the board advising the Fed includes
bankers from
Capital One and
Bank of New
York Mellon.
That means that, in addition to getting great gobs of free money, the banks
were also getting clear signals about
when
they were getting that money, making it possible to position themselves to
make the appropriate investments.
One of the best examples of the banks blatantly gambling, and winning, on
government moves was the Public-Private Investment Program, or PPIP. In this
bizarre scheme cooked up by goofball-geek Treasury Secretary Tim Geithner,
the government loaned money to hedge funds and other private investors to
buy up the absolutely most toxic horseshit on the market — the same kind of
high-risk, high-yield mortgages that were most responsible for triggering
the financial chain reaction in the fall of 2008. These satanic deals were
the basic currency of the bubble: Jobless dope fiends bought houses with no
money down, and the big banks wrapped those mortgages into securities and
then sold them off to pensions and other suckers as investment-grade deals.
The whole point of the PPIP was to get private investors to relieve the
banks of these dangerous assets before they hurt any more innocent
bystanders.
But what did the banks do instead, once they got wind of the PPIP? They
started
buying
that worthless crap again, presumably to sell back to the government at
inflated prices! In the third quarter of last year, Goldman, Morgan Stanley,
Citigroup and Bank of America combined to add $3.36 billion of exactly this
horseshit to their balance sheets.
This brazen decision to gouge the taxpayer startled even hardened market
observers. According to Michael Schlachter of the investment firm Wilshire
Associates, it was "absolutely ridiculous" that the banks that were supposed
to be reducing their exposure to these volatile instruments were instead
loading up on them in order to make a quick buck.
"Some of
them created this mess," he said, "and they are making a killing undoing
it."
CON #6
THE WIRE
Here's
the thing about our current economy. When Goldman and Morgan Stanley
transformed overnight from investment banks into commercial banks, we were
told this would mean a new era of "significantly tighter regulations and
much closer supervision by bank examiners," as
The New
York Times put it the very next day. In reality, however, the
conversion of Goldman and Morgan Stanley simply completed the dangerous
concentration of power and wealth that began in 1999, when Congress repealed
the Glass-Steagall Act — the Depression-era law that had prevented the
merger of insurance firms, commercial banks and investment houses. Wall
Street and the government became one giant dope house, where a few major
players share valuable information between conflicted departments the way
junkies share needles.
One of the most common practices is a thing called
front-running,
which is really no different from the old "Wire" con, another scam
popularized in
The Sting.
But instead of intercepting a telegraph wire in order to bet on racetrack
results ahead of the crowd, what Wall Street does is make bets ahead of
valuable information they obtain in the course of everyday business.
Say you're working for the commodities desk of a big investment bank, and a
major client — a pension fund, perhaps — calls you up and asks you to buy a
billion dollars of oil futures for them. Once you place that huge order, the
price of those futures is almost guaranteed to go up. If the guy in charge
of asset management a few desks down from you somehow finds out about that,
he can make a fortune for the bank by betting ahead of that client of yours.
The deal would be instantaneous and undetectable, and it would offer huge
profits. Your own client would lose money, of course — he'd end up paying a
higher price for the oil futures he ordered, because you would have driven
up the price. But that doesn't keep banks from screwing their own customers
in this very way.
The scam is so blatant that Goldman Sachs actually warns its clients that
something along these lines might happen to them.
In the
disclosure section at the back of a research paper the bank issued on
January 15th, Goldman advises clients to buy some dubious high-yield bonds
while
admitting
that the
bank itself
may bet
against
those same shitty bonds. "Our salespeople, traders and other professionals may provide oral
or written market commentary or trading strategies to our clients and our
proprietary trading desks that reflect opinions that are contrary to the
opinions expressed in this research," the disclosure reads. "Our
asset-management area, our proprietary-trading desks and investing
businesses may make investment decisions that are inconsistent with the
recommendations or views expressed in this research."
Banks like Goldman admit this stuff openly, despite the fact that there are
securities laws that require banks to engage in "fair dealing with
customers" and prohibit analysts from issuing opinions that are at odds with
what they really think. And yet here they are, saying flat-out that they may
be issuing an opinion at odds with what they really think.
To help them screw their own clients, the major investment banks employ
high-speed computer programs that can glimpse orders from investors before
the deals are processed and then make trades on behalf of the banks at
speeds of fractions of a second. None of them will admit it, but everybody
knows what this computerized trading — known as "flash trading" — really is.
"Flash trading is nothing more than computerized front-running,"
says the prominent hedge-fund manager. The SEC voted to ban flash trading in
September, but five months later it has yet to issue a regulation to put a
stop to the practice.
Over the summer, Goldman suffered an embarrassment on that score when one of
its employees, a Russian named Sergey Aleynikov, allegedly stole the bank's
computerized trading code. In a court proceeding after Aleynikov's arrest,
Assistant U.S. Attorney Joseph Facciponti reported that
"the bank has raised the possibility that there is a danger that somebody
who knew how to use this program could use it to manipulate markets in
unfair ways."
Six months after a federal prosecutor admitted in open court that the
Goldman trading program could be used to unfairly manipulate markets, the
bank released its annual numbers. Among the notable details was the fact
that a staggering 76 percent of its revenue came from trading, both for its
clients and for its own account. "That is much, much higher than any other
bank," says Prins, the former Goldman managing director. "If I were a client
and I saw that they were making this much money from trading, I would
question how badly I was getting screwed."
Why big institutional investors like pension funds continually come to Wall
Street to get raped is the million-dollar question that many experienced
observers puzzle over. Goldman's own explanation for this phenomenon is
comedy of the highest order. In testimony before a government panel in
January, Blankfein was confronted about his firm's practice of betting
against the same sorts of investments it sells to clients. His response:
"These are the professional investors who want this exposure."
In other words, our clients are big boys, so screw 'em if they're dumb
enough to take the sucker bets I'm offering.
CON #7
THE RELOAD
Not
many con men are good enough or brazen enough to con the same victim twice
in a row, but the few who try have a name for this excellent sport:
reloading.
The usual way to reload on a repeat victim (called an "addict" in grifter
parlance) is to rope him into trying to get back the money he just lost.
This is exactly what started to happen late last year.
It's important to remember that the housing bubble itself was a classic
confidence game — the Ponzi scheme. The Ponzi scheme is any scam in which
old investors must be continually paid off with money from new investors to
keep up what appear to be high rates of investment return. Residential
housing was never as valuable as it seemed during the bubble; the soaring
home values were instead a reflection of a continual upward rush of new
investors in mortgage-backed securities, a rush that finally collapsed in
2008.
But by the end of 2009, the unimaginable was happening: The bubble was
re-inflating. A bailout policy that was designed to help us get out from
under the bursting of the largest asset bubble in history inadvertently
produced exactly the opposite result, as all that government-fueled capital
suddenly began flowing into the most dangerous and destructive investments
all over again. Wall Street was going for the reload.
A lot of this was the government's own fault, of course. By
slashing interest rates to zero and flooding the market with money, the Fed
was replicating the historic mistake that Alan Greenspan had made not once,
but twice, before the tech bubble in the early 1990s and before the housing
bubble in the early 2000s. By making sure that traditionally safe
investments like CDs and savings accounts earned basically nothing, thanks
to rock-bottom interest rates, investors were forced to go elsewhere to
search for moneymaking opportunities.
Now we're in the same situation all over again, only far worse. Wall Street
is flooded with government money, and interest rates that are not just low
but flat are pushing investors to seek out more "creative" opportunities.
(It's "Greenspan times 10," jokes one hedge-fund trader.) Some of that money
could be put to use on Main Street, of course, backing the efforts of
investment-worthy entrepreneurs. But that's not what our modern Wall Street
is built to do. "They don't seem to want to lend to small and medium-sized
business," says Rep. Brad Sherman, who serves on the House Financial
Services Committee. "What they want to invest in is marketable securities.
And the definition of small and medium-sized businesses, for the most part,
is that they don't
have
marketable securities. They have bank loans."
In other words, unless you're dealing with the stock of a major, publicly
traded company, or a giant pile of home mortgages, or the bonds of a large
corporation, or a foreign currency, or oil futures, or some country's debt,
or anything else that can be rapidly traded back and forth in huge numbers,
factory-style, by big banks, you're not really on Wall Street's radar.
So with small business out of the picture, and the safe stuff not worth
looking at thanks to the Fed's low interest rates, where did Wall Street go?
Right back into the shit that got us here.
One trader, who asked not to be identified, recounts a story of what
happened with his hedge fund this past fall. His firm wanted to short — that
is, bet against — all the crap toxic bonds that were suddenly in vogue
again. The fund's analysts had examined the fundamentals of these
instruments and concluded that they were absolutely not good investments.
So they took a short position. One month passed, and they lost money.
Another month passed — same thing. Finally, the trader just shrugged and
decided to change course and buy.
"I said, 'Fuck it, let's make some money,'" he recalls. "I absolutely did
not believe in the fundamentals of any of this stuff. However, I can get on
the bandwagon, just so long as I know when to jump out of the car before it
goes off the damn cliff!"
This is the very definition of bubble economics — betting on crowd behavior
instead of on fundamentals. It's old investors betting on the arrival of new
ones, with the value of the underlying thing itself being irrelevant. And
this behavior is being driven, no surprise, by the biggest firms on Wall
Street.
The research report published by Goldman Sachs on January 15th underlines
this sort of thinking. Goldman issued a strong recommendation to buy exactly
the sort of high-yield toxic crap our hedge-fund guy was, by then, driving
rapidly toward the cliff.
"Summarizing our views," the bank wrote, "we expect robust flows .
. . to dominate fundamentals." In other words: This stuff is crap, but
everyone's buying it in an awfully robust way, so you should too. Just like
tech stocks in 1999, and mortgage-backed securities in 2006.
To sum up, this is what Lloyd Blankfein meant by "performance": Take massive
sums of money from the government, sit on it until the government starts
printing trillions of dollars in a desperate attempt to restart the economy,
buy even more toxic assets to sell back to the government at inflated prices
— and then, when all else fails, start driving us all toward the cliff again
with a frank and open endorsement of bubble economics. I mean, shit — who
wouldn't deserve billions in bonuses for doing all that?
Con
artists have a word for the inability of their victims to accept that
they've been scammed. They call it the
"True
Believer Syndrome."
That's sort of where we are, in a state of nagging disbelief about
the real problem on Wall Street. It isn't so much that we have inadequate
rules or incompetent regulators, although both of these things are certainly
true. The real problem is that it doesn't matter what regulations are in
place if the people running the economy are rip-off artists. The system
assumes a certain minimum level of ethical behavior and civic instinct over
and above what is spelled out by the regulations. If those ethics are absent
— well, this thing isn't going to work, no matter what we do. Sure, mugging
old ladies is against the law, but it's also easy. To prevent it, we depend,
for the most part, not on cops but on people making the conscious decision
not to do it.
That's why the biggest gift the bankers got in the bailout was not fiscal
but psychological. "The most valuable part of the bailout," says Rep.
Sherman, "was the implicit guarantee that they're Too Big to Fail." Instead
of liquidating and prosecuting the insolvent institutions that took us all
down with them in a giant Ponzi scheme, we have showered them with money and
guarantees and all sorts of other enabling gestures. And what should really
freak everyone out is the fact that Wall Street immediately started skimming
off its own rescue money. If the bailouts validated anew the crooked
psychology of the bubble, the recent profit and bonus numbers show that the
same psychology is back, thriving, and looking for new disasters to create.
"It's evidence," says Rep. Kanjorski, "that they still don't get it."
More to the point, the fact that we haven't done much of anything
to change the rules and behavior of Wall Street shows that
we
still don't get it. Instituting a bailout policy that stressed
recapitalizing bad banks was like the addict coming back to the con man to
get his lost money back. Ask yourself how well that ever works out. And then
get ready for the reload.
[From Issue 1099 — March 4, 2010]
Allegedly, Goldman Sachs
sold (to suckers) securities backed by risky home loans while it simultaneously
bet that those bonds would lose value
January 27, 2010 message from
my friend Larry (who prefers to remain anonymous)
WASHINGTON — One of
Congress' premier watchdog panels is investigating Goldman Sachs' role in
the subprime mortgage meltdown, including how the firm sold securities
backed by risky home loans while it simultaneously bet that those bonds
would lose value, people familiar with the inquiry said Friday.
The investigation is part of
a broader examination by the Senate Permanent Subcommittee on Investigations
into the roots of the economic crisis and whether financial institutions
behaved improperly, said the individuals, who insisted upon anonymity
because the matter is sensitive.....
Federal auditors found
that Goldman placed $22 billion of its swap bets against subprime
securities, including many it had issued, with the giant insurer American
International Group. In late 2008, when the government bailed out AIG,
Goldman received $13.9 billion....
http://www.mcclatchydc.com/251/story/82899.html
"Goldman under investigation
for its securities dealings," by Greg Gordon, McClatchy Newspapers,
January 22, 2010 ---
http://www.mcclatchydc.com/251/story/82899.html
WASHINGTON — One of
Congress' premier watchdog panels is investigating Goldman Sachs' role in
the subprime mortgage meltdown, including how the firm sold securities
backed by risky home loans while it simultaneously bet that those bonds
would lose value, people familiar with the inquiry said Friday.
The investigation is part of
a broader examination by the Senate Permanent Subcommittee on Investigations
into the roots of the economic crisis and whether financial institutions
behaved improperly, said the individuals, who insisted upon anonymity
because the matter is sensitive.
Disclosure of the
investigation comes amid a darkening mood at the White House, in Congress
and among the American public over the long-term economic impact of the
subprime crisis, prompting demands to hold the culprits accountable.
It marks at least the third
federal inquiry touching on Goldman's dealings related to securities backed
by risky home mortgages.
The separate,
congressionally appointed Financial Crisis Inquiry Commission, which was
created to investigate causes of the crisis, began holding hearings Jan. 13
and took sworn testimony from Goldman's top officer. In addition, the
Securities and Exchange Commission, which polices Wall Street, is
investigating Goldman's exotic bets against the housing market, using
insurance-like contracts known as credit-default swaps, in offshore deals,
knowledgeable people have told McClatchy.
Goldman, the world's most
prestigious investment bank, has denied any improprieties and said that the
use of "hedges," or contrary bets, is a "cornerstone of prudent risk
management."
Asked about the Senate
inquiry late Friday, Goldman spokesman Michael DuVally said only: "As a
matter of policy, Goldman Sachs does not comment on legal or regulatory
matters."
A spokeswoman for the Senate
subcommittee declined to comment on the investigation, which was spawned by
a four-part McClatchy series published in November that detailed the Wall
Street firm's role in the debacle, which stemmed from subprime loans to
millions of marginally qualified borrowers.
The subcommittee, part of
the Homeland Security and Governmental Affairs Committee, is led by veteran
Democratic Sen. Carl Levin of Michigan, who said last year that his panel
was "looking into some of the causes and consequences of the financial
crisis."
The panel has a history of
conducting formal, highly secretive investigations in which it typically
issues subpoenas for documents and witnesses, produces extensive reports and
sometimes refers evidence to the Justice Department for possible criminal
prosecution.
It couldn't immediately be
learned whether the panel has subpoenaed Goldman executives or company
records. However, the subcommittee has issued at least one major subpoena
seeking records related to Seattle-based Washington Mutual, which collapsed
in September 2008 after being swamped by losses from its subprime lending.
J.P. Morgan Chase then purchased WaMu's banking assets.
Goldman was the only major
Wall Street firm to safely exit the subprime mortgage market. McClatchy
reported, however, that Goldman sold off more than $40 billion in securities
backed by over 200,000 risky home loans in 2006 and 2007 without telling
investors of its secret bets on a sharp housing downturn, prompting some
experts to question whether it had crossed legal lines.
McClatchy also has reported
that Goldman peddled unregulated securities to foreign investors through the
Cayman Islands, a Caribbean tax haven, in some cases exaggerating the
soundness of the underlying home mortgages. In numerous deals, records
indicate, the company required investors to pay Goldman massive sums if
bundles of risky mortgages defaulted. Goldman has said its investors were
fully informed of the risks.
Federal auditors found that
Goldman placed $22 billion of its swap bets against subprime securities,
including many it had issued, with the giant insurer American International
Group. In late 2008, when the government bailed out AIG, Goldman received
$13.9 billion.
Goldman's chairman and chief
executive, Lloyd Blankfein, appeared to acknowledge last week that the firm
behaved inappropriately when he was asked about the secret bets in sworn
testimony to the Financial Crisis Inquiry Commission.
Blankfein first said that
the firm's contrary trades were "the practice of a market maker," then
added: "But the answer is I do think that the behavior is improper, and we
regret the result — the consequence that people have lost money in it."
A day later, Goldman issued
a statement denying that Blankfein had admitted improper company behavior
and said that his ensuing answer stressed that the firm's conduct was
"entirely appropriate."
Senate investigators were
described as having pored over Goldman's SEC filings in recent weeks.
Underscoring the breadth of
the Senate investigation is the disclosure by federal banking regulators in
a recent filing in the WaMu bankruptcy case.
In it, the Federal Deposit
Insurance Corp. revealed that the Senate subcommittee had served the agency
with "a comprehensive subpoena" for documents relating to WaMu, whose
primary regulator was the Office of Thrift Supervision.
The subcommittee's
jurisdiction is "wide-ranging," the FDIC's lawyers wrote. "It covers, among
other things, the study or investigation of the compliance or noncompliance
of corporations, companies, or individual or other entities with the rules,
regulations and laws governing the various governmental agencies and their
relationships with the public." The subpoena, they said, "is correspondingly
broad."
The Puget Sound Business
Journal first reported on the FDIC's disclosure.
Goldman's former chairman,
Henry Paulson, served as Treasury secretary during the bailouts that
benefitted the firm and while other Wall Street investment banks foundered
because of their subprime market exposure, its profits have soared.
In reporting a $13.4
billion profit for 2009 on Thursday, the bank sought to quell a furor over
its taxpayer-aided success by scaling back employee bonuses. It also has
limited bonuses for its 30 most senior executives to restricted stock that
can't be sold for five years.
MORE FROM MCCLATCHY
Goldman Sachs: Low Road to High Finance
Justice Department eyes possible fraud on Wall Street
Goldman admits 'improper' actions in sales of securities
Goldman: Blankfein didn't say firm's practices were 'improper'
Facing frustrated voters, more senators oppose Bernanke
Obama moves to restrict banks, take on Wall Street
Check out
McClatchy's politics blog: Planet Washington
Bob Jensen's threads on
subprime sleaze are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Through the Banking Glass Darkly
"FASB to Propose More Flexible Accounting Rules for Banks," by
Floyd Norris, The New York Times, December 7, 2009 ---
http://www.nytimes.com/2009/12/08/business/08account.html?_r=2&ref=business
Facing political pressure to
abandon “fair value” accounting for banks, the chairman of the board that
sets American accounting standards will call Tuesday for the “decoupling” of
bank capital rules from normal accounting standards.
His proposal would encourage
bank regulators to make adjustments as they determine whether banks have
adequate capital while still allowing investors to see the current fair
value — often the market value — of bank loans and other assets.
In the prepared text
of a speech planned for a conference in Washington, Robert H. Herz, the
chairman of the
Financial Accounting Standards Board, called on
bank regulators to use their own judgment in allowing banks to move away
from Generally Accepted Accounting Principles, or GAAP, which his board
sets.
“Handcuffing regulators to
GAAP or distorting GAAP to always fit the needs of regulators is
inconsistent with the different purposes of financial reporting and
prudential regulation,” Mr. Herz said in the prepared text.
“Regulators should have the
authority and appropriate flexibility they need to effectively regulate the
banking system,” he added. “And, conversely, in instances in which the needs
of regulators deviate from the informational requirements of investors, the
reporting to investors should not be subordinated to the needs of
regulators. To do so could degrade the financial information available to
investors and reduce public trust and confidence in the capital markets.”
Mr. Herz said that
Congress, after the
savings and loan crisis, had required bank
regulators in 1991 to use GAAP as the basis for capital rules, but said the
regulators could depart from such rules.
Banks have argued that
accounting rules should be changed, saying that current rules are
“pro-cyclical” — making banks seem richer when times are good, and poorer
when times are bad and bank loans may be most needed in the economy.
Mr. Herz conceded the
accounting rules can be pro-cyclical, but questioned how far critics would
go. Consumer spending, he said, depends in part on how wealthy people feel.
Should
mutual fund statements be phased in, he asked, so
investors would not feel poor — and cut back on spending — after markets
fell?
The House Financial Services
Committee has approved a proposal that would direct bank regulators to
comment to the S.E.C. on accounting rules, something they already can do.
But it stopped short of adopting a proposal to allow the banking regulators
to overrule the S.E.C., which supervises the accounting board, on accounting
rules.
“I support the goal of
financial stability and do not believe that accounting standards and
financial reporting should be purposefully designed to create instability or
pro-cyclical effects,” Mr. Herz said.
He paraphrased
Barney Frank, the chairman of the House committee,
as saying that “accounting principles should not be viewed to be so
immutable that their impact on policy should not be considered. I agree with
that, and I think the chairman would also agree that accounting standards
should not be so malleable that they fail to meet their objective of helping
to properly inform investors and markets or that they should be purposefully
designed to try to dampen business, market, and economic cycles. That’s not
their role.”
Banks have argued that
accounting rules made the financial crisis worse by forcing them to
acknowledge losses based on market values that may never be realized, if
market values recover.
Mr. Herz said the accounting
board had sought middle ground by requiring some unrealized losses to be
recognized on bank balance sheets but not to be reflected on income
statements.
Banking regulators already
have capital rules that differ from accounting rules, but have not been
eager to expand those differences. One area where a difference may soon be
made is in the treatment of off-balance sheet items that the accounting
board is forcing banks to bring back onto their balance sheets. The banks
have asked regulators to phase in that change over several years, to slow
the impact on their capital needs.
Bob Jensen's threads on fair value accounting
are at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
Please don't blame the accountants for the
banking meltdown ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#FairValue
Is this fraud in the name of good?
A win (Bankers) - Win (Homeowners) - Lose (Taxpayers) New Gimmick on Wall
Street?
If government wants to help the homeowners, why not cut out the middlemen
bankers?
"Wall St. Finds Profits Again, Now by Reducing
Mortgages," by Louise Story, The New York Times, November 21, 2009 ---
http://www.nytimes.com/2009/11/22/business/22loans.html?hp
As millions of Americans
struggle to hold on to their homes, Wall Street has found a way to make
money from the mortgage mess.
Investment funds are buying
billions of dollars’ worth of home loans, discounted from the loans’
original value. Then, in what might seem an act of charity, the funds are
helping homeowners by reducing the size of the loans.
But as part of these deals,
the mortgages are being refinanced through lenders that work with government
agencies like the Federal Housing Administration. This enables the funds to
pocket sizable profits by reselling new, government-insured loans to other
federal agencies, which then bundle the mortgages into securities for sale
to investors.
While homeowners save money,
the arrangement shifts nearly all the risk for the loans to the federal
government — and, ultimately, taxpayers — at a time when Americans are
falling behind on their mortgage payments in record numbers.
For instance, a fund might
offer to pay $40 million for a $100 million block of mortgages from a bank
in distress. Then the fund could arrange to have some of those loans
refinanced into mortgages backed by an agency like the F.H.A. and then sold
to an agency like Ginnie Mae. The trick is to persuade the homeowners to
refinance those mortgages, by offering to reduce the amounts the homeowners
owe.
The profit comes when the
refinancings reach more than the $40 million that the fund paid for the
block of loans.
The strategy has created an
unusual alliance between Wall Street funds that specialize in troubled
investments — the industry calls them “vulture” funds — and American
homeowners.
But the transactions also
add to the potential burden on government agencies, particularly the F.H.A.,
which has lately taken on an outsize role in the housing market and, some
fear, may eventually need to be bailed out at taxpayer expense.
These new mortgage investors
thrive in the shadows. Typically, the funds employ intermediaries to contact
homeowners and arrange for mortgages to be refinanced.
Homeowners often have no
idea who their Wall Street benefactors are. Federal housing officials, too,
are in the dark.
Policymakers have encouraged
investors and banks to put more consumers into government-backed loans. The
total value of these transactions from hedge funds is small compared with
the overall housing market.
Housing experts warn that
the financial players involved — the investment funds, their intermediaries
and certain F.H.A. approved lenders — have a financial incentive to put as
many loans as possible into the government’s hands.
“From the borrower’s point
of view, landing in a hedge fund or private equity fund that’s willing to
write down principal is a gift,” said Howard Glaser, a financial industry
consultant and former official at the Department of Housing and Urban
Development.
He went on: “From the
systemic point of view, there is something disturbing about investors that
had substantial short-term profit in backing toxic loans now swooping down
to make another profit on cleaning up that mess.”
Steven and Marisela Alva say
they do not know who helped them with their mortgage. All they know is that
they feel blessed.
Last December, the couple
got a letter saying that a firm had purchased the mortgage on their home in
Pico Rivera, Calif., from Chase Home Finance for less than its original
value. “We want to share this discount with you,” the letter said.
“I couldn’t believe it,”
said Mr. Alva, a 62-year-old janitor and father of three. “I kept thinking
to myself, ‘Something is wrong, something is wrong. This sounds too good.’ ”
But it was true. The balance
on the Alvas’ mortgage was ultimately reduced to $314,000 from $440,000.
The firm behind the
reduction remains a mystery. The Alvas’ new loan, backed by the F.H.A., was
made by Primary Residential Mortgage, a lender based in Utah. But the letter
came from a company called MCM Capital Partners.
In the letter, MCM said the
couple’s loan was owned by something called MCMCap Homeowners’ Advantage
Trust III. But MCM’s co-founders said in an interview that MCM does not own
any mortgages. They would not reveal the investor that owned the Alvas’ loan
because they had agreed to keep that client’s identity confidential.
Michael Niccolini, an
MCM founder, said, “We are changing people’s lives.”
Continued in article
"SEC Sues Value Line Inc. and Two Senior
Officers for $24 Million Fraudulent Scheme," SEC Press Release,
November 4. 2009 ---
http://www.sec.gov/news/press/2009/2009-234.htm
FOR IMMEDIATE
RELEASE 2009-234 Washington, D.C., Nov. 4, 2009 — The Securities and
Exchange Commission today charged New York City-based investment adviser
Value Line Inc., its CEO, its former Chief Compliance Officer and its
affiliated broker-dealer with defrauding the Value Line family of mutual
funds by charging over $24 million in bogus brokerage commissions on mutual
fund trades funneled through Value Line's affiliated broker-dealer, Value
Line Securities, Inc. (VLS).
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's Security Analyst Frauds ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"Efficient Market Theory and the Crisis:
Neither the rating agencies' mistakes nor the overleveraging by financial firms
was the fault of an academic hypothesis," by Jeremy J. Siegel, The Wall
Street Journal, October 27, 2009 ---
http://online.wsj.com/article/SB10001424052748703573604574491261905165886.html?mod=djemEditorialPage
Financial journalist and
best-selling author Roger Lowenstein didn't mince words in a piece for the
Washington Post this summer: "The upside of the current Great Recession is
that it could drive a stake through the heart of the academic nostrum known
as the efficient-market hypothesis." In a similar vein, the highly respected
money manager and financial analyst Jeremy Grantham wrote in his quarterly
letter last January: "The incredibly inaccurate efficient market theory
[caused] a lethally dangerous combination of asset bubbles, lax controls,
pernicious incentives and wickedly complicated instruments [that] led to our
current plight."
But is the Efficient Market
Hypothesis (EMH) really responsible for the current crisis? The answer is
no. The EMH, originally put forth by Eugene Fama of the University of
Chicago in the 1960s, states that the prices of securities reflect all known
information that impacts their value. The hypothesis does not claim that the
market price is always right. On the contrary, it implies that the prices in
the market are mostly wrong, but at any given moment it is not at all easy
to say whether they are too high or too low. The fact that the best and
brightest on Wall Street made so many mistakes shows how hard it is to beat
the market.
This does not mean the EMH
can be used as an excuse by the CEOs of the failed financial firms or by the
regulators who did not see the risks that subprime mortgage-backed
securities posed to the financial stability of the economy. Regulators
wrongly believed that financial firms were offsetting their credit risks,
while the banks and credit rating agencies were fooled by faulty models that
underestimated the risk in real estate.
After the 1982 recession,
the U.S. and world economies entered into a long period where the
fluctuations in variables such as gross domestic product, industrial
production, and employment were significantly lower than they had been since
World War II. Economists called this period the "Great Moderation" and
attributed the increased stability to better monetary policy, a larger
service sector and better inventory control, among other factors.
The economic response to the
Great Moderation was predictable: risk premiums shrank and individuals and
firms took on more leverage. Housing prices were boosted by historically low
nominal and real interest rates and the development of the securitized
subprime lending market.
According to data collected
by Prof. Robert Shiller of Yale University, in the 61 years from 1945
through 2006 the maximum cumulative decline in the average price of homes
was 2.84% in 1991. If this low volatility of home prices persisted into the
future, a mortgage security composed of a nationally diversified portfolio
of loans comprising the first 80% of a home's value would have never come
close to defaulting. The credit quality of home buyers was secondary because
it was thought that underlying collateral—the home—could always cover the
principal in the event the homeowner defaulted. These models led credit
agencies to rate these subprime mortgages as "investment grade."
But this assessment was
faulty. From 2000 through 2006, national home prices rose by 88.7%, far more
than the 17.5% gain in the consumer price index or the paltry 1% rise in
median household income. Never before have home prices jumped that far ahead
of prices and incomes.
This should have sent up red
flags and cast doubts on using models that looked only at historical
declines to judge future risk. But these flags were ignored as Wall Street
was reaping large profits bundling and selling the securities while Congress
was happy that more Americans could enjoy the "American Dream" of home
ownership. Indeed, through government-sponsored enterprises such as Fannie
Mae and Freddie Mac, Washington helped fuel the subprime boom.
Neither the rating agencies'
mistakes nor the overleveraging by the financial firms in the subprime
securities is the fault of the Efficient Market Hypothesis. The fact that
the yields on these mortgages were high despite their investment-grade
rating indicated that the market was rightly suspicious of the quality of
the securities, and this should have served as a warning to prospective
buyers.
With few exceptions (Goldman
Sachs being one), financial firms ignored these warnings. CEOs failed to
exercise their authority to monitor overall risk of the firm and instead put
their faith in technicians whose narrow models could not capture the big
picture. One can only wonder if the large investment banks would have taken
on such risks when they were all partnerships and the lead partner had all
his wealth in the firm, as they were just a few decades ago.
The misreading of these
economic trends did not just reside within the private sector. Former Fed
Chairman Alan Greenspan stated before congressional committees last December
that he was "shocked" that the top executives of the financial firms exposed
their stockholders to such risk. But had he looked at their balance sheets,
he would have realized that not only did they put their own shareholders at
risk, but their leveraged positions threatened the viability of the entire
financial system.
As home prices continued to
climb and subprime mortgages proliferated, Mr. Greenspan and current Fed
Chairman Ben Bernanke were perhaps the only ones influential enough to sound
an alarm and soften the oncoming crisis. But they did not. For all the
deserved kudos that the central bank received for their management of the
crisis after the Lehman bankruptcy, the failure to see these problems
building will stand as a permanent blot on the Fed's record.
Our crisis wasn't due to
blind faith in the Efficient Market Hypothesis. The fact that risk premiums
were low does not mean they were nonexistent and that market prices were
right. Despite the recent recession, the Great Moderation is real and our
economy is inherently more stable.
But this does not mean that
risks have disappeared. To use an analogy, the fact that automobiles today
are safer than they were years ago does not mean that you can drive at 120
mph. A small bump on the road, perhaps insignificant at lower speeds, will
easily flip the best-engineered car. Our financial firms drove too fast, our
central bank failed to stop them, and the housing deflation crashed the
banks and the economy.
Dr. Siegel, a professor of finance at the
University of Pennsylvania's Wharton School, is the author of "Stocks for
the Long Run," now in its 4th edition from McGraw-Hill.
Eugene Fama Lecture: Masters of Finance, Oct
2, 2009
Videos Fama Lecture: Masters of Finance From the American Finance Association's
"Masters in Finance" video series, Eugene F. Fama presents a brief history of
the efficient market theory. The lecture was recorded at the University of
Chicago in October 2008 with an introduction by John Cochrane.
http://www.dimensional.com/famafrench/2009/10/fama-lecture-masters-of-finance.html#more
Fama Video on Market Efficiency in a Volatile
Market
Widely cited as the father of the efficient market hypothesis and one of its
strongest advocates, Professor Eugene Fama examines his groundbreaking idea in
the context of the 2008 and 2009 markets. He outlines the benefits and
limitations of efficient markets for everyday investors and is interviewed by
the Chairman of Dimensional Fund Advisors in Europe, David Salisbury.
http://www.dimensional.com/famafrench/2009/08/fama-on-market-efficiency-in-a-volatile-market.html#more
Other Fama and French Videos ---
http://www.dimensional.com/famafrench/videos/
Jensen Comment
This does not mean the EMH and its wildly popular stepchild CAPM are not in deep
keeshee (theory and practice) ---
http://faculty.trinity.edu/rjensen/theory01.htm#EMH
Warren Buffett
did a lot of almost fatal damage to the EMH
If you really want to understand the problem you’re apparently wanting to study,
read about how Warren Buffett changed the whole outlook of a great
econometrics/mathematics researcher (Janet Tavkoli). I’ve mentioned this
fantastic book before --- Dear Mr.
Buffett. What opened her eyes is how Warren Buffet built his vast, vast
fortune exploiting the errors of the sophisticated mathematical model builders
when valuing derivatives (especially options) where he became the writer of
enormous option contracts (hundreds of millions of dollars per contract). Warren
Buffet dared to go where mathematical models could not or would not venture when
the real world became too complicated to model. Warren reads financial
statements better than most anybody else in the world and has a fantastic
ability to retain and process what he’s studied. It’s impossible to model his
mind.
I finally grasped what Warren was saying. Warren has such a wide body of
knowledge that he does not need to rely on “systems.” . . . Warren’s vast
knowledge of corporations and their finances helps him identify derivatives
opportunities, too. He only participates in derivatives markets when Wall
Street gets it wrong and prices derivatives (with mathematical models)
incorrectly. Warren tells everyone that he only does certain derivatives
transactions when they are mispriced.
Wall Street derivatives traders construct trading models with no clear idea
of what they are doing. I know investment bank modelers with advanced math
and science degrees who have never read the financial statements of the
corporate credits they model. This is true of some credit derivatives
traders, too.
Janet Tavakoli, Dear Mr. Buffett, Page 19
Bob Jensen's threads on the economic crisis
are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Société Générale Tradung Fraud in France
Jérôme Kerviel's duties included arbitraging equity derivatives and equity
cash prices and commenced a crescendo of fake trades. This is an interesting
fraud case to study, but I doubt whether auditors themselves can be credited
with discovery of the fraud. It is a case of poor internal controls, but there
are all sorts of suggestions that the bank was actually using Kerviel to cover
its own massive losses. Kerviel did not personally profit from his fraud,
although he may have been anticipating a bonus due to his "profitable"
fake-trade arbitraging.
Société Générale ---
http://en.wikipedia.org/wiki/Soci%C3%A9t%C3%A9_G%C3%A9n%C3%A9rale
On January 24, 2008, the bank announced that a
single futures trader at the bank had fraudulently lost the bank €4.9billion
(an equivalent of $7.2billionUS), the largest such loss in history.
The company did not name the trader,
but other sources identified him as
Jérôme Kerviel, a
relatively junior
futures
trader who allegedly
orchestrated a series of bogus transactions that spiraled out of control
amid turbulent markets in 2007 and early 2008.
Partly due to the loss, that same day two
credit rating agencies reduced the bank's long
term debt ratings: from AA to AA- by Fitch; and from Aa1/B
to Aa2/B- by Moody's (B and B- indicate the bank's
financial strength ratings).
Executives said the trader acted alone and that he
may not have benefited directly from the fraudulent deals. The bank
announced it will be immediately seeking 5.5 billion euros in financing. On
the eve and afternoon of January 25, 2008, Police raided the Paris
headquarters of Société Générale and Kerviel's apartment in the western
suburb of
Neuilly, to seize his computer files. French
presidential aide Raymond Soubie stated that Kerviel dealt with $73.3
billion (more than the bank's
market capitalization of $52.6 billion). Three
union officials of Société Générale employees said Kerviel had family
problems.
On January 26, 2008, the Paris prosecutors'
office stated that Jerome Kerviel, 31, in Paris, "is not on the run. He will
be questioned at the appropriate time, as soon as the police have analysed
documents provided by Société Générale." Kerviel was placed under custody
but he can be detained for 24 hours (under French law, with 24 hour
extension upon prosecutors' request). Spiegel-Online stated that he may have
lost 2.8 billion dollars on 140,000 contracts earlier negotiated due to DAX
falling 600 points.
The alleged fraud was much larger than the
transactions by Nick Leeson that brought down
Barings Bank
Main article:
January 2008 Société Générale trading loss incident
Other notable trading losses
April 10 message from Jagdish Gangolly
[gangolly@GMAIL.COM]
Francine,
1. In France, accountants and
auditors are regulated by different ministries; accountants by Ministry of
Finance, and auditors by the Ministry of Justice. Only auditors can perform
statutory audits. All auditors are accountants, but not necessarily the
other way round.
I am not sure there is a
fundamental difference when it comes to apportionment of blame and so on,
except that the ominous and heavy hand of the state pervades in France; even
the codes assigned to the items in the national chart of accounts is
specified in French law (in the so called Accounting Plan).
2. I do not think the
accountants/auditors were involved in the Societe Generale case. The
unauthorised trades were detected and the positions closed all within two
days or so. Unfortunately us US taxpayers were left holding the bag in the
long run; we paid $11 billion for the credit default swaps to SG.
Jagdish
--
Jagdish S. Gangolly
Department of Informatics
College of Computing & Information
State University of New York at Albany
Harriman Campus, Building 7A, Suite 220
Albany, NY 12222
Phone: 518-956-8251, Fax: 518-956-8247
April 11, 2010 reply from Francine McKenna
[retheauditors@GMAIL.COM]
Societe Generale was not
resolved that quickly. In the MF Global "rogue trading scandal" the
positions were closed overnights because the trades were in wheat which is
exchange traded and cleared by the CME. Societe General trader was working
with primarily non-exchange traded derivatives. They did not see it right
away and counterparties who could complain about margin calls did not exist.
The banks internal audit group
was ignored (like AIG) and the auditors gave a bank that had poor internal
controls and the ability for any controls to be overridden easily, a clean
bill of health.
Thanks for further
clarification of the French approach. I did not know they had accountants
and auditors but that makes it seem even more like the barristers and
solicitors division...
http://retheauditors.com/2008/10/14/what-the-auditors-saw-an-update-on-societe-generale/
http://retheauditors.com/2008/03/03/mf-global-socgen-and-rogue-traders-dont-fall-for-the-simple-answers/
Bob Jensen's threads on brokerage trading frauds are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"SEC Proposes Changes for 'Dark Pools',"
SmartPros, October 21, 2009 ---
http://accounting.smartpros.com/x67909.xml
Federal regulators are
proposing tighter oversight for so-called "dark pools," trading systems that
don't publicly provide price quotes and compete with major stock exchanges.
The Securities and Exchange
Commission voted Wednesday to propose new rules that would require more
stock quotes in the "dark pool" systems to be publicly displayed. The
changes could be adopted sometime after a 90-day public comment period.
The alternative trading
systems, private networks matching buyers and sellers of large blocks of
stocks, have grown explosively in recent years and now account for an
estimated 7.2 percent of all share volume. SEC officials have identified
them as a potential emerging risk to markets and investors.
The SEC initiative is the
latest action by the agency seeking to bring tighter oversight to the
markets amid questions about transparency and fairness on Wall Street. The
SEC has floated a proposal restricting short-selling - or betting against a
stock - in down markets.
Last month, the agency
proposed banning "flash orders," which give traders a split-second edge in
buying or selling stocks. A flash order refers to certain members of
exchanges - often large institutions - buying and selling information about
ongoing stock trades milliseconds before that information is made public.
Institutional investors like
pension funds may use dark pools to sell big blocks of stock away from the
public scrutiny of an exchange like the New York Stock Exchange or Nasdaq
Stock Market that could drive the share price lower.
"Given the growth of dark
pools, this lack of transparency could create a two-tiered market that
deprives the public of information about stock prices," SEC Chairman Mary
Schapiro said before the vote at the agency's public meeting.
Republican Commissioners
Kathleen Casey and Troy Paredes, while voting to put out the proposed new
rules for public comment, cautioned against rushing to overly broad
regulation that could have a negative impact on market innovation and
competition.
Dark pools might decide to
maintain stock trading at levels below those that trigger required public
display under the proposed rules, Paredes said. "Darker dark pools" could be
worse than the current situation, he suggested.
When investors place an
order to buy or sell a stock on an exchange, the order is normally displayed
for the public to view. With some dark pools, investors can signal their
interest in buying or selling a stock but that indication of interest is
communicated only to a group of market participants.
That means investors who
operate within the dark pool have access to information about potential
trades which other investors using public quotes do not, the SEC says.
The SEC proposal would
require indications of interest to be treated like other stock quotes and
subject to the same disclosure rules.
Continued in article
Bob Jensen's threads on mutual fund and index
fund and insurance company scandals are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#MutualFunds
Accounting Teachers About Cooking the Books
Get Caught ... er ... Cooking the Books
The media and blogs are conveniently pinning the
Huron debacle on its Andersen roots, and hinting that the Enron malfeasance bled
into Huron.
What I find ironic below is that the Huron
Consulting Group is itself a consulting group on technical accounting matters,
internal controls, financial statement restatements, accounting fraud, rules
compliance, and accounting education. If any outfit should've known better it
was Huron Consulting Group ---
http://www.huronconsultinggroup.com/about.aspx
Huron Consulting Group was formed in May of 2003
in Chicago with a core set of 213 following the implosion of huge Arthur
Andersen headquartered in Chicago. The timing is much more than mere coincidence
since a lot of Andersen professionals were floating about looking for a new home
in Chicago. In the past I've used the Huron Consulting Group published studies
and statistics about financial statement revisions of other companies. I never
anticipated that Huron Consulting itself would become one of those statistics. I
guess Huron will now have more war stories to tell clients.
The media and blogs are
conveniently pinning the Huron debacle on its Andersen roots, and hinting that
the Enron malfeasance bled into Huron.
Big Four Blog, August 5, 2009 ---
http://www.blogcatalog.com/blog/life-after-big-four-big-four-alumni-blog/eae8a159803847f6a73af93c063058f9
"Can hobbled Huron Consulting survive this
scandal?" by Steven R. Strahler, Chicago Business, August 4, 2009 ---
http://www.chicagobusiness.com/cgi-bin/news.pl?id=35019&seenIt=1
An accounting mess at Huron
Consulting Group Inc. that led to the decapitation of top management and the
collapse in its share price puts the survival of the Chicago-based firm in
jeopardy.
Huron’s damaged reputation
imperils its ability to provide credible expert witnesses during courtroom
proceedings growing out of its bread-and-butter restructuring and disputes
and investigations practices. Rivals are poised to capture marketshare.
“These types of firms have
to be squeaky clean with no exceptions, and this was too big of an
exception,” says Allan Koltin, a Chicago-based accounting industry
consultant. “I respect the changes they made and the speed (with which) they
made them. I’m not sure they can recover from this.”
Huron executives declined to
comment.
Late Friday, Huron said it
would restate results for the three years ended in 2008 and for the first
quarter of 2009, resulting in a halving of its profits, to $63 million from
$120 million, for the 39-month period. Revenue projections for 2009 were cut
by more than 10%, to a range of $650 million to $680 million from $730
million to $770 million.
The company said its hand
was forced by its recent discovery that holders of shares in acquired firms
had an agreement among themselves to reallocate a portion of their earn-out
payments to other Huron employees. The company said it had been unaware of
the arrangement.
“The employee payments were
not ‘kickbacks’ to Huron management,” the company said.
Whatever the description,
the fallout promises to shake Huron to its core. The company’s stock plunged
70% Monday to about $14 per share, and law firms were preparing to mount
class-action shareholder litigation.
“If the public doesn’t buy
that the house is clean, my guess is some of the senior talent will start to
move very quickly,” says William Brandt, president and CEO of Chicago-based
restructuring firm Development Specialists Inc. “Client retention is all
that matters here.”
Publicly traded competitors
like Navigant Consulting Inc. are unlikely to make bids for Huron because of
the potential for damage to their own stock. Private enterprises like
Mesirow Financial stand as logical employers as Huron workers jump ship.
“There certainly is
potential out there for clients and employees who may be looking at
different options, but at this point in the process it’s a little early to
tell what impact this will have,” says a Navigant spokesman.
Huron’s woes led to the
resignation last week of Chairman and CEO Gary Holdren and Chief Financial
Officer Gary Burge, both of whom will stay on with the firm for a time, and
the immediate departure of Chief Accounting Officer Wayne Lipski.
Mr. Holdren, 59, has a
certain amount of familiarity with turmoil.
He was among co-founders of
Huron in 2002, when their previous employer, Andersen, folded along with its
auditing client Enron Corp. He told the Chicago Tribune in 2007, “Initially,
when we’d call on potential clients, they’d say, ‘Huron? Who are you? That
sounds like Enron,’ or ‘Aren’t you guys supposed to be in jail? Why are you
calling us?’ ”
This year, it’s been money
issues dogging Huron. In the spring, shareholders twice rejected proposals
to sweeten an employee stock compensation plan.
Mr. Holdren’s total
compensation in 2008 was $6.5 million, according to Securities and Exchange
Commission filings. Mr. Burge received $1.2 million.
A Huron unit in June sued
five former consultants and their new employer, Sonnenschein Nath &
Rosenthal LLP, alleging that the defendants were using trade secrets to lure
Huron clients to the law firm. The defendants denied the charges. The case
is pending in Cook County Circuit Court.
"3 executives at Huron Consulting Group
resign over accounting missteps Consulting firm announces it will restate
financial results for the past 3 fiscal years,"by Wailin Wong, Chicago
Tribune, August 1, 2009 ---
http://archives.chicagotribune.com/2009/aug/01/business/chi-sat-huron-0801-aug01
Chief Executive Gary Holdren
and two other top executives are resigning from Chicago-based management
consultancy Huron Consulting Group as the company announced Friday it is
restating financial statements for three fiscal years.
Holdren’s resignation as CEO
and chairman was effective Monday and he will leave Huron at the end of
August, the company said in a statement. Chief Financial Officer Gary Burge
is being replaced in that post but will serve as treasurer and stay through
the end of the year. Chief Accounting Officer Wayne Lipski is also leaving
the company. None of the departing executives will be paid severance, Huron
said.
Huron will restate its
financial results for 2006, 2007, 2008 and the first quarter of 2009. The
accounting missteps relate to four businesses that Huron acquired between
2005 and 2007.
According to Huron’s
statement and a filing with the Securities and Exchange Commission, the
selling shareholders of the acquired businesses distributed some of their
payments to Huron employees. They also redistributed portions of their
earnings “in amounts that were not consistent with their ownership
percentages” at the time of the acquisition, Huron said.
A Huron spokeswoman declined
to give the number of shareholders and employees involved, saying the
company was not commenting beyond its statement.
“I am greatly disappointed
and saddened by the need to restate Huron’s earnings,” Holdren said in the
statement. He acknowledged “incorrect” accounting.
Huron said the restatement’s
total estimated impact on net income and earnings before interest, taxes,
depreciation and amortization for the periods in question is $57 million.
“Because the issue arose on
my watch, I believe that it is my responsibility and my obligation to step
aside,” said Holdren.
Huron said the board’s audit
committee had recently learned of an agreement between the selling
shareholders to distribute some of their payments to a company employee. The
committee then launched an inquiry into all of Huron’s prior acquisitions
and discovered the involvement of more Huron employees.
Huron said it is reviewing
its financial reporting procedures and expects to find “one or more material
weaknesses” in the company’s internal controls. The amended financial
statements will be filed “as soon as practicable,” Huron said.
James Roth, one of Huron’s
founders, is replacing Holdren as CEO. Roth was previously vice president of
Huron’s health and education consulting business, the company’s largest
segment. George Massaro, Huron’s former chief operating officer who is the
board of directors’ vice chairman, will succeed Holdren as chairman.
James Rojas, another Huron
founder, is now the company’s CFO. Rojas was serving in a corporate
development role. Huron did not announce a replacement for Lipski, the chief
accounting officer.
The company’s shares sank
more than 57 percent in after-hours trading. The stock had closed Friday at
$44.35. Huron said it expects second-quarter revenues between $164 million
and $166 million, up about 15 percent from the year-earlier quarter.
The company, founded
by former partners at the Andersen accounting firm including Holdren, also
said that it is conducting a separate inquiry into chargeable hours in
response to an inquiry from the SEC.
Bob Jensen's threads on accounting firm
frauds are at
http://faculty.trinity.edu/rjensen/fraud001.htm
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Question
How did banks circumvent mortgage regulations in before the subprime scandal
broke?
Jensen Comment
For once I would like to bless
Barney Frank, although as chairman of the House Financial Services Committee
when these scandals were taking place, he should have stopped this banking house
of cards before this banking fraud came tumbling down. In spite of yelling foul
now, Rep. Frank helped create this pile of "Barney's Rubble." Pardon me for not
blessing Barney now ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
Was he left in the dark about mortgage fraud? Wink! Wink!
I'm about to puke!
Hint
They used a ploy much like corporations used to keep real estate and other debt
of the balance sheet before accounting standard setters put an end to the sham.
For example, Avis Car rental at one time avoided putting millions of debt for
financing its cars by creating a sham subsidiary financing subsidiary and then
(in those good old days) did not consolidate the financing subsidiary into the
consolidated balance sheet of Avis. Similarly, Safeway appeared to not own any
stores or have any mortage debt on those stores because all this was hidden in
an unconsolidated subsidiary. It took way to long in the United States for the
FASB to put an end to the sham of off-balance-sheet-financing (OBSF):
FAS 94: Consolidation of All Majority-owned Subsidiaries--an amendment of
ARB No. 51, with related amendments of APB Opinion No. 18 and ARB No. 43,
Chapter 12 (Issued 10/87) ---
http://www.fasb.org/summary/stsum94.shtml
In the case of banks circumventing regulations on selling mortgages,
here's how it worked with sham mortgage company subsidiaries.
"Subprime and the Banks: Guilty as Charged," by Joe Nocera. The New
York Times, October 14, 2009 ---
http://executivesuite.blogs.nytimes.com/2009/10/14/subprime-and-the-banks-guilty-as-charged/
“There has not been a case made that there is an
enforcement problem with banks,” Edward Yingling, the head of the American
Bankers Association, said last week. “There is a problem with enforcement on
nonbanks.”
As I wrote in
my column last week, this has become something of
a mantra for the banking industry. We aren’t the ones who brought
the world to the brink of financial disaster,
they proclaim. It was those awful nonbanks,
the mortgage brokers and originators, who peddled those terrible subprime
loans to unsuspecting or unsophisticated consumers. They’re the ones who
need to be regulated!
Apparently, when you say something long enough and
loud enough, people start to believe it, even when it defies reality. Here,
for instance, is the normally skeptical
Barney Frank on the subject: “What happened
was an explosion of loans being made outside of the regular banking system.
It was largely the unregulated sector of the lending industry and the
underregulated and the lightly regulated that did that.”
To which I can now triumphantly reply: Oh,
really???
Last weekend, after the column was published, an
angry mortgage broker — someone who felt she and her ilk were being unfairly
scapegoated by the banking industry — sent me a series of rather eye-opening
documents. They were a series of fliers and advertisements that had been
sent to her office (and mortgage brokers all over the country) from
JPMorgan Chase, advertising their latest wares.
They were dated 2005, which was before the subprime mortgage boom got
completely out of control. They’re still pretty sobering.
“The Top 10 Reasons to Choose Chase for All Your
Subprime Needs,” screams the headline on the first one. Another was titled,
“Chase No Doc,” and described the criteria for a borrower to receive a
so-called no-document loan. “Got Bank Statements?” asked a third flier. “Get
Approved!” In a number of the fliers, Chase makes it clear to the mortgage
brokers that the bank doesn’t need income or job verification — it just
needs to look at a handful of old bank statements.
“There were mortgage brokers who acted unethically,
absolutely,” my source told me when I called her on Monday. (She asked to
remain anonymous because she still has to work with JPMorgan Chase and the
other big banks.) “But where do you think mortgage brokers were getting the
subprime mortgages they were selling to customers? From the big banks,
that’s where. Chase,
Wells Fargo,
Bank of America — they were all doing it.”
So enough already about how the banks weren’t the
problem. Of course they were. Here’s the evidence,
right here. Read ’em and weep.
Jensen Comment
If you really want to see how sleazy mortgage lending became, read about the on
Marvene's shack in Phoenix. She purchased the shack for $3,500 and later, with
no improvements, got a $103,000 mortgage. When the mortgage was foreclosed,
neighbors bought the shack and tore it down ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's threads on the banking scandals accompanied by taxpayer
bailouts ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's fraud updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
The Bailout's Hidden, Ignoble Agendas
Aesop: We hang the petty thieves and appoint
the great ones to public office.
Bankers bet with their bank's capital, not
their own. If the bet goes right, they get a huge bonus; if it
misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital
Louria Hahn, "Missing: How Poor Risk-Management Techniques
Contributed to the Subprime Mess," CFO Magazine, March 2008,
Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Fed is going to bail out these crooks with taxpayer
funds makes it all the worse.
The bourgeoisie can
be termed as any group of people who are discontented with what they
have, but satisfied with what they are
Nicolás Dávila |
That some bankers have ended up in prison is not a
matter of scandal, but what is outrageous is the fact that all the others are
free.
Honoré de Balzac
In the Opinion of Economics Professor Meltzer from Carnegie-Mellon University
"Preventing the Next Financial Crisis: Don't be fooled by the bond
market. Banks are holding prices down because they can buy Treasurys with free
money from the Fed," The Wall Street Journal, by Alan H. Meltzer,
October 22, 2009 ---
http://online.wsj.com/article/SB10001424052748704224004574489251193581802.html?mod=djemEditorialPage
The United States is headed toward a new
financial crisis. History gives many examples of countries with high actual
and expected money growth, unsustainable budget deficits, and a currency
expected to depreciate. Unless these countries made massive policy changes,
they ended in crisis. We will escape only if we act forcefully and soon.
As long ago as the 1960s, then French
President Charles de Gaulle complained that the U.S. had the "exorbitant
privilege" of financing its budget deficit by issuing more dollars. Massive
purchases of dollar debt by foreigners can of course delay the crisis, but
today most countries have their own deficits to finance. It is unwise to
expect them, mainly China, to continue financing up to half of ours for the
next 10 or more years. Our current and projected deficits are too large
relative to current and prospective world saving to rely on that outcome.
Worse, banks' idle reserves that are
available for lending reached $1 trillion last week. Federal Reserve
Chairman Ben Bernanke said repeatedly in the past that excess reserves would
run down when banks and other financial companies repaid their heavy
short-term borrowing to the Fed. The borrowing has been repaid but idle
reserves have increased. Once banks begin to expand loans or finance even
more of the massive deficits, money growth will rise rapidly and the dollar
will sink to new lows. Do we have to wait for a crisis before we replace
promises with effective restraint?
Many market participants reassure
themselves that inflation won't come by noting the decline in yields on
longer-term Treasury bonds and the spread between nominal Treasury yields
and index-linked TIPS that protect against inflation. They measure
expectations of higher inflation by the difference between these two rates,
and imply long-term investors aren't demanding higher interest rates to
protect themselves against it. But those traditional inflation-warning
indicators are distorted because the Fed lends money at about a zero rate
and the banks buy Treasury securities, reducing their yield and thus the
size of the inflation premium.
Further, the Fed is buying massive amounts
of mortgages to depress and distort the mortgage rate. This way of
subsidizing bank profits and increasing their capital bails out these
institutions but avoids going to Congress for more money to do so. It
follows the Fed's usual practice of protecting big banks instead of the
public.
The administration admits to about $1
trillion budget deficits per year, on average, for the next 10 years. That's
clearly an underestimate, because it counts on the projected $200 billion to
$300 billion of projected reductions in Medicare spending that will not be
realized. And who can believe that the projected increase in state spending
for Medicaid can be paid by the states, or that payments to doctors will be
reduced by about 25%?
While Chinese government purchases of our
debt may delay a dollar and debt crisis, they also delay any effective
program to reduce the size of that crisis. It is far better to begin
containing the problem before we blow a hole in the dollar and start another
downturn.
A weak economy is a poor time to reduce
current government spending or raise tax rates, but we don't require
draconian immediate changes. We do need a fully specified, multi-year
program to restore fiscal probity by reducing spending, and a budget rule
that limits the size and frequency of deficits. The plan should be announced
in a rousing speech by the president. The emphasis should be on reducing
government spending.
The Obama administration chooses to blame
outsize deficits on its predecessor. That's a mistake, because it hides a
structural flaw: We no longer have any way of imposing fiscal restraint and
financial prudence. Federal, state and local governments understate future
spending and run budget deficits in good times and bad. Budgets do not
report these future obligations.
Except for a few years in the 1990s, both
parties have been at fault for decades, and the Obama administration is one
of the worst offenders. Its $780 billion stimulus bill, enacted earlier this
year, has been wasteful and ineffective. The Council of Economic Advisers
was so pressed to justify the spending spree that it shamefully invented a
number called "jobs saved" that has never been seen before, has no agreed
meaning, and no academic standing.
One reason for the great inflation of the
1970s was that the Federal Reserve gave primacy to reducing unemployment.
But attempts to tame inflation later didn't last, and the result was a
decade of high and rising unemployment and prices. It did not end until the
public accepted temporarily higher unemployment—more than 10.5% in the fall
of 1982—to reduce inflation.
Another error of the 1970s was the
assumption there was a necessary trade-off along a stable Phillips Curve
between unemployment and inflation—in other words, that more inflation was
supposed to lower unemployment. Instead, both rose. The Fed under Paul
Volcker stopped making those errors, and inflation fell permanently for the
first time since the 1950s.
Both errors are back. The Fed and most
others do not see inflation in the near term. Neither do I. High inflation
is unlikely in 2010. That's why a program beginning now should start to
lower excess reserves gradually so that the Fed will not have to make its
usual big shift from excessive ease to severe contraction that causes a
major downturn in the economy.
A steady, committed policy to reduce
future inflation and lower future budget deficits will avoid the crisis that
current policies will surely bring. Low inflation and fiscal prudence is the
right way to strengthen the dollar and increase economic well being.
Dr. Meltzer is professor of political economy at Carnegie Mellon
University and the author of the multi-volume "A History of the Federal
Reserve" (University of Chicago, 2004 and 2010).
Breaking the Bank Frontline
Video
In Breaking the Bank, FRONTLINE producer Michael Kirk
(Inside the Meltdown, Bush’s War) draws on a rare combination of high-profile
interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to
reveal the story of two banks at the heart of the financial crisis, the rocky
merger, and the government’s new role in taking over — some call it
“nationalizing” — the American banking system.
Simoleon Sense, September 18,
2009 ---
http://www.simoleonsense.com/video-frontline-breaking-the-bank/
Bob Jensen's threads on the banking bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Banks Still Cannot Resist Understating Loan Loss
Reserves
BB&T Net Falls 58% as Bad Loans Surge
by
Matthias Rieker and Joan E. Solsman
Oct 20, 2009
Click here to view the full article on WSJ.com
TOPICS: Allowance
For Doubtful Accounts, Bad Debts, Banking, Loan Loss Allowance
SUMMARY: BB&T
Corp. is a Winston-Salem, N.C., bank that has been "...considered among the
best-run regional banks." The bank has "...reported a continued rise in
delinquent loans in states hit by the recession, such as North Carolina,
rather than those known more for being clobbered by the mortgage
meltdown....BB&T Chief Executive Kelly King said during a conference call
with investors that the company added $263 million to its loan-loss reserve,
which he called 'a significant number.' Some investors hoped BB&T would
write off bad loans more decisively than it did and build its loan-loss
reserve more aggressively, analysts said."
CLASSROOM
APPLICATION: Questions
relate to loan loss reserve process and understanding the implications of
types of loan losses-those on delinquent loans from states hit hard by
recession, rather than from states with significant real estate value
losses.
QUESTIONS:
1. (Introductory)
Describe the process of creating reserves against losses for loans and
writing off bad loans. Specifically describe when the expense for bad debts
impacts a bank's-or a company's-income calculation.
2. (Introductory)
How do trends in loan write-offs and loan delinquencies inform the process
of creating reserves for loan losses?
3. (Advanced)
What is the significance for future profits of not creating a sufficient
reserve for loan losses?
4. (Advanced)
Analysts following BB&T stated that they wished the bank would write off bad
loans "decisively" and build its loan-loss reserve "aggressively" even as
the bank's chief executive described the balance in the loan-loss reserve as
a "significant number." Why would analysts and investors prefer a "more
aggressive approach." Include in your answer a comment on the notion of
conservatism in accounting.
5. (Advanced)
What is the significance of the source of loans going bad-that is, loans
made in states hit hard by recession versus the real estate market downfall.
In your answer, also comment on commercial versus personal loan categories
as well.
Reviewed By: Judy Beckman, University of Rhode Island
"BB&T Net Falls 58% as Bad Loans Surge," by
Matthias Rieker and Joan E. Solsman, The Wall Street Journal, October 20, 20 ---
http://online.wsj.com/article/SB125595468300993939.html?mod=djem_jiewr_AC
If last week's earnings by
three of the largest U.S. banks gave investors hope that the end of steep
losses from soured loans might be closer, regional bank BB&T Corp. delivered
a setback Monday.
The Winston-Salem, N.C.,
bank, long considered among the best-run regional banks, reported a
continued rise in delinquent loans in states hit by the recession, such as
North Carolina, rather than those known more for being clobbered by the
mortgage meltdown.
"The core BB&T sees more
cracks in credit," said analyst Kevin Fitzsimmons of Sandler O'Neill &
Partners LP.
In 4 p.m. New York Stock
Exchange composite trading, BB&T fell $1.22, or 4.3%, to $27.03, with
investors also selling off other regional banks into the rising market
Monday. "Regionals simply don't have any firepower to withstand rapidly
eroding commercial assets" even if losses from consumer loans are
stabilizing, analyst Todd Hagerman of Collins Stewart LLC said.
BB&T Chief Executive Kelly
King said during a conference call with investors that the company added
$263 million to its loan-loss reserve, which he called "a significant
number." Some investors hoped BB&T would write off bad loans more decisively
than it did and build its loan-loss reserve more aggressively, analysts
said.
Third-quarter profit fell
58% to $152 million, or 23 cents a share, down from $358 million, or 65
cents a share, a year earlier.
Credit-loss provisions
soared 95% to $709 million from $364 million a year earlier, while rising
from the second quarter's $701 million. Nonperforming assets, or loans in
danger of going bad, rose to 2.5% from 1.2% a year earlier and 2.2% from the
previous quarter.
BB&T "has a lot more
real-estate exposure than the money centers, plus it does not have nearly as
much capital markets to offset" such losses than big banks such as Bank of
America Corp. and Citigroup Inc. that reported earnings last week, said Jeff
Davis of FTN Equity Capital Markets Corp.
Losses from bad loans "are
going to find the peak in the next two or three quarters," Mr. King said,
adding that "nonperformance of the industry and for us continue to increase
probably at a declining rate of increase."
BB&T strengthened its
capital base in August with a $963 million offering of common stock after it
purchased Colonial Bank, a unit of Colonial BancGroup Inc., Montgomery,
Ala., that was seized by regulators in August.
In June, BB&T became one of
the first U.S. banks to pay back the capital infusion it got from the
Treasury Department's Troubled Asset Relief Program.
In the latest quarter,
average client deposits were up 20% from a year earlier amid the Colonial
takeover, while average loans and leases held for investment showed a 6%
increase.
Why did the auditors approve such understated
loan loss reserves in the subprime scandals?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Another one from that Ketz guy
He knows about Altman’s Z-score model for non-manufacturers
---
http://en.wikipedia.org/wiki/Bankruptcy_prediction
"Hertz Diverts and Subverts (Where Are You,
Mary?)," by: J. Edward Ketz, SmartPros, October 2009 ---
http://accounting.smartpros.com/x67864.xml
In a recent perversion,
Hertz Global Holdings (HTZ) sued Audit Integrity because it had the audacity
to predict that Hertz was in danger of bankruptcy. This is another example
of issuer retaliation and it must stop. The Congress and the SEC need to
rein in corporate America when it attempts to enforce censorship against
anybody that criticizes them.
The facts in the case
are simple. Earlier this year Audit Integrity moved Hertz on to its watch
list for companies in financial distress. Hertz demanded a retraction and
sent a copy of the letter to 19 other firms that made the list, encouraging
them to join Hertz in “protecting the investing public.” Then Hertz sued
Audit Integrity for defamation. (See Sue Reisinger, “Hertz
GC Sues Analyst Who Said Company Could Go Bankrupt”)
Audit Integrity
responded with an
open letter to the SEC. James Kaplan, Chairman of
Audit Integrity, wrote “As Hertz’s ultimate goal was to silence an
independent research firm calling regulatory and investor attention to the
company’s real and material financial risk, the matter warrants an
investigation by the Securities and Exchange Commission.”
Quite frankly, the court
should just toss out the case. Any introductory student of mine can compute
the Altman Z-score and indeed discover that Hertz is in financial distress.
Its 2008 10-K is quite revealing, with net income a negative $1.2 billion
and EBIT a negative $164 million. Retained earnings has a deficit of almost
one billion dollars. And its capital structure is heavily tilted on the
debt side as its debt-equity ratio exceeds 10. Any neophyte would agree
with Audit Integrity.
Altman’s Z-score model for
non-manufacturers is:
Z = 6.56 * WC/TA + 3.26 *
RE/TA + 6.72 * EBIT/TA + 1.05 * BVE/TD
where WC = working capital
TA= total assets
RE = retained earnings
EBIT = earnings before interest and taxes
BVE = book value of equity and
TD = total debts.
One interprets the Z-score
as follows. If Z>2.6, then we predict the firm is healthy and relatively
free from financial distress. If 1.1<Z<2.6, the company is in the
indeterminate zone. It faces some financial distress, but more
investigation is needed to determine how serious it is. But, if Z<1.1, then
the model predicts that the firm faces a serious chance of going into
bankruptcy.
When I plug Hertz’s 2008
numbers into the model, I obtain a Z-score of 0.417. Altman’s model
therefore predicts bankruptcy. I guess Hertz should sue Professor Altman
for inventing such a model. After all, if the firm goes under, it must be
his fault.
A few years ago Senator
Wyden expressed concerns about corporate managers who attempt to intimidate
those who issue research reports critical of them and their operations. He
correctly stated that the impact of such retaliation could have an adverse
reaction on the publication of objective research, which in turn could have
a negative impact on the quality of information that is employed by the
investment community and could lead to an inefficient allocation of
resources.
Chairman Cox responded to
the Senator on September 1, 2005. He stated that he shared Sen. Wyden’s
concerns about issuer retaliation and its adverse impact on the investment
community. He promised to tackle the issue, but never did.
Mary Schapiro, it is your
turn. Are you going to embrace the mission statement of the SEC and be an
advocate for investors or are you going to be like your predecessor and say
one thing but behind the scenes enable managers and directors to defraud the
investment community?
Issuer retaliation is an
incredible problem in this country. If it isn’t stopped, independent
investors will stop performing independent research analyses. And there
will be more and more Enrons bursting on the scene.
Mary, where are you? Where
do you stand on the issues of the day?
Jensen Comment
An enormous problem faced by security analysts, credit rating agencies, and
auditors is that when a company is on the edge of bankruptcy, these
professionals are no longer confined to professionalism in evaluation. They
become decision makers to the extent that "yelling fire" greatly increases the
odds of helping to cause a fire.
Bob Jensen's threads on difficulties security
analysts encounter when trying (or not trying) to issue negative reports on
companies ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Question
Do you ever get the feeling while we debate accounting theory and standards that
we're just fiddling while investors burn?
"Is stock market still a chump's game? Small
investors won't have a fair shot until a presumption of integrity is restored.
It's not clear that Obama's proposed remedy will resolve the conflicts," by
Eliot Spitzer, Microsoft News, August 19, 2009 ---
http://articles.moneycentral.msn.com/Investing/Extra/is-stock-market-still-a-chumps-game.aspx
Link forwarded by Steve Markoff
[smarkoff@KIMSTARR.ORG]
One of America's great
accomplishments in the last half-century was the so-called "democratization"
of the financial markets.
No longer just for the upper
crust, investing became a way for the burgeoning middle class to accumulate
wealth. Mutual funds exploded in size and number, 401k plans made savings
and investing easy, and the excitement of participating in the growth of our
economy gripped an ever larger percentage of the population.
Despite a backdrop of
doubters -- those who knowingly asserted that outperforming the average was
an impossibility for the small investor -- there was a growing consensus
that the rules were sufficient to protect the mom-and-pop investor from the
sharks that swam in the water.
That sense of fair play in
the market has been virtually destroyed by the bubble burstings and market
drops of the past few years.
Recent rebounds
notwithstanding, most people now are asking whether the system is
fundamentally rigged. It's not just that they have an understandable
aversion to losing their life savings when the market crashes; it's that
each of the scandals and crises has a common pattern: The small investor was
taken advantage of by the piranhas that hide in the rapidly moving currents.
And underlying this pattern is
a simple theme: conflicts of interest that violated the duty the market
players had to their supposed clients.
It is no wonder that
cynicism and anger have replaced what had been the joy of participation in
the capital markets.
Take a quick run through a
few of the scandals:
-
Analysts at major
investment banks promote stocks they know to be worthless, misleading
the investors who rely on their advice yet helping their
investment-banking colleagues generate fees and woo clients.
-
Ratings agencies slap AAA
ratings on debt they know to be dicey in order to appease the issuers --
who happen to pay the fees of the agencies, violating the rating
agency's duty to provide the marketplace with honest evaluations.
-
Executives receive outsized
and grotesque compensation packages -- the result of the perverted
recommendations of compensation consultants whose other business depends
upon the goodwill of the very CEOs whose pay they are opining upon, thus
violating the consultants' duty to the shareholders of the companies for
whom they are supposedly working.
-
Mutual funds charge
exorbitant fees that investors have to absorb -- fees that dramatically
reduce any possibility of outperforming the market and that are set by
captive boards of captive management companies, not one of which has
been replaced for inadequate performance, violating their duty to guard
the interests of the fund investors for whom they supposedly work.
-
"High-speed trading"
produces not only the reality of a two-tiered market but also the
probability of front-running -- that is, illegally trading on
information not yet widely known -- that eats into the possible profits
of the retail clients supposedly being served by these very same market
players, violating the obligation of the banks to get their clients
"best execution" without stepping between their customers and the best
available price.
-
AIG (AIG,
news,
msgs) is bailed out, costing taxpayers
tens of billions of dollars, even though (as we later learned) the big
guys knew that AIG was going down and were able to hedge and cover their
positions. Smaller investors are left holding the stock, and all of us
are left picking up the tab.
The unifying theme is
apparent: Access to information and advice, the very lifeblood of a level
playing field, is not where it needs to be. The small investor still doesn't
have a fair shot.
While there have been
case-specific remedies, the aggregate effect of all the scandals is still to
deny the market the most essential of ingredients: the presumption of
integrity.
The issue confronting those
who wish to solve this problem is that there really is no simple fix.
Bob Jensen's threads on the economic crisis
are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"JPMorgan (read that Chase Bank) faces SEC
lawsuit," by Aline van Duyn and Francesco Guerrera, Financial Times, May 8,
2009 ---
JPMorgan Chase may be sued
by US regulators for violating securities laws and market rules related to
the sale of bonds and interest-rate swaps to Jefferson County, Alabama.
The potential Securities and
Exchange Commission action is the latest twist in a complex debt financing
saga which has already led to charges against Jefferson County officials and
which has left the municipality struggling to avoid default on over $3bn of
debt, much of it taken on to improve its sewage system.
JPMorgan said in a
regulatory filing, made late on Thursday just as the results of bank stress
tests were being released, that it had been told about the SEC action on
April 21. It said it “has been engaged in discussions with the SEC staff in
an attempt to resolve the matter prior to litigation”. The bank had no
further comment on Friday.
Jefferson County is one of
the most indebted municipalities in the US due to its expensive overhaul of
its sewage system. JPMorgan is one of the lenders which has repeatedly
extended the deadline on payments due by Jefferson County on its debt and
derivatives.
A law is currently being
considered that would create a new tax which would provide revenues to pay
the sewer debt. If Jefferson County defaults, it would be the biggest by a
US municipality, dwarfing the problems faced by California’s Orange County
in the 1990s.
The mayor of Birmingham,
Alabama, and two of his friends were last year charged by US regulators in
connection with an undisclosed payment scheme related to municipal bond and
swap deals.
The SEC alleged that Larry
Langford, the mayor, received more than $156,000 in cash and benefits from a
broker hired to arrange bond offerings and swap agreements on behalf of
Jefferson County, where Birmingham is located.
Although the details of the
SEC investigation are not known, it is likely to be related to the payment
scheme through which banks like JPMorgan paid fees to local brokers at the
request of Jefferson County.
The credit crisis has
brought to light numerous problems in the municipal bond markets. Many
borrowers relied on bond insurance to sell their deals, and the collapse in
the credit ratings of bond insurers has made it difficult for many to raise
funds or to do so at low interest rates.
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll,
The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print
The legislation's guidelines for crafting the
rescue plan were clear: the TARP should protect home values and consumer
savings, help citizens keep their homes and create jobs. Above all, with the
government poised to invest hundreds of billions of taxpayer dollars in
various financial institutions, the legislation urged the bailout's
architects to maximize returns to the American people.
That $700 billion bailout has since
grown into a more than $12 trillion commitment by
the US government and the Federal Reserve. About
$1.1 trillion
of that is taxpayer money--the TARP money and an additional $400 billion
rescue of mortgage companies Fannie Mae and Freddie Mac. The TARP now
includes twelve separate programs, and recipients range from megabanks like
Citigroup and JPMorgan Chase to automakers Chrysler and General Motors.
Seven months in, the bailout's impact is
unclear. The Treasury Department has used the
recent "stress test" results it applied to
nineteen of the nation's largest banks to suggest that the worst might be
over; yet the
International Monetary Fund, as well as economists
like New York University professor and economist Nouriel Roubini and New
York Times columnist Paul Krugman
predict greater losses in US markets, rising unemployment and
generally tougher economic times ahead.
What cannot be disputed, however, is the
financial bailout's biggest loser: the American taxpayer. The US government,
led by the Treasury Department, has done little, if anything, to maximize
returns on its trillion-dollar, taxpayer-funded investment. So far, the
bailout has favored rescued financial institutions by
subsidizing their
losses to the tune of $356 billion,
shying away from much-needed management changes and--with the exception of
the automakers--letting companies take taxpayer money without a coherent
plan for how they might return to viability.
The bailout's perks have been no less
favorable for private investors who are now picking over the economy's
still-smoking rubble at the taxpayers' expense. The newer bailout programs
rolled out by Treasury Secretary Timothy Geithner give private equity firms,
hedge funds and other private investors significant leverage to buy "toxic"
or distressed assets, while leaving taxpayers stuck with the lion's share of
the risk and potential losses.
Given the lack of transparency and
accountability, don't expect taxpayers to be able to object too much. After
all, remarkably little is known about how TARP recipients have used the
government aid received. Nonetheless, recent government
reports,
Congressional testimony and
commentaries offer those patient enough to pore over hundreds of pages of
material glimpses of just how Wall Street friendly the bailout actually is.
Here, then, based on the most definitive data and analyses available, are
six of the most blatant and alarming ways taxpayers have been scammed by the
government's $1.1-trillion, publicly funded bailout.
1. By
overpaying for its TARP investments, the Treasury Department provided
bailout recipients with generous subsidies at the taxpayer's expense.
When the Treasury Department ditched its
initial plan to buy up "toxic" assets and instead invest directly in
financial institutions, then-Treasury Secretary Henry Paulson Jr. assured
Americans that they'd get a fair deal. "This is an investment, not an
expenditure, and there is no reason to expect this program will cost
taxpayers anything," he
said in October 2008.
Yet the Congressional Oversight Panel
(COP), a five-person group tasked with ensuring that the Treasury Department
acts in the public's best interest, concluded in its
monthly report for February that
the department had significantly overpaid by tens of billions of dollars for
its investments. For the ten largest TARP investments made in 2008, totaling
$184.2 billion, Treasury received on average only $66 worth of assets for
every $100 invested. Based on that shortfall, the panel calculated that
Treasury had received only $176 billion in assets for its $254 billion
investment, leaving a $78 billion hole in taxpayer pockets.
Not all investors subsidized the
struggling banks so heavily while investing in them. The COP report notes
that private investors received much closer to fair market value in
investments made at the time of the early TARP transactions. When, for
instance,
Berkshire Hathaway invested $5 billion in Goldman Sachs
in September, the Omaha-based company received
securities worth $110 for each $100 invested. And when
Mitsubishi invested in Morgan Stanley
that same month, it received securities worth
$91 for every $100 invested.
As of May 15, according to the
Ethisphere TARP Index, which
tracks the government's bailout investments, its various investments had
depreciated in value by almost $147.7 billion. In other words, TARP's losses
come out to almost $1,300 per American taxpaying household.
2. As the
government has no real oversight over bailout funds, taxpayers remain in the
dark about how their money has been used and if it has made any difference.
While the Treasury Department can make
TARP recipients report on just how they spend their government bailout
funds, it has chosen not to do so. As a result, it's unclear whether
institutions receiving such funds are using that money to increase
lending--which would, in turn, boost the economy--or merely to fill in holes
in their balance sheets.
Neil M. Barofsky, the special inspector
general for TARP, summed the situation up this way in his office's April
quarterly report to Congress: "The American people have a right to know how
their tax dollars are being used, particularly as billions of dollars are
going to institutions for which banking is certainly not part of the
institution's core business and may be little more than a way to gain access
to the low-cost capital provided under TARP."
This lack of transparency makes the
bailout process highly susceptible to fraud and corruption.
Barofsky's report stated that twenty separate
criminal investigations were already underway involving corporate fraud,
insider trading and public corruption. He also
told the Financial Times
that his office was investigating whether banks manipulated their books to
secure bailout funds. "I hope we don't find a single bank that's cooked its
books to try to get money, but I don't think that's going to be the case."
Economist Dean Baker, co-director of the
Center for Economic and Policy Research in Washington, suggested to
TomDispatch in an interview that the opaque and complicated nature of the
bailout may not be entirely unintentional, given the difficulties it raises
for anyone wanting to follow the trail of taxpayer dollars from the
government to the banks. "[Government officials] see this all as a Three
Card Monte, moving everything around really quickly so the public won't
understand that this really is an elaborate way to subsidize the banks,"
Baker says, adding that the public "won't realize we gave money away to some
of the richest people."
3. The
bailout's newer programs heavily favor the private sector, giving investors
an opportunity to earn lucrative profits and leaving taxpayers with most of
the risk.
Under Treasury Secretary Geithner, the
Treasury Department has greatly expanded the financial bailout to troubling
new programs like the Public-Private Investment Program (PPIP) and the Term
Asset-Backed-Securities Loan Facility (TALF). The PPIP, for example,
encourages private investors to buy "toxic" or risky assets on the books of
struggling banks. Doing so, we're told, will get banks lending again because
the burdensome assets won't weigh them down. Unfortunately, the incentives
the Treasury Department is offering to get private investors to participate
are so generous that the government--and, by extension, American
taxpayers--are left with all the downside.
Joseph Stiglitz, the Nobel-prize winning
economist,
described the PPIP program in a
New York Times op-ed this way:
Consider an asset that
has a 50-50 chance of being worth either zero or $200 in a year's time. The
average "value" of the asset is $100. Ignoring interest, this is what the
asset would sell for in a competitive market. It is what the asset is
'worth.' Under the plan by Treasury Secretary Timothy Geithner, the
government would provide about 92 percent of the money to buy the asset but
would stand to receive only 50 percent of any gains, and would absorb almost
all of the losses. Some partnership!
Assume that one of the
public-private partnerships the Treasury has promised to create is willing
to pay $150 for the asset. That's 50 percent more than its true value, and
the bank is more than happy to sell. So the private partner puts up $12, and
the government supplies the rest--$12 in "equity" plus $126 in the form of a
guaranteed loan.
If, in a year's time,
it turns out that the true value of the asset is zero, the private partner
loses the $12, and the government loses $138. If the true value is $200, the
government and the private partner split the $74 that's left over after
paying back the $126 loan. In that rosy scenario, the private partner more
than triples his $12 investment. But the taxpayer, having risked $138, gains
a mere $37."
Worse still, the PPIP can be easily
manipulated for private gain. As economist
Jeffrey Sachs has described it, a
bank with worthless toxic assets on its books could actually set up its
own public-private fund to bid on those assets. Since no true bidder
would pay for a worthless asset, the bank's public-private fund would win
the bid, essentially using government money for the purchase. All the
public-private fund would then have to do is quietly declare bankruptcy and
disappear, leaving the bank to make off with the government money it
received. With the PPIP deals set to begin in the coming months, time will
tell whether private investors actually take advantage of the program's
flaws in this fashion.
The Treasury Department's TALF program
offers equally enticing possibilities for potential bailout profiteers,
providing investors with a chance to double, triple or even quadruple their
investments. And like the PPIP, if the deal goes bad, taxpayers absorb most
of the losses. "It beats any financing that the private sector could ever
come up with," a
Wall Street trader commented
in a recent Fortune magazine story. "I almost want to say it is
irresponsible."
4. The
government has no coherent plan for returning failing financial institutions
to profitability and maximizing returns on taxpayers' investments.
Compare the treatment of the auto industry
and the financial sector, and a troubling double standard emerges. As a
condition for taking bailout aid, the government required Chrysler and
General Motors to present
detailed plans on how the
companies would return to profitability. Yet the Treasury Department
attached minimal conditions to the billions injected into the largest
bailed-out financial institutions. Moreover, neither Geithner nor Lawrence
Summers, one of President Barack Obama's top economic advisors, nor the
president himself has articulated any substantive plan or vision for how the
bailout will help these institutions recover and, hopefully, maximize
taxpayers' investment returns.
The Congressional Oversight Panel
highlighted the absence of such a comprehensive plan in its
January report. Three months into
the bailout, the Treasury Department "has not yet explained its strategy,"
the report stated. "Treasury has identified its goals and announced its
programs, but it has not yet explained how the programs chosen constitute a
coherent plan to achieve those goals."
Today, the department's endgame for the
bailout still remains vague. Thomas Hoenig, president of the Federal Reserve
Bank of Kansas City,
wrote in the Financial Times
in May that the government's response to the financial meltdown has been "ad
hoc, resulting in inequitable outcomes among firms, creditors, and
investors." Rather than perpetually prop up banks with endless taxpayer
funds, Hoenig suggests, the government should allow banks to fail. Only
then, he believes, can crippled financial institutions and systems be fixed.
"Because we still have far to go in this crisis, there remains time to
define a clear process for resolving large institutional failure. Without
one, the consequences will involve a series of short-term events and far
more uncertainty for the global economy in the long run."
The healthier and more profitable bailout
recipients are once financial markets rebound, the more taxpayers will earn
on their investments. Without a plan, however, banks may limp back to
viability while taxpayers lose their investments or even absorb further
losses.
5. The
bailout's focus on Wall Street mega-banks ignores smaller banks serving
millions of American taxpayers that face an equally uncertain future.
The government may not have a long-term
strategy for its trillion-dollar bailout, but its guiding principle, however
misguided, is clear: what's good for Wall Street will be best for the rest
of the country.
On the day the mega-bank stress tests were
officially released, another set of stress-test results came out to much
less fanfare. In its
quarterly report on the health of individual banks and the banking industry
as a whole, Institutional Risk
Analytics (IRA), a respected financial services organization, found that the
stress levels among more than 7,500 FDIC-reporting banks nationwide had
risen dramatically. For 1,575 of the banks, net incomes had turned negative
due to decreased lending and less risk-taking.
The conclusion IRA drew was telling: "Our
overall observation is that US policy makers may very well have been
distracted by focusing on 19 large stress test banks designed to save Wall
Street and the world's central bank bondholders, this while a trend is
emerging of a going concern viability crash taking shape under the radar."
The report concluded with a question: "Has the time come to shift the policy
focus away from the things that we love, namely big zombie banks, to tackle
things that are truly hurting us?"
6. The bailout
encourages the very behaviors that created the economic crisis in the first
place instead of overhauling our broken financial system and helping the
individuals most affected by the crisis.
As Joseph Stiglitz explained in the New
York Times, one major cause of the economic crisis was bank
overleveraging. "Using relatively little capital of their own," he wrote,
banks "borrowed heavily to buy extremely risky real estate assets. In the
process, they used overly complex instruments like collateralized debt
obligations." Financial institutions engaged in overleveraging in pursuit of
the lucrative profits such deals promised--even if those profits came with
staggering levels of risk.
Sound familiar? It should, because in the
PPIP and TALF bailout programs the Treasury Department has essentially
replicated the very over-leveraged, risky, complex system that got us into
this mess in the first place: in other words, the government hopes to repair
our financial system by using the flawed practices that caused this crisis.
Then there are the institutions deemed
"too big to fail." These financial giants--among them AIG, Citigroup and
Bank of America-- have been kept afloat by billions of dollars in bottomless
bailout aid. Yet reinforcing the notion that any institution is "too big to
fail" is dangerous to the economy. When a company like AIG grows so large
that it becomes "too big to fail," the risk it carries is systemic, meaning
failure could drag down the entire economy. The government should force "too
big to fail" institutions to slim down to a safer, more modest size;
instead, the Treasury Department continues to subsidize these financial
giants, reinforcing their place in our economy.
Of even greater concern is the message the
bailout sends to banks and lenders--namely, that the risky investments that
crippled the economy are fair game in the future. After all, if banks fail
and teeter at the edge of collapse, the government promises to be there with
a taxpayer-funded, potentially profitable safety net.
The handling of the bailout makes at least
one thing clear, however. It's not your health that the government is
focused on, it's theirs-- the very banks and lenders whose convoluted
financial systems provided the underpinnings for staggering salaries and
bonuses, while bringing our economy to the brink of another Great
Depression.
Bob Jensen's threads how your money was put to word
(fraudulently) to pay for the mistakes of the so-called professionals of finance
---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Bob Jensen's threads on why the infamous "Bailout" won't
work ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#BailoutStupidity
Bob Jensen's "Rotten to the Core" threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
New Hints at Why the SEC Failed to Seriously Investigate Madoff's Hedge
Fund
After being repeatedly warned for six years that this was a criminal scam
It's beginning to look like a family "affair"
(The SEC's) Swanson later married Madoff's niece,
and their relationship is now under review by the SEC inspector general, who is
examining the agency's handling of the Madoff case, the Post reported. Swanson,
no longer with the agency, declined to comment, the Post said.
"SEC lawyer raised alarm about Madoff: report," Reuters, July 2, 2009 ---
http://news.yahoo.com/s/nm/20090702/bs_nm/us_madoff_sec
The Washington Post account is at ---
Click Here
A U.S. Securities and Exchange Commission lawyer
warned about irregularities at Bernard Madoff's financial management firm as
far back as 2004, The Washington Post reported on Thursday, citing agency
documents and sources familiar with the investigation.
Genevievette Walker-Lightfoot, a lawyer in the
SEC's Office of Compliance Inspections and Examinations, sent emails to a
supervisor saying information provided by Madoff during her review didn't
add up and suggesting a set of questions to ask his firm, the report said.
Several of the questions directly challenged Madoff
activities that turned out to be elements of his massive fraud, the
newspaper said.
Madoff, 71, was sentenced to a prison term of 150
years on Monday after he pleaded guilty in March to a decades-long fraud
that U.S. prosecutors said drew in as much as $65 billion.
The Washington Post reported that when
Walker-Lightfoot reviewed the paper documents and electronic data supplied
to the SEC by Madoff, she found it full of inconsistencies, according to
documents, a former SEC official and another person knowledgeable about the
2004 investigation.
The newspaper said the SEC staffer raised concerns
about Madoff but, at the time, the SEC was under pressure to look for
wrongdoing in the mutual fund industry. Walker-Lightfoot was told to focus
on a separate probe into mutual funds, the report said.
One of Walker-Lightfoot's supervisors on the case
was Eric Swanson, an assistant director of her department, the Post
reported, citing two people familiar with the investigation.
Swanson later married Madoff's niece, and their
relationship is now under review by the SEC inspector general, who is
examining the agency's handling of the Madoff case, the Post reported.
Swanson, no longer with the agency, declined to
comment, the Post said.
SEC spokesman John Nester also declined to comment,
citing the ongoing investigation by the agency's inspector general, the
newspaper said.
Our Main Financial Regulating Agency: The SEC Screw
Everybody Commission
One of the biggest regulation failures in history is the way the SEC failed to
seriously investigate Bernie Madoff's fund even after being warned by Wall
Street experts across six years before Bernie himself disclosed that he was
running a $65 billion Ponzi fund.
CBS Sixty Minutes on June 14, 2009 ran a rerun that is
devastatingly critical of the SEC. If you’ve not seen it, it may still be
available for free (for a short time only) at
http://www.cbsnews.com/video/watch/?id=5088137n&tag=contentMain;cbsCarousel
The title of the video is “The Man Who Would Be King.”
Also see
http://www.fraud-magazine.com/FeatureArticle.aspx
Between 2002 and 2008 Harry Markopolos repeatedly told
(with indisputable proof) the Securities and Exchange Commission that Bernie
Madoff's investment fund was a fraud. Markopolos was ignored and, as a result,
investors lost more and more billions of dollars. Steve Kroft reports.
Markoplos makes the SEC look truly incompetent or
outright conspiratorial in fraud.
I'm really surprised that the SEC survived after Chris
Cox messed it up so many things so badly.
As Far as Regulations Go
An annual report issued by
the Competitive Enterprise Institute (CEI) shows that the U.S. government
imposed $1.17 trillion in new regulatory costs in 2008. That almost equals the
$1.2 trillion generated by individual income taxes, and amounts to $3,849 for
every American citizen. According the 2009 edition of Ten Thousand Commandments:
An Annual Snapshot of the Federal Regulatory State, the government issued 3,830
new rules last year, and The Federal Register, where such rules are listed,
ballooned to a record 79,435 pages. “The costs of federal regulations too often
exceed the benefits, yet these regulations receive little official scrutiny from
Congress,” said CEI Vice President Clyde Wayne Crews, Jr., who wrote the report.
“The U.S. economy lost value in 2008 for the first time since 1990,” Crews said.
“Meanwhile, our federal government imposed a $1.17 trillion ‘hidden tax’ on
Americans beyond the $3 trillion officially budgeted” through the regulations.
Adam Brickley,
"Government Implemented Thousands of New Regulations Costing $1.17 Trillion in
2008," CNS News, June 12, 2009 ---
http://www.cnsnews.com/public/content/article.aspx?RsrcID=49487
Jensen Comment
I’m a long-time believer that industries being regulated end up controlling the
regulating agencies. The records of Alan Greenspan (FED) and the SEC from Arthur
Levitt to Chris Cox do absolutely nothing to change my belief ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
How do industries leverage the regulatory agencies?
The primary control mechanism is to have high paying jobs waiting in industry
for regulators who play ball while they are still employed by the government. It
happens time and time again in the FPC, EPA, FDA, FAA, FTC, SEC, etc. Because so
many people work for the FBI and IRS, it's a little harder for industry to
manage those bureaucrats. Also the FBI and the IRS tend to focus on the worst of
the worst offenders whereas other agencies often deal with top management of the
largest companies in America.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Credit Derivative Swap Fraud
"SEC Charges Pair with Insider Trading in Swaps," SmartPros, May 5, 2009
---
http://accounting.smartpros.com/x66466.xml
The Securities and Exchange
Commission on Tuesday charged a securities salesman and a portfolio manager
with insider trading in the first such case involving credit default swaps.
The SEC alleges that
Jon-Paul Rorech, a salesman at Deutsche Bank Securities Inc., tipped off
Renato Negrin, a former portfolio manager at hedge fund investment adviser
Millennium Partners LP, about a possible change in terms of a bond being
issued by VNU NV, a Dutch publishing company that owns Nielsen Media and
other media businesses, in 2006. Deutsche Bank was acting as the lead
underwriter of the VNU bond issuance.
With knowledge of the
potential change in bond terms, Negrin purchased credit default swaps on VNU
for a Millennium hedge fund, according to the SEC complaint. After news of
the bond terms was released, Negrin sold the swaps at a profit of $1.2
million, according to the SEC.
Credit default swaps are an
insurance-like contract that protects a buyer from potential losses that
might be incurred on an underlying financial investment, such as a corporate
bond or mortgage-backed security. Many of those types of underlying
investments have lost much of their value or increasingly defaulted amid the
credit crisis.
If the underlying financial
investment is not repaid, the buyer of the swap is covered in full for the
losses through the swap.
Credit default swaps have
been widely seen as one of the major factors in the credit crisis. The
trading of swaps helped push Lehman Brothers Holdings Inc. into bankruptcy
protection and American International Group Inc. the to brink of failure
before being bailed out by the government.
Richard Strassberg, a lawyer
representing Rorech, said in a statement that his client acted "consistently
with the accepted practice in the industry." Strassberg said Rorech did not
violate any securities laws tied to the sale of the VNU bonds.
A lawyer for Negrin was not
immediately available to comment on the case.
The SEC is asking for the
judge to force the two to repay the money gained from the transaction, plus
penalties and back interest on the allegedly ill-gotten gains.
The SEC's hedge fund working
group handled the investigation. The group has brought more than 100 cases
alleging fraud and manipulation by hedge funds over the past five years,
including more than 20 in 2009.
Bob Jensen's threads on derivative financial
instruments fraud ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Added Insights on How the CDO Scandals Worked
February 9, 2009 message from Phillip Chiu
[p_chill@hotmail.com]
Dear Professor Jensen,
I am writing on behalf of a group of
investors numbering several tens of thousands in Hong Kong who believe they
have been duped by Lehman Brothers in purchasing what is described as
‘credit-linked’ notes (a small portion is variously described as
‘equity-linked note’ and the like).
The complexity of the products only
gradually came to light after the bankruptcy of Lehman Brothers last
September, followed by the rather irresponsible conduct manifested by the
refusal of the distributor banks and the regulators (the Securities and
Futures Commission and the Hong Kong Monetary Authority) to answer queries
relating to the approval and sales of such Notes.
The Notes were being sold indiscriminately
to the public without any regard to suitability of the particular investor.
By a rough estimate (profiles of the victimized investors have been withheld
by the government), about 40% of the entire body of investors are retirees,
elderly, uneducated or suffering from other handicaps.
We believe that the so-called
credit-linked notes actually conceal poor quality synthetic CDO described as
‘underlying security’. Ostensibly the Notes are advertised as
‘credit-linked’ to a handful of well-known companies, but this is no more
than a façade in order to obscure the all-important role played by the
portfolios of credit derivatives. I attach the issue prospectus and
programme prospectus of one of the many series for your ease of reference.
From your remarkable wealth of knowledge
in white collar fraud, I wonder if you would be interested in having a look
of the attachment and considering adding this scam in your website. Being
mere amateurs in finance, we have been struggling to unravel the fraud
without any assistance from the banks and the regulators. We would be most
grateful for any advice from you such as similar deceptive practice
(mischaracterizing highly risky derivatives as ‘security’ in order to
mislead the investors in this instance), or any other aspects that you may
consider we should pay attention to.
No details about the ‘underlying security’
was given in the prospectuses and Lehman sought to excuse the non-disclosure
by asserting that final decision had not been made when the prospectus went
to print. The intervals between each series of the Notes could be as short
as one month which renders the assertion implausible. After all, some
issuers of similar notes have adopted the practice of revealing an ‘expected
portfolio’ and cognate details. We consider this a key aspect of intentional
withholding of information. Your opinion on this would be very much
appreciated.
May I thank you in advance for taking time
to read our request.
Yours faithfully
Philip Chiu
Attachment 1 ---
http://faculty.trinity.edu/rjensen/HongKongLehman01.pdf
Attachment 2 ---
http://faculty.trinity.edu/rjensen/HongKongLehman02.pdf
Re-arranging the deck chairs on the USS SEC
We understand why Ms. Schapiro would want to show some
love to the staff after the blistering attack it received last Wednesday on the
Hill. Said liberal New York Congressman Gary Ackerman, "You have totally and
thoroughly failed in your mission." Then he went negative, referring to the
SEC's difficulty in finding a part of the human anatomy "with two hands with the
lights on." Mr. Markopolos added that his many interactions with the agency "led
me to conclude that the SEC securities' lawyers, if only through their
investigative ineptitude and financial illiteracy, colluded to maintain large
frauds such as the one to which Madoff later confessed." . . . If Ms. Schapiro
seeks to learn from the SEC's recent history, she might start by considering the
most basic lesson from the Madoff incident. Private market participants spotted
the fraud, while SEC lawyers couldn't seem to grasp it. Rather than giving her
staff lawyers still more autonomy, she should instead be supervising them more
closely, while trying to harness the intelligence of the marketplace. Meantime,
investors should remember that their own skepticism and diversified investing
remain their best defenses against fraudsters.
"Just Don't Mention Bernie: Unleashing the SEC enforcers who were already
unleashed," The Wall Street Journal, February 10, 2009 ---
http://online.wsj.com/article/SB123423071487965895.html?mod=djemEditorialPage
Also see "High "Power Distance" at the SEC: Why Madoff Was Allowed to Take
Investors Down with Him," by Tom Selling, The Accounting Onion, December
10, 2009 ---
http://accountingonion.typepad.com/theaccountingonion/2009/02/high-power-dist.html
I don't think we in the U.S. are as low
a power distance society as we fashion
ourselves, and the redistribution of
wealth that has been occurring since the
1980s may be pushing us inexorably
towards Colombia. Also, it wasn't
difficult for me to think of a few
examples of where the SEC in particular
has been exhibiting symptoms
characteristic of a high power distance
country:
-
When asked why
he robbed banks, Willie Sutton
simply replied, "Because that's
where the money is." Lately, it
seems that the SEC staff (i.e., the
"co-pilots,") has shied away from
the big money, out of a mirror-image
version of the self-interest
(survival, in case of a staff
member) that motivated Mr. Sutton.
And that fear is not merely
paranoia, as tangibly illustrated
recently when a former SEC
investigator was
fired
after pursuing evidence that John
Mack, Morgan Stanley's CEO,
allegedly had tipped off another
investment company about a pending
merger.
-
The
Christopher Cox administration
instituted an unprecedented policy
that required the Enforcement staff
to obtain a special set of approvals
from the Commission in order to
assess monetary penalties as
punishment for securities fraud.
Mary Schapiro, the new SEC chair,
claims
that the policy, among other
deleterious effects, "discouraged
staff from arguing for a penalty in
a case that might deserve a
penalty…" In other words, the
co-pilots were "encouraged" to keep
a lid on embarrassing news that
reflected badly on members of the
pilot class.
-
And, lest you should not labor under
any illusion that enforcement of
accounting rules is a level playing
field, consider the case in 1992 (I
think) when the SEC effectively
handed out special permission to
AT&T to account for its acquisition
of NCR as a "pooling of interests."
Quite evidently, the SEC staff could
not bring the bad news to the
"pilots" that the merger with NCR
would not happen just because AT&T
did not technically qualify for the
accounting it so sorely "needed." To
put it in the stark terms of today,
the merger was simply "too big to
fail." (And perhaps not
coincidentally, acquiring NCR proved
to be one of the biggest wastes of
shareholder wealth in the history of
AT&T.)
Bob Jensen’s Rotten to the Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
You can read more about CDO scandals at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bank of America effectively
set up a branch in a Long Island office that helped Nicholas Cosmo carry out
a $380 million Ponzi scheme, according to a class-action lawsuit filed in
federal court.
The lawsuit, filed in
Federal District Court in Brooklyn late Thursday, contends that Bank of
America “established, equipped and staffed” a branch office in the
headquarters of Mr. Cosmo’s firm, Agape Merchant Advance. As a result, the
lawsuit contends that the bank knowingly “assisted, facilitated and
furthered” Mr. Cosmo’s fraudulent scheme.
“Bank of America was at the
epicenter of this scheme,” said the lawsuit, which seeks $400 million in
damages from the bank and other defendants. “Without Bank of America’s
participation, the scheme would not have succeeded and grown to such an
enormous size.”
Mr. Cosmo surrendered to
authorities at a Long Island train station in January in connection with a
suspected Ponzi scheme involving what Mr. Cosmo called “private bridge
loans” that promised investors returns of 48 percent to 80 percent a year.
Many of his 1,500 investors were blue-collar workers and civil servants.
Bank of America declined to
comment, saying that it had not yet seen the suit.
According to the suit,
representatives of Bank of America worked directly out of Mr. Cosmo’s West
Hempstead office, which was about 30 miles from the branch where Agape and
Mr. Cosmo maintained their bank accounts. In addition, Bank of America
provided on-site representatives at Agape with bank equipment and computer
systems that allowed direct access to the bank’s accounts and systems, the
suit said.
“Essentially, Bank of
America established a fully functional bank branch manned by its own
representatives within Agape’s offices, which is contrary to normal banking
practices,” the lawsuit said. As a result, the bank’s representatives had
“actual knowledge” that Mr. Cosmo was “diverting money to his own account”
and “engaging in virtually no legitimate business whatsoever.”
In a complaint filed against
Mr. Cosmo in January by the Commodities Futures Trading Commission, the
government contends that from 2004 to 2008, Mr. Cosmo operated a fraudulent
trading scheme in which investors were solicited to provide short-term
bridge loans but that the money instead went into commodities trading
contracts that lost money.
This is the second time that
Mr. Cosmo has been accused of fraud. He had previously served 21 months in
federal prison in Allenwood, Pa., for mail fraud. Upon his release in 2000,
his broker’s license was revoked. He founded Agape after leaving prison.
The lawsuit also names a
number of futures and commodities trading firms that, the lawsuit said,
“assisted Cosmo in running an illegal unregistered commodities pool.” The
suit says that the trading firms should “never have accepted this business,”
which violated “know your customer” duties that are required of these firms.
One of the firms named in
the suit was MF Global. Diana DeSocio, a spokeswoman for MF Global, said
that when the firm became aware of Mr. Cosmo’s background last October, it
closed Mr. Cosmo’s account and notified regulators.
Ms. DeSocio added that the
account that Mr. Cosmo had was an individual account and was not an account
set up on behalf of his investors.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
The Way Financial
Media Fraud Works
Video from YouTube
(not sure how long it will be online)
http://www.youtube.com/watch?v=dwUXx4DR0wo
From Jim Mahar's Blog on March 152, 2009 ---
http://financeprofessorblog.blogspot.com/
While
there was much hype in the days leading
up to the show, the actual interview was
pretty good. Jon Stewart vs Jim Cramer.
Here is the
link from The DailyShow
for the entire
episode.
It is also available (at least
temporarily) on
YouTube
Jon Stewart vs Jim
Cramer Interview Fight on Daily Show
---
http://www.youtube.com/watch?v=LceizefhP4k
Some talking
points:
* Stewart's main point seems to be that
while Cramer and CNBC claim to be
looking out for investors, in actuality
they are are nothing more than
entertainment at best and accomplices at
worst.
* It is interesting to see the
discussion on Short Selling and the way
that Cramer (and by inference other
hedge fund managers) essentially lied to
drive the price down. I would have to
think the SEC might be interested in
this.
* Stewart maintains that the financial
media plays a role in governance. They
dropped the ball.
* Cramer was good in admitting that
success (year after year of 30% returns)
changes our view and we forget that
things go wrong.
* Line of the day from Stewart: "We are
both snake oil salesmen, but I let
people know I sell snake oil.:
* Line of the day from Cramer: "No one
should be spared in this environment."
The whole interview (unedited) is also
available. Here is the 3rd part:
Video
from YouTube (not sure how long it will
be online)
http://www.youtube.com/watch?v=dwUXx4DR0wo
"The 'Market' Isn't So Wise After All:
This year saw the end of an illusion," by Thomas Frank, The Wall Street
Journal, December 31, 2008 ---
http://online.wsj.com/article/SB123069094735544743.html?mod=djemEditorialPage
As I read the last
tranche of disastrous news stories from this catastrophic year, I found
myself thinking back to the old days when it all seemed to work, when
everyone agreed what made an economy go and the stock market raced and the
commentators and economists and politicians of the world stood as one under
the boldly soaring banner of laissez-faire.
In particular, I
remembered that quintessential work of market triumphalism, "The Lexus and
the Olive Tree," by New York Times columnist Thomas Friedman. It was
published in the glorious year 1999, and in those days, it seemed, every
cliché was made of gold: the brokerage advertisements were pithy, the small
investors were mighty, and the deregulated way was irresistibly becoming the
global way.
In one anecdote,
Mr. Friedman described a visit to India by a team from Moody's Investor
Service, a company that carried the awesome task of determining "who is
pursuing sound economics and who is not." This was shortly after India had
tested its nuclear weapons, and the idea was that such a traditional bid for
power counted for little in this globalized age; what mattered was making
political choices of which the market approved, with organizations like
Moody's sifting out the hearts of nations before its judgment seat. In the
end, Moody's "downgraded India's economy," according to Mr. Friedman,
because it disapproved of India's politics. The Opinion Journal Widget
Download Opinion
Journal's widget and link to the most important editorials and op-eds of the
day from your blog or Web page.
And who makes sure
that Moody's and its competitors downgrade what deserves to be downgraded?
In 1999 the obvious answer would have been: the market, with its fantastic
self-regulating powers.
But something went
wrong on the road to privatopia. If everything is for sale, why shouldn't
the guardians put themselves on the block as well? Now we find that the
profit motive, unleashed to work its magic within the credit-rating
agencies, apparently exposed them to pressure from debt issuers and led them
to give high ratings to the mortgage-backed securities that eventually blew
the economy to pieces.
And so it has gone
with many other shibboleths of the free-market consensus in this tragic
year.
For example, it was
only a short while ago that simply everyone knew deregulation to be the path
to prosperity as well as the distilled essence of human freedom. Today,
though, it seems this folly permitted a 100-year flood of fraud. Consider
the Office of Thrift Supervision (OTS), the subject of a withering
examination in the Washington Post last month. As part of what the Post
called the "aggressively deregulatory stance" the OTS adopted toward the
savings and loan industry in the years of George W. Bush, it slashed staff,
rolled back enforcement, and came to regard the industry it was supposed to
oversee as its "customers." Maybe it's only a coincidence that some of the
biggest banks -- Washington Mutual and IndyMac -- ever to fail were
regulated by that agency, but I doubt it.
Or consider the
theory, once possible to proffer with a straight face, that lavishing
princely bonuses and stock options on top management was a good idea since
they drew executives' interests into happy alignment with those of the
shareholders. Instead, CEOs were only too happy to gorge themselves and turn
shareholders into bag holders. In the subprime mortgage industry, bankers
handed out iffy loans like candy at a parade because such loans meant
revenue and, hence, bonuses for executives in the here-and-now. The
consequences would be borne down the line by the suckers who bought
mortgage-backed securities. And, of course, by the shareholders.
At Washington
Mutual, the bank that became most famous for open-handed lending, incentives
lined the road to hell. According to the New York Times, realtors received
fees from the bank for bringing in clients, mortgage brokers got "handsome
commissions for selling the riskiest loans," and the CEO raked in $88
million from 2001 to 2007, before the outrageous risks of the scheme
cratered the entire enterprise.
Today we stand at
the end of a long historical stretch in which laissez-faire was glorified as
gospel and the business community got almost its entire wish list granted by
the state. To show its gratitude, the finance industry then stampeded us all
over a cliff.
To be sure, some of
the preachers of the old-time religion now admit the error of their ways.
Especially remarkable is Alan Greenspan's confession of "shocked disbelief"
on discovering how reality differed from holy writ.
But by and large
the free-market medicine men seem determined to learn nothing from this
awful year. Instead they repeat their incantations and retreat deeper into
their dogma, generating endless schemes in which government is to blame, all
sin originates with the Community Reinvestment Act, and the bailouts for
which their own flock is desperately bleating can do nothing but harm.
And they wait for
things to return to normal, without realizing that things already have.
Bob
Jensen's threads on the economic meltdown are at
http://faculty.trinity.edu/rjensen/2008bailout.htm
In particular note
http://faculty.trinity.edu/rjensen/2008bailout.htm#InvestmentBanking
Liars Poker II is called "The End"
The Not-Funny Punch Line is Not Until Page 9 of This Tongue in Cheek Explanation
of the Meltdown on Wall Street!
Now I asked
Gutfreund about his biggest decision. “Yes,” he said. “They—the heads of
the other Wall Street firms—all said what an awful thing it was to go public
(beg for a government bailout)
and how could you do such a thing. But when the
temptation arose, they all gave in to it.” He agreed that the main effect of
turning a partnership into a corporation was to transfer the financial risk
to the shareholders. “When things go wrong, it’s their problem,” he said—and
obviously not theirs alone. When a Wall Street investment bank screwed up
badly enough, its risks became the problem of the U.S. government. “It’s
laissez-faire until you get in deep shit,” he said, with a half chuckle. He
was out of the game.
This is a must read to understand what went wrong on Wall Street ---
especially the punch line!
"The End," by Michael Lewis December 2008 Issue The era that defined Wall Street
is finally, officially over. Michael Lewis, who chronicled its excess in Liar’s
Poker, returns to his old haunt to figure out what went wrong.
http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?tid=true
To this day, the willingness of a Wall Street
investment bank to pay me hundreds of thousands of dollars to dispense
investment advice to grownups remains a mystery to me. I was 24 years old,
with no experience of, or particular interest in, guessing which stocks and
bonds would rise and which would fall. The essential function of Wall Street
is to allocate capital—to decide who should get it and who should not.
Believe me when I tell you that I hadn’t the first clue.
I’d never taken an accounting course, never run a
business, never even had savings of my own to manage. I stumbled into a job
at Salomon Brothers in 1985 and stumbled out much richer three years later,
and even though I wrote a book about the experience, the whole thing still
strikes me as preposterous—which is one of the reasons the money was so easy
to walk away from. I figured the situation was unsustainable. Sooner rather
than later, someone was going to identify me, along with a lot of people
more or less like me, as a fraud. Sooner rather than later, there would come
a Great Reckoning when Wall Street would wake up and hundreds if not
thousands of young people like me, who had no business making huge bets with
other people’s money, would be expelled from finance.
When I sat down to write my account of the
experience in 1989—Liar’s Poker, it was called—it was in the spirit of a
young man who thought he was getting out while the getting was good. I was
merely scribbling down a message on my way out and stuffing it into a bottle
for those who would pass through these parts in the far distant future.
Unless some insider got all of this down on paper,
I figured, no future human would believe that it happened.
I thought I was writing a period piece about the
1980s in America. Not for a moment did I suspect that the financial 1980s
would last two full decades longer or that the difference in degree between
Wall Street and ordinary life would swell into a difference in kind. I
expected readers of the future to be outraged that back in 1986, the C.E.O.
of Salomon Brothers, John Gutfreund, was paid $3.1 million; I expected them
to gape in horror when I reported that one of our traders, Howie Rubin, had
moved to Merrill Lynch, where he lost $250 million; I assumed they’d be
shocked to learn that a Wall Street C.E.O. had only the vaguest idea of the
risks his traders were running. What I didn’t expect was that any future
reader would look on my experience and say, “How quaint.”
I had no great agenda, apart from telling what I
took to be a remarkable tale, but if you got a few drinks in me and then
asked what effect I thought my book would have on the world, I might have
said something like, “I hope that college students trying to figure out what
to do with their lives will read it and decide that it’s silly to phony it
up and abandon their passions to become financiers.” I hoped that some
bright kid at, say, Ohio State University who really wanted to be an
oceanographer would read my book, spurn the offer from Morgan Stanley, and
set out to sea.
Somehow that message failed to come across. Six
months after Liar’s Poker was published, I was knee-deep in letters from
students at Ohio State who wanted to know if I had any other secrets to
share about Wall Street. They’d read my book as a how-to manual.
In the two decades since then, I had been waiting
for the end of Wall Street. The outrageous bonuses, the slender returns to
shareholders, the never-ending scandals, the bursting of the internet
bubble, the crisis following the collapse of Long-Term Capital Management:
Over and over again, the big Wall Street investment banks would be, in some
narrow way, discredited. Yet they just kept on growing, along with the sums
of money that they doled out to 26-year-olds to perform tasks of no obvious
social utility. The rebellion by American youth against the money culture
never happened. Why bother to overturn your parents’ world when you can buy
it, slice it up into tranches, and sell off the pieces?
At some point, I gave up waiting for the end. There
was no scandal or reversal, I assumed, that could sink the system.
The New Order The crash did more than wipe out
money. It also reordered the power on Wall Street. What a Swell Party A
pictorial timeline of some Wall Street highs and lows from 1985 to 2007.
Worst of Times Most economists predict a recovery late next year. Don’t bet
on it. Then came Meredith Whitney with news. Whitney was an obscure analyst
of financial firms for Oppenheimer Securities who, on October 31, 2007,
ceased to be obscure. On that day, she predicted that Citigroup had so
mismanaged its affairs that it would need to slash its dividend or go bust.
It’s never entirely clear on any given day what causes what in the stock
market, but it was pretty obvious that on October 31, Meredith Whitney
caused the market in financial stocks to crash. By the end of the trading
day, a woman whom basically no one had ever heard of had shaved $369 billion
off the value of financial firms in the market. Four days later, Citigroup’s
C.E.O., Chuck Prince, resigned. In January, Citigroup slashed its dividend.
From that moment, Whitney became E.F. Hutton: When
she spoke, people listened. Her message was clear. If you want to know what
these Wall Street firms are really worth, take a hard look at the crappy
assets they bought with huge sums of borrowed money, and imagine what
they’d fetch in a fire sale. The vast assemblages of highly paid people
inside the firms were essentially worth nothing. For better than a year now,
Whitney has responded to the claims by bankers and brokers that they had put
their problems behind them with this write-down or that capital raise with a
claim of her own: You’re wrong. You’re still not facing up to how badly you
have mismanaged your business.
Rivals accused Whitney of being overrated; bloggers
accused her of being lucky. What she was, mainly, was right. But it’s true
that she was, in part, guessing. There was no way she could have known what
was going to happen to these Wall Street firms. The C.E.O.’s themselves
didn’t know.
Now, obviously, Meredith Whitney didn’t sink Wall
Street. She just expressed most clearly and loudly a view that was, in
retrospect, far more seditious to the financial order than, say, Eliot
Spitzer’s campaign against Wall Street corruption. If mere scandal could
have destroyed the big Wall Street investment banks, they’d have vanished
long ago. This woman wasn’t saying that Wall Street bankers were corrupt.
She was saying they were stupid. These people whose job it was to allocate
capital apparently didn’t even know how to manage their own.
At some point, I could no longer contain myself: I
called Whitney. This was back in March, when Wall Street’s fate still hung
in the balance. I thought, If she’s right, then this really could be the end
of Wall Street as we’ve known it. I was curious to see if she made sense but
also to know where this young woman who was crashing the stock market with
her every utterance had come from.
It turned out that she made a great deal of sense
and that she’d arrived on Wall Street in 1993, from the Brown University
history department. “I got to New York, and I didn’t even know research
existed,” she says. She’d wound up at Oppenheimer and had the most
incredible piece of luck: to be trained by a man who helped her establish
not merely a career but a worldview. His name, she says, was Steve Eisman.
Eisman had moved on, but they kept in touch. “After
I made the Citi call,” she says, “one of the best things that happened was
when Steve called and told me how proud he was of me.”
Having never heard of Eisman, I didn’t think
anything of this. But a few months later, I called Whitney again and asked
her, as I was asking others, whom she knew who had anticipated the cataclysm
and set themselves up to make a fortune from it. There’s a long list of
people who now say they saw it coming all along but a far shorter one of
people who actually did. Of those, even fewer had the nerve to bet on their
vision. It’s not easy to stand apart from mass hysteria—to believe that most
of what’s in the financial news is wrong or distorted, to believe that most
important financial people are either lying or deluded—without actually
being insane. A handful of people had been inside the black box, understood
how it worked, and bet on it blowing up. Whitney rattled off a list with a
half-dozen names on it. At the top was Steve Eisman.
Steve Eisman entered finance about the time I
exited it. He’d grown up in New York City and gone to a Jewish day school,
the University of Pennsylvania, and Harvard Law School. In 1991, he was a
30-year-old corporate lawyer. “I hated it,” he says. “I hated being a
lawyer. My parents worked as brokers at Oppenheimer. They managed to finagle
me a job. It’s not pretty, but that’s what happened.”
He was hired as a junior equity analyst, a helpmate
who didn’t actually offer his opinions. That changed in December 1991, less
than a year into his new job, when a subprime mortgage lender called Ames
Financial went public and no one at Oppenheimer particularly cared to
express an opinion about it. One of Oppenheimer’s investment bankers stomped
around the research department looking for anyone who knew anything about
the mortgage business. Recalls Eisman: “I’m a junior analyst and just trying
to figure out which end is up, but I told him that as a lawyer I’d worked on
a deal for the Money Store.” He was promptly appointed the lead analyst for
Ames Financial. “What I didn’t tell him was that my job had been to
proofread the documents and that I hadn’t understood a word of the fucking
things.”
Ames Financial belonged to a category of firms
known as nonbank financial institutions. The category didn’t include J.P.
Morgan, but it did encompass many little-known companies that one way or
another were involved in the early-1990s boom in subprime mortgage
lending—the lower class of American finance.
The second company for which Eisman was given sole
responsibility was Lomas Financial, which had just emerged from bankruptcy.
“I put a sell rating on the thing because it was a piece of shit,” Eisman
says. “I didn’t know that you weren’t supposed to put a sell rating on
companies. I thought there were three boxes—buy, hold, sell—and you could
pick the one you thought you should.” He was pressured generally to be a bit
more upbeat, but upbeat wasn’t Steve Eisman’s style. Upbeat and Eisman
didn’t occupy the same planet. A hedge fund manager who counts Eisman as a
friend set out to explain him to me but quit a minute into it. After
describing how Eisman exposed various important people as either liars or
idiots, the hedge fund manager started to laugh. “He’s sort of a prick in a
way, but he’s smart and honest and fearless.”
“A lot of people don’t get Steve,” Whitney says.
“But the people who get him love him.” Eisman stuck to his sell rating on
Lomas Financial, even after the company announced that investors needn’t
worry about its financial condition, as it had hedged its market risk. “The
single greatest line I ever wrote as an analyst,” says Eisman, “was after
Lomas said they were hedged.” He recited the line from memory: “ ‘The Lomas
Financial Corp. is a perfectly hedged financial institution: It loses money
in every conceivable interest-rate environment.’ I enjoyed writing that
sentence more than any sentence I ever wrote.” A few months after he’d
delivered that line in his report, Lomas Financial returned to bankruptcy.
Continued in article
http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?tid=true
Michael Lewis, Liar's Poker: Playing the Money Markets (Coronet, 1999, ISBN
0340767006)
Lewis writes in Partnoy’s earlier whistleblower
style with somewhat more intense and comic portrayals of the major players
in describing the double dealing and break down of integrity on the trading
floor of Salomon Brothers.
A Bit of History from the Roaring 1990s
What are some of
Frank Partnoy’s best-known works?
Frank Partnoy,
FIASCO: Blood in the Water on Wall Street (W. W.
Norton & Company, 1997, ISBN 0393046222, 252 pages).
This is the first of a somewhat
repetitive succession of Partnoy’s “FIASCO” books that
influenced my life. The most important revelation from
his insider’s perspective is that the most trusted firms
on Wall Street and financial centers in other major
cities in the U.S., that were once highly professional
and trustworthy, excoriated the guts of integrity
leaving a façade behind which crooks less violent than
the Mafia but far more greedy took control in the
roaring 1990s.
After selling a succession of phony
derivatives deals while at Morgan Stanley, Partnoy blew
the whistle in this book about a number of his
employer’s shady and outright fraudulent deals sold in
rigged markets using bait and switch tactics.
Customers, many of them pension fund investors for
schools and municipal employees, were duped into complex
and enormously risky deals that were billed as safe as
the U.S. Treasury.
His books have received mixed reviews,
but I question some of the integrity of the reviewers
from the investment banking industry who in some
instances tried to whitewash some of the deals described
by Partnoy. His books have received a bit less praise
than the book Liars Poker by Michael Lewis, but
critics of Partnoy fail to give credit that Partnoy’s
exposes preceded those of Lewis.
Frank Partnoy,
FIASCO: Guns, Booze and Bloodlust: the Truth About High
Finance (Profile Books, 1998, 305 Pages)
Like his earlier books, some investment
bankers and literary dilettantes who reviewed this book
were critical of Partnoy and claimed that he
misrepresented some legitimate structured financings.
However, my reading of the reviewers is that they were
trying to lend credence to highly questionable offshore
deals documented by Partnoy. Be that as it may, it
would have helped if Partnoy had been a bit more
explicit in some of his illustrations.
Frank Partnoy,
FIASCO: The Inside Story of a Wall Street Trader
(Penguin, 1999, ISBN 0140278796, 283 pages).
This is a
blistering indictment of the unregulated OTC market
for derivative financial instruments and the million
and billion dollar deals conceived in investment
banking. Among other things, Partnoy describes
Morgan Stanley’s annual drunken skeet-shooting
competition organized by a “gun-toting strip-joint
connoisseur” former combat officer (fanatic) who
loved the motto: “When derivatives are outlawed
only outlaws will have derivatives.” At that event,
derivatives salesmen were forced to shoot entrapped
bunnies between the eyes on the pretense that the
bunnies were just like “defenseless animals” that
were Morgan Stanley’s customers to be shot down even
if they might eventually “lose a billion dollars on
derivatives.”
This book has one of the best accounts of the
“fiasco” caused almost entirely by the duping of
Orange
County ’s Treasurer (Robert Citron)
by the unscrupulous Merrill Lynch derivatives
salesman named Michael
Stamenson. Orange
County eventually lost over a billion
dollars and was forced into bankruptcy. Much of
this was later recovered in court from Merrill
Lynch. Partnoy calls
Citron and Stamenson
“The Odd Couple,” which is also the title of Chapter
8 in the book.Frank Partnoy, Infectious Greed:
How Deceit and Risk Corrupted the Financial Markets
(Henry Holt & Company, Incorporated, 2003, ISBN:
080507510-0, 477 pages)Frank Partnoy, Infectious
Greed: How Deceit and Risk Corrupted the Financial
Markets (Henry Holt & Company, Incorporated,
2003, ISBN: 080507510-0, 477 pages)
Partnoy shows how corporations gradually
increased financial risk and lost control over overly
complex structured financing deals that obscured the
losses and disguised frauds pushed corporate officers
and their boards into successive and ingenious
deceptions." Major corporations such as Enron, Global
Crossing, and WorldCom entered into enormous illegal
corporate finance and accounting. Partnoy documents the
spread of this epidemic stage and provides some
suggestions for restraining the disease.
"The Siskel and
Ebert of Financial Matters: Two Thumbs Down for the
Credit Reporting Agencies" by Frank Partnoy,
Washington University Law Quarterly, Volume 77, No. 3,
1999 ---
http://ls.wustl.edu/WULQ/
4. What are
examples of related books that are somewhat more
entertaining than Partnoy’s early books?
Michael Lewis,
Liar's Poker: Playing the Money Markets (Coronet,
1999, ISBN 0340767006)
Lewis writes in Partnoy’s earlier
whistleblower style with somewhat more intense and comic
portrayals of the major players in describing the double
dealing and break down of integrity on the trading floor
of Salomon Brothers.
John Rolfe and Peter
Troob, Monkey Business: Swinging Through the Wall
Street Jungle (Warner Books, Incorporated, 2002,
ISBN: 0446676950, 288 Pages)
This is
a hilarious tongue-in-cheek account by Wharton and
Harvard MBAs who thought they were starting out as
stock brokers for $200,000 a year until they
realized that they were on the phones in a bucket
shop selling sleazy IPOs to unsuspecting
institutional investors who in turn passed them
along to widows and orphans. They write. "It took
us another six months after that to realize
that we were, in fact, selling crappy public
offerings to investors."
There are other books along a similar
vein that may be more revealing and entertaining
than the early books of Frank Partnoy, but he was
one of the first, if not the first, in the roaring
1990s to reveal the high crime taking place behind
the concrete and glass of Wall Street. He was the
first to anticipate many of the scandals that soon
followed. And his testimony before the U.S. Senate
is the best concise account of the crime that
transpired at Enron. He lays the blame clearly at
the feet of government officials (read that Wendy
Gramm) who sold the farm when they deregulated the
energy markets and opened the doors to unregulated
OTC derivatives trading in energy. That is when
Enron really began bilking the public.
Some of the many, many
lawsuits settled by auditing firms can be found at
http://faculty.trinity.edu/rjensen/Fraud001.htm
Bob Jensen's timeline of
Derivatives Financial Instruments scams ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
|
|
Bob Jensen's Rotten to the Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's timeline of Derivatives
Financial Instruments scams ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Bob Jensen's essay with its alphabet soup of appendices ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
From the Securities Law Professor Blog on
December 18, 2008 ---
http://lawprofessors.typepad.com/securities/
SEC Files Insider Trading Charges Against
Former Lehman Broker and Others
The SEC
filed
insider trading charges in another "pillow-talk" case, alleging that a
former registered representative at Lehman Brothers misappropriated
confidential information from his wife, a partner in an international public
relations firms, and tipped a number of clients and friends. The SEC's
complaint alleges that from at least March 2004
through July 2008, Matthew Devlin, then a registered representative at
Lehman Brothers, Inc. ("Lehman") in New York City, traded on and tipped at
least four of his clients and friends with inside information about 13
impending corporate transactions. According to the complaint, some of
Devlin's clients and friends, three of whom worked in the securities or
legal professions, tipped others who also traded in the securities. The
complaint alleges that the illicit trading yielded over $4.8 million in
profits. Because the inside information was valuable, some of the traders
referred to Devlin and his wife as the "golden goose." The complaint further
alleges that by providing inside information, Devlin curried favor with his
friends and business associates and, in return, was rewarded with cash and
luxury items, including a Cartier watch, a Barneys New York gift card, a
widescreen TV, a Ralph Lauren leather jacket and Porsche driving lessons.
The complaint alleges that,
based on the information provided by Devlin, the defendants variously
purchased the common stock and/or options of the following public companies:
InVision Technologies, Inc.; Eon Labs, Inc.; Mylan, Inc.; Abgenix, Inc.;
Aztar Corporation; Veritas, DGC, Inc.; Mercantile Bankshares Corporation;
Alcan, Inc.; Ventana Medical Systems, Inc.; Pharmion Corporation; Take-Two
Interactive Software, Inc.; Anheuser-Busch, Inc.; and Rohm and Haas Company.
At the time that Devlin tipped the other defendants about these companies,
each company was confidentially engaged in a significant transaction that
involved a merger, tender offer, or stock repurchase.
The SEC's complaint
names nine defendants as well as three relief defendants. The U.S.
Attorney's Office for the Southern District of New York filed related
criminal charges today against some of the defendants named in the SEC's
complaint.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Agency Theory Question
Why do corporate executives like fair value accounting better than shareholders?
Answer
Cash bonuses on the upside are not returned after the downturn that wipes out
the previous unrealized paper profits.
Phantom (Unrealized) Profits on
Paper, but Real Cash Outflows for Employee Bonuses and Other Compensation
Rarely, if ever, are they forced to pay back their "earnings" even in instances
of earnings management accounting fraud
"On Wall Street, Bonuses, Not Profits,
Were Real," by Louise Story, The New York Times, December 17, 2008 ---
http://www.nytimes.com/2008/12/18/business/18pay.html?partner=permalink&exprod=permalink
"Merrill’s record earnings in 2006 — $7.5
billion — turned out to be a mirage. The company has since lost three times
that amount, largely because the mortgage investments that supposedly had
powered some of those profits plunged in value.
“As a result of the extraordinary growth
at Merrill during my tenure as C.E.O., the board saw fit to increase my
compensation each year.”
— E. Stanley O’Neal, the former chief
executive of Merrill Lynch, March 2008
For Dow Kim, 2006 was a very good year.
While his salary at Merrill Lynch was $350,000, his total compensation was
100 times that — $35 million.
The difference between the two amounts was
his bonus, a rich reward for the robust earnings made by the traders he
oversaw in Merrill’s mortgage business.
Mr. Kim’s colleagues, not only at his
level, but far down the ranks, also pocketed large paychecks. In all,
Merrill handed out $5 billion to $6 billion in bonuses that year. A
20-something analyst with a base salary of $130,000 collected a bonus of
$250,000. And a 30-something trader with a $180,000 salary got $5 million.
But Merrill’s record earnings in 2006 —
$7.5 billion — turned out to be a mirage. The company has since lost three
times that amount, largely because the mortgage investments that supposedly
had powered some of those profits plunged in value.
Unlike the earnings, however, the bonuses
have not been reversed.
As regulators and shareholders sift
through the rubble of the financial crisis, questions are being asked about
what role lavish bonuses played in the debacle. Scrutiny over pay is
intensifying as banks like Merrill prepare to dole out bonuses even after
they have had to be propped up with billions of dollars of taxpayers’ money.
While bonuses are expected to be half of what they were a year ago, some
bankers could still collect millions of dollars.
Critics say bonuses never should have been
so big in the first place, because they were based on ephemeral earnings.
These people contend that Wall Street’s pay structure, in which bonuses are
based on short-term profits, encouraged employees to act like gamblers at a
casino — and let them collect their winnings while the roulette wheel was
still spinning.
“Compensation was flawed top to bottom,”
said Lucian A. Bebchuk, a professor at Harvard Law School and an expert on
compensation. “The whole organization was responding to distorted
incentives.”
Even Wall Streeters concede they were
dazzled by the money. To earn bigger bonuses, many traders ignored or played
down the risks they took until their bonuses were paid. Their bosses often
turned a blind eye because it was in their interest as well.
“That’s a call that senior management or
risk management should question, but of course their pay was tied to it
too,” said Brian Lin, a former mortgage trader at Merrill Lynch.
The highest-ranking executives at four
firms have agreed under pressure to go without their bonuses, including John
A. Thain, who initially wanted a bonus this year since he joined Merrill
Lynch as chief executive after its ill-fated mortgage bets were made. And
four former executives at one hard-hit bank, UBS of Switzerland, recently
volunteered to return some of the bonuses they were paid before the
financial crisis. But few think others on Wall Street will follow that lead.
For now, most banks are looking forward
rather than backward. Morgan Stanley and UBS are attaching new strings to
bonuses, allowing them to pull back part of workers’ payouts if they turn
out to have been based on illusory profits. Those policies, had they been in
place in recent years, might have clawed back hundreds of millions of
dollars of compensation paid out in 2006 to employees at all levels,
including senior executives who are still at those banks.
A Bonus Bonanza
For Wall Street, much of this decade
represented a new Gilded Age. Salaries were merely play money — a pittance
compared to bonuses. Bonus season became an annual celebration of the riches
to be had in the markets. That was especially so in the New York area, where
nearly $1 out of every $4 that companies paid employees last year went to
someone in the financial industry. Bankers celebrated with five-figure
dinners, vied to outspend each other at charity auctions and spent their
newfound fortunes on new homes, cars and art.
The bonanza redefined success for an
entire generation. Graduates of top universities sought their fortunes in
banking, rather than in careers like medicine, engineering or teaching. Wall
Street worked its rookies hard, but it held out the promise of rich rewards.
In college dorms, tales of 30-year-olds pulling down $5 million a year were
legion.
While top executives received the biggest
bonuses, what is striking is how many employees throughout the ranks took
home large paychecks. On Wall Street, the first goal was to make “a buck” —
a million dollars. More than 100 people in Merrill’s bond unit alone broke
the million-dollar mark in 2006. Goldman Sachs paid more than $20 million
apiece to more than 50 people that year, according to a person familiar with
the matter. Goldman declined to comment.
Pay was tied to profit, and profit to the
easy, borrowed money that could be invested in markets like mortgage
securities. As the financial industry’s role in the economy grew, workers’
pay ballooned, leaping sixfold since 1975, nearly twice as much as the
increase in pay for the average American worker.
“The financial services industry was in a
bubble," said Mark Zandi, chief economist at Moody’s Economy.com. “The
industry got a bigger share of the economic pie.”
A Money Machine
Dow Kim stepped into this milieu in the
mid-1980s, fresh from the Wharton School at the University of Pennsylvania.
Born in Seoul and raised there and in Singapore, Mr. Kim moved to the United
States at 16 to attend Phillips Academy in Andover, Mass. A quiet workaholic
in an industry of workaholics, he seemed to rise through the ranks by sheer
will. After a stint trading bonds in Tokyo, he moved to New York to oversee
Merrill’s fixed-income business in 2001. Two years later, he became
co-president.
Skip to next paragraph
Bloomberg News Dow Kim received $35
million in 2006 from Merrill Lynch.
The Reckoning Cashing In Articles in this
series are exploring the causes of the financial crisis.
Previous Articles in the Series »
Multimedia Graphic It Was Good to Be a Mortgage-Related Professional . . .
Related Times Topics: Credit Crisis — The Essentials
Patrick Andrade for The New York Times
Brian Lin is a former mortgage trader at Merrill Lynch who lost his job at
Merrill and now works at RRMS Advisors. Readers' Comments Share your
thoughts. Post a Comment »Read All Comments (363) »
Even as tremors began to reverberate
through the housing market and his own company, Mr. Kim exuded optimism.
After several of his key deputies left the
firm in the summer of 2006, he appointed a former colleague from Asia, Osman
Semerci, as his deputy, and beneath Mr. Semerci he installed Dale M.
Lattanzio and Douglas J. Mallach. Mr. Lattanzio promptly purchased a $5
million home, as well as oceanfront property in Mantoloking, a wealthy
enclave in New Jersey, according to county records.
Merrill and the executives in this article
declined to comment or say whether they would return past bonuses. Mr.
Mallach did not return telephone calls.
Mr. Semerci, Mr. Lattanzio and Mr. Mallach
joined Mr. Kim as Merrill entered a new phase in its mortgage buildup. That
September, the bank spent $1.3 billion to buy the First Franklin Financial
Corporation, a mortgage lender in California, in part so it could bundle its
mortgages into lucrative bonds.
Continued in article
Bob Jensen's threads on fair value accounting are a
http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue
Keeping Score on the SEC in 2008
"The SEC in 2008: A Very Good Year? A terrific one, the
commission says, tallying a fiscal-year record in insider-trading cases, and the
second-highest number of enforcement cases overall. But what would John McCain
say?" by Stephen Taub and Roy Harris, CFO.com, October 22, 2008 ---
http://www.cfo.com/article.cfm/12465408/c_12469997
|
It was a great year for Securities and
Exchange Commission enforcement, according to the SEC. In a fiscal-year-end
summary, it notes, for example, that it brought the highest number ever of
insider trading cases.
And altogether, it took the second-highest
number of enforcement actions in agency history.
"The SEC's role in policing the markets
and protecting investors has never been more critical," said Linda Chatman
Thomsen, director of the SEC's Division of Enforcement. "The dedicated
enforcement staff has been working around the clock to investigate and
punish wrongdoing."
The celebration of these records and
near-records, however, comes during a time of widespread charges of what
critics call lax policing by the regulator. They question its performance
before the powderkeg of subprime mortgage lending, amid loose standards
within major financial institutions, exploded into the worst global
financial crisis since the Great Depression. Just a month ago, Republican
presidential candidate John McCain promoted the replacement of SEC Chairman
Christopher Cox, while many legislators have supported folding the SEC and
other agencies into one larger, more encompassing financial regulator.
But this day, at least, was one for the
SEC proudly to recount the 671 enforcement actions it took during the most
recent fiscal year. And it made special note of how insider trading cases
jumped more than 25 percent over the previous year.
Among those trading cases, the SEC seemed
to prize most highly the charges against former Dow Jones board member David
Li, and three other Hong Kong residents, in a $24-million insider-trading
enforcement action, along with the charging of the former chairman and CEO
of a division of Enron Corp. with illegally selling hundreds of thousands of
shares of Enron stock based on nonpublic information.
Market manipulation cases surged more than
45 percent. They included charges against a Wall Street short seller for
spreading false rumors, and charging 10 insiders or promoters of publicly
traded companies who made stock sales in exchange for illegal kickbacks.
Among the major fraud cases, the SEC sued
two Bear Stearns hedge fund managers for fraudulently misleading investors
about the financial state of the firm's two largest hedge funds. The
regulator also charged five former employees of the City of San Diego for
failing to disclose to the investing public buying the city's municipal
bonds that there were funding problems with its pension and retiree health
care obligations and those liabilities had placed the city in serious
financial jeopardy.
Illegal stock-option backdating was also a
big focus of the agency in 2008. The SEC charged eight public companies and
27 executives with providing false information to investors based on
improper accounting for backdated stock option grants.
The SEC said that another growth area
involved cases against U.S. companies that use corporate funds to bribe
foreign officials, an activity precluded by the Foreign Corrupt Practices
Act. In 2008, the SEC filed 15 FCPA cases. Since January 2006, the SEC has
brought 38 FCPA enforcement actions — more than were brought in all prior
years combined since FCPA became law in 1977.
Bob Jensen's threads on creative
accounting are at
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
Also see
http://faculty.trinity.edu/rjensen//theory/00overview/AccountingTricks.htm
Peter, Paul, and Barney: An Essay on 2008 U.S. Government Bailouts of Private
Companies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Accounting and finance professors should use this video
every semester in class!
The best explanation ever of the sub-prime (meaning
lending to borrowers with much less than prime credit ratings) mortgage greed
and fraud.
The best explanation ever about securitized financial instruments and worldwide
banding frauds using such instruments.
The best explanation ever about how greedy employees will cheat on their
employers and their customers.
"House Of Cards: The Mortgage Mess Steve Kroft Reports How The
Mortgage Meltdown Is Shaking Markets Worldwide," Sixty Minutes Television on
CBS, January 27, 2008 ---
http://www.cbsnews.com/stories/2008/01/25/60minutes/main3752515.shtml
For a few days the video may be available free.
The transcript will probably be available for a longer period of time.
January 29, 2008 reply from Jim Fuehrmeyer
[jfuehrme@nd.edu]
Bob, you don’t know me, but I’m new to academia – I
took early retirement from Deloitte & Touche in Chicago to teach accounting
& auditing. I replied to the email, but it was rejected so I’m going to send
you my two cents. It’s probably a bit naïve, but what the heck.
Two things:
First, when do we start asking “the question” about
sub-prime lending in the first place? People who make the loans, sell the
loans and invest in the loans are making money (and now losing money) off of
folks who have no business being placed in a position to get easy credit to
begin with. I’m sorry, but I find it disgusting. I have no sympathy for
investors in these instruments and no sympathy for the lenders who
originated the loans.
Second, whether the (SPE) standard is 10% or 3% or 0.01%
so long as there’s a political process around that allows for the banks that
have “no continuing involvement” with the loans to be in a position to amend
them, we’re going to continue to live with the fiction that these financial
instruments can be off balance sheet. If the QSPE purchaser of the loans
doesn’t have the ability to amend them, I find it difficult to understand
how one argues it truly owns them; that it has the risks and rewards of
ownership. These securitized loans should be on balance sheet – and I think
that would put the breaks on sub-prime lending.
Jim Fuehrmeyer
January 29, 2008 reply from Bob Jensen
Hi Jim,
Thank you for the reply. May
I share it with the AECM and in my SPE module?
Actually the Sixty Minutes
show is very, very good with respect to your first question. The two
main problems were as follows:
-
Too many employees all along the way
wanted to make a quick buck even if it screwed their employers and
customers.
-
Real estate valuation for lending
purposes has always be ridden with fraud (remember the S&L fiasco
back in the 1980s). The fraud simply heated up in the sub-prime
bubble to a point where appraisers were valuing houses at 125% or
more of any realistic market value. Buyers loved it because they
could borrow more than value. Some borrowers took out second and
third mortgages and pocketed the cash. Then when the real estate
market took a nose dive, borrowers discovered that the value of
their homes was way below what they owed on their property. They
walked away from their homes rather than continue to pay off the
debt.
What the Sixty Minutes show did not stress is the inadequate accounting
internal controls all along this lending chain from a house in Stockton
to a bundled securitized financial instrument sold to a European bank.
Internal controls were either not put in place or ignored all along the
chain. And the auditors themselves signed off on these bad internal
controls just like they did in the S&L bubble.
Did the perpetrators all
along the chain know the risks of these poor internal controls?
Absolutely, at least up to the point where the final buyers of the
financial instruments that thought mortgaged-backed securities had more
value than the collateral itself. Was Merrill Lynch and the NYC banks
parties to the fraud just as much as the crooks that originally brokered
the fraudulent mortgages in Stockton --- Absolutely!!!!
Bob
Jensen
Where is insider
trading more evident and difficult to stop than in the U.S. capital markets ---
well England for one.
"Bradford & Bingley: Time the
FSA got serious on insider trading," by Martin Waller, London Times, June
6, 2008 ---
http://business.timesonline.co.uk/tol/business/columnists/article4076208.ece
A fraudulent market manipulation contributed to
the Wall Street meltdown
Phantom Shares and Market Manipulation (Bloomberg News
video on naked short selling) ---
http://video.google.com/videoplay?docid=4490541725797746038
"SEC Bars Adviser's Former Managing Director for Conversion,
Fraud," Securities Law Professor Blog,
November 21, 2008 ---
http://lawprofessors.typepad.com/securities/
The SEC imposed sanctions on
Brendan E.
Murray, formerly a managing
director of registered investment advisor Cornerstone Equity Advisers, Inc.
(Cornerstone) and secretary to Cornerstone's advisory clients the
Cornerstone Funds, Inc. (Funds), for willfully aiding and abetting, and
being a cause of, Cornerstone's violations of antifraud provisions of the
Investment Advisers Act of 1940. Cornerstone, a fiduciary to the Funds,
misappropriated client funds by knowingly inflating and falsifying vendor
invoices, directing the payments of the inflated amounts to an intermediary,
and instructing the intermediary to pay the vendors lesser amounts (or
nothing) while keeping the overage. The Commission found that Murray
participated in the scheme by creating, submitting, and authorizing payment
of the inflated invoices. The Commission also found that Murray, who as
secretary owed a fiduciary duty to the Funds, converted corporate funds by
knowingly submitting inflated invoices for reimbursement. The Commission
concluded that it is in the public interest to bar Murray from associating
with any investment adviser or investment company, to impose a
cease-and-desist order, to impose a civil money penalty in the amount of
$60,000, and to order disgorgement in the amount of $21,157 plus prejudgment
interest.
Bob Jensen's fraud updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Wachovia Agrees to Buy Back over $8.5
Billion in ARSs," Blog of the Corporate Law Center, University of
Cincinnati College of Law, August 16, 2008 ---
http://lawprofessors.typepad.com/securities/
The SEC and the New York
Attorney General announced on August 15 that investors, small businesses,
and charities who purchased auction rate securities (ARS) through and
Wachovia Capital Markets, LLC (collectively Wachovia) could receive over
$8.5 billion to fully restore their losses and liquidity through a
preliminary settlement that has been reached with Wachovia.
Continued in article
JP Morgan Chase and Morgan Stanley Also Agree
to Buy Back ARSs in Settlement with New York AG.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Shocking 25 Minute Video
A Rigged Trading System: "The odds are better in Las Vegas than on Wall Street"
This is the same fraud as the one committed by Max in the Broadway show called
The Producers (watch the Bloomberg video of how the fraud works)
Max sold over 100% of the shares in his play.
A fraudulent market manipulation contributed to the Wall Street meltdown
Phantom Shares and Market Manipulation (Bloomberg News
video on naked short selling) ---
http://video.google.com/videoplay?docid=4490541725797746038
Here's an Example of Devious Contract Writing on Wall Street
Remember those abusive tax shelters of all the Big Four accounting firms,
especially the shelters for which KPMG paid a $456 million fine? ---
http://faculty.trinity.edu/rjensen/fraud001.htm#KPMG
Another KPMG
defendant pleads guilty of selling KPMG's bogus tax
shelters
One of the five remaining
defendants in the government's high-profile tax-shelter
case against former KPMG LLP employees is expected to
plead guilty ahead of a criminal trial set to begin in
October, according to a person familiar with the
situation. The defendant, David Amir Makov, is expected
to enter his guilty plea in federal court in Manhattan
this week, this person said. It is unclear how Mr.
Makov's guilty plea will affect the trial for the
remaining four defendants. Mr. Makov's plea deal with
federal prosecutors was reported yesterday by the New
York Times. A spokeswoman for the U.S. attorney in the
Southern District of New York, which is overseeing the
case, declined to comment. An attorney for Mr. Makov
couldn't be reached. Mr. Makov would be the second
person to plead guilty in the case. He is one of two
people who didn't work at KPMG, but his guilty plea
should give the government's case a boost. Federal
prosecutors indicted 19 individuals on tax-fraud charges
in 2005 for their roles in the sale and marketing of
bogus shelters . . . KPMG admitted to criminal
wrongdoing but avoided indictment that could have put
the tax giant out of business. Instead, the firm reached
a deferred-prosecution agreement that included a $456
million penalty. Last week, the federal court in
Manhattan received $150,000 from Mr. Makov as part of a
bail modification agreement that allows him to travel to
Israel.
Paul Davies, "KPMG Defendant to Plead Guilty," The
Wall Street Journal, August 21, 2007; Page A11 ---
Click Here |
|
From The Wall Street Journal Weekly Accounting Review on September
19, 2008
Street Firms Accused of Tax Scheme
by Jesse
Drucker
The Wall Street Journal
Sep 11, 2008
Online Exclusive
Click here to view the full article on WSJ.com
ttp://online.wsj.com/article/SB122109613823821913.html?mod=djem_jiewr_AC
TOPICS: Accounting,
Corporate Taxation, Hedge Funds, IRS, Tax Evasion, Taxation,
Treasury Department, Withholding
SUMMARY: Some
Wall Street firms marketed allegedly abusive deals that helped
foreign hedge-fund investors avoid U.S. taxes, a probe found.
CLASSROOM
APPLICATION: With all of the publicity surrounding some of
the country's biggest investment banks and brokerage houses
these days, our students might be interested to read that those
firms developed some fairly sophisticated tax evasion schemes to
benefit foreign hedge-fund investors. In this article, the
schemes are explained, and a discussion of the law and evidence
is included.
QUESTIONS:
1. (Advanced) How were the big investment banks and
brokerage firms violating tax law? What type of taxes were they
avoiding?
2. (Advanced) Please explain the details of the example
of the scheme detailed in the article. What did the emails
indicate? What did the attorneys advise in regard to the plan?
3. (Advanced) What are the specifics of the law
involved? What are the estimated losses for the government? Why
do you think the firms proceeded with the plans?
4. (Advanced) What is the current news about many of
these firms? How do you think the information in this particular
article relates to the bigger problems the firms are now having?
5. (Advanced) What evidence does the government have
against these businesses? Is the evidence light or substantial?
What about this evidence surprises you most?
6. (Introductory) What are the responses from the
firms? Do you think that the firms have a strong or weak
defensive position?
Reviewed By: Linda Christiansen, Indiana University Southeast
|
"Street Firms Accused of Tax Scheme," by Jesse
Drucker, The Wall Street Journal, September 11, 2008 ---
http://online.wsj.com/article/SB122109613823821913.html?mod=djem_jiewr_AC
Some of the country's
biggest investment banks and brokerage firms -- including Morgan Stanley,
Lehman Brothers Holdings Inc., Citigroup Inc. and Merrill Lynch & Co. --
marketed allegedly abusive transactions that helped foreign hedge-fund
investors avoid billions of dollars in U.S. taxes over the past decade,
according to a report by Senate investigators.
The yearlong probe, which
relied in part on internal bank documents and emails, concludes that Wall
Street firms actively competed with one another in dreaming up complex
transactions that allowed hedge funds to avoid withholding taxes imposed on
dividends paid by U.S. companies.
Some of the internal emails
show that bank officials and hedge-fund managers were concerned the deals
might run afoul of the Internal Revenue Service. (See the text of the
report.)
The report is scheduled to
be released Thursday at a hearing in Washington by the Senate Permanent
Subcommittee on Investigations, which is examining what it says is $100
billion a year lost to offshore tax abuses.
The report is critical not
only of banks and hedge funds, but also of the IRS and the Treasury
Department for what the committee calls a failure to enforce the tax law
governing this area.
Foreign investors, such as
offshore hedge funds, are liable for a tax on the dividends they receive
from U.S. investments, generally at a rate of 30%.
However, Senate
investigators found that the investment banks commonly entered into
arrangements to give the hedge funds the economic value of dividends,
without actually triggering a withholding tax on dividend payments.
In one common transaction,
an offshore hedge fund would sell its stock to a U.S. investment bank just
before a dividend was to be paid, and simultaneously enter into a swap
arrangement with that bank to retain the economics of stock ownership.
The investment bank would
pay the hedge fund a "dividend equivalent," but didn't withhold any taxes
because the hedge fund technically didn't own the shares. A few days later,
the hedge fund would repurchase the stock from the investment bank.
A series of emails reviewed
by Senate investigators suggest that some banks and their clients had
concerns about how the IRS would view the transactions. In one email, a
Lehman official said: "Personally, I would not prepare anything and leave a
trail." A Lehman spokesman declined to comment.
One potential hedge-fund
client of Merrill told the firm that the outside law firm it had consulted
expressed concerns, particularly when the deals were used repeatedly.
According to the attorney, "repeated use, coincidentally around dividend
payment time, would provide a strong case for the IRS to assert tax evasion.
So yes, looking at it in a vacuum, it works, it is the repeated 'overuse',
e.g. pigs trying to be hogs, that proves problematic."
The report says a $32
billion special dividend by Microsoft Corp. in 2004 spurred many of the big
banks to sell products that would allow their hedge-fund clients to avoid
paying the associated taxes.
Merrill stopped doing some
of the deals after the committee began its investigation, according to an
internal bank email cited in the report.
"We believe we acted in good
faith when we advised our clients, and believe we acted appropriately under
existing tax law," said a Merrill spokesman.
Citigroup voluntarily
approached the IRS and paid $24 million in withholding taxes after an
internal audit, investigators found. The report questions why the bank
didn't pay taxes on other deals as well. A Citigroup spokesman said its "tax
treatment of the transactions at issue is proper under applicable tax law."
Data from Morgan Stanley
indicate that over one seven-year period, the transactions helped clients
avoid taxes of more than $300 million, according to the report. A Morgan
Stanley spokeswoman said: "We believe that Morgan Stanley's trading at issue
fully complied and continues to comply with all relevant tax laws and
regulations."
Investigators cited an
internal analysis prepared by hedge fund Maverick Capital Management
estimating that such deals helped it avoid $95 million in taxes over an
eight-year period. A Maverick spokeswoman didn't respond to requests for
comment.
The Senate committee has
conducted several investigations into abusive tax deals. The "IRS has been
looking at this for years," said Sen. Carl Levin (D., Mich.), the
committee's chairman. "The time for looking is over."
An IRS spokesman said the
agency has "a number of open investigations under way involving the kinds of
issues that were identified in the report."
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bankers bet with their bank's capital, not
their own. If the bet goes right, they get a huge bonus; if it
misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital
Louria Hahn, "Missing: How Poor Risk-Management Techniques
Contributed to the Subprime Mess," CFO Magazine, March 2008,
Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Fed is going to bail out these crooks with taxpayer
funds makes it all the worse.
The bourgeoisie can
be termed as any group of people who are discontented with what they
have, but satisfied with what they are
Nicolás Dávila |
The Treasury Department on Sunday seized
control of the quasi-public mortgage finance giants, Fannie Mae and Freddie Mac,
and announced a four-part rescue plan that included an open-ended guarantee to
provide as much capital as they need to stave off insolvency.
"U.S. Unveils Takeover of Two Mortgage Giants,"
by Edmund L. Andrews, The New York Times, Septembr 7, 2008 ---
http://www.nytimes.com/2008/09/08/business/08fannie.html?hp
At a news
conference on Sunday morning, the Treasury secretary Henry M. Paulson Jr.
also announced that he had dismissed the chief executives of both companies
and replaced them with two long-time financial executives. Herbert M.
Allison, the former chairman of TIAA-CREF, the huge pension fund for
teachers, will take over Fannie Mae and succeed Daniel H. Mudd. At Freddie
Mac, David M. Moffett, currently a senior adviser at the Carlyle Group, the
large private equity firm, will succeed Richard F. Syron. Mr. Mudd and Mr.
Syron, however, will stay on temporarily to help with the transition.
“Fannie Mae and
Freddie Mac are so large and so interwoven in our financial system that a
failure of either of them would cause great turmoil in our financial markets
here at home and around the globe,” Mr. Paulson said. “This turmoil would
directly and negatively impact household wealth: from family budgets, to
home values, to savings for college and retirement. A failure would affect
the ability of Americans to get home loans, auto loans and other consumer
credit and business finance. And a failure would be harmful to economic
growth and job creation.”
Mr. Paulson refused
to say how much capital the government might eventually have to provide, or
what the ultimate cost to taxpayers might be.
The companies are
likely to need tens of billions of dollars over the next year, but the
ultimate cost to taxpayers will largely depend on how fast the housing and
mortgage markets recover.
Fannie and Freddie
have each agreed to issue $1 billion of senior preferred stock to the United
States; it will pay an annual interest rate of at least 10 percent. In
return, the government is committing up to $100 billion to each company to
cover future losses. The government also receives warrants that would allow
it to buy up to 80 percent of each company’s common stock at a nominal
price, or less than $1 a share.
Beginning in 2010,
the companies must also pay the Treasury a quarterly fee — the amount to be
determined — for any financial support provided under the agreement.
Standard & Poor’s,
the bond rating agency, said Sunday that the government’s AAA/A-1+ sovereign
credit rating would not be affected by the takeover.
Mr. Paulson’s plan
begins with a pledge to provide additional cash by buying a new series of
preferred shares that would offer dividends and be senior to both the
existing preferred shares and the common stock that investors already hold.
The two companies
would be allowed to “modestly increase” the size of their existing
investment portfolios until the end of 2009, which means they will be
allowed to use some of their new taxpayer-supplied capital to buy and hold
new mortgages in investment portfolios.
But in a strong
indication of Mr. Paulson’s long-term desire to wind down the companies’
portfolios, drastically shrink the role of both Fannie and Freddie and
perhaps eliminate their unique status altogether, the plan calls for the
companies to start reducing their investment portfolios by 10 percent a
year, beginning in 2010.
The investment
portfolios now total just over $1.4 trillion, and the plan calls for that to
eventually shrink to $250 billion each, or $500 billion total.
“Government support
needs to be either explicit or nonexistent, and structured to resolve the
conflict between public and private purposes,” Mr. Paulson said. “We will
make a grave error if we don’t use this time out to permanently address the
structural issues presented by the G.S.E.’s,” he added, a reference to the
companies as government-sponsored enterprises.
Critics have
long argued that Fannie and Freddie were taking advantage of the widespread
assumption that the federal government would bail them out if they got into
trouble. Administration officials as well as the Federal Reserve have argued
that the two companies used those implicit guarantees to borrow money at
below-market rates and lend money at above-market returns, and that they had
become what amounted to gigantic hedge funds operating with only a sliver of
capital to protect them from unexpected surprises.
Continued in
article
IN OTHER words, foreseeing that wealthy individuals would be reluctant to lend
their money to the poor as the seventh year approached, the Bible commanded them
to lend it anyway. Yet Hillel, seeing that the wealthy were disregarding this
injunction and depriving the poor of badly needed loans, changed the biblical
law to ensure that money would be lent by providing a way of recovering it.This
was a watershed in the evolution of Judaism. The biblical law of
debt-cancellation is motivated by a deep concern, which runs through the
Mosaic code (also see
Halakhah) and the prophets, for the poor, who are to be periodically
forgiven by their creditors in order to prevent their becoming hopelessly mired
in debt. One could not imagine a more Utopian piece of social legislation. But
this, as Hillel the Elder realized, was precisely the problem with it:
the regulation was having the paradoxical consequence of
only making life for the poor harder by preventing them from borrowing at all.
Herbert Gintis, Commentary, Jul/Aug2008, Vol. 126 Issue 1, pp. 4-6
Selling New
Equity to Pay Dividends: Reminds Me About the South Sea Bubble of
1720 ---
http://en.wikipedia.org/wiki/South_Sea_bubble
"Fooling Some
People All the Time"
"Melting into
Air: Before the financial system went bust, it went postmodern," by
John Lanchester, The New Yorker, November 10, 2008 ---
http://www.newyorker.com/arts/critics/atlarge/2008/11/10/081110crat_atlarge_lanchester
This is also why the
financial masters of the universe tend not to write books. If you have been
proved—proved—right, why bother? If you need to tell it, you can’t truly
know it. The story of David Einhorn and Allied Capital is an example of a
moneyman who believed, with absolute certainty, that he was in the right,
who said so, and who then watched the world fail to react to his irrefutable
demonstration of his own rightness. This drove him so crazy that he did what
was, for a hedge-fund manager, a bizarre thing: he wrote a book about it.
The story began on May
15, 2002, when Einhorn, who runs a hedge fund called Greenlight Capital,
made a speech for a children’s-cancer charity in Hackensack, New Jersey. The
charity holds an annual fund-raiser at which investment luminaries give
advice on specific shares. Einhorn was one of eleven speakers that day, but
his speech had a twist: he recommended shorting—betting against—a firm
called Allied Capital. Allied is a “business development company,” which
invests in companies in their early stages. Einhorn found things not to like
in Allied’s accounting practices—in particular, its way of assessing the
value of its investments. The mark-to-market
accounting that Einhorn favored is based on the
price an asset would fetch if it were sold today, but many of Allied’s
investments were in small startups that had, in effect, no market to which
they could be marked. In Einhorn’s view, Allied’s way of pricing its
holdings amounted to “the you-have-got-to-be-kidding-me method of
accounting.” At the same time, Allied was
issuing new equity, and, according to Einhorn,
the revenue from this could be used to fund the dividend payments that were
keeping Allied’s investors happy. To Einhorn,
this looked like a potential Ponzi scheme.
The next day, Allied’s stock
dipped more than twenty per cent, and a storm of controversy and
counter-accusations began to rage. “Those engaging in the current
misinformation campaign against Allied Capital are cynically trying to take
advantage of the current post-Enron environment by tarring a great and
honest company like Allied Capital with the broad brush of a Big Lie,”
Allied’s C.E.O. said. Einhorn would be the first to admit that he wanted
Allied’s stock to drop, which might make his motives seem impure to the
general reader, but not to him. The function of hedge funds is, by his
account, to expose faulty companies and make money in the process. Joseph
Schumpeter described capitalism as “creative destruction”: hedge funds are
destructive agents, predators targeting the weak and infirm. As Einhorn
might see it, people like him are especially necessary because so many
others have been asleep at the wheel. His book about his five-year battle
with Allied, “Fooling Some of the People All of the Time” (Wiley;
$29.95), depicts analysts, financial journalists, and the S.E.C. as being
culpably complacent. The S.E.C. spent three years investigating Allied. It
found that Allied violated accounting guidelines, but noted that the company
had since made improvements. There were no penalties. Einhorn calls the
S.E.C. judgment “the lightest of taps on the wrist with the softest of
feathers.” He deeply minds this, not least because the complacency of the
watchdogs prevents him from being proved right on a reasonable schedule: if
they had seen things his way, Allied’s stock price would have promptly
collapsed and his short selling would be hugely profitable. As it was,
Greenlight shorted Allied at $26.25, only to spend the next years watching
the stock drift sideways and upward; eventually, in January of 2007, it hit
thirty-three dollars.
All this has a great
deal of resonance now, because, on May 21st of this year, at the same
charity event, Einhorn announced that Greenlight had shorted another stock,
on the ground of the company’s exposure to financial derivatives based on
dangerous subprime loans. The company was Lehman Brothers. There was little
delay in Einhorn’s being proved right about that one: the toppling company
shook the entire financial system. A global
cascade of bank implosions ensued—Wachovia, Washington Mutual, and the
Icelandic banking system being merely some of the highlights to date—and a
global bailout of the entire system had to be put in train.
The short sellers were proved right, and also came to
be seen as culprits; so was mark-to-market accounting, since it caused
sudden, cataclysmic drops in the book value of companies whose holdings had
become illiquid. It is therefore the perfect moment for a short-selling
advocate of marking to market to publish his account. One can only speculate
whether Einhorn would have written his book if he had known what was going
to happen next. (One of the things that have happened is that, on September
30th, Ciena Capital, an Allied portfolio company to whose fraudulent lending
Einhorn dedicates many pages, went into bankruptcy; this coincided with a
collapse in the value of Allied stock—finally!—to a price of around six
dollars a share.) Given the esteem with which Einhorn’s profession is
regarded these days, it’s a little as if the assassin of Archduke Franz
Ferdinand had taken the outbreak of the First World War as the timely moment
to publish a book advocating bomb-throwing—and the book had turned out to be
unexpectedly persuasive.
Heavy Insider
Trading ---
http://investing.businessweek.com/research/stocks/ownership/ownership.asp?symbol=ALD
Allied's
independent auditor is KPMG
KPMG has a lot of problems
with litigation ---
http://faculty.trinity.edu/rjensen/fraud001.htm
Bob Jensen's
threads on the collapse of the Banking System are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's
threads on fraud are at
http://faculty.trinity.edu/rjensen/Fraud.htm
Also see Fraud Rotten at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's
threads on accounting theory are at
http://faculty.trinity.edu/rjensen/theory01.htm
Also see the theory of fair value accounting at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
History of Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
More on the Bare Sterns Scandal
From Jim Mahar's blog on July 1, 2008 ---
http://financeprofessorblog.blogspot.com/
Financier Starts Sentence in Prostitution Case
- NYTimes.com
It has not been a good
year for Jeff Epstein. A billionaire money advisor who owned his own island
in the Caribbean as well as a large townhouse in NY, Epstein used to be
known for his secrecy,
smart friends, dislike of suits and ties, and yoga.
That has changed in the past year. In fact, it has changed in a big way!
Read on:
Financier Starts Sentence in Prostitution Case - NYTimes.com:
"On Monday morning, he
turned himself in and began serving 18 months for soliciting
prostitution....It is a stunning downfall for Mr. Epstein...a tabloid
monument to an age of hyperwealth. Mr. Epstein owns a Boeing 727 and the
largest town house in Manhattan. He has paid for college educations for
personal employees and students from Rwanda, and spent millions on a
project to develop a thinking and feeling computer and on music intended
to alleviate depression.
But Mr. Epstein also
paid women, some of them under age, to give him massages that ended with
a sexual favor, the authorities say."
In addition to these charges,
he was also recently was identified as a major investor in Bear Stearns'
(where he used to work) hedge funds that collapsed last year:
Remember a month or so
ago when the
WSJ had a series of articles on Bear? I thoght
they were great. Well this may be better! By Bryan Burrough who helped write
"Barbarians at the Gate" (one of my all time favorites).
From Jim Mahar's blog on June 30, 2008 ---
http://financeprofessorblog.blogspot.com/
What Really Killed Bear Stearns? - Mergers, Acquisitions, Venture Capital,
Hedge Funds -- DealBook - New York Times:
One look in:
"According to Mr.
Burrough’s account, Bear did not have a liquidity problem, at least at
first. In fact, he said it had more than $18 billion in cash to cover
its trades when the week began. There were no major withdrawals until
late in the week, after rumors flew that the company was in trouble.
A top Bear executive
told Mr. Burrough, “There was a reason [the rumor] was leaked, and the
reason is simple: someone wanted us to go down, and go down hard.”
Bear executives
frantically tried to find the source of the rumors, but failed to do so
in time. They have their suspicions, and they have turned over the names
to federal authorities that are investigating the matter."
If that was all the article
would be great, but there is so much more. Granted some is based on rumor
and sort of one sided and designed to sell magazines, but who cares? A very
good read!
And the NY Times Deal Book goes
even further providing links to Fed meetings on the collapse. This will
definitely be used in class!
Jensen Comment
Maybe a young little chippie bird sang like a canary.
Question
Are our U.S. standard setters bent transitioning to IFRS (and its loopholes) in
the U.S. like fools rushing in where angels fear to tread?
"IFRS Chaos in France: The Incredible Case of
Société Générale," by Tom Selling, The Accounting Onion, March 7, 2008
---
http://accountingonion.typepad.com/
IFRS Chaos in France:
The Incredible Case of Société Générale "Breaking
the Rules and Admitting It" is the title of Floyd
Norris's column describing the accounting by Société Générale for the losses
incurred by their rogue trader Jérôme Kerviel; the title is provocative
enough, but it's still not adequate to describe this amazing story. Although
I am reluctant to come off as a prudish American unfairly criticizing suave
and sophisticated French norms, what Société and its auditors have
perpetrated would be regarded here as the accounting equivalent of
pornography.
I don't aim to re-write
Norris's excellent column, who rightly asks what a case like this says about
the prospects for IFRS adoption in the U.S. But, I want to make two
additional points. To tee them up, here's an encapsulation of the sordid
tale:
Société Générale chose to
lump Kerviel's 2008 trading losses in 2007's income statement, thus netting
the losses of the later year with his gains of the previous year. There is
no disputing that the losses occurred in 2008, yet the company's position is
that application of specific IFRS rules (very simply, marking derivatives to
market) would, for reasons unstated, result in a failure of the financial
statements to present a "true and fair view." You might also be interested
to know that the financial statements of French companies are opined on by
not just one -- but two -- yes, two -- auditors. Even by invoking the "true
and fair" exception, Société Générale must still be in compliance with IFRS
as both E&Y and D&T have concurred. How could both auditors be wrong? C'est
imposible. The first point I want to make is that Société's motives to
commit such transparent and ridiculous shenanigans are not clearly apparent
from publicly available information. My unsubstantiated hunch is that it has
to do with executive compensation. For example, could it be that 2007
bonuses have already been determined on same basis that did not have to
include the trading losses (maybe based on stock price appreciation)?
Moreover, pushing the losses back to 2007 could have bee the best way to
clear the decks for 2008 bonuses, which could be based on reported earnings
-- since the stock price has already tanked.
The second point was made by
Lynn Turner, former SEC Chief Accountant in a recent email. The PCAOB and
SEC are considering a policy of mutual recognition of audit firms whereby
the PCAOB would promise not to inspect foreign auditors opining on financial
statements filed with the SEC. Instead, the U.S. investors would have to
settle for the determination of foreign authorities. Thus, if the French
regulators saw nothing wrong with the actions of local auditors -- even
operating under the imprimaturs of EY or D&T -- then the PCAOB could not say
otherwise.
Never mind the black eye the
Société debacle gives IFRS, this sordid case must surely signal the SEC that
mutual recognition would be a step too far; however, I'm not counting on the
current SEC leadership to get the message.
"Loophole Lets Bank Rewrite the Calendar," by
Floyd Norris, The New York Times, March 7. 2008 ---
http://www.nytimes.com/2008/03/07/business/07norris.html?ref=business
It is not often that a major
international bank admits it is violating well-established accounting rules,
but that is what Société Générale has done in accounting for the fraud that
caused the bank to lose 6.4 billion euros — now worth about $9.7 billion —
in January.
In its financial statements
for 2007, the French bank takes the loss in that year, offsetting it against
1.5 billion euros in profit that it says was earned by a trader, Jérôme
Kerviel, who concealed from management the fact he was making huge bets in
financial futures markets.
In moving the loss from 2008
— when it actually occurred — to 2007, Société Générale has created a furor
in accounting circles and raised questions about whether international
accounting standards can be consistently applied in the many countries
around the world that are converting to the standards.
While the London-based
International Accounting Standards Board writes the rules, there is no
international organization with the power to enforce them and assure that
companies are in compliance.
In its annual report
released this week, Société Générale invoked what is known as the “true and
fair” provision of international accounting standards, which provides that
“in the extremely rare circumstances in which management concludes that
compliance” with the rules “would be so misleading that it would conflict
with the objective of financial statements,” a company can depart from the
rules.
In the past, that provision
has been rarely used in Europe, and a similar provision in the United States
is almost never invoked. One European auditor said he had never seen the
exemption used in four decades, and another said the only use he could
recall dealt with an extremely complicated pension arrangement that had not
been contemplated when the rules were written.
Some of the people who wrote
the rule took exception to its use by Société Générale.
“It is inappropriate,” said
Anthony T. Cope, a retired member of both the I.A.S.B. and its American
counterpart, the Financial Accounting Standards Board. “They are
manipulating earnings.”
John Smith, a member of the
I.A.S.B., said: “There is nothing true about reporting a loss in 2007 when
it clearly occurred in 2008. This raises a question as to just how creative
they are in interpreting accounting rules in other areas.” He said the board
should consider repealing the “true and fair” exemption “if it can be
interpreted in the way they have interpreted it.”
Société Générale said that
its two audit firms, Ernst & Young and Deloitte & Touche, approved of the
accounting, as did French regulators. Calls to the international
headquarters of both firms were not returned, and Société Générale said no
financial executives were available to be interviewed.
In the United States, the
Securities and Exchange Commission has the final say on whether companies
are following the nation’s accounting rules. But there is no similar body
for the international rules, although there are consultative groups
organized by a group of European regulators and by the International
Organization of Securities Commissions. It seems likely that both groups
will discuss the Société Générale case, but they will not be able to act
unless French regulators change their minds.
“Investors should be
troubled by this in an I.A.S.B. world,” said Jack Ciesielski, the editor of
The Analyst’s Accounting Observer, an American publication. “While it makes
sense to have a ‘fair and true override’ to allow for the fact that broad
principles might not always make for the best reporting, you need to have
good judgment exercised to make it fair for investors. SocGen and its
auditors look like they were trying more to appease the class of investors
or regulators who want to believe it’s all over when they say it’s over,
whether it is or not.”
Not only had the losses not
occurred at the end of 2007, they would never have occurred had the
activities of Mr. Kerviel been discovered then. According to a report by a
special committee of Société Générale’s board, Mr. Kerviel had earned
profits through the end of 2007, and entered 2008 with few if any
outstanding positions.
But early in January he bet
heavily that both the DAX index of German stocks and the Dow Jones Euro
Stoxx index would go up. Instead they fell sharply. After the bank learned
of the positions in mid-January, it sold them quickly on the days when the
stock market was hitting its lowest levels so far this year.
In its annual report,
Société Générale says that applying two accounting rules — IAS 10, “Events
After the Balance Sheet Date,” and IAS 39, “Financial Instruments:
Recognition and Measurement” — would have been inconsistent with a fair
presentation of its results. But it does not go into detail as to why it
believes that to be the case.
One rule mentioned, IAS 39,
has been highly controversial in France because banks feel it unreasonably
restricts their accounting. The European Commission adopted a “carve out”
that allows European companies to ignore part of the rule, and Société
Générale uses that carve out. The commission ordered the accounting
standards board to meet with banks to find a rule they could accept, but
numerous meetings over the past several years have not produced an
agreement.
Investors who read the 2007
annual report can learn the impact of the decision to invoke the “true and
fair” exemption, but cannot determine how the bank’s profits would have been
affected if it had applied the full IAS 39.
It appears that by pushing
the entire affair into 2007, Société Générale hoped both to put the incident
behind it and to perhaps de-emphasize how much was lost in 2008. The net
loss of 4.9 billion euros it has emphasized was computed by offsetting the
2007 profit against the 2008 loss.
It may have accomplished
those objectives, at the cost of igniting a debate over how well
international accounting standards can be policed in a world with no
international regulatory body.
From Jim Mahar's blog on January 25,
2008 ---
Kerviel joins ranks of
master rogue traders:
"In being identified as the lone wolf
behind French investment bank Société
Générale's staggering $7.1-billion loss
Thursday, Jérôme Kerviel joined the
ranks of a rare and elite handful of
rogue traders whose audacious
transactions have single-handedly
brought some of the world's financial
powerhouses to their knees.
This notorious company includes Nick
Leeson, who brought down Britain's
Barings Bank in 1995 by blowing
$1.4-billion, Yasuo Hamanaka, who
squandered $2.6-billion on fraudulent
copper deals for Sumitomo Corp. of Japan
in 1998, John Rusnak, who frittered away
$750-million through unauthorized
currency trading for Allied Irish Bank
in 2002 and Brian Hunter of Calgary, who
oversaw the loss of $6-billion on hedge
fund bets at Amaranth Advisors in 2006.
|
A group of 14 student-loan
companies that benefited from a federal subsidy loophole collected nearly
three times the amount they may have been entitled to claim without the
maneuver, according to a set of independent audits of their operations.
If those audit findings are
representative of all loan companies that received subsidies under a program
that guaranteed some lenders a 9.5-percent return on their loans, it would
mean the government lost nearly $1.2-billion in improper payments over a
six-year period.
That's about twice the
loss previously suggested by outside estimates after the Bush administration
agreed last year to let the loan companies keep all the money they had taken
so far through the loophole, with the understanding that they wouldn't take
any more (The
Chronicle, January 28, 2008).
"I'm astounded by the audits
so far," said Rep. Thomas E. Petri, a Wisconsin Republican who serves on the
House education committee. The findings should prompt the Education
Department to demand audits of all other lenders to find out how much was
lost, Mr. Petri said.
Yet executives of some of
the loan companies that took payments under the 9.5-percent interest-rate
program—a group that consists mostly of state-chartered agencies and other
nonprofit corporations—said they saw little reason for concern.
Loan agencies "across the
nation have moved forward beyond the 9.5 loan issue," said Patricia Beard,
chief executive of the South Texas Higher Education Authority. Anyone
concerned about the welfare of student borrowers should instead devote
"attention to something that matters to the nation," such as the overall
downturn in capital markets, Ms. Beard said.
A Break Became a Windfall
The losses stem from the
government's program of providing subsidy payments to private lenders that
issue student loans. One element of that program, created in 1980 at a time
of relatively high interest rates, promised nonprofit lenders a fixed
9.5-percent rate of return.
That subsidy rate became a
financial windfall for those lenders in later years when market rates fell.
Some lenders extended that advantage through a "recycling" process in which
they passed new loan money through old accounts, thereby claiming them to
the Education Department as eligible for the expired 9.5-percent subsidy
rate.
After years of
deliberations on how to handle that type of activity, the Education
Department ruled in January 2007 that the largest user of the recycling
tactic, Nelnet, a for-profit Nebraska student loan company formed in 1998
from a nonprofit lender, had been allowed to receive $323-million more in
subsidy payments than it should have (The
Chronicle, February 2, 2007).
In what the department
described as a settlement, it let Nelnet keep the $323-million but required
the company to forgo expected future payments under the 9.5-percent program,
estimated at $882-million. The department then agreed to let any other loan
companies keep billing through the 9.5-percent program if they provided an
independent audit proving they were not claiming the subsidy on any
improperly recycled loan money (The
Chronicle, February 6).
Nelnet and other lenders had
repeatedly asked the Education Department as early as 2002 for confirmation
that the recycling tactic was legal. In a letter of May 29, 2003, Terry J.
Heimes, president of Nelnet Education Loan Funding, a corporate subsidiary,
described the company's approach and pleaded for a response.
"We intend to proceed under
the analysis described above and assume its correctness, unless we are
directed otherwise by you," Mr. Heimes wrote to Angela S. Roca-Baker, an
official in the department's Office of Federal Student Aid, according to a
September 2006 audit of the case by the department's inspector general.
Continued in article
"College Administrator’s Dual Roles Are a
Focus of Student Loan Inquiry," by Sam Dillon, The New York Times,
April 13, 2007 ---
http://www.nytimes.com/2007/04/13/education/13loans.html?_r=1&oref=slogin
Walter C. Cathie, a vice
president at Widener University, spent years working his way up the ranks of
various colleges and forging a reputation as a nationally known financial
aid administrator. Then he made a business out of it.
He created a consulting
company, Key West Higher Education Associates, named after his vacation home
in Florida. The firm specializes in conferences that bring college deans of
finance together with lenders eager to court them.
The program for the next
conference, slated for June at the Marriott Inner Harbor at Camden Yards in
Baltimore, lists seven lenders as sponsors. One sponsor said it would pay
$20,000 to participate. Scheduled presentations include “what needs to be
done in Washington to fight back against the continued attacks on student
lenders” and the “economics and ethics of aid packaging.”
Investigations into student
lending abuses are broadening in Washington and Albany. Mr. Cathie is still
at Widener, and his roles as university official and entrepreneur have put
him center stage, as a prime example of how university administrators who
advise students have become cozy with lenders.
Widener, with campuses in
Pennsylvania and Delaware, put Mr. Cathie on leave this week after New
York’s attorney general requested documents relating to his consulting firm
and told the university that one lender, Student Loan Xpress, had paid Key
West $80,000 to participate in four conferences.
Mr. Cathie said in an
interview yesterday that he still hoped to pull off the June event. “Though
who knows, if nobody comes, I guess it’ll implode,” he said.
Several of the scheduled
speakers said in interviews that they were canceling.
“Yes, I’ve made money,” he
said, “but I haven’t done anything illegal. So I’d sure like this story to
get out, that — you know, Walter Cathie is a giving individual, that he’s
been very open, that he’s always taken the profits and given back to
students.”
He said he had donated some
consulting profits to a scholarship fund in his father’s name at Carnegie
Mellon University, where he worked for 21 years. “I’ve been in this business
a long time, I’ve always been a student advocate, and I haven’t done
anything wrong,” Mr. Cathie said.
Others say his case
illustrates how some officials have become so entwined with lenders that
they have become oblivious to conflicts of interest.
“The allegations made
against Mr. Cathie and his institution point at the structural corruption of
the student lending system,” said Barmak Nassirian, a director of the
American Association of Collegiate Registrars and Admissions Officers.
The system has become so
complex, and involves so much money, Mr. Nassirian said, “the temptation has
become too great for many of the players to take a little bite for
themselves.”
The program for the
conference in June lists corporate sponsors. One is Student Loan Xpress,
whose president, according to documents obtained by the United States
Senate, provided company stock to officials at several universities and at
the Department of Education.
Another is Education Finance
Partners Inc., which Attorney General Andrew M. Cuomo of New York has
accused of making payments to 60 colleges for loan volume. Neither company
returned calls for comment.
The program lists as a
speaker Dick Willey, chief executive of the Pennsylvania Higher Education
Assistance Authority, a state loan agency facing calls for reform after
reports that board members, spouses and employees have spent $768,000 on
pedicures, meals and other such expenses since 2000.
Mr. Willey’s spokesman,
Keith New, said that Mr. Willey would not speak at the conference, but that
the agency intended to sponsor it with a “platinum level” commitment of
$20,000.
Mr. Cathie came to Widener
in 1997, initially as its dean of financial aid, after years at Allegheny
College, Carnegie Mellon and Wabash College in Indiana, building a
background in enrollment management and financial aid.
In 1990, well into his
tenure at Carnegie Mellon, Mr. Cathie and his boss, William Elliott, an
admissions official who is today Carnegie Mellon’s vice president for
enrollment, began organizing annual conferences for college administrators
to debate policy issues, both men said.
They named their conferences
the Fitzwilliam Audit after the Fitzwilliam Inn in New Hampshire, where they
were held, Mr. Cathie said.
Continued in article
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's threads on higher education
controversies are at
http://faculty.trinity.edu/rjensen/HigherEdControversies.htm
Bob Jensen's threads on controversies of accounting
standard setting are at
http://faculty.trinity.edu/rjensen/Theory01.htm#MethodsForSetting
"8 Accused of Kickbacks, Fraud at Wall Street
Brokerage Firms," SmartPros, May 23, 2008 ---
http://accounting.smartpros.com/x61954.xml
Question
Do currency fund managers earn their astronomical fees?
"NYU Stern Finance Professor’s New Research Shows Most
Actively Managed Currency Funds Fail to Outperform a New Benchmark," Business
Wire, February 26, 2008 ---
Click Here
Do most currency fund managers deserve
their high fees? According to a new study by NYU Stern Finance Professor
Richard Levich and co-author Momtchil Pojarliev, Head of Currencies at
Hermes Investment Management, the answer is no. Their study is the first to
challenge conventional wisdom that professional currency hedge fund managers
earn very large returns and that the appropriate benchmark is zero. Arguing
that the appropriate benchmark is not zero, but rather the realized return
on several easily replicated currency strategies (Carry, Trend, Value and
Volatility), Professor Levich and Mr. Pojarliev find that just as equity
fund indexes tend to outperform mutual fund managers, a collection of
currency return indices outperforms most currency fund managers.
Performing an analysis for an index of
many currency funds, and also for 34 individual funds over the 2001-06
period, Professor Levich and Mr. Pojarliev find that:
- 75
percent of currency fund managers do not outperform a benchmark based on
several easily implemented trading strategies
- Most
returns that currency fund managers earn are related to a few simple
trading styles, or trading factors
- 25
percent of managers in the sample do earn genuine excess returns; and
some of those appear related to timing ability
Their findings could put pressure on fees
charged by currency fund managers since it is possible for investors to
easily replicate most returns of currency managers at low cost by using
newly created exchange traded funds related to the author’s
new benchmark for performance.
Continued in article
We hang the petty thieves and appoint the great
ones to public office.
Aesop
That
some bankers have ended up in prison is not a matter of scandal, but
what is outrageous is the fact that all the others are free.
Honoré de Balzac |
"Holding back the banks: Predatory banking practices are likely to
continue while political parties are too close to corporations and regulators
lack teeth," by Prem Sikka, The Guardian (in the U.K.), February 15,
2008 ---
http://commentisfree.guardian.co.uk/prem_sikka_/2008/02/holding_back_the_banks.html
Politicians
and regulators have been slow to wake up to the destructive
impact of banks on the rest of society. Their lust for profits
and financial engineering has brought us the
sub-prime crisis and possibly a
recession. Billions of pounds have been
wiped off the value of people's
savings, pensions and investments.
Despite
this, banks are set to make
record profits (in the U.K.) and their
executives will be collecting bumper salaries and bonuses. These
profits are boosted by
preying on customers in debt, making
exorbitant
charges and failing to pass on the
benefit of cuts in
interest rates. Banks indulge in
insider trading, exploit
charity laws and have sold suspect
payment protection insurance policies.
As usual, the annual financial reports published by banks will
be opaque and will provide no clues to their antisocial
practices.
Some
governments are now also waking up to the involvement of banks
in organised
tax avoidance and evasion. Banks have
long been at the heart of the tax avoidance industry. In 2003,
the US Senate Permanent Subcommittee on Investigations
concluded (pdf) that the development
and sale of potentially abusive and illegal tax shelters have
become a lucrative business for accounting firms, banks,
investment advisory firms and law firms. Banks use clever
avoidance schemes,
transfer pricing schemes and
offshore (pdf) entities, not only to
avoid their
own taxes but also to help their rich
clients do the same.
The role
of banks in enabling
Enron, the disgraced US energy giant,
to avoid taxes worldwide, is well
documented (pdf) by the US Senate
joint committee on taxation. Enron used complex corporate
structures and transactions to avoid taxes in the US and many
other countries. The Senate Committee noted (see pages 10 and
107) that some of the complex schemes were devised by Bankers
Trust, Chase Manhattan and Deutsche Bank, among others. Another
Senate
report (pdf) found that resources were
also provided by the Salomon Smith Barney unit of Citigroup and
JP Morgan Chase & Co.
The
involvement of banks is essential as they can front corporate
structures and have the resources - actually our savings and
pension contributions - to provide finance for the complex
layering of transactions. After examining the scale of tax
evasion schemes by
KPMG, the US Senate committee
concluded (pdf) that complex tax
avoidance schemes could not have been executed without the
active and willing participation of banks. It noted (page 9)
that "major banks, such as Deutsche Bank, HVB, UBS, and NatWest,
provided purported loans for tens of millions of dollars
essential to the orchestrated transactions," and a subsequent
report (pdf) (page111) added "which
the banks knew were tax motivated, involved little or no credit
risk, and facilitated potentially abusive or illegal tax
shelters".
The
Senate report (pdf) noted (page 112)
that Deutsche Bank provided some $10.8bn of credit lines, HVB
Bank $2.5bn and UBS provided several billion Swiss francs, to
operationalise complex avoidance schemes. NatWest was also a key
player and provided about $1bn (see
page 72 [pdf])
of credit lines.
Deutsche
Bank has been the subject of a US
criminal investigation and in 2007 it
reached an out-of-court settlement with several wealthy
investors, who had been sold aggressive US tax shelters.
Some
predatory practices have also been identified in other
countries. In 2004, after a six-year investigation, the
National Irish Bank was fined £42m for
tax evasion. The bank's personnel promoted offshore investment
policies as a secure destination for funds that had not been
declared to the revenue commissioners. A government report found
that almost the entire former senior management at the bank
played some role in tax evasion scams. The external auditors,
KPMG, and the bank's own audit committee were also found to have
played a role in allowing tax evasion.
In the UK,
successive governments have shown little interest in mounting an
investigation into the role of banks in tax avoidance though
some banks have been persuaded to inform authorities of the
offshore accounts held by private
individuals. No questions have been asked about how banks avoid
their taxes and how they lubricate the giant and destructive tax
avoidance industry. When asked "if he will commission research
on the levels of use of offshore tax havens by UK banks and the
economic effects of that use," the chancellor of the exchequer
replied: "There are no plans to
commission research on the levels of use of offshore tax havens
by UK banks and the economic effects of that use."
Continued in article
"Bringing banks to book Financial institutions
are not going to voluntarily embrace honesty and social responsibility - there
is little evidence they do so now," by Prem Sikka, The Guardian,
February 27, 2008 ---
http://commentisfree.guardian.co.uk/prem_sikka_/2008/02/bringing_banks_to_book.html
Anyone visiting the
websites of banks or browsing through their annual reports will
find no shortage of claims of "corporate social responsibility".
Yet their practices rarely come anywhere near their claims.
In
pursuit of higher profits and bumper executive rewards,
banks have inflicted both the credit crunch and sub-prime
crisis on us. Their sub-prime activities may also be steeped
in
fraud and mis-selling of
mortgage securities. They have
developed onshore and offshore structures and practices to
engage in
insider trading,
corruption,
sham tax-avoidance transactions
and
tax evasion. Money laundering is
another money-spinner.
Worldwide
over $2tn are estimated to be
laundered each year. The laundered
amounts fund private armies, terrorism, narcotics, smuggling,
corruption, tax evasion and criminal activity and generally
threaten quality of life. Large amounts of money cannot be
laundered without the involvement of
accountants, lawyers, financial
advisers and banks.
The US is the
world's biggest laundry and European countries are not far
behind. Banks are required to have internal controls and systems
to monitor suspicious transactions and report them to
regulators. As with any form of regulation, corporations enjoy
considerable discretion about what they record and report.
Profits come above everything else.
A
US government report (see page 31)
noted that "the New York branch of ABN AMRO, a banking
institution, did not have anti-money laundering program and had
failed to monitor approximately $3.2 billion - involving
accounts of US shell companies and institutions in Russian and
other former republics of the Soviet Union".
A US Senate
report on the Riggs Bank noted that it had developed novel
strategies for concealing its trade with General Augusto
Pinochet, former Chilean dictator. It noted (page
2) that the bank "disregarded its
anti-money laundering (AML) obligations ... despite frequent
warnings from ... regulators, and allowed or, at times, actively
facilitated suspicious financial activity". The committee
chairman
Senator Carl Levin
stated that "the 'Don't ask,
Don't tell policy' at Riggs allowed the bank to pursue profits
at the expense of proper controls ... Million-dollar cash
deposits, offshore shell corporations, suspicious wire
transfers, alteration of account names - all the classic signs
of money laundering and foreign corruption made their appearance
at Riggs Bank".
The Senate
committee report (see
page 7) stated that:
"Over
the past 25 years, multiple financial institutions operating
in the United States, including Riggs Bank, Citigroup, Banco
de Chile-United States, Espirito Santo Bank in Miami, and
others, enabled [former Chilean dictator] Augusto Pinochet
to construct a web of at least 125 US bank and securities
accounts, involving millions of dollars, which he used to
move funds and transact business. In many cases, these
accounts were disguised by using a variant of the Pinochet
name, an alias, the name of an offshore entity, or the name
of a third party willing to serve as a conduit for Pinochet
funds."
The Senate
report stated (page
28) that "In addition to opening
multiple accounts for Mr Pinochet in the United States and
London, Riggs took several actions consistent with helping Mr
Pinochet evade a court order attempting to freeze his bank
accounts and escape notice by law enforcement". Riggs bank's
files and papers (see
page 27) contained "no reference to or
acknowledgment of the ongoing controversies and litigation
associating Mr Pinochet with human rights abuses, corruption,
arms sales, and drug trafficking. It makes no reference to
attachment proceedings that took place the prior year, in which
the Bermuda government froze certain assets belonging to Mr
Pinochet pursuant to a Spanish court order - even though ...
senior Riggs officials obtained a memorandum summarizing those
proceedings from outside legal Counsel."
The bank's
profile did not identify Pinochet by name and at times he is
referred to (see
page 25) as "a retired professional,
who achieved much success in his career and accumulated wealth
during his lifetime for retirement in an orderly way" (p
25) ... with a "High paying position
in Public Sector for many years" (p
25) ... whose source of his
initial wealth was "profits & dividends from several business[es]
family owned" (p
27) ... the source of his current
income is "investment income, rental income, and pension fund
payments from previous posts " (p
27).
Finger is
also pointed at other banks. Barclays France, Société
Marseillaise de Credit, owned by HSBC, and the National Bank of
Pakistan are facing
allegations of money laundering. In
2002,
HSBC was facing a fine by the Spanish
authorities for operating a series of opaque bank accounts for
wealthy businessmen and professional football players.
Regulators in India are investigating an alleged $8bn (£4bn)
money laundering operation involving
UBS.
Nigeria's
corrupt rulers are estimated to have
stolen
around £220bn over four decades and channelled them through
banks in London, New York, Jersey,
Switzerland, Austria, Liechtenstein, Luxembourg and Germany. The
Swiss authorities repatriated some of the monies stolen by
former dictator
General Sani Abacha.
A report by the Swiss federal banking commission noted (page
7) that there were instances of serious individual failure
or misconduct at some banks. The banks were named as "three
banks in the Credit Suisse Group (Credit Suisse, Bank Hofmann AG
and Bank Leu AG), Crédit Agricole Indosuez (Suisse) SA, UBP
Union Bancaire Privée and MM Warburg Bank (Schweiz) AG".
Continued in article
Jensen Comment
Prem Sikka has written a rather brief but comprehensive summary of many of the
bad things banks have been caught doing and in many cases still getting away
with. Accounting standards have be complicit in many of these frauds, especially
FAS 140 (R) which allowed banks to sell bundles of "securitized" mortgage notes
from SPE's (now called VIEs) using borrowed funds that are kept off balance
sheet in these entities called SPEs/VIEs. The FASB had in mind that responsible
companies (read that banks) would not issue debt in excess of the value of the
collateral (e.g., mortgage properties). But FAS 140 (R) fails to allow for the
fact that collateral values such as real estate values may be expanding in a
huge bubble about to burst and leave the bank customers and possibly the banks
themselves owing more than the values of the securities bundles of notes. Add to
this the frauds that typically take place in valuing collateral in the first
place, and you have FAS 140 (R) allowing companies, notably banks, incurring
huge losses on debt that was never booked due to FAS 140 (R).
FAS 140 (R) needs to be rewritten ---
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
However, the banks now control their regulators! We're not about to see the SEC,
FED, and other regulators allow FAS 140 (R) to be drastically revised.
Also banks are complicit in the "dirty secrets" of credit cards and credit
reporting ---
http://faculty.trinity.edu/rjensen/FraudReporting.htm#FICO
Then there are the many illegal temptations which lure in banks such as
profitable money laundering and the various departures from ethics discussed
above by Prem Sikka.
Lessons Not Learned from Enron
Bad SPE Accounting Rules are Still Dogging Us
From The Wall Street Journal Accounting Weekly Review on October 19,
2007
Call to Brave for $100 Billion Rescue
by David
Reilly
The Wall Street Journal
Oct 16, 2007
Page: C1
Click here to view the full article on WSJ.com
TOPICS: Advanced
Financial Accounting, Securitization
SUMMARY: This
article addresses a proposed bailout plan for $100 billion
of commercial paper to maintain liquidity in credit markets
that have faced turmoil since July 2007, and the fact that
this bailout "...raises two crucial questions: Why didn't
investors see the problems coming? And how could they have
happened in the first place?" The author emphasizes that
post-Enron accounting rules "...were supposed to prevent
companies from burying risks in off-balance sheet vehicles."
He argues that the new rules still allow for some
off-balance sheet entities and that "...the new rules in
some ways made it even harder for investors to figure out
what was going on."
CLASSROOM
APPLICATION: The bailout plan is a response to risks and
losses associated with special purpose entities (SPEs) that
qualified for non-consolidation under Statement of Financial
Accounting Standards 140, Accounting for Transfers and
Servicing of financial Assets and Extinguishments of
Liabilities, and Financial Interpretation (FIN) 46(R),
Consolidation of Variable Interest Entities.
QUESTIONS:
1.) Summarize the plan to guarantee liquidity in commercial
paper markets as described in the related article. In your
answer, define the term structured investment vehicles (SIVs).
2.) The author writes that SIVs "...don't get recorded on
banks books...." What does this mean? Present your answer in
terms of treatment of qualifying special purpose entities (SPEs)
under Statement of Financial Accounting Standards 140,
Accounting for Transfers and Servicing Financial Assets and
Extinguishments of Liabilities.
3.) The author argues that current accounting standards make
it difficult for investors to figure out what was going on
in markets that now need bailing out. Explain this argument.
In your answer, comment on the quotations from Citigroup's
financial statements as provided in the article.
4.) How might reliance on "principles-based" versus
"rules-based" accounting standards contribute to solving the
reporting dilemmas described in this article?
5.) How might the use of more "principles-based standards"
potentially add more "fuel to the fire" of problems
associated with these special purpose entities?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED
ARTICLES:
Call to Brave to $100 Billion Rescue: Banks Seek
Investors for Fund to Shore Up Commercial Paper
by Carrick Mollenkamp, Deborah Solomon and Craig Karmin
The Wall Street Journal
Oct 16, 2007
Page: C1
Plan to Save Banks Depends on Cooperation of Investors
by David Reilly
The Wall Street Journal
Oct 15, 2007
Page: C1
|
March 18, 2008 reply from Paul Williams
[Paul_Williams@NCSU.EDU]
Bob, Can't speak for Jagdish, but you're
right. Now that the Federal government has intervened to affect the
absorption of Bear/Stearns by JPMorgan/Chase (JP Morgan's connections with
government and the power he wielded are well known, institutions are slow to
change), how can anyone take "market efficiency" seriously? If these
financial institutions are too important to be allowed to fail, then how are
they in any meaningful sense "private" enterprises with only "private"
consequences for their ineptitude?
When thousands of well-paying U.S. jobs
were being lost or replaced with Mcjobs, where was the full force and
authority of the U.S. government to save those people? Oh, but let Wall
Street face the prospect of losing its jobs and income and the Feds are
johnny on the spot prepared to lend as much money as it takes at prime rate
for all. The regulatory legislation of the 1930s was enacted for good
reasons -- not because of some left-wing conspiracy to take over the country
(Barbara Merino and Marilyn Neimark wrote an interesting paper some years
ago pointing out that the New Deal saved Wall Street from its own excesses).
With the hubris we've come to expect from
the free-market ideologues, we got the repeal of Glass-Steagal and the
near-complete deregulation of finance. What regulation is left is
underfunded and completely inadequate to the task. Finance's entrepreneurial
talents have been unleashed to create ever more complicated side-bets in the
presumption that they know something about "managing risk." Apparently they
don't know as much as they think they do. Keynes noted a long time ago that
it is absurd social policy to allow the capital formation of a nation to be
determined by a bunch of gamblers.
But as the economist Lester Thurow opined
some years ago, "We seem to make the same mistakes about every 60 years or
so." The dollar hasn't always been the world's reserve currency; other
currencies have had their turn and disturbingly they lost that status when
their respective issuers "financialized" their economies.
Bob Jensen's threads on accounting theory are at
http://faculty.trinity.edu/rjensen/theory01.htm
A Man from Fidelity Who Had No Fidelity
The Securities and Exchange Commission accused a former
Fidelity Investments stock trader and a broker of profiting illegally by trading
on confidential information about orders to buy shares of Covad Communications
Group Inc. David Donovan, 45 years old, of Marblehead, Mass., was forced to
resign in March 2005 after Fidelity learned of the allegedly illegal trading,
which occurred in a three-month period in 2003, according to the SEC's
complaint. According to a civil lawsuit filed by the SEC on Wednesday, Mr.
Donovan obtained confidential information from Fidelity's order database that
Fidelity was buying and intended to continue buying a big chunk of Covad stock
for its advisory clients, a move which would likely drive up the price of the
San Jose, Calif., technology company.
Judith Burns, The Wall Street Journal, April 18, 2008 ---
http://online.wsj.com/article/SB120848685804625435.html?mod=todays_us_money_and_investing
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's "Congress to the Core" threads are
at
http://faculty.trinity.edu/rjensen/FraudCongress.htm
The Mouse That Roared
Hundreds of super-rich American tax cheats have, in
effect, turned themselves in to the IRS after a bank computer technician in the
tiny European country of Liechtenstein came forward with the names of US
citizens who had set up secret accounts there, according to Washington lawyers
investigating the scheme. The bank clerk, Heinrich Kieber, has been branded a
thief by the government of Liechtenstein for violating the country's bank
secrecy laws.
Brian Ross and Rhoda Schwartz,
"Day of Reckoning? Super Rich Tax Cheats Outed by Bank Clerk," ABC News,
July 15, 2008 ---
http://abcnews.go.com/print?id=5378080
From The Wall Street Journal's Accounting Weekly Review on
July 25, 2008
Offshore Tax Evasion Costs
U.S. $100 Billion, Senate Probe of UBS, LGT
Indicates
by Evan
Perez
The Wall Street Journal
Jul 17, 2008
Page: C3
Click here to view the full
article on WSJ.com
http://online.wsj.com/article/SB121624391105859731.html?mod=djem_jiewr_AC
TOPICS: Accounting
Irregularities, Auditing, Income Tax, Income
Taxes, Internal Auditing, Internal Controls,
International Auditing, Investment Banking,
Tax Avoidance, Tax Evasion, Tax Havens, Tax
Laws, Tax Shelters, Taxation
SUMMARY: The
U.S. loses about $100 billion annually due
to offshore tax evasion, according to a
senate probe that is taking aim at Swiss
bank UBS AG and Liechtenstein's LGT Group
for allegedly marketing tax-evasion
strategies to wealthy Americans.
|
CLASSROOM
APPLICATION: The article is useful
for emphasizing the interrelationships in accounting
disciplines that students may find unexpected, such as
information systems analysis, auditing internal controls,
international relationships, and taxation.
QUESTIONS:
1. (Introductory) "The Senate committee subpoenaed
several U.S. taxpayers, who investigators say maintained LGT
accounts that were unknown to the IRS, in violation of
reporting requirements." According to this quotation in the
article, what is illegal about the investment accounts held
by the U.S. residents, who were subpoenaed by the Senate
Permanent Subcommittee on Investigations?
2. (Introductory) What report provides the basis
for the accusations described above? Hint: you may find a
copy of the report through links in the on-line article or
by going directly to http://online.wsj.com/public/resources/documents/071708PSIReport.pdf
3. (Advanced) The attorney for one family whose
members have been subpoenaed to appear at the Senate
hearings argues that "the report, referred to in question 2
above, was a 'rush to judgment'. The attorney also was
quoted in the first related article as saying that "families
and businesses all over the world use a variety of tax
structures to legitimately protect their assets.' What are
some possible scenarios of legitimate international
investments?
4. (Advanced) "UBS in recent months has conceded
that both its private bank and its investment bank, which is
responsible for some $38 billion in write-downs tied to
subprime securities, suffered from a lack of internal
controls in recent years." How did this investigation give
rise to findings of internal control weaknesses at UBS AG?
How will UBS AG solve the problems with its banking
customers arising from these internal control failures? In
your answer, define the term "internal control weakness" and
state who might conduct a review of the UBS AG internal
controls.
5. (Advanced) 'UBS says it is working with
authorities to correct any past compliance failures." How
are the actions that UBS AG must now take, are affecting its
customer relationships?
Reviewed By: Judy Beckman, University of
Rhode Island
RELATED ARTICLES:
Lowy Family Faces Tax-Shelter Probes
by Evan Perez and Kris Hudson
Jul 19, 2008
Page: A3
UBS Move Will Affect U.S. Clients
by Carrick Mollenkamp
Jul 18, 2008
Page: C3
|
"Offshore Tax Evasion Costs U.S. $100 Billion, Senate Probe of
UBS, LGT Indicates," by Evan Perez, The Wall Street Journal, July 17,
2008; Pagehttp://online.wsj.com/article/SB121624391105859731.html?mod=djem_jiewr_AC
The U.S. loses about $100 billion annually
due to offshore tax evasion, according to a Senate probe that is taking aim
at Swiss bank UBS AG and Liechtenstein's LGT Group for allegedly marketing
tax-evasion strategies to wealthy Americans.
U.S. clients hold about 19,000 accounts at
UBS, with an estimated $18 billion to $20 billion in assets, in Switzerland,
according to the findings from the Senate probe and Justice Department
prosecutors.
The findings by the Senate Permanent
Subcommittee on Investigations come ahead of a hearing Thursday featuring
testimony from senior officials from the Internal Revenue Service and the
Justice Department related to investigations into alleged tax evasion.
The probe adds fuel to a burgeoning effort
by tax authorities around the globe to shatter the veil of bank secrecy that
tax havens hide behind in catering to the world's elite.
Investigators weren't able to obtain data
about LGT, but said the IRS has identified at least 100 accounts with U.S.
clients at the Liechtenstein bank.
Democratic Sen. Carl Levin, of Michigan,
chairman of the subcommittee, is pushing legislation to tighten requirements
that could force more disclosure by banks. "We are determined to tear down
these walls of secrecy and to break through the iron rings of deception," he
said at a briefing Tuesday.
Documents highlighted in the Senate probe
include one LGT memorandum that describes a client using accounts to move
funds "to the USA and Panama and may be classified as bribes."
An LGT spokesman said it provided
information to the committee investigators, and characterizes as "dated"
many of the documents.
The committee has subpoenaed several U.S.
taxpayers, who, investigators say, maintained LGT accounts unknown to the
IRS.
The four on the witness list are: Peter
Lowy, of Beverly Hills, Calif., whose family controls Australian
shopping-mall developer Westfield Group; Steven Greenfield, a toy importer
from New York; Shannon Marsh, whose family owned a construction company in
Fort Lauderdale, Fla.; and William Wu, of Forest Hills, N.Y.
According to documents cited in the
investigation, the Lowy family once maintained through LGT a series of
Liechtenstein-based foundations that in 2001 held $68 million in assets. The
foundations are similar to trust accounts in U.S. and other jurisdictions.
The Liechtenstein foundations were at the subject of a settlement between
the Lowy family entity and Australian tax authorities more than a decade
ago.
Attorneys for Messrs. Greenfield and Wu
declined to comment. An attorney for Mr. Marsh didn't return calls seeking
comment.
Robert S. Bennett, an attorney for Mr.
Lowy, said his client was traveling and couldn't attend Thursday's hearing.
"The Lowy family has done nothing improper," Mr. Bennett said, adding that
the family believed the subcommittee report was a "rush to judgment."
For investigators and prosecutors, the
biggest break has come from testimony given by former employees of UBS and
LGT. UBS banker Bradley Birkenfeld pleaded guilty June 19 to helping his
U.S. clients evade taxes. He told U.S. prosecutors that the Swiss bank
generates some $200 million a year in revenue from U.S. clients, prosecutors
say.
Investigators also have been aided by
information from Heinrich Kieber, a former employee of LGT, who has turned
over account data to tax authorities in Germany, Australia, the U.S. and
other nations.
The data have aided investigations in
several countries; in Spain Tuesday, police raided offices of several
financial firms accused by prosecutors of aiding rich Spanish citizens
connect with bankers in Liechtenstein.
UBS is in talks with the IRS and Justice
Department. Authorities are having a tougher time seeking help from
Liechtenstein, which is clinging to its secrecy laws. UBS is sending a
senior wealth-management official to testify; LGT declined to offer
testimony Thursday, saying its client-secrecy laws would prevent any
official from answering the questions senators have.
A UBS spokeswoman said the company
continues to work with authorities to correct any improprieties found by the
investigation.
Bob Jensen's "Congress to the Core Threads" are at
http://faculty.trinity.edu/rjensen/FraudCongress.htm
The government's proposals for preventing
another banking crisis are inadequate and will not work without major surgery
I have an article today on The Guardian website
with the title "After Northern Rock". The lead line reads "The government's
proposals for preventing another banking crisis are inadequate and will not
work without major surgery". It is available at
http://commentisfree.guardian.co.uk/prem_sikka_/2008/02/after_northern_rock.html
As many of you will know Northern Rock, a UK bank,
is a casualty of the subprime crisis and has been bailed out by the UK
government, which could possibly cost the UK taxpayer £100 billion. My
article looks at the reform proposals floated by the government to prevent a
repetition. These have been formulated without any investigation of the
problems. Within the space permitted, the article refers to a number of
major flaws, including regulatory, auditing and governance failures, as well
offshore, remuneration and moral hazard issues.
The above may interest you and you may wish to
contribute to the debate by adding comments.
As always there is more on the AABA website
(
http://www.aabaglobal.org <http://www.aabaglobal.org/>
).
Regards
Prem Sikka
Professor of Accounting
University of Essex
Colchester, Essex CO4 3SQ UK
"Too close for comfort The FSA report on
Northern Rock (United Kingdom) appeases the corporate elites. But in doing so,
it fails to address the underlying causes of the crisis," by Prem Sekka,
The Guardian, March 27, 2008 ---
http://commentisfree.guardian.co.uk/prem_sikka_/2008/03/too_close_for_comfort.html
The Financial
Services Authority
(FSA) report on Northern Rock is
hugely disappointing. The report is the result of an in-house
investigation rather than the outcome of an independent inquiry.
Though some regulatory deckchairs are to be reupholstered, it
shows no awareness of systemic failures or the shortcomings of
neoliberal ideologies that have left the economy teetering on
the edge of a recession.
Northern Rock
is not the first time that the financial regulators have failed.
Equitable Life and
Independent Insurance are still fresh
in people's minds. The Bank of England, the FSA's regulatory
predecessor, was not any better either, as evidenced by its role
in the BCCI debacle. Though
BCCI was closed in 1991, there has
been no independent investigation to this day. The absence of a
thorough investigation may have saved some political skins but
no lessons seem to have been learnt.
The FSA report
associates regulatory failures with a lack of resources and key
personnel, but says nothing about the capture of the regulators
by corporate interests. Regulators need to be solely dedicated
to protect the interests of savers. That task requires them to
keep a certain distance from the regulated and developing
different values, vocabularies and agendas, saying "no" to
corporate requests for light regulation, monitoring their
business plans and testing financial products for its capacity
to cause mass destruction. To ensure that the FSA does not
continue to be a cheerleader for major corporations, we need
more openness. All correspondence between the FSA and any
financial institution must be publicly available. Yet there is
little sign of such changes in the FSA report.
Successive
governments talk about licensing gambling and casinos, but have
done little to effectively regulate the biggest casino of all,
the City of London. The FSA has permitted companies to use our
savings to gamble on virtually everything from oil, gas,
commodities, food, interest rate and exchange rate movements,
often without adequate public accountability. This
institutionalised gambling is promoted as "risk management", but
has created new risks that inflict hardship on millions of
people. The FSA has plans to bail out banks and speculators but
has no proposals for managing the risks inflicted on normal
people.
Continued in article
"Former Banker Convicted of Insider Trading," by
Michael J. de la Merced, The New York Times, February 5, 2008 ---
http://www.nytimes.com/2008/02/05/business/05insider.html?_r=1&ref=business&oref=slogin
A former Credit Suisse banker accused of
leaking confidential information about several major deals, including the
$45 billion buyout of TXU, as part of a $7.5 million insider trading scheme
was convicted Monday in Federal District Court in Manhattan
After three days of deliberation, the jury
found the former banker, Hafiz Muhammad Zubair Naseem, 37, guilty of one
count of conspiracy and 28 counts of insider trading for relaying insider
information to Ajaz Rahim, a high-level banker in Pakistan and once Mr.
Naseem’s boss.
From the beginning, the case against Mr.
Naseem was notable for its scope and the way it coincided with a two-year
boom in mergers. In the last two years, prosecutors have filed insider
trading cases, some involving broad schemes, involving bankers at nearly all
the top securities firms.
But none roped in financiers as
high-ranking as Mr. Rahim, the former head of investment banking at Faysal
Bank in Karachi and one of the most successful traders in Pakistan. And few
involved deals as big as the acquisition of TXU, the Texas power giant that
was bought by Kohlberg Kravis Roberts and TPG Capital.
“We respectfully disagree with the jury’s
verdict,” a lawyer for Mr. Naseem, Michael F. Bachner, said Monday, adding
that Mr. Naseem would file an appeal.
Mr. Naseem came to the United States in
2002 to earn a business degree at New York University. He worked briefly at
JPMorgan Chase before moving to Credit Suisse’s energy group in March 2006.
Prosecutors said that Mr. Naseem used his
position as a banker almost immediately to feed information about deals to
Mr. Rahim, who traded on the tips before the mergers were announced. They
offered as evidence scores of phone calls Mr. Naseem made and e-mail
messages he sent from his office, including one message that read, “Let the
fun begin.”
Beginning in the fall of 2006, regulators
at the New York Stock Exchange were tracking suspicious trading in the
options of Trammell Crow before its purchase by the CB Richard Ellis Group.
The investigation eventually widened to nine deals, including the TXU buyout
and Express Scripts’ failed bid for Caremark Rx. Credit Suisse was an
adviser on all nine deals.
Lawyers for Mr. Naseem have derided
prosecutors’ evidence as circumstantial at best.
Mr. Rahim, who also faces charges, remains
in Pakistan. But Mr. Naseem has borne the brunt of the government’s case. He
was initially denied bail after prosecutors deemed him a flight risk. Mr.
Naseem later posted a $1 million bond but was mostly confined to his home in
Rye Brook, N.Y.
Continued in article
From Jim Mahar's blog on January 25, 2008 ---
Kerviel joins ranks of master
rogue traders:
"In
being identified as the lone wolf behind French
investment bank Société Générale's staggering
$7.1-billion loss Thursday, Jérôme Kerviel joined
the ranks of a rare and elite handful of rogue
traders whose audacious transactions have
single-handedly brought some of the world's
financial powerhouses to their knees.
This notorious company includes Nick Leeson, who
brought down Britain's Barings Bank in 1995 by
blowing $1.4-billion, Yasuo Hamanaka, who squandered
$2.6-billion on fraudulent copper deals for Sumitomo
Corp. of Japan in 1998, John Rusnak, who frittered
away $750-million through unauthorized currency
trading for Allied Irish Bank in 2002 and Brian
Hunter of Calgary, who oversaw the loss of
$6-billion on hedge fund bets at Amaranth Advisors
in 2006.
Surprise! Surprise! Insider Trading Never Ceases
A former Credit Suisse Group banker and a former
Pakistani financier were indicted yesterday by a federal grand jury on charges
of conspiring to make illegal insider trades related to acquisitions on which
the bank advised. The indictment, filed in Federal District Court in Manhattan,
names as defendants Hafiz Muhammad Zubair Naseem, who worked at the New York
office of Credit Suisse, which is based in Zurich, and Ajaz Rahim, former head
of investment banking at Faysal Bank in Karachi, Pakistan. They must appear in
court to enter a formal plea to the charges.
"Two Are Indicted in Insider Trading Case," The New York Times, July 4,
2007 ---
http://www.nytimes.com/2007/07/04/business/04insider.html
Insider Trading at Bear Stearns
A former broker at Bear Stearns, Ken Okada, is expected
to plead guilty in a wide-ranging insider-trading case, becoming the ninth
person to admit wrongdoing in a scheme that also involved employees at UBS and
Morgan Stanley. An assistant United States attorney, Andrew Fish, revealed the
expectation in a letter to a federal judge presiding over a related case brought
by the Securities and Exchange Commission. The letter was entered into court
records yesterday. Mr. Okada is one of 13 people charged by federal prosecutors
in Manhattan in March.
The New York Times, November 15, 2007 ---
http://www.nytimes.com/2007/11/15/business/15insider.html?ref=business
Ex-Merrill Lynch Analyst
Sentenced for Insider Trading
A former Merrill Lynch analyst caught in a sprawling $7 million insider trading
scheme must serve more than three years in prison to show Wall Street that
sharing inside secrets will not be met with leniency, a judge said yesterday.
The judge, Kenneth M. Karas of United States District Court in New York, said he
was sending the former trader, Stanislav Shpigelman, to prison because he did
not want those entrusted to protect secrets about stocks to think stellar
academic backgrounds and great families would protect them from punishment for
financial crimes.
"Ex-Merrill Lynch Analyst Sentenced for Insider Trading," The New York Times,
January 6, 2007 ---
http://www.nytimes.com/2007/01/06/business/06insider.html
Jensen Comment
This is only the first round. Generally scum bags like this get greatly reduced
or suspended sentences on appeal. It's far worse to be poor and steal a loaf of
bread.
Bob Jensen's threads on why white
collar crime pays even if you get caught are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
With the holidays approaching, a Wall Street
colleague may sidle up and suggest a contribution to the SIV Superfund. Your
esoteric reading is likely to lead you astray here. This is not a campaign to
cure the simian immunodeficiency virus, a subject that recently occupied you for
hours on Wikipedia. It's a self-help bailout fund organized by banks for their
friendly neighborhood "structured investment vehicles." . . . Banks are supposed
to know better than to borrow short and lend long, which can be profitable as
heck until short-term rates skyrocket or short-term lenders disappear
altogether. No, banks didn't commit this folly directly. They set up
off-balance-sheet SIVs to borrow short and lend long, while shifting some of the
proceeds back to the bank sponsors as fat "fees." Citigroup, for one, collected
$24 million last year from its biggest SIV, equivalent to about 38% of the
profits funneled to outside investors. But weren't the outside investors
supposed to bear any loss? Otherwise the banks were obliged to recognize the
SIVs on their own balance sheets with suitable reserves. Yet now you hear
murmurs that banks offered informal guarantees and staked their "reputational
capital" to lure investor cash into the SIVs. Some say that contributing to the
superfund would be contributing to "moral hazard," i.e., encouraging bad
behavior.
Holman W. Jenkins, Jr., "UnimpresSIV,"
The Wall Street Journal, October 31, 2007; Page A20 ---
http://online.wsj.com/article/SB119377701493476654.html
Misleading Financial Statements:
Bankers Refusing to Recognize and Shed "Zombie Loans"
One worrying lesson for bankers and regulators
everywhere to bear in mind is post-bubble Japan. In the 1990s its leading
bankers not only hung onto their jobs; they also refused to recognise and shed
bad debts, in effect keeping “zombie” loans on their books. That is one reason
why the country's economy stagnated for so long. The quicker bankers are to
recognise their losses, to sell assets that they are hoarding in the vain hope
that prices will recover, and to make markets in such assets for their clients,
the quicker the banking system will get back on its feet.
The Economist, as quoted in Jim Mahar's blog on November 10, 2007 ---
http://financeprofessorblog.blogspot.com/
After the Collapse of Loan Markets Banks
are Belatedly Taking Enormous Write Downs
BTW one of the important stories that are coming out is
the fact that this is affecting all tranches of the debt as even AAA rated debt
is being marked down (which is why the rating agencies are concerned). The
San Antonio Express News reminds us that conflicts of interest exist here
too.
Jime Mahar, November 10, 2007 ---
http://financeprofessorblog.blogspot.com/
Jensen Comment
The FASB and the IASB are moving ever closer to fair value accounting for
financial instruments. FAS 159 made it an option in FAS 159. One of the main
reasons it's not required is the tremendous lobbying effort of the banking
industry. Although many excuses are given resisting fair value accounting for
financial instruments, I suspect that the main underlying reasons are those
"Zombie" loans that are overvalued at historical costs on current financial
statements.
Daniel Covitz and Paul Harrison of the
Federal Reserve Board found no evidence of credit agency conflicts of interest
problems of credit agencies, but thier study is dated in 2003 and may not apply
to the recent credit bubble and burst ---
http://www.federalreserve.gov/Pubs/feds/2003/200368/200368pap.pdf
In September 2007 some U.S. Senators
accused the rating agencies of conflicts of interest
"Senators accuse rating agencies of conflicts of interest in market turmoil,"
Bloomberg News, September 26, 2007 ---
http://www.iht.com/articles/2007/09/26/business/credit.php
Also see
http://www.nakedcapitalism.com/2007/05/rating-agencies-weak-link.html
Bob Jensen's threads on fair value accounting are at
http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue
Question
Why have "new" concerns arisen over naked short selling?
From The Wall Street Journal Accounting Weekly Review on July 13, 2007
"Blame the 'Stock Vault'?" by John R. Emshwiller and Kara Scannell, The
Wall Street Journal, July 5, 2007, Page: C1
Click here to view the full article on WSJ.com
TOPICS: Accounting
SUMMARY: The Depository Trust & Clearing Corp. (DTCC) "...is the middleman
[for all U.S. stock trade transactions] that helps ensure delivery of shares to
buyers and money to sellers." Rather than physically exchanging shares of stock
and cash for their clients' trading, brokerage houses maintain bank-like
accounts of "securities entitlements" at the DTCC; "almost all stock is now kept
at [the DTCC's] central depository and never leaves there." The SEC requires
that trades be completed within 3 days, but "if the stock in a given transaction
isn't delivered in the three-day period, the buyer, who paid his money, is
routinely given electronic credit for the stock." This mechanism essentially
provides cover for naked short-selling. Though it is an illegal practice, the
SEC has no procedure to enforce the three-day requirement and thus eliminate the
possibility of naked short-selling. "Critics contend that DTCC and the SEC have
been too secretive with delivery-failure data" and thus are not upholding laws
requiring "a free and transparent market."
QUESTIONS:
1.) What is the Depository Trust & Clearing Corp. (DTCC)? Why was it
established?
2.) Based on the information in the article, describe the organization of the
DTCC in terms of a balance sheet equation. What assets does the entity hold?
What are its liabilities? Hint: think in terms similar to a bank which holds
cash for its customers and which shows demand deposits on its balance sheet as
liabilities.
3.) Refer to your answer to question 2 and to the statement in the article
that the DTCC credits stock buyers' brokerage accounts with "securities
entitlements", which then can be sold to another stock buyer. Is the term
"credit" used in the same way as the description of a credit balance in a
balance sheet equation? Support your answer.
4.) What is naked short-selling? Why do you think this practice is illegal?
5.) According to the description in the article, how do DTCC practices allow
for naked short selling?
6.) What is "transparency" in a market? How could improvements to DTCC
reporting help to improve the transparency in U.S. securities markets?
7.) How is the issue of transparency in reporting by the DTCC similar to
transparency in financial reporting by corporate entities?
8.) What actions are the SEC and the DTCC considering to respond to the claim
of insufficient transparency in this area?
Reviewed By: Judy Beckman, University of Rhode Island
"Blame the 'Stock Vault'?" by John R. Emshwiller and Kara Scannell, The
Wall Street Journal, July 5, 2007, Page: C1
Click here to view the full article on WSJ.com
At issue is a nefarious twist on short-selling, a
legitimate practice that involves trying to profit on a stock's falling
price by selling borrowed shares in hopes of later replacing them with
cheaper ones. The twist is known as "naked shorting" -- selling shares
without borrowing them.
Illegal except in limited circumstances, naked
shorting can drive down a stock's price by effectively increasing the supply
of shares for the period, some people argue.
There is no dispute that illegal naked shorting
happens. The fight is over how prevalent the problem is -- and the extent to
which DTCC is responsible. Some companies with falling stock prices say it
is rampant and blame DTCC as the keepers of the system where it happens.
DTCC and others say it isn't widespread enough to be a major concern.
The Securities and Exchange Commission has viewed
naked shorting as a serious enough matter to have made two separate efforts
to restrict the practice. The latest move came last month, when the SEC
further tightened the rules regarding when stock has to be delivered after a
sale. But some critics argue the SEC still hasn't done enough.
The controversy has put an unaccustomed spotlight
on DTCC. Several companies have filed suit against DTCC regarding delivery
failure. DTCC officials say the attacks are unfounded and being orchestrated
by a small group of plaintiffs' lawyers and corporate executives looking to
make money from lawsuits and draw attention away from problems at their
companies.
Historic Roots
The naked-shorting debate is a product of the
revolution that has occurred in stock trading over the past 40 years. Up to
the 1960s, trading involved hundreds of messengers crisscrossing lower
Manhattan with bags of stock certificates and checks. As trading volume hit
15 million shares daily, the New York Stock Exchange had to close for part
of each week to clear the paperwork backlog.
That led to the creation of DTCC, which is
regulated by the SEC. Almost all stock is now kept at the company's central
depository and never leaves there. Instead, a stock buyer's brokerage
account is electronically credited with a "securities entitlement." This
electronic credit can, in turn, be sold to someone else.
Replacing paper with electrons has allowed
stock-trading volume to rise to billions of shares daily. The cost of buying
or selling stock has fallen to less than 3.5 cents a share, a tenth of
paper-era costs.
But to keep trading moving at this pace, the system
can provide cover for naked shorting, critics argue. If the stock in a given
transaction isn't delivered in the three-day period, the buyer, who paid his
money, is routinely given electronic credit for the stock. While the SEC
calls for delivery in three days, the agency has no mechanism to enforce
that guideline.
'Phantom Stock'
Some delivery failures linger for weeks or months.
Until that failure is resolved, there are effectively additional shares of a
company's stock rattling around the trading system in the form of the shares
credited to the buyer's account, critics say. This "phantom stock" can put
downward pressure on a company's share price by increasing the supply.
DTCC officials counter that for each undelivered
share there is a corresponding obligation created to deliver stock, which
keeps the system in balance. They also say that 80% of the delivery failures
are resolved within two business weeks.
There are legitimate reasons for delivery failures,
including simple clerical errors. But one illegitimate reason is naked
shorting by traders looking to drive down a stock's price.
Critics contend DTCC has turned a blind eye to the
naked-shorting problem.
Denver Lawsuit
In a lawsuit filed in Nevada state court,
Denver-based Nanopierce Technologies Inc. contended that DTCC allowed
"sellers to maintain significant open fail to deliver" positions of millions
of shares of the semiconductor company's stock for extended periods, which
helped push down Nanopierce's shares by more than 50%. The small company,
which is now called Vyta Corp., trades on the electronic OTC Bulletin Board
market. In recent trading, the stock has traded around 40 cents. A Nevada
state court judge dismissed the suit, which prompted an appeal by the
company.
Continued in article
Credit Default Swaps: Another Stumbling Block for Fair Value
Accounting and FAS 133/IAS 39
The banks, as counterparties, are on the hook for
billions in insurance they bought to hedge credit-derivatives positions. The
insurance policies, called credit default swaps, have exploded in popularity in
the last few years, with some $45 trillion outstanding. Closely watched bond
guru Bill Gross of Pacific Investment
Management calls banks' participation in the CDS market a ponzi scheme
that may trigger losses of $250 billion. Bank disclosure
is sketchy, and the market is hard to evaluate for lack of information. Credit
default swaps are sold over the counter, are not traded on an exchange and are
outside the close scrutiny of regulators. 'The ultimate systemic risk caused by
the weakened positions of the monoline insurers is overwhelming and scary,' said
CIBC World Markets analyst Meredith Whitney in a late-December research note.
'The impact will be sizable and very negative for the banks.'"
Liz Moyer, "You Should Worry About Ambac, Forbes, January 17, 2008
---
Click Here
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's threads on credit swaps can be found under
"Credit Derivative and Credit Risk Swap" at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
Corrupt Corporate Governance
For years, the health insurer didn't tell investors
about personal and financial links between its former CEO and the "independent"
director in charge of compensation
Jane Sasseen, "The Ties UnitedHealth Failed to Disclose: For years, the
health insurer didn’t tell investors about personal and financial links between
its former CEO and the "independent" director in charge of compensation,"
Business Week, October 18, 2006 ---
Click Here
Bob Jensen's threads on "Corporate Governance" are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance
Bob Jensen's thread on "Outrageous Compensation" are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
"Gluttons At The Gate: Private equity are using slick new tricks
to gorge on corporate assets. A story of excess," by Emily Thornton, Business
Week Cover Story, October 30, 2006 ---
Click Here
Buyout firms have always been aggressive. But an
ethos of instant gratification has started to spread through the business in
ways that are only now coming into view. Firms are extracting record
dividends within months of buying companies, often financed by loading them
up with huge amounts of debt. Some are quietly going back to the till over
and over to collect an array of dubious fees. Some are trying to flip their
holdings back onto the public markets faster than they've ever dared before.
A few are using financial engineering and bankruptcy proceedings to wrest
control of companies. At the extremes, the quick-money mindset is
manifesting itself in possibly illegal activity: Some private equity
executives are being investigated for outright fraud.
Taken together, these trends serve as a warning
that the private-equity business has entered a historic period of excess.
"It feels a lot like 1999 in venture capital," says Steven N. Kaplan,
finance professor at the University of Chicago. Indeed, it shares elements
of both the late-1990s VC craze, in which too much money flooded into
investment managers' hands, as well as the 1980s buyout binge, in which
swaggering dealmakers hunted bigger and bigger prey. But the fast money--and
the increasingly creative ways of getting it--set this era apart. "The deal
environment is as frothy as I've ever seen it," says Michael Madden,
managing partner of private equity firm BlackEagle Partners Inc. "There are
still opportunities to make good returns, but you have to have a special
angle to achieve them."
Like any feeding frenzy, this one began with just a
few nibbles. The stock market crash of 2000-02 sent corporate valuations
plummeting. Interest rates touched 40-year lows. With stocks in disarray and
little yield to be gleaned from bonds, big investors such as pension funds
and university endowments began putting more money in private equity. The
buyout firms, benefiting from the most generous borrowing terms in memory,
cranked up their dealmaking machines. They also helped resuscitate the IPO
market, bringing public companies that were actually making money--a welcome
change from the sketchy offerings of the dot-com days. As the market
recovered, those stocks bolted out of the gate. And because buyout firms
retain controlling stakes even after an IPO, their results zoomed, too, as
the stocks rose. Annual returns of 20% or more have been commonplace.
The success has lured more money into private
equity than ever before--a record $159 billion so far this year, compared
with $41 billion in all of 2003, estimates researcher Private Equity
Intelligence. The first $5 billion fund popped up in 1996; now, Kohlberg
Kravis Roberts, Blackstone Group, and Texas Pacific Group are each raising
$15 billion funds.
And that's the main problem: There's so much money
sloshing around that everyone wants a quick cut. "For the management of the
company, [a buyout is] usually a windfall," says Wall Street veteran Felix
G. Rohatyn, now a senior adviser at Lehman Brothers Inc. (LEH ) "For the
private equity firms with cheap money and a very well structured fee
schedule, it's a wonderful business. The risk is ultimately in the margins
they leave themselves to deal with bad times."
Continued in article
Insiders are still screwing the investing public
"Trading in Harrah's Contracts Surges Before LBO Disclosure: Options,
Derivatives Make Exceptionally Large Moves; 'Someone...Was Positioning'," by
Dennis K. Berman and Serena Ng, The Wall Street Journal, October 4, 2006;
Page C3 ---
http://online.wsj.com/article_print/SB115992145253481882.html
Trading in Harrah's Entertainment Inc. options and
derivatives contracts reached a fevered pitch in the days leading up to news
of a potential leveraged buyout of the gambling giant, making it the latest
in a string of recent deals marked by unusual trading activity.
At one point last week, the volume of "call"
options, contracts to buy a specific number of shares by a fixed date at a
specified price, increased to almost six times the August average. At about
the same time, movements in the credit-default swap market suggested that
traders in the sophisticated financial instruments were anticipating a
potential buyout.
Harrah's said Monday that it had received a $15.1
billion buyout offer from private-equity firms
Apollo Management and Texas Pacific Group. The
$81-a-share offer caused Harrah's shares to jump 14% and its bonds to fall
11% as the company's credit ratings were cut to "junk" by Standard & Poor's.
Yesterday, the shares fell 1.3%, or 97 cents, to $74.71 as of 4 p.m. in New
York Stock Exchange composite trading. The Las Vegas company is reviewing
the buyout proposal and isn't certain a transaction will be sealed.
Last Thursday, two trading days before the offer
was announced, options traders exchanged 23,597 call contracts, nearly six
times the August volume, according to Options Clearing Corp.
"Clearly, someone out there was positioning for
some movement in Harrah's," said Stacey Briere Gilbert, Susquehanna
Financial Group's chief options strategist. "I don't know whether they were
positioning for an LBO, but for something."
Derivatives tied to Harrah's bonds also moved. The
price of a five-year credit-default swap that protects an investor against a
default in $10 million of Harrah's bonds climbed 24% last week to $114,000
annually, according to Markit Group.
The price of Harrah's swaps more than doubled to
$265,000 after Monday's announcement.
These derivatives, which trade over the counter and
are much more active than the bonds to which they are tied, are lightly
regulated and traded mostly by big banks and hedge funds. Some investors use
them to hedge against a debt default, while others use them to speculate on
whether a company's default risk is rising or falling.
As the options and derivatives markets experienced
abnormal swings, Harrah's publicly traded shares were relatively flat last
week. "The stock market is by far the slowest to respond," Ms. Briere
Gilbert said.
In a leveraged buyout, the company being acquired
often ends up taking on additional debt, increasing its risk of default and
causing the price of the swaps to rise. The firm's existing bonds also tend
to fall in value on such news, pushing their yields higher as investors
demand greater returns to compensate for the additional risk.
In a market awash in rumor, speculation, and
sometimes dumb luck, it can be hard to pinpoint who was trading and why such
trading began. Often, an options trade unrelated to a deal can set off
"piggyback" buying from traders hoping to catch a lucky break. Many such
rumors -- as with a recent round of talk about Starwood Hotels & Resorts
Worldwide Inc. -- create a trading stir that ends in a whimper. No deal ever
materialized for Starwood.
Question
Is the market for credit default swaps rife with insider
trading?
That depends on what you mean by insider
trading.
See "Credit Default Swaps: The Land of Efficient Insider Trading?" DealBroker
---
http://www.dealbreaker.com/2007/04/credit_default_swaps_the_land.php
Use the term in a loose
sense—say defining “insider trading” as trades where one party has material
nonpublic information unavailable to their trading counterparts—and the
answer is clearly yes. There is a lot of that sort of insider trading in the
credit default market, and there is likely to be even more as the market
grows and more players gather around the table.
But since federal securities
regulations against insider trading apply only to insider trading in
securities, the question of whether this counts as "insider trading" in a
strictly legal sense is murkier. Credit default swaps do not fit the
traditional definition of securities. Prior to the enactment of the
Commodity Futures Modernization Act of 2000, there was a lot of debate over
the legal answer to the question of whether they should be categorized with
the most common types of securities-stocks and bonds. The CFMA split the
difference by declaring that swaps were not securities but that insider
trading and other federal anti-fraud measures still applied to swaps where
the underlying credit was a security, such as those based on publicly traded
bonds.
But this has been
controversial from the start. Few of those trading in the credit default
swap market were calling out for protection from insider trading. Many hedge
funds and other debt-holders active in the credit default market lack the
kind of internal controls and so-called “Chinese Walls” that investment
banks and brokerages have had to build to prevent insider trading in
securities. And most of the other market participants are aware that this is
the situation. In short, there is plenty of asymmetrical information in the
credit default swap market but that fact is widely--even
symmetrically--known. Moreover, the legal status of more complex financial
products not directly tied to individual securities remains murky.
Regardless, it seems the
regulators are exactly crying out to enforce insider-trading laws against
the traders in the credit default market either. Right now no US regulatory
agency claims oversight jurisdiction for credit-default swaps. Not the SEC.
Not the Commodity Futures Trading Commission. Not the Treasury Department.
Not the Federal Reserve.
Since no one enforces
insider trading laws in the credit default swap market, and apparently no
one has the jurisdiction to enforce insider trading laws, it seems the laws
only apply to the market in some metaphysical, theoretical sense. There's
something of a tree falling in an empty forest thing going on with the
application of insider trading laws to credit default swaps. If a statute
applies insider trading regs to credit default swaps but no one enforces it,
does the tree make any sound?
Over on his new blog at
Portfolio, Felix Salmon points us toward the remarks of Erik Sirri, the
director of the SEC's division of market regulation.
Salmon writes:
Sirri came out and said what
everybody in the markets knows but nobody wants to admit: "In a world of
important pricing efficiency, you want insiders trading because the price
will be more efficient. That is as it should be."
Sirri then went on to
explain that insider-trading laws should still exist, for the purpose of
investor protection. But he added that he thought it "very important" that
credit default swaps be traded – something which won't happen if the
tradable contracts fall under insider-trading regulations while the present
bilateral contracts don't.
Sirri’s
rationale here seems relatively simple. Insider trading laws have efficiency
costs but the government has made the decision that in the case of markets
for securities those costs are outweighed by the gains in investor
protection and investor confidence. Part of the reason for deciding things
in this way is because the government, corporate America and the large
brokerages want ordinary investors to feel confident they are playing on
something of a level playing field with those with potentially better access
to information. But in trades involving more sophisticated players trading
more sophisticated financial products, it’s far from clear that this
rationale applies. Do we really need to protect hedge funds from other hedge
funds and investment banks in credit default swap trading? The enforcement
and compliance costs with insider trading rules may outweigh the benefits.
Nonetheless, it is
entertaining watching the easily scandalized become so easily scandalized
when a regulator mentions the benefits of insider trading. One question: why
are so many of the easily scandalized also British?
Continued in article
Bob Jensen's threads on Credit Derivatives
are under the C-Terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
Things
You Should Know About Credit Card Companies
Dirty Secrets of Credit
Card Companies ---
http://faculty.trinity.edu/rjensen/FraudReporting.htm#FICO
From PBS:
Things a Credit Card Holder Should Know (including online tests for students)
Secret History of the
Credit Card --- http://www.pbs.org/wgbh/pages/frontline/shows/credit/
You can watch the
entire Frontline video from the link on the above site.
Question
What is "pump-and-dump" brokerage fraud?
"Brokers Are Indicted in Fraud Case," The Wall Street Journal, August
3, 2006, Page D2 ---
Click Here
Eight brokers, including the nephew
of the chief executive of microcap Stratus Services Group Inc., have been
indicted in an alleged "pump-and-dump" scheme to artificially inflate the
New Jersey temporary-staffing company's stock, Manhattan District Attorney
Robert M. Morgenthau said.
At a press conference, Mr. Morgenthau
said Christopher Janish of Parsippany, N.J.; Joseph Barile of Long Branch,
N.J.; Arthur Caruso of Secaucus, N.J.; Marat Beksultanov of Brooklyn; and
four other individuals defrauded hundreds of clients out of at least $13
million by inducing them to buy shares in lightly traded Stratus.
Prosecutors declined to name the other individuals because they haven't yet
been arraigned.
Four companies, including brokerage
firm Essex & York Inc. and investment fund
Pinnacle Investment Partners
L.P., also have been charged in the matter.
Continued in article
Question
Why are brokerage firms are still Congress to the core?
"The Soft Dollar Scandal," by Benn Steil, The Wall Street
Journal, June 19, 2006; Page A15 ---
http://online.wsj.com/article/SB115068121938383835.html?mod=opinion&ojcontent=otep
The SEC will shortly issue its
long-awaited final "interpretive release" on a brokerage industry
practice that would make Tony Soprano blush. Known as "soft dollars,"
the practice involves a broker charging a fund manager commission fees
five to 10 times the market rate for a trade execution, in return for
which the broker kicks back a substantial portion in the form of
"investment-related services" to the manager. Magazines, online
services, accounting services, proxy services, office administration,
computers, monitors, printers, cables, software, network support,
maintenance agreements, entrance fees for resort conferences -- all
these things are bought through brokers with soft dollars. And in one of
the industry's loveliest ironies, fund managers even pay inflated
commissions in return for trading cost measurement services which
invariably tell them that their brokers cost too much.
Why do the fund managers do it?
Why don't they buy items directly from their suppliers, and then choose
brokers on the basis of lowest trading cost? The reason is clear. If the
fund manager buys items directly from the suppliers, he pays with his
firm's cash. If he buys them through brokers when executing trades,
however, the law, or the SEC, lets him use his clients' cash.
How widespread is the practice?
Some 95% of institutional brokers receive soft dollars, about a third of
which were found by the SEC in the late 1990s to be providing illegal
services to fund managers, well outside the scope of
"investment-related." Surveys find that fund managers routinely choose
brokers based on criteria having nothing to do with trade execution.
How much does this practice cost
investors? My own analysis suggests that the cost in bad trading alone
amounts to about 70 basis points a year, or about 14 times the estimated
cost of the market timing abuses that dominated headlines in 2004.
The Senate Banking Committee held
hearings on soft dollars in March 2004. Chairman Richard Shelby
indicated at the time that the SEC would "get more than a nudge" to
eliminate clear abuses, defined as services which could not reasonably
be held to constitute "research." So what has our champion of investor
rights decided to do for us? Punt the ball back to Congress. In its
initial guidance last October, expected to be substantially reiterated
in the forthcoming final verdict, the commission's long-awaited crack
down amounted to little more than a memorandum to fund managers
instructing them to read the law, cut out a few egregious abuses (office
furniture is a no-no, though resort conferences are still fine), and pay
only "reasonable" commissions.
How does the "reasonable"
commission regime work in practice? Put simply, the higher the price tag
on the soft-dollar goodies, the more trading the fund manager does with
the broker to acquire them, which is clearly antithetical to investor
protection.
To his credit, freshman SEC
Chairman Christopher Cox issued a thoughtful statement in advance of
last October's guidance, diplomatically describing soft dollars as an
"anachronism" -- referring to the politics of unfixing fixed commissions
30 years ago, and Congress's insertion of the Section 28(e) safe harbor
into the Exchange Act, allowing client trading commissions to pay for
research. But it was under the SEC's watch that the safe harbor
ballooned into a safe coastal resort, in which client-financed
commission payments have become so generous that a broker for one of the
nation's largest fund management companies made the headlines in 2003 by
thanking the funds' traders with a lavish dwarf-chucking bachelor party.
It is therefore time for Congress and the SEC to stop punting the ball
back and forth, and for Congress finally to abolish the "anachronism."
As a Wall Street Journal reader
in good standing, I'm not calling for more rules and market
intervention. Quite the opposite. It is in the nature of a
government-sanctioned kickback scheme that serial interventions by
regulators will be required to pacify the fleeced. This is a simple
property rights issue, and treating it sensibly as such would require
less government intervention in the future.
The solution is simple. If a fund
manager wants to buy $10,000 worth of research, let him write a check to
the provider. That's how you and I would buy it -- we wouldn't expect to
get it by making a thousand phone calls through Verizon at 10 times the
normal price. There is a legitimate debate over whether the cost of
research should be charged to the fund manager, which would then recoup
it transparently through the management fee, or deducted directly from
the clients' assets.
The first option was recommended
by former Gartmore chairman Paul Myners in his famous 2001 report to the
U.K. Treasury. The second would, in any case, be a dramatic improvement
on the status quo. If the government did not force funds to buy research
through brokers in order to pass the cost on to clients, the SEC's "best
execution" requirements, meaningless in a soft-dollar environment, would
actually become part of a fund manager's DNA. No longer forced to choose
between soft dollars for his firm or good trades for his client, he will
finally have an incentive to seek out value-for-money in both research
and trading, as it will benefit both his firm and his client.
What do mutual fund traders
think? At a November conference, I surveyed 35 of them anonymously. The
majority, 46%, said that fund managers should buy independent research
with "hard dollars," out of their own assets rather than those of the
investors; 37% backed option two above, paying the providers directly
rather than through commissions, which the SEC currently prohibits. A
mere 17% supported the status quo, soft dollars. The problem is that
fund managers have no incentive to move away from soft dollars while
their competitors are legally using them to inflate profits.
So who actually loses from
Congress correcting its mistake? Brokers. But shed no tears for them.
Middlemen always lose when kickback schemes are ended.
Mr. Steil is director of international economics
at the Council on Foreign Relations.
Popular Mortgage Web Site Under Scrutiny
A lawsuit against Bankrate.com, which alleges
that the Web site has become a haven for "bait-and-switch" loan pitches,
underlines the difficulty consumers can have in locating reliable
financial information online.
Michael Hudson, "Popular Mortgage Web Site Under Scrutiny: Lawsuit
Against Bankrate Spotlights Difficulty of Getting Sound Financial Data
Online," The Wall Street Journal, July 12, 2006 ---
http://online.wsj.com/article/SB115266435444704096.html?mod=todays_us_personal_journal
Bob Jensen's mortgage advice is at
http://faculty.trinity.edu/rjensen/FraudReporting.htm#MortgageAdvice
Investors in Hedge Funds Do So at Their Own Peril
Hedge Funds Are Growing: Is This Good or Bad?
When the ratings agencies downgraded General
Motors debt to junk status in early May, a chill shot through the $1
trillion hedge fund industry. How many of these secretive investment
pools for the rich and sophisticated would be caught on the wrong side
of a GM bond bet? In the end, the GM bond bomb was a dud. Hedge funds
were not as exposed as many had thought. But the scare did help fuel the
growing debate about hedge funds. Are they a benefit to the financial
markets, or a menace? Should they be allowed to continue operating in
their free-wheeling style, or should they be reined in by new
requirements, such as a move to make them register as investment
advisors with the Securities and Exchange Commission?
"Hedge Funds Are Growing: Is This Good or Bad?" Knowledge@wharton,
June 2005 ---
http://knowledge.wharton.upenn.edu/index.cfm?fa=viewArticle&id=1225
"Court Says S.E.C. Lacks Authority on Hedge Funds," by Floyd Norris, The
New York Times, June 24, 2006 ---
Click Here
A federal appeals court ruled yesterday that the
Securities and Exchange Commission lacks the authority to regulate hedge
funds, dealing a possibly fatal blow to the commission's efforts to oversee
a rapidly growing industry that now has $1.1 trillion in assets.
A three-judge panel of the United States Court of
Appeals for the District of Columbia Circuit ruled unanimously that the
commission exceeded its power by treating investors in a hedge fund as
"clients" of the fund manager. The commission has authority over any manager
with at least 15 clients, and it used that to require hedge fund managers to
register.
The ruling, unless overturned on appeal, means that
Congressional action would be required to grant the S.E.C. the authority to
force hedge fund managers to register, or for the commission to impose any
other rules on such funds.
The ruling does not leave such funds totally above
the law since they are treated like any other investor in determining
whether they violated securities laws. As a result, the decision will not
affect an S.E.C. investigation into possible insider trading by a major
hedge fund manager, Pequot Capital Management, which was disclosed in a New
York Times article yesterday.
Christopher Cox, who became S.E.C. chairman after
the rule was adopted, said the commission would review the issue, but
stopped short of indicating that it would continue to seek authority over
hedge funds.
"The S.E.C. takes seriously its responsibility to
make rules in accordance with our governing laws," Mr. Cox said in a
statement. "The court's finding, that despite the commission's investor
protection objective its rule is arbitrary and in violation of law, requires
that going forward we re-evaluate the agency's approach to hedge fund
activity."
He said the commission would "use the court's
decision as a spur to improvement in both our rule making process and the
effectiveness of our programs to protect investors, maintain fair and
orderly markets, and promote capital formation."
As hedge funds have grown, and as some have
collapsed amid fraud or because they took excessive risks, pressures to
regulate them have grown. But fund managers have protested that the vast
majority have acted responsibly and should not be subjected to what James C.
McCarroll, a lawyer with Reed Smith, a New York law firm, said yesterday
were "regulatory overlays and burdens" approaching those faced by mutual
funds.
The S.E.C. rule, adopted in December 2004 on a
3-to-2 vote, called for fund managers with more than $30 million in assets
and at least 15 investors to register with the commission. Nearly 1,000
managers did so by the deadline of Feb. 1, 2006.
The S.E.C. rule exempted funds that imposed
two-year lockups on investors' money, meaning the money could not be
withdrawn for at least that long, leading a number of funds to impose such
lockups. Some may choose to remove or ease those rules now.
Hedge funds, as the appeals court opinion written
by Judge Arthur R. Randolph noted, "are notoriously difficult to define."
But they generally are open only to wealthy investors and charge fees based
on a percentage of the assets under management plus a portion of the
profits.
The growth of hedge funds has made some managers
incredibly wealthy, with incomes dwarfing even those of high-paid corporate
chief executives. Alpha, a publication of Institutional Investor, reported
that two hedge fund managers earned more than $1 billion each in 2005.
The pressure for more oversight of hedge funds grew
after one fund, Long-Term Capital Management, almost collapsed in 1998. The
Federal Reserve, fearful that such a collapse could cause systemic risk,
encouraged Wall Street firms to mount a rescue, which they did.
The emergence of activist hedge funds, which
sometimes act in concert with each other and can become the largest
shareholders of some companies, has also increased calls for regulation,
both here and in Europe. A German politician called such funds "locusts"
that plundered German companies and then fired German workers. Some European
governments have pushed for international regulation of such funds.
The decision to push for S.E.C. registration was
made by Mr. Cox's immediate predecessor, William H. Donaldson. Mr. Donaldson
argued that the funds had grown so large they could cause systemic risk to
the financial markets, and that a gradual process of "retailization,"
through such trends as "fund of funds" that allow relatively small
investments, had made it more important for regulators to have at least some
knowledge of what was going on in the funds.
Bob Jensen's threads on hedge funds are under the H-Terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#H-Terms
Bob Jensen's threads on proposed reforms are at
http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm
Just Another in a Long Line of Prudential Rip-Offs
Prudential to Cough Up $600 million to settle charges of Improper Mutual Fund
Trading
"Brokerage unit admits criminal wrongdoing, DOJ says," by Alistair Barr &
Robert Schroeder, MarketWatch, August 29, 2006 ---
http://www.the-catbird-seat.net/Prudential.htm
Prudential Financial Inc.'s brokerage unit agreed
on Monday to pay $600 million to settle charges that former employees
defrauded mutual fund investors by helping clients rapidly trade funds.
The payment -- the largest market-timing settlement
involving a single firm -- ends civil and criminal probes and allegations by
the Department of Justice, the Securities and Exchange Commission and
several other regulators including New York Attorney General Eliot Spitzer.
Prudential Equity Group, a subsidiary of Prudential
Financial (PRU) admitted criminal wrongdoing as part of its agreement with
the Justice Department. Prudential Equity Group was formerly known as
Prudential Securities.
Prudential will pay $270 million to victims of the
fraud, a $300 million criminal penalty to the U.S. government, a $25 million
fine to the U.S. Postal Inspection Service and a $5 million civil penalty to
the state of Massachusetts, according to the Justice Department.
"Prudential to Pay Fine in Trading," by Landen Thomas Jr., The New York
Times, August 29, 2006 ---
Click Here
Prudential Financial, the life insurance company,
agreed yesterday to pay with federal and state regulators that one of
its units engaged in inappropriate mutual fund trading.
The payment, the second-largest levied against a
financial institution over the practice, may bring to a close a three-year
investigation into the improper trading of mutual funds that has ensnared
some of the largest names on Wall Street and the mutual fund industry.
The settlement with the Justice Department, which
covers trades totaling more than $2.5 billion made from 1999 to 2000, is
also the first in the market timing scandal in which an institution has
admitted to criminal wrongdoing.
Such a concession by Prudential, part of a deferred
prosecution agreement that will last five years, underscores the extent to
which the improper trading practices were not only widespread at Prudential
Securities, but also condoned by its top executives, despite repeated
complaints from the mutual fund companies.
"The Winding Road to Grasso's Huge Payday," by Landon Thomas,
The New York Times, June 25, 2006 ---
http://www.nytimes.com/2006/06/25/business/yourmoney/25grasso.html
In the spring of 2003, the chairman of the New York
Stock Exchange, Richard A. Grasso, had his eyes on a very rich prize.
Although Mr. Grasso's annual compensation at the time was about $12 million,
on a par with the salaries of Wall Street titans whose companies the
exchange helped regulate, he had accumulated $140 million in pension savings
that he wanted to cash in — while still staying on the job.
Now Henry M. Paulson Jr., the chairman of Goldman
Sachs and a member of the exchange's compensation committee, was grilling
Mr. Grasso about the propriety of drawing down such an enormous amount and
suggested that he seek legal advice. So Mr. Grasso said he would call Martin
Lipton, a veteran Manhattan lawyer and the Big Board's chief counsel on
governance matters. Would it be legal, Mr. Grasso subsequently asked Mr.
Lipton, to just withdraw the $140 million if the exchange's board approved
it? Mr. Grasso told Mr. Lipton that he worried that a less accommodating
board might not support such a move, according to an account of the
conversation that Mr. Lipton recently provided to New York State
prosecutors. (Mr. Grasso has denied voicing that concern.) Mr. Lipton said
he told Mr. Grasso not to worry; as long as directors used their best
judgment, Mr. Grasso's request was appropriate.
Mr. Grasso continued to fret. What about possible
public distaste for the move? Yes, there would be some resistance from
corporate governance activists, Mr. Lipton recalled telling him, but given
his unique standing in the business community he was "fully deserving of the
compensation."
Then Mr. Lipton, a founding partner of Wachtell
Lipton Rosen & Katz and a longtime adviser to chief executives on the hot
seat, dangled another, hardball option in front of Mr. Grasso. If a new
board resisted a payout, Mr. Lipton advised, Mr. Grasso could just sue the
board to get his $140 million. The conversation represented a pivotal moment
at the exchange, occurring when corporate governance and executive
compensation were already areas of public concern. Mr. Grasso eventually
secured his pension funds. But the particulars surrounding the payout later
spurred Mr. Paulson to organize a highly publicized palace revolt against
Mr. Grasso, leading to the Big Board's most glaring crisis since Richard
Whitney, a previous president, went to jail on embezzlement charges in 1938.
An examination of thousands of pages of depositions
from participants in the Big Board drama, as well as other recent court
filings, highlights the financial spoils available to those in Wall Street's
top tier. It also shines a light on deeply flawed governance practices and
clashing egos at one of America's most august financial institutions, all of
which came into sharp relief as Mr. Grasso jockeyed to secure his $140
million.
ELIOT SPITZER, the New York State attorney general,
sued Mr. Grasso in 2004, contending that his Big Board compensation was
"unreasonable" and a violation of New York's not-for-profit laws. With a
trial looming this fall, prosecutors have closely questioned both Mr. Lipton
and Mr. Grasso about their phone call. Prosecutors are likely to highlight
Mr. Grasso's own doubts about the propriety of cashing in his pension; on
two separate occasions Mr. Grasso withdrew his pension proposal from board
consideration before finally going ahead with it.
The depositions paint a portrait of Mr. Grasso as a
man who paid meticulous attention to every financial perk, from items like
flowers and 99-cent bags of pretzels that he billed to the exchange, to his
stubborn determination to corral his $140 million nest egg. While the board
ultimately approved his deal, court documents also show a roster of all-star
directors, including chief executives of all the major Wall Street firms,
often at odds with one another or acting dysfunctionally.
A recent filing by Mr. Spitzer contended that Mr.
Grasso's chief advocate, Kenneth G. Langone, a longtime friend and chairman
of the Big Board's compensation committee, was less than forthcoming in
keeping the exchange's 26-member board in the loop about how Mr. Grasso's
rising pay was also inflating his retirement savings.
Continued in article
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's threads on corporate governance are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance
Bob Jensen's threads on outrageous executive compensation are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm
Morgan Stanley Hit for Millions and Billions in Civil Suits
"Morgan Stanley Settles Email Case for $15 Million," by Judith Burns, Susanne
Craig, and Jed Horowitz, The Wall Street Journal, May 11, 2006; Page C3
---
http://online.wsj.com/article/SB114727870115749075.html?mod=todays_us_money_and_investing
Morgan Stanley agreed to pay $15 million to settle
a civil lawsuit with the Securities and Exchange Commission over failure to
produce tens of thousands of emails during probes of conflicts of interest
among Wall Street analysts and other issues between late 2000 and mid-2005.
New York-based Morgan Stanley neither admitted nor
denied the SEC's charges, which have been previously reported by The Wall
Street Journal. The SEC said $5 million of the fine will go to the New York
Stock Exchange and the NASD, formerly the National Association of Securities
Dealers, to settle separate related proceedings.
A Morgan spokesman said the firm is glad the matter
is behind it. The firm continues to negotiate with regulators about failure
to produce emails in probes of its retail brokerage unit.
It is appealing a much larger headache: Last May
the firm was ordered to pay billionaire financier Ronald Perelman $1.45
billion over a lawsuit that, in the end, focused largely on the firm's
inability to produce documents. In that case, the judge concluded that in
many instances Morgan Stanley's actions "were done knowingly, deliberately
and in bad faith." The firm is appealing the verdict. Oral arguments for the
appeal are scheduled for June 28 in state court in West Palm Beach, Fla.
According to the SEC, Morgan Stanley failed to
"diligently search" for backup tapes containing emails until 2005 and
couldn't produce some emails because the company overwrote backup tapes. In
addition, the SEC said Morgan made "numerous misstatements" about its email
retention. The SEC charged the company with failing to provide records and
documents in a timely manner, as required by U.S. securities laws.
According to the SEC complaint, it received an
anonymous tip in the fall of 2004 that Morgan Stanley had destroyed some
electronic documents and failed to produce others.
Morgan Stanley and nine other firms agreed in 2003
to pay $1.4 billion as part of a so-called global settlement over charges
that they issued biased research to win investment banking business.
The fine won't reopen the global settlement,
according to people familiar with the matter, and isn't likely to help the
hundreds of investors who failed in their attempt to win damages against the
firm, in part because Morgan Stanley was unable to produce emails.
The SEC also said Morgan Stanley was lax in
searching for and delivering emails during its investigations of Wall
Street's distribution of hot initial public offerings during the dot-com
boom. Morgan Stanley paid $40 million in 2005 to settle SEC allegations of
improper IPO allocation practices.
Continued in article
Question
What is laddering in the IPO markets?
Definition of Laddering:
This practice artificially inflates the value of stocks.
Laddering occurs when underwriters of IPOs obtain commitments from investors to
purchase shares again (after they have begun trading publicly) at a specified,
higher price.
www.securitiesfraudfyi.com/securities_fraud_glossary.html
"J.P. Morgan Agrees To Settle IPO Case For $425 Million," by Randall Smith
and Robin Sidel, The Wall Street Journal, April 21, 2006; Page C4 ---
http://online.wsj.com/article/SB114556881547831668.html?mod=todays_us_money_and_investing
J.P. Morgan Chase & Co. agreed to pay $425 million
to settle civil charges of improperly awarding hot new stock issues during
the market bubble, indicating Wall Street's tab for the class-action case
could hit $4 billion.
The financial-services company reached a memorandum
of understanding with investor plaintiffs to settle the federal case,
according to Melvyn Weiss, chairman of the executive committee of six law
firms representing plaintiffs.
A J.P. Morgan spokesman confirmed the agreement in
principle, which is subject to court approval. He said it would have "no
material adverse affect on our financial results," indicating the bank has
likely already set aside funds to cover it.
The lawsuit accused underwriters of improperly
pumping extra air into the stock-market bubble in 1999 and 2000 by requiring
investors who got shares of hot initial public offerings to buy more shares
at higher prices once trading began.
The alleged practices by the 54 underwriter
defendants could have worsened losses of investors who bought at the higher
prices when the bubble burst, the plaintiffs charged. The practices at issue
became known as "laddering."
Continued in article
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Yawn, more fraud on top of a mountain of fraud at Merrill Lynch
Merrill Lynch & Co. has agreed in principle
to pay $164 million to settle 23 class-action lawsuits related to
its stock-research coverage of Internet companies during the
tech-stock bubble era. The settlements leave Merrill with two suits
still pending out of an initial 150 in which investors claimed to
have been misled by the company's former top tech-stock analyst,
Henry Blodget, and his team. The suits alleged that Mr. Blodget
recommended 27 stocks to help Merrill win investment-banking
assignments, even as he privately disparaged many of them.
Jed Horowitz, "Merrill to Settle Research Suits," The Wall Street
Journal, February 18, 2006; Page B2 ---
http://online.wsj.com/article/SB114020205518977166.html?mod=todays_us_money_and_investing
The Never-Ending Saga of Merrill Lynch Fraud
The appeal has unsealed a trove of documents
offering a rare glimpse of a Wall Street firm pursuing a tempting profit
opportunity over the objections of internal watchdogs. On repeated occasions
some Merrill employees voiced concern that the three brokers were doing
something wrong and took steps to stop them. Yet their immediate bosses often
pushed back, allowing the trading to continue.
"How Merrill, Defying Warnings, Let 3 Brokers Ignite a Scandal: Bosses
Back Lucrative Trades By Stars, Then Fire Them; Big Defamation Judgment 'Rewards
Outweigh the Risks'," by Susanne Craig and Tom Lauricella, The Wall Street
Journal, March 27, 2006; Page A1 ---
http://online.wsj.com/article/SB114342880710008788.html?mod=todays_us_page_one
SEC fines Merrill Lynch Again and Again and Again and Again . . .
Merrill Lynch & Co. agreed to pay $2.5 million and to
hire an independent consultant to settle allegations that it failed to promptly
produce email records, the Securities and Exchange Commission said yesterday.
Federal regulators had accused the New York brokerage firm of repeatedly failing
to furnish email from October 2003 through February 2005. The SEC said Merrill
Lynch had failed to retain certain business-related emails and that its policies
and procedures designed for the prompt production of email were deficient.
Siobhan Hughes, "Merrill to Pay Fine Over Emails" The Wall Street Journal,
March 14, 2006; Page C5 ---
http://online.wsj.com/article/SB114229015078797024.html?mod=todays_us_money_and_investing
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
German Bank to Settle Fraud Claims for $134 Million
Deutsche Bank AG said it expects to pay
about $134 million as part of a settlement with federal, state, and
self-regulatory agencies related to investigations into
market-timing issues. The German bank also said its Scudder
Distributors business has received a so-called Wells notice from the
National Association of Securities Dealers regarding noncash
compensation to "associated persons of NASD member firms." A Wells
notice allows recipients to respond before the regulator takes civil
action.
Gepffrey Rogow, "Deutsche Bank Offers Payment To Settle
Market-Timing Probe, The Wall Street Journal, January 28,
2006; Page B13 ---
http://online.wsj.com/article/SB113840210055558647.html?mod=todays_us_money_and_investing
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's threads on banking and securities frauds are at
http://faculty.trinity.edu/rjensen/FraudCongress.htm
Question
What really fueled Hitler's regime? Hitler's Bank Bares Its Dark Past
Dresdner's self-financed study reveals that greed
rather than ideology inspired its zealous support for the regime, even to
helping build Auschwitz. There's no way to put a positive spin on German
industry's collaboration with the Nazi regime before and during World War II, so
Dresdner Bank Chief Executive Herbert Walter didn't try. Presenting the results
of an independent study of Dresdner's role in the Holocaust, Walter admitted:
"It confronts us with bitter historical truths. We accept these truths, even
when they are painful."
Jack Ewing, "Hitler's Bank Bares Its Dark Past: Hitler's Bank Bares Its
Dark Past," Business Week, February 22, 2006 ---
Click Here
Painful is hardly a strong enough word. According
to the study by a team of historians from German universities, Dresdner
functioned as the house bank to Hitler's Schutzstaffel (SS), lending more
money than any other bank to the organization that was at the forefront of
the most ghastly atrocities. Dresdner, co-founded by Eugen Gutmann, who was
Jewish, quickly expelled its Jewish employees after the Nazi takeover and
arbitrarily cut the pension payments of Jewish retirees. The bank even owned
a stake in the construction company that built the crematorium at the
Auschwitz concentration camp.
It has become almost a ritual for big German
companies to finance detailed studies of their Nazi collaboration.
Volkswagen, DaimlerChrysler (DCX ), Siemens (SI ), and even menswear maker
Hugo Boss (HUGSF ) have owned up to their histories. Part of the motivation
may be genuine remorse, but companies also have learned that attempts to
spin history can backfire.
MONEY MOTIVE
Bertelsmann suffered severe embarrassment in 1998 when a German journalist,
Hersch Fischler, punctured the myth that the Gütersloh-based media giant had
resisted the Nazis and suffered a shutdown of its book-publishing business
as a result. In fact, the company later conceded, Bertelsmann had profited
handsomely from supplying morale-building books to German troops and was
shut down near the end of the war only to save paper.
Since then, companies have learned that it's better
to confront the past themselves than to wait for an enterprising historian
or journalist to do so. The self-examination is a prerequisite to being a
global player from Germany. "Apparently, they expect to be more involved in
the global community in the next decade. They want to start in a clear
position," says Cees B.M. van Riel, a professor who teaches corporate
communications at RSM Erasmus University business school in Rotterdam, The
Netherlands.
As Walter conceded in a statement, Dresdner
suppressed its own history until the mid-1990s when, under pressure from
critics, it commissioned the study. Dresdner's close ties to top Nazis were
already well-known; Chief Executive Karl Rasche, an SS member, was tried and
sentenced to a prison term at Nuremberg.
But the study makes clear that Dresdner's wartime
culpability was much deeper, and the motive was money rather than politics
or Nazi pressure. The bank "took advantage of all the business opportunities
opened up by the aggressive and racist policies of the Third Reich," study
co-author Johannes Bähr concludes.
OVERZEALOUS COOPERATION
Despite the bank's own Jewish origins, it played a key role in the
persecution of German Jews, according to the study. After Jewish employees
were expelled in 1933, Dresdner exceeded even Nazi race laws in cutting
their pensions or severance payments. As Jewish businesses were being "Aryanized,"
the bank hired thuggish "business consultants" to intimidate owners and
seize control.
After the war began, bank executives knew early on
about crimes taking place in concentration camps, according to the study.
Dresdner provided banking services to numerous SS facilities. The bank was a
major shareholder in a construction company, based in Breslau (now the
Polish city of Wroclaw), which built crematoriums at the Auschwitz death
camp. "Particularly in the case of its most reprehensible activities, the
bank could have operated differently," Bähr writes.
Continued in article
Correcting this CEO IPO fraud is long overdue
"A Major Perk For Executives Takes a Big Hit: McLeod Ruling Makes It
Tougher To Accept Lucrative IPO Shares; Broader Definition of 'Spinning'," by
Michael Siconolfi, The Wall Street Journal, February 21, 2006; Page C1
---
http://online.wsj.com/article/SB114048274500878570.html?mod=todays_europe_money_and_investing
Corporate executives, take note: The definition of
improper stock trading in your brokerage account just got broader.
A New York state court recently found former
telecommunications executive Clark E. McLeod liable for receiving hot new
stocks in his personal brokerage account. The rationale: His company was
sending business to the same securities firm, Citigroup Inc.'s Salomon Smith
Barney, that doled him the new stocks.
That is a big change. Previously, "spinning" of
initial public offerings of stock involved a direct quid pro quo. In a
common form, securities firms allocated IPOs to the personal accounts of
corporate executives, so the shares could then be sold, or "spun," for quick
profits -- in exchange for business from the executives' companies.
IPO shares are coveted because they often surge on
their first trading day. Spinning has raised concerns among investors that
the IPO market is rigged.
Bottom line: Senior executives now could skate on
thin legal ice if they receive IPO shares from a Wall Street firm with which
their company at some point does business, and don't disclose it to their
board or shareholders.
The ruling has broader ramifications. Even though
Mr. McLeod lived and worked in Cedar Rapids, Iowa, the judge said the New
York attorney general could bring the case because the transactions were
made through a New York firm. Most securities firms do business in New York.
This is an "expansive interpretation" of corporate
executives' duty, says Joseph Grundfest, a former commissioner at the
Securities and Exchange Commission and now a law and business professor at
Stanford University.
The ruling comes as the IPO market heats up again.
So far this year, there have been 32 new stock issues brought to market,
raising $5.8 billion; the average first-day gain has been 11%, according to
Richard Peterson, a senior researcher at Thomson Financial, a New York
financial-data provider.
Mr. McLeod, 59 years old, declined to comment. He
will appeal the "completely novel" ruling, says one of his lawyers, Richard
Werder, a partner at Jones Day.
A former mathematics and science teacher, Mr.
McLeod started a long-distance company out of his garage in 1980. He
eventually founded McLeod Inc., a telecom upstart now known as McLeodUSA
Inc. that fell victim to the bursting of the technology-stock bubble. He
left as chief executive in April 2002; McLeodUSA emerged from bankruptcy-law
protection last month. He currently is CEO of Fiberutilities of Iowa, a
utility-management company.
Continued in article
Bob Jensen's threads on outrageous executive compensation are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
Bob Jensen's updates on fraud are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Executive Loses Case on Trading," by Gretchen Morgenson, The New York
Times, February 11, 2006 ---
http://www.nytimes.com/2006/02/11/business/11wall.html
Eliot Spitzer, the New York attorney general, sued
the executive, Clark E. McLeod, and four other high-profile
telecommunications executives in 2002, contending that they had steered
investment banking business to Salomon Smith Barney in exchange for inflated
ratings on their companies' stocks and hot new shares of other companies.
Mr. McLeod netted $9.96 million in profits on 34
stock allocations from 1997 to 2000, the court filings said. Salomon Smith
Barney received more than $77 million in underwriting fees from McLeodUSA.
In a decision issued Thursday, Justice Richard B.
Lowe III of New York State Supreme Court in Manhattan wrote that Mr.
McLeod's acceptance of initial public offering shares from the same
brokerage firm that his company used as an investment banker, a practice
known as spinning, was "a sophisticated form of bribery."
Continued in article
Will Wall Street ever
learn about how to restore and maintain integrity?
Security Analysis and the "Booster Shot
Hypothesis"
From Jim Mahar's Blog on October
25, 2005
SSRN-Strength of Analyst Coverage Following IPOs by
Christopher James, Jason Karceski
James and Karceski report that firms who have poor
IPO performance get more than just price stabilization in the after market.
However, while price stabilization tends to end relatively quickly, the
firms whose IPO did poorly also get longer term more favorable coverage in
the period following their IPO. This supports the "booster shot" hypothesis.
"Firms with poor aftermarket performance are
given higher target prices and are more likely to receive strong buy
recommendations, especially by analysts affiliated with the lead
underwriter. This favorable coverage is relatively short-lived, lasting
for only the first one or two analyst reports, typically less than six
months."
What is so cool about this finding is that James
and Karceski do not find the same degree of positive recommendations for
stocks that went up immediately after their IPO. This finding is important
for it seemingly differentiates the momentum stories from the so-called
"booster shot" explanation.
"Another alternative is that analysts
pre-commit to provide more than a favorable recommendation. As suggested
by Michaely and Womack (1999), analysts may commit to provide a "booster
shot" by increasing the strength of their recommendation in the face of
an unfavorable market response to the IPO. This argument suggests a
negative relationship between strength of affiliated coverage and stock
price performance."
The findings?
"Lead analysts post much higher relative target
prices for IPO firms that have non-positive initial returns and for
firms that trade at or below the IPO offer price when coverage is
initiated. For these broken deals, lead analyst target price ratios are
on average more than 26 and 36 percentage points higher than target
price ratios for firms with zero or negative initial returns or for
firms with non-positive return to coverage."
To control for the "of course it is not a strong
buy, it has already gone up" phenomena, the authors use a group of analysts
that were not associated with the IPO. The authors find that analysts
associated with lead underwriters are more positive on the stock (which is
consistent with the booster shot hypothesis):
"Lead analysts are also more optimistic relative to
other analysts in broken deals in their recommendations as well. The average
lead analyst target price ratio for broken deals is 14 percentage points
higher than the average target price ratio set by other analysts."
Interestingly the ranking of investment bankers
seems to matter (or at least the ranking of their clientele).
"Virtually all (96%) of the 85 broken deals
underwritten by a top-ranked underwriter received coverage. In contrast,
only 53% of broken deals underwritten by less prestigious underwriters
received coverage. The percentage of IPOs underwritten by top-ranked
underwriters that receive coverage does not differ significantly by whether
or not the IPO is a broken deal. In contrast, broken deals underwritten by
less prestigious underwriters are significantly less likely to receive
coverage than successful IPOs underwritten by less prestigious underwriters
(the t statistic is -3.68). Thus, one reason to use a top-rated underwriter
appears to be a higher likelihood of analyst support if returns are poor in
the aftermarket." Very interesting.
Cite: James, Christopher M. and Karceski, Jason J.,
"Strength of Analyst Coverage Following IPOs" (February 28, 2005). AFA 2006
Boston Meetings Paper
http://ssrn.com/abstract=600721
"Millennium Settles in 'Timing' Case; Funds, Executives to Pay $180 Million,"
by Ian McDonald and Gregory Zuckerman, The Wall Street Journal, December
2, 2005; Page C1 ---
http://online.wsj.com/article/SB113345122389011396.html?mod=todays_us_money_and_investing
Hedge funds run by New York money manager
Millennium Management LLC and four of the firm's top executives agreed to
pay $180 million to settle regulatory charges that they tricked mutual-fund
firms into allowing them to make trades that cheated other investors.
The executives, including Millennium founder Israel
Englander, used more than 100 "shell companies" to open more than 1,000
brokerage accounts and make more than 76,000 rapid trades in mutual funds
from 1999 to 2003, according to civil complaints filed by New York Attorney
General Eliot Spitzer and the Securities and Exchange Commission. Rapid
trades in and out of funds -- known as market timing -- are barred by most
fund firms because they raise expenses and lower returns for long-term
shareholders.
The case "shows the lengths people will go in order
to deceive mutual funds and profit from market timing," said Helene Glotzer,
associate regional director in the SEC's New York office. More settlements
with hedge funds that improperly traded in mutual funds are likely in coming
months, she said.
"The fraudulent practices increased in intensity
and amount as mutual funds became more vigilant in trying to stop
market-timing activities," added Charles Caliendo, an assistant attorney
general in New York.
Mr. Englander declined to comment through a
spokesman and didn't respond to an email. In a letter to investors
yesterday, he said, "We have addressed our issues forthrightly and as
promptly as circumstances permitted."
Since Mr. Spitzer shook up the sleepy mutual-fund
world with allegations of improper trading in September 2003, 15 firms have
reached settlements totaling more than $3.5 billion in fines, penalties and
fee cuts for investors. Millennium is the second hedge fund to settle.
Canary Capital Partners was the first; it paid $40 million.
Millennium's Mr. Englander, who has built a
reputation as one of the most successful traders on Wall Street since
founding the firm in 1989, will personally pay a $30 million penalty and
will be banned from working for an SEC-registered investment fund for three
years. The 57-year-old Mr. Englander will still be able to work at
Millennium, which is an unregistered investment adviser. Millennium and the
individuals settled without admitting or denying wrongdoing.
New York authorities say the mutual-fund trades
totaled more than $52 billion. In addition, they say Millennium traded more
than $19 billion improperly through fund-like accounts held in insurance
products such as variable annuities, which are essentially tax-deferred
retirement accounts with an insurance wrapper that typically guarantees a
given payout if the contract holder dies. Millennium also received same-day
pricing for some trades made after the market closed in an illegal practice
known as "late trading," they say.
Investors in Mr. Englander's funds will bear the
brunt of the pain. Under the settlement, outside investors in Millennium's
$5.4 billion funds will pay $106 million of the $180 million bill,
disgorging gains that came from the allegedly improper trading. The balance
will be paid by the firm and its executives.
Continued in article
It's always serious when the NASD finally takes action
Citigroup Inc.'s Smith Barney unit
expressed disappointment with an arbitration ruling awarding $2.5
million to an investor who alleged he received bad stock-option
advice from brokers in Citigroup's Smith Barney branch in Atlanta.
Smith Barney spokeswoman Kimberly Atwater said the company was
"disappointed with this decision, which is inconsistent with those
made in other cases." Virginia resident Travis Brown claimed during
the National Association of Securities Dealers hearing that the
brokers advised him to use an "exercise and hold" strategy with his
WorldCom stock options from 1999 to 2000. Mr. Brown's account lost
value as WorldCom's stock price began to tumble in 2000.
"Ruling Disappoints Smith Barney," The Wall Street Journal,
April 12, 2005; Page A6 ---
http://online.wsj.com/article/0,,SB111327048205304284,00.html?mod=todays_us_page_one
Analyst forecasts: A "consensus" of one analyst
When you think of a person whose opinion counts most
for a company, the CEO, chairman or chief financial officer probably comes to
mind. But for nearly 700 public U.S. companies, the one analyst who covers the
stock ranks right up there. That might sound farfetched, but consider mutual
fund tracker Morningstar, which reported 70% higher earnings in its most recent
quarter, but saw its stock whacked 6% anyway the day of the earnings release.
Its results fell short of the "consensus" that actually was the estimate of the
one analyst who covers the company. "It's kind of scary," says that analyst,
Marvin Loh of DE Investment Research. "If they miss me, they miss the estimate."
Matt Krantz, "'Consensus estimate' may be from one analyst," USA Today,
December 6, 2005 ---
http://www.usatoday.com/money/markets/us/2005-12-06-stock-analysts_x.htm
It's beyond me why anybody does business with Morgan Stanley
Morgan Stanley's past actions hardly inspire
confidence that the firm can be relied upon to analyze the legal potential of
the documents. All Wall Street firms play hardball when clients bring
arbitration cases. But Morgan Stanley is famous for its scorched-earth tactics.
The firm often stonewalls routine requests for documents and stalls even when
arbitration panelists order that materials be produced. During an October 2003
arbitration, for example, Morgan Stanley was penalized $10,000 a day until it
complied with an order that documents be produced. "Enough is enough," the
arbitration panel wrote. Morgan Stanley seems similarly obstructionist in its
dealings with regulators. New Hampshire's securities department last month cited
it for "improper and inadequate production of documents" in a case involving
allegations of improper sales. Jeffrey Spill, deputy director of the state's
Bureau of Securities Regulation, said in a statement: "What we have seen is a
consistent pattern of delay and obfuscation in relation to document production,
in addition to inadequate recordkeeping, both here in New Hampshire and in other
jurisdictions." Morgan Stanley settled the case W.A.O.D.W. - without admitting
or denying wrongdoing.
Gretchen Morgenson, "All That Missing E-Mail ... It's Baaack," The New York
Times, May 8, 2005 ---
http://www.nytimes.com/2005/05/08/business/yourmoney/08gret.html
Ex-Specialists Face Indictment For NYSE Deals
Several former New York Stock Exchange traders who
oversaw stock auctions on the floor face indictment today on charges that they
traded to benefit their firms at the expense of their customers, people familiar
with the matter said. The criminal probe by federal prosecutors in New York City
grew out of a civil case against the seven firms that employ the traders, known
as specialist firms. Without admitting or denying wrongdoing, those NYSE
specialist firms last year paid a total of $247 million to settle charges that
their employees interfered with customer orders or put them aside, usually for
just a few crucial seconds, so they could trade their firm's own money, taking
advantage of their knowledge of which way the market was moving.
Kara Scannell and Aaron Lucchettii, "Ex-Specialists Face Indictment For NYSE
Deals," The Wall Street Journal, April 12, 2005; Page C1 ---
http://online.wsj.com/article/0,,SB111327015694304271,00.html?mod=todays_us_money_and_investing
Fraud Beat on Insider Trading
"Oracle's Chief in Agreement to Settle Insider Trading Lawsuit," by Jonathan
D. Glater, The New York Times, September 12, 2005 ---
http://www.nytimes.com/2005/09/12/technology/12oracle.html
Lawrence J. Ellison, chief executive of Oracle, has
reached a tentative agreement under which he would pay $100 million to
charity to resolve a lawsuit charging that he engaged in insider trading in
2001, a lawyer involved in the case said.
The unusual settlement, which requires the approval
of Oracle's board and could still break down, would be one of the largest
payments made to resolve a shareholder suit of this kind, known as a
derivative lawsuit. Typically in derivative lawsuits, damages are paid
directly to the company. Under the terms of the settlement, Mr. Ellison
would designate the charity and the payments, to be made over five years,
would be paid in the name of Oracle. It is unclear whether the payments
would be tax-deductible by Mr. Ellison.
The lawsuit charged that Mr. Ellison, known for his
brash and combative pronouncements, sold almost $900 million of shares ahead
of news that Oracle would not meet its expected earnings target. The same
amount of stock, after the announcement, was worth slightly more than half
as much.
According to the court docket for the case, which
was filed in Superior Court in San Mateo, Calif., a hearing on the
settlement - which requires court approval - is scheduled for Sept. 26.
Under the terms of the agreement, the lawyers who brought the case for
shareholders would receive about $22.5 million, separate from the $100
million payment.
Continued in article
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's threads on Congress to the Core are at
http://faculty.trinity.edu/rjensen/FraudCongress.htm
KPMG scandal reveals the shady dealings of some large banks
Jonathan Weil, "How Big Banks Played Key Role In Tax Shelters," The Wall
Street Journal, August 19, 2005 ---
http://online.wsj.com/article/0,,SB112440575755717142,00.html?mod=todays_us_money_and_investing
In February 1998, two managers at UBS AG in London
received an anonymous letter warning that the Swiss bank's derivatives unit
was "offering an illegal capital-gains tax evasion scheme to U.S.
taxpayers." The cost to the Internal Revenue Service: "hundreds of millions
of dollars a year," according to the missive.
"I am concerned that once IRS comes to know about
this scheme they will levy huge financial/criminal penalties on UBS," said
the letter, which named three UBS employees the author believed were
involved. "My sole objective is to let you know about this scheme, so that
you can take some concrete steps to minimise the financial and reputational
damage to UBS."
UBS responded by halting all trades related to two
KPMG LLP tax shelters, known as Foreign Leveraged Investment Program and
Offshore Portfolio Investment Strategy, or Flip and Opis. Several months
later, though, the bank "resumed selling the products, stopping only after
KPMG discontinued the sales," according to an April report by the U.S.
Senate Permanent Subcommittee on Investigations. Citing UBS documents, the
report said the bank appeared to have reasoned that its participation "did
not signify its endorsement of the transactions and did not constitute
aiding or abetting tax evasion." The identity of the 1998 letter's author, a
self-described UBS "insider," hasn't surfaced publicly. A UBS spokesman
declined to comment.
Continued in Article
Bob Jensen's threads on KPMG scandals are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
SEC Chairman William Donaldson has quietly
made it known to the White House that he would like to remain the
nation's top securities cop, but the business lobby would like nothing
more than to see him gone.
"Bush's Donaldson Dilemma," by Deborah Solomon and John D.
McKinnon, The Wall Street Journal, December 20, 2004, Page A4
--- http://online.wsj.com/article/0,,SB110350099382804351,00.html?mod=home_whats_news_us
Will Bush be able to stand up to the most powerful people on the
planet? --- http://faculty.trinity.edu/rjensen/fraudCongress.htm#InvestmentBanking
You Can't
Beat the Most Powerful People on the Planet!
Business Groups Begin Quiet Campaign to Oust SEC's Donaldson
AccountingWeb, December 16, 2004 --- http://www.accountingweb.com/item/100230
The Business Roundtable, the U.S. Chamber
of Commerce, the National Association of Wholesaler-Distributors
played a critical role in reelecting President Bush. Now the groups
are part of a quiet effort to convince the President
Believing the post-Enron reforms have led
to a strangled business environment, in part because of the greater
authority given to the SEC by the Sarbanes-Oxley corporate reform
legislation. The Journal reported that the groups believe the reform
effort has gone to far and threatens to hamper the economy by
discouraging corporate risk taking.
They seek an SEC chair who understands the
challenges faced by executives and their boards. They claim the
current chairman, William Donaldson, does not understand their
concerns.
Since Donaldson is a close friend of the
Bush family and was appointed chairman two years ago by President
Bush, efforts to oust him are expected to be quiet, the Journal
reported, predicting his possible departure early next year.
While the groups are angling for a
softening of the harsh regulatory and enforcement climate that was
generated in the wake of corporate scandals, they understand there
would be little public support for any backtracking of the progress
made to clean up corporate America.
Thomas Donohue, the feisty president of the
Chamber of Commerce, insisted to the Journal that he has "no
idea about a campaign to get rid of Donaldson." But he has been
the most public of the lobbyists in calling for change at the SEC.
The Chamber has even sued the agency over its new rules requiring
independent directors at mutual fund companies, the Journal
reported.
"I am very anxious to find ways to get
Congress, the press, the administration and the judicial system to
focus on the implementation of Sarbanes-Oxley and the runaway system
of corporate destruction being run by (New York Attorney General)
Eliot Spitzer and the people who work at the SEC and the Justice
Department," Donohue told the Journal. "It's time for all
of us to take a look at what is being done."
It took nerve for William H. Donaldson, the S.E.C.
chairman, to wade into those issues, which previous chairmen had been unwilling
or unable to address in detail. His action helped force the Big Board to move to
faster electronic trading for some orders, a major accomplishment. But now
the rulemaking effort has slowed, and Mr. Donaldson's plan to pass a rule this
week was stalled as opponents gained one more delay in an effort to rouse
opposition. A Republican commissioner, Paul S. Atkins, was critical of the
proposal, saying the commission should get out of the way and let competition
among markets benefit everyone. He did not address how to avoid having such
competition benefit brokers rather than their customers. The S.E.C. is seeking
more public comment.
Floyd Norris, "3 Years After Enron, Resistance to New Rules Grows," The
New York Times, December 17, 2004 --- http://www.nytimes.com/2004/12/17/business/17norris.html?oref=login
Bob Jensen's threads on "Congress to the Core" are at http://faculty.trinity.edu/rjensen/fraudCongress.htm
At least they will spend a little time in prison
A federal judge in Houston gave two former
Merrill Lynch & Co. officials substantially shorter prison sentences
than the government was seeking in a high-profile case that grew out
of the Enron Corp. scandal. In a separate decision yesterday,
another Houston federal judge said that bank-fraud charges against
Enron former chairman Kenneth Lay would be tried next year,
immediately following the conspiracy trial against Mr. Lay, which is
set for January. Judge Sim Lake had previously separated the
bank-fraud charges from the conspiracy case against Mr. Lay and his
co-defendants, Enron former president Jeffrey Skilling and former
chief accounting officer Richard Causey. The government had been
seeking to try Mr. Lay on the bank-fraud charges within about the
next two months . . . Judge Ewing Werlein, Jr. sentenced former
Merrill investment banking chief Daniel Bayly to 30 months in
federal prison and James Brown, who headed the brokerage giant's
structured-finance group, to a 46-month term. The federal probation
office, with backing from Justice Department prosecutors, had
recommended sentences for Messrs. Bayly and Brown of about 15 and 33
years, respectively. Mr. Brown had been convicted on more counts
than Mr. Bayly.
John Emshwiller and Kara Scannell, "Merrill Ex-Officials' Sentences
Fall Short of Recommendation," The Wall Street Journal, April 22,
2005, Page C3 ---
http://online.wsj.com/article/0,,SB111410393680013424,00.html?mod=todays_us_money_and_investing
Jensen Comment: I double dare you to go to the top of this
document and search for every instance of "Merrill" ---
http://faculty.trinity.edu/rjensen/FraudCongress.htm
Update on October 2007
Then how come Merrill Lynch is on the verge of
escaping the wrath of investors because of its involvement in some of
Enron's corporate and accounting frauds?
The
Securities and Exchange
Commission lays out the facts in various documents
such as
Litigation Release No. 20159 and Accounting and
Auditing Enforcement Release No. 2619, and in the related
Complaint in the U.S. District Court.
"The Accounting Cycle: The Merrill
Lynch-Enron-Government Conspiracy," by: J. Edward Ketz, SmartPros,
October 2007 ---
http://accounting.smartpros.com/x59129.xml
In a 2004 trial, a jury found these four
Merrill executives guilty of participating in a fraudulent scheme. The
former Merrill managers appealed the verdicts, and amazingly the Fifth
Circuit tossed them out. The appellate court held that those bankers
provided "honest services" and that they did not personally profit from
the deal.
That argument assumes that getaway drivers
supply honest services to bank robbers; after all, an oral agreement to
repurchase the investment at 22 percent return is a strong signal that
something is amiss with the transaction. The argument also shows a lack
of understanding how managers profit in the real world. Investment
bankers advance their careers by bringing in business that generates
income for the bank; Merrill Lynch's executives did that with the Enron
barge transaction, thereby promoting their careers, their promotions,
and their salaries and bonuses, even if in an indirect fashion.
Bob Jensen's threads on the Enron scandals are at
http://faculty.trinity.edu/rjensen/FraudEnron.htm
Riggs Bank is expected to plead guilty to a criminal charge arising
from its services for foreign embassies and rich clients. Fine
Could Hit $18 Million In Money-Laundering Case; PNC Deal's Fate Is
Unclear
"Riggs Is Set to Plead Guilty to Crime," by John R. Wilke
and Mitchell Pacelle, The Wall Street Journal, January 26, 2005
--- http://online.wsj.com/article/0,,SB110668953418935714,00.html?mod=home_whats_news_us
Riggs Bank N.A., whose international
dealings helped trigger a federal crackdown on money laundering by
U.S. financial institutions, is expected to plead guilty to a
criminal charge arising from its services for foreign embassies and
wealthy clients, including former Chilean dictator Augusto Pinochet.
The Riggs board has been presented with a
plea agreement by prosecutors in which the bank would admit to one
count of violating the Bank Secrecy Act by failing to file reports
to regulators on suspicious transfers and withdrawals by clients,
people close to the case said.
Directors are expected to accept the plea
and the bank would pay a fine of between $16 million and $18
million. The deal could be announced as soon as tomorrow, these
people said.
Continued in the article
This is what happens when
Republicans win elections (and I'm a Republican)
The SEC is facing resistance from two
Republican commissioners over the stiff fines
it has been imposing on companies.
Deborah Solomon, "As Corporate Fines Grow, SEC Debates How Much Good They
Do," The Wall Street Journal, November 12, 2004 --- http://online.wsj.com/article/0,,SB110021198122471832,00.html?mod=home_whats_news_us
Bob Jensen's threads on why white collar crime pays (even when you get caught)
are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
Investors appear to be losing the war with
Wall Street
"The Street's Dark Side: The markets can still be
treacherous for investors," by Charles Gasparino, Newsweek
Magazine, December 20, 2004 --- http://www.msnbc.msn.com/id/6700786/site/newsweek/
The hammer came down quickly on Wall Street
after the stock-market bubble burst. Regulators and lawmakers, under
pressure to avenge the losses of millions of average Americans duped
by unscrupulous brokers and corporate book-cookers, imposed swift
reforms. Eliot Spitzer, the crusading New York state attorney
general, demanded big brokerage firms overhaul their fraudulent
stock research (they had been hyping companies that paid them huge
investment banking fees). Congress passed the Sarbanes-Oxley Act to
tighten up accounting and other standards for corporate behavior.
With the reforms in place, Wall Street was again "an
environment where honest business and honest risk-taking will be
encouraged and rewarded," William Donaldson, chairman of the
Securities and Exchange Commission, declared in a speech last year.
Despite the changes, however, Wall Street
remains a treacherous place for the small investor. The big
financial firms are still rife with conflicts that put their own
interests, and those of big banking clients, ahead of everyone
else's. (Just last week, for example, Citigroup was fined $275,000
for steering customers to invest in certain Citigroup funds that
were "unsuitable'' for them.) Also, watchdog agencies like the
SEC, even with bulked-up resources, continue to be ill-equipped to
root out corporate crime. And when investors think they've been
cheated, the system for ruling on their complaints remains stacked
against them. "There are all sorts of practices and conflicts
of interest on Wall Street that still have to be addressed, "
says John Coffee, a Columbia University law professor.
Question
What are hedge funds and why are they so controversial?
Answers
Definition from VAN --- http://www.hedgefund.com/abouthfs/what/what.htm
A
hedge fund can be classified as an alternative investment.
Alternative investments are investments other than stocks and bonds.
A U.S. "hedge fund" usually is a U.S. private investment
partnership invested primarily in publicly traded securities or
financial derivatives. Because they are private investment
partnerships, the SEC limits U.S. hedge funds to 99 investors,
at least 65 of whom must be "accredited."
("Accredited" investors often are defined as investors
having a net worth of at least $1 million.) A relatively recent
change in the law (section 3(c)7) allows certain funds to accept up
to 500 "qualified purchasers." In order to be able to
invest in such a fund, the investor must be an individual with at
least $5 million in investments or an entity with at least $25
million in investments. The General Partner of the fund usually
receives 20% of the profits, in addition to a fixed management fee,
usually 1% of the assets under management. The majority of hedge
funds employ some form of hedging -- whether shorting stocks,
utilizing "puts," or other devices.
Offshore
hedge funds usually are mutual fund companies that are domiciled in
tax havens, such as Bermuda, and that can utilize hedging techniques
to reduce risk. They have no legal limits on numbers of non-U.S.
investors. Many accept U.S. investors, although usually only
tax-exempt U.S. investors. For the purposes of U.S. investors,
these funds are subject to the same legal guidelines as U.S.-based
investment partnerships; i.e., 99 U.S. investors, etc.
Hedge
funds are as varied as the animals in the African jungle. Over the
years, many investors have assumed that hedge funds were all like
the famous Soros or Robertson funds - with high returns, but also
with a lot of volatility. In fact, only a small percentage of all
hedge funds are "macro" funds of that type. Among the
others, there are many that strive for very steady,
better-than-market returns. VAN tracks 14 different styles of hedge
funds, in addition to a number of sub-styles.
The Loophole: Locked-up
funds don't require oversight. That means more risk for
investors.
"Hedge Funds Find an Escape Hatch," Business Week,
December 27, 2004, Page 51 ---
Securities
& Exchange Commission Chairman William H. Donaldson recently
accomplished a major feat when he got the agency to pass a
controversial rule forcing hedge fund advisers to register by 2006.
Unfortunately, just weeks after the SEC announced the new rule on
Dec. 2, many hedge fund managers have already figured out a simple
way to bypass it.
The easy
out is right on page 23 of the new SEC rule: Any fund that requires
investors to commit their money for more than two years does not
have to register with the SEC. The SEC created that escape hatch to
benefit private-equity firms and venture capitalists, which
typically make long-term investments and have been involved in few
SEC enforcement actions. By contrast, hedge funds, some of which
have recently been charged with defrauding investors, typically have
allowed investors to remove their money at the end of every quarter.
Now many are considering taking advantage of the loophole by locking
up customers' money for years.
TROUBLING
QUESTIONS
Securities lawyers say phones are ringing off the hook with
questions from hedge funds considering circumventing registration.
Some firms have already held small seminars packed with hedge fund
managers discussing the potential cost and hassle of registering.
Analysts estimate there are over 7,000 hedge funds, with roughly $1
trillion in assets; many may be looking for an out. Lindi L.
Beaudreault, an attorney at Washington-based law firm LeClair Ryan
estimates that "one third of unregistered hedge fund advisers
are seriously considering locking up their investors' money for two
years" to avoid registering.
Hedge funds
seeking to skirt SEC registration raises troubling questions given
their recent track record. In the last five years, the SEC has
authorized or brought 51 cases against hedge fund advisers for
allegedly defrauding investors of over $1 billion. And some SEC
officials are already conceding that the exemption could be
problematic. "If we see a significant invasion of the rule,
we'll have to rethink," says Paul F. Roye, director of the
division of investment management at the SEC.
The SEC did
anticipate that some hedge funds would try to take advantage of the
loophole. It concluded that investors would have the smarts to steer
clear of any fund trying to evade the rule. But it may be tough for
investors to distinguish between funds that are lengthening their
so-called lockup periods simply to avoid registering, versus those
with legitimate reasons for a longer investment horizon, such as a
strategy based on turning around troubled companies. Already,
investors in 5% of hedge funds with more than $1 billion in assets,
many of which had voluntarily registered before the rule was
introduced, have agreed to funds' demands that they hand over their
money for two years or more, according to Chicago-based researcher
Hedge Fund Research Inc. Still, if hedge fund exceptions become the
rule, Donaldson's coup might turn out to be a Pyrrhic victory.
Thom Calandra, a former columnist for CBS
MarketWatch.com, will pay more than $540,000 to settle federal
regulators' charges that he used an investment newsletter to pump up
the price of penny stocks he owned before selling them.
Eric Dash, "Ex-Columnist Fined in Stock Trading Scheme," The
New York Times, January 11, 2005 --- http://www.nytimes.com/2005/01/11/business/media/11tout.html
Regulators are concerned about Wall Street
firms tipping off selected investors to information about securities
offerings.
"Securities Cops Probe Tipoffs Of Placements," by Ann Davis,
The Wall Street Journal, December 16, 2004; Page C1 --- http://online.wsj.com/article/0,,SB110315579554001426,00.html?mod=home_whats_news_us
Regulators are examining
whether insiders at Wall Street firms that oversee big securities
offerings for corporate clients have tipped off selected investors
with valuable information about deals that can cause stock prices to
fall.
Two recent cases demonstrate
the regulators' concern: Federal prosecutors this week charged a
former SG Cowen trader with trading on confidential knowledge that
the firm's corporate clients were about to issue millions of dollars
of new stock. Last month, the Ontario Securities Commission in
Canada accused the Canadian brokerage house Pollitt & Co. and
its president in a civil action of tipping off some clients to a
pending deal involving bonds that could later be converted to stock.
The Ontario authorities also accused one client of acting on the
tip.
Forget it! The DC part of
Washington DC means Donate Cash
"SEC Loves NYSE," The Wall Street Journal, December 6,
2004; Page A14
Never underestimate
the ability of a bureaucracy to wiggle backward. After many months of heavy
breathing, the Securities and Exchange Commission is about to take stock
trading back several decades. If you're thinking: Hmmm, this will help the New
York Stock Exchange, you're right.
Back in February, the
SEC proposed an overhaul of the national market system, called Reg NMS. The
idea was to modernize an increasingly laborious and inefficient structure put
in place in the 1970s. The main driver for reform, especially from
institutional investors who often trade on behalf of smaller investors, was
the trade-through rule.
So where was Levitt before Spitzer
did his job? While heading up the SEC, Levitt always seemed willing to
take on the CPA firms, but he treaded lightly (really did very little) while the
financial industry on Wall Street ripped off investors bigtime. It never
ceases to amaze me how Levitt capitalizes on his failures.
Forget Enron, WorldCom or mutual funds. The crisis
enveloping the insurance industry is "the scandal of the decade, without a
question" and "dwarfs anything we've seen thus far."
Arthur Levitt as quoted by SmartPros, October 25, 2004 --- http://www.smartpros.com/x45590.xml
Bob Jensen's threads on insurance frauds are at http://faculty.trinity.edu/rjensen/fraudCongress.htm#MutualFunds
Bob Jensen's fraud updates --- http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Of all the
lawsuits, one filed against Mr. Winnick last October in federal court in
Manhattan holds special significance. J. P. Morgan Chase and other leading banks
are seeking $1.7 billion in damages from Mr. Winnick and other Global Crossing
executives, contending that the group engaged in a "massive scam" to
"artificially inflate" the company's performance to secure desperately
needed loans. Mr. Winnick, whose lawyers dispute the accusations, declined to be
interviewed for this article. Among other things, the suit refocuses
attention on exactly what Mr. Winnick knew about his company's finances during
times when it was borrowing heavily and he was selling hundreds of millions of
dollars in stock. It also outlines a troubling series of meetings he held with
Mr. Lay and other Enron executives just months before their company crumpled.
Timothy O'Brian, "A New Legal Chapter for a 90's Flameout," The New
York Times, August 15, 2004 --- http://www.nytimes.com/2004/08/15/business/yourmoney/15win.html
J.P. Morgan is facing scrutiny for helping finance hedge fund Canary
Capital Partners' improper trading in mutual-fund shares
"SEC Probes J.P. Morgan Role In Canary's Improper Trades," by Tom
Lauricella, The Wall Street Journal, December 30, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110435632010212266,00.html?mod=todays_us_money_and_investing
Bob Jensen's threads on investment banking and mutual fund scandals are at http://faculty.trinity.edu/rjensen/fraudCongress.htm
Bob Jensen's threads on derivative financial instruments frauds are at http://faculty.trinity.edu/rjensen/fraudCongress.htm#DerivativesFrauds
"SEC Won't Charge, Fine Global
Crossing Chairman: Agency's Donaldson Goes Against Staff, Noting Winnick's
Nonexecutive Role," by Deborah Solomon, The Wall Street Journal,
December 13, 2004; Page A1 --- http://online.wsj.com/article/0,,SB110290635013498159,00.html?mod=todays_us_page_one
The
Securities and Exchange Commission won't file civil securities charges against
former Global Crossing Ltd. Chairman Gary Winnick over disclosure violations
or impose a $1 million fine, according to people familiar with the matter.
The
action came despite objections from the SEC's
two Democratic members and represents a rare
reversal by the commission of its enforcement staff. It also caps a lengthy
investigation of Global Crossing, the former Wall Street darling that helped
set off a gold rush to capitalize on the Internet boom of the late-1990s.
. . .
The SEC had
been expected to fine Mr. Winnick $1 million for failing to properly disclose
a series of transactions undertaken by the telecom company, and he had
tentatively agreed to pay that sum as part of a settlement agreement. But at a
closed-door commission meeting last week, SEC Chairman William Donaldson and
his two fellow Republican commissioners,
Cynthia Glassman and Paul Atkins, opposed a staff recommendation to charge Mr.
Winnick. Mr. Donaldson expressed concern that Mr. Winnick was a nonexecutive
chairman and hadn't signed off on the inadequate disclosure, these people
said.
"How Banks Pretty Up The Profit Picture: Playing with
loan-loss reserves can produce deceiving earnings," Business Week,
February 21, 2005 --- http://yahoo.businessweek.com/magazine/content/05_08/b3921110_mz020.htm
Last year the banks had an easy way to juice their
profits. All they had to do was allocate a little less money to loan-loss
reserves -- the money they set aside to cover bad debt. As the economy has
improved and defaults have slowed, many decided they didn't need as much in
reserve as they did in 2003, and presto, their earnings per share would rise a
few cents.
But investors who assume the profits are humming and
decide to buy bank stocks could be in for a shock. In 2005 many banks won't
have this profit source. Some have already pared loan-loss reserves as much as
they reasonably can, analysts say. "A lot of banks may do this from time
to time to meet estimates," says Brian Shullaw, senior research analyst
at SNL Financial in Charlottesville, Va.
The trouble with whittling away the reserves is that
as banks write more loans, they will have to replenish the reserves. Plus, if
credit conditions worsen as economic growth slows and interest rates rise,
they will need to set aside even more, eating further into profits.
Do a little digging, and the current numbers don't
look so great. Detroit's Comerica Inc. (CMA ) had one of the largest drops in
its loan-loss reserves relative to total assets, according to a study of large
banks' fourth-quarter earnings done by SNL for BusinessWeek. Not only did
Comerica fail to add money in the fourth quarter, it also extracted $21
million from the pot. That gave it an extra $98 million in income, or 57 cents
a share, that it didn't have last year. The bank beat analysts' earnings
estimates by 10 cents. Comerica Chief Credit Officer Dale Greene says muted
loan growth, coupled with major improvement in credit quality, justify the
move.
Others, such as Citigroup (C ), garnered a few extra
cents from replenishing reserves by a smaller amount than before. But it was
enough to help them beat analysts' earnings estimates by a penny or two. Citi
Chief Financial Officer Sallie L. Krawcheck said in a Jan. 20 conference call
that the reserving process was done in mid-quarter based on a mathematical
formula. She noted: "We as a company work very hard to systematize the
process around rigorous analytics."
Of course, banks can't just shift funds around
willy-nilly. Accounting rules dictate that they have to justify decreases in
loan-loss allowances, for example by citing substantial improvement in credit
trends. This past quarter, a bevy of bank earnings releases cited fewer
nonperforming loans, improving asset quality, and a stronger underlying global
economy as reasons for smaller loan-loss provisions. Bill Lewis, leader of the
U.S. banking practice at PricewaterhouseCoopers, notes that subjectivity is
often involved, but "most banks, in light of heightened regulatory
scrutiny, are more precise in their estimation methodologies today than they
have been in the past."
Maybe so, but even if the decreases in reserves are
perfectly justifiable, there are still problems with this common industry
practice. Besides cutting reserves to the core, banks "are increasing the
cyclicality of earnings," says Richard Bove, a banking analyst at Punk,
Ziegel & Co. "When bad times come, you know they are going to be
increasing the size of the reserves." Already, Citi's Krawcheck has
warned analysts not to expect substantial reductions in provisions in the
future.
Continued in the article
Unethical Stock Brokers, Bankers, and
Investment Advisors in Every Small Town
One of the most unethical things stock brokers, bankers, and
investment advisors can do is to steer naive customers into mutual
funds that pay the brokers kickbacks rather than suitable funds for
the investors. The well known and widespread brokerage firm of
Edward Jones & Co. to pay $75 million to
settle charges that it steered investors to funds without disclosing
it received payments. Add this to banker's pretenses at being
independent dispensers of "fair" advice and you have a
Congressness all the way to the core of small towns.
The
sad part is that many people who want mutual funds can get straight
forward information from reputable mutual funds like Vanguard and
avoid having to pay a financial advisor anything and avoid the risk of
unethical advice from that advisor
Judge tells the jury that Morgan Stanley did it
The judge in a high-profile lawsuit brought
by financier Ron Perelman said she regarded Morgan Stanley's failure
to produce documents as "offensive" and would instruct the jury that
the Wall Street firm helped to defraud Mr. Perelman. In what
legal experts called a highly unusual ruling, Florida Judge
Elizabeth Maass wrote that she will tell the jury that Morgan
Stanley had a role in helping appliance maker Sunbeam Corp. conceal
accounting woes that reduced the value of Mr. Perelman's investment
in Sunbeam. The ruling increases the possibility that a jury will
find against Morgan Stanley and force the firm to pay Mr. Perelman
some or all of the $680 million he says he lost on the investment.
In addition he is seeking $2 billion in punitive damages
Suzanne Craig and Kara Scannell, "Judge's Fraud Ruling Puts Heat On
Morgan Stanley, Law Firm," The Wall Street Journal, L March
24, 2005; Page A1 ---
http://online.wsj.com/article/0,,SB111162256208888176,00.html?mod=home_whats_news_us
A Citigroup bond trade on Eurex resulted in market manipulation,
said Germany's financial regulator, which referred the case to a
criminal prosecutor.
"Citigroup Trading Case Is Given to Prosecutor: German
Regulator Decides August Bond Move Resulted In Market
Manipulation," by Edward Taylor in Frankfurt and Mitchelle
Pacelle in New York, The Wall Street Journal, January 25, 2005,
Page C1 --- http://online.wsj.com/article/0,,SB110660720204234515,00.html?mod=home_whats_news_us
By
Germany's financial regulator said it has
found that Citigroup Inc.'s controversial bond trade last August
resulted in market manipulation and has referred the case to the
public criminal prosecutor in Frankfurt.
The individuals involved could face a fine
or jail time, if charged and convicted.
"We have passed on the case to the
public prosecutor. There are indications that market manipulation
took place in connection with Citigroup's bond trade. The market
manipulation took place on Eurex," the futures and options
exchange, said Sabine Reimer, a spokeswoman for the regulator known
as BaFin.
BaFin declined to discuss the details of
its investigation, including how many people were involved, or
whether any other companies were involved. German law focuses on
prosecuting individuals, not corporate entities.
Yesterday, Citigroup spokesman Daniel
Noonan said, "We are disappointed that the BaFin has referred
to the prosecutor the question of whether action should be brought
against individuals involved in the MTS matter. We will continue to
cooperate fully with all authorities reviewing this matter."
The criminal probe comes at a sensitive
time for Citigroup. Chief Executive Officer Charles Prince has
stated repeatedly in recent months that one of his primary goals is
to boost the company's reputation for ethics, which has been
battered by a string of regulatory scandals stretching back to its
involvement with Enron Corp. and the former WorldCom Inc. (now MCI).
"It's a key priority for this
management team to take open issues off the table," he told
analysts last week, adding that "it pains me to spend the money
to do it." In October, Mr. Prince fired three senior executives
over a regulatory scandal in Japan, which resulted in the loss of
Citigroup's private-banking license in that country.
BaFin started investigating a trade by
Citigroup in October, looking for evidence of potential manipulation
of the futures market on Eurex. In August, Citigroup placed €11
billion ($14.36 billion) of sell orders on the bond markets,
including the EuroMTS bond-trading platform. As a result, the price
of euro-zone government bonds fell, prompting traders to rush to
Eurex in an effort to staunch their losses, causing further market
disruption. Citigroup eventually bought back some of the bonds,
booking a profit.
Citigroup hasn't commented publicly about
the status of the bond investigation. In an interview in October,
Mr. Prince commented on the controversial trading at the firm's
London trading desk. He said "as far as we can tell" the
trading wasn't illegal, but he characterized it as "a
completely knuckleheaded thing to do." The controversial
trading underlined a need to send a strong message to Citigroup
traders, he said, that they cannot operate as if they worked for
hedge funds and "chew up Citi for your narrow, desk-based
interests."
The potential for criminal charges against
Citigroup employees is noteworthy. In recent years, Citigroup has
settled a number of regulatory probes in the U.S., including a
criminal probe in New York by Manhattan District Attorney Robert M.
Morgenthau into financings it arranged for Enron. Citigroup
employees didn't face criminal charges in any of those cases.
Continued in article
"Two minutes that shook Europe's bond markets," by Aline
van Duyn and Päivi Munter, The New York Times, September
9, 2005 --- http://faculty.trinity.edu/rjensen/FraudCongressCitiGroup.htm
It is likely that Citigroup netted a profit
of about €15m - perhaps more depending on the bank's starting
position and how much of the trading was done for its proprietary
trading book.
The trades' wider repercussions, though,
are now becoming clear. The world's biggest bank has raised the
hackles of European governments and exposed weaknesses at the heart
of the eurozone capital markets. The barrage of criticism from its
competitors and customers, and the possibility of action from the
FSA, are particularly galling for Citigroup: it has promised to keep
its hands clean and set exemplary standards of behaviour following
huge fines for malpractice in the US.
Citigroup's gain, of course, was someone
else's loss. Big trading banks - ABN Amro, Deutsche Bank, Barclays
Capital, JP Morgan Chase, UBS - nursed losses estimated at
€1m-€2m. “We were hit, but that happens every once in a
while,” said the head of trading at one bank. “Pretty much all's
fair in the inter-dealer market and Citigroup spotted a way to make
a quick buck. I guess we just have to say well done to them.”
Not everyone saw it that way. Many smaller,
local European banks are also signed up as MTS dealers: for these
banks a loss of €1m-€2m is more difficult to shrug off. Banks
were soon on the telephone to government treasury officials. They,
in turn, called Citigroup. “We told Citigroup we didn't appreciate
it and felt it was against the spirit of the primary dealer
contract,” said an official at a European government treasury.
“We feared for the liquidity of our bonds.” Some European
governments were clearly furious that the MTS system had been used
in such a way. “By some European government treasuries, this trade
was perceived as open warfare,” said a head of debt capital
markets at a large European bank.
Citigroup had hit upon the weaknesses in a
trading system that is at the heart of the borrowing strategies of
many European governments. The bank - which counts those same
governments among its biggest clients - also touched a nerve within
the 5½-year old euro project.
Governments had to cede control over
monetary policy to join the single currency. But they fought hard to
keep fiscal policy out of the clutches of Brussels. As a
consequence, all 12 eurozone countries still borrow in the bond
markets for themselves.
The biggest buyers of their debt are local
financial institutions such as banks, insurance companies and
pension funds. Most are subject to stringent rules that require them
to invest heavily in domestic assets - a handy source of money for
governments spending more than they earn.
The euro, though, threatened to end
governments' access to this easy money. Since financial instruments
in at least 10 other countries were now priced in the same “local
currency”, an institution in one country could buy bonds issued by
other eurozone members with no qualms. Many government treasuries
were worried that, if investors piled into German bonds - the
benchmark for the whole region - it could cut the liquidity of their
bonds and raise borrowing costs.
Take Austria and Germany. Although both
countries have top-notch AAA credit ratings, the lower liquidity of
Austria's bonds means it must pay more for its debt than Germany:
only five-one-hundredths of a percentage point more, but multiplied
by many billions of euros borrowed every year, it adds up to extra
expense for taxpayers.
To fight back, governments needed to
enhance the liquidity of their bonds - and their main weapon was to
promote greater electronic trading of their bonds through the MTS
system.
MTS, a privatised platform operator created
by the Italian treasury to trade domestic government bonds, and
which retains close ties to the Italian government, sensed
opportunity. Government issuers and banks signed a “liquidity
pact” through the MTS system. For banks, this meant agreeing
always to trade for certain minimum amounts. Such a quote-driven
system is unusual: most electronic trading, and telephone trading,
is order-driven. But banks were prepared to subsidise their MTS
business by trading unprofitably because European governments, when
choosing banks for lucrative business such as derivatives
transactions or syndicated bond sales, often picked those that came
top of the list in terms of MTS trading volumes.
Continued in the article
"Opinions Labeling Deals 'Fair' Can Be Far From
Independent," by Ann Davis and Monica Langley, The Wall Street
Journal, December 29, 2004 --- http://online.wsj.com/article/0,,SB110427249753011370,00.html?mod=home%5Fpage%5Fone%5Fus
Banks That Do Them Often Are Advisers on
Transactions And Have Fees at Stake A High-Profit-Margin Item
In the biggest U.S. merger this year, J.P.
Morgan Chase & Co. announced last January it would acquire Bank
One Corp. To assure investors it was paying a fair price, J.P.
Morgan told them in a proxy filing it had obtained an opinion from
one of "the top five financial advisors in the world."
Itself.
The in-house bankers at J.P. Morgan
endorsed the $56.9 billion price -- negotiated by their boss -- as
"fair."
But during the negotiations, Bank One Chief
Jamie Dimon had suggested selling his bank for billions of dollars
less if, among other conditions, he immediately became chief of the
merged firm, according to a person familiar with the talks. That
suggestion wasn't accepted by J.P. Morgan.
To some J.P. Morgan shareholders who are
now suing over the deal, it raises the question: Did Morgan's
in-house evaluators endorse a higher price to keep CEO William
Harrison in power longer? "Only by retaining a conflicted
financial adviser could Harrison control the process and justify
paying more than was necessary for Bank One," the investors
said, in a pending suit in Delaware Chancery Court.
J.P. Morgan denies that assertion,
according to a spokesman, who said that executives at the bank would
have no comment. J.P. Morgan, which had disclosed its use of an
in-house advisory team, says it made sense to use bankers intimately
familiar with its business, and that the board's lawyers said it
wasn't necessary to get another opinion. The bank says it negotiated
the best deal possible given that it didn't want to hand immediate
control to a newcomer. It also says that other shareholders -- from
Bank One -- have sued claiming the price was unfairly low.
Boards of directors get "fairness
opinions" to show they've independently checked out the price
of a deal, thus giving themselves some legal protection from unhappy
shareholders. But it is an open secret on Wall Street that fairness
opinions can be anything but arm's-length analyses.
Investment bankers frequently
write fairness opinions for clients with whom they have longstanding
business ties and with whom they hope to continue having
relationships. Indeed, an opinion is commonly written by the very
bank that suggested the merger or acquisition in the first place --
and that now is acting as adviser on that deal.
In such cases, the investment
bank stands to collect a far larger fee if the deal goes through
than if it does not. If it goes through, the advisory bank will
collect a "success fee" that dwarfs the opinion fee. And,
in a further incentive to bless high-priced deals, the success fee
is usually tied to the deal's price.
As if these potential
conflicts weren't enough, when the merging parties are financial
firms, the parties typically get their fairness opinions not from
outsiders but from folks right down the hall.
Now, securities regulators
may weigh in. The National Association of Securities Dealers has
launched an enforcement inquiry into conflicts that can arise with
fairness opinions. The NASD is also seeking comment on potential new
rules requiring more disclosure of the financial incentives that
bankers and their clients have for endorsing deals. There isn't any
move to do away with the opinions.
Fairness opinions often vet
prices that were set by company executives who, the bankers know,
have strong financial incentives to push through a deal. The
opinions often are crafted at the last minute, as bleary-eyed
bankers scramble to cobble together projections to justify the final
price at an impending board meeting or news conference.
In the case of Bank
of America Corp.'s recent purchase of FleetBoston Financial
Corp., Bank of America called in Goldman
Sachs Group as adviser the weekend before the deal was
announced. Goldman got $25 million for providing advice, including
$5 million for a fairness opinion. Morgan
Stanley, which advised Fleet, also collected $25 million, an
undisclosed part of it for its fairness opinion. The $47.7 billion
deal closed April 1.
"Fairness opinions are
one of the highest profit margin businesses on Wall Street. In the
BofA-Fleet deal, profitability must surely be setting new
heights," said Thomas Brown, a hedge-fund manager with a Web
site that follows bank stocks, in a column after the deal was
announced. Believing that BofA overpaid, Mr. Brown contended that
"the large dollar payment was necessary to get the names of two
prestigious firms to provide fairness opinions on a questionable
transaction."
Continued in the article
Bob Jensen's threads on derivative
financial instruments fraud by these same players are at http://faculty.trinity.edu/rjensen/fraudCongress.htm#DerivativesFrauds
The
SEC is assessing whether fund managers are pocketing rebates on
stock-trading commissions that should go back to investors.
"SEC
Examines Rebates Paid To Large Funds ," by Susan Pulliam and
Gregory Zuckerman, The Wall Street Journal, January 6, 2005, Page C1
--- http://online.wsj.com/article/0,,SB110496678233318071,00.html?mod=home_whats_news_us
T
he
Securities and Exchange Commission has launched a broad examination
of whether managers of big mutual funds and hedge funds are
pocketing rebates on stock-trading commissions that should be
directed back to investors, people familiar with the matter say.
The move is
the latest in a series of efforts by federal regulators to stamp out
possible improper payments received by favored Wall Street clients
for trading business.
At issue
are commissions that these large investors pay to Wall Street firms
to execute stock trades. Typically, the funds pay commissions
totaling as much as five cents a share. But part of these
commissions -- two cents or so -- sometimes is sent back to
money-management firms in the form of rebates, depending on how much
business they generate for the Wall Street firms, and how much they
pay for services such as stock research, among other things.
This
practice isn't improper if it is disclosed and the rebates benefit
fund holders. The SEC is seeking to find out whether some money
managers, including hedge-fund managers, have used any kinds of
rebates to enrich themselves or their firms, or to pay for items
that don't benefit fund holders, the people say.
"It's
something that's talked about in the business. Some hedge funds
don't put that rebate back into their funds, but rather keep it for
themselves," says David Moody, a lawyer at Purrington Moody LLP
in New York who represents hedge funds. "If a rebate is going
to the fund manager, and not the fund, that is a big deal. It's not
the fund manager's money."
The issue
is significant for fund holders, particularly in an era of slimmer
gains in the stock market. Money managers pay huge commissions to
Wall Street. Last year, hedge funds alone paid at least $3 billion
in commissions, estimates Richard Strauss, an analyst at Deutsche
Bank. Though it is unclear how much of these commissions were
rebated, even a sliver going into the pockets of fund managers could
amount to large sums of money lost by investors.
The
examination into rebate practices is part of a broader effort by
regulators to curb abuses relating to how Wall Street rewards
privileged clients. The National Association of Securities Dealers
and the SEC recently launched an investigation into gifts and
business entertainment awarded by Wall Street to its best clients.
That investigation has led to disciplinary actions by firms against
14 trading employees at mutual-fund companies and elsewhere.
Meanwhile, the SEC's enforcement chief, Stephen Cutler, and Lori
Richards, head of examinations at the SEC, long have been interested
in the issue of trading commissions paid by money managers,
particularly hedge funds.
Commission
rebates are the latest in a string of longstanding industry
practices now under regulatory scrutiny. On the heels of sweeping
investigations by New York Attorney General Eliot Spitzer, the SEC
has begun to open broad investigations into entire industries when
evidence of problems surface, even if they initially appear
isolated. Last year, as part of this initiative, the SEC began
looking at oil-company reserve accounting after problems surfaced at
Royal Dutch/Shell Group.
Continued
in article
Question
If you bought mutual funds from a stock broker working for Edward E. Jones,
Inc., what nasty secret was probably not revealed to you by your broker?
Answer
Edward D. Jones disclosed that it received
$82.4 million in secret payments from seven funds as incentives to
sell their products.
'Jones Discloses Secret Payments From Fund Firms," by Laura
Johannes and John Hechinger, The Wall Street Journal, January
14, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110565044387025581,00.html?mod=todays_us_money_and_investing
Edward D. Jones & Co. received $82.4
million in secret payments from seven mutual-fund firms in the first
11 months of 2004, through a lopsided fee structure that in some
cases gave the brokerage firm more compensation for selling poorly
performing funds than for selling stellar performers.
The disclosures were posted yesterday, on
Jones's Web site as required by its $75 million agreement to settle
regulatory charges that it failed to adequately disclose the
payments to investors. They are by far the most detailed figures
ever made public on the industry practice of mutual-fund companies
paying brokerage firms to induce them to sell their products, an
arrangement known as revenue sharing. Unlike front-end sales
commissions, which are widely disclosed to consumers, revenue
sharing has been largely secret.
Revenue sharing is legal, but federal and
state regulators have argued that the industry's failure to disclose
the payments defrauds consumers by hiding brokers' conflicts of
interest. Federal regulators allege that the large payments that
Edward D. Jones got from its seven preferred mutual-fund families
would cause brokers to pick those funds over other fund companies
that aren't paying the firm. Other brokerage firms have begun to
make disclosures about these payments in the face of increased
regulatory scrutiny.
Edward D. Jones, of St. Louis, has nearly
10,000 sales offices nationally, making it the largest network of
brokerage outlets in the U.S. Its revenue-sharing practices were the
subject of a page-one article in The Wall Street Journal in January
2004. Jones's spokesman John Boul declined to comment for this
article, although Jones and other brokers long have argued that
preferred lists help them narrow choices among the thousands of U.S.
mutual funds.
According to Jones's disclosures, the
brokerage firm received two types of revenue-sharing payments. One
was a one-time payment based on the dollar amount of a particular
mutual-fund family's shares sold by Jones's brokers. The other:
annual "asset fees" based on the total value of a fund
family's assets held by Jones's clients.
From the CFO Journal's Morning
Ledger on August 15, 2015
Broker settles over pricing on muni bonds
http://www.wsj.com/articles/edward-jones-to-pay-20-million-to-settle-sec-muncipal-bond-charges-1439474284?mod=djemCFO_h
Brokerage firm Edward Jones has agreed to pay $20 million
to settle charges that it overcharged clients in new municipal-bond sales,
the SEC said. The agency said the firm’s practice cost customers at least
$4.6 million. It is the SEC’s first pricing-related case against an
underwriter selling new municipal securities.
Jensen Comment
One of the most unethical
things stock brokers and investment advisors can do is to steer naive customers
into mutual funds that pay the brokers kickbacks rather than suitable funds for
the investors. The well known and widespread brokerage firm of Edward Jones &
Co. to pay $75 million to settle
charges that it steered investors to funds without disclosing it received
payments.
The sad part is
that many people who want mutual funds can get straight forward information from
reputable mutual funds like Vanguard and avoid having to pay a financial advisor
anything and avoid the risk of unethical advice from that advisor.
Blast from the Past
"Edward Jones Agrees to Settle Host of Charges,"
by Laura Johannes and John Hechinger, and Deborah Solomon, The Wall Street
Journal, December 21, 2004, Page C1 ---
http://online.wsj.com/article/0,,SB110356207980304862,00.html?mod=home_whats_news_us
Edward D. Jones & Co. agreed
to pay $75 million to settle regulatory charges that it steered investors to
seven "preferred" mutual-fund groups, without telling the investors that the
firm received hundreds of millions of dollars in compensation from those
funds.
The settlement, tentatively
agreed to by the Securities and Exchange Commission, the National
Association of Securities Dealers and the New York Stock Exchange,
represents the largest regulatory settlement to date involving revenue
sharing at a brokerage house, an industry practice in which mutual-fund
companies pay brokerage houses to induce them to push their products.
Even so, California Attorney
General Bill Lockyer called the settlement "inadequate" given payments from
the funds that he said totaled about $300 million since January 2000, and
declined to join it and filed a civil lawsuit against Edward D. Jones
yesterday in Sacramento County Superior Court.
Mr. Lockyer called Edward D.
Jones "the most egregious example we have reviewed so far" of secret
revenue-sharing arrangements. California's suit, if it reaches trial, could
seek repayment of the entire amount the brokerage house received, plus the
"hundreds of millions" lost by investors who were sold inferior funds, Mr.
Lockyer said.
Edward D. Jones, of St.
Louis, has nearly 10,000 sales offices nationally, comprising the largest
network of brokerage outlets in the U.S. Its revenue-sharing practices were
the subject of a
page-one article in The Wall Street Journal in January. In a statement
yesterday, the company said it will "take immediate steps to revise customer
communications and disclosures." Edward D. Jones said it has neither
admitted nor denied the regulators' claims. The company added it "intends to
vigorously defend itself" against the charges brought by the California
attorney general.
Continued in article
Fraud
in College Savings Account Plans Known as 529 Plans
"SEC Divulges Details Of How Edward Jones Pushed Mutual
Funds," by Laura Johannes and John Hechinger, The Wall Street
Journal, December 23, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110375449642307605,00.html?mod=home_whats_news_us
Edward D. Jones & Co.
brokers were awarded points toward trips to Caribbean and European
resorts for selling customers mutual funds from firms that were
secretly making cash payments to the brokerage house, the Securities
and Exchange Commission said.
The SEC made final a $75
million settlement agreement, first disclosed Monday (see article),
in which the commission said Edward D. Jones accepted tens of
millions of dollars in secret fees from seven preferred fund groups,
potentially tainting the Jones brokers' investment advice to
customers in favor of those funds.
The money will go to
reimburse investors, who the regulators contend were harmed because
they didn't know their brokers might be unduly influenced by bonuses
and other incentives to sell the preferred funds. The New York Stock
Exchange and the National Association of Securities Dealers joined
with the SEC in the regulatory action and settlement agreement.
The trip contest was one of
several new details of Jones practices disclosed in an SEC order
issued yesterday. According to the SEC, Jones ran sales contests
twice a year, sponsored by preferred mutual-fund firms, which then
got exclusive access to Jones representatives during the trips.
Brokers could stay in five-star accommodations and were treated to
fine dining, skiing and tours, federal regulators said. Normally,
sales of all mutual funds counted toward contest points, according
to the SEC order, but for 90 days in the fall of 2002, only a
"subset" of the preferred funds counted toward contest
points, which could be used for trips to Davos, Switzerland;
Biarritz, France; the Caribbean islands of St. Martin and Tortola;
and other locations.
In the 12-page order,
regulators also took Edward Jones to task for promoting
college-savings plans offered only by the fund families that made
the secret payments. These popular savings vehicles, known as 529
plans, let parents save money for college without paying taxes on
investment income or withdrawals, as long as the money is used for
college expenses. Investment firms manage the plans on behalf of
state governments.
Edward D. Jones said it
offered 14 different 529 plans, but, in fact, it sold only three,
those from American Funds, Hartford
Mutual Funds Inc. and Marsh
& McLennan Cos.' Putnam Investments, according to people
familiar with the matter. Two of those companies -- the managers of
the American and Putnam funds -- made additional revenue-sharing
payments so brokers would steer clients to the plans they manage,
these people said.
The action against Jones represents the first on 529
plans as part of a NASD sweep of 20 brokerage firms that sell the college-saving
accounts. Regulators are concerned that secret payments are leading parents into
higher-cost or worse-performing options. And, in some cases, investors aren't
being told that they could get state income-tax breaks in certain states, such
as New York
Continued in article
"Regulators Find
Problem Trading At Edward Jones," by Susanne Craig and John
Hechinger, The Wall Street Journal, December 29, 2004, Page C1
--- http://online.wsj.com/article/0,,SB110426846698811278,00.html?mod=home%5Fwhats%5Fnews%5Fus
Firm Acknowledges to Government
That It Failed to Disclose Practices
Leading to Penalty and Shake-Up
In late 2003, St. Louis
brokerage house Edward D. Jones & Co. took out advertisements in
newspapers across the country, shaking its finger at the
"anything goes" approach that led to abuses in the
mutual-fund industry. Now, the company has acknowledged to the
Justice Department that it failed to disclose mutual-fund sales
practices that led to a $75 million penalty from regulators and a
shake-up in its executive suite.
In a Securities and Exchange
Commission filing late Monday, Jones also disclosed that regulators
had found thousands of instances of the firm's improperly allowing
mutual-fund trades made after 4 p.m. Eastern time to receive that
day's price. The practice, called late trading, is considered one of
the more clear-cut and egregious abuses of the mutual-fund scandal
because it can allow favored clients to skim profits from long-term
investors.
Regulators didn't identify
any specific instances of abusive late trading, but said Jones
didn't have the proper systems in place to prevent "any
unlawful late trading that may have existed." Jones settled
these allegations without admitting or denying them.
The firm, which operates the
largest network of retail brokerage offices in the U.S., also
disclosed in the SEC filing that Doug Hill, its managing general
partner, who signed the ad, is stepping down at the end of 2005 in
the wake of a settlement with federal regulators over the tens of
millions of dollars in undisclosed fees the firm received from
mutual-fund companies to push their products.
A spokeswoman for Jones
declined to comment on the filing. Yesterday, Mr. Hill's lawyer said
that his client, who declined to comment, was committed to restoring
the firm's image. He added that Jones never considered what it was
doing to be questionable.
Federal regulators say Jones
improperly encouraged its brokers to steer customers toward seven
"preferred" mutual-fund companies that secretly paid the
brokerage house. That practice, common in the industry, is called
"revenue sharing." Jones' revenue-sharing practices were
the subject of a page-one Wall Street Journal article in January
2004. Historically, 95% to 98% of Jones sales of mutual funds have
been from these funds, regulators found.
Regulators believe
undisclosed payments may have hurt clients because brokers had an
incentive to put them into inferior or inappropriate products just
to get the incentives, which included trips, with an average value
of $5,000, to destinations such as Davos, Switzerland, and the
British Virgin Islands. Some brokers were provided $1,000 cash for
one trip billed as a "shopping spree."
The filing by Jones, a
private partnership, included a laundry list of other infractions,
including findings that the firm failed to preserve e-mails for at
least two years as required by regulators. The filing also included
the firm's agreement with the U.S. attorney's office for the Eastern
District of Missouri, which had been conducting a criminal
investigation of Jones and found that the firm gave inaccurate
statements to the SEC in response to a so-called Wells notice. Wells
notices warn that regulators may file civil charges and give firms a
chance to defend themselves. As part of the agreement with the U.S.
attorney, Jones acknowledged making inaccurate statements.
The documents didn't spell
out those statements, but people familiar with the matter say U.S.
Attorney James Martin's office took exception to Jones's vigorous
defense of its revenue-sharing agreements in its Wells response. The
spokeswoman for Jones declined to comment, as did Mr. Martin.
Continued in article
Will it ever be possible to prevent Wall Street from
becoming Congress to the core without freezing it?
This is a Very Depressing Commentary About Continued Rot
Investors appear to be losing the war with Wall
Street
"The Street's Dark Side: The markets can still be treacherous for
investors," by Charles Gasparino, Newsweek Magazine, December 20,
2004 --- http://www.msnbc.msn.com/id/6700786/site/newsweek/
The hammer came down quickly on Wall Street after the
stock-market bubble burst. Regulators and lawmakers, under pressure to avenge
the losses of millions of average Americans duped by unscrupulous brokers and
corporate book-cookers, imposed swift reforms. Eliot Spitzer, the crusading New
York state attorney general, demanded big brokerage firms overhaul their
fraudulent stock research (they had been hyping companies that paid them huge
investment banking fees). Congress passed the Sarbanes-Oxley Act to tighten up
accounting and other standards for corporate behavior. With the reforms in
place, Wall Street was again "an environment where honest business and
honest risk-taking will be encouraged and rewarded," William Donaldson,
chairman of the Securities and Exchange Commission, declared in a speech last
year.
Despite the changes, however, Wall Street remains a
treacherous place for the small investor. The big financial firms are still rife
with conflicts that put their own interests, and those of big banking clients,
ahead of everyone else's. (Just last week, for example, Citigroup was fined
$275,000 for steering customers to invest in certain Citigroup funds that were
"unsuitable'' for them.) Also, watchdog agencies like the SEC, even with
bulked-up resources, continue to be ill-equipped to root out corporate crime.
And when investors think they've been cheated, the system for ruling on their
complaints remains stacked against them. "There are all sorts of practices
and conflicts of interest on Wall Street that still have to be addressed, "
says John Coffee, a Columbia University law professor.
. . .
Conflicts (Continued): During the 1990s,
brokerage firms, regulators and lawmakers agreed to tear down the
legal barriers that forced commercial bankers and investment bankers
to operate independently. Wall Street quickly sought out merger
partners, creating behemoths like Citigroup and JPMorgan Chase. They
touted the convenience of one-stop shopping for consumers. But they
also created incentives for staffers in different divisions to steer
business to each other that would help the overall company.
Spitzer's probe, for example, showed that many research analysts,
supposedly peddling objective ratings, were working hand in glove
with banking colleagues to win lucrative underwriting business from
big corporate clients. The carrot for analysts: their compensation
was tied in large part to the banking business they helped win.
That's why analysts like Jack Grubman of Salomon Smith Barney told
investors that he thought WorldCom was a "buy,'' even as it
fell from more than $60 a share down to penny-stock territory.
Spitzer's settlement with Wall Street in
2002 was supposed to establish a higher wall separating banking and
research; analysts could no longer work with bankers to pitch to
corporate clients, and their pay had to be separated from such
deals. But what's really changed? Analysts, under the guise of
"due diligence,'' can still meet with executives around the
time they're considering which investment bankers to hire. And many
Wall Street firms acknowledge that investment-banking fees continue
to flow into a pool of money used to pay analysts.
Are analysts' judgments more objective?
Consider Google, which went public in August. Morgan Stanley's top
Internet analyst, Mary Meeker, has been among Google's biggest
boosters. Meeker was not supposed to play a direct role in helping
Morgan land a slot to underwrite the IPO. But Morgan confirms that
she did talk with Google founders Larry Page and Sergey Brin in
meetings and lunches before the IPO. People familiar with the deal
say those meetings helped play a big role in helping Morgan land the
Google underwriting work. Meeker, along with the other four analysts
whose firms underwrote the IPO, have been devoted cheerleaders of
the stock, even as it has climbed from its $85 IPO price to above
$171, a 101 percent increase in a matter of months. Clearly, it was
a great call for those who bought at the outset. But many
professional investors are now betting that at these levels, the
stock is too pricey and due for a fall (recently the so-called short
position on the stock jumped 34 percent in a month). Some Wall
Street firms agree, particularly those who weren't part of the IPO
underwriting. Morgan officials say that Meeker's call reflects her
belief in the stock's potential.
Weak Watchdogs: If Wall Street firms could
use a few more walls, the regulators charged with overseeing the
firms could use fewer. The task of policing sprawling companies like
Citigroup and JPMorgan Chase, which employ hundreds of thousands of
people, is difficult enough. But the responsibilities for regulating
them are also divided among different agencies—the Federal Reserve
oversees banking, while the SEC regulates the securities side.
NEWSWEEK has learned a nasty turf battle has erupted between the two
agencies. The SEC wanted to examine possible leaks of confidential
information from a firm's bank-debt departments to its trading desk.
People at the SEC say it could open up a whole new area of
insider-trading abuse. Counterparts at the Fed, however, "went
nuts," according to a high-level SEC official, and tried to
block the exam. SEC chairman William Donaldson conceded in a recent
interview with NEWSWEEK that the Fed's mission has at times put it
at odds with SEC. Neither agency would comment on the incident.
"We're a cop,'' he said, noting that the Fed's main task is to
protect the banking system. "We have two different roles,"
he added.
A more fundamental problem with much of
Wall Street oversight is the notion of "self-regulation.''
Because of their limited resources, regulators ask Wall Street firms
to police themselves in some areas. Their legal and
"compliance" departments, for example, are supposed to
provide "frontline'' regulation of their own brokerage
departments. It doesn't always work out that way. Just ask Robert
Pellegrini, who owns a winery on New York's Long Island. He says lax
oversight allowed his financial adviser, Todd Eberhard, to steal
about $1.2 million from his brokerage account. Eberhard later
pleaded guilty to criminal securities fraud for making improper
client trades, and he awaits sentencing that could land him in jail
for 25 years. Pellegrini says in an arbitration claim that for
several years, UBS PaineWebber processed Eberhard's illegal trades,
despite numerous red flags. A simple background check by
PaineWebber, his lawyer Jake Zamansky says, would have showed that
three other firms refused to clear trades for Eberhard because of
customer complaints. Eberhard Investment Advisors was not even
registered with the NASD. A spokeswoman for PaineWebber said it
"fully complied with its obligations as a clearing firm"
and will "vigorously defend the allegations."
Justice Served? When customers like
Pellegrini think they've been misled by a Wall Street broker, they
have only one option for pressing their claim: to submit to
arbitration. (Investors, when they sign up for a brokerage account,
effectively sign away their right to use any system to settle a
dispute.) But investors complain the deck is stacked against them,
because the arbitrators are appointed by the industry, resulting in
decisions that often favor the Wall Street firms. Investors won
about half their cases last year, for example. Spitzer has said they
should be winning more. Speaking before a private meeting of lawyers
in Ft. Lauderdale, Fla., two weeks ago, Spitzer, according to a
lawyer who was present, said he was frustrated that arbitration
panels were blocking the use of evidence of conflicted research that
he released as part of his investigation.
Investors appear to be losing the war with
Wall Street in recovering money over conflicted research. Attorney
Seth Lipner estimates that only 30 percent of all cases alleging
that investors lost money because they relied on conflicted research
has resulted in an award of money. Lipner blames the terms of the
$1.4 billion settlement that Spitzer reached with Wall Street—the
firms were allowed to pay the fine and agree to certain structural
changes without having to admit guilt for misleading investors.
"It has basically allowed arbitration panels to throw cases
out," Lipner says. A spokesman for Spitzer says it's up to the
courts to determine guilt, and that he simply laid out the evidence
so investors could recoup their money. All of which proves that the
best defense may be a twist on the old warning: caveat investor.
Regulators are concerned about Wall Street firms
tipping off selected investors to information about securities offerings.
"Securities Cops Probe Tipoffs Of Placements," by Ann Davis, The
Wall Street Journal, December 16, 2004; Page C1 --- http://online.wsj.com/article/0,,SB110315579554001426,00.html?mod=home_whats_news_us
Regulators are examining
whether insiders at Wall Street firms that oversee big securities
offerings for corporate clients have tipped off selected investors
with valuable information about deals that can cause stock prices to
fall.
Two recent cases demonstrate
the regulators' concern: Federal prosecutors this week charged a
former SG Cowen trader with trading on confidential knowledge that
the firm's corporate clients were about to issue millions of dollars
of new stock. Last month, the Ontario Securities Commission in
Canada accused the Canadian brokerage house Pollitt & Co. and
its president in a civil action of tipping off some clients to a
pending deal involving bonds that could later be converted to stock.
The Ontario authorities also accused one client of acting on the
tip.
Regulators also are concerned
about inadvertent tip-offs. The Securities and Exchange Commission,
the New York Stock Exchange and other regulators are especially
worried about information related to corporate stock and bond deals
that are executed quickly, sometimes overnight. Such deals require
brokerage houses to contact potential buyers to see if they are
interested in buying the newly available securities, thereby giving
them insider information that could be misused. (See
a related article.)
Continued in article
Bob Jensen's threads on proposed reforms are at http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm
Bob Jensen's fraud conclusions are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm
According
to a joint survey by PricewaterhouseCoopers and the Economist
Intelligence Unit, financial institutions have equated good corporate
governance with meeting the demands of regulators rather than
improving the quality of management. PwC suggests how
to comply and improve in order to reap the potential
strategic advantages of improved governance.
SmartPros, April 7, 2004 --- http://www.smartpros.com/x43179.xml
Securities regulators are probing whether
fund companies directed trades toward firms that lavished them with
"excessive" gifts. SEC, NASD Investigate Whether
Securities Firms Gave Excessive Presents
Deborah Solomon, "Probe Focuses on Gifts to Advisers," The
Wall Street Journal, November 25, 2004, Page c19 --- http://online.wsj.com/article/0,,SB110123997986182154,00.html?mod=home_whats_news_us
The just don't get it! Chartered Jets, a Wedding At
Versailles and Fast Cars To Help Forget Bad Times.
As financial companies start to pay out big
bonuses for 2003, lavish spending by Wall Streeters is showing signs
of a comeback. Chartered jets and hot wheels head a list of
indulgences sparked by the recent bull market.
Gregory Zuckerman and Cassell Bryan-Low, "With the
Market Up, Wall Street High Life Bounces Back, Too," The Wall
Street Journal, February 4, 2004 --- http://online.wsj.com/article/0,,SB107584886617919763,00.html?mod=home%5Fpage%5Fone%5Fus
The
turnabout has cost a well-known regulator her job; the director of the
department's securities unit was fired for agreeing to the settlement
pact, which the higher-ups later deemed too lenient.
Susanne Craig (see below)
Securities
regulators have accused H&R Block Financial Advisors of fraud in
selling customers nationwide some $16 million of Enron bonds in late
2001 and touting them as a safe investment when the energy-trading
giant had begun to collapse.
SmartPros, November 9, 2004 --- http://www.smartpros.com/x45778.xml
Bob Jensen's threads on the Enron scandal are at http://faculty.trinity.edu/rjensen/FraudEnron.htm
It must be nice to get paid nearly $20 million for cheating
Bank of America Corp., which has paid
more than $1 billion during the past year in scandal-related
settlements and penalties while absorbing a huge acquisition, paid
its chairman and chief executive, Kenneth Lewis, a total of $19.3
million in compensation, according to a proxy filing with the
Securities and Exchange Commission. The 57-year-old Mr. Lewis, in
his fourth year of running the Charlotte, N.C., company, which ranks
third in assets among U.S. banks, received a salary of $1.5 million,
unchanged from 2003. His bonus rose 6% to $5.7 million from $5.4
million a year earlier.
Betsy McKay, "Bank of America Pays Its CEO $19.3 Million Amid
Penalties: Total for Lewis Followed $1 Billion in Settlements,
Absorption of Acquisition," The Wall Street Journal, March
29, 2005; Page A6 ---
http://online.wsj.com/article/0,,SB111205640746091429,00.html?mod=todays_us_page_one
Bob Jensen's Fraud Updates area at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Two months ago, shortly before Japan
ordered Citigroup to close its private banking unit there for, among
other things, failing to guard against money laundering, Charles O.
Prince, the chief executive, commissioned an independent examination
of his bank's lapses. When he received the assessment in mid-October,
he got an eyeful.
"It's Cleanup Time at Citi," by Timothy L. O'Brien and
Landon Thomas, Jr., The New York Times, November 7, 2004 --- http://www.nytimes.com/2004/11/07/business/yourmoney/07citi.html
Citibank CEO blames incompetent auditors!
Dismissed Former Executive Says Auditors Failed to Flag Problems in
Japanese Operations
"Citigroup's Jones Denies Blame," by Mitchell Pacelle,
The Wall Street Journal, November 19, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110081710259278531,00.html?mod=home%5Fwhats%5Fnews%5Fus
Thomas W. Jones, one of the
three top Citigroup
Inc. executives dismissed last month, accused his former employer of
unfairly holding him accountable for a private-banking scandal in
Japan.
"Do I feel there's
anything more I could have done?" asked Mr. Jones, former chief
executive of Citigroup investment and asset-management units, in
reference to the private-banking problems in Japan. "The answer
is 'no.' "
In an interview, Mr. Jones,
dressed in a dark, pin-striped suit, attributed the regulatory
actions in Japan to problems that stretched across business lines,
and said that Citigroup auditors in New York had failed to flag the
problems for him and other executives at the financial-services
firm's Park Avenue headquarters.
"Given the
responsibilities and seniority of the three individuals, it was
appropriate for each of them to leave the company," a Citigroup
spokeswoman responded. "The decision was made after a thorough
and thoughtful review that was supported by, among other things, the
work of an independent, outside adviser." She declined to
comment further on Mr. Jones's comments.
In September, Japanese
regulators yanked Citigroup's private-banking license and charged
the company with violations ranging from failure to implement
safeguards against money laundering to misleading customers about
the risks of investments. The then-head of Citigroup's global
private bank, Peter Scaturro, reported to Mr. Jones.
On an Oct. 19 internal
memorandum, Chief Executive Officer Charles Prince said that Messrs.
Jones and Scaturro and Vice Chairman Deryck Maughan would leave
Citigroup. In announcing the departures, Citigroup said nothing
about the involvement of the three executives in the problems in
Japan. But people familiar with the dismissals linked the departures
to the report on the private-banking problem, which was prepared by
former U.S. Comptroller of the Currency Eugene Ludwig.
The 55-year-old Mr. Jones
said the report by Mr. Ludwig's Promontory Financial Group
attributed the Japan problems to a host of factors, including
Citigroup's overall control structure. Mr. Jones said his name came
up in Mr. Ludwig's report only in two footnotes, and didn't appear
at all in a Citigroup filing to Japanese regulators that identified
"responsible" managers.
Continued in article
More of
How Large Stock Brokerages are Congress to the Core:
Morgan Stanley
Merrill Lynch
Ameritrade Holdings
Charles Schwab
E.Trade Financial Corp.
In the largest civil settlement in United
States history (prior to 1998), a
federal judge on November 9, 1998 approved a US$1.03 billion
settlement requiring dozens of brokerage houses (including Merrill
Lynch, Goldman Sachs, and Salomon Smith Barney) to pay investors who
claimed they were cheated in a wide-spread price-fixing scheme on the
NASDAQ.
Wikipedia --- http://en.wikipedia.org/wiki/NASDAQ
The
Securities and Exchange Commission is looking at brokerage firms
suspected of failing to get customers the best stock prices, people
briefed on the inquiry said.
"SEC said to eye broker trading," CNN Money, November
8, 2004 --- http://money.cnn.com/2004/11/08/markets/sec-brokerage.reut/index.htm
The Securities and Exchange Commission is
investigating about a dozen brokerage firms that may have failed to
obtain the best price for stocks traded for customers, the New York
Times reported Monday, citing people briefed on the inquiry.
The brokers under scrutiny include Morgan
Stanley (down $0.03 to $53.75,
Research), Merrill Lynch (up
$0.22 to $56.42, Research), Ameritrade
Holdings (Research), Charles
Schwab (up $0.10 to $9.72,
Research) and E.Trade Financial
Corp. (down $0.25 to $13.19,
Research), the report said.
Regulators are looking specifically at the
way these companies traded Nasdaq-listed stocks during early morning
trade, the report said.
After examining trading data from the last
four years, the investigation found evidence that trades were often
processed in ways that favored the firms over their clients, the
Times said, citing unnamed sources.
The newspaper's sources said regulators are
examining two methods of executing trades known as internalization
and payment for order flow.
Internalization is when a broker executes
an order from securities in its own account rather than from a
market order. Payment for order flow occurs when retail brokers send
aggregated small orders to market makers. In some instances, some
stock exchanges or market makers will pay for routing the order
From
Orange
County
to Enron and Beyond
Whenever a huge financial scandal surfaces, more often than not
Merrill Lynch pays up.
Eliott Spitzer once said that his smoking gun could have shot Merrill
completely out of the water if the economic consequences would not
have been so enormous. When
will Merrill ever clean up its act?
A jury has convicted four former Merrill Lynch executives and a former
Enron finance executive for helping push through a sham deal to pad
the energy company's earnings
"5 Executives Convicted of Fraud in First Enron Trial," The New York Times,
November 3, 2004
--- http://www.nytimes.com/aponline/business/03WIRE-ENRON.html
Student Assignment on Fraud: Compare the Stockton Versus Orange County
Bankruptcies
The Cause of Stockton's Bankruptcy: Lousy Risk Disclosures on Bond
Sales for Stockton's Pension Funds
"How Plan to Help City Pay Pensions Backfired," by Mary Williams
Walsh, The New York Times, September 3, 2012 ---
http://www.nytimes.com/2012/09/04/business/how-a-plan-to-help-stockton-calif-pay-pensions-backfired.html?_r=1
Jeffrey A. Michael, a finance professor in
Stockton, Calif., took a hard look at his city’s
bankruptcy this summer and thought he saw a
smoking gun: a dubious bond deal that bankers had pushed on Stockton just as
the local economy was starting to tank in the spring of 2007, he said.
Stockton sold the bonds, about $125 million worth,
to obtain cash to close a shortfall in its pension plans for current and
retired city workers. The strategy backfired, which is part of the reason
the city is now in Chapter 9 bankruptcy. Stockton is trying to walk away
from the so-called pension obligation bonds and to renegotiate other debts.
After reviewing an analysis of the bond deal,
underwritten by the ill-fated investment bank, Lehman Brothers, and watching
a recording of the Stockton City Council meeting where Lehman bankers
pitched the deal, Mr. Michael concluded that “Stockton is entitled to some
relief, due to deceptive and misleading sales practices that understated the
risk.”
“Lehman Brothers just didn’t disclose all the risks
of the transaction,” he said. “Their product didn’t work, in the same way as
if they had built a marina for the city and then the marina collapsed.”
Financial analysts and actuaries say essentially
the same pitch that swayed Stockton has been made thousands of times to
local governments all over the country — and that many of them were drawn
into deals that have since cost them dearly.
Since virtually all pension obligation bonds turn
on the same basic strategy that Stockton followed, Mr. Michael’s research
could be a road map for avoiding more such problems, or perhaps for seeking
redress. His analysis was part of his August economic forecast for the
region, which he prepares as director of the Business Forecasting Center at
the University of the Pacific.
There are about $64 billion in pension obligation
bonds outstanding, and even though issuance has slowed, more of the bonds
are coming to market, even now.
Officials in Fort Lauderdale, Fla., are scheduled
to vote on a $300 million pension obligation bond on Wednesday, for
instance. Hamden, Conn., has amended its charter to allow for the bonds to
rescue a city pension fund that is wasting away. Oakland, Calif., recently
issued about $211 million of the bonds, following the lead of several other
California cities and counties.
The basic premise of all pension obligation bonds
is that a municipality can borrow at a lower rate of interest than the rate
its pension fund assumes its assets will earn on average over the long term.
Critics contend that municipalities that try this are in essence borrowing
money and betting it on the stock market, through their pension funds. The
interest on pension obligation bonds is not tax-exempt for this reason.
Alicia H. Munnell, director of the Center for
Retirement Research at Boston College, looked at outcomes for nearly 3,000
pension obligation bonds issued from 1986 to 2009 and found that most were
in the red. “Only those bonds issued a very long time ago and those issued
during dramatic stock downturns have produced a positive return,” Ms.
Munnell wrote with colleagues Thad Calabrese, Ashby Monk and Jean-Pierre
Aubry. “All others are in the red.” Only one in five of the pension
obligation bonds issued since 1992 has matured, so the results could change
in the future.
Among the places where the strategy has failed
miserably is New Orleans, which sold about $170 million of such debt in 2000
to produce cash to finance the pensions of 820 retired firefighters. Until
then, New Orleans had never funded their benefits and simply paid them out
of pocket, leaving the retirees fearful that in a budget squeeze, the city
might renege.
City officials based the deal on the expectation
that the bond proceeds would be invested in assets that would pay 10.7
percent a year — an unusually aggressive assumption, but one that made the
numbers work. New Orleans’s credit was weak, and its borrowing rate was
expected to be 8.2 percent. To get the rate on the bonds down as much as
possible, New Orleans also issued variable-rate debt, combined with
derivatives in an attempt to hedge against rate increases.
But instead of earning 10.7 percent a year, the
bond proceeds the city set aside for the firefighters’ pensions lost value
over the years, first in the dot-com crash and then in the financial crisis.
And instead of hedging against interest rate increases, the derivatives
failed, leaving New Orleans paying 11.2 percent interest. The city also has
a $115 million balloon payment coming due on the debt in March.
Continued in article
Jensen Comment
An interesting assignment for students might be to compare the bad investment
causes of bankruptcy of Stockton, CA versus Orange County , CA,
Listen to Part of a Sixty Minutes video that I made available to my my
students learning how to account for derivative financial instruments ---
http://www.cs.trinity.edu/~rjensen/000overview/mp3/SIXTY01.mp3
Boo to Merrill Lynch
Listen to Part of a Sixty Minutes video that I made available to my my
students learning how to account for derivative financial instruments ---
http://www.cs.trinity.edu/~rjensen/000overview/mp3/SIXTY01.mp3
Merrill Lynch was a major player in the infamous Orange County fraud when
selling derivative financial instruments. You can read more about this at
http://faculty.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds
It constantly amazes me how often the name Merrill Lynch crops up in news
accounts of both outright frauds and concerns over ethics. The latest account
is typical. A senior vic
They were an
admixture of old-fashioned and uncouth, a duo almost as unlikely as Neil Simon's
odd couple. The seventy-year-old had been married to the same woman for forty
years, in the same job for more than twenty, and in the same place--Orange
County, California--forever. The fifty-four-year-old had recently divorced and
remarried, switched jobs often and moved even more frequently, most recently to
a million-dollar home in swanky Moraga, east of Oakland, California. Despite
their obvious differences, they spoke on the phone virtually every day for many
years. They first met in 1975 and had traded billions of dollars of securities
with each other. The elder of the pair was the Orange County treasurer, Robert
Citron; the younger was a Merrill Lynch bond salesman, Mike Stamenson. Together
they created what many officials described as the biggest financial fiasco in
the United States: Orange County's $1.7 billion loss on derivative
Frank Partnoy, Page 157 of Chapter 8 entitled "The Odd Couple"
F.I.A.S.C.O. : The Inside Story of a Wall Street Trader
by Frank Partnoy
- 283 pages (February 1999) Penguin USA (Paper); ISBN: 0140278796
A longer passage from Chapter 8 appears at
http://faculty.trinity.edu/rjensen/fraud.htm#DerivativesFraud
A second passage beginning on Page 166
reads as follows:
Also
on December 5, Orange County filed the largest municipal bankruptcy petition
in history. Orange County's funds covered nearly two hundred schools,
cities, and special districts. The losses amounted to almost $1,000 for
every man, woman, and child in the county. The county's investments,
including structured notes, had dropped 27 percent in value, and the county
said it no longer could meet its obligations.
The
bankruptcy filing made the ratings agencies look like fools.
Just a few months before, in August 1994, Moody's Investors Service had
given Orange County's debt a rating of Aa1, the highest rating of any
California county. A cover memo to the rating letter stated, "Well done,
Orange County." Now, on December 7, an embarrassed Moody's declared Orange
County's bonds to be "junk"--and Moody's was regarded as the most
sophisticated ratings agency. The other major agencies, including S&P, also
had failed to anticipate the bankruptcy. Soon these agencies would face
lawsuits related to their practice of rating derivatives.
On
Tuesday, January 17, 1995, Robert Citron and Michael Stamenson delivered
prepared statements in an all-day hearing before the California Senate
Special Committee on Local Government Investments, which had subpoenaed them
to testify. It was a pitiful display. Citron left his wild clothes at
home, testifying in a dull gray suit and bifocals. He apologized and
pleaded ignorance. He said, "In retrospect, I wish I had more education and
training in complex government securities." Stuttering and subdued,
appearing to be the victim, Citron tried to excuse his whole life: He didn't
serve in the military because he had asthma; he didn't graduate from USC
because of financial troubles; he was an inexperienced investor who had
never even owned a share of stock. It was pathetic.
Stamenson also said he was sorry and cited the enormous personal pain the
calamity had produced. He pretended naivete. He said Citron was a highly
sophisticated investor and that he had "learned a lot" from him.
Stamenson's story was as absurd as Citron's was sad. When Stamenson
asserted that he had not acted as a financial adviser to the county, one
Orange County Republican, Senator William A. Craven, couldn't take it
anymore and called him a liar. Stamenson finally admitted that he had
spoken to Citron often--Citron had claimed every day--but he refused to
concede that he had been an adviser. At this point Craven exploded again,
asking, "Well, what the hell were you talking about to this man every day?
The weather?" Citron's lawyer, David W. Wiechert, was just as angry. He
said, "For Merrill Lynch to distance themselves from this crisis would be
akin to Exxon distancing themselves from the Valdez."
Bob Jensen's timeline of derivative financial instruments frauds ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
"Morgan Stanley Could
Face Action By Washington State," by Susanne Craig, The Wall
Street Journal, May 11, 2004, Page C1 --- http://online.wsj.com/article/0,,SB108422706197307350,00.html?mod=home_whats_news_us
Washington state's top
securities regulator is moving toward enforcement action against Morgan
Stanley for allegedly giving Microsoft
Corp. employees unsuitable investment advice for their big
stock-option holdings, scrapping a previously negotiated settlement
pact.
The turnabout has cost a
well-known regulator her job; the director of the department's
securities unit was fired for agreeing to the settlement pact, which
the higher-ups later deemed too lenient.
Helen Howell, the state's
director of financial institutions, said in an interview that the
subordinate was terminated for several reasons. Among them, Ms.
Howell was concerned that the planned settlement "was not tough
enough" and might not be legally enforceable. The subordinate,
Deborah Bortner, who had been the state's director of securities for
more than a decade, maintained in an interview that the firing was
politically motivated and reflected a desire by Ms. Howell to score
points with the public by bringing a high-profile enforcement action
against a big Wall Street firm.
For her part, Ms. Howell said
the action was prompted by a desire to better address what she
deemed "systemic problems" with "lack of
supervision" of stock brokers at Morgan Stanley, in alleged
violation of Washington state securities law. She said the matter
came to a head when lawyers in the state's attorney general's office
"informed us the agreement Deb reached was unenforceable. If
Morgan Stanley decided to take steps not to do the things [agreed
to], we couldn't do much." This was because the terms
themselves were "in a side agreement," she said.
Morgan Stanley disagrees,
however, saying it has signed side agreements in the past and the
documents are enforceable, a spokesman for the firm said.
The developments underscore
state and federal financial regulators' heightened interest in being
tough on Wall Street in the wake of numerous scandals over
accounting frauds, stock-trading misdeeds and conflict-ridden
financial advice that consumer advocates say should have caught
regulators' attention sooner.
In the dispute with Morgan
Stanley, the regulators maintain that two of its stockbrokers
wrongly advised three Microsoft employees to exercise thousands of
their Microsoft stock options, then sell some of their Microsoft
shares to finance purchases of risky technology and
telecommunications stocks, according to a complaint served on the
firm by the regulators late last year that has never been made
public. The brokers also encouraged the employees to finance some of
the investment moves by borrowing against their stock holdings,
further amplifying the damage when the stock market dropped, the
complaint says. One of the state's biggest concerns was the alleged
failure of the firm to better supervise its employees.
Microsoft, based in Redmond,
Wash., is one of the state's biggest employers. During the tech
boom, the value of many Microsoft employees' options soared. That
attracted the attention of many Wall Street brokers, who saw the
potential for a windfall in investment advice.
Since the boom went bust,
many clients with devastated portfolios have sued, maintaining that
the Wall Street firms were too aggressive for their conservative
tastes. As the state's director of securities, Ms. Bortner had
investigated some of the allegations that Morgan Stanley's brokers
wrongly pushed them into unsuitable investments. Some of these cases
have gone to securities arbitration and three have received no
award. Morgan Stanley, according to a person close to the firm, has
settled a handful of other cases for nominal amounts.
Ms. Bortner and Morgan
Stanley reached an agreement to resolve the matter last month, and
Morgan had begun to implement some of the changes. The firm agreed,
among other things, to pay approximately $200,000 and provide
additional training for its financial advisers, according to people
familiar with the matter. It would neither admit nor deny
wrongdoing. The firm, the people say, had signed this agreement.
While Washington officials had sent the firm a copy of the pact, the
state hadn't signed the document.
Then, late last month Morgan
Stanley learned Ms. Bortner had been removed from her job and the
deal was off, these people said. "As far as I am concerned, an
agreement isn't done until it is signed by both parties," said
Ms. Howell. She said the state countered with a stronger settlement
offer, but it was rejected by the firm on Friday.
Morgan Stanley is now bracing
for Washington State to bring an enforcement action, a much more
serious outcome than a settlement agreement, with potentially
stiffer penalties. Ms. Howell confirmed this is one of the options
she has. But first the matter would go to an administrative hearing,
where Morgan Stanley could make its argument against further action.
Morgan Stanley, meanwhile, is
considering taking the state to court to force it to uphold the
agreement, the people close to the firm said. "We have a
legally binding agreement in place with the State of
Washington," the Morgan Stanley spokesman said.
Continued in the article
"Adding Insult to Injury: Firms Pay Wrongdoers' Legal
Fees," by Laurie P. Cohen, The Wall Street Journal,
February 17, 2004 --- http://online.wsj.com/article/0,,SB107697515164830882,00.html?mod=home%5Fwhats%5Fnews%5Fus
You buy shares in a company. The government
charges one of the company's executives with fraud. Who foots the
legal bill?
All too often, it's you.
Consider the case of a former Rite Aid
Corp. executive. Four days before he was set to go to trial last
June, Frank Bergonzi pleaded guilty to participating in a criminal
conspiracy to defraud Rite Aid while he was the company's chief
financial officer. "I was aggressive and I pressured others to
be aggressive," he told a federal judge in Harrisburg, Pa., at
the time.
Little more than a month later, Mr.
Bergonzi sued his former employer in Delaware Chancery Court,
seeking to force the company to pay more than $5 million in unpaid
legal and accounting fees he racked up in connection with his
defense in criminal and civil proceedings. That was in addition to
the $4 million that Rite Aid had already advanced for Mr. Bergonzi's
defense in civil, administrative and criminal proceedings.
In October, the Delaware court sided with
Mr. Bergonzi. It ruled that Rite Aid was required to advance Mr.
Bergonzi's defense fees until a "final disposition" of his
legal case. The court interpreted that moment as sentencing, a time
that could be months -- or even years -- away. Mr. Bergonzi has
agreed to testify against former colleagues at coming trials before
he is sentenced for his crimes.
Rite Aid's insurance, in what is known as a
directors-and-officers liability policy, already has been depleted
by a host of class-action suits filed against the company in the
wake of a federal investigation into possible fraud that began in
late 1999. "The shareholders are footing the bill" because
of the "precedent-setting" Delaware ruling, laments Alan
J. Davis, a Philadelphia attorney who unsuccessfully defended Rite
Aid against Mr. Bergonzi.
Rite Aid eventually settled with Mr.
Bergonzi for an amount it won't disclose. While it is entitled to
recover the fees it has paid from Mr. Bergonzi after he is
sentenced, the 58-year-old defendant has testified he has few
remaining assets. "We have no reason to believe he'll
repay" Rite Aid, Mr. Davis says.
Rite Aid has lots of company. In recent
government cases involving Cendant Corp.; WorldCom Inc., now known
as MCI; Enron Corp.; and Qwest Communications International Inc.,
among others, companies are paying the legal costs of former
executives defending themselves against fraud allegations. The
amount of money being paid out isn't known, as companies typically
don't specify defense costs. But it totals hundreds of millions, or
even billions of dollars. A company's average cost of defending
against shareholder suits last year was $2.2 million, according to
Tillinghast-Towers Perrin. "These costs are likely to climb
much higher, due to a lot of claims for more than a billion dollars
each that haven't been settled," says James Swanke, an
executive at the actuarial consulting firm.
Continued in the article
"Morgan Stanley Is
Fined Over Bad-News Delay," by Susanne Craig, The Wall Street
Journal, July 30, 2004, Page C1 --- http://online.wsj.com/article/0,,SB109111883749277775,00.html?mod=home_whats_news_us
Morgan
Stanley agreed to a $2.2 million fine to resolve allegations
that it dragged its feet in disclosing 1,800 incidents of customer
complaints and more serious misconduct involving its stockbrokers,
the first of many such cases that securities cops say they plan to
bring against Wall Street firms.
The National Association of
Securities Dealers, which launched an investigation into the delays
several months ago, charged Morgan Stanley for supervisory failures
relating to the late filings and barred it from registering new
brokers for one week. It also required the firm to hire an
independent consultant to review its supervisory systems and
procedures in this area. In settling, Morgan Stanley neither
admitted nor denied the allegations.
This is the largest fine
levied against a securities firm for the tardy filing of paperwork.
While $2.2 million is pocket change for a big brokerage firm, the
action is about more than money: It is a public embarrassment to a
firm of Morgan Stanley's stature.
"A .320 batting average
in baseball may be pretty good, but getting it right 32% of the time
when it comes to this type of information that investors are
entitled to is woefully inadequate," said Barry Goldsmith, the
NASD's executive vice president for enforcement. Of the 1,800 tardy
filings, more than half -- 52% -- were more than 90 days late.
The NASD said Morgan
Stanley's late filings delayed several regulatory investigations and
may have compromised state securities regulators' ability to review
applications from brokers changing firms.
A Morgan Stanley spokeswoman
said: "We began to implement a program of corrective action [on
its filings] prior to finalizing this agreement and are moving
quickly to conclude that process."
Continued in the article
"An 'Oops' at the Bank of 'Wow'," by Gretchen Morgenson,
The New York Times, August 1, 2004 --- http://www.nytimes.com/2004/08/01/business/yourmoney/01com.html
VERNON W. HILL II, the founder and chief
executive of Commerce Bancorp Inc., credits his "wow the
customer" philosophy for taking his company from a little-known
local institution in southern New Jersey to the fastest-growing
retail bank in the nation. By keeping branches open weekends and
evenings and by eliminating what he calls the "annoying fees''
and "stupid rules'' found at other banks, Mr. Hill has flouted
industry convention. And with a stock price that is up 135 percent
in the past five years, he has elicited more than a few wows from
Wall Street, too.
Now, however, Mr. Hill, a former real
estate executive and owner of fast-food franchises, can hear a
different sort of wow from shareholders - one of shock. They
recently learned that two of the bank's top executives and one of
its former directors are embroiled in an influence-peddling scandal
in Philadelphia. An indictment announced on June 29 by the United
States attorney for the Eastern District of Pennsylvania named 12
individuals in a pay-to-play arrangement involving Corey Kemp,
Philadelphia's former treasurer.
According to the indictment, Mr. Kemp
handed out the city's money management and bond underwriting
business to financial institutions that entertained him with
restaurant meals and tickets to sporting events and that gave him
sizable loans despite his abysmal credit rating. Among those
indicted were Glenn K. Holck, president of Commerce Bank's
Pennsylvania unit, and Stephen M. Umbrell, its regional vice
president. At the heart of the scheme, the indictment says, was
Ronald A. White, a lawyer who sat on a Commerce regional board until
last year.
Perhaps ominously for Commerce, the
indictment refers to five phone conversations taped by investigators
in which Mr. Hill discussed matters relating to Mr. Kemp with the
individuals named in the indictment. In an interview on Friday, Mr.
Hill declined to describe the nature of the conversations.
Mr. Kemp, Mr. White, Mr. Umbrell and Mr.
Holck have all pleaded not guilty.
Commerce says that the bank and its
executives did nothing wrong. While Mr. Holck and Mr. Umbrell have
been suspended, the bank is paying their legal expenses. In a July
13 conference call with analysts to discuss second-quarter results,
Mr. Hill promised to institute new policies to increase
oversight of the bank's dealings with government officials.
Continued in the article.
"Partners in Crime," Fortune,
October 13, 2003 --- http://www.fortune.com/fortune/specials/2003/1027/enron.html
The untold
story of how Citi, J.P. Morgan Chase, and Merrill Lynch helped Enron
pull off one of the greatest scams ever. The complicity of so many
highly regarded Wall Street firms in the Enron scandal is stunningly
documented in internal presentations and e-mails, many of which have
never before been published. It seems that the banks have gotten off
easy so far.
From the AccountingWEB.com, March 3, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=98815
FleetBoston Financial Corp. has disclosed
that its Fleet Specialist Unit will pay $59.4 million in a
settlement with the Securities and Exchange Commission and the New
York Stock Exchange. The settlement stems from an investigation of
the NYSE’s five largest specialist firms, who were accused of
failing to oversee traders who improperly traded ahead of their
customers. In a preliminary agreement announced Feb. 17, the
specialists agreed to pay a total of $240 million — $155 million
in disgorgement of ill-gotten gains plus penalties of about $85
million.
Until FleetBoston Financial made its annual
filing Tuesday with the SEC, it was not known how much Fleet
Specialist Inc. would pay in restitution and penalties.
The Boston bank holding company said the
settlement includes a censure, a cease-and-desist order, and an
"undetermined form of undertaking," according to the Wall
Street Journal. It also said the settlement wouldn't resolve
regulatory charges against individuals.
The agreement involves no admission or
denial of wrongdoing and is subject to approval by the SEC and NYSE.
Bank of America will pay $69 million to settle a class-action suit
alleging it was among top U.S. financial firms that participated in a
scheme with Enron's top executives to deceive shareholders.
"Bank of America Settles Suit Over the Collapse of
Enron," by Rick Brooks and Carrick Mollekamp, The Wall Street
Journal, July 4, 2004 --- http://online.wsj.com/article/0,,SB108879162283854269,00.html?mod=home_whats_news_us
Bank
of America Corp. became the first
bank to settle a class-action lawsuit alleging that some of the
U.S.'s top financial institutions participated in a scheme with
Enron Corp. executives to deceive shareholders.
The Charlotte, North
Carolina, bank, the third-largest in the U.S. in assets, agreed to
pay $69 million to investors who suffered billions of dollars in
losses as a result of Enron's collapse amid scandal in 2001. In
making the settlement, Bank of America denied that it "violated
any law," adding that it decided to make the payment
"solely to eliminate the uncertainties, expense and distraction
of further protracted litigation," according to a statement.
The settlement with Bank of
America raises the possibility that it could cost other banks and
securities firms still embroiled in the suit much more to settle the
allegations against them, should they decide to do so. Bank of
America had relatively small-scale financial dealings with Enron
compared with other banks, and was sued only for its role as an
underwriter for certain Enron and Enron-related debt offerings.
In contrast with other
financial institutions being pursued by Enron shareholders, led by
the Regents of the University of California, which lost nearly $150
million from Enron, Bank of America wasn't accused of defrauding the
energy company's shareholders. Other remaining defendants in the
class-action suit, filed in 2002 in U.S. District Court in Houston,
are alleged to have helped Enron with phony deals to inflate the
energy company's earnings, potentially exposing those banks and
securities firms to much steeper damages.
William Lerach, the lead
attorney representing the University of California, predicted that
the $69 million payment from Bank of America "will be the
precursor of much larger ones in the future, especially with the
banks that face liability for participating in the scheme to defraud
Enron's common stockholders."
Still, it won't be clear
until additional settlements are reached or the suit goes to trial
whether Bank of America was able to negotiate a better agreement
because of its willingness to strike a deal with Enron shareholders
before other defendants. Bank of America's payment to settle the
claims against it represents more than half its potential exposure,
Mr. Lerach added.
Citigroup Inc. and J.P.
Morgan Chase & Co., still defendants in the suit, declined to
comment. Enron shareholders also sued Merrill Lynch & Co.;
Credit Suisse First Boston, a unit of Credit Suisse Group; Deutsche
Bank AG; Canadian Imperial Bank of Commerce; Barclays PLC;
Toronto-Dominion Bank; and Royal Bank of Scotland PLC. Named as
defendants in the class-action suit before it was amended to include
the banks and securities firms were several Enron officers and
directors and its former outside auditor, Arthur Andersen LLP.
The only other firm to settle
allegations against it in the class-action suit is Andersen
Worldwide SC, the Swiss organization that oversees Andersen
Worldwide's independent partnerships. In 2002, it reached a $40
million deal with the University of California that released
Andersen Worldwide from the suit. That agreement also raised
questions among some other Enron claimants about whether they would
recover anything more sizable from Enron's accounting firm.
The University of
California's board of regents, a 26-member supervisory panel, is
expected to give final approval to the settlement agreement with
Bank of America later this month. A trial in the Enron class-action
suit is set to start in October 2006.
Enron also triggered huge
losses for Bank of America shortly after the energy company
collapsed. Bank of America incurred a charge of $231 million related
to its lending relationship with Enron Corp. The bulk of that
stemmed from $210 million in loans that were charged off, which
essentially means the bank declared them worthless. Four Bank of
America employees tied to the bank's relationship with Enron left
the bank in January 2002, a week after Bank of America took the
Enron-related charge.
Bob Jensen's threads on the Andersen and Enron scandals are at http://faculty.trinity.edu/rjensen/FraudEnron.htm
Boo to Merrill Lynch
Merrill Lynch was a major player in the infamous Orange County
fraud when selling derivative financial instruments. You can
read more about this at http://faculty.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds
It constantly amazes me how often the name Merrill Lynch crops up
in news accounts of both outright frauds and concerns over ethics.
The latest account is typical. A senior vice president at
Merrill Lynch testified that the firm received a lead role in a $2.1
billion bond offering for Tyco shortly after hiring a stock analyst
favored by Tyco executives for his bullish coverage.
"Merrill Manager Offers Testimony About Tyco Deal," by
Colleen Debaise, The Wall Street Journal, February 3, 2004 --- http://online.wsj.com/article/0,,SB107574602208418145,00.html?mod=mkts_main_news_hs_h
A senior vice president at Merrill Lynch
& Co. testified that the firm received a lead role in a $2.1
billion bond offering for Tyco International Ltd. shortly after
hiring Phua Young, a stock analyst favored by Tyco executives for
his bullish coverage.
The suggestion of a "quid pro
quo" was raised as jurors in the trial of Tyco's former top
executives were shown an August 1999 e-mail message from Sam Chapin,
the senior vice president, to Merrill's then-chairman David Komansky.
In the e-mail, Mr. Chapin wrote that
then-Tyco Chief Executive L. Dennis Kozlowski "wanted to
recognize the commitment that you and I had made to him to address
our equity-research coverage of Tyco."
Mr. Chapin also said in the e-mail,
"To demonstrate the impact this hire has on our relationship,
Dennis Kozlowski called me on Phua's first day of work to award us
the lead management of a $2.1 billion bond offering."
Mr. Kozlowski and Mark H. Swartz, Tyco's
former chief financial officer, are on trial in New York State
Supreme Court on charges they improperly used Tyco funds to enrich
themselves and others.
Prosecutors seemed to use Mr. Chapin's
testimony to bolster charges that the former executives committed
securities fraud by misleading investors, in part by getting Merrill
to hire Tyco's favored analyst. Testimony last month showed that Mr.
Kozlowski curried favor with the analyst by hiring a private
detective agency to perform a background check on Mr. Young's
fiancee, at the cost of $20,000 in Tyco funds.
The behind-the-scenes story of Mr. Young's
hiring also appears to be another example of the cozy relationship
during the Bubble Era between corporate executives and the
supposedly-independent analysts at investment banks.
Mr. Chapin, a 20-year Merrill investment
banker, testified that he spoke to Messrs. Kozlowski and Swartz
about stock research when he became Merrill's "relationship
manager" for Tyco in 1999.
The executives complained about coverage
from Jeanne Terrile, the Merrill analyst then covering Tyco.
"They did not believe that she fully understood their strategy
for growth and development," he said.
In contrast, Mr. Young, then at Lehman
Brothers, had a high stock rating on Tyco. When Mr. Chapin spoke to
Mr. Kozlowski about hiring Mr. Young for Merrill, the Tyco chief
described Mr. Young as a "hard-working analyst [who] did a very
good job of covering Tyco," Mr. Chapin testified.
After that conversation, Mr. Chapin said he
interviewed Mr. Young even though Merrill's equity-research group
was leading the effort to recruit stock analysts. Mr. Chapin said it
wasn't unusual for the research group to ask investment bankers to
provide feedback on prospective hires.
Shortly afterward, Merrill hired Mr. Young
to cover Tyco, and moved Ms. Terrile into a different job. Mr.
Chapin testified that he then received a phone call from Mr.
Kozlowski with the news about the $2.1 billion bond offering.
At Merrill, Mr. Young continued to be a
Tyco cheerleader even as the conglomerate's stock came under siege.
The analyst, who once referred to himself in an e-mail as a
"loyal Tyco employee," was eventually fined by regulators
for issuing exaggerated claims and dismissed by Merrill in 2002. He
has denied the accusations and has filed an arbitration claim
against Merrill.
Kozlowski attorney Stephen Kaufman sought
to play down any improprieties, pointing out that Mr. Young had won
a top rating from Institutional Investor at the time Merrill hired
him. He asked Mr. Chapin if that designation was the equivalent of
winning an Oscar, but Judge Michael Obus wouldn't allow the
question.
Continued in the article.
"Stewart Trial Hears Key Witness," by Matthew Rose and
Kara Scannell, The Wall Street Journal, February 4, 2004 ---
"Oh my God, get Martha on the
phone."
The government's star witness against
Martha Stewart testified Tuesday that that is how his former boss at
Merrill Lynch & Co. reacted when informed that ImClone Systems
Inc.'s chief executive and members of his family were trying to dump
their shares of the biotechnology firm in late 2001.
"You have to tell her what's going
on," Douglas Faneuil quoted his former boss, broker Peter
Bacanovic, as saying in a subsequent call. Mr. Faneuil said he asked
if he was allowed to do that.
"Of course. You must. You've got to.
That's the whole point," Mr. Faneuil said Mr. Bacanovic
responded.
Continued in the article
If you want to read more about ethics failures at Merrill Lynch,
just search for the word Merrill at http://faculty.trinity.edu/rjensen/FraudCongress.htm
Enron
Email Messages From the
Federal Energy Regulatory
Commission (FERC)
Western Energy Markets:
Major Issuance on March 26,
2003 - Information Released
in Investigation --- http://www.ferc.gov/industries/electric/indus-act/wem/03-26-03-release.asp
Enron
Email: 92% of the Enron
emails have been returned
the FERC web site. April
7, 2003 Order [PDF] |
April 22, 2003 Order [PDF]
| May 14, 2003 Order [PDF]
Scanned
Documents: This database
was created from paper
documents provided to FERC
during its investigation
of Western energy markets.
The documents were scanned
and coded (indexed).
Additionally, the images
underwent an optical
character recognition
(OCR) process that created
computer-readable full
text. This database
consists of fielded data
captured during coding,
full text and TIFF images.
First and last Bates
numbers were assigned by
Aspen and any other
numbers that appeared on a
document were captured in
a field called “Other_No”.
The Aspen-assigned number
is comprised of the FERC
box number and a
sequential number for each
scanned page in a box. The
value in the FirstBates
field is hyper linked to
the corresponding group of
scanned images that
comprise the database
record. Database records:
Over 85,000; Document
images: Over 150,000
Transcript:
This database was created
from transcripts related
to this case. Database
records: 40 records
PA02-2-000
Trading Floor Audio Files
- Audio files in mp3
format. Portland General
Electric.
PA02-2-000
Enron Database Extracts
PA02-2-000
Portland General Electric
Data
PA02-2-000
Western Sellers
Submissions - Corrected
and validated long-term
transactions (used in
regression analysis)
submitted in response to
the March 5, 2002 FERC
letter order to all
jurisdictional and
non-jurisdictional sellers
with wholesales sales in
US portion of Western
Systems Coordinating
Council.
"Market Regulators Scrutinize Odd Muni-Bond Trading
Patterns," by Randall Smith and Aaron Lucchetti, The Wall
Street Journal, January 27, 2004 --- http://online.wsj.com/article/0,,SB107513054068911619,00.html?mod=home%5Fwhats%5Fnews%5Fus
Unusual trading patterns in the
municipal-bond market that may be resulting in differences of more
than 10% between prices at which customers buy and sell the same
bonds on the same day are being studied by securities regulators,
according to people familiar with the probes.
The probes are being conducted by the
staffs of the Securities and Exchange Commission and the National
Association of Securities Dealers, based on pricing anomalies drawn
to their attention in part by an industry critic who runs a
bond-pricing Web site and the Municipal Securities Rulemaking Board,
the people said.
The regulators are looking at whether
different securities dealers have traded certain municipal bonds
among themselves at successively higher or lower prices, adversely
affecting the prices customers receive when they buy or sell the
bonds.
Continued in the article
"The Market's Most Valuable Stock Is Trust," by Robert J.
Shiller, The Wall Street Journal, September 26, 2003 --- http://online.wsj.com/article/0,,SB106444647678083300,00.html?mod=todays%255Fus%255Fopinion%255Fhs
New York State Attorney General Eliott
Spitzer's charges of improper trading practices by several leading
mutual fund families are another blow to public trust in financial
institutions. Mutual funds have been the place you would advise the
most unsophisticated investors to go: Mutual funds were designed for
grandpa and grandma, and repeatedly recommended to them by all kinds
of benevolent authorities. Thus scandals in the mutual fund sector
are potentially much more damaging to public trust in our financial
institutions than are scandals in other sectors -- such as the one
playing out in the New York Stock Exchange right now.
Trust is a primordial form of human social
cognition. We instinctively seek to surround ourselves with others
we trust, and desire a stable situation where we know who we can
rely on. Trust has emotional correlates. We do not "sleep
easily" if we feel a lack of a basic sense of trust in those
who relate to us.
Trust in investments, therefore, is
something rather different from belief in earnings prospects, or
even in the likelihood of high returns. Those are rational,
quantitative, calculations. People's decisions to invest in stocks
are related to some more basic factors, like whether they have a
good feeling about investing in stocks, or, alternatively, just
prefer to forget about them completely for peace of mind.
After the stock market crash of 1929, and
after the sequence of financial scandals revealed from the 1920s,
most U.S. investors appeared to put stocks totally out of their
mind, and just forgot about them for decades. A 1954 public opinion
survey commissioned by the New York Stock Exchange found that at
that time only 23% of the adult population could even remember how
to define a stock adequately, and only 40% knew that the NYSE does
not own the stocks listed for sale to the public. Only 10% would
even consider common stock as a way to invest some extra money. We
do not want more people to sink back into such a backward financial
state of mind in the future, but that is the direction of tendency
now.
At a rational, quantitative level
everything appears to be all right among investors. According to the
Yale School of Management Stock Market Confidence Indexes for
February through July of this year, 89% of individual investors and
87% of institutional investors expect the stock market to go up in
the succeeding year. These are at close to the highest levels of
optimism observed since we started collecting these data in 1989.
And yet, their quantitative expectations
for the market are not necessarily going to translate into a
long-term increase in demand that will promote market values. There
is also a sour attitude among investors, fed by market declines and
the sequence of scandals.
In 1996, near the beginning of the fastest
upswing of the bull market, I noticed so many people expressing
great faith that the stock market is the best long-term investment
that I decided to try to tabulate, as part of my surveys of
high-income Americans, how many thought this way. I asked how much
they agreed with the statement: "The stock market is the best
investment for long-term holders, who can buy and hold through the
ups and downs of the market." The percentage of those who said
they agreed strongly with this statement was already quite high,
69%, in 1996; but it rose even higher, to 76%, in 1999, right before
the crash. After the market debacle, and after the scandals, the
percentage who agreed strongly then fell to 60% in 2001-2 and 39% in
2003. Whatever their opinions about what the stock market will do
this year, they just aren't so sanguine about it as a long-term
investment.
Continued in the article.
September 19, 2003 message from Risk Waters Group [RiskWaters@lb.bcentral.com]
Merrill Lynch has agreed sweeping reforms that will
require all complex structured finance transactions effected by a third party
with the bank to be authorised by a new Special and Structured Products
Committee (SSPC). The development is the result of a deal struck with the US
Department of Justice (DoJ) over charges of conspiracy with Enron. The bank has
also agreed for the SSPC to be monitored for 18 months by an independent
auditing firm. At the same time, a DoJ-selected attorney will review and oversee
the work of the auditing firm. Merrill Lynch has declined to comment on any
aspect of the deal. The co-operation agreement arose after three former Merrill
executives were indicted on Wednesday by a federal grand jury on charges of
conspiracy to commit wire fraud and falsify books and records. Merrill Lynch has
accepted responsibility for the conduct of the three defendants - Daniel Bayly,
former head of global investment banking; James Brown, head of Merrill's
strategic asset lease and finance Group; and Robert Furst, the Enron
relationship manager for Merrill Lynch in the investment banking division.
April 29, 2003 Update
The
$1.4 billion settlement sounds like a big number, but the crooks are
only giving back a small fraction of the take.
"Wall
Street Firms Settle Charges Over Research in $1.4 Billion Pact,"
by Randall Smith, Susanne Craig, and Deborah Solomon, The
Wall Street Journal, April 29, 2003, Page C1
In
a pact that could change the face of Wall Street, 10 of the nation's
largest securities firms agreed to pay a record $1.4 billion to
settle government charges involving abuse of investors during the
stock-market bubble of the late 1990s.
The
long-awaited settlement, which followed an intense investigation
that brought together three national regulatory bodies and a dozen
state securities authorities, centers on civil charges that the Wall
Street firms routinely issued overly optimistic stock research to
investors in order to curry favor with corporate clients and win
their lucrative investment-banking business. The pact also settles
charges that at least two big firms, Citigroup
Inc.'s Citigroup Global Markets unit, formerly Salomon Smith Barney,
and Credit
Suisse Group's Credit Suisse First Boston, improperly doled out
coveted shares in initial public offerings to corporate executives
in a bid to win banking business from their companies.
Regulators
unveiled dozens of previously undisclosed examples of financial
analysts tailoring their research reports and stock ratings to win
investment-banking business. They added up to a scathing critique
that scorched all the firms involved. The boss of one star analyst,
Internet expert Mary Meeker of Morgan
Stanley, praised her for being "highly involved" in
the firm's investment-banking business. An analyst at the UBS
Warburg unit of UBS
AG explained she soft-pedaled concerns about a drug because its
developer was "a very important client."
"I
am profoundly saddened -- and angry -- about the conduct that's
alleged in our complaints," said William Donaldson, chairman of
the Securities and Exchange Commission. "There is absolutely no
place for it in our marketplace and it cannot be tolerated."
The
penalties included lifetime bans from the securities business for
two former star analysts, Jack Grubman of Salomon and Henry Blodget
of Merrill
Lynch & Co., who were charged with issuing fraudulent
research reports and agreed to pay penalties of $15 million and $4
million, respectively. Both the firms and the individuals consented
to the charges without admitting or denying wrongdoing. But the
regulators vowed to pursue cases against analysts and their
supervisors as far up the chain of command as possible.
Bowing
to political pressure from Congress, the regulators, which also
included the National Association of Securities Dealers, the New
York Stock Exchange and state regulators led by New York's Eliot
Spitzer, also won a promise by the firms not to seek insurance
repayment or tax deductions for $487.5 million of the settlement
payments.
The
agreement sets new rules that will force brokerage companies to make
structural changes in the way they handle research. Analysts, for
instance, will no longer be allowed to accompany investment bankers
during sales pitches to clients. The pact also requires securities
firms to have separate reporting and supervisory structures for
their research and banking operations, and to tie analysts'
compensation to the quality and accuracy of their research, rather
than how much investment-banking fees they help generate.
Moreover,
stock research will be required to carry the equivalent of a
"buyer beware" notice. Securities firms, regulators said,
must include on the first page of research reports a note making
clear that the reports are produced by firms that do
investment-banking business with the companies they cover. This, the
firms must acknowledge, may affect the objectivity of the firms'
research.
Continued in the article.
THE
REFORMS
The main points of
the settlement:
• A clear
separation of stock research from investment banking
• "Independent"
research for investors at no cost
• Better
disclosure of stock rankings
• Ban of IPO
"spinning"
• $1.4 billion
payout, including a $387.5 million investor fund
• Penalties
aren't tax deductible for the firms
WHO ALLEGEDLY DID WHAT
Issued fraudulent
research reports
CSFB
Merrill Lynch
Salomon Smith Barney
Issued unfair
research, or research not in good faith
Bear Stearns
CSFB
Goldman Sachs
Lehman Brothers
Merrill Lynch
Piper Jaffray
Salomon Smith Barney
UBS
Received or made
undisclosed payments for research
UBS
Piper Jaffray
Bear Stearns
Morgan Stanley
J.P. Morgan
Engaged in
spinning of IPOs
CSFB
Salomon Smith Barney
Source:
Securities and Exchange Commission --- www.sec.gov
|
Additional Reading
Regulators
Unveil Research Settlement
• Settlement
Creates Restitution Fund
• Spitzer
Views Salomon Notes as Key
• More
Lawsuits Could Follow Deal
• How
You Come Out in Settlement
• See
excerpts of firms' internal e-mails released by regulators.
• See
who's paying what and where it's going.
• See a
gallery of key players.
• Listen to the SEC's
press conference.
• See
other resources available online.
Question
Who are the real bad guys that paid the NYSE's Richard Grasso nearly $140+
million per year to cover their evil ways? They willingly paid this
because Grasso was so darn good at his job protecting them.
Answer:
The best account of the inherent corruption in the NYSE system that I have read
is an editorial by John C. Bogle (founder of the huge Vanguard Group) that
appears on the Editorial Page (Page A10) of the September 19, 2003 edition of The
Wall Street Journal --- http://online.wsj.com/article/0,,SB106393576986578400,00.html?mod=opinion%255Fmain%255Fcommentaries
The NYSE has perpetuated myths that
mislead regulators and the investing public into believing that
specialists serve the public. For instance, the NYSE asserts that
investors need specialists because without them, "who is going to
be there to buy or sell when nobody else wants to?" The NYSE
claims that the specialist reduces market volatility by acting as the
buyer or seller of last resort.
SpecialistMan, by JOHN C. BOGLE
Selected quotations are shown below:
While the NYSE bills itself as "a
private company with a public purpose," there is no doubt that
its chairman's most important role is to protect the interests of
its members. And no interest is more important than the protection
of the trading profits derived by the NYSE's floor-based
specialists. Thanks in large part to Mr. Grasso's efforts, the NYSE
has, until recently, enjoyed a remarkable level of prestige,
providing the cover necessary to protect its inherently unfair and
inefficient trading system.
Every security traded on the NYSE is
assigned exclusively to a specialist firm. The specialist ultimately
sees every order in its assigned stocks submitted to the exchange
either electronically or through brokers on the floor. But while the
NYSE grants specialists a privileged position in order to maintain a
"fair and orderly market" (which, curiously, is nowhere
defined), the specialist is also permitted to simultaneously trade
for his own account -- an obvious conflict of interest.
NYSE rules attempt to limit the
specialist's ability to improperly use inside information by
limiting specialists to trading only when there is a temporary
disparity between supply and demand, buying when there are no other
buyers and selling when there are no other sellers. Yet if
specialists really traded only when there is an absence of buyers or
sellers, one would think they would lose money.
The fact is that specialists are
profitable, in Samuel Johnson's words, "beyond the dreams of
avarice." A forthcoming study by Precision Economics will
reveal that publicly traded firms with specialist units last year
enjoyed pre-tax profit margins ranging from 35% to 60%. Labranche,
the largest NYSE specialist, generated more than a quarter of a
billion dollars in revenues, almost entirely from trading for its
own account on the floor. Pretty profitable for trading only when
nobody else wants to!
. . .
The NYSE has perpetuated myths that mislead
regulators and the investing public into believing that specialists
serve the public. For instance, the NYSE asserts that investors need
specialists because without them, "who is going to be there to
buy or sell when nobody else wants to?" The NYSE claims that
the specialist reduces market volatility by acting as the buyer or
seller of last resort.
Think about that: Envision SpecialistMan,
emerging amongst the bedlam of a fast falling stock with a giant
"S" on his chest. Quickly calming the crowd, he exclaims
"I will buy from every one of you because it is my duty, even
though I will lose money." They sell their shares to
SpecialistMan, praising him for his willingness to selflessly
provide liquidity, regardless of the impact on his profits.
While this notion is ridiculous on its
face, it is still put forward to defend the NYSE specialist when
nearly every other major instrument is traded completely
electronically without anyone being given an informational
advantage. The truth is that when a stock like Enron starts
falling, just like everyone else, SpecialistMan gets out of the way.
We ought to ask ourselves why we even want a specialist to
manage the decline of a stock. In an efficient market, that is the
last thing we should want. The market should be permitted to clear
-- move to its equilibrium point -- as quickly as possible, without
somebody trying to manage the process. A slowly declining stock only
hurts buyers at the expense of sellers, and vice versa.
Continued in the article.
A hedge-fund manager arranged
with mutual-fund firms to improperly trade fund shares, reaping
millions of dollars in profits at the expense of other investors, New
York Attorney General Spitzer alleged.
"Spitzer Kicks Off Fund
Probe With a $40 Million Settlement," b Randall Smith and Tom
Lauricella, The Wall Street Journal, September 4, 2003 --- http://online.wsj.com/article/0,,SB106263200637481300,00.html?mod=todays%255Fus%255Fpageone%255Fhs
New York
Attorney General Eliot Spitzer, opening a new front in allegations
of financial-market abuses, charged that a hedge-fund manager
arranged with several prominent mutual-fund companies to improperly
trade their fund shares -- some after the market's close -- reaping
tens of millions of dollars in profits at the expense of individual
investors.
Edward J.
Stern, managing principal of Canary Investment Management LLC,
agreed without admitting or denying wrongdoing that his company will
pay a $10 million fine and $30 million in restitution. That settled
civil charges that Mr. Stern violated New York state's business law
against using fraud, false statements, deception and concealment in
trading securities. But Mr. Spitzer said future charges were
"almost certain" to be brought against mutual-fund
companies themselves and possibly others. Fund companies cited, but
not named as defendants, in Mr. Spitzer's complaint include Bank of
America Corp., Bank One Corp., Janus Capital Corp., and Strong
Capital Management Inc.
"Bank of America Janus to Make Reparation," by
Jonathan Stempel, Reuters, September 9, 2003)
Bank of America Corp., which regulators
said helped a hedge fund illegally trade mutual funds, on Monday
pledged to reimburse shareholders hurt by improper trading at its
Nations Funds unit. The Charlotte, North Carolina-based bank said
Nations Funds' independent trustees will hire an outside firm to
determine if fund shareholders lost money. Bank of America, the No.
3 U.S. bank, is one of four companies that New York Attorney General
Eliot Spitzer says helped hedge fund Canary Capital Partners LLC
make illegal, short-term "market timing" bets in return
for lucrative fees.
Question
How many Vice (appropriately named VICE) Presidents were in Enron at
the time of its collapse? Take a guess!
Surprise! Surprise!
Merrill Lynch was in the middle of the tricky dealings.
"Tiny Transaction Is Big Focus Of Prosecutors in Enron
Case," by John R. Emshwiller and Ann Davis, The Wall Street
Journal, November 10, 2003 --- http://online.wsj.com/article/0,,SB106841538138102000,00.html?mod=home%5Fpage%5Fone%5Fus
A tiny deal that initially was buried in
the rubble of Enron Corp.'s collapse has turned into an important
building block in the government's effort to prosecute executives at
the failed energy giant.
The deal hinged on the sale of an interest
in three barges, which were to produce electricity for the
government of Nigeria, and generated only $12 million in profit for
Enron. But it has led to indictments of eight people, more than any
other Enron deal, and offers a telling glimpse into how the
government investigation is evolving.
Investigators learned about the barge
transaction almost immediately after they started looking at Enron's
problems in late 2001. To investigators, the deal looked suspicious,
in part because it was executed so quickly. But it was just one of
"a host of transactions that could start unraveling," if
probed hard enough, says a person familiar with the early
investigation. The deal contributed about 1% to Enron's reported
1999 net income of $893 million. There were plenty of other
similarly curious transactions for investigators to examine, some of
which involved hundreds of millions of dollars and potentially
offered more direct links to top Enron executives.
But as Justice Department lawyers slogged
through the maze of Enron transactions, the barge deal started
looking increasingly attractive. For one thing, some of the bigger
deals were extremely complex, making them hard to explain to a jury.
Also the accounting treatment for many of them had been blessed by
Enron's outside auditor, Arthur Andersen LLP. Such approval makes it
much harder to prosecute an executive for knowingly committing
criminal acts, since the executive can argue that he or she relied
in good faith on outside experts.
In the case of the barge deal, some of the
evidence suggested that a crucial aspect of the transaction had been
hidden from the outside auditors. It was comparatively simple and
explicitly documented in internal e-mails and documents. Though
small, the deal's resulting earnings had helped Enron meet its
profit target for 1999 and the company had rushed to get the deal
done by Dec. 31. The involvement of Merrill Lynch & Co., as the
buyer of the interest in the barges, was another draw for
prosecutors, particularly because the nation's biggest brokerage
firm had done the deal mostly as a favor for a valued corporate
client, according to congressional testimony by a Merrill official.
The focus on the Nigerian barges comes as a
special task force of about half a dozen U.S. Justice Department
attorneys and a platoon of FBI agents pick their way through the
Enron fiasco. When the energy giant collapsed in late 2001, it left
behind a labyrinth of alleged financial fraud and self-dealing
involving private partnerships run and partly owned by Enron
insiders.
As prosecutors sift through Enron's various
deals, they have so far charged about two dozen individuals with
crimes ranging from fraud and conspiracy to money laundering and
insider trading. While most of those charged have pleaded not guilty
and await trial, a handful have reached plea agreements with the
government and are cooperating. Only one former Enron executive,
Treasurer Ben Glisan Jr., is in prison. Former Chief Financial
Officer Andrew Fastow has been indicted for fraud and other charges,
including two counts related to the barge sale. He pleaded not
guilty and is scheduled to go to trial in April.
A big unanswered question is whether
prosecutors will bring charges against Enron's two former chief
executive officers, Kenneth Lay and Jeffrey Skilling. The two men
have denied any wrongdoing, and neither appears to be implicated in
the barge case. Mr. Lay last week agreed to turn over documents to
the Securities and Exchange Commission, after refusing to do so for
more than a year.
In the past year, prosecutors have charged
four Enron executives and four Merrill Lynch executives on
conspiracy to commit wire fraud and falsifying books and records in
connection with the Nigerian barge deal. Among them were Mr. Fastow
and Daniel Bayly, Merrill's former
head of global investment banking.
But it was the indictment of two
lower-level executives that sent tremors through the ranks of the
two companies. One of them was Daniel Boyle, formerly one of Enron's
650 vice presidents. By all accounts, Mr. Boyle didn't help put
together the Nigerian deal. But he was one of several people who
listened in on a brief conference call that the government considers
key to proving that the barge transaction was fraudulent. The other
executive was James Brown, a Merrill finance specialist who had
actually warned Merrill executives against doing the barge deal,
arguing that it might help Enron manipulate its earnings. He was
overruled and told to help with the transaction, according to a
report by Neal Batson, the court-appointed examiner in Enron's
bankruptcy case.
To employees at Enron and Merrill, the
indictments were a disturbing sign that prosecutors were willing to
dive into an obscure deal and come up with lesser figures to indict.
Mr. Boyle's indictment "was a scary day for lots of us,"
says one former Enron middle manager. The 47-year-old Mr. Boyle was
known inside Enron as someone who worried about the company's
aggressive, deal-making culture, according to former colleagues.
Some executives worried that they had
incriminated themselves by helping investigators. Mr. Brown
initially was viewed by investigators and others as something of a
whistleblower because he had opposed the barge deal in its early
stages. But his cooperation backfired. Besides being indicted for
his role in the transaction, he was charged with perjury; Merrill
attorneys found an e-mail he had sent that helped convince
prosecutors that he had lied to authorities.
Continued in the article.
Question
What is initial public offering (IPO) spinning and why is it illegal?
Answer
"IPO 'Spinning' Is Under Fire; Securities Firms Are Charged:
Regulators Say Exchanges Of Business May Be Bribes," by Randall
Smith, The Wall Street Journal, April 29, 2003 --- http://online.wsj.com/article/0,,SB105157294734000800,00.html?mod=article-outset-box
WASHINGTON
-- Regulators took special aim at IPO "spinning" Monday,
warning that corporate executives who received hot initial public
offerings of stock in exchange for investment-banking business may
have accepted "virtual commercial bribery" from Wall
Street and could be forced to disgorge IPO profits.
Securities
regulators Monday, as part of a broader $1.4 billion global-research
pact, brought formal spinning charges against two of the securities
firms in the settlement, the Credit Suisse First Boston unit of Credit
Suisse Group and the former Salomon Smith Barney unit of Citigroup
Inc.
Spinning
occurs when securities firms allocate initial public stock offerings
to the personal brokerage accounts of corporate or venture-capital
executives -- so the shares can then be sold, or "spun,"
for quick profits -- in a potential bid to get future business from
the executives' companies.
CSFB
declined to comment. But Charles Prince, chairman and chief
executive of Citigroup's global corporate and investment bank, said
in an unusual public apology accompanying the settlement: "We
deeply regret that our past research, IPO and distribution practices
raised concerns about the integrity of our company and we want to
take this opportunity to publicly apologize to our clients,
shareholders and employees."
New
York Attorney General Eliot Spitzer, who has filed suit against five
telecommunications executives who received hot IPOs, warned
executives who received IPO profits that should have gone to their
companies may be forced to return those profits to the companies.
Under
a legal doctrine known as "corporate opportunity,"
executives are barred from taking personal advantage of financial
opportunities that come to them by virtue of their position at the
company. Rather, executives are supposed to offer the opportunity to
their companies.
And
Robert Glauber, chairman and CEO of the National Association of
Securities Dealers, said the cases sent Wall Street "an
unmistakeable signal ... that hot IPOs cannot be doled out to
corporate insiders as virtual commercial bribes." The spinning
charges Monday were brought by the Securities and Exchange
Commission and the NASD.
Monday's
charges included new details about how Salomon Smith Barney, now
named Citigroup Global Markets, directed the IPO shares to corporate
executives through a special team of two brokers that functioned as
a separate branch.
Between
June 1996 and August 2000, Bernard Ebbers, the former WorldCom Inc.
CEO, received a total of $11.5 million in profits on 21 IPOs from
Salomon; in the same period, WorldCom, now named MCI, paid Salomon
$76 million in investment-banking fees, according to the settlement
papers filed Monday. Both firms neither admitted or denied
wrongdoing.
The
executives named in Mr. Spitzer's suit were Mr. Ebbers, Philip
Anschutz, the former chairman and founder of Qwest
Communications International Inc.; Joseph Nacchio, former Qwest
CEO; Stephen Garofalo, founder of Metromedia Fiber Network Inc.; and
Clark E. McLeod, founder of McLeod Telecommunications. The
executives have denied wrongdoing.
Continued in the article.
In what marks the first time a corporate executive has been
penalized for participating in the practice known as IPO spinning,
former Quest Communications International Inc. Chairman Phillip F.
Anschutz has agreed to pay millions in the settlement. http://www.accountingweb.com/item/97566