In 2017 my Website was migrated to the clouds and reduced in size.
Hence some links below are broken.
One thing to try if a “www” link is broken is to substitute “faculty” for “www”
For example a broken link
http://faculty.trinity.edu/rjensen/Pictures.htm
can be changed to corrected link
http://faculty.trinity.edu/rjensen/Pictures.htm
However in some cases files had to be removed to reduce the size of my Website
Contact me at 
rjensen@trinity.edu if you really need to file that is missing

 

Rotten to the Core --- Part 1
Scroll Down

Rotten to the Core Part 2
http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm

 

Bob Jensen at Trinity University 

 

The Professions of Investment Banking and Security Analysis are Rotten to the Core
Aided by CPA Auditors, Lawyers, Members of Congress and Other Leaders in Government  


Timeline of Financial Scandals, Auditing Failures, and the Evolution of International Accounting Standards ----
http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#DerivativesFrauds
For a faster scroll down this same page --- Click Here


Introductory Quotations (including Eliot Spitzer's Case Book)

The Saga of Auditor Professionalism and Independence --- http://faculty.trinity.edu/rjensen/fraud001.htm#Professionalism

Can You Train Business School Students To Be Ethical? The way we’re doing it now doesn’t work. We need a new way

Securities Fraud History and Highlights

The Most Criminal Class Writes the Laws 

Accountant and Auditor Scandals  

Private Equity Crooks

The Vultures Feeding on Insolvency 

Insolvent Vultures Feeding on Creditors and Taxpayers

Mutual Fund, Index Fund, and Insurance Company Scandals  

Investment Banking, Banking, Brokerage, Banking, and Security Analysis Scandals
(Investors are still losing the war in spite of all the promises made.)

Peter, Paul, and Barney: An Essay on 2008 U.S. Government Bailouts of Private Companies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm

The Pension Fund Consulting Racket

Playing Favorites:  Why the Fed Lets Banks Off Easy on Corporate Fraud  

From Enron to Earnings Reports, How Reliable is the Media's Coverage?

Insurance Company Scandals  

Medicare and Medicaid Fraud  

The Crookest of them All:  Lawyers

Credit Rating Agencies

Bob Jensen's threads on how credit card companies are cheating you are at http://faculty.trinity.edu/rjensen/FraudReporting.htm#FICO

Accelerated share repurchase (ASR) Manipulation of Earnings-Per-Share (EPS)

Avoid Investing in Nations Ridden With Crime 

Real Estate Fraud   

Many Companies Avoided Taxes Even as Profits Soared in Boom 

Billionaires & Accounting Scandals

 

Ponzi Schemes Where Bernie Madoff Was King
See http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#Ponzi

Exploiting the Poor
http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#ExploitingThePoor

Fraud at the World Bank
See http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#WorldBank 

Fraud Around the World 
See http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#WorldFraud

A Topic for Class Debate 
See http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#Debate

Women of Wall Street Get Their Day in Court 
See http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#Women  

Derivative Financial Instruments and "Fairness Opinion" Frauds
See http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#DerivativesFrauds

LTCM:  The Trillion Dollar Bet
See http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#LTCM

Government Subsidies and Pork Barrels 
U.S. Government Accountability (Governmental Accounting)
See http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#LTCM

The End of Wall Street? 
See http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#EndOFWallStreet

Video: Fora.Tv on Institutional Corruption & The Economy Of Influence ---
See ttp://www.simoleonsense.com/video-foratv-on-institutional-corruption-the-economy-of-influence/

Global Corruption (in legal systems) Report 2007 ---
http://www.transparency.org/content/download/19093/263155
 

Accounting Education Shares Some of the Blame --- http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm#AccountingEducation 

Charity Frauds --- http://faculty.trinity.edu/rjensen/FraudReporting.htm 

Bob Jensen documents on derivative financial instruments are linked at 
http://faculty.trinity.edu/rjensen/caseans/000index.htm
 

Bob Jensen's glossary on derivative financial instruments is at 
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
 

Monthly Updates on the Above Fraud Categories --- http://faculty.trinity.edu/rjensen/FraudUpdates.htm 

The Worst Fraudsters
"Who's the Worst? Expanded to More Categories," Dennis Elam, Elam Blog, October 30, 2013 ---
http://www.professorelam.typepad.com/

From the IRS
IRS Criminal Investigation Issues Fiscal 2012 Report, IR-2013-50, May 10, 2013 ---
http://www.irs.gov/uac/Newsroom/IRS-Criminal-Investigation-Issues-Fiscal-2012-Report

Notable Fraudsters --- http://en.wikipedia.org/wiki/Fraud#Notable_fraudsters

Fraud Detection and Reporting --- http://faculty.trinity.edu/rjensen/FraudReporting.htm 

Bob Jensen's American History of Fraud ---  http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm

Bob Jensen's Other Fraud Documents --- http://faculty.trinity.edu/rjensen/fraud.htm 

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://www.sec.gov/
Division of Corporation Finance: Current Accounting and Disclosure Issues --- http://www.sec.gov/divisions/corpfin/acctdisc_old.htm

The Heroes of Financial Fraud, The Atlantic, April 2009 --- http://meganmcardle.theatlantic.com/archives/2009/04/the_heroes_of_financial_fraud.php

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 threads on fraud are at http://faculty.trinity.edu/rjensen/Fraud.htm


I'm giving thanks for many things this Thanksgiving Day on November 22, 2012, including our good friends who invited us over to share in their family Thanksgiving dinner. Among the many things for which I'm grateful, I give thanks for accounting fraud. Otherwise there were be a whole lot less for me to study and write about at my Website ---


Some of the many, many lawsuits settled by auditing firms can be found at http://faculty.trinity.edu/rjensen/Fraud001.htm

Recent Financial Reporting and Disclosure Initiatives
  • Initiative to Address Improper Earnings Management
  • Rules Governing Independence of the Accounting Profession
  • New Rules for Audit Committees and Reviews of
    Interim Financial Statements
  • Materiality in the Preparation or Audit of Financial Statements
    (SAB 99)
  • Restructuring Charges, Impairments, and Related Issues (SAB 100)
  • Interpretive Guidance on Revenue Recognition (SAB 101)
  • Proposed Rule for Disclosure about Valuation and Loss Accruals, Long-Lived Assets
  • Proposed Rule for Guarantors and Related Issuers
  • Matters Involving Auditor Independence
  • Recent Enforcement Action -- America Online, Inc.

Other Commission Rules and Proposals Affecting Registration
and Reporting

  • Interpretive Release on the Use of Electronic Media
  • Regulation of Takeovers and Security Holder Communications
  • EDGAR

Current Accounting and Disclosure Issues

  • Segment Disclosure
  • Issues Associated With SFAS 133, Accounting for Derivative Instruments and Hedging Activities
  • Amortization Periods Selected for Goodwill
  • Accounting for Intangibles Relating to Customer Relationships
  • Purchase Adjustments to Acquired Company's Loss Accruals
  • Allowance for Loan Losses
  • Internal Costs Associated with an Acquisition
  • Redeemable Securities and "Deemed Liquidation Events"
  • Changes in Functional Currency
  • Effects of Changes to Financial Statements Filed with the Commission in an IPO
  • Market Risk Disclosures
  • Revenue and Cost Recognition in Co-Marketing Arrangements
  • Write-Offs of Prepayments for Services, Occupancy or Usage
  • Cost or Equity Method of Accounting
  • Accounting for Extended Warranty Plans
  • SFAS 45 Guidance Limited to Franchise Agreements
  • Disclosures about "Targeted Stock"
  • Gain on Sale or Securitization of Financial Assets
  • Combining Companies in a Pooling of Interests
  • Issues in the Extractive Industry

Internationalization of the Securities Markets

  • Foreign Issuers in the U.S. Market
  • International Accounting Standards
  • International Disclosure Standards – Amendments to Form 20-F

Other Information About the Division of Corporation Finance
and Other Commission Offices and Divisions

  • The SEC Website and Other Information Outlines
     
  • Corporation Finance Staffing and Phone Numbers
     
  • Division Employment Opportunities for Accountants

Business schools, eager to impart ethics, are paying white-collar felons to recite the error of their ways

"Using Ex-Cons to Scare MBAs Straight," by Porter, Business Week, April 24, 2008 --- Click Here

Bob Jensen's threads on white collar crime include the following links:

http://faculty.trinity.edu/rjensen/Fraud.htm

http://faculty.trinity.edu/rjensen/Fraud001.htm

http://faculty.trinity.edu/rjensen/FraudUpdates.htm


Question
Where were (are) the lawyers in the recent corporate governance and investment scandals?
Report of the Task Force on the Lawyer's Role in Corporate Governance, New York City Bar, November 2006 --- http://online.wsj.com/public/resources/documents/WSJ-CORP-GOV-FINAL_REPORT.pdf
Bob Jensen's threads on corporate governance are at http://faculty.trinity.edu/rjensen/fraud001.htm#Governance

January 29, 2008 message from Sikka, Prem N [prems@essex.ac.uk]

Dear Bob.

Here is an item for your website.

I have been writing regular blogs for The Guardian, a UK national newspaper. The articles are available at http://commentisfree.guardian.co.uk/prem_sikka/index.html and offer a critical commentary on business and accountancy matters. For three days after each article the website takes readers' comments and colleagues are welcome to add comments, critical or otherwise. The most recent article appeared on 29 January 2008.

There is now also an extensive database of corporate and accountancy misdemeanours on the AABA website ( http://www.aabaglobal.org <https://exchange5.essex.ac.uk/exchweb/bin/redir.asp?URL=http://www.aabaglobal.org/> ) and may interest scholars, students, journalists and citizens concerned about the abuse of power.

Regards

Prem Sikka
Professor of Accounting
University of Essex
Colchester, Essex CO4 3SQ
UK
Office Tel: +44(0)1206 873773
Office Fax: +44 (01206) 873429

Jensen Comment
I added Professor Sikka's message to the following sites:

http://faculty.trinity.edu/rjensen/FraudUpdates.htm

http://faculty.trinity.edu/rjensen/Fraud.htm

http://faculty.trinity.edu/rjensen/Fraud001.htm

http://faculty.trinity.edu/rjensen/FraudCongress.htm

 

Introductory Quotations

  • 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:

    1. Too many employees all along the way wanted to make a quick buck even if it screwed their employers and customers.
    2. 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

    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=3315and 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.

    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 billionWorse, 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 passedThe 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/

    YouTube - Jon Stewart vs Jim Cramer Interview Fight on Daily Show ---
    http://www.youtube.com/watch?v=LceizefhP4k

    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 i
    f 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 f
    iduciaries.

    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#B
    ailout
     

    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 billionWorse, 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 passedThe 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.)

     

    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

    EXECUTIVE SUMMARY – GLOBAL CORRUPTION BAROMETER 2007...................2

    PAYING 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

    CORRUPTION 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

    EXPERIENCE V. PERCEPTIONS OF CORRUPTION DO THEY ALIGN?...................10

    Figure 8. Corruption Perceptions Index v. citizens’ experience with bribery 11

    LEVELS 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

    PUBLIC SCEPTICISM OF GOVERNMENT EFFORTS TO FIGHT CORRUPTION IN

    MOST PLACES .......................................................................................................13

    Table 3. How effectively is government fighting corruption? The country view 13

    CONCLUSIONS ......................................................................................................13

    APPENDIX 1: THE GLOBAL CORRUPTION BAROMETER 2007 QUESTIONNAIRE15

    APPENDIX 2: THE GLOBAL CORRUPTION BAROMETER – ABOUT THE SURVEY17

    APPENDIX 3: REGIONAL GROUPINGS..................................................................20

    GLOBAL CORRUPTION BAROMETER 2007..........................................................20

    APPENDIX 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:

     

    1. 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 

       

    2. 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 

       

    3. 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.


       

    4. 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.

       

    5. 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 a
    t 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

    The 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
     
    MUTUAL FUND SITES

    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
    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.
    Alliance 1.69%
    Federated 1.53%
    AIM 1.50%
    Fidelity 0.82%
    American 0.79%
    Vanguard 0.28%

    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 PLCCitigroup 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, malinvestmentmust 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.


    PBS Frontline:  Why don't some of biggest fraudsters in history go to prison?
    "The Untouchables," Frontline, January 22, 2013 ---
    http://www.pbs.org/wgbh/pages/frontline/untouchables/?elq=923e1cf54bd4465092ea4b303aac1291&elqCampaignId=511

    "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

    Sarbanes–Oxley Act (Sarbox, SOX) ---
    http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act

     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#B
    ailout
     

    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.

    Stanford Closer Look Series


     
     
    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-Dealingfor 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 JournalThe 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 titledThe Indymac Slap in Our Facethat 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 WSJ Video

    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

    1. Pay cash under the table to credit rating agencies
    2. Promise a particular credit rating agency future multi-million contracts for rating future issues of bonds
    3. 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 WSJ Video

    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

    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)

     


    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 Accused in Ponzi Lawsuit," by Leslie Wayne, The New York Times, March 27, 2009 ---
    http://www.nytimes.com/2009/03/28/business/28ponzi.html

    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/

    YouTube - Jon Stewart vs Jim Cramer Interview Fight on Daily Show ---
    http://www.youtube.com/watch?v=LceizefhP4k

    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

    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 ---

    Saturday, January 26, 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.

    "Government Losses on 9.5-Percent Loan Loophole May Exceed $1-Billion," by Paul Baskin, Chronicle of Higher Education, September 18, 2008 ---
    http://chronicle.com/daily/2008/09/4654n.htm?utm_source=at&utm_medium=en

    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:

    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 authors 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 ---

    Saturday, January 26, 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

    The 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.
    · Firing Offense · 'A Carrot From Andy'
    · The Anti-Roadshow?  

    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 

     

    Stock Analysts:  They Still Don't Get It

    "Wall Street Analysts Still Give Banking Clients High Ratings," by Randall Smith, The Wall Street Journal, April 7, 2003, Page C1 --- http://snurl.com/StockAnalystsApril7

    Some investors, heartened by regulatory scrutiny of stock-research conflicts, expect big changes in the way securities firms rate stocks of their corporate clients.

    They shouldn't.

    Despite a raft of new rules enacted to curtail the influence of investment banking on Wall Street research, the nation's top securities firms still consistently give higher ratings to stocks of their own banking clients, according to a review of the firms' research disclosures. The statistics, which recently began appearing at the back of all Wall Street research reports under regulatory reform measures enacted last summer, quantify for the first time a pattern that lies near the heart of the uproar over alleged stock-research bias, and one that has persisted on Wall Street for decades.

    The upshot: Individual investors still must take Wall Street research with a chunk of salt, some specialists say.

    "There's still a hesitancy to put a sell on a banking client," says Chuck Hill, director of research at Thomson First Call, which tracks analysts' stock ratings and earnings estimates. "There's still a good possibility that some firms are still biasing things in favor of their clients -- not to the extent they had been, but there's still some of that in there."

    Historically, Wall Street firms have tended to pick up coverage of companies for which they underwrite securities sales, including initial public offerings, and analysts have played a key role in evaluating the companies before agreeing to manage those sales. So securities firms argue that they wouldn't underwrite, say, an IPO if they didn't believe their analysts would issue a positive stock recommendation.

    Conversely, if analysts wouldn't be comfortable recommending the stock at that level, a Wall Street executive says, "we won't do the deal." In addition, he says, it's only natural for top securities firms to "want to do investment-banking business with the better-quality companies," which would also lead the firm to rate clients higher than average.

    That said, take a look at the numbers. At Goldman Sachs Group Inc., 79% of all stocks with the highest "outperform" rating were investment-banking clients, based on the firm's most recent tally. But 61% of the stocks with the lowest "underperform" rating were clients. At Morgan Stanley, 40% of all stocks rated "overweight" were investment-banking clients, while 27% of stocks rated "underweight" were clients.

    At Merrill Lynch & Co., 35% of the stocks rated "buy" were clients, but clients accounted for 21% of those rated "sell." At Citigroup Inc.'s recently rechristened Smith Barney brokerage network, 47% of all stocks rated "outperform/buy" were clients, while 37% of the stocks rated "underperform/sell" were clients. And at Credit Suisse Group's Credit Suisse First Boston, 49% of stocks rated "outperform" were clients, but 33% of those rated "underperform" were clients.

    "We would try to underwrite better-quality companies, with strong fundamentals," says William Genco, chairman of Merrill's research-recommendation committee. As a former analyst who covered environmental-services companies for more than 30 years, Mr. Genco says he wouldn't allow the firm to underwrite securities sales for companies he didn't consider "suitable," and has vetoed as many as a dozen deals on that basis.

    As a result, Mr. Genco says, "If you're underwriting companies that have positive fundamentals, you're more likely to have a positive recommendation on their stock."

    At Goldman, Kim Ritrievi, co-director of investment research for the Americas, says "the determination of ratings has nothing to do with whether someone is a client or not." Ms. Ritrievi wouldn't address why the highest rating category contained more clients on a percentage basis, saying she didn't want to speculate on the reasons.

    Continued in the article.





    A potential investor came to seek investment advice from a financial analyst (F.A.). The F.A. told the investor, " I have the experience, you have the money."

    Several weeks later, after the investor has lost all the money from following the advice of the F.A., the investor came to see the F.A. and the F.A. said to the investor:

    "You have the experience, I have the money!"


    Update on March 20, 2003

    SEC Charges Merrill Lynch, Four Merrill Lynch Executives with Aiding and Abetting Enron Accounting Fraud

    Merrill Lynch Simultaneously Settles Charges for Permanent Anti-Fraud Injunction and Payment of $80 Million in Disgorgement, Penalties and Interest

    For details see http://faculty.trinity.edu/rjensen/fraud033103.htm

     

    The Biggest Crime of All:  They Still Don't Get It

    "A Buffett Warning on Executive Pay," by Bloomberg News, The New York Times, March 17, 2003 

    Warren E. Buffett, the billionaire investor, says that companies will not regain investors' trust as long as compensation for chief executives, including stock options, keeps rising while the share prices of their companies fall. "What really gets the public is when C.E.O.'s get very rich and stay very rich and they get very poor," Mr. Buffett told chief executives at a conference on corporate governance on Friday night in Charlotte, N.C. Mr. Buffett's views on responsibilities of executives and directors have gained new prominence after accounting scandals at WorldCom and Enron, the two biggest bankruptcies, shook investors' confidence and costs stockholders billions of dollars. Regulators and executives, including Bank of America's former chief executive, Hugh L. McColl Jr., who helped arrange the meeting, have sought advice from Mr. Buffett on topics like executive pay and corporate governance. Mr. Buffett, 72, the largest shareholder in Coca-Cola and American Express, was paid $356,400 in 2001 as chief executive of Berkshire Hathaway, his investment company based in Omaha. "It is vital that we earn back the trust of the American public," Mr. Buffett said. "We will get it back when we deserve it. When I start reading the proxy statements a year from now, I'll know whether American businessmen and businesswomen are serious about wanting to really give back to the system what the system has given to them."

    "Wall Streets CEOs Still Get Fat Paychecks Despite Woes," by Susanne Craig, The Wall Street Journal, March 3, 2003

    Chiefs' Packages Decline Overall Still, $10 Million or More Isn't Bad

    Stock markets are down. Corporate public offerings are out. Investors are on the sidelines. And financial firms continue to cut staff.

     But there is still a bull market in one pocket of Wall Street -- the pay of securities-firm CEOs.

    Amid one of the worst operating environments in years, Wall Street chief executives continue to pull down annual paychecks topping $10 million. Even though their pay is down overall, it is still turning heads in many quarters. Morgan Stanley's CEO Philip Purcell received a 2002 pay package of $11 million. Goldman Sachs Group Inc.'s Henry Paulson made $12.1 million and Lehman Brothers Holdings Inc.'s Richard Fuld took home a pay package valued at $12.5 million.

     

    Citigroup Inc.'s Chief Executive Sanford I. Weill, whose banking firm has been dogged by regulatory probes this year, volunteered not to receive a cash or stock bonus for 2002 because the share price of the company, which owns Salomon Smith Barney, dropped 25% during the year.

    But Citigroup's board granted Mr. Weill stock options for 2003 with an current estimated value of $17.9 million, more than the $17 million cash bonus Mr. Weill received in 2001. At Bear Stearns Cos., one of the few securities firms that actually saw its profit rise in 2002, CEO James Cayne saw his total compensation more than double to $19.6 million last year.

     

    The still-hefty paychecks are drawing criticism as being out of whack with these tough economic times. On Wall Street, fees from the most profitable businesses -- such merger-and-acquisition advice and underwriting initial public offerings of stock -- have all but dried up.

    "The problem is there is no strong indication the bear market is over and we are a long way from justifying these type of packages," says Mike Corasaniti, director of research at boutique investment firm Keefe, Bruyette & Woods Inc. and an adjunct professor in the business department of  Columbia University in New York .

     

    "In good times boards justify the big pay packages by saying the executives are doing a great job and in bad times they justify the pay by saying they are managing in a difficult environment. No matter what, they seem to find a way to rationalize it."

    Officials at the various firms declined to comment

    Of course, a Wall Street CEO's pay is tied to performance. And the job hasn't been easy. But the tough decision to cut staff may have in fact boosted the pay packages of many top executives, as the cost-cutting measures kicked in. With the exception of a few firms, notably Credit Suisse Group's Credit Suisse First Boston, most Wall Street firms have actually been making money during the bear market. CSFB reported a loss for 2002 of $811 million, due to $813 million in charges to cover items ranging from 1,500 previously announced job cuts to a provision for civil-litigation costs.

    Bob Jensen's related comments are at http://faculty.trinity.edu/rjensen//FraudConclusion.htm 

    Also see http://faculty.trinity.edu/rjensen/fraudVirginia.htm 

     

     


    Update in February 2003
    Stock analysts will now have to certify the truthfulness of their research reports, under a recent unanimous ruling by federal regulators.
    http://www.accountingweb.com/item/97116 

    At last some progress is being made where the apple is the most Congress.  Citigroup will propose a settlement to federal regulators that includes plans to sever ties between its research and investment-banking businesses and pay a fine of hundreds of millions of dollars. The plans were detailed in a meeting with Spitzer.

    "Citigroup Is Ready to Settle Probes Into Stock Research:  Proposal Would Split Banking, Research, May Include a Multi-Million Dollar Fine." by Charles Gasparino, Susan Pulliam, and Randall Smith, The Wall Street Journal, September 27, 2002 --- http://online.wsj.com/article/0,,SB1033094081491689833,00.html 

    Citigroup Inc., seeking to end several investigations into its stock-research practices, will meet with federal regulators Friday to propose a settlement that includes plans to completely sever ties between its research and investment-banking businesses, and pay a fine that could reach hundreds of millions of dollars, people familiar with the matter say.

    The plans were detailed in a meeting Thursday with New York State Attorney General Eliot Spitzer, who has been investigating the activities of Citigroup's Salomon Smith Barney securities unit. His investigation has centered on whether Salomon's research analysts published overly rosy stock recommendations to win investment-banking business, and whether the firm allocated initial public offerings of stock to corporate executives in a bid to win their firms' financing business. A Citigroup spokeswoman declined to comment Thursday.

    In the meeting with Mr. Spitzer, lawyers from Citigroup floated a plan that envisions the formation of a separate research unit within the financial-services giant -- in hopes of creating a model for the industry. The attorneys also conceded that Citigroup considers the current industry model for research to be "broken," and ripe for change, according to a person with knowledge of the matter.

    The degree to which the firm would separate the analysts at its Salomon Smith Barney securities unit from the firm's investment and commercial bankers isn't clear. Citigroup lawyers said they would provide more details to the Securities and Exchange Commission, the Nasdaq Stock Market and the New York Stock Exchange during the meeting today. The thrust of Citigroup's efforts would be to resolve all of its regulatory liabilities at once.

    Also see 
     
     SEC May Punish Executives
    Who Snared Shares of IPOs

    SEC Chief Pitt to Seek a Split
    Of Street's Banking, Analysts

     


     

    "Conseco's Colorful Crash It may not have the buzz of Enron, but this fiasco still scores on the shame scale," by Andy Serwer, Fortune, September 16, 2002 ---  http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209384 

    Picture the scene: Conseco CEO Steve Hilbert and his CFO, sitting down to lunch at the Four Seasons in New York with Salomon Smith Barney analysts Colin Devine and Bill Ryan. Devine and Ryan know this isn't going to be a picnic. They just blasted the major insurance and consumer-lending company in a high-profile research report. But they never expected what happened next. "How the fuck could you do this to me?" Hilbert bellowed, as startled diners turned to stare. "Don't you know I spent $20 fucking million in fees at your firm last year?!" Wow!

    That tete-a-tete took place in the spring of 1999, Devine says, when CEOs could yell things like that and analysts in said situations would usually fold. Hilbert doesn't acknowledge swearing; he concedes only that he was angry. But Devine didn't fold (Ryan left Salomon), and of course he was right. Conseco was Congress to the core. Now it's on the edge of bankruptcy.

    Conseco is overshadowed by mega-disasters like Enron and WorldCom, but it's still a doozy. (If Conseco sounds familiar to faithful Street Life readers, it's because I wrote about it in June of last year-- Two Titans Play Conseco in the Middle. More on that in a minute.) Consider that Conseco's recent earnings restatement of $368 million for the year 1999 was the ninth largest in U.S. history, according to a New York University study. That Conseco is now the subject of a formal SEC investigation. That the company is not making interest payments on its $6.5 billion in debt.

    As if that weren't enough, there's an incredible cast of characters here, including Steve Hilbert, who built Conseco brick by brick. Legend has it that Hilbert met his sixth wife, Tomisue, when she popped topless out of a cake at his stepson's bachelor party. Hilbert has previously denied this but acknowledges that Tomisue did work as an exotic dancer.

    The beginning of the end for Conseco came when Hilbert bought Green Tree Financial--a mobile-home lender--for $6.7 billion in 1998. By spring 2000 the company had begun to flag. Exit Hilbert and enter Gary Wendt, the big, swinging GE exec who pledged to put the company in order. The stock jumped on the news. And then began a remarkably public battle between veteran raiders Carl Icahn, who was shorting the stock, and Irwin Jacobs, who was long (the subject of my article last year). All the while Devine, who was savaged by Jacobs and Wendt for not buying the turnaround story, stuck by his guns. "There were three things happening," says Devine. "Subpar earnings for the insurance business. Deteriorating credit quality at the old Green Tree business. And too much debt." Devine says that the company wasn't merely a victim of a weak economy during Wendt's tenure. The ex-head of GE Capital actually made matters worse. "The worst loans ever made by Conseco were within the past two years," he says. (The company denies that.) Meanwhile, Devine estimates that Wendt will end up taking more than $75 million out of Conseco for his trouble. The company says it's some $10 million less.

    Continued at http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209384 


    "How Star CSFB Banker Pressed For Shares in IPOs for Friends," by Randall Smith and Susan Pulliam, The Wall Street Journal, September 5, 2002.  An excerpt is quoted below:

     

    For weeks, Salomon Smith Barney has been probed for directing hot new stocks to executives whose firms did business with the Wall Street firm.

    Soon, the big unit of Citigroup Inc. may have company in the spotlight.

    Frank Quattrone, the star technology-industry investment banker at Credit Suisse First Boston, pressed for greater allocations of IPOs for corporate executives whose companies had hired his firm to do investment-banking work, according to e-mail records and people familiar with the firm.

    The e-mail records and other accounts of Mr. Quattrone's efforts are likely to become part of a probe by securities regulators into whether Wall Street firms improperly used the lure of quick profits on initial public offerings of stock to win investment-banking business during the 1990s stock boom.

    Investigators for the National Association of Securities Dealers recently sought to interview John Schmidt, former chief of the brokerage group that worked with Mr. Quattrone, about how CSFB doled out hot IPOs to tech-group clients as part of a probe into so-called spinning, according to people familiar with the request. And just Wednesday, congressional investigators said they were broadening their probe into Wall Street's IPO practices to CSFB and Goldman Sachs Group Inc.

     

    CSFB and Mr. Quattrone didn't have any immediate comment Wednesday; the NASD also declined to comment. Goldman said the firm would cooperate, but was "surprised to have been asked" for IPO data, saying it allocates IPOs properly.

     

    Mr. Quattrone's actions in the tech IPO market long have been widely watched. His technology group helped CSFB lead-manage the largest number of hot IPOs in the dot-com boom, according to Thomson Financial. The brokers who worked with him, led by Mr. Schmidt, ran a group of accounts for more than 160 investment-banking clients, most of whom received between a few hundred and 1,000 shares of every CSFB-linked IPO, according to people familiar with the accounts. Each of the clients participated on a proportional basis in all the IPOs.

     

    The accounts' performance was sizzling, rising by an estimated 600% in 1999 and 100% in 2000, according to one person familiar with their operation. The clients generally were offered the chance to open such accounts -- known as "Friends of Frank" accounts -- only after they had selected CSFB to lead their IPOs or arrange other transactions, the people familiar with them said.

     

    The number of these plum accounts grew to 160 in early 2000 from 26 in January 1999, according to one CSFB e-mail. And the total size of the accounts grew to a peak of $150 million from $50 million in early 1999, according to a person familiar with them. Broker who managed accounts in the group routinely would sell about one-third of its allocation a few days after the IPO, another third about a month later and the rest at some subsequent point, the same person said.

     


    Under pressure, a slew of companies are now changing the way they do business. Will it last? 

    "In Corporate America It's Cleanup Time Under pressure, a slew of companies are now changing the way they do business. Will it last?" by Jerry Useem,  FORTUNE, September 16, 2002 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209348    

    Even at a time when hunting for the "next Enron" has become a national sport, Krispy Kreme Doughnuts would seem a highly unlikely target. The North Carolina-based purveyor of crullers and Hot Original Glazed has long enjoyed a sweet reputation with customers and investors. But early this year some shareholder questions turned sour. In particular, why was Krispy Kreme using a "synthetic lease" to finance a mixing factory--an off-balance-sheet practice that carried a whiff of Enron-style finance? CEO Scott Livengood felt the criticism was undeserved, and that his company was already a model of transparency. "It was guilt by association," he says. "But in this new environment, it was shoot first and ask questions later."

    So Livengood formed a governance committee of independent board members, which recommended a hasty overhaul of governance and accounting practices. Krispy Kreme's synthetic lease is toast. All inside board members, save Livengood, will eventually be replaced with outsiders. Corporate loans to executives have been banned. And the top five executives can now sell their stock only in preplanned, immediately disclosed blocks.

    To avoid even a passing resemblance to Enron's notorious partnerships, furthermore, the company has terminated a mutual fund that let executives invest directly in Krispy Kreme franchises--and it returned only the initial, unappreciated sums the executives had invested. "I really regret the things that have put us in this position," says Livengood. "But there's been a tremendous amount of damage done to the credibility of honest people."

    It's cleanup time in corporate America, and a new set of rules is in force. Some of those rules are, of course, literal, such as those proposed by the New York Stock Exchange or contained in Congress's Sarbanes-Oxley Act. But some are taking hold as a result of fear--fear of disgusted, distrustful investors and their various avengers, including SEC investigators and New York State attorney general Eliot Spitzer (see Eliot Spitzer: The Enforcer

    ). "You've got a totally disaffected individual investor community, and they're angry," says former Securities and Exchange Commission chairman Arthur Levitt. "They're going to differentiate between companies that stand with them and companies that don't."

    This is a huge change of heart that has come remarkably fast. Between 1992 and 1999, the number of companies beating First Call estimates by exactly one penny quadrupled--and investors rewarded those companies for what was seen as great reliability. Now, says Baruch Lev, an accounting professor at New York University, "there will be suspicion of exactly meeting estimates, or beating them by a penny"--the presumption being that those companies could be accused of cooking their books. Corporate executives feel the heat. In a poll taken by Kennedy Information, publisher of Shareholder Value magazine, 46% said the wave of scandals had harmed the way investors viewed their companies, while 43% were changing the way they did business.

    The most visible change has been a stampede to expense stock options; as of press time, 81 companies had announced they would treat stock options as a cost of doing business. But the cleanup has extended to insider selling, financial disclosure, even CEO pay--all issues that fed the image of corporate corruption. "Hopefully, this will convince my mother that companies are serious and that the numbers can be trusted," says Peggy Foran, vice president for corporate governance at Pfizer.

    At Citigroup, under fire for its financing of Enron and WorldCom, CEO Sandy Weill is adopting what Prudential analyst Mike Mayo sarcastically calls "just-in-time corporate governance." Besides doing an about-face on the issue of expensing all stock options, Weill has set up a special governance committee, pledged to avoid any deals involving hidden off-balance-sheet transactions, and reaffirmed a "blood oath" never to sell more than 25% of his Citigroup stock.

    Continued at http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209348 


    "The Enforcer:  Forget the perp walks. What he wants is change--top to bottom," by MNark Gimein,  FORTUNE, September 16, 2002 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209347

    On Wall Street right now, there may be no person as feared as the attorney general of New York State. This is in some ways an utterly banal statement, one that probably won't surprise anybody who has been following press coverage of Eliot Spitzer's campaign against corruption in the financial world, a crusade that has already netted a $100 million fine from Merrill Lynch and is now continuing with an investigation of Citigroup's Salomon Smith Barney. But in another way it is quite extraordinary, really kind of unbelievable, because of one very striking fact: Spitzer has become the most feared man on Wall Street without arresting a single executive and, amazingly, without so much as indicting one investment bank, or a single employee of an investment bank.

    In this fact is encapsulated what might be the essence of Spitzer's character, and the reason this unlikely enforcer might be the pivotal figure in the broad-ranging rethinking of American business. If any single person has goaded U.S. corporations to change most vigorously in the last months (well, any single person besides Jeffrey Skilling), it has been Spitzer. He has done it with a staff of no more than 15 or 20 lawyers working on securities law, a legal staff smaller than that of a third-tier investment bank. And he has done it without yet prosecuting a single big securities case.

    Spitzer has been criticized for this as an arrogant meddler and an opportunist with an eye on New York's 2006 race for governor (he's almost certain to win a second term as attorney general this fall). But he has persevered in his mission of shaming and compelling the investment banks and their executives--right up to Sandy Weill, the head of conglomerate Citigroup--to end the despicable practice of giving their clients investment advice so dishonest and fraught with conflicts of interest that it has become worthless.

    At first glance, Spitzer, 43, hardly seems a prime candidate for the job of articulating the anger over corporate corruption that has gripped ordinary Americans. "Articulate" is an Eliot Spitzer word, as are "rearticulate" and "recalibrate" and "critique." He is a policy enthusiast who drags friends to lectures and seminars on public affairs in his spare time. He is a product of Princeton and Harvard Law School, and even spent a couple of years working on mergers and acquisitions at top-tier law firm Skadden Arps. Thanks to his family's real estate fortune (he owns a string of Manhattan properties), he can afford to live with his wife, Silda Wall, and three daughters in exactly the kind of Fifth Avenue building favored by financial barons. He quips that half his friends are investment bankers and the other half are lawyers who represent investment bankers.

    The last time we went through a spasm of greed and retribution on Wall Street, in the late 1980s, the iconic figure in law enforcement was U.S. Attorney Rudolph Giuliani. It was Giuliani who was responsible for putting Ivan Boesky and Michael Milken in jail. But it was also Giuliani who was responsible for pulling an investment banker off the floor of Kidder Peabody in handcuffs--on charges that were dropped because the U.S. Attorney's office never amassed enough evidence for a trial. Giuliani, by the way, now represents Merrill Lynch in private practice.

    Spitzer, by contrast, is the antithesis of that stock character of law-enforcement legend, the street-brawling prosecutor. "Prosecutors have classically done a very good job of putting people in jail, but it doesn't change anything," says Michael Cherkasky, Spitzer's former boss in the Manhattan D.A.'s office racketeering unit. For Spitzer, putting people in jail is not the point of the prosecutor's job. Look at his biggest case at the Manhattan D.A.'s office, in which he showed both his creativity and his penchant for thinking big. Instead of using a mole to penetrate New York City's closed garment world, he opened a full-fledged garment factory (and in classic Spitzerian fashion, made sure his workers had health insurance). He wound up shutting down gangster Tommy Gambino's extortion business by prosecuting the mob boss, who was already facing the prospect of jail on other charges, on (of all things!) antitrust grounds and exacting a $12 million civil penalty. That paid for five years of intensive oversight and led to wholesale reform of the trucking business in Manhattan.

    Continued at  http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209347


    "Now Here This:  Wall Street's Research Stinks.  Here's How to Fix It.," by Bill Alpert, Barron's, December 2, 2002, pp. 23-26

    . . . Wall Street, and the institutions that issue its analysts their MBAs and CFAs, have trained stock analysts to discount future earnings four different ways.  But they have failed to teach them skills like how to design financial models that can be proved or disproved with real-world research.  Analysts make detailed forecasts for a company's products, for example, in the mistaken belief they're supplying the reasons for their stock-price target.  But given their paltry real-world data on those products, analysts can't possible show why their forecast is more reasonable than any number of contradictory forecasts.  The phony precision in most 2010 sales estimates, for example, betrays how few analysts understand what inferences their data will bear.

    .We suggest improvements in research methods that would be clearly visible in an investment report.  That way, investors need not rely on the assurances of Wall Street--and its regulators--that analysts have gone straight; investors will be able to look directly at the report for evidence of good work.

    . . . 

    The Morgan Stanley analysts wouldn't talk to us, so they did not explain to us how they--or anybody--could make so many simultaneous estimates.  Using algebra or astrology, it is simply impossible to pin down so many answers with so little input.  "People who try to predict so many variables fall into a trap," says Wharton finance professor Simon Benninga.  "They think that more detail is actually going to clarify the picture, when sometimes the best picture is a very sketchy picture."  Benninga didn't review the Morgan Stanley report, but he counsels his students to keep their models simple enough, so as not to miss the forest for the trees.

    . . . 

    Instead of overloading spreadsheets with variables plucked from the air, stock analysts should spend some time collecting original data on the few things that matter.  Brokerage firms leave their analysts little time to go out in the field.  The analysts are too busy marketing stocks and publishing research tomes.

     The above quotations are only excerpts from the article.


    "In Search Of the Last Honest Analyst," by David Rynecki, Fortune, June 10, 2002 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208085 

    During the boom the analyst's job was to cozy up to the company brass, not to question them. Or so the evidence would suggest. Recent disclosures of Merrill Lynch e-mails, in which allegedly independent researchers hyped stocks to the public while privately trashing them, are only the latest exhibits. The pumped-up stocks--no surprise--were those of companies with which Merrill had a lucrative investment-banking relationship. In a settlement with New York State's attorney general, the securities firm has agreed to pay a $100 million civil penalty, reform its analyst-compensation system, and apologize for failing to address the obvious conflicts of interest. But as FORTUNE and others have pointed out, the numbers have long illustrated the failure of Wall Street research. Last June, during the height of the recession--when even the most optimistic CEOs were unable to hide the bad news--investment analysts couldn't find a stock they couldn't tout. Of 26,451 buy, hold, and sell recommendations, only 213 were sells.


    "Merrill Defends Enron Research But Analyst Says Pressure Existed,"
    Charles Gasparino and Randall Smith, Wall Street Journal, July 31, 2002

    During more than two decades as a stock-research analyst, many of them covering big energy companies, John Olson has spoken with many top executives. But none of those conversations stood out like the one he had with Kenneth Lay. In the late 1990s Mr. Lay, the Enron Corp. chief executive, was unhappy that Mr. Olson, then at Merrill Lynch & Co., had placed a "neutral" rating on Enron stock, and wanted him to upgrade his call, the analyst says. Mr. Olson says in an interview that Mr. Lay told him he "just didn't get it."

    But Mr. Olson, now 60 years old, says he wouldn't budge. So Mr. Lay complained to Merrill investment bankers who at the time were denied Enron investment-banking business and the lucrative underwriting fees they produced. "We are for our friends," Mr. Olson says Mr. Lay told him. It was only after Mr. Olson left Merrill under pressure in August 1998 that Merrill eventually did win tens of millions of dollars in Enron banking business and upgrade the company's stock to an "accumulate." It is "very, very clear why I left Merrill," says Mr. Olson, now at Sanders Morris Harris, a small Houston securities firm. "There was a clear preference for positive recommendations regarding Enron, and I wasn't going to give them that."

    A Merrill spokesman vigorously denies that Mr. Olson was forced out because of his negative calls. "We had a consolidation in research," says Merrill spokesman Bill Halldin. A spokeswoman for Mr. Lay said he had no comment. What is undeniable is the close relationship between Merrill and Enron, which was the focus of a congressional hearing Tuesday. The hearing -- which focused on previously disclosed transactions Merrill did with Enron, as well as Mr. Olson's dealings with the former energy company -- has turned up the heat at Merrill and comes as federal investigators begin to zero in on the roles of big securities firms and banks in Enron's spectacular collapse last year. "Investors trusted you," Democrat Richard Durbin of Illinois said at Tuesday's hearing. "They believed you were the cop on the beat. Instead, you were the dog in the lap." G. Kelly Martin, president of Merrill's international-brokerage division, responded that the research process is "rigorous" and operates as a separate part of the firm. But he added, "We don't get everything right, as human beings."


    "Analyst's Forecasts and Brokerage-Firm Trading," by Paul J. Irvine, The Accounting Review, January 2004, pp. 125-149.

    ABSTRACT
    Using unique data on brokerage-firm trading, I examine whether analysts' earnings forecasts and stock recommendations affect their brokerage firms' share of trading in the forecast stocks.  I find that individual analyst's forecasts that differ from the consensus forecast generate significant brokerage-firm trading in the forecast stocks in the two weeks after the forecast release date, affirming that analysts' forecasts affect their brokers' commission revenue.  However, I find no evidence that analysts' forecast errors--the difference between forecast earnings and actual earnings--increase brokerage-firm trading.  This result suggests that analysts cannot generate trade for their employers simply by adding error to their forecasts.  I find that buy recommendations generate relatively more trading, both buying and selling, through the analyst's brokerage firm.  Collectively, these results suggest that analysts can generate higher trading commissions through their positive stock recommendations than by biasing their forecasts.



    Conclusion
    I cannot observe directly whether analysts are biasing their forecasts.  As a result, my conclusion that trading incentives are unlikely to affect analysts' forecasts is based partly on the indirect evidence obtained from analyzing ex post forecast errors.  Neither can I observe trading by investors who receive an analyst's earnings forecast or stock recommendation and choose to trade with a different brokerage-firm.  Thus, my results should not be interpreted as representing the total effect of analysts' forecasts and recommendations on their investors' trading.  Despite these limitations, my study establishes that investors trade on the information in analysts' forecasts, and that analysts' favorable stock recommendations increase their employers' market share of trading in the recommended stock.  Thus, my results suggest that, as long as the amount of trading done by their employers is a factor in analysts' compensation, then the potential for biased recommendations remains, even if regulators remove analysts' incentives to promote their firms' stock offerings by effectively separating research departments from underwriting departments.


    Question:  What is "laddering?"

    Answer:
    See "Breaking the Banks," by Shawn Tully, Fortune, June 10, 2002, Page 26  --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=207949 

    But the Spitzer investigation will do far more than, say, separate analysts' pay from investment banking deals; it could also vastly increase the financial damages Wall Street faces. That has investors worried: Since Spitzer released the damning e-mails on April 8, Merrill Lynch stock has tumbled 23%. The six leading U.S. banks have since shed $48 billion, one-tenth of their market capitalization.

    The threats against Wall Street lurk in two corners. First, the settlements with New York and other states over corrupt research will be costly, especially for Merrill. Spitzer is demanding around $100 million in fines. But dozens of other states and their chagrined Merrill clients will likely win lesser amounts. David Trone of Prudential Securities reckons that Merrill will have to pay between $500 million and $1 billion. Spitzer is now examining Salomon Smith Barney, Goldman Sachs, and other firms. If e-mails show that their analysts purposely misled investors, they may face Merrill-sized payments too.

    Perhaps more damaging, however, is that Spitzer's investigation could add momentum to civil suits over Wall Street's handling of IPOs. A Who's Who of class-action attorneys, from Fred Isquith to Mel Weiss, have filed 310 lawsuits against 45 underwriters and the flimsy startups they brought public, demanding $50 billion to $60 billion in damages. Investors are mostly ignoring these suits, given the precedent (Credit Suisse First Boston settled a similar case last year with the SEC for a modest $100 million). "The market underestimated the financial threat to the other firms when the SEC and the Justice Department failed to file more serious charges against CSFB for market manipulation," says John Coffee, a securities-law professor at Columbia University. An aggressive SEC investigation could immensely strengthen the civil lawsuits.

    And the SEC, clearly embarrassed by Spitzer's crusade, is anxious to show renewed zeal in punishing wrongdoing on Wall Street. The agency is now pursuing a charge far more serious than inflated commissions, a practice known as "laddering." Under laddering, an underwriter agrees to give fund managers IPO shares only if they agree to buy even more shares at higher prices after the stock goes public. Laddering inflates the prices that small investors then pay and is "blatantly illegal market manipulation," says Coffee.

    FORTUNE has learned that the SEC may have found a smoking gun. On April 29, the SEC's New York office summoned Nicholas Maier, the former syndicate manager for hedge fund Cramer & Co. and author of the recent Trading With the Enemy, to testify. Maier confirmed that firms he dealt with regularly engaged in the practice. The SEC lawyers then showed Maier a document, known in the trade as an IPO "book," from a leading Wall Street firm for a 2000 offering. The lawyers made it clear that they believe the sheet demonstrates laddering by showing the amounts and share prices at which the funds promised to buy a stock before it opened for trading. Typically, the banks dumped the shares shortly thereafter.

    If the SEC can prove laddering, it could collect several hundred million from each of the guilty firms, according to legal experts. Then the chance that investors will win their civil suits improves dramatically, as plaintiffs could use the same evidence the SEC did. Those settlements might reach well over $1 billion, says litigation consultant James Newman. That's 10% of what U.S. banks earned last year. Should that happen, Poseidon's initial blast may look like a small tremor.


    Concerning the Self-Regulation Record of the National Association of Securities Dealers:  Build a Shield Around the Bad Guys
    "We tell all our clients now, as a matter of policy, 'Do not complain to NASD enforcement,' " says Pat Sadler, a lawyer in Georgia who serves on the NASD's national arbitration and mediation committee. He adds, "Our cooperation with the NASD cannot help our customer. It can only hurt them."
    USA Today,
    May 24, 2002, Editorial Page
    Bob Jensen's "Congress to the Core" threads are at http://faculty.trinity.edu/rjensen/fraud.htm#Cleland 


    More on Congress to the Core

    One of the enormous moral hazards faced by security analysts is that many companies will exclude them from information sources if they dare say bad things about those companies.  This continues to be reflected in the sad outcomes in the far right column of the table below.

    I  added the following reference and table to this module.

    "Should Your Trust Wall Street's New Ratings?
    Even in the Bear Market A "Sell" Remains a Rarity But Better Guidance id Coming"
    by Jeff D. Opdyke, The Wall Street Journal, July 17, 2002, Page D1

     

    Word Games
    Many Wall Street firms have unveiled simpler ratings for stocks.  Here's a look at how they work?
    Morgan Stanley (March 2002) New Ratings:  Overweight   Neutral   Underweight Percentage of Current "Sell" Ratings:  20.90%
    Merrill Lynch (September) New Ratings:  Buy              Neutral                 Sell Percentage of Current "Sell" Ratings:  05.80%
    Prudential (May 2001) New Ratings:  Buy              Neutral                 Sell Percentage of Current "Sell" Ratings:  03.50%
    Goldman Sachs (Fourth Quarter) New Ratings:  Outperform  In-line     Underperform Percentage of Current "Sell" Ratings:  01.50%
    Lehman Brothers (Aug. 1) New Ratings:  Overweight   =weight   Underweight Percentage of Current "Sell" Ratings:  01.00%
    J.P. Morgan Chase (August) New Ratings:  Overweight   Neutral   Underweight Percentage of Current "Sell" Ratings:  00.90%
    Credit Suisse First Boston (September) New Ratings:  Outperform  In-line     Underperform Percentage of Current "Sell" Ratings:  00.40%

    The next big (law) thing:  Class-action suits against investment banks.
    http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208138


     

    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."

    For updates on derivative financial instruments frauds, go to http://faculty.trinity.edu/rjensen/fraud.htm#DerivativesFraud 


    On April 12,  I reported on the Merrill Lynch indictment by the State of New York --- http://faculty.trinity.edu/rjensen/fraud041202.htm 

    Nice Going Merrill Lynch:  To Hell With the Widows and Orphans
    The pressures put on the Merrill Lynch internet group to appease both investment bankers and clients led the group to ignore the bottom two categories of the five-point rating system (“reduce” and “sell”) and to use only the remaining ratings (“buy”, “accumulate” and “neutral”). The absence of clear guidance from Merrill Lynch management on how to resolve the conflicts created by these pressures led respondent Henry Blodget, the head of the internet group, in a moment of candor, to threaten to “start calling the stocks (stocks, not companies)... like we see them, no matter what the ancillary business consequences are."
    Chief of the Investment Protection Bureau of the New York State Department of Law and am of counsel to Eliot Spitzer, Attorney General of the State of New York before the Supreme Court of the State of New York, April 2002 
    (Dan Gode from NYU sent me this Merrill Lynch Indictment as an email attachment.)
    Bob Jensen's similar "Go to Hells" from Investment Bankers are listed at http://faculty.trinity.edu/rjensen/fraud.htm#Cleland  
    Bob Jensen's April 12, 2002 updates on the Enron/Andersen scandals are at http://faculty.trinity.edu/rjensen/fraud041202.htm 

    On April 25, we learned that the "Congress to the core" investment banking and security analyst scandals are gaining national criminal investigation levels and that the Enron/Andersen scandals are being overshadowed by a much larger and more Congress cancer investment markets.

    "Stock Hyping Under The Microscope," CBS Evening News, April 25, 2002 --- http://www.cbsnews.com/stories/2002/04/25/eveningnews/main507282.shtml

    (CBS) When George Zicarelli, a videotape editor at CBS News, invested his life savings with Salomon Smith Barney in 1999, the firm recommended a hot new fiber optic company called Global Crossing.

    "And then the stock starts dropping," said Zicarelli. As the stock, which Zicarelli first bought at $50 a share, began to swan dive, Salomon's star tech analyst, Jack Grubman, stuck to his "buy" rating and said he was "still bullish."

    "I constantly asked my broker to reassure me. And he constantly reassured me," said Zicarelli. In the end, Zicarelli said, he lost more than $450,000 on Global Crossing.

    "Close to half a million dollars altogether."

    But after learning that analyst Grubman was making millions in investment banking deals from the very companies whose stocks he was recommending, Zicarelli is now seeking damages from Grubman and Salomon Smith Barney.

    Zicarelli isn't unique in his experience. On Thursday, New York Attorney General Eliot Spitzer announced that his office and the Securities and Exchange Commission are heading a multi-agency investigation of investment analysts with conflicts of interest.

    The inquiry will be conducted by the SEC, the New York Stock Exchange, the National Association of Securities Dealers, Spitzer, the North American Securities Administrators Association and several states, according to a statement released by Spitzer and the SEC.

    "I think there is a crisis of accountability right now," Spitzer told CBS News Correspondent Anthony Mason before Thursday's announcement of the inquiry.

    It's possible that Zicarelli could get some settlement resulting from the inquiry. He has also hired an attorney, Jacob Zamansky, to pursue matters directly.

    "Jack Grubman and Salomon Smith Barney have misled investors with thoroughly conflicted stock research," said Zamansky. Zamansky has already won $400,000 in damages for another client from Merrill Lynch. He says the two cases are similar.

    "Absolutely," said Zamansky. "It's the same issue."

    The issue is the credibility of Wall Street's investment advice and potential charges of criminal fraud. And it's not just burned investors out for blood. Wall Street hasn't faced this kind of legal scrutiny in decades.

    "It may only be the tip of the iceberg," said Spitzer, who has been investigating Merrill Lynch.

    After subpoenaing company e-mails, Spitzer revealed that Merrill's former Internet analyst Henry Blodget, while publicly touting a stock called Infospace, was privately ridiculing it as a "powder keg" and "a piece of junk."

    Spitzer said that across the entire investment industry there is "a desire and an urge to push the boundaries in a way that means fraud on almost a daily basis. And that can't be permitted."

    SEC Chairman Harvey L. Pitt said the disclosures that resulted from Spitzer's investigation, as well as practices uncovered by the SEC, the New York Stock Exchange and the National Association of Securities Dealers, "reinforced the commission's conclusion that further inquiry is warranted."

    Salomon Smith Barney has refused to comment. Merrill Lynch's chief financial officer, according to the Wall Street Journal, has called its analyst's actions "inappropriate." That may not be enough, said Spitzer, who wants both reform and an admission of wrongdoing.

    "If they continue to maintain that what happened was inappropriate, but wasn't illegal, then there will be no settlement. Then there will be much tougher sanctions. There could be criminal charges. And the fate of the company is in their hands."

    Among ordinary investors like George Ziccarelli, Wall Street's credibility has already taken a beating.

    "I believed 'em," he said. "I know it sounds dumb now. But I did."

    On May 22, 2002, Merrill Lynch announced a controversial $100 million settlement that has not been approved by all 50 states and does not prevent huge civil lawsuits.  The settlement itself will be paid out of petty cash and the suggested reforms do not go far enough in the eyes of most investor protection groups.


    Business Week Cover Story on May 2, 2002
    Spitzer: "My Job Is to Protect Investors" New York's Attorney General explains why he released the Merrill Lynch e-mail and why the Street may need cleaning now more than ever
     http://www.businessweek.com/bwdaily/dnflash/may2002/nf2002052_2194.htm 

    New revelations about brokers and analysts who push iffy stocks--without pointing out, say, their investment banking relations with the company--have investors hopping mad. Lawsuits and investigations have plunged Wall Street into crisis, and the implications are huge.

    Available to subscribers http://www.businessweek.com/premium/content/02_19/b3782001.htm?c=bwinsidermay03&n=link3&t=email 

    Eliot Spitzer is no stranger to controversy. Since taking office in January, 1999, the 42-year-old New York State Attorney General has sued the gun industry -- a case he plans to argue himself -- and filed the first-ever suit against utility companies in other states, alleging that they're polluting New York air. 

    He dropped another bombshell on Apr. 8, when he publicly displayed a series of e-mail messages that had been sent among Merrill Lynch research staffers. Spitzer says they're concrete proof that analysts were recommending stocks they didn't believe in. Although initially, Merrill said the messages were taken out of context, at a shareholders' meeting on Apr. 26, Merrill Lynch CEO David H. Komansky apologized to shareholders and clients for the firm's conduct.

    Since then, Spitzer has taken heat from Wall Street, regulators, and other politicians, who have dubbed his investigation everything from "self-serving" to "a witch-hunt." In a May 1 interview with BusinessWeek Banking Editor Heather Timmons, Spitzer defended his inquiry, dismissed his critics, and waxed philosophical about what's wrong with Wall Street. Edited excerpts of their conversation follow:

    Q: When you spoke during an Apr. 30 memorial service for your one-time boss, Manhattan Special Commissioner Edward F. Stancik, you said the legendary investigator strongly believed that "sunshine was a great disinfectant." That seems like an apt description of what you're trying to do on the Street -- drag everything into a public venue in order to expose, and consequently clean up, any corruption.
    A:
    That's what I'm trying to do. To a certain extent the remedies we're promoting are "sunshine." We want to permit investors to understand conflicts [of interest] and potential conflicts. We need to go beyond mere sunshine though, and not just say that disclosure alone is sufficient. We need to go beyond the proposed National Association of Securities Dealers [NASD] rules, to more structural changes. We hope to really create a buffer between analysts and investment-banking fees.

    There is another piece of this, and that's how do you protect the analysts from the pressure that will be inevitably applied by the investment banking side of the business?

    Q: Isn't there also the issue of how do you protect analysts from pressure applied by corporations?
    A:
    Correct. There are many points of potential conflict. If I'm Company X, and I'm going to an investment house, and I want them to underwrite my offering, I can say implicitly or explicitly, "How is your analyst going to cover me?" I've [heard about this from all perspectives, from having spoken] to at least 100 investment bankers and CEOs who have felt the pressure being pitched both ways.

    For example, CEOs have told me "When they came in to solicit my business, they offered me a strong buy if we took the business to them." Sometimes [the pressure] is used by the investment house, sometimes it's used by the client company as a bargaining chip: "If you want my business you'll have to deliver."

    The critical issue is: How do we insulate the analysts to insure integrity in his or her reports?

    Q: Do you have a solution?
    A:
    Well, we have a bunch of things we've been talking to Merrill about -- we've had some ideas, and they have some ideas. I think the people in the industry -- the ones who live with it and the ones who understand it -- are at least as likely as I to come up with some creative ideas. We haven't settled, and we aren't about to settle, but we've had some useful conversations. [He declined to give details.]

    Continued at  http://www.businessweek.com/premium/content/02_19/b3782001.htm?c=bwinsidermay03&n=link3&t=email  

     


    "The Devil Is in the E-Mail;" by Alex Salkever, Business Week, April 23, 2002 --- 
    Once, brokerages could bury prosecutors in mountains of irrelevant paper. Now, as Merrill Lynch is learning, e-dirt is much easier to dig.

    In computer-security circles, Wall Street is considered a premier customer. Each major brokerage and investment-banking house spends huge sums to ensure that no one, but no one, breaks into its computer systems. It's money well spent. Trust is the stock in trade of brokers and investment bankers. Investors must feel that their money is safe from a slick cybercrook. And the threat is real. It's entirely conceivable that a sophisticated hacker could empty a bank's coffers of millions of dollars with some simple keystrokes. 

    LOOSE USE. 

    Now, it turns out that the biggest digital-security threat facing giant brokerage houses and investment banks may have nothing to do with firewalls, intrusion detection, and security engineers. It may lie with the loose use of e-mail and instant messaging by employees, who write things they would never dare to say out loud. Witness the disturbing case that New York State Attorney General Eliot Spitzer is building against Merrill Lynch, the largest brokerage and investment bank in the U.S. Spitzer's probers have uncovered scads of e-mail implying that Merrill employees, including star Internet analyst Henry Blodget, privately disparaged companies they were publicly promoting. Blodget called at least two of the companies a "piece of sh-t" at the same time that Merrill was recommending them to investors, according to documents released by the New York AG's office. Spitzer alleges that Merrill fudged research calls to please investment-banking clients, namely, publicly traded companies that Merrill analysts were following. Skeptics have doubted a separation between banking and research The AG still hasn't declared whether the case he's building against Merrill will be civil or criminal. That alone has the Street on edge. And Spitzer has already made it clear that Merrill is only the first in what could be a long list of targets. Should his allegations of misconduct hold up in court, Merrill could face millions in settlement payouts.

     


    Nice going Lehman:  To Hell With the Widows and Orphans
    Richard Gross, an analyst at Lehman Bros., maintains a "strong buy" rating on Enron as the stock declines from $81 to $0.75. A Lehman spokesperson helpfully explains to the New York Times that the firm was advising Dynegy on its purchase of Enron's pipeline, and it is Lehman's policy not to change the firm's rating on any company involved in a deal in which Lehman is an adviser.
    Number 55 among the 101 Dumbest Moments in Business reads as follows at http://www.business2.com/dumbest/

    Nice Going Paine Webber:  To Hell With the Widows and Orphans
    "The Man Who Paid the Price for Sizing Up Enron," by Richard A. Oppel, Jr., The New York Times, March 27, 2002, Page C1 ---  http://www.nytimes.com/2002/03/27/business/27ENRO.html 

    Enron (news/quote) executives pressed UBS PaineWebber to take action against a broker who advised some Enron employees to sell their shares in August and was fired by the brokerage firm within hours of the complaint, according to e-mail messages released today by Congressional investigators.

    The broker, Chung Wu, of PaineWebber's Houston office, sent a message to clients early on Aug. 21 warning that Enron's "financial situation is deteriorating" and that they should "take some money off the table."

    . . .

    The episode illustrates just how easily Enron appears to have thrown its weight around at a Wall Street firm, which may have satisfied a big corporate customer at the expense of some retail customers. PaineWebber managed Enron's stock option program for employees and handled brokerage accounts for many company executives. It also did substantial investment banking work for Enron, which generated fees for the firm. PaineWebber said that Mr. Wu was fired because he had violated policies by sending unauthorized e-mail messages to more than 10 clients and by failing to disclose that PaineWebber's research analyst had rated Enron a "strong buy."

    But the day that Mr. Wu was fired was the day that Enron's chairman, Kenneth L. Lay, was both shedding some of his own shares and talking up the stock. On Aug. 21, Mr. Lay sold $4 million of stock to the company. He also sent an e-mail message to employees saying that one of his highest priorities was to restore investor confidence, adding that that "should result in a significantly higher stock price."

    The message complaining to PaineWebber about Mr. Wu was sent by Aaron Brown, an Enron official who PaineWebber said helped oversee the stock option program. Mr. Brown could not be reached for comment. A switchboard operator at Enron said today that Mr. Brown no longer worked at the company, and a spokesman did not respond to questions.

    Mr. Wu, who declined to comment through his lawyer today, previously asserted that Enron was behind his dismissal, but today's disclosure was the first to show pressure was applied by Enron officials. Mr. Wu now works for A. G. Edwards.

    A PaineWebber spokesman declined to elaborate on the matter involving Mr. Wu but pointed to a letter sent to Congress last week.

      Continued at http://www.nytimes.com/2002/03/27/business/27ENRO.html 


    JP Morgan – whose lawyers must be working overtime – is refuting any wrongdoing over credit default swaps it sold on Argentine sovereign debt to three hedge funds. But the bank failed to win immediate payment of $965 million from the 11 insurers it is suing for outstanding surety bonds.
    Christopher Jeffery Editor, March 2, 2002, RiskNews http://www.risknews.net 
    Note from Bob Jensen:  The above quotation seems to be Year 2002 Déjà Vu  in terms of all the bad ways investment bankers cheated investors in the 1980s and 1990s.  Read passage from Partnoy's book quoted at http://faculty.trinity.edu/rjensen/book02q1.htm#022502 


    Charles Schwab is waging war against Wall Street. He's launching a major campaign to capture midmarket customers--with nearly $11 trillion in investments--from white-shoe rivals rocked by scandal. The lure? Squeaky-clean financial advice from a firm with no investment banking arm. Pummeled by a big drop in revenues since the tech bust, Schwab badly needs to win this bet. For BW subscribers : http://www.businessweek.com/premium/content/02_22/b3785001.htm?c=bwinsidermay24&n=link1&t=email  

    For all as of (May 28, 2002) : http://www.businessweek.com/magazine/content/02_22/b3785001.htm?c=bwinsidermay24&n=link1&t=email 


    "System Failure:  Corporate America:  We Have a Crisis," Fortune Magazine Cover Story, June 24, 2002 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208314

    Rebuild the Chinese Wall Here's the single most important fact about securities research at the big Wall Street firms: It loses money. Lots of money. According to David Trone at Prudential Financial, the typical giant brokerage firm spends $1 billion a year on research. But big institutional investors--the clients--only pay about $500 million in trading commissions in return for research. (Historically research has been paid for with trading commissions.) And if you want to understand why research became so corrupted during the late, great bubble--and so tied to investment banking--that's the reason. By serving as an adjunct of their firm's investment bankers, research analysts were, in effect, attaching themselves to a huge profit center. Participation in banking deals is why analysts felt justified commanding seven-figure salaries--and why bankers (and companies for that matter) felt justified in demanding that analysts say only nice things in their research reports to investors. As a respected research analyst puts it, "Corporations are indirectly subsidizing research on themselves because they pay the banking fees that pay for what is called objective research."

    When analysts first started participating openly in dealmaking some 30-odd years ago, they were said to have "jumped the wall"--a reference, of course, to the Chinese wall that was supposed to separate analysts from investment bankers. Today nobody uses that phrase. Why would they? There is no Chinese wall anymore.

    We should know by now that research with integrity is simply not possible without a Chinese wall. But the most common reform proposal being kicked around--that researchers should not be paid directly for their investment-banking work--doesn't go nearly far enough in resurrecting it. It's way too easy to get around. Still, there is a surprisingly simple fix: Enact a regulation that forbids analysts from being involved in banking deals, period.

    Think about it for a second: Why are analysts involved in deals in the first place? The standard answer you get from Wall Street is that they are there to protect investors. They are supposed to "vet" deals on behalf of the investing public--and if they think an IPO doesn't pass the smell test, they are supposed to have the power to force the firm to pass on it. But we all know that is not how it works in reality--if it ever did. In fact, analysts serve as a marketing tool, implicitly (and sometimes explicitly) promising favorable coverage if their firm is allowed to underwrite the deal.

    Under our proposal, investment bankers will have to do their own vetting, something they're perfectly capable of handling, thank you very much. Having been shut out of the banking process, the analyst will be able to evaluate the company only after it has gone public--when he can make his own decision about whether to cover it. Indeed, shut out of banking, analysts will once again serve only one master: the investor.

    How will analysts earn their seven-figure salaries--and how will the big firms make money on research? We don't know--but we don't really care. Fixing their broken business model is the brokerage industry's problem, not ours. It's possible that analysts will have to take big pay cuts. More likely brokerage firms will have to make a choice: Either openly subsidize research--on the grounds that it offers value to the firm's clients--or shut down their research operations and leave serious securities analysis to dedicated research boutiques like Sanford Bernstein or Charles Schwab, which is trying to set up a system to provide objective research for small investors. Either way we'll be better off than we are now, getting research we can't trust from analysts mired in conflicts of interest.

     


    While watching the CSPAN television special on Enron (Part 2) on January 16, I learned that CSPAN provides some really useful helpers for educators and students at http://www.cspan.org/classroom/ 
    There are special materials from CSPAN's week long series entitled "The Enron Bankruptcy"

    The Enron Bankruptcy page is at http://www.c-span.org/enron/index.asp 
    The links called "Review" allow you to download video which will playback on your computer.  I especially encouraging the downloading of the Tuesday, January 15 "Review" video.

    I was particularly impressed, as were all people who phoned in, by the testimony of Scott Cleland (see Tuesday, January 15) and then click on the following link to read his opening remarks to a Senate Committee on December 18.  If you think the public accounting profession has an "independence problem," that problem is miniscule relative to an enormous independence problem among financial analysts and investment bankers --- two professions that are literally Congress to the core.  Go to http://www.c-span.org/enron/scomm_1218.asp#open 

    SEN. DORGAN: Mr. Andrews, thank you very much.

    Mr. Cleland, you represent, you're the chief executive officer of the Precursor Group. We appreciate very much your willingness to participate today. Why don't you proceed.

    MR. SCOTT CLELAND: Thank you for the honor of testifying again and for allowing me to go early.

    I'm Scott Cleland, founder and CEO of the Precursor Group. We're an independent broker dealer. We provide investment research to institution investors. We do no investment banking, no proprietary trading, we don't manage money, and none of our analysts are allowed to own individual stocks. Before entering the investment business I worked for the U.S. government and gained experience in improving internal controls at the U.S. Treasury Department, and the U.S. Office of Management and Budget.

    My message to you is very simple today. There are more Enrons out there ready to blow up and devastate more investors, but you won't know about it because the system of internal controls, the early warning systems are so rampantly affected by conflicts of interest. And it doesn't need to be that way. Government and industry, if they would just officially discourage the conflicts of interest, I think a lot of the problem could be addressed. If the system worked as designed, essentially we wouldn't have had the first panel, we would have had, a couple of years ago, a stock that was battered, but we wouldn't have had a devastating meltdown. It was a frighteningly swift collapse. That was because this thing had been going on for three or four years and none of the watchdogs spotted it.

    The stakes are really high here. As baby-boomers are nearing retirement age, the nation is increasingly requiring -- depending on 401(k)s and other types of market instruments to supplement social security. So now, more than ever, we need to restore the integrity of the markets. The problem is obvious. Just like an ounce of prevention is worth a pound of cure, unsanitary conditions breed disease. Conflicts of interest now plague the system. Government and industry have not been vigilant enough to keep the system clean because almost all of the watchdogs, supposedly watching the system are not paid by investors, but paid by somebody else.

    But what's this plague of conflicts of interest. Let me briefly run through eight that are glaring. Companies can routinely get consulting fees -- companies now routinely pay consulting fees to audit companies that are supposed to keep the company honest. In government that would be a violation of public trust.

    Two, auditors are increasingly doing the companies' inside audit work and also doing their independent outside work. That's like grading your own papers or hearing your own appeal.

    Three, through the investment banking back door, company interests effectively pay for most of the research that's produced in the United States, the problem is the average American doesn't get the joke that most all of the research they're reading is paid by investment banking by the companies.

    Four, it's common for analysts to have a financial stake in the companies they're covering. That's just like, essentially, allowing athletes to bet on the outcome of the game that they're playing in.

    Five, most payments for investment research is routinely commingled in the process with more profitable investment banking and proprietary trading. The problem with this is it effectively means that most research analysts work for the companies and don't work for investors.

    Six, credit agencies may have conflicts of interest.

    Seven, analysts seeking investment banking tend to be more tolerant of pro-forma accounting and the conflict there is, essentially, the system is allowing companies to tell -- you know, to make up their own accounting. To describe their own financial performance, that no one then can compare objectively with other companies.

    Eight, surprise, surprise, companies routinely beat the expectations of a consensus of research analysts that are seeking their investment banking business.

    Common sense suggests that conflicts of interest breed trouble. I believe the focus of congressional and regulatory oversight should be on how to improve the current system, how to prevent future Enrons from happening. So I have five simple commonsense recommendations:

    One, officially discourage conflicts of interest. Make it U.S. policy to discourage financial conflicts of interest and, definitely, don't economically reward conflicts of interest in the law or in regulation.

    Two, I think it's pretty simple, prohibit auditors from consulting for companies that they audit, and from reviewing their own work, you know doing the independent review of their own internal review.

    Three, you really need to strengthen the objectivity of the overall investment research system. Discourage the bundling of banking, trading and research. Because the commingled nature of commissions when there is not a transparent, an official separate accounting for each type of business, essentially what it means is, is that the more profitable parts of banking and trading are rewarded and it discourages research objectivity. One idea you've heard many times is that trading they suggest we need to get best execution for investors, best execution of trader. I suggest there should be some evidence or some emphasis put on getting best research execution for investors.

    My last recommendation is that there needs to be increased awareness among the press and among the government to stock manipulation. Two instances: when the press headlines gives prominence in a story to pro forma accounting financial results, the press is lending credibility to a serious conflict of interest because they are allowing public companies to make up their own accounting so that they can't be compared or judged relative to other people.

    The second thing is the press lends credibility to another conflict of interest by being allowed to be spun. In playing along with the companies, in the street, in their quarterly expectations game that inflates stock prices.

    So I thank you very much for testifying to avert future Enrons it is very simple: make it official U.S. policy to discourage conflicts of interest where necessary.

    Thank you, Mr. Chairman.

    SEN. DORGAN: Mr. Cleland, thank you very much.

    Mr. Andrews, when you indicated that there were some mistakes in judgment, might I ask the issue of the JEDI, the partnership that was kept off their books in which Enron essentially was at risk for its own JEDI stake and all of Chewco which is another partnership, Enron was at risk for both its stake and the stake of Chewco's and was essentially kept off the books. Is that what you're referring to when you talk about the mistake in judgment by the accounting firm, by your firm?

    MR. ANDREWS: Senator, the Chewco investment is actually the one that I referred to that's the subject of the 10(a) reporting that was actually an illegal act. The other SPE is the one that was a mistake in judgment. The smaller of the two which accounted for 20 percent of the restatement and essentially what occurred there is that in, dated back to 1997, the information that our team reviewed in 1997 was concluded that it met the requirements of the SPEs which -- not to get technical on it -- but if you have three percent, if an outsider has three percent and control, you are allowed to have, in fact, required, for that entity to be off your books. We believed it met that tests. The company believed it met that test when it was set up. Subsequent information actually in October of this year, was revealed that we made an error in judgment. It was not information that was withheld from us, but it was an error in judgment. When we realized that error we pointed it out to the company and the company made that correction.

    SEN. DORGAN: How big was that correction?

    MR. ANDREWS: That correction was 20 percent of the restatement amount. I don't have the exact dollar amount, but it's 20 percent of the restatement amount.

    SEN. DORGAN: Let me ask, should it raise a red flag for an auditor of a firm who's setting up a special purpose entity such as one of the partnerships we've described, JEDI, Chewco, is it LMJ? When a firm is setting up special purpose entities for transaction in its own firm's stock, should that raise a red flag for auditors?

    MR. ANDREWS: Senator, special purpose entities are structured in accordance with the accounting rules, generally accepted accounting principles, are in fact, what provide the guidance for those entities themselves and you have to comply with the structure of those rules. Obviously those are rules that the profession has that according to their structure you have to comply with those.

    SEN. DORGAN: But you're answering a question I didn't ask. I'm asking whether an auditor should see some areas of concern if a firm is setting up a special purpose entity for transactions in its own stock.

    MR. ANDREWS: Well, the company --

    SEN. DORGAN: I'm asking for your judgment about that.

    MR. ANDREWS: Right, the company should report it in accordance with those rules and it's our responsibility as auditors to review that.

    SEN. DORGAN: Should it raise a red flag for an auditor if the chief financial officer of a company is personally involved in complex financial transactions in their own firm? This was the case with Mr. Fastow who had a personal stake, as I understand it, in the success of these SPEs and was compensated in that matter. Should that concern an auditor and did it concern Andersen?

    MR. ANDREWS: Senator, as it pertains to related party transactions, again, the accounting and disclosure rules require that related party transactions be reviewed and disclosed where there would be material on financial statements and, in this case, that related party transaction was disclosed in the footnotes to the Enron financial statements.

    SEN. DORGAN: Do you have those footnotes with you?

    MR. ANDREWS: Chairman, I do not.

    SEN. DORGAN: The reason I ask is I've read some of those footnotes and I think it would have been impossible for even the most experienced analyst to understand what those footnotes meant, and that is of concern. Did Arthur Andersen in any way participate in structuring or designing any of the special purpose enterprises or limited partnerships that were the subjects of the restatements of earnings?

    MR. ANDREWS: Chairman, we performed our work as auditors, we did not design or structure the transactions.

    SEN. DORGAN: Let me ask a question raised by Mr. Cleland, and I raised it in my opening statement. An accounting firm that is reviewing the books in a fair manner for a company and then represents that review to investors and others, if that company is also under contract for other consulting services, let's say they are paid $25 million for auditing services and have $27 million on another consulting contract, is that not an inherent conflict of interest?

    MR. ANDREWS: Chairman, we believe we are independent of Enron and we take -- we accept the responsibility of the importance of maintaining our independence and integrity. The rules related to what an auditor can do and cannot do are subject to regulation and we conform and abide by those. As I mentioned in some of my testimony, opening statement at least, the $27 million that we were paid in terms of consulting, a significant part of that actually was for work that an auditor really must do or has to do.

    For example, we performed the work related to Enron's registration statement, comfort letters, tax work, things of that nature that really an auditor has to do. The disclosure as to what goes in to which pot, if you will, as to what's called an "audit fee" versus a "non-audit fee," is subject to the regulation of the proxy disclosures that the SEC passed last year and many audit related services actually go in the non-audit related category in that disclosure.

    SEN. DORGAN: Mr. Cleland, did I get any of my questions just answered?

    MR. CLELAND: You know, it goes back to if it's tolerated, if it abides by the letter of the regulation, then it's not necessarily a violation of the public trust. I think there's a question of the letter of the law and the spirit of the law and what I'm averring is that we need to get back to the spirit of the public integrity -- the integrity of markets and investor confidence in the system, and that goes beyond the little -- letter of the law.

    SEN. DORGAN: Senator McCain?

    SEN. MCCAIN: Following up on Senator Dorgan's comments, Mr. Andrews, do you believe that being paid for consulting as well as auditing creates an appearance of a conflict of interest?

    MR. ANDREWS: Senator, again, we believe we were independent. In terms of the appearance of conflict of interest, as I said and I believe, it's important for us to have the public trust and if public trust is shaken by the confidence of that, it's our responsibility to restore that, so it's --

    SEN. MCCAIN: Do you believe that it creates an appearance of conflict of interest?

    MR. ANDREWS: Many people have stated that it creates an appearance of conflict of interest.

    SEN. MCCAIN: Mr. Cleland, from reading your very powerful statement, full complete statement that was submitted for the record, the next time I watch Lou Dobbs' guest or someone on MSNBC or CNBC or Bloomberg, some so-called expert that is recommending that I purchase a stock, it's very likely that that person has some financial interest?

    MR. CLELAND: You 'betcha. And the reason why I think we were asked to testify is we are a Telecom Tech research firm and this happened in the Telecom Tech. This is deja vu. I mean if you look in Fortune magazine this week there is a little thing that said, "Dot-com death watch."

    And there's 591 dot-coms that died. So Enron is a big, spectacular, huge hit. But this has been happening for the last year, you know, hundreds of times.

    SEN. MCCAIN: And it may even be likely that at the ITO stage these individuals made a whole lot of money.

    MR. CLELAND: Tons of money.

    SEN. MCCAIN: That was the history of it, the stock would go way up and they had initial purchases. Do you think that maybe, again speaking of the press, that perhaps those guests who sound so convincing, they're all handsome men and women who are very bright, smarter than anybody I know, do you think that maybe they should, before they make these great recommendations, including their overall over-winning confidence in the future of the stock market starting some six months ago, that they should at least reveal their conflict of interest so that the viewer would know that or in their, I speak of television, but it's true of radio and print as well?

    MR. CLELAND: Well, certainly there should be greater disclosure, but disclosure has kind of been viewed as the cure and, you know, it papers over the problem. The problem is, is when people call them research analysts, the connotation that the average American has when they hear "research," they think objective, they think scientific, they think analytic and they think conflict-free. That's the connotation we're taught when we're in school of what the definition of what research is. That's not what investment research is today.

    SEN. MCCAIN: Do you believe that any auditing corporation who receives consulting money as well as auditing money creates an appearance of conflict of interest?

    MR. CLELAND: Without question, it creates an appearance of conflict. From my years in the government at the Treasury Department, the Office of Management and Budget, the State Department, and you all know in the public eye, the appearance can be as damaging as the actual conflict and so that's why in the government policy the people that have the public trust you're supposed to avoid even the appearance of conflicts of interest.

    SEN. MCCAIN: Let's talk about SPEs a second, Mr. Andrews. Clearly, clearly you say there was one illegal and one, quote "error in judgment," why wouldn't your people detect something like this. As I understand it, it was a fairly large amount of money, about $172 million, I believe, something like that. How do you miss something like that?

    MR. ANDREWS: Senator, an audit, of course -- well first of all Enron is a large, complex company that had over 3,000 subsidiaries, it was at one point, seventh on the Fortune 100 list. So a large complex company, and an audit, of course, is performed on a sample of transactions to provide reasonable assurance that the financial statements are not materially misstated. So an audit does not look at every transaction. In the case of Enron, they had a number of special purpose entities and the two that you've mentioned are two of those that were called into question. On one of those, the smaller of them, when our team reviewed the information originally they did not detect an element of that that would have required that entity to fail that SPE test. It was an honest mistake in judgment. When we found out about it subsequently, we brought it to the company's attention and they corrected that error.

    The second one, which is the one you referred to as an illegal act, actually information came to us, actually in early November, we do not know if an illegal act has been performed but information came to us that would have required the accounting for that item to be different than it was originally done. Originally it was not recorded on the books and it needs to be consolidated with the entity. We don't know why we did not have that information that was referred under 10(a) to the audit committee of the company and it is currently under investigation.

    SEN. MCCAIN: How many SPEs did they have?

    MR. ANDREWS: I don't have the exact number, but there were several hundred.

    SEN. MCCAIN: Several hundred SPEs?

    MR. ANDREWS: Yes.

    SEN. MCCAIN: Mr. Cleland, I -- Mr. Andrews, I understand you are the messenger here today and I appreciate you coming forward to testify and help us understand this situation. I thank you for being here today.

    Mr. Cleland?

    MR. CLELAND: Just as a comment on that. The thing that I think all of us should be just stunned and amazed at is, this is a problem that should have been caught in 1997, in 1998, in 1999, and in 2000. That's what a system of internal controls is supposed to be about. Mistakes are made, but we have a system that can't cascade, hopefully, more than one year. And when something cascades for four years on top of each other, you have an Enron. And, hopefully, that's what you're gleaning from all this, is that the system that is supposed to catch these things and fix them so that maybe Enron got a stock battering, but all these people in the first panel didn't need to be here. They might have had a lower nest egg, but they would have still had a nest egg.

    SEN. MCCAIN: And efforts to reform this system have been stymied at several areas of government. Do you have any comment about that?

    MR. CLELAND: Well, I think that you know the legal process, you all know better than anybody that if you try and do it through legislation there are all sorts of ways that it can get stopped. I have a simple suggestion. The U.S. Senate should do a resolution that says, "We, you know, stand up for the integrity of the investment system, we think conflicts of interest are not a good idea."

    You ought to suggest your House colleagues do that and I'll bet you it's 100-0 and 435 to zero. And all of a sudden you get a sense of the Congress real loud and clear that says, "Yes, integrity of the public markets is a good idea, and yes, conflicts of interest tempt people in ways we shouldn't tempt them."

    Why do I make sure that none of our research analysts may own an individual stock? I don't want to tempt them. Human nature is something in this. Now why is Wall Street the way it is? They have been tempted with, not millions, we're talking tens of millions, hundreds of millions of dollars, you're tempted with that amount of money and there's all sorts of reasons why you would look the other way.

    SEN. DORGAN: Mr. Cleland, thank you.

    I'm going to call on Senator Wyden, but I want to follow up for just one moment on the point that Senator McCain made.

    Mr. Fastow -- just to focus on one piece of this, Mr. Fastow, as I understand it, received $30 million in management fees for these off-the-book partnerships and we don't know what the ownership stake was but the $30 million was just for management fees. Now this is an officer of the company making a substantial amount of money in management fees and perhaps an ownership stake and when questioned about who were the other investors in these partnerships, the answer is, they are private.

    So among the answers we are requesting is, let's allow some sunshine to shine in here and find out who owned these. How did they profit? When did they profit? How much did they profit? So that's what we're trying to get to and I think that's what Senator McCain was alluding to as well. And I've just asked Mr. Cleland -- I asked the question of Mr. Andrews, I don't think I got an answer -- but do you think it's an inherent conflict of interest for a CFO of a company to have an ownership stake in the partnerships off the books and be paid commissions for running them and so on and so forth?

    MR. CLELAND: Yes, that's a no-brainer. It's an unbelievable conflict of interest.

    SEN. DORGAN: Senator Wyden?

    MR. CLELAND: Because one thing is public and the other is private and so there's no accountability. That's why it is a conflict.

    SEN. DORGAN: Senator Wyden?

    SEN. WYDEN: Thank you, Mr. Chairman.

    Mr. Andrews, in the early 1990s I participated in more than 30 hearings as a member of the House in the accounting profession. Those hearings were chaired by John Dingell, and after the hearings I wrote a law with Mr. Dingell's assistance that was designed to prevent this kind of problem and everything about what we did was designed to do what Mr. Cleland talked about which was to set off those early warning lights. And I'm going to take you through that statute and have you tell me what your company was doing to, in effect, comply with the law. I'm just going to go step by step, through it.

    The first part of the law says that every single audit has to have procedures in place to detect illegal acts. What did you have in place, and in particular, did you revise those procedures as more and more evidence came to light suggesting that there was a problem there?

    MR. ANDREWS: Senator, as you know I'm not the individual that actually managed the individual Enron engagement so I don't have all the detail of what we did on the audit. But our audits on this engagement were performed in accordance with the professional standards.

    I think our people did the appropriate work, which includes within that scope the appropriate consideration of establishing their audit scope to take into account the responsibility for illegal acts.

    SEN. WYDEN: But did you change it over time? I mean my knowledge at this point is that it would be one thing to have a set of procedures at the beginning, but as Mr. Cleland said, all this evidence starts flowing in, you've got a law in the books and would suggest to me that the procedures should have changed over time. Did they?

    MR. ANDREWS: Senator, I do not know how our procedures changed over time but I do want to make -- point out one thing that if my testimony in any way was misleading is that we at this point have one item that came to our attention in November that we have reported to the audit committee under 10(a) as required. We do not know if that was an illegal act or not, so at this point in time we do not know if we have any illegal acts of the company.

    SEN. WYDEN: Let's continue to go through the law. The second part of the law goes right to the heart of what all of my colleagues are talking about, these related party transactions. I mean these are just the breeding ground for financial hide-and-seek and conflicts of interests. Current law says that there have to be procedures to identify related party transactions that are material to the financial statements. What procedures did you have so as to again identify those related party transactions early on, as Mr. Cleland is talking about?

    MR. ANDREWS: Senator, again, our audit procedures incorporated the audit steps, if you will, to identify related parties and to discuss related parties, and to see that related party transactions, that the company disclose those related party transactions in accordance with general accepted accounting principles. The responsibility for related party transaction, first to identify them and to disclose them is foremost the company's, and it's our responsibility as auditors to do appropriate auditing procedures related to that. Again, a related party transaction is not wrong as long as it's accounted for, approved properly and disclosed.

    SEN. WYDEN: Again, it just seems to me that at this point there is just the vaguest, most skimpy information out there about these partnerships, and if you look at section 2 of this law that John Dingell and I wrote, it sure looks to me like there wasn't a whole lot of disclosure of those related party transactions.

    Now the third part of the law says that when illegal acts occur or may have occurred, may have occurred, you're supposed to bring it to the attention of the authorities. You've described brining it to the attention of the authorities years after the warning lights should have gone off, years after the warning lights should have gone off. Why did that happen?

    MR. ANDREWS: Senator, the particular transaction that you are referencing -- again, if I have in any way been unclear on that -- that was a transaction that was entered into a few years ago in which we did not have, the company did not provide us with all the information to reach the right conclusion on that transaction. It was actually early November of 2001 that, upon a request for additional information that the special committee of Enron's board had, we got a package of information that contained information we did not previously receive when that transaction was recorded.

    When we got that information it was crystal clear to us that the accounting for that transaction had been incorrect and within 24 hours we took that information to the audit committee and asked that the company appropriately investigate it and report those findings back to us so that we could consider then our responsibilities beyond that.

    SEN. WYDEN: Well, again, it just looks to me that the firm moved after all the horses were out of the barn and we wrote a law that was designed to have the firm move years and years earlier. Now, let me, because time is short, ask you about just a couple of other matters.

    It is my understanding that Andersen's serve not only as Enron's in-house auditor but also as the outside auditor as well. So in effect, it looks to me like Andersen is auditing its own work. Do you think that's appropriate for an internal in-house auditor to also serve as the outside person?

    MR. ANDERSON: Senator, in the case of Enron, we did not audit our own work and we certainly concur that we should not audit our own work. What we did at Enron, actually, our services that are referred to as internal audit services are actually part of the external audit fee, part of the $25 million. We rendered two reports on Enron: one is a financial statement audit, if you will, the opinion on the financials; and the second is a report on internal controls which many have advocated. That's actually -- that responsibility is codified under the SCPA guidelines, so that's an external audit activity.

    The only internal audit activity we did in 2000 really related to requests that Enron asked us to review a system, the controls a system that another Big Five firm had actually installed. Now prior to 2000, in the 1994 to 1998 period we did perform internal audit services for Enron. But beginning in 1998 they rebuilt their internal audit department and since that time what we have done is really render those two reports which are external audit activities.

    And occasionally when they would request it, we would do additional services. But we do not audit our own work. I certainly concur with your statement that it's inappropriate for an external auditor to audit its own work.

    SEN. WYDEN: This is eye-glazing stuff, you know, Mr. Andrews. I mean I've sat through 30 accounting hearings and I saw just how this is sort of like prolonged root canal work, but I'll tell you, at the end of the day, people get hurt when auditing firms take years to do what that law which went into effect several years before all of this went on, could have brought to light.

    Now let me ask you about a couple of other matters. In the testimony before the House the CEO said it wasn't clear why relevant information about one of the big special partnerships was not provided to us. Under the Financial Fraud Disclosure Act, who bears the responsibility for obtaining the relevant information?

    MR. ANDREWS: Well, Senator, as an auditor we expect all relevant information to be provided to us. In the case of these transactions we believe that it's quite clear what relevant information would be appropriate for us to review as well as for the company to review. In this case we don't know why, as he stated in his testimony as I did today, we do not know why we did not have a component of that relevant information. Again, when it came to our attention, we reacted instantly to take the appropriate actions under 10(a).

    SEN. WYDEN: But again, under the law, shouldn't you have been bearing down to get that relevant information? I mean, what I'm struck by is that -- and I'm sure we're going to run a lawyers full employment program and argue about this for some time -- there may have been technical compliance here, but all of this seems to me to be maneuvering that is different than what the Congress intended when we passed that law. I mean, when we passed that law it said you had to have all the relevant financial information. I don't know how you certified the accuracy of their books for years and years. How could you have satisfied the -- certified the accuracy of their books when you couldn't get the information.

    MR. ANDREWS: Senator, obviously we don't know what we don't know. We didn't realize in this particular case, in this one transaction, we did not realize that we did not have the information. Again, an audit looks at a sample of transactions, does not audit every transaction and it's our professional responsibility to do that. And when we obtained the information, we reacted to it as required under 10(a).

    SEN. WYDEN: The point really is, the law change, Mr. Andrews, the law change when we got that law to detect and disclose financial fraud on the books but you all are acting like very little has changed. When you say, "We didn't know what we didn't know." The whole point was when you saw suspicious activity you were supposed to set off the red warning lights. The watchdogs were supposed to wake up from their slumber and get it to the attention of the proper authorities and it just seems to me in this case years were taken before that was done.

    I thank you, Mr. Chairman.

    SEN. DORGAN: Senator Wyden, thank you very much. You're raising questions about an area that's critically important, in fact, the number of restatements of earnings, very substantial restatements of earning in this country today ought to cause alarm here in Congress and across the country. I don't understand how what can happen after the fact is for the best minds in the country to say, "Oh, we've made a mistake of a $100 million or a half-a-billion dollars." It's happening all too often and maybe is the subject of another hearing at another time.

    Senator Fitzgerald?

    SEN. FITZGERALD: Thank you, Mr. Chairman.

    Mr. Cleland, I wanted to thank you for your testimony. I thought it was superb and I'd like to work with you implementing some of your recommendations.

    MR. CLELAND: Thank you, Senator.

     


    We are such stuff / as dreams are made on
    William Shakespeare

    This is such stuff/ as nightmares are made on:
    This passage demonstrates the miserable ethics of investment banking and the crying need for FAS 133 that went into effect in 1998.  The passage is written by Frank Partnoy, FIASCO:  The Inside Story of a Wall Street Trader (New York:  Penguin Books, 1999, ISBN 0 14 02.7879 6, pp. 65-67)
    Note especially the customers that were targeted for these high risk derivative financial instruments.

    From a salesman's perspective, he may as well have been selling exploding Ford Pintos.  A salesman cared only about making the sale, not about the damage it might cause later.  All derivatives salesmen knew that eventually some of their trades would blow up, and some of their clients would then go up in flames.  If the losses really got ugly, you always could quit the firm.  If you had a reputation for selling dangerous high-margin derivatives, it would be easy to get another job.

    From the firm's perspective it was important to make as much money up front as possible on these trades.  Take out a big fee, plant the time bomb, walk away, and wait.  Of course, after the explosion the derivatives losers would sue, but as long as the firm had made enough money up front and could defend the lawsuit adequately, it would be fine.  The important message I took from the disclaimers was this: The way you made money selling derivatives was by trying to blow up your clients.

    I examined the two-page term sheet.  It said this trade was a one-year bond with a guaranteed annual coupon payment of 11.25 percent.  That was a huge coupon, especially given that the bond was issued by a U.S. agency.  U.S. agencies are virtually risk-free, and a normal bond issued by one would pay a coupon of maybe half that much.  What was the catch?

    The formula for principal redemption said the return of the amount you originally invested was linked to the difference in one year between the value of the Thai baht and a "basket" of currencies.  This basket was composed of approximately 84 percent U.S. dollars, 10 percent Japanese yen, and 6 percent Swiss francs.  If in one year the baht and the basket had changed by the same amount, you would get all of your principal back.  So if you bought $100 million of this derivative, and the baht matched the basket, you would receive a whopping $11.25 million coupon plus $100 million in principal, an enormous total return.  However, if the changes in the baht and the basket did not match exactly, you might get less than your entire principal amount back; you might even get zero.

    Was there any reason to expect the baht to match the basket?  First Boston said yes.  Thailand had a "managed currency," which meant its central bank, the Bank of Thailand, adjusted the daily value of the baht based on certain variables, including the value of Thai foreign trade.

    First Boston had designed this basket to duplicate the formulas they believed the Bank of Thailand was using to manage the baht.  Although the Bank of Thailand kept those formulas top secret, First Boston claimed it had discovered them.

    If First Boston was right, you would earn the cool, calm 11.25 percent and never realize you had been in the eye of a storm.  However, if the Bank of Thailand zigged when you thought it would zag, you would be swept into a monsoon and wiped out.  This trade was a perfect example of the tactic cited by the infamous BT salesman: "Lure people into that calm and then just totally fuck 'em."  (After a few years in that calm, investors were stunned in July 1997, when the Bank of Thailand announced it was abandoning the formulas, and the baht--together with its associated derivatives--immediately collapsed.)

    You might have some questions about this derivative.  Who was buying it and why?  Were they just speculating, or did they believe First Boston had discovered a secret formula?  And if this trade was such a good bet, why was First Boston offering to sell the trade, rather than taking the risks itself?  Was First Boston taking the other side of this bet, or were they hedging somehow?  Why were U.S. government agencies involved in this trade, issuing bonds linked to a complex formula based on how the Bank of Thailand managed its currency?  And most importantly, how much money was First Boston making on the sales of these derivatives?

    I asked one of the salesmen a few of these questions, starting with, "Who buys these things, anyway?"

    No answer.  The salesman refused to tell me.  I thought the buyers might include hedge funds, the swashbuckling traders who placed big, sophisticated bets in nearly every market.  I mentally ticked off a list of the most sophisticated private hedge funds.  They had names like Quantum or Tiger or Gordian Knot.  I decided to pester the salesman until I got an answer.

    "Is it Quantum?"  Quantum, originally started by financier George Soros, was now the largest hedge fund in the world.  Quantum and Soros had made (and lost) billions speculating on foreign exchange rates.

    "No way.  Are you kidding me?"  It was a stupid question.  The top hedge funds were much too sophisticated to buy this trade from First Boston.  They could place such bets on their own, without paying First Boston's hefty fees.  Whom did that leave?

    "Other investment banks?"

    "No again."  A second stupid question.  Another bank, such as Morgan Stanley or Goldman Sachs, was more likely to be selling the trade than buying it.

    "How about mutual funds?"  I knew the big funds played in emerging markets derivatives.  Could Fidelity or Templeton be a buyer?

    "Nope."

    "Commercial banks?"

    "No."

    I was running out of choices.  I pressured the salesman to admit who was buying the Thai baht trade.

    "Look, I'm not gong to tell you any names, but if I tell you who the main categories of buyers are, will you leave me alone?"

    "OK."  I cold badger him for names later.

    He said, "State pension funds and insurance companies."

    "What?"  I was shocked.

    He just smiled.

    "Really?"  I asked him.  I couldn't believe it.  "State pension funds and insurance companies?"

    The salesman simply nodded.  He said state pension funds were among the biggest buyers of structured notes, of which this Thai trade was but one example.  Generally the list of structured note buyers included the State of Wisconsin and several counties in California, including Orange County, although the salesman noted that this Thai trade was small and unusual and that state pension funds and insurance companies typically bought other types of structured notes.

    Sate of Wisconsin?  Orange County?  That seemed ridiculous.  Why were they buying these risky derivatives trades?  The next thing you know, someone would try to claim Procter & Gamble was a big derivative buyer.

    I asked, "What about insurance companies?"  They're conservative investors.  Why would they buy these structured notes?"

    He looked at me as if I were a moron.  "Come on.  These notes are issued by U.S. government agencies.  They're rated AAA or AA, and they're the only way for an insurance company to play the foreign exchange markets. Isn't it obvious?"

     

    The following is quoted from Page 96:

    Michael Lipper of the fund-tracking company Lipper Analytical Services said that the warnings applied to mutual funds, too; 475 of 1,728 stock, bond, and balanced funds had invested billions in derivatives, yet such holdings "magically seem to disappear" the day funds have to file statements with shareholders.  Although mutual funds are forbidden by government regulation from using leverage to buy securities with borrowed money, the Investment Company Institute, a Washington-based mutual fund trade group, announced that mutual funds not only held derivatives worth $7.5 billion (2.13 percent of total assets), they owned $1.5 billion of the special derivatives called structured notes, of which PERLS was one type.  For example, Fidelity Investment's $10 billion Asset Manger fund had $800 million invested in structured notes in the last quarter of 1993, including leveraged bets on Finnish, Swedish, and British interest rates.  One note, based on Canadian rates and leveraged thirteen times, had gained 33 percent the previous year; in the first four months of 1994, that same note plunged 25 percent.  What was worse, the mutual fund trade groups didn't even seem to know about the purchases of PLUS Notes.

     Bob Jensen's other illustrations of how the professions of financial analysis and investment banking are Congress to the core are given at http://faculty.trinity.edu/rjensen/fraud.htm#Cleland 

    The following February 21 message was forwarded by George Lan [glan@UWINDSOR.CA

    In addition to trying to catch a tiger by the tail, today's auditors of derivatives may also have to contend with : . 

    LYONS (liquid yield option notes) . 
    CATs (certificates of accrual on Treasury certificates) . 
    COUGRs (certificates of accrual on treasury certificates) . 
    TIGRs (Treasury investment growth certificates) .
     ZEBRAs (zero coupon eurosterling bearer or registered accruing certificates) .
    OPOSSMS (option to purchase or sell specified mortgage-backed securities) 

    Journal of Accountancy (November 1990), from which the above definitions come from, has a fascinating glossary of selected financial instruments. The list must be extended by now as it is stated in the glossary that, "Wall Street innovators devise new financial instruments faster than Campbell's make alphabet soup." Some other esoteric names mentioned in the glossary include : flip-flop notes, COPS, DARTS, PIK, STRIPS, Butterfly spread and CIRCUS. 

    George

     


    Credit Suisse First Boston -- the investment bank that managed some of the most hyped stock offerings of the Internet boom era -- agrees to pay a $100 million fine for improperly pumping up share prices --- http://www.wired.com/news/business/0,1367,49930,00.html 

    See also:
    New IPO Rallying Cry: This is War
    Bankrupt? So What? Lawyers Ask

    The Pension Fund Consulting Racket

    Yet another example of how fraud works in high finance
    It was a prudent move. While LandAmerica CFO G. William Evans says the review turned up nothing irregular at the Richmond, Virginia-based company, it appears some pension consultants have been recommending money managers based on self-interest, and not on the needs of their clients. Indeed, a study of 24 pension consultants conducted by the Securities and Exchange Commission found that more than half of the advisory firms earned money from both retirement-plan clients and money-management funds. According to the SEC study, issued in May, most of these pension advisers had relationships with unaffiliated broker-dealers or operated their own broker-dealers — thus providing themselves with an easy way to receive indirect payments from money managers.
    Randy Myers, "Games They Play:  The other shoe has yet to drop on pension consultants' possible conflicts of interest. But companies can't afford to wait," CFO Magazine, December 1, 2005 --- http://www.cfo.com/article.cfm/5193393/c_5243641?f=magazine_alsoinside

    SEC Finds Retirement-Fund Issues
    A government examination of retirement-fund consulting uncovered significant conflicts of interest between consulting firms and the money managers they recommend to clients, according to people familiar with the matter. A months-long study to be released today by the Securities and Exchange Commission is expected to confirm what regulators have long suspected: the existence of undisclosed financial ties between consultants and money-management firms that can influence the recommendations consultants make to their retirement-fund clients.
    Deborah Solomon, "SEC Finds Retirement-Fund Issues," The Wall Street Journal, May 16, 2005; Page C3 --- http://online.wsj.com/article/0,,SB111620205687434194,00.html?mod=todays_us_money_and_investing


    Nowhere are the conflicts of interest for financial services conglomerates more potentially lucrative - and more obscure - than in the management of pension assets.

    "How Consultants Can Retire on Your Pension," by Gretchen Morgenson and Mary Williams Walsh, The New York Times, December 12, 2004 --- http://www.nytimes.com/2004/12/12/business/yourmoney/12pension.html 

    Nine years ago, William Keith Phillips, a top stockbroker at Paine Webber, met with the trustees of the Chattanooga Pension Fund in Tennessee to pitch his services as a consultant. He gave them an intriguing, if unusual, choice. They could pay for his investment advice directly, as pension funds often do, or they could save money by agreeing to allocate a portion of its trading commissions to cover his fees. Under a commission arrangement, Mr. Phillips told the trustees, the fund would be less likely to incur out-of-pocket expenses, leaving more money to invest for its 1,600 beneficiaries.

    Seven and a half years later, Chattanooga's pension trustees discovered just how expensive that money-saving plan had been. According to an arbitration proceeding they filed against Mr. Phillips, the agreement cost the fund $20 million in losses, undisclosed commissions and fees. And since 2001, Chattanooga has had to raise nearly $3.7 million from taxpayers to keep the $180 million fund fiscally sound.

    The Chattanooga trustees fired Mr. Phillips in 2003 and, last October, filed arbitration proceedings against him, UBS Wealth Management USA, formerly the Paine Webber Group, and his new firm, Morgan Stanley. The case, which is pending, accuses the consultant of, among other things, fraud and breach of fiduciary duty. The commission arrangement was central to the problem because it put Mr. Phillips's interests ahead of his client's, the fund said in its complaint.

    "The very important and in many ways unique relationship that a pension fund board has with its consultant is based on trust," said David R. Eichenthal, finance officer and chairman of the general pension plan for the city of Chattanooga. "To the extent that Phillips breached that trust, we thought it was important for the pension fund to do everything possible to hold him accountable for the results."

    Pension experts say the Chattanooga case is hardly rare among retirement funds. The Securities and Exchange Commission is concerned enough about conflicts of interest among consultants who advise pension funds on asset allocation, selection of money managers and other investment matters that it is conducting an industrywide inquiry. The results of the S.E.C.'s investigation are expected soon, and enforcement actions may follow.

    Aubrey Harwell, a lawyer for Mr. Phillips, declined to make him available for this article. Mr. Harwell said: "No. 1, these are allegations and not proven facts. And No. 2, the performance during the days that Keith Phillips was consulting were well beyond the benchmarks." Details of the commission arrangement, he added, were fully disclosed to the pension fund. But this is not the first time a pension client has sued Mr. Phillips. In 2000, the Metro Nashville Pension Plan filed an arbitration based on similar accusations. That arbitration was settled two years later, with UBS paying $10.3 million to the pension fund.

    As financial services conglomerates have added a wide array of operations in recent years, the possibility of conflicts of interest has also grown. And nowhere are the conflicts more potentially lucrative - and more obscure - than in the management of pension assets.

    "Recommendations to pension funds regarding asset allocation, money manager selection and securities brokerage policies are frequently driven by undisclosed financial arrangements," said Edward A. H. Siedle, president of Benchmark Financial Services Inc., in Ocean Ridge, Fla., and a former lawyer for the S.E.C. "Pensions often accept that poor investment performance is attributable to unfortunate investment assumptions when, in fact, more sinister forces were at work. Investment performance often is compromised as the result of conflicts of interest, undisclosed financial arrangements, excessive fees and fraud."

    An estimated $5 trillion sits in thousands of pension funds across the nation, run for the benefit of private company, state or municipal workers who rely on the funds for retirement income. Some funds are huge, with billions of dollars under management, and are overseen by a board of finance professionals. Many, however, are tiny, with just a few million dollars invested. These funds are often run by volunteers less versed in the ways of Wall Street.

    Pension fund boards typically hire a consultant to advise them on investment strategies and the hiring of money managers. Problems can crop up when these pension consulting firms, which have a fiduciary duty to the fund, put their own interests first.

    JUST as pension funds come in many sizes, so, too, do the consulting firms that serve them. Some are one-person operations while others work within a large financial-services firm. Among the biggest companies in pension consulting are Mercer Inc., a unit of Marsh & McLennan, and Callan Associates, a privately held company based in San Francisco.

    In recent years, however, Wall Street firms have played an increasingly large role in the world of pension consulting. Merrill Lynch, Smith Barney and Morgan Stanley are all big in this field.

    The potential for conflicts is greatest at firms with brokerage or trading operations, pension authorities say, and it almost always involves how the consultants are compensated.

    The trouble is, much of a consultant's pay can be hidden from view. The Chattanooga complaint said Mr. Phillips and his colleagues controlled and manipulated the information given to the pension board, keeping it in the dark about excessive fees and conflicts inherent in the recommendations they made to the fund. Mr. Phillips's reports on the pension fund's performance were misleading, the complaint said, because they did not take into consideration all of the fees and commissions it paid.

    Continued in article


    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

     


    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 FED versus the SEC:  Yet Another Example of Where Accounting Standards Are Not Neutral

    "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 

    When the Financial Accounting Standards Board released its exposure draft of new accounting rules for special-purpose entities (SPEs), in late 2002, the nation's financial regulators sent FASB chairman Robert H. Herz decidedly mixed signals.

    On the one hand, the Securities and Exchange Commission wanted Herz to make the rules effective as soon as possible. SPEs were the prime vehicle for the fraud that brought Enron down, and were widely used by other companies to take liabilities off their balance sheets, obscure their financial condition, and obtain lower-cost financing than they deserved. Not surprisingly, the SEC was anxious to head off other financial fiascos resulting from such abuse.

    At the same time, however, the Federal Reserve Board pressed Herz to slow down. That's because the new rules threatened to complicate the lives of the Fed's most important charges: large, multibusiness bank holding companies that happen to earn sizable fees by arranging deals involving SPEs. Stuck between this regulatory rock and hard place, Herz told the Fed and the SEC to get together and work out a timetable that satisfied both constituencies.

    And they did. But the rules, known as FIN 46 (FASB Interpretation No. 46), have only recently taken effect in some cases, and have yet to do so in others. While the delay in the rules' effective date may reflect the complexity of the transactions covered by FIN 46 as much as the controversy generated by the rules themselves, the conflict between the Fed and the SEC over the matter stems from a deeper problem: the Fed and the SEC have very different regulatory missions that can sometimes come into serious conflict.

    The problem surfaced in December 2002 during congressional hearings on the extensive role that certain banks—including Citigroup, J.P. Morgan Chase & Co., and Merrill Lynch & Co.—played in deceptive transactions involving Enron SPEs. Those hearings by the Senate Permanent Subcommittee on Investigations, led by Sen. Carl Levin (D-Mich.), identified what he and then­ranking minority member Sen. Susan M. Collins (R-Maine) termed "a current gap in federal oversight" of the banks that helped them aid and abet Enron's fraud. "The SEC does not generally regulate banks, and bank regulators do not generally regulate accounting practices overseen by the SEC," notes the report, which went on to say that this "is a major problem and needs immediate correction."

    That correction has yet to be made. The onus of doing so is on the Fed, as the chief regulator of the nation's financial system. Yet Fed chairman Alan Greenspan shows little inclination to do much about the problem.

    Yes, the markets have recovered from Enron, at least for the time being. But the penalties and other punishment that regulators meted out to the banks for their role in the fraud display at best a worrisome inconsistency. And that suggests that problems arising from the regulatory gap identified by senators Levin and Collins could recur. Unless the gap is closed, it could undermine other regulatory efforts aimed at improving corporate governance. That, in turn, might have a short-term impact on investor confidence, still fragile some two years after Enron's failure. And in the long term, future Enrons could slip through the gap undetected.

    If nothing else, the question of what should be done about it deserves a place on the agenda when the Senate considers Greenspan's nomination for a fifth term, as is expected after his current four-year stint ends in June.

    No Firewalls
    To be sure, both Citigroup and Chase agreed, after their role at Enron was exposed, to avoid new financing arrangements that pose similar legal and reputational risk. And under FIN 46, all deals involving SPEs must be disclosed on the balance sheet of either the bank, the borrower, or a third party. But it remains to be seen how effective the new rules will be in preventing future off-balance-sheet frauds (see "Longer Paper Routes").

    Complicating matters is the combination of commercial and investment banking and insurance blessed by the Gramm-Leach-Bliley Act of 1999, which ended the last vestiges of separation enacted by the Glass-Steagall Act and made the Fed the financial system's primary regulator. But while the central bank supervises private banks involved in these lines of business, including Citigroup and Chase, the Fed's primary interest isn't stopping financial fraud, but making sure the U.S. banking system remains safe and sound. "The Fed doesn't even believe in firewalls," says Dimitri B. Papadimitriou, president of the Levy Economics Institute at Bard College.

    Continued in the article


    From The Wall Street Journal Accounting Weekly Review on March 21, 2008

    SEC Aims to Let Firms Explain Crunch Thorns
    by David Reilly and Kara Scannell
    The Wall Street Journal

    Mar 14, 2008
    Page: C1
    Click here to view the full article on WSJ.com ---
    http://online.wsj.com/article/SB120545073858135101.html?mod=djem_jiewr_AC
     

    TOPICS: Accounting, Financial Accounting, GAAP, Mark-to-Market

    SUMMARY: The recent market turmoil is impacting companies with balance sheets full of marketable securities presented at low market values, and some parties suspect this is causing ripple effects throughout the economy. The SEC plans to tell companies that they can provide ranges for the values of securities that are difficult to gauge. The risk with this proposal is that companies could present overly rosy views of the losses they are facing. Under the plan, businesses will have the option of giving investors a sense of how values can swing -- providing a range of the possible deviations from the current market value. Companies could use those ranges to try to guide investors away from the harsh reality of the markets, lulling them into complacency.

    CLASSROOM APPLICATION: This article can be used in financial accounting classes on the topic of balance sheet presentation of securities. Obviously, mark-to-market accounting is a very timely issue. Rep. Barney Frank and other in Congress are concerned that mark-to-market accounting is causing a downward spiral in the economy. This article allows you to show students the issues related to mark-to-market accounting, and more broadly, how the financial accounting treatment of an aspect of a business can have ripple effects on the markets and the economy.

    QUESTIONS: 
    1. (Introductory) What is the general rule for valuing assets on the balance sheet? In what situations must assets be valued at market price instead?

    2. (Introductory) Why is market price not the general rule for presenting assets on the balance sheet?

    3. (Advanced) What is "mark-to-market accounting?" How is this accounting rule thought to be negatively impacting the U.S. economy? Do you find it surprising that accounting treatment of one class of assets could have these types of ripple effects?

    4. (Advanced) What option is the SEC offering to companies? Why is the SEC proposing this plan?

    5. (Advanced) What are some of the potential downsides to this plan? What are the advantages associated with this idea? Do you think that the advantages outweigh the disadvantages or vice versa?

    6. (Advanced) What additional information must companies include with the range of values for securities? Why would the SEC require this additional information?

    7. (Introductory) Do you think that if the SEC does adopt this proposed guidance that it will be a permanent adoption? Why or why not?
     

    Reviewed By: Linda Christiansen, Indiana University Southeast
     

    "SEC Aims to Let Firms Explain Crunch Thorns:  Market Prices Still Apply But Plan Offers Leeway; Risk of Too-Rosy Views, by DavReilly and Kara Scannell, The Wall Street Journal, March 14, 2008; Page C1 --- http://online.wsj.com/article/SB120545073858135101.html?mod=djem_jiewr_AC

    Just as companies are closing their books on another tumultuous quarter, regulators are working on a plan that would let them tell investors that things may not be as lousy as they seem.

    The Securities and Exchange Commission is expected to tell public companies that while they still need to use market prices for many of the instruments they hold no matter how bad those prices look, they can also give investors a wider range of the possible values for those securities.

    The guidance is aimed at giving investors more information about prices that are difficult to gauge because many markets have seized up in recent months. Some observers worry, though, that companies could use the opportunity to soften the blow of big losses in markets where the value of even safe securities have been battered by mortgage defaults, hedge-fund implosions, worries about inflation and recession fears.

    Chairman of the House Financial Services Committee Barney Frank, a Democrat from Massachusetts, says there is an urgent need to look at mark-to-market accounting because it's having a "downward pull" on the economy. Mr. Frank says he is in touch with regulators and will hold a hearing when Congress returns from break next month.

    The SEC move won't change the actual accounting for instruments torched by the credit crunch. In many cases, companies will still have to use market prices and so record big hits to profit, on instruments that some executives believe won't ultimately show long-term losses. But they will allow companies to give a range of alternatives in the text of their earnings reports.

    Until now, if a company said a security was worth X when the market priced it at Y, it risked running afoul of regulators, who could challenge its method for coming up with that alternative figure.

    The SEC plans to tell companies, as soon as next week, that they can provide ranges for the values that surround those market prices. But the agency, whose plans could change, is expected to suggest that companies explain how they've come up with the values, especially in cases where there isn't an active market for a security and, as a result, a model has to be used for pricing.

    The risk is that this could also allow companies to present overly rosy views of the losses they are facing. That could lull investors and analysts into a false sense of comfort, some fear, much in the same way overly optimistic assumptions about mortgage defaults spurred the current crisis.

    "It probably does give business some discretion and wiggle room," says James Cox, a securities-law professor at Duke University. "They're going to be able to describe a range of possible outcomes without going to the more-conservative outcome.

    "The minute you start introducing ranges and judgments, it's a fertile area for opportunistic behavior," Prof. Cox said. "I'm not against it, but we need to understand there will be instances of inappropriate or fraudulent behavior."

    Others argue investors are better off with more information, even if abuse is possible.

    "If management has a heartfelt judgment as to a range of values, investors might like to hear that," said Michael Young, a partner with Willkie Farr & Gallagher LLP who specializes in financial-reporting issues. "Can a range be manipulated? Sure. But a range communicates the imprecision of these numbers, and it's useful for investors to see the highly judgmental nature of the process."

    The SEC's soft-touch approach -- not backing off the use of market-value accounting while providing a way for companies to soften the blow of currently depressed prices -- echoes other recent efforts by the agency to alleviate market stress. In December, the SEC sent letters to more than a dozen financial institutions "reminding" them of their obligation to disclose a host of details about their exposure to off-balance-sheet financing vehicles.

    In January, the SEC's chief accountant took a more-controversial step, saying banks and mortgage companies could modify mortgages without triggering accounting rules that would put the debt onto the company's balance sheet. To address liquidity problems in the market for auction-rate securities, the SEC said Wednesday that local governments could buy their own debt. If governments step in, it can prevent auctions from failing and triggering high interest rates.

    The SEC's effort on mark-to-market disclosures is expected to come in the form of a letter that will be posted on the agency's Web site. It is timed to be sent by the end of the first quarter, which is when all companies need to comply with market-value measurement rules when using market prices for financial instruments.

    "It would be an appropriate time to remind people of their obligations and suggest what they might want to highlight in their report," said John Nester, a spokesman for the SEC.

    For instance, the SEC is considering recommending companies explain how they got the market-value number, disclose the extent to which that number depends on financial models, and provide the potential variability of that number, or how firm or sensitive to change it is, and a reasonable range.

    The SEC's guidance is seen as a precursor to a larger debate over how best to price securities, especially when markets freeze up. That comes amid a growing outcry among companies, as well as some regulators and investors, who say the use of such market values is exacerbating the current financial crisis.

    Two weeks ago, during testimony before the Senate banking committee, Federal Reserve Chairman Ben Bernanke noted his agency's unease over the use of mark-to-market accounting and said it is "one of the major problems we have in the current environment." But he added that there wasn't a clear alternative to the approach.

    Three Articles from the American Bankers Association on Fair Value Accounting (as of the end of 2007) --- http://www.cs.trinity.edu/~rjensen/Calgary/CD/FairValue/AmericanBankersAssn/

    Bob Jensen's threads on fair value accounting are at http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue

    Bob Jensen's threads on SPEs, VIEs, and FIN 46 are at http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm 


    The result is unwelcome distortions. It's clear, Henry said, that erroneous securities pricing can lead to poor capital allocations in an economy—not to mention investor disappointment with subsequent events. The data support the idea that media spin of financial results affects subsequent stock prices, Henry said. Yet, what causes media spin? Henry argued it isn't entirely clear that, as the authors posited, reporters put a positive spin on company earnings in an unspoken quid pro quo exchange for exclusive future information. That conclusion ignores an interpretation that financial analysts with investment banking ties are at least as beholden to companies as reporters. Indeed, Henry argued, "the analysts may be spinning the media" when reporters call for interpretation.
    Frederick Rose (See below)

    Bob Jensen Comment
    Media reporters walk a very fine line due to the possible causal impact of of errors in good news/bad news reports versus the impact of delay while checking for accuracy (e.g., insider dumping of shares due to delayed bad news reports).  Even an accurate reports may cause inequity due to the herd instinct of investors and automatic trigger point by and sell orders in computers.  For example, if the media leaks out that a drug company might receive an unfavorable FDA decision, shareholders may panic and sell to sharks like Carl Ichan (Icahn made over $250 million on panic sales of Imclone).  At the other extreme a good news report might send share prices into a bubble that greatly increases share prices to levels that cannot possibly be sustained in the long run.  The point is that media reports are not neutral, nor are they intended to be neutral in capital markets.  However, to the extent that these reports are false or misleading, the impact may be socially and economically damaging.  Even when accurate, they may incite overreactions.  It's tough to be a reporter and/or an editor when trying to be fair minded to the public.  It's also tough to uncover "truth" in a timely manner.

     

    From Enron to Earnings Reports, How Reliable is the Media's Coverage? --- http://www.gsb.stanford.edu/news/headlines/media_econ_perf_wkshop.shtml 

    By Frederick Rose

    FOR FURTHER INFORMATION: Helen K. Chang, 650-723-3358, Fax: 650-725-6750

    March, 2004

    STANFORD GRADUATE SCHOOL OF BUSINESS — When it comes to financial news, many of us are comforted by the image of a vigilant news media whose hounding reporters hammer executives, scour data for economic weakness around the world, and haunt factory gates for tell-all tales of troubles on the production line.

    The reality is very different, as academics and top reporters who covered some of the 1990s' greatest financial debacles outlined in papers and presentations at a March 5-6 Stanford University workshop on the media and economic performance. The sessions were organized by the Stanford Institute for International Studies with participation from faculty at the Stanford Graduate School of Business and visiting scholars from around the country.

    Consider the quarterly interactions at financial reporting time among publicly traded companies, financial analysts, and the press. "Who's spinning whom?" asked Peter Blair Henry, associate professor of economics at the Stanford Business School. "Are companies and analysts spinning the media, or do the media spin news as they see fit?" The issue is important when studying stock market reaction to corporate financial results, Henry noted in appraising work by Luigi Zingales of the University of Chicago and Alexander Dyck of Harvard University.

    Zingales and Dyck considered cases of earnings "surprises"—usually bad news. They asked whether companies influenced their share prices by emphasizing so-called "street earnings"—a calculation stripped of certain corporate costs—rather than full results under generally accepted accounting principles (GAAP). Zingales and Dyck found stock prices reacted strongly in the short run to the earnings type used in media reports. The media reports were in turn influenced by the order of presentation in quarterly financial press releases.

    The result is unwelcome distortions. It's clear, Henry said, that erroneous securities pricing can lead to poor capital allocations in an economy—not to mention investor disappointment with subsequent events. The data support the idea that media spin of financial results affects subsequent stock prices, Henry said. Yet, what causes media spin? Henry argued it isn't entirely clear that, as the authors posited, reporters put a positive spin on company earnings in an unspoken quid pro quo exchange for exclusive future information. That conclusion ignores an interpretation that financial analysts with investment banking ties are at least as beholden to companies as reporters. Indeed, Henry argued, "the analysts may be spinning the media" when reporters call for interpretation.

    Missing Big Stories
    If news media may play a misleading role over short periods, what about their ability to spot economic rot over time? Here, too, the news is not good, reporters from influential financial publications said in a separate panel discussion. In frank after-the-fact appraisals from the reporting trenches, panelists explored oversights, flaws, and outright failure in the now-classic case of Enron Corp. and, on an even larger, international scale, the Russian stock and currency crisis of 1998.

    Few foreign journalists watched 1990s Russia as closely as Edward Lucas, who spent the decade reporting for the British newspaper The Independent, the British Broadcasting Corporation, and later The Economist. Lucas said Russia was seen with a skewed eye during the era, thanks to a misled "hurrah chorus" of diplomats, bankers, investors, and journalists. "We were all grateful for the downfall of Communism," Lucas noted. Russia was mislabeled a recovering first world economy rather than the developing nation it was. "It was assumed that Russia was too big to fail," he said.

    After the first sharp contractions with the fall of the Soviet regime in 1989 and the early 1990s, Russia's economic decline appeared to slow. A speculative stock bubble built with an onrush of Western funds. While a patina of comfort cosseted a privileged few in Moscow, the lives of ordinary Russians were often in ruin. A barter economy erupted in which workers peddled goods such as tires stolen from their workplaces for foodstuffs stolen from farms. Incipient civil war lingered.

    Yet reporters from Western media failed to sound an alarm. More speculative investment funds poured in month after month from the West. For the media, at least some of the problem was institutional—a cadre of head-office foreign editors whose views of Russia had been shaped during reporting stints in the Cold War era of the 1970s and 1980s, Lucas said. The idea of impending economic collapse in a free, capitalist Russia "just wasn't the music they wanted to hear," Lucas said.

    "Accent the positive" was the guiding principle for all Westerners in Russia, said Bill Powell, a Newsweek reporter at the time. He said investment bankers—in Moscow to drum up business—told him "with a straight face" that the sight of starving coal workers trying to trade coal for food was evidence of an admirable entrepreneurial spirit alive and well within Russian society. Powell recalled writing about Russian soldiers who committed suicide because they weren't being paid and couldn't feed their families. "I wrote it and yet I did not explicitly connect the insight that this was a society so out of control that almost no one paid their taxes," he said.

    For much of the 1990s Russia's gross domestic product contracted. Unemployment soared, and often those who had jobs weren't properly compensated. It was estimated that just 40 percent of the nation's workforce was paid in full and on time. In August 1998, the Russian government floated the ruble, defaulted on its domestic debt, and declared a 90-day moratorium on commercial bank payment to foreign creditors. In many ways, the government was acknowledging what was already reality. In the first eight months of 1998, the stock market had plunged 75 percent in value. Exports of oil, natural gas, and other raw materials—which strikingly accounted for nearly half of all of Russia's output—continued to prop up the economy, but domestic demand fell nearly 8 percent through 1998 and investment tumbled 28 percent that year, according to International Monetary Fund figures. Yet much of this was unnoted in the Western press.

    The Russian case perhaps comprised sins of omission. Domestic financial news has been increasingly contorted by sins of commission, journalists said. Richard Waters, West Coast director for the London-based Financial Times, noted a rapid sharpening of corporate public relations expertise. "It's amazing how much better companies have gotten at telling reporters what they want to tell them," said Waters, who added that "the amount of spin in the financial world certainly has come to rival that in Washington."

    New PR Tactics
    "It's no secret that journalists trade access for soft treatment," Waters noted. And corporate PR increasingly has taken advantage of this. Forgoing usually wasted efforts to soften up reporters by socializing, public relations practitioners are using more nuanced techniques—both of carrot and stick. "Access is the carrot," said Waters, but now "bullying of the media has gone to new heights." Waters said he "has seen companies go out of their way to besmirch good reporters" by calling publishers and network executives to complain about coverage.

    Against this trend, journalists must struggle "to keep ourselves in line, asking tough questions." The Financial Times now is seeking to counter some of the public relations strategies by using "specialist reporters" skilled in financial analysis and other tools to ferret out stories that otherwise might be missed and back up the day-to-day coverage.

    At Enron, there were missed leads aplenty, said Bethany McLean, a senior writer at Fortune magazine credited with an early article questioning the strength of Enron's structure. McLean is the co-author with Peter Elkind of The Smartest Guys in the Room, a study of fraud and financial foibles at what was once one of the nation's most admired companies.

    As McLean pointed out, her Fortune article, "Is Enron Overpriced?" appeared in March 2001. Yet in 1993 an article in Forbes sharply questioned Enron's troubling mark-to-market accounting for assets, which claimed profits for investments long before it was clear that they would in fact evolve. A few years later, an article in Fortune again signaled concern. Some of this information sat in very public litigation material that might have alerted other journalists, McLean said. But "all of this disappeared from the radar screen" and "by the late 1990s, all of that had been forgotten," she added.

    "Enron was a perfect story that everybody wanted to believe," McLean noted. In 2001, Jeffrey Skilling, then president of Enron, "famously said that the company's brand new, money-losing broadband trading operation was already worth over $36 billion—and the Wall Street analysts believed him." McLean's own publication joined the parade. "Unfortunately in 2001, we fell victim to this; completely forgetting all the work that went before, we published a really positive story about Enron." In fact, said McLean, mere months before the company declared bankruptcy, "you would have been really hard pressed to find any sharp story about Enron."

    Only when a talkative Wall Street short-seller, betting against companies' stock rising, spotted an analysis of Enron's mark-to-market accounting in a Texas regional edition of the Wall Street Journal did a tip start floating that journalists should focus more sharply on the company. That was an insight that McLean picked up and ran with, relying on her own skills as a former Goldman, Sachs & Co. financial analyst to pick through the company. And so the first red flag of Enron's final months was raised.

    Chance brought in one of two Wall Street Journal reporters who would finally crack the Enron puzzle. John Emshwiller, a senior national correspondent and one of the paper's most skilled investigative reporters, happened to be on weekend duty in June 2001 when Skilling, Enron's storied strategist, resigned suddenly. It was a shocking move that would draw national attention the following week. "Not only that, but Enron had cited 'family' reasons for Skilling's departure—which was pretty odd because Skilling was divorced," Emshwiller noted dryly.

    Emshwiller was lucky. Skilling returned a Sunday call from Emshwiller, something that executives who resign suddenly rarely do. Skilling, who seemed in a confessional mood, had run into a skilled questioner and analyst. "It was one of the strangest interviews I've ever had," recalled Emshwiller, who is the coauthor with Rebecca Smith of 24 Days, a study of the two reporters' work during the surprisingly swift downfall of Enron.

    Emshwiller elicited from Skilling an odd admission that he likely would have resigned if Enron's stock price hadn't been falling. The reporter quickly wrote the first, questioning piece about Skilling's resignation, which ran in the next day's Wall Street Journal. But there was more. In putting together a story on a company he knew little about, Emshwiller's analytical eye was drawn to a mention of partnerships that seemed peculiar. This later became the base for further study and stories. And then came a series of calls from a mysterious company insider "who led us into the darker side of Enron," Emshwiller recounted.

    The darker side of corporate life was too little explored by the media in the 1990s, some workshop presentations hinted. In an emerging study of "CEO Superstars," Ulrike Malmendier, assistant professor of finance at the Business School, suggested that the media not only missed and misreported elements of the world's economic boom in the 1990s but also was inclined to glorify many of the wrong people. In an analysis of various awards, cover stories, and kudos accorded by such financial magazines as Business Week, Fortune, and Financial World, Malmendier found that companies led by superstar CEOs, after a brief jump in stock price, saw share values dwindle two years out.

    An excited question interrupted Malmendier's presentation. "Do you mean to say that I should short stocks led by winners of these awards?" an audience member asked Malmendier. "Yes," she said, adding that her results are still very preliminary and that work continues.

    — Frederick Rose

     

     


    The AIG Mess --- http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout


    "Medical Bills Driving Most Middle-Class Bankruptcies: Private insurance isn't covering costs as promised, report's authors say," HealthDay News via Forbes, June 4, 2009 ---
    http://www.forbes.com/feeds/hscout/2009/06/04/hscout627785.html

    June 4 (HealthDay News) -- In 2007, medical problems and expenses contributed to nearly two-thirds of all bankruptcies in the United States, a jump of nearly 50 percent from 2001, new research has found.

    Since the data used in the study were collected prior to the current economic downturn, it's likely that the current rate of medical-related bankruptcies is even higher, said the researchers at Harvard Law School, Harvard Medical School and Ohio University.

    They randomly surveyed 2,314 bankruptcy filers in early 2007 and found that 77.9 percent of those bankrupted by medical problems had health insurance at the start of the bankrupting illness, including 60 percent who had private coverage.

    Most of those bankrupted by medical problems were "solidly middle class" before they suffered financial disaster -- two-thirds were homeowners and three-fifths had gone to college. In many cases, these people were hit at the same time by high medical bills and loss of income as illness forced breadwinners to take time off work. It was common for illness to lead to job loss and the disappearance of work-based health insurance.

    The study also found that well-insured families often had to cope with high out-of-pocket medical costs for co-payments, deductibles and uncovered services. Medical bills for medically bankrupt families with private insurance averaged $17,749, compared to $26,971 for the uninsured and $22,568 for those who initially had private coverage but lost it during their illness.

    The highest average costs were incurred by people with diabetes ($26,971) and neurological disorders ($34,167), the researchers found.

    Hospital bills were the largest single expense for about half of all medically bankrupt families, while prescription drugs were the largest expense for 18.6 percent, according to the study in the August issue of the American Journal of Medicine, which was published online June 4.

    "Our findings are frightening. Unless you're Warren Buffett, your family is just one serious illness away from bankruptcy," lead author Dr. David Himmelstein, an associate professor of medicine at Harvard Medical School, said in a news release from the Physicians for a National Health Program.

    "For middle-class Americans, health insurance offers little protection. Most of us have policies with so many loopholes, co-payments and deductibles that illness can put you in the poorhouse. And even the best job-based health insurance often vanishes when a prolonged illness causes job loss -- precisely when families need it most. Private health insurance is a defective product, akin to an umbrella that melts in the rain," Himmelstein said.

    The findings show that, as a nation, "we need to rethink health reform," added study co-author Dr. Steffie Woolhandler, an associate professor of medicine at Harvard Medical School and a primary care physician.

    "Covering the uninsured isn't enough. Reform also needs to help families who already have insurance by upgrading their coverage and assuring that they never lose it. Only single-payer national health insurance can make universal, comprehensive coverage affordable by saving the hundreds of billions we now waste on insurance overhead and bureaucracy," Woolhandler said in the news release.

    "Unfortunately, Washington politicians seem ready to cave in to insurance firms and keep them and their counterfeit coverage at the core of our system. Reforms that expand phony insurance -- stripped-down plans riddled with co-payments, deductibles and exclusions -- won't stem the rising tide of medical bankruptcy," Woolhandler concluded.

    More information

    The American Academy of Family Physicians has more about health insurance.

    Bob Jensen's threads on insurance fraud are at http://faculty.trinity.edu/rjensen/FraudRotten.htm#Insurance

     


    The SEC and Eliot Spitzer (bless his heart) launched probes into sales by insurance firms of products that help customers burnish results.  Industry executives say companies can reap distinct accounting benefits by obtaining loans dressed up as insurance products. Under U.S. generally accepted accounting principles, companies are allowed to use insurance recoveries to offset losses on their income statements -- often without disclosing them. To qualify as insurance under the accounting rules, financial contracts must involve a significant transfer of risk from one party to another.

    "Fresh Probes Target Insurers' Earnings Role," by Theo Francis and Jonathan Weil, The Wall Street Journal, November 8, 2004, Page C1 --- http://online.wsj.com/article/0,,SB109988032427267296,00.html?mod=home_whats_news_us 

    The Securities and Exchange Commission and New York Attorney General Eliot Spitzer each have launched investigations into sales by insurance companies of questionable financial products that help customers burnish their financial statements, according to people familiar with the matter.

    The SEC's enforcement division is conducting an industrywide investigation into whether a variety of insurance companies may have helped customers improperly smooth their earnings by selling them financial-engineering products that were designed to look like insurance but in some cases were little more than loans in disguise, people familiar with the matter say. The agency is focusing on a universe of products that are intended to achieve desired accounting results for customers' financial statements, as opposed to traditional insurance, whose primary goal is transferring risk of losses from a policyholder to the insurer selling the coverage.

    Meanwhile, New York state investigators are preparing to issue subpoenas as soon as this week to several large insurance companies. After months of combing through industry documents in its continuing probe of insurance-broker compensation, Mr. Spitzer's office has grown increasingly concerned about insurance-industry products, detailed in The Wall Street Journal last month, that customers can use to manipulate their income statements and balance sheets.

    Although Mr. Spitzer's office and the SEC began looking into the issue separately, they have discussed sharing information and resources, according to a person familiar with the probes.

    Normally, an insurer is paid a specific amount of premiums to take on a risk of uncertain size and timing. In the "insurance" at issue, the risk of loss to the insurer selling the policy is limited and sometimes even eliminated -- partly because, in these policies' simplest form, the premiums are so high; other times, the loss already has occurred.

    Industry executives say companies can reap distinct accounting benefits by obtaining loans dressed up as insurance products. Under U.S. generally accepted accounting principles, companies are allowed to use insurance recoveries to offset losses on their income statements -- often without disclosing them. To qualify as insurance under the accounting rules, financial contracts must involve a significant transfer of risk from one party to another.

    Continued in the article

    Bob Jensen's threads on off balance sheet debt schemes are at http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm 


    From The Wall Street Journal Accounting Weekly Review on June 13, 2008

     

     
    SEC, Justice Scrutinize AIG on Swaps Accounting
    by Amir Efrati and Liam Pleven
    The Wall Street Journal

    Jun 06, 2008
    Page: C1
    Click here to view the full article on WSJ.com ---
    http://online.wsj.com/article/SB121271786552550939.html?mod=djem_jiewr_AC
     

    TOPICS: Advanced Financial Accounting, Auditing, Derivatives, Fair Value Accounting, Internal Controls, Mark-to-Market Accounting

    SUMMARY: The SEC "...is investigating whether insure American International Group Inc. overstated the value of contracts linked to subprime mortgages....At issue is the way the company valued credit default swaps, which are contracts that insure against default of securities, including those backed by subprime mortgages. In February, AIG said its auditor had found a 'material weakness' in its accounting. Largely on swap-related write-downs...AIG has recorded the two largest quarterly losses in its history."

    CLASSROOM APPLICATION: Financial reporting for derivatives is at issue in the article; related auditing issues of material weakness in accounting for these contracts also is covered in the main article and the related one.

    QUESTIONS: 
    1. (Introductory) What are collateralized debt obligations (CDOs)?

    2. (Advanced) What are credit default swaps? How are these contracts related to CDOs?

    3. (Advanced) Summarize steps in establishing fair values of CDOs and credit default swaps.

    4. (Introductory) What is a material weakness in internal control? Does reporting write-downs of such losses as AIG has shown necessarily indicate that a material weakness in internal control over financial reporting has occurred? Support your answer.
     

    Reviewed By: Judy Beckman, University of Rhode Island
     

    RELATED ARTICLES: 
    AIG Posts Record Loss, As Crisis Continues Taking Toll
    by Liam Pleven
    May 09, 2008
    Page: A1
     


    "SEC, Justice Scrutinize AIG on Swaps Accounting," by Amir Efrati and Liam Pleven, The Wall Street Journal,  June 6, 2008; Page C1 ---
    http://online.wsj.com/article/SB121271786552550939.html?mod=djem_jiewr_AC

    The Securities and Exchange Commission is investigating whether insurer American International Group Inc. overstated the value of contracts linked to subprime mortgages, according to people familiar with the matter.

    Criminal prosecutors from the Justice Department in Washington and the department's U.S. attorney's office in Brooklyn, New York, have told the SEC they want information the agency is gathering in its AIG investigation, these people said. That means a criminal investigation could follow.

    In 2006, AIG, the world's largest insurer, paid $1.6 billion to settle an accounting case. Its stock has been battered because of losses linked to the mortgage market. The earlier probe led to the departure of Chief Executive Officer Maurice R. "Hank" Greenberg.

    Officials for AIG, the SEC, the Justice Department and the U.S. attorney's office declined to comment on the new probe. A spokesman for AIG said the company will continue to cooperate in regulatory and governmental reviews on all matters.

    At issue is the way the company valued credit default swaps, which are contracts that insure against default of securities, including those backed by subprime mortgages. In February, AIG said its auditor had found a "material weakness" in its accounting.

    Largely on swap-related write-downs, which topped $20 billion through the first quarter, AIG has recorded the two largest quarterly losses in its history. That has turned up the heat on management, including CEO Martin Sullivan.

    AIG sold credit default swaps to holders of investments called collateralized-debt obligations, or CDOs, backed in part by subprime mortgages. The buyers were protecting their investments in the event of default on the underlying debt. In question is how the CDOs were valued, which drives both the value of the credit default swaps and the amount of collateral AIG must "post," or essentially hand over, to the buyer of the swap to offset the buyer's credit risk.

    AIG posted $9.7 billion in collateral related to its swaps, as of April 30, up from $5.3 billion about two months earlier.

    Law Blog: Difficulties in Valuation 'Best Defense'

    Bob Jensen's threads on credit derivatives (scroll down) --- http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms


    "Insurance Investigations Under Way Over Fees," by Josephe B. Treaster, The New York Times, April 24, 2004 --- http://www.nytimes.com/2004/04/24/business/24insure.html 

    Two new investigations have been opened into the insurance industry, industry executives and officials said yesterday. Both focus on incentives and other fees paid by insurance companies to commercial insurance brokers.

    In New York, the office of Eliot Spitzer, the state attorney general, has issued subpoenas to the country's three biggest insurance brokers: Marsh Inc., the world's largest broker and a unit of the Marsh & McLennan Companies, which is based in New York; Willis Group Holdings, also in New York; and Aon, a Chicago company that ranks immediately behind Marsh in size. The three companies, which account for most of the commercial insurance brokerage business, all confirmed receiving the subpoenas.

    In California, John Garamendi, the insurance commissioner, said last night that he was looking into potential conflicts of interest in several insurance brokerage companies across the country but declined to identify the targets.

    At issue in the investigations are payments made by insurance companies to brokers for exceeding targets on the sale of policies and for providing consulting services. Although the payments have been a routine practice for many years in the industry, it is not clear whether the payments are in fact legal. Regulators and industry analysts say the costs of the bonuses are passed on to customers; there is concern, too, that customers may be getting inappropriate insurance.

    Some experts say the payments are only illegal when they are not disclosed to customers, but the Washington Legal Foundation, a nonprofit research organization that brought the situation to the attention of investigators, says that, in any case, they raise questions about whether a broker's recommendations are honest and unbiased.

    In a letter, the foundation noted a statement by the New York State Department of Insurance to brokers and insurance companies in 1998 saying that a failure of a broker to disclose the payments from insurance companies may be a violation of New York state insurance law "as a dishonest or untrustworthy practice.'' Through a spokesman, Gregory V. Serio, the superintendent of insurance in New York, declined to comment on the investigations.

    Over the years, the risk managers who buy insurance for major corporations have expressed concerns about the insurance company payments. But neither regulators nor investigators have taken action until now.

    In raising questions about the practice, Mr. Garamendi said that "the broker is presumed to work on behalf of the customer and the bonuses or commissions for volume sales, especially, can be a conflict in that they may cause the broker to divert business to an insurance company that may not provide the best deal for the insurance customer.''

    Marsh, Aon and Willis Group Holding said the subpoenas demanded information on "compensation agreements" between them and the insurance companies that sell policies to American corporations.

    In its statement, Aon, noted that the payments that Mr. Spitzer was investigating were "a long-standing practice within the insurance industry," adding that "many major carriers have these agreements with brokers."

    Vinay Saqi, an analyst at Morgan Stanley, said in a note to investors earlier this year that the payments from insurance companies accounted for 2 to 6 percent of brokers' revenue. Most of the rest of the brokers' money comes from fees paid by corporate customers.

    Continued in article


    Largest Health Care Scam Ever: Fake Genetic Testing Result Scheme Results in $2.1 Billion in Medicaid Losses ---
    https://www.newsweek.com/largest-health-care-scam-ever-fake-genetic-testing-result-scheme-results-21-billion-medicaid-1461901

    Jensen Comment
    Essential to the scheme were unbelievably greedy doctors.


    Questions
    What is one of the most frightening thing about universal health care patterned after Medicare/Medicaid at all ages?

    Answer
    Increased opportunity for massive fraud.

    Link forwarded by Rose
    "Blatant Medicare fraud costs taxpayers billions Officials say outrageous fraud schemes are 'off the charts'," by Mark Potter, MSNBC, December 11, 2007 --- http://www.msnbc.msn.com/id/22184921/from/ET/

    On an FBI undercover tape, the fraud was plain to see: A patient came to a South Florida AIDS clinic, signed some papers, walked into an office and was handed $150 in cash. She politely thanked the workers and left, her visit to the doctor finished without ever receiving any treatment.

    According to records seized by investigators, the office staff (who was assured of the patient's cooperation) used her name to fraudulently bill Medicare for a list of expensive treatment and medications.

    Law enforcement officials said it's just one of the many widespread, organized and lucrative schemes to bilk Medicare out of an estimated $60 billion dollars a year — a staggering cost borne by American taxpayers.

    Officials say the array of criminals running these schemes are stealing blatantly from the social safety net that cares for 43 million seniors and the disabled, and along the way are hurting honest patients, physicians and legitimate businesses.

    "These people have absolutely nothing to do with health care," said Kirk Ogrosky, a prosecutor with the U.S. Justice Department. "They're thieves that would be committing other types of crimes if they weren't committing Medicare fraud."

    Outrageous fraud called "off the charts" While Medicare fraud is a national scourge, found primarily in large urban areas, federal authorities said the very worst of it these days is in South Florida— particularly in Miami-Dade County.

    Most of these schemes, they said, are found in the cities of Miami and Hialeah, where they are often concentrated in parts of the Cuban immigrant community.

    After visiting the region, and seeing the extent of the fraud, Michael Leavitt, the U.S. Secretary of Health and Human Services, said, "In a decade and a half of public service, this was the most disheartening, disgusting day I have ever spent. We have to fix this."

    A recent report by the inspector general for the Department of Health and Human Services noted that 72 percent of the Medicare claims submitted nationwide for HIV/AIDS treatment in 2005 came from South Florida alone. That percentage is of great concern to authorities, since only eight percent of the country's HIV/AIDS Medicare beneficiaries actually live in South Florida, a clear indication that the level of fraud was, as one official put it, "off the charts."

    To attack the fraud, the Justice Department this year set up a strike force at a remote office park near Miami, and in just six months prosecutors filed 74 cases charging 120 people with allegedly trying to steal $400 million from Medicare.

    While officials claimed the concentrated law enforcement efforts led to a $1.4 billion drop in Medicare billing in the area (another clear indication of the phony nature of many of the earlier claims), they said they have still barely scratched the surface of the fraud schemes involving bogus clinics, fake medicines, and illegitimate medical supply companies.

    "The problem is far from solved," said Timothy Delaney, a supervisor for the FBI's Miami office. "For every one owner we arrest, another one pops up, maybe even two, tomorrow. It's so lucrative that we have yet to turn the tide."

    Illegal billing for non-existent medical equipment One of the most common schemes is the illicit billing for DME, or durable medical equipment, such as oxygen generators, breathing machines, air mattresses, walkers, orthopedic braces and wheelchairs. This scheme involves billions of dollars a year in illegal claims.

    Raul Lopez, the president of the Florida Association of Medical Equipment and Services and the director of a legitimate medical supply company, said the fraud is so widespread it hurts the many valid DME companies, which are struggling to compete.

    "We're here providing services to patients that need healthcare services, and as a result of the fraud our industry is suffering enormously," he said.

    Unlike real DME companies, which have showrooms, warehouses, public offices, trained staff and professional record-keeping, the fraudulent companies are usually shell companies with shadowy business practices, hidden owners, and tiny, locked offices which are only there to create the illusion of legitimacy. They rarely have any medical products for actual sale or delivery.

    "They're lined up in hallways one after the other, office after office with a locked door, no foot traffic, no employees, no medical equipment," said Ogrosky. "We're talking about billing that goes up in the tens of millions of dollars for places that don't exist."

    FBI agents looking for suspected front-companies that Medicare records show are actively billing rarely find much to search. "We often don't see places. We find vacant lots, we see mailboxes, we see an office suite shared by 30 companies. We're not finding legitimate companies where we can go in and do a search warrant," said Delaney.

    On a recent trip to some shopping centers and office buildings in the Miami area, FBI agents Brian Waterman and Christopher Macrae knocked on the doors of several purported medical supply companies. Most of the offices were locked during business hours, with no signs of any activity. Calls to the offices went unanswered.

    Referring to one of the closed offices, Waterman said, "The amount of money in dollars that this company is billing for in the last month are close to a half million dollars. We're just trying to find out what they're billing for and what they're doing."

    Continued in article

    Bob Jensen's fraud updates are at http://faculty.trinity.edu/rjensen/FraudUpdates.htm


    The Trial Bar:  The Crookest of Them All

    The alleged conspiracy flows from litigation after Hurricane Katrina. The Scruggs Law Firm established a tort consortium called the Scruggs Katrina Group to shake down the insurance industry for not paying enough in claims, even though most homeowner policies excluded flood damage. Not atypically, a dispute emerged between Mr. Scruggs and one of the group's attorneys, John Griffin Jones, over how to divide the $26.5 million in attorneys' loot from a mass settlement with State Farm Insurance Co. According to the indictment, after Jones v. Scruggs moved to court, Mr. Scruggs attempted to buy off presiding circuit court Judge Henry Lackey. Judge Lackey reported the bribery overture and assisted with an FBI investigation. Presumably the Judge wore a wire, since the U.S. Attorney's case so far seems based largely on evidence gathered from secret conversations.
    "The Trial Bar on Trial," The Wall Street Journal, November 30, 2007 --- http://www.opinionjournal.com/editorial/feature.html?id=110010925


    "Feds Now Say Dreier Bilked Investors Of $380 Million," Liz Moyer, Forbes, December 12, 2008 ---
    http://www.forbes.com/2008/12/11/legal-fraud-dreier-biz-wall-cx_lm_1211dreier_print.html

    Prosecutors have expanded their investigation of prominent New York attorney Marc Dreier, uncovering hundreds of millions more of missing funds in what they characterize as an "extraordinary" fraud played out over two years.

    A federal magistrate judge ordered Dreier to remain behind bars Thursday, denying bail because of the "enormous risk of flight." Dreier was arrested in New York Sunday evening and has been charged with fraud in an alleged brazen scheme to bilk sophisticated hedge funds.

    Assistant U.S. Attorney Jonathan Streeter said in court Thursday the loss from the alleged fraud is $380 million, well more than the $113 million cited in criminal charges filed Monday because of new information pouring into the prosecutor's office.

    The alleged fraud has been carried out since at least January 2006, Streeter said, and targeted some of the most sophisticated institutional investors. Dreier, a Harvard and Yale-educated litigator with a roster of celebrity clients at the 238-attorney firm he founded in 1996, is a "Houdini of impersonation and false pretenses," Streeter said at Thursday's bail hearing.

    Dreier's lawyer, Gerald Shargel, had asked that Dreier be released on a $10 million bond signed by Dreier's 19-year-old son and 85-year-old mother and allowed to live under house arrest at his beach home in Quogue, N.Y., or at his Manhattan apartment.

    Shargel also told Judge Douglas Eaton that Dreier was prepared to meet with the court-appointed receiver of the Dreier LLP law firm Thursday evening to help identify and locate assets and would provide a complete financial statement. None of Dreier's money is overseas, he said.

    But Streeter successfully argued the government's case that Dreier could have squirreled away substantial assets overseas. Much of the $380 million is unaccounted for, he said. With his firm in tatters and his U.S. property to be seized--and with overwhelming evidence against him--Dreier had nothing to lose by skipping out of the country, he said.

    Prosecutors initially accused Dreier of selling $113 million of fake notes to two hedge funds in October in an elaborate scheme that involved forgery and ruse. Canadian law enforcement arrested Dreier last week alleging he impersonated the senior counsel of a major Canadian pension fund to effect a similar scheme.

    The evidence now shows the activity may have targeted many more hedge funds over a far longer period of time, Streeter says.

    On top of that, employees and partners of the Dreier law firm learned last week that tens of millions were missing from client escrow accounts and other firm accounts.

    Dreier even managed to transfer $10 million by telephone from escrow accounts to his personal account last Thursday while sitting in a Canadian jail awaiting a bail hearing, the documents say.

    Dreier, the only equity partner, is the only person authorized to make transfers from the escrow accounts, according to court documents. A statement by a Dreier law partner says $37.5 million of $38 million attributed to a single client had been transferred from the firm's escrow accounts into an account controlled by Dreier, but the statement didn't give a time frame for that transfer.

    The tip-off about the missing funds was a request by a Dreier partner, Norman Kinel, to Dreier to disburse $38 million in client escrow funds for unsecured creditors of 360 Networks, a Seattle telecommunications company that emerged from bankruptcy in 2002. The Dreier firm represents the unsecured creditors.

    Kinel first requested the funds on Dec. 1. On Dec. 2, when he realized the transfer hadn't been made, he twice requested the funds again. He learned of Dreier's arrest on Dec. 3 and, through a lawyer, contacted the Federal Bureau of Investigation and the U.S. attorney.

    John Provenzano, the law firm's controller, said in the court documents that at the time of Kinel's request, the escrow accounts had only $19 million in them.

    Dreier was in contact with partners at the firm last week, according to the court documents. Asked about the missing escrow funds for 360 Networks, Dreier is reported to have said he could have sold some of the art collection to return the money if he had been allowed to return to New York.

    "I understood from his conversation that Mr. Dreier was implicitly admitting he had improperly used client escrow funds," says the court declaration by Joel Chernov, one of the partners at Dreier who was on that phone call.

    Dreier's world started collapsing in October, his lawyer said, when an accounting firm employee told him he would go to the police after finding out Dreier allegedly falsified accounting materials using the firm's name as part of his scheme.

    Even then, his lawyer argued, Dreier left the U.S. a few times and came back, compelling evidence that he was not a flight risk. He traveled to Dubai on business in October and to St. Bart's in the Caribbean right before Thanksgiving, "knowing full well his life was unraveling," Shargel said. He had a private plane available to him in Canada last week but decided to fly commercial back to the U.S., where authorities were waiting at LaGuardia Airport to arrest him.

    Dreier led an opulent, jet-setting life by most reports, with several homes and a 120-foot yacht. Now he sits in a maximum security wing of the federal prison in Manhattan, where he has no books, no television and no visitors. His lawyer asked the judge Thursday to at least have him moved to a more suitable part of the prison. "You could lose your mind in there," Shargel argued.

    Bob Jensen's fraud updates are at http://faculty.trinity.edu/rjensen/FraudUpdates.htm


    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

     


    Lawyers Like the Subprime Litigation Cash Cow

    "The finger of suspicion," The Economist, December 19, 2007 --- http://www.economist.com/finance/displaystory.cfm?story_id=10337884

    FINANCIAL firms have already been drenched by mortgage-related losses. Now a wave of litigation threatens to assail them. According to RiskMetrics, a consulting firm, between August and October federal securities class-action lawsuits were filed in America at an annualised pace of around 270—more than double last year's total and well above the historical average. At this rate, claims could easily exceed those of the dotcom bust and options-backdating scandal combined.

    At most risk are banks that peddled mortgages or mortgage-backed securities. Investors have handed several writs to Citigroup and Merrill Lynch. Bear Stearns has received dozens over the collapse of two leveraged hedge funds. A typical complaint accuses it of failing to make adequate reserves or to explain the risks of its subprime investments, and of dubious related-party transactions with the funds. Several firms, including E*Trade, a discount broker with a banking arm sitting on a radioactive pile of mortgage debt, are being sued for allegedly failing to disclose problems as they became apparent to managers.

    But one thing that sets the subprime litigation wave apart from that of the 2001-03 bear market is its breadth. After the collapses of Enron and WorldCom, lawsuits were targeted at a fairly narrow range of parties: bust internet firms, their accountants and some banks. This time, investors are aiming not only at mortgage lenders, brokers and investment banks but also insurers (American International Group), bond funds (State Street, Morgan Keegan), rating agencies (Moody's and Standard & Poor's) and homebuilders (Beazer Homes, Toll Brothers et al).

    Borrowers, too, are suing both their lenders and the Wall Street firms that wrapped up their loans. Several groups of employees and pension-fund participants have filed so-called ERISA/401(k) suits against their own firms. Local councils in Australia are threatening to sue a subsidiary of Lehman Brothers over the sale of collateralised-debt obligations (CDOs), the Financial Times has reported. Lenders are even turning on each other; Deutsche Bank has filed large numbers of lawsuits against mortgage firms, claiming they owe money for failing to buy back loans that soured within months of being made.

    “It seems that everyone is suing everyone,” says Adam Savett of RiskMetrics' securities-litigation group. “It surely can't be long before we get the legal equivalent of man bites dog, where a lender sues its borrowers for some breach of contract.”

    Continued in article


    Lawyers Love Asbestos Fraud

    "DJ's Free Pass for Tort Fraud," by Lester Brickman, The Wall Street Journal, December 26, 2007; Page A11 --- http://online.wsj.com/article/SB119863054713149915.html?mod=opinion_main_commentaries
     

    The defects of the U.S. Department of Justice have been the subject of much commentary. But the allegations of incompetence or worse pale when compared to the free pass it has given to doctors and lawyers to commit mass tort fraud, exceeding $30 billion in the past 15 years.

    Over one million potential litigants have been screened by agents for tort lawyers in asbestos, silica, silicone breast implant and diet drug (fen-phen) litigation. The lawyers sponsoring these screenings have paid over $100 million for medical reports to support the 700,000 or more claims generated by these screenings. There is compelling evidence, much of it reviewed in my published writings, that the vast majority of these medical reports, including chest X-ray readings, echocardiograms, pulmonary function tests and diagnoses are bogus.

    U.S. District Court Judge Janis Jack, appointed by President Bill Clinton, blew the whistle on this type of fraud two years ago. It was, she stated, "clear that lawyers, doctors and screening companies were all willing participants . . . [in a scheme to] manufacture . . . [diagnoses] for money."

    For a while, it appeared that Judge Jack's extensively documented findings would spur law enforcement to curb mass tort fraud. Indeed, the U.S. Attorney's Office for the Southern District of New York, which launched an investigation of fraudulent asbestos claims more than three years ago, was invigorated by Judge Jack's findings to empanel a grand jury.

    But it now appears as if neither this U.S. Attorney's Office nor the parent Department of Justice is going to prosecute mass tort fraud. Six months ago there were signs that Justice was moving forward on some key cases involving one or more of the litigation doctors. Now, unfortunately, that activity appears to have all but ceased.

    The dimensions of this fraud are stunning. An asbestos screening of 1,000 potential litigants generates about 500-600 diagnoses of asbestosis. If these same occupationally exposed workers were examined in clinical settings, approximately 30-50 would be diagnosed with asbestosis. The total take for "excess" asbestos diagnoses is more than $25 billion, of which $10 billion has gone to the lawyers. More billions for bogus claims in the diet drug (fen-phen) and silicone breast implant litigations can be added to this bill.

    A comparative handful of doctors and technicians are responsible for the vast majority of bogus medical tests and diagnoses. To indict and prosecute those responsible would require testimony from other doctors that the mass-produced diagnoses cannot have been rendered in good faith.

    To be sure, doctors can differ in reading X-rays or making a diagnosis. But when a doctor has been paid millions of dollars to produce 5,000 or even 50,000 diagnoses in the course of mass-tort screenings -- and when panels of experts have found the vast majority of these to be in error -- the most compelling conclusion is that the diagnoses were "manufactured for money."

    Prosecutors on the federal and state level are nonetheless concerned that such a "battle of the experts" will raise reasonable doubt in the minds of juries, and so they decline to prosecute these doctors, let alone the lawyers who hired them. This decision, however, gives the doctors a special dispensation to commit fraud.

    Asbestos litigation screenings ceased about four years ago when it appeared that the Congress would create an administrative resolution of asbestos claims, and Judge Jack's findings attracted prosecutorial interest. But now that it has become clear that this Department of Justice has retired from the mass-tort fray, temptations are proving too powerful to resist.

    A few weeks ago, a full-scale asbestos litigation screening was held in Bartlesville, Okla. Lawyers may be dipping their toes in the water to see if prosecutors will respond.

    If so, they will find that the tepid response of this Justice Department is just what their doctors ordered. We can then expect a resumption of the generation of bogus claims on a mass scale. This would indeed be a shameful reflection on this or any Department of Justice.

    Mr. Brickman is a professor of law at the Cardozo School of Law of Yeshiva University.


    Credit Rating Agencies Became Corrupt to the Core

    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


    Credit Rating Firms --- http://en.wikipedia.org/wiki/Credit_rating_firms
    Credit Rating Firms are rotten to the core --- http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies

    From the CFO Journal's Morning Ledger on March 10, 2016

    Moody’s to pay Calpers $130 million to settle lawsuit
    Moody’s Investors Service has agreed to pay $130 million to end a prominent lawsuit alleging crisis-era misconduct, a record settlement for the world’s second-largest ratings firm. The California Public Employees’ Retirement System alleged in a 2009 lawsuit that Moody’s and two other ratings firms made “negligent misrepresentations” when they awarded rosy grades to residential mortgage bonds that later soured.


    "CREDIT RATING AGENCIES: USELESS TO INVESTORS," by Anthony H. Catanch Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, June 6, 2011 --- http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/113

    "Ending the Credit Ratings Racket:  Seven years after the financial crisis, the SEC enacts a critical reform," The Wall Street Journal, September 18, 2015 ---
    http://www.wsj.com/articles/ending-the-ratings-racket-1442615384?mod=djemMER

    America’s financial system is sturdier today thanks to some rare good news from a Washington regulator. Seven years after the financial crisis, the Securities and Exchange Commission has taken a big step toward ending a policy that helped cause the mess.

    For decades before the crisis, SEC staff had recognized a small group of private credit-rating agencies—including Standard & Poor’s, Moody’s and Fitch—as official judges of risk. Federal regulators referred to these favored companies in their rules and even forced financial institutions to invest in paper rated highly by this anointed cartel.

    When the members of the cartel turned out to be wrong about the risks in mortgage-backed securities, the result was catastrophic because the government had forced so many other firms to follow their advice.

    The new rule enacted by the commission this week says that instead of simply holding assets rated highly by the cartel, the operators of money-market mutual funds must instead rely on their own analysis to select securities presenting minimal credit risk. Investors probably assume that’s what mutual fund companies do already, and many of them do. All of them should.

    Kudos to SEC Commissioner Daniel Gallagher, who has the welcome habit of breaking Beltway decorum. In various public fora, Mr. Gallagher kept reminding his colleagues that this needed reform was being ignored while they went about drafting rules that had nothing to do with addressing the causes of the last crisis or preventing the next one.

    This week’s reform leaves one SEC rule that still carries an endorsement of the ratings cartel—so-called Regulation M for securities offerings. SEC Chair Mary Jo White should now get her agency all the way out of the business of deciding whose opinions about credit risk ought to be followed. Let markets decide whose opinions have value. It will make financial crises less likely.

    There’s also need for reform outside Washington. Too many state pension systems still show too much deference to the cartel. A rating expresses a point of view, not a guarantee.

    Continued in article

     
    Credit Rating Firms Were Rotten to the Core:  At last the DOJ is taking some action (Bailout, Credit Rating Agendies, Agencies, Banks, CDO, Bond Ratings, CDO. Auditing, Fraud)
    citation:
    "DOJ vs. Rating Firms,"  by David Hall, CFO.com Morning Ledger, February 5, 2013
    journal/magazine/etc.:
    CFO.com Morning Ledger
    publication date:
    Februry 5, 2013
    article text:

    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

    "CREDIT RATING AGENCIES: USELESS TO INVESTORS," by Anthony H. Catanch Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, June 6, 2011 --- http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/113

    In 2008 it became evident that credit rating firms were giving AAA ratings to bonds that they knew were worthless, especially CDO bonds of their big Wall Street clients like Bear Stearns, Merrill Lynch, Lehman Bros., JP Morgan, Goldman, etc. ---
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze

     

    The Advantage of a Shredded Paper Trail
    From the CFO Morning Ledger Newsletter on February 11, 2012

    S&P left paper trail, but not Moody’s. The reason the DOJ may be going after Standard & Poor’s and not rival Moody’s may be because S&P left a paper trail and Moody’s didn’t. Former Moody’s employees tell the WSJ that Moody’s took careful steps to avoid creating a trove of potentially embarrassing employee messages like those that came back to haunt S&P in the U.S.’s lawsuit. Moody’s analysts had limited access to instant-message programs and were directed by executives to discuss sensitive matters face to face. The crackdown on communications came after a 2005 investigation by then-New York Attorney General Eliot Spitzer into Moody’s ratings on some mortgage-backed deals.

    Bob Jensen's threads on the credit rating agency scandals ---
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze

    Credit Rating Firms --- http://en.wikipedia.org/wiki/Credit_rating_firms
    Credit Rating Firms were rotten to the core --- http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies

    In 2008 it became evident that credit rating firms were giving AAA ratings to bonds that they knew were worthless, especially CDO bonds of their big Wall Street clients like Bear Stearns, Merrill Lynch, Lehman Bros., JP Morgan, Goldman, etc. ---
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze

    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

    "CREDIT RATING AGENCIES: USELESS TO INVESTORS," by Anthony H. Catanch Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, June 6, 2011 --- http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/113

     

    "DOJ vs. Rating Firms,"  by David Hall, CFO.com Morning Ledger, February 5, 2013

    The government is taking its get-tough-on-Wall-Street stance to the next level with the DOJ’s lawsuit against Standard & Poor’s. The suit alleges that S&P from September 2004 through October 2007 “knowingly and with the intent to defraud, devised, participated in, and executed a scheme to defraud investors in” CDOs and securities backed by residential mortgages, the WSJ reports at the top of A1 today. The two sides have been discussing a possible settlement for months, but the penalties the DOJ was targeting – more than $1 billion – made S&P squeamish. The firm was also worried that if it admitted wrongdoing, as the DOJ wanted, that could leave it vulnerable to other lawsuits.

    S&P and other rating firms have argued in the past that their opinions are protected by the First Amendment — and judges have thrown out dozens of suits based on that argument, the Journal says. This case will test that argument against the Justice Department’s view that the First Amendment wouldn’t protect a ratings firm if it defrauded investors by ignoring its own standards.

    Neil Barofsky, the former inspector general for the Troubled Asset Relief Program, said the DOJ move looks like an effort to get “some measure of accountability” for the financial crisis, which was “something that’s been really lacking across the board.” And Jeffrey Manns, a law professor at George Washington University, tells Reuters that the suit sends a message to “the rating industry at large that the government is serious about holding rating agencies responsible, and that they must be much more careful.”

    http://online.wsj.com/public/page/cfo-journal.html

    Jensen Comment
    The DOJ actions do not worry the credit rating firms nearly so much as the hundreds of billions of potential tort lawsuits awaiting in the wings, lawsuits by damaged investors who relied on those phony credit ratings.

    The credit rating firms, in turn, will blame CPA audit firms who gave clean audit opinions on junk.

    Bob Jensen's threads on the credit rating agency scandals ---
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze

     

    Where were the auditors?
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

     


    "CREDIT RATING AGENCIES: USELESS TO INVESTORS," by Anthony H. Catanch Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, June 6, 2011 --- http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/113


    Question
    Auditing firms sign independent audit reports certifying conformance with GAAP on financial statements. Suppose that in an effort to avoid being sued by certain users of financial statements, the CPA firms ban the association of their names and audit reports for certain types of uses of those financial statements, e.g., the auditor's name cannot be associated with financial statements used for mergers and acquisitions?

    From The Wall Street Journal Accounting Weekly Review on July 23, 2010

    Bond Sale? Don't Quote Us, Request Credit Firms
    by: Anusha Shrivastava
    Jul 21, 2010
    Click here to view the full article on WSJ.com

    TOPICS: Bonds, Financial Reporting

    SUMMARY: The nation's three dominant credit ratings providers-Standard & Poor's, Moody's Investors Service, and Fitch Ratings--are all "...refusing to allow their ratings to be used in documentation for new bond sales...The landmark Dodd-Frank financial reform law... will make ratings firms liable for the quality of their ratings decisions, effective immediately. The companies say that, until they get a better understanding of their legal exposure, they are refusing to let bond issuers use their ratings.... Once the bill is signed into law, advice by the services will be considered "expert" if used in formal documents filed with the Securities and Exchange Commission. That definition would make them legally liable for their work, meaning that it will be easier to sue a firm if a bond doesn't perform up to the stated rating. That is a change from the current law, which considers ratings merely an opinion, protected like any other media such as a newspaper."

    CLASSROOM APPLICATION: The article is useful to help students understand the role of ratings agencies and may be used when introducing bond issuances or simply as part of discussing current events with the passage of the Dodd-Frank Financial Reform Law.

    QUESTIONS: 
    1. (Advanced) What does a bond rating agency do? How does a ratings agency participate in the financial reporting process? How is its work beyond the scope of the financial reporting process? In your answer, define the term "financial reporting."

    2. (Introductory) What did the Dodd-Frank financial reform law include as a provision regarding the work of ratings agencies? Why was that provision included in this new law?

    3. (Introductory) Why have the bond rating agencies "refused to let bond issuers use their ratings"? How has that impacted corporations planning to obtain bond financing?

    4. (Advanced) If the bond ratings cannot be used in bond offerings, how are these ratings used?

    Reviewed By: Judy Beckman, University of Rhode Island

    RELATED ARTICLES: 
    Law Remakes U.S. Financial Landscape
    by Damina Paletta and Aaron Lucchetti
    Jul 16, 2010
    Page: A1

    "Bond Sale? Don't Quote Us, Request Credit Firms," by: Anusha Shrivastava, The Wall Street Journal, July 21, 2010 ---
    http://online.wsj.com/article/SB10001424052748704723604575379650414337676.html?mod=djem_jiewr_AC_domainid

    The nation's three dominant credit-ratings providers have made an urgent new request of their clients: Please don't use our credit ratings.

    The odd plea is emerging as the first consequence of the financial overhaul that is to be signed into law by President Obama on Wednesday. And it already is creating havoc in the bond markets, parts of which are shutting down in response to the request.

    Standard & Poor's, Moody's Investors Service and Fitch Ratings are all refusing to allow their ratings to be used in documentation for new bond sales, each said in statements in recent days. Each says it fears being exposed to new legal liability created by the landmark Dodd-Frank financial reform law.

    The new law will make ratings firms liable for the quality of their ratings decisions, effective immediately. The companies say that, until they get a better understanding of their legal exposure, they are refusing to let bond issuers use their ratings.

    That is important because some bonds, notably those that are made up of consumer loans, are required by law to include ratings in their official documentation. That means new bond sales in the $1.4 trillion market for mortgages, autos, student loans and credit cards could effectively shut down.

    There have been no new asset-backed bonds put on sale this week, in stark contrast to last week, when $3 billion of issues were sold. Market participants say the new law is partly behind the slowdown.

    "We are at a standstill right now," said Bingham McCutchen partner Ed Gainor, who specializes in asset-backed securities.

    Several companies are shelving their bond offerings "indefinitely," according to Tom Deutsch, executive director of the American Securitization Forum, which represents the market for bonds backed by assets such as auto loans and credit cards. He said he knew of three offerings scheduled for coming weeks that are now on hold.

    The change caught the ratings agencies by surprise. The original Senate version of the bill didn't include the provision. It was only on June 30, when the Dodd-Frank bill was passed, that the exemption was removed. The Senate passed the amended version on July 15. The offices of Sen. Christopher Dodd (D-Conn.) and Rep. Barney Frank (D-Mass.) didn't immediately respond to a request for comment.

    Rating firms have warned that sections of the legislation concerning ratings' firms legal liability could cause them to pull back from certain parts of the market.

    In an April 21 conference call, Moody's Chief Executive Raymond McDaniel told investors that "we remain concerned that the bill's liability provisions would lead to unintended consequences that could negatively impact the credit markets."

    If greater liability provisions were passed, he continued, "we would implement appropriate changes."

    He added that Moody's, a unit of Moody's Corp., would rethink whether it still made sense in a new regulatory environment to give ratings "for as many small and perhaps marginal issuers as possible."

    The confusion comes as investors, bankers and ratings companies across Wall Street seek to digest the intricacies of the new law, the most sweeping since the 1930s. The overhaul touches on virtually every part of the financial-services world, part of an effort by lawmakers to head off another financial crisis.

    Ratings providers became a lightning rod for criticism after the financial crisis. Their overly rosy assessments of many bonds, particularly complex securities and bonds backed by subprime mortgages, were blamed for helping fuel the meltdown of the credit markets.

    In response, the Dodd-Frank bill revamped how the government treated credit-ratings firms, which receive a special government designation that allows them certain privileges and market access

    Once the bill is signed into law, advice by the services will be considered "expert" if used in formal documents filed with the Securities and Exchange Commission. That definition would make them legally liable for their work, meaning that it will be easier to sue an firm if a bond doesn't perform up to the stated rating.

    That is a change from the current law, which considers ratings merely an opinion, protected like any other media such as a newspaper.

    Prior to the Dodd-Frank bill, issuers were allowed to include the description of the ratings in the offering documents without the consent of the rating firms. Now, they will have to get written permission. And the rating providers are concerned that giving such consent exposes them to liability they haven't been exposed to in the past.

    Unlike many parts of the larger financial-overhaul bill, these changes go into effect as soon as it is signed into law. The speed of the move has spooked the three firms.

    All issued statements in recent days saying they will continue to issue bond ratings. But they said they won't allow those ratings to be used in formal documents accompanying bond sales, known as prospectuses and registration statements.

    One solution to the logjam is for sellers of bonds to offer their deals privately. That means they would offer ratings that can be used in private transactions but not in deals registered with the SEC and sold to the general public. The private market is much smaller and more expensive than the public one.

    On Friday, S&P, a unit of McGraw-Hill Cos., issued a release saying it would "explore mechanisms outside of the registration statement to allow ratings to be disseminated to the debt markets."


    Teaching Case
    From The Wall Street Journal Weekly Accounting Review on June 25, 2010

    Legal Fights Loom over Ratings-Firm Liability Rule
    by: Jeannette Neumann
    Jun 18, 2010
    Click here to view the full article on WSJ.com

    TOPICS: Corporate Governance, Disclosure, Disclosure Requirements, Financial Reporting, Legal Liability, Securitization

    SUMMARY: "A panel of Senate and House lawmakers negotiating final details of a financial-overhaul bill agreed this week to allow investors to bring legal action against credit-rating firms that 'knowingly or recklessly' fail to 'conduct a reasonable investigation of the rated security.'" At least one legal analyst comments that the questions of "recklessly" and "reasonable" are likely to be the subjects of a string of lawsuits before their definitions are settled.

    CLASSROOM APPLICATION: The three articles in this week's review all cover issues in disclosure and other corporate governance matters. All three articles are useful in any financial accounting or ethics course covering corporate social responsibility and governance issues. This article in particular continues coverage of the financial reform legislation stemming from the U.S. financial crisis.

    QUESTIONS: 
    1. (Introductory) What is the purpose of credit-rating firms such as McGraw-Hill Cos. Standard & Poor's Corp. and Moody Corp.'s Moody's Investors Service?

    2. (Introductory) What is the role that these entities are considered to have played in the financial crisis? (Hint: see the related article to answer this question.)

    3. (Advanced) What will be the implication of allowing "investors to bring legal action against credit-rating firms..."?

    4. (Advanced) Why would "ratings firms 'fear litigation more than they fear regulation'"?

    Reviewed By: Judy Beckman, University of Rhode Island

    RELATED ARTICLES: 
    Buffett to Testify to Crisis Panel on Moody's
    by Aaron Lucchetti
    May 27, 2010
    Online Exclusive

     

    "Legal Fights Loom over Ratings-Firm Liability Rule," by: Jeannette Neumann, The Wall Street Journal, Jun 18, 2010 ---
    http://online.wsj.com/article/SB10001424052748703650604575313153186936336.html?mod=djem_jiewr_AC_domainid

    Credit-rating firms are a big step closer to facing a harsher liability standard on their work. But it could take years for courts to decide what the planned rules mean.

    A panel of Senate and House lawmakers negotiating final details of a financial-overhaul bill agreed this week to allow investors to bring legal action against credit-rating firms that "knowingly or recklessly" fail to "conduct a reasonable investigation of the rated security."

    The new standard, if passed into law, likely would make it easier for investors to sue the ratings companies, such as McGraw-Hill Cos.' Standard & Poor's and Moody's Corp.'s Moody's Investors Service, which for long have enjoyed near immunity from liability for ratings gone awry.

    But "what an 'investigation' is in this context is not an easy question," said Jonathan Macey, a professor of corporate governance and securities regulation at Yale Law School. "You're going to spend tons of time litigating that question."

    Ratings firms and others studying the industry have maintained a tougher legal standard will come at a price. For one, companies may increase the cost of rating debt to balance the risk of litigation, said Joseph Mason, a professor of finance at Louisiana State University.

    Ratings firms "fear litigation more than they fear regulation" because past regulation efforts haven't "been that draconian," said Scott McCleskey, a former Moody's compliance officer who has testified before Congress about the industry. He is now working at Complinet Inc. as managing editor, North America.

    The new liability standard "strikes the right balance," Mr. McCleskey said, because it makes it easier for investors to sue credit-rating agencies, but it doesn't open the floodgates for a slew of lawsuits.

    Representatives of the three major credit-rating firms, including Fitch Ratings, a unit of Fimalac SA, didn't immediately comment.

    The news comes as the industry had a win in the Capitol Hill negotiations—a proposed delay in implementation of a quasigovernment board that would assign initial ratings for structured-finance bonds.

    Rating firms had resisted the idea, and members of a conference committee on Wednesday agreed that the Securities and Exchange Commission should study whether to establish the entity, which would be designed to address potential conflicts of interest in the credit-ratings business.

    Under the new plan, the SEC would be required to implement the proposed new board unless it determines that an alternate mechanism is more appropriate.

    As for the higher liability standard, industry critics say it is high time the credit rating firms faced one. Raters were blamed for catalyzing the housing bubble by assigning their highest ratings to billions of dollars of financial products that later turned out to be worthless.

    The credit rating agencies have invoked the First Amendment, largely with success, when faced with claims that their ratings were too high or too low. The First Amendment cannot protect the ratings companies from claims of fraud, lawyers say. But plaintiffs have a high legal hurdle to establish that a firm issued a fraudulent rating.

    The credit rating agencies are "essentially liability proof and it's not because they're infallible," said Columbia Law School professor John Coffee, who helped craft the liability standard for the Senate bill, the version that was eventually chosen this week by the conference committee.

    The goal of the new standard is to "make litigation a credible deterrent" by creating an incentive for the firms to step up due diligence measures, said Mr. Coffee. While some maintain that the phrase a "reasonable investigation" is unclear, Mr. Coffee says that if a rating company hires a due diligence firm to vet the data they are using for their rating, that should stand up in court as a "reasonable investigation."

    Would the new standard have helped prevent the credit crisis? Not necessarily, said Mr. Macey, the Yale professor. "I don't think it would have significantly altered the probability of having this debacle" because the firms are still so tightly-knit into the financial system, he said. "It fails that litmus test."

    The agreement on the liability standard is set to be included in a conference report to be sent to the House and the Senate for final approval. The provision could still be altered before a final compromise.


    Question
    Can any of you identify the mystery "Fraud Girl" who will be writing a weekly (Sunday) column for Simoleon Sense?

    Hint
    She seems to have a Chicago connection and seems very well informed about the blog posts of Francine McKenna.
    http://retheauditors.com/
    But I really do know know who is the mystery "Fraud Girl."

    "Guest Post: Fraud Girl Says, “Regulators, Ignore the Masses — It’s Your Responsibility!!”
    (A New SimoleonSense Series on Fraud, Forensic Accounting, and Ethics)

    Simoleon Sense, April 25, 2010 --- Click Here
    http://www.simoleonsense.com/guest-post-fraud-girl-says-regulators-ignore-the-masses-it%e2%80%99s-your-responsibility-must-follow-series-on-fraud-forensic-accounting-and-ethics/
     

    I’m exceptionally proud to introduce you to Fraud Girl, our new Sunday columnist. She will write about all things corp governance, fraud, accounting, and business ethics. To give you some background (and although I can not reveal her identity). Fraud girl recently visited me in Chicago for the Harry Markopolos presentation to the local CFA. We were incredibly lucky to meet with Mr. Markopolos  and enjoyed 3 hours of drinks and accounting talk. Needless to say Fraud Girl was leading the conversation and I was trying to keep up. After a brainstorm session I persuaded her to write for us and teach us about wall street screw-ups.

    So watch out, shes smart, witty, and passionate about making the world a better place. I think Sundays just got a lot better…

    Miguel Barbosa
    Founder of SimoleonSense

    P.S. For Questions or Comments:  Reach fraud girl at:    FraudGirl@simoleonsense.com 

    Regulators, Ignore the Masses — It’s Your Responsibility

    Men in general judge more by the sense of sight than by the sense of touch, because everyone can see but only a few can test feeling. Everyone sees what you seem to be, few know what you really are; and those few do not dare take a stand against the general opinion, supported by the majesty of the government. In the actions of all men, and especially of princes who are not subject to a court of appeal, we must always look to the end. Let a prince, therefore, win victories and uphold his state; his methods will always be considered worthy, and everyone will praise them, because the masses are always impressed by the superficial appearance of things, and by the outcome of an enterprise. And the world consists of nothing but the masses; the few have no influence when the many feel secure.

    -Niccolo Machiavelli, The Prince

    Why are Machiavelli’s words so astonishingly prophetic? How does a 500 year old quote explain contagion, bubbles, and Ponzi schemes? Do financial decision makers consciously overlook reality or do they merely postpone due diligence? That is the purpose of this series — to analyze financial fraud(s) and question business ethics.

    Recent accounting scandals i.e. Worldcom, Enron, Madoff, reveal a variety of methods for boosting short term performance at the expense of long run shareholder value. WorldCom recorded bogus revenue, Enron boosted their operating income through improper classifications, and Madoff ran the largest Ponzi scheme in history. Sure these scandals were unethical, deceived the public, and made a ton of money. But what is the most striking similarity? Each of these companies was seen as the golden goose egg; an indestructible force that could never fail. Of course, the key word is “seen”, regulators, attorneys, financial analysts, and auditors failed to see reality. But why?

    Fiduciaries are entrusted with protecting the public and shareholders from crooks like Skilling, Pavlo, and Schrushy. An average shareholder lacks the knowledge and expertise of a prominent regulator, right? Shareholders don’t perform the company’s annual audit, review all legal documentation, or communicate with top executives. No, shareholders base their decisions off information that is “accurate” and “meticulously examined”.

    Unfortunately in each of these instances regulators failed to take a stand against consensus and became another ignorant face in the crowd. “Everyone sees what you seem to be, few know what you really are; and those few do not dare take a stand against the general opinion”. Who are the few that really know who these companies are? The answer should be evident. What isn’t clear is why these cowardly few are in charge of overseeing our financial markets.

    When Auditors Look The Other Way

    A week ago, I came across this article: Ernst & Young defends its Lehman work in letter to clients. I chuckled as I was reading it, remembering Roxie Hart from the play Chicago shouting the words “Not Guilty” to anyone who would listen. Like Roxie, the audit team pleaded that the media was inaccurate. In recording Lehman’s Repo 105 transactions, they claimed compliance with GAAP and believed the financial statements were ‘fairly represented’. But, fair reporting is more than complying with GAAP. Often auditors are “compliant” while cooking the books (a mystery that still eludes me). In this case, the auditors blatantly covered their eyes and closed their ears to what they must have known was deliberate misrepresentation of Lehman Brother’s financial statements.

    We will explore the Lehman Brothers fiasco in next week’s post…but here’s the condensed version. Days prior to quarter end, Lehman Brothers used “Repo 105” transactions, which allowed them to lend assets to others in exchange for short-term cash. They borrowed around $50 Billion; none of which appeared on their balance sheet. Lehman instead reported the debt as sales. They used the borrowed cash to pay down other debt. This reduced both their total liabilities and total assets, thereby lowering their leverage ratio.

    This was allegedly in compliance with SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities that allowed Lehman to move the $50 Billion of assets from its balance sheet. As long as they followed the rules, auditors could stamp [the] financial statements with a “Fairly Represented” approval and issue an unqualified opinion.

    Clearly in this case complying was unethical and probably illegal. Howard Schilit, the author of Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, once said, “You [the auditor] work for the investor, even though you are paid by someone else”. He insists that auditors should look beyond the checklists and guidelines and should instead question everything. Auditors are the first line of defense against fraud and the shareholders are dependent upon the quality of their services. So I ask again, with respect to Lehman Brothers, were the auditors working for the investors or where they in the pockets of senior management?

    What can we do?

    An admired value investor believes in a similar tactic for confirming the honesty of companies. It’s known as “killing the company”, where in his words, “we think of all the ways the company can die, whether it’s stupid management or overleveraged balance sheets. If we can’t figure out a way to kill the company, then you have the beginning of a good investment”. Auditors must think like this, they must kill the company, and question everything. If you can’t kill a company, then (and only then) are the financial statements truly a fair representation of the firms operations.

    There was no “killing” going on when the lead auditing partner said that his team did not approve Lehman’s Accounting Policy regarding Repo 105s but was in some way comfortable enough with them to audit their financial statements. This engagement team failed in looking beyond SFAS 140 and should have realized what every law firm (aside from one firm in London) was stating; that the accounting methods Lehman Brothers used to record Repo 105s were a deliberate attempt to defraud the public.

    So I repeat: Ignoring reality is not an option. Ignoring the crowd, however, is an obligation.

    See you next week….

    -Fraud Girl

    Bob Jensen's threads on fraud are linked at
    http://faculty.trinity.edu/rjensen/Fraud.htm

    Bob Jensen's Fraud Updates are at
    http://faculty.trinity.edu/rjensen/FraudUpdates.htm

    Bob Jensen's threads on accounting news are at
    http://faculty.trinity.edu/rjensen/AccountingNews.htm


    "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 banks and brokerages ---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking

    Bob Jensen's Fraud updates ---
    http://faculty.trinity.edu/rjensen/FraudUpdates.htm


    "KPMG chief calls for audit reform," by Mario Christodoulou, Accountancy Age, June 18, 2010 ---
    |http://www.financialdirector.co.uk/accountancyage/news/2264982/kpmg-chief-calls-audit-reform
    Thank you to David Albrecht for the heads up.

    KPMG’s senior partner has added his voice to growing calls for reform to audit in the wake of the crisis.

    In a speech at the ICAEW on Wednesday John Griffith-Jones he said it is was time for “really bold thinking” about the future of audit.

    He suggested auditors might work “collaboratively” with regulators and rating agencies, along with boards and management to discuss risk.

    “What is the point, they and others ask, of doing extensive and increasingly elaborate audits of the financial accounts of our banks, when audits failed to identify the huge and systemic risks which led to the near collapse of the Global banking system in the Autumn of 2008?” he said.

    “It is a straightforward question; It deserves a straightforward answer.”

    It followed an earlier call from PwC senior partner Ian Powell to reform the audit model.

    “The overall model is long overdue some serious market-wide discussion. For me, the fundamental questions revolve around the scope of the audit; should this be extended and the nature of audit reporting extended with it,” he said in an April speech to ICAS members.

    Also in April, Graham Clayworth, audit partner at BDO, said the profession needed to consider providing assurance around a company’s business model and risks, typically, “front of the book” disclosures.

    “We have to ask what comfort the auditor can give in terms of the information that is in the front… “The concession that the profession will have to make for additional liability limits will be to extend work that the auditor does at the front of the book,” said.


    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

    1. Pay cash under the table to credit rating agencies
    2. Promise a particular credit rating agency future multi-million contracts for rating future issues of bonds
    3. 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


    Ketz Me If You Can
    "CPA Firms and Credit Rating Agencies," by J. Edward Ketz, Smartpros, June 2010 ---
    http://accounting.smartpros.com/x69608.xml

    My father-in-law tells the story about when he was a young lad the cows wandered into the garlic patch; he drank the milk and gagged. While milk and garlic are great, they weren't meant to be combined. In the same way, I wonder why some are thinking about combining accounting firms and credit rating agencies.

    The Financial Times ran the story on May 16.  In particular, the reporters claimed that KPMG and PwC were evaluating whether to enter the world of credit rating, even quoting John Griffith Jones from KPMG that the firm was in fact “passively considering it.”  PwC’s Richard Sexton added that CPA firms were always looking for ways to grow their business.

    My first reaction was obvious—wouldn’t this relationship create a conflict of interest?  The auditor examines the accounting reports and attests the assertions by management contained in those reports.  A credit rating agency takes the quantitative and qualitative disclosures in the accounting reports—and other information—and evaluates the entity’s ability to repay the credit obligations on a timely basis.  An enterprise that engaged in both tasks might be pulled to give a thumbs up for some accounting shenanigan to assure it received the fees of both audit and credit rating activities, rationalizing that it could always downgrade the firm’s rating. 

    If you think such rationalization is impossible, consider the strategic decisions made by Arthur Andersen in their Waste Management audit, as well as some of the others.  To his credit, Mr. Jones acknowledged these conflicts of interest.

    Let’s also review the structure of the audit process and the credit rating evaluation process.  The audit firm is paid by the firm it audits.  In today’s world, the credit rater is paid by the company it evaluates.  Before the 1970s, this was not true; in fact, today’s conflicts of interest were avoided when rating agencies made their money by selling the information to investors.  (See my essays on the
    performance of credit raters and on the SEC study of credit rating agencies.)

    Notice that both business models are the same: revenues come from the party being evaluated.  While neither structure is ideal, the audit process works as well as it does because securities laws allow aggrieved investors to sue auditors if it appears the auditor did not perform an adequate job.  It isn’t perfect, but at least these disincentives help align the interests of auditors with the interests of the investment community
    .

    Continued in article

    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

    1. Pay cash under the table to credit rating agencies
    2. Promise a particular credit rating agency future multi-million contracts for rating future issues of bonds
    3. 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 »

     


    "One Cheer for Barney Frank:  The credit raters lose their oligopoly," The Wall Street Journal, December 23, 2009 ---
    http://online.wsj.com/article/SB10001424052748703523504574603983503610564.html

    The House-passed rewrite of financial regulation is a disappointment for investors and taxpayers. But one portion of the bill represents significant reform—and a vast improvement from an early draft we described in October.

    Congressmen Barney Frank and Paul Kanjorski (D., Pa.) have produced legislation that would likely end the credit-ratings racket enjoyed by Standard & Poor's, Moody's and Fitch. During the housing bubble, these government-anointed judges of credit risk slapped their triple-A ratings on billions of dollars of mortgage-backed securities. The consequences for investors were catastrophic.

    The Frank-Kanjorski provision that recently passed the House not only eliminates all laws that require the use of these "Nationally Recognized Statistical Ratings Organizations." The bill also instructs all the major financial regulators to remove such requirements from their rules. This is a subtle but enormously important change from the October draft, because most of the federal edicts that guaranteed profits for S&P and the gang were contained in agency rules, not laws.

    The House-passed bill also repeals an exemption that credit-raters have enjoyed from the Securities and Exchange Commission's Regulation Fair Disclosure. No longer will they have access to corporate information that is denied to average investors.

    Also removed from the bill was a bizarre "joint liability" scheme in which all the credit raters would be responsible for each other's work, so that a bad report by Fitch could be grounds for a lawsuit against Moody's. Unable to restrain themselves entirely from bestowing gifts upon trial lawyers, House Democrats have instead increased liability for the raters on their own work.

    The Senate should avoid such public display of affection toward the plaintiffs bar but embrace the House language that strikes at the heart of the ratings cartel. Obliterating investor requirements to use credit-ratings agencies would amount to major reform all by itself. Perhaps the House and Senate should simply agree on that, pass a bill now, and then start over with a new mission for regulatory reform: break up the too big to fail racket.

    Bob Jensen's threads on the history of credit rater scandals ---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies


    "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

    As the housing market collapsed in late 2007, Moody's Investors Service, whose investment ratings were widely trusted, responded by purging analysts and executives who warned of trouble and promoting those who helped Wall Street plunge the country into its worst financial crisis since the Great Depression.

    A McClatchy investigation has found that Moody's punished executives who questioned why the company was risking its reputation by putting its profits ahead of providing trustworthy ratings for investment offerings.

    Instead, Moody's promoted executives who headed its "structured finance" division, which assisted Wall Street in packaging loans into securities for sale to investors. It also stacked its compliance department with the people who awarded the highest ratings to pools of mortgages that soon were downgraded to junk. Such products have another name now: "toxic assets."

    As Congress tackles the broadest proposed overhaul of financial regulation since the 1930s, however, lawmakers still aren't fully aware of what went wrong at the bond rating agencies, and so they may fail to address misaligned incentives such as granting stock options to mid-level employees, which can be an incentive to issue positive ratings rather than honest ones.

    The Securities and Exchange Commission issued a blistering report on how profit motives had undermined the integrity of ratings at Moody's and its main competitors, Fitch Ratings and Standard & Poor's, in July 2008, but the full extent of Moody's internal strife never has been publicly revealed.

    Moody's, which rates McClatchy's debt and assigns it quite low value, disputes every allegation against it. "Moody's has rigorous standards in place to protect the integrity of ratings from commercial considerations," said Michael Adler, Moody's vice president for corporate communications, in an e-mail response to McClatchy.

    Insiders, however, say that wasn't true before the financial meltdown.

    "The story at Moody's doesn't start in 2007; it starts in 2000," said Mark Froeba, a Harvard-educated lawyer and senior vice president who joined Moody's structured finance group in 1997.

    "This was a systematic and aggressive strategy to replace a culture that was very conservative, an accuracy-and-quality oriented (culture), a getting-the-rating-right kind of culture, with a culture that was supposed to be 'business-friendly,' but was consistently less likely to assign a rating that was tougher than our competitors," Froeba said.

    After Froeba and others raised concerns that the methodology Moody's was using to rate investment offerings allowed the firm's profit interests to trump honest ratings, he and nine other outspoken critics in his group were "downsized" in December 2007.

    "As a matter of policy, Moody's does not comment on personnel matters, but no employee has ever been let go for trying to strengthen our compliance function," Adler said.

    Moody's was spun off from Dun & Bradstreet in 2000, and the first company shares began trading on Oct. 31 that year at $12.57. Executives set out to erase a conservative corporate culture.

    To promote competition, in the 1970s ratings agencies were allowed to switch from having investors pay for ratings to having the issuers of debt pay for them. That led the ratings agencies to compete for business by currying favor with investment banks that would pay handsomely for the ratings they wanted.

    Wall Street paid as much as $1 million for some ratings, and ratings agency profits soared. This new revenue stream swamped earnings from ordinary ratings.

    "In 2001, Moody's had revenues of $800.7 million; in 2005, they were up to $1.73 billion; and in 2006, $2.037 billion. The exploding profits were fees from packaging . . . and for granting the top-class AAA ratings, which were supposed to mean they were as safe as U.S. government securities," said Lawrence McDonald in his recent book, "A Colossal Failure of Common Sense."

    He's a former vice president at now defunct Lehman Brothers, one of the highflying investment banks that helped create the global crisis.

    From late 2006 through early last year, however, the housing market unraveled, poisoning first mortgage finance, then global finance. More than 60 percent of the bonds backed by mortgages have had their ratings downgraded.

    "How on earth could a bond issue be AAA one day and junk the next unless something spectacularly stupid has taken place? But maybe it was something spectacularly dishonest, like taking that colossal amount of fees in return for doing what Lehman and the rest wanted," McDonald wrote.

    Ratings agencies thrived on the profits that came from giving the investment banks what they wanted, and investors worldwide gorged themselves on bonds backed by U.S. car loans, credit card debt, student loans and, especially, mortgages.

    Before granting AAA ratings to bonds that pension funds, university endowments and other institutional investors trusted, the ratings agencies didn't bother to scrutinize the loans that were being pooled into the bonds. Instead, they relied on malleable mathematical models that proved worthless.

    "Everyone else goes out and does factual verification or due diligence. The credit rating agencies state that they are just assuming the facts that they are given," said John Coffee, a finance expert at Columbia University. "This system will not get fixed until someone credible does the necessary due diligence."

    Nobody cared about due diligence so long as the money kept pouring in during the housing boom. Moody's stock peaked in February 2007 at more than $72 a share.

    Billionaire investor Warren Buffett's firm Berkshire Hathaway owned 15 percent of Moody's stock by the end of 2001, company reports show. That stake, largely still intact, meant that the Oracle from Omaha reaped huge financial rewards while Moody's overlooked the glaring problems in pools of subprime mortgages.

    A Berkshire spokeswoman had no comment.

    One Moody's executive who soared through the ranks during the boom years was Brian Clarkson, the guru of structured finance. He was promoted to company president just as the bottom fell out of the housing market.

    Several former Moody's executives said he made subordinates fear they'd be fired if they didn't issue ratings that matched competitors' and helped preserve Moody's market share.

    Froeba said his Moody's team manager would tell his team that he, the manager, would be fired if Moody's lost a single deal. "If your manager is saying that at meetings, what is he trying to tell you?" Froeba asked.

    In the 1990s, Sylvain Raynes helped pioneer the rating of so-called exotic assets. He worked for Clarkson.

    "In my days, I was pressured to do nothing, to not do my job," said Raynes, who left Moody's in 1997. "I saw in two instances -- two deals and a rental car deal -- manipulation of the rating process to the detriment of investors."

    When Moody's went public in 2000, mid-level executives were given stock options. That gave them an incentive to consider not just the accuracy of their ratings, but the effect they'd have on Moody's -- and their own -- bottom lines.

    "It didn't force you into a corrupt decision, but none of us thought we were going to make money working there, and suddenly you look at a statement online and it's (worth) hundreds and hundreds of thousands (of dollars). And it's beyond your wildest dreams working there that you could make that kind of money," said one former mid-level manager, who requested anonymity to protect his current Wall Street job.

    Moody's spokesman Adler insisted that compensation of Moody's analysts and senior managers "is not linked to the financial performance of their business unit."

    Clarkson couldn't be reached to comment.

    Clarkson's own net worth was tied up in Moody's market share. By the time he was pushed out in May 2008, his compensation approached $3 million a year.

    Clarkson rose to the top in August 2007, just as the subprime crisis was claiming its first victims. Soon afterward, a number of analysts and compliance officials who'd raised concerns about the soundness of the ratings process were purged and replaced with people from structured finance.

    "The CEO is from a structured finance background, most of the people in the leadership were from a structured finance background, and it was putting their people in the right places," said Eric Kolchinsky, a managing director in Moody's structured finance division from January 2007 to November 2007, when he was purged, he said, for questioning some of the ratings. "If they were serious about compliance, they wouldn't have done that, because it isn't about having friends in the right places, but doing the right job."

    Another mid-level Moody's executive, speaking on the condition of anonymity for fear of retribution, recalls being horrified by the purge.

    "It is just something unthinkable, putting business people in the compliance department. It's not acceptable. I was very upset, frustrated," the executive said. "I think they corrupted the compliance department."

    One of the new top executives was Michael Kanef, who was experienced in assembling pools of residential mortgage-backed securities, but not in compliance, the division that was supposed to protect investors.

    "What signal does it send when you put someone who ran the group that assigned some of the worst ratings in Moody's history in charge of preventing it from happening again," Froeba said of Kanef. Clarkson and Kanef, who remains at Moody's, were named in a class-action lawsuit alleging that Moody's misled investors about its independence from companies that paid it for ratings.

    Kanef went after Scott McCleskey, the vice president of compliance at Moody's from the spring of 2006 until September 2008, and the man that Moody's said was the one to see for all compliance matters.

    "It's speculation, but I think Scott was trying to get people to follow some rules and people weren't ready to accept that there should be rules," Kolchinsky said.

    McCleskey testified before the House of Representatives Oversight and Government Reform Committee on Sept. 30 and described how he was pushed out on the heels of the people he'd hired.

    "One hour after my departure, it was announced that I would be replaced by an individual from the structured finance department who had no compliance experience and who, to my recollection, had been responsible previously for rating mortgage-backed securities," McCleskey testified.

    His replacement, David Teicher, had no compliance background. SEC documents describe him as a former team director for mortgage-backed securities from 2006 to 2008.

    McCleskey had raised concerns about the integrity of the ratings process, and Moody's had excluded him from meetings in January 2008 with the Securities and Exchange Commission about the eroding quality of pools of subprime loans that Moody's had blessed with top ratings.

    SEC officials, however, didn't bother to seek out McCleskey, even though he was the "designated compliance officer" in company filings with the agency. The SEC maintains that its officials met with Kanef because he was McCleskey's superior.

    SEC spokesman Erik Hotmire said that officials met with Kanef because "we ask to interview whomever we determine is appropriate."

    Another former Moody's executive, requesting anonymity for fear of legal action by the company, said the agency might've understood what was going wrong better if it had talked to the hands-on compliance officials.

    "If they had known he'd (Kanef) come from structured finance, the conflict of having him in that position should have been evident from the start," the former executive said.

    Others who worked at Moody's at the time described a culture of willful ignorance in which executives knew how far lending standards had fallen and that they were giving top ratings to risky products.

    "I could see it coming at the tail end of 2006, but it was too late. You knew it was just insane," said one former Moody's manager. "They certainly weren't going to do anything to mess with the revenue machine."

    Moody's wasn't alone in ignoring the mounting problems. It wasn't even first among competitors. The financial industry newsletter Asset-Backed Alert found that Standard & Poor's participated in 1,962 deals in 2006 involving pools of loans, while Moody's did 1,697. In 2005, Standard & Poor's did 1,754 deals to Moody's 1,120. Fitch was well behind both.

    "S&P is deeply disappointed in the performance of its ratings on certain securities tied to the U.S. residential real estate market. As far back as April of 2005, S&P warned investors about increased risks in the residential mortgage market," said Edward Sweeney, a company spokesman. S&P revised criteria and demanded greater buffers against default risks before rating pools of mortgages, he said.

    Still, S&P continued to give top ratings to products that analysts from all three ratings agencies knew were of increasingly poor quality. To guard against defaults, they threw more bad loans into the loan pools, telling investors they were reducing risk.

    The ratings agencies were under no legal obligation since technically their job is only to give an opinion, protected as free speech, in the form of ratings.

    "As an analyst, I wouldn't have known there was a compliance function. There was an attitude of carelessness, or careless ignorance of the law. I think it is a result of the mentality that what we do is just an opinion, and so the law doesn't apply to us," Kolchinsky said.

    Experts such as Columbia University's Coffee think that Congress must impose some legal liability on credit rating agencies. Otherwise, they'll remain "just one more conflicted gatekeeper," and the process of pooling loans — essential to the flow of credit — will remain paralyzed and economic recovery restrained.

    "If (credit) remains paralyzed, small banks cannot finance the housing demand. They have to take them (investment banks) these mortgages and move them to a global audience," said Coffee. "That can't happen unless the world trusts the gatekeeper."

    "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

    Bob Jensen's threads on the scandals of credit rating companies (corrupt to the core) ---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies

    Big Four uditors who live in glass houses should not throw stones ---
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms


    Here’s an expanded view of questions raised about which constituencies credit rating agencies (and by analogy auditing firms) really serve.

    A message forwarded by my anonymous friend Larry on October 18, 2009

    How Moody's sold its ratings -- and sold out investors | McClatchy ---
    http://www.mcclatchydc.com/politics/story/77244.html
    Instead, Moody's promoted executives who headed its "structured finance" division, which assisted Wall Street in packaging loans into securities for sale to investors. It also stacked its compliance department with the people who awarded the highest ratings to pools of mortgages that soon were downgraded to junk. Such products have another name now: "toxic assets."

    "In 2001, Moody's had revenues of $800.7 million; in 2005, they were up to $1.73 billion; and in 2006, $2.037 billion. The exploding profits were fees from packaging . . . and for granting the top-class AAA ratings, which were supposed to mean they were as safe as U.S. government securities," said Lawrence McDonald in his recent book, "A Colossal Failure of Common Sense."

    Nobody cared about due diligence so long as the money kept pouring in during the housing boom. Moody's stock peaked in February 2007 at more than $72 a share.

    Billionaire investor Warren Buffett's firm Berkshire Hathaway owned 15 percent of Moody's stock by the end of 2001, company reports show. That stake, largely still intact, meant that the Oracle from Omaha reaped huge financial rewards while Moody's overlooked the glaring problems in pools of subprime mortgages.

    A Berkshire spokeswoman had no comment.

    Moody's wasn't alone in ignoring the mounting problems. It wasn't even first among competitors. The financial industry newsletter Asset-Backed Alert found that Standard & Poor's participated in 1,962 deals in 2006 involving pools of loans, while Moody's did 1,697. In 2005, Standard & Poor's did 1,754 deals to Moody's 1,120. Fitch was well behind both.

    http://www.mcclatchydc.com/politics/story/77244.html

    Jensen Comment
    I’m frantically searching the writings of my very technical hero, Janet Tavakoli, to discover that all this is not true about my other hero, Warren Buffett. Of course there are huge unknowns, at this point in time, and varying degrees of culpability.

    Janet is pretty rough on the ratings agencies in her writings. However, she’s always kind to Warren. One of my all-time favorite books is her Dear Mr. Buffet book. On Page 107, Janet writes as follows:

    At the end of 2007, Berkshire Hathaway owned 78 million shares of Moody’s Corporation, one of the top three rating agencies (the same shares owned when I first met Warren Buffett in 2005), representing just over 19 percent of the capital stock. The cot basis of the shares is $499 million. At the end of 200, the value was just under $1 billion. By the end of 2006, the value was around $3.3 billion, but it dropped to $1.7 billion at the end of 2007. The sharp increase in revenues is due chiefly to revenues generated from rating structured financial products, and the sharp decrease was due to the disillusionment of the market with the integrity of the ratings.

    On Page 109, Janet continues to berate the rating agency cartel (where I think it might be possible to substitute auditors for rating agencies interchangeably):

    The rating agencies seem to not care about the market’s forgiveness since not only have they not apologized ---  a necessary but not sufficient condition --- they seem to feel the market should change. Specifically, the market should change its point of view about what it expects from the rating agencies. Yet it seems that the market has the right to expect rating agencies to follow the basic principles of statistics.

    The tactic has mainly been successful because the rating agencies act as a cartel, leveraging their joint power to have fees magically converge and have ratings so similar that they have participated overrating AAA structured products backed by dodgy loans in 2007 that took substantial principal losses. Meanwhile, many market professionals, including me, pointed out in print that the AAA ratings were maeaningless. The rating agencies presented a farily united front in defending their methods (except for Fitch, which also participated on overrated CDOs and later seemed more responsive to downgrading structured products.

    . . .

    “Ma and pa” retail investors found that AAA product ended up in their pension funds and mutual funds because their money managers gave too much credence to an AAA rating.

    But nowhere have I yet found where Janet alludes to any insider profiteering on the part of Warren Buffett who also lost billions of dollars in the crash The difference between “ma and pa” and Mr. Buffet is that a billion dollars is pocket change to Warren Buffet. He can easily recoup his losses legitimately in trades with stupid hedge fund managers and bankers that rely too much on fallible models (at least that’s what mathematician Janet Tavakoli tells us in a very enlightening way).

    Expert Financial Predictions (John Stewart's hindsight video scrapbook) --- http://www.technologyreview.com/blog/post.aspx?bid=354&bpid=23077&nlid=1840
    You have to watch the first third of this video before it gets into the scrapbook itself
    The problem unmentioned here is one faced by auditors and credit rating agencies of risky clients every day:  Predictions are often self fulfilling
    If an auditor issues going concern exceptions in audit reports, the exceptions themselves will probably contribute to the downfall of the clients
    The same can be said by financial analysts who elect to trash a company's financial outlook
    Hence we have the age-old conflict between holding back on what you really secretly predict versus pulling the fire alarm on a troubled company
    There are no easy answers here except to conclude that it auditors and credit rating agencies appeared to not reveal many of their inner secret predictions in 2008
    Auditing firms and credit rating agencies lost a lot of credibility in this economic crisis, but they've survived many such stains on their reputations in the past
    By now we're used to the fact that the public is generally aware of the fire before the auditors and credit rating agencies pull the alarm lever
    On the other hand, financial wizards who pull the alarm lever on nearly every company all the time lose their credibility in a hurry

    Bob Jensen's threads on credit rating agencies are at
    http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies

    Bob Jensen's threads on auditor professionalism are at
    http://faculty.trinity.edu/rjensen/fraud001.htm#Professionalism


    Hilarious at First --- and Then You Think About It
    Link forwarded by Jim Fuehrmeyer [jfuehrme@nd.edu]

    "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.
    "

    The three firms that dominate the $5 billion-a-year credit rating industry - Standard & Poor's, Moody's Investors Service and Fitch Ratings - have been faulted for failing to identify risks in subprime mortgage investments, whose collapse helped set off the global financial crisis. The rating agencies had to downgrade thousands of securities backed by mortgages as home-loan delinquencies have soared and the value of those investments plummeted. The downgrades have contributed to hundreds of billions in losses and writedowns at major banks and investment firms. The agencies are crucial financial gatekeepers, issuing ratings on the creditworthiness of public companies and securities. Their grades can be key factors in determining a company's ability to raise or borrow money, and at what cost which securities will be purchased by banks, mutual funds, state pension funds or local governments. A yearlong review by the SEC, which issued the results last summer, found that the three big (credit rating) agencies failed to rein in conflicts of interest in giving high ratings to risky securities backed by subprime mortgages.
    "SEC Puts Off Vote on Rules for Rating Agencies," AccountingWeb, November 19, 2008 --- http://accounting.smartpros.com/x63855.xml
    Jensen Comment
    It’s beginning to look like Wall Street is rearing up once again to prevent the SEC from imposing reforms on credit rating agencies. In spite of the crisis, it will once again be business as usual with the credit rating agencies having conflicts of interest not in the interest of investors.
     


    What should be done about credit rating companies?

    "Ratings Downgrade,"  by James Surowiecki, The New Yorker, September 28, 2009 ---
    http://www.newyorker.com/talk/financial/2009/09/28/090928ta_talk_surowiecki

    When Barack Obama went to Wall Street last week to make the case for meaningful financial regulation, he took well-deserved shots at some of the villains of the financial crisis: greedy bankers, reckless investors, and captive regulators. But to that list he could have added credit-rating agencies like Standard & Poor’s and Moody’s. By giving dubious mortgage-backed securities top ratings, and by dramatically underestimating the risk of default and foreclosure, the agencies played a key role in inflating the housing bubble. If we’re going to reform the system, fixing them should be high on the list.

    Unfortunately, that’s not an easy task, since over the years the government has made the agencies an increasingly important part of the financial system. Rating agencies have been around for a century, and their ratings have been used by regulators since the thirties. But in the seventies the S.E.C. dubbed the three biggest agencies—S. & P., Moody’s, and Fitch—Nationally Recognized Statistical Rating Organizations, effectively making them official arbiters of financial soundness. The decision had a certain logic: it was supposed to make it easier for investors to know that the money in their pension or money-market funds was going into safe and secure investments. But the new regulations also turned the agencies from opinion-givers into indispensable gatekeepers. If you want to sell a corporate bond, or package a bunch of mortgages together into a security, you pretty much need a rating from one of the agencies. And though the agencies are private companies, their opinions can effectively have the force of law. The ratings often dictate what institutions like banks, insurance companies, and money-market funds can and can’t do: money-market funds can’t have more than five per cent of their assets in low-rated commercial paper, there are limits on the percentage of non-investment-grade assets that banks can own, and so on.

    The conventional explanation of what’s wrong with the rating agencies focusses on the fact that most of them are paid by the very people whose financial products they rate. That problem needs to be fixed, and last week the S.E.C. proposed new rules to address conflicts of interest. But there’s a much bigger problem, which is that, even though nearly everyone knows that the agencies are compromised and exert too much influence, the system makes it impossible not to rely on them. In theory, of course, the mere fact that a rating agency says a particular bond is AAA (close to risk-free) doesn’t mean that investors have to buy it; the agencies’ opinions should be just one ingredient in any decision. In practice, the government’s seal of approval, coupled with those regulatory requirements, encourages investors to put far too much weight on the ratings. According to a recent paper on the subject by the academics Darren Kisgen and Philip Strahan, that’s true even when the agency doing the rating doesn’t have a long track record. During the housing bubble, investors put a huge amount of money into AAA-rated mortgage-backed securities—which would have been fine had the rating agencies’ judgments been sound. Needless to say, they weren’t. Despite subprime borrowers’ notoriously shaky finances, the agencies failed to allow for the possibility that housing prices might fall sharply.

    The rating agencies’ role in inflating the bubble is well known. Less obvious is their role in accelerating the crash. Agencies have typically resisted changing their ratings on a frequent basis, so changes, when they occur, tend to be belated, widespread, and big. In the space of just a few months between late 2007 and mid-2008 (after the housing bubble burst), the agencies collectively downgraded an astonishing $1.9 trillion in mortgage-backed securities: some securities that had carried a AAA rating one day were downgraded to CCC the next. Because many institutional investors are prohibited from owning too many low-rated securities, these downgrades necessarily led to forced selling, magnifying the panic, and prevented other investors from swooping in and buying the distressed debt cheaply. In effect, the current system pushes many big investors to buy high and sell low.

    Rating agencies existed long before they carried a government imprimatur, and, their recent dismal performance notwithstanding, they’ll exist in the future, if only because few investors have the patience to sort through all the bond offerings and structured-finance deals out there. But we need a divorce: the rating agencies shouldn’t be government-sanctioned and government-protected institutions and their judgments shouldn’t be part of the rules that govern how investors can act.

    Given how rarely real reform happens in Washington, that may sound like a hopeless goal. But last summer the S.E.C. seriously considered enacting a series of proposals that would have gone some way toward uncoupling the rating agencies from the regulatory system. The plan fizzled, however, thanks in part to pressure from a surprising source: big investors. Oddly, the ratings system, broken as it is, remains attractive to many investors who have been burned by it. For one thing, it provides an easily comprehensible standard: without it, we’d need to come up with new ways of measuring risk. More insidiously, the ratings system provides a ready-made excuse for failure: as long as you’re buying AAA-rated assets, you can say you’re being responsible. After the housing crash, though, we know how illusory those AAA ratings can be. It’s time for investors to face reality: working with a fake safety net is more dangerous than working without any net at all.

    Bob Jensen's threads on credit rating agencies ---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies


    A Video of Hope compared with a Video of Despair

    Video 1
    University of the Pacific President Pamela A. Eibeck addresses the campus community and online viewers in a Fall Welcome address on September 10, 2009 --- http://www.vimeo.com/6534192 

    Jensen Comment
    What impressed me is the enthusiasm of the University of the Pacific's new president who selected to move to a community hardest hit by the subprime mortgage scandals, economic crises of empty houses, very high unemployment, and several years of really severe drought on the surrounding farms and ranches. Stockton is largely an agricultural community.

    Video 2
    CBS Sixty Minutes featured how bad things became in Stockton's economy and its fraudulent mortgage lenders..
    The Sixty Minutes Module is entitled "House of Cards" --- http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody

    This is an example of a community and a university  and new university president that are not giving up as the "house of cards" collapses about them. The fall was aided and abetted by the credit rating agencies like Moody's and Standard & Poors.

    As for Pamela Eibeck and her son, you might also read the November 22, 2009 tidbit in the Chronicle of Higher Education ---
    http://chronicle.com/article/Moms-the-PresidentIm/49228/


    "Rating agencies lose free-speech claim," by Jonathon Stempel, Reuters, September 3, 2009 ---
    http://www.reuters.com/article/GCA-CreditCrisis/idUSTRE5824KN20090903

    Credit rating agencies may find it harder to argue that their opinions deserve free speech protection after a judge rejected efforts by Moody's Investors Service and Standard & Poor's to dismiss a fraud lawsuit.

    In a case alleging that inflated ratings on risky mortgages led to investment losses, U.S. District Judge Shira Scheindlin said on Wednesday that ratings on notes sold privately to a group of investors were not "matters of public concern" deserving broad protection under the First Amendment of the U.S. Constitution.

    The Manhattan judge said investors may pursue their lawsuit accusing Moody's, S&P and Morgan Stanley (MS.N), which marketed the notes, of issuing false and misleading statements about the notes, which were backed by subprime mortgages and other debt.

    Scheindlin's ruling may affect lawsuits by pension funds -- including the nation's largest, the California Public Employees' Retirement System, or CalPERS -- and other investors that want to hold banks and rating agencies responsible for exaggerating the value and safety of debt in order to win fees.

    "This is potentially a very significant opinion," said Joseph Mason, a finance professor at Louisiana State University's business school in Baton Rouge.

    "It seems they have found a hole in the First Amendment defense, the agencies' primary line of defense," he said. "There is a feeling throughout the investment industry that agencies committed an egregious breach, but the issue is how to gain traction under the law. This opinion seems to give hope."

    Rating agencies typically get broad free-speech protection similar to that afforded journalists and plaintiffs must often show that ratings reflect "actual malice" before they can recover. That protection, of course, is not absolute.

    "The First Amendment doesn't allow anyone to commit fraud," said George Cohen, a professor at the University of Virginia School of Law.

    Sean Egan, managing director of Egan-Jones Ratings Co, an independent agency critical of how rivals are compensated, called Scheindlin's ruling "a watershed event. This is the first major breach in the First Amendment defense, and makes it substantially easier for other plaintiffs."

    FEES TIED TO RATINGS

    The ruling concerned the Cheyne Structured Investment Vehicle, a package of debt that included subprime mortgages.

    Scheindlin said Cheyne issued some notes with "triple-A" ratings, the same as the U.S. government, and others that won "the highest credit ratings ever given to capital notes."

    Meanwhile, the rating agencies were paid more than three times their normal rate and their fees were "contingent upon the receipt of desired ratings," she said.

    Desirable ratings did nothing to save the Cheyne SIV. It went bankrupt in August 2007.

    "You can't yell fire in a crowded theater, but here it seems the agencies were doing the opposite," said Jonathan Macey, a professor at Yale Law School. "There was a fire, but they were saying there was nothing to worry about and taking money for saying that."

    Continued in article

    Jensen Comment
    Expert Financial Predictions (John Stewart's hindsight video scrapbook) --- http://www.technologyreview.com/blog/post.aspx?bid=354&bpid=23077&nlid=1840
    You have to watch the first third of this video before it gets into the scrapbook itself
    The problem unmentioned here is one faced by auditors and credit rating agencies of risky clients every day:  Predictions are often self fulfilling
     

    If an auditor issues going concern exceptions in audit reports, the exceptions themselves will probably contribute to the downfall of the clients
     

    The same can be said by financial analysts who elect to trash a company's financial outlook
    Hence we have the age-old conflict between holding back on what you really secretly predict versus pulling the fire alarm on a troubled company
     

    There are no easy answers here except to conclude that it auditors and credit rating agencies appeared to not reveal many of their inner secret predictions in 2008
     

    Auditing firms and credit rating agencies lost a lot of credibility in this economic crisis, but they've survived many such stains on their reputations in the past
     

    By now we're used to the fact that the public is generally aware of the fire before the auditors and credit rating agencies pull the alarm lever
     

    On the other hand, financial wizards who pull the alarm lever on nearly every company all the time lose their credibility in a hurry

    Bob Jensen's threads on fraud in the subprime lending scandals ---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies

    Bob Jensen's threads on fraud in credit rating agencies are at
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze

    Where were the auditors ---
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms


    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 


    Among Friends
    The question is why these guys got the insider information in the first place?

    "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 


    "Let's (Credit) Grade Wall Street Like Colleges:  The more rating agencies the better," The Wall Street Journal, September 15, 2009 --- http://online.wsj.com/article/SB10001424052970203917304574413072842297920.html#mod=djemEditorialPage

    Is Harvard really the best?

    It turns out that depends on who you ask—and what you ask. As students across America return to campus for the new school year, new editions of three prominent college guides variously rank Harvard at No. 1, No. 5, and No. 11. Therein lies a timely lesson for our system of credit ratings.

    Some students know from their earliest days they want to go to Harvard, while others may want to follow mom or dad to East Carolina or Purdue. Many more rely on the annual college guides to help them make one of the most important financial decisions in their lives—in much the same way an investor might look to Moody's to tell them about the reliability of a corporate bond. The question with both is just how reliable those ratings are.

    When the housing bubble popped, our financial institutions learned—the hard way—that the mortgage-backed securities on their balance sheets did not merit the AAA-grades the credit ratings agencies had assigned them. Similar complaints have long been advanced about the trustworthiness of college guides. As the dominant player, U.S. News & World Report's annual America's Best Colleges guide has borne the brunt of this criticism.

    In public, college presidents, deans, and spokesmen pooh-pooh the U.S. News rankings. In private, however, many do what they can to boost their schools up the rankings ladder. One area open to manipulation has to do with the "peer assessment" category that accounts for a quarter of the U.S. News ranking.

    Earlier this year, Inside Higher Ed reported on a charmingly frank presentation by a Clemson University official who admitted her school's officials use the peer assessment to rate "all programs other than Clemson below average." The university denied the charge. But further reporting revealed that Clemson President James Barker had given his only "strong" rating to his own school, while giving lower grades to every other college in the land.

    The revelations have been an embarrassment for Clemson. Still, the woman who set off the firestorm was surely right when she said, "I'm confident my president is not the only one who does that." Other schools, after all, have found themselves in the news for manipulating the way they report to U.S. News everything from their average SAT scores and alumni giving to per pupil spending and class profiles.

    So if the U.S. News report is so flawed, where's the lesson for Wall Street? The answer lies in the new competition the U.S. News guide has spawned. In the last few years, the Washington Monthly and Forbes have each offered guides of their own. They are joined by the American Council of Trustees and Alumni, which measures colleges by whether they require seven core subjects the authors deem essential for a solid liberal arts education. There's even the conservative Intercollegiate Studies Institute's "Choosing the Right College," which offers advice about the best professors and courses to seek out on campuses.

    Different measures, of course, lead to different results. The latest U.S. News guide has Harvard and Princeton tied for No. 1, followed by Yale. Over at the Washington Monthly, by contrast—where editors measure colleges by how well they do at promoting social mobility, national service and research—Harvard falls to No. 11. And the top three slots are taken by public universities in the University of California system: UC Berkeley, UC San Diego and UCLA.

    Then there's Forbes, which just ranked West Point as "America's Best College." The Forbes ratings include student satisfaction with courses, post-graduate employment success (including salary data and entries in Who's Who), the likelihood of graduation within four years, and the average level of debt graduates are stuck with.

    Which guide is best at picking the best? The answer is that no single measurement or guide can tell everyone everything. The more measures students and parents have, the fuller the picture before them, and the better equipped they are to make a smart decision. Because the federal government is not in the business of certifying particular college guides, moreover, they compete by persuading students and parents to buy them on the quality and relevance of their findings.

    At a time when the Securities and Exchange Commission is looking for ways to improve the flawed credit ratings that contributed so much to our financial crisis, it might do well to stop anointing particular credit rating agencies. Forcing these firms to compete for customers the way the college guides do would give us better ratings—and fewer investors lulled into the complacency that comes from thinking Uncle Sam has done the due diligence. At least when it comes to ratings, the Groves of Academe have a thing or two to teach our captains of finance about competition.

    Bob Jensen's threads on systemic problems of accountancy (including the aggregation ratings of nutrients in vegetables) are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#BadNews

    • Systemic Problem:  All Aggregations Are Arbitrary
    • Systemic Problem:  All Aggregations Combine Different Measurements With Varying Accuracies
    • Systemic Problem:  All Aggregations Leave Out Important Components
    • Systemic Problem:  All Aggregations Ignore Complex & Synergistic Interactions of Value and Risk
    • Systemic Problem:  Disaggregating of Value or Cost is Generally Arbitrary
    • Systemic Problem:  Systems Are Too Fragile
    • Systemic Problem:  More Rules Do Not Necessarily Make Accounting for Performance More Transparent
    • Systemic Problem:  Economies of Scale vs. Consulting Red Herrings in Auditing
    • Systemic Problem:  Intangibles Are Intractable

    Bob Jensen's threads on credit rating agencies ---
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze


    "Rating agencies lose free-speech claim," by Jonathon Stempel, Reuters, September 3, 2009 ---
    http://www.reuters.com/article/GCA-CreditCrisis/idUSTRE5824KN20090903

    Credit rating agencies may find it harder to argue that their opinions deserve free speech protection after a judge rejected efforts by Moody's Investors Service and Standard & Poor's to dismiss a fraud lawsuit.

    In a case alleging that inflated ratings on risky mortgages led to investment losses, U.S. District Judge Shira Scheindlin said on Wednesday that ratings on notes sold privately to a group of investors were not "matters of public concern" deserving broad protection under the First Amendment of the U.S. Constitution.

    The Manhattan judge said investors may pursue their lawsuit accusing Moody's, S&P and Morgan Stanley (MS.N), which marketed the notes, of issuing false and misleading statements about the notes, which were backed by subprime mortgages and other debt.

    Scheindlin's ruling may affect lawsuits by pension funds -- including the nation's largest, the California Public Employees' Retirement System, or CalPERS -- and other investors that want to hold banks and rating agencies responsible for exaggerating the value and safety of debt in order to win fees.

    "This is potentially a very significant opinion," said Joseph Mason, a finance professor at Louisiana State University's business school in Baton Rouge.

    "It seems they have found a hole in the First Amendment defense, the agencies' primary line of defense," he said. "There is a feeling throughout the investment industry that agencies committed an egregious breach, but the issue is how to gain traction under the law. This opinion seems to give hope."

    Rating agencies typically get broad free-speech protection similar to that afforded journalists and plaintiffs must often show that ratings reflect "actual malice" before they can recover. That protection, of course, is not absolute.

    "The First Amendment doesn't allow anyone to commit fraud," said George Cohen, a professor at the University of Virginia School of Law.

    Sean Egan, managing director of Egan-Jones Ratings Co, an independent agency critical of how rivals are compensated, called Scheindlin's ruling "a watershed event. This is the first major breach in the First Amendment defense, and makes it substantially easier for other plaintiffs."

    FEES TIED TO RATINGS

    The ruling concerned the Cheyne Structured Investment Vehicle, a package of debt that included subprime mortgages.

    Scheindlin said Cheyne issued some notes with "triple-A" ratings, the same as the U.S. government, and others that won "the highest credit ratings ever given to capital notes."

    Meanwhile, the rating agencies were paid more than three times their normal rate and their fees were "contingent upon the receipt of desired ratings," she said.

    Desirable ratings did nothing to save the Cheyne SIV. It went bankrupt in August 2007.

    "You can't yell fire in a crowded theater, but here it seems the agencies were doing the opposite," said Jonathan Macey, a professor at Yale Law School. "There was a fire, but they were saying there was nothing to worry about and taking money for saying that."

    Continued in article

    Jensen Comment
    Expert Financial Predictions (John Stewart's hindsight video scrapbook) --- http://www.technologyreview.com/blog/post.aspx?bid=354&bpid=23077&nlid=1840
    You have to watch the first third of this video before it gets into the scrapbook itself
    The problem unmentioned here is one faced by auditors and credit rating agencies of risky clients every day:  Predictions are often self fulfilling
     

    If an auditor issues going concern exceptions in audit reports, the exceptions themselves will probably contribute to the downfall of the clients
     

    The same can be said by financial analysts who elect to trash a company's financial outlook
    Hence we have the age-old conflict between holding back on what you really secretly predict versus pulling the fire alarm on a troubled company
     

    There are no easy answers here except to conclude that it auditors and credit rating agencies appeared to not reveal many of their inner secret predictions in 2008
     

    Auditing firms and credit rating agencies lost a lot of credibility in this economic crisis, but they've survived many such stains on their reputations in the past
     

    By now we're used to the fact that the public is generally aware of the fire before the auditors and credit rating agencies pull the alarm lever
     

    On the other hand, financial wizards who pull the alarm lever on nearly every company all the time lose their credibility in a hurry

    Bob Jensen's threads on fraud in credit rating agencies are at
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze

    Where were the auditors ---
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms


    Question
    Why shouldn't you trust the bond raters assigning letter grades to credit risk?

    "Triple-A Trouble," by Justin Fox, Time Magazine, March 24, 2008, Page 32 --- http://www.time.com/time/magazine/article/0,9171,1722275,00.html

    The People at Moody's and Standard & Poor's are used to catching flak when debt markets blow up. Why didn't they see the bankruptcy of California's Orange County coming in 1994? Why did they fail to account for the currency risks brewing in Thailand and Indonesia and South Korea in 1997? And how was it that they were still rating Enron's debt as investment grade four days before the company went belly-up in 2001?

    The furor over such missteps usually fades quickly. After a congressional hearing or two, the ratings agencies have always been allowed to go their merry and profitable way. And why not? Inability to see into the future isn't a crime, plus there has usually been someone else available to take the fall--like Arthur Andersen in the Enron case.

    This time around, though, the ratings agencies didn't just fail to see a financial calamity coming. They helped cause it. Why did collateralized debt obligations (CDOs) based partly on risky subprime mortgages lead to so much trouble? Because Moody's and S&P awarded them dubiously generous letter grades. It's the same story for the mostly incomprehensible tizzy over bond insurance.

    What can we do about this? There's actually a simple answer: just declare our independence from bond ratings.

    The practice of giving letter grades to bonds to reflect their riskiness was pioneered by John Moody in 1909. But the industry took its current form only in the early 1970s. That's when Moody's and its competitors switched from selling research to investors to charging bond issuers to rate their goods. This approach wasn't unheard of: you have to advertise in Good Housekeeping to get the Good Housekeeping Seal of Approval. What made it problematic was that at about the same time, the Securities and Exchange Commission (SEC) exalted the status of the ratings by writing them into the rules governing securities firms' capital holdings. Since then, the use of bond ratings in regulation has only grown. Many institutional investors are banned from owning non-investment-grade bonds. Bank-capital requirements--the cash and equivalents banks need to keep on hand--give more weight to highly graded securities. And this is increasingly the case not just in the U.S. but around the world.

    What all this amounts to, argues Frank Partnoy, a derivatives salesman turned University of San Diego law professor, who is one of the sharpest critics of the ratings status quo, is a "regulatory license" for the ratings agencies. It's certainly a license to print money. Moody's, the lone ratings firm for which data are available, made $702 million in after-tax profit last year, up from $289 million just five years before. Its operating profit margin was a stunning 50% of revenue. By comparison, Google's was 30%.

    To keep that profit machine going, Moody's and S&P have to keep finding new things to rate. And they're under intense pressure from issuers and investors alike to get as many securities as possible into the top ratings categories. The result is grade inflation, especially in new products like CDOs. That's how banks and investors around the world ended up owning billions of dollars in triple-A mortgage junk. It also helps explain the growth of bond insurers, companies that used their own triple-A ratings to bump ever more bond issues into the top categories--even as their businesses ceased to be triple-A safe.

    One way to combat these tendencies would be to subject the raters to tight regulation by the sec. But that understaffed agency is unlikely to be up to the task, especially since it's not clear what exactly the task would be.

    Which leaves the alternative suggested by Partnoy and several economists: cleansing the federal code of its reliance on bond ratings. Among the simplest fixes would be removing the ban on pension funds' holding debt securities rated lower than BBB. The funds can make far riskier investments in stocks and hedge funds, after all. Bank-capital requirements do have to take into account the quality of securities, but there are market-based measures that could at least partly replace ratings.

    "The experiment we ran with government relying on the ratings agencies to do its job has failed," Partnoy says. Time for a new experiment.


    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


    "The Accounting Cycle:  Poor Performance of Credit Rating Agencies," by J. Edward Ketz, SmartPros, December 2007 --- http://lyris.smartpros.com/t/204743/5562870/4383/0/

    Soon after Merrill Lynch disclosed its $8.4 billion write-down because of problems with collateralized debt obligations (CDOs) and other financial instruments relating to subprime mortgages, the credit rating agencies started downgrading the securities. But, this is like the proverbial soldier who watches a raging battle from afar; when the war is over, he proceeds to bayonet the wounded. 

    Merrill Lynch and other banks got into the CDO business several years ago. The CDOs received an imprimatur from agencies such as Moody's, Standard & Poor's, and Fitch. Some CDOs were even evaluated as investment grade securities. The analysts at Moody's, Standard & Poor's, and Fitch apparently ignored the risks involved in the subprime mortgage market as well as the risks in real estate prices.

    This segment generated lots of money for Merrill Lynch and the other banks. The CDO business brought in millions and millions of revenues. This line of business was at least as profitable for the bond rating agencies, too, as their ratings produced massive amounts of money.

    Not surprisingly, problems developed because the financial institutions were lending funds to marginal borrowers, those with less-than-stellar credentials for loan applicants. When some of these riskier borrowers defaulted on their mortgages, the CDOs started losing value. The credit rating agencies did nothing; presumably, they felt that the CDOs still had investment grade status.

    With the losses by Merrill Lynch out in the open, everybody knows not only that the CDOs have less fair value, but also that the credit raters aren't earning their keep. Unfortunately, members of Congress believe that they should hold investigations on the matter. I say unfortunate because such a move would be a waste of time, energy, and money.

    Recall the downfall of Enron and the high credit ratings that Enron received from the credit rating agencies. These agencies did not downgrade Enron's debt until after the 2001 third quarter results became public and Enron's stock price started its nosedive. When Congress passed the Sarbanes-Oxley Act in 2002, section 702(b) required the SEC to conduct a study of credit rating agencies to determine why these credit rating agencies did not act as useful watchdogs and warn the public about Enron's true situation. It accomplished little at the time; if Congress holds hearings now, nothing new will be learned. Until policy makers focus on the institution of credit ratings and follow the cash, they waste their time with investigations.

    Moody's and the other agencies make money by charging the business entities who are issuing debt. It doesn't take a genius to see the conflict of interest. The credit agencies lean on the issuer for more money or risk receiving a poor rating. Payment not only entitles one to a good rating, but also it gives one the privilege of not receiving a downgrade unless bad news becomes public.

    The SEC barely mentions this institutional feature in its "Report on the Roles and Function of Credit Rating Agencies in the Operation of the Securities Markets."

    This essay, written in January, 2003, practically ignores the problem. On page 41, the SEC report states, "The practice of issuers paying for their own ratings creates the potential for a conflict of interest." The SEC goes on to review comments by the large rating agencies themselves on how they manage this potential conflict of interest.

    The comments are pathetic. First, the SEC and the managers at credit rating agencies mangle the English language when they refuse to identify conflicts of interest for what they are. My dictionary defines conflict of interest as "the circumstance of a public officeholder, corporate officer, etc., whose personal interests might benefit from his or her official actions or influence." The term does not mean that they actually do benefit, but calls attention to the possibility. Calling such circumstances "potential conflicts of interests" merely attempts to push ethics aside. I can understand this behavior by the managers, but I don't comprehend the words of the SEC staff.

    Second, the comments rely heavily on the assertions of the credit rating agencies themselves. Managers of these agencies claim there is no problem, and of course the SEC should listen to them and accept every word as truth. Yeah, right!

    Third, on page 42 of the report, the SEC promises to explore whether these credit rating agencies "should implement procedures to manage potential conflicts of interest that arise when issuers [pay] for ratings." Either the SEC did not keep its promise or such actions are inadequate. Clearly, the credit rating agencies have not responded any differently to the CDO problem than they did with Enron's circumstances.

    Policy makers can reduce the problems by reducing the very real conflict of interests that perniciously raises its ugly head from time to time. The solution is to prohibit credit rating agencies to receive any funds from the issuers. If the ratings have any merit, then investors will be willing to pay for them.

    This essay reflects the opinion of the author and not necessarily the opinion of The Pennsylvania State University.

    Bob Jensen's threads on hiding debt with CDOs are at http://faculty.trinity.edu/rjensen/Theory01.htm#CDO


    "WorldCom Case Against Banks To Go to Trial," by Diya Gullapalli, The Wall Street Journal, December 16, 2004; Page C4 --- http://online.wsj.com/article/0,,SB110315786738701568,00.html?mod=technology%5Fmain%5Fwhats%5Fnews 

    In a decision that threatens to keep the underwriters of two bond offerings from WorldCom Inc. embroiled in litigation, a federal judge yesterday rejected a motion to dismiss a class-action case by the remaining defendants.

    While the firms said they had relied upon auditor Arthur Andersen LLP's clean bill of health on WorldCom when selling the bonds, the judge said the underwriters should have done their own legwork to size up the telecommunications company, which filed for bankruptcy after a massive accounting fraud.

    Continued in the article

    Bob Jensen's threads on the Worldcom fraud are at http://faculty.trinity.edu/rjensen/fraudenron.htm#WorldCom 


    Credit rating agencies were especially criticized in the accounting and finance scandals for their close ties and less than objective ratings of firms like Enron.  Frank Partnoy is highly critical of the lack of integrity of rating agencies.  Several references written by Partnoy are shown below:

    Senate Testimony by Frank Partnoy --- http://faculty.trinity.edu/rjensen/FraudEnron.htm#FrankPartnoyTestimony 

    Article by Frank Partnoy
    "The Siskel and Ebert of Financial Matters: Two Thumbs Down for the Credit Reporting Agencies" (Washington University Law Quarterly, Volume 77, No. 3, 1999) --- http://ls.wustl.edu/WULQ/ 
    Also see  http://faculty.trinity.edu/rjensen/FraudCongressPartnoyWULawReview.htm 

    Books by Frank Partnoy

    "An End to the Exclusive Rating Franchise? June 16, 2003, by Joseph Neu --- http://www.fas133.com/search/search_article.cfm?page=1&areaid=1318 

    Treasurers’ love-hate relationship with credit rating agencies is something we have followed with interest of late (see 3/24/03). In part, this is because it is easy to be sympathetic with the treasurers’ argument that the rating process is way too subjective relative to its potential impact on a corporation’s financial wellbeing. But this begs the question: What is the more objective alternative?

    Defining treasury’s interests ahead of change. We aren’t the only ones who have taken an increasing interest in the role of rating agencies of late. In the wake of the corporate scandals in the US, and the “lagging” nature of credit rating indications, the SEC has been mandated by Sarbanes-Oxley to revisit the role of rating agencies, the state of regulatory scrutiny over them and, most especially, the special status that it grants a few rating agencies (i.e., NRSROs) to provide regulatory benchmarks.

    In its latest effort, the SEC has issued a concept letter, asking for public comments on related questions (see here).

    All this makes now an opportune time for treasurers to consider the current rating processes, as executed by the rating agencies, and weigh the potential alternatives to determine what sort of process they might like to see, and who other than the current NRSROs they would like to rate them. Given the potential for change at hand, now is the time to make your voices heard.

    And by no means should this call to action be limited to treasurers in the US. As we’ve noted, the Americanization of capital markets globally have made obtaining a rating (and managing a rating agency relationship) increasingly critical abroad. Indeed, the Association for Corporate Treasurers (ACT) in the UK held a recent conference on the subject, aptly titled Rating Agencies: Prophet’s, Judges or Mere Mortals? There, as elsewhere, treasurers expressed the desire for greater transparency in the rating process. They also want more reliance on replicable quantitative analysis that could be used to help them manage their rating.

    Ideally, were there a standard analytical model, it could be embedded into a risk management application to help treasury track a shadow rating. This, in turn, could help treasurers determine how different actions might impact that rating.

    An opportunity for broker-dealers. That the ACT conference was sponsored by Merrill Lynch may be telling as well. Could broker-dealers find a way to break into the seemingly lucrative franchise enjoyed by Moody’s and S&P? If not in the US, then perhaps they can abroad, where the concept of NRSRO is not as well established.

    One scenario treasurers (and the SEC) should consider, therefore, is what if broker-dealers offered credit “rating” services?

    At first, this might appear to make the rating management game more like that played with equity analysts. This used to mean talking analysts into the right quarterly earnings (or non-earnings) targets (with influence from the investment banking business offered), and managing EPS (or proforma results) accordingly. But, given the current scrutiny of broker-dealer analysts’ objectivity, it is hard to see how they would be allowed to expand the business of using their analysts on the credit side to assign buy/sell signals on debt.

    Their opening to this market, however, could come in the form of their own internal risk models, which the SEC is considering allowing broker-dealers to use as an alternative to NRSRO ratings to help determine capital charges on debt securities.

    If a broker-dealer is holding your paper for whatever reason, wouldn’t you want to know how their model “rating” compared to the rating agencies’ (and why shouldn’t you know)?

    Risk analytics vs. rating analyst. To some extent, this information will find its way to the market. After all, the models broker-dealers employ to determine internal capital charges are not all that different from those they use to price credit risk for external use (e.g., for credit derivatives). The models could also be used to help fund managers optimize portfolios from a risk management perspective and sell them paper with the right risk profile to fill the gaps.

    At some point, the markets must be allowed to determine how best to utilize traditional credit ratings in conjunction with emerging credit risk-assessment provided by analytical models, without regulatory favoritism. Risk modeling and analytics have advanced quite a bit in the last decade, which is why the rating agencies themselves have developed (or acquired) model-based risk analytics capabilities in parallel to traditional rating services. Both approaches should be considered by treasurers—and both should held to objective standards by regulators.


    Probably the most technical and complete muck raking about credit rating agency conflicts of interest arose in a law paper by Frank Partnoy (my hero) with particular reference to evidence uncovered in the Enron investigation.  It is particularly revealing how the credit rating agencies helped to artificially inflate Enron's credit rating.  Time Magazine reported on this on January 14, 2002.  But the most complete analysis of how Congress these agencies are to the core is in the following reference from my hero:

    "The Siskel and Ebert of Financial Matters:  Two Thumbs Down for Credit Reporting Agencies," by Frank Partnoy Washington University Law Quarterly, Volume 77, No. 3, 1999 --- http://faculty.trinity.edu/rjensen/FraudCongressPartnoyWULawReview.htm 


    A recent academic study compared ratings by Moody's with those of Egan-Jones. William H. Beaver, professor of accounting at Stanford's graduate school of business, Catherine Shakespeare, assistant professor at the University of Michigan Business School and Mark T. Soliman, also at Stanford, analyzed ratings on some 800 companies made by both services from 1997 to 2002.  The academics found that Egan-Jones's ratings changes were more timely than those of Moody's, coming up to six months sooner. The study also found much higher stock returns after rating changes by Egan-Jones than by those of Moody's.  "Using several tests we find that the noncertified firm, EJR is more responsive and closely associated with investors," the study noted.
    "Wanted: Credit Ratings. Objective Ones, Please," by Gretchen Morgenson, The New York Times, February 6, 2005 --- http://www.nytimes.com/2005/02/06/business/yourmoney/06gret.html?oref=login  

    For years, the nation's credit rating agencies have thrived, booking mouth-watering profits from operations that are riddled with conflicts and shielded from competition.

    Soon, however, that may finally change. And investors should be better off for it.

    Within the next two months, the Securities and Exchange Commission will press a new regulatory framework for the industry to ensure that debt ratings published by the big three - Standard & Poor's, Moody's Investors Service and Fitch Ratings - are a result of thorough analysis, not a desire for fatter profits.

    "I think it's fair to say that the oversight of the industry is insufficient," said Annette L. Nazareth, director of market regulation at the Securities and Exchange Commission. "We want the firms to commit to meet certain standards with respect to policies and procedures on conflicts of interest and solicitation of ratings. Right now we don't have that at all."

    Now that would be an upgrade, long overdue. Indeed, given how regulators have attacked conflicts of interest among Wall Street firms, insurance companies and other financial services concerns, it's astounding that the ratings agencies have been allowed to go on this way for so long.

    Rating agencies play an enormous role in a huge market. After all, far more debt is issued than stock; last year, corporations issued $1.2 trillion in straight debt versus $146 billion raised in common stock, according to Thomson First Call. An additional $1.4 trillion was issued last year in mortgage debt and asset-backed securities.

    All that paper needed a rating before it could be sold to the public. As such, the financial markets rely heavily on the companies that rate them.

    Since 1931, for example, the Federal Reserve Board, the Comptroller of the Currency and federal and state laws have regulated the debt held by banks and other financial institutions, using credit ratings assigned to the debt. Pension funds, banks and money market funds are barred from buying debt issues that carry ratings below a certain level.

    But not just any rating agency's rating, mind you. In 1975, the S.E.C. ruled that the laws relating to debt carried by banks and financial institutions refer only to ratings provided by agencies that it recognizes. Right now, these are the big three and a much smaller fourth, Dominion Bond Rating Service of Canada.

    What you have, in other words, is an oligopoly.

    Even more troubling, this oligopoly earns its keep from fees charged to the companies whose debt it rates. This conflicted business model means that the paying customers for these agencies are the corporations they analyze, not the investors who look to the ratings for help in assessing a company's creditworthiness.

    Other industry practices also lend themselves to producing less-than-rigorous analysis. For example, rating agencies typically receive the largest fees when they analyze an initial bond issue. After that a nominal fee is levied, providing something of a disincentive to do in-depth, time-consuming work.

    And because the nation's courts have ruled that the work of these agencies is opinion and therefore protected by the First Amendment, the big three are protected from lawsuits from investors contending defective analysis. Such lawsuits could act as policing mechanisms.

    To make matters worse, these companies have recently begun to expand the services they offer to corporations, leading regulators to fear that ratings could be swayed by revenues earned on other products.

    These problems are on the agenda for Tuesday, when Senator Richard C. Shelby, the Alabama Republican who is chairman of the Banking, Housing and Urban Affairs Committee, will hold hearings on the state of the rating agencies. Executives from the big three are scheduled to testify.

    This is not the first time that Standard & Poor's, Moody's and Fitch have been in the hot seat. When Enron and WorldCom failed, investors were stunned by how long it had taken the agencies to recognize the companies' declining fortunes. For example, all three agencies had rated Enron an investment-grade company until four days before it filed for bankruptcy. They had rated WorldCom similarly until a few months before it collapsed.

    The rating agencies stress that they analyze debt issuers' financial positions to try to predict for investors an entity's ability to pay off its debt. They are not in place to audit auditors, they say, and cannot root out fraud. Their mandate is to provide transparency to the financial market.

    IN an interview on Friday, Raymond W. McDaniel, Jr., president of the Moody's Corporation, acknowledged the industry's conflicts but said his company manages them effectively. "We do not link analyst compensation, including bonus compensation, to the ratings they have on the companies they follow or to the amount of fees they receive from those companies," he said. "Beyond that, we have a collection of business conduct policies and codes of practice and behavior which the entire Moody's population is required to adhere to." Top executives at Standard & Poor's, a division of the McGraw-Hill Companies, and Fitch, a unit of Fimalac, were not available for comment, but both companies said they were aware of the potential for conflicts and careful to prevent them.

    Increased competition would certainly help investors who are troubled by the conflicts. Unfortunately, companies hoping to break into the ratings game must first earn the all-important designation from the S.E.C. Such nods do not come often.

    One upstart concern that has applied unsuccessfully to the S.E.C. is Egan-Jones Ratings, of Philadelphia. It rates approximately 800 companies and had warned of problems at WorldCom, Enron and Global Crossing well before other agencies. Egan-Jones does not accept payment from companies it rates; investors who use its services pay the freight.

    A recent academic study compared ratings by Moody's with those of Egan-Jones. William H. Beaver, professor of accounting at Stanford's graduate school of business, Catherine Shakespeare, assistant professor at the University of Michigan Business School and Mark T. Soliman, also at Stanford, analyzed ratings on some 800 companies made by both services from 1997 to 2002.

    The academics found that Egan-Jones's ratings changes were more timely than those of Moody's, coming up to six months sooner. The study also found much higher stock returns after rating changes by Egan-Jones than by those of Moody's.

    "Using several tests we find that the noncertified firm, EJR is more responsive and closely associated with investors," the study noted.

    There is no evidence, of course, that Moody's tardiness is a result of a conflicted business model. And Mr. McDaniel maintains that ratings stability and accuracy are what customers want. "The market has become extremely intolerant of false positives or false negatives, and encouraged the ratings to only be moved when there is not a likelihood that they would be reversed," he said.

    But Sean J. Egan, managing director of Egan-Jones, said: "Timely, accurate credit ratings are critical for robust capital markets. Investors, issuers, workers and pensioners will continue to be hurt by the flawed credit rating industry until someone addresses the basic industry problems."

    Maybe, just maybe, that process has begun.

    February 6, 2005 message from Tom Lechner [lechner@oswego.edu]

    Thanks for another insightful post.

    I assume you mean if your credit score FALLS that Capital One will increase your rate.

    Incidentally, MBNA more than doubled my interest rate, even though my score was rising and I never missed a payment.

    You say your credit report and score are free. A free credit report is currently only available for those in the west. Those of us in the east have to wait until fall. I do not know of any source of free credit scores. Do you?

    Tom Lechner

    Dr. Thomas A. Lechner
    Dept. Accounting, Finance & Law
    SUNY - Oswego Oswego, NY 13126

    February 6, 2005 reply from Bob Jensen

    I was careless in mentioning that you can get a free credit report and FICO score. Not everyone can get these as of yet. There is a stupid, perhaps technically necessary, lagged in part of this that began in the West and will roll across the country in phases. It is very important to read the rules of the road at http://www.ftc.gov/bcp/conline/edcams/credit/ycr_free_reports.htm 

    Some outfits are advertising free credit reports now, but read the fine print and consumer beware:

            http://www.freecreditreportservice.com/exp1 

            http://snipurl.com/CreditReportFeb_6 

    Thank you Tom Lechner!

    Bob Jensen


    For dirty secrets of the credit card companies themselves go to http://faculty.trinity.edu/rjensen/FraudReporting.htm#FICO 


    Accelerated share repurchase (ASR) Manipulation of Earnings-Per-Share (EPS)

    Games Corporations Play
    What's special about ASRs is that the business firm simulates a normal repurchase program but enjoys an immediate EPS jump. The accounting rules seem to allow the entity instantly to reduce the number of shares outstanding.

    "The Accounting Cycle How Wall Street Helps Managers Fudge EPS," by: J. Edward Ketz, SmartPros, March 2006 --- http://accounting.smartpros.com/x51842.xml

    Managers are smart enough to know that earnings per share (EPS) is the most important statistic found within a financial report. Since they are evaluated on the basis of financial performance and performance is gauged by EPS, business executives do a number on EPS. If you can't earn it legitimately and if you don't want to out-and-out make it up, do the next best thing. Just stretch the truth as far as you can and hope nobody finds out. Wash, rinse, and spin: that's their motto!

    Accelerated share repurchase (ASR) programs are the new game in town. They involve derivative contracts on the business enterprise's own stock in an attempt to inflate EPS. Managers seek ways to reduce the denominator in EPS, and, for a fee, Wall Street is happy to oblige.

    Not that derivatives on one's own stock are new. In the heyday of the late 1990s and early 2000s, firms would write put options or go long on forward contracts on their common stock. Neither instrument hedged anything; they were merely contracts that bet that their stock prices would climb over the life of the derivative. If they did, the company would gain the premium in the case of the written put options, for the buyers of these instruments would let the options lapse. In the case of the forward purchase contract, the corporation would buy back its own shares at old, cheaper prices. Alternatively, the participants in the forward contract could cash-settle the gain/loss on the forward.

    These cute derivatives paid handsomely as long as the stock market cooperated by generating higher prices. As soon as the market turned south, the shareholders in these business enterprises discovered huge losses. Recall the saga of EDS, which engaged in both activities, writing put options and having forward purchase contracts. The stock price of EDS took a nosedive in 2001 and 2002, and the firm lost $225 million on their gamble.

    Today those games have been replaced with the ASR racket. SFAS No. 150 has virtually eliminated the incentive for writing put options or engaging in forward purchase contracts on one's stock because it requires the firm to mark the instruments to market, placing gains and losses into the income statement. Until and unless the FASB amends SFAS No. 150 to do the same with ASRs, business entities can employ ASRs without marking them to market. Any gains or losses bypass the income statement and go into equity.

    ASRs work like this. The counterparty, usually a financial institution, borrows the company's shares from investors and sells the stock short. The company purchases shares from the counterparty and simultaneously enters into a forward sale contract with the counterparty. Later the counterparty purchases shares in the open market to cover its short position. At maturity the forward contract is settled by selling the shares at the exercise price or by the net cash amount.

    What's special about ASRs is that the business firm simulates a normal repurchase program but enjoys an immediate EPS jump. The accounting rules seem to allow the entity instantly to reduce the number of shares outstanding.

    Managers in a variety of corporations have participated in ASRs, and they have accounted for them in the manner described. They include Cardinal Healthcare, Cendant, Duke Energy, Hewlett-Packard, and Waste Management. (Gee, haven't we seen these firms in recent news stories?)

    The problem with ASRs is that it is all nonsense. The forward should be marked to market rather than bypassing the income statement. Moreover, while the firm has repurchased the common shares, it also has promised to sell them (or cash-settle) in the forward contract. In my mind the forward negates the repurchase aspect and so the denominator ought to stay the same. Instead of treating the two transactions separately, the corporation should account for them as joint set of transactions.

    Why do these managers persist in exaggerating financial statements to improve their performance evaluation? Why don't they try to tell it like it was instead of telling it like they wanted it to be? Don't these managers care to tell investors and creditors the truth?

    And why are investment bankers playing the huckster? They are playing with fire when they peddle these tricks to managers. Didn't they learn anything from the financial meltdown in 2001-2002? Weren't they humiliated by criminal investigations by the Justice Department? Didn't they lose enough money in the lawsuits they settled out of court, and aren't they bothered by the remaining lawsuits still in play? How many more criminal investigations and how many more civil suits do they wish to face? These games have to end -- if they endure, more financial implosions are in the forecast, hurting managers and investments bankers as well as investors and creditors.

    Bob Jensen's threads on accounting for derivatives are at http://faculty.trinity.edu/rjensen/caseans/000index.htm

     


    Avoid Investing in Nations Ridden With Crime

    From Stanford University
    Don't Invest in Crime-Ridden Russia Says Investor Who Once Made a Fortune in Russia

    Hermitage Capital Management went from $25 million to $4 billion by investing in undervalued Russian companies. Today, its founder, Bill Browder, Stanford MBA '89, says anyone investing in Russia long term "is out of their mind." . . . Today, Browder says it is Hermitage that has become a victim of the criminal activity and official corruption that still pervade Russia's economy. He has gone public with accusations that Russian fraud artists and high-level government officials colluded to steal companies owned by Hermitage, intimidate or jail Hermitage lawyers, and rob the Russian treasury of at least $230 million. Hermitage's saga is a cautionary tale of the risks of investing in Russia today, according to a video, posted on YouTube, that Browder showed the Stanford audience. "Anyone who would make a long-term investment in Russia right now, almost at any valuation, is completely out of their mind," declared Browder. "My situation is not unusual. For every me, there are 100 others suffering in silence."
    "Don’t Invest in Russia Today, Warns Bill Browder," Stanford GSB News from Stanford University, November 2009 ---
    http://www.gsb.stanford.edu/news/headlines/browder09.html

    Jensen Comment
    Also many Russian Websites are lethal and send out computer/network destroying viruses and malware. The most dangerous sites are the so-called security sites that might send you a fake email that a virus has been found on your computer --- the virus will indeed find its way to your computer if you follow the link to the Web site or open an attachment. An overwhelming proportion of the porn sites are Russian, and these are often lethal to computers and networks. The same can be said for gambling sites. Even the so-called legitimate sites such as those run by native Americans in Canada frequently cheat according to an eye-opening module on CBS Sixty Minutes this year.

    Organization and Development of Russian Business: A Firm-Level Analysis edited by Tatiana Dolgopyatova, Ichiro Iwasaki, and Andrei A. Yakovlev (Palgrave Macmillan; 2009, 326 pages; $95). Research that draws on data on joint-stock companies collected in a survey throughout Russia.
     

    Bob Jensen's Fraud Updates are at http://www.gsb.stanford.edu/news/headlines/browder09.html

    Bob Jensen's Rotten to the Core threads are at http://faculty.trinity.edu/rjensen/FraudRotten.htm


    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.

    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

     

     


    Real Estate Fraud

    Over the course of the history of America, real estate fraud has been the most prevalent kind of fraud.  See Bob Jensen's history of fraud in America at http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm 



    Marvene is a poor and unemployed elderly woman who lost her shack to foreclosure in 2008.
    That's after Marvene stole over $100,000 when she refinanced her shack with a subprime mortgage in 2007.
    Marvene wants to steal some more or at least get her shack back for free.
    Both the Executive and Congressional branches of the U.S. Government want to give more to poor Marvene.
    Why don't I feel the least bit sorry for poor Marvene?
    Somehow I don't think she was the victim of unscrupulous mortgage brokers and property value appraisers.
    More than likely she was a co-conspirator in need of $75,000 just to pay creditors bearing down in 2007.
    She purchased the shack for $3,500 about 40 years ago --- http://online.wsj.com/article/SB123093614987850083.html


    Marvene Halterman, an unemployed Arizona woman with a long history of creditors, took out a $103,000 mortgage on her 576 square-foot-house in 2007. Within a year she stopped making payments. Now the investors with an interest in the house will likely recoup only $15,000.
    The Wall Street Journal slide show of indoor and outdoor pictures --- http://online.wsj.com/article/SB123093614987850083.html#articleTabs%3Dslideshow
    Jensen Comment
    The $15,000 is mostly the value of the lot since at the time the mortgage was granted the shack was virtually worthless even though corrupt mortgage brokers and appraisers put a fraudulent value on the shack. Bob Jensen's threads on these subprime mortgage frauds are at http://faculty.trinity.edu/rjensen/2008Bailout.htm
    Probably the most common type of fraud in the Savings and Loan debacle of the 1980s was real estate investment fraud. The same can be said of the 21st Century subprime mortgage fraud. Welcome to fair value accounting that will soon have us relying upon real estate appraisers to revalue business real estate on business balance sheets --- http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue

    The Rest of Marvene's Story --- http://faculty.trinity.edu/rjensen/FraudMarvene.htm

    Accounting Implications

    CEO to his accountant:  "What is our net earnings this year?"
    Accountant to CEO:  "What net earnings figure do you want to report?"

    The sad thing is that Lehman, AIG, CitiBank, Bear Stearns, the Country Wide subsidiary of Bank America, Fannie Mae, Freddie Mac, etc. bought these
    subprime mortgages at face value and their Big 4 auditors supposedly remained unaware of the millions upon millions of valuation frauds in the investments. Does professionalism in auditing have a stronger stench since Enron?
    Where were the big-time auditors? --- http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

    September 30, 1999

    Fannie Mae Eases Credit To Aid Mortgage Lending

    By STEVEN A. HOLMES

    In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

    The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

    Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

    In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

    ''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.'' 
    Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

    In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

    ''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the Americ an Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

    Under Fannie Mae's pilot program, consumers who qualify can secure a mortgage with an interest rate one percentage point above that of a conventional, 30-year fixed rate mortgage of less than $240,000 -- a rate that currently averages about 7.76 per cent. If the borrower makes his or her monthly payments on time for two years, the one percentage point premium is dropped.

    Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary mark et. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.

     


    Flipping Frauds
    Among the more common schemes seen by IRS criminal investigators is property flipping that involves false statements to lenders. (On its own, flipping -- in which a buyer pays a low price for property and then resells it quickly for much more -- is legal.) Also on the list: the use of two sets of settlement statements and the use of fraudulent qualifications, as when a real-estate agent helps a buyer fabricate an employment history or credit record.

    Ray A. Smith, "Real-Estate Boom Means a Boom In Real-Estate Fraud, IRS Says," The Wall Street Journal, February 25, 2005 --- http://snipurl.com/REfraudFeb24 


    They weren't working solely in their clients' best interest.
    The study was instigated by Steven D. Levitt, a self-described "rogue economist" who has applied the analytical tools of his trade to everything from sumo wrestlers to drug-dealing gangs; his work is cataloged in the forthcoming book "Freakonomics," written with Stephen J. Dubner.  Professor Levitt had fixed up and sold several houses in Oak Park, Ill., a suburb of Chicago. When working with real estate agents, he said, "I got the impression they weren't working solely in their clients' best interest."
    Daniel Gross, "Why a Real Estate Agent May Skip the Extra Mile," The New York Times, February 20, 2005 --- http://www.nytimes.com/2005/02/20/business/yourmoney/20view.html 
    Jensen Comment:  Steven Levitt is a terrific economics professor at the University of Chicago.  You can get a list of his publications at http://www.src.uchicago.edu/users/levit/ 


    "The Role of Fair Value Accounting in the Subprime Mortgage Meltdown," Journal of Accountancy, May 2008 --- http://www.aicpa.org/pubs/jofa/may2008/in_my_opinion.htm

    As the credit markets froze and stocks gyrated, investors and pundits naturally looked for someone, or some thing, to blame. Fair value accounting quickly emerged as an oft-cited problem. But is fair value really a cause of the crisis, or is it just a scapegoat? And might it have prevented an even worse calamity? On the following pages, the JofA presents three views on the debate.

     "Both Sides Make Good Points," by Michael R. Young

    How often do we get to have a raging national debate on an accounting standard? Well, we’re in one now.

    And while the standard at issue—FASB Statement no. 157, Fair Value Measurements—is fairly new, the underlying substance of the debate goes back for decades: Is it best to record assets at their cost or at their fair (meaning market) value? It is an issue that goes to the very heart of accountancy and stirs passions like few others in financial reporting. There are probably two reasons for this. First, each side of the debate has excellent points to make. Second, each side genuinely believes what it is saying.

    So let’s step back, take a deep breath, and think about the issue with all of the objectivity we can muster. The good news is that the events of the last several months involving subprime-related financial instruments give us an opportunity to evaluate the extent to which fair value accounting has, or has not, served the financial community. Indeed, some might point out that the experience has been all too vivid.

    WHAT HAPPENED We’re all familiar with what happened. This past summer, two Bear Stearns funds ran into problems, and the result was increasing financial community uncertainty about the value of mortgage backed financial instruments, particularly collateralized debt obligations (CDOs). As investors tried to delve into the details of the value of CDO assets and the reliability of their cash flows, the extraordinary complexity of the instruments provided a significant impediment to insight into the underlying financial data.

    As a result, the markets seized. In other words, everyone got so nervous that active trading in many instruments all but stopped.

    The practical significance of the market seizure was all too apparent to both owners of the instruments and newspaper readers. What was largely missed behind the scenes, though, was the accounting significance under Statement no. 157, which puts in place a “fair value hierarchy” that prioritizes the inputs to valuation techniques according to their objectivity and observability (see also “Refining Fair Value Measurement,” JofA, Nov. 07, page 30). At the top of the hierarchy are “Level 1 inputs” which generally involve quoted prices in active markets. At the bottom are “Level 3 inputs” in which no active markets exist.

    The accounting significance of the market seizure for subprime financial instruments was that the approach to valuation for many instruments almost overnight dropped from Level 1 to Level 3. The problem was that, because many CDOs to that point had been valued based on Level 1, established models for valuing the instruments at Level 3 were not in place. Just as all this was happening, moreover, another well-intended aspect of our financial reporting system kicked in: the desire to report fast-breaking financial developments to investors quickly.

    To those unfamiliar with the underlying accounting literature, the result must have looked like something between pandemonium and chaos. They watched as some of the most prestigious financial organizations in the world announced dramatic write downs, followed by equally dramatic write downs thereafter. Stock market volatility returned with a vengeance. Financial institutions needed to raise more capital. And many investors watched with horror as the value of both their homes and stock portfolios seemed to move in parallel in the wrong direction.

    To some, this was all evidence that fair value accounting is a folly. Making that argument with particular conviction were those who had no intention of selling the newly plummeting financial instruments to begin with. Even those intending to sell suspected that the write-downs were being overdone and that the resulting volatility was serving no one. According to one managing director at a risk research firm, “All this volatility we now have in reporting and disclosure, it’s just absolute madness.”

    IS FAIR VALUE GOOD OR BAD? So what do we make of fair value accounting based on the subprime experience?

    Foremost is that some of the challenges in the application of fair value accounting are just as difficult as some of its opponents said they would be. True, when subprime instruments were trading in active, observable markets, valuation did not pose much of a problem. But that changed all too suddenly when active markets disappeared and valuation shifted to Level 3. At that point, valuation models needed to be deployed which might potentially be influenced by such things as the future of housing prices, the future of interest rates, and how homeowners could be expected to react to such things.

    The difficulties were exacerbated, moreover, by the suddenness with which active markets disappeared and the resulting need to put in place models just as pressure was building to get up-to-date information to investors. It is hardly surprising, therefore, that in some instances asset values had to be revised as models were being refined and adjusted.

    Imperfect as the valuations may have been, though, the real-world consequences of the resulting volatility were all too concrete. Some of the world’s largest financial institutions, seemingly rock solid just a short time before, found themselves needing to raise new capital. In the aftermath of subprime instrument write-downs, one of the most prestigious institutions even found itself facing a level of uncertainty that resulted in what was characterized as a “run on the bank.”

    So the subprime experience with fair value accounting has given the naysayers some genuine experiences with which to make their case.

    Still, the subprime experience also demonstrates that there are two legitimate sides to this debate. For the difficulties in financial markets were not purely the consequences of an accounting system. They were, more fundamentally, the economic consequences of a market in which a bubble had burst.

    And advocates of fair value can point to one aspect of fair value accounting—and Statement no. 157 in particular—that is pretty much undeniable. It has given outside investors real-time insight into market gyrations of the sort that, under old accounting regimes, only insiders could see. True, trying to deal with those gyrations can be difficult and the consequences are not always desirable. But that is just another way of saying that ignorance is bliss.

    For fair value advocates, that may be their best argument of all. Whatever its faults, fair value accounting and Statement no. 157 have brought to the surface the reality of the difficulties surrounding subprime-related financial instruments. Is the fair value system perfect? No. Is there room for improvement? Inevitably. But those favoring fair value accounting may have one ultimate point to make. In bringing transparency to the aftermath of the housing bubble, it may be that, for all its imperfections, the accounting system has largely worked.

    --------------------------------------------------------------------------------

    Michael R. Young is a partner in the New York based law firm Willkie Farr & Gallagher LLP, where he specializes in accounting irregularities and securities litigation. He served as a member of the Financial Accounting Standards Advisory Council to FASB during the development of FASB Statement no. 157. His e-mail address is myoung@willkie.com.

    --------------------------------------------------------------------------------

    "The Capital Markets’ Needs Will Be Served: Fair value accounting limits bubbles rather than creates them," by Paul B.W. Miller

    With regard to the relationship between financial accounting and the subprime-lending crisis, I observe that the capital markets’ needs will be served, one way or another.

    Grasping this imperative leads to new outlooks and behaviors for the better of all. In contrast to conventional dogma, capital markets cannot be managed through accounting policy choices and political pressure on standard setters. Yes, events show that markets can be duped, but not for long and not very well, and with inevitable disastrous consequences.

    With regard to the crisis, attempts to place blame on accounting standards are not valid. Rather, other factors created it, primarily actors in the complex intermediation chain, including:

    Borrowers who sought credit beyond their reach.

    Borrowers who sought credit beyond their reach.

    Investment bankers who earned fees for bundling and selling vaporous bonds without adequately disclosing risk.

    Institutional investors who sought high returns without understanding the risk and real value.

    In addition, housing markets collapsed, eliminating the backstop provided by collateral. Thus, claims that accounting standards fomented or worsened this crisis lack credibility.

    The following paragraphs explain why fair value accounting promotes capital market efficiency.

    THE GOAL OF FINANCIAL REPORTING The goal of financial reporting, and all who act within it, is to facilitate convergence of securities’ market prices on their intrinsic values. When that happens, securities prices and capital costs appropriately reflect real risks and returns. This efficiency mutually benefits everyone: society, investors, managers and accountants.

    Any other goals, such as inexpensive reporting, projecting positive images, and reducing auditors’ risk of recrimination, are misdirected. Because the markets’ demand for useful information will be satisfied, one way or another, it makes sense to reorient management strategy and accounting policy to provide that satisfaction.

    THE PERSCRIPTION The key to converging market and intrinsic values is understanding that more information, not less, is better. It does no good, and indeed does harm, to leave markets guessing. Reports must be informative and truthful, even if they’re not flattering.

    To this end, all must grasp that financial information is favorable if it unveils truth more completely and faithfully instead of presenting an illusory better appearance. Covering up bad news isn’t possible, especially over the long run, and discovered duplicity brings catastrophe.

    SUPPLY AND DEMAND To reap full benefits, management and accountants must meet the markets’ needs. Instead, past attention was paid primarily to the needs of managers and accountants and what they wanted to supply with little regard to the markets’ demands. But progress always follows when demand is addressed. Toward this end, managers must look beyond preparation costs and consider the higher capital costs created when reports aren’t informative.

    Above all, they must forgo misbegotten efforts to coax capital markets to overprice securities, especially by withholding truth from them. Instead, it’s time to build bridges to these markets, just as managers have accomplished with customers, employees and suppliers.

    THE CONTENT In this paradigm, the preferable information concerns fair values of assets and liabilities. Historical numbers are of no interest because they lack reliability for assessing future cash flows. That is, information’s reliability doesn’t come as much from its verifiability (evidenced by checks and invoices) as from its dependability for rational decision making. Although a cost is verifiable, it is unreliable because it is a sample of one that at best reflects past conditions. Useful information reveals what is now true, not what used to be.

    It’s not just me: Sophisticated users have said this, over and over again. For example, on March 17, Georgene Palacky of the CFA Institute issued a press release, saying, “Fair value is the most transparent method of measuring financial instruments, such as derivatives, and is widely favored by investors.” This expressed demand should help managers understand that failing to provide value-based information forces markets to manufacture their own estimates. In turn, the markets defensively guess low for assets and high for liabilities. Rather than stable and higher securities prices, disregarding demand for truthful and useful information produces more volatile and lower prices that don’t converge on intrinsic values.

    However it arises, a vacuum of useful public information is always filled by speculative private information, with an overall increase in uncertainty, cost, risk, volatility and capital costs. These outcomes are good for no one.

    THE STRATEGY Managers bring two things to capital markets: (1) prospective cash flows and (2) information. Their work isn’t done if they don’t produce quality in both. It does no good to present rosy pictures of inferior cash flow potential because the truth will eventually be known. And it does no good to have great potential if the financial reports obscure it.

    Thus, managers need to unveil the truth about their situation, which is far different from designing reports to prop up false images. Even if well-intentioned, such efforts always fail, usually sooner rather than later.

    It’s especially fruitless to mold standards to generate this propaganda because readers don’t believe the results. Capital markets choose whether to rely on GAAP financial statements, so it makes no sense to report anything that lacks usefulness. For the present situation, then, not reporting best estimates of fair value frustrates capital markets, creates more risk, diminishes demand for a company’s securities and drives prices even lower.

    THE ROLE FOR ACCOUNTING REPORTING Because this crisis wasn’t created by poor accounting, it won’t be relieved by worse accounting. Rather, the blame lies with inattention to CDOs’ risks and returns. It was bad management that led to losses, not bad standards.

    In fact, value-based reporting did exactly what it was supposed to by unveiling risk and its consequences. It is pointless to condemn FASB for forcing these messages to be sent. Rather, we should all shut up, pay attention, and take steps to prevent other disasters.

    That involves telling the truth, cleanly and clearly. It needs to be delivered quickly and completely, withholding nothing. Further, managers should not wait for a bureaucratic standard-setting process to tell them what truth to reveal, any more than carmakers should build their products to minimum compliance with government safety, mileage and pollution standards.

    I cannot see how defenders of the status quo can rebut this point from Palacky’s press release: “…only when fair value is widely practiced will investors be able to accurately evaluate and price risk.”

    THE FUTURE Nothing can prevent speculative bubbles. However, the sunshine of truth, freely offered by management with timeliness, will certainly diminish their frequency and impact.

    Any argument that restricting the flow of useful public information will solve the problem is totally dysfunctional. The markets’ demand for value-based information will be served, whether through public or private sources. It might as well be public.

    --------------------------------------------------------------------------------

    Paul B.W. Miller, CPA, Ph.D., a professor of accounting at the University of Colorado, served on both FASB’s staff and the staff of the SEC’s ­Office of the Chief Accountant. He is also a member of the JofA’s Editorial Advisory Board. His e-mail address is pmiller@uccs.edu.

    --------------------------------------------------------------------------------

    "The Need for Reliability in Accounting Why historical cost is more reliable than fair value," by Eugene H. Flegm

    In 1976, FASB issued three documents for discussion: Tentative Conclusions on Objectives of Financial Statements of Business Enterprises; Scope and Implications of the Conceptual Framework Project; and Conceptual Framework for Financial Accounting and Reporting: Elements of Financial Statements and Their Measurement. These documents started a revolution in financial reporting that continues today.

    As the director of accounting, then assistant comptroller-chief ­accountant, and finally as auditor general for General Motors Corp., I have been involved in the resistance to this revolution since it began.

    Briefly, the proposed conceptual framework would shift the determination of income from the income statement and its emphasis on the matching of costs with related revenues to the determination of income by measuring the “well offness” from period to period by measuring changes on the two balance sheets on a fair value basis from the beginning and the ending of the period. The argument was made that these data are more relevant than the historic cost in use and not as subjective as the concept of identifying costs with related revenues. In addition, those in favor of the change claimed that the fair value data was more relevant than the historic cost data and thus more valuable to the possible lenders and investors, ignoring the needs of the actual managers and, in the case of private companies, the owners.

    RELEVANCY REQUIRES RELIABILITY It seems to me that the recent meltdown in the finance industry as well as the Enron experience would have made it clear that to be relevant the data must be reliable.

    Enron took advantage of the mark-to-market rule to create income by just writing up such assets as Mariner Energy Inc. (see SEC Litigation Release no. 18403).

    Charles R. Morris writes in his recently released book, The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash, that “Securitization fostered irresponsible lending, by seeming to relieve lenders of credit risk, and at the same time, helped propagate shaky credits throughout the global financial system.”

    There is much talk of the need for “transparency,” and it now appears we have completely obscured a company’s exposure to loss! We still do not know the extent of the meltdown!

    ASSIGNING BLAME We are still trying to assign blame—Morris identifies former Federal Reserve Chairman Alan Greenspan’s easy money policies—and certainly the regulators allowed the finance industry to get out of control. However, FASB and its fascination with “values” and mark to market must be a part of the problem.

    Holman W. Jenkins Jr. began his editorial, “Mark to Meltdown,” (Wall Street Journal, p. A17, March 5, 2008) by stating, “No task is more thankless than to write about accounting for a family newspaper, yet it must be shared with the public that ‘mark to market,’ an accounting and regulatory innovation of the early 1990s, has proved another of Washington’s fabulous failures.”

    Merrill Lynch reported a $15 billion loss on mortgages for 2007. Citicorp had about $12 billion in losses, and Bear Stearns failed. These huge losses came from mortgages that had been written up to some fictitious value based on credit ratings during the preceding years! In addition there is some doubt that those loss estimates might be too conservative and at some point in the future a portion of them may be reversed.

    THE BASIC PURPOSE OF ACCOUNTING Anyone who has ever run an accounting operation knows that the basic purpose of accounting is to provide reliable, transaction-based data by which one can control the assets and liabilities and measure performance of both the overall company and its individual employees.

    A forecast of an income statement each month as well as an analysis of the actual results compared to the previous month’s forecast are a key factor in controlling a company’s operations. The balance sheet will often be used by the treasury department to analyze cash flows and the need for financing. I do not know of a company that compares the values of the beginning and ending balance sheets to determine the success of its operations.

    How did we reach the current state of affairs where the standard setters no longer consider the stewardship needs of the manager but focus instead on the potential investor or creditor and potential values rather than transactional results?

    The problem developed because of the conflict between economics, accounting and finance—and the education of accountants. All three fields are vital to running a company but each has its place. In what some of us perceive to be an exercise of hubris, FASB has attempted to serve the needs of all three fields at the expense of manager or owner needs for control and performance measurements.

    HOW WE GOT HERE The debate over the need for any standards began with the 1929 market crash and the subsequent formation of the SEC. Initially, Congress intended that the chief accountant of the SEC would establish the necessary standards. However, Carmen Blough, the first SEC chief accountant, wanted the American Institute of Accountants (a predecessor to the AICPA) to do this. In 1937 he succeeded in convincing the SEC to do just that. The AICPA did this through an ad hoc committee for 22 years but finally established a more formal committee, the Accounting Principles Board, which functioned until it was deemed inadequate and FASB was formed in 1973.

    FASB’s first order of business was to establish a formal “constitution” as outlined by the report of the Trueblood Committee (Objectives of Financial Statements, AICPA, October 1973). With the influence of several academics on that committee, the thrust of the “constitution” was to move to a balance sheet view of income versus the income view which had arisen in the 1930s. Although the ultimate goal was never clarified, it was obvious to some, most notably Robert K. Mautz, who had served as a professor of accounting at the University of Illinois and partner in the accounting firm Ernst & Ernst (a predecessor to Ernst & Young) and finally a member of the Public Oversight Board and the Accounting Hall of Fame. Mautz realized then that the goal was fair value accounting and traveled the nation preaching that a revolution was being proposed. Several companies, notably General Motors and Shell Oil, led the opposition that continues to this day.

    The most recent statement on the matter was FASB’s 2006 publication of a preliminary views (PV) document called Conceptual Framework for Financial Reporting: Objective of Financial Reporting and Qualitative Characteristics of Decision-Useful Financial Reporting Information. It is clear that FASB has abandoned the real daily users who apply traditional accounting to manage their businesses. The PV document refers to investors and creditors only. It mentions the need for comparability and consistency but does not attempt to explain how this would be possible under fair value accounting since each manager would be required to make his or her own value judgments, which, of course, would not be comparable to any other company’s evaluations.

    The only reference to the management of a company states that “…management has the ability to obtain whatever information it needs.” That is true, but under the PV proposal management would have to maintain a third set of books to keep track of valuations. (The two traditional sets would be the operating set based on actual costs and sales, which would need to be continued to allow management or owners to judge actual performance of the company and personnel, while the other set is that used for federal income tax filings.)

    Since there are about 19 million private companies that do not file with the SEC versus the 17,000 public companies that do, private companies are in a quandary. The majority of them file audited financial statements with banks and creditors based on historical costs and for the most part current GAAP. They are already running into trouble with several FASB standards that introduce fair value into GAAP. What GAAP do they use?

    Judging by the crash of the financial system and the tens of billions of dollars in losses booked by investment banks this year, the answer seems clear: Return to establishing standards that are based on costs and transactions, that inhibit rather than encourage manipulation of earnings (such as mark to market, FASB Statements no. 133 and 157 to name a few), and that result in data as reliable as it can be under an accrual accounting system.

    The analysts and other investors and creditors will have to do their own estimates of a company’s future success. However, the success of any company will depend on the quality of its products and services and the skill of its management, not on a guess at the “value” of its assets. Writing up assets was a bad practice in the 1920s and as bad a practice in recent years.

    --------------------------------------------------------------------------------

    Eugene H. Flegm, CPA, CFE, (now retired) served for more than 30 years as an accounting executive for General Motors Corp. He is a frequent contributor to various accounting publications. His e-mail address is ehflegm@earthlink.net.

    --------------------------------------------------------------------------------

    Jensen Comment
    There are many factors that interacted in causing the subprime scandals of 2008. But the one key factor that could have prevented both the Savings & Loan scandals in the 1980s and the Subprime Mortgage scandals of 2008 is professionalism in the real estate appraising industry. In both of these immense scandals real estate appraisers repeatedly provided fair value estimates above and beyond anything that could be considered a realistic fair value. There's genuine moral hazard in the relationships between real estate appraisal firms and real estate brokerage firms who desperately want buyers to get financing needed to close the deals. Banks also want desperately to close the deals so they can sell the mortgages to mortgage buyers like Fannie Mae and Freddie Mac quasi-government corporations designed to buy up mortgages from banks.

    These huge scandals provide evidence of the unreliability and nonstationarity of fair value estimates. The freight train that's hauling in fair value standards to replace existing standards in the FASB and the IASB is fraught with peril. There are, of course, many instances where fair value is the only reasonable choice such as in derivative financial instruments where historical cost is usually zero or some miniscule premium paid relative to the huge risks involved. There are other instances such as with leases and pensions having contractual future cash flows where fair value estimation is reasonably accurate. But more often than not fair value estimates are little more than pie in the sky.

    As earnings numbers are increasingly impacted by unrealized adjustments for fair values, many of which wash out to a zero cumulative effect over time, the more firms are contracting based upon earnings before unrealized fair value adjustments. Labor unions are increasingly concerned that companies can manage earnings by such simple devices as implementation of hedge accounting effectiveness testing. Companies like Southwest Airlines exclude these unrealized fair value changes in earnings from compensation contracts with employees in order to ease the fears of employees.

    This is the driving force behind the FASB's bold initiative to eliminate bottom line reporting.
    Five General Categories of Aggregation
    "The Sums of All Parts: Redesigning Financials:  As part of radical changes to the income statement, balance sheet, and cash flow statement, FASB signs off on a series of new subtotals to be contained in each," by Marie Leone, CFO Magazine, November 14, 2007 --- http://faculty.trinity.edu/rjensen/Theory01.htm#ChangesOnTheWay

    "Profit as We Know It Could Be Lost With New Accounting Statements," by David Reilly, The Wall Street Journal, May 12, 2007; Page A1 --- http://faculty.trinity.edu/rjensen/Theory01.htm#ChangesOnTheWay

    "A New Vision for Accounting: Robert Herz and FASB are preparing a radical new format for financial, CFO Magazine, by Alix Stuart, February 2008, pp. 49-53 --- http://faculty.trinity.edu/rjensen/Theory01.htm#ChangesOnTheWay

    Bob Jensen's threads on fair value accounting --- http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue  

    Bob Jensen's threads on alternative valuations --- http://faculty.trinity.edu/rjensen/Theory01.htm#UnderlyingBases

    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


    "Many Companies Avoided Taxes Even as Profits Soared in Boom," by John D. McKinnon, The Wall Street Journal, April 6, 2004 --- http://online.wsj.com/article/0,,SB108120535291874840,00.html?mod=home_whats_news_us 

    More than 60% of U.S. corporations didn't pay any federal taxes for 1996 through 2000, years when the economy boomed and corporate profits soared, the investigative arm of Congress reported.

    The disclosures from the General Accounting Office are certain to fuel the debate over corporate tax payments in the presidential campaign. Corporate tax receipts have shrunk markedly as a share of overall federal revenue in recent years, and were particularly depressed when the economy soured. By 2003, they had fallen to just 7.4% of overall federal receipts, the lowest rate since 1983, and the second-lowest rate since 1934, federal budget officials say.

    The GAO analysis of Internal Revenue Service data comes as tax avoidance by both U.S. and foreign companies also is drawing increased scrutiny from the IRS and Congress. But more so than similar previous reports, the analysis suggests that dodging taxes, both legally and otherwise, has become deeply rooted in U.S. corporate culture. The analysis found that even more foreign-owned companies doing business in the U.S. -- about 70% of them -- reported that they didn't owe any U.S. federal taxes during the late 1990s.

    "Too many corporations are finagling ways to dodge paying Uncle Sam, despite the benefits they receive from this country," said Sen. Carl Levin (D., Mich.), who requested the study along with Sen. Byron Dorgan (D., N.D.). "Thwarting corporate tax dodgers will take tax reform and stronger enforcement." A 1999 GAO study on corporate tax payments reached similar results.

    The latest report has given new ammunition to the campaign of Democratic presidential challenger Sen. John Kerry, who has criticized President Bush for failing to crack down on corporate tax dodgers. Mr. Kerry wants to end corporations' ability to park their overseas earnings in tax havens, in order to discourage outsourcing; in return, he is proposing a lower U.S. corporate tax rate.

    A spokeswoman said that Mr. Kerry "wants to make America more fair, so that average Americans don't have to pick up the tab for corporate-America profits."

    Tomorrow, Mr. Kerry is expected to outline his ideas for reducing the budget deficit. Yesterday, he criticized Mr. Bush for dropping a budget rule, used in prior administrations, mandating that any new tax breaks be paid for by revenue or spending cuts elsewhere in the budget.

    To be sure, Mr. Kerry has supported some of the most recent big corporate breaks, such as those contained in a 2002 economic stimulus bill. And the latest GAO report focused on tax avoidance that took place entirely during the Clinton years.

    A spokesman for the Bush campaign said Mr. Kerry's own campaign has acknowledged its plan wouldn't stop outsourcing. "Sen. Kerry has a habit of putting forth political statements that wouldn't achieve the policy goals that he says they would," Bush spokesman Scott Stanzel said.

    An IRS spokesman noted that the agency recently has stepped up enforcement activity for business taxpayers. The Bush administration's 2005 budget request includes a 10% increase for IRS enforcement, mostly to go after more corporations.

    The GAO report also may further fuel a drive in Congress to crack down on a variety of corporate tax-dodging strategies, such as a recently discovered leasing maneuver that allows companies to buy up depreciation rights to public transit lines, highways and water systems. Senate tax-committee leaders have released a list of companies involved that includes a number of well-known financial firms, such as First Union Commercial Corp., a unit of Wachovia Corp. Wachovia has defended its involvement, saying the transactions are legal.

    The new report also could spur further IRS action against tax-shelter peddlers and their customers. The IRS is closely examining tax-shelter deals sold by accounting firms such as KPMG LLP, for example. That firm recently experienced a management shake-up in response to the inquiry.

    Conservatives depicted the GAO report as an argument for tax-code overhaul for both corporations and individuals. Dan Mitchell, a fellow at the Heritage Foundation, a conservative think tank, also noted in corporations' defense that they have an obligation to shareholders to pay as little tax as they legally can.

    The report examined a sample of tax information for the years 1996 through 2000; for 2000, it covered about 2.1 million returns filed by U.S.-controlled corporations and 69,000 filed by foreign-controlled corporations. It showed that big companies -- defined as those with at least $250 million in assets or $50 million in gross receipts -- were more likely to pay taxes than smaller ones. Still, the GAO said 45.3% of large U.S.-controlled companies and 37.5% of large foreign-controlled companies had no tax liability in 2000. More than 35% paid less than 5% of their income.

    The basic federal corporate-tax rate for big corporations is 35%. But the federal tax code also offers many credits and loopholes that allow many companies to pay far less than that.

    Continued in the article

    One of the biggest loopholes is the tax law that says firms can reduce the amount of taxes actually owed by deducting the intrinsic difference between share price and strike price on the date employee stock options are exercised.  This type of compensation requires no cash outlays for corporations but allowed companies like Cisco to declare over $2 billion in Year 2000 profits but pay no taxes due to stock option compensation.

    Another huge sham is how companies with foreign operations declare a headquarters offshore (often in Bermuda or the Cayman Islands) which is little more than a post office box or a one-room rental void of employees and furniture that shields foreign revenue from taxation.

    The reason that corporations pay no tax is that corporate lobbyists have engineered loopholes with their friends in Congress.  The U.S. has the best representatives money can buy.

    The sad part is some of our leading international accounting firms pushed even beyond the legal limits in selling sham tax shelters to large and supposedly prestigious corporations --- http://faculty.trinity.edu/rjensen/Fraud.htm#KPMG 


    "THE DECLINE OF CORPORATE INCOME TAX REVENUES," By Joel Friedman, Center on Budget Policy and Priorities --- http://www.cbpp.org/10-16-03tax.htm 

    Corporate income tax revenues are sensitive to economic conditions, and the recent slowdown in the economy has played a significant role in the collapse of corporate revenues. But the economy explains only part of the decline. Tax cuts for corporations enacted over the past few years have also contributed significantly. Based on Joint Committee on Taxation estimates, provisions enacted in 2002 and 2003 reduced taxes for businesses by over $50 billion in 2003, and corporations are by far the largest beneficiaries of these tax breaks.

    Corporate revenues are further diminished by aggressive tax avoidance strategies, including the sheltering of corporate profits overseas. No precise estimates of the extent of these tax shelter activities exist. In testimony before the Senate Finance Committee in March 2000, the Joint Committee on Taxation stated that “the data are not sufficiently refined to provide a reliable measure of corporate tax shelter activity.” Using the evidence that is available, however, the Joint Committee concluded that “there is a corporate tax shelter problem” and that “the problem is becoming widespread and significant.”  Similarly, former IRS Commissioner Charles Rossotti identified abusive corporate tax shelters as "one of the most serious and current compliance problem areas."  Internal IRS studies on tax sheltering, recently disclosed by the General Accounting Office, indicate that “tens of billions of dollars of taxes are being improperly avoided and the potential for the proliferation of abusive tax shelters is strong.”


    In essence, the U.S. tax code gives [U.S. multinationals] more in tax breaks for foreign operations than it collects in revenues.
    John D. McKinnon (See below)

    From The Wall Street Journal Accounting Educators' Review on May 7, 2004

    TITLE: U.S. Overseas Tax is Blasted 
    REPORTER: John D. McKinnon 
    DATE: May 05, 2004 
    PAGE: A4 LINK: http://online.wsj.com/article/0,,SB108370777246501914,00.html  
    TOPICS: Tax Laws, Taxation

    SUMMARY: A study undertaken by Congress's Joint Committee on Taxation concludes that the U.S. government, if it were to switch to a territorial approach to taxation, would collect "$60 billion more over 10 years than the current system would raise." "In essence, the U.S. tax code gives [U.S. multinationals] more in tax breaks for foreign operations than it collects in revenues..."

    QUESTIONS: 
    1.) What is the overall objective of current U.S. tax law with respect to multinational corporations? What is the objective of tax breaks and deductions allowed against income earned by multinationals in other countries?

    2.) How is it possible that the current status of U.S. tax law results in a system which costs the U.S. government more than it collects in tax revenues from this system? How would a "territorial approach" to taxation differ from this current system?

    3.) Tax law is designed not only to raise revenues for the government but also to encourage behavior beneficial to society and the economy. How do some argue that current tax law influences corporate decisions in locating operations and resultant job growth prospects?

    4.) Others argue that changes to current tax law would do more harm than good in influencing job growth in the U.S. economy. What are the factors that argue against changing the current tax law in this area? Specifically comment on how these factors influence U.S. job growth prospects.

    5.) A spokesman for Eli Lilly, the pharmaceutical company, says his employer considers a variety of factors in deciding where to locate operations. Suppose that you are a top manager considering opening a new operation to serve a foreign market that covers several countries. List all factors that you expect to consider in your decision making process.

    6.) What "added bonus for companies' reported profits" comes with income earned in low-tax countries which management commits to reinvest in those countries? Through what mechanism does this decision influence reported profits? That is, specifically describe what income statement accounts are influenced by this decision and why the accounting reflects this influence.

    Reviewed By: Judy Beckman, University of Rhode Island 
    Reviewed By: Benson Wier, Virginia Commonwealth University 
    Reviewed By: Kimberly Dunn, Florida Atlantic University

    --- RELATED ARTICLES --- 
    TITLE: Review & Outlook: Export Tax Follies 
    REPORTER: WSJ Editors 
    PAGE: A14 
    ISSUE: May 05, 2004 
    LINK: http://online.wsj.com/article/0,,SB108371159350602084,00.html 


    The Corporate Income Tax is Also Plunging to Insignificance in States Having Income Taxes

    The decline of corporate tax revenue in Massachusetts' is typical of what has happened in most states --- http://www.massbudget.org/cc_presentation.pdf 

    Massachusetts’ Vanishing Corporate Income Tax – Trends

    In 1968, the personal income tax yielded twice as much revenue as the corporate income tax; it now generates 13 times as much. In 1968, the sales tax and the corporate income tax produced roughly equal amounts of revenue; the revenue.

     


    The enormous decline in importance of corporate income taxation on in funding of both State and Federal government in the U.S is very sad when compared with the costs of compliance including societal costs listed below:

    If you juxtapose those costs against the plunging revenues that society gains from corporate income taxation, it would seem that corporate taxation is an extremely costly way to raise so little revenue.

    Chances of repeal are slim, however, since so many law firms have vested interests in corporate taxation.  These same law firms have the most powerful influence on changing tax law since so many State and Federal legislators are lawyers.


    "Emerging from Bankruptcy, WorldCom Faces $1B Tax Bill, AccountingWEB, April 20, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99044 

    As WorldCom is about to emerge from the biggest bankruptcy in U.S. history, its former home state claims it owes $1 billion in back taxes. 

    Reuters reported that more than 12 states have made $500 million in claims against the bankrupt phone company. The states also filed a motion to have KPMG removed as WorldCom’s auditor. Mississippi’s $1 billion claim came to light Friday when the U.S. bankruptcy court judge heard arguments on the states’ KPMG motion.

    Continued in the article

    Bob Jensen's threads on the Worldcom scandal are at http://faculty.trinity.edu/rjensen/FraudEnron.htm#WorldCom 

    Bob Jensen's threads on KPMG's legal woes are at http://faculty.trinity.edu/rjensen/fraudFirms.htm#KPMG 


    Surprise! Surprise!

    Audits of corporations continue to drop, despite the Bush administration's hard line on tax cheats, a study released this week shows. IRS officials don't dispute the findings, but said the report didn't tell the whole story.

    "Big Corporations Escape IRS Scrutiny, Audits Drop," AccountingWEB, April 13, 2004 --- http://www.accountingweb.com/item/99017

    Audits of corporations continue to drop, despite the Bush administration’s hard line on tax cheats, a study released Monday shows.

    The Internal Revenue Service conducted face-to-face audits on only 29 percent of the largest corporations in 2003, compared with 34.7 percent in 1999. In looking at all corporations, big or small, face-to-face audits dropped to 7 percent in 2003 from 15 percent in 1999, according to the Transactional Records Access Clearinghouse, a research organization associated with Syracuse University.

    IRS officials didn't dispute the findings, but said the report didn’t tell the whole story, the Wall Street Journal reported. The figures are for completed audits, so the report doesn’t reflect the new tax shelter investigations under way, IRS officials said. Tight enforcement budgets have also hindered the agency’s efforts.

    "There's been a lag" in the corporate-enforcement turnaround, said IRS Commissioner Mark Everson. "Our expectations are we're turning that corner now, and the decrease has stabilized in '04. ... This is the hinge year we're in."

    IRS officials predict corporate audit rates for medium-size companies will jump from a projected 7.5 percent this year to 13 percent in 2007. For larger corporations, the audit rate should rise to 30 percent from 26 percent over the same time period.

    One area where enforcement has begun to turn around is in audits, collections and penalties against individuals. The IRS said in a statement Friday that audits of taxpayers who earn $100,000 or more were up 52 percent from two years ago.

    In fact, the IRS said Friday that it plans to inspect corporate executives' tax returns at twice the current rate, including a hard look at corporate perks, such as stock options, private jets and luxury apartments.

    The IRS last year audited 24 major corporations in a sampling of industries and locations to see if they were following the rules when paying their executives. That study led agents to look into tax returns filed by some corporate leaders. Their discovery? Some hadn't filed returns at all.

    Oversight will increase over executive stock options, business and personal use of fringe benefits, improper use of family limited partnerships, "golden parachute" benefit packages, life insurance misused as a vehicle to transfer wealth, offshore employee leasing practices that improperly hide money abroad and deferred compensation agreements.


    "The Problem of Corporate Tax Shelters Discussion, Analysis and Legislative Proposals," Department of the Treasury, July 1999 ---  http://www.treas.gov/press/releases/reports/ctswhite.pdf?IMAGE.X=30\&IMAGE.Y=11 

    This Report is focused on curbing corporate tax shelters within the Federal income tax system. The Treasury Department recognizes, however, that in light of the increased avoidance of corporate income taxes through the use of tax shelters, some may call for the replacement of the corporate income tax with a new tax regime, or integration of the corporate and individual income tax systems in order to eliminate corporate tax shelters once and for all. A detailed analysis of these approaches is beyond the scope of this paper. It is unlikely, however, that corporate tax shelters would end as a result of fundamental tax reform or integration. 

    Periodically, there are calls for fundamental tax reform to address, among other things, the complexity of the Federal income tax system. For example, some have argued for replacing the progressive rate structure with a flat rate, while others have argued for replacing the income tax base with consumption-based taxes, such as a sales tax or a value added tax (VAT). 

    In 1992, the Treasury Department issued a report on the integration of the individual and corporate tax systems. 414 The primary goal of integration would be to tax corporate income once and reduce or eliminate the economic distinctions arising under the current two-tiered system. The report examines in detail several different integration prototypes to stimulate debate on the desirability of integration. With respect to publicly traded corporations, some have argued for a form of integration that would replace the corporate income tax with an annual tax on shareholders measured by the market value of the corporation’s stock.

    In the case of fundamental tax reform and integration, a corporation would still be required to determine a tax base, albeit under the new system, to determine its tax liability or the tax allocable to its shareholders. Under any system, corporations and their shareholders would continue to have an interest in minimizing their collective tax liabilities. For example, even if the corporate and individual income taxes were integrated, shareholders (and, correspondingly, corporations) would have an interest in postponing the payment of taxes attributable to corporate earnings. In addition, a fundamentally new tax regime would have sufficiently unclear or complex areas that could result in a significant avoidance of tax.

    Continued in the report


    Hi Mac,

    Firstly, in the high-flying 1990s in which this study was done virtually all these corporations were making high profits. For example, Cisco reported $2 billion in profits and nearly a billion dollars of tax expense. Then by deducting the intrinsic value of employee stock options (which is never a corporate expense under FAS 123), they wiped out their tax liability on their tax expense. The intrinsic value write-off was never a cash loss to Cisco and eventually was lost by most employees who exercised their options but did not sell their stock before Cisco's shares plummeted in value. See "Accounting for Tax Benefits of Employee Stock Options and Implications for Research," Accounting Horizons, Vo. 16, No. 1, March 2002, pp. 1-16.

    Secondly, setting up a corporate "headquarters" in the Cayman Islands or Bermuda is often little more than renting a postal box or renting an empty room in some obscure building. Recently, a television show featured trying to find these so-called foreign headquarters used for shielding taxes on foreign profits.

    Thirdly, the negotiating skills of the IRS are hamstrung by the special interest tax breaks written into tax law by U.S. legislators on the dole from the companies seeking tax breaks. Millions of dollars are spent buying legislators in order to save billions in corporate taxes.

    MORE THAN 60% OF U.S. FIRMS didn't pay federal taxes for 1996 through 2000, federal budget officials said. Their report shows how deeply rooted corporate tax avoidance, legal and otherwise, has become. 
    John D. McKinnon (see above) 
    The sad part is some of our leading international accounting firms pushed even beyond the legal limits in selling sham tax shelters to large and supposedly prestigious corporations.

    Some of the tax shams are revealed in detail by Amy Dunbar at http://faculty.trinity.edu/rjensen/Fraud.htm#KPMG 

    Bob Jensen

    -----Original Message----- 
    From:  MacEwan Wright, Victoria University 
    Sent: Tuesday, April 06, 2004 6:28 PM 
    Subject: Re: How to earn billions and pay no taxes!

    The problem here is that companies do not pay taxes becuase that do not make a "taxable profit". Accordingly, they are not in a "position" to distribute this non existent profit. The investors make their money on the growth in value of the shares they hold. Eventually the government will get something when the investor sells and realises a taxable capital gain. It should also be noted that the tax regime uses its own accounting rules to calculate taxable profit that has nothing to do with GAAP or IFRS or anything like that. The extent to which companies can play at "transfer pricing" is probably the key to the game. This depends on the point at which a company will accept the costs of moving its entire operation out of the country to avoid further tax costs (and can make that move). It also depends on the negotiating skills of the taxation authorities. It is a neat balancing act for taxation authorities the world over. 

    Kind regards, 
    Mac Wright


    Hi Denny,

    Yes, but the sad part is that employees took the fall on taxes instead of the corporations. Corporations got to deduct each employee's ESO intrinsic value. Employees had to report the intrinsic values in their tax returns when options were exercised and no cash was received, paid their taxes, and then watched in many instances while their stock values plunged following the 1996-2000 period studied by the GAO in which 60% of the corporations paid no taxes at all. I think this is one of the major reasons companies like Microsoft abandoned ESO compensation plans following the damage done to employees by corporations seeking to eliminate corporate taxes with ESOs.

    Many companies that stick with ESO plans following the new IASB and FASB requirements for expensing stock options when granted to employees are probably doing so for tax purposes and are, thereby, passing on two heavy risks to employees. Risk 1 is that the granted options will one day have intrinsic value. Risk 2, if there is intrinsic value and the options are eventually exercised, the employee pays the tax before any cash is received from the sale of the acquired stock. If the stock plunges in value while the employee still holds the stock, the employee does not get a symmetrical break on recovering taxes paid on the shares at the date the options were exercised.

    The fact that employers might one day recover their tax losses and employees probably will not recover their tax losses creates an asymmetry that I do not view as equitable.

    IRS Topic 427 - Stock Options

    If you are granted a statutory stock option under an employee stock purchase plan or an employee incentive stock option (ISO) plan, you generally do not include any amount in your gross income as a result of the grant or exercise of your option. However, you may be subject to Alternative Minimum Tax in the year you exercise an ISO. For more information, refer to the Instructions for Form 6251.

    You have taxable income or deductible loss when you sell the stock you received by exercising the option. You generally treat this amount as a capital gain or loss. However, if you do not meet special holding period requirements, you will have to treat income from the sale as ordinary income. Refer to Publication 525, Taxable and Nontaxable Income, for specific details on the type of stock option, rules for when income is reported and how income is reported for income tax purposes.

    If you are granted a nonstatutory stock option, the amount of income to include and the time to include it depends on whether the fair market value of the option can be readily determined and whether your rights in the stock are vested when you receive it. For most nonstatutory options, there is no taxable event when the option is granted and the fair market value of the stock received on exercise, less the amount paid, is included in income when the option is exercised. For specific information and reporting requirements, refer to Publication 525.

    Bob Jensen

    -----Original Message----- 
    From: Dennis Beresford Sent: Wednesday, April 07, 2004 6:54 AM 
    Subject: Re: How to earn billions and pay no taxes!

    Bob,

    Keep in mind that, in general, when a corporation is allowed to deduct expense for stock options for tax purposes, the individuals involved have to pay taxes on those same amounts - usually at a higher rate than the corporation.

    Denny Beresford


    Yes Richard, but if we allow 60% of our corporations to pay no taxes whatsoever in the most profitable period in U.S. history (1996-2000), why not just abandon corporate income taxes? Saying that we have income taxes for most major corporations is a myth. The unfortunate part is that those corporations had to waste millions (frictions) legislating tax shelters and paying tax advisors to find ways to eliminate taxes due. Why not eliminate corporate taxes and their frictions? In the best of times, corporate income taxes only accounted for 10% of the budget. Today it is even less since corporate earnings are lower. 

    http://www.commondreams.org/headlines01/0520-04.htm 

    http://www.thirdworldtraveler.com/Class_War/ClassWars_NextAttack.html 

    Why not just toss in the towel on corporate income taxes, Bermuda tax shams, ESO shams, KPMG street car leasing shams, and the like? Eliminate the corporate tax myth and tax the employees since employees are really paying more taxes than their employers.

    See http://faculty.trinity.edu/rjensen/FraudCongress.htm#TaxAvoidance 

    Also see http://faculty.trinity.edu/rjensen/Fraud.htm#KPMG 

    Bob Jensen

    -----Original Message----- 
    From: Richard C. Sansing Sent: Wednesday, April 07, 2004 7:12 
    Subject: Re: How to earn billions and pay no taxes!

    The corporate income tax deduction associated with the exercise of a non-qualified employee stock option is not "tax avoidance" any more than is the payment of cash salary. The difference in the GAAP and tax treatments of options is a problem with the GAAP treatment, not the tax rule. Statistics that fail to distinguish between the effects of employee stock option deductions and "sham tax shelters" are essentially meaningless. Those who lump the two together are either confused or are being disingenuous.

    Richard C. Sansing 
    Associate Professor of Business Administration 
    Tuck School of Business at Dartmouth 
    100 Tuck Hall Hanover, NH 03755

    Hi Richard,

    I don't think we are applying "sham" to the same thing. I guess what I am really saying is that the corporate tax code is "the" sham if we convince the public that there is a tax on corporate incomes when most corporations, especially large corporations, end up paying no income taxes in their most prosperous period in history (1996-2000).

    You may call all these ESO and other tax deductions legitimate costs of doing business, but if corporations were really losing as much money as is being claimed on their corporate tax returns, they would all be out of business today.

    Am I missing something here Richard, or is the fact that these "losing" companies not only survived but thrived pointing to some type of sham going on in the corporate tax code?

    Bob Jensen

    -----Original Message----- 
    From: Richard C. Sansing 
    Sent: Wednesday, April 07, 2004 8:56 AM 
    Subject: Re: How to earn billions and pay no taxes!

    --- Bob Jensen wrote:

    I define "sham" in the corporate tax structure as anything that allows companies to report $2 billion in profit like Cisco did in Year 2000 and pay no corporate income taxes due to ESOs that Cisco employees exercised.

    --- end of quote ---

    Fine. That requires that you embrace the (soon to be changed) "options aren't expenses" perspective regarding ESOs. I find that perspective to be without merit, and regard the problem as one of Cisco's accounting earnings being overstated as opposed to their taxable income being understated. But now the basis of our disagreement is clear.

    Richard C. Sansing 
    Associate Professor of Business Administration 
    Tuck School of Business at Dartmouth 
    email: Richard.C.Sansing@dartmouth.edu 

    April 7 Additional Reply from Richard Sansing

    --- Bob Jensen wrote:

    Am I missing something here Richard, or is the fact that these "losing" companies not only survived but thrived pointing to some type of sham going on in the corporate tax code?

    --- end of quote ---

    Both. First let's see what you are missing by looking at the 7/29/2000 financial statements of Cisco Systems. Cisco reports $4.3 billion of pretax book income; $2.5 billion US and $1.8 billion foreign. They also report that the current portion of income tax expense is $2.5 billion; $1.8 federal and the rest state and foreign.

    Did they pay $1.8 billion to the US federal government? No, they did not. According to their cash flow statement, they saved $2.5 billion on ESO deductions, which implies about $2.5/.35 = $7.1 billion of tax deductions.

    Cisco has a lot of other book-tax differences, some decreasing taxable income relative to book income (their deferred tax asset went way down, primarily due to "unrealized gains from investments." This looks like a situation in which some investments are being marked to market for book but not tax). Others increased taxable income relative to book (permanently nondeductible merger related expenses--see the tax rate reconciliation schedule.) But the ESO deductions are the dominant effect, and are large enough to turn $2.5 billion of US income into a taxable loss (and even a net operating loss carryover, as evidenced by Cisco's $1 billion deferred tax asset from loss and credit carryovers.)

    So what do we learn from all this? I think we learn very little by looking at one year of data because the corporation's taxable income is largely dictated by their employees' stock option exercise decisions; see a working paper by John Graham, Mark Lang, and Doug Shackelford ("Employee Stock Options, Corporate Taxes, and Debt Policy") to see one effort at getting a handle on this very complicated issue.

    Serious researchers investigating these issues have not found evidence of an increase in tax shelter activity; see "The Relation Between Financial and Tax Reporting Measures of Income" by George Plesko and Gil Manzon, 55 Tax Law Review (2001-2002): 175-214. But there is still a lot of hard work to do in terms of improving our understanding of these issues. There is certainly a lot of "smoke" out due to anecdotal evidence regarding some very questionable tax shelters. Actually sorting this out with the data that are available is a difficult task.

    On the other hand, we don't learn anything about these very important issues by junk statistics like the "60% of firms pay no taxes" that gives equal weight to General Electric and some firm with $100K of assets and makes no effort to distinguish between ESO deductions and sham tax shelters.

    Richard C. Sansing
    Associate Professor of Business Administration
    Tuck School of Business at Dartmouth
    email: Richard.C.Sansing@dartmouth.edu 

    April 7, 2004 reply from Amy Dunbar

    I don't think the word "sham" is being used for the tax deduction. The objection is to the underlying behavior of corporate executives who focused on managing stock prices. When Congress enacted the cap on CEO compensation, the use of stock options increased. And with the increased use came increased focus on how to increase stock price or whatever measure was being used to get around Sec. 162(m). Then FASB backed down on requiring reporting options as an expense. Partnoy states in Insidious Greed, p. 159, that "the increase in the use of stock options coincided with a massive increase in accounting fraud by corporate executives, who benefited from short-term increases in their stock prices." Coincidence? We each draw our own conclusions.

    Amy Dunbar 
    UConn

    April 7, 2004 reply from MacEwan Wright, Victoria University [Mac.Wright@VU.EDU.AU

    Dear Bob, 

    If Dennis (and your point 1.) correctly cover the position it is an example of moving the tax liability the individual. It also demonstrates my point that the tax rules and the accounting standards are not the same (and for reasons of public policy probably never will be). Australia is not in the fortunate postion of the USA when it comes to regulation. It does not represent a vast market that can be withdrawn from a corporation if it fails to follow the basic rules. Also trade is a greater portion of the GDP. Where there is trade there is the opportunity to play at transfer pricing. Further, with a very open economy, the ability of companies to move themselves outside the country is greater. Thus our tax authorities have to be skilful at negotiating imperfect compromises (point 3).

    From Australia's perspective, centralized taxation plays a much bigger role in the supply of core public goods, such as medical and educational products than in many other countries. Thus, to a certain extent it is desirable, if equitable outcomes are to be achieved. Feed into this equation the fact than the majority of Australians are shareholders, and you have an interesting political mix. The problem remains however how do you make the system equitable. The struggle continues with each country trying to find its own balance.

    I understand that the IRS are able to do terrible things to individuals, but are less able to threaten big business because of the financial nexus between US politicians and big business.

    Well, that is a political problem. Perhaps (dread the thought) compulsory electoral registration, and compulsory voting would dent the nexus. In Australia, (described by one of your encyclopedias as - Elections Nil - Hereditary Monarchy) compulsory voting was introduced after they held an election and nobody came. With everyone voting, the swinging voter becomes a real political force.

    As to point 2; why am I not surprised. Somebody makes good money by collecting the mail from the mailbox, and sending it across to the corporate "US Office", or in the case of Parmalat? Italian office? Australian tax law has some interesting rules surrounding such places as the Cayman Island, Cook Islands, Channel Islands Etc.

    Kind regards, 
    Mac


    April 7, 2004 reply from Amy Dunbar [Amy.Dunbar@BUSINESS.UCONN.EDU

    Does anyone know the outcome of the trial to determine whether Myron Scholes and his partners had to pay additional taxes with respect to Long-Term Capital Management? http://www.globalpolicy.org/nations/launder/regions/2003/0714scholes.htm 

    Amy Dunbar UConn

    "A Tax Shelter, Deconstructed,: by David Cay Johnston,  The New York Times, July 13, 2003 --- http://www.globalpolicy.org/nations/launder/regions/2003/0714scholes.htm 

    Tax sheltering is one of those activities that people normally carry on behind closed doors. But in a federal courthouse in New Haven, the doors have been thrown wide open and bright lights have been trained on one room in the house of Mammon that is tax avoidance in America today.

    Being revealed is a plan arranged by a great economic mind, Myron S. Scholes, winner of a Nobel in economics, while a partner in the giant hedge fund, Long-Term Capital Management. The partners hoped to recycle a tax shelter that had already enabled Rhône-Poulenc Rorer, Electronic Data Systems and a half-dozen other major corporations escape taxes on a total of $375 million in earnings. Dr. Scholes sought to duplicate the maneuver for his investment group, on profits that also totaled $375 million.

    Long-Term Capital, of course, would collapse in 1998 – a fall so spectacular that the Federal Reserve established a bailout to avert what it feared would become a worldwide financial panic. (The short, expensive life of Long-Term Capital and the story of its famous founders were captured in the title of a best-selling book by Roger Lowenstein, "When Genius Failed.")

    For Dr. Scholes, Long-Term Capital Holdings v. United States is a test of whether his mastery of economics and tax law led him along a slippery slope toward an embarrassing and costly confrontation with the government. The trial will determine whether he and his partners must pay $40 million in taxes and $16 million in penalties and interest.

    For ordinary Americans, the case may be a lesson in how the rich and well-connected can mine the tax code in ways that are unavailable to others. And for the government, the trial is a challenge with huge consequences for federal budgets: Can it encourage all taxpayers to obey the law by pursuing a few prominent cases, making examples of those it judges to be violators, mostly through civil actions like the Long-Term Capital case and a very few criminal prosecutions?

    As a hedge fund, Long-Term Capital, which was officially organized in the Cayman Islands, was an unregulated investment pool that by law was open only to the very wealthy. John W. Meriwether, the Wall Street bond trader, created it in 1993 with a few of his investment friends, including Dr. Scholes and Robert C. Merton, the Harvard economist with whom Dr. Scholes shared the Nobel in 1997.

    Dr. Scholes, whom colleagues have described as the consummate analyst, brought much intellectual firepower to Long-Term Capital. "This is a guy who will look at a problem and tries to devise some sort of intellectual structure that explains it," said Burton G. Malkiel, a Princeton economist who worked closely with him in the late 1980's to analyze the financial markets' crash of 1987. "If you talk to him about a problem, he immediately says, `How can we model this?' "

    Dr. Scholes traces his fascination with market dynamics to his childhood in the gold-mining territory of northern Canada. What was it, he says he wondered back then, that makes prices fluctuate? "From an early age, I was very, very fascinated by uncertainty," he once said on the public television program "Nova."

    The big idea that he had to offer to Long-Term Capital was to make money in the securities markets by applying a technique for valuing stock market options that he had helped invent. Known as the Black-Scholes method, it was described in a paper that he and Dr. Merton wrote in 1973 with Fischer Black of the University of Chicago. The method would become the standard for options traders; it is now widely used to value executive stock options, as well. The paper ultimately won the Nobel for Dr. Scholes and Dr. Merton.

    Long-Term Capital was an instant success. With Mr. Meriwether and the two famous economists heading the investment team, it quickly raised $5 billion of equity, which they used as leverage to raise $95 billion in loans. The founding partners put in $300 million of their own money but closed the fund to outsiders, with two exceptions, both of whom are now at the core of the tax case.

    Despite its name, Long-Term Capital engaged mostly in rapid-fire trading in and out of stocks, bonds and synthetic forms of ownership like futures contracts and sometimes-exotic derivatives. The firm's traders, in Greenwich, Conn., produced phenomenal returns - 28.1 percent in 1994, 58.8 percent in 1995 and 57.5 percent in 1996.

    But that very success also created what Dr. Scholes saw as a problem: a huge income tax bill. Short-term trading profits were taxed at the time at 39.6 percent, the highest income tax rate. The prospect of losing such a big part of their windfall did not please Long-Term Capital investors. One day in March 1996, a possible solution came into view. From the moment that Dr. Scholes learned of it, he understood its potential to defer, even eliminate, taxes on more than one-third of a billion dollars of profits.

    The tax shelter did not come to his firm by way of strangers, but from Babcock & Brown, an investment bank in San Francisco whose general counsel, Jan Blaustein, had been the girlfriend of Dr. Scholes for more than two years. They would marry in 1998. The shelter was in the form of stock, in companies like Electronic Data Systems, Rhône Poulenc and Qwest, that had a combined market value of about $4 million but that also had a potential worth of more than 90 times that to Long-Term Capital's partners.

    The stock had been assigned by Babcock & Brown to three London investors, who did not have to pay American taxes, through a series of multilayered leasing arrangements that gave them tax deductions worth $375 million. The Londoners could not use the deductions themselves, but they could sell the stock, and the deductions that went with them, to American investors.

    The Londoners would make money on the transaction, the American investors would eliminate their tax liability on up to $371 million in stock-trading profit. And Babcock & Brown and its network of lawyers, banks and other associates would earn big fees. Everybody would be happy - everybody, that is, except the federal government. And so it was that in auditing Long-Term Capital's tax returns, the Internal Revenue Service disallowed the use of $106 million of deductions to reduce the taxes owed by partners of the firm. Long-Term Capital then paid part of the $40 million in taxes that it owed, but sued for a refund in Federal District Court in New Haven, where the trial has been under way for three weeks and appears to be about half way over.

    Both sides knew that the outcome would depend on whether Long-Term Capital could convince Judge Janet Bond Arterton that it had not simply bought the shares in question for use as a tax dodge, but had done so for a legitimate economic purpose. Under a doctrine known as economic substance, courts have long held that if a business transaction has no value except to create tax losses, then it can be disallowed by the I.R.S. Otherwise, tax lawyers could just move symbols around on pieces of paper, and their clients would never pay taxes.

    In testimony last week, Dr. Scholes tried to show that the acquisition had an economic rationale beyond just acquiring tax losses. He viewed the transaction, he said, as a way to establish and a strong business relationship with Babcock & Brown. It was a relationship that he hoped to develop, he said, though he acknowledged that his partners did not share his passion. Indeed, once the tax shelter deal was finished, so was Long-Term Capital's relationship with Babcock & Brown.

    On cross-examination by the government, Dr. Scholes, who was the principal author of a $130 textbook, "Taxes and Business Strategy," that he used to teach graduate business students at Stanford, tried to minimize his knowledge of taxes. He conceded, however, that he knew that basic tax rules required wringing a profit from a tax shelter without regard to its tax benefits if the shelter was to stand. His testimony also showed that he worked hard to imbue the tax-favored stock with value, ordering analyses, soliciting legal opinions and even flying to London to meet with one of the three owners to make sure, he said, that they were not people who would bring disrepute on Long-Term Capital.

    His way to show a profit from the tax shelter was to make both the three Londoners and Babcock & Brown investors in Long-Term Capital, even though the firm, in theory, had been closed to outside investors. That presented another problem. Neither the Londoners nor Babcock & Brown wanted to put up any money, and neither was willing to assume any risk of losing money should the fund go broke, as it would do in 1998.

    So Dr. Scholes arranged to lend them millions of dollars at an interest rate of 7 percent, which, contrary to usual banking practice, was lower that the rate he could have gotten from most clients. Then he used his expertise as one of the creators of the Black-Scholes method to write several options guaranteeing that the investors could not lose money, he told Charles P. Hurley, the lead Justice Department lawyer in the case.

    In one of the deals, the three Londoners put tax-favored stock with a market value of $2.5 million into Long-Term Capital and, at the low interest rates, borrowed $5 million, more than half of which went to pay off an existing loan they had on their stock. To make sure that they could not lose the value of their stock or the amount they borrowed, they paid $61,000 for a put option designed and priced by Dr. Scholes.

    After 14 months, the Londoners cashed out and walked away with a 22 percent profit, by Dr. Scholes's calculations. They also paid the partnership fees of about $900,000, he estimated in testimony. Those fees, plus the value of the new relationship with Babcock & Brown, were the profits that Dr. Scholes said made the tax shelter valuable in its own right.

    Against that, Long-Term Capital paid more than $500,000 to the Shearman & Sterling law firm in New York for an opinion letter. The letter said that one part of the tax shelter deal should survive an I.R.S. audit. Long-Term Capital paid $400,000 to King & Spalding in Washington for a similar opinion letter on another part of the deal.

    Larry Noe, the tax director of Long-Term Capital, received a bonus of between $50,000 and $100,000 for his work in bringing in the tax shelter, though Dr. Scholes made it clear that the firm had resisted paying anything extra to Mr. Noe for his successful efforts on the partnership's behalf.

    Taken together, those costs equaled or exceeded the $900,000 in fees that Dr. Scholes was able to wring from the tax shelter apart from the tax benefits. In other words, unless the $900,000 was all profit, the shelter could not make a profit apart from the tax savings.

    Then came the coup de grâce. Mr. Hurley slipped in a question about whether Dr. Scholes had sought, and received, a bonus for himself of several million dollars for his role in strengthening the tax shelter. Dr. Scholes confirmed that he had, but that it had been paid in extra partnership shares, not cash.

    Counting his bonus, the tax shelter cost far more than its economic value of $900,000 in fees, making it hard to prove it met the economic-substance requirement. On the witness stand, Dr. Scholes appeared to realize how Mr. Hurley's questioning had shown that apart from the tax benefits, the deal could not have come to close to turning a profit, in large part because he took that bonus. "I'm being trapped here," he blurted out.

    Dr. Scholes has told friends that most of his wealth has been wiped out in the collapse of Long-Term Capital. If the court rules in the government's favor, he stands to owe millions of dollars to the I.R.S.

    Continued in the article

    You can read more about the rise and fall of Long-Term Capital Management at http://faculty.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds 

    There is a tremendous (one of the best videos I've ever seen on the Black-Scholes Model) PBS Nova video explaining why LTCM collapsed.  Go to http://www.pbs.org/wgbh/nova/stockmarket/ 
    This video is in the media libraries on most college campuses.  I highly recommend showing this video to students.  It is extremely well done and exciting to watch.

    One of the more interesting summaries is the Report of The President’s Working Group on Financial Markets, April 1999 --- http://www.ustreas.gov/press/releases/reports/hedgfund.pdf 

    The principal policy issue arising out of the events surrounding the near collapse of LTCM is how to constrain excessive leverage. By increasing the chance that problems at one financial institution could be transmitted to other institutions, excessive leverage can increase the likelihood of a general breakdown in the functioning of financial markets. This issue is not limited to hedge funds; other financial institutions are often larger and more highly leveraged than most hedge funds.

    What went wrong at Long Term Capital Management? --- http://www.killer-essays.com/Economics/euz220.shtml 

    The video and above reports, however, do not delve into the tax shelter pushed by Myron Scholes and his other LTCM partners. A nice summary of the tax shelter case with links to other documents can be found at http://www.cambridgefinance.com/CFP-LTCM.pdf 

    At one time, Long-Term Capital was the largest hedge fund in history with more than $100 billion in assets.  Its partners included legendary bond trader John Meriwether, and Nobel Prize-winning economists Robert Merton and Myron Scholes.  Following Long-Term ’s demise, its partners sued the U.S. government over a substantial tax dispute.

    Cambridge Finance Partners was retained by the U.S. Department of Justice to provide economics and finance consulting services in this highly publicized matter.  CFP assembled a team of experts, including Nobel Prize winner Joseph Stiglitz, and assisted the government attorneys with all aspects of the case.  Following a four and one-half week trial, parties await the U.S. District Court ’s ruling.

    LTCM Trial Gives Inside Peek At Executives and Their Taxes
    How many Nobel Prize-winning economists does it take to determine whether a tax shelter is illegal?… At least three,,according to a trial that opened here in federal court Monday.
    Wall Street Journal ,June 24,2003

    Meriwether Provides a Glimpse Into LTCM at Tax-Shelter Trial
    The trial casts a light on the complex and varied methods the ultra rich can use to avoid paying taxes.
    Wall Street Journal
    ,July 3,2003

    Partner Testifies That Tax Shelter of Hedge Fund Was Legitimate
    A Nobel Prize-winning economist who was a partner in Long-Term Capital Managemenr testified today in a trial that will determine whether he and his partners must pay $56 million in taxes and penalties.  The trial,which is in its third week and is expected to last several weeks more, is an important test of the government ’s resolve in its battle against tax shelters.
    New York Times
    ,July 8,2003

    Partner Questioned on Tax Shelter Profits
    The two men who faced off in federal court here this morning seemed ill matched for a game of intellectual chess, one a career trial lawyer for the Justice Department, the other a Nobel laureate in economics.…Under questioning by his own lawyer on Tuesday, Dr. Scholes, a partner in the hedge fund,coolly explained that he knew the tax shelter must have had real economic substance to survive I.R.S. review.…Today, he appeared to wilt after he answered a question showing that the shelter could not have turned a profit,and with no question pending, Dr. Scholes revealed what was on his mind. "I ’m being trapped here," he blurted out..
    New York Times,
    July 9,2003

    [I ]n a federal courthouse in New Haven, the doors have been thrown wide open and bright lights have been trained on one room in the house of Mammon that is tax avoidance in America today for the government, the trial is a challenge with huge consequences
    N
    ew York Times ,July 13,2003

    Nobel Winner Stiglitz Says Deals At LTCM Had ‘No Economic Value ’
    In the battle of the Nobel Prize winners in federal court here to determine the legality of a tax shelter, Nobel laureate Joseph E. Stiglitz didn't pull any punches.
    Wall Street Journal ,July 18,2003

    Case Statistics 


    Hi Ron,

    In the U.S., corporate treasurers from big banks like Wachovia replied as follows:

    ***************** 
    Dear Tax Commissioner,

    Since KPMG helped us buy a trolley car in Germany, I no longer owe any corporate income tax on our $1 billion of corporate profit.

    So Sorry,

    Auf Wiederschauen,

    Christy Phillips Wachovia, http://finance.pro2net.com/x42104.xml 
    *************************

    Bob Jensen's threads are at the following two sites:

    http://faculty.trinity.edu/rjensen/Fraud.htm#KPMG 

    http://faculty.trinity.edu/rjensen/FraudCongress.htm#TaxAvoidance 

    Bob Jensen

    -----Original Message----- 
    From:  Ron Perrin 
    Sent: Wednesday, April 07, 2004 6:26 PM 
    Subject: Re: How to earn billions and pay no taxes!

    To clarify MacEwan Wright's notes on the Aussie tax system, let me advise that July each year, every Australian taxpayer or taxpaying organisation receives a letter from the Australian Taxation Office. It simply reads

    Dear Taxpayer

    How many monies did you make last financial year?

    (Insert figure here->)$.........

    That's wonderful, now please send them to us.

    M Carmody Commissioner for Taxation*

    Ron Perrin 
    Sub Dean Faculty of Commerce 
    University of Wollongong 
    New South Wales Australia


    Billionaires & Accounting Scandals

    "Billionaires & Accounting Scandals," AccountingWeb, March 21, 2006 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=101919

    Philip F. Anschutz is a modest billionaire with an estimated wealth of only $6.4 billion. He is rated 89th in the current list in Forbes’ The World’s Billionaires. Before starting Qwest Communications in 1996, his father owned a contract drilling company and he bought his dad out in 1961, according to the Washington Post. After striking it rich in Wyoming and Utah’s oil fields, Anschutz moved into stocks and real estate.

    He came to own most of the railroads in the West and laid fiber-optical cable along his rail lines, connecting them at central hubs in strategic locations in order to provide high-speed data and T1 services for businesses, according to Wikipedia. Qwest incorporated in 1996, then acquired LCI in 1997 and added residential and business long distance to their pallet of services.

    And with all his success, he became the non-executive chairman of Qwest Communications International, Inc. after he stepped down as CEO in 2002. In 2002, the company he built also announced it had incorrectly accounted for optical-capacity revenue, between the years 1999 to 2001, to the amount of $3.8 billion, according to ComputerWire. This accounting scandal has not tainted his reputation.

    George Soros is ranked 71st in Forbes’ The World’s Billionaires. In September 1986, George Soros was a very large investor in Harken Energy when it purchased Spectrum 7 that was our standing President George W. Bush’s ailing oil venture. Spectrum 7 specialized in selling limited partnerships, according to Wikipedia. In 1986, tax laws changed the tax status of these financial instruments that had generated liberal tax write-offs before the change.

    George W. Bush was given an active membership on the Harken board and initially given an $80,000 yearly consulting contract that increased to $120,000 in 1989. Bush was given $500,000 in Harken stock and options valued at $131,250. According to Wikipedia, Bush acquired another $600,000 in Harken stock under the company’s Non-qualified Incentive Plan. Bush also received two loans, at below-market 5% interest, totaling $180,375. in 1986 and 1988. Harken stock was purchased with these loans and his Harken stock holdings were converted to stock options which Bush says were never exercised.

    It was generally thought that Harken Energy was buying political influence by having George H.W. Bush’s son on their board, but this was confirmed by David Corn’s interview with George Soros. To Corn’s question, “…What was the deal with Harken buying up Spectrum 7,” Soros responded, “…We were buying political influence. That was it. He was not much of a businessman,” according to Wikipedia.

    Carl Icahn is no.53 in Forbes’ The World’s Billionaires. He has earned his reputation as a corporate raider. He has been buying weak telecommunications companies and merging them into publicly held company XO Communications, of which he owns 61 percent, according to CorpWatch. In an odd transaction, XO Communications auctioned off their wireline businesses for $700 million to Carl Icahn, himself. Of the proceeds of the auction, $400 million will be used to retire the company’s long-term debt.

    Some investors say that Icahn rigged the auction to start with and surprised everyone but himself when he emerged as the winning bidder. CorpWatch reports others are saying that Icahn may have lead the company into trouble in order to sweeten the deal for himself.

    Andrew Bogen, an attorney for the minority XO shareholder R2 Investments, told CorpWatch, “It is inescapable that he used his dual position as debt holder and the guy who runs the company in a way that favors himself. We think Carl Icahn made all the important decisions about who was permitted to bid – and that he had full information on other bids when he made his.”


    A federal judge on Friday sentenced Joseph P. Nacchio, the former chief executive of Qwest Communications International, to six years in prison in what prosecutors called the largest insider-trading case in history.
    Dan Frosch, The New York Times, July 28, 2007 --- http://www.nytimes.com/2007/07/28/business/28qwest.html


    Note the Link to Company Audits

    "The corporate kleptomaniacs Companies are boosting their profits through cartels and price-fixing strategies. It is time to jail their executives for picking our pockets," by Prem Sikka, The Guardian, April 19, 2008 --- http://commentisfree.guardian.co.uk/prem_sikka_/2008/04/the_corporate_kleptomaniacs.html

    Companies increasingly take people for a ride. They issue glossy brochures and mount PR campaigns to tell us that they believe in "corporate social responsibility". In reality, too many are trying to find new ways of picking our pockets.

    Customers are routinely fleeced through price-fixing cartels. Major construction companies are just the latest example. Allegations of price fixing relate to companies selling dairy products, chocolates, gas and electricity, water, travel, video games, glass, rubber products, company audits and almost everything else. Such is the lust for higher profits that there have even been suspected cartels for coffins, literally a last chance for corporate barons to get their hands on our money.

    Companies and their advisers sell us the fiction of free markets. Yet their impulse is to build cartels, fix prices, make excessive profits and generally fleece customers. Many continue to announce record profits. The official UK statistics showed that towards the end of 2007 the rate of return for manufacturing firms rose to 9.7% from 8.8%. Service companies' profitability eased to 21.2% from a record high of 21.4%. The rate of return for North Sea oil companies rose to 32.5% from 30.1%. Supermarkets and energy companies have declared record profits. One can only wonder how much of this is derived from cartels and price fixing. The artificially higher prices also contribute to a higher rate of inflation which hits the poorest sections of the community particularly hard.

    Cartels cannot be operated without the active involvement of company executives and their advisers. A key economic incentive for cartels is profit-related executive remuneration. Higher profits give them higher remuneration. Capitalism does not provide any moral guidance as to how much profit or remuneration is enough. Markets, stockbrokers and analysts also generate pressures on companies to constantly produce higher profits. Companies respond by lowering wages to labour, reneging on pension obligations, dodging taxes and cooking the books. Markets take a short-term view and ask no questions about the social consequences of executive greed.

    The usual UK response to price fixing is to fine companies, and many simply treat this as another cost, which is likely to be passed on to the customer. This will never deter them. Governments talk about being tough on crime and causes of crime, but they don't seem to include corporate barons who are effectively picking peoples' pockets.

    Governments need to get tough. In addition to fines on companies, the relevant executives need to be fined. In the first instance, they should also be required to personally compensate the fleeced customers. Executives participating in cartels should automatically receive a lifetime ban on becoming company directors. There should be prison sentences for company directors designing and operating cartels. That already is possible in the US. Australia's new Labour government has recently said that it will impose jail terms on executives involved in cartels or price fixing. The same should happen in the UK too. All correspondence and contracts relating to the cartels should be publicly available so that we can all see how corporations develop strategies to pick our pockets and choose whether to boycott their products and services.

    Is there a political party willing to take up the challenge?

    Bob Jensen's threads on large accounting firms are at http://faculty.trinity.edu/rjensen/Fraud001.htm

    Bob Jensen's threads on The Saga of Audit Firm Professionalism and Independence are at http://faculty.trinity.edu/rjensen/Fraud001.htm#Professionalism 


    World Bank Fraud

    From The Wall Street Journal Accounting Weekly Review on April 23, 2009

    Report Faults World Bank's Anti-Fraud Methods
    by Bob Davis
    Apr 17, 2009
    Click here to view the full article on WSJ.com ---
    http://online.wsj.com/article/SB123992586755527389.html?mod=djem_jiewr_AC

    TOPICS: Auditing, Auditing Services, Internal Auditing, Internal Controls

    SUMMARY: The World Bank's Independent Evaluation Group produced a report in fall 2008, which cited the bank's fraud-detection procedures in its main program providing aid to poor countries as a material weakness. This $40 billion program is called the International Development Association (IDA). "[World] Bank staffers said that the IDA program faces particularly difficult challenges because corruption is often a problem in especially poor countries....Generally, the IDA received good marks and the results 'should overall be considered a quite respectable outcome,' the report said."

    CLASSROOM APPLICATION: The application of internal control procedures, and their independent testing, outside of corporations can be an eye-opener for students.

    QUESTIONS: 
    1. (Introductory) What is the World Bank?

    2. (Introductory) Who issued a report on the internal controls in place in World Bank programs? Why was this review of internal controls undertaken?

    3. (Advanced) Describe a corporate function similar to the group that undertook the review described in answer to question 2 above.

    4. (Advanced) Which World Bank program has been found to have material weaknesses in control systems? What system has been found as a material weakness?

    5. (Advanced) Define the terms "material weakness" and "significant deficiency" in relation to audits of corporate internal control systems.

    6. (Advanced) Do you think that the meaning of these terms in the report on World Bank programs is the same as the definitions you have provided? Why or why not?

    Reviewed By: Judy Beckman, University of Rhode Island

     

    "Report Faults World Bank's Anti-Fraud Methods," by Bob Davis, The Wall Street Journal, April 17, 2009 ---
    http://online.wsj.com/article/SB123992586755527389.html?mod=djem_jiewr_AC

    The World Bank's fraud-detection procedures in its main aid program to poor countries were labeled a "material weakness" in an internal report, adding to the bank's woes in handling corruption issues.

    The bank's Independent Evaluation Group gave it the lowest possible rating for fraud-detection procedures in the $40 billion aid program, called the International Development Association. That could hurt contributions to the effort, which gives grants and interest-free loans to the world's 78 poorest countries.

    The 690-page report, the first for the program, was completed last fall. Since then it has been the subject of lengthy discussions between World Bank management and the independent evaluation unit over whether the single designation of "material weakness," the lowest of four ratings, was justified. None of the program's other marks were as low; six other areas were labeled "significant deficiencies."

    "The bank's traditional control systems weren't designed to address fraud and corruption," one of the report's authors, Ian Hume, said in an interview. "They were designed for efficiency and equity -- the cheapest possible price." That increases the risk that corruption could occur in the use of IDA grants, he said.

    The World Bank has been pilloried by critics for years for not taking corruption seriously enough, and some staffers worried that the report's publication was being delayed for political reasons. The U.S., in particular, pushed for its publication, said bank staffers.

    "We have had a tough but cordial interaction with [World Bank] management along the way," said Cheryl Gray, director of the evaluation group.

    The report was published on the unit's Web site late Wednesday, but not publicized. Its presence was noted by a small icon on the bottom right of the page. Ms. Gray says that the group didn't intend to bury the report and said the unit didn't put out a press release because the report was "technical and jargony." After an inquiry from The Wall Street Journal, it was given greater prominence on the Web site. Ms. Gray said she had planned to make the change anyway.

    The report concluded that the World Bank "has until recently had few if any specific tools" to directly address fraud and corruption "at all stages in the lending cycle." An advisory panel that backed the "material weakness" designation wrote that fraud and corruption issues "involve a considerable reputation risk, involving at least a potential loss of confidence by various stakeholders."

    The Obama administration recently asked Congress to approve a three-year, $3.7 billion contribution to the bank's IDA program. A Democratic congressional staffer said it was too early to tell whether the report would make passage more difficult. Overall, the World Bank won commitments in December 2007 for $41.6 billion in funding for IDA over three years.

    Bank staffers said that the IDA program faces particularly difficult challenges because corruption is often a problem in especially poor countries. "We operate in some of the most difficult and challenging environments in the world," Fayez Choudhury, the World Bank's controller, said in an interview. "We are always looking to up our game."

    The bank's management pressed to get the fraud-and-corruption designation improved by a notch to "significant deficiency." It argued that the evaluation group didn't take into account steps it had taken over the past year to improve its controls.

    "The bank is firmly committed to mainstreaming governance and anticorruption efforts into its development work," said a management statement. It listed a number of improvements including the creation of an independent advisory board. The bank said it is trying to better integrate fraud prevention and corruption prevention generally into its operations.

    The report doesn't examine cases of actual corruption, though it notes there have been several instances that have received publicity, including health-clinic contracts in India. Rather, it looks at the systems and procedures in place to identify and prevent corruption.

    The report uses standards similar to those applied to corporate controls. Generally, the IDA received good marks and the results "should overall be considered a quite respectable outcome," the report said.

    For decades, the World Bank largely ignored corruption, figuring that some graft was the price of doing business in poor countries. Starting in 1996, however, former World Bank President James Wolfensohn focused more attention on the issue, as did his successor, Paul Wolfowitz, who held up loans to some poor countries because of concerns about corruption. That led to charges that the bank was enforcing corruption rules selectively.

    After Mr. Wolfowitz came under fire earlier for showing favoritism to his girlfriend, a bank employee, some developing nations dismissed the bank's efforts as hypocritical. Mr. Wolfowitz resigned in 2007 and the World Bank's current president, Robert Zoellick , has been trying to depoliticize the corruption issue, especially by beefing up the Department of Institutional Integrity, the main antifraud unit at the bank.

    Reviews of other institutions have also turned up designations of "material weakness." A U.S. Treasury "accountability report" for the year ended Sept. 30, 2008, for instance, found four such designations, including three involving the Internal Revenue Service's modernization, computer security and accounting, and one involving government-wide financial statements.

    Bob Jensen's threads on fraud are at http://faculty.trinity.edu/rjensen/fraud.htm


    Yawn:  Just Billions More in World Bank Frauds Coming to Light
    Corruption is an endemic problem in bank projects, swallowing unknown but significant chunks from its $30 billion-plus annual portfolio. No less a problem has been the bank staff's ferocious resistance to anything that might stand in the way of its lending ever more money to projects run by the same governments that tolerate this malfeasance. Yet nothing we've seen so far can compare to what has now been uncovered about five health projects in India, involving $569 million in loans. The projects were the subject of a "Detailed Implementation Review," a lengthy forensic examination undertaken by Ms. Folsom's Department of Institutional Integrity, known within the bank as INT. As of this writing the bank has not publicly released the review, though it's been shared with the bank's board. But we've seen a copy and are posting its executive summary on www.wsj.com/opinion  and www.OpinionJournal.com   (click here to see it).
    "World Bank Disgrace," The Wall Street Journal, January 14, 2008; Page A12 --- http://online.wsj.com/article/SB120026972002987225.html

    January 15, 2008 reply from Randy Kuhn [jkuhn@BUS.UCF.EDU]

    I am in no way surprised. As a part of the Deloitte audit team the first year after we “won” the engagement, I can clearly speak on the attitudes displayed by some World Bank staffers. The CFO at the time was an ex-employee of the previous auditing firm and frankly treated us with utter contempt repeatedly commenting on how much better the other firm was. I was not permitted to speak or ask questions in any Bank meetings that I attended (direct order from the CFO). If I wanted clarification on anything, I needed to schedule time with staffers through a central person. Even when formally scheduled, staffers would blow me off and tell me to reschedule when I arrived at the agreed upon time and the firm ate the costs of these inefficiencies. Due to confidentiality reasons, I cannot reveal any of the control weaknesses but, in general, there was either an overall lack of appreciation for the value of internal controls or lack of understanding of their purpose. As more issues like these are revealed, however, I am led to believe there might have been other underlying reasons for the constant battles we faced auditing the Bank.


    Question
    Why doesn't Section 401 of the Sarbanes-Oxley Act apply to attestation of internal controls in the World Bank?

    "World Bank Reckoning," The Wall Street Journal, September 13, 2007; Page A16 --- http://online.wsj.com/article/SB118964274677625838.html

    Since we're talking about the world's second most out-of-control international bureaucracy -- no prizes for guessing the first -- we shouldn't get our hopes up. But in the past week some prominent outsiders have been forcing the World Bank to reckon with the alien concept of accountability. Now it's up to new bank President Robert Zoellick to see that their efforts bear fruit.

    First up is former Federal Reserve Chairman Paul Volcker. For the past five months, Mr. Volcker and a panel of international experts have been conducting an independent review of the Department of Institutional Integrity, the bank's anticorruption unit known internally as the INT. Their report, which readers can find on OpinionJournal.com, is being released to the public today.

    In sober and measured terms, Mr. Volcker's report provides a devastating indictment of what it calls the bank's "ambivalence" toward both corruption and its own anticorruption unit. "There was then, and remains now, resistance among important parts of the Bank staff and some of its leadership to the work of INT," the report says (our emphasis).

    It goes on to say that, "Some resistance is more parochial. There is a natural discomfort among some line staff, who are generally encouraged by the pay and performance evaluation system to make loans for promising projects, to have those projects investigated ex post, exposed as rife with corruption, creating an awkward problem in relations with borrowing clients." To put it more plainly, the report is saying that every incentive at the bank is to push more money out the door, and bank employees hate the anticorruption effort because it interferes with that imperative.

    The report endorses the work of the INT, which was created a mere six years ago and which has been under what it calls a "particularly strong" institutional attack ever since. The INT, the Volcker panel says, "is staffed by competent and dedicated investigators who work hard and long hours with professionalism" and deploy "advanced investigative methods to detect and substantiate allegations of fraud and corruption." And it goes on to recommend that the anticorruption crusaders "should be nurtured and maintained as an exemplary investigative organization" within the bank.

    In a phone interview yesterday, Mr. Volcker added that he gives "high marks" to current INT director Suzanne Rich Folsom. Mr. Volcker's endorsement should stop cold the recent attempts by some in the bank's entrenched bureaucracy to run Ms. Folsom out of the bank, as they did Paul Wolfowitz.

    The bank is also being put on notice by the U.S. Senate through provisions in its foreign operations appropriations bill. The provision threatens to withhold 20% of U.S. funds to the bank's International Development Association arm (which provides interest-free loans to the world's poorest countries) until it is assured that the bank "has adequately staffed and sufficiently funded the Department of Institutional Integrity." The bill also demands that the bank provide "financial disclosure forms of all senior World bank personnel." Now, that will get the bureaucracy's attention.

    Notably, it's a Democrat -- Evan Bayh of Indiana -- who's taken the lead on this issue. Mr. Bayh has ordered a Government Accountability Office report on the effectiveness of IDA loans and their susceptibility to corruption, the bank's procurement procedures, as well as the legendary pay packages enjoyed by its senior management. "There's a tendency [at the bank] to say 'just give us the money and go away,'" the Senator told us by phone yesterday. "Until there are some tangible consequences, they won't take us seriously. We shouldn't let that happen."

    Continued in article

    Bob Jensen's fraud updates are at http://faculty.trinity.edu/rjensen/FraudUpdates.htm

    Note that there's a pretty good summary of the Sarbanes-Oxley Act at http://en.wikipedia.org/wiki/Sarbanes-Oxley


    Ponzi Schemes Where Bernie Madoff is King
    Go to http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#Ponzi

     


    Exploiting the Poor

    Go to http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#ExploitingThePoor

     

     


    Fraud Around the World

    Go to  http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#WorldFraud


    Topics for Class Debate

    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 getting the message --- http://aaahq.org/AM2003/WyattSpeech.pdf 

    Even better examples can be found in the likes of Merrill Lynch, Morgan Stanley, leading investment banks, leading insurance companies, and leading mutual funds that were Congress to the core but not necessarily on the edges where thousands of employees earned honest livings in ethical dedication to their professions.  Their new leaders still don't seem to be getting the message --- http://faculty.trinity.edu/rjensen/fraudCongress.htm 

    The problem is how to clean out the core without destroying all that is good in an organization.  Another side of the problem is how to protect the public from bad organizations filled with mostly honest employees.

    Most of us view The Wall Street Journal (WSJ) as a good source for reporting on financial and accounting fraud and scandal.  By "reporting" I mean that WSJ reporters actually canvas the world and ferret out much of which later gets reported on TV networks (TV networks tend to rely on what newspapers like the WSJ actually discover).  But an editor of the WSJ actually stated to me one time that the WSJ is really two newspapers bundled into one.  The bulk of the paper is devoted to reporting.  But the Editorial Page is often devoted to defending the crooks that are scandalized on Page 1 of the WSJ.  My best example is the saga of felon Mike Milken who was constantly scandalized on Page 1 and defended on Page A14 (or wherever the Editorial Page happened to be that day).

    I tend to have a knee jerk reaction to get the bad guys or the incompetent guys who should never be put in charge.  But in fairness there is something to be said for using a hammer where a scalpel might do the job.  We have two hammers in the United States.  One is called government regulation.  The other is called tort litigation.  Both can badly injure the innocent along with the guilty.  We have one major scalpel that is very dull and almost never used properly.  That is punishment that deters white collar crime.  White collar crime pays in the United States.  The criminal generally gets away with the crime or gets a very light punishment before retiring in luxury from the take of his or her crime.  In the meantime the crook's honest colleagues like the many employees of Andersen and Enron take the fall.  For my complaints about leniency and white collar crime see http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays 

    Now the top crime fighters (Donaldson and Spitzer) in the U.S., who I think are well intended, are taking the heat from Page A14 of the WSJ while Page 1 of the WSJ thinks they are often citing them for their good works.  

    And let's not forget the class of gutless wonders, who were incompetent in their jobs while leading government regulatory agencies, and are now raking in millions because of their prior incompetence.  Does the name Arthur Levitt ring a bell? 
    Hint:  He headed up the SEC in the 1990s when the worst corporate, mutual fund, investment banking, and insurance scams raking in billions of dollars were taking place right under his nose.  

    "Mutual Displeasure," Editorial, The Wall Street Journal,  January 17, 2005; Page A14 --- http://online.wsj.com/article/0,,SB110591631511827345,00.html?mod=todays_us_opinion 

    The Washington rumor mill has it that SEC Chairman William Donaldson is fighting for his job after a checkered two-year tenure. Whatever the merits of that gossip, Mr. Donaldson has been handed a golden opportunity to both exert some intellectual leadership and quiet his critics by reconsidering the agency's rule on mutual fund "independence."

    That step, we'd add, would also help restore some SEC credibility. No one denies the recent corporate scandals deserved a tough response, and the federal prosecution of individual offenders has usually hit the right targets. Far less thoughtful has been the Donaldson SEC's habit of punishing business as a class, especially with broad new rules that seem designed mainly to keep up with New York Attorney General Eliot Spitzer. An agency once admired for thoroughness has become known for its slapdash rule-making -- from shareholder access to hedge funds to stock-exchange regulation.

    The mutual fund "reform" of last summer is a case in point. Red-faced that Mr. Spitzer exposed the late-trading offenses, the SEC rushed to show its relevance with a regulation requiring that 75% of all mutual fund board directors be "independent," including the chairman. What this means in practice is that folks like Edward Johnson, who has run Fidelity Investments for three decades without scandal and whose reputation has helped to attract investors, now must step aside.

    Of hundreds of funds managing $7.5 trillion in assets, some 80% have chairmen from management, while about half fail the 75% "independent" standard. The process of identifying, recruiting and appointing independent members will not only be costly but will divert resources away from more profitable uses. The independent directors of one small fund ($218 million assets) estimate compliance with just the 75% independent director rule would cost its shareholders an average of $20,000 a year.

    The requirement is so arbitrary that Congress has asked the SEC to justify its actions, while the U.S. Chamber of Commerce is suing to have it thrown out. And with good cause. The SEC may not even have the authority under the 1940 Investment Company Act to require corporate governance standards -- and the agency knows it. That's why, rather than mandate the requirements straight out, it instead made the industry's continued use of certain standard regulatory exemptions (which the SEC does have power to grant) contingent on adopting the new requirements.

    Under the 1940 Act that established mutual fund standards, Congress considered and rejected a requirement that even a simple majority of the fund's directors be independent. Congressional testimony at the time noted that many investors were "buying" the management of a particular person, and that they wouldn't be served by a board that constantly overrode that person's decisions.

    Now, it's possible to argue that new times call for new ways to make boards more accountable. Yet the SEC didn't even try. Agencies have an obligation to examine what new rules mean for competition and capital formation, and when the mutual fund rule got rolling Republican Commissioner Cynthia Glassman called for economic analysis of independent- vs. management-chaired funds, as well as of the rule's costs. Mr. Donaldson claimed he too wanted more info.

    No report was ever done. Mr. Donaldson ignored research that did exist, in particular a Fidelity-sponsored study showing that fund companies with independent chairmen have worse investment performance. "There are no empirical studies that are worth much," he pronounced when he and the two Democratic Commissioners approved the rule by 3-2 vote in June. "You can do anything you want with numbers." Well, yes, as the SEC vote showed.

    The process was such a stinker that the two other GOP SEC Commissioners filed a rare official dissent. They noted the rule was arbitrary (why 75%?) and failed to consider less onerous alternatives, and they bemoaned the lack of analysis. The SEC had acted by "regulatory fiat" and "simply to appear proactive." Ouch.

    Led by New Hampshire Senator Judd Gregg, Congress has passed legislation demanding the SEC submit a report to Congress by May showing a "justification" for the new rule, including whether independent boards perform better or have lower expenses. But the SEC is so far giving Congress the back of its hand and last week rejected a U.S. Chamber request to delay the rule's imposition.

    What's really going on here is that an SEC regulatory staff that failed in its earlier mutual-fund oversight now wants to punish the law-abiding as well as the guilty. This is unnecessary, but it's also unfair. Far from being an embarrassing turnaround, a reassessment is a chance for Mr. Donaldson to prove that both he and his agency are more interested in getting things right, than simply getting things done.

    I might point out that my take on this is that Page A14 of the WSJ  is part and parcel to the establishment on Wall Street and Page 1 of the WSJ is written by reporters who are more concerned with discouraging egregious fraud and incompetence.

     

    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 

    "How Hazards for Investors Get Tolerated Year After Year." by Susan Pulliam, Susanne Craig, and Randal Smith, The Wall Street Journal, February 6, 2004 --- Scroll down at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#Debate 

    "OVERCOMPENSATING In Fraud Cases Guilt Can Be Skin Deep," by Alex Berenson, The New York Times, February 29, 2004 --- Scroll down at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#Debate 


    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


    Question
    Are many share repurchases motivated more out of executive greed than shareholder benefits?
    In accounting classes, it might be stressed that increased executive compensation is one of the incentives of buying treasury stock.

    "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

    Repurchase of shares has the potential to enable company executives to make huge profits. A simple example would help to illustrate the point. Suppose a company has earnings of £100 and 100 shares. Now the earnings per share are £1. Suppose the company decides to use its surplus cash to buy back 50 shares. After repurchase, it has only 50 shares in circulation. So the earnings per share (EPS) are now £2. The significance of this is that many executive remuneration schemes link profits to EPS. Without creating an iota of additional wealth, directors can increase earnings per share, their bonuses and share options. The company pays out real cash to buy back its shares. Such cash could have been used to bolster capital, liquidity or research and development, or could even have been put away for a rainy day. In some cases, companies have taken on extra debts to buy back their own shares, which opens them up to higher interest charges and vulnerability. Of course, there is the forlorn hope that the reduction in the number of shares might make the remaining shares somehow more marketable, or that the repurchase of shares might assure markets and push up the share price.

    One US
    study estimated that about 100 companies a month were buying back their shares. Nearer home, Alliance & Leicester announced a £300m share buyback at nearly £12 a share. Soon afterwards it was rescued by Banco Santander at just £3.17 a share. HBOS had a £750m share buyback programme and has now been bailed out by the UK taxpayer. Barclays bought back 2m shares at 451p. In recent weeks, its share price has been about a third of that and the bank had to raise additional money from Middle East investors. Northern Rock also has a history of buying back its shares and had to be bailed out by the taxpayer as well.

    Continued in article


    Women of Wall Street Get Their Day in Court

    "The Women of Wall Street Get Their Day in Court," by Patrick McGeehan, The New York Times, July 11, 2004 --- http://www.nytimes.com/2004/07/11/business/yourmoney/11wall.html 

    Before Eliot Spitzer, the crusading attorney general of New York, became their main adversary, the firms were at war with large numbers of their own employees - specifically, women who had worked for them and, in some cases, still did. In 1996 and 1997, lawsuits against Merrill Lynch and Smith Barney cracked open a Pandora's box of complaints from female brokers about hostile and unfair environments they said they found at brokerage offices. Settling those suits has cost the firms more than $100 million.

    Now, as they work to repair the self-inflicted damage to their reputations from the stock-analyst scandals of the last few years, Wall Street firms are girding for another round of attacks on their treatment of women.

    The main event of the summer will be the trial in the federal government's discrimination suit against Morgan Stanley. The jury was selected on Friday afternoon.

    In an opening argument scheduled to be heard tomorrow by Judge Richard M. Berman in United States District Court in Manhattan, a lawyer for the Equal Employment Opportunity Commission is expected to tell jurors that Morgan Stanley allowed managers and employees in one unit of its investment bank to mistreat their female colleagues, pay them less and promote them more slowly and less often than men. More than two dozen women who have worked there are expected to recount incidents of what they said was sexual harassment, including lurid details about their colleagues' entertaining clients at strip clubs.

    Continued in the article

    Frank Partnoy wrote about sexual degeneracy on Wall Street in his various books. (See below)


     

    Derivative Financial Instruments Frauds

    Go to  http://faculty.trinity.edu/rjensen/FraudRottenPart2.htm#DerivativesFrauds