February 23, 2007
Another SetBack for Prosecutors of NYSE Specialists
A federal district court judge threw out the jury conviction of David Finnerty, a specialists charged with defrauding customers by interpositioning his own bids between customer bid and offers. The judge hled that the prosecution have proven interpositioning and that interpositioning was a violation of NYSE rules but faulted the prosecution for a lack of proof of customer expectations (something that the prosecutors should have had no problem putting in evidence). The Judge held that traders cannot be expected to have knowledge of the specific New York Stock Exchange rules. One would think that a specialists who holds himself out to trading by NYSE rules and does not do so is acting fraudulently, even if customers do not know of the specific rules on the specific violation in question -- the fraud is that the specialist claims to act by rules and in fact does not. The damages are due to suboptimal price matching (one or both of the customers to most interpositioned trades could have recieved a better price without the conduct).
Prosecutors charged 15 specialists with front running and/or interpositioning, dropped 7 of the cases, lost in 2 trials, secured guilty pleas in 2 cases, and won three cases before juries only to have one of the three, Finnerty's, reversed. One defendant remains on the lam. The prosecutors seem anxious to appeal the Finnerty case, as they should; the district court judge may have fabricated an element of the crime that does not (and ought not) exist. The two who pled are not probably sorry they did; these cases have proven very hard for prosecutors to win. Anyone know why?
Manhattan Investment Fund Bankruptcy
A federal bankruptcy judge in New York City, Burton Lifland, has ordered Bear Stearns to repay a banktrupt hedge fund, Manhattan Investment Fund, up to $160 million in "transfer" payments. Bear Stearns was acting as a prime broker for the now defunct hedge fund. The judge ruled that Bear Stearns should have known that the fund was in trouble and continued to accept money from the fund for prime brokerage services. Since Bear used some of the funds to close out positions on which Bear Stearns could have been liable, the funds were "transferred" from the fund to the bank and could be recovered by the bankruptcy trustee (so as to repay hedge fund creditors). The position has upset the investing banking community, which now much reassess risk profiles on their prime brokerage businesses. An appeal is likely.
President's Work Group Hedge Fund Report
The President's Working Group on Financial Markets (the heads of the Treasury, Federal Reserve, Securities and Exchange Commission and Commodity Futures Trading Commission) issued it report on whether to regulate hedge funds. The answer -- to the dismay of the New York Times, Democrats, and many law school academics -- is no. The Working Group discusses the advantages of hedge funds and the risk (investor fraud; excessive risk-taking) and concluded that counter parties could and should monitor and control their risks in dealing with hedge funds and that wealthy investors could look out for themselves. Even the milder forms of regulation, more forced disclosure, were rejected as unnecessary. The report is sensible and, I believe, correct. Many will disagree. With Democratic in control of the executive, this report would have been very, very different. Much, out of the news, is at stake in the next election.
The proposed merger of XM Satellite Radio Holdings Inc and Sirius Satellite Radio Inc. must run the "definition of market" gauntlet. If regulators responsible for enforcing federal anti-trust rules (the Clayton Act in particular) define the market narrowly, they will attempt to block the merger. If regulators define the market broadly, they will step aside. Experienced antitrust attorney known that in most cases the definition of the market is the ball game. Once defined the rules apply more or less mechanically. Is the market satellite radio? all radio? radio and Internet? radio, Internet and television? radio, internet, television and iPods?? The problem is complicated by technology advances -- yesterday's market does not look like today's or tomorrow's. It is also complicated by economic and political theory -- should government be active or passive-- and by real politics -- which party controls the regulators (and who are that party's constituents). All is in play here, forecasting, economics, political theory, and real politik. I would let 'em merge.
PIK Toggle Notes
The debt floated in private equity leveraged buyouts is increasingly innovative on a very old theme. How does one make equity look enough like debt for the IRS?? The newest old trick is Pay In Kind Toggle Notes: When cash is short, in essence, the debt may postpone cash interest payments but the interest rate is bumped up. This is very close to preferred stock. I am sure there are numerous lawyer opinion letters on the fact that PIK Toggles are debt for the IRS. I hope the IRS agrees. The legal divide between debt and equity for tax purposes is less and less sustainable and ought to be reconsidered. At minimum we would not have so many lawyers and accountants charging fees for creating instruments that sit on the boundary.
Decline in Securities Class Actions
The debate over the cause in the recent decline in securities class actions in federal court continues to rage. Some say managers are behaving better (due to SOX??); I have argued that the troubles of Milberg Weiss have an underestimated effect. My argument to date has focused on the high percentage of cases bought by Milberg Weiss (and its two successors) over the years. I may have missed the boat. Milberg Weiss is in trouble because of allegations that it paid individuals to be plaintiffs. The major effect of the case may be on the ability of all firms, not just the successors of Milberg Weiss, to find individual shareholders to be lead plaintiffs. Once a suit has begun, some institutional investors will step up but the institutional investors are only rarely the initiating plaintiffs. Plaintiff's firms need that one shareholder who will step up and lend her name to the initial filing. How does one find such shareholders that do not expect some compensation for their time (other than costs and expenses)?? The old, under the table payment system used by some has been exposed and is now way too risky. The problem of attracting shareholders as plaintiffs may be part of the reason for the decline.