December 23, 2008
The Madoff mess will test the limits of suits against auditors. Madoff's auditor, an obscure three person firm run out of a strip mall, is not likely to have much cash. Lawyers are not suing the auditors of fund of funds managers that sent individual investors to Madoff. The auditors of the intermediaries should have, apparently, warned the intermediaries of the shaky auditing of Madoff. The suits are novel and a stretch. Madoff's auditor suffers from a classic auditor's conflict, trying to keep a client happy and, at the same time, performing sound auditors for the client's investors. The auditors of the intermediaries do not have the clear conflict - their audit clients, the intermediaries, have a clear stake in knowing the truth about the health of a fund into which they put individual's cash. An argument againt the auditors of intermediaries will rest on a test prudent and reasonable actions. A duty of care, not a duty of loyalty argument, is harder to win. In any event, there is also the nagging third party beneficiary problem in the case (can investors sue?? for what??) that dogs even traditional cases..
Suing the SEC
A frustrated Madoff investor has sued the SEC for not acting on tips that Madoff was running a Ponzi scheme. The suit is an extreme long shot, given the SEC's sovereign immunity. But who knows what the right judge may do. [Hint: Try Judge Kaplan.]
Cerberus and Chrysler
Cerberus is apparently willing to dump its equity in Chrysler if bond holders or others will take equity for their debt. Indeed, Cerberus could simply give the company to its workers in exchange for a full release from all worker obligations (including health care and pensions). Then we would see how the UAW could do running a company
FASB and Mark-to-Market
The FASB has begun a review of the mark-to-market rules that have attracted the ire of so many in the financial community. The major complaint -- financial institutions have to write down assets that they do not intend to sell and the write downs adversely affect required capital ratios (both in legal regulations and in financial covenants in debt instruments requiring collateral). If the capital ratios slip under limits, the financial institution must sell assets to raise cash (a distress sale), further lowering asset values. The standard financial institutions want -- no forced write downs unless the holders are going to trade -- is unworkable. Any standard must depend on the nature of the market for the assets. If the assets are illiquid, there is an argument for not applying mark-to-market rules; if the assets are liquid and an established market is deep, there is no argument. FASB must then set market definition rules for write downs. This will not be easy. If financial institutions to not like the affect of write downs on assets traded in liquid and deep markets they should 1) argue for exemptions in regulatory capital requirements in tough times and 2) not agree to silly financial covenants in their negotiated agreements with creditors. FASB should not bail them out.