Monday, April 19, 2010
Posted by Jeff Lipshaw
Well, gosh, I haven't had this much fun reading the Wall Street Journal and the New York Times on a Monday morning in a long time. First of all, I want to note that while I use the first rate Choi & Pritchard, Securities Regulation 2d (great teacher's manual!), as the casebook for my class, I disagree with the idea of teaching Rule 10b-5 litigation before teaching the 1933 Act stuff on public offerings. So I teach the book out of order. The benefit is that we are moving into the elements of Rule 10b-5 in the next two weeks, and I'm thinking about scrapping my prepared materials in favor of this case. (A more devious me would use it as a question on the final exam.) I just want it to be noted that my syllabus is evidence I predicted this crisis, and now am in a position to benefit from it.
Second, I can't help being amused by some of the public commentary. The Wall Street Journal carries a headline referring to a statement by Gordon Brown (the British Prime Minister) that Goldman was "morally bankrupt." Oh, come on. That puts Goldman in the class of all other occupations that make money on the churn, like real estate brokers, executive recruiters, Las Vegas casinos, every state that conducts a lottery or allows parimutuel betting on horses, car dealers, and advertising agencies.
Third, in the past I advocated a standard of conduct in which one ought not to engage in conduct that one would be embarrassed to see highlighted on the front page of the Journal or the Times. I think I need to amend that to include that one ought not to be in a business in which one cannot explain the products being sold if they were to appear on the front page of the Journal or the Times. Let me give a breaking news example. My friend Erik Gerding has run a series of very helpful commentaries over at Conglomerate. I am pretty sure I disagree with a number of his conclusions (perhaps because having done deals in the real world for a long time I am more jaundiced about the number of times anybody actually gets led down the primrose path, and particularly in the never-never land of financial products). But that's what makes betting on horse races or synthetic CDOs. I've commented on one of his more interesting insights, but I decided to bring it out of the hinterlands of the way comments work over there. (I am grateful to Erik for having found the article and opened the debate on this aspect!)
Erik highlights this morning a paper by Arora et al., entitled "Computational Complexity and Information Asymmetry in Financial Products" to the effect that it really was material to the synthetic CDO investors that Mr. Paulson selected the Reference Portfolio. The gist of the paper is that it's very easy to create a computationally complex system from simple factors, but almost impossible to work the other way and select the factors that gave rise to the resulting system. Hence, conclude the authors, if an arranger of CDOs wants to hide "lemon" assets among the good ones, it's an intractable computational problem to find the lemons. See this blog post to which Erik links for another good explanation.) Thus, if Paulson had a hand in selecting the Reference Portfolio he really did have an advantage over those poor victims at IDK Deutsche Industriebank and ABN Amro.
Granted that blogging often is to research what journalism is to literature; nevertheless we don't always believe what we read in the newspaper and we need to be careful in assessing real-time commentary. The gist of my comment over at Conglomerate is that I think there's a flaw in Erik's move from applying the "Intractability Theory" in cash CDOs to a justification for a conclusion that who selected the Reference Portfolio in a synthetic CDO is material. In a cash CDO, there is only a long position - that is, the arranger has no interest other than in having investors believe that the underlying assets and the collateral are all good. The lemons in that case are the underlying mortgage assets. (Indeed, much of the math in the Arora paper is beyond me, but I believe that the authors argue the computational complexity increases the farther you get from the actual lemons, say by creating CDOs out of the CDOs.) Part of the problem may be terminology: the cash CDOs themselves are "derivatives" because their value derives from the value of the underlying assets. The point is that if the arranger-seller did slip in some lemons, the buyer would never be able to discover it.
How does that carry over to somebody who isn't actually compiling a portfolio of mortgages to package in a CDO to sell to investors, but instead is selecting the securities on which to bet in a synthetic CDO? Let's assume Paulson did select the synthetic portfolio. He doesn't want to slip a lemon asset in among the good assets. He wants ALL the assets to be lemons, not because he's trying to hide a pig in a poke (as if he were the actual arranger of a CDO), but because he wants to bet against the whole portfolio. He doesn't accomplish his goal at all if he gets IKB and ABN Amro to bet on really good assets with a lemon hidden among them. He ought to be worried that there are GOOD assets baked in there that he can't find!
Even assuming that Arona et al. have a point, I suspect Paulson doesn't qualify as the arranger who had the information advantage. The Reference Portfolio consisted of fewer than 100 already assembled CDO securities, each with a notional value of $22,222,222, and each being made up of many, many underlying mortgages (indeed, the flip book refers to the CDO security as "midprime" if the average weighted FICO score was above 625, and as "subprime" if the equivalent number was below 625). To put it more simply, if you are the bettor looking from the outside at a synthetic CDO portfolio, looking either to be long like IKB or ABN Amro or short like Paulson, and not the actual arranger of the cherries, peaches, plums, and lemons that went into the portfolio, you are no better off, informationally speaking, in trying to gauge whether you want to bet for it or against it.
From the web page of the Massachusetts Board of Bar Overseeers comes this disciplinary summary:
The respondent was an Assistant United States Attorney for the Department of Justice in the District of Columbia. From December 2004 through April 2005, the respondent was responsible for prosecuting a caseload of felony drug and gun charges. Between January and April 2005, the court dismissed six cases assigned to the respondent for want of prosecution because the respondent had failed adequately to prepare the cases for trial. In three cases, the respondent failed to order drug analyses sufficiently in advance of scheduled trial dates to have the analyses available for trial. In two other cases, the respondent failed to take necessary steps to secure the appearance at trial of the primary witnesses in the cases. In the sixth case, the respondent did not order a timely drug analysis, and he failed to take necessary steps to secure the appearance of necessary police witnesses. The District of Columbia Rules of Professional Conduct applied to the respondent’s conduct. See Mass. R. Prof. C. 8.5(b)(1). The respondent’s failure to prepare the six cases for trial violated District of Columbia Rules of Professional Conduct 1.1, 1.3, and 3.2.
The respondent failed without good cause to respond to bar counsel’s requests for information made in the course of investigating the respondent’s conduct in these cases. On March 11, 2009, the Supreme Judicial Court for Suffolk County entered an order of immediate administrative suspension of the respondent’s license to practice law due to his failure to cooperate with the investigation. The order of administrative suspension required the respondent to comply with all of the provisions of S.J.C. Rule 4:01, § 17, if the respondent was not reinstated within thirty days from the date of the order. The respondent was not reinstated by April 10, 2009. The respondent knowingly failed without good cause to comply with the order of administrative suspension and the requirements of S.J.C. Rule 4:01, § 3(3) and § 17.
By intentionally failing without good cause to respond to requests for information from bar counsel made in the course of the processing of a complaint, the respondent violated S.J.C. Rule 4:01, § 3(1)(b), and Mass. R. Prof. C. 3.4(c), 8.1(b) and 8.4(g). By failing to comply with the suspension order and S.J.C. Rule 4:01, §§ 3(3) and 17, the respondent violated Mass. R. Prof. C. 3.4(c) and 8.4(d) and (h).
On October 26, 2009, bar counsel and the respondent filed a stipulation with the Board of Bar Overseers in which the respondent admitted to this misconduct and the cited rule violations. The stipulation recommended a suspension from the practice of law for one year and one day.
On January 11, 2010, the Board of Bar Overseers voted to accept the parties’ stipulation, and, on January 28, 2010, the Supreme Judicial Court for Suffolk County, (Cordy, J.), ordered that the respondent be suspended from the practice of law for one year and one day, effective immediately.
The case is Matter of Brooks. Note the choice of law aspect of the case applying the District of Columbia's ethical rules to a lawyer admitted to practice in Massachusetts(Mike Frisch)
Sunday, April 18, 2010
Posted by Alan Childress
Admittedly 120 years too late, and not exactly on-topic to the blog, but Warren and Brandeis have now published their landmark article on the iPad! Or any PC, or Kindle, iPhone, iTouch, BlackBerry, or Mac. They do not do Droid.
I wanted to post a link to the Amazon DTP version of The Right to Privacy and my Foreword and other materials in the compilation (including active TOC, linked notes, and period photos and press clips provided to me, graciously,
by Amy Gajda, who did extensive research up on SSRN on the infamous backstory). Sorry to charge for the ebook, but that is Amazon rules for non-bigtime-publishers (and I must make it a buck more on July 1). You can get my own contribution part of it free anyway, below.
Any free Amazon app for those devices, even just on the PC or a laptop, will work great to read this and their ebooks (which do include 20,000 free classics), or on Kindle. I will try to post some more old pics later this week...
From the blurb:
If readers here want to do a similar compilation, formatting, and Foreword to classic legal scholarship in pre-1923 U.S. books, for digital readers, ask firstname.lastname@example.org . You must be willing to write original work or annotations, and work from source materials not just scanned crap. The goal is high quality ebooks, not the formatting nightmares that are out there now (even the online versions of The Right to Privacy are all full of substantive errors, including one on a Harvard site!)
The most influential piece of legal scholarship in history, many scholars say, is this 1890 Harvard Law Review article by two Boston lawyers (one of whom later became a legendary Supreme Court Justice). Warren and Brandeis created -- by cleverly weaving strands of precedent, policy, and logic -- the legal concept of privacy, and the power of legal protection for that right. Their clear and effective prose stands the test of time, and influenced such modern notions as "inviolate personality," the law's "elasticity," and the problems of "piracy." They resisted the label of "judicial legislation" for their proposals. And they foresaw the threat of new technology.
Most of all, they asserted the fundamental "right to be let alone," and its implications to modern law are profound. Their privacy concept has grown into a constitutional law norm raising issues about abortion, drug testing, surveillance, sexual orientation, free speech, the "right to die," and medical confidentiality. All these spinoffs trace their origins to this master work. It is simply one of the most significant parts of the modern canon of law, politics, and sociology.
The Foreword shares not only this import and effect, but also the fascinating backstory behind the article. Its origins are found in Warren's own prickly experiences with the press, famously after its reports on his family weddings. One myth was recently debunked by Gajda: it could not have been his daughter's wedding that upset him. The newer legend is explained, including the role of The Washington Post and the emerging paparazzi. This was no mere academic exercise to Warren and Brandeis, it turns out. The Foreword adds a biographical summary of each author, noting some less-known questions about Brandeis's own judicial ethics later in life (debunking another myth), as well as noting the possible tension between the privacy right and the First Amendment that Brandeis championed.
[You can also, without needing an app, Download Foreword TRTP2]
Posted by Jeff Lipshaw
It's certainly not my goal to defend Goldman Sachs any more than it is to defend bookies. And I acknowledge that as to materiality, it's entirely possible that you get to the trier of fact on the question whether the actual selector of the Reference Portfolio was something for which there is a substantial likelihood that a reasonable investor would find that the information significantly altered the total mix. (That's the legal standard.) But, as we teach our students, the mere materiality of undisclosed information doesn't create liability for its omission; as opposed to a misrepresentation, the culpability of an omission depends first on a duty to disclose.
So here's a quote from the Goldman Sachs flip book under "Risk Factors." And remember this thing wasn't going to Mom and Pop up in Lowell; it was going to IKB Deutsche IndustrieBank and ABN Amro:
- Goldman Sachs may, by virtue of its status as an underwriter, advisor or otherwise, possess or have access to non-publicly available information relating to the Reference Obligations, the Reference Entities and/or other obligations of the Reference Entities and has not undertaken, and does not intend, to disclose, such status or non-public information in connection with the Transaction. Accordingly, this presentation may not contain all information that would be material to the evaluation of the merits and risks of purchasing the Notes.
- Goldman Sachs does not make any representation, recommendation or warranty, express or implied, regarding the accuracy, adequacy, reasonableness or completeness of the information contained herein or in any further information, notice or other document which may at any time be supplied in connection with the Transaction and accepts no responsibility or liability therefore. Goldman Sachs is currently and may be from time to time in the future an active participant on both sides of the market and have long or short positions in, or buy and sell, securities, commodities, futures, options or other derivatives identical or related to those mentioned herein. Goldman Sachs may have potential conflicts of interest due to present or future relationships between Goldman Sachs and any Collateral, the issuer thereof, any Reference Entity or any obligation of any Reference Entity.
Isn't there a real question whether Goldman owed a legal duty that would make the omission actionable? Didn't Goldman tell the Investors in the flip book that it might well have non-public information relating to the Reference Portfolio? Didn't it say that it might have "short positions in . . . other derivatives identical or related to those mentioned here"? This is the "bespeaks caution" doctrine: optimistic forecasts or projections in a prospectus aren't actionable if they are accompanied by meaningful disclaimers or warnings of the risk involved.
I'd like to be a fly on the wall when the sophisticated investor representatives get deposed on this issue.
Q: "Did you read the flip book?"
A: "Well, parts of it."
Q: "Which parts?"
A: "The parts that talked about the Reference Portfolio."
Q: "Did you read the disclaimer about 'non-public information' that Goldman might have?"
A: "I don't recall at this time."
Q: "You don't disagree that the disclaimer is there, do you?"
Q: "Did you ask Goldman to reveal to you the undisclosed information?"
A: "I don't recall at this time."
Q: "Did you read the risk factor that said Goldman might be shorting the identical reference portfolio?"
A: "I don't recall at this time."
Q: "Did you actually ask Goldman if it was shorting the identical reference portfolio?"
A: "I don't recall at this time."
Q: "Remind me again how long you've been in this business."
I find myself in a funny position, intellectually speaking. The lawyer in me, applying a legal model to what I've seen so far, is saying this case is a real stretch. The business ethicist in me is saying, "ugh, what a squirrelly business to be in. You must have to take a scalding shower when you get home every night to play it that close to the vest." The sociologist-psychologist-philosopher-Tina Turner in me is saying: "Well, of course, Jeff, what's law got to do with it?" The cognitive scientist in me is saying, "It all depends on the metaphor. If you think of Goldman as the bookie, and ABN Amro as a high roller, you reach one result. If you think of Goldman as your doctor or lawyer, you reach another one."