February 12, 2010
Financial Stability One Year Later
FINANCIAL STABILITY PLAN - ONE YEAR LATER FEBRUARY 10, 2010 (from the Treasury Secretary):
“It was one year ago today that the Obama Administration outlined a Financial Stability Plan to address the four problems at the heart of the financial crisis: frozen credit markets, weakened bank capital, a backlog of troubled mortgage assets on bank balance sheets, and falling home prices. At the time, with America in a deep recession, it did not matter if you were a company large or small, a family trying to buy a house, a car or even to put your kids in college; loans were not available.
“A year later, the actions we took, alongside the Recovery Act, have worked to restore economic growth and financial stability. Access to credit is improving and the cost of borrowing for businesses, consumers, homeowners, and state and local governments have fallen sharply. In addition, we have achieved this progress at much lower cost than anticipated. By encouraging private capital solutions rather than relying on public funds, the expected cost of stabilizing the financial system has fallen by more than $400 billion. We expect it will fall even further. And if Congress joins the President in adopting a Financial Crisis Responsibility Fee, Americans will not have to pay one cent for TARP.
“These measures of the direct financial costs of the crisis do not capture the economic devastation caused by the crisis. The financial system is healing, but still damaged, and we have a lot of repair work still ahead.”
Posted at the website is further detail about actions in the past year.
Dodd Reaches Out to Corker on Financial Reform
Yesterday Senate Banking Committee Chairman Chris Dodd (D-CT) issued the following statement on developments in financial reform negotiations.
“For over a year, the Senate Banking Committee has been grappling with how best to address the many problems that led to the financial crisis.”
“In that time Senator Corker has proved to be a serious thinker and a valuable asset to this committee. For that reason, I called him Tuesday night and asked him to negotiate the financial reform bill with me. We met in my office on Wednesday and given the importance of these issues he agreed.”
“While many difficult questions remain, financial reform is in a strong position due to the good work done by Banking Committee members, both Democrats and Republicans, to work out this bill.”
“I am more optimistic than I have been in several weeks that we can develop a consensus bill to bring about the reforms the financial sector so desperately needs to prevent another economic crisis.”
So will there be financial reform in our lifetime? Stay tuned...
Former Brocade Communications Officer Settles Charges Related to Backdated Options
On February 3, 2010, the United States District Court for the Northern District of California entered Final Judgment as to Michael J. Byrd, former CFO and COO of Brocade Communications,based on his Consent submitted in order to settle the Commission's action against him. The Commission's complaint against Byrd, alleged that while Brocade's former CEO was engaged in a years-long fraudulent stock options backdating scheme, Byrd at times received information about certain stock options and should have fully investigated to determine whether Brocade's financial statements accurately reflected the necessary compensation expenses.
Under the terms of the settlement, which he agreed to without admitting or denying the allegations against him, Byrd is further ordered to pay a civil penalty of $175,000 and to pay disgorgement, plus prejudgment interest, of $249,843. Securities and Exchange Commission v. Michael J. Byrd, Case No. 3:07-cv-04223-CRB (N.D. Cal.)
February 10, 2010
SEC Shut Down Because of Snow?
Nothing's going on at the SEC, at least to the public eye, because of the snow. Here's the forlorn posting on its "What's New" site:
New materials may be forthcoming. Please check back later in the afternoon.
Georgia Supreme Court Addresses Holder Claims, Loss Causation & Brokers' Duties
The Georgia Supreme Court recently answered three important questions relating to a customer's claims against his broker-dealer. Holmes v. Grubman, 2010 WL 424225 (Ga. Feb. 8, 2010). This is yet another case brought by a WorldCom investor against Citigroup Capital Markets and Jack Grubman. The case got to the state supreme court via a circuitous route. The investor filed for bankruptcy and filed this claim for damages in the bankruptcy proceeding, which transferred the case and consolidated it for pre-trial purposes in the S.D.N.Y. There the district court dismissed the case, but the Second Circuit, on appeal, certified three questions to the Georgia Supreme Court:
- Does state tort law recognize holders' claims? YES, both for fraud and negligent misrepresentations, so long there was a direct communication from the speaker to the plaintiff and the plaintiff can show direct actual reliance.
- Does the customer have the burden of proving loss causation, or proximate cause, at trial in a case involving misrepresentations about publicly traded securities? YES, he musst show that the truth concealed by the defendant entered the marketplace and precipitated the drop in the stock price.
- Does a broker-dealer owe the customer in a non-discretionary account any fiduciary duty apart from the proper execution of the trade? YES, a broker-dealer has a heightened duty to a customer of a non-discretionary account when he recommended an investment that the customer previously rejected or to which the defendant has a conflict of interest. The court does not explain why it chooses not to recognize a suitability obligation whenever the broker makes a recommendation, consistent with NASD Conduct Rule 2310.
February 9, 2010
Judge Questions Terms of Proposed SEC-BofA Settlement
Judge Rakoff has questions about the proposed SEC-BofA settlement. He thinks that the $150 million penalty is "still quite small," wonders if the court should exercise oversight over the implementation of some of the corporate governance changes and questions why the SEC's version of the facts differs from the allegations set forth in the New York AG's complaint -- specifically, the reasons for the firing of BofA GC Mayopoulos. He expects to make a decision by Feb. 19.
Target Date Funds: Pro or Con?
Regarding the ongoing debate over target date funds: Apparently the Investment Company Institute has prepared a paper called "Dispelling Target Date Fund Myths with the Facts." I say "apparently" because I cannot find it on the ICI website. The BrightScope Blog offers a response to the ICI's paper called"Real Facts About Target Date Funds", which I could find. BrightScope offers this Note:
Notes: It is important to note that the authors are generally supportive of the growth of target date funds. It is our belief that they hold great promise for the generation of American workers who will be dependent upon defined contributions plans for their retirement income security. But, if these instruments are to be the “number one savings vehicle in America” we think they should be held to a very high standard of quality. Like any new investment instrument they are not without their flaws, but it is up to market participants and the regulators to ensure that the funds, their regulation, and their disclosure are aligned in the best interests of American workers. BrightScope’s general views in the white paper are not shared unanimously by Target Date Analytics and Matthew Hutcheson.
February 8, 2010
SIFMA's Ryan Asserts Financial Services Industry Has ReformedIn an opinion piece in The Washington Post that appeared last Friday, SIFMA President and CEO Tim Ryan argues that while recent proposals by the Obama Administration have suggested that the financial services industry hasn't changed, in fact, the industry has made signficant reforms, has paid back most of the TARP monies, and is helping financing America's economic recovery. WPost, 18 months later, a reformed financial services industry
Two Investment Firms Settle New York's Pay-to-Play Investigation
The New York AG's Office announced that it has secured agreements with two major investment firms in the ongoing New York State Pension Fund investigation. Markstone Capital adopts the Public Pension Fund Reform Code of Conduct and agrees to return $18 Million to the New York State Common Retirement Fund. Wetherly Capital Group and its Broker-Dealer DAV/Wetherly Financial will exit the placement business and return $1 Million to the Common Retirement Fund. According to AG Cuomo, Markstone and Wetherly are the eighth and ninth firms to adopt the Code of Conduct.
The Code of Conduct bans investment firms from hiring, utilizing, or compensating placement agents, lobbyists, or other third-party intermediaries to communicate or interact with public pension funds to obtain investments. To avoid pay-to-play schemes, the Code prohibits investment firms (and their principals, agents, employees, and family members) from doing business with a public pension fund for two years after the firm makes a campaign contribution to an elected or appointed official who can influence the fund’s investment decisions. This provision also bars all firms currently doing business with the pension fund from making such campaign contributions. Investment firms must also disclose any conflicts of interest to public pension fund officials or law enforcement authorities, to increase transparency and avoid abuse in the management of public pension funds.
February 7, 2010
Tung on Banker Pay for Performance
Pay for Banker Performance: Structuring Executive Compensation for Risk Regulation, by Frederick Tung,
Emory University - School of Law, was recently posted on SSRN. Here is the abstract:
Excessive risk taking by firm managers did not originate with the Financial Crisis of 2007-08. Though bankers had special incentives to take big risks in the period before the Crisis, the incentive effects of equity-based compensation have been understood for some time. Bankers’ equity-based pay structure at the time of the Crisis was a natural outgrowth of the pay-for-performance movement that began in the 1990s and now informs all of corporate executive pay. Longstanding government guaranties of bank liabilities additionally served to intensify bankers’ risk taking incentives.
I propose to ameliorate this gamblers’ incentive with a new approach to compensation at the largest banks, one that explicitly accounts for the possibility of excessive risk taking and in-centivizes bankers against it. I propose that bankers be paid in part with public subordinated debt securities issued by their own banks. Market pricing of this debt will be particularly sensitive to downside risk at the bank. Including it in bankers’ pay arrangements and personal portfolios will therefore give bankers direct personal incentives to avoid excessive risk.
My approach has important advantages over recent banker pay reform proposals. The largest banks are owned and operated as wholly-owned subsidiaries of bank holding companies (BHCs), which also typically own other financial institutions. Two proposals – one by Lucian Bebchuk and Holger Spamann, and another by Sanjai Bhagat and Roberta Romano – would compensate bankers with BHC securities. But because BHCs own other institutions besides the given banking subsidiary, BHC securities can offer bankers only noisy and indirect incentives with respect to risk taking at the bank. My approach overcomes this problem by paying bankers with debt securities issued by the bank itself, a course unavailable with these other proposals.
Partnoy on Historical Perspectives on the Financial Crisis
Historical Perspectives on the Financial Crisis: Ivar Kreuger, the Credit-Rating Agencies, and Two Theories About the Function, and Dysfunction, of Markets, by Frank Partnoy, University of San Diego School of Law, was recently posted on SSRN. Here is the abstract:
This Essay discusses two historical parallels between the current financial crisis and the financial crisis of the late 1920s and 1930s. First, financial innovation was at the core of both crises. In particular, the machinations of Ivar Kreuger illuminate how financial innovation tends to outstrip the ability, and perhaps the willingness, of investors and intermediaries to process information. Second, reliance on credit ratings began as a response to the 1929 crash and became a primary cause of the recent crisis. During the 1930s, regulators developed rules based on credit ratings; those rules are the ancestors of today’s widespread regulatory reliance on ratings. Without financial innovation and overreliance on credit ratings, the recent crisis likely would not have occurred, and certainly would not have been as deep.
Cheffins on Corporate Governance and the 2008 Meltdown
Did Corporate Governance 'Fail' during the 2008 Stock Market Meltdown? The Case of the S&P 500, by Brian R. Cheffins, University of Cambridge - Faculty of Law; European Corporate Governance Institute (ECGI), was recently posted on SSRN. Here is the abstract:
In 2008, share prices on U.S. stock markets fell further than they had during any one year since the 1930s. Does this mean corporate governance “failed?” This paperarticle argues generally “no,” based on a study of a sample of companies at “ground zero” of the stock market meltdown, namely the 37 firms removed from the iconic S&P 500 index during 2008. The study, based primarily on searches of the Factiva news database, reveals that institutional shareholders were largely mute as share prices fell and that boardroom practices and executive pay policies at various financial firms were problematic. On the other hand, there apparently were no Enron-style frauds, there was little criticism of the corporate governance of companies that were not under severe financial stress and directors of troubled firms were far from passive, as they orchestrated CEO turnover at a rate far exceeding the norm in public companies. The fact that Given that corporate governance functioned tolerably well in companies removed from the S&P 500 and given that a combination of regulation and market forces will likely prompt financial firms to scale back the free-wheeling business activities that arguably helped to precipitate the stock market meltdown, implies that the case is not yet made out for fundamental reform of current corporate governance arrangementspractices as a general matter.
Morley & Curtis on Mutual Fund Exit
Exit, Voice and Fee Liability in Mutual Funds, by John Morley, Yale Law School Center for the Study of Corporate Law, and Quinn Curtis, Yale School of Management; Yale University - Law School, was recently posted on SSRN. Here is the abstract:
Unlike shareholders of ordinary companies, mutual fund shareholders do not sell their shares - they redeem them from the issuing funds for cash. We argue that this uniquely effective form of exit almost completely eliminates mutual fund investors’ incentives to use voting, boards and fee liability. Investors will never become active in their funds regardless of the investors’ sophistication or the size of their stakes and regardless of whether the mutual fund market is competitive. We also catalogue a number of unintended and harmful ways in which exit distorts voting, boards and fee liability. Exit interacts with voting, for example, to make firing managers impossible and to prevent investors from receiving notice of fee increases. Exit also interacts with fee liability to cause recoveries to go to the wrong investors and to discourage investors from moving to lower-fee funds. Though exit gives investors a powerful tool to protect their interests, the net effect of exit on many investors is ambiguous, because investors who do not use their rights to leave underperforming funds cannot expect activism by other investors to improve the funds. Ultimately, exit causes mutual funds to look more like products than ordinary companies. Voting, boards and fee liability should therefore be eliminated. Whatever benefits they now achieve could be achieved more effectively and at lower cost by product-style regulation that applies automatically without investor action or that prompts investors to use exit rights effectively.
Conti-Brown on Measurement of Financial Risk
A Proposed Fat-Tail Risk Metric: Disclosures, Derivatives and the Measurement of Financial Risk, by Peter Conti-Brown, Stanford Law School, was recently posted on SSRN. Here is the abstract:
This paper argues that the financial regulatory reform currently debated in the U.S. Congress misses a key opportunity to address one of the central causes of the financial crisis: the failure of risk models to account for high impact, low probability events. The paper proposes a legal solution that will create a more robust metric: require mandatory disclosure of a firm’s exposure to contingent liabilities, such as guarantees for the debts of off-balance sheet entities, and all varieties of OTC derivatives contracts. Such disclosures - akin to publicly traded corporations’ filing of 10-Ks with the SEC - will allow regulators and researchers to approximate an apocalyptic, black-out, no-bankruptcy-protection and no-bailout scenario of a firm's implosion; force firm’s to maintain daily record-keeping on such obligations, a task which has proved difficult in the past; and, most importantly, will open up a crucial subset of data that has, until now, been opaque or completely invisible. With such data, researchers, over time, will develop analytical and econometric tools that better assess the consequences of remote events for individual firms and, more importantly, the economy as a whole.