Posts filed under “Legal”
Sometimes the gains from a new regulatory regime are obvious. The creation of the Federal Deposit Insurance Corp. is a perfect example. Your bank deposits are guaranteed by the government up to some stated amount, no matter the recklessness or irresponsibility of the bankers running the place. It wasn’t always this way. Before the FDIC, bank runs were common and depositors could and did lose all their money. The changes were an enormous improvement, allowing people to safely deposit their cash without fear of a run on the bank in times of trouble. Savings increased, stress over bank accounts fell, bank lending rose. The entire economy benefitted. It was pretty hard to misconstrue the impact: a win-win-win.
In the late 1990s and early 2000s, a series of scandals led to major regulatory changes in how Wall Street analysts did their jobs. A brief litany of related outrages would have to include: the WorldCom and Enron accounting scandals; manipulation of initial public offering pricing; private calls to larger investors that gave them an unfair advantage on the timing of analyst upgrades and downgrades; and slanted analyst reports on companies in order to winning investment banking business. A series of investigations by the Securities and Exchange Commission led to improved corporate disclosure underRegulation Fair Disclosure in 2000 and Congress passed the Sarbanes-Oxley Act in 2002, laying out rules on financial reporting, corporate governance and auditing. On top of that, in 2003 the state of New York forced Wall Street to clean up the way their analysts did business, clamping down on the conflicts that led to biased research and forecasts.
The net result of these regulatory changes? Analysts are now honestlywrong, instead of being dishonestly wrong.
You may shrug that off as no big improvement — wrong is wrong, after all. But it means that individual investors are no longer being duped by analysts and investment banks.
When it comes to market confidence, fairness is a big improvement.
I was reminded of this issue recently by a new study accepted for publication by the CFA Institute’s Financial Analysts Journal titled, “Did Analyst Forecast Accuracy and Dispersion Improve Following the Increase in Regulation Post 2002?” by Hassan Espahbodi, Pouran Espahbodi and Reza Espahbodi.
As Bloomberg News reported:
More than a decade after a government crackdown on conflicts of interest on Wall Street, a new study says stock analysts are no better now than they used to be at predicting corporate earnings. Actually, they’re worse, according to the paper, which reviewed how close profit estimates came to what companies ended up reporting from fiscal year 1994 to 2013.
Perhaps you forgot what it was like in the 1990s. It was a time of madness, an era of dizzying market gains and a full-on technology bubble. As is their wont, unsophisticated individual investors decided to jump in with both feet late in the cycle. I look at the 1995 Netscape IPO as the turning point where the public seemed to have lost its head over equity trading. This was after prices had already risen a lot and price-to-earnings ratio were looking rich.
Investment bankers saw a market hungry for new issues. They fulfilled that demand. There is nothing wrong with selling IPOs to those who want them; all of the basic securities laws still applied. But there were enormous loopholes that allowed all sorts of inappropriate behavior and misleading marketing. To restore public confidence in financial markets and to increase a sense of fairness, those new rules and laws were passed.
Reza Espahbodi, one of the authors of the aforementioned report, and a professor at Washburn University, states the obvious: “Even though conflicts of interest are being reduced because of rules, we’re still back to square one because we don’t have accurate forecasts,” he told Bloomberg reporters Joseph Ciolli and Oliver Renick in a phone interview.
To draw that conclusion is to miss the point. You can’t regulate accuracy in forecasts. After all, that is what analysts do — they make educated guesses about how a company, industry or the economy might perform in the future.
That nobody does this consistently well isn’t a failure of regulation; rather the matter represents a fundamental misunderstanding of human capabilities. As we have detailed so many times before (seethis, this, this, this, this, this, this, this, this and this), people are terrible at making predictions. That they keep trying is a testament to both persistence (a good trait) and foolishness (a not so good trait).
Regardless, there have been enormous changes forced on research departments everywhere. The results are somewhat mixed. Research is a much less profitable business than it once was, a result of numerous factors, including (but by no means exclusively) the new regulations. However, the research departments of investment banks are no longer selling one group of clients down the river for the benefit of another group of clients. That was more or less the earlier state of affairs.
More than 10 years after the big Wall Street analyst settlement, the analyst community isn’t any better. And when forecasts are wrong, it probably isn’t because analysts are corrupt or cheating or favoring one group of clients over another. It is because of the preposterous job requirement that they say what will happen in the future.
It would be great if analysts were correct. If they can’t achieve that — and they can’t — at least they’re honestly wrong now.
Originally: Wall Street Analysts, Honestly Wrong at Last
After seven years, the federal government has finally received its comeuppance. U.S. Judge Thomas C. Wheeler gave the Federal Reserve a severe tongue lashing, a tsk-tsking for the central bank’s financial-crisis overreach. That ought to teach ‘em. The actual result of the case is to confirm the status quo. In “emergencies,” restraint on government adds…Read More
This is an amazing decision; you should read the entire thing!
“The main issues in the case are: (1) whether the Federal Reserve Bank of New York possessed the legal authority to acquire a borrower’s equity when making a loan under Section 13(3) of the Federal Reserve Act, 12 U.S.C. § 343 (2006); and (2) whether there could legally be a taking without just compensation of AIG’s equity under the Fifth Amendment where AIG’s Board of Directors voted on September 16, 2008 to accept the Government’s proposed terms. If Starr prevails on either or both of these questions of liability, the Court must also determine what damages should be awarded to the plaintiff shareholders. Other subsidiary issues exist in varying degrees of importance, but the two issues stated above are the focus of the case . . .”
The weight of the evidence demonstrates that the Government treated AIG much more harshly than other institutions in need of financial assistance. In September 2008, AIG’s international insurance subsidiaries were thriving and profitable, but its Financial Products Division experienced a severe liquidity shortage due to the collapse of the housing market. Other major institutions, such as Morgan Stanley, Goldman Sachs, and Bank of America, encountered similar liquidity shortages.
Thus, while the Government publicly singled out AIG as the poster child for causing the September 2008 economic crisis (Paulson, Tr. 1254-55), the evidence supports a conclusion that AIG actually was less responsible for the crisis than other major institutions. The notorious credit default swap transactions were very low risk in a thriving housing market, but they quickly became very high risk when the bottom fell out of this market. Many entities engaged in these transactions, not just AIG. The Government’s justification for taking control of AIG’s ownership and running its business operations appears to have been entirely misplaced. The Government did not demand shareholder equity, high interest rates, or voting control of any entity except AIG. Indeed, with the exception of AIG, the Government has never demanded equity ownership from a borrower in the 75-year history of Section 13(3) of the Federal Reserve Act. Paulson, Tr. 1235-36; Bernanke, Tr. 1989-90 . . .
The Government’s unduly harsh treatment of AIG in comparison to other institutions seemingly was misguided and had no legitimate purpose, even considering concerns about “moral hazard.”4 The question is not whether this treatment was inequitable or unfair, but whether the Government’s actions created a legal right of recovery for AIG’s shareholders.
Turning to the issue of damages, there are a few relevant data points that should be noted. First, the Government profited from the shares of stock that it illegally took from AIG and then sold on the open market. One could assert that the revenue from these unauthorized transactions, approximately $22.7 billion, should be returned to the rightful owners, the AIG shareholders. Starr’s claim, however, is not based upon any disgorgement of illegally obtained revenue. Instead, Starr’s claim for shareholder loss is premised upon AIG’s stock price on September 24, 2008, which is the first stock trading day when the public learned all of the material terms of the FRBNY/AIG Credit Agreement. The September 24, 2008 closing price of $3.31 per share also is a conservative choice because it represents the lowest AIG stock price during the period September 22-24, 2008. Yet, this stock price irrefutably is influenced by the $85 billion cash infusion made possible by the Government’s credit facility. To award damages on this basis would be to force the Government to pay on a propped-up stock price that it helped create with an $85 billion loan. See United States v. Cors, 337 U.S. 325, 334 (1949) (“[V]alue which the government itself created” is a value it “in fairness should not be required to pay.”).
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In the end, the Achilles’ heel of Starr’s case is that, if not for the Government’s intervention, AIG would have filed for bankruptcy. In a bankruptcy proceeding, AIG’s shareholders would most likely have lost 100 percent of their stock value . . .
Particularly in the case of a corporate conglomerate largely composed of insurance subsidiaries, the assets of such subsidiaries would have been seized by state or national governmental authorities to preserve value for insurance policyholders. Davis Polk’s lawyer, Mr. Huebner, testified that it would have been a “very hard landing” for AIG, like cascading champagne glasses where secured creditors are at the top with their glasses filled first, then spilling over to the glasses of other creditors, and finally to the glasses of equity shareholders where there would be nothing left. Huebner, Tr. 5926, 5930-31; see also Offit, Tr. 7370 (In a bankruptcy filing, the shareholders are “last in line” and in most cases their interests are “wiped out.”).
Richard Fuld, the former chief executive officer of Lehman Brothers, is the Shaggy of finance. On the cause of the financial crisis and the collapse of Lehman Brothers, his claim is, “It wasn’t me.” Seven years after he drove the 158-year old firm he ran with an iron fist into bankruptcy, he has reappeared to…Read More
Dissenting Statement Regarding Certain Waivers Granted by the Commission for Certain Entities Pleading Guilty to Criminal Charges Involving Manipulation of Foreign Exchange Rates Commissioner Kara M. Stein May 21, 2015 I dissent from the Commission’s Orders, issued on May 20, 2015, that granted the following waivers from an array of disqualifications required by federal…Read More
The Cop Is On the Take
Government corruption has become rampant:
- Senior SEC employees spent up to 8 hours a day surfing porn sites instead of cracking down on financial crimes
- Nuclear Regulatory Commission workers watch porn instead of cracking down on unsafe conditions at nuclear plants
- An EPA employee who downloaded 7,000 porn files, then spent 2-6 hours each workdaywatching porn. He’s been doing it for years … but the EPA never fired him. Another EPA employeeharassed 16 women co-workers … and then was promoted to a higher-paying job with more responsibility, where he harassed more women
- NSA spies pass around homemade sexual videos and pictures they’ve collected from spying on the American people
- NSA employees have also been caught using their mass surveillance powers to spy on love interests, such as girlfriends, obsessions or former wives … and to eavesdrop on American soldiers’ intimate conversations with their wives back home. And see this (“routinely shared salacious or tantalizing phone calls that had been intercepted” … “‘Hey, check this out … there’s good phone sex’”)
- An employee of the Transportation Security Administration admitted that TSA agents share – and laugh at – nude scans of passengers. Another TSA employee says that screeners make excuses so they can grope and fondle travelers that they’re attracted to
- Investigators from the Treasury’s Office of the Inspector General found that some of the regulator’s employees surfed erotic websites, hired prostitutes and accepted gifts from bank executives … instead of actually working to help the economy
- The Minerals Management Service – the regulator charged with overseeing BP and other oil companies to ensure that oil spills don’t occur – was riddled with “a culture of substance abuse and promiscuity”, which included “sex with industry contacts”
- Agents for the Drug Enforcement Agency had dozens of sex parties with prostitutes hired by the drug cartels they were supposed to stop (they also received money, gifts and weapons from drug cartel members)
Time to dust off the old juris doctor sheepskin, and wonder aloud about the legal advice that Goldman Sachs has gotten over the past few years. It’s a question worth asking as I review the firm’s recent history of unforced errors in the courtroom. The most recent case in point: the collapsing prosecution of former Goldman computer…Read More
In 2011, the Securities and Exchange Commission published a study, mandated by the Dodd-Frank Act, which concluded that all financial advisers and stock brokers should be placed under “a uniform fiduciary standard.” Basically this meant that brokers and advisers would have an obligation to put the interests of clients first and must disclose any conflicts of…Read More