Slouching Towards Wall Street… Notes for the Week Ending Friday, 19 August 2011
“You know how to whistle, don’t you, Steve…? You just put your lips together and… blow…”
The movie is “To Have And Have Not,” starring Humphrey Bogart and Lauren Bacall, based on the novel by Ernest Hemingway, with screenplay by William Faulkner. (A future Oscar winner, a future Golden Globe winner, and two future Nobel Prize-winners. And no — they don’t make them like that anymore.)
Those practiced at putting their lips together will rejoice at the news that the SEC has initiated its whistleblower program (SEC release 2011-167, 12 August) complete with a webpage (www.sec.gov/whistleblower) that spells out how to claim a bounty if you submit information leading to “a successful SEC enforcement action with more than $1 million in monetary sanctions.” This is most clearly attributable to the public grandstanding and justified self-backslapping of Harry Markopolos, whom the SEC ignored with a passion, repeatedly and over a very long period, thus missing completely the shenanigans of one Bernard Madoff. Several months ago Markopolos was quoted as saying the “new SEC” was a changed organization. His evidence at the time? “They listen to me.” We’ll see…
Corporations fear the Office of the Whistleblower (which sounds like an agency staffed by Erie and Bert of Sesame Street) will encourage people to rat out their employers, rather than trying to fix things from within. As with any new law or standard, we agree that there will be abuses. But Enforcement director Robert Khuzami says this program gives the SEC tools to provide swift and sure action to prevent investor losses. Says Whistleblower-in-chief Sean McKessy, “securities fraud is not a victimless crime,” making it critical that folks step forward the moment they become aware of fraud. The SEC says benefits will include better and more timely tips, but our favorite is the notation that “with fewer than 4,000 employees to regulate more than 35,000 entities, the SEC cannot be everywhere at all times.” Now they tell us.
Speaking of blowing the whistle, will no one propose an Office of the Congressional Whistleblower to have folks rat out Washington? First and second shoes were dropped in quick succession this week in a case that is all about Congressional malfeasance, and very little about how wicked the banks are. All right, we will stipulate to the banks being wicked, but that doesn’t let the lawmakers off the hook.
The Wall Street Journal reports (15 August, “Favoritism On Forex Alleged”) that Florida and Virginia filed suits against Bank of New York Mellon within eleven minutes of each other. As an aside, we are told the bank insists on being called “BNY Mellon,” not “Bank of New York Mellon.” This may have to do with Bank of New York having laundered money for the Russian mob, we don’t know, but using the “Bank of New York” name is apparently like saying “British Petroleum.” It just really irks them.
The Florida and Virginia state pension plans say they got Mellon-oma when the bank “improperly charged for currency trades” and “favored other clients with red-carpet treatment and better pricing.” Let’s blow the whistle on the states attorneys general: this looks like a case of Emptors who failed to Caveat, and of failed legislative oversight of public funds. The bank’s currency operations are regulated. It’s just that the market regulations and laws leave a loophole wide enough to drive a truck through. The bank may have driven the truck, but neither Florida nor Virginia officials did anything to stop them.
Virginia’s AG accuses the bank of using false prices for some 73,000 currency trades executed for State of Virginia public funds. The bank says the allegations “reflect a flawed misunderstanding of foreign currency markets.” We agree, though we thought that if it was a “misunderstanding,” it was already “flawed.” We suppose the Beany-Melloners would say that money talks, even if English is not its first language.
The rules that govern currency trading permit executing brokers certain discretion in pricing, within the bounds of actual market prices. In particular: while they have to be actual market prices, they don’t have to be Beany-Mellon’s actual prices, which means a broker can at its discretion give a customer the worst (or best) price of the day on a given trade. Florida’s AG says the bank considered the State a “range of day” client, resulting in their currency trades being executed at the worst daily prices. We believe the bank operated correctly within those rules, which should make them legally not liable, if less than honorable.
The rule allows a broker, under certain circumstances, to execute at its discretion, and within the range of market prices on a given day. This is called a “not held” order, meaning you trust the broker’s discretion to give you the best price they can obtain. As long as the price you receive was a real price in the market at the time your trade is time stamped, you can not argue, even if the broker executed the trade at a different time and price. With some digging you could find out when, and at what price, the broker executed the original trade. This would show whether the broker made an additional profit on the transaction.
Buying at a low price, then printing the trade to the customer at a higher price appears to be perfectly legal. This looks like the same argument Senator Carl “Sh*tty” Levin and his panel refused to allow the public to comprehend while raking Goldman Sachs over the coals about Timberwolf and Fabulous Fabrice Tourre. They kept asking Goldman whether Goldman had a duty to act in the client’s best interest. But Levin and his cronies all knew that, under law, Goldman had no such duty. Let’s blow our whistle: the reason they have no such duty is because Congress was afraid to impose it. If Congress required Wall Street firms to act solely in their clients’ best interests, who would pay for their campaigns. And if big pharma and the insurers get the message that Congress wants every business run in the interest of the consumers, where would America be?
State officials who oversee states’ pension money have a fiduciary responsibility to all those firemen and police officers and teachers that Phil Angelides of the Financial Crisis Commission got so exercised about. If a broker takes an order from a fiduciary, that does not make the broker a fiduciary. If BNY Mellon had standing instructions permitting them to give a client the worst price of the day, how can their customer be shocked when they consistently get the worst price of the day? For our money, state officials in Virginia and Florida were not minding the store.
In a classic Wall Street lookaway, the Journal expressed its horror at a Labor Department proposal to broaden the definition of “fiduciary” to cover all financial professionals servicing retirement accounts (12 August, “The Borzi Savings Bomb.”) The Journal scoffs that Assistant Secretary Phyllis Borzi has not produced any “serious economic study that shows widespread fraud or malfeasance in the retirement savings industry.” Secretary Borzi knows exactly what she is talking about — and exactly what Senator Levin and his panel were afraid to declare openly. It’s not fraud or malfeasance, but the inherently conflicted nature of the business. Imposition of a fiduciary standard may be the only legal tool for disarming this landmine.
This story has plenty of fiduciaries, but they don’t have any money, so there’s no point suing them. They are the state officials charged with overseeing pension monies. If Florida’s pension managers understood the operation of the currencies markets, they could have insisted on better pricing. It is not BNY Mellon’s fault that the rules allow them to whipsaw their own customers. Whistle blow on Congress.
The State of Florida’s Chief Financial Officer, Jeff Atwater, is a former president of Florida’s senate. Courtesy of Florida governor Scott’s transparency initiative, the website myflorida.com reveals that Atwater receives an annual salary of $128,971.92 . Not much to go after there. Prior to his stint in public service, Atwater was president and CEO of Barnett Bank of Broward County, then Market President of Riverside National Bank, which was closed by the FDIC and declared a “failed bank.” We are not aware of any allegation that Atwater contributed to the bank’s demise, and he was subsequently appointed in charge of government efficiency appropriations.
Atwater’s predecessor as Chief Financial Officer, Adelaide “Alex” Sink, was previously president of Florida operations for Bank of America. She lost the governor’s race in 2010, making her one half of the only married couple in US politics to have lost gubernatorial elections (her husband, Bill McBride, lost in 2002). She is also a direct descendant of Chang Bunker, one half of the famed original Siamese twins, Chang and Eng, which has nothing to do with fiduciary responsibility, but is a fascinating bit of information.
Unlike the low-paid state bureaucrats who were the actual fiduciaries, BNY Mellon has money. True to script, we expect BNY Mellon will end up settling, even if no criminal activity is uncovered. The state AGs will flog their victory, the money will disappear down the toilet of state finances, and the conflicted social model that is Washington and Wall Street will continue. It’s the American way. Talk about blowing the whistle — how about a fiduciary standard for politicians?
That irrepressible madcap clown prince of Capitol Hill is at it again. Senator Chuck “Chuckles” Grassley can’t resist poking fun at the folks in finance. His latest hoot-fest was the letter he sent SEC Chair Schapiro on 17 August asking her to comment on a letter sent to him by Mr. Darcy Flynn. Flynn, who spent thirteen years at the SEC enforcement division, was moved in 2010to a position overseeing what the SEC calls “records disposition.” In short order Flynn determined that the “disposition” included the destruction of thousands of “Matter Under Investigation” dossiers, or MUIs. Flynn believed the destruction of MUI files violated federal recordkeeping laws and informed the National Archives and Records Administration. NARA launched an inquiry into the matter in July, 2010 (NY Times, 18 August, “File Disposal Still An Issue For SEC”).
Rolling Stone’s own Matt “Kid Squid” Taibbi describes an “Orwellian” SEC that “devised an elaborate and possibly illegal system under which staffers were directed to dispose of the documents” relating to closed MUIs (Rolling Stone, 17 August, “Is The SEC Covering Up Wall Street Crimes?”). Taibbi’s article, which should be required reading for all citizens, says this could violate the NARA’s directive under which SEC records must be archived for 25 years. Taibbi quotes an unnamed “high ranking SEC official” saying some 18,000 files have been wiped forever from the Agency’s electronic memory, “including Madoff.” This reaffirms one of our greatest disappointments: the SEC’s utter failure to catch Madoff may have been truly the result of sheer incompetence, without a shred of malfeasance. We find that truly scary.
Taibbi says two Madoff MUIs are known to have been wiped, as well as a Lehman Bros fraud dossier, and insider trading MUIs relating to firms including Goldman, Lehman, SAC Capital, and AIG. The very basis of regulatory oversight is analyzing patterns of behavior (when it was an independent regulator, the NYSE used to distribute a compliance guidebook titled Patterns of Supervision). Senator Grassley is right on the money when he charges this practice “handicaps the SEC’s ability to create patterns in complex cases.” Cold cases are revived when a smart cop notices that a recent crime fits a pattern of cases that had long been written off as unsolveable. The SEC appears to have made a decision, purely on bureaucratic grounds, that smart grizzled cops will have nothing to work with, even when they hit the nail on the head. One is tempted to look for motive. But apparently there is none. This is an affront to the conspiracy theorist in us, and it horrifies the citizen in us. We leave it to your worst psychotic fantasies to imagine what our lives would be like if our military were as effective as our financial regulators.
Darcy Flynn is still employed by the SEC, even as he pursues his whistleblower case through Congressional hearings. His lawyer is Gary Aguirre, whom the SEC paid $755,000 last year to settle a wrongful termination whistleblower lawsuit. Readers of this Screed will recall Mr. Aguirre as the enforcement lawyer who came too close for comfort in the original Pequot Capital investigation. Aguirre complained that his investigation was being undermined and was soon fired. The Pequot matter went into limbo, including the possible implication of John Mack. Enforcement Director Linda Chatman Thomsen told Morgan Stanley that there was “smoke, but no fire” in the investigation and Mack was hired by Morgan in the middle of an ongoing SEC investigation. Thomsen is now a partner at Davis Polk & Wardwell, Mack is still CEO of Morgan Stanley. But under Chairman Schapiro the Pequot matter was revived. The firm closed last year when its founder, the legendary Arthur Samberg, made a deal with the SEC to shutter the firm, accept a permanent bar from the industry, and pay $28 million in fines and restitution.
Aguirre now runs The Aguirre Law Firm (“Financial litigation is a challenging game. Put a consistent winner on your side.”) We are not privy to his fee arrangement with Mr. Flynn, but in keeping with the newfound religion evidenced by the SEC’s new whistleblower program, we would bet he is working on contingency.
Easy On The Transparency, Folks
Sometimes our right hand doesn’t know what our far right hand is doing.
Like a bad joke about Latin American banana politics, Brazilian President Dilma Rousseff is cracking down on corruption with one hand, while quashing government transparency with the other.
In less than three months, four cabinet ministers have been bounced and dozens of lesser officials have followed them out the doors, all under allegations of corruption. The sole exception was the defense minister whom the president publicly sacked after he publicly boasted that he had voted for Rousseff’s opponent, and that the women she appointed as cabinet ministers were “idiots.” It is lost on no one that those who have been shown the door were all inherited from the Lula years, with implications for Brazil’s 2014 presidential elections, when party faithful were hoping for Lula’s triumphal return.
Despite this house-cleaning, Brazilian journalist Miriam Leitao takes President Rousseff to task for vetoing cost control bills (O Globo, 16 August). Leitao says the Presidenta vetoed a bill that would require the government to record treasury loans to BNDES — the national economic and social development bank — in the federal budget. These loans are advanced by the government to BNDES, which in turn makes loans at well below market rates to Brazil’s largest corporations. Currently, there is no accountability or transparency around this process. Recording the loans in the budget would reflect their impact on federal finances, and would make BNDES’ financings transparent to Brazil’s electorate.
Leitao recently published a fascinating book Saga Brazileira (“Brazilian Saga”), a history of Brazil’s money. Under the military dictatorship (1964-1985) projects were initiated by the government and listed on the budget as “resources to be identified later.” There were categories of government expenditures officially labeled “Extra-Budgetary Operations,” and “Operations Without Budgetary Limit.” We thought President Rousseff, who was jailed and tortured under the military regime, would take every possible step to do away with the fiscal and monetary abuses that subjected her country to decades of social instability. Thanks to Rousseff’s veto, Brazil’s banks continue their incestuous relations and the nation’s largest companies look to remain off-book wards of the state.
Aren’t you glad that could never happen here?
Would You Buy A Used Economy From These People?
The sequel to the S&P downgrade of US debt is this week’s announcement of “super downgrades” of states and municipalities. The Wall Street Journal (18 August, “Ratings Cuts Hit Main Street”) says S&P downgraded the city of Manassas Park, VA, from AA- to BBB — “a five-notch tumble” that appears not atypical in today’s market. In this environment the Journal reports that the City of Los Angeles voluntarily dropped its S&P rating after taking a downgrade over their large holding of Treasurys.
Analysts have noted an upsurge in super downgrades since 2009, variously attributed to “the heightened regulatory environment,” “fiscal challenges facing municipal credits,” and now the knock-on effect of the downgrade of US Treasury debt. Oddly, no one mentions the role of the rating agencies themselves. We believe the raters may have caused this whole phenomenon single handedly.
Loyal readers of the Screed, we call your attention to our piece of 25 June 2010 (that’s right, more than a year ago) titled “Of Municipal Bondage,” where we report that the major rating agencies had upgraded municipal debt across the board.
What caught our eye at the time was Fitch raising ratings on some 38,000 individual municipal issues. In April of 2010 (quoting from last June’s Screed — interested readers can request a copy of the entire column at sales@hedgeye.com ) “Fitch raised its ratings on 40 states, the District of Columbia, Puerto Rico and the Virgin Islands. Fitch was careful to point out that these were not upgrades, but that the company was ‘recalibrating’ its ratings in acknowledgement that municipal borrowers have superior repayment histories to like-rated corporate borrowers. Compared to corporate and sovereign debt, said Fitch, municipals were ‘underrated.’”
Fitch was not alone. S&P performed a similar recalibration earlier, and Moody’s did so at around the same time. These moves were applauded by the National League of Cities, which praised the upgrades as long overdue. The League “has long called for passage of legislation to address problems associated with different credit rating scales for different securities,” wrote their spokesperson, noting with satisfaction that bond rating parity was included in Senator Dodd’s 2010 financial services reform proposal.
Issuers were pleased that raters were rating municipalities on the likelihood of default, instead of applying their arcane models. And it was a windfall for issuers, as pension funds would suddenly be able to purchase issues that had formerly been off-limits, by virtue of upward “calibrations” from triple-B to single-A. This reminds us of families we know who went from being Austro-Hungarian, to Romanian, to Russian, all without ever leaving the comfort of their dining room. As the locals can attest, the winters are just as cold no matter whose name is on the currency.
The current spate of super downgrades is not being reported as the obverse of last year’s upward recalibration — we have seen not one mention of a link between the mass upgrades of spring 2010 and the current downgrades. Obviously, just as certain issues suddenly became suitable for certain portfolios, they must now be jettisoned as they lose their investment grade status. This will lead to a snowball effect that will force some municipalities into financial difficulties, as they will not be able to roll their current bonds with new issues. You may want to dust off Meredith Whitney’s default scenario.
As to S&P’s downgrade of US debt: what took you guys so long? Any investor will tell you that the first place you look when assessing a company is the quality of management. This is far more important than the product they manufacture, the market sector in which they function, or the niche they occupy. Let’s face it, if the US government were a company, would you buy the stock? In traditional Wall Street obfuscate-ese, the semi-notch S&P downgrade is the equivalent of a shift from Outperform to Market Perform. In other words, this screams “Sell!”
Municipalities who are shocked and angry over super downgrades should have started their whining way back last spring when the raters gratuitously raised ratings across the board, giving Wall Street more paper to play with, and giving municipal issuers greater access to the markets, despite the fact that nothing fundamental had changed. The flood of new issue money into states that did not qualify to float offerings the day before is like using heroin to treat methadone addiction.
At the time we wrote, “if the municipalities have trouble, they will go to the states. If the states have trouble, they will go to the federal government. If the federal government defaults, no one will be left to sue Fitch.” We truly hate to say We Told You So. After all, we live here too.
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