Rolfe Winkler

Reader note: off on vacation the next few days so posting will be light. But LOTS of great links today….2 days of reading here!

Must Read – Volcker’s rules: DOA (Pethokoukis, Reuters) It appears the administration was never seriously considering a big push to get the “Volcker Rules” limiting bank size and proprietary trading added to financial reform legislation. My colleague Jimmy P. has a pithy, incisive analysis of what’s happening.

Must Read — How JP Morgan treats its clients, scandalously and in bad faith (Felix) Great find from Felix. Judge Rakoff is at it again, this time ruling against JP Morgan, which Rakoff says acted in bad faith. “The gist is that JP Morgan took one of its longest-standing clients in Mexico — Grupo Televisa — and tried to hand all of its secrets over to its biggest rival, Carlos Slim. And the way it tried to do that was by selling Slim a loan larded up with covenants which would essentially force Televisa to reveal any and all information to the holder of the debt.”

China sells Treasurys….or did they? (EconompicData) Great post. The WSJ follows their lead today.

Stripping away the disguise of derivatives (Das, FT) Explaining how derivatives can be used to mask debt. Not a long piece, but read slowly if you’re not familiar with the terms.

Treasury Secretary would lead new systemic risk council (Chan, NYT) The idea that a systemic risk council will help avert crises is foolish when you think about it. None of the regulators that will be on the council has done a very good job “leaning against the wind” in the past.  Yet together they are going to be able to not only reach consensus about systemically risk firms, but actually take corrective action?

IMF to sell 191 tons of gold on open market (Pardomuan/Wroughton, Reuters) It sold 400 tons not long ago, half of which was scooped up by India. Gold still makes sense in the long-run as insurance against a dollar crisis, but with the dollar likely to get stronger in the short run on the back of continued debt problems in Europe, it may be possible to add to gold positions below $1,000…

Ackman may make $170 million on grand-slam General Growth bet (Taub/Burton, Bloomberg) And he could make much more if Simon ups its bid or another bidder emerges at a price higher than Simon’s offer of $9. The market expects a higher price in the end, what with the shares trading near $13. Ackman bought his for 46¢! He’s said the shares are worth at least $24, but with the cash component of Simon’s offer just $6, it would make sense to take some profits…

Goldman’s Rococo PR prince (Abelson, NY Observer)

States sink in benefits hole (Merrick, WSJ) As of June 30, 2008 the 50 states collectively faced a $1 trillion funding deficit between what they’ve promised to public sector retirees and the funds they’ve actually set aside. And the data were collected before the bottom fell out of the market, so the gap is likely worse. Keep this in mind when liberal economists try to explain away the federal debt as manageable. If banks got bailouts, you can bet public sector employees will, so consider these funding gaps as obligations of the federal government…

Muni threat: Cities weigh Chapter 9 (Dugan/Maher, WSJ) It isn’t just states facing budget trouble.

Feather starfish swimming (Youtube) Wow.

Gadget Noir…

Judge Rakoff has rejected the settlement deal between the SEC and Bank of America. He clearly wasn’t happy with it to begin with, and subsequent briefs from the two parties did nothing to allay his concerns. At the end of the day, he hated the idea that B of A shareholders, on whose behalf the SEC actually brought the case, would end up paying the fine for executives’ wrongdoing.

So what’s the next step? According to the Reuters story, “Rakoff directed the parties to prepare for a possible trial that would begin no later than February 1, 2010.”

That doesn’t mean there will be a trial. The parties could come back with a settlement more to Rakoff’s liking.

But presumably that would have to involve naming names. Who were the executives responsible for misleading shareholders? B of A has refused to answer that question and the SEC seems to think it doesn’t have the leverage to force it out of them.

I’m happy to see this development. I’m on-record saying the SEC should pick more fights. The truth of the matter is that we need more accountability at the top. The point behind Sarbanes-Oxley, for instance, was that executives would take more responsibility for their misdeeds, in this case Ken Lewis and John Thain.

Too often, “The Corporation” gets the blame and pays the fine. But that isn’t justice, nor does it deter bad behavior.

(Here’s the PDF of Rakoff’s full order)

The latest briefs are in in the SEC/Bank of America case and it’s more of the same. BofA claims it didn’t mislead investors because they should have known Merrill’s people would be bonused. The SEC says that’s ridiculous, that the disclosure statement laying out the bonuses should have, ya know, been disclosed. The fact that it wasn’t means BofA misled shareholders.

The bottom line is that these filings break no new ground. The reason Judge Rakoff ordered BofA and Merrill to file additional briefs on the 24th and again today was because he was dissatisfied with the settlement to begin with. He wanted names. What’s the point of fining shareholders if they were the ones misled by company executives? Shouldn’t those executives be held responsible?

Since neither side gave Rakoff what he asked for, I imagine he may order them back to court for another hearing.

In the meantime, Andrew Cuomo will pick up the SEC’s fumble and run with it. Yesterday his office wrote a letter to BofA’s lead lawyer Lewis Liman complaining that BofA is obstructing its investigation.

The key dispute has to do with attorney-client privilege, which Cuomo’s office says can’t be used as both “sword and shield.” Since BofA executives are claiming they relied on their lawyers to determine what was published in public filings — it’s the lawyers’ fault if anything was misleading — they can’t simultaneously hide the details of those discussions behind attorney client privilege.

Cuomo is giving them till next Monday to reconsider their strategy, otherwise his office will proceed with “charging decisions.” What that means isn’t clear and today Cuomo’s office declined comment.

In the meantime, we’ll wait for Judge Rakoff to weigh in on the latest filings.

At the bottom is the SEC’s latest brief for Judge Rakoff.

Having gone through BofA’s, one finds –publicly disclosed for the first time — the “disclosure schedule” that outlined bonuses BofA had agreed Merrill could pay:

“Variable Incentive Compensation Program (‘VICP’) in respect of 2008 … may be awarded at levels that (i) do not exceed $5.8 billion in aggregate value (inclusive of cash bonuses and the grant date value of long-term incentive awards)…

It’s also on page 10 of the SEC’s brief.

Why does this matter?  Because this is the language that BofA conveniently forgot to include in the SEC filing detailing the merger before it was approved.

BofA’s argument is that even though the filing said Merrill couldn’t pay bonuses without its consent, the fact that the filing referenced the disclosure schedule means shareholders should have been aware Merrill would pay bonuses anyway.

You’d think shareholders would want to see something like that. So why wasn’t the schedule included in the SEC filing?

[BofA CEO Ken] Lewis, [fomer Merrill CEO John] Thain and [former Merrill COO Greg] Fleming were all asked by [SEC] staff why this information was set forth in a disclosure schedule as opposed to the text of the merger agreement itself, but none of them could provide an answer.

But of course they couldn’t.

There’s much more in the brief.

(For easier reading, click “toggle full screen” top-right and then “+” to zoom in)

SEC BRIEF – 8-24-09

Hopped over to courtroom 14-B at 500 Pearl Street yesterday afternoon where I saw Judge Jed Rakoff hammer SEC and Bank of America lawyers over the proposed settlement regarding Merrill Lynch bonuses.

The news is that Rakoff refused to approve the settlement.  He ordered the lawyers to get to the bottom of the “who/what/where” of the case, saying the settlement “seems to be lacking in transparency.”  He’s asked them to file briefs answering those questions on the 24th, and then responses on September 9th.

The hearing itself was very interesting.  Rakoff was clearly very skeptical of the arguments presented by both legal teams, which seemed rather unimpressive.

The judge wondered immediately why, given the “serious questions” raised in its complaint, the SEC wasn’t going after more facts.  If BofA and Merrill conspired to lie to shareholders about bonuses that had been agreed to when the merger was signed, then why isn’t the SEC trying to figure out who is responsible?  “Was it some sort of ghost?  Who made the decision not to disclose [the bonuses]?” said Rakoff.

David Rosenfeld, lead lawyer for the SEC, meekly replied that they haven’t made any allegations against specific individuals.  This clearly didn’t satisfy Rakoff who argued that to make the complaint, they “must have determined who physically committed these acts.”

[By the way, Rosenfeld struck a few of us in the gallery as badly prepared.  He seemed to stumble a lot, and the judge and court reporter repeatedly told him to speak up.  He wasn't familiar with specifics so frequently had to defer to another SEC lawyer.  Even though the hearing revolved around BofA's proxy filing, Rosenfeld and his team didn't have a copy of the document with them.]

So who led the merger negotiations when the discussion of bonuses came up?  The SEC offered two names: Greg Curl for BofA and Greg Fleming for Merrill.  Of which the SEC says it has only spoken to one: Fleming.

Were details of those negotiations circulated to top management?  Yes, Merill CEO John Thain and BofA CEO Ken Lewis were aware of them according to the SEC’s lawyers.

But according to BofA’s lawyer, Cleary Gottlieb’s Lewis Liman, they apparently weren’t aware of what was in “the disclosure schedule,” the document where bonus details were laid out.  That schedule was supposed to be attached to the SEC filing detailing the merger.  Conveniently, it wasn’t.  And of course that’s nobody’s fault.

Oddly, given Liman’s insistence that the proxy was very thorough, Rakoff didn’t ask him why the disclosure schedule wasn’t attached.

Rakoff also asked the SEC lawyers why the settlement is so puny.  A $33m fine for $3.6 billion worth of misconduct?  “Why isn’t this a grossly unfair amount?” he asked.  SEC lawyer David Rosenfeld seemed badly prepared for this question.  He cited the Wachovia/First Union case, saying that $37 million settlement was the right precedent.  Again the judge was skeptical, noting it revolved around $500 million worth of misconduct.  Here you have $3.6 billion.

More to the point, perhaps, Rakoff asked why the settlement is being collected from the corporation and “not from individuals responsible for orchestrating the misleading [SEC filing]?”  Rosenfeld mumbled something about the degree of misconduct, the need for deterrence and finding the closest precedent to justify the structure of the settlement.  As for going after specific individuals, Rosenfeld says he can’t.  The executives are all hiding behind attorney-client privilege.  The judge was not impressed with this excuse, noting that if BofA execs are asserting they relied on advice of counsel, which they seem to be, then they have to waive privilege.

Liman offered some pretty pathetic arguments of his own…

• People shouldn’t have been surprised by the Merrill bonuses because the company had already accrued $12 billion for that purpose through Q3.

What do you do with this?  Merrill may have had an accounting entry saying they owed their people bonus money, but Merrill wouldn’t have lasted long enough to PAY the bonuses had it not been for bailouts.

• He argued that $3.6 billion wasn’t a lot of money.  After all it worked out to an average of $91k per recipient.

“I’m glad you think $91k isn’t a lot of money,” retorted the judge.  And in any case, as NY Atty General Cuomo reported two weeks ago, nearly 700 Merrill employees got bonuses north of $1 million.  149 got more than $3 million.

• Liman also trotted out the cliché about bonuses being necessary for “retention.”  To this Rakoff responded with the obvious: “how many banks were hiring people when the bonuses were paid?”

• My least favorite defense argument was about the structure of TARP.  Since it came in the form of preferred stock, which has a fixed dividend, Liman argued its value wasn’t impacted by expenses like bonuses.

Liman forgets that besides preferred, TARP investments included warrants, essentially options to buy common stock.  Of course the common is impacted by expenses.

And how is the value of preferred stock not impacted when $3.6 billion is subtracted from the balance sheet?  That’s a lot less cushion protecting preferred stockholders in bankruptcy.  Not exactly a far-fetched scenario only a few months back.

• Last Liman argued that no one could have been misled by the bonuses because they weren’t a surprise.  He waved his hands in the air suggesting it would be impossible to find anyone, anywhere in the press who didn’t expect Merrill employees to get incentive comp.  This is Wall Street(!) he protested.

Indeed it is.