July 18, 2008
The Usual Suspects
Given the recent turmoil in the financial markets, it's a bit hard to keep up with the morality plays and the villains.
After the Enronesque fall of Bear Stearns, the villains of the moment were the two Bear Stearns executives who were indicted for not throwing in the towel timely.
Then, over the past several weeks, speculators who facilitate markets to hedge energy costs became targets of the demagogues.
And now this week, with the demise of Fannie Mae and Freddie Mac, SEC Chairman Christopher Cox issued an emergency order attempting to curtail naked short-sellers of the stock of the embattled government sponsored entities and also the stocks of Lehman Brothers, Goldman Sachs, Merrill Lynch and Morgan Stanley.
What on earth is Christopher Cox, a supposedly sophisticated securities lawyer, doing issuing orders that hinder the efficient functioning of markets?
Folks, the problem is not that stock prices of the GSE's and the investment banks are low because some nasty market manipulators have been targeting them. Larry Summers has a much more rational explanation for the GSE's demise. Instead of rethinking those misguided policies that led to the bubble in the GSE's stock price, Cox is engaging in a classic case of shooting the messenger by attempting to limit a price-setting mechanism for shares of stock.
Short selling -- the act of betting against a stock by borrowing it, selling it and then purchasing the stock later at a lower price to repay the loan -- plays an important role in well-functioning markets. If short selling is repressed, then optimists will dominate in the marketplace, which generally results in stocks becoming overpriced. Stated simply, persecuting the short-sellers contributes to stock bubbles. Larry Ribstein summed up the absurdity of the Cox's action well:
“[I]n our wacky world of regulation, as we step up liability to get out the truth about securities, we stomp down an important mechanism for getting the truth out about securities.”
And in addressing the above question about Cox, Craig Pirrong had an interesting 1993 encounter with the SEC chaiman regarding short-selling (and with Hillary and Bill Clinton, too, but that's a sideshow) that prompts him to make the following observation about Cox:
Given my 1993 experience with Chris Cox, I have my suspicions that the new short selling restrictions aren’t based on any empirical evidence or deep economic reasoning -– instead they are a reflection of Cox’s anti-shorting prejudices (and the prejudices of like-minded folks at the SEC) -– prejudices that he displayed in 1993.
When are we going to learn that knee-jerk regulatory responses such as Cox's latest often do more economic harm than good, not the least of which is the perpetuation of myths that distract investors from prudent risk allocation?
Update: Chron business columnist Loren Steffy agrees with me. And Don Boudreaux today identifies the underlying human dynamic behind such witch hunts:
We humans have a long and embarrassing history of blaming devils for distressing aspects of reality that we don't understand. Droughts, floods, plagues, and erupting volcanoes have all been ascribed to the machinations of unseen super-powerful entities – as ill-defined as they are ill-intentioned – who manipulate a reality to which they are immune but to which we mortals must inevitably bend.
Today's witch hunt for speculators who allegedly are driving oil prices to heights unconnected with the realities of supply and demand is just the latest entry in this pageant of ignorance.
This post from two years ago addressed the same dynamic in connection with the death of Ken Lay. And Arnold Kling chimes in with an absolutely spot-on analysis about the folly of attempting to limit the pricing mechanism of markets:
In the mortgage market, people saw risk-takers outperforming prudent lenders. So they took more risks. There is no simple fix for that. For the foreseeable future, we can count on investors sticking to prudence when it comes to mortgage lending. We don't need any regulations to close that barn door.
But somewhere, some time, in some other market, there will be another outbreak of excessive risk-taking. You can't make the system idiot-proof. They'll just build a better idiot.
Update II: The SEC is already retrenching from its "emergency" order (W$J article here).
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July 14, 2008
Be careful, Mr. Wagoner
General Motors CEO Rick Wagoner made some interesting public comments this past week in Dallas regarding the besieged automaker's bankruptcy prospects:
"Under any scenario we can imagine, our financial position, or cash position, will remain robust through the rest of this year," Mr. Wagoner said Thursday while in Dallas to speak to a business organization. He said the company has plenty of options to shore up its finances beyond 2008, although he declined to outline them.
The comments failed to boost investor sentiment as GM shares fell 6.2% to $9.69 in 4 p.m. New York Stock Exchange composite trading Thursday. The stock has been trading at its lowest levels in more than 50 years as concerns mount about the company's financial position amid a steep decline in U.S. sales.
GM and other U.S. auto makers are reeling as the slow U.S. economy depresses sales and as high gasoline prices push many would-be buyers to small, more-fuel-efficient vehicles and away from the higher-margin SUVs and trucks. Through June, for instance, GM's U.S. sales slipped 16%, more than offsetting strength in overseas markets.
GM has about $24 billion in cash but is burning an estimated $3 billion a quarter, prompting talk that it will need a significant cash influx to get to 2010.
"We have no thought of [bankruptcy] whatsoever," Mr. Wagoner said in response to an audience question during the Dallas event.
Now, I am not involved with GM, but I have been involved over the past 30 years in my share of big company reorganizations. Contrary to Wagoner's statements, GM has almost certainly "thought" of bankruptcy and GM management probably continues to examine whether a reorganization under chapter 11 of the Bankruptcy Code makes sense for the company, which it just might. Frankly, not to examine such alternatives would be egregious mismanagement. Any seasoned investor knows this and the market is clearly pricing that risk by lowering the company's stock price.
So, despite all that, if GM ends up in bankruptcy, is Wagoner at risk of being indicted for misleading investors regarding the company's ongoing bankruptcy analysis? Stated another way, will Wagoner be indicted for breaching the obligation to throw in the towel?
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July 11, 2008
An Enron "hero" is looking for work?
This JoAnn Greco/Portfolio.com article bemoans that "famed Enron whistleblower" Sherron Watkins is having a hard time finding a job. Those dastardly employers just don't trust honest employees such as Watkins, now do they?
On the other hand, perhaps the reason that Watkins can't find a job is that prospective employers do more research than Ms. Greco bothered to do for her article and discover that Watkins wasn't really a whistleblower even though she disingenuously presented herself to Congress, the mainstream media and the public as one.
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July 8, 2008
The latest Enron book
Harvard Business School issued this press release and interview yesterday of Malcolm S. Salter, the Harvard professor who has written the latest book -- Innovation Corrupted: The Origins and Legacy of Enron's Collapse (Harvard University Press) -- in what seems to be a continuing stream on the demise of Enron. From the looks of it, Professor Salter has figured out that the recent collapse of Bear Stearns is a good hook for his book:
Q: Can an Enron-type calamity happen again? Why or why not?
A: Perverse incentives are legion throughout our system today. For example, perverse incentives for both mortgage brokers and investment bankers helped create the subprime crisis that we are now living through. Many boards are also still struggling to improve their oversight. Preventing future Enron-type disasters will require the kind of attention to board oversight, financial incentives, and ethical discipline that I address in Innovation Corrupted.
Interestingly, Professor Salter notes that Enron's collapse was triggered by its third-quarter 2001 charge against earnings and equity write-down, which were relatively small in comparison to the losses, charges and write-downs that Wall Street firms have endured over the past year during the sub-prime meltdown:
In the third week of October 2001, Arthur Andersen, Enron's highly compromised outside auditor, "discovered" several large accounting irregularities related to the off-balance-sheet partnerships. This forced Lay—who returned as CEO after Skilling resigned that August—to announce a $544 million charge against earnings, and a $1.2 billion write-down in shareholders' equity, largely related to the impending closure of Enron's Raptor partnerships. Within weeks, Enron collapsed into bankruptcy as its trading partners quickly lost faith—proving, once again, that even a hint of negligence or misconduct can be devastating to a company.
Ah, yes. That pesky trust-based business model.
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July 4, 2008
Nice job, but what about that other case?
This Wall Street Journal editorial pats itself on the back justifiably for swimming against the mainstream media tide in opposing from the outset former New York Attorney General Eliot's Spitzer's popular but dubious litigation and propaganda campaign against former New York Stock Exchange chief executive officer, Richard Grasso. The Spitzer-inspired case against Grasso fell apart earlier this week under the weight of multiple negative appellate decisions.
The Journal deserves much credit for standing up to Spitzer's bullying tactics when few others in the mainstream media were willing to do so. But what does the Journal say about turning a relative blind eye toward this even worse prosecutorial abuse?
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June 20, 2008
The obligation to throw in the towel
So, the shoe finally dropped on the two Bear Stearns executives who managed the two Bear hedge funds that imploded in mid-2007. A copy of the indictment is here.
As I read the indictment, the government is contending that Messrs. Cioffi and Tannin were required to disclose to investors immediately in February and March, 2007 that the two of them feared that the two funds might be "toast" even as Cioffi and other Bear executives were fighting market pessimism toward the funds and urging investors to maintain trust in their ultimate financial merit. So, with their careers riding on whether the funds would survive, Cioffi and Tannin were supposed to throw in the towel and light a match to the funds by disclosing to the market their concerns about the heightened risk of a meltdown.
Stated simply, according to the Feds, about the time you think your trust-based business might be toast, it's already too late. Inasmuch as you are required to disclose to the markets that you think the business might be toast, that disclosure will understandably prompt the market to lose trust in your business, which means that your company is kaput. So, the smart thing to do is never to voice (and sure as heck don't write any emails!) your concern to anyone regarding the downside risk of your business. That lack of communication might dampen internal company analysis regarding risk of loss, but what the hell -- at least you won't get indicted for misleading investors when your company fails.
Just another chapter in the twisted policy implications that result from regulating business through criminalizing businesspeople's risk-taking. Larry Ribstein has typically insightful observations along the same lines, while Bess Levin muses over the Feds' suggestion that investors didn't know exactly what they were buying when investing in Bear's funds.
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June 17, 2008
Criminalizing Failure
As Larry Ribstein reports, the Enron prosecutorial veterans are already picking up the usual suspects in regard to the Bear Stearns meltdown.
Meanwhile, John Carney wonders whether any investors really feel safer as a result of these criminal probes?
And although Bear struck out, do we really want to deter potentially beneficial risk-taking by criminalizing it when it fails?
Finally, wouldn't it make more sense to allocate the resources spent on criminalizing such risk-taking toward educating investors in trust-based businesses on how to hedge their risk of loss?
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June 16, 2008
Bill King's story
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As Republican presidential nominee John McCain is doing his best to stoke public prejudice against job-creators and wealth builders, longtime Houston lawyer and businessman Bill King is promoting his new book, Saving Face (Somerset 2008), which is King's personal history of the savings & loan crisis of the late 1980's and early 1990's. Ironically, McCain knows quite a bit about the back story to King's book. McCain was one of the Keating Five, the Congressional supporters of former Lincoln Savings & Loan chairman and CEO Charles Keating, who was convicted of various corporate fraud crimes and served four years in prison as a result of highly-stoked but substantively-thin prosecutions that were ultimately overturned on appeal. Keating eventually pled guilty to a single count of bankruptcy fraud to limit further prison time and insulate a family member from prosecution. For a thorough review of the mendacity of the Keating prosecutions, pick up a copy of Dan Fischel's book, Payback: The Conspiracy to Destroy Michael Milken and his Financial Revolution (HarperCollins 1995).
King's story is the Houston version of Keating's and a precursor of the prosecutorial abuse that the post-Enron criminal prosecutions in Houston generated a decade later. Not only does King do an excellent job of explaining the financial, economic, regulatory and political underpinnings of the S&L crisis, he explores how the government wielded its prosecutorial power indiscriminately to serve up scapegoats to a salivating mainstream media and an ill-informed public. King is thinking about running for Houston mayor in 2009 and, based on the depth and perspective that he exhibits in Saving Face, King would probably be a fine mayor. The following is King's overview of Saving Face, which I recommend highly:
These days I find myself cringing when I hear media accounts that fraudulent and greedy mortgage brokers are responsible for all of the woes of the current housing bubble and the sub-prime defaults. I do so because the recriminations are an all too familiar echo of an earlier debacle. One to which I had a ring-side seat.
Many of you who have known me for some years know that shortly after law school I made the somewhat less-than-fortuitous career decision of joining a law firm that specialized in representing savings and loans. At the time it did not seem like a bad decision. The Houston real estate market was enjoying an unprecedented boom and the savings and loan industry had just been deregulated. Investors were clamoring to get into the business.
Within a few years of joining the law firm, I began investing in savings and loans and related businesses. By 1986, notwithstanding that I had started with barely two nickels to rub together after working my way through law school, I had built a small, but respectable, business empire consisting of savings and loan holdings, title companies, and real estate investments. However, within a couple of years, everything I had built evaporated into thin air.
The Houston market collapsed when the price of oil fell from over $34 per barrel in 1984 to $9 the next year. It did not recover to above $20 until 2002. Manufacturing jobs in the region fell by nearly 50% and for the first time in history Texans' personal income declined.
Bankruptcies in Houston tripled between 1983 and 1987. All but one of Texas' major banking holding companies failed. Harris County's population actually declined from 1985 to 1989. It was the first and only time in Houston's history that it has lost population. If you did not live through these times, the magnitude of melt down is hard to imagine.
It is certainly difficult to lose everything that you have worked for, but the environment that existed in the late 1980s and early 1990s had an even more ominous aspect. As the public became increasingly aware that the savings and loan crisis was going to take a major taxpayer bailout, there were ever more strident cries to hold someone responsible.
The complexity of confluence of interest rates, regulatory policy, oil prices, the Tax Reform Act of 1986, and the collapse of large portions of the real estate market that actually explained the collapse was too great to be reduced to sound bites. Politicians and bureaucrats began pointing the finger at those in the industry, and soon, the "S&L crook" was born. And there were enough egregious cases for the politicians and bureaucrats to hold up as "proof" of their argument that the "S&L crooks" caused the crisis.
The proposition that fraud and insider abuse had sunk the savings and loan industry was eventually discredited. In 1993, a National Commission concluded that fraud had caused less than 15% of the total problem. But in the heat of the moment, there was little interest in cool, scholarly reflection on the problems of the industry.
As the 1980s came to a close I watched as many friends, associates and former clients in the S&L industry were swept up in a maelstrom of civil and criminal litigation. Naively, it never occurred to me that I might be caught up in such a dispute as well. But I was.
Eventually, I prevailed in my battle with the regulators, but as you might imagine, it was an experience that left an indelible mark and from which it took me many years to recover. For some time I have been jotting down notes for a book about these experiences. For a couple of reasons, I recently decided to finalize such a book.
First, as many of you know, I am considering a candidacy for mayor of Houston in 2009. We all know too well that "negative campaigning" has become the standard today. Certainly going bankrupt in the savings and loan business will provide potential opponents ready ammunition. So first and foremost, I want to put the issue squarely on the table. If I decide to become a candidate, there will undoubtedly be some voters who will be troubled by these experiences. Some will believe difficult times such as the ones I went through are a crucible that better prepares a person for leadership. Most, I expect, will simply want to be advised of the facts so that they can be weighed with other issues bearing on their decision.
But beyond the potential political implications, the troubling similarities between what I saw in the S&L collapse of the 1980s and the sub-prime crisis playing out before us now demands some consideration. It is a well worn adage, but nonetheless true, that if we do not learn from our history, we are doomed to repeat our mistakes. Perhaps relating what I saw during the saving and loan industry collapse will provide some perspective on the current financial crises.
So for these reasons I have written Saving Face: An Alternative and Personal Account of the Savings and Loan Debacle. I have attempted in the book to tell the story of what I experienced during these times, but at the same time, to place my experiences in a larger, national context. I believe my story has some relevance to anyone experiencing trying times generally, and certainly to those in the Houston real estate industry, many of whom lived through these times as I did.
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June 15, 2008
The Refco Question
Ellen Podgor has the sentencing memos in regard to former Refco CEO Phil Bennett's plea deal. They are interesting reading, but what they do not answer is the most intriguing question that remains unanswered from the entire Refco affair:
Why did Bennett risk taking Refco public in the first place?
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June 12, 2008
An odd spokesman for limiting corporate criminal liability
The always-alert Ellen Podgor notes that former Enron Task Force chief Andrew Weissmann (see also here and here) recently wrote an amicus brief on behalf of various business and defense-oriented organizations in the United States v. Ionia Management, S.A. case currently pending at the Second Circuit. In the brief, Weissmann advocates that the appellate court "adopt a standard for vicarious corporate criminal liability" . . . that limits "the application of respondeat superior."
As you may recall, Weissmann promoted precisely the opposite standard while engineering the destruction of enormous wealth and tens of thousands of jobs in prosecuting Arthur Andersen out of business.
It's better late than never that Weissmann apparently now understands the error of his prior ways. I wonder whether he will admit that to the Second Circuit panel?
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June 3, 2008
So, what's the difference?
Mel Weiss was sentenced to 2.5 years in prison yesterday for making undisclosed payments to class representatives in class action lawsuits that his firm handled. As noted here about a year ago, Weiss didn't have much of a choice given the trial penalty that he was facing.
Meanwhile, in return for being the key witness against former Enron CEO Jeff Skilling, Enron Task Force prosecutors "paid" Andy Fastow with a lighter prison sentence than the one the prosecutors disclosed to the jury and the judge during Skilling's trial. Those same prosecutors also withheld from Skilling's defense team exculpatory statements about Skilling that Fastow made before he elected to accept the prosecutors "payment" of a lighter sentence and testify against him. The lead prosecutors involved in arranging Fastow's testimony have gone on to presumably lucrative careers in private practice. Skilling is serving an effective life prison sentence.
As Larry Ribstein has long contended, paying kickbacks should not be condoned. However, the hyprocrisy reflected by the above-described state of affairs is not going to be solved by demonizing Mel Weiss.
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May 30, 2008
The Bear Stearns lesson
Yesterday brought the final installment of Kate Kelly's extraordinary three-part W$J series on the fall of Bear Stearns (Kelly also contributed to today's story on Bear's final shareholders meeting). My goodness, was Kelly a fly on the wall over at Bear's office during all of this? Dear John Thain has an interesting critical analysis of the series here, here and here, while Larry Ribstein and John Carney point out that Kelly apparently fell for what has become known as "the loophole legend" in regard to JP Morgan's buyout of Bear.
Although all the articles in the series are fun reading, Kelly's most insightful observation comes from the second installment:
It was the beginning of a frantic 72 hours that would bring the Wall Street firm to its knees and threaten the stability of the global financial system. . . . The brokerage's sudden fall was a stark reminder of the fragility and ferocity of a financial system built to a remarkable degree on trust. Billions of dollars in securities are traded each day with nothing more than an implicit agreement that trading partners will pay up when asked. When investors became concerned that Bear Stearns wouldn't be able to settle its trades with clients, that confidence evaporated in a flash. Trading partners, eager to avoid losses, began to disappear almost as quickly. That further fueled rumors of trouble. Some partners, spotting a chance to profit, made bets against Bear Stearns, helping accelerate its demise. . . .
Even after the Bear Stearns lesson, our understanding of the pesky trust-based business model is still not what it should be. Improving the investing public's understanding of how best to hedge the risk of investing in trust-based businesses is a far more productive response to Bear Stearns-type business failures than this.
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May 29, 2008
The instinct against the money-makers
I swear, you can't make this stuff up.
As Larry Ribstein cogently explains, Southwest Airlines has taken advantage of futures markets over the past several years to hedge its fuel costs (previous posts on Southwest's hedging program are here). That hedging program has been one of the major factors in allowing Southwest to remain one of the only profitable U.S. airlines. Along the same lines, Bloomberg's Matthew Lynn explains how such markets provide an essential function in re-directing resources in the overall economy.
Meanwhile, Congress is trying to hamstring the very markets (see also here) that provided Southwest and many other businesses with the platform on which they hedged fuel-cost and other business risk. The wealth and lower prices generated from those hedges is not inconsequential.
Finally, the Justice Department continues its advocacy of an effective life sentence for one of the men primarily responsible for developing the robust markets that facilitate Southwest and others' wealth creation for shareholders and lower costs for customers.
And these folks in Congress and the Justice Department are supposed to be representing our interests?
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May 19, 2008
The cost of Spitzerism
On Friday, February 11, 2005, shares of American International Group closed at $73.12 per share.
Last Friday, after Eliot Spitzer and the meltdown in the subprime mortgage markets, AIG's shares closed at $39.34 per share.
James Freeman of the Wall $treet Journal, one of the only mainstream media outlets to expose Spitzer's extortion of AIG for what it truly was, reports here on the massive reduction of wealth to which Spitzer's unbridled regulation of AIG contributed greatly. Larry Ribstein, who was one of the first bloggers to shed light on this injustice, surveys the economic carnage here.
My question: Where is the rest of the mainstream media in reporting on this enormous destruction of wealth to AIG shareholders?
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May 17, 2008
Look at what Mary Flood has been reading
Chronicle legal reporter Mary Flood covered many of the Enron-related criminal trials, so it was only natural for her to pick up a copy of former Enron Task Force prosecutor, law professor and current Oregon attorney general candidate John Kroger's new book, which includes several chapters on his work in several Enron-related criminal cases.
You may remember Kroger. He is the fellow who tried early on to broker his experience on the Task Force to make a name for himself in academic circles. He was involved in preparing some of the worst carnage that the Task Force generated -- the Arthur Andersen debacle, the Enron Broadband disaster, and the Nigerian Barge abomination.
Ms. Flood reports on her blog that the Enron-related chapters of Kroger's book are downright bizarre:
[Kroger's book] is a self-congratulatory look at Kroger's years as a federal prosecutor. The four somewhat conflicted chapters on Enron talk alternately about his prowess, his lack of knowledge, how careful prosecutors were, how ruthless prosecutors were, how terrific his case against the Enron broadband executives was and how it hasn't been successful in court. [. . .]
What may be most surprising about the book is Kroger's admission of a lack of knowledge about how to go about these cases, an admission that the DOJ was out for quick scalps, and an admission that they threatened many witnesses. These are especially odd to see in print given that one of the allegations the defense made was prosecutorial misconduct in this case -- too much threatening and coercing of witnesses. One witness in the 2005 case even testified a member of the task force tried coerce him out of testifying for the defense.
Kroger frequently brags about his own prowess as an interrogator and lawyer, even guessing the broadband cases might be over now if he'd tried them. And he casts doubt on just about everyone else in the process.
Despite talking about the pressure the task force was under to get scalps and how aggressive they were, he creates a hypothetical conversation to illustrate how a defense attorney might try to trick a witness into saying no crimes were committed.
Amid the sometimes stunning hubris seems to be much angst about the decision of others to charge Lea Fastow in order to get to her husband and thus get to Jeff Skilling and Ken Lay.
He questions his colleagues, not just over the Lea Fastow charging decision (even including a mean-spirited comment a fellow prosecutor made about the Fastow children possibly winding up in foster care) but in general saying, in his career as a prosecutor he learned:
". . . that even well-intentioned prosecutors can present false testimony at trial, that a just process and a just result cannot always be obtained at the same time, that informants are both necessary and deceitful, that a certain small percentage of agents are corrupt, that our law enforcement policies often encourage crime rather than prevent it, and that successful interrogation requires the ethically questionable manipulation of other human beings.''
Just another chapter in the increasingly dubious legacy of the Enron Task Force.
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May 6, 2008
The subprime mortgage criminal lottery
Well, well, well. Look who is resurfacing in connection with the creation of the Justice Department's latest criminal Task Force to investigate whether crimes were committed when the subprime-mortgage market collapsed (just what we need -- another corporate crime lottery):
Federal prosecutors are stepping up their scrutiny of players in the subprime-mortgage crisis, with a focus on Wall Street firms and mortgage lenders.
Prosecutors in the Eastern District of New York in Brooklyn have formed a task force of federal, state and local agencies that will involve as many as 15 law-enforcement agents and investigators.
The U.S. attorney for the office, Benton J. Campbell, who supervises about 150 prosecutors, said the group will look into potential crimes ranging from mortgage fraud by brokers to securities fraud, insider trading and accounting fraud.
You may remember Campbell. He was the lead prosecutor on the Enron-related criminal trial known in these parts as the first Enron Broadband trial, which ended in an embarrassing loss for Enron Task Force after the prosecution was caught threatening defense witnesses (see also here) and propounding false testimony from one of its key witnesses during the trial. Sort of what you would expect from a trial in which the Task Force advocated an unwarranted expansion of a criminal law intended to punish kickbacks and bribes against business executives who did no such thing.
Interestingly, in the Wall Street investigation, Campbell thinks there actually may be a non-criminal explanation about the meltdown in the sub-prime market:
Mr. Campbell said the "jury is still out" on just how much criminal activity the office might find, particularly on Wall Street, which saw a sudden decline in the value of securities backed by pools of mortgages last year. "There are market forces in play in that area, and that doesn't necessarily mean there is fraud," said Mr. Campbell, 41 years old.
H'mm. How many damaged lives and careers would have been salvaged had Campbell and his fellow Enron Task Force prosecutors been so open-minded?
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April 27, 2008
Thoughts for a Sunday
The NY Times' Adam Liptak has penned a couple of interesting articles recently (here and here) on a frequent topic of this blog (here, here, here, here, here, here, here, here, here, and here) -- the troubling incarceration rate in the United States.
With only 5% of the world's population, the U.S. now houses almost a quarter (2.3 million!) of the world's prisoners. One in 100 adults in the U.S. is now behind bars and 751 people are in U.S. prisons or jails for every 100,000 in population. The only other major industrialized nation that even comes close to that rate of incarceration is Russia with 627 prisoners for every 100,000 people. England’s rate is 151, Germany’s is 88 and Japan’s is 63. Attempting to keep all of this in perspective, Pepperdine University's James Q. Wilson provides this recent op-ed that puts the U.S. incarceration rate in a more favorable light with regard to reducing serious crime.
Among other things, these incarceration numbers certainly makes one wonder why on earth we are sending folks like Jeff Skilling, the NatWest Three, the Merrill Four and Jamie Olis to prison?
Meanwhile, in this five-part LA Times debate, Reason's Jacob Sullum takes on the Heritage Foundation’s Charles Stimson over one of the main reasons for the high U.S. incarceration rate -- drug prohibition. At least in this first installment, Sullum makes a much more compelling case than Stimson. And Peter Gordon has this sage observation about the genesis of drug prohibition.
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April 21, 2008
Remember Refco?
Amidst the current turmoil in the financial markets, the recent conviction on criminal fraud charges of a former Refco Inc executive barely registered on the radar screen. The details from the meltdowns from years past are just old news now.
However, the criminal conviction and plea deals arising from the Refco affair still leave a troubling question unanswered -- why did Refco's owners take it public in the first place?
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March 24, 2008
The Enron Task Force laid bare
In this previous post on former Enron CEO Jeff Skilling's Supplemental Brief regarding prosecutorial misconduct in connection with covering up exculpatory evidence contained former Enron CFO Andrew Fastow's interview notes, I noted that the Skilling brief would likely have a ripple effect on the re-trial of three former Merrill Lynch executives in connection with the Enron-related criminal case known as the Nigerian Barge case.
Well, based on this extraordinary motion filed on behalf of former Merrill executive James Brown, that ripple effect has turned into a tsunami of evidence that includes, but is not limited to, the Fastow interview notes. I have bookmarked the sections of the above-linked motion in Adobe Acrobat to facilitate ease of review.
As with the Lay-Skilling case, the Nigerian Barge case has long represented much of what is wrong with the Department of Justice's regulation of business-through-criminalization approach in the post-Enron era. After prosecuting Arthur Andersen out of business in the intensely anti-business, post-Enron climate, the Enron Task Force threatened to do the same to Merrill Lynch unless the firm served up some sacrificial lambs, which it did with Mr. Brown, Daniel Bayly, Robert Furst and William Fuhs.
Through a deferred prosecution agreement with Merrill, the Task Force then proceeded to hamstring the defendants' defense by limiting access to other Merrill Lynch executives involved in the barge transaction. Moreover, the Task Force intimidated other potentially exculpatory witnesses by threatening to indict them if they cooperated with the defense. After bludgeoning a couple of plea deals from former key witnesses Ben Glisan and Michael Kopper, the Task Force proceeded to put on a paper-thin case against the defendants, which was good enough to obtain convictions in the hyper-anti-Enron climate of Houston in 2004.
Of course, most of the convictions were vacated on appeal (and in Fuhs' case, reversed and rendered), but not before each of the former Merrill defendants and their families had incurred the incalculable human cost of these misguided prosecutions. Now, Brown's motion provides a specific and detailed case that the Enron Task Force engaged in not only a wide-ranging cover-up of evidence that was exculpatory to the Merrill defendants, but also offered testimony at trial that the Task Force lawyers knew was contradicted by evidence and testimony that they had in their possession.
The lives and careers that have been damaged in the Nigerian Barge case are the inevitable carnage that results from giving incentivized prosecutors the overwhelming power of government to paint transactions as frauds and manipulate ignorance about them as a means to regulate merely questionable business transactions. A truly civil society would find a better way.
Update: As usual, Ellen Podgor asks the key question -- why are the Fastow notes so late in coming?
Update 2: The Chronicle's Kristen Hays has an article on the Brown motion here.
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March 18, 2008
The Economist gets it
Following on recent posts here and here, The Economist produces the best mainstream media article that I've seen to date placing the prosecutorial misconduct of the Enron Task Force toward former Enron executives Jeff Skilling and Ken Lay in the context of the most recent demise of a trust-based business, Bear Stearns:
For many people, the mere fact of Enron’s collapse is evidence that Mr Skilling and his old mentor and boss, Ken Lay, who died between his conviction and sentencing, presided over a fraudulent house of cards. Yet Mr Skilling has always argued that Enron’s collapse largely resulted from a loss of trust in the firm by its financial-market counterparties, who engaged in the equivalent of a bank run. Certainly, the amounts of money involved in the specific frauds identified at Enron were small compared to the amount of shareholder value that was ultimately destroyed when it plunged into bankruptcy.
Yet recent events in the financial markets add some weight to Mr Skilling’s story—though nobody is (yet) alleging the sort of fraudulent behaviour on Wall Street that apparently took place at Enron. The hastily arranged purchase of Bear Stearns by JP Morgan Chase is the result of exactly such a bank run on the bank, as Bear’s counterparties lost faith in it. This has seen the destruction of most of its roughly $20-billion market capitalisation since January 2007. By comparison, $65 billion was wiped out at Enron, and $190 billion at Citigroup since May 2007, as the credit crunch turned into a crisis in capitalism.
The Economist article goes on to compare the similarity of certain of Ken Lay's public comments regarding Enron's liquidity in the turbulent post 9/11 markets (for which he was eventually prosecuted) with those of Bear Stearns and Lehman Brothers executives during the current turmoil in the financial markets. As this post from almost two years ago notes, the source of the information upon which Lay based his positive statements is the same fellow (former Enron CFO Andrew Fastow) whose exculpatory statements regarding Skilling and Lay the Enron Task Force improperly withheld in connection with their criminal trial. And the revelations of this latest round of prosecutorial misconduct with regard to Fastow comes on top of the Task Force's blatant misrepresentation (see also here) of Fastow's plea deal to the Lay-Skilling jury during the trial.
As usual, Larry Ribstein places all of this in context:
I'm constructing a "narrative" for the prosecutorial misconduct case: Prosecutors desperate for a conviction, their careers turning on the outcome, have a key witness, Andy Fastow. The problem is, the guy has, in [Enron Task Force prosecutor John] Hueston's words, a "heartstopping history of self-dealing." Obviously the government couldn't afford any additional shadow on Fastow's credibility. Yet in the government interviews it seems his story got more negative on the defendants over time. Could be a big problem for Fastow on the witness stand, as the defense sought on cross to show he was changing his story to suit his jailers. Could the prosecutors afford to give these notes to the defense? Why not just turn over a summary? By the time the truth came out (if it ever did) they could do a dance about how the differences were inconsequential.
The government is saying the differences are inconsequential. So why, then, didn't they produce the notes as repeatedly requested, rather than summarizing them? I think those prosecutors have some explaining to do.
Update: Warren Meyer also notes the similarities between Bear Stearns' demise and that of Enron.
Posted by Tom at 6:55 PM | Comments (4) | TrackBack (0)
March 17, 2008
The Nacchio debacle
I'm shocked, absolutely shocked, that a former Enron Task Force member would have ever been involved in improperly suppressing exculpatory testimony at trial that would ultimately lead to the Tenth Circuit's reversal of the conviction of former Qwest CEO, Joseph Nacchio.
Larry Ribstein and Ellen Podgor break down and comment on the Tenth Circuit decision. As an aside, the expert witness who was improperly excluded in the Nacchio trial -- Daniel Fischel -- was the author of the book that exposed the true nature of, and motive behind, Rudolph Giuliani's prosecution of Michael Milken.
Posted by Tom at 9:21 PM | Comments (1) | TrackBack (0)
March 16, 2008
That pesky trust-based business model
Over the weekend, we learned that the Fed had bailed out New York-based investment bank Bear Stearns during this unsettled time in the financial markets.
Almost seven years ago, a much larger company that shared many characteristics with Bear Stearns -- Houston-based Enron -- did not even generate serious consideration for a Fed bailout before it went under in the turbulent post-9/11 financial markets.
In between those two events, one of the world's wealthiest insurers and another company that is similar in many respects to Bear Stearns and Enron -- American Insurance Group -- barely escaped a similar fate by cutting a deal with the now-disgraced former Governor and Attorney General of New York to cut loose the executive primarily responsible for creating AIG's vast wealth.
The fact of the matter is that Enron was -- and Bear Stearns and AIG are -- trust-based businesses that fundamentally depend on the trust of the markets to sustain their value. Once that trust is lost, such companies lose value quickly and dramatically (a case in point -- JP Morgan Chase's proposed $236 million purchase price for Bear Stearns comes just hours after Bear's market cap was $3.5 billion this past Friday and $20 billion as of January, 2007). Although unfortunate for the owners of such companies, such a dramatic loss of wealth does not necessarily mean that any criminal conduct caused or was even involved in the loss. Rather, such loss is simply one of the risks of investing in a company based on a trust-based business model. The sooner we all recognize and understand this risk -- and avoid the mainstream media's promotion of myths about them -- the quicker we can put a stop to injustices such as this while advancing the discussion of how best to hedge the risk of such potential losses.
Posted by Tom at 6:52 PM | Comments (0) | TrackBack (0)
March 14, 2008
The stench of prosecutorial abuse
The stench of prosecutorial abuse has long hung over the Enron-related criminal cases. But the extent of that abuse became crystal clear this afternoon when the Fifth Circuit Court of Appeals granted former Enron CEO Jeff Skilling's motion to unseal his supplemental brief relating to the government's interview notes of former Enron CFO and chief Skilling accuser, Andrew Fastow. I bookmarked the supplemental brief in Adobe Acrobat to facilitate ease of review.
The brief reveals suppression of exculpatory evidence by the Enron Task Force on a massive scale. The entire brief is devastating to the Task Force's prosecution of Skilling and the late Enron chairman, Ken Lay. But if you do not have time to read the entire brief, read the excellent 11-page introduction, which includes the following passage:
The raw notes are shocking. The 420 pages of contemporaneous notes, which we have spent the last many weeks comparing to the thousands of pages of trial record and the Task Force’s pretrial disclosures, confirm our worst fears. On the most crucial issues in Skilling’s case—especially where it was only Fastow’s word against Skilling’s—the Task Force suppressed vital exculpatory evidence from its “composite” FBI Form 302s for Fastow and all other disclosures given to Skilling. The Task Force then proceeded to present critical testimony and argument at trial it knew was contradicted by the evidence withheld from Skilling.
Much of the suppressed evidence directly relates to—and refutes—the Task Force’s pivotal contention that Skilling orally agreed to “secret side deals” to manipulate Enron’s financial statements. This “side deal” theory underlies every count of conviction against Skilling. By depriving Skilling of key exculpatory evidence that Fastow conveyed in his interviews, the Task Force was able to skew the proof and convince the jury to accept Fastow’s word over Skilling’s. As the Task Force later told Fastow’s sentencing judge and recounted in a law review article, Fastow’s testimony and credibility were the cornerstones to convicting Skilling. . . . Enron Task Force Prosecutor John C. Hueston, Behind the Scenes of the Enron Trial: Creating the Decisive Moments (“Hueston”), 44 AM. CRIM. L. REV. 197, 197-99 (2007). The substantial evidence the Task Force kept from Skilling all shares one chatacteristic—it was harmful to the Task Force’s case against Skilling. . . .
The implications of this brief reach far beyond the Skilling appeal. For example, the already-reeling re-prosecution of the three former Merrill Lynch bankers in the Enron-related Nigerian Barge case would appear to be over -- the Enron Task Force in the first trial of that case not only withheld exculpatory evidence, but put on incriminating testimony from former Enron treasurer and Fastow confidant Ben Glisan that directly contradicted the exculpatory evidence that Fastow provided to Task Force prosecutors during his interviews. Other Enron-related criminal cases -- as well as plea bargains -- could well be affected.
I've often noted on this blog that fair-minded people can disagree over whether the government's prosecutorial power is an appropriate tool to regulate business. However, my fervent hope is that even those who favor using the state's awesome power to criminalize merely questionable business transactions will be appalled by what the prosecution did in the criminal case against Skilling and Lay, as well as the other Enron-related criminal cases. In truth, none of us would be able to survive, as Thomas More reminds us, "in the winds that blow" from the unjust exercise of the government's overwhelming prosecutorial power. I continue to hope that Jeff Skilling's unjust conviction and sentence are reversed on appeal, not only for his and his family's benefit, but also for ours.
Update: The Chronicle's Kristen Hays, who is the only mainstream media reporter who I know of following this story, has an article on the Skilling brief here (the Chronicle story links to the copy of the Skilling supplemental brief that I bookmarked in Adobe Acrobat to facilitate ease of review; the Skilling supplemental brief on file with the Fifth Circuit is not bookmarked).
Probably in response to an off-the-record response from the DOJ, Hays writes that the Skilling supplemental brief contends that "some of [Fastow's] initial statements to authorities were not as damning as those in his testimony." That's a stark understatement of what the Skilling supplemental brief describes.
The initial Fastow statements set out in the Skillling brief were not only not as damning as Fastow's trial testimony, they were irreconcilable with that trial testimony and described completely legal activity, even by Fastow. Consequently, had the Enron Task Force not been able to to pry Fastow off his original story, the core of the Task Force's case against Skilling and Lay would have have contradicted by Fastow, who was Skilling's main accuser at trial. And the fact that the DOJ did not disclose to the Skilling defense team how Fastow's incriminating testimony evolved over time from his exculpatory initial statements while Fastow and the Task Force were negotiating a dubious plea deal is beyond reprehensible. What is the DOJ going to say now, that they didn't disclose the exculpatory earlier statements to Skilling's defense team because Fastow was protecting Skilling in these initial meetings? Yeah, right.
Update 2: The blogosphere is picking up the story quickly, as Larry Ribstein, Ellen Podgor (see also here) and Warren Meyer have already commented. Curious, isn't it, that the mainstream media is lagging well behind. Could it be that the story simply does not comport with the media's pre-conceived notions of the Enron saga?
Update 3: The WSJ's John Emshwiller, who covered the Lay-Skilling trial for the WSJ despite legitimate questions about his objectivity, reports on the latest developments here.
Update 4: John Hueston, the former Enron Task Force prosecutor who is quite proud of his work in nailing Skilling and Lay on an admittedly weak case (see here, here, here and here), is mentioned often in the Skilling supplemental brief because of the law review article he authored that is cited in the passage above. Hueston's law firm bio used to link to a copy of the article, but the firm took the link down some time ago. However, Cara Ellison, who has followed the Enron-related criminal cases closely, provides this handy link to Hueston's article.
Update 5: A bookmarked copy of the DOJ's reply to the Skilling Supplemental Brief can be downloaded here. The DOJ argues essentially that, put in what the DOJ considers to be the proper context, each portion of the Fastow interview notes on which Skilling relies to establish Brady violations contains information that Skilling already had prior to trial or is evidence that would have had "minimal" value in impeaching Fastow. Frankly, the DOJ's analysis stands Brady on its head. The essence of Brady is that the prosecution does not retain the power to make such determinations regarding exculpatory evidence unilaterally -- that information is a part of the mix that the jury and the Court sort out in determining facts and in applying the law. If what the Enron Task Force withheld here is truly harmless error, then the DOJ's need of 70+ pages to explain why that is the case belies that contention. Ellen Podgor passes along similar thoughts regarding the DOJ's brief here.
Posted by Tom at 6:47 PM | Comments (5) | TrackBack (0)
March 11, 2008
The Spitzer Lesson
The mainstream media and the blogosphere have been buzzing over the past 24 hours regarding the fall from grace of New York's governor and former Lord of Regulation, Eliot Spitzer. As noted in this previous post, there is an under-appreciated human element in such dubious criminal problems as Spitzer fell into. So, I have a great deal of compassion for the members of Spitzer's family, although Spitzer's many victims would certainly attest that he showed none for them. Larry Ribstein has related and typically insightful thoughts regarding why the revelers in Spitzer's fate should be concerned about the way in which he was brought down.
But I hope that the most important lesson that Spitzer's political career teaches us is not lost amidst the glare of a tawdry sex scandal. As with Rudy Giuliani before him, Spitzer rose to political power through the misuse of the state's overwhelming prosecutorial power to regulate business interests. In so doing, Spitzer manipulated an all-too-accommodating mainstream media, which never misses an opportunity to take down an easy target such as a wealthy businessperson. Spitzer is now learning that the same media dynamic applies to powerful politicians, as well.
However, as noted earlier here, where was the mainstream media's scrutiny when Spitzer was destroying wealth, jobs and careers while threatening to go Arthur Andersen on American Insurance Group and other companies? Where was the healthy skepticism of the unrestrained use of the state's prosecutorial power to regulate business where business had no available regulatory procedure with which to contest Spitzer's actions? As Dealbreaker's John Carney noted at the time of that earlier post:
Why didn’t [the mainstream media covering Spitzer's investigation of Grasso] reveal the slimy tactics of the Spitzer squad? We suspect part of the problem was the fear of being “cut off” of access. Reporters compete for scoops, and often those scoops depend on sources who will leak information to them. In the NYSE case, reporters assigned to the story were largely at the mercy of the investigators, who could cut-off uncooperative reporters, leaving them without copy to bring to their editors while their competitors filed stories with the newest dirt. They probably felt—not unrealistically—that their very jobs were on the line.
This reveals an unfortunate state of affairs. Playing bugle boy while government officials call the tunes from behind a veil of anonymity is not investigative journalism—it’s hardly journalism at all. It’s closer to propaganda. It would have been far better had the journalists turned their backs on the Spitzer squad, or even revealed these tactics to the public. Sure they may have lost some “good” stories but they could have painted a truer picture of what was going on. But that’s probably too much to hope for.
And, as noted here, the same prosecution manipulation of the mainstream media contributed to the utter lack of balance in the media's reporting on the Enron criminal prosecutions.
Alas, change does not come easily to the mainstream media. Late last week, this post reported on developments that could well expose an egregious abuse of prosecutorial power in connection with the prosecution for former Enron CEO, Jeff Skilling. Why has no mainstream media outlet intervened in that case and demanded that the information about potentially serious governmental misconduct be made public?
The Spitzer lesson is not easily embraced.
Update: Following on the theme of this post, the W$J's Kimberly Strassel reviews the mainstream media's complicity in portraying Spitzer as something that he is not, and Charlie Gasporino -- who wrote the book about Spitzer that foreshadowed these issues -- comments along the same lines here.
Posted by Tom at 7:20 AM | Comments (2) | TrackBack (0)
March 7, 2008
What's going on in the Skilling appeal?
First, thank you to all of the many readers who have communicated their concerns and prayers for the family crisis that is precluding me from daily blogging for now. Your kind thoughts and words are comforting and much appreciated.
But now for a quick blog post. While working this week, I was checking the docket of an appeal in which I am involved at the Fifth Circuit Court of Appeals. While there, I ambled over to the docket of the appeal of former Enron CEO Jeff Skilling just to see if there was anything interesting happening. Check out the following recent entries:
3/4/08 Motion filed by Appellant Jeffrey K Skilling to file supplemental briefs. [5976818-1] Supplemental brief included? (Y/N): Y, to unseal A's suppl. brief brief [5976818-2] Date of COS: 3/3/08 Sufficient [Y/N]: Y [06-20885] (jmw) 3/5/08 Motion filed by Appellant Jeffrey K Skilling [5976825-1] to place supplemental brief under seal. Date of COS: 3/4/08 Sufficient [Y/N]: Y [06-20885] (jmw) 3/5/08 Response/opposition filed by Appellee USA to motion to file supplemental briefs [5976818-1] by Appellant Jeffrey K Skilling. Reply to Resp/Opp due on 3/14/08. Date of COS: 3/4/08 Sufficient [Y/N]: y [5976831-1] [06-20885] (jmw) 3/7/08 Reply filed by Appellant Jeffrey K Skilling to response/opposition [5976831-1], motion to file supplemental briefs [5976818-1] Reply to Resp/Opp due ddl satisfied., motion to unseal brief [5976818-2] Sufficient [Y/N]: Y [5978302-1] [06-20885] (jmw)
Translated, the foregoing means that Skilling's appellate team filed a motion on Tuesday requesting that the Fifth Circuit grant permission to the parties to file supplemental briefs and, because of confidentiality concerns, requested that the supplemental brief be filed under seal (in other words, not for public consumption). The government must have been expecting the Skilling motion because they filed a respons