Monthly Archives: December 2004

The criminalization of investment banking

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NY Times business columnist Floyd Norris hits the nail on the head in his column today in which he observes that the rebound in the investment banking industry this year must be tempered with the plight of Daniel Bayly, the former head of global investment banking at Merrill Lynch. Mr. Bayly was one of five defendants convicted in the Justice Department’s questionable Enron-related prosecution known as the Nigerian Barge case. As Mr. Norris notes:

[T]he real man of the year on Wall Street – or at least the man whose plight is emblematic of the new Wall Street reality – will not be sharing in those bonuses. Instead, Daniel Bayly is awaiting sentencing in federal court in Houston, where he is likely to be ordered to spend a few years in prison for doing something that few on Wall Street would have seen as a crime.
Mr. Bayly, the former head of global investment banking at Merrill Lynch, was caught up in the Enron scandal. He signed off on a deal that Merrill did with Enron, in which Merrill “bought” the now-infamous Nigerian barges from Enron at the end of 1999, thereby allowing Enron to report phony profits. The government viewed the transaction as a disguised loan.
Mr. Bayly’s role in all this was not a large one. His approval was needed for Merrill to go ahead, and he seems to have been principally concerned that there were safeguards to ensure Merrill would get its money back.
The amount of money involved inflated Enron’s profits by only $12 million, just over 1 percent of the $893 million in profits Enron reported for the year. But it allowed the company to meet investor expectations.
The government persuaded the jury that Merrill officials understood the purpose of the transaction was to inflate Enron’s profits and that the accounting was phony. Mr. Bayly’s lawyers said he believed it was proper.

The result, notes Mr. Norris, is that prosecutors are now treating investment bankers as if they were bartenders:

To many on Wall Street, however, whether or not the client’s accounting was proper was a question of little importance, just as a Porsche dealer has no reason to worry that he will get in trouble if a customer chooses to drive faster than the speed limit.
The risk that bankers now confront is that they will be treated the same way bartenders are in some states, where the man who sold the drunk driver his final drink can be held liable for the damages that result.
It used to be that when a company went bankrupt as a result of fraud, the only deep pocket available belonged to the auditor. The collapse of Arthur Andersen after the Enron fraud served as a warning that that pocket might not be so deep, a fact that has been reinforced by the limited insurance now available to auditors.
The current reality is that investment and commercial bankers are the new deep pockets. They used to get high fees for devising transactions whose primary purpose was to mislead investors. Now they will be sued by the Securities and Exchange Commission and by private lawyers if there is any evidence the bankers knew the company’s accounting was suspicious. The Justice Department may even deem such an act to be a felony, and there is no assurance that it will not bring criminal charges against an investment bank as well as against its officials.

How does this new risk reality affect the market? Mr. Norris has a suggestion:

As the profits pour in from the rebound in investment banking fees, investors might hesitate in bidding up the industry’s shares. As Mr. Bayly’s conviction demonstrates, the risks of the investment banking business are much greater than they used to be.

Read the entire piece. And as you ponder the policy implications of the Justice Department’s prosecution of businessmen such as Mr. Bayly over merely questionable business transactions, take note of the fact that Mr. Bayly is currently facing a prison sentence that could be longer than that of true business criminal Martin Frankel.

Judge Gilmore to instruct jury on Justice Dept. refusal to disclose death penalty analysis

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Following on the matters addressed in this earlier post, U.S. District Judge Vanessa Gilmore ruled on Thursday that she will instruct the jury regarding the government’s failure to comply with her prior order to disclose the basis of its decision to seek the death penalty against one of the defendants in the criminal case in Houston against against the two remaining defendants accused in the deaths of 19 illegal immigrants who were being smuggled into this country in the back of a blistering hot trailer.
Houston defense attorney Craig Washington accused the government of singling out one of the defendants for the death penalty because he is black. During a prior hearing in the case, Washington presented evidence that this case was the only one in which the government had sought the death penalty out of almost 70 illegal smuggling cases. Prosecutors denied that race was a factor, pointing out that they did not seek the death penalty for the other black defendant in the case and that the basis of the government’s decision to seek the death penalty is subject to executive privilege.
I have not researched either the merits of Judge Gilmore’s ruling or the government’s claim of executive privilege in this matter. Nevertheless, Judge Gilmore’s order appears to be nothing more than a mechanism to ensure a full and fair trial of all issues in a death penalty case. Her refusal to acquiesce quietly to the Justice Department’s refusal to comply with her order is refreshing. Judges in the Enron-related criminal cases — please take note.

Tech humbles Cal in Holiday Bowl

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Before the fourth ranked Cal Bears football team complain too loudly again about being passed over by Texas for the Bowl Championship Series Rose Bowl game, they need to compare this game with this game.
Indeed, the Pac-10 Conference is fortunate that USC was left out of the BCS Championship Game last season. In my view, that’s the only justification for choosing the undefeated Trojans for this season’s championship game over Auburn, which is also undefeated and played a far tougher schedule than USC.

9th Circuit reverses big judgment in favor of Anna Nicole

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Get ready for another round of jokes on the late night talk shows as the U.S. Court of Appeals for the Ninth Circuit overturned an $88 million bankruptcy court judgment in favor of former stripper, zaftig model, reality show star and current Trimspa spokeswoman Anna Nicole Smith against the estate of her late husband, Houston oilman J. Howard Marshall, II. Here is the Ninth Circuit opinion and the Chronicle story on the case is here.
E. Pierce Marshall of Dallas, the son of J. Howard Marshall, is the main beneficiary of the late Mr. Marshall’s estate. Forbes estimates E. Pierce Marshall’s net worth at $1.6 billion. Most of the late Mr. Marshall’s fortune was generated through his stake in privately held Koch Industries.

Updating the Yukos case — Gazprom will not get Yugansk after all

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In a surprise move, the Russian government announced Thursday that Yuganskneftegaz (“Yugansk”) — the main oil production unit of bankrupt Russian oil giant OAO Yukos — will not be conveyed to to Russian gas giant OAO Gazprom as widely anticipated. Rather, the Russian government announced that Yugansk will be used to create a new government-owned oil company and that a minority stake of up to 20% in that company will be offered to China’s state energy company.
Here are the earlier posts on the Yukos chapter 11 case and related matters.
The new plan for Yugansk will be a major shot in the arm for China’s efforts to obtain access to new fuel reserves for its burgeoning economy. China’s economy has been the largest factor in the surging world oil demand of recent years, but the Russian government has heretofore always declined Chinese efforts to invest in the Russian oil and gas industry. The plan also confirm that the Russian government’s campaign against Yukos will result in the re-nationalization (is that a word?) of a large part of what had been Russia’s largest oil unit and one of the relatively few Russian companies that was able to attract foreign investors.
Gazprom is controlled by the Russian government but also has private shareholders. After a Houston Bankruptycy Court enjoined Gazprom and Western Banks two weeks ago from participating in the Russian government’s controversial auction of Yugansk to pay for Yukos’ alleged $28 billion tax debt, Gazprom appeared to have found a way around the TRO by using the Russian oil company OAO Rosneft to acquire Yugansk. Gazprom and Rosneft are in the process of merging.

Pros versus Amateurs?

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In this Opinion Journal piece, Edward Jay Epstein reviews former KGB Col. Victor Cherkashin’s new book, Spy Handler: Memoir of a KGB Officer (Basic Books, January 1, 2005). Although there is no assurance that the ongoing reform movement in the Central Intelligence Organization is going to remedy the longstanding problems that have evolved in that agency over the past generation, Col. Cherkashin’s book makes clear that the U.S. has little to lose by seeking to correct the CIA’s deficiencies. In short, the KGB played the CIA like a fiddle during the Cold War.
Mr. Cherkashin had a distinguished 40 year career in the KGB that began in 1952 under Stalin, included a hitch as deputy KGB chief at the Soviet Embassy in Washington from 1979 to 1985, and ended when the Soviet Union disintegrated in 1991. During that period, Col. Cherkashin primary mission was to organize KGB operations aimed at undermining the CIA’s integrity, confidence and morale, and he was pretty darn good at his job:

Mr. Cherkashin describes in detail how he helped convert two American counterintelligence officers–one well-placed in the CIA’s Soviet Russia Division, the other in the FBI–into moles. Their names are notorious now, but over the course of a decade Aldrich Ames and Robert Hanssen operated with anonymous stealth, compromising most of the CIA’s and FBI’s espionage efforts in the Soviet Union.

But Mr. Cherkashin does not attribute his success solely to his personal cleverness:

Mr. Cherkashin skillfully torments his former adversary, the CIA, by attributing a large part of the KGB’s success to the incompetence of the CIA leadership, or its madness. He asserts, in particular, that the CIA had been “all but paralyzed” by the “paranoia” of James Jesus Angleton, the CIA’s longtime counterintelligence chief, who suspected that the KGB had planted a mole in the CIA’s Soviet Russia division.

Mr. Cherkashin is right that Mr. Angleton’s concern retarded, if not “paralyzed,” CIA operations in Russia. After all, if the CIA was indeed vulnerable to KGB penetration, as Mr. Angleton believed, it had to assume that its agents in Russia would be compromised and used for disinformation. This suspicion would recommend a certain caution or tentativeness, to say the least. Mr. Cherkashin’s taunt about Mr. Angleton’s “paranoia” echoed what was said by Mr. Angleton’s critics in the CIA, who resented his influence, believing that polygraph tests and other security measures immunized the CIA against such long-term penetration.

But of course Mr. Angleton was right, too. On Feb. 21, 1994, Mr. Ames, the CIA officer who had served in the Soviet Russia division, was arrested by the FBI. He confessed that he had been a KGB mole for almost a decade and had provided the KGB with secrets that compromised more than 100 CIA operations in Russia. Mr. Hanssen was caught seven years later.

Since Mr. Cherkashin had managed the recruitment of Mr. Ames and helped with that of Mr. Hanssen, his accusation that Mr. Angleton was paranoid for suspecting the possibility of a mole has the exquisite irony of a stalker following his victim in order to tell him that he is not being followed. Mr. Cherkashin adds a further twist by suggesting that Mr. Angleton’s “paranoia” made it easier for the KGB to recruit demoralized CIA officers as moles. According to this tortured logic, if the CIA — and its counterintelligence staff — had acted more ostrich-like, by denying the existence of moles in its ranks, the KGB would never have found Aldrich Ames or penetrated the agency in other ways.

Read the entire review.

Mack Brown’s rich new deal

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The University of Texas announced Wednesday that the UT System Board of Regents has approved a deal in which UT football coach Mack Brown‘s current contract — which pays him $2.017 million annually — will be replaced with the 10-year deal that will pay him $2.159 million in 2005 and $100,000 more than that amount each year through the 10 year term of the contract.
The new contract is the fourth most lucrative one for a college football coach. Only Bob Stoops at Oklahoma ($2.3 million), the departing Nick Saban at LSU ($2.3 million) and Tommy Tuberville at Auburn ($2.28 million) make more than Brown. Due to one-time $1.6 million bonus he received on his 53rd birthday this past August, Brown was the highest paid college coach in 2004 with earnings $3.6 million.
Geez, just think what Brown could make at UT if he could ever manage to beat Oklahoma — to whom his teams have lost five straight times — or win a conference championship, something that none of his teams has ever accomplished during Brown’s 17 years of being a head coach on the major college level. Not to have won a conference championship at a school with the resources and talent of Texas is a major blemish on Brown’s resume.
Moreover, Brown’s Texas teams have had a history of playing poorly in big games. They have lost five consecutive losses to Oklahoma and Brown is clearly overmatched by his nemesis, OU Coach Stoops. Brown’s Texas teams have lost both Big 12 championship games in which they have played, including the galling upset by Colorado in 2001 that prevented that Texas team from getting a BCS bowl berth.
The bowl record of Brown’s Texas teams (3-3) is similarly tarnished. Last year’s 28-20 loss to Washington State in the Holiday Bowl was particularly awful, as Texas made WSU’s zone blitzs appear to be a new invention in football.
So, one certainly has to admire UT for keeping up with the compensation levels of the elite group of teams in college football, which is where UT aspires to be. However, a valid question remains as to whether Mack Brown deserves it.
In more troubling news for UT, assistant coach Dick Tomey, who is largely responsible for the development of the UT defense this season into an elite unit, will be departing the UT staff next season to take the head coaching job at San Jose State. Perhaps even more troubling from an emotional standpoint, Tomey is attempting to persuade UT graduate assistant coach and former QB great Major Applewhite to join him as an assistant on his San Jose staff.

Continental inks big deal for Boeing 7E7s

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Houston-based Continental Airlines announced Wednesday that it will order Boeing Co.’s new high-efficiency 7E7 aircraft and accelerate the delivery of other Boeing aircraft that it previously ordered. Continental’s 7E7 aircraft order is the first by a U.S. airline and is a shot in the arm for Boeing’s marketing of the new aircraft.
Continental is buying 10 7E7s from Boeing with the first of the planes scheduled for delivery in 2009. The list purchase price on the aircraft is approximately $1.3 billion, although Continental will probably pay less than list.
The 7E7 deal illustrates that airlines are banking on reducing operating costs in an attempt to gain an advantage in the brutally competitive airline industry. The 7E7 is made of carbon-fiber composite materials instead of metals such as aluminum that are used on other aircraft, so Boeing is promoting the aircraft as being at least 20% cheaper to operate than older aircraft. Moreover, Boeing believes that the aircraft will be cheaper to manufacture.
Continental will use the 7E7s on international flights, and the purchase is part of a deal between Continental and Boeing under which Continental is attempting to increase the efficiency of its international flights, which are already more profitable than its domestic flights. Continental also will take delivery in 2006 of six Boeing 737-800 aircraft that were previously scheduled for delivery in 2008, and it will lease eight Boeing 757-300 aircraft next year. Continental will use those 737s and 757s on its domestic routes and deploy its 757s and 767s on its international routes.

Tsunami Relief Donation

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I have added a hyperlink on the right side of the blog for Amazon’s Red Cross Tsunami Relief Donation page.
The power of the Internet allows us to make a donation quickly and easily to help subsidize relief efforts for this disaster. If you are financially able to do so, please take advantage of this wonderful resource. As of this post, the Amazon page has generated $1.9 million in donations for the relief effort.
If you prefer to make your donation through another organization, The Command Post has provided this extensive listing of hyperlinks to various relief organizations.

Updating the Yukos case — Yukos defaults on huge loans

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OAO Yukos, the Russian oil company wallowing in a chapter 11 case in Houston, had its credit-rating slashed to default status yesterday after it failed to make the interest payments on a $1 billion loan from a syndicate of western banks and a $1.6 billion loan to Menatep, which is also its largest shareholder. Security for the loans was Yukos’ interest in Yuganskneftegaz (“Yugansk”), the oil unit that the Russian government auctioned off earlier this month to defray Yukos’ alleged $27 billion in overdue taxes. Here are the earlier posts on the Yukos chapter 11 case.
Meanwhile, in Houston, Deutsche Bank filed a motion to dismiss the Yukos chapter 11 case with the Houston Bankruptcy Court on Tuesday. Duetsche Bank was was one of a group of Western banks that had committed to finance OAO Gazprom‘s acquisition of Yugansk at the Russian government’s auction before the Houston Bankrutpcy Court’s temporary restraining order enjoined the bank and other Western financial institutions from participating in the auction.
In its motion, Deutsche Bank asserted that Yukos had tried to “artificially manufacture” a presence in the U.S. in order to seek bankruptcy protection. In obtaining the TRO earlier this month, Yukos had preliminarily persuaded the Bankruptcy Court that it had jurisdiction over Yukos based on, among other things, the fact that it had stablished a bank account in Houston, that its chief financial officer had recently moved to Houston and was working there, and that approximately 15% of Yukos is owned by investors from the United States.