Politicians Get a Black Mark over Blackstone

Its funny how supposedly populist politicians act when they are forced to make a decision that would do some good for the little guy. This thought came to mind as I was reading the coverage of the impending Blackstone IPO and the immense windfall of riches that CEO Steve Schwartzman and his colleagues will receive. They apparently have exposed a tax loophole that has garnered a lot of press recently. The main focus has been whether or not the IPO windfall should be taxed at the corporate rate of 35 percent or a special rate of 15 percent reserved for partnerships, among other tax code minutiae.

And while Wall Street sends its legions of lobbyists to the Capitol to influence a potential bill that could slice private equity profits nearly in half, other interesting underlying themes arise. Namely: the questionable tax record of Senator Charles Schumer and whether or not private equity has reached its peak.

To address the tax situation, Senate Finance Chairman Max Baucus and his Republican colleague Charles Grassley are leading the charge to close the supposed loopholes. Interesting, however, was Schumer’s reaction to the bill, who also sits on the Senate Finance Committee. Though he normally favors taxing the “rich,” his comments suggested that on this one, he’s on the fence at best. The woman who would be president, Hillary Clinton is equally perplexed.

Schumer’s office’s official position according to reports is that the Senator is “taking a careful look at the legislation.” Senator Clinton’s office followed suit. The reason for indecision is that Steve Schwarzman is one of their richest constituents as well as major <http://www.opensecrets.org/indivs/search.asp?key=H9VHC&txtName=Schwarzman&t
xtState=(all%20states)&txtCand=Schumer&txtAll=Y&Order=N> donor of tens of thousands of campaign contribution dollars. Forgetting Senator Clinton for a second, on the surface there is nothing wrong were it not for Schumer’s hypocritical votes to tax the investor class by lumping them into the “rich” category.

For example he opposed the 2006 tax cut package, including a two-year extension of the reduced 15 percent tax rate for capital gains and dividends, currently set to expire at the end of 2008. If you’re wondering exactly how deeply this will affect individual investor’s wallet, economist John Rutledge in an interview estimated that raising the dividend rate alone, “would reduce the value of the S&P 500 stocks by between 5% and 8.5%, roughly a $500 to $700 billion decline in the wealth of the 52% of American households that own stock.”

Schumer has also voted against repealing the marriage penalty and against lowering all individual income tax rates. One would have thought based on his record a tax specifically targeted at billionaire private equity barons would be a no-brainer for Schumer. The fact that he is hesitating shows that Schwartzman’s donations are having their desired affect.

Furthermore, this isn’t the first time Schumer has changed his stripes when it comes to taxing the super rich. He was able to insert a <http://www.nysun.com/article/33000?access=805807> special tax break into an unrelated bill for a wealthy New York developer named Robert Congel – also a donor – that funded a mega-mall in Syracuse New York with tax-exempt bonds.

Chuck Schumer’s record consistently shows that when it comes to the uber-wealthy New Yorkers, tax breaks and loopholes are ok, but tax cuts that would help middle and upper class investors are not. I ask you, who needs a tax break more: the billionaire or the “thousand-aire” who has a mortgage and a portfolio just barely large enough to retire on?

And speaking of leaving ordinary investors high and dry, though I am certainly no investment guru, it seems like the Blackstone IPO is a dumb investment to begin with. It can be argued that private equity has reached its peak and returns are poised to decline. Why else would private equity barons be looking to cash out and subject themselves to new taxes and regulatory scrutiny?

Further, with cheap financing on the decline, deals are going to become more expensive and less profitable. Making matters worse, undervalued acquisition targets are dwindling so where is the growth potential?

Unfortunately the sales and marketing geniuses on Wall Street are going to rally investors big and small into buying Blackstone shares. And in five years I’m quite sure Steve Schwartzman and his cronies will still be <http://online.wsj.com/article/SB118169817142333414.html?mod=hpp_us_pageone>
eating cracked crab that goes for $400 per claw and hiring out Rod Stewart to play private shows while ordinary investors will be stuck wondering what happed to their Blackstone stock.

Down in Washington, Senator Schumer will be wondering how to tax the poor saps.

The Wall Street Shell Game – Wanna Play?

Recently, The Wall Street Journal buried a story about a settlement reached between the SEC and Morgan Stanley. The SEC found that after retail investors in their Private Wealth Management unit placed an order to buy a stock, Morgan Stanley would quote them a marked-up price, usually no more than a penny more than the stock’s actual price. According to the article, Morgan Stanley would do this on a massive scale and profit handsomely.

But that gain is likely only one of three profit centers Morgan Stanley and other major Wall Street brokerages are making off the backs of high net worth retail investor clients. The real profits exist on a much darker and sinister level. It’s known in the industry as getting a “threefer,” and the ease at which the scheme is carried out is a result of the erosion of the specialist floor broker at the New York Stock Exchange and the rise of aptly-named “dark pools.”

The easiest way to understand the “threefer” is to consider this scenario:

A major Wall Street brokerage accepts a sell order from a retail investor for 10,000 shares of a thinly traded stock. Revenue stream number one comes from the fee the retail investor must pay the brokerage to sell the stock. The brokerage then enters into what is known as “the dark pool,” where the hedge fund sharks swim. Avoiding any stock exchange or floor trader, the brokerage and the hedge fund negotiate a trade. The brokerage then marks up the stock price representing revenue stream number two and the penny markup represented in the WSJ article.

The hedge fund now sells 9,000 shares and keeps 1,000 in its own portfolio. So, the hedge fund turns back to the brokerage to execute the order via the brokerage’s pipeline to a major exchange. The hedge fund pays a fee for the pipeline to the brokerage, which completes the “threefer,” but the illicit profits don’t end there.

Why would a hedge fund make profitless trades and pay a major Wall Street brokerage for the trouble? Well, when the hedge fund buys the stock, it will be executed through a program in 1,000-share increments usually reducing the stock’s price by a few cents. Once the trade is complete, the hedge fund will ride the stock back up using the 1,000 shares it kept, sometimes increasing its stake if the arbitrage gains are significant enough. The scheme is virtually risk free and equates to a license to print money.

Worse yet, the above scenario occurs all day everyday in plain sight and is a major reason hedge funds can produce outsized returns. High net worth investors are most susceptible because their buy and sell orders are large enough to affect stock prices.

Every investor, whether institutional or retail, is entitled to the “best execution” of his or her buy/sell orders, meaning the best possible price. Institutional investors buy and selling huge positions so they are less likely to be taken advantage of because they’ll check the data.

How can a retail investor do the same? Morgan Stanley and all brokerages are actually required to disclose where a trade was executed. The rule requiring them to do so is SEC 606. The disclosure comes in the form of the confirmation document your brokerage will send to you, usually buried somewhere in the ninth or tenth item. You might see four letter acronyms representing the other market participant. Ask your broker for details on these mysterious four letter words.

If they won’t tell you or do come clean and the four letter acronyms represent a hedge fund or other firm with a proprietary trading desk, you’ve probably fallen victim to Wall Street’s secret little shell game.

So what’s the harm here? The rich-guy investor only paid a penny a share more. No harm no foul, right? Think again. The stock market is based on the principle that a stock price is the reflection of the way the market views it at a particular time. The Wall Street shell game creates a manufactured price. If there’s no guarantee that a stock is priced at market value, then the market will lose confidence, which is bad for investors big and small.

My Legal Quest to Hold Mortgage Lenders Accountable

As an attorney with a long track record of advocacy on behalf of individual investors wronged by their brokers, I am certainly proud of every judicial victory, big or small, scored on their behalf.

However, one in particular stands out as a career-defining moment. In 2001, I filed a complaint against Merrill Lynch on behalf of a New York doctor who lost $500,000 after following firm analyst Henry Blodget’s tainted stock recommendations. That complaint became the catalyst for then New York attorney-general Eliot Spitzer’s investigation into conflict-of-interest abuses on Wall Street and the subsequent $1.4 billion global settlement he wrangled from the top names in investment banking.

Having trod through some of Wall Street’s muck as long as I have, I thought I had seen it all with respect to so-called financial professionals taking advantage of the Little Guy. Not quite.

I’ve uncovered a mortgage lending scandal on Long Island that I strongly suspect is indicative of widespread fraud and dubious lending practices throughout the industry. It is my sincere hope that a related lawsuit I filed today will similarly catch the attention of appropriate prosecutors and further fuel much-needed industry reforms, this time within the mortgage lending business.

Over the last five months, my firm has been conducting its own investigation on behalf of more than a dozen Long Island and Florida working-class retirees who collectively have been bilked out of more than $100 million by Peter J. Dawson, a once high-flying “financial planner” who is currently in jail awaiting trial on grand larceny charges. It gives me great pleasure to have been instrumental in putting him behind bars.

Dawson, president of BMG Advisory Services, worked out of one of Long Island’s most prestigious office buildings, which gave him a patina of legitimacy. Over the course of 15 years, he convinced dozens of unsophisticated retirees to surrender their existing variable annuity policies and mortgage their paid-off homes so that he could invest the proceeds in new annuities on their behalf. Dawson promised that these annuities would pay a higher rate of interest than their home mortgages, thereby generating additional retirement income. Dawson assured clients that his office would pay the monthly mortgage bills.

Unfortunately for those he ensnared, he didn’t invest all the mortgage proceeds. Instead, he siphoned off some $100 million to support his lavish lifestyle, which reportedly included several properties and a lavish antiques collection. His victims are now in danger of losing their own homes because they have little or no income to cover their monthly mortgage payments; foreclosure may be imminent. The victims are mostly retired senior citizens, including a legally blind firefighter, an electrician suffering from Lupus, an ailing sanitation worker, and even a priest.

Although Dawson masterminded the fraudulent scheme, about a dozen other mortgage companies were active participants, including well-known outfits like Countrywide Home Loans and Washington Mutual, two of the nation’s biggest home lenders; PHH Corp., a NYSE-listed company that has agreed to be acquired by an affiliate of The Blackstone Group and the financing and asset management unit of General Electric; and The First National Bank of Long Island.

No doubt these mortgage company participants will dismissively invoke Sergeant Shultz’s classic “I know nothing” defense if called on the carpet. After all, there are currently no hard and fast rules or regulations requiring mortgage lenders to determine whether the loans they make are “suitable” for their borrowers. Granted, it’s quite possible that none of the lenders knew that Dawson was absconding with the monies they advanced, but they had plenty of reasons to be suspect of him.

Among the warning signs:

• Prior to starting his own firm, Dawson worked at various brokerage firms. Dawson’s U4 form, an easily available document that lists all previous charges made against a broker, contains four customer complaints, including an allegation that he induced a customer to take out a $250,000 mortgage to invest in an annuity whose interest rate was lower than the mortgage rates. “Unsuitable investments followed,” according to the complaint.
• The mortgage closings for Dawson’s clients were typically held at his office, or in at least one highly irregular instance, a hotel room. None of Dawson’s clients were represented by an attorney. Representing the mortgage lenders at most of these closings was an attorney named Ida D’Angelo or one of her associates. Ms. D’Angelo last year was indicted for mortgage fraud by the Deputy Attorney General in charge of the New York’s Organized Crime Task Force for mortgage fraud. The indictment’s complaint against D’Angelo does not pertain to her activities involving Dawson’s clients.
• In most instances, the mortgage monies were given directly to Dawson , not his clients, which also should have raised warning signs.
• By any standard, none of Dawson’s clients should have been granted mortgages. They had little or no income and there was no rational reason for them to assume mortgage debt given their late stage in life, and in several instances, their poor health.

Earlier today, I filed a lawsuit asking the New York State Supreme Court to issue a declaratory judgment ordering all the defendant banks and mortgage companies to void and cancel the mortgage loans they made to Dawson’s clients and to immediately terminate and freeze all foreclosure proceedings against them.

Sadly, it shouldn’t take a court order to force the defendant lending institutions to do what is so abundantly the proverbial “right thing”. But morals and fairness have never been the hallmarks of the U.S. banking industry, especially when there is money at stake. The Dawson case underscores why Congress should impose suitability rules on all the nation’s home lenders.

Whether Dawson’s victims can ultimately keep their homes is in the hands of a Long Island judge. If a declaratory judgment is granted, it will establish a valuable legal precedent and put irresponsible mortgage lenders on notice that they will be held legally accountable for their wrongdoing. More important, it could serve as the catalyst for much-needed industry reforms that will level the playing field for unsophisticated borrowers who are otherwise at the mercy of ruthless financial planners who line their own pockets at the expense of those less financially savvy.

As we saw with my client’s case against Merrill Lynch in 2001, it only takes a spark to light a fire.