Investor Beware

Investors “Stuck” High and Dry in WexTrust Fraud Case

The Paulson Plan…2.0

Two years ago, if you mentioned “The Paulson Plan,” you would be referring to Wall Street’s attempt to further deregulate themselves under the cloak of patriotism.

“We need less rules or else America will be less competitive,” they told us.

Today, we are again debating “The Paulson Plan,” and indeed, America’s competitiveness is at stake but this time, universally it is acknowledged that Wall Street’s unbridled greed put us here in the first place.  Secretary Paulson, with his $500 million Goldman Sachs pedigree, is unarguably a member of the club.

And so at this juncture, I believe it is appropriate that we ask ourselves, can we trust this man with a trillion dollar blank check when he’s singing such a different tune on regulatory reform?  Mind you, this is not a critique of the band-aid solutions Secretary Paulson has orchestrated to date - that’s what history books are for - but rather hand raised on behalf of investors.

As an investor advocate, I see nothing in this bail-out that addresses the systematic fraud that was committed against investors.  As I’ve written about before, many investors are still holding distressed securities that were pitched to them as cash equivalents, conservative long term securities and any number of other ways contrary to the truth. Therefore, as a condition to unloading toxic debt onto the taxpayers - as is The Paulson Plan 2.0 - Wall Street should be required to make their customers whole.  Whether its an investor that bought auction rate securities, Citigroup’s ELKS (derivatives), short-term bond funds, preferred stock of financial firms, hedge funds or whatever the case may be, if an investor was mislead they should get their money back.

Frankly, it’s shameful that investor protection is even still an issue after the tech-bubble destroyed millions of investors’ net worth.  The systemic problem can be summed up in an email uncovered from a Merrill Lynch executive as she prodded her brokers to sell more auction rate securities: “Let’s move these microwave ovens!!!” she said.

Well, if Wall Street considers its products like microwave ovens, then they deserve to be regulated as such.  Which is why I subscribe to the idea of a consumer protection agency for investors.  As Yale professor and predictor of the real estate bubble Robert Shiller suggests, the financial services industry should be “democratized.”  He recommends a consumer advocate akin to the Consumer Products Safety Commission to look after the little guy, ensure disclosures are prominent and clear, and perhaps most importantly identify inherent conflicts of interests.

I hear the cat calls…what about the SEC?  Isn’t that what they are there for?

The SEC was created in 1934 as a result of the stock market crash of 1929.  Given its performance since then, it’s only fitting that it should be replaced as the guardian of the individual investor in the midst of the greatest financial disaster since those dark days.

It’s also no coincidence that the phrase “white-collar crime” was coined during the Great Depression.  In the aftermath of every financial crisis, there are those that have paid the price for their roles.  This was true during the S&L crisis and the dot-com bubble. Similar fallout is justified today.

So a little comeuppance is in order for the Wall Street’s C-suite executives that either knowingly or unknowingly stuck their head in the sand while the American financial system was destroyed.  Lehman Brothers, for example, should not get a free pass for the rosy assessment of its balance sheet and for saying that short-seller David Einhorn’s comments about their valuations “had no basis in fact.”

Simply put, I’m not comfortable with the fact that financial services industry executives who have put the United States in grave danger should only have net-worths of $5 million instead of $500 million.  It would be one thing if these individuals put their own money at stake - something entrepreneurs should receive tax incentives for doing - but these people gambled with other people’s money and lost.

Its sometimes said that the best way to rob a bank is to own one.  Wall Street did that and much, much more.

Finally, there’s a lot of discussion about executive compensation on Wall Street.  You won’t get an argument from me that its out of control, but socializing incentives sets an awfully distressing precedent.  Rather, as I’ve advocated before, Wall Street should be compensated over prolonged periods during which time it can be assessed whether their performance had long-term benefit to shareholders.  Brokers and the mad-scientists behind the structured products movement would be measured according to how many customers filed arbitration cases.  Investment bankers would be held accountable for the client’s performance after an M&A transaction.  And CEOs would have to show sustained increases to shareholder’s equity.

These considerations arguably are only the beginning.  So again let’s ask ourselves, is the former CEO of Goldman Sachs who we want crafting the biggest financial bail-out in history?

Suing Your Broker Is Easier Said Than Done

Mr.Cuomo: ARS Investors Don’t Need a Spitzeresque Settlement

After learning that New York Attorney General Andrew Cuomo is set to bring charges against UBS related to their marketing of auction rate securities, I am of mixed emotions. On the one hand I am pleased that the scandal is resulting in complaints, but I am only cautiously optimistic that the charges and potential settlement will be in the investors’ best interest.

Don’t get me wrong, Mr. Cuomo’s action is certainly welcomed and clearly warranted. Auction rate securities were pitched to investors as cash equivalents and liquidity risks were hidden, which is why I was particularly pleased to see that Mr. Cuomo could file charges against individuals at UBS and seek a broad resolution for investors whose money is tied up in the ARS permafrost.

But a resolution is only as good as its terms and I have reservations that an eventual settlement won’t go far enough. Specifically, it is typical for Wall Street to settle these types of matters without admitting guilt or acknowledging responsibility. Wall Street steadfastly bargains for this because it limits their liability to investor claims. Recall that Eliot Spitzer’s global Wall Street settlement included this “out” clause and many investors lost arbitration claims because of it.

Another common occurrence during the Spitzer regime was Wall Street scapegoating. So long as Mr. Cuomo targets individuals, he should follow the trail as high as it leads and not allow Wall Street’s top brass to sacrifice a few bit players.

Moreover, a resolution that simply makes UBS customers “whole” also is a mistake. For many months ARS holders were prevented from participating in more lucrative investments and making large purchases, such as homes, automobiles and tuition payments. It is reasonable that they should be awarded damages for those lost opportunity costs. And finally, some investors are facing legal fees which should be paid for by UBS.

A UBS settlement could serve as a case study for other ARS investigations. Cuomo and other State securities regulators are investigating Citigroup, Merrill Lynch, J.P. Morgan Chase, Goldman Sachs, Wachovia and many other institutions for similar practices.

We’ve been through the era of headlines, photo-ops and slaps on the wrist. Mr. Cuomo has an opportunity to substantively alter the way in which Wall Street markets its products.

As I said, I am cautiously optimistic.

Senator Grassley and the SEC

It’s well known to anyone with experience representing individual investors that the SEC is shamefully ineffective when it comes to regulating the major brokerage firms. To wit: the SEC might have prevented the collapse of the auction rate securities market. The agency knew of extensive wrongdoing in the marketplace as far back as 2006, but instead of mandating a wholesale cleanup and imposing extensive fines, it chose to let Wall Street off with barely a wrist slap

It also can be argued that the SEC might have prevented the collapse of Bear Stearns. It’s publicly known that the SEC dropped an investigation of Bear’s valuations of collateralized debt obligations just months before the firm collapsed. We now know those valuations weren’t worth the paper they were printed on.

Sen. Charles Grassley, the ranking member of the Senate Finance Committee, admirably and justifiably wants to know why the SEC dropped its Bear investigation. But according to today’s Wall Street Journal, the SEC responded to the Senator as if he was just a reporter.

“The commission does not disclose the existence or nonexistence of an investigation or information generated in any investigation unless made a matter of public record in proceeding before the Commission or the courts,” the SEC responded in a letter.

It doesn’t take a rocket scientist to figure out what’s going on here. The SEC’s decision to close its Bear investigation represents yet another monumental agency failure. The agency knows full well that Congress will be outraged if the truth about its failure to protect investors becomes publicly known. Let’s hope that Senator Grassley is sufficiently outraged by the SEC’s response and continues to aggressively pursue this matter. The findings won’t be pretty, but maybe it will finally lead to some real – and much needed – regulatory reform.

Chairman Waxman’s CEO Compensation PR Stunt

Next month, Congress will be schlepping in the former chief executives of several financial services firms damaged by the subprime crisis to question them about their compensation packages. House Oversight and Government Reform Chairman Henry Waxman (D-Calif.) has sent letters to Angelo Mozilo, CEO of Countrywide Financial, Charles Price, former CEO of Citigroup and Stanley O’Neil, former CEO of Merrill Lynch. According to reports Chairman Waxman intends to ask them why they “stand to collect tens of millions of dollars in severance payments and other compensation,” even as their current and former companies are losing billions of dollars in the subprime mortgage meltdown.

It’s certainly understandable to perceive these golden parachutes as obscene. Mr. Mozilo is supposedly getting more than $110 million on top of the $47 million he got last year, while Countrywide Financial erased billions of dollars in shareholders equity. Mr. Prince is allegedly getting more than $29 million in “accumulated benefits” and supposedly even received a bonus for 2007. Mr. O’Neal walked away with more than $161 million in “accumulated benefits.” Citigroup and Merrill together have written down more than the GDP of most third world countries.

By any measure, paying these men hundreds of millions of dollars for their recent performance is not justified – which is exactly why Mr. Waxman is calling in the wrong people. It should instead be the corporate board members overseeing the compensation committees that should explain the payouts. Maybe executive compensation consultants hired by corporate boards should face questioning too, such as Hewitt Associates of Lincolnshire, Illinois, and Mercer Human Resources, which were involved in the decision to give Dick Grasso over $100 million. The ones who accepted authorized pay shouldn’t be flogged.

The individuals Chairman Waxman should have sent letters to include Harley Snyder, CEO of HSC, Inc., John Finnegan, Chief Executive Officer of The Chubb Corporation and Alan J.P. Belda, Chairman and CEO of Alcoa, who chaired the compensation committees of Countrywide, Merrill Lynch, and Citigroup, respectively. Hopefully not lost on Chairman Waxman would be the fact that all these men hold the title of CEO. In this elite fraternity, sometimes one hand washes the other. For example, Mr. O’Neil was just named to the board of Alcoa. It would of course be too obvious of a conflict for Mr. Prince to serve on Alcoa’s board, so Mr. Belda got the next best thing. The point is, those holding the power don’t have the motivation to change the status quo.

Chairman Waxman needs to get to the source of the problem which lies squarely with the board of directors and compensation committee members. Not holding them accountable is like patching a leaky roof with duct tape every time it rains. Unfortunately, without their presence next month’s hearings are the equivalent to nothing much more than a witch hunt wrapped-up in a PR stunt.

If Chairman Waxman was truly interested in relating compensation to performance, why stop at publicly held companies? He should call in sports stars like Alex Rodriguez, Carl Pavano, and Albert Belle, notoriously over-paid underperformers. I know what you’re thinking. Congress holding hearings with professional baseball players sounds ridiculous, doesn’t it?