Market Cop heading back to the station
Market Cop is joining the Post's uber-economics and financial blog, Political Economy, where you can find the latest updates on white collar crime and SEC-related affairs. Thanks for reading!
Are former Fed officials gaining access to secret information?
In its story about the problem of former Federal Reserve officials gaining access to secret market-moving information at the central bank, Reuters has found a really good solution:
Ben Bernanke should come out and give a press conference after each meeting of the Federal Open Markets Committee, which sets monetary policy.
The European Central Bank holds a press conference after its key meetings that gives its president, Jean-Claude Trichet, a chance to explain the reasoning behind its actions in a public forum.
"If Bernanke can't stop the leaks he ought to have a full press conference after the meeting. It's inappropriate for certain people to gain an advantage on information from the Fed," said Ernest Patrikis, a former No. 2 official at the Federal Reserve Bank of New York and now a partner at law firm White & Case.
The story notes how some former Fed officials, like former Fed governor Larry Meyer, are talking to people at the Fed about the confidential internal discussions leading up policy decisions. Then, Meyer and other former Fed officials (and other people who haven't worked at the central bank but are close to its officials) write notes to their clients summarizing what they found out. For this, they get paid millions.
Meyer and the Fed refused to talk to Reuters about the story.
But the situation is a bit more cloudy than it sounds. The Reuters story talks about how Meyer talked to folks at the Fed and summarized what he learned just nine days after one of the meetings. Official summaries aren't released for three weeks.
Reuters notes that five days after the Meyer memo, a Wall Street Journal reporter echoed many of the same ideas as did Meyer. Some reporters have access to Fed officials on the condition they can't be named. Fed officials talk to outsiders before making official pronouncements so they can brace the market.
In addition, it's hard to see how valuable the information gleaned would be. Sure, it can move markets, but in which way is often hard to know.
The Fed already is a pretty opaque place. As the setter of monetary policy and an important regulator, it needs to be careful not to let the perception that its former officials are looking to profit on their connections to the place, because that would raise big questions about what's motivating its current officials.
Will regulators challenge questionable pension accounting?
A pair of articles over the weekend raised serious concerns about the nation's public pensions. The Wall Street Journal explored how public pensions continue to assume they'll earn a nearly 8 percent return each year despite the volatility and poor performance of the past few years. And The New York Times looked at how states are using accounting techniques to generate immediate savings by cutting the pension benefits of future workers.
The question is whether federal regulators will take a stand against questionable pension practices. Their authority is limited; the purview of public pensions falls squarely in the discretion of state law.
But the SEC is attuned to the issue. Earlier this year, a specialized SEC enforcement unit based in Philadelphia began investigating potential wrongdoing involving pensions.
Last month, the agency charged New Jersey with civil fraud for lying in financial documents about whether it had covered its pension obligations to teachers and other state employees.
In an interview last month, Elaine C. Greenberg, chief of the municipal securities and public pensions unit, told me, "We have a concern that there could be other states and municipalities or local governments out there that are not adequately disclosing the extent of their pension fund liabilities."
There is a huge debate about how states account for their pensions. Many states use an accounting method that economists say seriously understate how much they'll have to pay out to pension recipients and what they already have covered.
The Pew Center for the States says pension funds nationwide are underfunded by more than a half-trillion dollars.
SEC employees win battle to dress casual
Some of the Securities and Exchange Commission's rank-and-file employees have won a quiet battle with top officials: They no longer have to wear formal business attire when out on the job.
Under former SEC chairman Christopher Cox, members of the agency's Office of Compliance Inspections and Examinations were required to wear formal business attire when they were in the field reviewing the operations of financial firms.
Almost 2,000 times a year, SEC examiners visit firm offices, examine paperwork, interview employees and analyze data to ensure that companies are complying with securities rules. Some exams are periodic and routine, while others are surprise probes.
After then-OCIE director Lori Richards imposed the requirement on staff in 2008, the union representing agency employees filed a grievance with the SEC arguing that they should not be required to wear formal attire. They wanted to wear the same attire as the employees who worked for firms they were examining, which was often more casual.
Only after months of negotiations, the arrival of SEC Chairman Mary Schapiro and the arrival of a new OCIE director did the agency agree to relax the requirement and permit examiners to wear attire matching that of people working for the firm under review.
"The business world has for many years been moving towards less rigid attire standards, and it didn't make sense for OCIE to refuse to acknowledge that reality," union attorney Ralph Talarico said in a summer newsletter. "I was gratified that we were able to reach a reasonable compromise on this issue for SEC examination staff."
Under the new attire rules, which appear to have taken effect late last year, SEC officials also can call ahead to a firm that is facing an examination and ask what people in the office wear, so that SEC examiners can dress to the same standard. (Of course, this doesn't include surprise exams where examiners simply show up on the doorstep of a firm.)
Says the SEC union newsletter:
When Charles II decreed in the 1660s that men must wear a coat, cravat and wig while at court, he probably did not know how far the "suit" concept would travel into the future. In the 1800s, Beau Brummel (pictured here) is often credited with establishing the tradition of the contemporary business suit.
Despite the longevity of Mr. Brummel's concept, business casual attire is today widely accepted as a neat, crisp look that is entirely appropriate in many contemporary business settings. Although it is a more relaxed and comfortable way to dress, it is still professional, neat and pulled together. It does not detract from the professionalism of the many individuals who dress in this fashion every day.
Grassley calls SEC response on alleged retaliation 'extremely disturbing'
A senior Senate Republican is calling into question the Securities and Exchange Commission's response to allegations that top officials in the Fort Worth office retaliated against employees who raised concerns about an agency examination program.
Sen. Charles Grassley (Iowa), the ranking Republican on the Senate Finance Committee, has asked for a briefing from top SEC officials about the treatment of two employees in the Fort Worth office. The senator wanted to know why that although the inspector general recommended the SEC take disciplinary action against the Fort Worth officials none had been taken.
In a letter to SEC Chairman Mary Schapiro, Grassley wrote: "These facts and circumstances are extremely disturbing and paint a picture of a culture at the SEC, which endorses retaliation against employees who attempt to improve operations by reporting mismanagement to headquarter."
The letter follows a pair of reports by the SEC inspector general and an article in The Washington Post about the problems at the Fort Worth office.
The Post article cites an SEC inspector general's report that concluded that two SEC employees, Julie Preuitt and Joel Sauer, faced "inappropriate" sanctions from their bosses in Fort Worth when they raised concerns about a new review process for financial firms.
Preuitt, who had warned presciently about a potential scam at R. Allen Stanford's Houston-based business, told superiors she was concerned that the office was more interested in boosting statistics about the number of firms the office examines rather than actually uncovering fraud.
According to inspector general reports and interviews, Preuitt was also essentially demoted after vocalizing her complaints.
Later, the program she opposed was suspended in favor of programs to verify assets claimed by investment companies in the wake of the large number of Ponzi schemes disclosed in the past two years.
Grassley tied to the agency's actions in Fort Worth to its broader desire to attract whistleblowers, who can provide regulators with inside information on wrongdoing.
"You have previously assured me that in leading the Securities and Exchange Commission (SEC/Commission), you intend to value whistleblowers and ensure that they are able to make protected disclosures in order to help managers improve operations at the Commission," Grassley said. "However, it appears that this commitment to valuing dissent within the Commission is not being fully implemented."
Grassley asked the SEC to explain why it had not disciplined the Fort Worth managers. The SEC responded:
[P]rior to imposing discipline, the senior-level Ft. Worth managers had solicited advice . . . from other Commission officials responsible for disciplinary actions. It has not been alleged, nor is there any reason to believe, any of the advising parties had reason to retaliate against the two employees. Because the actions were deemed appropriate and senior-level Ft. Worth managers relied on the guidance that was provided, management determined their actions were not retaliatory.
Grassley was not pleased with this response.
"The implication ... is that a retaliatory personnel action can be laundered of its retaliatory intent by simply consulting with others who had no retaliatory intent and obtaining their concurrence," he wrote. "Such a policy would make a mockery of whistleblower protections throughout government."
SEC votes to allow proxy access
The Securities and Exchange Commission voted 3 to 2 on Wednesday to make it easier for shareholders to nominate directors to sit on corporate boards, addressing concerns that boards often fail to conduct effective oversight of executives' decisions.
SEC Chairman Mary Schapiro and two Democratic commissioners voted to make it easier for investors -- or groups of investors -- who collectively own 3 percent of a firm's shares for three years to nominate directors for boards. The commission's two Republican members opposed the proposal.
Business groups argue that the costs of the proposal would be immense and that narrow interests, such as labor or environmental groups, could hijack the process.
Currently, shareholders can only nominate directors at annual meetings. But that is often too late because months earlier the company sends ballots to investors who won't be able to attend the annual meeting. These statements list candidates for the board, making it virtually impossible for a candidate first nominated at an annual meeting to receive enough votes to win a spot on the board.
The SEC's vote Wednesday will allow shareholders to nominate directors in the proxy statements. A shareholder or coalition of shareholders will be able to nominate one board member if the board has a total of seven or fewer members, or 25 percent of the total board size if it is larger.
"As a matter of fairness and accountability, long-term significant shareholders should have a means of nominating candidates to the boards of the companies that they own," Schapiro said.
SEC spins judge's words in defending Citigroup settlement
The SEC's argument to a federal judge about why she should approve the agency's proposed $75 million settlement with Citigroup goes something like this:
Another judge in another case with another bank said that judges should generally, but not always, defer to a regulator when it reaches a settlement with a company. Even if the settlement, as the judge called it in that particular case, was "half-baked justice" and "inadequate and misguided."
Judge Ellen S. Huvelle of U.S. District Court for the District of Columbia refused on Monday to accept the $75 million settlement between the SEC and Citi over allegations the bank hid nearly $40 billion in subprime exposure from investors. During a hearing, she asked a host of questions about the SEC's investigation into Citigroup and how the agency decided on the size of the penalty and on the individual executives who also face sanctions.
In withholding her approval, Huvelle was channeling Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York, who caused a lot of pain for the SEC late last year and early this year when he rejected a settlement the agency reached with Bank of America over allegations the bank hid important financial information from investors.
After the SEC added new charges, nearly quintupled the fine, provided voluminous additional documents to the judge and imposed additional sanctions, Rakoff reluctantly approved the settlement.
What's remarkable is that in trying to persuade Huvelle to endorse the Citi settlement, the SEC is embracing Rakoff's approval of the Bank of America settlement.
In a memorandum filed with Huvelle, the SEC cites Rakoff's approval order three times, more than any case it cites as precedent. But it leaves out the stinging words Rakoff used to describe the settlement.
For example, in its Citi memorandum, the SEC quotes Rakoff writing that "the law requires the Court to give substantial deference to the S.E.C. as the regulatory body having primary responsibility for policing the securities markets."
But it leaves out the passage that immediately preceded this comment: "So should the Court approve the proposed settlement as being fair, reasonable, adequate, and in the public interest? If the Court were deciding that question solely on the merits -- de novo, as the lawyers say -- the Court would reject the settlement as inadequate and misguided."
Also in the Citi memorandum, the SEC quotes Rakoff writing that "the Court would fail in its duty if it did not give considerable weight to the S.E.C.'s position."
But again, the SEC ignores the paragraph that came immediately before:
[T]he proposed settlement ... is far from ideal.... Its greatest defect it that it advocates very modest punitive, compensatory, and remedial measures that are neither directed at the specific individuals responsible for the nondisclosures nor appear likely to have more than a very modest impact on corporate practices or victim compensation. While better than nothing, this is half-baked justice at best.
And yet elsewhere in the SEC's Citi memorandum, the agency defends the $75 million settlement amount by comparing it to the court's approval of "a settlement that required Bank of America to pay a penalty of $150 million to be distributed to harmed shareholders in connection with proxy disclosure violations."
But once again, the agency leaves out Rakoff's opinion of the $150 million settlement:
The part of the proposed settlement that presents the greatest difficulty is, however, the penalty package, which essentially consists of a $150 million fine.... The amount of the fine appears paltry. An even more fundamental problem, however, is that a fine assessed against the Bank, taken by itself, penalizes the shareholders for what was, in effect if not in intent, a fraud by management on the shareholders.
In the end, perhaps the SEC would like Huvelle to channel Rakoff all the way, ultimately approving the Citi settlement -- but not before requiring of the agency months of pleading, new charges, additional fines and sanctions, and a much more thorough discussion of the investigative record.
Managing Wall Street banker compensation
In the years before the crisis, bank executives made millions in short-term profits even when those profits turned out to be fleeting and the risky decisions the executives made turned out to be disastrous.
What was worse, many of these decisions amounted to leveraged bets. The upside was unlimited -- but the risks were also multiplied many times over.
One of the most overlooked parts of the new financial reform law holds arguably the most promise for changing how Wall Street behaves -- but it also could be among the most controversial if regulators try to use their full powers to dictate banker pay. (Don't bet that they will.)
In most ways, when it comes to banker pay, the financial reform bill is rather modest. It doesn't impose specific caps like those that faced some banks that received extraordinary financial aid from taxpayers. Specific requirements in the law include better disclosures about pay and more oversight by the boards of directors of banks.
But the secret weapon may be a requirement that regulators, within nine months, write rules for banks and other financial institutions that would prohibit pay structures that encourage excessive risk-taking.
If regulators are aggressive about this, their decisions about how pay on Wall Street should work could have as powerful an effect as any other new regulation contained in the financial reform law. That's because they'll be managing the incentives that bankers face in making decisions about risk. If they can better manage these incentives, they'll be striking at the human core of the financial system -- what motivates individuals to make choices about where capital should flow.
Recently, a number of noted scholars on compensation issues have been advocating a new approach to pay. Historically, the basis for incentive pay has been stock performance. In this model, a financial executive's pay, in the short term and long term, is linked to his or her company's stock price. In that sense, an executive's livelihood is linked to that of shareholders.
But as we learned in the financial crisis, a much broader category of stakeholders in a large financial firm are just as important to think about in designing pay structures. That includes preferred shareholders; bondholders; depositors; and even the government as guarantor.
To better represent this broad range of stakeholders, Alex Edmans and Qi Liu of the Wharton School at the University of Pennsylvania recommend that banker pay be tied to bonds as well as to equity.
We start with a model in which the CEO chooses between a risky and a safe project. The risky project can sometimes create value (e.g. investing in R&D) but sometimes destroy value (e.g. diversification from one's core business into derivatives trading, as with Enron and AIG). A CEO who holds only equity will take the risky project even when it destroys value because, if he gets lucky and it pays off, his equity will soar, but if it fails, it's bondholders who suffer most of the losses (as in the recent crisis). Equity holders' losses are capped by limited liability -- thus, if the firm is already close to bankruptcy and equity is close to zero, things can't get any worse and so the manager may "gamble for resurrection", taking riskier and riskier projects to try to salvage the firm. ... If the firm goes bankrupt, he loses his bonus regardless of whether creditors recover 80c in the dollar or 10c in the dollar. ...
Lucian Bebchuk, an adviser to the Treasury on compensation issues, argues for a similar model. But he advises that pay should be linked to the value of a bank's credit default swaps -- which indicate a probability that a bank will go bust.
Rather than tying executive pay to a specified percentage of the value of the bank's common shares, compensation could be tied to a specified percentage of the aggregate value of the bank's common shares, preferred shares, and all the outstanding bonds issued by the bank. Because such a compensation structure would expose executives to a broader share of the negative consequences of risks taken, it would reduce their incentives to take excessive risks.
Nevertheless, while such a compensation structure would lead executives to internalize the interests of preferred shareholders and bondholders, thereby improving incentives, it would be insufficient to induce executives to internalize fully the interests of the government as the guarantor of deposits. To do so, executive payoffs could be made dependent on changes in the value of the banks' credit-default swaps, which reflect the probability that the bank will not have sufficient capital to meet its full obligations.
In the end, these models, for all their intricacy, would achieve something simple: They'd make compensation less volatile. There would be less upside but also less downside. And that will probably mean less risk-taking and less innovation, but less danger of a serious financial crisis.
SEC enforcement division gets to keep its subpoena power
The SEC's enforcement division will get to keep its power to subpoena.
Earlier today, I noted that today was the last day of a one-year trial in which the enforcement division was given the power to issue subpoenas directly.
Until then, investigators had to come before the agency's commissioners to request permission to file subpoenas, a process that was widely viewed as a hindrance to conducting swift probes into financial wrongdoing.
An SEC spokesman didn't get immediately back to me. But a new rule was posted on the SEC Web site indicating that enforcement division would hold on to the power. As a result, the enforcement director and several deputies can issue subpoenas as part of investigations into financial wrongdoing:
The Commission has determined that it is appropriate to extend the Division's authority to issue formal orders of investigation. In making this determination, the Commission considered the increased efficiency in the Division's conduct of its investigations permitted by the delegation, and the Division's continued effective communication and coordination in addressing pertinent legal and policy issues with other Commission Divisions and Offices when formal order authority is invoked.
Is the SEC enforcement division about to lose subpoena power?
To great fanfare, SEC Chairman Mary Schapiro last year gave the authority to issue subpoenas directly to the agency's enforcement division.
Until then, investigators had to come before the agency's commissioners to request permission to file subpoenas, a process that was widely viewed as a hindrance to conducting swift probes into financial wrongdoing.
But little noticed at the time was that this grant of power came with an expiration date:
Aug. 11, 2010 - or today.
So says the federal rule: "These orders designate the enforcement staff authorized to issue subpoenas in connection with investigations under the federal securities laws. This action is intended to expedite the investigative process by removing the need for enforcement staff to seek Commission approval prior to performing routine functions. The Commission is adopting this delegation for a one-year period, and at the end of the period will evaluate whether to extend the delegation (though any formal orders issued during this period will remain in effect)."
UPDATED, 2:15 p.m.: As of 2:50, an SEC spokesman didn't get back to me. But the SEC posted a new rule indicating that the enforcement division will hold to this power.
There's little question that grant of subpoena power has at least temporarily boosted the number of cases in which subpoenas are being issued. (Technically, the enforcement division director (or anyone he deputizes) was given the power to issue formal orders of investigation, which allow for the filing of subpoenas. Until then, all investigations are informal and parties don't have to respond to SEC inquiries.)
For instance, as of late March, the commission has issued more than twice as many formal orders (496 to 223) in fiscal year 2009 as in fiscal year 2008.
But there are lingering questions. Has the enforcement staff run investigations better as a result of the subpoena power? Have commissioners stayed informed and closely monitored investigations in which subpoenas are issued? Are investigators issuing subpoenas prematurely just because of the ease of doing so?
King & Spalding lawyer Russell G. Ryan described some of his concerns with the new subpoena power in a post last year.