Wednesday, November 30, 2011

Wall Street's Opacity Protection Team meets Judge Rakoff [update]

In a MarketWatch article, A new era of Wall Street transparency, U.S. District Judge Jed Rakoff takes on Wall Street's Opacity Protection Team.
In any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth. In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers,” the judge wrote. 
“Even in our nation, apologists for suppressing or obscuring the truth may always be found.
Judge Rakoff calls out Wall Street's Opacity Protection Team.
But the SEC, of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances.”
It is the SEC that was set up to ensure that market participants have access to all the useful, relevant information in an appropriate, timely manner so that the risk of any investment can be fully assessed prior to making the investment decision.
The SEC defended the settlement it reached with the bank....
In defending its actions, the SEC confirms the late Mark Pittman's observation that the regulators are members of Wall Street's Opacity Protection Team.
“The court’s criticism that the settlement does not require an ‘admission’ to wrongful conduct disregards the fact that obtaining disgorgement, monetary penalties, and mandatory business reforms may significantly outweigh the absence of an admission when that relief is obtained promptly and without the risks, delay, and resources required at trial....”

The SEC focuses on what is essentially a cost of doing business for a Wall Street firm.  It ignores the fact that the SEC had reached prior settlements with the bank that included mandatory business reforms that, if implemented, would have prevented the sale of the security which gave rise to the proposed settlement.

Rakoff’s ruling is likely to have far-reaching ramifications on Wall Street and at the SEC. 
The consent judgment settlement reached between Citi and the regulatory body, in which Citi had the ability to neither admit to any wrongdoing nor deny the allegations held against it, was a common one that the SEC typically reached with firms that it accused of wrongdoing.... 
The fact that this type of settlement is commonly used by the SEC does not mean that it is a good practice.

In fact, using it frequently makes this type of settlement look like the equivalent of a parking ticket.  As everyone knows, parking tickets are at best a nuisance and do not change people's behavior.
If Rakoff’s ruling proves to be popular in the public sphere, then it is possible that other judges might start scrutinizing settlements between the SEC and Wall Street firms more closely, and the SEC would also be compelled to be stricter in its discipline of firms who flout rules.
I can only hope that the ruling is extremely popular in the public sphere.

This ruling shows the degree of regulatory capture that has occurred at the SEC.  The SEC needs to be compelled to be stricter in its discipline of firms who flout its rules.
As Adam Sorensen of Time magazine notes: 
Rakoff’s ruling is one small dose of exactly what Wall Street’s critics have been hankering for. 
The conflict ... is basically over whether securitization fraud cases will get swept under the rug. 
And you’d be hard pressed to find a realistic outcome more appealing to protesters hoisting ‘Jail the Banksters’ signs in Zuccotti Park than a public fraud trial for a major Wall Street institution and a rebuke to what Occupiers see as an overly sympathetic federal government. 
Judge Rakoff just gave them both of those things.”
That being said, it is still unlikely that the facts of the Citi fraud case will be uncovered, even though a trial date of July 16, 2012 has been set.
Of course, Citi will just agree to pay a bigger fine for its parking ticket.  There is precedence for paying a bigger fine and that is why SEC settlements are simply a cost of doing business as opposed to being a tool to bring about changes in the conduct of business.
In 2009, the SEC sued Bank of America (NYSE:BAC) , claiming that the bank had lied to shareholders about bonuses paid out to Merrill Lynch executives when it sought approval to acquire the troubled firm. The agency reached a $33 million settlement, which Rakoff first rejected. However, the judge later relented and approved a $150 million settlement in February 2010, even though he said the agreement was “half-baked justice at best.” 
If history is to repeat itself, what will probably happen is that the SEC will increase the penalty Citi has to pay — perhaps an amount closer to the $550 million Goldman coughed up — and Rakoff will approve the new settlement. 
Then again, populist anger toward big banks has grown since the SEC-Bank of America settlement last year, as exemplified by the nationwide Occupy movement, and perhaps Rakoff, augmented by the pro-transparency public sentiment and a growing public profile as a take-no-nonsense judge, will insist on holding the SEC and Citi accountable to the public this time around.
Clearly, this is what it is going to take if Wall Street's Opacity Protection Team is ever going to be defeated.

Jesse Eisinger wrote an article in ProPublica that also addressed how Wall Street views fines from regulators.

I asked Richard Kramer, who used to work as a technology analyst at Goldman Sachs until he got fed up with how it did business and now runs his own firm, Arete Research, what was going wrong. He sees it as part of the business model. 
“There have been repeated fines and malfeasance at literally all the investment banks, but it doesn’t seem to affect their behavior much,” he said. “So I have to conclude it is part of strategy as simple cost/benefit analysis, that fines and legal costs are a small price to pay for the profits.”
Always nice to get confirmation of my analysis and the need for transparency as the solution.

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