Financial Crisis Symposium: A Progressive Analysis

I would like to thank my colleagues here at the Corporate Justice Blog for an absolutely wonderful conference at the University of Utah S.J. Quinney College of Law entitled, Financial Crisis Symposium that offered a progressive exploration of the cause of the current financial crisis.

Unfortunately due to a prior family obligation, I was unable to physically attend. However, I did watch the conference via web stream and participated via email. The marvels of modern technology truly are a wonderful thing.

The morning panel consisting of Professors Cheryl Wade, Steven Ramirez, Regina Burch and moderated by Todd J. Clark was absolutely superb. I was intrigued that each of the morning panelist thought that Sarbanes-Oxley (SOX) has been a failure. I believe that SOX is a powerful piece of legislation that has been under-utilized and watered-down by the incessant lobbying that the “cost” of SOX compliance outweighs the “benefit” of SOX compliance. As a result, the application of SOX has not done the job that it was designed to do. I suppose then in that respect I would agree that SOX has failed to keep the proverbial barbarians at the gate from storming the citadel and has left the investing public and average Americans to the tender mercy of American corporate hospitality.

The afternoon panel consisting of Professors Timothy A. Canova, andré douglas pond cummings, Joseph Grant, Christian Johnson and moderated by Jena Martin-Amerson was equally superb. Professors Canova, cummings, and Grant each provided a unique perspective as to how the Financial Modernization Act of 1999, also known as the "Gramm-Leach-Bliley Act," opened the door and set the stage for the current financial crisis. Deregulation of the financial services sector was lauded as necessary to provide synergy and to maintain American corporate competitiveness. The reality has been that the Financial Modernization Act of 1999, weakened the authority of the American central bank, the Federal Reserve, weakened the ability of the federal regulators to regulate the markets and left the American public unprotected from corporate mismanagement, greed, and fraud.

On behalf of the viewing public, thank you for a job well done.

Lydie Nadia Cabrera Pierre-Louis
St. Thomas University School of Law

Inspector General Issues Madoff Report: SEC Criticized For Investigatory Failure

Recently, the Office of Inspector General (“OIG”) issued a Report of Investigation into the Securities and Exchange Commission (“SEC”) failure to investigate and uncover Bernard Madoff’s Ponzi scheme. The Report finds that no SEC personal had any financial or other inappropriate relationship that hindered their investigatory duties. However, the Report openly criticizes the SEC for failing to adequately investigate six (6) separate substantive complaints that should have raised red flags concerning Madoff’s operation. Additionally, the OIG’s Report indicates that the SEC further ignored two (2) published articles that should have called Madoff’s operations into question.

The Report notes:

“The OIG investigation did find, however, that the SEC received more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation of Bernard Madoff and BMIS for operating a Ponzi scheme, and that despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed. The OIG found that between June 1992 and December 2008 when Madoff confessed, the SEC received six…substantive complaints that raised significant red flags concerning Madoff’s hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading. Finally, the SEC was also aware of two articles regarding Madoff’s investment operations that appeared in reputable publications in 2001 and questioned Madoff’s unusually consistent returns.”

In face of all the red flags, the SEC clearly failed in its role as securities industry watchdog. The Madoff Report is interesting reading, and well worth the time and effort. At the end of the day, the OIG's Report chronicles how the SEC botched the investigation of Madoff, and postponed his day of atonement some sixteen (16) years.

Hopefully, the SEC has learned some valuable, albeit embarrassing lessons, that it won’t soon repeat. The lesson learned: Regulators don’t fall asleep on your watch the general public is relying upon you to do your job. To err is human. We all make mistakes. However, this has been one of the costliest mistakes resulting from a failure of oversight that we will hopefully see for some time to come.

On Piercing the Corporate Veil

First off, I must thank my colleagues here at the Corporate Justice Blog for inviting me to guest-post here. It's a privilege.

This week, I taught my Business Associations students about piercing the corporate veil. Among the cases we covered is one of the classics (and one of my favorites), Baatz v. Arrow Bar. In this South Dakota case, a husband and wife injured in an accident with a drunk, uninsured motorcyclist sue the corporation that owns the bar at which the motorcyclist was served (asserting dram shop liability under an applicable statute) and also sue the shareholders of the corporation on a veil piercing theory. The shareholders and their daughter (who is the manager of the bar) move for summary judgment and it is granted. So the case against them is dismissed, and the decision is affirmed on appeal.

Some students do not like the result in this case. In particular, they point to the thin capitalization of the corporation with loans (which the court finds is not dispositive in the veil-piercing analysis), the failure of the corporation to buy insurance, and the fact that the daughter of the owners was the bar manager. Of course, these students are very sympathetic to the plaintiffs' plight--an uninsured (and likely judgment-proof) motorist and a corporation with limited wherewithal are the only other potentially responsible parties.

I fear that true middle age has set in (if the shoe fits . . . ) given my commentary on the case this year. I found myself saying something akin to the following: if you don't like the result in this case (as to the dismissal of the case against the shareholders), then maybe you don't like the corporate form altogether. My thought was directed mostly at those who rely on the undercapitalization argument for veil piercing. Here (in my view), the shareholders were not using the corporate form to commit fraud or other wrongful conduct or injustice. (The dissent apparently disagrees, when it characterizes the individual plaintiffs actions as fraudulent and states: "As a result of this holding, the message is now clear: Incorporate, mortgage the assets of a liquor corporation to your friendly banker, and proceed with carefree entrepreneuring.") However, the shareholders' capitalization of the entity was not egregiously low, in any case. (In fact, Internet searches reveal that, although the couple who originally owned Arrow Bar are both deceased, the bar continues to be operated by their daughter.) In essence, state legislatures allow individuals to use corporations in just this way, to shield themselves from personal liability for the obligations of the business, whether in contract or tort or under a statutory law. Those same state legislatures could mandate and enforce minimum capital requirements (and in fact they used to do so). So, our problem--if we don't like the veil-piercing result in Baatz--is with the corporation, an easy target in the new millennium.

Or is it? Perhaps the more essential and direct problem with the result in the Baatz case is that businesses selling alcohol in South Dakota, at least at that time, were neither required to maintain a minimum capital nor maintain a minimum amount of dram shop insurance. Since bars are required to be licensed to sell alcohol (through the liquor permitting process), it would seem that there is an easy way to enforce these types of requirements without changing or eviscerating corporate law or the corporate form. This type of solution would give the plaintiffs in Baatz the possibility of some relief for their injuries while, at the same time, preserving the corporate form as an engine of commerce.

I welcome your further thoughts . . . .

Guest Bloggers

We are pleased to confirm that respected and gifted corporate law experts Joan MacLeod Heminway and Z. Jill Barclift have accepted invitations to provide commentary as guest bloggers on the Corporate Justice Blog.




We look forward to reading and interacting with each of their insights and commentaries in coming weeks.

The Financial Crisis Symposium

The University of Utah S.J. Quinney College of Law will host a progressive exploration into the financial crisis today, Friday, September 25th, beginning at 9:00 a.m. mountain standard time (11:00 a.m. eastern standard time).

The webstream with live chat capability will begin at 9:00 a.m. here:

http://dashboard.law.utah.edu/financialcrisis/

We encourage participation and commentary. E.mail questions will be taken from webstream participants via the chat capability.

The Financial Crisis: Regulatory and Corporate Governance Critiques and Reforms

The University of Utah S.J. Quinney College of Law will hold a symposium tomorrow, Friday, September 25, 2009, that will explore the current state of the economy and examine the financial crisis one year after it landed like a financial “tsunami” (Alan Greenspan’s word). This symposium will explore the root causes of the crisis and will examine the Obama administration responses to it. In addition, panelists will discuss the proposed regulations being considered currently by congress to assess whether appropriate steps are being taken to stave off a similar debacle in the future. one of the key discussions that will take place will focus on diversity in the corporate boardroom.

The conference webpage is here: http://today.law.utah.edu/2009/09/financialcrisis/

The e.mail invite is here: http://dashdev.law.utah.edu/financialcrisis/email/

The webstream (which will commence at 9:00 a.m. mountain standard time (11:00 a.m.est)) can be accessed here: http://dashboard.law.utah.edu/financialcrisis/

We encourage participation from those in attendance and individuals watching the webstream. Questions will be taken via e.mail from folks participating in the webstream. Diverse viewpoints are welcomed and encouraged.

The event poster and schedule appear below:

A New World Financial Order: G-20 Leaders Discuss International Regulation

On Thursday, the world leaders from the 20 most powerful countries (G-20) will gather in Pittsburgh, PA to discuss the matters affecting their respective countries. On the top of every leader’s list is financial regulation. Many are concerned that despite the harsh realities of failing economies, concrete reforms are likely to remain a distant prospect, primarily because the G-20 has no law-making power. EU Ambassador to the United States John Bruton stated that "G-20s don't make the detailed decisions ... But they can create the conditions…. for reforms.” However, any real reform will have to be drafted, adopted, and implemented by national authorities not the G-20.

President Obama and the leaders of Britain, Germany and France are expected to try to reignite the fervor of a year ago to regain momentum for international financial reform by raising the sensitive issue of executive compensation. There is recommendation that executive bonuses should be linked to the long-term performance of investment decisions and the financial condition of banks’ balance sheets to discourage short-term risk taking. Ambassador Bruton stated that “[t]here is a high level of anger in Europe about the fact that the remuneration packages have been designed to emphasize short-term returns." G-20 leaders will also recommend comprehensive regulation of the over-the-counter (OTC) derivatives markets, hedge funds, credit rating agencies and debt securitization.

When Lehman Brothers collapsed in September 2008, freezing world capital markets, the G-20 leaders were galvanized around one single point-- tighter financial regulation. Now its been a year later, economies are stabilizing with the help of their respective governments, markets are rebounding – in the U.S. the Dow Jones industrial average, is up approximately 50 percent since February – there is a light at the end of the tunnel (and it is not the proverbial train). The G-20 leaders have less of an impetus to “create the conditions” for international financial regulation reform.

The reality is to introduce tough new capital requirements for banks, at this time, may actually harm banks’ balance sheets because governments want banks to lend more to help spur economic recovery. Stephen Green, chairman of the British Bankers' Association and HSBC bank, wrote in a letter to British Prime Minister Gordon Brown that "[t]he simple fact remains that financial institutions cannot take steps to further increase the amount of capital they hold and at the same time lend that capital to businesses and consumers."

Debates on details and timing for reform are growing heated. The Financial Stability Board (FSB), the G-20's policy coordinating arm, last week cited "challenges in maintaining an appropriate balance and pace of regulatory reform." Europe is suspicious about a U.S. push for banks to adopt a leverage ratio. There is a worry in Europe that adopting a leverage ratio that goes beyond being just a "backstop" to Basel II would undermine the Basel rules. There is still no consensus on how to define a leverage ratio or what assets should be included.

Many nations have already pledged to take new steps to strengthen regulation of the global financial system. However, the continental Europeans and the United States have stressed different elements of reform. The European Union is pushing for restrictions on bankers' pay in order to eliminate what they see as perverse incentives that encouraged irresponsible risk-taking. The United States has put more emphasis on forcing banks to raise the quality and quantity of capital they have on hand to cover potential losses in an effort to better protect taxpayers from having to pay for banks' mistakes. Joe Engelhard, policy analyst at investment research firm Capital Alpha Partners stated that the G-20 might produce a consensus on capital standards, but it will take much longer to settle on "the exact levels of the new capital and leverage ratios and even longer to agree to the new liquidity regime."

The G-20 members are working on a framework for regulatory reform with firmer deadlines. Ultimately, though, it is up to national legislatures to follow through. The U.S. Congress is working on a proposal to overhaul financial regulation.

Lydie Nadia Cabrera Pierre-Louis
St. Thomas University School of Law

Subprime Bailouts and the Predator State

I finally finished "Subprime Bailouts and the Predator State," and posted it on SSRN. The conclusion will not surprise any visitors to this blog. The abstract sums it up:

Recent bailouts in response to the subprime crisis evince an ad hoc government response that benefited general unsecured creditors and managers within the financial sector, while inflicting great loss upon taxpayers. The bailouts violated notions of the rule of law and sound macroeconomic science. In fact, the bailouts were followed by restricted lending and capital hoarding. This paper argues that such bailouts should be powerfully discouraged by imposing a legal framework including civil, criminal and administrative sanctions designed to discourage CEOs and other senior managers from flirting with too-big-to-fail status. Specifically, such managers would face near-automatic termination, discharge of employment agreements, the loss of protections under the Private Securities Litigation Reform Act, civil fines for causing losses to TBTF firms through unsafe and unsound practices, criminal sanctions for recklessly causing a loss to TBTF firms, and the prospect of administratively ordered prudential divestitures of operating units when a regulator identifies a firm as being TBTF. The goal is to eliminate the attractiveness of TBTF and thereby avert the huge costs implicit in TBTF. This should assure that bailouts are not a function of political power rather than sound economic science.

The only comment to add here is this: the resources at stake with this issue are mind boggling. We are talking trillions. It is hard to imagine how much “trillions” really is. If things go well the entire fiasco will cost a mere $1 trillion. But the collateral damage to the economy is at least that much. Frankly, I predict the final tally will be closer to $10 trillion than $2 trillion. Assuming the conservative guess of $2 trillion: that is still $6000 for every man, woman and child in the US. So, for a family of four think $24,000 if we are lucky. The next time anyone suggests this nation cannot afford social justice (from reparations to universal health care to better education) it will be because of these obscene bailouts.

And, now the Obama Administration seeks to codify the Bush/Paulson approach, with relatively minor modifications. The perverse incentives from this approach will cost even more in the future.

PROFESSOR STEVEN A. RAMIREZ

LOYOLA UNIVERSITY CHICAGO

SEC V. BANK OF AMERICA: JUDGE RAKOFF HAS NO RUBBER STAMP

On September 14, 2009, a phenomenal and extraordinary thing happened: A judge took a courageous stand in the face of enormous pressure, deciding to reject a proposed settlement, and looked out for and vindicated the rights of shareholders and taxpayers alike. Generally, where parties to a civil lawsuit agree to a mutual settlement, in most cases, judges merely rubber stamp those settlement agreements and dismiss the case and move on to the next cases on their overwhelming dockets.

On August 3, 2009, the Securities and Exchange Commission (“SEC”) filed a civil complaint against Bank of America in the United States District Court for the Southern District of New York. The Complaint alleged that Bank of America materially lied to its shareholders in a November 3, 2008 proxy statement that solicited the shareholders’ approval of the $50 billion acquisition of Merrill Lynch & Co. (“Merrill”). In essence, the Complaint alleges that Bank of America lied to shareholders by representing that Merrill had agreed not to pay year-end performance bonuses and other discretionary incentive compensation to executives prior to closing the agreed upon merger between Bank of America and Merrill without Bank of America’s consent. Indeed, bonuses and other discretionary compensation payments were made that amounted to $5.8 billion, or nearly 12% of the total consideration exchanged in the merger.

Interestingly, however, on the very same day that the SEC’s Complaint was filed, the SEC and Bank of America sought the Court’s approval of a proposed final Consent Judgment. Under the Consent Judgment, Bank of America would not admit or deny the allegations in the Complaint, would be enjoined from making future false statements in proxy solicitations, and would pay the SEC a fine of $33 million. Again, when parties reach an amicable solution to their problems courts defer to the parties’ judgment in most cases. NOT THIS TIME!!! Judge Jed Rakoff said no way. In his September 14, 2009 Memorandum Order he rejected the proposed SEC and Bank of America settlement as neither fair, reasonable, nor adequate. Judge Rakoff’s well-reasoned and considerate Order speaks volumes. Judge Rakoff observed: “In other words, the parties were proposing that the management of Bank of America – having allegedly hidden from the Bank’s shareholders that as much as $5.8 billion of their money would be given as bonuses to the executives of Merrill who had run that company nearly into bankruptcy – would now settle the legal consequences of their lying by paying the S.E.C. $33 million more of their shareholders’ money...This proposal to have the victims of the violation pay an additional penalty for their own victimization was enough to give the Court pause.”

What about vigorous enforcement? Judge Rakoff pointed out that “…the parties’ submission, when carefully read, leave the distinct impression that the proposed Consent Judgment was a contrivance designed to provide the S.E.C. with the façade of enforcement and the management of the Bank with a quick resolution of an embarrassing inquiry – all at the expense of the sole alleged victims, the shareholders.” Judge Rakoff’s clear displeasure with the SEC’s role as regulatory enforcer did not stop here. Later in his Order, Judge Rakoff observes:

“Oscar Wilde once famously said that a cynic is someone “who knows the price of everything and the value of nothing.” Oscar Wilde, Lady Windermere’s Fan (1892). The proposed
Consent Judgment in this case suggests a rather cynical relationship between the parties: the
S.E.C. gets to claim that it is exposing wrongdoing on the part of the Bank of America in a
high-profile merger; the Bank’s management gets to claim that they have been coerced into
an onerous settlement by overzealous regulators. And all this is done at the expense, not only
of the shareholders, but also of the truth.”

Did the SEC really pursue the most culpable parties and players in the Bank of America case? No. Interestingly, the SEC chose not to pursue the lawyers and executives at Bank of America responsible for the misrepresentations about Merrill it found offensive in the Bank of America proxy statement. Judge Rakoff’s Order assesses the “advice of counsel” defense and the issue of waiver. It is troubling that the SEC decided to take a pass at pursuing the parties most responsible (i.e. Bank of America’s lawyers and executives).

Judge Rakoff was particularly troubled by Bank of America’s acceptance of TARP funds. Judge Rakoff noted: “Undoubtedly, the decision to spend this money was made even easier by the fact that the U.S. Government provided the Bank of America with a $40 billion or so “bail out,” of which $20 billion came after the merger…To say, as the Bank now does, that the $33 million does not come directly from U.S. funds is simply to ignore the overall economics of the Bank’s situation.” In Judge Rakoff’s mind Bank of America’s initial agreement and willingness to enter into a $33 million settlement constitutes corporate waste.

This is a case that might set a new regulatory tone for the SEC. Further, corporations might now take pulse when trying to quickly settle a matter and make it go away by dangling money in the face of regulatory enforcers. At any rate, I applaud Judge Rakoff for having the courage to call out the questionable regulatory and litigation tactics employed by the SEC, and the actions of Bank of America in connection with the Merrill merger. Finally, shareholders have found a defender and champion in the form of Judge Rakoff. Judge Rakoff shows us courageously that there are no rubber stamps in his courtroom. I think that years from now we will look back at this as a watershed moment when the balance of power began to shift back in the direction of shareholders. Additionally, the earnestness and enforcement vigor of the SEC will be under intense scrutiny moving forward. Only time will tell what impact this case has on the legal landscape.

Economic Recovery?

With the recent announcement of the Disney/Marvel acquisition and the unsolicited bid by Kraft Foods for Cadbury, it appears the the Mergers and Acquisitions market is finding new footing. Financial periodicals are trumpeting this new acquisition activity as a sign that the broader global markets are recovering and that the near economic meltdown precipitated by the Lehman Brothers-Bear Stears-AIG debacle are becoming distant memories. While the $4 billion Disney acquisition of Marvel and the potential $16.7 billion coupling of Kraft Foods and Cadbury are heartening economic signs, the White House worries whether we are forgetting too soon the financial industry failures that precipitated the still lingering unemployment figures and decimated retirement accounts affecting millions of Americans.

This week, President Obama called together the "captains of industry" to sternly remind them that new regulatory systems need to be implemented in order to protect against recurrence and potential break down of the financial system in the United States. As financial titans return to profitability, President Obama warned:

"'It is neither right nor responsible after you've recovered with the help of your government to shirk your obligation to the goal of wider recovery, a more stable system, and a more broadly shared prosperity,' Obama said in a stern bid to boost his regulation proposals.

The president's speech reflected public sentiment that taxpayers were immeasurably harmed from last year's financial collapse — and that, barring change, it could happen again. As investment giants return to profit, millions of Americans are still coping with unemployment, home foreclosures and retirement portfolios that got washed away in the storm."

Some fear that, as reported by the Wall Street Journal, the impetus for regulatory overhaul has dissipated as the economy churns forward. Lobbyists in Washington, D.C. are now fully engaged in fighting against new regulation as the environment for radical overhaul has waned. As discussed on this blog previously, the Obama administration seeks wide ranging reform, including vast oversight being situated within the Federal Reserve.

President Obama chose the one-year anniversary of the collapse of Lehman Brothers to remind America and its financial leaders, that the time for relaxing and a return to status quo was inappropriate. President Obama reminded:

"'Unfortunately, there are some in the financial industry who are misreading this moment,' Obama told a quiet audience of leaders from the investment sector. 'So I want them to hear my words,' Obama said. 'We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis. ... Those on Wall Street cannot resume taking risks without regard for consequences.'"

The next several months will prove crucial as Congress debates and the White House urges regulatory overhaul of the U.S. financial system. If the recent judicial slap down of the Securities and Exchange Commission is any indication (rejecting the SEC/Bank of America settlement) then plenty of fire remains in the belly of some who continue to be sick and tired of financial sector excess and reckless disregard.

- andré douglas pond cummings
University of Utah S.J. Quinney College of Law

Remembering Lehman on the First Anniversary of Its Collapse: Part II

Lehman Brothers’ collapse exactly one year ago, on Sept. 15, 2008, ignited a massive contraction in the $3.6 trillion money market industry, which provides short-term loans often referred to as commercial paper, used by businesses worldwide to cover everyday expenses, including payroll and utilities. The panic left companies such as Goodyear Tire & Rubber Co., whose operations are a long way from Wall Street stranded with insufficient cash and ravaged the investment accounts of millions of unsuspecting average Americans.

Everyone knew that Lehman was too big to fail without dire consequences. Tim Geithner, Treasury Secretary, recently said in an interview with Fortune that regulators expected bad things from Lehman’s collapse, but things proved even worse than they expected. When Lehman filed for bankruptcy its commercial paper was transferred to the Reserve Primary Fund. As result, Reserve Primary Fund became the first big money-market mutual fund to have its net asset value fall below $1 per share. It was the first time in history that a money market mutual fund opened with less than $1 per share net asset value. The event scared millions of average investors and prompted the U.S. government to guarantee money fund accounts to avoid a deposit run that could have destroyed short-term financial markets. The U.S. government has been keeping the American financial system functioning every since because companies that were too big to fail, did fail.

Wall Street was aware that the unregulated subprime mortgage lending business and the securitization of such inferior loans into investment vehicles such as collateralized debt obligations (CDOs) had pushed the financial system to the breaking point. What the Wall Street bankers failed to calculate was that short term borrowing would be literally frozen and would throw the global economy into a tailspin. The failure of Wall Street bankers and regulators to understand the importance of commercial paper and how that market would be negatively affected by Lehman’s collapse was critical because its aftershocks came closest to destroying the world economy. The run on money market funds, considered the safest investments after bank deposits, and also the principal buyers of commercial paper, sent shockwaves through the global economy. World stock markets lost $2.85 trillion, or more than 6 percent of their value, within three days of Lehman’s bankruptcy filing. Worldwide the cost of banks borrowing overnight funds from other banks, as measured by the London Interbank Offered Rate, or LIBOR, jumped 4.29 percentage points between Friday, Sept. 12, 2008 and Tuesday, Sept. 16, 2008. “We did not expect how the Lehman Brothers' bankruptcy would transmit through the commercial paper market and cause all the stress in the money funds,” said David Nason, a former assistant Treasury secretary for financial institutions under Treasury Secretary Paulson.

The financial chieftains inclusive of Goldman Sachs and JP Morgan Chase tried desperately to unwind their derivatives trades and keep bank-to-bank loans flowing, but they ignored the commercial paper market, the lifeblood of the economy. It was an oversight that would flat-line the American economy. Within a week of Lehman’s bankruptcy filing, the U.S. government stepped in to halt withdrawals from money market funds and provided a $1.6 trillion backstop for the commercial paper market. With these first defensive measures, the U.S. government became committed to strengthening the American financial industry regardless of the cost. “They put the entire financial system at risk, and they didn’t have to,” said Harvey R. Miller, a partner at Weil Gotshal & Manges LLP in New York who represented Lehman in the bankruptcy. Miller stated that “[government officials] were warned. I told them, ‘Armageddon is coming. You don’t know what the consequences will be.’ Their response was, ‘We have it covered.’” Lehman’s problems stemmed from borrowing too much to finance too many hard-to-sell investments, such as mortgage-backed securities, that were rapidly declining in value as a result of the deteriorating real estate market. Lehman was different because the U.S. government let it declare bankruptcy rather than bail Lehman out, as it had bailed out Bear Stearns, Merrill Lynch and Long-Term Capital Management because no one, not even the U.S. government, wanted to be responsible for Lehman’s undeterminable losses, which could tally into the millions or even billions. As a result, Lehman’s creditors were wiped out as well as its stockholders and the aftershocks are still reverberating in the world economy.

On the one year anniversary of Lehman’s collapse, "policymakers haven’t learned the key lesson of Lehman’s collapse," said Richard Bernstein, CEO of Richard Bernstein Capital Management LLC in New York and former chief investment strategist for Merrill Lynch. Bernstein added “[by] designating certain institutions as too big to fail, and not having a thorough regulatory process to match, practically invites another catastrophe.” Perhaps the U.S. government should consider breaking up financial behemoths such as Bank of America Corp. and Citigroup Inc., or limit their expansion, instead the U.S. government has given them billions of dollars in tax incentives and loan guarantees that enabled them to grow even bigger and have created a factual predicate were it could all fall apart, again.

Lydie Nadia Cabrera Pierre-Louis
St. Thomas University

Priorities, Incivility, Corporate Justice, Race and Joe Wilson

In what is becoming an infamous moment, South Carolina Representative Joseph Wilson blurted out "You Lie!" during President Barack Obama's live televised message to a joint session of Congress on Wednesday evening, September 9, 2009. President Obama was passionately urging Congress to reform health care in the United States and end business as usual in connection with America's broken health care system. While Representative Wilson's outburst has been roundly condemned by both Democrats and Republicans, and while Wilson has apologized for his outrageous act of incivility, much deeper issues underly this unprecedented outburst.

First, as has been discussed on this blog previously, the effort to reform health care in the United States has stoked amazing incivility and premeditated outrage in town hall meetings across the country. Radically false and irresponsible attacks (i.e., death panels, nazi germany, government takeover, etc.) have been levied against those promoting reform.
Representative Wilson's outburst fits neatly into this tactic of incivility and the seemingly preferred course of misinformation, outrage and shouting, over reasoned debate and open discussion. This outrage, fanned by corporate interests, is particularly mystifying to me.

Perhaps the mystery can be explained by the priorities of those that either are truly outraged or those that simply feign outrage. Some that decry reforming health care because it will add to the federal deficit and that reform simply cannot be paid for are those same individuals that voted repeatedly to fund a war and cut taxes during the Bush administration. The Obama administration inherited unprecedented federal deficit levels based primarily on less revenue being collected (tax cuts) and increased spending (war costs in Iraq).

In an extraordinarily honest moment, the Wall Street Journal admitted as much:

"We've never fretted over budget deficits, at least if they finance tax cuts to promote growth or spending to win a war. But these deficit estimates are driven entirely by more domestic spending and already assume huge new tax increases." -- Wall Street Journal, August 26, 2009.

Government deficits are fine, according to the Wall Street Journal, if they fund the right economic priorities. Clearly, tax cuts and war spending are fine, deficits be damned. Just as clearly, domestic spending is not fine, particularly if it seeks to insure all Americans. Critics of health care reform that decry new spending are the same stewards that approved unprecedented federal government deficits so long as they funded tax cuts and a war. Deficit spending debate is about nothing, if not divergent priorities.

Second, when President George W. Bush delivered "State of the Union" addresses and speeches to joint sessions of Congress, long after his "weapons of mass destruction" justification for going to war in Iraq were debunked as false and pretextual, no member of Congress ever deigned to shout out "You Lie!" to a President that obviously had. What motivates a member of Congress to engage in the most reprehensible bout of incivility when a President is promoting health care reform (saving lives, insuring American citizens) that did not motivate a reprehensible bout of incivility when a President was promoting an immoral justification for going to war (ending lives, soldiers dying, etc.)? The seedy underbelly of Wilson's outburst and much of the motivation in town hall outrage is race and racism.

The first time a Congressperson ever shouts out "You Lie!" to a U.S. President speaking to Congress was when an African American president was addressing Congress and the outburst was by a white, conservative Congressman. In my mind, this is no coincidence. The outrage at town hall meetings and the cry from some in attendance linking President Obama to Nazi Germany and Hitler is no coincidence. Some Americans are having a lot of trouble coming to grips with a black President.

Finally, will the Insurance Company Regime, the very embodiment of Corporate America and the great American Corporation, allow true health care reform? The opposition has been breathtaking. The pressure applied by lobbyists to Congresspersons has likely been intense. A President seems to have steeled for the battle. The outcome is not clear, and to paraphrase Frederick Douglass, the entrenched will not give up power unless it is wrested from their icy grip.

Remembering Lehman on the Eve of the First Anniversary of Its Collapse: Part I

As we approach the first anniversary of Lehman Brothers’ collapse, a failure that many believe triggered the current global economic crisis, we should perhaps pause and reflect on the topsy-turvy financial year that Americans have survived. This is not an anniversary that Richard S. Fuld, Lehman’s former chairman and chief executive officer is looking forward to celebrating. Fuld has been vilified and humiliated before a congressional panel last October and named in nearly 40 different legal actions. “I’ve been pummeled, I’ve been dumped on, and it’s all going to happen again. I can handle it. You know what, let them line up,” Fuld stated recently. To be fair to Fuld, he took control of Lehman in 1994 at one of Lehman’s darkest hours and rebuilt it into the fourth-largest U.S. investment bank, a Wall Street powerhouse whose massively profitable mortgage banking machine inspired rivals’ envy. The question remains, however, how did it all go wrong? Is Fuld really to blame for Lehman’s demise or was Lehman the first victim of a massive systemic failure in the American financial services industry? Perhaps, more importantly, why didn’t the federal government save Lehman like it saved, Long-Term Capital Management, a hedge fund in the late 1990s, Bear Stearns a mere six months before Lehman’s collapse, Merrill Lynch at the same time that it allowed Lehman to collapse, Bank of America, Goldman Sachs, AIG and countless other financial institutions after it allowed Lehman to collapse, that were deemed too big to fail?

On Friday, September 12, 2008, U.S. Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke assembled thirty of the most powerful figures in the American banking industry to the headquarters of the U.S. Federal Reserve in New York. The group of thirty was told Merrill Lynch and Lehman Brothers were on the brink of collapse. The U.S. government would not bail them out because it was only a week since the U.S. government had agreed to rescue Fannie Mae and Freddie Mac. It was up to the thirty banking executives in the room to save Merrill and Lehman. The future of the entire global banking system was now under threat because the collapse of these two Wall Street giants would deal a huge blow to the world’s confidence in the U.S. financial industry. In particular it would raise questions as to whether American financial service companies could make good on their debts, if Lehman and Merrill were to collapse.

Ken Lewis, chief executive officer of Bank of America, was interested in buying Merrill, but Lehman was out of the question, primarily because no one was really sure of the Lehman’s true financial condition, that is--the true state of the Lehman’s finances, the true worth of thousands of “esoteric contracts” to which Lehman was a counterparty. There could be billions of dollars in liability for the company that eventually purchased Lehman. Lehman’s potential liability for its outstanding loans was not clear and no one wanted to take on such a tremendous risk. Except perhaps Barclays, a 300 year-old British bank, who wanted flagship operations in the United States. The Financial Services Authority and Bank of England were adamant in their belief that the U.S. Federal Reserve would not allow Lehman to fail. They had grave reservations about the idea of a Barclays-Lehman deal. They wanted reassurances from the U.S. government, in particular they wanted guarantees as a condition precedent to the deal. If Barclays were to purchase Lehman blind, unsure of the liabilities Barclays would inherit from the “esoteric contracts,” the U.S. government would have to provide some insurance for Lehman’s and eventually Barclays’ potential losses. The U.S. government refused not because it did not want to save Lehman but because the U.S. government itself did not know what the ceiling of the potential Lehman losses would be. Lehman was too big for the U.S. government to rescue. The Barclays deal was dead and so was Lehman.


On Monday, September 15, 2008, 158 years after it was founded, Lehman filed for bankruptcy. It was a catastrophic event. Shockwaves were felt throughout the global banking industry. Within days, Halifax Bank of Scotland had been rescued by Lloyds of London. Within two weeks, Bradford & Bingley was nationalized. Within a month, the British government had given financial bailouts to Lloyds of London and Royal Bank of Scotland with an unprecedented £37bn. Banks were in crisis everywhere. Not to be outdone, the United States developed a $700bn Troubled Asset Relief Program (TARP) to bailout American banks. On September 21, 2008, Goldman Sachs and Morgan Stanley were given permission from the U.S. government to convert their status from investment banks to regulated commercial banks, marking the end of the last two major independent Wall Street investment banks. It was the end of an era.

A year later, as we remember Lehman, the American banking system is still fragile, recovery is slow, and many questions and lessons exist regarding the near-death experience of the American banking system. "You had an old 19th century-style panic," said Cary Leahey, senior economist at Decision Economics. "There was no single catalyst" for the upheaval. Economists believe that big investment banks and other influential financial market players had taken on massive risks, borrowing heavily to bet on securities tied to subprime real estate loans which were outside the scope of regulators’ authority. As a result, when the U.S. housing market collapsed, this sent the walls crashing down, freezing credit markets and economic activity in the worst crisis since the Great Depression. Hugh Johnson, chairman and chief investment officer at Johnson Illington Advisors stated that "there was a belief that the financial crisis could not be solved and would lead to a second Great Depression.” The U.S. government took aggressive action. The new regulatory focus may curb the excesses that led to the boom and bust of Lehman. However, the current focus on regulation and risk mitigation "have enormous implications for the availability of risk capital in the U.S. and the primacy of the U.S. financial system," said Joel Naroff of Naroff Economic Advisors.

What shall be remembered about the Lehman collapse?

First, although some historic names have vanished forever and others are mere shadows of their former selves, Wall Street hasn't changed all that much. It still operates on the principle of an insider club where disclosure is minimal even to regulators. The best interest of the public is not the primary concern. Business is good and likely to get better. Simply look at the second quarter earnings report for the major financial service firms. Previously on July 22, 2009, I commented on the amazing second quarter earnings of the large banks that had received TARP funds and queried whether they really needed the TARP funds, in the first place? Currently, the burgeoning need for Wall Street’s capital raising services will be a welcomed relief in a world that's suffered trillions of dollars in losses over the past two years.

Second, regulators and central bankers could not save Lehman because Lehman was too big to save. The huge uncertainty of Lehman’s potential losses illustrated that the world's capital markets have become too powerful relative to the central banks. "The U.S. government didn't let Lehman fail; it didn't have the authority to save it," Treasury Secretary Tim Geithner said in an interview with Fortune.
"The fundamental constraint was that the Treasury at that point had no authority" to put capital into Lehman, and "the central bank did not have the ability to fill a capital hole." There was no buyer willing to assume most of Lehman's obligations, as Morgan Stanley did for Bear Stearns. The U.S. government would have been risking unlimited losses because Lehman didn't have enough collateral to back hundreds of billions or trillions of dollars of outstanding loans.

Third, the American financial markets can overwhelm the U.S. government’s resources. Lehman shall remain an unfortunate footnote in U.S. financial history. However, Lehman's collapse underscores for all of us that financial regulation is not only fashionable, it is instrumental for the survival of the American financial system and global economic stability. Despite everything that has transpired, hope is not lost. In the words of Mr. Fuld, “I’m not a defeatist. I do believe at the end of the day that good guys do win.”

Lydie Nadia Cabrera Pierre-Louis
Assistant Professor of Law
St. Thomas University

Pfizer Agrees To Pay Record $2.3 Billion Fine

A couple of days ago, Pfizer entered into a settlement with the federal government whereby the company agreed to pay the largest fine levied against a U.S. company by the federal government. Pfizer agreed to pay a record $2.3 billion and pled guilty to one felony count to settle federal criminal and civil charges in connection with the marketing of the painkiller Bextra, the anti-psychotic drug Geodon, the antibiotic Zyvox, and the epilepsy drug Lyrica . This is the fourth settlement that Pfizer has entered into with the federal government since 2002 over the marketing of its drugs, fines in those previous settlements totaled $513 million. Government attorneys indicated that these previous fines, and Pfizer’s repeated violations, factored into the imposition of such a stiff fine in the current case. Pfizer generated $48.3 billion in revenue last year, so in many ways, this fine represents a small drop in the bucket for Pfizer.

Under federal law, pharmaceutical companies are banned from marketing drugs for other than their approved uses. Promotion and marketing for non-approved purposes is called “off-market” label marketing, and is thus illegal. However, doctors may legally prescribe “off-label” medications to treat illnesses for which the drug was not approved; however, pharmaceutical companies run afoul of the law in their overt marketing of such “off-label” drugs. The criminal complaint against Pfizer charged the company with sending doctors on all-expense paid vacations to resorts, providing free massages, and payments of kickbacks to get the doctors to prescribe Pfizer’s drugs off-label.

In order to resolve the civil charges, Pfizer entered into a five (5) year “corporate integrity agreement” with the Department of Health and Human Services (“HHS”). The corporate integrity agreement gives HHS the ability to monitor Pfizer’s marketing activities.

In terms of deterrent effect, only time will tell whether other companies take heed of Pfizer’s predicament and subsequent punishment. The jury will remain out on the issue of deterrence. In criminal law one of the main underpinnings of harsh punishment is deterrence. Interestingly, in spite of the harsh punishment of one as an example, crime and criminals still flourish and are bountiful. What a novel way to close the budget deficit? Substantially fine corporations that break the law and do bad things!!! Someone in Washington should have thought about this a long time ago.

Dangerous Discourse About the Financial Collapse and Poverty Among Minorities

Several weeks ago, I purchased a book, “Animal Spirits", written by George A Akerlof, the Koshland Professor of Economics at the University of California at Berkeley, and Robert Shiller, the Arthur M. Okun Professor of Economics at the Cowles Foundation for Research in Economics, and Professor of Finance at the International Center for Finance at Yale University. The book, subtitled “How Human Psychology Drives the Economy, And Why It Matters for Global Capitalism”, was published this year by Princeton University Press. In the book’s preface, the authors explain that they draw “on an emerging field called behavioral economics” to describe “how the economy really works.” They claim to explain “why ignorance of how the economy really works has led to the current state of the world economy….”

After looking at the Table of Contents, I decided to read the book’s penultimate chapter first. This chapter, “Why Is There Special Poverty among Minorities?” especially appealed to me because of my interest in the intersection of business and economic issues with racial justice concerns. I was both surprised and pleased to see that a discussion about economics would include consideration of the unique issues with which people of color grapple. In my experience, most discussions about race fail to include an examination of business and economic factors, and almost all of the discourse about business and economics ignores the significance of race and racism in American society.

To say that I was disappointed in this chapter would be a gross understatement. The authors attempted to explain the persistent and seemingly intractable problem of poverty among African Americans without mentioning the economics, behavioral or otherwise, of centuries of slavery and generations of overtly racist economic policies in the decades after slavery ended. Perhaps, I thought while reading the chapter, the authors intended to deal only with recent phenomena that precipitated the current crisis. Maybe delving into an historical account of slavery’s present-day impact was beyond the scope of the book. As I read the short chapter, I searched in vain for some brief explication about this nation’s recent experiences with predatory subprime lending and its impact on communities of color. The authors never mentioned predatory lending. They wrote a chapter about poverty and minorities and the recent financial crisis without mentioning the fact that predatory lending drained billions of dollars from communities of color. They said nothing about predatory lending’s contribution to the destruction of an already fragile black middle class. The authors omitted any discussion of the fact that predatory lenders, some of them public companies and major financial institutions, targeted Black and Latino communities.

What did the authors say in this chapter? They talked about the impact of communal stories and the way narratives create insider and outsider groups – a we and a they. And then, the authors told a story about a group of black men “who hang around a carry-out store in one of Washington’s most blighted neighborhoods.” The authors describe the stories of the lives of these men, and the anger with which they live. They describe a “knife fight” between two of the men, and the refusal of some to commit to long-term relationships with the women in their lives. The authors tell stories of the employment opportunities that some of the men squander. One of the men cheats on his girlfriend and slaps her in an argument. In other words, the authors perpetuate the kind of stereotypes and narratives that inflame racial strife. The stories of these men do not explain the problem of poverty among African Americans. This problem cannot be explained without understanding slavery’s legacy and the recent targeting of Black and Latino communities by predatory lenders.

A Sweet Securities and Exchange Commission Settlement Deal for VeriFone

The Securities and Exchange Commission (SEC) settled charges against VeriFone Holdings Inc. (VeriFone) and a former finance department employee, Paul Periolat, regarding allegations that VeriFone, a provider of electronic pay services, filed false accounting records which boosted the company’s gross margins and income reported to shareholders for three consecutive quarters in 2007. The falsification resulted in an overstatement of earnings by more than $37 million.

VeriFone settled with the SEC without admitting or denying the allegations. VeriFone consented to a permanent injunction against violations of the reporting, internal controls, and other provisions of the federal securities laws. Periolat, now an ex-employee, consented to a permanent injunction against further violations of certain antifraud, reporting, internal controls, and other provisions of the federal securities laws, and Periolat has to pay a $25,000 civil penalty fine. There were no other charges or any monetary penalty assessed against VeriFone.

This is perhaps one of the sweetest settlements for a public company who has breached its fiduciary duty of care to shareholders and presumptively violated Sarbanes-Oxley (SOX) Section 302. The facts concerning VeriFone’s wrongdoing are not unusual but the speed and the terms under which the SEC settled the investigation are unusual. The SEC sued VeriFone on Tuesday, September 1st and the case was settled on the same day.

The SEC alleged that VeriFone made unsupportable alterations to its records to compensate for an unexpected decline in gross margins, overstating VeriFone’s operating income by a total of 129 percent. The SEC further alleged that when internal VeriFone reports showed that gross margins would be markedly lower than previously released guidance to analysts, senior management "was convinced that previously released guidance to analysts were correct and directed finance employees to figure out and fix the problem” so VeriFone could report results in line with forecasts and thereby avoid “an 'unmitigated disaster." The SEC specifically alleged that VeriFone’s former supply chain controller, Periolat, made large manual adjustments to inventory balances on VeriFone’s books each quarter, dramatically increasing both gross margins and operating income. The accounting irregularities came to light during a routine annual audit in November 2007. A few weeks later, VeriFone announced it would restate earnings for the first three quarters of fiscal 2007. VeriFone’s stock fell by 46 percent to $26.03 the day of the announcement, wiping out $1.8 billion from VeriFone’s market capitalization. It is this type of corporate misconduct which encouraged Congress back in 2002 in the wake of historical corporate scandals to adopt comprehensive legislation to increase the accuracy, level of disclosure, and ultimately the accountability for corporate financial mis-reporting.

In 2002, with the seemingly endless financial and management scandals that were then coming to light, including the collapse of Enron and, even more dramatic, the collapse of WorldCom, Congress adopted SOX to remedy the damage that had been caused to investor confidence in the markets. SOX has set the requisite standard for public companies regarding financial transparency and accuracy. The responsibility is on companies’ chief executive officers (CEOs) and chief financial officers (CFOs) to ensure that their financial reporting is transparent and accountable. As such, VeriFone is under a federal statutory duty to implement long-term strategies to establish and evaluate internal control over its financial reporting. It is not enough for CEOs and CFOs to merely sign off on the financials. CEOs and CFOs must certify as to the financial accuracy and effective internal controls currently in place and must to attest to the transparency and accountability of company’s financials. This duty to implement and maintain effective internal controls has long existed under a corporation’s common law fiduciary duty of care. In re Caremark is the seminal case regarding a corporation’s fiduciary duty to implement and maintain effective internal controls. Professor William Gregory’s law review article in the Akron Law Review entitled, The Fiduciary Duty of Care: A Perversion of Words, is an excellent discussion of the confusion that often exist between the duty of loyalty and the duty of care.

SOX Section 302 entitled “Corporate Responsibility for Financial Reports” requires CEOs and CFOs of public companies to certify the information in the company's annual and quarterly reports to the SEC, as well as the company's internal controls are effective. Marc J. Fagel, director of the SEC’s San Francisco regional office stated that through poor oversight and controls, VeriFone senior management allowed an employee to make millions of dollars of unsubstantiated accounting adjustments that enabled the company to meet its guidance to Wall Street. VeriFone maintains that Periolat acted without scrutiny or authorization from more senior management. This means that VeriFone’s internal controls failed and three quarterly reports filed with the SEC in 2007 were inaccurate which violated SOX Section 302 and was a breach of VeriFone’s fiduciary duty of care to its shareholders.

Marc J. Fagel further stated that public companies need to ensure that their financial statements give an accurate assessment of their financial results, and are not improperly adjusted to meet analyst expectations. It is this “tough” language of necessary compliance with federal regulations and, yet “soft” settlement for breach of those regulations which is so perplexing. Perhaps the answer turns on intent. The SEC complaint did not accuse VeriFone of intending to misstate its financial results or to mislead anyone. However, VeriFone’s internal controls were not effective. It is this lack of effective internal controls which should have triggered SOX liability and a breach of VeriFone’s duty of care to its shareholders. These are not issues of intent. These are issues of negligence. VeriFone’s CEO Douglass Bergeron recently stated that “over the past 18 months, the company has substantially improved its governance and internal controls in order to prevent a recurrence of this type of event." Perhaps such sweet reassurances will bring comfort to regulators and shareholders.