A New Twist on Insider Trading: Expert Network Consultant Firms

A little over a week ago, Reuters broke a news story about Joseph "Chip Skowron's arrest on criminal securities fraud and conspiracy charges. Skowron is an Ivy League-educated doctor who left a Harvard University residency program to become a stock picker on Wall Street. Skowron worked for several prominent hedge funds, before he became the manager of FrontPoint Partners' healthcare funds. FrontPoint is a spinoff from Morgan Stanley.

Skowron violated trading restrictions imposed by FrontPoint, in attempting to avoid a loss from adverse hepatitis drug trials conducted at Human Genome Sciences, Inc., a company Skowron's hedge fund invested in. According to the U.S. Attorney's allegations, FrontPoint avoided $30 million in losses by selling their Human Genome holdings prior to Human Genome's public announcement of problems with its hepititis C drug treatment on January 23, 2008. FrontPoint Partners has not been accused of any wrongdoing, but agreed to pay to a $33 million settlement to the Securities and Exchange Commission (SEC), without any admission of guilt.

Where did Skowron's insider tips come from? FrontPoint paid $900,000 to a firm named Guidepoint Global to gain access to that company's network experts or consultants. Guidepoint Global is in the business of matching hedge funds with industry analysts. In this case, Dr. Yves Benhamou, a 51 year old Parisian infectious disease expert, a consultant to both a biotech firm and the expert networking firm (Guidepoint Global), was paired with Skowron and FrontPoint. According to prosecutor's allegations, Skowron, in violation of FrontPoint ethics rules, cut a side deal with Dr. Benhamou beginning in 2007. Dr. Benhamou, the network expert, allegedly provided insider trading tips to Skowron about Human Genome Sciences, Inc.

What is an expert network? By definition, it is a group of professionals who are paid by outsiders for their specialized information and research services. Expert networks can be very large, encompassing tens of thousands of individuals with high-level knowledge of a variety of subjects. Experts are commonly paid the high fees associated with the provision of consulting services and may work under the umbrella of a large company that assembles the expert-professionals, markets their services and contracts their work.

The facts and allegations brought forward by the SEC read like an international spy novel. to seal their secret arrangment Skowron met Dr. benhamou at a hotel in Barcelona in April 2007 and gave him an evelope with over $7,000 in cash. A few months later, Skowron paid for a lavish stay at a New York hotel for Dr. Benhamou and his wife. Finally, after getting tipped off about Human Genome, Skowron and Dr. Benhamou met in a Milan hotel bar, where Skowron passed an evelope filled with at least $10,000 in cash to Dr. Benhamou in April 2008. Dr. Benhamou has since pled guilty to securities fraud charges, conspiracy charges, and for making false statements to FBI agents. Dr. Benhamou is cooperating with federal investigators and prosecuters according to the terms of his plea agreement.

The lesson learned is that we need to watch the relationships between hedge funds and expert network firms and consultants. Let me be clear--not all of these relationships are inherently wrong nor evil, nor merit oversight and scrutiny. Some bad apples are spoiling the cart. Not all expert networks are bad, most provide legitimate information to hedge fund managers in areas outside the manager's expertise. However, it is clear that the SEC and federal investigators are paying more attention to relationships between hedge funds and expert network firms, and their temptation to engage in insider trading. "Prosecuters say expert network relationships are not inherently wrong but that some consultants have crossed the line by taking fees to leak corporate secrets to hedge fund traders and analysts."

Undoubtedly, expert networks are creating new regulatory challenges for the SEC. The jury is somewhat out on how these organizations will be treated or regulated. In the coming months and years the SEC's approach to expert networks will be interesting to watch. I will try to keep you posted.

Levin-Coburn Report Outlines Causes of Financial Crisis

Last week, a bi-partisan commission of U.S. Senators, including both conservative Senators and Tea Party favorites such as Tom Coburn, Rand Paul and Scott Brown, released a 635 page report which details the causes of the financial market crisis of 2008. This report includes bi-partisan recommendations such as “Narrow Proprietary Trading Exceptions,” and “Design Strong Conflict of Interest Prohibitions.” This release, similar to the official release of the Financial Crisis Inquiry Commission report, was met with a decided yawn by national media.

Following a quick review, it appears that the Levin-Coburn report lays primary blame for the financial collapse at the feet of reckless Wall Street executives, federal regulators “who cast a blind eye,” and out-of-control incompetent credit rating agencies who downplayed the serious risks of “crap” mortgage backed securities and collateralized debt obligations in order to maintain record breaking fees collected from the very entities requesting the ratings. Megabanks like Washington Mutual and Countrywide also aggressively shifted their sales from lower risk fixed rate loans to subprime adjustable loans, flooding the market seeking greater profit margins. Senator Levin pointed out that “rampant conflicts of interest are the threads that run through every chapter of this sordid story.” Notably, the Community Reinvestment Act came up only one time in the report, signifying again the miniscule role it played in the crisis: buried in footnote 495.

Importantly, this report sends a clear signal to the Justice Department that laws have been broken – not just by low hanging fruit such as brokers and borrowers (see Charlie Engle), but by Wall Street titans, like Goldman Sachs CEO Lloyd Blankfein. “Federal regulators should review the [investment banking] activities described in this Report to identify any violations of law.” Will federal regulators take up the Report's invitation to investigate Wall Street executives that acted recklessly?

A $65 Trillion Question: Why not Free Movement of People?

I have long argued that the free movement of people would constitute a powerful means of enhancing economic growth while empowering people. In American Corporate Governance and Globalization I argued: "The one free market ideal that seems not to be on the agenda of globalization is quite telling: there is little provision for the free movement of people. The free movement of people would allow migration to wherever wages would be the highest, in accordance with free market precepts. Economists conclude that barriers to the free movement of people are costing the world economy 70 percent of world GDP in forgone output." My conclusion in 2007 was that our flawed system of corporate governance permits CEOs to harvest large compensation payments from short term profits; therefore CEOs only seek a globalization that is powerfully rigged towards cheap labor by stranding labor in low cost locales.

Recently, Harvard economist Lant Pritchett published the most compelling economic argument I have seen in favor of free movement of people in The Cliff at the Border, a chapter in the Growth Commission's newest volume Equity and Growth in A Globalizing World. Prichett states: "In contrast to these modest gains from further liberalization of goods or capital markets, estimates of the gains from the fanciful counterfactual of a complete liberalization of labor mobility are that the world GDP would roughly double. At current levels of GDP, this implies gains of $65 trillion." He further notes that: "The point is that, at the margin, the gains to poor people from relaxing the existing barriers to labor mobility are enormous relative to everything else on the development table."

The WTO exists to breakdown trade barriers, such as restrictions on labor mobility. Moreover, the current round of trade talks--the Doha Round--specifically focuses upon development. The WTO should place the $65 trillion labor mobility question at the top of the agenda. Its importance dwarfs all other issues that have stalled the trade talks.

Further, the labor mobility issue dovetails with the $100 trillion currency reserve issue. The rapid development of the least economically powerful nations would assuage the baseless fear that many workers in developed countries have regarding more expansive immigration--that they will face declining wages and fewer job opportunities (economists show the opposite is true: immigration actually raises native wages overall and increases worker specialization and productivity). First, rapid development would expand demand for all goods produced throughout the world economy. Second, rapid development would diminish the incentives for labor to exit undeveloped nations.

Thus, if the WTO wishes to pursue development it should pursue labor liberalization and currency reserve reform. The economic case is simply overwhelming that a sturdier globalization requires a legal construction that addresses currency reserves and labor mobility.

Perhaps even more importantly, however, are the political implications of such reforms. Free movement of people would mean that nation states would need to compete for the best and brightest human resources. Laborers would seek out locations where their productivity and quality of life would be maximized. As Joseph Stiglitz recognizes, if nations had to compete for talented people then "Governments would compete in providing economic security, low taxes on ordinary wage earners, good education, and a clean environment—things workers care about."

Free movement of people is both an economic as well as political game-changer.

Wall Street Increasing Retirement Age for Board Members

Last month, the Wall Street Journal published an article documenting a phenomenon that should cause pause for those concerned about effective corporate governance: the graying of corporate boards. Many publicly traded companies, citing a shrinking pool of experience and unproven and risky newcomers, have raised mandatory retirement ages to hang on to board members, typically male, typically white, who are well into their 70’s and beyond.

When German luxury automaker BMW showed its 60 year-old director the door in 2006, wary that a company that desired to anticipate “tomorrow’s auto technology today” would have a hard time doing that with “an elder statesman,” the forced out executive complained because “he liked being the captain of the ship.” In the United States, it appears that this BMW executive may have had the mandatory retirement age elevated in order to allow him to remain as “captain of the ship” despite bylaws and corporate statements that call for mandatory retirement at a certain age.

Critics of elevating retirement ages to keep older executives around longer note that longtime directors are more susceptible to losing their outside perspective. Further, critics note that restricting the “up and out” of mandatory retirement makes it harder to bring in fresh corporate oversight amongst entrenched executives, suggesting that the entrenched are less responsive to shareholder concerns, Finally, increasing the retirement age just pushes back the difficult day when leadership must tell these old, proud executives that they have outgrown their usefulness.

In light of the recent financial market crisis, logic would seem to dictate that new blood is needed on Wall Street, enabling fresher vision and less reckless leadership. It appears that Wall Street has not received this message, as many companies are manipulating their own retirement rules to keep oldtimers around to fill their board seats.

A $100 Trillion Question: Why not Bank Currency Reserves?

Nations across the world are back on track to continue to accumulate trillions in foreign currency reserves after a slow down attributable to the financial crisis. Currency reserves give nations the ability to protect their currency in crisis--by selling their reserves in exchange for their own currency they restrict the supply of their currency and stabilize its value. But many nations hold far more reserves than necessary for that function.

Excess reserve accumulation depreciates the value of their national currency and artificially strengthens the currency purchased for reserves. As 60% of all reserves are held in the form of dollars (followed by Yen, Euros and Pounds), reserve accumulation means an artificially stronger dollar. Reserve accumulation thus allows accumulating nations to sell more exports to the US as well as other developed nations and pursue export-led growth.

This rapid accumulation of dollar reserves directly contributed to the subprime debacle by lowering interest rates and spurring excessive debt through the constant demand for dollar-denominated assets. To be more precise:

"This is not to say that reserve accumulation was the only cause for the current crisis. Yet the core issue remained the Chinese [and others] willingness to fund America’s consumption and borrowing habit. Without this support, interest rates in the US would almost certainly have been substantially higher, acting as a circuit breaker for the developing debt-consumption bubble."

The accumulation of vast currency reserves also drains durable demand from the global economy in that nations could have used the wealth dedicated to reserve accumulation to develop their own domestic economies rather than funding unsustainable debt levels in the US and throughout the developed world. There is an urgent need for a new legal framework to channel reserve accumulation into more productive uses.

In a new law review article, entitled Taking Economic Human Rights Seriously After the Debt Crisis, I propose that the IMF, World Bank and the WTO be reconfigured to pursue economic human rights to foster macroeconomic growth and stability. In particular, I argue that these global institutions channel the $10 trillion in currency reserves into low cost development loans to foster economic human rights through a massive effort to create health, education and other infrastructure throughout the developing world. This would be giant leap forward for global economic development and growth as the fractional reserve banking of currency reserves could support $100 trillion in development loans, aimed at the most deeply disempowered people. Naturally, the most deeply disempowered populations hold the greatest economic potential. Thus, this proposal would spur growth worldwide.

Here is the abstract:

"The debt crisis of 2007-2009 and its continuing economic fallout reveal costly flaws in the current legal construction of globalization. Most notably, the system of dollar based currency reserves led to excessive debt in the US and diminished durable consumption worldwide. Vindication of economic human rights can sustain consumption and support macroeconomic growth and stability. Even before the crisis, economic human rights demonstrably facilitated economic growth and stability. Unfortunately, economic human rights suffered from deficient legal enforcement mechanisms and billions of global citizens suffered from deficient economic development as a result. Yet, the nearly $10 trillion in currency reserves proves that the world economy holds sufficient wealth to mobilize these human resources. This paper suggests that the IMF, the World Bank and the WTO place economic human rights front and center in terms of all facets of their operations. It also argues that these global institutions be reconfigured to expand the issuance of special drawing rights as an alternative reserve currency. Currency reserves could be banked with the IMF and leveraged (through fractional reserve banking) to fund massive development lending to actualize economic human rights."

Mozilo Freed, Engle Imprisoned: A Story of How Executives Skate and Borrowers Pay

On the heels of news that Angelo Mozilo, the former CEO of now-defunct Countrywide, who made more than $500 million in bonuses by peddling toxic and poisonous loans in the run-up to the financial market crisis or 2008, has been absolved of any criminal wrong doing, the New York Times reports that the Obama Justice Department is aggressively imprisoning individuals that took out the toxic loans, but not even criminally investigating the lenders or executives that were wildly writing and authorizing them.

As carefully documented by the NY Times, Charlie Engle, a 48 year-old man whose accomplishments include overcoming a serious drug addiction to become one of the best marathon runners in the world, eventually running across the Sahara Desert in 2006 with two others, has been imprisoned for 21 months for overstating his income on two “liar loans” that he took out at the encouragement of his mortgage broker several years ago. Despite weak evidence (forensic handwriting analysis indicated that Engle’s signature on at least one “liar loan” was forged), the government pursued its case against Engle as if HE was responsible for collapsing the global economy (while individuals like Dick Fuld, Joseph Cassano, Angelo Mozilo and others, much better candidates for governmental pursuit for collapsing the economy, remain criminally uncharged with ill gotten bonuses intact).

Particularly outrageous in Engle’s case is the way in which the government brought its case. The IRS special investigation was initiated by an IRS agent watching the documentary “Running the Sahara” and wondering whether Engle was funding his training by speculating in the real estate market bubble. Confident that Engle was speculating in real estate in order to fund his marathon running and his Sahara Desert run of 2006, this agent pursued Engle with a complement of multiple agents and investigators, the involvement of multiple theories, entailing personal dumpster diving at Engle’s home, using an attractive and flirtatious female undercover agent, and involving a hidden wire. All this to “catch” Engle in the deception of misstating his income on two investment home applications, encouraged and supported by a mortgage broker.

So, Angelo Mozilo who engaged in widespread and systematic deception in selling self-described “toxic” and “poisonous” loans to the pubic, was criminally absolved, but Charlie Engle for taking out two of the types of loans that Mozilo was widely and recklessly peddling, is imprisoned for engaging in deception? Just another enormous disappointment in the way the financial market crisis has been handled by the Obama administration and those agencies and legislators charged with representing and protecting the public. Apparently, Engle must be the low-hanging fruit that the government is willing to charge, while Mozilo, Cassano, Fuld, and others are untouchable. Seriously?

Subprime Mortgage Bonds Making a Comeback?

On April 1, 2011, the Wall Street Journal reported that subprime mortgage loan bonds are “back in vogue with long-term investors.” In what apparently was not an April Fool’s Day joke or spoof, the Wall Street Journal detailed how subprime mortgage loan bonds, perhaps the primary progenitor of the recent financial market crisis, are attracting investors anew based on the greater risk that these bonds allow investors to assume.

The WSJ portrayed this reemergence of subprime mortgage loan bond investment as a sign of economic recovery and a kind of healing of the credit markets, rather than as an ominous sign that investors and Wall Street banks refuse to learn lessons from past failures. The article reports that this renewed investment interest in ultra risky vehicles, like subprime loan bonds, “underscores how investors have regained the courage to take on more risk as the economy recovers.” Subprime loan bonds are securities that are backed by hundreds or even thousands of loans to homeowners with spotty credit histories.

What is motivating this renewed interest in extraordinarily risky subprime bonds? The WSJ credits higher subprime bond yields due to the Federal Reserve’s policy of pushing rates of return down on more conservative investments. Even large life insurance companies, like bailout poster child AIG, are jumping back into the subprime bond investment arena. An executive at bailed out J.P Morgan sounds intoxicated with excitement: “Getting an opportunity to look at a portfolio like this in the secondary market is exciting and appealing.” The Fed also noted a “high level of interest by investors” on these dangerous subprime bond products.

A voracious appetite for subprime loan investment instruments drove mortgage lenders in the early part of this century to create ridiculous loans to satisfy investor appetite – loans that lenders admitted were “toxic” and “poisonous.” This news feels like déjà vu all over again.

Despite what feels to me like an alarming development, a Senior VP at Moody’s claims that we are not “back to the old days.” Did this Moody's credit rating agency executive (still with financial market crisis blood on his hands) mean to say, we are not “back to the old days, yet”? As detailed repeatedly in this blog space, Dodd-Frank and other recent legislation does little to protect against history repeating itself on the subprime loan investment front.

10 Largest Insider Stock Trades in 2010

Here is some food for thought. Did you ever wonder which ten (10) executives sold their company's stock and cashed in large profits in 2010? Well, if this thought did cross your mind, here goes the answer:

1. Steve Ballmer, $2 billion CEO, Microsoft No. of shares sold: 75 million Price: $25.26 - $27.18 When: 10 sales over the course of November 2010 Sold for: $2.0 billion


2. Larry Ellison, $1.4 billion CEO, Oracle No. of shares sold: 51 million Oracle shares and 360,000 Leapfrog shares Price: $26.92 - $29.45 and $5.38 - $6.36 When: 71 sales between September and December 2010 Sold for: $1.4 billion


3. Ralph Lauren, $860.3 million CEO, Polo Ralph Lauren No. of shares sold: 10.9 million Price: $78.17 - $113.72 When: 22 sales during the year Sold for: $860.3 million


4. Jeff Bezos, $793 million CEO, Amazon.com No. of shares sold: 6 million Price: $115.93 - $165.23 When: 30 sales between February and November 2010 Sold for: $793.0 million


5. Larry Page, $493 million Co-founder, Google No. of shares sold: 916,674 Price: $403.03 - $630.00 When: 1,241 sales between February and December 2010 Sold for: $493.0 million


6. Sergey Brin, $481.2 million Co-founder, Google No. of shares sold: 916,674 Price: $433.87 - $619.39 When: 2,012 sales between February and December 2010 Sold for: $481.2 million


7. Marc Benioff, $243.8 million CEO, Salesforce.com No. of shares sold: 2.5 million Price: $61.28 - $149.27 When: 252 sales during the year Sold for: $243.8 million


8. Steve Wynn, $103.3 million CEO, Wynn Resorts No. of shares sold: 1 million Price: $103.30 When: Dec. 1, 2010 Sold for: $103.3 million


9. John Hammergren, $70.4 million CEO, McKesson No. of shares sold: 2.2 million Price: $61.46 - $70.37 When: 15 sales over the course of June, July and August 2010 Sold for: $70.4 million


10. Dennis Wilson, $57.3 million Chairman, Lululemon Athletica No. of shares sold: 1.3 million Price: $38.11 - $71.62 When: 30 sales between January and October 2010 Sold for: $57.3 million

Anything stick out? There are no women or people of color on this list. I'm just sayin...??? Perhaps I shouldn't think out loud. What do you think about this list?

Republicans Aim to Water Down Consumer Financial Protection Bureau

The GOP has shown once again what side it is on. Not the side of middle class and working people. The Consumer Financial Protection Bureau ("CFPB"), one of the hallmarks of the Dodd-Frank Wall Street Financial Reform Act, is being threatened even before it emerges to life. On Wednesday, House Republicans unveiled a number of measures designed to dilute, and emasculate the CFPB. Beginning July 21, 2011, the CFPB is set to regulate credit cards, mortgages, and financial products like payday loans. The CFPB, an independent federal agency, is funded by fees charged to banks by the Federal Reserve. Aside from vowing to underfund the CFPB, House Republicans unveiled plans to do the following:

• Replace the director of the CFPB with a five-member committee;


• Make it easier for Congress to overrule and veto CFPB rules and regulations;


• Prevent the CFPB from exercising any newly mandated powers until the Senate confirms the putative director of the CFPB; and


• Curtail the ability of CFPB financial examiners from riding shotgun on banking examinations with other regulatory agency officials until the bureau is officially up and running.

Wise men and women have remarked that we never learn from history. When we look back over the continuing Great Recession that began in 2006-2007, what have we truly learned and observed? Not much. We have bailed out Wall Street and failed to adequately protect middle class and working class Americans. If this concerns you like it concerns me, get active and call your Congressional representative.