Blog PostsBush administration and Stoneridge case
By John Barkdull at Mar 22, 2010 |
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Searching through the files on the Stoneridge case, I came across Robert Borosage's item at Huffington Post. Published just before the Supreme Court decided the case, Borosage reports that, at the urging of Treasury Secretary Hank Paulson (former Goldman Sachs CEO), Bush intervened to insist that the Solicitor General side with the defendants. The SEC had urged that the government side with the plaintiffs, which would have meant the administration was backing third party liability. It is a bit surprising that a Chris Cox-led SEC would take this position, but perhaps that indicates just how damaging to honest dealing the Supreme Court decision actually was.
“Wall Street’s investment banks,” Borosage presciently wrote, “just got another step closer to making defrauding investors an accepted line of business... If the Wall Street banks have no liability for fraudulent schemes they concoct, the scandals of the last decade will look like chior boy pranks compared to what is to come.” (Huffington Post, June 13, 2007)
It was evident at the time that the stakes of the Stoneridge decision included the Enron cases. As noted, Stoneridge was a major reason plaintiffs dropped $40 billion of suits against Enron's third party helpers. Of course, Enron was bankrupt and could not provide any relief.
Now, not long ago, the report on the Lehman Brothers collapse came out, indicating that plenty of financial manipulation was underway well before bankruptcy. The report suggests that the company's accounting firm, Ernst and Young, assisted Lehman in its 105 schemes to boost the balance sheet. Once again, the main culprit is broke and can provide no relief. It would seem to me that accountants, lawyers, brokers, and the like could once again be on the hook for their part in helping Lehman deceive investors. Does Stoneridge, along with related decisions, bar private suits against Lehman's aiders and abettors? Are there other avenues to recover some of the losses?
Kuttner takes note
By Barkdull, John at Apr 13, 2010 14:32 PM
Robert Kuttner, published on Huffington Post:
http://www.huffingtonpost.com/robert-kuttner/next-banking-reform_b_516502.html
One backstop, that has been weakened in recent years both by Congressional action and by Supreme Court rulings, is the right of investors or creditors injured by fraudulent behavior to sue. The original securities laws of the Roosevelt era envisioned that this kind of litigation--"private right of action"--would keep both corporations, their auditors and the SEC honest. But bipartisan legislation in the 1990s and two major Supreme Court decisions on 1994 and 2008 have effectively eliminated liability for aiding and abetting securities fraud. You can be sure if this right were still available, Ernst and Young would have though twice about giving Lehman a clean bill of health.
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More on Lehman
By Barkdull, John at Apr 13, 2010 14:21 PM
Yesterday's NYT reports that Lehman Brothers bought and transformed a small company known as Hudson Castle to hide some of its financial dealings from scrutiny ("Lehman Channeled Risks through 'Alter-Ego' Firm," April 12, 2010, http://www.nytimes.com/2010/04/13/business/13lehman.html?ref=global-home). Hudson Castle is still in business. Writes the Times: "Entities like Hudson Castle are part of a vast financial system that operates in the shadows of Wall Street, largely beyond the reach of banking regulators. These entities enable banks to exchange investments for cash to finance their operations and, at times, make their finances look stronger than they are."
Lehman and other banks use deals with such firms to transfer temporarily risky investments off the books. If Hudson Castle had been entirely independent, one might say it was business as usual. But Lehman exerted “an unusual level of control over the firm.” Lehman wanted to maintain the appearance of an arm’s length relationship with Hudson Castle, which was “central to some Lehman deals up until the bank collapsed.” The false impression of Hudson Castle’s independence reduced Lehman’s “headline risk” if deals went sour, and reduced the firm’s “moral obligation” to support risky off the books investments.
“This should have been disclosed, given how critical this relationship was,” said Elizabeth Nowicki, a professor at Boston University and a former lawyer at the S.E.C. “Part of the problems with all these bank failures is there were a lot of secondary actors — there were lawyers, accountants, and here you have a secondary company that was helping conceal the true state of Lehman.”
Would investors who lost money in the Lehman collapse have recourse against Hudson Castle for its part in concealing the bank’s sorry condition? The case seems parallel to Stoneridge: a third party helps a company create a misleading impression of its financial condition so as to deceive investors and others. It is hard to imagine that the management at Hudson Castle failed to understand what was happening, especially in light of Lehman’s close ties to the company. Lehman would bear primary responsibility, of course, for failing to disclose important facts about its business. Yet, Hudson Castle, managed by a former Lehman executive, actively participated, it appears, in aiding Lehman's deception. Prior to Stoneridge, this might have made the firm liable, but after it would be shielded from civil action unless Hudson Castle itself made false statements to the public regarding Lehman's condition.
Now Lehman is bankrupt. Hudson Castle still operates, providing similar services to investment banks today. If third party liability were not barred, would Hudson Castle be liable to civil action so that harmed investors could recover some of the losses Hudson Castle appears to have helped create? How many other Hudson Castles were and are helping to conceal significant financial deals?
From the Times:
“How can anyone — regulators, investors or anyone — understand what’s in these financial statements if they have to dig 15 layers deep to find these kinds of interlocking relationships and these kinds of transactions?” said Francine McKenna, an accounting consultant who has examined the financial crisis on her blog, re: The Auditors. “Everybody’s talking about preventing the next crisis, but they can’t prevent the next crisis if they don’t understand all these incestuous relationships.”
The debate on financial regulation taking place today is in regard to different approaches to enforcement. The focus is on whether there should be a consumer credit watchdog, and whether it should be independent or housed in the Fed. It appears to me that this is a debate that the financial manipulators win either way. For the focus on enforcement draws attention away from the much more effective alternative of the right of private action. No regulatory agency can track, monitor, and discipline the vast network of financial firms in the US and around the world. The right of defrauded investors to recover damages, by contrast, would ensure that someone with a significant interest will be keeping tabs on every corner of the financial industry. Without it, financial manipulators will gladly pay trivial fines long after they have reaped fortunes from deceptive dealings.
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