To be a CD, or Not to be a CD, That is the Question
The facts are seemingly pretty clear. So why is the SEC suing SIPC (the brokerage industry insurance fund) for the first time ever? Allen Stanford is accused of running a $7 billion Ponzi scheme. Investors bought CDs from Stanford’s Antigua-based bank through his brokerage arm. The investors held the actual CDs and now those CDs are virtually worthless. The SEC claims that this is a clear matter of securities fraud and investors should be made whole. SIPC counters that the investors bought and held physical certificates of deposit from a bank, therefore this was not a securities transaction but bank fraud. This battle will be fought between government agency and industry insurance fund, but the loser should not be the investors. CD, CDO, or CDS – the key to any investment is to know who stand behinds it and who insures it.
Penalties for Bad Decisions ~ The “20/20 Hindsight Rule”
UK Regulators are investigating the idea of instituting sanctions on bank executives who make bad decisions. Such sanctions would not require extensive litigation – but would be ‘automatic’ sanctions that could be levied by the Bank of England against top bank brass. How would these sanctions work?
That is not clear yet, but the proposal is clearly a response to the heavy government losses caused by the bank bailouts of the last couple of years. It may be my American sensibilities talking, but I can’t imagine a functioning financial system without the “business judgment rule.” The business judgment rule is the guiding principle that officers and directors of a corporation are immune from liability for losses incurred in corporate transactions that are within their authority and power to make when made in good faith. Netflix has admitted that their recent rate increase was a mistake, but should their CEO be fined for the error in judgment? No. If we start penalizing for bad decisions, the result could be no decisions. If decisions are made in good faith they shouldn’t be punishable. Like the time I bought my wife that vacuum cleaner for her birthday.
A Bear of a Hangover
Some headaches don’t seem to go away. In 2006 Bear Stearns settled a late trading and deceptive market timing suit with the SEC for $250 million. In 2008 Bear collapsed and JPMorgan acquired the broker. Now comes the twist. Bear, as is common in SEC settlements, did not admit to guilt in signing the settlement. JPMorgan is asking Bear’s old insurers to cover the $250 million. The policy reads that losses incurred though “any deliberate, dishonest, fraudulent or criminal act or omission” are not covered, as long as there was an “adverse final adjudication to that effect.” JPMorgan is asserting that the settlement was not a final adjudication proving deliberate or criminal act. The New York State Court of Appeals felt otherwise and has come down on the side of the insurers, holding that the money paid in settlement did not constitute an insurable loss under the policy because the actions that led to the settlement represented an intentional violation of the law. JPMorgan is stuck with the $250 million headache for the time being.
Washington Mutual’s collapse and purchase by JPMorgan Chase was the climax of the 2008 credit crisis. The FDIC has recently settled its civil suit against five top defendants involved in the failed institution for $75 million. (The bank had $250 million in D&O insurance.) But now like a very small phoenix, a portion of WaMu will rise from the ashes. WaMu’s long-suffering creditors will receive $7 billion and with approximately $200 million in equity and debt the newly emergent WaMu will become an investment company and mortgage reinsurer. Not quite the financial giant it once was, but no one likes to be compared to their past selves.
Getting Used to Rejection
Judges routinely approve proposed settlement agreements between private parties, however, in the last few weeks we have seen a number of high profile cases where judges have rejected settlements for various reasons. Investors in Thema, a former “feeder fund” for Madoff’s failed brokerage, were suing HSBC who acted as trustee. The US District Judge hearing the case rejected the $62.5 million settlement (or about 20% of the investor’s losses) citing inadequate disclosure of legal costs. The matter was a class action suit, which means that many of the injured parties were not actively involved in the proceedings. In such matters judges are more inclined to intercede to make sure that everyone’s interests are protected. Actors, and now plaintiff’s attorneys, just have to get used to rejection.