Tuesday, June 25, 2013

Don't Do it Online!

With the upcoming FINRA examinations on the use of social media, there is a heightened awareness of the use of Facebook, Twitter and LinkedIn for business purposes. But let us not forget the problems with your personal use of social media. 

While some of us may wish for an Internet delete button, it does not exist, and what you say and do online, even in a personal account, may come back to haunt you - professionally as well as personally.

Here is a reminder, and some suggestions, from LifeHacker - How You're Unknowingly Embarrassing Yourself Online (and How to Stop)

Monday, June 24, 2013

Final Step in the Acquisition of Smith Barney Arrives

A final handshake on Morgan Stanley’s acquisition of Smith Barney will tie up some lingering loose ends, including a smoother clearing process for client assets, in one of the largest wealth management industry deals in the past decade. After a four-year process, Morgan Stanley has agreed to purchase the remaining 35% share of Smith Barney from Citigroup as soon as next week, the firm announced on Friday.
Finishing Touches On Citi Deal Boost Morgan Stanley Wealth Management

The attorneys at Sallah Astarita & Cox include veteran securities litigators and former SEC Enforcement Attorneys. We have decades of experience in securities litigation matters, including the defense of enforcement actions, as well as disputes between brokers and their firms. For more information contact Mark Astarita at 212-509-6544 or at mja@sallahlaw.com

Sunday, June 23, 2013

Stopping Bank Crises Before They Start

This is a Wall Street Journal Oped 6/24/2013

Regulating the riskiness of bank assets is a dead end. Instead, fix the run-prone nature of bank liabilities.

In recent months the realization has sunk in across the country that the 2010 Dodd-Frank financial-reform legislation is a colossal mess. Yet we obviously can't go back to the status quo that produced a financial catastrophe in 2007-08. Fortunately, there is an alternative.

At its core, the recent financial crisis was a run. The run was concentrated in the "shadow banking system" of overnight repurchase agreements, asset-backed securities, broker-dealers and investment banks, but it was a classic run nonetheless.

The run made the crisis. In the 2000 tech bust, people lost a lot of money, but there was no crisis. Why not? Because tech firms were funded by stock. When stock values fall you can't run to get your money out first, and you can't take a company to bankruptcy court.

This is a vital and liberating insight: To stop future crises, the financial system needs to be reformed so that it is not prone to runs. Americans do not have to trust newly wise regulators to fix Fannie Mae and Freddie Mac, end rating-agency shenanigans, clairvoyantly spot and prick "bubbles," and address every other real or perceived shortcoming of our financial system.

Runs are a pathology of financial contracts, such as bank deposits, that promise investors a fixed amount of money and the right to withdraw that amount at any time. A run also requires that the issuing institution can't raise cash by selling assets, borrowing or issuing equity. If I see you taking your money out, then I have an incentive to take my money out too. When a run at one institution causes people to question the finances of others, the run becomes "systemic," which is practically the definition of a crisis.

By the time they failed in 2008, Lehman Brothers and Bear Stearns were funding portfolios of mortgage-backed securities with overnight debt leveraged 30 to 1. For each $1 of equity capital, the banks borrowed $30. Then, every single day, they had to borrow 30 new dollars to pay off the previous day's loans.

When investors sniffed trouble, they refused to roll over the loans. The bank's broker-dealer customers and derivatives counterparties also pulled their money out, each also having the right to money immediately, but each contract also serving as a source of short-term funding for the banks. When this short-term funding evaporated, the banks instantly failed.

Clearly, overnight debt is the problem. The solution is just as clear: Don't let financial institutions issue run-prone liabilities. Run-prone contracts generate an externality, like pollution, and merit severe regulation on that basis.

Institutions that want to take deposits, borrow overnight, issue fixed-value money-market shares or any similar runnable contract must back those liabilities 100% by short-term Treasurys or reserves at the Fed. Institutions that want to invest in risky or illiquid assets, like loans or mortgage-backed securities, have to fund those investments with equity and long-term debt. Then they can invest as they please, as their problems cannot start a crisis.

Money-market funds that want to offer better returns by investing in riskier securities must let their values float, rather than promise a fixed value of $1 per share. Mortgage-backed securities also belong in floating-value funds, like equity mutual funds or exchange-traded funds. The run-prone nature of broker-dealer and derivatives contracts can also be reformed at small cost by fixing the terms of those contracts and their treatment in bankruptcy.

The bottom line: People who want better returns must transparently shoulder additional risk.

Some people will argue: Don't we need banks to "transform maturity" and provide abundant "safe and liquid" assets for people to invest in? Not anymore.

First, $16 trillion of government debt is enough to back any conceivable demand for fixed-value liquid assets. Money-market funds that hold Treasurys can expand to enormous size. The Federal Reserve should continue to provide abundant reserves to banks, paying market interest. The Treasury could offer reserves to the rest of us—floating-rate, fixed-value, electronically-transferable debt. There is no reason that the Fed and Treasury should artificially starve the economy of completely safe, interest-paying cash.

Second, financial and technical innovations can deliver the liquidity that once only banks could provide. Today, you can pay your monthly credit-card bill from your exchange-traded stock fund. Tomorrow, your ATM could sell $100 of that fund if you want cash, or you could bump your smartphone on a cash register to buy coffee with that fund. Liquidity no longer requires that anyone hold risk-free or fixed-value assets.

Others will object: Won't eliminating short-term funding for long-term investments drive up rates for borrowers? Not much. Floating-value investments such as equity and long-term debt that go unlevered into loans are very safe and need to pay correspondingly low returns. If borrowers pay a bit more than now, it is only because banks lose their government guarantees and subsidies.

In the 19th century, private banks issued currency. A few crises later, we stopped that and gave the federal government a monopoly on currency issue. Now that short-term debt is our money, we should treat it the same way, and for exactly the same reasons.

In the wake of Great Depression bank runs, the U.S. government chose to guarantee bank deposits, so that people no longer had the incentive to get out first. But guaranteeing a bank's deposits gives bank managers a huge incentive to take risks.

So we tried to regulate the banks from taking risks. The banks got around the regulations, and "shadow banks" grew around the regulated system. Since then we have been on a treadmill of ever-larger bailouts, ever-expanding government guarantees, ever-expanding attempts to regulate risks, ever-more powerful regulators and ever-larger crises.

This approach will never work. Rather than try to regulate the riskiness of bank assets, we should fix the run-prone nature of their liabilities. Fortunately, modern financial technology surmounts the economic obstacles that impeded this approach in the 1930s. Now we only have to surmount the obstacle of entrenched interests that profit from the current dysfunctional system.

Thursday, June 20, 2013

FINRA Targeting Social Media

A targeted examination letter from theFINRA has turned up the heat on firms using social media.  According to On Wall Street, the letter makes six requests ranging in scope from a general explanation of social media use to the names and Central Registration Depository numbers of the top 20 producing advisors using social media. As the first broad "sweep" done on social media, it illustrates that FINRA will be holding firms to a higher standard of compliance in this relatively new communication channel, said Jimmy Douglas, director of alliances and industry relations Smarsh,

I am not sure that I agree with Mr. Douglas, who has a financial interest in a "higher standard of compliance" as a director of Smarsh, but this is certainly an indication that FINRA is preparing to conduct examinations, and to file charges, for misuse of social media.

My practice areas all converge at the intersection of the Internet and broker-dealer regulation and regularly advise firms and brokers on the use of the Internet, Twitter, Facebook and LinkedIn. Some of my commentary on social media is here at the blog. We can expect signifcant fines by FINRA for social media violations.  If your firm receives an inquiry from FINRA regarding your use of social media, give me a call at 212-509-6544, or send me an email at mja@sallahlaw.com, and let's see if we can help you avoid those issues.

FINRA Launches Social Media Spot-Checks | On Wall Street

Wednesday, June 19, 2013

Report: Wealthiest Clients Want to Consolidate Advisors

Here is an interesting report - the World Health Report 2013 found that the majority of wealth managers are keeping their richest clients happy. More than 60% of high-net-worth clients expressed a high degree of trust in both their wealth managers and their firms.

More good news - 52.6% of high-net-worth clients prefer to work with a single firm to “manage all of their financial needs,” according to the report.

World Wealth Report: Wealthiest Clients Want to Consolidate Advisors

Janney Adds Advisors from Morgan Stanley and Ameriprise

Financial advisors continue to change firms and a quick pace. Janney has added two former Morgan Stanley advisors and a branch manager from Ameriprise to its ranks. Industry veterans.  Alfred DeRenzis and Scott Ford joined in the Baltimore, Md., office from Morgan Stanley, and former Ameriprise manager Gregg Torretta joined in Fort Lauderdale, Fla. DeRenzis and Ford oversee around $159 million in assets and join as senior vice president/wealth management and first vice president/wealth management, respectively.

Advisors who are contemplating changing firms or becoming RIAs are advised to seek experienced legal counsel to assist in that transition. The attorneys at Sallah Astarita & Cox have been working with advisors for decades. Call 212-509-6544 if you are contemplating a move - or email us at mja@sallahlaw.com

Janney Adds Advisors from Morgan Stanley, Ameriprise

Piper to Buy Edgeview Partners

Investment bank and asset management firm Piper Jaffray Cos. is buying middle-market advisory firm Edgeview Partners LP.  Financial terms were not disclosed. Edgeview Partners specializes in mergers and acquisitions. Piper Jaffray said Monday that the deal will strengthen its position in middle-market mergers and acquisitions and provide a complementary investment banking business. The transaction also gives Piper Jaffray more resources for private equity firms.

Piper Jaffray buying Edgeview Partners

Tuesday, June 18, 2013

SEC Charges Whittier Trust and Fund Manager in Insider Trading Investigation Into Expert Networks

The SECcharged a South Pasadena, Calif.-based wealth management company and a former fund manager with insider trading on non-public information about technology companies. The charges are the agency’s latest in its ongoing investigation into expert networks and hedge fund trading.

The SEC alleges that Whittier Trust Company and its fund manager participated in an insider trading scheme involving the securities of Dell, Nvidia Corporation, and Wind River Systems. The fund manager generated profits and avoided losses for funds he managed at Whittier Trust by trading on confidential information that he obtained from another Whittier Trust fund manager who he supervised. The other manager was charged by the SEC in January 2012 and is currently cooperating with the investigation.

Whittier Trust and the fund manager agreed to pay nearly $1.7 million to settle the charges.
“Time and again, [the fund manager] received what he knew was inside information from [the other manager] and traded on it to generate illicit gains for the funds he managed,” said Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office. “Now, he and Whittier Trust join a long list of insider trading perpetrators who have been held accountable by the SEC for their transgressions.”

The SEC has charged more than three dozen individuals and firms in enforcement actions arising out of its expert networks investigation, which has uncovered widespread insider trading at several hedge funds and other investment advisory firms. The first series of charges were brought in 2011.

The attorneys at Sallah Astarita & Cox include former SEC staff attorneys and vetran securities litigators. We have extensive experience in insider trading cases, including recently obtaining a dismissal of insider trading charges against a client. See SEC Loses Insider Trading Case for more information. For more information regarding the defense of insider trading cases and investigations, contact us by email or visit our website at www.sallahlaw.comFor more information on this case, visit SEC Charges Whittier Trust and Fund Manager in Insider Trading Investigation Into Expert Networks.
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Mankiw on the 1%

Greg Mankiw has an intereting new article draft, titled "Defending the 1%"  It's mistitled really, as the main point I got out of it is the more interesting question, "Can transfers really help the bottom 50%?"

It's a very well written (as one would expect) and survey of economic issues surrounding the idea of greatly expanded taxation of upper income people to fund transfers. Go read it, I won't do it justice in a summary.

As Greg notes, much of the success of the 1% is not rent-seeking, nor inherited wealth, but entrepreneurs who innovated and got spectacularly wealthy in the process.

It's not clear how Steve Jobs getting hugely rich hurts the rest of us. (Greg makes a few jabs at financial profits, but readers of this blog know that's a more nuanced issue.) It's not clear how any of us even know if Jobs had $100 million, $1 billion, or $1 Gazillion when he died, though it makes a huge difference to measured inequality.  And I like Greg's emphasis that it doesn't make much philosophical or moral sense to draw national borders around income-transfer moral philosophy.  Look for the kidney story too.

Greg chose not to argue with the very tricky measurement issues, instead just quoting Pikkety and Saez' numbers.  That's a good issue for another day -- other measures give very different results.

One of Greg's main points is that our inequality is the result of an interplay between supply and demand for talented skilled people.
I am more persuaded [than by Stiglitz] by the thesis advanced by Claudia Goldin and Lawrence Katz (2008) in their book The Race between Education and Technology. Goldin and Katz argue that skill biased technological change continually increases the demand for skilled labor. By itself, this force tends to increase the earnings gap between skilled and unskilled workers, thereby increasing inequality. Society can offset the effect of this demand shift by increasing the supply of skilled labor at an even faster pace, as it did in the 1950s and 1960s. In this case, the earnings gap need not rise and, indeed, can even decline, as in fact occurred. But when the pace of educational advance slows down, as it did in the 1970s, the increasing demand for skilled labor will naturally cause inequality to rise. The story of rising inequality, therefore, is not primarily about politics and rent-seeking but rather about supply and demand.
Having stated it this way, I'm disappointed Greg didn't explore supply more. Why is it that America has not responded this time by increasing the supply of skilled workers? The obvious suspects are easy to name, and do not bode well for the left's suggestion that permaent confiscatory taxation plus transfers are the answer to the "problem."

Greg does a good job of painting the standard incentive problem with tax and transfer redistribution. However, he states it in its classic, static form. More transfers means less work effort. In reality, hours of work don't really respond that much, as there are only so many hours in a day and income and substitution effects offset. To make this come alive, we need to think harder about the margin of working vs. not working.

And investing. Here the two points come together, and I don't think Greg's article nor the literature put the pieces in one place. We need a dynamic perspective. If inequality comes from a mismatch between supply and demand for skill, then keeping the incentives in place to acquire skill is vital. If there is a strong income-based transfer scheme in place, yes, there  is less incentive to work overtime. And yes, there is less incentive to work at all at least legally. But most of all, there is less incentive to go to school, to pick hard courses (face it, art history is a lot more fun than python and Java 101), pursue expensive advanced graduate education or innovate. One can imagine a spiral, or inequality laffer curve: Demand for skill outpaces supply, inequality rises, we put in place an income based transfer scheme, less people acquire skils, inequality rises...

Greg has a great section, "listening to the left" which I will now invite as well. Forget about the 1%. Pretend wealth grows on trees. Let's just think of the fortunes of the bottom 50%. Can we actually help them? Is there any historical precednent of a successful society that pays large means-tested amounts to young and working-age men and women, without destroying their incentives to gain skills and become middle class, to say nothing of the next Steve Jobs?

Social security doesn't count; the question is sending checks to young, healthy, but low-skilled working age people.  Short-term doesn't count. I want to know of an instance in which, maintained over a generation or two, such a system did anything more than perpetuate an unskilled largely dysfuncitonal underclass, which achieved much more than reliably voting for politicians who endorse its transfers. (The model "send money to Democratic voters" does explain the proposed policies pretty well!) The reputed wonders of living in Sweden or other welfare states don't count: their benefits are in kind, and not means tested.

It's easy to come up with incentive-destruction horror stories, American welfare, European dole, and so on.  Small cash transfers coupled with restricted educational opportunities and large labor market wedges, as faced by refugees and many European immigrants, seem particularly destructive. Tom Sowell writes whole books of examples.  But it's too easy to listen to the choir. To those of you advocating large cash transfers, when has this ever worked?   I'm curious to hear a clear historical precedent for the policies you advocate for the US. 

Two seconds

The weekend wall street journal had an interesting article about high speed trading, Traders Pay for an Early Peek at Key Data. Through Thompson-Reuters, traders can get the University of Michigan consumer confidence survey results two seconds ahead of everyone else. They then trade S&P500 ETFs on the information.

Source: Wall Street Journal

Naturally, the article was about whether this is fair and ethical, with a pretty strong sense of no (and surely pressure on the University of Michigan not to offer the service.)
It didn't ask the obvious question: Traders need willing counterparties. Knowing that this is going on, who in their right mind is leaving limit orders on the books in the two seconds before the confidence surveys come out?

OK, you say, mom and pop are too unsophisticated to know what's going on. But even mom and pop place their orders through institutions which use trading algorithms to minimize price impact. It takes one line of code to add "do not leave limit orders in place during the two seconds before the consumer confidence surveys come out."

In short, the article leaves this impression that investors are getting taken. But it's so easy to avoid being taken, so it seems a bit of a puzzle that anyone can make money at this game. 

I hope readers with more market experience than I can answer the puzzle: Who is it out there that is dumb enough to leave limit orders for S&P500 ETFs outstanding in the 2 seconds before the consumer confidence surveys come out?

Monday, June 17, 2013

Good Markets, More Broker Transitions

We have seen an uptick in financial advisors changing firms as the markets continue to improve. Wells Fargo Advisors just announced that it has hired nine financial advisors from Morgan Stanley, Merrill Lynch and RBC Capital Markets with $1.12 billion in assets under management.

Transitioning between firms is a important, and stressful time. Too many advisors do not seek the assistance of counsel when they change firms, despite the fact that there is significant sums of money and future business at stake. We represent advisors across the country in their transition efforts, including protocol compliance, promissory note negotiation, and review, advise and negotiation of employment agreements, promissory notes, transition payments, and everything in between.

Most of that work is done on a flat fee basis, at a reasonable cost.

And it is certainly less expensive than hiring us to review the documents years later, when the advisor is looking to leave that same firm. Call us at 212-509-6544 or email me at mja@sallahlaw.com

Wells Fargo Hires 9 Advisors Managing $1.12B 
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You Need Permission to Send Commercial Text Messages - 16.5 Million Dollar Settlement

Just like the rules for emails, you need to have permission to send commercial text messages or a prior business relationship. Papa John's learned that when a  customer calls on the phone to order a pizza, that is not permission to spam the customer's cell phone with text messages.

Papa John's Settles Text Spamming Suit for $16.5 Million


SEC, FINRA Warn Investors About Pump-And-Dump Stock Spam

The SEC and the Financial Industry Regulatory Authority (FINRA) issued a warning to investors about a sharp increase in e-mail linked to "pump-and-dump" stock schemes.

The investor alert entitled Inbox Alert - Don't Trade on Pump-And-Dump Stock E-mails notes that the latest McAfee Threats Report confirms a steep rise in spam e-mail linked to bogus "pump-and-dump" stock schemes designed to trick unsuspecting investors. These false claims could also be made on social media such as Facebook and Twitter as well as on bulletin boards and chat room pages.

"Investors should always be wary of unsolicited investment offers in the form of an e-mail from a stranger," said Lori Schock, Director of the SEC's Office of Investor Education and Advocacy. "The best response to investment spam is to hit delete."

"Spam e-mail is the bait used to lure people into making bad investment decisions. No one should ever make an investment based on the advice of an unsolicited email," said Cameron Funkhouser, Executive Vice President of FINRA's Office of Fraud Detection and Market Intelligence.

Pump-and-dump promoters frequently claim to have "inside" information about an impending development. Others may say they use an "infallible" system that uses a combination of economic and stock market data to pick stocks. These scams are the inbox equivalent of a boiler room sales operation, hounding investors with potentially false information about a company.

The attorneys at Sallah Astarita & Cox, LLC have decades of experience in stock fraud litigation. For more information contact us by email or visit our website at www.sallahlaw.comFor more information on this particular matter,  visit SEC, FINRA Warn Investors About Pump-And-Dump Stock Spam.
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SEC Charges Revlon with Misleading Shareholders in Going Private Transaction

The SEC charged cosmetics and beauty care manufacturer Revlon with violating federal securities laws when the company misled shareholders during a "going private transaction."

Going private transactions can occur in many forms and typically involve the company delisting and deregistering its stock and cashing out their shareholders so the company or a private equity firm can acquire all of the outstanding shares. An SEC investigation found that during a voluntary exchange offer to satisfy a significant debt to its controlling shareholder, Revlon engaged in "ring fencing" that deprived its independent board members from knowing critical information: the transaction's consideration had been deemed inadequate by a third party who evaluated whether current and former employees invested in Revlon common stock through the company's 401(k) plan could exchange their shares.

Revlon agreed to settle the SEC's charges and pay an $850,000 penalty.

"Going private transactions create opportunities for shareholder abuse and can have coercive effects on minority shareholders," said Antonia Chion, Associate Director in the SEC's Division of Enforcement. "By erecting informational barriers, Revlon kept critically important information from its board and, in turn, misled investors."

According to the SEC's order instituting settled administrative proceedings, controlling shareholder MacAndrews and Forbes (M&F) asked Revlon in 2009 to offer minority shareholders the option to exchange their common stock shares on a one-for-one basis for preferred shares with certain financial characteristics. The exchanged shares would then be provided to M&F to pay down Revlon's debt. The trustee administering Revlon's 401(k) plan decided that 401(k) members could tender their shares only if a third-party financial adviser made an "adequate consideration determination," which involved assessing whether the value of the preferred stock 401(k) members would receive was at least equal to the fair market value of the exchanged common stock shares. The third-party financial adviser ultimately found that the consideration offered in the transaction was inadequate for tendering 401(k) shareholders.

The attorneys at Sallah Astarita & Cox, LLC are available for consultation on going private transactions, as well as representing in claims involving misrepresentations in connection with such transactions. For more information contact us by email or visit our website at www.sallahlaw.com. For more information on this case, visit SEC Charges Revlon with Misleading Shareholders in Going Private Transaction.

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SEC Announces More Charges in Massive Kickback Scheme to Secure Business of Venezuelan Bank

The SECcharged the former head of the Miami office at brokerage firm Direct Access Partners (DAP) for his role in a massive kickback scheme to secure the bond trading business of a state-owned Venezuelan bank.

The SEC charged four individuals last month who enabled the global markets group at DAP to generate more than $66 million in revenue from transaction fees related to fraudulent trades they executed for Banco de Desarrollo Económico y Social de Venezuela (BANDES). A portion of this revenue was illicitly paid to the Vice President of Finance at BANDES, who authorized the fraudulent trades.

The SEC alleges that the managing partner of the global markets group was an integral participant in the wide-ranging fraudulent scheme that included sham arrangements to hide the kickback payments and route money to the BANDES official through shell corporations. The managing partner and others charged in the scheme deceived DAP's clearing brokers, executed internal wash trades, interpositioned another broker-dealer in the trades to conceal their role in the transactions, and engaged in massive roundtrip trades to pad their revenue.

"For a scheme this bold to succeed, it required the sneaky collaboration of several individuals including the head of the Miami office," said Andrew M. Calamari, Director of the SEC's New York Regional Office. "[The managing partner] and the others may have believed they were covering their tracks, but the SEC's exam and enforcement teams unraveled their fraud."

In a parallel action, the U.S. Attorney's Office for the Southern District of New York announced criminal charges against the managing partner.

The attorneys at Sallah Astarita & Cox, LLC  have decades of experience in securities fraud investigations and in defending white collar criminal cases. For more information contact us by email or visit our website at www.sallahlaw.com. For more information on this case, visit SEC Announces More Charges in Massive Kickback Scheme to Secure Business of Venezuelan Bank.

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Former Mutual Fund Directors Agree to Settle Claims That They Failed to Properly Oversee Asset Valuation

The SEC announced a settlement in an enforcement proceeding against eight former directors of five Regions Morgan Keegan open- and closed-end funds that were heavily invested in securities backed by subprime mortgages. The proceeding, which began in December 2012, alleged that the directors failed to satisfy their pricing responsibilities under the federal securities laws.

Under the securities laws, fund directors are responsible for determining the fair value of portfolio securities for which market quotations are not readily available. In addition, fund directors must determine the methodologies to be used to fair value securities and must periodically reevaluate the appropriateness of those methodologies. The Commission made clear in Accounting Series Release No. 118 (Dec. 23, 1970) and In the Matter of Seaboard Associates Inc., Investment Company Act Release No. 13890 (April 16, 1984) that while fund directors may engage others to assist them to calculate fair values of these securities, they continue to be ultimately responsible to determine fair value in good faith.

The settled order finds that the eight directors failed to satisfy these responsibilities. Specifically, the directors delegated their fair valuation responsibility to a valuation committee without providing adequate substantive guidance on how fair valuation determinations should be made. The directors then made no meaningful effort to learn how fair values were being determined. They received only limited information about the factors involved with the funds' fair value determinations, and obtained almost no information explaining why particular fair values were assigned to portfolio securities. The limited information provided to the directors was particularly problematic because fair valued securities comprised a significant percentage of the funds' net asset values (NAVs) - in most cases above 60 percent.

The settled order finds that the valuation committee to whom the directors delegated the fair valuation responsibilities did not utilize reasonable procedures and often allowed the portfolio manager to arbitrarily set values. As a result, the settled order finds that the funds overstated the value of their securities as the housing market was on the brink of financial crisis in 2007. The SEC and other regulators previously charged Morgan Keegan and others, and the firms later agreed to pay $200 million to settle charges related to that conduct.

For more information regarding SEC enforcement actions and the defense of those accused, contact Mark Astarita at Sallah Astarita & Cox, LLC. For more information on this particular case, seeit Former Mutual Fund Directors Agree to Settle Claims That They Failed to Properly Oversee Asset Valuation.
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Friday, June 14, 2013

SEC Charges CBOE for Regulatory Failures

This is a twist that we haven't seen since the SEC went after the NASD. The SEC has charged the Chicago Board Options Exchange (CBOE) and an affiliate for various systemic breakdowns in their regulatory and compliance functions as a self-regulatory organization, including a failure to enforce or even fully comprehend rules to prevent abusive short selling.

CBOE agreed to pay a $6 million penalty and implement major remedial measures to settle the SEC's charges. The financial penalty is the first assessed against an exchange for violations related to its regulatory oversight. Previous financial penalties against exchanges involved misconduct on the business side of their operations.

Self-regulatory organizations (SROs) must enforce the federal securities laws as well as their own rules to regulate trading on their exchanges by their member firms. In doing so, they must sufficiently manage an inherent conflict that exists between self-regulatory obligations and the business interests of an SRO and its members. An SEC investigation found that CBOE failed to adequately police and control this conflict for a member firm that later became the subject of an SEC enforcement action. CBOE put the interests of the firm ahead of its regulatory obligations by failing to properly investigate the firm's compliance with Regulation SHO and then interfering with the SEC investigation of the firm.

According to the SEC's order instituting settled administrative proceedings, CBOE demonstrated an overall inability to enforce Reg. SHO with an ineffective surveillance program that failed to detect wrongdoing despite numerous red flags that its members were engaged in abusive short selling. CBOE also fell short in its regulatory and compliance responsibilities in several other areas during a four-year period.

"The proper regulation of the markets relies on SROs to aggressively police their member firms and enforce their rules as well as the securities laws," said Andrew J. Ceresney, Co-Director of the SEC's Division of Enforcement. "When SROs fail to regulate responsibly the conduct of their member firms as CBOE did here, we will not hesitate to bring an enforcement action."

For more information, visit SEC Charges CBOE for Regulatory Failures.
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Thursday, June 13, 2013

Job market doldrums

Three recent views on the dismal labor market pose an interesting contrast.

Alan Blinder wrote a provocative WSJ piece on 6/11, Fiscal Fixes for the Jobless Recovery. A week prviously, 6/5, Ed Lazear wrote about The Hidden Jobless Disaster. And John Taylor has a good short blog post Job Growth–Barely Keeping Pace with Population

All three authors emphasize that the unemployment rate is a poor measure of the labor market. Unemployment counts people who don't have a job but are actively looking for one. People who give up and leave the labor force don't count. Employment is a more interesting number, and the employment-population ratio a better summary statistic than the unemployment rate. After all, if unemployment falls because everyone who is looking for a job gives up, I don't think we'd see that as a good sign.

Source: Wall Street Journal
Ed Lazear made this interesting chart. As he explains,

Every time the unemployment rate changes, analysts and reporters try to determine whether unemployment changed because more people were actually working or because people simply dropped out of the labor market entirely... The employment rate—that is, the employment-to-population ratio—eliminates this issue by going straight to the bottom line, measuring the proportion of potential workers who are actually working.

While the unemployment rate has fallen over the past 3½ years, the employment-to-population ratio has stayed almost constant at about 58.5%, well below the prerecession peak. Jobs are always being created and destroyed, and the net number of jobs over the last 3½ years has increased. But so too has the size of the working-age population. Job growth has been just slightly better than what it takes to keep the employed proportion of the working-age population constant. That's why jobs still seem so scarce.

The U.S. is not getting back many of the jobs that were lost during the recession. At the present slow pace of job growth, it will require more than a decade to get back to full employment defined by prerecession standards....

Why have so many workers dropped out of the labor force and stopped actively seeking work? Partly this is due to sluggish economic growth. But research by the University of Chicago's Casey Mulligan has suggested that because government benefits are lost when income rises, some people forgo poor jobs in lieu of government benefits—unemployment insurance, food stamps and disability benefits among the most obvious. The disability rolls have grown by 13% and the number receiving food stamps by 39% since 2009.
John Taylor makes the point nicely with another graph, which contrasts the labor force participation rate to the BLS' forecast of what should have happened from demographic effects.

The graph comes from a recent paper Chris Erceg and Andrew Levin.

I part company a bit with Lazear on his conclusions
... the various programs of quantitative easing (and other fiscal and monetary policies) have not been particularly effective at stimulating job growth. Consequently, the Fed may want to reconsider its decision to maintain a loose-money policy until the unemployment rate dips to 6.5%.
If low employment is "structural," resulting from the worker-side disincentives as well as employer-side disincentives -- policy uncertainty, regulatory threats, NLRB, Obamacare, Dodd-Frank, EPA, and so on -- then the problem isn't lack of "demand" in the first place. If the problem has nothing to do with the Fed, and if $2 trillion of QE didn't do anything to help it, why does the solution have anything to do with the Fed?

The greater surprise is to hear so much agreement from Alan Blinder:
The Brookings Institution's Hamilton Project, with which I am associated, estimates each month what it calls the "jobs gap," defined as the number of jobs needed to return employment to its prerecession levels and also absorb new entrants to the labor force. The project's latest jobs-gap estimate is 9.9 million jobs. At a rate of 194,000 a month, it would take almost eight more years to eliminate that gap.

.... policy makers should be running around like their hair is on fire.
Lazear said "a decade."  More suprising agreement on the impotence of monetary policy:
The Federal Reserve has worked overtime to spur job creation, and there is not much more it can do.
As you might imagine, I'm not such a fan of Blinder's suggested fixes. He starts with traditional simple Keynesian recommendations that  the government should hire people and "spend" more. No need to refight that here. The more interesting recommendations follow as he warms up to his latest clever scheme.
... the basic idea is straightforward: Offer tax breaks to firms that boost their payrolls.

For example, companies might be offered a tax credit equal to 10% of the increase in their wage bills over the previous year. ...

Another sort of business tax cut may hold more political promise....Suppose Congress enacted a partial tax holiday that allowed companies to repatriate profits held abroad at some bargain-basement tax rate like 10%. The catch: The maximum amount each company could bring home at that low tax rate would equal the increase in its wage payments as measured by Social Security records.

For example, if XYZ Corporation paid wages covered by Social Security of $1 billion in 2012 and $1.1 billion in 2013, it would be allowed to repatriate $100 million at the superlow tax rate. The reward for boosting its payroll by $100 million would thus be a $25 million tax saving. That looks like a powerful incentive.

...companies could claim the tax benefit only for individual earnings below the Social Security maximum ($113,700 in 2013). No subsidies for raising executive pay.
I find this most interesting at the level of basic philosophy; how we think about economic policy.

There are huge, longstanding, tax and regulatory disincentives to hiring people. Income tax, payroll taxes, health care and other mandates, and NLRB, OSHA, and so on. There are the high marginal taxes to labor implied by social insurance programs, as Mulligan points out.  If we want to increase the incentive for companies to hire people and people to take the jobs, why add another tax break to an obscenely complex tax code, rather than fix some of the existing disincentives? 

Is this really the right way to run a country? When "policy makers" want more employment, they slap on a complex, tax break on top of a mountain of disncentives. Presumably they then will remove this tax break, and pages 536,721 to 621,843 of the tax code describing it, despite the lobbying by large corporations who have figured out how to exploit it for billions of dollars, once the Brookings Institution decides that there is "enough" employment (!), and "policy-makers" no longer need to encourage it? 

How are the existing hundreds of bits of social engineering in the tax code working out? Do we really need more of this?  Isn't it time to return to a tax code that raises money for the government at minimal distortion?

The contrast between the benevolent "policy-maker" (no dictator ever had such power) and the reality of how the tax code in this country is actually enacted is pretty striking.

I have to say, I'm a bit disappointed in the end by both. They agree that the US economy is about 10 million jobs short. Something big is in the way. Lazear at least mentions some candidates, though many are long-standing. But the stirring conclusion from Lazear is only to continue a loose monetary policy that he says has been ineffective so far, and the conclusion from Blinder is the sort of clever scheme that economists cook up in late-night cocktail parties piling one more quickly-exploitable bit of social engineering on top of a tax code rife with them. Neither recommendation comes close to 10 million jobs, or addressing any sort of clear story why those jobs have vanished.

Thursday, June 6, 2013

Two on financial reform

I recently read two interesting items in the long-running financial regulation saga.

First, a very thoughtful, clear, and succinct speech by Philadelphia Fed President Charles Plosser titled "Reducing Financial Fragility by Ending Too Big to Fail." It's interesting to see a (another?) Fed President basically say that the whole Dodd-Frank / Basel structure is wrong-headed. Two little gems:
 There is probably no better example of rule writing that violates the basic principles of simple, robust regulation than risk-weighted capital calculations.
Remember that Title II resolution is available only when there are concerns about systemic risk. Just imagine the highly political issue of determining whether a firm is systemically important, especially if it has not been designated so by the Financial Stability Oversight Committee beforehand....

...Creditors will perceive that their payoffs will be determined through a regulatory resolution process, which could be influenced through political pressure rather than subject to the rule of law
No surprise, I agree.

Second, Anat Admati and Martin Hellwig have an addition to their "Banker's new clothes" book (my review),  23 Flawed Claims Debunked.  Don't miss the fun footnotes.  Anat and Martin get some sort of medal for patience in wading through dreck.

Bipartisan Mercantilism

From the press release here and here
Wednesday, June 5, 2013 WASHINGTON, D.C. — Following new figures that show a 34 percent jump over last month’s [my emphasis] U.S.-China trade deficit, U.S. Sens. Sherrod Brown (D-OH), Jeff Sessions (R-AL), Chuck Schumer (D-NY), Lindsey Graham (R-SC), Debbie Stabenow (D-MI), Richard Burr (R-NC), Susan Collins (R-ME), and Robert Casey (D-PA), today introduced the Currency Exchange Rate Oversight Reform Act of 2013... 
 ...the bill would use U.S. trade law to counter the economic harm to U.S. manufacturers caused by currency manipulation, and provide consequences for countries that fail to adopt appropriate policies to eliminate currency misalignment. The senators’ introduction comes in advance of upcoming talks between President Obama and Chinese President Xi.
Obviously, this is a political shot across the bow to the Obama Administration to press mercantilist trade restrictions in the upcoming discussions with China. Still, why cloak it in such nonsense as
“It is universally accepted that China and other major countries intentionally manipulate their currency to create an advantage for themselves in the marketplace” [Senator] Graham said.
Well, not "universally."

The "complete summary" continues,
"the bill specifies the applicable investigation initiation standard, which will require Commerce to investigate whether currency undervaluation by a government provides a countervailable subsidy if a U.S. industry requests investigation... 
I'm glad to see that industries which don't like to compete with Chinese manufacturers will become experts in monetary policy.
The legislation requires Treasury to develop a biannual report to Congress that identifies... "fundamentally misaligned currencies" based on observed objective criteria...
I cannot find what those "objective criteria are." Let us know, guys and gals, a Nobel Prize in economics awaits you.

If they don't like the Chinese peg, maybe next they can target Texas for its 1-1 peg to the Ohio dollar, which is obviously sucking business to Texas.

When they're done with "currency manipulation" perhaps they can get to the serious business of impeaching the Easter Bunny.

(Thanks to Alex Walsh at the Birmingham News for pointing me to the link.)


I wrote a short essay on immigration for Hoover's "Advancing A Free Society" series. It's here, and reproduced below.  The whole set of essays in Hoover's Immigration Reform series is worth perusing.

Since writing it, and also reading Steve Chapman's good editorial on the subject (Chicago Tribune, Townhall) the e-verify system seems like an even bigger nightmare. Every employer in the country must check that every applicant has the Federal Government's permission to work before employing him or her.

Beyond the points raised in the essay below, it's an interesting coincidence that this e-verify is in the news at the same time as the IRS scandal. Congressional Republicans get the cognitive-dissonance award of the year for this one.

Surely, it will never happen that e-verify agents target selected groups for more careful scrutiny or slow processing, because they might want to vote one way or another, or because they have expressed unpopular opinions? Surely employers with unpopular political opinions have nothing to fear here?

Surely, with the technology in place, Congress will never expand the power to dictate who has the right to work and who doesn't? It won't try to deny work or work in certain industries to people convicted of crimes?  Especially people convicted of vague white collar crimes like say "consipracy?" Surely, it will never happen that people's right to work is blocked for getting in trouble with other federal agencies like the NLRB, EPA, EEOC, etc? Surely, this system won't be used to ensure that the victim of the latest SEC witch hunt can never work in the securities industry again?

Surely, Congress will never expand the system to make sure anyone who gets a job has paid up their health insurance, paid their taxes, and changed their lightbulbs to the new low-energy mandates? Surely, Congress and the agency will never use the system to deny the right to work to people accused of "hate speech" or other unpopular exercises of first-amendment privileges?

Surely. Your papers, please?

The Hoover essay:

Immigration Policy: Purpose and Unintended Consequences

The immigration policy discussion and legislative proposals suffer from a huge gaping problem: nobody can articulate what the point is. What are the objectives? People want to come to the United States, work, pay taxes, start businesses, buy houses, and join our society. Why are we keeping them out?

Well, obviously, people who don’t work and want to come only to receive government checks and other benefits are a drain. But our immigration policies and proposals are not crafted to solve that problem. And it’s easy to solve: require a payment at the border, or post a large bond, say $10,000, which is refunded after five years or so of paying taxes, having a job and health insurance, and staying out of jail. Obviously, we don’t want criminals and terrorists, but that desire hardly explains our laws or the proposals on the table.

The vague charge that immigrants will “take jobs” and lower American’s wages is not established at all in economics, and it doesn’t make much sense anyway. It surely doesn’t explain why we keep out people who want to start businesses. Our ancestors didn’t steal Native Americans’ jobs to get rich; they created new businesses and opportunities. Land and capital are plentiful in the United States, so why would we expect new immigrants to be any different?

Furthermore, whether an immigrant works in a US factory and produces a good which undercuts that good produced by a US worker, or whether the immigrant works at a factory in Mexico and produces the same good–probably cheaper–the effect on US wages is the same. By keeping the immigrant out, the factory just moves to Mexico.

Finally, even if keeping foreigners out boosted Americans’ wages, such a policy is a pure transfer. Would the US government send marines to Mexico, to steal a prospective migrant’s cow, or take his wages and send the cow or the wages as a subsidy to US workers? And then charge a sales tax on both the Mexican and the US product, raising its price and sending that as a subsidy to American workers as well? That’s exactly what restricting immigration to prop up wages accomplishes, as it is exactly what trade restrictions accomplish. We send foreign aid and development assistance to lots of countries (well, to their governments, but the intent is to help people). We then try to impoverish them to our benefit.

Political and social arguments carry a little more weight. Face it, many Republicans are anxious about immigrants because they fear they will vote Democratic. A thirteen-year disenfranchisement seems well crafted to exploit that worry. Stories of extremists who immigrate who live off welfare, and commit acts of terrorism stoke fears that the melting pot is broken. But if that were the genuine concern, our immigration laws should favor hardworking, entrepreneurial immigrants likely to adopt our culture. If we have so little faith in the power of our ideas, perhaps we should reexamine them.

If we worry about culture wars, and voting citizens who do not have the basic command of US history, political philosophy, legal and social traditions, that battle was lost, and should be won, in the disastrous public schools, not by keeping entrepreneurs on the doorstep.

Rudderless policies are even more prone to unintended consequences. Under the proposed e-verify system, all employers are supposed to verify the work eligibility status of all employees, including domestic works, in a gargantuan national database.

The result is fairly predictable. The only way to get around the e-verify system would be to make the worker fully illegal. So, rather than have a worker with illegal immigration status, but in the social security system and withholding taxes, we would move to an under-the-table cash economy. And once the company moved to accommodate some illegal workers, why not avoid taxes, regulations, health insurance penalties, and all the rest of it by paying the Americans in cash as well? The immigration law has a huge hole in it: How do people who want to come to work in the United States in the future come here legally? Even if the current illegal immigrants are allowed to stay, if we keep denying entry, new ones will keep coming, and we will be back in the same mess all too soon. You can tell that this must be the plan, because otherwise we wouldn’t need to talk about e-verify. If everyone who wants to come and work can, you don’t need to do fancy verification. You only need that if you conceive of a new, large stock of people in the country trying to work and being barred from doing so.

Immigration law should be like drivers’ licensed law or passport applications: setting out the procedure by which anyone who wants to move to the United States can go about doing so.