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Along Comes Mary


For once, then, something.
- Robert Frost

We flatter ourselves to think that Mary Schapiro has been reading these columns - no doubt in secret, and behind a locked door.  We have been flogging our idea of a high-level SWAT team of Wall Street compliance professionals (indeed, as recently as last week, qv).  Now the SEC has announced a program very much along the lines of our proposal.  With nary a gloat, we offer the following from this week's SEC release:


SEC Announces New Initiative to Identify and Assess Risks in Financial Markets


Washington, D.C., April 30, 2009 - The Securities and Exchange Commission today announced a new effort to identify and assess risks in the financial markets by attracting seasoned industry professionals to the agency's Office of Risk Assessment.
"It's a great way to bring in highly-seasoned financial experts who can help us keep pace with the practices of Wall Street and protect investors," said Chairman Mary Schapiro, "and provide industry veterans the unique opportunity to help us restore confidence in the markets."
The SEC will immediately begin recruiting candidates with extensive experience in the financial markets.

Now for the bad news.

Right off the bat, there is the inherent timidity of government initiatives in the face of generational entrenched bureaucracies.  Scrolling down the application information, we note - "The Program will initially include three full-time Fellow positions," and that "Salary is commensurate with experience. In 2009, salaries for Industry and Markets Fellows range from $108,286 to $227,300.


According to the SEC website, their job might include:


* identifying products, practices, and processes that pose risks to investors and markets; assisting staff in identifying and collecting additional information necessary to better understand the scope or impact of the risk; [Translation: telling the SEC what they really should be looking at, instead of the checklists and other nonsense they waste most of their time on.]


* developing educational/informational programs and materials to help familiarize SEC staff with current industry practices, products, trends and related risks; [Translation: explaining to the SEC staff how the industry actually works - from the perspective of people who have spent their careers on the inside.]


* working closely with managers in offices and divisions to help design responses and solutions to identified risks; [Translation: creating procedures that will actually prevent crime; also, coming up with punishments that will really hurt.] and


* engaging in discussions with representatives from a wide range of institutions, including but not limited to regulated and unregulated market participants, domestic and international regulators, academics and others. [Translation: acting as interpreter between the SEC and Wall Street.]

This is a once-in-a-generation opportunity to retool the inner workings of one of the most needlessly convoluted agencies in a government already noted for being Byzantinely labyrinthine.  (Or should that be "labyrithinely Byzantine"?)  Chairman Schapiro is widely credited with effectively combining the NYSE and NASD into FINRA, during which she engaged in pitched battles with warring embedded bureaucracies on both sides.  The NASD, a largely useless agency when Schapiro took it over, was nothing compared to the scope, size, and massive uselessness of the SEC.  (Note that we define "uselessness" as a function of size, budget, and target influence on the marketplace.)  The three "Industry and Markets Fellows" - terms limited to two years, with a single possible renewal - will be faced with a task better tackled by the fifty professionals we have been advocating.  Our approach also contemplated higher salaries, designed to attract serious Wall Street talent.


The job description reads as though written for a specific candidate - someone's nephew was fired during a round of cuts at Cadwalader, Wickersham & Taft.  After six years of late-night slogging and sucking up to senior partners, his dreams of making Partner had suddenly gone up in smoke - then along came Mary.  Or whoever.


We wonder how the selection process will actually work. Don't bet on the low salaries being a deterrent, as candidates are coming in for two years, plus a possible further two - in other words, just enough time to ride out what is likely to be the worst of the economic downturn, see a reconstituted Wall Street get back on its feet, and re-emerge into the private sector with "SEC" on the resume.  Pace Obama and the radical reimagining of government, it looks like the old-school revolving door is at work again.

Rounding out our proposal, we saw our Gang of Fifty pairing Wall Streeters with State Securities Commissioners and AGs to drill down on specific local challenges.  Thus, the SEC could provide insight into market abuses arising from Nevada's permissive approach to incorporating, and could coordinate with the Connecticut AG on the Securities Ratings Agencies case.  New York AG Cuomo would presumably want an entire cadre of his own - and such an idea is still not out of the question.  If the SEC won't bite, perhaps the Empire State will.


Just a thought.


Even though it looks to us to be way too small, we are tentatively cheering for this new program.  Even this little something is immeasurably better than the nothing we had before.  We will give Chairman Schapiro the benefit of the doubt: our guess is that when this idea was first broached, the lifers inside the SEC went ballistic.  Think of it - the notion of a bunch of investment bankers and traders telling the government how to regulate the market...  But if the public is made to understand this, and recognizes the benefits to the marketplace, things could rev up in no time.  All it takes is for the press to run with this in a positive way.

We wish Chairman Schapiro well, and we look for this program to expand - if not by fiat, then by stealth.  If not be stealth, then perhaps by acclaim.

The Lookaway

Misdirection - what we call the "Lookaway" - is studied by ninjitsu practitioners and by professional magicians. The Lookaway relies on common physiological and neural patterns, which are manipulated, forcing our attention to unconsciously shift away from the real action just long enough to accomplish the goal - be it sleight of hand, or a fatal attack to a vulnerable body part.

The Lookaway also applies in the financial markets.  When we are distracted by one set of seemingly important facts, other forces operate unfettered.  Usually, these forces are not even identified until they have created a very loud and nasty explosion.  Whether you are making money, or losing it, nothing provides a better Lookaway than fast and extreme movements of large quantities of cash.

The SEC has a new proposal out to impose restrictions on short selling.  Linklaters, the global law firm, sent us a thorough and lucid piece spelling out the specifics of the Proposal, and detailing the various options.  It is Linklaters' own comment on the SEC's position, though, that we find most illuminating.  We excerpt it here:

"The SEC is facing considerable political pressure to take action to restrict short sales... due to the widespread perception of the ability of hedge funds and other short sellers to talk down, and then to engage in unrestricted short selling of financial stocks...[which]  contributed materially to... the current financial crisis.  There is also a widespread assumption... that the Original Uptick Rule, which was in effect during the period between 1938 to 2007, did in fact help cushion the market, and indeed the broader economy, from collapse brought about by 'bear raids' and other short sellers."  They go on to observe that there is little love in the air for hedge funds or other professionals, but also that there is sparse empirical evidence to support the notion of re-establishing an Uptick Rule or other restrictions.
Here's the Lookaway.


Political pressure to crack down on short sellers lies along a continuum with the slaughter of the Kulaks.  High-visibility gentlemen in $2000 suits and Park Avenue addresses are on the fecal roster of everyone from the Speaker of the House, to the Che T-shirt crowd.  People will always hate those who rise high, but taking the billionaires to task in the interest of the SEC making headlines is not an efficient use of taxpayer dollars.


Short sellers are the original Smart Guys on Wall Street, capitalizing on the fact that they always know more than the Longs.  The Shorts are smarter than the Longs, work longer hours, do lots more research and are better informed, and have greater insight into human nature and the mechanisms that move markets. 


The FSA - the UK financial markets regulator - in their Discussion Paper 09/1, "Short Selling", issued in February - concluded that any restriction on short selling would limit both information and liquidity in the markets, without substantially adding to investor protection.  They quote an almost identical conclusion from the SEC's own report in the aftermath of the Pilot Program banning short selling on a basket of financial stocks.  Both government regulatory bodies come to the same conclusion: available data do not support the imposition of a regulatory ban or severe restriction on the practice of short selling.


How smart are the Shorts?  Floyd Norris' blog (http://norris.blogs.nytimes.com/ 30 April, "Is Naked Shorting Gone?") shares his correspondence with Patrick Byrne, Chairman of Overstock.com and a longtime foe of dirty-dealing short sellers.  The takeaway from this exceptionally articulate gentleman's analysis is that the shorts have managed to divert public attention to Upticks and Downticks, when the real skullduggery goes on in the world of settlements and deliveries.  We will return to this in greater detail in future posts, but - pun intended - the long and the short of it is, fails to deliver are covered up by a series of machinations to which the traders, the executing firms, and the prime brokers are all privy.  On a trade-by-trade basis, these wafflings do not cause obvious harm to the investors.  Yet, taken cumulatively, they can create immense pressure on the stocks in question, while possibly also cloaking the effect on firms' capital.


Stay tuned as we look closer into these practices.  Meanwhile, Norris' blog always makes excellent reading.  As the sign in our local pizzeria says: When you get something good, remember where you got it.

Secondhand Smoke: Our Paranoid Fantasy Du Jour

I admit that two times two makes four is an excellent dictum, but if we are to give everything its due, two times two makes five is sometimes a very charming thing too.
  - Dostoevsky, "Notes From Underground"

We hate it when we have missed the obvious.  Our only consolation is that everyone else missed it too.  When things suddenly seem to add up, it is useful to recall Dostoevsky's dictum.  Now an old two plus two is suddenly coming back into focus.

Floyd Norris, writing in his NY Times blog (27 April, "How Not To Regulate") describes the purposely lugubrious pace of Christopher Cox' Chairmanship at the SEC.  Cox was given a mandate to craft consensus at the Commission.  To obtain that consensus, says Norris, "Mr. Cox agreed to throw up a series of procedural hurdles in the way of the enforcement staff investigating and settling cases. Some former enforcement directors thought Linda Thomsen, the enforcement director Mr. Cox inherited, should have quit in protest. Had she done so, the result might have been an enforcement director who did not believe in enforcement. So she stayed, and took much of the blame."


Thomsen was made Chief of the Enforcement Division in May 2005, under outgoing SEC Chair Donaldson.  On 2 June, Cox was appointed SEC Chairman.  On 28 June, Thomsen - the ink barely dry on her appointment - took a call from Morgan Stanley counsel Mary Jo White, seeking insight into the SEC's position vis-à-vis Mack, who was Morgan's choice for CEO.
Thomsen, as we have noted, told White that there was "smoke, but no fire" in the Mack investigation.


Fast forward to November of that same year, when Thomsen fired Gary J. Aguirre, the SEC Enforcement attorney heading the Pequot investigation, finally closing the investigation in 2006 with no charges being brought. 


While some outside the Commission believe senior personnel, such as the Enforcement Chief, have discretion in having sub rosa communication with outsiders, the Commission's own Inspector General did not share that view, and issued a 191-page report that found "serious questions about the impartiality and fairness" of the SEC's investigation of possible insider trading at Pequot Capital.  The report recommended disciplining Thomsen, and derided the "common practice" of giving outside lawyers access to high-level SEC officials. 
Within hours of Thomsen and White speaking, Mack was named CEO of Morgan Stanley, a position he holds to this day.  Which means that, now that the SEC has re-opened the Pequot investigation, they will know where to find him.


We admit to being conspiraholics, and so we just love it when events click.
Like (former - tough beans!) BofA Chairman Ken Lewis testifying that (former - whew!) Treasury Secretary Paulson told him that (still serving... Hmmm...) Fed Chairman Bernanke insisted that BofA complete the Merrill Lynch acquisition, and that if Lewis opened his mouth about how bad Merrill's books were, he'd be fired and replaced with someone more pliable.
We have some new questions regarding a Commissioner who purposely Did Nothing, and an Enforcement Chief who, by all accounts, was known as being exceptionally tough on corruption.  Did Chairman Cox "tell" (wink-wink) Linda Thomsen to "tell" (nod-nod) Morgan Stanley about John Mack?  Like Hank Paulson "told" Ken Lewis to shut up and swallow?  We think it is likely that Cox knew about it before the fact, albeit under the cover of some form of Plausible Deniability.


Like Paulson and Bernanke deciding that they know what's best for the markets, and they will make the rules - here we have two senior government officials deciding who gets what information, and when.  Presumably, in their minds, this is a legitimate twisting of the rules in the service of market stability.  In other words: those who make the law, also decide who gets to be Above the Law. 


The body had not yet cooled, metaphorically speaking, when, in the January interregnum between the Bush and Obama Administrations, the SEC re-opened the Pequot matter.  Watch for "Smokey" Thomsen to be called in to testify, and we sincerely hope there will be questions about Who Knew What, and When Did They Know It? 

Chairman Cox may be brought in as well, and we expect an awkward moment or two. Cox apparently declared himself appalled at Thomsen's mishandling of the Pequot investigation.  His side of the story would seem to be, he was a newly-minted Chairman, working alongside a newly-minted Enforcement Chief, and watching helplessly as she eviscerated a long-running and exceptionally high-profile investigation.  We can not speculate whose idea it was to fire Aguirre, but if Chairman Cox is pulled into the re-opened proceedings, you can be sure this will be asked.  And as we know, the court of public opinion convicts, not on the basis of Beyond Reasonable Doubt, nor on Preponderance of the Evidence, but more along the lines of "Weren't you also in the room at the time?"

We are trying to imagine the political outsider brought in with a mandate to get everyone working together.  He is handed a longtime insider, newly promoted to a high-visibility spot, and in the midst of an investigation with the potential to rock Wall Street from end to end.  Cox calls Thomsen into his office and says, "This is Major Stakes.  Have you got the goods?"  Thomsen pats her pockets, rummages in her briefcase and says, "I had it... it's right... " She snaps her bag shut, pushes her glasses up on her nose and tells Cox.  "It'll turn up."

Chairman Cox may be fairly criticized for many things, but we wonder whether the botched Pequot investigation will turn out to be, not his first major cover-up as SEC Commissioner, but his first major head-slap.

And remember, New York Attorney General Cuomo may get to jump on this one before it's over.  We can't wait for the new season of this Reality Show.


Pigs is Pigs


You can put lipstick on a pig, but it's still a pig.
  - Barack Obama

Owning the Debate: Israeli newspaper Haaretz reports (27 April) "Ultra-Orthodox Deputy Health Minister Yakov Litzman declared that Israel would call the new disease 'Mexico Flu,' rather than 'Swine Flu', as pigs are not kosher."

America's pork producers (you know their advertising: "The other white meat") have chimed in, asking that the illness be referred to as H1N1, in recognition that eating pork does not cause this disease.  May have at one point incubated in swine, and there appears to be evidence that it affects humans who live in close proximity to large pig populations.  This gives credence to Vice President Biden's warning to stay away from enclosed spaces, especially when there are pigs around.  When boarding an airplane, we advise you demand to switch seats if the passenger next to you is a pig.

While our research is merely anecdotal, we note the health section of the website IslamOnline.net, which says "There is no evidence that it is transmissible to people through eating pork or any other products obtained from pigs. If pork is properly cooked, it will not transmit the virus, which is destroyed at a temperature of 160°F/70°C.  It is worth noting that consuming pork or any product derived from pigs is forbidden in Islam."

Indeed, every commentary on this illness makes the point that the best way to prevent infection is frequent washing of the hands.

This reminds us of an encounter witnessed in the men's room at the late, great Bear Stearns.  One gent was at the sink when another came in, used the urinal, zipped up and prepared to leave.  The first gentleman, wiping his hands on a paper towel, said, "At Harvard, they taught us to wash our hands after we pee."  The other replied, "At City College they taught us not to pee on our hands."


President Obama has just returned from a trip to Mexico.  There he was hosted by Felipe Solis, Director of Mexico's Museo Nacional de Antropologia, as reported in the Mexican newspaper El Norte (25 April).  Professor Solis, according to press reports, embraced President Obama, then accompanied him into the Museum where they examined an Aztec calendar and dined together.  The next day Solis was hospitalized with flu-like symptoms.  Within one week, he was dead.

The President and First Lady have returned hale and sound, for which we are grateful.  We marvel at the coincidence that this worldwide health scare blossomed from the very spot where the President stood - indeed, perhaps from the very man who embraced him.  Conspiracy theories aside - even we will not speculate on this one - we are comforted by the knowledge that both Obamas went to Harvard.  Presumably they were taught to wash their hands.  

Moshe Silver

Chief Compliance Officer