The verdict is in: nearly 20 years of keeping the SEC budget starved and cowed have rendered a once competent and feared agency incapable of doing more than winning cases on illegal parking, um, insider trading.
The SEC’s performance in the case at issue, SEC v. Stoker, was such a total fail that the odds are high that any motivated member of the top half of the NC readership would have done a better job of arguing this case pro se than the SEC did. Even though this case was argued before a jury (ooh, scary! They might go into My Eyes Glaze Over mode on CDO details), the basic issues were simple. The CDO squared that Citigroup director Brian Stoker marketed to investors was presented as having its assets selected by an independent asset manager. This is crucial. Just as investors in mutual funds understand they are hiring a fund management firm, and they compete on track records, so to were managed CDOs sold on the notion that the managers were serving the interests of the investors. And this is particularly important for CDOs, since the fact that the final asset list is made available shortly before closing makes it pretty much impossible for investors to evaluate a CDO on their own even if they had the skills and motivation. As we wrote in an earlier post:
The Alternative Banking Group of Occupy Wall Street’s amicus brief in support of Judge Rakoff’s position in the pending appeal makes clear what would be involved in assessing them (boldface original):
The Citigroup CDO at issue in this case was a “hybrid” – this meant that the CDO included cash bonds, and simultaneously made it possible (through CDS) to bet against the housing market. The fact that the security was also a “CDO squared” meant that it was a repackaging of approximately sixty bonds issued by other CDOs, which in turn were backed by fifty to one hundred tranches of MBS bonds, making the leverage on the mortgage market even greater. It appears that this single CDO transaction was backed by approximately three thousand MBS bonds which, by a conservative estimate, were backed by approximately fifteen hundred MBS transactions. Each MBS transaction contained, on average, over two thousand mortgage loans, with an average balance of approximately $160,000. Therefore, in aggregate, the Class V Funding III transaction referenced approximately three million subprime mortgage loans with an aggregate balance of around five hundred billion dollars.
In fact, the manager on the deal in question (Credit Suisse) was NOT independent, but was chosen because it would go along with Citi’s plan to design the CDO to satisfy the interest of short investors, most important, Citi itself, which took down over half the CDS in the deal, and also stuffed $92 million of its toxic bonds in the cash portion (the non-CDS component). Citi made $160 million while investors lost roughly $700 million.
So what did the SEC’s strategy appear to be? This seems to have been a parallel to the approach in the Goldman suit against Goldman’s Fabrice Tourre: to target an non-executive and get him to roll the higher ups. But Tourre and Stoker were both enough made men to be willing to fight. Stoker had a $2.2 million guarantee for 2007. Guys like that do not want to lose their access to the industry meal ticket.
So what was Stoker’s defense? That he was being scapegoated, and Citi should really be on trial. Huh? In prosecutions, whether other parties are being charged is irrelevant. The question at hand is: did the party on trial engage in the conduct in question or not? Saying, “I was only the car driver in the robbery, I didn’t enter the convenience store” does not get you off of being an accessory to a crime. It’s pretty bloomin’ obvious that Stoker misrepresented the deal to investors. He had held securities industry licenses; he knew what the standards were.
I have a raft of disgusted messages from attorneys in my inbox. This one is typical:
We might as well give up the notion that anyone can ever be held accountable by the SEC if they can’t win this case. It was a lay up and they blew it.
A seasoned trial attorney remarked that the note from the jury was “just sad”. The note in question:
This verdict should not deter the S.E.C. from investigating the financial industry, to review current regulations and modify existing regulations as necessary.
But it will do precisely that. Having been exposed as inept, the SEC is guaranteed to avoid another public embarrassment. So they will continue to draft claims that get good PR and settle cases. And it is a no brainer that the Obama Administration will refer to this decision as further proof that it is just too hard to pin anything on those bank executives. One has to wonder, given SEC enforcement chief Robert Khuzami’s deep involvement in the CDO business (he was general counsel of the Americans at Deutsche Bank from 2004 to 2009) and the Administration’s insistence that it’s pointless to even try to prosecute bank executives, whether this case was thrown, as opposed to merely lost. But absent evidence, never attribute to malice that which can be explained by incompetence.
Charles Ferguson and Eliot Spitzer are right. If anyone was really serious about going after bank misdeeds, the path of action would be to go after how bankers pay for drugs and prostitutes on the company dime. This would not be hard to prove and the threat of jail time would get them to sing. But it’s long been apparent that the problem is not the lack of viable courses of action, but lack of will to undermine the rule of our financial overlords.