Wednesday, January 30, 2008

So what does "trader realism" tell us, Ben?

According to Stein, professional traders, (like judges in the "legal realism" model) start from their desired conclusion, and work backward to rig up the necessary premises.

"Traders can see masses of data any minute of any day. They can find data to support hitting the 'buy' button or the 'sell' button. They don’t act on the basis of what seems to them the real economic situation, but on what’s in it for them."

Of course, classical economists would say, traders act on what's in it for them! So does everybody in the system, at least according to the classical model Stein may think he's refuting here. The difference may be this: Stein thinks the decision whether a "sell" or a "buy" has more "in it for them" has a non-rational, even an irrational, element based on, say, the corporate politics of the broker-dealer, quirks of bonus policies, idiosyncratic personalities.

A classicist who doesn't wish to conform to stereotype too tightly can of course acknowledge that traders sometimes act in ways hard to model. Still, those who consistently act on irrational factors will lose money. They won't stay in business for long. And if there are a lot of traders, and a lot of trading going on, then the irrational aspects are factored out within the whole system, the noise is filtered out and the market conveys information efficiently.

Stein's reason for believing this model is wrong and his "trader realism" has pierced a veil? An uncheckable anecdote. A "close friend of mine, now deceased," who used to be a trader in London for a major financial house, told him a story about shorting IBM on a dare from the boss, and then geting on the phone to spread rumors, talking down the price of IBM so his short position would pay off.

That's it. After the household meatloaf, the law school memories, the trader/judge analogy, we get around to a theory based on a single recollected story from one unnamed person who has shuffled off the mortal coil. Wow! On such evidence, many people seem to believe that Elvis continues to walk about and order Slurpees at various Quickie Marts.

Those of you who wish to follow reactions to his column ... as I've noted, the blogosphere is full of them. Here are just two links to get you going:



Blodgett is harsh, Weiss is critical-but-sympathetic.

It's a tad anachronistic, but I can't help feeling that Oscar Wilde had Stein in mind when he had a character in one of his plays warn that "even these metallic problems have their melodramatic side."

Tuesday, January 29, 2008

Ben Stein's "trader realism"

In The New York Times this Sunday, Ben Stein has explained market volatility in a conspiracy-theorist spirit.

Stein isn't the type of guy who stocks up on canned food and worries about the black helicopters of the UN. He's perhaps best known as an actor (having played Ferris Bueller's teacher, having hosted game shows on television etc.) but he seems to think of himself more as an economist in the line of his father, Herb Stein, who chaired the council of economic advisors under Presidents Nixon and Ford.

At any rate, Stein seems to have carved out a niche for himself somewhere in between the worlds of financial punditry and entertainment. The actor who can discourse eruditely about economics, the finance pundit who can play a role.

His column Sunday begins with a personal note -- he reminds us that he is Herb Stein's kid, and tells us that when he was a child monetarism was a subject for dinner table discussion, over the meatloaf.

From this we seque to his law school education, to his absorption of the ideas known as "legal realism," and from there at last to the point. He has decided that what economics/finance needs is the sort of veil-piercing that the realist scholars brought to the world of law.

I once wrote a book which was largely devoted to the defense of formalism against realism within jurisprudence, so I guess I'n not the audience Stein had in mind when he introduced his conspiracy theory in this roundabout way.

If you'd like to read the column itself, please do sohere. I'll describe the theory to which his effort at veil-piercing has led him tomorrow.

Monday, January 28, 2008

New York Times Inc.

New York Times Inc. has its annual shareholders' meeting in April.

Activist investors have indicated there will be a proxy fight. Two funds who've made those statements, Harbinger and Firebrand, now own between them 4.9% of the company's equity.

When these two firms buy a significant share, they're implying (a) we think the underlying assets are valuable, and (b) we think that existing management is depressing that value.

This isn't the first time Harbinger and Firebrand have worked together. They pushed for a change on the board of Gateway, a computer manufactuer, in 2006. As a result Scott Galloway, Firebrand's chief executive, ended up on that board.

I don't know how cause and effect work out here, but Gateway was acquired by a Taiwanese company, Acer, a year later. Did Galloway press for that? Will he press for NYT Inc. to put itself on the auction block too, if he ends up on their board? I don't know.

I do know, though, that newspaper-companies have been attractive takeover targets in the last two years.

So far the Harbinger/Firebrand forces seem to be emphasizing divestiture, not consolidation. They're suggesting that the NYT company owns too many non-core products.

Sunday, January 27, 2008

"I Know That Sounds Irresponsible"

I think of James Cramer just as "the scary guy," because when I see him on television I'm always afraid a chair is going to come crashing at me through the screen.

Fortunately, there's a YouTube Cramer-clips collage available now that gives you the gist of Cramer's performance in the last year or so without the fear factor.

The highlight is a clip from October 2007, in which Cramer notes that stock market prices were then at record levels, that prices were way above the valuation of the underlying assets, but that the bull market would continue anyway.

It seems that somebody named Don Harrold put this together, but I saw it on Seeking Alpha, and I'll link you there.

Click Here.

The clip begins with a challenge to Jim from Rick Santelli. Jim responds by saying that he's been correctly "bearish" all along, and that Rick clearly hasn't been watching his show. But the clips proving otherwise, interspliced with Maria Bartiromo's lovely laugh, follow immediately.

The "I know that sounds irresponsible" comment comes less than two minutes in.

Wednesday, January 23, 2008


Glenn Greenberg, the chief of Chieftain Capital, is ticked off with Comcast, and with its CEO Brian Roberts, for an obvious reason: Comcast stock is down 40% over the past year.

Roberts' defenders, including the folks at the Motley Fool website, will tell you that the situation isn't of Roberts' making, that there are industry-wide difficulties with cable. The high cost of providing it, to start with. The increasing appeal of satellite TV.

Still, there are obvious answers to that. Is Comcast stock losing value because the company is staying in a dying industry. That's hardly a reason for confidence in its management! Couldn't Roberts' team diversify the company's assets and products?

Perhaps they don't have any very pressing incentive? The company has a dual-share structure, so that Brian Roberts and the rest of the Roberts family (Brian's father is the company founder) have 33% of its voting power, while owning only 1% of the shares.

The story in yesterday's WSJ suggested there's not a lot that Greenberg can do about the situation (except, of course, to sell his stock). He'd need allies to do more, and they haven't shown themselves yet.

Also: didn't he know about the dual share structure when he bought in? If not, why not?

For the rest of us, the question is whether such a structure, with its management-entrenching superstock, is a good or bad policy idea. Is it something the SEC ought to worry about? or just the natural result of freedom of contract? does it have a causal impact on performance?

I've been piling up a lot of questions, and offering no answers. Let's make a few simple declarative sentences to end upon.

Early this morning (before I wrote this) someone from Malaysia reached this site by running a search for the name "Glenn Greenberg." I'm always delighted at the thought of an international audience, and I hope that particular visitor found my biographical observation on Mr. Greenberg, yesterday's entry, of some value.

That's going to have to suffice as an ending!

Tuesday, January 22, 2008

Hank Greenberg's kid

Any baseball fan with any sense of history knows who Hank Greenberg was. Not Maurice Greenberg, nicknamed Hank, of AIG, whom I've written about here before. I mean the Detroit Tigers slugger Hank Greenberg.

That Greenberg helped make the Tigers the American League champs in both 1934 and 1935 -- his second and third years in the big leagues.

He lost some playing time due to injuries and, like many of his generation, lost years more playing time to the war, serving with distinction in the Air Corps. He was released in the middle of 1945, in time to help the Tigers in the home stretch of the season -- they won the World Series that year, with two WS homes from him.

And so forth. Why do I bring this up in "Proxy Partisans"? Because a story in the WSJ today informs me that Glenn Greenberg, the founder of Chieftain Capital Management Inc., is THAT Greenberg's son. And Chieftain is involved in a proxy fight with Comcast, of which I'll write tomorrow.

Glenn Greenberg's mother is Caral Gimbel, the heiress of an old department store fortune. I'm reminded of the old Christmas movie, "Miracle on 34th Street." A Macy's Santa Claus (who also happens to be the real thing) tells a Mother and son that the toy they want they would be better off buying at Gimbel's than there. "Mr. Macy" is of course initially furious to hear his Santa has done such a thing, but the word-of-mouth on the act of scrupulous honesty rebounds to his store's credit.

Ah ... memories.

Monday, January 21, 2008

Insider Trading and mergers

About a year and a half ago, Gretchen Morgenson of the NY Times wrote a story with the lead, "The boom in U.S. corporate mergers is creating concern that illicit trading before deal announcements is becoming a systemic problem."

It wasn't merely US mergers she was concerned about, though, despite the wording of that lead. She cited a study by the UK's answer to the SEC, their Financial Services Authority: that showed that in 2004, 29% of companies involved in mergers experienced abnormal trading before public announcements. The FSA also said that in 2001, the comparable figure had been 21%.

What accounts for the increase? Perhaps it simply became more difficult to keep a secret between 2001 and 2004.

Ms Morgenson also quoted a money manager named Herbert Denton: "Martha Stewart got hurt very badly for something that happens every single day on Wall Street. It's a falseness and a hollowness to the capitalist system when you are pretending that things are pristine and they are not. Either the SEC should get very, very serious and prosecute a lot of people or forget about it."

I'd raise my hand for the second option there. "Systemic problem" solved.

Sunday, January 20, 2008

Insider Trading

Here's a link to a discussion of insider trading -- specifically, an interview of law professor Henry Manne, who believes most such trading ought to be legal click here.

I bring it up specifically because I've been thinking about mergers, and an impending merger is one of the classic contexts in which charges of insider trading arise. I'll refer to inside traders as ITs for short.

A merger offer, as we discussed here last week, will generally involve a "control premium," i.e. a price for the stock of the target company above its market value. If one were aware ahead of time that such an offer was, well ... in the offing ... one would of course start scooping up the stock in order to sell it again after the offer has become public and the control premium is on the table.

The big question is: who does the IT cheat? and how?

The IT certainly isn't committing a fraud in the classic sense. At common law, a fraud is a misrepresentation by one party upon which the counter-party relies, to the counter-parties' legal detriment. If the IT buys up stock of a merger target through a public exchange, it seems to me just stretching a point to the point of torture on the rack to claim that the sellers of that stock are reliance upon anybody's representation (through silence) that there ISN'T any merger in the works.

Furthermore, in general the sellers will get a higher price if there has been some leakage of word of the impending merger than they'll get if there hasn't been, so clamping down on the ITs and limiting the buying in the pre-announcement period is what does them hard. Not the IT, but the prosecution thereof.

More tomorrow.

Wednesday, January 16, 2008

Oracle to Buy BEA

The price works out to $19.375 per share.

So BEA's management, by holding out and demanding $21 when the subject first arose, in October, has done something positive for its shareholders. Oracle was at first offering only $17 a share, remember.

It looked at first as if BEA's management was going to face a proxy battle from a malcontented Carl Icahn. But they seem to have brought him on board successfully, and he'll reap his share of the control premium Oracle's paying.

It's nice to report that everybody is happy, isn't it?

Of course, Oracle's shareholders might not be entirely thrilled. The general rule is that after such an announcement, the market price of the target rises, and that of the acquirer falls.

Just before the original $17 offer, the market value of BEA shares was about $14. The market, presumably anticipating that there would be other bids, immediately brought that value up above $18 on the first offer, then it began to lose ground as the target resisted.

BEA's value fell below $14.75 last week, but recovered in the last three trading days, even though the broader market was taking a beating. Hmmm. Evidence word of a deal was leaking out? You didn't hear it from me. Anyway, at close of Nasdaq's business yesterday it was at $15.58.

This morning it'll presumably head up toward the value stipulated in the announcement. I'm guessing it won't quite get there, i.e. that there will be a discount allowing for the possibility that the deal will do awry between announcement and closing.

I'll next post here on Sunday. Perhaps that will be a good time to address the broad issue of insider trading in advance of such announcements.

POSTSCRIPT: I was right, above, to draw the inference that Icahn is on board with this deal. In was only an indirect inference when I wrote it, but after I had posted these thoughts, I learned of an explicit statement Mr. Icahn put out this morning: "This transaction is an excellent example of the great results that can be achieved for all constituencies when the shareholder activist is able to work cooperatively with management."

Tuesday, January 15, 2008

CNET's bylaws

Enough background. We've cracked open the coconut and can drink the milk of the dispute between CNET and the activist investor leading the proxy fight, JANA Partners.

CNET's bylaws provide as follows:

"Any stockholder of the Corporation that has been the beneficial owner of at least $1,000 of securities entitled to vote at such meeting for at least one year may submit a director nomination to the Board of Directors or, if designated by the Board of Directors, a Nominating Committee."

As you can see, that concerns nominees specifically, not resolutions such as JANA's effort to expand the size of the board.

Another bylaw discusses resolutions:

Any stockholder of the corporation that has been a beneficial ownerof at least $1,000 of securities entitled to vote at an annual meeting for at least one year may seek to transact other corporate business at the annual meeting, provided that such business is set forth in a written notice and mailed by certified mail to the Secretary of the Corporation and received no later than 120 calendar days in advance of the date of the Corporation’s proxy statement released to security-holders in connection with the previous year’s annual meeting of security holders. … Notwithstanding the foregoing, such notice must also comply with any applicable federal securities laws establishing the circumstances under which the Corporation is required to include the proposal in its proxy statement or form of proxy.


JANA hasn't satisfied the one-year deadline, so (on CNET's reading of these rules) it isn't entitled to propose resolutions or board nominees.

JANA wants the courts either to declare the one-year period invalid or to reinterpret it out of existence. As to the two nominees, it has a good case here. Delaware courts have been vigilant about allowing shareholders a fair shot at getting nominees on the ballot, and are likely to see this holding period as excessive.

As to proposing resolutions, JANA's case seems weaker.

Steven Davidoff explains this all quite well and gives the pertinent links. I'll indulge my own lazy tendencies this morning and simply link to him.

Davidoff is here.

Monday, January 14, 2008

Control premiums: some theory

Let's speak in broad theoretical terms for a day. In a classic "hostile takeover," some outside entrepreneur decides that the target corporation has valuable assets which are being incompetently managed. This suggests an arbitrage play -- acquire the corporation, and with it both (a) the assets and (b) the ability to fire the incompetent managers.

By hypothesis, the acquired company will be of greater value with the new bosses, and the market price of the stock will soon reflect that higher value. So in the imagery of the old west, our entrepreneur, having ridden into town on a capital-markets horse and installed the new sheriff, sells his interest in the town for a profit, and rides back out.

The problem is that its difficult to sneak up on a town/company like that. The increase in the company stock price might come too soon. Suppose a particular turn-around artist has gained a reputation for previous gun-slinging escapades of this sort. When he starts buying stock in a new company, other market participants, checking with EDGAR, learn of this and the stock becomes more valuable immediately on the expectation that he'll continuing buying and then work his magic.

Or it becomes more valuable simply because even market participants not especially impressed by this gunslinger's reputation decide to hold out for a higher price to see if he'll pay it.

For either or both reasons, he'll end up paying a hefty "control premium" before he can install a new sheriff/management.

This, of course, raises the bar for the new management. In order for the entrepreneur to profit, it isn't enough for the new bosses to be better than the old boss. They have to be SUFFICIENTLY better to justify the control premium he's already paid. And then some.

Not surprisingly, then, there's a lot of interest in developing ways to take over the control of a company without paying a control premium.

From one point of view, waging a proxy battle for control of the board of directors is exactly that.

As Milton Friedman said, though: there ain't no such thing as a free lunch. Proxy fights have their own expenses and risks.

All of this has been by way of illuminating my comment yesterday that (a) CNET had created a new poison pill for itself to ward off a takeover attempt and (b) that the real battle will be on the proxy front and related litigation.

CNET's present governance structure involved staggered board terms. This year, only two of the incumbents will stand for re-election. That's not enough to change control othe company. Still, on January 7, New York based hedge fund JANA Partners announced that it will nominate Paul Gardi and Santo Politi for those two seats.

Also, JANA announced it will seek an expansion of the size of the board of directors from eight to 13. This is the "loophole" I mentioned yesterday. If it can get that increase, then the company will have to hold an election for the five newly created seats as well as for the two common up for a vote anyway. Seven seats on the hypothetical board of 13 will of course be a majority.

Will CNET have to hold an election for seven seats, or only for two? We'll go a bit further into this question tomorrow.

Sunday, January 13, 2008

What is CNET?

CNET Networks (Nasdaq: CNET) announced on Friday that its board has adopted a poison pill plan in order to try to thwart any unfriendly takeover.

Well, of course, they didn't announce it using the phrase "poison pill." Its a sharehlders rights plan, naturally! But if it scares off bidders who might otherwise have offered shareholders a control premium for their shares, this assertion of their rights might seem empty to some of them.

CNET's corporate website (not to be confused with their consumer website) is:

They provide internet content and games under a variety of brand names. They've had a good deal of success at this, but 2007 was a very choppy year for them in terms of stock price.

At any rate, the new poison pill is a move to protect a flank, but it doesn't represent the front line in CNET management's efforts to preserve corporate autonomy. The front line is a proxy contest along with related litigation.

CNET's bylaws are confusingly written, so it isn't clear whether the activists who want to take control through proxy votes can do so in a single election or not. The board is staggered, so that one would usually answer, "not." Yet there maybe a loophole in the staggering. And there may be a loophole in the loophole.

I'll see if I can make it all clear over the next couple of days.

Wednesday, January 9, 2008

Beware cries of "crisis"!

It wasn't that long ago (two and a half years, to be precise) that one could encounter anguished talk about the "asbestos liability crisis" devastating U.S. based corporations, and the need for a "global settlement" to be developed in committee rooms on Capitol Hill.

The legislative efforts failed, the Fairness in Asbestos Resolution Act has disappeared, and the unmanaged crisis seems rather to have fizzled away.

One of the corporations that had been most exposed to tort liability of "crisis" proportions was auto parts supplier Federal-Mogul, of Southfield, Michigan. F-M entered bankruptcy court protection in 2001 in an effort to resolve its asbestos liabilities. It was a long haul but the company emerged out from under the court's protection two weeks ago, December 27.

The company was exposed to the mass tort claims mostly by inheritance, via certain acquisitions it had made over the years. It also had some operational exposure. Between 1965 and 1981 Federal-Mogul had operated a division called Vellumoid, which had sold a gasket cut from asbestos-containing sheet material. Plaintiffs alleged they had been exposed to the asbestos while removing the gaskets in the process of repairing automobiles.

I don't know the particulars of how these claims have been resolved, but they must have been resolved somehow -- the asbestos claimants committee agreed to the reorganization plan in November.

Complex and protracted litigation isn't by itself a crisis. It is a byproduct of a complex world and the co-existence of a lot of contending interests.

My own guess would be that all the affected interests have been better served by the failure of the Congressional settlement than they would have been by its success.

And yes, I said yesterday that I planned to write something about the proxy fight at CNET today. But, hey, plans change. We'll get to CNET next week. See ya Sunday.

Tuesday, January 8, 2008

Lubys: The Other Foot

The story so far: The Pappas family runs Lubys,with the brothers occuping the CEO and COO posts. The incumbent board is happy with this, although some investors, notably Ramius Capital, object that given the other interests of the Pappas' this is a situation rife with conflict.

Yesterday, we spoke about how the incumbent board responds to the conflicts charge while playing defense. We saved for today the fact that their chief response has been to take the offensive. The conflict shoe, they say, is on the other foot.

As CEO Chris Pappas said in a letter to the Houston Chronicle, which it printed this Sunday: "Ramius ... doesn't care about Luby's history or our future. Ramius doesn't bring relevant restaurant experience, only a risky notion to strip Luby's of its real estate assets, the sort of short-term financial scheme typical of Wall Street thinking."

The general charge here is a common one, that there is an inherent opposition between Wall Street and Main Street, and that it the opposition between the New Yorkers who care only about the next quarter's bottom line -- or who aren't even thinking that far ahead, because they're hoping the get a quick churn-around on the stock maybe this afternoon or tomorrow -- and those decent heartland-dwelling folk who stick around to build a business over years or decades.

Personally, I think that opposition is nonsensical. If the accounting is done honestly, next quarter's bottom line will be what it is because of long-term considerations, the two are only in opposition if the corporate management is allowing or encouraging its accountants to let them be in opposition. And the big problem in such a case is in the heartland, not on Wall Street.

As to real estate ... this is a more specific example of the broader nonsense of the above quoted rhetoric. Yes, Ramius has said that if its nominees get on the board they'll study the possibility of real estate sales. And why should they not? Is it essential to the success of a restaurant that it own the land its sitting on? Surely not. Indeed, maybe Lubys are sitting on leased land as it is (anbd sometimes the leasor is another Pappas family interest), so the question of whether some land ought to be sold is a question of moving along a continuum, not a matter of yes-or-no.

In general, I think Luby incumbents have presented a plausible defense to the charges of conflict, but their offense Sticks. Maybe neither side has any conflicts of a sort about which non-aligned shareholders ought to worry. In that case, the shareholders may have to study the respective track records of the two sides to make up their minds.

They'll have to do so without any further assistance from me, though, because this blog must move onward, ever onward. Tomorrow, I plan to discuss JANA and CNET.

Monday, January 7, 2008

Lubys, continued

On Friday, both the incumbent board and the dissident slate in the Lubys proxy contest filed their "definitive proxy soliciting materials" with the SEC.

(By the way, the company itself uses the apostrophe, re-positions it, or drops it according to context, so Lubys, Lubys', and Luby's are each correct.)

As I mentioned yesterday, the Pappas brothers run Lubys. I wasn't so clear yesterday about the fact that the Pappas' also run privately owned restaurant chains under variants of the family name: Pappadeaux, Pappasito's, Pappas Bros. Steakhouse, Pappas Seafood House and Pappas Bar-BQ.

The dissidents argue that this creates a conflict. The interests of the shareholders of Lubys might well be served by competitive actions vis-a-vis those privately owned chains that the Pappas' themselves are unlikely to undertake.

Indeed, the Pappas own the land on which some of the Lubys restaurants sit, and within this landlord-tenant relationship there is further room for dealings at the expense of the tenant's shareholders.

The incumbent board replies that the Pappas' are among the largest sharehholders in Lubys, so their interests are aligned with those of the other shareholders, that they are only two members of a ten-member board, which has "worked diligently to supervise the efforts of Management in turning the company around," and that in fact the Pappas' have turned the company around.

"Luby's today has the financial strength to execute on its strategic growth plan...."

Further, the incumbents take the position that the "conflict of interest" shoe is on the other foot. I'll write tomorrow about Luby's case against Ramius.

Sunday, January 6, 2008

Luby's: Fish or Beef

Investors in Luby's, a cafeteria-style restaurant chain, at any one of which you might well find yourself standing in line behind some fellow who's hesitating between the fish plate or the beef, have a choice to make of their own. Stick with the Pappas family, or go with the dissident slate.

And the professional kibitzers -- otherwise known as proxy advisory services -- are saying the "fish" offered by the company's largest shareholder, Ramius, looks good.

They've still got a bit more than a week to fill up their plate and take a seat. The annual meeting is January 15.

Luby's has been a publicly held corporation since 1973 and has been listed on the New York Stock Exchange since 1982. The two members of the Pappas family, Christopher and Harris, arrived in 2001. Currently, Chris P is the CEO and Harris P is the COO. And there's the rub.

But it's a lazy Sunday and I'll stop here, holding back discussion of the pros and cons of Pappas family control for tomorrow.

As for Ramius, I'll simply observe that my regular readers may remember the name.

Wednesday, January 2, 2008

Eliot Spitzer and research

Another of the causes associated with Spitzer during his A-G days was the clamp-down on sell-side research.

Investment banks and brokerage firms have research departments that sell reports into the market. Sometimes the price of these reports comes bundled into brokerage commissions. In other words, a broker says to a stock trader/buyer, "pay my commissions and you get access to my institution's reports/analyses for free."

Of course, it isn't for free. TANSTAAFL. But it is included. This bundling is also known as "softing," or the use of "soft dollars."

At any rate, there is an obvious danger of conflict of interest present in institutional mingling of research and the business of selling stock. Is the researcher writing a true analysis, or an advertisement that's supposed to look like an analysis?

During the late 1990s dotcom and telecomm boom, a Solomon Smith Barney analyst, Jack Grubman, became notorious for his cheerleaderish ways. He actually attended meetings of the board of directors of WorldCom, a Smith Barney client, obviously a big no-no according to traditional ideas of arms-length analysis.

Of course his reports on the value of WorldCom's stock were enthusiastic. He told investors they should "load up the truck" with the stuff.

Investors who believed him kept loading up until that truck drove off a cliff.

Grubman was the most notorious such "analyst," but there were clearly others, and in reaction to such stories, Spitzer pressed for and got a "global settlement" from industry that chganged the way research is done.

There's something to be said for Spitzer's work in this line.

One ought to note, though, that the real problem is the boom-bust cycle itself, and a national monetary policy that encourages the cycle. At the top of a boom, there is always a lot of "irrational enthusiasm," and Grubmans will appear in some form or other. To attack the particular form in which the latest Grubman appeared will, for the most part, simply cause a change in the formalities, until the United States as a country can work toward an evenly-rotating economy, one without the bipolar affect.

These last three days have been enough on the subject of Governor Spitzer's present and his past. I'll be back with another entry here Sunday, and I hope then to return to the core concern of this blog -- proxy fights, and the folks who wage them.

Tuesday, January 1, 2008

Eliot Spitzer and mutual funds

Spitzer, before his present term as Governor of New York began, was the state's Attorney General. This is an elective post in NY. He first won it in 1998, and won re-election easily in 2002.

He reconceived the role of that office, making himself the "sheriff of Wall Street." Probably two investigations stand out in that regard: one into market-time and late trading within mutual funds; one into the influence of investment banks upon market research.

As to mutual funds, it came to Spitzer's attention beginning in 2003 that certain managers of publicly traded mutual funds were allowing favored clients to engage in two practices that seemed to guarantee them (the favored) easy profits.

One of these practices was "late trading," i.e. the favored ones would file trades at the previous day's price after the market close. The other was "market timing," i.e. the purchase or sale of shares in the funds more frequently than allowed under the funds publicly published rules.

The cool thing about bringing actions against white-collar defendants (as another aspiring prosecutor/poltician, Rudy Giuliani, had discovered before Spitzer) is that there is no equivalent of the code of silence that often obtains among more hardened criminals. The public accusation, and the "perp walk" if matters go that far, is itself a devastating blow to most of Wall Street's denizens, and they'll often tell the enforcement authorities what they want to hear, or sign a consent decree, much more readily than their counter-parts.

The suspicion has gathered itself around both Spitzer's and Giuliani's handiwork, then, that they were picking off low-hanging fruit.

Nearly all of the mutual fund managements whom Spitzer charged with allowing market timing or late trading settled, so he didn't have to prove wrong-doing in court. He got his consent decrees, got fines, re-organized the industry under threat of continued vigilance, and took his bows.

The one instance in which someone did fight, interestingly, didn't go well for his office. in August of 2005 Spitzer the only trial arising from these investigations ended indecisively. A jury could not reach a verdict on all counts in a case brought against Theodore Sihpol, III, a broker with Bank of America who introduced the hedge fund Canary Capital to that bank.

Canary was the supposedly favored trader, indeed the first one targeted by Spitzer's investigations into this practice -- Sihpol its supposed puppet allowing the shenanigans.

After a hung jury, the state could of course have pressed for another trial. But both parties had had enough,so that in October 2005, the Mr. Sohpol settled a follow-up case that the SEC had brought in the wake of Spitzer's charges (agreeing to pay a $200,000 fine and accepting a five-year ban from the securities industry) and the state of New York withdrew all remaining charges against Mr. Sihpol.

The Washington Post, in reporting on the October resolution, quoted a former federal prosecutor, Evan T. Barr, who spoke for many when he said: "The resolution of the case on such favorable terms for the defense certainly calls into question whether Sihpol should have been indicted in the first place."

But Spitzer had had two years of favorable publicity by then and was well on his way to the Governor's office.

I think Mr. Sihpol has an almost heroic stature under the circumstances, and I look forward to his return to the fray in 2010.