Tag Archives: law

Defending Kickbacks

By James Kwak

The Wall Street Journal reports that the SEC will soon decide (well, sometime this year) whether brokers should be subject to a fiduciary standard in their dealings with clients, as registered financial advisers are today. At present, brokers only need to show that investments they recognize are “suitable” for their clients—roughly speaking, that they are in an appropriate asset class.

Not surprisingly, the brokerage industry is up in arms. They want to be able to push clients into the products for which they receive the highest commissions—a practice that (they say) could be more difficult under a fiduciary standard. According to one lobbyist,

a universal fiduciary standard could end up hurting many investors. Lower- and middle-income investors often turn to brokers who are compensated through product commissions, he says, because such clients are less attractive to financial advisers who are compensated based on a percentage of assets under management. Higher costs could prompt some brokers to drop commission-based accounts in favor of more-lucrative accounts that charge a percentage of assets under management, leaving many lower- and middle-income investors without anyone to turn to for investment advice.”

(That’s a paraphrase by the Journal writer, not a direct quotation.)

Continue reading

What Might Have Been . . .

By James Kwak

I was reading the plea deal in the SAC case, which was approved by the judge yesterday, and then I started reading the criminal indictment filed by the U.S. Attorney’s Office. What I noticed was how relatively simple it was for the prosecutors to convict SAC Capital for the insider trading committed by its employees. In short, because the firm enabled and benefited from the employees’ crimes, the firm was itself criminally liable.

Looking back at the enormous amount of effort the Southern District has put into Preet Bharara’s crusade against insider trading, you have to wonder what they might have accomplished had they instead targeted, say, fraud committed by Wall Street banks that contributed to the financial crisis. That’s the topic of my new column in The Atlantic. One of the frustrations of post-crisis legal proceedings is that it’s so hard to show that any senior executives themselves committed fraud, since they can usually plead some combination of ignorance and incompetence instead. Failing that, though, the government could have put more resources into flipping lower-level employees and then filing criminal indictments against their banks. Yesterday Bharara claimed, “when institutions flout the law in such a colossal way, they will pay a heavy price.” But only if the Department of Justice chooses to go after them.

The Absurdity of Fifth Third

By James Kwak

No, I’m not talking about the fact that a major bank is named Fifth Third Bank. (As a friend said, why would you trust your money to a bank that seems not to understand fractions?) I’m talking about Fifth Third Bancorp. v. Dudenhoeffer, which was heard by the Supreme Court last week.

The plaintiffs in Fifth Third were former employees who were participants in the company’s defined contribution retirement plan. One of the plan’s investment options was company stock, and the employees put some of their money in company stock. (Most important lesson here: don’t invest a significant portion of your retirement assets in your company’s stock. Remember Enron? Anyway, back to our story.) As you probably guessed, Fifth Third’s stock price fell by 74% from 2007 to 2009—this is a bank, you know—so the plaintiffs lost money in their retirement accounts.

The claim (I’m looking at the 6th Circuit opinion)  is that the people running the retirement plan knew or should have known that Fifth Third stock was overvalued in 2007, and they breached their fiduciary duty to plan participants by continuing to offer company stock as an investment option and by failing to sell the company stock that was owned by the plan. The suit was dismissed in the district court for failure to state a claim, so on review the courts are supposed to accept all the plaintiffs’ allegations as correct.

Continue reading

More Pseudo-Contrarianism

By James Kwak

I accidentally glanced at the link to David Brooks’s recent column and—oh my god, is it stupid. You may want to stop reading right here to avoid being exposed to it.

Continue reading

More on Wasting Shareholders’ Money

By James Kwak

A few weeks ago I wrote a post about my most recent “academic” paper, on the issue of whether corporate political contributions might constitute a breach of insiders’ fiduciary duty toward shareholders. The thrust of that paper was that some political contributions could be contested as breaches of the duty of loyalty—for example, if a CEO causes the corporation to give money to a candidate who promises to lower the CEO’s individual income taxes—which would result in the courts applying a higher standard of review.

Joseph Leahy, another law professor, recently directed me to a paper that he wrote last year (but is still being edited for publication in the Missouri Law Review) on basically the same topic. He argues first that corporate political contributions do not qualify as “waste” (which has a precise legal definition), barring the kind of extreme facts that you only see in law school hypotheticals. I agree with that, although my only discussion of the point was in a footnote (79).

Continue reading

“Telling a lie does not make you guilty of a federal crime”

By James Kwak

That’s what Jesse Litvak’s lawyer said at the start of his trial earlier today. And technically speaking, it’s true. If you’re trying to sell a bond to a client, and during the course of the conversation you say you can bench press 250 pounds when you can only bench 150, that’s not a federal crime. But if you lie about a material aspect of the bond and the client relies on your lie in buying the bond, that’s another story.

Litvak’s case is (barely) in the news because it has a financial crisis connection; some of the buy-side clients he is alleged to have defrauded were investment funds financed by the infamous Public-Private Investment Program (PPIP) set up in 2009 using TARP money, and hence one of the counts against Litvak is TARP-related fraud. But it bears on a much more widespread, and much more important feature of over-the-counter (OTC) securities markets.

Continue reading

Unequal Justice

By James Kwak

If I write about a legal matter on this blog, it usually involves battalions of attorneys on each side, months of motions, briefs, and hearings, and legal fees easily mounting into the millions of dollars. That’s how our legal system works if, say, you lie to your investors about a synthetic CDO and the SEC decides to go after you—even if it’s a civil, not a criminal matter.

But most legal matters in this country don’t operate that way, even if you face the threat of prison time (or juvenile detention), and all the collateral consequences that entails (ineligibility for public housing, student loans, and many public sector jobs, to name a few). Theoretically, the Constitution guarantees you the services of an attorney if you are accused of a felony (Gideon v. Wainwright), misdemeanor that creates the risk of jail time (Argersinger v. Hamlin), or a juvenile offense that could result in confinement (In re Gault). The problem is that this requires state and counties to pay for attorneys for poor defendants, which is just about the lowest priority for many state legislatures, especially those controlled by conservatives.

Continue reading

The Prosecution That Isn’t Happening

By James Kwak

People keep asking why no senior executive has gone to jail for the misdeeds that produced the financial crisis—and cost the United States more than $6 trillion, or $50,000 per household, in lost economic output. The usual answers are that no one did anything wrong (oh, come on) or, more realistically, that it’s too hard to convict individuals in complex financial fraud cases.

At the same time, however, the U.S. Attorney’s office for the Southern District of New York—the district that includes Wall Street—has amassed a 79-0 record in insider trading cases, including yesterday’s jury verdict against Mathew Martoma, a trader at the hedge fund firm SAC Capital Advisors. In Martoma’s case, he obtained confidential information about a clinical trial for a drug being manufactured by two pharmaceutical companies and, according to the jury, convinced his boss, Steven Cohen, to unload the firm’s positions in those two stocks.

Continue reading

The Problem with 401(k) Plans

By James Kwak

Apparently my former professor Ian Ayres has made a lot of people upset, at least judging by the Wall Street Journal article about him (and co-author Quinn Curtis) and indignant responses like this one from various interested parties. What Ayres and Curtis did was point out the losses that investors in 401(k) plans incur because of high fees charged at the plan level and high fees charged by individual mutual funds in those plans. The people who should be upset are the employees who are forced to invest in those plans (or lose out on the tax benefits associated with 401(k) plans.)

In their paper, Ayres and Curtis estimate the total losses caused by limited investment menus (small), fees (large), and poor investment choices (large). Those fees include both the high expense ratios and transaction costs charged by actively managed mutual funds and the plan-level administrative fees charged by 401(k) plans.

Continue reading

What’s Liberty Got To Do With It?

By James Kwak

Constitutional law is not my field. I think we spent one day on the Commerce Clause in my constitutional law class. I’ve barely been following the Supreme Court oral arguments this week because I figured (a) they would be silly, (b) we won’t know anything useful until June, and (c) with the rest of the commentariat focusing on it I would have nothing to add. But even at that distance, I can’t help but be shocked by the ludicrous nature of the proceedings, best represented by the framing of the case in terms of individual freedom and government coercion. According to the Times, the case may turn on Anthony Kennedy’s notion of liberty.

What’s wrong with this? Liberty should have nothing to do with this case. I’ll repeat the analysis, made my dozens of law professors more expert than I (Charles Fried, for example). The question is whether Congress has the power to impose the individual mandate under the Commerce Clause, which gives it the power to regulate interstate commerce. If the individual mandate does in fact regulate interstate commerce, then it’s fine unless it violates some other part of the Constitution.

Continue reading

What Good Is the SEC?

By James Kwak

This week’s Atlantic column is my somewhat belated response to Judge Jed Rakoff’s latest SEC takedown, this time rejecting a proposed settlement with Citigroup over a CDO-squared that the bank’s structuring desk created solely so that its trading desk could short it. I think Rakoff has identified the heart of the issue (the SEC’s settlements are unlikely to change bank behavior, so what’s the point?) but he’s really pointing to a problem that someone else is going to have to fix: we need either a stronger SEC or stronger laws. I’d like to see an aggressive, powerful SEC that can deter banks from breaking the law, but we don’t have one now.

Thoughts on Law School

By James Kwak

A number of friends have asked me what I thought about David Segal’s article in the Times a couple weeks ago on law schools, so I thought I would share my thoughts here. The short answer is that I thought it was pretty silly.

I admit that law schools aren’t perfect. The simple fact that many (no one really knows how many) law school graduates can’t find jobs as lawyers is a problem. Now, it’s not obvious that that’s the fault of law schools as a group: when you pile a severe recession on top of an ongoing shift among law firms away from first-year associates and toward contract lawyers, the number of entry-level jobs is going to go down, and no matter how good a job the law schools do, that isn’t going to increase the number of jobs. Furthermore, you could make exactly the same criticism about all of higher education: it leaves people with large debts, and many don’t get jobs; imagine the article you could write about humanities Ph.D. programs! Still, Segal’s earlier article pointed out some of the ways in which rankings pressure has pushed some law schools to be less than candid about their graduates’ job prospects, which can’t be good. (And people like making fun of anything that has to do with lawyers. It comes with the territory.)

Continue reading

Richard Posner Is My New Hero

By James Kwak

Yes, I have said some critical things about Posner in the past, usually about his penchant for abstract theoretical arguments that presume perfectly functioning markets. But I’m happy to say we can make common cause on an issue of much greater importance: the Bluebook.

The Bluebook is the 511-page “uniform system of citation” that is prescribed by — well, actually, by the editors of the main student law reviews at Columbia, Harvard, Penn, and Yale — and enforced by the student editors of law reviews (almost) everywhere. But  it is not enforced by the courts, whose citation systems vary from jurisdiction to jurisdiction and are not effectively enforced by anyone, anyway. Posner calls it “a monstrous growth, remote from the functional need for legal citation forms, that serves obscure needs of the legal culture and its student subculture.”[1]

Continue reading

Yet Another Reason to Like Elizabeth Warren

By James Kwak

Bob Lawless points me to this 2006 blog post by Elizabeth Warren. Warren describes a first-year contracts class on the case that upheld a fine-print forum selection clause (a clause saying that if you want to sue us, you have to sue us in X jurisdiction–Florida, in this case) on the back of a cruise ship ticket.

Warren’s entire class (Harvard, let me say for the record) insists that, as a factual matter, this decision is good for consumers because . . . well, regular readers of this blog should be able to fill in stock Mickey Mouse economistic hand-waving as well as any first-year law school student. Of course! Forcing people to sue in Florida (or to accept binding arbitration in the forum of the company’s choice) deters frivolous lawsuits and lowers costs for the company, and it can pass those savings onto consumers. Why does it pass those savings onto consumers instead of putting them into shareholders’ (or managers’) pockets? Because in a perfect competitive market, if Alpha Cruise Lines doesn’t, then Beta Cruise Lines will, and Beta will underprice Alpha, . . . Consumers will read the fine print and can make an informed choice between the lower price with the forum selection clause and the higher price without the forum selection clause.

Continue reading

We Were Wrong (About the Supreme Court)

By James Kwak

Last November, we criticized a decision by the Court of Appeals for the Seventh Circuit in Jones v. Harris Associates in which Judge Frank Easterbrook wrote that mutual fund companies can charge their mutual funds whatever they can get away with (assuming disclosure and absent fraud), because prices are set by The Market. The case was remarkable because of a dissent by Judge Richard Posner, part of his recent (partial) disavowal of his earlier free market views, arguing that markets could not be trusted to set mutual fund fees. However, we predicted that the Supreme Court would pass up the opportunity to strike a blow on behalf of mutual fund investors and against excessive mutual fund fees:

“It can take the easy way out and resolve the case on the sole question of what ‘fiduciary duty’ means. Or it could limit itself to deciding what standard should be used in reviewing mutual fund fees and then tell the 7th Circuit to hear the case again. Most likely it will either sign off on the efficient-markets myth or dodge the question in one of these ways.”

We were partially right; technically speaking, the Court (opinion here) simply clarified the standard to be used when assessing mutual fund fees. Substantively speaking, however, it went a bit further. As Jennifer Taub explains, not only did it strike down Easterbrook’s bit of outdated free market theory, it also held that courts should compare the fees that a mutual fund company charges its captive mutual funds and those it charges institutional clients who can negotiate fees directly. In Jones v. Harris Associates, Harris Associates was charging its captive mutual funds fees that were more than double those it charged institutional asset management clients.

It still doesn’t look that great for the plaintiffs–mutual fund investors who claim they were charged excessive fees. The district court that first heard the case found that, under the existing Gartenberg standard, the plaintiffs had no case. The Supreme Court in its opinion said that it was reaffirming Gartenberg, but as Taub and William Birdthistle have pointed out, it really was modifying Gartenberg slightly in a pro-plaintiff way. So what happens now is that the case goes back to the Seventh Circuit to deal with the case in a manner consistent with the Supreme Court ruling (and I think the Seventh Circuit could hand it back to the district court). But it’s still a small step.