SEC

Best Way to Curb Irrational Exurberance?

by Fred Smith on July 28, 2009

in Deregulate to Stimulate, Economy, Precaution & Risk, Regulation

Zachary Goldfarb, a Washington Post staff writer, discusses (p. A10, “SEC Moves to Limit Short Sales of Stocks”) this SEC proposal – sympathetically.  The article is naïve – buying the complaint of “High-profile Wall Street executives” that short sellers “played an outsized role in crashing the stock values of several major financial services companies.”  Now, it is certainly true that when an asset value is falling, some will anticipate further declines and sell short – just as many will anticipate that an asset whose values are rising will rise further and buy long.

But in politics, as elsewhere, while success has a thousand fathers, losses are orphans.  Thus, many clamor for curbs on short selling, but there are few calling for curbs on those betting on things still going up.  That is we critique irrational exurberance but we penalize only rational prudence.  The story betrays this bias wonderfully in a telling quote: “The SEC [proposed rules are]… making it more difficult for speculators to pounce on a stock when it is already declining sharply.”  (italitics mine).

Imagine SEC rules designed to make it more difficult for speculators to pounce on a stock when it is already increasing sharply!

When markets boom, politicans take credit.  When markets tank, politicians blame the speculators.  Unfortunately, this bias means that Congress may further cripple the market’s ability to stabilize, to ensure that all information positive as well as negative reaches the market price.  Suppressing information is a bad deal – in civil societies and in the market.

Your Interests Are My Interests

by Cord Blomquist on March 11, 2009 · 2 comments

in Features, Regulation, Tech & Telecom, Zeitgeist

If you’re a fan of professional print journalism, you may be a little worried as of late.  Denver’s Rocky Mountain News just closed its doors after nearly 150 years in the news game.  Meanwhile the San Francisco Chronicle and the Seattle Post-Intelligencer are both on life support.  Even the New York Times, the largest newspaper in America, has cut its dividend and mortgaged its headquarters for $225 million.

It seems clear that the age of broadsheet newspapers is coming to an end, yet the web hasn’t come to its rescue.  Partially this is because ad rates from the old world of print were inflated to reflect the size of the total audience of the paper.  Online ads, by contrast, are micro-targeted at just those folks who advertisers believe are most likely to buy their products or services.  This makes sense, but the numbers involved are still staggering.

Consider that the New York Times online as of 2007 had about 13 million unique users.  Compare that to its weekday circulation of 1.1 million and its weekend circulation of about 1.6 million.  The Grey Lady’s web presence had tenfold the reach of the paper, yet online revenue made up only about 10% of the Times total revenue.  That means that a product with ten times the reach is getting only 1/10th of its old-school equivalent.

Long story short: the industry needs all the help it can get.

This is where Google comes in.  Along with being a giant in the search industry, Google is empowering a network of publishers to the tune of $4.2 billion in revenue passed to them in 2007—according to members of Google’s DC office, the 2008 numbers are even larger.  In fact, Google knows it is better to give than to receive—it gives more money out to its publisher network than it keeps for itself in profits.

Now this giant of monetization is introducing an even better advertising mechanism, Google’s “Interest Based Advertising” program.  IBA works by collecting information whenever a user visits a site that features a Google AdSense network ad.  This information is turned into a sort of a profile that helps to focus ads on a per-user basis, rather than just basing that ad on the content of the web page alone.

This means that advertisers will have a more effective means of getting their message out online—news that should be music to the faltering print news industry’s ears, not to mention their loyal readers.

Understandably, this news sounds ominous to many.  Tracking your browsing?  And we were worried about the Bush administration tapping our phones!

However, unlike when dealing with government looky lous, you have the choice to tell Google to mind their own business.  Also, Google is telling consumers about the program.  Folks concerned with privacy issues call these elements “notice” and “choice.”

The notice comes in the form of clear labels on all Google-based ads, something the company already does with the exception of some of their print ads.  Currently, all ads served by Google feature their name, but some don’t feature the name of company paying for the ad spot.  Now that will change.  Users will know that Google is serving the ad and who’s paying them to do so.

Additionally, Google is allowing users to choose—this is the control part—how they’re classified by the new program.  Their Ads Preferences Manager will let users view, delete, or add interest categories associated with their browser so that the advertising they see will at least be relevant to them.

Finally, Google is also giving consumers the ultimate control over the program in the form of a set of tools to permanently opt-out.  They have even designed plug-ins for browsers that will maintain your opt-out choice.

It remains to be seen how this program—and others started much earlier by Yahoo! and other Google competitors—will increase revenues for publishers.  However, since all of these systems are designed to serve more relevant ads to consumers, it would seem that all parties involved stand to benefit.

Yet, there is sometimes no satisfying the privacy alarmists. The AP relayed this comment from EPIC’s Marc Rotenberg:

“This is a very serious development,” said Marc Rotenberg, executive director of the Electronic Privacy Information Center. “I don’t think the world’s largest search engine should be in the business of profiling people.”

Yet, with all Google is doing to allow users to opt-out of this system, one wonders if Mr. Rosenberg and those who share his opinion believe there should be any innovation whatsoever in online advertising, or if the industry should simply come to a stand-still.

Criticism of Google’s plan seems especially dubious given the alternatives offered.  Mr. Rotenberg believes that the FTC should reexamine Google’s merger with DoubleClick.  Translation: consumers are too dumb to manage their privacy, so the FTC should do it for them by tearing apart business deals that are deemed unsavory.

The appropriate level of privacy in our lives can’t be set by the government. It can only be set by free people able to explore the full range of choices offered in the marketplace.  When you consider not only Google’s consumer-friendly ad program, but other products like pre-paid cell phones, nameless debit accounts, proxy servers, anonymous email accounts, and the like, privacy seems to be out there for those who want it.

The best advice for those who want privacy: don’t go online.  The Internet is the modern public square, no more a private retreat than is a public park.  Technologies can help to mask your identity, but ultimately much can be found out about who you are online.  The only thing stopping that now is the free market’s respect for contracts and the choices of consumers.  Attacking that very freedom to choose is no way to secure great privacy in the future.

SEC penalty policy change could harm innocent investors

by John Berlau on February 6, 2009 · 2 comments

in Bailout Watch, Politics as Usual, Precaution & Risk, Sanctimony, Zeitgeist

In one of her first actions as SEC chairman, Mary Schapiro announced today that she was getting rid of a policy that required SEC officials to get approval from the commissioners before negotiating corporate penalties. According to the Associated Press, “Schapiro said that practice ‘just sends the wrong message.’”

But Schapiro should perhaps focus a little less on message and a little more on an action’s consequences for investors the SEC is supposed to protect. Because unfortunately, this change will have the effect of further harm to shareholder victims of corporate fraud.

Corporate penalties take money not from individual executives guilty of fraud, but from the corporate treasury that ultimately belong to the ordinary investors in the company. Frequently, these penalties have the effect of harming shareholder victims of corporate fraud twice: once when the corporate executives misuse a company’s money, and a second time when when the corporate penalty further reduces the company’s assets that belong to all shareholders. That’s why it is more just and more effective for the SEC to levy penalties against individual wrongdoers rather than the corporation as a whole.

The 2006 policy Schapiro wants to reverse was prompted by concerns expressed for former Commissioner Paul Atkins and others that the interests of innocent shareholders weren’t being given enough weight in negotiation of corporate penalties. The rule was a sensible change that didn’t outlaw corporate penalties, but ensured that their use was carefully considered by SEC commissioners before enforcement staff could levy an arbitrary fine that could harm shareholder interests.

Moreover, the policy only applied to penalties on corporations, not individuals accused of wrongdoing or private broker-dealers such as the firm of Bernard Madoff.

Schapiro, whom I have praised previously for her regulatory prudence, is correct in wanting the agency go after corporate wrongdoers with full force. But she should seriously rethink instituting this policy change that would have the unintended but predictable effect of punishing innocent shareholders twice.

Madoff: Hiding in Plain Sight, Thanks to SEC

by John Berlau on December 28, 2008 · 18 comments

in Bailout Watch, Features, Nanny State, Personal Liberty, Politics as Usual, Precaution & Risk, Regulation, Zeitgeist

When news broke of Bernard Madoff’s alleged $50 billion worldwide Ponzi scheme, news accounts first protrayed him as a shadowy hedge fund manager outside the scope of regulation by the Securities and Exchange Commission. But as the sheer magnitude of the fraud became clearer, so did the picture of Madoff’s place in the Wall Street-Washington world.

Madoff’s businesses were actually subject to a variety of financial regulations, something Madoff would actually use as a selling point to investors. Last year in a speech, Madoff said, “In today’s regulatory environment, it’s virtually impossible to violate rules.” He registered as an investment adviser in 2006, and had been under the SEC’s extensive regulatory framework for securities broker-dealers since he founded his firm almost 50 years ago.

And far from being a shadowy figure, Madoff was a pillar of the financial establishment. He showered campaign contributions on politicians, mostly Democrats. He was also quite chummy with many of the financial regulators charged with overseeing him.

For instance, Clinton administration SEC Chairman Arthur Levitt, who has championed onerous mandates like the burdensome Sarbanes-Oxley accounting mandates to preserve “market intergrity,” appointed Madoff during his SEC tenure to what the New York Times describes as “a large advisory commission … that explored the rapidly changing structure of the financial markets.”

An even closer connection was SEC assistant inspections director Eric Swanson who, according to CNBC reporter Charles Gasparino, “was part of the team that examined Madoff’s brokerage firm” in 1999 and again in 2004. “During those exams, the SEC team said it found almost nothing wrong,” Gasparino writes in The Daily Beast. In 2007, after leaving the SEC, Swanson married Madoff’s niece Shana, who is the regulatory compliance attorney at her uncle’s firm

While there is no evidence of wrongdoing with regard to Madoff by either Levitt or Swanson, SEC officials, for whatever reason, looked the other way, despite numerous allegations and “red flags,” some received as early as 1992. And since 1999, rival investment manager Harry Markopolos had sent the agency detailed analysis of why he though Madoff consistent postive returns were mathematically impossible without running a Ponzi scheme or insider trading. In a 2005 submission he made to the SEC that was recently made public by the Wall Street Journal, Markopolos charged that it was “highly likely” that “Madoff Securities is the world’s largest Ponzi scheme.”

But despite the SEC’s incompetence in heeding these warnings, many are still arguing that to prevent future Madoff-type frauds, we need more regulations that give more power to the SEC. But it’s hard to see how any additional powers could have made a difference in this case, given that the SEC almost seemed determined to look the other way for violations of the most basic rules against securities fraud that had long been in place.

Since hedge funds were among Madoff’s clients (and biggest victims, as this WSJ editorial points out), calls are again being intensified for further hedge fund regulation to bring them under the cumbersome registration process for investment advisers. (The SEC already has full authority to investigate hedge funds and other unregistered investment entitities if there are suspicions of fraud.) This is what the agency tried to do a few years ago, only to have a three-judge federal appeals court panel throw out the rule in 2006 in a unanimous finding that the agency had stretched the law.

But the SEC can’t argue that this would have helped them prevent Madoff’s fraud, because, as noted above, Madoff had registered as an investment adviser in 2006, and was registered as a broker-dealer for decades.

This broker-dealer registration gave the SEC full power to investigate all affiliated businesses. As MarketWatch commentator David Weidner pointed out (in a column with a curious headline about “lack of regulation” that is the exact opposite of the author’s point — often columnists, unlike bloggers, don’t wite their own headlines), “Broker-dealers are supposed to be the most scrutinized of the investment community. If Madoff was running separate businesses, the SEC and FINRA should have been looking at all of them as a whole.”

In fact, the fact that Madoff was under such heavy regulation probably helped him in constructing the alleged facade. As business reporters Binyamin Appelbaum and David S. Hilzenrath wrote in their perceptive Washington Post article, “the fraud Madoff allegedly constructed was successful in part because it avoided the appearance of risk.” The article quoted an expert as saying that SEC regulators “had to make judgments, and they decided to look at derivatives, short sales, insider trading, all the things that Madoff never had.”

So The SEC was too busy hounding unregistered hedge funds, short-sellers, and entrepreneurial companies for trivial minutiae from Sarbanes-Oxley and other mandates to notice the fraud right in front of them. The regulators didn’t just “drop the ball,” as President-Elect Barack Obama recently asserted. They lost focus on where the most important “ball” was.

Getting that “ball” back by paying attention to warning signs about where the real fraud is, and rolling back the mounds of red tape on honest investors and entrepreneurs that also wastes the time the agency has to go after the real problems, must be the number one priority of newly designated SEC chairman Mary Schapiro.

Too Bad Daschle Isn’t at SEC — Backed Sarbanes-Oxley Relief

by John Berlau on November 20, 2008

in Bailout Watch, Economy, Healthcare, Insurance, Legal, Politics as Usual, Precaution & Risk

President-Elect Barack Obama just nominated former Senate Democratic Leader Tom to be his Secretary of Health and Human Services. Much is being written about Daschle being a Washington insider, which he certainly is, but after leaving the Senate after his defeat in 2004, Daschle has commendably taken on the Beltway conventional wisdom on an important issue: The Sarbanes-Oxley accounting mandates.

In late 2005, Daschle became one of the first Democrats to criticize the 2002 law, rushed through Congress in the wake of the Enron and WorldCom falures, for its unintended consequences on entrepreneurs. In doing so he helped make the cause of Sarbox relief and reform biparisan. In a Wall Street Journal op-ed Daschle co-wrote with former Senate Republican Leader Bob Dole, the authors told readers of “small and mid-sized capitalization companies who say that their access to capital from publicly-traded stock markets has been made prohibitively expensive.” They pointed out that “studies have shown that the additional cost per company for compliance averages $1.4 million to $4.4 million,” and explained that “although increased auditing fees amount to a small burden for Fortune 500 companies as a percentage of revenue, the doubling or tripling of auditor bills, accompanied by additional accounting and legal fees, can be the difference between a profit and a loss for emerging businesses.”

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Liberals Against Libertarians

by Fred Smith on October 15, 2008 · 5 comments

in Bailout Watch, Economy

That liberals wish libertarians to go away is, perhaps, not surprising. But the issue is much more serious than even Jonah Goldberg realizes. McCain’s championing of “getting the monied interests out of politics” and Obama’s pledge to eliminate their influence both amount to an attempt to eliminate economic interest groups (and, indeed, interest groups that are in any way allied with economic interests – such as independent free market groups) from politics. But, politics is about interest group influences. If economic interest groups are eliminated, only ideological groups are left – right and left groups driven by cultural, ethnic, environmental or other religious values. Is that world likely to prove more tolerant, more compassionate, more “concerned?”

My personal vision of the future is to find myself about to testify in Congress on some creative expansion of the state. As I’m about to testify, the chairman speaks up: “Mr. Smith, before you begin, I have a question I’d like you to answer. Are you now or have you ever been associated with the wealth producing sector of the United States?”

A world where economic interests are disenfranchised – indeed, even de-legitimized – is a world that will have little regard for economic – and, thus, indivdiual – liberty.

Ideologues have created far more horrors than have even the most rampant of business villains. My understanding is that Stalin, Hitler, Pol Pot and Mao Tse Tung were not motivated by profits.

Paulson bailout would worsen contagion-spreading accounting rules

by John Berlau on September 22, 2008 · 1,225 comments

in Economy, Legal, Nanny State, Politics as Usual, Precaution & Risk

My colleague Hans Bader is correct that most of the aims of Treasury Secretary Henry Paulson’s $700 billion bailout — stopping the “contagion” of securitized loans that have become illiquid — could be achieved if mark-to-market accounting rules were “immediately relaxed by federal agencies like the SEC that enforce them.” As I wrote in my Wall Street Journal op-ed this weekend, because the mark-to-market rules require writedowns of performing loans based on the last sale of similar assets, good “banks holding mortgages that haven’t been impaired often have to adjust their books based on another bank’s sale — even if they plan to hold their loans to maturity.” (And commenter “Topcat” misses the point of the post. Because agencies like the SEC and Federal Deposit Insurance Corporation use mark-to-market to measure the solvency of banks and brokerages, these firms are certainly not “free to disregard the regulatory rule for valuation and apply their own.”)

But the bailout — in addition to putting taxpayers on the hook and massively increasing government’s role in the economy — would likely make mark-to-market and hence the credit crisis worse, according to experts who have reviewed Paulson’s plan. Paulson proposes a “reverse auction” approach by which government would choose the lowest selling price to by a financial firm’s mortgage-backed securities. But unless mark-to-market rules were changed, this sale would force other firms to write down their assets to this price.

An Associated Press story paraphrases American Enterprise Institute scholar Vincent Reinhart, a former Federal Reserve monetary affairs director, as saying that “if the auctions set too low a price for mortgage-related assets, other institutions with bad debt may be forced to take the distressed valuation onto their books under mark-to-market accounting rules.” A Wall Street Journal news article similarly observes that “buying for pennies on the dollar … would further hurt financial institutions, since they would have to write down the losses and take additional hits to their balance sheets.”

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The ‘Naked’ Truth — Short sellers are unsung financial heroes

by John Berlau on September 19, 2008 · 11 comments

in Economy, Legal, Nanny State, Politics as Usual, Precaution & Risk

At the peak of the real estate boom, there was one group of individuals who said the bubble was about to pop. They pointed to overvalued land and bad underwriting of loans. And they bet their own money on their beliefs. Who are these unsung prophets of the subprime bust: the much-maligned short-sellers, whom both Britain, as Iain Murray reported yesterday, and now the U.S. Securities and Exchange Commission temporarily want to ban in an effort to keep the share price of financials from going further down.

On Thursday, John McCain foolishly called for the ouster of SEC Chairman Chris Cox because Cox hadn’t cracked down on so-called “naked” short sellers and supposedly “kept in place trading rules that let speculators and hedge funds turn our markets into a casino.”

McCain would have been on better ground asking for Cox’s ouster based on his refusal to push for reform of the growth-killing and counterproductive Sarbanes-Oxley accounting mandates and for opposing CEI’s lawsuit against the law’s unconstitutional Public Company Accounting Oversight Board. The “naked” short-selling McCain was referring to — which doesn’t mean that someone is shorting a stock disrobed at their computer, but refers to when someone trades with shares that aren’t there — is already illegal. (Although the SEC steps recently taken to prevent it could have costly effects on broker-dealers who would have to redesign their computer systems. More on that in another blog post.)

But later that evening, Cox would apparently prove the even bigger fool by reportedly telling Congress that the SEC was going to temporarily ban all short selling! According to the Associated Press, “Cox told the lawmakers the SEC may put in a temporary emergency ban on all short-selling — not just the aggressive forms it already has targeted, according to a person familiar with the matter. The ban might apply to stocks of selected financial companies, to all financial companies or even possibly to all public companies.”

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