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SEC Charges Execs with Fraud at Fannie & Freddie

Following up on our September post "Big Bucks, No Whammies?" about the SEC's apparent inaction on the wells notices they had served to the execs of Fannie & Freddie. We write to report that Whammies finally came with  Friday's headlines . The SEC brought fraud charges after all, not just against Daniel Mudd, former CEO of Fannie Mae but also five others now charged with deliberately misleading government officials about the extent of their subprime exposure.

The NYTimes explores the charges in greater detail and there are new reports that an FBI investigation into the same conduct is underway which means the guys could face criminal charges.    Following the SEC announcement speculation had already begun that Mudd would soon step down as CEO at Fortress Investment Group (FIG).

“Can you really run a trading and investment firm with a guy accused of fraud in the corner office?”   a Fortress employee was reported to have asked.  Apparently not when the accusations become official. (UPDATE:  Mudd took leave as CEO of Fortress on Wednesday December 21)

Mudd has been on the board at Fortress since 2007,and was appointed CEO of Fortress when he left Fannie amid scandal after the bailout in 2008 Fortress is a publicly traded hedge fund which recently introduced new subprime mortgage bonds onto the market.... 

PCAOB Continues to Find Audit Deficiencies Among Big Four Accounting Firms

Nearly a decade after the accounting world was turned on its ear by the Enron and Worldcom scandals, it appears there are still worrisome issues with audits conducted by the industry’s biggest firms.  The Public Company Accounting Oversight Board (“PCAOB”)—the body created in the wake of the earlier scandals to oversee the accounting agency—issued recent reports detailing its study of audits performed by Big Four firms PriceWaterhouseCoopers (“PWC”) and KPMG.  Those reports found a troubling rate of audit deficiencies at both firms; detailing flaws in 28 of 75 audits by PWC and 12 of 54 audits by KPMG.  In some cases, the flaws went to the heart of the audit.  The reports note that PWC, in some cases, “failed to obtain sufficient appropriate audit evidence to support its audit opinion,” and that KPMG sometimes failed “to identify, or to address appropriately, financial statement misstatements, including failures to comply with disclosure requirements.”  The PCAOB study, which examined audits from 2010, also found that the deficiency rates for both firms were higher than in previous years. 

The PCAOB’s findings are good reminder that even audits conducted by the largest accounting firms are susceptible to significant error.  It is clear that the auditing industry still has a way to go before investors can rely on any accounting firm’s stamp of approval.

Wall Street’s “Moral Minority”

A New York Times article has revealed that long before Occupy Wall Street, the Sisters of St. Francis of Philadelphia were battling Wall Street over corporate responsibility. For the last thirty years, the Sisters have used the investments in their retirement fund to become Wall Street’s moral minority.

Using their status as shareholders, the nuns fought with Kroger over farm worker rights, with McDonald’s over childhood obesity, and with Wells Fargo over lending practices. They have met face-to-face with the heads of Lockheed Martin, BP, and General Electric. Most recently, they advised Goldman Sachs executives that the bank should protect consumers, rein in executive pay, increase its transparency, and remember the poor.

With their moral authority, the Sisters of St. Francis “can really bring attention to issues,” said Robert McCormick, chief policy officer of Glass, Lewis & Company, the proxy voting firm. “You haven’t seen shareholder activism until you see a nun battling it out with the CEOs. They can be devastating,” said Michael Passoff in a 2005 article on religious shareholder activists. Passoff works in the Corporate Social Responsibility Program for As You Sow, a leading organization in the strategizing and organizing of shareholder campaigns.

The nuns have been waging this war since 1980, when St. Francis Sister Nora Nash formed a committee with her community to combat troubling developments at the businesses in which they invested their retirement fund. The Roman Catholic order of over 500 nuns has teamed up with other orders and faith-based investing groups on shareholder resolutions. Much of Sister Nora’s activism takes place under the Interfaith Center on Corporate Responsibility, an umbrella group which includes Jews, Quakers and Presbyterians.

Sister Nora said that she and the order “want social returns, as well as financial ones.” She added, “when you look at the major financial institutions, you have to realize there is greed involved.”

The full New York Times article can be found here.

Wall Street Firms' Broken Promises

When the New York Times recently analyzed SEC enforcement actions during the last 15 years, it found at least 51 cases in which 19 Wall Street firms had broken antifraud laws they had agreed never to breach. In his November 7, 2011 article, the Times’ Edward Wyatt explained that, in settling securities fraud cases, the SEC typically demands pledges from the companies that they will never again violate one of the main antifraud provisions of the nation’s securities laws. In other words, the SEC asks companies not to do something the law already forbids.

As Mr. Wyatt points out, the commission wrested such a promise from Citigroup when the company agreed last month to pay $285 million to settle civil charges that it had defrauded customers during the housing bubble. He says: “Citigroup’s main brokerage subsidiary, its predecessors or its parent company agreed not to violate the very same antifraud statute in July 2010. And in May 2006. Also as far back as March 2005 and April 2000.”

In spite of the prevalence on Wall Street of repeat offenders – Morgan Stanley, JPMorgan Chase and Bank of America among the many – the SEC said in a court filing Monday that it had not brought any contempt charges against large financial firm in the last 10 years.

According to Senator Carl Levin, a Michigan Democrat and chairman of the Senate permanent subcommittee on investigations, the SEC’s method of settling fraud cases is “a symbol of weak enforcement. It doesn’t do much in the way of deterrence, and it doesn’t do much in the way of punishment, I don’t think.”

A Chance "To Talk About What's Broken" - Warren's take on Occupy Wall Street

Controversy surrounding Elizabeth Warren's position on Occupy Wall Street has been widely publicized this week, perhaps obscuring the simplicity and integrity of her words on the movement.    

Have you seen this powerful video yet? 

"I have been protesting Wall Street for a very long time. Occupy Wall Street is an organic movement, it expresses enormous frustration and gives a great faith all across the country for people to talk about what’s broken."

  

 



ISS and Other Shareholder Firms Recommend ‘NO’ to Murdoch Family

Institutional Shareholder Services (“ISS”) recommended that shareholders of News Corporation, in the company’s next annual meeting scheduled for October 21, should vote against the re-election of 13 out of 15 board members to establish more independent oversight of management.  Specifically, ISS recommended shareholders vote against Chief Executive Officer Rupert Murdoch, his sons, James and Lachlan, and ten other directors.  In a report released earlier this week, ISS said, “The company’s phone hacking scandal, which began its public denouement in July 2011, has laid bare a striking lack of stewardship and failure of independence by a board whose inability to set a strong tone-at-the-top about unethical business practices has now resulted in enormous costs – financial, legal, regulatory, reputational and opportunity – for the shareholders the board ostensibly serves.”

ISS is not the only advisory firm that is advising News Corp’s shareholders to vote against the Murdoch family.  Glass Lewis & Co. has similarly recommended that shareholders vote against James and Lachlan Murdoch and four other directors and that shareholders should “carefully consider the nature of the relationship” each director had with the Murdoch family.  Further, Glass Lewis said that “applying oversight has not been a strength of the News Corp board” and that it had “consistently failed to achieve standards of good governance due to the board’s historical deference.”  The Australian Council of Superannuation Investors and advisory firm Pension Investment Research Consultants in Britain have also recommended that the Murdoch brothers have to go.

Moreover, the Local Authority Pension Fund Forum in Britain is advising its members that James Murdoch’s presence on the Board was “causing significant reputational damage” to the company, and his re-election should be opposed.  The Local Authority Pension Forum also wants Rupert Murdoch removed from the board in order “to secure News Corp’s long-term future such reform is necessary.” 

Big Bucks. No Whammies?

Tick Tock. Tick Tock.  In a scenario reminscent of the classic game show Press Your Luck.  It appears Former Fannie Mae CEO Daniel Mudd  may get a reprieve  courtesy of new Dodd-Frank stopwatch.  Mudd was put on notice March 11th that he could face regulatory action for his role in misrepresenting the underwriter's subprime exposure to investors and government agencies.  But Dodd-Frank amendments enacted last year introduced a 180 day time limit compelling Commission staff  to "either file an action or provide notice to the Director of the Division of Enforcement of its intent to not file an action,” within 180 days of the Wells Notice. 

The probe centers on his time at Fannie Mae and his role in creating the subprime debacle that would shock the country and the world.  But given the radio silence, observers wonder if  new admendments that were intended to make the agency more proactive in handling such cases have backfired.   

An alternate theory is that the inaction is related to reports that the SEC is winding down its investigations of Fannie & Freddie the NY Times reported that Fannie settlement talks were underway and fraud charges would likely be dismissed.  

As we explore more in the Pomerantz Monitor this month.  Fannie & Freddie Conservator the FHFA  also announced in early September that they'll seek to recover $196 billion in new actions against 17 banks for misrepresenting CDO risks to the underwriters.

For his part, Mudd has shown little remorse.  His failure, he said, was only that he could not maintain the “delicate balance,” required to meet such expectations.   Since taking over the CEO position at Fortress Investment Group Mudd's appetite for subprime has continued unabated.  In May, the publicly traded hedgefund unveiled subprime bond Springleaf acquired from AIG.  They  even managed to secure triple A rating from S&P after that agency had downgraded US treasury securities. 

So far, for Mudd its big bucks, and no whammies. 

Institutions Urge the SEC for New Proxy Access Rule

Fourteen institutional investors including the California Public Employees’ Retirement System, Connecticut Retirement Plans and Trust Funds, New York City Pension Funds, New York State Office of the Comptroller and North Carolina Department of State Treasurer are urging the SEC to issue new regulations on proxy access in order to give shareholders the right to include their candidate for the Board of Directors on a company ballot.  The institutional investors issued the following statement:

The SEC’s rule granting shareowners full proxy access was the right rule when it was issued – and it’s the right rule today. The merits of proxy access by shareowners have been discussed for several years, but the 2008 financial crisis exposed how complacent many company boards of directors had become, and investors paid a heavy price. We have accumulated far too many examples of unaccountable directors on boards which have ignored shareowner proposals, fallen short of their duty to oversee management and, too often, overcompensated CEOs and senior executives relative to performance results when they failed to deliver shareowner value.

Giving long-term shareowners with substantial stakes in the company the right to nominate directors would add a powerful tool to keeping boards accountable and companies financially healthy. Investors needed that authority leading up to the downturn – and nothing has changed since then. It is a rule that will help level the playing field in director elections.

We applaud the SEC’s Commissioners for their leadership and hard work over the years in bringing forward rules on the use of the proxy to nominate corporate directors. The decision in July by the District of Columbia Circuit Court of Appeals invalidating the SEC’s rule was disappointing. But now is not the time to give up. We strongly urge the SEC to issue new rules on full proxy access and continue its commitment to providing long-term shareowners with the right to have a say in who runs the companies they own. It’s a principle whose time has come and one that will further restore accountability, integrity, and order in our financial markets.

Say-on-Pay Update

As we have reported in earlier posts on “Say-on-Pay,” the Dodd-Frank Act provides for an advisory shareholder vote to approve executive and board compensation at most public companies.  While companies have overwhelmingly passed their Say-on-Pay votes this proxy season, 39 out of approximately 2000 companies have reported failures.  Twenty-five percent of these failures have occurred in the energy sector, and almost all failed votes have followed on the heels of a “no” recommendation by the institutional investor watchdog, Institutional Shareholder Services.

The Dodd-Frank Act also provides that shareholders decide how frequently Say-on-Pay votes are held -- the options ranging from every one to three years.  As expected, companies who failed this year’s Say-on-Pay vote also saw their shareholders demand such votes every year.

While these votes are advisory in nature, plaintiffs are using failures to bolster unjust enrichment and corporate waste claims in shareholder lawsuits.  The stronger cases have coupled these claims with federal claims under the proxy rules, often attacking a company’s “Pay-for-Performance” policies.  So far, two such shareholder lawsuits -- against KeyCorp and Occidental Petroleum -- have settled.  A significant part of the KeyCorp settlement included substantial compensation policy reforms.  The terms of the settlement in Occidental (whose CEO Ray Irani has been paid almost $300 million over the past decade) are largely confidential.  The remaining cases are pending.

We are encouraged that shareholders are standing up for the principle -- both at the corporate ballot box and in litigation when necessary -- that public companies should not increase executive compensation as shareholder returns decline.

Executives’ Personal Portfolios Hedged

The New York Times reported Saturday that more than a quarter of Goldman Sachs’ partners used various hedging strategies from July 2007 through November 2010, based on its reporters’ analysis of regulatory filings. According to a Goldman spokesperson quoted by The Times, only 10 top Goldman executives are barred from hedging their Goldman shares. One Goldman partner avoided several millions of dollars in losses by putting a collar on 175,000 shares in a transaction entered into several months prior to the financial crisis, The Times reported.

A 2010 paper by professors Bettis, Bizjak and Kalpathy found that executives tended to place hedges after significant share price increases relative to the market, and that zero-cost collar and prepaid variable forward hedges tended to precede significant declines in the company share price, according to a summary on “Executive Pledging and Hedging” on the Stanford.edu Knowledgebase.

The SEC is drafting regulations under the Dodd-Frank Act to require U.S. issuers to disclose company policies permitting employees or directors to enter into transactions designed to hedge decreases in value of the firm stock.