Category Archives: Law

The Hidden Cost of Credit Ratings

justice

The NY Times’ “The Hidden Cost of Trading Stocks” paints a concise and damning picture of yet another malpractice in financial services.  This has been a recurring theme.   

Another storm may be brewing – this time for the credit ratings industry.  

It is standard practice for issuers to hire ratings agencies to rate their securities.  This practice has lead to incentives to give higher ratings when trying to get business from securities issuers, putting the ratings agencies in the position of representing the issuers when they are given special status to serve and protect investors.  They are not even required to disclose the conflict of interest.  The closest we get to protection is a lawsuit when they explicitly advertise objectivity.

It now looks like 16 states will each get their chance to sue individually.  This may be the beginning of a big and positive change.  If conflicts of interest did influence credit ratings, it would shift capital and damage economic efficiency even when it is not misdirecting pension money into a mortgage bubble.  I wonder if we will see a social media movement to influence reform like we are seeing with network neutrality and “common carrier” status.  I hope so.

 

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Private drones

Private droneIt’s becoming easy; we’re on the cusp. Soon, you will be able to assemble or buy a private drone that can go anywhere, record video, deliver a payload, retrieve a thing, whatever. Land, sea, and sky. Automated surveillance systems can be easy to control. Can you click on a spot on a map? That’s pretty much all you need.

How do we respond as a society when anyone can spy or kill as easily as clicking an app? How do you trace an attack that is delivered from the sky from anyone anywhere? How do you handle alibis when you can schedule a crime with cron?

I don’t know the answer, but it’s a continuation of a long trend toward putting more lethal power into more hands. I hope some smart people are thinking well about this.

Somehow, I don’t think a drone shield is going to be enough.

Crisis of Confidence

I, through my firm, was a customer of PFG, the latest registered broker dealer to steal from its clients’ accounts – first reports indicate $200 million may have been taken.  This pattern is becoming too frequent. Innocent victims have lost money yet again.  How did it come to this?

Broken Markets

Self-regulation by an oligopoly… I don’t think there is any economist or politician who wanted this outcome, but special interests and lobbying have led to this.  This is how the futures industry works today.

Capitalism is broken without fair rule of law and regulation, and today top firms organize and self-regulate with practices that add cost but lack teeth. This discourages competition from smaller companies, but it also gives the largest companies free reign to raid their clients’ accounts and hide their crimes for years. So far it seems there is little or no accountability when they are discovered.

If market participants cannot expect basic protections, then they will leave, prices will fall, volume will shrink, and markets will whither.  Companies will have less access to capital and be exposed to more risk, and the economy and workers will suffer.  We’re already a long way down this path.

The economic ideal and the allure of free markets is only possible when regulation protects innocent market participants, minimizes fraud and cheating, and does not deter innovation. That means expanded domain of the SIPC, the SEC should have unlimited authority to monitor accounts and communication (opt-in would be fine), and companies should only minimally participate in their own oversight. With this structure, investors would be protected, transparency would reduce fraud, and free markets could flourish with competition and innovation.

Sounds obvious, but don’t hold your breath.

Corporate Corruption

There are a lot of types of corporate corruption, but they all start from an imbalance in power and oversight.  There is one tiny change could have a huge impact on this problem: allow shareholders to nominate people for elections of the Board of Directors of public companies.  It’s a small, seemingly obvious shareholder right, but it would have a big impact.

Management should not have the exclusive right to nominate their bosses. In fact, because the Board of Directors is supposed to represent the owners’ interest, it seems crazy that owners can not nominate. When the owners of a company are empowered to nominate Board members, management comes back under control, compensation comes back to reality, performance is scrutinized better, and the interests of investors are better served.

In private equity and smaller firms of every kind, this is always how it has worked.  Major shareholders often join Boards of private companies and nominate other Board members.  How public companies ever achieved the ability to control the Board nominations without rights for shareholders, I’ll never understand.

Too much

There are so many other ways that markets are broken and corruption is bringing us down.  Is it too much to fix?  Are we destined to watch for the rest of our lives as the emerging markets grow right past us and Americans fight amongst ourselves? Is our political and influence machinery too dogmatic or corrupt to embrace new good ideas together?

I’m not confident.

The Independent Globalist: an instruction manual

I drink your milkshake

You drank my milkshake!

Independent globalists optimize after-tax returns, labor, and supply chains into the tax and regulatory regimes that are most favorable.

It’s an optimization exercise and a chess game.  This seems to be the dominant strategy:

1) After-Tax Returns

The equation: taxes + regulation.   Taxes are simple; they reduce your profits by their rate.  Regulation is more complicated because it costs money to comply, but there are also opportunity costs from business activities that are no longer available.

The game: reduce and eliminate taxes and regulation.  Express the stresses of international competition to pressure national politics using one issue at a time in the countries where you do business.

2) Labor

The equation: salary + benefits, including long term commitments.  Retirement, health care, and other benefits have costs, but also may reduce employee turnover.

The game: reduce and eliminate costs within each role.  Divide operational units and move them to locations with optimal rules and costs.  Use the placement of these units to pressure politics to reduce labor’s collective bargaining rights.

3) Supply Chains

The equation: price.  Commodities and other non-labor costs are priced on global markets, and are mostly fungible.

The game: reduce and eliminate regulations that internalize costs of production for your suppliers.

Net Neutrality: No Compromise

To begin talking about Net Neutrality, it helps to clarify what the internet is. It’s simply data sent via TCP/IP (the protocol for sending data through routers). Some people host web sites, others connect to their company e-mail, others do other things – it’s all the internet.

Understanding that the internet is just a connection using TCP/IP, then Net Neutrality is simple, too. Net Neutrality simply means that your ISP may not interfere with the internet. They may not censor your packets (the data that is sent via TCP/IP). This means they can’t censor your news, keep you off of Skype, restrict your sending and receiving, or otherwise interfere with your communications.

Any compromise on this is wrong for two reasons: 1) Your ISP should not have the right to interfere with your free speech, and 2) ISPs should not be able to tax the value creation of the media industry.

ISPs should not be able to interfere with consumer access to media companies, nor tax those companies for access to consumers. ISPs should not be able to interfere with our speech or block our access to the speech of others.

ISPs are in the business of providing internet access, but they don’t own the internet; any attempts to eliminate net neutrality would violate our consumer rights and hurt the economy.

Jim Cramer is a dirtbag

Jim Cramer admits to manipulating the market for certain stocks and inventing false rumors which he then spread through the media (including CNBC). He says that this is how hedge fund managers operate normally, and gives the impression that insiders and market manipulators can (and should) use these strategies to earn excess returns.

Let me assure you that he is wrong. The behavior he talks about certainly does happen, but it is not ethical, normal, good, or as pervasive as he implies. Most funds do NOT utilize this strategy. Jim Cramer and any fund managers who use these strategies give the industry a bad name. Worse still, they are the reason that Federal and State regulators must be so intrusive and vigilant. The general public is right to criticize this behavior, but other fund managers should be the loudest critics because he’s part of the reason that our industry is over-regulated.

Somebody should punch him in the nose (or fine the crap out of him and put him in jail).

[UPDATE – 3/23]

The video has been pulled from YouTube by claims of copyright infringement by Jim’s company, TheStreet.com. Pulling the video doesn’t make him less of a dirtbag. For your information, a detailed account is available here: http://seekingalpha.com/article/30257

Copyleft 101

NewScientist has a very good survey article regarding copyleft. They discuss the legal implications of waiving the exclusivity rights, as well as the philosophical differences in vision regarding the commercialization of intellectual properties.