Re:Balance -- Jim Peterson

The SEC's Mary Schapiro on the Myths of GAAP/IFRS Convergence: The Lady Doth Protest Too Much

            Local news item: “Last night the high school drama club played Shakespeare. Shakespeare lost.”

 Last week, SEC Chairman Mary Schapiro played the 2010 annual conference of the chartered financial analysts. Her speech is here.

Credibility lost.

Her ambitious list of messages included a major tilt at four “myths” about the SEC’s lukewarm attitude toward GAAP/IFRS convergence and globally merged accounting standards.

In protesting that “you can’t always believe what you hear,” Schapiro’s pushback suffers the inductive fallacy that opposition to your critics is not the same as proof of your own position.

Whether or not the agency’s own “commitment to international standards has flagged,” Schapiro either could not face – or is still denying – the implacable international antagonisms to convergence that her agency lacks the capacity to resolve.

 There is, indeed, no more eloquent concession of the “convergence gap” than Schapiro’s own admission that “US GAAP and IFRS are currently not converged in a number of key areas,” including “the accounting for financial assets (the very types of securities at the center of the financial crisis), revenue recognition, consolidation principles, and leases.”

 Any other problems, Madame Chairman? These on her list are so comprehensively grave that they will keep the international standards standoff alive until the end of time. 

 It’s not necessary to believe Schapiro to be as malign as Shakespeare’s Queen Gertrude, or to fault the bona fides of her commitment to the “fundamental principle” of “comprehensive and neutral accounting standards.” Because on the prospect of core-level GAPP/IFRS convergence, she is committed as were the pre-Copernican astronomers to the “fundamental principle” of an earth-centric solar system.

 It’s just that while good faith is fine, eventually it must yield to reality.

 In assessing the feckless attitude of America’s chief securities regulator, it helps to keep at hand a glossary of trans-Atlantic euphemism. That is:

•  ·      When a Frenchman says, “We need to be pragmatic,” what he means is, “Agree to do it our way – or there’s no deal.”
• ·      When an Italian says, “You don’t understand how things are done here,” the unspoken message is, “You have no chance – cut your losses and head for home.”
• ·      And when the typical balls-out American attitude gives way to Schapiro’s concession to “understand the importance of process to a successful conclusion (her emphasis, not mine), it means “We know we’re screwed for now, so we’ll kick the can down the road and try to sell it as success.”

The targets for Schapiro’s spin were not clear, as she advanced the assertion that discussion on accounting principles “is often limited to specialized journals and a handful of websites for the kind of people that can tell a repo 105 from a 401(k).”

As if her pimping would be seductive. Weighing in from his base in Minnesota, academic blogger Dave Albrecht (here) made it clear that he did not just fall off the turnip truck, with a trenchant Twitter message that the intelligence level of Schapiro's constituents other than the mainstream brown-noses is entitled to more respect: “Ridiculous comments, sad that some might believe her.”

Also counting against Schapiro’s credibility is that, despite building her speech on the three obvious pegs of the SEC’s mission, initiatives and priorities, she gave not a single reference to a most basic issue – the continued viability of the global assurance function.  

Anyone still thinking that the life-threatened auditors have “had a good crisis” over the last three years (here) has not spent recent time around the courthouses – the latest bullets added to the Big Four firms’ deadly game of Russian roulette being Ernst & Young’s inclusion in the Lehman Brothers litigations (here) and the two-billion dollar claim against PwC by the winding-up board of Iceland’s Glitnir Bank (here).

On the very day of Schapiro’s speech, with its bare one-phrase reference to her “overseeing … the PCAOB,” that agency published a list of some 400 non-US companies whose auditors could not be inspected because of obstacles under their home-countries’ laws (here).    

The PCAOB claims to be “currently prevented” from its mission – as if the issues of non-US confidentiality, data protection and privilege have not been readily knowable since before Sarbanes/Oxley birthed the agency birth back in 2002.

A good index of global-scale companies, whose audits are out of reach of the PCAOB, could be built from that list: a quick sample of household names from around Europe includes AB InBev, Nokia, Total, AXA, Daimler, Deutsch Bank, SAP, Ryanair, Luxottica, ArcelorMittal, ING, Ericcson, ABB, Credit Suisse, Royal Bank of Scotland, WPP, BP, AstraZeneca, Pearson and Unilever. 

To be really transparent, the internationally toothless PCAOB might publish its short list of those companies for whom audit inspection did not present obstacles (a sub-set whose total market capitalization would not make a flyspeck on the windshield of the world’s economic engine). Or, perhaps, the far longer list of those companies for whom auditor inspections have not even been attempted.

Schapiro claimed that “investors – from anywhere across the globe – come under the SEC’s umbrella of protection. ” 

She might more candidly confess to all investors, “bring your own foul weather gear – you’re on your own.”

 

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Trust Matters: Charlie Green and I on Ethics Training, Corporate Standards and Society's Limited Expectations from Government

I talk often with Charlie Green -- author, speaker and consultant, and expert on the theme of trust in business relationships. His blog, Trust Matters, is a ready and regular source of wisdom.

We spoke at length this week, on a broad range of related subjects. Charlie has posted the interview as the latest in his series of Trust Quotes. Here are several excerpts:

CHG: What concerns do you have about the effectiveness of teaching about trust, ethics and governance in the business schools and universities?

JP: It’s my belief that much of the teaching is at best ineffective and at worst a misleading waste of time – although I am sensitive to the way this is received among my colleagues in academia. Jeff Skilling and Andy Fastow were celebrated as executives to be admired, and either one would have scored an A+ on any university-level course in ethics or governance.

****

CHG: Both “doing good” and “doing well” are byproducts of a cultural devotion to doing business from a certain set of principles? Care to say something about what those principles look like?

JP: One of the finest defense lawyers I ever knew, the late Peter Fleming, had nothing but scorn for elaborate codes of behavior – governance, accounting principles, whatever. His guidance required one page: “Can you credibly defend this decision in front of a jury?”

****

CHG: What can we reasonably expect from government by way of contribution to good corporate behavior?

JP: I’m a deep skeptic on the ability of regulators to either detect or to deter bad behavior. Not that oversight and enforcement are not necessary. But it seems to me pretty clear that the post-Enron imposition of Sarbanes/Oxley did not lead to an outbreak of virtue.

Look at the many examples over the last three years....Law enforcement is by nature always going to be reactive, behind the curve of the inevitable misbehavior of those who would burst the limits...It goes back in part to why societies evolve their laws and codes of behavior. People don’t become law-abiding because more laws are passed.

I invite you to the interview in its entirety. And Charlie and I would both welcome your reactions and comments.

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Goldman Sachs and the Fabulous Future of Fabrice Tourre

Is there a future at Goldman Sachs for Fabrice Tourre? The self-styled “fabulous Fab” was the only individual clipped as co-defendant in the suit by the Securities and Exchange Commission over Goldman’s late 2006 flogging of the exotic financial derivative Abacus, a credit default obligation based on a portfolio of toxic subprime mortgages.

Tourre is now safe-housed in London -- Goldman having evidently taken the strategic decision to keep their erstwhile wonder-boy clasped in close embrace for the duration of its legal exposures. 

For which, by contrast, compare the unpleasant consequential exposures for Société Générale, whose rogue ex-trader Jérôme Kerviel’s just published tell-all, “L’Engrenage, Mémoire d’un Trader”, re-ignites the early 2008 agony of his multi-billion euro infliction; or Arthur Andersen’s ready disavowal and jettison of Enron engagement partner David Duncan, before its own flame-out in 2002.

It would be inductively flawed for Tourre to assume continued enjoyment of his employer’s long-term hospitality. Thanksgiving turkeys, fattening in luxury through the autumn, learn to their dismay of the radical adjustment in their life-style when the farmer’s late-November strategy brings down the axe. Equally, Tourre’s useful life at Goldman is tied entirely to the resolution of its concerns with law enforcement.

So, being well-advised, he should expect to become chum for the sharks either as part of a settlement or directly thereafter.

Unless of course he can prove his present value by re-programming the energy with which he hawked the Abacus product to Goldman’s ready market of credulous believers. 

And how? The British bookmakers have already captured the odds-making on the survival prospects of the Tory/Lib Dem coalition. This year’s action on the NCAA basketball tournament is over. And the consequences of BP’s blown well in the Gulf of Mexico are priced into existing petroleum futures.

Other exotic alternatives? Given the volatility of emerging information about the organized church, arising from Chile to Germany, what about “clerical futures,” tied to the predicted tenure and turn-over of a portfolio of Catholic bishops, or the likelihood of Episcopal schism based on gay ordinations?

Or perhaps a wager on the total first-year sales volume of Apple’s iPad – directly tied to the roll-out of the device itself rather than the prosaic proxy of AAPL’s stock price?

Or here: our cultures now encourage wagers on the duration of life itself, through life insurance, viatical settlements and reverse mortgages -- and pre-nuptial agreements are increasingly used to manage the business side of romantic associations. Do the investment bankers’ innovators not see an unexploited niche market for financial products tied to the durability of marital contracts?

A full range of investment opportunities should be available. A customized wager on the likelihood of the neighbors’ break-up would require frequent re-pricing, depending on the level of loud arguments and broken crockery. By contrast, standardized trades could be tied to the five-year intervals celebrated in the etiquette books – call them “anniversary futures,” denominated wood, tin, pearl, silver, and golden, and priced accordingly.

The records of the domestic courts would also make historical data available to underpin trading opportunities in “marriage pools” -- say, by parish or profession or income level -- with divisions into tranches and risk ratings differentially assigned and priced. 

Consider the risk-disclosure language in the offering documents: triple-AAA ratings for the likely fidelity of a group of unadventurous stay-at-home actuaries – or junk-level assessment for the ten-year prospects of wander-lustful professional golfers or soccer players or elected officials.

These ideas might generate a certain reticence among portions of the investor community. Betting against the probity of the local clergy might infringe some sensitivities. Hard-core adherents to the sanctity of life-long vows might be uncomfortable taking bear positions. But no more so than the occasional unease with the role of short-sellers in the equities markets – recalling that nobody actually forced Goldman’s clients to buy those doubtful-looking CDO’s.

A host of small details would remain to be worked through – whether insider status would extend to clergy or divorce lawyers, for example.

But these are small concerns, and “the Fab” has time on his hands. 

Unless, being smarter than a turkey, he is already busy trading the over/under on his departure date.

 

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How Dangerous is the Two-Billion Dollar Suit Against PwC Over Iceland's Glitnir Bank? The Answer is Blowin' in the Wind

Especially for PricewaterhouseCoopers, the bad news out of Iceland just won’t let up.

First it was the October 2008 collapse of the country’s entire banking system – including its three largest banks – and the departure of their former leaders for congenial places of refuge.

 Then it was the volcano with the unpronounceable name, closing airports world-wide in a demonstration that it is not nice to disregard the forces of nature.

 And on Wednesday came the announcement of a two-billion-dollar lawsuit, brought in New York by the winding-up board of Reykjavik-based Glitnir against its former chairman, chief executive and other leadership, lead investor Jon Asgeir Johannesson, and its auditors PwC -- here.

 It’s an updated reprise of the hitchhikers’ bumper sticker from the 1970’s: “Cash, ash or crash – nobody rides for free.”

 (Okay, for those who don’t remember the original – here.)

 Although asset-freezing orders were apparently issued out of the High Court in London affecting Johannesson’s real estate holdings, those among the individual defendants presently outside the reach of the American or Icelandic legal systems poured scorn on the proceedings – here.

 Bombastic posturing from sheltered jurisdictions will cut no ice with the litigation process in America, however, and PwC itself issued the predictably bland statement (here) about standing by its opinions.

 Well it should, because the days are over when litigation arising out of the non-English countries could be disregarded as trivial, disrespected as the works of immature jurisdictions where outcomes were negotiable against a backdrop of mutual accommodation and inconsequential impacts.

 Instead, PwC faces a real lawsuit (for the complaint, here), in a real court – Manhattan’s New York Supreme – brought on behalf of the bank’s creditors and advised by Steptoe & Johnson and Slaughter & May – real lawyers who know their billions from their millions. Nor, any more than any of the other Big Four accounting firms, does PwC have the resources to absorb a ten-figure litigation blow (here). 

 So the proceeding is mightily more serious for PwC than a few days of flight delays. The Glitnir proceedings show yet again that the world of life-threatening auditor litigation has become as borderless as the skies of global air travel.

 Blowing smoke is not going to make this one go away.   

 

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The Future of Goldman Sachs: Sound, Fury, and the Human Appetite for Risk

 

If correctly read, the thermometer on the temperature of the body politic suggests that the public fever of the last weeks on the SEC’s charges against Goldman Sachs has broken.

A reader expressed her cooled reaction to Goldman’s design of an exotic, tradable mortgage-based product on which the shorts and longs were symmetrically affected: “Why not – after all, that’s what they do!”

It’s not just Warren Buffett's avuncular cheerleading at the Berkshire Hathaway shareholders’ meeting in Omaha, however directly interested, or the related embrace of the mainstream media (for both, see the NYT’s Andrew Ross Sorkin on May 3, here).

More, the brevity of public attention proves again Samuel Johnson’s 18^th century observation that “nothing focuses the mind like a hanging” – whether the present dependent subject is the British Parliament, BP’s oil containment efforts or the Greek noose around the neck of the Euro.

As it moves off-screen, Goldman’s future does not depend on the usually attenuated inter-connections between Main Street and Wall Street. It will lie, rather, in the hands of law enforcement officers, whose reputation enhancement will incline them to nick off a pound of flesh or two and move on to resolution; legislators ready to take up other posturings; and, especially, clients and trading partners whose self-interest will be well served by Goldman’s robust survival.

Which, the more I ponder, is as it must be.

Populist outrage at the business model behind Goldman’s esoteric designs always lack emotional coherence – the unease of those uninformed and unfamiliar with the operation of complex financial products showing again that a little information can be worse than none at all.

As the behavioral academics say, it’s very much to do with how the issues are framed.

For one example: conventional reaction would likely be negative in response to an opinion poll, “Would you support wagering on the length of a human life?”

Yet that is the entire basis for the life insurance industry, which – no less than Goldman’s Abacus product – is in the long run (costs, time value and enterprise profits included) a zero-sum proposition. Large pools of underwriters’ capital wager on the uncertain but ultimate timing of the inevitable mortality of those on whom the bets are made.

And a broad range of legitimately insurable interests are required – it only being frowned upon to allow, for example, the sole care-giver of a fragile elder to take a large policy for his own benefit.

Likewise, while the disconnect between aspirations and responsibilities played no small part in the foundational irrationality of the credit crisis, ownership of a family home has been widely promoted as a virtue. Meanwhile, despite the faint odor of disrepute not unlike that sometimes attached emotionally to short sellers in the equities markets, a niche market for reverse mortgages develops, by which the home equity of aged owners is bought out under pricing based on lifetime occupancy and actuarial expectancy tables.

Even at the personal level, the comparison has always been striking between motorcycle riders in America – who dutifully keep to their lanes although exercising a libertarian right to ride bare-headed – and those in France, for whom helmet compliance is inviolate but so is the chance to careen around traffic and down the dividers.

All of which shows that variations in risk appetites are pervasive, ranging from the ubiquity of casinos and lotteries to the cultural variations in personal safety judgments to the stream of innovations in mitigation techniques – whether product safety devices or hedging derivatives.

So while the particulars of Goldman’s innovations would, and will, outstrip the comprehension of its outsiders – beyond the atavistic spasms of short-term insult at the sheer amounts of money involved – its fundamental instincts are no different from those broadly inherent in the animating principles of human society in general.

In other words, they are part of us.

 

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Valuing Goldman's Next Sh*tty Deal: How About a Little Wager?

  The race is not to the swift, nor the battle to the strong.

-- Ecclesiastes 9:11

But that’s the way to bet it.

--Damon Runyon

 A reader has just asked how, under a cascade of falling knives, Goldman Sachs might shelter itself?

 Media coverage of last Thursday’s Senate hearings tip-toed around the use by Subcommittee on Investigations Chairman Carl Levin (D.-Mich.) of the internal nomenclature of the “sh*tty deals,” like pedestrians in sandals on my dog-infested Paris street.

 The odor of the entire sordid proceedings was unrelieved by the insistence of more punctilious editors on asterisks and euphemisms, nor was the dignity of America’s upper legislative chamber improved.

 Goldman confronts a quartet of threats, of which only the latter two will be serious:

•  The Senate’s orgy of finger-pointing is now old news, supplanted by the BP oil spill, the Times Square car bomb and the British elections.
•  The eventual financial services legislation to emerge from the Congress will be pernicious and misguided, but no less survivable by Goldman than by any other banks.
•  The SEC’s suit over the subprime-mortgage-backed product designed and sold at the behest of hedge fund manager John Paulson, and the potentially broader and more crippling criminal investigation by Justice, will resolve in due course.
•  And, ultimately, there will be a franchise value effect of the verdict to be rendered by the court of public opinion.   

 In reaction to the reader’s query, Goldman might well re-deploy the energy and creativity of its SEC co-defendant, the young hot-shot Fabrice Tourre. The self-styled “fabulous Fab” is now evidently side-lined in its London office – under the classically sound tactical decision to keep him on board rather than throw him overboard into the waiting jaws of the sharks of law enforcement.

 That is, Tourre as a pitchfork veteran around the Goldman sh*t-pile should see the threats to Goldman’s franchise value as both a challenge to new product development and an opportunity to generate both revenue and rehabilitation.

 Namely:

 The street already sponsors talk of a settlement between Goldman and the SEC, which will affect the company’s now-depressed stock price. But why would a simple office pool on the outcome be the only bet? Rather than pursue the mundane approach of speculation in either GS itself or its vanilla options, a creative derivatives engineer would build a whole suite of investment products tied to the timing and cost of the resolution.

 The simplest tradable derivative would be on the straight-dollar over/under of the SEC settlement – the likelihood of a litigated defense victory being as much an unimaginable outlier as, say, the industry’s prior assessment of the collapse of LTCM, Bear Stearns or Lehman Brothers.

 Those interested in handicapping the competing litigation capabilities of the SEC and Goldman’s counsel could test their assessments in the marketplace. Also, Goldman is said to be facing potential legal expenses of up to $100 million – certainly enough to set up a special fund whose performance would be tied to the cubic volume of the court filings.

 Those believing that Goldman is Satan reincarnate rather than the Lord’s messenger could take faith-based bear positions on the outcome, while those cynics who profess skepticism that politics underlie the SEC’s case would do the opposite.

 As for the more threatening criminal proceedings, opportunities arise to speculate on the stability of Goldman’s reputational capital. With the Fab’s proven ability to spin gold out of subprime sh*t, it would be child’s play to devise a “reputational index” that could be traded long or short – perhaps tied to the firm’s movement in league tables or deal flow.

 Subsidiary products could handicap the odds on the most likely individual candidates to be thrown under the litigation bus -- including (probably in inverse order) CEO Lloyd Blankfein, COO Gary Cohn, CFO David Viniar, and the soon-to-be dispensable Mr. Tourre himself.

 What is critical for Goldman, of course, is to capture for itself not only the hedging opportunities but also the vigorish on all this activity, rather than leave anything at the table for the competition.

 Having the inside track on the timing of litigation developments, costs and strategies would seem to require scrupulous care not to be seen as arbitraging its privileged position or trading under conflicting interests. But if its claim to sponsor’s neutrality in the original CDO deal is given credence, Goldman should have nothing to worry about.

 

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