Wall Street Law Blog

Reconcile This: Former Bear Stearns Exec. Either Lied to FCIC or Pulled An Ollie North

Lying Under Oath to The Financial Crisis Inquiry Commission is the Equivilent of Perjury.

The Law:

United States Code, Title 18, Section 1001:

"Whoever, in any matter within the jurisdiction of any department or agency of the United States knowingly and willfully falsifies, conceals work covers up by any trick, scheme or device, a material fact, or makes any false, fictitious or fraudulent statements or representations, or makes or uses any false writing or document knowing the same to contain any false, fictitious or fraudulent statement or entry, shall be fined under this title, imprisoned not more than five years, or both."

FROM THE RECORD OF PROCEEDINGS BEFORE THE FINANCIAL CRISIS INQUIRY COMMISSION.

Excerpted from the FCIC Official Transcript

Hearing date: May 5, 2010, Session One.

Sworn Testimony of Witness Samuel H. Molinaro, Jr., (former CFO / COO/ EXECUTIVE COMMITTEE MEMBER, The Bear Stearns Companies Inc.)

FCIC TESTIMONY (from the official transcript):

Some context here is crucial. In the same FCIC hearing, Molinaro testified that Bear Stearns knew that falling home prices was one of the biggest risks the company faced. And yet, according to the former CFO and COO, Bear Stearns did not model the impact of a "nationwide decline in housing prices." Moreover (as far as Molinaro could recall), there were no concerns or even discussions at Bear Stearns about the possibility of a drop home in prices across the United States.

Wait! Pause. Take a deep breath. Go back and re-read the previous paragraph. Good? Good.

Now answer this question: DO YOU BELIEVE THE TESTIMONY OF SAM MOLINARO?

We, the trusting staff at Wall Street Law Blog, do not. But, to be fair, we have reviewed a few documents that we are willing to bet came to the attention of Molinaro and the other members of senior management at Bear Stearns.

Consider, for instance, this excerpt from a research report about the housing bubble that Bear Stearns published in September 2006. In it, Bear warns that the ratio of home prices to income was "[a]bout as stretched as it has ever been!"

And how about this conclusion from the same Bear Stearns report?

The report - which was one of many warnings Bear issued about the bubble - is from the fall of 2006. That's about a year and a half before Bear Stearns collapsed. Note that Bear Stearns specifically states that home prices were already falling, but cautions that "housing conditions have barely begun to normalize, and it will likely be some time before we begin to see signs of a trough."

 

Now, again we ask: DO YOU BELIEVE MOLINARO?

By Brett Sherman

Risky business on Wall St: Contrary to claims of some, there is securities fraud in them thar risks.

 

• RISKY BUSINESS IS (usually) OK IF CLEARLY DISCLOSED TO INVESTORS.

 

• HOWEVER, MATERIAL MISREPRESENTATIONS ABOUT RISK is something else altogether (something called fraud).

By Brett Sherman, The Sherman Law Firm

Deception is the essence of fraud.  Bear Stearns deceived investors (and the markets generally) about crucial facts, including (a) the firm's management philosophy and approach to risk management, (b) performance of Bear's core mortgage businesses, and (c) the financial condition of the former investment bank.

Today, Wall Street Law Blog looks at one aspect of fraud at Bear Stearns - The Executive Committee lied time and again about risk management at the former investment bank.

 

                   Bear Stearns Umbrella "Risk Managed"

Risk Management LIES:

Please note that time and space limitations require us to list only a few material misrepresentations.  But we assure you that we can, if necessary, go on for hundreds of pages and thousands of years (a little hyperbole is ok now and then)-

 

• The risk management infrastructure and processes remain conservative and consistent with past practices. This structure and strong risk management culture has allowed the firm to operate for all of its history as a public company without ever having an unprofitable quarter.
  

 

• By maintaining a strict approach to risk, and by allocating capital wisely, we have achieved one of the lowest levels of trading revenue volatility on Wall Street. At Bear Stearns, we know we cannot predict the future, but mitigating the risks ahead this part of the foundation upon which this firm was built....
  

 

• True to our culture, we continue to search for ways to run our business more efficiently, always balancing risk and reward.
  

 

• Our commitment to excellence and measured approach to balancing risk and reward has kept Bear Stearns focused...We continue to avoid short term trends by staying focused on the long term strengths of our businesses.
  

 

• Our culture of risk management -- I just want to emphasize it is central to everything we do...So, risk management comes first and then growth.
  

 

• The philosophy of creating value over the long term also drives our approach to product innovation and entering new businesses... This philosophy is evident in the disciplined approach we take to managing the firm's risk...

• We're very proud of the way we do risk management. It's an integral part of our culture

 

• dedication to risk evaluation and management that has given us the ability to expand carefully and conservatively.
  

 

• The strict risk discipline imposed on our trading desks is reinforced by the strong sense of ownership that permeates the culture of the corporation.
  

 

• You can expect us to continue to adhere to our core values, including this consistent and deliberate approach to risk...
  

 

And we could go on and on and on...

Risk Management TRUTHS:

AT THE SAME TIME BEAR STEARNS WAS BUSY REASSURING INVESTORS HOW GREAT THE FIRM WAS AT MANAGING RISK, SENIOR MANAGEMENT KNEW BEAR'S RISK MANAGEMENT SYSTEM SUCKED.

 

THE EVIDENCE (some of it)

February 4, 2008 - internal Bear Stearns email to members of Bear's management committee, with reminder of meeting with outside consulting firm Oliver Wyman and attached risk presentation entitled: "RISK GOVERNANCE DIAGNOSTIC, RECOMMENDATIONS, AND CASE FOR ECONOMIC CAPITAL DEVELOPMENT PLAN"

Really, the slide called "Gaps in Risk Management" says it all.

 On that slide, consultant Oliver Wyman described a risk management system that was about as bad as it gets.  Some of the risk management lowlights, according to the Wyman Report- 

• Bear Stearn's did not have any formal system for determining the company's risk-appetite. It seems to us that it just may be kind of hard to manage risk when there is no guidance about how much risk a business is willing to assume.

• No uniform requirements or system for approval of trades. Again, it sure seems like a firm with 15,000 employees would need formal systems for things like trade approvals.

• Risk management personnel frequently had little advance notice of proposed transactions.  Worse, Bear's traders and business desks apparently did not feel compelled to provide very much information to the firm's risk managers. To us, this suggests that few people really wanted input from Bear's risk managers.

• Bear's internal risk limits were often ignored or overridden by management without regard for additional risk exposure. To us, this suggests that risk limits were put in place to placate regulators rather than to actually manage risk.

• Bear Stearns had no formal policies or procedures to evaluate risks of its business operations. Oliver Wyman used the term "ad hoc" to describe how Bear made strategic risk decisions.
  

• Risk management personnel at Bear Stearns lacked "stature" (i.e., respect and authority). They were second class citizens with little influence over actual business practices.
  

 

In sum, Bear Stearns management did not articulate a risk-appetite for the company (or at least no specific guidelines for risk tolerance were communicated throughout the company); Bear Stearns did not listen to or respect its risk managers;  Bear Stearns had no formal procedures for risk managers or business units to follow; and there was no real methodology for making risk management decisions.

Other slides from the presentations show that Bear had poor channels of communication regarding risk-taking and no effective plan for matching capital to risk (i.e., Bear did not determine its capital needs based on its risk exposures) 

CONCLUSION

 

The Wyman Report is an exhibit introduced by the Financial Crisis Inquiry Commission during the FCIC'. In May 2010, five former Bear Stearns senior executives gave testimony before the FCIC (FCIC.gov), about the shadow banking system and the collapse of Bear Stearns.

In a recent post, Phil's Stock World reacted to the hearings so perfectly that, despite our best efforts, Wall Street Law Blog could not top Phil's summary.  So, with all due credit given, we excerpted part of the post.  Phil's Stock World pointed out that, during their testimony, Bear's former honchos seem to have blocked out some relevant stuff, including:

[Bear's ] insanely high leverage (up to 42:1), large holdings of MBS, poor risk management, and overnight borrowing from the repo market ($50 to $60 billion) had nothing to do with their collapse. They did nothing wrong and were the victims of a conspiracy of evil traders who seized upon their temporary lack of liquidity and sent them over the edge when investors irrationally lost confidence. Talking about an alternate universe, these folks should be sent to St. Helena to think about cause and effect for a while. Jimmy Cayne would probably just play bridge there."  

 The post from Phil's (you can read the rest here) had us hooked at "St. Helena."    

* * *

 

Bottom line here?

Bear Stearns deliberately promoted a supposed commitment to high quality risk management that, during the 2000's at least, was a total fiction.  In other words, Bear Stearns constant touting of its risk management prowess was material and false.

Our favorite synonym for material misrepresentation is a word we like to call fraud.  And - as we will show in future posts - Bear's fraud went much deeper than its false claims about risk management. 

 

 

A Strong Risk Management Culture??? (encore post)

Profits were just too big for Bear's Ace Greenberg to stop the "locomotive"

Alan "Ace" Greenberg was the man most responsible for the so-called "strong culture of risk management" at Bear Stearns.

                                                 Greenberg joined Bear Stearns in 1949
 

Ace Greenberg was Chairman of the Bear Stearns Executive Committee until the firm collapsed.

Ace Greenberg led the Bear Stearns risk committee until at least 2007.

Ace Greenberg was the man who said many times that his number one rule was to take small losses before they turned into big, crippling losses. He also presided over Bear's famously intimidating Monday afternoon risk meetings.

***

SO- What did super strict risk manager Ace Greenberg tell PBS Frontline in an interview for an episode called "Inside the Meltdown?"

****

Speaking after Bear collapsed, Greenberg discussed how he felt and what he did (and did not do) about the housing/mortgage bubbles back in the days when Bear was still raking in the profits:  

Ace Greenberg:

"I thought ... the speculation was crazy. I thought it was crazy to see ads where people would lend you 140 percent of the assessed value of your house. I thought that was nuts.    

I was [nervous], and I felt some things were going on that were just nuts.... But I wasn't as vociferous as I should have been, maybe.

It's very hard to stop a locomotive going 60 miles per hour. It takes a lot of braking power to stop that.

And this stuff was highly lucrative when it was working.

Excesses did occur. So did I know things were getting a bit out of hand?  Yes. Was I as vociferous as I should have been? Maybe not.  

As I said, it's hard to turn off the spigot when things are profitable.

[W]e were big boys. I'm not complaining. We made mistakes. 

I guess it's a question of overexuberance and getting caught up in thinking the good times are here forever and they never are. 

So these things, if they're not built on solid ground, they just disintegrate in a hurry..." 

****

TRANSLATION (or, more accurately, our take at Wall Street Law Blog):

Ace knew Bear Stearns was sitting on a powder keg, but so much money was rolling in that he didn't have the guts to do anything . Rather than manage risks, he (and Bear Stearns) simply managed to take them.

****

Conclusion

Greenberg's comments - and his demeanor - during the interview (we watched it a bunch of times) were quite stoic. Of course, Ace, Jimmy Cayne, and their fellow Executive Committee members made immense fortunes during the bubble years (and that takes into account all paper stock "losses" they "suffered" when the roof caved in).

Public shareholders didn't fare quite as well as the Executive Committee.

Our guess is that Bear's other shareholders would find Ace Greenberg's comments about being "big boys," making "mistakes," and allowing "excesses" a touch upsetting.

We wonder how judges, juries, and arbitrators will react...

(Note - the entire Greenberg interview - portions of which were edited out of the televised program - is available @ PBS.org.)

By Brett Sherman, The Sherman Law Firm
(Disclaimer- we represent former Bear Stearns shareholders in litigation; we may not be entirely objective about these issues).