Wall Street Law Blog

Bear Stearns collapsed 5 years ago; fraud remains overwhelming success

Part 1:  Introduction -

Understanding securities fraud at Bear Stearns - Backstory of The Global Financial Crisis

Five years later, why should anyone care whether Bear Stearns (through Senior Management) committed securities fraud? 

Because...

(a) To understand how securities fraud by top executives at Bear Stearns toppled what was the fifth largest Wall Street investment bank is to understand why all of Wall Street's major investment banks subsequently disappeared.

(b)  The fraud that caused the end of the era of the traditional Wall Street investment bank gave birth to a chain of events that evolved into the worst financial crisis since the Great Depression.  

-and-

(c) As a direct result of their own securities fraud and other illegal conduct, members of senior management at Bear Stearns collected enormous financial windfalls that they did not earn and do not deserve to keep.  Senior management's windfalls came at the expense of America's economy and the economies of other countries around the world (and, on a "closer to home" level, executive committee members enriched themselves at the expense of Bear's own employees and shareholders).  

There are two basic elements of the financial windfalls that, to date, Bear's executive committee members have managed to retain-

First, Bear Stearns paid its Executive Committee members enormous cash bonuses for "leading" the company to record revenues from 2002 through 2006 with the same unsustainable high-risk business model that (a) caused Bear's failure and (combined with the same, similar, and/or related misconduct at Merrill Lynch and Lehman Brothers and Citi,and Goldman Sachs and insurance giant AIG -- to name a few of the responsible companies) (b) ultimately produced the global financial crisis.  

The second (and far more lucrative) element of the financial windfalls reaped by senior management came from selling massive amounts of Bear Stearns stock at artificially high prices.  The record "success" Bear Stearns achieved because of its fraudulent and unsustainable business model temporarily produced record high share prices for Bear Stearns common stock.   Indeed, from January 2000 to January 2007, the share price for BSC stock quadrupled.  

 During this period of stock price inflation, Bear's five top executives -- all of them members of the former investment bank's executive committee -- reportedly sold more than $1 billion dollars worth of stock-based compensation from prior years. 

Again, the story of unjust enrichment at Bear Stearns is a microcosm of unjust compensation practices all over Wall Street.

So far, securities fraud by Bear's former leaders has been a tremendous success.  The primary reason for this is, we believe, the sheer complexity of the fraud.   From the housing bubble to "affordability mortgages" to the different kinds of derivative securities that were part and parcel of the long running course of securities fraud at Bear Stearns (and on Wall Street generally), the misconduct at issue revolves around a lot of intimidating stuff. 

From easier (but not easy) to understand  concepts like subprime and Alt-a mortgages to harder (often headache inducing) "structured products" like mezzanine collateralized debt obligations, credit default swaps to fixed income terms like yield spreads, it is a daunting task to peel back the layers of fraud on Wall Street during the 2000s.   

"Fraud by complexity" is very dangerous.  Until Main Street has a far better understanding of what happened on Wall Street, then the corrupt rigged game that senior management for the old investment banks played so well for so long will resurface in slightly different form sooner rather than later.  

A deeper examination of securities fraud at Bear Stearns is, we at Wall Street Law Blog believe, a great place to start parsing fact from fiction and isolating the complex -- but ultimately fascinating -- story of the genesis of a financial catastrophe.  

 

The Wall Street Law Blog, a Publication of The Sherman Law Firm.

 

Difference maker? An Admission that Bear Stearns Chose Not to Share With Its Shareholders (Corrected)

-Warning:

If you owned shares of BSC (the former NYSE ticker symbol for Bear Stearns common stock) when Bear's share price was falling during 2007 and early 2008, you may be somewhat pissed off by an admission that Bear made to the SEC.  

If I had owned shares of BSC, I am pretty sure I would freak.  I am positive that, if I was a Bear Stearns shareholder back then, I would have sold every single hare I owned immediately upon learning what Bear told the SEC in a letter dated January 31, 2008.  

The January 2008 letter, signed on behalf of Bear Stearns by SAM MOLINARO - at the time Bear's CFO and COO - says, among other interesting things, this:

We believe that based on the Company's level of involvement in subprime lending and the broader impact on global credit markets, a material adverse impact on the Company's financial condition, results of operations or liquidity is reasonably possible.

Translation: There is a real possibility that Bear Stearns' subprime exposure could cause the company to suffer severe financial damage.  

Wait.  I know what you are thinking.  You were going to say something like this:  So What?  Everyone on Earth knows that Bear's mortgage exposure was a pretty big factor in the collapse of the investment bank.  

True.  But not everyone knew that on January 31, 2008.  Certainly, there was a great deal of concern about Bear.  And if you were a stockholder of the Bear Stearns Companies Inc. in 2007 and 2008, you were concerned about the value of your investment.  After all, Bear was widely known as the king of mortgage securitization at a time when it clearly was definitely not (in the words of Mel Brooks playing Louis XIV in Brooks' classic History of The World, Part 1) "good to be the king."   

-BUT-

Bear Stearns executives repeatedly addressed all that.  They denied that the firm had anything other than temporary problems based on difficult market conditions that were the natural result of an inevitable turn in the business cycle.  

Top executives devoted themselves to damage control.  And the story they told did not vary.  The short version of the fairy tale went like this- 

TOUGH MARKETS; REAL, BUT TEMPORARY PROBLEMS;  HEALTHY BALANCE SHEET;  AMPLE LIQUIDITY; BRIGHT FUTURE...

* * *

-THE REST OF THE STORY

After shares of BSC peaked at a price north of $150 in January 2007, the stock began a long bumpy slide toward the abyss.  Stockholders outside the small cloistered circle of truly informed insiders, were in a tough spot. The issue, of course, was whether to sell while the price headed south, or hang in there, ride out the storm and hope Bear's problems were temporary.  

Senior management at Bear Stearns understood that they had a ton of influence over whether the market saw the Bear Stearns glass as half empty or half full.  Bear's top executives pushed the half full angle. In other words, they decided to be extremely optimistic about the situation. 

For example, management claimed that, in formulating Bear's growth strategy, the executive committee had expected and accounted for trouble in the mortgage markets.  Yes, they acknowledged market conditions were probably worse than anticipated.  But Bear's unique expertise with distressed mortgages, they said, meant great things for Bear Stearns in the not too distant future.  

Management even portrayed the drop in the Bear Stearns stock price in a positive light.  What could be good about the price slide?  Management took the position that the market had overreacted to temporary market conditions and oversold the stock.  Speaking at Bear's October 3, 2007 investor day, then CEO Jimmy Cayne called the stock a "compelling value."

In his investor day speech later that morning, CFO Sam Molinaro expanded on Cayne's compelling value comment.  Molinaro gave a detailed presentation to investors and analysts to show them why the price decline created an investing opportunity.  Molinaro's argument was based on a comparison of Bear's then current price to book value ratio and Bear's similar price-to book calculations during a series of prior market crises. 

In each prior instance, the stock had quickly rebounded and investors who bought shares during other crises realized substantial gains.  The problem with Molinaro's explanation was that Bear's true book value was really much lower than reported.  

In any event, Bear Stearns' executives kept pushing silver lining scenarios through 2007 and early '08.  This strategy was rational from their personal perpectives because these guys owned a lot of stock. They had a vested interest in propping up the share price up for as long as they could.

--MISREPRESENTING EXPOSURE TO MORTGAGE RISK

Because subprime and other risky mortgages were at the heart of market concerns about Bear Stearns, management made a concerted effort to promote the great job the company had done to reduce mortgage-related risk exposures.

For example, eight days after Molinaro admitted in the January 31, 2008  letter that it was "reasonably possible" that Bear's subprime exposure could have a "material adverse impact...," Molinaro made one of a series of road-show presentations, this time at a Credt Suisse conference, on what amounted to a good-will / propaganda tour on behalf of Bear Stearns in late '07 and early '08.  

The following slide was part of Sam Molinaro's presentation at the Credit Suisse conference-

  

In light of the admission in the SEC letter about a week earlier, there is a term for the message conveyed by this slide.  That term is material misrepresentation.  Another one is securities fraud.

By Brett Sherman

The Sherman Law Firm

Bear Stearns, Merrill Lynch Expected Housing Disaster (our all-time most viewed post; first published Oct. 2010)

"These aren't simply the comments of some junior level analysts" Lee Sherman, securities litigation consultant

the question of foreseeability asks at what point in time senior management at these investment banks should have foreseen the possibility of the disasters that eventually befell them.

the significance of these reports is that they conclusively establish the views of top economic analysts at Merrill Lynch and Bear Stearns. Whether plaintiffs' attorneys prove that senior management at the two investment banks actually read the reports ought to be immaterial.

UPDATE: Because Bear Stearns Execs' FCIC testimony largely focused on allegedly unforeseeable, "unprecedented" market forces to defend their lack of competent management, Wall Street Law Blog decided to re-post one of our favorites. 

Long before their respective employers ceased to exist as independent companies, former Merrill Lynch Top North American Economist David A. Rosenberg and former Bear Stearns Chief Equities Investment Strategist Francois Trahan published research reports with explicit warnings about asset and credit bubbles in the U.S. housing and mortgage markets.

As early as August 2004, Mr. Rosenberg, Chief Economist at Merrill Lynch for North America, published a detailed analysis regarding the precarious state of the American housing market. Rosenberg warned that there could serious problems ahead in an Economic Commentary entitled: "Housing: If not a Bubble Then an Oversized Sud."

Former Bear Stearns Chief Equities Investment Strategist Francois Trahan first published a report that raised serious questions about housing and real estate investments in a May 2005 report called "REIT all About it." Trahan and his team at Bear Stearns followed their 2005 report with publications in 2006 that explicitly warned about the difficult future facing the U.S. housing market and even raised the possibility of a global credit crisis. The 2006 Bear Stearns reports definitively described the housing market as an unsustainable "bubble" and further cautioned that the term bubble was not one the Bear team used lightly.

It was not until 2008 that overcommitments to mortgage-backed securities (a byproduct of the housing boom), CDO's and related products tied to residential and commercial mortgages caused Merrill Lynch and Bear Stearns to suffer backbreaking losses so severe that Merrill sold itself to Bank of America and Bear Stearns narrowly avoided bankruptcy with a Fed-assisted fire sale to JP Morgan.

--Background

Along with a number of other Wall Street firms, Merrill Lynch and Bear Stearns lost tens of billions of dollars because of their firms' respective commitments to securities backed by mortgages in the "subprime" and "Alt-A" categories. Subprime and Alt-A residential mortgages are considered risky loans because they carry higher default rates than "conforming" mortgages (also called prime mortgages, or agency-quality mortgages). Typical subprime or Alt-A borrowers cannot qualify for a conforming mortgage due to factors that include, but are not limited to, bad credit histories, personal bankruptcies, insufficient income, and the inability to make sufficiently large down-payments.

--Significance of the Merrill Lynch and Bear Stearns reports

While the ultimate import of the reports remains to be seen, The Sherman Law Firm says there is no doubt that the documents are crucial to the touchstone litigation element of foreseeability. "In a litigation sense," said Managing Attorney Brett Sherman, "the question of foreseeability asks at what point in time senior management at these investment banks should have foreseen the possibility of the disasters that eventually befell them."

According to The Sherman Law Firm, the reports at issue may show that senior management at Merrill Lynch and Bear Stearns should have foreseen the liklihood of a looming financial crisis with ample time to permit business model shifts that may have prevented crippling losses and, ultimately, the end of these former pillars of Wall Street as independent companies.

--Likely Defenses and Response

When confronted with documents like the reports at issue, senior managers may respond that they cannot be expected to read the huge volumes of research produced by their companies. The view of Brett Sherman, securities fraud lawyer and Managing Attorney of The Sherman Law Firm is that "the significance of these reports is that they conclusively establish the views of top economic analysts at Merrill Lynch and Bear Stearns. Whether plaintiffs' attorneys prove that senior management at the two investment banks actually read the reports ought to be immaterial."

Litigation strategist and recently retired attorney Lee Sherman - a frequent consultant to The Sherman Law Firm, former municipal court judge, and founding partner of a top Philadelphia area firm - concurred. "These aren't simply the comments of some junior level analysts," Sherman said. "I mean, we're talking about the Senior North American Economist of Merrill Lynch and the Chief Equities Strategist at Bear Stearns. Any claims by their CEOs and the other senior decision makers at these banks to the effect that they should not have been well-aware of the opinions and outlooks of the top economic and market experts at their companies are simply not credible." 

Lee Sherman continued: "Remember, from mid-2004 until the subprime crisis had clearly arrived, the Fed steadily raised interest rates. For lesser quality borrowers, most of whom had adjustable rate mortgages, higher interest rates meant higher default rates. To say the least, there was great uncertainty as rates were rising about where we were headed. Then, the housing market slowed. I'm talking about 2005 now, before home values really fell off the table. It strikes me as incredible that the kinds of warnings in these reports were out there for years, yet seem to have gone unheeded."

The Sherman Law Firm represents investors in securities fraud / investment loss claims of all types, including claims against investment banks for losses related to mismanagement and other misconduct during the housing and credit bubbles.

Brett Sherman, The Sherman Law Firm

Should investors opt-out of securities fraud class action settlements?

By Brett Sherman

 

The road less taken:  

Opt-outs and securities fraud litigation... Why some individual investors may be better off going it alone in securities fraud litigation or arbitration.

We originally wrote this piece in May 2008.  While we have edited and updated the text, please note the following:

NERA has published more recent data that is NOT included in our post. However, NERA's updated statistics do not change our conclusions. Readers may review the most recent statistics by visiting the NERA website.


-Introduction-

Based on research and experience, The Sherman Law Firm has concluded that any individual investor who-

(a) has suffered substantial stock losses, and

(b) is a class member in a securities fraud class action,

may ultimately recover a significantly higher percentage of the investor's stock losses by choosing to opt out of large class of anonymous plaintiffs. Thus, opting out of a class action and proceeding with individual claims in court or arbitration should receive careful consideration.

-Background-

Class Actions

A class action is a special breed of lawsuit in which a group of plaintiffs that share substantially similar legal claims against one or more defendants band together in a single lawsuit.

Class actions are known as "representative actions," because one or more plaintiffs are actually named in the class action complaint. Along with their attorneys, these named plaintiffs pursue the case as representatives for the entire class.  Class members who are not named do not actively participate in the lawsuit.

Most class action claims settle. The end result, however, is that - after attorney fees and expenses are deducted from the settlement amount - there often is not much money distributed to individual class members.

In a 2006 post, Lawsuitssearch.com wrote:

"Often being part of a class action lawsuit is not financially advantageous to an individual. Even though the defendant named in the case may be required to pay out a large sum of money, one individual who is part of the class action will only receive a small portion of that sum."

A study published by NERA Economic Consulting (NERA) supported the statement of Lawsuitsearch.com. NERA's report included the following, rather shocking, statistic:

The average settlement recovery in securities fraud class actions was only 2.2% of total investor stock losses.


-What does it mean to "Opt out"?-

Our own experiences at The Sherman Law Firm and Wall Street Law Blog provide anecdotal evidence that many (if not most)investors who suffer stock losses do not even know that they are entitled to opt out of class action litigation.

A shareholder who chooses to opt out of a class action generally hires his or her own lawyer and proceeds against the company in an individual litigation.  Assuming the case has merit, any recovery is likely to be substantially more than two percent of investor losses.

Conclusion-

This post is intended to compare the relative merits of class action litigation versus opt out litigation in securities fraud cases.

Based on our research and experience, we believe that shareholders with substantial losses have a dramatically better chance to recover a higher percentage of losses in individual opt out cases rather than as participants in class actions.

Disclaimer (we know, we know... But we are lawyers) -

Every case is different. This post does not take into account unique circumstances such as quality of counsel or facts which may be unique to any individual. This post is information, not legal advice. Class members should consult with an attorney to make an informed decision about whether to pursue claims as part of a class action or through individual litigation.

THE SHERMAN LAW FIRM represents individuals and entities in securities litigation, and readers should consider this post as an advertisement for attorney services.

The Sherman Law Firm, CLICK HERE to visit our website

Bear Stearns, Cioffi and Tannin - Criminal Acquittals of Fund Mgrs Does Not Mean No Securities Fraud at former Investment Bank

(UPDATED)

The acquittal of former Bear Stearns fund managers Ralph Cioffi and Matthew Tannin on criminal charges means a lot to the two men and their friends and families (and rightfully so).

However, the verdict in U.S. v Cioffi and Tannin should not have any bearing on fraud at Bear Stearns.  

For years, Bear's CEO - consummate salesman and card-sharp Jimmy Cayne - led a campaign to convince investors, potential investors, customers, counter-parties and everyone else with an interest in Wall Street and business (you know who you are) that Bear Stearns was (among many other things):

    (a) Wall Street's premier risk manager.

    (b) A company focused on building shareholder value through long-term growth to such a degree that Bear Stearns passed up opportunities for big short-term profits from industry "fads" to stick to its "long-range vision." 

AND

    (c) A company positioned to succeed regardless of market conditions.  As late as October 2007, Bear mortgage chief Tom Marano bragged at the firm's investor day that Bear had a "mortgage franchise for all seasons." (Remember that, mostly due to mortgages, Bear Stearns took a write-down of nearly $2 billion about a month later, and in December 2007, the company announced an $850 million loss for thquarter).

Bear Stearns insisted that its "strong risk management culture" started at the top of the company and was deeply ingrained in all Bear Stearns employees. 

Bear's leaders insisted that their company avoided large "directional bets" on asset classes because Bear Stearns considered such gambling far too risky.  To our knowledge, Bear Stearns did not any caveat about an exception by which the firm would lay immense, bet the ranch-style bets on housing, mortgages and mortgage related securities.

Under Jimmy Cayne, Bear Stearns constantly reinforced its commitment to excellence in risk management and taking the slow, steady road to shareholder growth.  

These kinds of representations were lies; nothing less than a propaganda campaign designed to inspire confidence and win trust from clients, investors, the media and the financial services industry.  

In other words, Bear Stearns presented a completely false image to the public. Cayne and his lieutenants deliberately created a "brand" for Bear Stearns with no basis in reality (at least not during this decade).  

The true Bear Stearns, we now know, was a high-risk, reckless operation focused on short-term profits and little else.

Put simply, deliberate misrepresentations and omissions by Bear's senior officers induced shareholders to invest in a company that bore little resemblance to The Bear Stearns Companies Inc. 

----------------------------------------       

Still unsure whether there was fraud at Bear Stearns?  You want something concrete?  

OK. We could cite about 100 facts to clinch it for you. We'll save most of those for an upcoming post.  

For now, we'll just stick with Bear's lies about top notch risk management.  In our opinion, the following few illustrations say everything you need to know about Bear's alleged culture of strong risk management:

• Bear's mortgage businesses were the firm's cash cows. The SEC Inspector General found that the mortgage risk-management infrastructure at Bear Stearns was a virtually useless anachronism.  

• Amazingly, Bear's mortgage risk models were roughly ten years old.  More amazingly, the models did not even address the risks of mortgage delinquencies or defaults.  

• The SEC Inspector General also found that Bear Stearns risk management personnel were not trained or competent to assess risks associated with mortgages and mortgage-backed securities.  

• At the risk of beating a dead horse, we are saying that - according to the SEC Inspector General - Bear Stearns did not have even one risk employee in risk management who was capable of managing risks related to Bear's mortgage and mortgage securities operations. 

Apparently Jimmy Cayne considered these issues too minor to disclose.  Or maybe he was kidding about that whole "best in class" risk management thing.  

The essence of fraud is deceit.  At Bear Stearns, senior management spent years deceiving investors. The securities laws are meaningless if Bear's officers and directors are not held accountable for massive losses suffered by the former investment bank's many shareholders.

By Brett Sherman, The Sherman Law Firm

Stay tuned - WSLB will lay out innumerable other reasons why Bear Stearns / JP Morgan are liable for BSC shareholder losses in future posts.

Time confirms Bryan Burrough's Bear Stearns article as nonsense (one of our most viewed posts)

 

VERIDCT? VANITY NOT FAIR -

BRETT D SHERMAN; WALL STREET LAW BLOG  

 

 

 

 

  

"Instead of evidence there's just pure speculation. 'Where there's smoke, there's fire,' might be a nice sound bite but its not evidence. Before we unleash the hounds of war on rumor mongers, shouldn't we require more than this?"  Dealbreaker.com 

PART ONE, INTRODUCTION 

"Bringing Down Bear Stearns" - which appears in the August 2008 edition of Vanity Fair Magazine - is supposed to be a work of serious journalism.   Instead of the crisp feel of hard news, however, writer Bryan Burrough's article comes across as a polished, slick page-turner.   Allusions to "shadowy" conspiracies, corporate sabotage, and a complicit media abound.   However, Burrough's near complete omission of actual evidence to support his story should consign "Bringing Down Bear Stearns" to the realm of pulp fiction.   

With an appealing film noir style potboiler about the fall of Bear Stearns, Vanity Fair and Bryan Burrough dispensed misinformation (sometimes called propaganda) to an unwitting public.   By creating a false perception of  "events" that may never have happened and almost certainly did not bring down Bear Stearns, VF and Burrough dangerously manipulated the truth.  Without objectively verifiable facts, without a reasonable number of reliable sources, and without better explanations of how Burrough's villains wrought  supposed mischief, there is nothing in the article to make  Burrough's "suggestions" credible.   

Still, Vanity Fair published the piece like it was gospel.  The writing, based on innuendo and rumor rather than on facts, was irresponsible.  The publishing was equally so.  "Bringing Down Bear Stearns" is dangerous because it portrays one man's theories as truths. Without a whole lot more evidence, Vanity Fair probably should not have published the article at all.  In the alternative, VF could have published the article with disclaimers about the lack of corroboration for Mr. Burrough’s hypothesis.  The magazine made the indefensible choice to present “Bringing Down Bear Stearns” as hard news.   

 

 

PART TWO:  BURROUGH’S MYTHICAL THREE-HEADED MONSTER 

 

 

The article is the work of Bryan Burrough  (co-author of the classic business expose  Barbarians at the Gate).  The basic idea of the VF article is that, between March 10 and March 16, 2008, Bear Stearns may have been the unwitting victim of a lightning-fast knockout by a three-headed monster.     

First, Burrough points to an unidentifiable cartel of ruthless financiers who may have successfully pulled off a secret plan to destroy Bear Stearns through a combination of aggressively spreading rumors about alleged liquidity problems at Bear Stearns while they were shorting Bear Stearns stock on a presumably massive scale.   We're talking James Bond villains, secret mountain hideaways, and a plot to rule the world.  Okay, I may be exaggerating - but not by much. 

In Burrough's words, many believe there was "a malicious attack by so-called short sellers, the Vultures of Wall Street, who bet that a firm's stock will go down."  Interestingly, Burrough fails to point out to Vanity Fair readers what short-selling is, or that shorting is a perfectly legal and important hedging strategy.  It is not even remotely a stretch to say that short-selling is a crucial component of everyday Wall Street trading.   Firms like Bear Stearns are (or were) shorted every day.  Moreover, Bear Stearns itself engaged in short-selling on a vast scale and made a lot of money loaning shares to short-sellers.   

If short sellers did illegally bring down Bear Stearns, why does "Bringing Down Bear Stearns" fail to ever touch on what the alleged illegal activity actually was and how it was accomplished?  Instead, Burrough - a talented writer - implies that all short-selling is evil .  Burrough also uses his skilled pen to convey the impression that he believes ‘the short-selling conspiracy’ is fact without devoting even a sentence to explaining the facts behind the alleged conspiracy.  Just what happened and when?  Burrough can’t help us out there.  

Cryptically, Burrough sums up by telling the reader that the short-selling conspiracy "theory is surprisingly difficult to prove..."  Why is it difficult to prove?  What type of evidence is required.  Just what are you saying specifically Mr. Burrough?   Without any answers, the writer simply moves on, leaving this reader thoroughly confused. 

 

Though Mr. Burrough apparently is comfortable discussing short-sellers without at least a rudimentary definition of what short-sellers do, I am not.  Please forgive the digression, but here is Wall Street Law Blog's short explanation of short selling -

 

Short selling is the act of selling shares you don't actually own because you are betting that the share price will fall.  In a winning short-sale, you borrow shares you don't actually own from institutions like Bear Stearns, and sell them at today's price.  If the price does go down, then your bet was right.  You buy an equal amount of shares at the lower price, return them - called covering your short - and the spread between your sell price and the later lower buy price, minus the cost of borrowing the shares, is your profit.

Villain number two in Burrough’s rogues’ is financial news network CNBC.  According to Burrough, CNBC drove Wall Street into a frenzy the week of March 10 by near-constant  reporting of a rumored liquidity problems at Bear Stearns - a rumor that Burrough paints as unquestionably false without much explanation outside of his (or Bear's) oft-repeated mantra that Bear Stearns had $18 billion in cash reserves.  Burrough claims that CNBC's reporting was a huge factor in scaring banks and other financial institutions into pulling assets from Bear Stearns and, by week's end, refusing to extend Bear the credit the firm needed to stay in business.   

It is preposterous to blame CNBC for the end of Bear Stearns.  A rumor of a liquidity crisis at Bear Stearns (assuming the story is properly sourced) is a news story worthy of reporting.  The financial media reports rumors every day of the week.  More importantly, rumors are an important factor that drive market activity on Wall Street every single day.  With respect to Bear Stearns, the primary activity during the week of March 10 was that assets were pouring out of the investment bank.  

The story of a rapid weakening of Bear's financial position - whether started by fact or fiction - was certainly true by midweek.  It was the type of news that CNBC, given its central role in the financial media, had a duty to report.  For Burrough to imply that CNBC merits responsibility for Bear's rapid death because the network reported on a dynamic, evolving situation regarding Bear's liquidity (or lack thereof) tells me that he lacks a fundamental understanding of the role of the broadcast news media in America.

In a New York Post piece, CNBC anchor Charlie Gasparino - singled out by Burrough as one of the alleged rumor-mongers regarding problems at Bear Stearns - responded strongly to the Vanity Fair story: "What we were talking about [the week of March 10, 2008] was market activity. . . In those critical hours we were reporting what was happening in the markets. What are we going to do? Ignore it?" Gasparino continued: "If Bryan Burrough wrote something substantively and factually accurate about the way we covered the story there would be a problem [with CNBC's coverage], but he didn't. He was incredibly sloppy." CNBC's Ticked at Vanity Fair, New York Post, July 11, 2008. 

In the very same New York Post article,  even Bryan Burrough (one would guess with a lawyer whispering in his ear) backtracks from his attack on CNBC.  Burrough now "says his intention wasn't to place the blame on CNBC.  'The idea that CNBC did in Bear Stearns [Burrough now claims] is ridiculous. ..' "  Perhaps Burrough needs to spend some time re-reading Vanity Fair article before making such an indefensible claim.   

To cite just one example of Burrough's numerous attacks on CNBC, describes the alleged fallout from an on-air exchange between CNBC's David Faber and Bear Stearns CEO Alan Schwartz after Faber asked Schwartz about a trade that another firm allegedly refused to complete with Bear Stearns (the trade eventually was completed): 

  

"It was a killer statement: Faber was saying, in essence, that Bear’s status as a trader, the basis of its business, was in question." 

“You knew right at that moment that Bear Stearns was dead, right at the moment he asked that question,” a Wall Street trader of 40 years told me. “Once you raise that idea, that the firm can’t follow through on a Trade, it’s over. Faber killed him. He just killed him.” 

 Does anyone who read the article honestly believe that Bryan Burrough did not intend to place blame on CNBC?   

The third and final pillar of  Burrough’s  ‘Kill the Bear’ triumvirate is the great novation scandal.  If you don't remember this part of Burrough's Vanity Fair article, that is because Burrough pretty much lets the topic linger until beyond the point in a very long magazine article where all but the most attentionally- gifted readers toss the magazine aside and start looking around the room for the remote control.   

#a2a2a2;">Late in his article, Burrough halfheartedly (or maybe I was just tired) point a finger at investment bank Goldman Sachs and hedge funds SAC Capital Partners and Citadel, for instigating a "flood" of novation requests that gathered steam on March 11-12  (where investors looked to other investment banks to replace Bear Stearns as counter-parties in certain transactions).  The flood of novation requests allegedly reached the point where Goldman itself (a rival of Bear in the lucrative business area of Prime Brokerage), Deutchebank, and Credit Suisse eventually felt that they had to refuse or delay decisions about whether to accept orders for Bear novations.  

According to Burrough, Bear Stearns believes that this information was then intentionally leaked to - you guessed it – CNBC, in order to create a crisis of confidence in Bear.  To date, former Bear Stearns executives have done a fair share of shouting about the novation issue as a deliberate attempt to bring the firm down.  There hasn't been any publicly disclosed evidence of misconduct by Goldman or any other firm.  Still, Burrough reports this part of  the story as though Deep Throat had whispered the information to him in a dark parking garage.  

PART THREE:  A LESSON IN SPIN AND INNUENDO 

As I read and re-read "Bringing Down Bear Stearns," it sure seemed that the writer's agenda was to exonerate the investment bank from any substantial blame for its own demise.  At the very least, Burrough wanted to convince readers that there is a strong possibility that Bear Stearns fell due to some premeditated conspiracy, with villians and all.   

After all, how many magazines can you sell by suggesting that bad leadership, multiple scandals, lousy finances, poor risk management, almost non-existent supervision, and plain poor business practices were the chief causes of Bear's death?  How much buzz would a piece like that generate?  No need to answer.

Although Burrough devotes a number of pages to descriptions of  Bear's "self-inflicted wounds" in 2007 and early 2008, and admits that Bear's missteps did substantial damage to Bear's reputation and finances, Burrough is all too willing to discount these issues, consigning them to the dustbin of pre-March 10, 2008 history. It felt to me like Burrough wanted readers to believe that Bear's financial scandals, huge losses, change in leadership, etc., etc., etc., were in the past, events Bear was watching through its rear view mirror as they disappeared over the horizon into irrelevancy.

Consider the manner in which Burrough described the optimistic outlook of the CFO of Bear Stearns early on the morning of March 10, 2008:

[A]s he drove in from his Connecticut home to the glass-sheathed Midtown Manhattan headquarters of Bear Stearns, Sam Molinaro wasn’t expecting trouble. Molinaro, 50, Bear’s popular chief financial officer, thought he could spot the first rays of daylight at the end of nine solid months of nonstop crisis.

What impression could Burrough possibly intend to create in this passage other than that the bad times were over for Bear Stearns?  Following Burrough's imagery-rich description of CFO Molinaro's conclusion that, on March 10, 2008, everything at Bear Stearns was A-OK, most readers cannot help drawing the logical next inference -  since Bear Stearns was (allegedly) financially healthy in March 2008, the company must have been destroyed by the outside.  Bear Stearns - the Vanity Fair article seems to repeatedly shout - cannot be responsible for its own downfall.

But Mr. Burrough, were is the evidence?  Any evidence?  A few anonymous sources, some creative innuendo, and rank speculation are a poor substitute for objectively verifiable facts and specific explanations about how key players (such as the evil, secret short-sellers)  could have possibly been responsible for "Bringing Down Bear Stearns."  For that matter, in a magazine like Vanity Fair, shouldn't you have explained what short-selling even is? Do your editors even know?

A crucial fact - apparently unrecognized, ignored, or forgotten by Burrough - is that Bear Stearns was in fact a very unhealthy investment bank during the week of March 10, as it had been for a long time.   For one thing, the firm still held far too many poorly regarded, and totally illiquid, “toxic” mortgage-backed securities in its portfolio.   Bear Stearns also was way over-leveraged.  Most reports put Bear's debt to equity ration at somewhere between 30:1 and 35:1, the highest of any big investment bank on Wall Street.  (In layman's' terms an investment bank that is leveraged 30:1 means it has borrowed 30  dollars for every one if its own dollars it spends).   

The fact was that, as a practical matter, Bear Stearns was insolvent the week of March 10, 2008.  While Bear’s officers were busy telling the public that nothing was wrong with its finances, the truth was that Bear carried $29 billion of mortgage-backed securities and related investments on the asset side of its balance sheet.  Bear certainly would have sold these securities to stay alive rather than just throwing in the towel and disappearing into the JP Morgan Chase behemoth.  There were no buyers for the portfolio.  It was illiquid. 

When there are no buyers for a security a company needs to sell, the securities are worthless.  Therefore, the so-called $29 billion in assets was, in reality, worth nothing to Bear Stearns.  JP Morgan certainly wanted no part of  the toxic securities portfolio.  Jamie Dimon has insisted time and again that he would not have agreed to purchase Bear if it meant taking on the risky securities.  Eventually, the federal government essentially bought the securities from JP Morgan in order to facilitate the deal between Morgan and Bear Stearns. 

Why is this important?  Because, during the week of March 10, 2008,  Bear Stearns had $29 billion of worthless “assets” listed on its balance sheet.  Subtract that $29 billion and Bear Stearns is insolvent.  Its senior executives and directors were responsible for knowing that the $29 billion had nominal value.   Officers like Ace Greenberg and CEO Alan Schwartz misled the public, including Bear’s shareholders, when they went on television or put out press releases to (falsely) assure the public that Bear’s financial condition was healthy and strong.  Bear’s balance sheet was, in reality, a disaster.   There is a legal term for this conduct – we call it fraud.

 

 

PART FOUR:  BRINGING DOWN THE HOUSE OF BEAR   

-CONCLUSION-

The BigPicture.com draws the main point against conspiracy theorists very well: "If your financial condition is so precarious that rumors can bring you down, then it is the finances, and not the rumors, that are to blame." The Big Picture; Who Killed Bear Stearns? 

What killed Bear Stearns is no mystery.  Bear died because the investment bank itself created an environment in which the banks with which it did business, and upon which Bear Stearns relied for the capital it needed to run its business, no longer had any faith in Bear Stearns.  The company began to seriously founder in June 2007 with the now infamous and possibly criminal failure of two subprime dominated hedge funds.  Bear Stearns never recovered from the hit to its finances or, perhaps more importantly, to its reputation from the hedge fund fiasco.

Thus, by March 2008, Bear Stearns found itself in very cold waters.  The once-respected investment bank was sailing alone; the Titanic waiting for an iceberg.  If the fatal blow had not come during the week of March 10, the odds are high that another disaster would have killed the firm another week. Bear Stearns was listing badly - undermined by scandal, massive financial losses, alleged criminal conduct, poor investment management decisions, questionable leadership, bad stock performance, and acts that put the company's integrity in question. 

Bear Stearns created an unsustainable business model. The week of March 10, 2008 was simply the iceberg that sent Bear Stearns to the bottom. 

 

BY BRETT SHERMAN, THE SHERMAN LAW FIRM

EDITOR - Wall Street Law Blog

Unforeseeable? No way. Part 3, Securities Fraud at Bear Stearns series (updated)

By Brett Sherman, The Sherman Law Firm

Part 4 of the series is in final edits... In case you want to catch up, you can read Part 1 of our series on bear stearns' securities fraud here;  Part 2 of Wall Street Law Blog's securities fraud at Bear Stearns part 2, here)

 

The official story from the powers that (used to) be at Bear Stearns is that almost nobody called the housing bubble until it was too late.  The FCIC rightly rejected this nonsense, and so should you.

The following excerpts are from a May 2005 report by a team of analysts led by Francois Trahan.  Mr. Trahan was Institutional Investor's Number 1 Ranked Strategist in 2005.  And he was similarly honored in 2006.  Which company employed Francois Trahan as Chief Strategist in 2005 and 2006?  Which company published the report excerpted below?  Yep.  You're right.  BEAR STEARNS. 

The report, published about 3 years before Bear Stearns collapsed, says it all -

 

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And, in case you wonder whether this is the only warning sounded by Francois Trahan and his team at Bear Stearns, Wall Street Law Blog is happy to tell you that the answer is - Nope.  At least 2 more reports followed in 2006, and with each report the warnings grew ever louder.  (Click here to see excerpts from 2006 Bear Stearns report)

To remind readers why we still focus our attention on Bear Stearns, we gladly restate the reason - Because the biggest and most devastating financial fraud in history is, right now, the most successful financial fraud in history. 

A Harvard University study reports that Bear Stearns' top 5 officers took home more than $1.4 BILLION in CASH from 2000 through 2008. 

Most of the thousands of other Bear Stearns shareholders were not quite as fortunate as Jimmy Cayne and his top lieutenants (you may have heard something about this).

Predatory Subprime Lending Nothing New - Familiar Abuses an Issue in 1998

 

 

Whoa Nelly... Take a peek into the FTC archives.   Subprime mortgage lending was a disaster in the 1990's too...

 

 

 

 

*INTRODUCTION 

Precisely one decade before JP Morgan announced an agreement to buy Bear Stearns for $2 per share (later increased to $10 per share), the FTC heard and adopted testimony on abusive subprime lending practices.  

That's right, 10 years to the day before Bear Stearns collapsed, the FTC highlighted serious problems in the subprime lending industry.

 

Two subprime abuses the FTC described way back in March 1998:

 

 

 

• 1990's SUBPRIME LENDERS FREQUENTLY BASED UNDERWRITING DECISIONS ON HOME EQUITY RATHER THAN ABILITY TO REPAY

 

• SUBPRIME LENDERS IN THE 1990'S CONVINCED BORROWERS TO REFINANCE AGAIN AND AGAIN. 

     

 

MARCH 16, 1998; FTC PRESS RELEASE ON ABUSIVE PRACTICES IN SUBPRIME LENDING

*FTC Testifies On Enforcement And Education Initiatives To Combat Abusive Lending Practices 

(Excerpted and reprinted from http://www.ftc.gov; highlighted by Wall Street Law Blog)

"Subprime lending refers to the extension of high interest rates or higher fee loans to higher risk borrowers." 

 

"Predatory practices in the subprime mortgage lending market such as 'equity stripping,' 'packing,' andnd 'flipping' and the threat these practices pose to vulnerable homeowners were the subjects of testimony delivered today..."

 

"[The subprime] segment of the lending industry has grown substantially since the early 1990s."

 

 

"In addition to an expansion in the number of loans, the Commission's testimony notes that the composition of the industry is changing..."

 

"One of the most dramatic changes has been the growth in subprime mortgage lending by large corporations that operate nationwide..."

 

Abusive subprime lending practices in the 1990's

*EQUITY STRIPPING

"Equity stripping occurs when a loan is made based on the equity in a property rather than on a borrower's ability to repay the loan." 

"As a general rule, loans made to individuals who do not have the income to repay such loans usually are designed to fail. They frequently result in the lender acquiring the borrower's home and any equity the borrower had in the home."  

A Wall Street Law Blog reminder:

Remember, this is from 1998!  Wall Street CEOs claimed to be shocked by lending practices during the recent subprime crash...

*LOAN PACKING

"Packing is the practice of adding credit insurance or other "extras" to increase the lender's profit on a loan. Lenders often stand to make significant profits from credit insurance and, therefore, have strong incentives to induce consumers to buy it as part of a loan."  

*MORTGAGE FLIPPING

"Flipping occurs when a lender induces a borrower to repeatedly refinance a loan, often within a short time frame, charging high points and fees each time..."

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Brett Sherman, The Sherman Law Firm

Publishers - Wall Street Law Blog

Another Brick in the Wall of Securities Fraud at Bear Stearns (updated)

*FRAUD BY SILENCE AND COVER-UP*     

By Brett Sherman

An individual's creditworthiness is highly correlated to mortgage default risk. In other words, the worse a borrower's credit history, the more likely it is that the borrower will default. 

A subprime borrower is more likely to default than an individual with strong credit background. Indeed, it cannot be disputed that subprime mortgages have always been riskier for lenders than conforming mortgages. It is specifically because subprime loans have relatively high default rates - and are therefore risky by definition - that subprime borrowers must pay higher interest rates than individuals who qualify for conforming mortgages. 

To prevent lenders from taking excessive risks, both prime and nonprime mortgage applicants historically have been subject to a rigorous underwriting process. In the later years of the housing bubble, lending standards simply disappeared for subprime mortgage applicants. 

Today, it is well known that subprime lenders (including Bear Stearns' own mortgage subsidiaries) progressively reduced subprime underwriting requirements during the housing bubble.  At the time, however, Bear Stearns failed to disclose (a) that lending standards were eroding, or (b) that the reason for lowering underwriting requirements was to preserve the immense profits from sales of mortgage securities. 

By 2004-2005, Bear Stearns knew that the supply of "qualified" subprime borrowers was dwindling. To keep the Company's mortgage inventories large enough to maintain and expand its incredibly profitable mortgage securitization and sales platforms, new mortgage origination rates had to stay high.  The only way lenders could assure a steady supply of new mortgages for the securitization machines of Bear Stearns and others was to increase the universe of the subprime borrowers. And the only way to increase the number of "qualified" borrowers was to relax, and eventually almost eliminate, subprime lending standards. 

Because mortgage default risk grows as credit quality and income shrink, Bear Stearns cannot credibly argue that the firm did not know that new batches of collateralized debt obligations were backed by far more risky loans than in prior years. 

Bear Stearns certainly knew that the MBS and CDOs the firm sold to investors in the later years of the bubble were loaded with junk mortgages.  Therefore, there is no doubt that Bear Stearns knew that the inevitable disruption of rising home prices could very well produce vast numbers of mortgage defaults by low credit homeowners. 

Despite all that it knew about the ever precarious quality of subprime loans, Bear Stearns continued to collude with credit rating agencies to obtain investment grade ratings. Worse, Bear Stearns still publicly insisted that its mortgage securities were extremely safe investments.

Sales of newer "vintage" collateralized debt obligations grew at an incredible rate through early 2007. At the time, Bear Stearns' decision to omit material and specific new risk disclosures (and/or to lie about the prospects of its MBS businesses) allowed the Company's stock price to artificially inflate. 

When defaults of low quality MBS and CDOs started to spike in late winter/early spring 2007, the high risk nature of the more recent crop of mortgages became apparent.  Soon thereafter, Bear Stearns' stock price began its long slide into oblivion. 

Failing to make plain English, honest, accurate and specific risk disclosures about the junk mortgages in the MBS and CDOs the firm created and sold is one way Bear Stearns committed securities fraud during the financial crisis. 

There were many others...

March 2006: Wall Street concedes problems in housing market (WSLB Time Machine)

EXACTLY 2 YEARS AFTER BEAR STEARNS COLLAPSED, WE THOUGHT WE'D SHARE SOME WARNING SIGNS FROM ALMOST EXACTLY 2 YEARS BEFORE THE EVENTS OF MARCH 2008...

As reported by Bloomberg...

Bear Stearns, Lehman Mortgage Growth Crimped by Housing Market

"Executives at Lehman Brothers Holdings Inc. and Goldman Sachs Group Inc. said revenue from mortgage bonds in the U.S. is dropping as rising interest rates depress home sales. Lehman, the fourth-biggest U.S. securities firm, is cutting almost 200 jobs at two home-lending units in California.

Bear Stearns Cos. Chief Financial Officer Sam Molinaro said on a March 16 conference call after the company reported first-quarter earnings that he sees ``weakness'' for new mortgages across the industry."

 

Please check out the Bloomberg piece in its entirety.  It raises some interesting questions (as usual) - like, if you know there are problems with your main revenue stream in 2006, how can any competent risk management not take steps to make sure that the problem cannot snowball in the way that it did, driving two legendary firms out of business.

Brett Sherman, The Sherman Law Firm