PHI 2397 C
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George Soros: "The Crisis & What to Do About it," The New York Review of Books, (December 4, 2008)
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"The crisis was caused by the system itself. This fact -- that the defect was inherent in the system -- contradicts the prevailing theory, which holds that financial markets tend toward equilibrium and that deviations from the equilibrium either occur in a random manner or are caused by some sudden external event to which markets have difficulty adjusting. The severity and amplitude of the crisis provides convincing evidence that there is something fundamentally wrong with this prevailing theory and with the approach to market regulation that has gone with it. To understand what has happened, and what should be done to avoid such a catastrophic crisis in the future, will require a new way of thinking about how markets work."

- markets should not be left to themselves, some regulation is needed

Ethical issues
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- reckless, overly risky transactions - with consequences for others (people not related to the transaction, "collateral damage")
-- other = employees, buyers of homes or investments, taxpayers
--- companies in trouble, but bonuses paid to executives
--- optics/ethics of this?
- securitization of instruments, too abstract, uncalculable worth (even high-ups and experts couldn't value them)
- insufficient government regulation in the housing sector
- insufficient government regulation in the financial sector
-- government "gave a free hand" to the financial industry in the form of lack of regulation
-- different US States had different standards and regulations
- some enterprises "too big to fail".... so too big to exist?
-- possible break-up of large companies?
- in housing and financial transactions: deception, fraud

Recent Case: Oct 1, 2012, J.P. Morgan Chase sued by New York State Gov't Attorney General
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- fraud allegation: "kept investor in dark" about mortgage-backed bonds specifically (issued) by Bear Stearns, investment bank taken over by JP in 2008 (at "fire sale price" urged by Fed Gov't)
- this is a civil lawsuit, by Fed-State task force set up by Predident Obama
- determine if there is an actual misrepresentation or fraud

Goldmann Sachs fined $550m in 2010
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Wall Street investment banking firm
- fined $550m in 2010 by SEC for misleading clients in selling CDOs, mortgage-backed securities in 2007
- largest penalty ever by SEC, however profits that year were $13.4b
- money from fine went to US govt and to investors

- Goldmann Sachs, one business line was selling these securities as highly valuable
-- another business line was hedging/betting against/shorting the same securities
-- a clear case of misrepresentation/fraud

Goldmann had received:
- $5b investment from Berkshire Hathaway
- $10b from US govt TARP (Troubled Asset Relief Program) in 2008. Repaid with interest


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Enron: Energetic Rise, Dramatic Fall 2001
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- Enron Corp: energy company, Houston Texas, started 1985
- Before fall, multi-billion corp
-- world's largest energy corp
-- seventh in Fortune 500
- Enron started as an energy exploration/production/delivery in natural gas and others
- Enron over-committed delivery of natural gas, at a loss as well due to natural gas prices rising past the futures contract
-- subsequently futures in communications as well
- overcommitted, promised to deliver more quantities than they could deliver, and at a loss-making price (due to rising prices)
- Enron did not properly record its losses onto its own balance sheets
- instead, allocated the losses into "Special Purpose Entities," SPEs
-- subject to a limit of a certain percentage on the company's assets, and with transparency

What Enron Did
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- benefitted from deregulation in energy sector, and...:
-- futures contracts, originally innovative, but..
--- pricing? figuring assets? based on assumptions, but not realistic
- "Special Purpose Entities" or SPEs were used to "store" losses off the balance sheet in the SPE, but in reality they were loss holding subsidiaries
-- legal in principle, not in fact: see text
-- $38b debt in SPEs, only $13b of debt on Enron's books
-- eg: outside partners or investors for SPE, but often Enron provides $
- execs: loans to themselves
- execs: on the eve of the bankruptcy, received huge bonuses and sold a lot of stocks
- Warnings, attempted whistleblowing (Sharron Watkins), but got stonewalled by execs

- CEO: Ken Lay, then Jeffrey Skilling CEO, then Lay again.....
- Andrew Fastow, CFO
- May 2006, Lay and Skilling guilty of fraud and conspiracy
-- Lay dies before sentencing (heart attack)
- Skilling: 24 years, appealed but... not successful, but got sentence reduced by a bit
- Fastow: 6 years

- Fall 2008: U.S. Court. Many shareholders partial compensation from fund by banks and financial institutions that benefited (aided Enron?), total over $6b = 50% of investor loss

Result: Sarbanes-Oxley Act (SOX) United States, 2002
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Response to scandals at Enron etc, especially regarding accounting
- new gov't body: Public Company Accounting Oversight Board
-- oversee, investigate, discipline, accounting firms and public companies (in addition to SEC)

Rules:
-CEO/CFO must certify the financial statement
- new standards/rules for accounting
- audit committees of the company must be independent
- accountants can't also be consultants (to the same company), possible conflict of interest/lack of independence
- major changes to financial situation must be promptly public
- heavier penalties for fraud etc

Critique:
- too much regulation and too fast from the gov't?
- Too much cost, overreaction?

Canada:
- no federal securities regulatory authority
-- everything is provincial/territorial
- only industrialized country without a federal body
- CSA = Canadian Securities Administrators -> just an association of the provincial/territorial agencies
-- ie: Ontario Securities Commission, etc

Pressure to match U.S.; it was needed anyway
1. Ontario Bill 198 in 2002 as parallel to SOX
- similar in other provinces, etc
2. New initiative 2010 by Fed gov't to set up Canadian Securities Regulatory Authority, ie federal authority via Canadian Securities Act passed by Harper gov't

- law challenged in Supreme Court by several provinces, mainly Alberta, Quebec, Manitoba, N.B.
- Supreme Court 2011 rules: Fed gov't lacks constitutuional authority
- Reference Re Securities Act, [2011] S.C.R 837


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