Saturday, November 8, 2014

The Democrats Cede the Ideas Market to the GOP - That's a Feat!

Democrats apparently failed to turn out their base in Florida and elsewhere. How much of a surprise is that given that, as usual, the Democrats did not seem to stand for anything and therefore let the Republicans frame the issues?

It seems all the Democrats talked about was “outside money.” The Koch Brothers failed spectacularly in 2012, when Obama was on the ballot. The Democrats said nothing this time to get their base voters off their couches.

The Democrats ran scared of Obama, the Affordable Care Act, and their entire legislative record. They therefore let the Republicans, who offered no program but not-Obama, totally frame the debate. 

Did Democrats say “I’m for Obama when he’s right, and he’s been right more than he’s been wrong”? Or “the Republicans want to repeal Obamacare, but are they willing to allow the insurance companies to return to the bad old days of refusing to insure people with pre-existing conditions”? 
Did Democrats remind people that it was the Republicans who prevented this country from rebuilding its infrastructure back in 2009 and 2010, preventing a jump-start of the economy that could have meant millions of good jobs and laid the framework for decades of economic growth, or did they run from the issue?
Did Democrats talk about global warming and show that Republican opposition to dealing with it created a present threat to us? 
Did Democrats point out that the Republicans had gutted our public health system?
Did Democrats defend the reforms in the financial markets and show how the Republicans threaten another financial collapse if they dismantle those reforms?
If so, I didn’t hear it or see it.

As usual, the Democrats seemed to be afraid of talking about ideas. As usual, they ceded the “idea market” to the Republicans. Now that was a feat.

How many times can you expect to rouse people with little more than “they’re going to take away your Medicare and Social Security!”? Is there a single Democrat who said “Yes, in the next ten years it looks like we’re going to have to make some changes to Medicare and Social Security, but there’s no need for panic now”? If so, I saw no evidence of it.
Democratic strategists will say that these issues are too complicated to talk about in campaign commercials. Well, if that’s the case, how do plaintiffs ever win lawsuits involving complicated scientific or financial issues? And the messages that the Democrats did deliver surely didn’t work.

[A modified version of this post appeared as a Letter to the Editor in the Miami Herald, November 8, 2014.]

Thursday, June 26, 2014

Dark pools and high-frequency trading -- SHHH!!! Don't wake up the SEC or Congress!

The New York Attorney General sued Barclays Capital, Inc., a registered broker-dealer and investment advisor, and its U.K.-based parent company, Barclays PLC, for fraud. (Kudos to the excellent site,, for continued ongoing coverage of dark pools, etc.)

The complaint, if true, is another blood-boiler, because Barclays is portrayed a nest of lying thieves. But even if the lawsuit fails, the allegations are enough to scare the living you-know-what out of any broker-dealer or investment advisor that depends on retail brokerage customers to butter their bread. Why? Because if the average retail brokerage customer knew the perils of trading in U.S. markets today, he or she would take all their money out and put it into … oh hell, they'd probably leave it where it is and go back to sleep.

The complaint alleges that Barclays, which operated a dark pool (a vehicle for matching buyers and sellers of stock off the floor of the New York Stock Exchange), lied to institutional investors about the extent to which they would be protected against trading abuses by high frequency traders (HFTs) if they routed their orders to Barclays' dark pool.

This is 21st century fraud we're talking about with this case. We're not talking about lazy brokers recommending highly speculative stocks without adequate due diligence. We're not talking about accounting fraud creating inflated values for blue-chip stocks. We're talking about the "simple" matter of getting your stock trade executed at the best available price -- best execution. In other words, if you want to buy stock, that you pay as little as possible, and if you want to sell stock, that you get as much as possible. 

This blog post is not about the Barclays case. They either lied to institutional investors or they didn't. If they didn't, some other dark pool operator stretched the truth to attract order flow (a license to print money) did. This blog post is just a series of ruminations about dark pools, HFTs, and the ludicrousness of the idea that the SEC is effectively policing the markets to prevent trading abuses. 

Stock brokers are supposed to provide best execution to their clients. Stock exchanges are designed to provide best execution by letting all market participants know of pending buy and sell orders and by other means designed to promote transparency and liquidity. Stock exchanges are supposed to lead to best pricing (highest possible sale prices and lowest possible buy prices). But trading routed to the exchanges has dropped over the years, in part because institutional traders (with large blocks of stock to buy or sell) began seeing price transparency as a roadblock to obtaining best prices. 

The days when Mom and Pop could expect their stock purchases or sales to be routed by their stock brokers to a stock exchange are gone--long gone. If they want to, they can direct their broker to send their trade to an exchange to be executed. Except when the market is in great turmoil, there is only a small chance that it would make a big difference. If not "directed," the chance is that Mom's and Pop's order will be routed by their broker to a variety of "routing venues," such as electronic communications networks or"ECNs," alternative trading systems or "ATSs," over-the-counter ("OTC")market makers, and proprietary trading firms. Some are called "dark pools." 

An ATS is a non-exchange trading venue that matches buyers and sellers to find counterparties for transactions. "Dark pool" is not a term defined in the securities laws, but FINRA defines a dark pool as “an ATS that does not display quotations or subscribers’ orders to any person or entity, either internally within an ATS dark pool or externally beyond an ATS dark pool (other than to employees of the ATS).”  

Basically, dark pools are useful to traders of large blocks of stock who do not want publicity about their order to generate a price rise or drop in anticipation of the order's execution. As an SEC official explained to the Congress way back in 2009 in testimony presciently entitled "Testimony Concerning Dark Pools, Flash Orders, High Frequency Trading, and Other Market Structure Issues":

Traders are loath to display the full extent of their trading interest. Imagine a large pension fund that wants to sell a million shares of a particular stock. If it displayed such an order, the price of the stock would likely drop sharply before the pension fund could sell its shares. So the pension fund, assuming it could execute its trade at all, would be forced to sell at a worse price than it might have if information about its order had remained confidential.

In the not-so-distant past, the pension fund might have placed the order, or some part of it, with a broker-dealer, which would attempt to find contraside interest (whether on the floor of an exchange or by calling around to other traders), preferably without giving up enough information to move the market against its client. Information leakage about a larger order was a serious problem, and the "market impact" of large orders would impose a major cost on investors.

Historically, many dark pools developed as computerized ways of searching for contraside trading interest while preserving confidentiality. While early dark pools were designed to cross large orders, and such pools still exist today, most of the newer dark pools are designed to trade smaller-sized orders. 

Since the mid-2000s, brokers have been required to disclose to the SEC information concerning their order routing practices. What they show is that a small portion of the orders entrusted to brokers are routed to the exchanges. For many firms, the vast majority of trades go to "market centers" or other "routing venues". Often these market centers are affiliated with the broker. (Barclays runs a dark pool.) And much of the trading on all markets is now conducted by high-frequency traders (HTFs), who use advanced logarithms to place orders and pay for high-speed access to exchanges and market centers to gain precious milli-second time advantages over non HTFs.

High frequency trading, if properly limited by still-nonexistent anti-manipulative rules, can serve to make markets more efficient by providing needed liquidity to tighten spreads (the difference between high bids and low asks). But the biggest peril from the liquidity provided to non-exchange trading venues is that the liquidity can disappear immediately: HTFs can walk away from the market and stop trading on a moment's notice. But exchanges have specialists -- market-making brokers that are obligated to supply liquidity, i.e., to be a buyer when there are no buyers and a seller when there are no sellers. Exchanges can be the locus of giant price drops, but at least there is a regulatory structure designed to provide a good measure of market stability. But HTFs have no such responsibility. This can increase volatility -- the wide swings in prices in which the little guy, who is not glued to his or her computer screen, gets slaughtered. In addition, HFTs can engage in predatory practices, such as putting in mock orders that smoke out possible contra party interest, but are then pulled back--all essentially instantaneously. The SEC has long known about predatory practices by HFTs but has done little or nothing about it. It is "studying" things.

Brokers claim they monitor the trading that goes on in dark pools in order to prevent HFTs from gaining unfair advantages over other traders. TD Ameritrade, for example, claimed in an email to this blogger: "We monitor these market centers closely and very frequently, and we adjust our order-routing strategy accordingly." Maybe. But the fraud alleged in the Barclays complaint is that Barclays, in order to attract order flow from institutional clients to its dark pool, lied to potential clients about the extent of trading (labeled "predatory" or "toxic" by Barclays) by high-frequency traders in its pool. The more the level of toxic trading, the more the institutions were likely to pay more or receive less for their buys and sells.

High frequency trading and dark pools are simply products of the microchip's ability to flatten markets by getting rid of the middle man -- in this case, by narrowing the spreads between the highest bid (offer to buy) and the lowest ask (offer to sell). Unless the SEC proposes to abolish the use of microchip in the securities markets, HTFs and dark pools and the rest are here to stay. 

For what it's worth, we are probably talking about yesterday's issue. The HTFs' best days may very well be behind them, as competition among HTFs may have reduced spreads to the point where there is less money to be made by HTFs. It's part of the end of the OTC market as it long existed... middlemen squeezing a few cents from both buyers and sellers they brought together. 

Another thing is that dark pools grew into prominence because the securities exchanges allowed high-frequency traders to pay the exchanges to get special treatment and thereby trade ahead of pending orders. In the words of the New York AG's lawsuit against Barclays:

These firms pay a premium for “direct data feeds” from the public exchanges, which are high-speed data feeds that travel faster and contain more information than market data available to ordinary investors by other, less expensive means.

Those speed and technology advantages allow high frequency traders to profile
the pending orders on an exchange in order to detect the presence of large pending orders,
usually from institional investors. This “information leakage,” allows high frequency traders to trade ahead of an anticipated stock purchase or otherwise have an impact on price. Speed and technology advantages also allow for strategies that seek to exploit the small, temporary pricing dislocations in a security that occur because of differential and/or delayed access to market data.

In other words, dark pools grew partly as a refuge from predatory practices on the exchanges. Who could expect, or want, ATSs to go away under these circumstances? 

The last point is the utter irrelevance of the SEC in all of this. As usual, the SEC has been  lost in action -- just as it was in the early 2000s when another New York AG, Elliot Spitzer, "scooped" the SEC about a whole range of trading abuses, such as conflicted buy-side stock analysts, etc. 

Yes, the SEC Chair, Mary Jo White, in June of 2014, gave not one, but two speeches on HTFs, dark pools and other market centers, issuing the old bromides about protecting confidence in the market, and announcing that she had directed the SEC staff to start preparing rules designed to make things fairer. 

If anyone believes that the SEC will move vigorously and effectively and enact a set of rules that will make all better, please let me know so I can sell you some bridges. Or better yet, if you think that Congress will act, I'll sell you some dark pools after they've been overtaken by some extra-terrestial market thingy. 

In the meantime, go here for far more insightful, but somewhat dated, analyses of what has happened to the stock market in the past ten years. 

Kind of makes you long for the good old days of Bernie Madoff, market maker and execution broker extraordinaire, and the fight over decimalization. 

Thursday, June 19, 2014

Why You Should Put Quotation Marks around "Iraq" for Dummies (this includes you, W)

Obama is being blamed by the Republicans for losing "Iraq". They're the ones  who insisted on invading "Iraq" in 2003 with no basis and without paying the slightest bit of attention to what "Iraq" was and what would happen after the first days of "shock and awe." Not only was there no Plan A, there was no Plan B.  So they got rid of Saddam Hussein, banned his supporters from the new "government," and handed "Iraq" over to Shia Muslims and the bastion of Shia Islam, Iran.

The idea--propagated most recently by the GOP's leading college dropout and draft dodger, Dick Cheney--that Iraq was "won" by the Americans after the surge is so ridiculous that it should not have to be rebutted. 

Here's what you need to know. It's a little more complicated than this, but this is post-doctorate scholarship compared to the bilge that W and Co. had the US swallow.

1."Iraq" was created after World War I by the British and the French from the remnants of the Ottoman Empire (France got "Syria" and Britain got "Iraq"). Borders were drawn arbitrarily and without any recognition of who was located within the borders of "Iraq" or what would be the consequences of drawing the lines.

2. "Iraq" is not and never has been a nation-state. There is not and never has been any nationalistic loyalty or dedication to a unified state. There is no and never has been any self-identification as "Iraqis" by any of the three major population groups. 

3. "Iraq" is composed of three principal groups. According to the CIAMuslims make up about 75% of "Iraqis," of whom about 2/3 are Shia and the remainder Sunni. About 20% (all in the North) are Kurdish. The remainder are Turkoman, Assyrian, Christians, etc. 

4. The Shia hate the Sunnis, the Sunni hate the Shia, and neither group get along with the Kurds, who are massed in the north. Yes, Shia and Sunni are fellow Muslims. But their split goes back to the death of Mohammed. By God, that's over 500 years before the Magna Carta.

Iran is a Shia nation. Anyone with half a noodle understood that by our getting rid of Saddam, who was a Sunni, the main gainers would be the Shia within Iraq, and that, thereafter, the Shia, having been kept down by Saddam (and by his predecessor Sunni rulers), would ally with our enemy, Iran, and put their boot on the Sunnis' neck. And that the only real hope was a decentralized Iraq with each region consisting of and governed by one of the three main groups. (That's what's happened with the Kurds.)

Here's what Obama did wrong: instead of exposing the US to the truth--that the invasion of Iraq was stupid, stupid, stupid, and that unless the American people wanted to be exposed to the never-ending tribal strife within "Iraq," the only sensible thing to do would be to exit, stage left, and let "the market" take over--he mumbled meaningless bromides, expressed his "support for the troops," and crossed his fingers, all to avoid crossing the right wing. (Has Bob Shrum been hiding in the Rose Garden all these years?)  True, the American electorate hate to face up to the fact that sometimes there are no good choices. American "exceptionalism" creates a false sense that we never have to make choices if we don't like either option. Obama has lacked the guts to tell people the truth. Just like every other politician. Now it's his war. What a dummy.

Thursday, March 6, 2014

Big, Big Law Firm's Chair Indicted for Cooking the Books in a Big, Big Way

We already knew that Dewey & LeBoeuf LLP, a "Real Big" law firm with offices in 28 cities from Tbillsi to Doha and everywhere in between, went bankrupt in 2012 amidst reports of huge upfront, undisclosed bonuses to supposed rainmakers and partner "defections" when word got around of who was sacrificing for the team and who wasn't. For a no-doubt whitewashed discussion of this wonderfully inspiring example of partnerships in action, read the truly dry discussion of the demise of the firm at pp.  19-21 of the January 7, 2013 Disclosure Statement accompanying the firm's second amended plan of liquidation.

Now truly a "Really Big Shoe" has dropped. Steven Davis, the Chair of Dewey & LeBoeuf, and the firm's top administrators, have been indicted by the New York County DA for grand larceny. They are charged with cooking the books of Dewey & LeBoeuf for four years to keep the firm afloat, during which time it borrowed hundreds of millions of dollars, which it used to pay the light bill and  secret bonuses to "laterals" who would make rain by the lake-full. The indictment reads like virtually every accountants' liability case I have ever worked on: make bookkeeping entries to turn expenses into assets, over, even better, revenues; get clients to backdate checks to make it appear that the bucks were made in year 1, not year 2 (thereby making it that much harder to make the numbers in year 2); restore previously written-off uncollectible receivables (thereby decreasing expenses and creating phony assets); reclassify of counsel salaries as partner compensation (thereby decreasing expenses); etc. 

What are we as lawyers to make of this? Yawn and move on? Well, besides that...

Do we chalk it up to a bunch of really crooked lawyers and staff who would go to great lengths to keep up the charade that this was a profitable enterprise that could afford sky-high compensation?

Or do we look deeper and see the source of this apparent crookery in the overwhelming  greed that has so infected our profession?

Let me reminisce. I graduated from Harvard Law School in 1971. This was a time of great ferment on the campus of this staid and hide-bound institution (at least then). Students demonstrated to abolish grades. When the SDS occupied University Hall on the college campus, twelve HLS students (me included) mockingly seized the library. The dean at the time, Derek C. Bok, sent in doughnuts and cider to the library "occupiers". Shortly thereafter, he became President of the University. There were many more (and more serious) indications that the social and political changes that were sweeping the nation between 1968 and 1971 had reached HLS.

On our twenty-fifth graduation anniversary, Derek Bok sent a letter to each of the Class of 1971. In it, he excoriated us for having contributed to the monetization of the law practice. The movement to force out or lower the compensation of "non-productive" partners is a very complicated phenomenon, but for this former BigLaw lawyer, now safely ensconced in solo practice, the breakup of the old model (or at least myth) that law firms were partnerships, that professionalism was the benchmark, and that pursuit of the almighty dollar, while important, was not the be-all and end-all of law practice -- that if you wanted to get really, really rich practicing law, do PI work and latch on to the biggest-paying accidents -- is a sad story all around.   

Somewhere in the 1970s, probably beginning with hostile takeovers, New York deal lawyers got damned envious looking at their banker clients get huge fees for doing not that much in issuing fairness opinions or manufacturing poison pills. The lawyers said "We want to get rich too!" So, slowly but surely, the worship of the Dollar became the accepted cultural norm. It spread like wildfire throughout the nation's big law firms, and, of course, some not-so-big.

Now it's one thing to do this with your money. Find or develop rain-makers. Have them make rain. Bill the crap out of the files. Ride your associates to bill, bill, bill. (And make sure to judge them only on their "hours." Look the other way when they cheat and put down hours they didn't really incur. Don't pay that much attention to young lawyers who can write and think and have good judgment if their hours don't meet their quota. And never, ever treat them as individual human beings.) Collect a ton of money. Pay the lawyers at the top of the pyramid huge amounts of money. And move on to the next year of that never-ending treadmill. If that's your version of a happy, fulfilling life, and you're not using anyone else's money to achieve this version of bliss, then God bless.

But it's a far different thing to do this with someone else's money. This is not new stuff. I represented the Miami partners of a national accounting firm that was devastated by changes in Wall Street in around the 1987 crash. (Yes, children, there was a crash in 1987.) The firm had borrowed money to pay the partners their accustomed compensation. (They also had two large offices in New York. But that's another story) Guess what? R.I.P. There are so many others. Finley, Kumble, for one. There was a firm that, thirty years ago, knew how to live (at least for a while) on borrowed money.

Repeat after me: Borrowing money to pay expenses is not the same as borrowing money to build a building or buy equipment. Borrowing money to pay compensation is an invitation for disaster, because if you can't earn enough to pay your partners what they "expect," and have to borrow money to make up the slack,  the margin of error before the bank calls the loan is very small. It's what the indictment said happened at Dewey.  

The real question is how much distance separates (i) making billings and collections the sole measure of a lawyer's worth, (ii) borrowing money to pay the alleged superstars, and (iii) making a few phony accounting entries to boost revenues and lower expenses so that the merry-go-round can continue to round-and-round for another year? If you think that this is alarmist, read the article in the Washington Lawyer a few years ago by Abe Krash, a veteran partner of the firm still known as Arnold & Porter (f/k/a Arnold, Porter & Fortas, for those with a long memory). It remains a dire warning to the dozens of law firms that fancy themselves as BigLaw worthies but are in a struggle to survive. And see last year's more sensationalistic article in The New Republic, which drily noted that "no relationship in the legal profession is more fraught than the one between partners and their money.").

Thursday, February 27, 2014

Second Circuit's Late and Undeserved Christmas Gift to the SEC

In a recent 2-1 decision, S.E.C. v. Contorinis, ___ F.3d ___ (2d Cir. Feb. 14, 2014)  the Second Circuit  gave the S.E.C. a late, undeserved Christmas present. It is the latest in a line of cases that have all but eliminated the line between "damages" and "disgorgement." 

A fund manager was tipped by an investment banker about a pending acquisition on which the banker was working. The fund manager bought shares of the target for the fund, which he did not control, and sold them at a $7.2 million profit when the acquisition was announced. The court affirmed the order of the district court that the fund manager "disgorge" the $7.2 million the fund earned and an an additional $2.5 million in post-judgment interest. The process by which the Second Circuit reached this result was tortuous and a petition for rehearing by the panel and en banc would appear sure to follow. 

SEC Chair Mary Jo White

What makes this case doubly interesting is not just the weak doctrinal support for the panel's decision, but also the fact that a separate panel of the Second Circuit, in affirming the fund manager's criminal conviction for the same wrongdoing, reversed the finding of another district judge that the fund manager be required, under the criminal forfeiture statute, to make restitution of $12,000,000, the amount of the Fund's profits and avoided losses as a result of the use of material non-public information about the acquisition. The criminal panel, including the dissenting judge in the subsequent Second Circuit S.E.C. decision (Judge Chin), held that the criminal forfeiture statute requires the forfeiture of only those funds "acquired" by the defendant or someone working in concert with him or as a result of his criminal conduct. The court explained: "While property need not be personally or directly in the possession of the defendant, his assignees, or his co-conspirators in order to be subject to forfeiture, the property must have, at some point, been under the defendant's control or the control of his co-conspirators in order to be considered 'acquired' by him. Thus, the Second Circuit held that the amount that the fund manager could be required to forfeit was his "salaries, bonuses, dividends, or enhanced value of equity in the Fund," which turned out to be $427,000.

Ironically, the nature of a criminal forfeiture order is penal while the nature of the equitable remedy of disgorgement in a civil case is remedial and not "punitive." It is difficult to square those two concepts in trying to explain the disparate results in the Contorinis civil and criminal cases. What the "criminal" panel held that the criminal forfeiture statute commands -- a criminal defendant cannot be required to forfeit money he or a confederate did not acquire, i.e., control -- was said by the "S.E.C." panel to place no limit on the potential reach of a trial court's equitable authority. The end result makes no common sense.

"Disgorgement" is a judicial construct, said to derive from the court's equitable authority once it is invoked by the filing of an S.E.C. civil injunctive action. Disgorgement has been recognized as an available "equitable remedy" in such actions since at least the 1960s, and there is a long litany of principles that the courts have announced in fashioning the contours of that remedy. All are faithfully recited (and basically ignored) in the S.E.C. v. Conorinis decision:

  • Disgorgement "serves to remedy securities law violations by depriving violators of the fruits of their illegal conduct." 
  • "The paramount purpose of enforcing the prohibition against insider trading by ordering disgorgement is to make sure that wrongdoers will not profit from their wrongdoing.” 
  • "Disgorgement is an equitable remedy, imposed to force a defendant to give up the amount by which he was unjustly enriched.  By forcing wrongdoers to give back the fruits of their illegal conduct, disgorgement also has the effect of deterring subsequent fraud.”
  • "Because disgorgement does not serve a punitive function, the disgorgement amount may not exceed the amount obtained through the wrongdoing. 
  • "Because disgorgement is not compensatory, it forces a defendant to account for all profits reaped through his securities law violations and to transfer all such money to the court, even if it exceeds actual damages to the victim.  
  • "Because disgorgement’s underlying purpose is to make lawbreaking unprofitable for the law-breaker, it satisfies its design when the lawbreaker returns the fruits of his misdeeds, regardless of any other ends it may or may not accomplish."

All of this verbiage, culled from decades'  worth of Second Circuit cases familiar to securities practitioners and judges throughout the federal system, leads one to believe that the court would follow the same rationale as its fellow panel in the criminal case: since the fund manager did not control the profit made by the fund, and since the fund was not the manager's alter ego, he would not be required to disgorge that profit. But that was not the result.

The court recognizes that the case presented "an ambiguity in the concept of disgorgement." On the one hand, disgorgement embodies the "equitable principle that wrongdoers should not benefit from their misdeeds, and thus should relinquish any profits obtained from them." On the other, while the defendant "did not pocket the profits from his trades, it was he who utilized the inside information, executed the trades, and secured the resulting profit for the benefit of his clients." The issue, the court states, is "whether an insider trader can be required to disgorge not only the profit that he personally enjoyed from his exploitation of inside information, but also the profits of such exploitation that he channeled to friends, family, or clients." 

The court starts by drawing a parallel to the tipper-tippee relationship. The cases admitted have held that a tipper who provides inside information to one who he expects will trade on that information is required to disgorge the tipper's profits. (An interesting case on this issue is S.E.C. v. Gowrish, a 2011 Northern District of California decision in which the court, on equitable grounds, limited the defendant tipper's disgorgement to what he personally received from the scheme, equal to 3% of the total profits earned by the tippers and sub-tippees and the defendant himself.) Assuming that these cases are properly decided, what use do they have in this case? 

The court concludes that there is no reason to have a different rule for a person who simply enters a trade for the other person's account. The problem with the analysis is that this is not a "tipping" case (at least insofar as what the defendant did with the material non-public information he received). It should be analyzed on its own terms: The defendant received the information and put it to use for the benefit of the fund he managed but did not control. His benefit was the $400,000 he was required to forfeit in the criminal case. Analogizing this situation to a tipping case does not clarify the propriety of the disgorgement order in this case. 

After drawing the tipping analogy, the court turns to the fact that the defendant directed the transactions and thus controlled what would occur. This, the court reasons, means that he was at fault and benefited from his wrongdoing:  "[I]t was Contorinis’s business to make trades on behalf of the Paragon Fund. Not only did he profit directly from the additional incentive compensation he received based on his successful (but corrupt) trades, but by making profitable trades on behalf of his clients he enhanced his reputation and increased the likelihood of his receiving future benefits as a fund manager." This is mushy thinking based on a mushy principle from Dirks: that the defendant must expect to benefit from the tip. The S.E.C. goes to great lengths to argue "personal," meaning psychological, benefit. Some courts have rejected such arguments. A good example is the Commission's unsuccessful attempt in a 2004 Ohio district court case to argue that the tipper benefited from tipping his barber despite the fact that there was no evidence of any business or even personal relationship between the two.

According to the court, the case is even closer than a tipper case to "the bedrock disgorgement case of the insider who executes illegal trades using his own money, and donates the profit to a third party." This case is not that "bedrock disgorgment case." In the bedrock case, the defendant personally profits and decides to send the money to someone else. In this case, however, he never receives -- controls -- the profit of his wrongdoing. The court's formal recitation of its holding makes the anomaly of this decision crystal clear: "[T]he district courts possess discretion to allocate disgorgement liability for insider trading to those responsible for the illegal acts, including to those with investment power over third-party accounts used to make illegal investments as well as to tippers." This sounds not of unjust enrichment but of punishment for wrongdoing. Again, the issue is not whether the defendant has committed a violation of section 10(b) and rule 10b-5; it is whether this supposedly equitable remedy can be stretched to encompass money that the defendant never controlled and could never control. 

There are other arguments that the court tosses out: the "uncertainty" principle ("A wrongdoer’s unlawful action may create illicit benefits for the wrongdoer that are indirect or intangible. Because it would be difficult to quantify the advantages of an enhanced reputation or the psychic pleasures of enriching a family member, to require precise articulation of such rewards in calculating disgorgement amounts would allow the wrongdoer to benefit from such uncertainty. As our precedents make clear, the risk of uncertainty in the amount of disgorgement is not properly so allocated."); and the distinction between the purposes of disgorgement in a civil case and forfeiture in a criminal case ("disgorgement is an equitable remedy that prevents unjust enrichment, and criminal forfeiture a statutory legal penalty imposed as punishment … "unjust enrichment may . . . be prevented by requiring the violator to disgorge the unjust enrichment he has procured for the third party").

None of these particular arguments is convincing. The uncertainty argument is misplaced: it has been used in other cases but deals with the difficulty of measuring the amount of profit caused by sloppy bookkeeping by the defendant. The court's analysis of the differences between civil disgorgement and criminal forfeiture appears to be a conclusion is search of a rationale: if the basis of disgorgement is the doctrine of unjust enrichment, then the issue is whether the defendant was enriched, not whether he engaged in unjust conduct.

The court's decision is unmoored. It fails to deal with the central issue: that unjust enrichment requires that the person against whom a restitution or disgorgement order must have controlled the money, at least momentarily. In this case, the defendant was convicted in a criminal trial. Punishment would or will follow. The issue left unanswered is whether an equitable remedy designed to prevent a wrongdoer from personally profiting from his wrongdoing can apply to profits earned by an entity that the defendant did not control. Analogies carry the remedy and the S.E.C. only so far. The dissent by Judge Chin dismantles the majority's opinion in short order: this is not a tipping case, because the "tippee" (the fund) was not in cahoots with the defendant; requiring him to "return" money he never received is in conflict with the rule that disgorgement not be used as a penalty; and the applicability of the reasoning of the Contorinis criminal decision -- that forfeiture cannot be extended "to a situation where the proceeds go directly to an innocent third party and are never possessed by the defendant."

The Court would have been well advised to base its decision on the principles underlying the equitable remedy of disgorgement or restitution rather than on analogies to cases in which the theory has been applied. Its review of the Restatement of the Law, Restitution and Unjust Enrichment (Third), would have made clear that the remedy of disgorgement or restitution is focused on depriving a wrongdoer of the profits of his wrongdoing ("A person is not permitted to profit by his own wrong.") The courts' extension of the disgorgement over the years beyond that basic limiting principle (tipping and "joint and several liability" being the doctrinal vehicles for that extension) reflect more a concern lest the remedy be insufficient to the regulatory goal than a thoughtful exercise in equitable judging. 

The modern developments in the disgorgement remedy have never received scrutiny by the Supreme Court. The S.E.C. may have pushed the remedy, in cases like this one, so far from disgorgement's origins that the same Court that ignored the S.E.C.'s arguments in the recent SLUSA case may severely trim the Commission's disgorgement sails. Even if Contorinis does not reach the Supreme Court, those sails may very well be trimmed by the Second Circuit on a petition for rehearing en banc.

Wednesday, January 8, 2014

Was Ted Williams Nuts?

It would be hard to conclude Theodore Samuel Williams did not suffer from some mental illness. This is the main conclusion I have drawn from reading the engrossing new biography of Ted Williams by Ben Bradlee, Jr., The Kid: The Immortal Life of Ted Williams. I say this with increased reverence for Ted the person after reading this book.

Ted the Hawker
Friends gave me this book for the holidays. I almost threw it away. I have previously read two biographies of Number 9. Growing up as I did in New England, I worshipped him from when I was seven years old, in 1954, to when he retired from the Boston Red Sox in 1960 at his ripe old age of 42 (and at mine of thirteen.) What else could I learn?

I already knew, and would never forget, that Williams hit .4059 (rounded to .406) in '41, was twice voted the MVP (robbed at least twice more), had a .344 life time average, hit 521 homers, won the '41 All Star Game with a home run at what later became Tiger Stadium, with that inviting right field porch, hit .200 in the only (1946) World Series he ever played in, with a shoulder he injured in a post-season inter-squad game caused by the fact that the Dodgers and the Cards had a 3-game playoff to decide who won the National League, hit a homer at the '46 All Star game in Boston off of the eeuphus pitch (akin a slow-pitch softball pitch) off of Rip Sewell, broke his shoulder at the '50 All Star Game at Comiskey Park, hit .388 with 38 homers in '57 at the age of 38-39, etc.

But the fascination of Bradlee's biography is his detailed review of the life of Ted the person, not Ted the player. He focused his life on two things, besides hunting, fishing and screwing, which were mere pastimes: hitting a baseball, which he studied and analyzed and dissected and wrote about like no one else, and convincing himself that he really was "the greatest hitter that ever lived."  The book evidences his great self-doubts, which seems to have been the unifying force in his life. Not that most of the people who saw him play ever doubted that he was the greatest hitter that ever lived. And who cares, anyway? Wouldn't a rational person be satisfied with knowing that, by the age of 24, he had established that he was among the two or three greatest hitters of all time?

The guy had more buddies than anyone I have ever heard of. Guys who were totally devoted to him. He had any woman he wanted... and he wanted plenty. His second and third wives were drop-dead gorgeous, but he treated them like dirt when he was around, and in any case seemed to spend most of his time off on extended fishing or hunting trips all over the world. 

Wife No. 2 - Dolores Wettach (doesn't even do her justice)

He had three kids, one of whom (his daughter) he was estranged from, one of whom (his no-good son) he was devoted to, and one of whom he tolerated (his second daughter), but all of whom he abused with foul language and foul moods. He could be incredibly thoughtful and caring and, in the same conversation, foul-mouthed and intemperate. He was extremely intelligent, although uneducated. He mastered everything he tried, from hitting to fishing to hunting to flying airplanes in the Marines. Yet he had an enduring, and endearing, naiveté towards people, in particular a baseball memorabilia crook, who swindled him, and his rotten son, who used a power of attorney to steal his father blind.

The reviews of this book seem to focus most heavily on how his son, John Henry, connived to get his dad's corpse airlifted to a "cryonics" laboratory, where Ted Williams' head was cut off and the head and the rest of the corpse are separately being frozen so that when advances in medical science allow it, they can be thawed out and ... who the hell knows?

But the true pith of this book is the incredible contrast between the foul-mouthed, public-spitting, cranky, face that Ted Williams all too often showed to the press, to the public, to his friends and to his family, and the incredible devotion to him by those who knew him best. 

Dominic DiMaggio, Joltin' Joe's younger brother, played with Williams for eleven years. Dom was a quiet contrast to the loud, brash Williams. He went on to great business success. He had a great family life. What did he need an enduring friendship with Williams for? But when Ted Williams' vision failed him after a couple of strokes and he could no longer watch Red Sox games on satellite TV and call DiMaggio the next day to discuss the previous night's game, DiMaggio called him and filled him in, and cursed himself if he missed a game. And when Ted failed, the two old Bosox pals, Dom and Johnny Pesky, drove to Florida to spend a few last days with their beloved pal. Undoubtedly, that wasn't because Ted Williams was the greatest hitter who ever lived.

The one criticism I have of Bradlee is that while he exhaustively catalogues the endless incidents of loutish behavior, and meticulously shows that he was emotionally deprived by a distant father and a wacky mother (who spent all of her time in Salvation Army activities all over San Diego, forcing Ted and his younger brother to sit in front of their house at 10 PM waiting for either parent to show up), he makes no real attempt to determine whether he was mentally ill in any way. Aside from one off-handed quote from someone who suggested that Ted Williams was bipolar, Bradlee is silent on how to characterize his mental state. I think that for a guy who was as meticulous as Theodore Samuel Williams, the only thing left to read about him is for some psychiatrist to read Bradlee's book and present his or her conclusions. Maybe the shrink can fly out to Scottsdale for a consultation in case Ted is thawed out and can talk.