SEC: Missing In Action

by Lisa Doby, Rebel Traders | February 7, 2008

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Apparently, some in the Securities and Exchange Commission (SEC) think that “investors” are partly to blame for the credit/banking/financial derivatives problems we are facing. Ok, fair enough, everyone shares the blame. The following excerpts are from an article published by Reuters on February 5th 2008 titled “SEC may recommend credit rater guidelines by July”1 

“The SEC is charged with ensuring credit rating agencies follow their stated procedures for managing conflicts of interest as well as ensuring they make the adequate disclosures. The agency does not have jurisdiction over how the firms come up with their ratings.”

“We may engage in some rulemaking, such as better disclosure about rating performance, better conflicts (of interest) management,” Erik Sirri, head of the SEC’s division of trading and markets, said on Tuesday at the Reuters Regulatory Summit here.”

“Credit rating agencies are just one of many groups that has been blamed in the subprime fallout. Banks, regulators and mortgage lenders have also come under fire for their role in the crisis that has rocked markets and forced thousands of homeowners into foreclosure.”

“There’s a lot of blame here, and I’m not saying credit rating agencies aren’t culpable … but I think investors have to shoulder their fair share of blame here,” said Sirri. “A lot of investors did not do their due diligence.” (emphasis added) 

But, who are these “investors”? And did they really fail to “do their due diligence?” Well Mr. Sirri, there are some school districts in Pennsylvania who tried to get good advice and were burned, anyway! A story that was published by Bloomberg on February 1st, 2008 titled “Hidden Swap Fees by JPMorgan, Morgan Stanley Hit School Boards”2 tells the story of a school board in Pennsylvania that did their due diligence and still got burned. 

The SEC doesn’t regulate derivatives, but it does “have the authority to oversee how banks conduct transactions.” SEC Chairman Cox says that “…all financial firms should tell clients what their fees are before signing any deals.” If this information is true, and I have no reason to doubt it, then this is fraud. This money was “stolen” from every taxpayer in those school districts. Here are a few excerpts from the Bloomberg article:

“James Barker saw no way out. In September 2003, the superintendent of the Erie City School District in Pennsylvania watched helplessly as his buildings began to crumble…”

…”David DiCarlo, an Erie-based JPMorgan Chase banker, told Barker and the school board on Sept. 4, 2003, that all they had to do was sign papers he said would benefit them if interest rates increased in the future, and the bank would give the district $750,000, a transcript of the board meeting shows”…
…”What New York-based JPMorgan Chase didn’t tell them, the transcript shows, was that the bank would get more in fees than the school district would get in cash: $1 million. The complex deal, which placed taxpayer money at risk, was linked to four variables involving interest rates. Three years later, as interest rate benchmarks went the wrong way for the school district, the Erie board paid $2.9 million to JPMorgan to get out of the deal, which officials now say they didn’t understand”…

…”The Pennsylvania deals show that school districts routinely lose when making derivative deals. They pay fees to banks that are as much as five times higher than typical rates and overpay advisers by as much as 10-fold. That means banks often underpay schools on upfront amounts, as JPMorgan Chase did in Erie, public records show. And school officials aren’t always well served by their supposedly independent advisers, whose fees are paid by the banks selling the deals — only if the sale is made”… (emphasis added)

And, let’s not forget our legislative bodies’ culpability, either: 

Just five years ago, municipal derivative deals weren’t sanctioned in Pennsylvania, the sixth-most-populous U.S. state. Then, in September 2003, the state Legislature adopted a law allowing schools and towns to use interest-rate swaps to lower borrowing costs and raise cash.

I do fault the school districts for one reason: If you can’t figure out a business deal in your own head, then maybe there is a problem with the deal! That’s a pretty big gamble they have taken with somebody else’s money- yours and mine. And this is not just a local event, this has happened many times and in many other states. I strongly urge you to read the full story posted by Bloomberg (see link below). The details provided in the Bloomberg article of what was done to these school districts made me very angry. 

A few more questions for the SEC, please. Where were you when all of these slick derivatives, with all of their fancy names and initials, were being created and sold to mutual funds, pension funds, and teacher’s retirement funds? Are these the same investors to which you refer, the people who have been diligently saving for retirement? Oh, sure, these are some savvy investors who should have been doing “due diligence.” They trusted “advisers” and they trusted that the people who were hired to manage those funds knew what they were doing. How were they to know that the fox was guarding the hen house? But, when they learn that’s the case, don’t count on winning back that trust again so easily. 

1 Reuters Article
2 Bloomberg Article

Copyright © 2008 Lisa Doby
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Lisa Doby | Rebel Traders | Palmyra, NJ USA | Email | Website

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