Yet, evidence suggests that when Senator Schumer triggered the collapse of IndyMac Bancorp back in July, he may have been trying to manipulate downward the company’s value on behalf of campaign contributors who were looking to buy.  If true, Schumer could be prosecuted or sued for securities fraud.

In 1942, the SEC caught wind of a company president who, angling for a controlling stake in the firm, induced existing shareholders to sell out cheaply by deliberately understating the company’s value.  The SEC responded, in 1948, with SEC Rule 10b-5, now known as the 1934 Exchange Act’s “anti-fraud provision.”  It applies equally to transactions in public and private company shares.  The rule is relatively short yet expansive in scope:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

a. To employ any device, scheme, or artifice to defraud,
b. To make any untrue statement of a material fact, or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
c. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

In other words, anything that anyone intentionally does or says in “interstate commerce” — in the context of the purchase or sale of any “security” — to deceive or mislead anyone violates the law.  Civil and criminal sanctions may be applied against violators.

Fast-forward 60 years to June 22, 2008. At that point in time, the WSJ reports that IndyMac Bancorp was in financial distress, searching for a capital infusion.   Oaktree Capital Management, LP was performing “due diligence,” digging through IndyMac’s books to determine what price to offer, if any.  Oaktree’s thing is buying companies on the cheap, shortly before or even after they go bankrupt.  Chairman Howard Marks reportedly told the WSJ, “We’re bargain hunters. And we have a long history in distress.”

On June 22, Oaktree’s Managing Director, Skarden Baker, wrote an e-mail to Chairman Howard Marks that read, in part: “I am taking the view of doing enough here [at IndyMac] to jump in if it goes to receivership.”  In other words, it would suit Oaktree just fine if IndyMac went under.  Conveniently, Oaktree-affiliated investors have contributed $700K to Senate Democrats during Chuck Schumer’s four years in charge of the Senate Democrat Campaign Committee.

Four days later, on June 26, 2008, Senator Schumer — in a “highly unusual” move, publicized a letter he had written to bank regulators, raising doubts about IndyMac’s viability.  That letter read, in part:

“I am concerned that IndyMac’s financial deterioration poses significant risks to both taxpayers and borrowers,” the senator wrote, warning that “the bank could face a failure if prescriptive measures are not taken quickly.”

Schumer’s publication of this letter triggered the very bankruptcy Oaktree was hoping for, according to this OTS press release:

The OTS has determined that the current institution, IndyMac Bank, is unlikely to be able to meet continued depositors’ demands in the normal course of business and is therefore in an unsafe and unsound condition. The immediate cause of the closing was a deposit run that began and continued after the public release of a June 26 letter to the OTS and the FDIC from Senator Charles Schumer of New York. The letter expressed concerns about IndyMac’s viability. In the following 11 business days, depositors withdrew more than $1.3 billion from their accounts.

Later, in August, 51 former IndyMac employees asked California AG Jerry Brown to investigate Schumer for violations of California’s banking laws.  Predictably, Brown declined.  It seems possible, however, that Schumer could be prosecuted or sued under Rule 10b-5.  No word at this point on whether anyone is contemplating such a move.  Either way, Schumer’s antics in relation to IndyMac shed new light on the phrase, “Loose lips sink ships.”

Parenthetically, small business owners may want to note that Rule 10b-5 applies to interstate communications in relation to the purchase or sale of private and public company securities.  That is, even if a company is not an SEC registrant, the SEC’s anti-fraud provisions apply.  They should also keep in mind that all companies must register with the SEC unless they fall under a specific exemption from registration.

At it’s September 24 meeting, the Financial Accounting Standards Board conceded that its contingent liabilities disclosure proposal had met with serious resistance among financial statement preparers and their attorneys.  Users, however, wanted even more than the truly outlandish disclosure concessions embodied in the Exposure Draft.

The end result was that the FASB scheduled a “redeliberation” of the proposal to give FASB staff time to develop and test an “alternative” that “attempts” to respond to the concerns raised by preparers and their attorneys.  We can only hope that today’s pro-market-regulation hysteria will subside between now and next year when the FASB meets to reconsider this misguided proposal.

Some of the user comment letters reveal a staggeringly simplistic mindset.  One Chartered Financial Analyst with a Yale economics PhD who serves as Executive VP of a Boston asset management firm unbelievably wrote:

We believe that FAS 5 should require companies to disclose all known severe threats whether or not they are expected to be resolved within a year.

Seriously.  “All known severe threats.”  The writer, however, generously allowed she didn’t mean that all of these threats should be quantified:

Recognizing the need to ensure that disclosures are made in a cost-effective manner, [my company] would like to suggest that “remotely probable” risks that are not expected to be resolved within one year be described in a narrative form, but would not need to be quantified other than to specify that they may be severe.”

Maybe they don’t teach game theory to Yale PhDs.  But do you really need game theory to realize that if a company broadcasts a complete narrative description of all known severe threats regardless of how remote they are in time, that competitors and short sellers will exploit that information to hurt the company’s current shareholders?  If an airline broadcasts the departure time and location of a jet that has only one of two engines operating, what should we expect Al Qaeda to do?

Even if we dialed back the disclosure obligation to say, “Quantify all known severe threats expected to be resolved in one year,” — essentially what the current proposal would require — we would be handing enormously prejudicial information to opposing litigants and competitors.  The FASB’s proposal provides a so-called “exemption” from disclosing prejudicial in limited circumstances but even that exemption holds that

In no circumstance may an entity forgo disclosing the amount of the claim or assessment against the entity (or, if there is no claim amount, an estimate of the entity’s maximum exposure to loss); providing a description of the loss contingency, including how it arose, its legal or contractual basis, its current status, and the anticipated timing of its resolution; and providing a description of the factors that are likely to affect the ultimate outcome of the contingency along with the potential impact on the outcome.

Forcing a company to disclose its “maximum exposure to loss” is tantamount to exposing its bottom line in a negotiation.  Why would an investor who cares about the company ever want it to reveal such sensitive information?

Investors should reject this proposal because (a) it is likely to provide highly unreliable information about the disclosing entity (until litigation is finally resolved, no one really knows what’s going to happen); and (b) the very disclosure of such information can change the outcome of pending litigation or negotiation.  It is likely to do more harm than good to the very companies in which investors have invested their funds.

Citi said: “Without our willingness to engage in this transaction, hundreds of billions of dollars of value would have been seriously threatened. We stood by while others walked away. Now, our shareholders have been unjustly and illegally deprived of the opportunity the transaction created.”

Citi believes that it has strong legal claims against Wachovia, Wells Fargo and their officers, directors, advisors and others for breach of contract and for tortious interference with contract. Citigroup plans to pursue these damage claims vigorously on behalf of its shareholders. However, Citigroup has decided not to ask that the Wells Fargo-Wachovia merger be enjoined.

While Citigroup insists that it has “strong legal claims,” the fact that it is unwilling to file for an injunction against the Wells Fargo deal suggests either that Citi’s claims are not as strong as it says or Citi is no longer as interested — for a variety of possible reasons — in closing a deal.

I’ve maintained from the beginning that Citi’s documentation does not show an enforceable agreement. Perhaps Citi has some evidence of an oral pact, but publicly available information suggests that Citi’s negotiators didn’t do a very effective job of getting Wachovia’s binding commitment. This is a common failure in business negotiation. If you want to close, you have to get commitment.

“Wachovia believes its agreement with Wells Fargo is proper, valid and is in the best interest of shareholders, employees and the American taxpayers [however]. . . Citigroup is always free to make a superior offer to Wachovia.” (Courtesy WSJ Law Blog)

But these are no ordinary circumstances. The nation’s banking system would benefit, it seems, from an early resolution of the battle. Against this backdrop . . .

Judge Ramos is playing the game as if there is no banking crisis. Late Sunday night (really late), Ramos physically left his home in Connecticut to return to the State of New York in an effort to keep alive his earlier injunction against Wachovia’s negotiations with Wells Fargo. That injunction was vacated shortly before by a federal court judge. Ramos’ new injunction — courtesy DealBook — appears below.

All this raises the question, why does New York Supreme Court Judge Ramos go to such lengths to keep things up in the air? It’s not as if Citigroup has produced anything that resembles a binding commitment by Wachovia to sell. It has not. Is Judge Ramos putting his ego ahead of his country?

Citi appears to have done a poor job of working up its bid for Wachovia (grossly underestimating its value) and an even poorer job of attempting to pin down Wachovia to actually do the deal. In addition, it appears that Citi may have deliberately leaked the confidential “Exclusivity Agreement” to the press and put on a public (though questionable) show of legal force in order to batter Wachovia’s stock price and, thereby, make the deal an even better one for Citigroup.

Wachovia’s brass, on the other hand, appear to have done a masterful job under very trying circumstances — made all that much worse by federal government meddling — of putting itself in a position to create an auction environment for its own sale. Brilliant work, Mr. Steele. The subtext is that Wachovia appears to be worth much more than anyone thought a week ago. Likely, Citigroup will have more to put on the record. But what they’ve offered so far is distinctly unimpressive.

By the way, The Deal Professor’s conclusion, “It is now Oct 3, in case anyone is counting. So, the Wells Fargo deal clearly violates the explicit terms of this agreement,” was premature.  These new documents make it appear more likely that Wachovia did not violate the exclusivity agreement while Citigroup did violate the confidentiality agreement.

Whatever Wachovia’s true value, Citigroup appears to have no legitimate claim to it. What I see in this letter is an agreement to keep talking, exclusively, until October 6. After that, all bets are off. There’s nothing in the exclusivity “agreement” that binds Wachovia to conclude what the “agreement” explicitly calls a “proposed transaction.”

It’s a classic, unenforceable agreement to agree and — if Citi cannot produce more evidence of a binding deal — it’s a cautionary tale to owners, managers, buyers and sellers of businesses of all sizes. Binding agreements must do more than bind the parties to talk with each other.

Congress take note: regulators can get it wrong on both ends — high and low. Lucky for Wachovia’s shareholders — and the financial markets — Wachovia’s board didn’t listen. Best to let the market do its work and get out of the way.

Speaking of which, what about U.S. GAAP’s “fair value” accounting regime? How much was Wachovia really worth 24 hours ago? Either U.S. GAAP was lying then or it’s lying now. What’s the point of having companies report assets at “fair value” when fair value is so context-dependent and fluctuates by 750% in a matter of hours? Fair value makes sense in some contexts, particularly in highly liquid markets. In others, it is likely to be materially misleading.

The bill grants extraordinarily expansive power to the Secretary of the Treasury to control not only banking, but, indirectly, the entire U.S. economy.  In granting this power,  Act Section 103, copied below, requires the Secretary to “take into consideration” a list of nine items.  Like the powers granted, the list is broad and vague.  Against this backdrop, you would expect robust control and governance, real oversight to ensure that the broad powers granted are used appropriately.  The reality — discussed after Section 103, below — is exactly the opposite.

Because the judicial review mechanism in the bill is virtually non-existent (you can only sue to stop the Secretary’s actions if you believe it violates the Constitution), a wisely-crafted bill should include independent oversight of the power-holders and their actions.  Yet it does not.

Rather, the bill creates a five-person Financial Stability Oversight Board composed of precisely those people who will wield all the power including the Secretary of the Treasury himself.  (See Section 104(b), below.) This Board — whose members would necessarily be involved in any abuse of the power — will be responsible for telling the Congress when it happens.

Going a step further, Section 108 of the bill (also below) requires the Secretary to write regulations “to address and manage or to prohibit conflicts of interest that may arise in connection with the administration and execution of the authorities provided under this Act.”  Perhaps the Secretary’s first regulation could be to prohibit the Secretary from attending Oversight Board meetings.

Example: The entire bill is aimed at empowering the Secretary of the Treasury to buy “troubled assets,” defined in the excerpt reproduced below. Included among these poor creatures are things they call “other financial instruments” which the drafters forgot to define. Maybe it was intentional? Observe:

Apparently, we’re all supposed to know what they’re talking about. Result? The Senate is poised to authorize the Secretary of the Treasury to buy on the behalf the American people — at his unfettered discretion — an undefined category of assets.

Isn’t this what got AIG into trouble in the first place? We can do better, can’t we?

I have not researched the constitutional implications of Congress authorizing the SEC to issue such an order, but I stand by my original statement that even without Section 132, the SEC could “suspend” FASB 157 next week through abbreviated due process. I think the President could do so today, if he believes — as some seem to be suggesting — that the Statement constitutes a threat to the security of the United States.

However, the emphasis on FASB 157 as the accounting culprit (if accounting can be said to be a culprit) is misplaced. FASB 157 merely establishes methods for valuing assets. It does not, itself, trigger application of those methods. This theme was elucidated in more detail by Lynn Turner one week ago. Readers with a stomach for more technical detail may find this JP Morgan Research Memo worth a look.