Think it Through

Ted Kennedy is gone but he is still helping Barack Obama. The person who Kennedy tutored and entrusted with the job of chief counsel to the Senate Judiciary Committee during the 70’s and early 80’s has taken the first meaningful step to bring about a correction in the way Wall Street compensates its executives.

Kenneth Feinberg, the administration’s pay czar has ordered companies who have received taxpayer bailout money to cut the pay to their highest executives.

Feinberg is the first person in the Administration to take action that responds to the bitterness felt by Americans toward government enabling Wall Street executives to reap millions of dollars in pay after they have caused the ruination of the economy. This resentment could possibly deepen as the recession hangs on and the dollars and cents concerns of voters dominate the 2010 elections – more so than Afghanistan or health care.

When Feinberg says the government will “order” reductions in pay to executives of bailed out companies, it represents the first time anyone associated with the Obama administration has used such a verb. In New York a few days ago, President Obama’s message to Wall Street was: “I would ask that you join us” in reforming Wall Street practices. Last Sunday on the ABC news show This Week the President’s closest political advisor David Axelrod, when asked about the Wall Street bonuses, said: “we have, as I said, limited sway other than moral suasion with some of these – a lot of these institutions.”

Feinberg is someone who is more adept at using the law to achieve a specific goal than relying on an “ask:” or an appeal to one’s sense of morality. He has a reputation as a tough negotiator who knows Wall Street but is not a person of Wall Street.

As the press secretary for the House Judiciary Committee at the same time that Feinberg was running Kennedy’s Senate Judiciary Committee, I noticed that staffers on the committees would call him Senator Feinberg behind his back – sometimes jealously, but always with an acknowledgement of some truth to the label.

Ted Kennedy, being secure and smart, promoted this because it made him a more effective senator. Since Kennedy trusted Feinberg’s skills and integrity the Senator could be several places at once and get more done.

Today, over 30 years later, Obama is indicating the same type of confidence in Feinberg. The announcements this week by the pay czar represent just the beginning of reforms on executive pay. Perhaps most importantly, they start to move away from the idea that Wall Street will – or even should – be moved by moral suasion. Stephen Labaton reports for the New York Times that the federal government asked the insurance industry to repay $45 million dollars in bonuses, and so far only $19 million has been paid back. I am surprised that it is as high as $19 million. You cannot blame Wall Streeters for being greedy — they are in the business of making money. That is what they do. It is up to the government to keep them honest through tough regulation and oversight.

Much more is needed than Feinberg’s first step. In June I posted an idea that would apply a direct correction to Wall Street bonuses. Under my proposal, corporations that pay their top executives bonuses while the companies are losing money would be required to pay the federal government a tax worth ten times the bonus. It is a conservative idea, to incentivize sound business practices. It might have made a number of corporations think twice before handing out bonuses last year. For example, AIG gave $38 million to top executives while it was losing $99 billion, and Citigroup handed out $60 million in bonuses while it was losing $18 billion.

After months of hearing Larry Summers and Tim Geithner make excuses for the government’s failure to force reforms on executive pay, Ken Feinberg is a breath of fresh air. We can only hope that he takes an increasing role in the Treasury Department’s dealings with Wall Street, to the point where the Summers and Geithner acolytes begin to refer to him as Secretary Feinberg.

Here is a suggestion for President Obama to overcome Republican objections to a cap on executive pay on the grounds that it interferes with the internal decisions of businesses: instead of proposing a cap on executive pay, borrow a theme from Ronald Reagan, who used the themes of individualism, freedom, and self-determination to employ the tax code as an incentive and a substitute for government regulation.

I propose the Democrats give up on the idea of a cap and instead offer a government incentive for merit pay for corporate executives. This would come in the form of disincentive for businesses to pay billions to executives who have failed. Here’s how it would work: a corporation that loses money but chooses to pay bonuses to its top executives at the end of the year must pay the federal government a large tax equal to ten times the bonus – call it surtax on corporate stupidity and gluttony.

It is a conservative approach to good behavior. Do not dictate. Incentivize. Who would be affected?

• Insurance giant AIG would have thought twice about paying its directors $38 million in bonuses when it was losing $99 billion last year. If they were that determined to give the bonuses, the federal government would not have stopped them, but they would have had to pay $380 million for their decision.
• Citigroup might have balked at paying its top execs $60 million in bonuses when they led the company to become $18 billion in the hole; and
• General Motors might have hesitated before paying its top officers $26 million in bonuses last year while it was losing nine billion dollars.

Merit pay. What a concept. It works in small businesses and in corporations at the lower levels. Why stop there? It is an idea that both Democrats and Republicans could embrace.

When the U.S. Government sent Eugene V. Debs to prison in 1918 for distributing antiwar pamphlets in violation of the Espionage and Sedition Act of 1917, the industrial barons breathed a sigh of relief. In the first two decades of the 20th century, big business detested Debs, the five-time Presidential candidate of the Socialist Party, champion of workers’ rights, and general trouble-maker for industry. He was sentenced to a ten-year prison term, but President Harding let him out in 1920. His arrest was clearly political.

Today, sitting in an Arizona jail cell is a man who during the 80’s and 90’s was detested by the new industrial barons of the 21st century – the CEOs of high tech corporations and financial security firms and giant accounting and insurance companies, especially the ones accused of securities fraud. They hated and feared his resourcefulness, his tenacity, and his gift for seeing through the veneer of false quarterly statements. As a lawyer, he was not intimidated by their power, and he amassed a personal fortune by winning settlements against large corporations engaged in securities fraud.

During the Clinton Administration, he warned Congress and the President of a rising tide of financial fraud and pleaded with Congress not to shut the court house doors to average investors, not to loosen regulations on derivatives and other shaky instruments, and not to reduce the funds for the Security and Exchange Commission. Republicans and some high level Democrats with ties to the financial industry, like Senators Chris Dodd and Harry Reid, and then Congressman Charles Schumer, ignored and even ridiculed his admonishments.

The louder he spoke, and the more lawsuits he filed against companies, the more enemies he made in high places. He had a target on his back, drawn by the business elite, who were pressuring the government to investigate their tormentor. Shortly after George Bush became President, word leaked out that the federal government was indeed pursuing a case against him.

Six years later, in the fall of 2007, the United States government charged San Diego lawyer Bill Lerach and other members of his firm with deceiving the courts about whether they paid people to be their plaintiffs. Lerach pled guilty.

Lerach was wrong to break the rules on paying plaintiffs and even more wrong not to admit it right away. Lerach was a victim of his enormous ego and an insatiable appetite for all that life can offer. He was not going to let something he perceived as trivial, such as the prohibition on paying plaintiffs, limit his ability to make money or cause mayhem in corporate boardrooms. He felt he could not wait for plaintiffs to come to him. When he saw fraud, he wanted to file a case.

From 1991 to 1997, I conducted opinion research, helped prepare Congressional testimony and handled some public relations for the National Association of Securities Lawyers, which included Lerach. I worked directly with him a number of times, and each time I came away impressed by his brain and his ability to focus but worried about his total lack of self-doubt and his constant hunger for more, more , more, of whatever interested him at the time. It is not hard to believe he would have gone too far.

I believe it is important, however, to separate the person from the product of his labors. While Lerach’s motives may have been monetary, his impact was immensely salutary for society. You cannot say that about the people who wanted him to go away.

In an era of government deregulation and non-enforcement, he became practically the only entity that made swindlers think twice. The records show he won over $10 billion in claims for millions of investors who believed they were defrauded by financial swindlers. In nearly every case, the fraud defendants insisted on sealing the records, closed to public scrutiny. Then they would stand on the courthouse steps and intone how they have paid ransom money to Bill Lerach in a frivolous lawsuit, just to make the suit go away. The way it works when you are at the top is: hide the facts, pay huge settlements, which corporate insurance covers, and then denounce the suits as meritless.

Lerach was a leading watchdog in hundreds of cases, helping to uncover the Savings & Loan scandals of the ’80s, as well as the Enron and Worldcom debacles. Corporate wrong-doers everywhere celebrated when he was convicted in February 2008 and sentenced to two years in prison.

There is no excuse for Lerach breaking the law. But we should also recognize that the laws, the regulations, the court procedures, even the press coverage are all stacked in favor of the powerful. Every day Lerach was on the prowl evened the odds a little bit for the rest of us.

I realize Lerach is no martyr, like Eugene v. Debs. He is an aggressive lawyer who sought fortune and fame. You will not see his name on Amnesty International’s list of political prisoners. But when you consider the wide discretion prosecutors have in terms of whom to spend their resources investigating, you might conclude that Lerach’s imprisonment is a political act by our government.

President Obama could make a political statement of his own if he pardoned Lerach. It would send Wall Street a message louder than the day’s opening bell – the junk yard dog may soon be back at the gate, so watch your step.

image used under CC license from f-l-e-x.

When President Obama says “shame on” those corporate executives on Wall Street who took $18.4 billionno real legal means to do so – it all rings hollow to me. It is as meaningless as Sen. Dodd’s comments yesterday that if he gets really angry at the Wall Streeters, he will hold a committee hearing on the topic. in bonuses last year and Senator Chris Dodd fulminates that we will “use all legal means” to get the money back – knowing full well there are probably

Recognizing that most experts say it is not possible to pass laws limiting compensation or to force companies to take away bonuses already given, there are some things our leaders could do that are more effective than denouncing the bonuses.

For starters, the President and the Treasury Secretary could call upon the executives who received the excessive bonuses to give the money back to the companies. The President should address the nation, urge the banks and securities companies to list the bonuses and the executives who received them, and urge the executives to return the money to their struggling companies.

Next, since the Treasury Department is propping up many of these firms with bailout money, and many such as Bank of America, its subsidiary Merrill Lynch, and American International Group, are on track to receive billions more.  The Treasury Secretary should inform all the companies on Wall Street receiving bailout money that they may have money deducted from their next federal bailout checks unless a large proportion of the executive bonuses are returned. Call it bailout minus bonus.

All of these things will be more effective than Presidential finger wagging or Senatorial bloviating.

The President can use his moral authority to move the nation to demand changes on Wall Street. President Obama could make this his first effort to bring the country together around the value of responsibility that he stressed in his inaugural speech. It is an opportunity he should not pass up.

President Obama’s pledge to bring back some meaningful regulation of the financial markets may be more difficult than he imagines. The reason: Senate Democratic leaders not only enabled the deregulation, they were cheerleaders.

In America, unlike other nations, the structure of investor protections against securities fraud stands on two separate legs: Government regulators and private lawsuits. Senator Chris Dodd, Chairman of the Senate Banking Committee, and other Democrats, worked diligently to saw off both legs.

Here is how the people’s representatives took the side of fraud defendants over the fraud victims.

STEP ONE: CURTAIL PRIVATE INVESTOR LAWSUITS

When in the mid 1990’s Dodd and fellow Democrats Charles Schumer, Patty Murray, and Harry Reid worked to curtail private lawsuits by investors who were victims of securities fraud, they weakened what has traditionally been the most effective deterrent to securities fraud.

Their actions represent the result of a determined effort by giant corporations seeking to do away with accountability in the financial markets because they felt it got in the way of their profits. In 1992 these companies spent millions of dollars on lobbying to get Congress to enact a law to shield them from private lawsuits. (Siconolfi, Michael, and Anita Raghavan. “Securities Firms Make Large Gifts to Congressmen.” Wall Street Journal 22 Aug. 1995: C1+.)

The Coalition to End Abusive Securities Suits, or CEASS as it was known, included some large accounting firms caught in fraud scandals of the 1980’s and 90’s, such as Arthur Anderson, Coopers and Lybrand, Ernst and Young, Deloitte Touché. Other CEASS members included securities firms and insurance companies, such as Prudential Securities, Chubb insurance, Morgan Stanley, and Amdahl corp. It was the beginning of a massive, costly, and successful lobbying effort.

The CEASS lobby in the early 1990’s pushed hard for Congress to approve a new law that would make it more difficult for people to bring class action lawsuits in federal courts against companies allegedly involved in securities fraud. The legislation was called the Private Securities Litigation Reform Act of 1995 (PSLRA), and it changed the rules to require that investors prove intentional lying by company executives in order to get into court. This standard is so high that investors now practically need to have an executive make a videotape and say he lied before investors can challenge suspicious behavior.

Making these lawsuits harder to bring to court diminishes the main deterrent to securities fraud in the U.S., since federal and state government regulators are notoriously understaffed. Most of the big cases, such as the billion dollar scandal of Charles Keating’s Lincoln Savings and Loan selling worthless bonds to elderly retirees in the late 1980’s, were uncovered by private lawsuits which then led to SEC investigations. Under the new standards in the PSLRA of 1995, the Keating fraud and others like it would not have been uncovered. We now know the sleepy state of federal watchdogs is one reason why Bernie Madoff was able to operate for decades without getting caught.

Two members of Congress championed the Private Securities Litigation Reform Act of 1995, and took credit for its enactment over President Clinton’s veto:

Republican Christopher Cox, then a Congressman from Orange County, California. Cox collected campaign contributions from high tech executives who also happened to be fraud defendants.

Democratic Senator Chris Dodd, Chairman of the Senate Banking Committee, who became very popular among banks and securities companies who were fraud defendants and among insurance companies who pay the investor settlements in financial fraud cases.

Dodd enjoyed the eager support of many top Democrats in favor of restricting investors’ access to the courts.

Not everyone thought this was a keen idea, however. Consumer groups, states attorneys general who enforce the securities laws, the AARP, and the securities regulators in all 50 states sent messages to Cox and Dodd that the bill was a bad idea that would weaken safeguards against fraud. (”Less protection for investors.” Consumer Reports Sept. 1995.)

Rick Roberts, a former Securities and Exchange Commissioner under the first President Bush, warned in September 1995, “if you look at the whole picture, congress is taking away the right to bring an action if there is a fraud; it’s cutting the level of information investors receive; and third it will try to slash the SEC budget so there are no public remedies. If I was an investor, I would be getting very queasy about plugging my money into the securities market.”

STEP TWO: LETTING THE FOX GUARD THE HENHOUSE AT SEC

In 2004, President Bush appointed Chris Cox to be Chairman of the SEC and the Senate, with the approval of Dodd and the other Democrats, voted unanimously to confirm Cox. In so doing, Dodd and the Democrats agreed to place the protection of investors in the hands of a man who had already made it his cause to shred the most potent deterrent to securities fraud.

As chairman, Cox allowed securities firms to avoid legal requirements to be audited by accounting firms that were registered with the government. The result was that firms like Bernie Madoff’s used their own accountants to do friendly audits and fraud can remain undetected for years. Also, under Cox, the SEC’s budget declined in 2006, and 07.

Why bring up all of this recent history? Because when Sens. Dodd and Schumer cried out this week about how the SEC “missed Madoff,” it is hard to remain silent.

President Obama and Treasury Secretary Geithner should know the sorry record of the Congressional team it has inherited, before they suit up to pitch for stronger protections for investors. And voters should know when their Senators talk like Teddy Roosevelt and act like Jay Gould.