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Monday, December 10, 2007

SEC, Spitzer: Swing and a Miss at Bear Stearns

Every year in New York around this time it's tradition that the ball gets dropped. The problem is this year it has nothing to do with New Year's Eve and Times Square. Today's Wall Street Journal revealed that the S.E.C. and former New York attorney general Elliot Spitzer dropped enforcement cases pertaining to whether Bear Stearns improperly valued mortgage backed securities and in doing so, harmed investors. The investigations would almost certainly have stemmed the tide of valuation inflation currently plaguing Wall Street and protected the myriad hedge funds, institutional investors and high net worth individuals who bought the poisonous debt. Translation: They Dropped the Ball.

Two cases in particular were investigated. In one case an SEC investigator went so far as to recommend a large civil enforcement penalty against Bear Stearns. In the other Bear Stearns allegedly sold bonds it priced at 90 cents on the dollar but after it unloading them, re-priced the value of the same bonds at 30 cents on the dollar before agreeing to purchase them back. Both cases were dropped and there was no comment as to why.

The dropped investigations highlight the rampant conflicts of interest and potential for fraud between Bear Stearns and its now collapsed internal hedge funds raised in the arbitration case we filed on behalf of the investors in the hedge funds. Claimants allege that Bear Stearns was moving toxic low quality collateralized debt obligations over to the fund at inflated market values. In essence, it's alleged that among other things, Bear Stearns was artificially creating a market for this debt by using dubious "mark to model" techniques and questionable transfers. Bear Stearns will eventually have to explain how it valued these transactions.

By the same token, the regulatory community must answer for why their leadership was asleep at the wheel. Poor leadership, in fact, is one reason Wall Street is in crisis to begin with. Bear Stearns execs reward the rank and file through end of the year performance bonuses and according to the Wall Street Journal story "traders long have had a motive to inflate the value of securities because their bonuses often are tied to them."

Without any downward pressure from regulators and a culture of greed/eat what you kill encouraged by Wall Street, is any wonder that things got so far out of control?

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