The key to Yahoo! chief Jerry Yang’s apparently successful attempt to avoid being Microserfed was the threat to enter into a partnership with Google. Under the proposal, Yahoo! would outsource to Google important paid search terms, a move that struck many as all but admitting that Yahoo was incompetent at monetizing search terms and that seems to have driven away Microsoft’s Steve Ballmer.

It was a cagey move but is it legal? Can the management of a public company targeted for opposition adopt a perhaps suicidal business plan to drive away suitor? Maybe not. Although Delaware courts—which, for quirky federalist reasons, get to decide these things—give companies broad leeway to undertake defensive measures, there are supposed to be limits to this sort of thing. Stephen Bainbridge, one of our favorite law professors, explains that Yang’s takeover defense might be acceptable to Delaware courts if he could prove it was part of Yahoo’s long-term business plan. But that seems implausible—everyone knows they came up with this as an ad-hoc defense.

If Microsoft really wanted to get hostile, they might have actually been able to get a Delaware court to stop Yahoo from running into the arms of Google.

Using a strategic partnership as a poison pill [Bainbridge]

More auction rate securities lawsuits are hitting the courts. A lawsuit was filed today in federal court in Manhattan alleging that Morgan Stanley “deceptively marketed” auction-rate securities as cash alternatives, Market Watch is reporting.

"Instead of disclosing the true nature of ARS and the substantial liquidity risks associated with them, Morgan Stanley continued to push as many ARS as possible onto its customers in order to unload the inventory off its already troubled balance sheet," the lawsuit said.

The complaint seeks to compel Morgan Stanley to refund investor money by having it rescind millions of dollars of ARS transactions. It also seeks compensatory and punitive damages. The lawsuit is being brought as a class-action suit on behalf of thousands of investors who acquired auction-rate securities from Morgan Stanley between March 25, 2003, and Feb. 13, 2008,.

Similar suits have been filed against Deutsche Bank and UBS. Merrill Lynch has also been threatened with lawsuits by investors, although none have been filed. Goldman Sachs has been rumored to have been quietly bailing out some customers, including high ranking Goldman executives, whose assets were frozen when the auction failes.

Morgan Stanley sued over auction-rate securities marketing [Market Watch]

One thing that was clear to everyone involved in the deal for JP Morgan Chase to take over Bear Stearns was that there would be lots of litigation. The unusual features of the deal—including JP Morgan’s option to buy the Bear Stearns headquarters even if the deal doesn’t close, the non-solicitation clause, and the option for JP Morgan to purchase 20% of Bear’s shares—amount to an extraordinarily firm lock-up, and the JP Morgan deal team wasn’t shy about mentioning their deal protection on Sunday night’s conference call.

It took less than a day for the first shareholder lawsuit over the collapse of Bear Stearns to be filed in federal court in New York. Coughlin Stoia Geller Rudman Robbins, a San Diego-based law firm, filed a suit yesterday alleging that Bear Stearns and its leaders made false statements about the firm's financial condition and failed to disclose information investors needed to know to evaluate the company's value, the New York Sun reports. The suit seeks certification for a class action on behalf of investors who bought Bear Stearns common stock between December 14, 2006, and March 14, 2008. James Cayne, Alan Schwartz, Warren Spector, Samuel Molinaro, and the chairman of the executive committee, Alan Greenberg are all named as defendants.

As Ted Frank points out on the Point of Law blog, one irony of the shareholder lawsuits is that the expectation of them wound up reducing the payout to Bear Stearns shareholders. “One of the reasons shareholders are getting so little is because of the billions of dollars of litigation reserves JP Morgan has built into the valuation,” he writes. The lawsuits are expected to generate hundreds of millions in litigation costs, and—very possibly—the litigation costs could actually exceed the purchase price JP Morgan plans to pay for the company.

Bear Stearns thoughts [Point of Law]
Amid Bear Stearns Rubble, Lawyers Swoop In [New York Sun]

Angry Bear Stearns shareholders and class-action lawyers eager to represent them in the inevitable lawsuits of Bear’s sale to JP Morgan Chase are already sounding off against the deal. As soon as the deal was announced, a Bear Stearns investor asked JP Morgan executives “Why is this better for shareholders of Bear Stearns than a Chapter 11 filing?”

In the eyes of many on Wall Street, the answer is obvious. In the first place, they see Bear’s investors as risk-takers who deserve to bear the brunt of the collapse of the company. The enormous trading volume on Friday suggests that many of the investors of those currently holding shares of Bear Stearns bought the stock after news of trouble spread last week.

What’s more, the deal is seen as an important effort to stop a ripple effect from bringing down other financial institutions. It extends the guarantee of JP Morgan over Bear Stearns’s trading positions, giving Bear clients and counterparties the reassurance of a backstop in JP Morgan’s balance sheet. The Fed was desperate to avoid a bankruptcy, according to many reports, and actively encouraged Bear Stearns to accept this deal. In a statement, Bear Stearns Chief Executive Alan Schwartz said the deal "represents the best outcome for all of our constituencies based upon the current circumstances."

That’s a strange way of looking at a deal for a Delaware company, Gordon Smith points out. After the jump, find out why.

There are gray storm clouds hanging over Wall Street this February but Merrill Lynch’s Greg Fleming appears to be weathering the storm. The Securities and Exchange Commission has initiated a formal investigation into whether the brokerage knew more than it revealed to shareholders about the value of its subprime investments prior to announcing the giant write-downs with its third-quarter results. Federal prosecutors have opened a preliminary investigation, leading to speculation that criminal charges could possibly brought against some Merrill executives. But sources at Merrill Lynch say Fleming, who continues in his role as president of the bank after the losses forced the departures of a co-president and the chief executive, was not involved in the businesses reportedly being scrutinized and they do not expect him to be a subject of the investigation.

Wall Street abounds with speculation that Greg Fleming, who has managed to hold on to his position as sole president of Merrill Lynch through a whirlwind of management changes, might finally be facing a challenge that could shake him out of his elevated position.

Fleming’s presidency has endured the worst losses in the history of Merrill, internal criticism, and alleged pressure from newly minted chief executive John Thain. Although the Justice Department’s investigation is in its earliest stage, rumors are already spreading, both within and outside of Merrill, that the threat of a criminal investigation might bring Fleming down.

The rule that all business failures become criminal matters is bearing out in the subprime mess. Yesterday we learned of an FBI probe. (Gary Weiss expertly dissects it over on Portfolio.) This morning we learned that New York Attorney General Andrew Cuomo’s office is considering employing the ancient and dreaded Martin Act against Wall Street.

What makes the state law so powerful is that its broad definition of securities fraud doesn’t require a prosecutors to prove intent. It was a favorite weapon of Loathsome Eliot Spitzer when he held the AG’s office. Now Cuomo is looking to use it to show fraud in the packaging of mortgage bonds and derivatives, according to the Wall Street Journal.

“The attorney general's office has issued Martin Act subpoenas, which don't spell out whether matters are civil or criminal in nature, according to people familiar with the matter. So far, the recipients include financial firms Bear Stearns Cos., Deutsche Bank AG, Morgan Stanley, Merrill Lynch & Co., and Lehman Brothers Holdings Inc., possibly among others,” the Journal said.

“When they start using the Martin Act, you don’t run, you don’t hide, you don’t fight. You settle early, and often,” a veteran of an earlier round of Martin Act subpoenas told us.

These investigations can have serious costs for the target banks. Management gets distracted, legal costs skyrocket and settlements usually involve heavy fines. What’s more, the AG office can be much more difficult to deal with than the SEC, and it is much less predictable. Perhaps even more than the SEC, federal prosecutor and FBI investigations, this could spell serious trouble for Wall Street.

State Subprime Probe Takes a New Tack [Wall Street Journal]

So who is on this list of 14 companies under investigation by the FBI for their involvement in the subprime mortgage crisis? The FBI apparently intends to keep us in suspense because they won’t give details. All we know is that they are looking into “allegations of fraud at various stages of the mortgage process, from companies that bundled the loans into securities to the banks that ended up holding them.”

So let’s recklessly speculate. Two companies that are sure to be on the list are Bear Stearns—which is already under investigation by federal prosecutors and the SEC—and Countrywide, which is both the biggest home loan lender and also facing an SEC inquiry. Goldman Sachs is very likely on the list. It was accused on the pages of the Sunday New York Times of misleading clients by packaging CDOs while shorting the mortgage market. We know that at least one Senator read the article and has been making a stink, and we know that federal investigators often get their leads by reading the paper. What’s more, Goldman Sachs has said that it is cooperating with an unnamed government agency.

Morgan Stanley has also admitted to cooperating with unnamed government authorities. At first, everyone assumed this was the SEC. But why wouldn’t they come out and say that? More likely they declined to name the agency out of fear that saying they were cooperating with the FBI would tar them with serious criminality—rather than the everyday Wall Street shenanigans implied by an SEC investigation.

So that gives us four good leads. Who else is a cylon on the list? No doubt some additional mortgage companies and some home builders. Maybe the ratings agencies are also. Leave your guesses in the comments section below.

FBI Launches Subprime Probe [Wall Street Journal]

The Supreme Court’s decision in the case known as Stoneridge is probably one of important securities law rulings in years. The ruling today declared that fraud claims brought under federal securities laws are not allowed against third parties—investment bankers, vendors, accountants, lawyers—that did not mislead investors but did business with companies that did. Already self-styled shareholder advocates are crying foul, declaring that the decision is a major blow to shareholder rights.

We’ll leave the technical legal questions aside for now. (But watch for a round-up of reactions later today.) For now let us simply say that as a policy matter, the scheme liability claim that trial lawyers urged the courts to adopt promised to be a disaster for shareholders. Although securities fraud from misleading company statements can be highly damaging to individuals with concentrated holdings in fraudulent companies, these individuals are rare. The broader investing public is far more diversified, and this type of fraud rarely damages diversified investors. Over time, a diversified investors gains and losses from misstatements tend to balance each other.

Think about it this way. A diversified investor has an even chance of being a buyer or a seller of shares in a company whose price is inflated due to fraud. In some transactions, the investor will buy stock at fraud-inflated prices. In others, he will sell stock at fraud-inflated prices. Over time, these gains and losses tend to cancel each other out.

While an overall reduction of fraud would benefit investors, it’s unlikely that scheme liability for third-parties would have this effect. But the cost of avoiding or insuring against scheme liability could be enormous. In short, the scheme liability theory rejected by the court today would have been a huge dead-weight cost on business profits—and therefore on returns to investors. Far from ruling against shareholder interests, the Supreme Court today handed investors an enormous victory against special interests and trial lawyers.

Earlier on DealBreaker: Stoneridge discussed.

Breaking: The Supreme Court ruled against scheme liability in the closely watched Stoneridge case. The result is a blow to self-styled shareholder advocates and their friends in the plaintiff's bar but ultimately a win for actual shareholders who faced losses from a potential litigations explosion under the scheme liability theory. Here and hear (heh) are two early reports from DealBreaker on the case.

What's "scheme liability?" It was the idea that third parties could be held liable for securities fraud committed by companies with whom they do business. This would have made investment bankers, accountants law firms and suppliers liable for fraud committed by their public company clients. Today's decision greatly curbs this risk.

We'll probably have more to say on this once we've properly digested the opinions.

Update: The Associated Press tags the story with a stupidly misleading headline: "Court Rules Against Investors." Hey, AP, pay attention: not all investors were on the side of the plaintiff's bar in this case that threatened to let shareholders of companies that misstate earnings and commit fraud raid the treasuries of other companies that did business with them.

Shareholder Suits Against Vendors, Banks Limited by High Court [Bloomberg]

How long did you think it would take? Business headlines always wind up in the office of a prosecutor. And so, this morning we learn that New York Attorney General Andrew Cuomo is st\arting a probe of Wall Street firms and their roles in the sub-prime mess.

Wall Street Firms Are Subpoenaed [Wall Street Journal]

We noted in yesterday’s Opening Bell that Amaranth had filed a lawsuit against JP Morgan, claiming the bank undermined its efforts to stave off collapse. We’re late to the details of the lawsuit because we were overtaken by events yesterday but we’ve now had a chance to review the lawsuit.

Amaranth’s main claim is that JP Morgan interfered with Amaranth’s negotiations with Goldman Sachs and Citidel, forcing Amaranth to cut a more expensive deal with JP Morgan. According to Amaranth’s lawsuit, Goldman had agreed to take over its money-losing positions in the natural gas market for a $1.85 billion payment from Amaranth. But JP Morgan, which as acting as the hedge fund’s clearing broker, refused to execute the transaction and Goldman walked. The suit also claims that Citadel initially to assume the positions $1.85 billion but the JP Morgan executives talked Citadel out of it, according the lawsuit.

With nowhere else to turn, Amaranth ended up selling its positions to JP Morgan—which took them over in exchange for a $2.5 billion payment.

JP Morgan is denying any wrong doing, of course, and calls the lawsuit “baseless.” But there have long been questions about the many roles JP Morgan played in the collapse of Amaranth. At the very least, JP Morgan’s role as Amaranth’s broker gave it insider knowledge of Amaranth’s trading strategies—which may have allowed its traders better access to information than some of the outside bidders. In the months after Amaranth’s collapse, several top energy traders were left the bank under somewhat murky circumstances. And from what we know about lawsuits, this may well be just the start of things. Amaranth could use this lawsuit to start a discovery process that would include depositions of JP Morgan executives and review of internal documents in hopes of uncovering even broader wrong-doing.

Amaranth’s Dream-Team Law Firm: Beck, Webb & Boies [LawBlog]
Amaranth's lawsuit [Wall Street Journal]
Amaranth's letter to investors regarding the lawsuit [Wall Street Journal]
Amaranth Sues JPMorgan for Disrupting Transactions [Bloomberg]

The lawyers for admitted sex-offender Jeffrey Epstein are girding their loins for the flood of lawsuits they expect from young women who may claim to have been victimized by Epstein in his pursuit of erotically charged massages. First things first: make sure you tag the girls as little junkie sluts who are just out for a dollar.

"You are a girl who is broke who uses drugs. Here's your shot at getting some money," one source tells Page Six.

Now admittedly, when a guy as rich as Epstein is rumored to be lands in trouble, there will definitely be con-artists and frauds who will seek a fast buck by alleging to be victims. As a girl we know likes to say, "Shit on yourself for long enough, and the flies will start to notice." But the lawyers don’t just expect suits from random buck-seekers. Apparently they’ve identified quite a few girls—forty according to Page Six—who they expect could “come forward.” Some of these girls didn’t even give Epstein a rub down—but they were in his house, apparently.

It seems Epstein’s lawyers have given up trying to save their client’s reputation. Now it’s just about trying to save his cash. Because if they cared about his reputation, they might not want to emphasize how many random girls, possibly drug addicts, who just happened to be wandering around Epstein’s house at any given moment.

But then again, we’ve never hung out with Epstein so maybe this is just standard in his circle. No biggie. Really. Who doesn’t have random strung-out teenagers over for lunch regularly?

The lawyers are also reportedly establishing some sort of claims fund, a lump sum settlement to pay off all the alleged victims of Epstein’s massage habit. Which makes us feel kind of bad for the settlement fund, Oh, settlement fund! How far you have fallen. From smoking suits across the country to this low-state. Don’t worry, settlement fund. Their will be better days.

Sex Case Victims Lining Up [Page Six]

We’ve allowed our concern over the possible fate of shareholder proxy access rules to take a back seat over the last couple of days to our following the Stoneridge case. You know, the one about whether shareholders of one company can bring a securities law fraud case against another company on the theory of"scheme liability.” Today is no different.

So just in case your obsessions track ours, we’ll speed things up for you with a host of links to some of the relevant commentary.

• Jonathan Alder on the Volokh conspiracy explains why everyone is paying attention to this little case about cable set-top boxes. “A decision for the petitioners (the plaintiff shareholders) could ease the way for lawsuits against bankers, accountants, and perhaps even lawyers who provide services to firms that misstate their earnings or otherwise defraud their investors,” he writes.

• “As the Court concluded an hourlong hearing in a vitally important securities case, there seemed hardly a chance — even a remote one — that federal law against stock fraud would be read to give investors a significant new tool to go after stock fraud themselves,” the Scotus blog writes.

• Law Professor Stephen Bainbridge has no fewer than four posts on Stoneridge up and seems to be generating new ones every time we look. Just go to his main business associations page and start reading.

• Larry Ribstein thinks this might not be a total victory for the defendants and those worried about corporate liability to a new type of shareholder suit. He’s betting the Supreme Court will “deny liability in this case but throw some bone to the plaintiffs to resurrect some form of aiding and abetting liability in some future case with incredibly strong allegations.”

• If you’re still with us at this point, then you’ll probably want to read the pdf transcript of the oral arguments. Because you’re a shareholder rights or corporate governance nerd. (Smile when you call yourself that.)

You knew this was coming. Apparently US prosecutors are investigating the two failed Bear Stearns hedge funds. The U.S. attorney in Brooklyn requested that Bear Stearns turn over information on the two failed funds hedge funds, whose failure cost investors $1.6 billion, said these people. This is just the beginning of course, no one has been subpoenaed. Yet.

While the Bear funds certainly made colossal mistakes, nothing we’ve heard so far has indicated criminality. Of course, creative prosecutors have found ways to criminalize business failure in the past, so don’t dismiss this investigation too quickly. There are people in jail right now who never could have known that what they were doing would be considerable a criminal offense by the courts.

Some will no doubt be happy that the guys who lost all that money may face criminal charges someday. But the less vengeful of us might want to think twice about enjoying the another instance of regulating finance through criminal prosecutions. How well has that been working out?

One thing is for certain: this will be red meat for shareholder plaintiff’s lawyers, who will seize upon the criminal investigation as a chance to file complaints about Bear Stearns. And, of course, hope to collect fees from an eventual settlement.

None of this is really surprising. But if we were slightly less hungover today, we might muster a bit more outrage over this.

Prosecutors Begin Probe of Bear Funds [Wall Street Journal]

Piranhas are nasty little fish known for their sharp teeth and an aggressive appetite for meat and flesh. And today the Commodity Futures Trading Commission announced that it had hooked one of the little buggers.

In a case first brought by the the CFTC in May, a federal court in California has fined Robert Joseph Beasley and his firm, Longboat Global Funds Management, for committing fraud by misrepresenting certain investments held by his commodity pool, Piranha Capital. The CFTC claimed the defendants had Piranha Capital loan $4 million to other Beasley controlled entities without letting investors know that Beasley was running them. They say Beasley misled investors about the security of the loans, and then didn’t collect interest or principal on them. He then allegedly used the value of the unpaid interest payment to calculate his fees. Nice work if you can get it. And not get caught.

The order imposes restitution totaling $13.8 million, of which Beasley is responsible for $4.5 million. The order also requires Beasley to pay a $500,000 civil monetary penalty and Longboat to pay a $1 million penalty.

“One has to wonder about a firm that names itself after a flesh eating fish,” the hedge fund newsletter FinAlertnatives quips.

CFTC Press Release [CFTC]
CFTC Fines ‘Fishy’ Hedge Fund Firm For Fraud [FinAlternatives]

It looks like Brian Hunter is getting his way. Yesterday his lawyers asked a federal court to block an energy regulator, the Federal Energy Regulatory Commission, from filing a lawsuit against him on the grounds that it was infringing on the jurisdiction of another regulator, the Commodity Futures Trading Commission. This morning the CFTC responded by filing a civil enforcement action against him and Amaranth Advisors.

Our favorite hedge fund newsletter, FinAlternatives, nicely points out the irony.

Hunter and his lawyers may now regret the vigorous defense of the CFTC’s right to bring such charges they put on in court yesterday and in court filings on Monday. During those proceedings, Hunter’s attorneys argued that the Federal Energy Regulatory Commission did not have the authority to bring civil charges against him, as it had said it intended to do. The CFTC and FERC collaborated on the Amaranth investigation.

“FERC is not [emphasis in original] statutorily authorized to regulate futures markets for energy commodities, which include natural gas futures contracts,” Hunter’s lawyers wrote in their complaint against FERC. “FERC’s assertion of jurisdiction to bring an enforcement action is an impermissible encroachment on the exclusive statutory jurisdiction of the CFTC, and is beyond the scope of FERC’s statutory authority to regulate wholesale energy markets.”

A similar lawsuit from FERC is expected to be announced later today.

Amaranth, Hunter Hit With Market Manipulation Charges [FinAlternatives (free registration required)]
Complaint Against Amaranth Advisors and Brian Hunter [pdf]

Mariane Pearl (pictured), famous for reenacting events in Angelina Jolie's films, is suing Pakistan's largest bank for funding an "Islamic charity" allegedly connected to her husband's death.

Habib Bank maintained accounts for Al Rashid Trust, which is considered the United Way for terrorists, ensuring every cave ("command center") has a set of unoxidized monkey bars and improving bomb manual literacy one terror cell at a time. The Trust is accused of serving as a front for funneling money to terrorists and Daniel Pearl’s body was found on a member of the “charity’s” property (maybe it was an after-school honor killing program?). The bank allegedly knew about all this, hence the lawsuit (it’s the “knowing” part that nabs you in U.S. law, presumably).

Pakistani officials are still giggling that the West doesn’t realize that "Islamic charity" means a tax free haven for funding terrorist groups. Some details about the case, from the Wall Street Journal:

The Pearl case was filed by the plaintiffs firm Motley Rice of Mount Pleasant, S.C., which is also pursuing a host of Middle Eastern banks and companies on behalf of the victims of the Sept. 11 attacks. In that case, which is moving slowly through the same judicial district, several prominent defendants including some major banks have been dismissed from the litigation. U.S. law bans knowingly providing "material support" to terrorist groups and also permits terrorism victims to bring civil suits on similar grounds.

As we learned with the Swiss, it is tough to prove (and by prove we mean do anything about) that a bank is complicit in “knowingly supporting” its client’s actions, especially with the flimsy long arm of prosecuting international corporate entities.

Daniel Pearl's Widow Sues Pakistan's Largest Bank [Wall Street Journal]

We got so caught up in the excitement over the board of directors, Bancroft family, Rupert Murdoch, News Corp drama that we’d totally forgotten about the insider trading angle to this story. But fortunately we have the Securities and Exchange Commission to remind us that prior to the public learning of the deal, a Hong Kong couple with ties to Dow Board member David Li, chief executive and chairman of the Bank of East Asia, allegedly engaged in insider trading.

According to published reports, the SEC has issued a Wells Notice to Li, informing him that it plans on filing civil charges against him.

For those of you who have never gotten one—a Wells notice is a sort of like a bill from the utility company stamped Final Notice. Except that instead of shutting off your electricity, if you don’t respond to the notice you wind up getting sued by the SEC. It’s basically your last chance to convince them that they shouldn’t file a lawsuit against you. Or, as a friend of ours once put it, it’s a notice that it’s time to move your funds off-shore, get out of the country and hire some very good lawyers.

SEC to File Civil Charges Against Dow Jones Director [Wall Street Journal]

The federal judge in the tax shelter case against former KPMG executives dismissed the charges against 13 of the defendants. In a 64-page opinion, Judge Lewis Kaplan wrote that he had “reached this conclusion only after pursuing every alternative short of dismissal and only with the greatest reluctance.”

A little over a year ago, Kaplan issued a stunning indictment of the conduct of the federal prosecutors in the case. He found that the prosecutors had violated the due process rights of the accused by pressuring KPMG not to pay for the legal defense of its employees. "Those who commit crimes - regardless of whether they wear white or blue collars - must be brought to justice. The government, however, has let its zeal get in the way of its judgment. It has violated the Constitution it is sworn to defend," Kaplan said in his written opinion last June.

Charges against three KPMG defendants—Robert Pfaff, John Larson and David Greenberg, all former senior tax advisers at KPMG—still stand, as do the charges against a lawyer and an investment adviser who were not employed by KPMG. The judge said Pfaff, Larson and Greenberg had not proven that KPMG would have paid their defense costs. The lawyer and the investment adviser were outside advisers not KPMG employees at the time, and so KPMG would not have paid for their defense in any case.

The case arose out of the accounting scandals of the late nineties. The defendants were accused of creating tax shelters that allowed clients to avoid billions of dollars in taxes. Because the case has been sullied by prosecutorial misconduct, no legal judgment has ever been rendered on the legality of the shelters.

In a strange twist, last month the prosecutors requested a dismissal of the case. It is widely believed that the prosecutors sought the dismissal so that they could appeal Kaplan’s earlier rulings against the high-pressure tactics they had employed against the defendants and KPMG. As the New York Times puts it: “Prosecutors, in court filings a couple of weeks ago, had essentially dared Judge Kaplan to do what he did today. At the time, the move was seen as an effort by prosecutors to get the case moving again.”

Charges Dropped in KPMG Tax Case [New York Times]
Judge Dismisses Charges Against 13 in KPMG Case [Wall Street Journal]