Federal prosecutors are preparing to file criminal charges against managers of two Bear Stearns hedge funds that collapsed at the dawn of the credit crisis last year. Although it's being described as the conclusion of a year long investigation, it seems very likely that Ralph Cioffi and Matthew Tannin there wouldn't be facing criminal charges if Bear Stearns hadn't collapsed.

"Of course what's really happening here is that the hedge fund managers are taking the fall for the collapse of Bear, and the even broader reverberations from that, including the controversial merger, the bailout and the credit markets' woe," law professor Larry Ribstein writes. "As with Enron, the public is screaming for action. When in doubt, throw somebody in jail. The public will eventually calm down, by which time the now impoverished defendants will be in jail or being exonerated on appeal."

We wonder if the urge to prosecute doesn't arise from an unrealistic confidence in markets. Regulators and prosecutors believe that preserving investor confidence is their mandate. Massive losses due to innocent if colossal errors about market directions undermine market confidence but there's little a government official can do about that. If your goal is restoring investor confidence, you're extra-motivated to find criminal wrong-doing and fraud because you can reassure investors that their losses are do to bad apples rather than risk inherent in the markets.

The Enronization of Bear [Ideoblog]

You'd think that if we've learned anything from the past few waves of financial crisis, we'd have learned that shorts sellers play an important role in financial markets.

Shorts can check otherwise unbridled financial enthusiasm, improve price discovery and have often pointed out accounting chicanery at powerful public companies. Shareholders and management are incentivized to overlook or cover-up problems. They want stocks to go up. Regulators often lack institutional incentives to investigate wrong-doing.

But shorts, like John Paulson of Paulson & Company or Jim Chanos of Kynikos Associates, can make fortunes by uncovering hidden problems. In short (sorry), they are providing the market with a valuable service--let's call them positive externalities--all while pursuing profit.

Nonetheless, we haven't learned this lesson at all. Today the Financial Times reported that the UK securities regulator, the FSA, is going to impose new disclosure rules on short sellers who take positions on the shares of companies undertaking new share issuances.

We've often complained that regulatory generals are constantly fighting the last war. Following the accounting scandals that led to the collapse of Enron, we got Sarbanes-Oxley. And fear about hedge funds following the collapse of Long Term Capital Management led to calls to regulate hedge funds.

All the while, real systemic threats to our economy and financial system were being built right into the American dream by mortgage companies, commercial banks and investment banks. Our homes are now our hassles, and none of the sound and fury from the SEC, the Fed or Capitol Hill about financial regulation raised a peep about it until it was too late.

But what if this focus on regulations aimed at the last crisis is misplaced? That is, what if it basically isn't possible to regulate away the threats to our financial system because the rewards for risky behavior are just too great. After the jump, some thoughts from Graeme Yell of the Hay Group

Carl Icahn got the go ahead from the Federal Trade Commission to scoop up huge amounts of Yahoo stock. Icahn owns around 10 million Yahoo shares now, and has options to acquire another 49 million. He said he's seeking clearance from the FTC to buy up to $2.5 billion of the stock.

In our not-so-free market, you need the FTC's approval to make stock purchases worth $63 million or more.

In other news, we just noticed that Jerry Yang and Steve Ballmer apparently played golf together last weekend. They may or may not have chatted about a deal but probably not the straight-up acquisition that Icahn wants. Icahn, of course, hates executives who play golf. Is there any chance that Ballmer and Yang arranged the meeting over golf to piss off Icahn?

Icahn gets antitrust go-ahead for Yahoo stock buy [Yahoo--heh]

Opponents of hedge fund regulation scored a win yesterday when California backed away from its plans to regulate hedge funds. Since the registration of hedge funds with the Securities and Exchange Commission was over-turned by the federal courts, several states have considered enacting their own regulatory schemes. Such moves have typically been opposed by the hedge fund industry, which has recently become active in federal and state lobbying efforts.

“California withdrew its proposal this month after many hedge fund industry officials suggested the lightly regulated investment funds could move to another state if California started regulating them,” DealBook reported this morning.

California is thought to have the largest concentration of hedge funds outside of New York, Connecticut and the Dallas area. California’s high-concentration of wealth and agreeable climate make the state very attractive to fund managers. But faced with the threat of extensive regulation, many could choose to relocate to states less prone to regulation.

“Yes, and they would take with them all those huge houses, big cars and taxes paid by hedge fund managers,” law professor Larry Ribstein explains. “California is used to having its regulatory way because many firms can’t avoid its market. But hedge funds can operate just fine without California.”

California’s surrender on hedge fund regulation nicely illustrates how federalism forces states to compete with each other, and can check excessive regulation. This is sometimes decried by critics of federalism as a “race to the bottom” but there’s little evidence to suggest that states are forced to lower regulatory levels on investment managers to below optimum levels. If investors desired more hedge fund regulation, hedge funds would have financial incentives to locate in states with greater regulations. Hedge fund investors, however, seem to doubt that they would benefit from new regulations that go beyond traditional legal strictures against things like theft and fraud.

California Drops Hedge Fund Proposal [DealBook]
Hedge funds and jurisdictional competition [Ideoblog]

Yesterday a cameraman for the Free Press caught two members of the audience napping during an FCC hearing on net neutrality at Harvard Law School. Now we don’t blame them for snoozing through a meeting about net neutrality—our eyes glaze over just thinking about it—but it does raise the question: why would you go to an FCC hearing if you are bored by that type of thing?

Portfolio’s Sam Gustin has answered the question: they were there because cable giant Comcast paid them to be there. Comcast had planned to pack the meeting with its local employees, and had paid some people off the street to show-up early and hold places in the line for the employees.

“Some of those placeholders, however, did more than wait in line: they filled many of the seats at the meeting, according to eyewitnesses,” Gustin reports. “As a result, scores of Comcast critics and other members of the public were denied entry because the room filled up well before the beginning of the hearing.”

Money can't buy you love, but it can buy you napping bodies to keep your critics at bay.

Comcast Astroturfs the Old-Fashioned Way [Portfolio.com]

We’ve been on a bit of a tear today about the politics of regulation. So why quit when we’re having so much fun with it? As we noted today, calls for additional regulation often depend on a double standard under which market process are characterized by imperfect information and dominated by self-interest while regulatory processes are somehow viewed as well-informed and public-minded. Why are people so attracted to regulatory solutions when despite the lack of evidence for concrete benefits?

David Hirshleifer has a delightful paper that sees through one prominent anti-market double standard and suggests an answer—several in fact—about why regulation is unduly attractive. His approach is simple. He points out that the findings of behavioral psychology—that people are often irrational, biased and ill-informed—apply to regulators as well as investors and consumers.

“The psychological attraction theory of regulation holds that regulation is the result of psychological biases on the part of political participants and regulators, and the evolution of regulatory ideologies that exploit these biases,” he writes.

The cumulative effect of these biases is overregulation. “[Since the universe of possible tempting regulations is unlimited, the theory predicts a general tendency for overregulation, and for rules to accrete over time like barnacles, impeding economic progress. The theory also predicts occasional drastic increases in regulation in response to market downturns or disruption.”

You can download the paper here. (Hat tip to Ribstein.)

The first time we heard the term market failure we assumed the term referred to the occasional inability of market processes to withstand government interference. Later a good friend who was majoring in economics explained to us that this was not the standard understanding of the term. It was another case of our own conceptual dyslexia, where we learn last the simple things and never quite grasp by instinct what strikes everyone as obvious. But we’re stubborn and our initial impression has always colored the way we look at these things.

So the same thing happened later when someone used the term “systemic risk” in a discussion of hedge funds. We assumed they were talking about the risk posed to alternative investments by busybody regulators hungry for campaign donations. It turns out that the systemic risk wasn’t to hedge funds at all—it was a risk allegedly created by hedge funds to everyone else. Who would have thunk it?

We’re still not sure we had it wrong. With many hedge funds having been brutalized by the credit markets in recent months, it does seem that we were at least half right. The systemic risk in the financial system wasn’t being created by hedge funds, it was being absorbed by them. Without a doubt, their appetite for risk may have added to overall risk in the market. The appetite for mortgage backed derivatives, for instance, surely contributed to the mortgage bubble.

[More after the jump.]

To their credit, lawmakers, regulators and the media have not yet begun to frame the story of the subprime mortgage mess in criminal terms. Forget Ben Stein because his antics have now made him forgettable. Even Gretchen Morgenson had to note in her Sunday column that the story of subprime profiteering was one of greed and not criminality. (Strangely, the entire Sunday Business section of the Times wasn't available online this morning.)

But the call for criminalization has already begun on the fringes and we wouldn't be surprised if before long we start hearing this from more mainstream publications. And if not criminalization, we expect the call for regulation to grow louder with each pasing day. It's a familiar dynamic, where market failure is addressed with regulation.

We're sometimes accused to have a knee-jerk reaction against regulation. This is unfair. Our problem seems to be a stubborn refusal to subscribe to the double standard that sees market failures and assumes available government solutions. But unless a plan for regulation addresses why the mechanisms and incentives proposed will result in effective regulation at acceptable costs, we think it best to avoid handing power over to government clerks.

Take the proposals to further regulate the ratings agencies. Sure they seem to have catastrophically failed to assess the risk in many credit products tied to mortgages. And, yes, they are rife with conflicts of interest. But we've heard precious little by way of practical solutions to these problems more detailed than abstract calls for "oversight" and "transparency." If wishing were a strategy, this would be enough. But the good intentions of those who see the market as an imperfect process is unlikely to transform the government into an effective institution.

There's a specter haunting these discussions, the specter of Sarbanes-Oxley. Our last round of financial scandal produced a clumsy and costly regulatory structure of unproven effectiveness. It would be a shame to repeat that mistake after this round of market failure.

One thing you can always count on is that as geographic scope of businesses and finance grow, someone will call for the harmonization of the relevant legal and regulatory structures. Roger Ehrenberg blasts that familiar horn today, calling for "common regulatory frameworks" in order to minimize regulatory arbitrage and cut down on the "immense friction [involved in] operating regulated businesses across markets due to different rules and standards.” Felix Salmon applauds him, and calls for even more of the same. Somehow this is meant to be a lesson from our current credit crisis.

This is a terrible idea. Competing, conflicting regulatory frameworks may not be as efficient as an ideally-designed comprehensive system but it avoids many of the mistakes and oversights of the kind of harmonized regulatory framework we are ever likely to get. The availability of exit and avoidance, experimentation and local checks on corruption and capture are under-rated sources of regulatory strength. A harmonized system with do away with the nimbleness we praised earlier, and there’s little reason to suspect we’d get a system better able to catch abuses, fraud, waste and errors than that we have now. Less abstractly, if none of the regulators saw our current credit crisis coming, how would having a common framework have helped them avoid it?

We wrote about this ages ago in the context of European takeover law, and what we said still applies: let a thousand regulatory regimes bloom.

What has the Credit Crisis Taught Us? [Information Arbitrage]
Dreaming of Regulatory Cooperation [Portfolio]

In the demonological pantheon of the subprime crisis orthodoxy, the deepest level of hell are reserved for unscrupulous lenders. Uncreditworthy borrowers live at a slightly higher plane, nearby unvigiliant regulators. But the cant and caterwauling of the orthodox overlooks that much of the world was focused on quite different concerns before the mortgage bills for the ownership society came due.

Despite our best efforts, we’re still cursed with a memory that reaches past this morning’s headlines. We cannot forget that the problem with the CDO market was supposed to be insider trading instead of the weakness of the underlying financial assets. And it was meant to be hedge funds that posed a systemic risk to the financial system rather than our venerable investment banks, money centers, trading houses and brokerages. The great accounting scandal was backdated stock options rather than marked-to-model financial products. In short, all the heat and light generated by our various guardians was aimed in the wrong direction.

Yet so strongly held was the belief in the old orthodoxy that, if you listen closely or read the New York Times business section on Sunday, you can still hear those who wonder whether or not insider trading or hedge fund manipulation is somehow behind our current troubles. There is not much evidence of this, as SEC Commissioner Paul Atkins pointed out recently.

“Although we and our counterparts in government are monitoring and looking into the origins of the events of the last year, it does not seem that hedge funds were the origin of the subprime problems,” Atkins said. If anything, some hedge funds and their investors seem to have been the first casualties of the current debacle rather than the causes.

We don’t mean this as a criticism of those guardians. Rather, it seems to us an indication that the actual risks in our innovative financial world are difficult to detect and that none of our journalistic and political institutions are particularly well-adapted to early detection. What we need is modesty in forward looking, crisis-avoiding regulations—often we may be aiming our resources where they are not needed, and diverting our attention from where they are. As the fellows at Goldman used to say, since we can’t tell where things are going, we’d best stay nimble. There’s a very good chance that once again the orthodoxy is hunting down imaginary demons.

The Treasury's Entity is seen as a Citigroup bailout by lot of people for the very simple reason that it is a Citigroup bailout. That might not be the only thing it is, but stupid is as stupid does, and one thing this stupid thing does (or will do, if it ever gets off the ground) is bailout Citigroup, which is reportedly on the hook for as much as $80 billion from it’s four mammoth SIVs. Since the fund could buy Citigroup's SIVs, it would reduce the amount that Citigroup would need to write off. And reducing write-offs is something Citi desperately wants to do right now.

There’s at least a fair amount of quiet clapping about the Treasury Department’s role in creating the Entity. Citigroup, some say, is too big to fail, and the Treasury Department should step in to prevent the kind of financial market disorder that would come from the toppling of the towering financial giant.

But this kind of logic has some rethinking the wisdom of the financial regulatory reforms that allowed banks such as Citi to grow so large in the first place. When lawmakers reformed depression era laws that stood in the way of these financial super-markets, they tended to sound libertarian notes about allowing financial innovation and the operation of the free market to control the size and scope of Wall Street firms. The era of government planning was over. So the Glass-Steagall Act of 1933, which had separated investment houses from commercial banks—most famously requiring JP Morgan to part from Morgan Stanley—was changed to permit the growth of the universal banks.

Many now think that the universal bank is a failed strategy. From Citi to Merrill to Bear Stearns, there are calls for Wall Street firms to slim down, break-up and concentrate on the core businesses that made them wealthy and famous to begin with. But was it a failure? If growing into financial giants allowed them to unilaterally acquire a secret—and nearly costless—government insurance policy, it seems like a great gamble. The executives and shareholders get the upside, while the broader public insures against failure.

“What a scam that is,” writes William Greider in The Nation.

And it’s a scam the Greider thinks is over. Banking regulation will inevitably make a big comeback, he predicts.

“At least the unambiguous truth about ‘financial modernization’ is now on the table for all to see,” he writes. “That should keep the Wall Street guys from whining for a while about the oppressive nature of bank regulation. The next reform era, when it does finally arrive, will head in the opposite direction--restoring public protections for the little guys against the greedy excesses of big hogs.”

What Greider doesn’t mention is that this era of new regulations might be coming too late. Or, rather, right on time, depending on your point of view. Resistance to a new wave of banking regulation requiring bank breakups and dividing Wall Street according to regulatory fiats rather than market demand is likely to be weak in an era when many think the financial supermarket model has failed and should be abandoned. No-one expends much time, money or energy defending a right to do something they don’t want to do anyway. What’s more, there will be plenty of money made by investment bankers spinning-off, selling and acquiring the fragments they are shoring up against the ruins of the toppled giants. Some of these people may actually be the same ones who made fortunes building the giants.

And we’ll all raise a glass to the only saloon in town where it’s never last call: the Wall Street punch bowl.

Citibank: Too Big to Fail? [The Nation]

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]

The resignation today of Attorney General Alberto Gonzales has ignited speculation about who might fill the top spot at the Justice Department. On Wall Street some are wondering whether the Gonzales’ resignation might help or hurt investment banks, brokerages and corporate America on a number of pending legal issues.

The Justice Department handles more than just the prosecutions of organized criminals, drug dealers and terrorists. It is also involved in law-enforcement in the finance community and corporate America. Chief among the legal issues that concern Wall Street is so-called ‘scheme-liability,’ where banks may be found guilty for assisting the corporate fraud of their clients. Wall Street is also concerned with other issues of institutional liability, for instance whether to prosecute an entire company or an individual when fraud is alleged by executives and employees. Wall Street firms are generally friendly towards insider trading prosecutions, except perhaps when prosecutors get zealously creative and go after financiers whose acts are not widely thought of as illegal.

Under Gonzales, the Justice Department has had a mixed record on Wall Street issues. Gonzales himself, a former corporate lawyer whose list of clients once included Enron, is viewed as having a generally pro-business outlook. Some critics, who asked not to be named for fear of political or legal retaliation, dispute this.

“He’s pro-successful business,” one critic said. “But if your company is in trouble, his Justice department made no bones about going after you.”

The Department has aggressively prosecuted the folks its lawyers like to call ‘wrong-doers,’ including accountants who helped clients develop aggressive tax-avoidance structures, executives involved in back-dating and a host of others involved in the business scandals of the late nineties and early part of this decade. Since Gonzales ran into trouble following revelations of the firing of several government lawyers, many have seen the department as “rudderless.”

“It’s been an asylum run by inmates,” said one court observer.

There is a widespread view on Wall Street that career government prosecutors tend to be more hostile to business than political appointees with more experience in the private sector. There is a fear that a “rudderless” Justice department will drift into a more aggressive current for prosecuting alleged wrong-doing by corporate executives and Wall Street financiers. The hope on Wall Street is that Gonzales’ replacement will be named quickly and come from a background that displays some sympathy for business.

Several names are being talked about as potential nominees. The Wall Street Journal’s Law Blog has a great rundown of the likely suspects. Whether this will be a boon or a bane for Wall Street firms will likely depend on who President George Bush appoints to replace Gonzales, and how quickly that appointment is made. As the day goes on, we’ll profile some of the leading candidates for the job.

Who Will Be Our Next Attorney General? [WSJ's Law Blog]

"Brian Hunter simply did not undertake any manipulative trading and we are going to prove it,” said Michael S. Kim. Kim is a partner at the Kobra Kai dojo Kobre & Kim lawfirm that advises Hunter’s new hedge fund, Solengo.

Earlier today the CFTC filed a lawsuit charging that Hunter, who was trading gas for Amaranth at the time, had illegally manipulated the natural gas futures market by exploiting the New York Mercantile Exchange’s rules for determining the settlement price on futures contracts. Prices for futures contracts are set according to the volume-weighted averages of trades executed during between 2:00 p.m. and 2:30 p.m. on the last day of trading for each contract, a period known as the “closing range.”

According to the CFTC’s lawsuit, Hunter attempted to push the price of the futures contracts down by dumping large amounts of the contracts into the closing range. The complaint states that Amaranth traders would buy up large amounts of gas contracts prior to the closing range, then dump them in order to depress prices. Amaranth wanted lower prices because it held a huge short position in the contracts, the CFTC report alleges.

Hunter’s lawyers say that the contention that Amaranth desired lower prices prices is contradicted by a recent report from the Senate Permanent Subcommittee on Investigations, which they say concluded that Amaranth sought rises in natural gas futures prices.

“None of these various government bodies can come up with a consistent theory of Mr. Hunter’s alleged misconduct because in fact there was no misconduct” said Mr. Kim, “These accusations from the CFTC and the FERC against Brian Hunter are aimed at finding a scapegoat to bear the public outrage over ever-increasing energy prices. We will not stand idly by as the regulators use Brian for political cover, their action is meritless and we will prove it.”

After our review of confidential trading documents, which you may download here,* DealBreaker has concluded that Brian Hunter should tell us whether he wanted to inflate or deflate the prices in the gas futures markets while he was making these trades. Pointing out that the government is confused, inconsistent and probably abusing its power is a bit like pointing out that the Pope is Catholic. That’s what governments do.

But just because the government is out to get you, doesn’t mean you didn’t do anything wrong. So come on, Brian, give up the goods. Was Amaranth after a higher or a lower price?

*We're totally kidding about those confidential documents. Sorry.

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]

Securities regulators will review the $11 billion distribution and service fees charged by many mutual funds. Yesterday the Securities and Exchange Commission said it will hold a roundtable discussion on June 19 to discuss the fees.

Often referred to as “12b-1 fees” after the Investment Company Act rule that allows them, the fees were instituted in 1980 as a temporary measure to compensate fund managers for the costs of marketing the fees and attracting new investment. The idea was that mutual fund investors would benefit from economies of scale if fund managers could use part of the fund assets to build larger funds.

Now the fees have become a regular part of the mutual fund business, with even some closed-end funds—which are closed to new investment dollars—charging 12b-1 fees. SEC Commissioner Chris Cox says that the fees need to be reviewed because their use has departed widely from the original purpose.

"When the Commission adopted Rule 12b-1 more than a quarter century ago, the idea was that 12b-1 fees would be a temporary solution to address specific distribution problems, as they arose. But today's uses of 12b-1 fees have strayed from the original purposes underlying the rule, and it is time for a thorough re-evaluation," said SEC Chairman Christopher Cox.

After the jump, read the full SEC release regarding the fees.

Four Ernst & Young partners were indicted today for allegedly creating illegal tax shelters for the firms wealthiest clients. At the same time prosecutors announced it would not bring charges against the accounting firm.

The four worked in a group Ernst & Young set up in 1998 to create tax shelters for clients making more than $10 million per year. At first it sported the color name Viper, which officially stood for Value Ideas Produce Extraordinary Results. At some point someone seems to have thought snakes in the accounting firm was not the best idea and the name was changed. But the goal of helping clients minimize taxes remained.

The accounting firm may have helped its clients create more than $7.56 billion in tax deductions, according to the business reporters at ABC News. The firm collected a fee of between 1.25% and 2% for ever dollar of tax deduction created, for a total of more than $115.7 million, according to the indictment.

The indictments come after a long investigation that stems back to the plethora of tax shelters that were big business for the accounting firms during the stock market rally of the late nineties. The decision not to charge Ernst & Young will likely be taken as a signal that the Justice Department is ratcheting down the investigations into the tax shelters of the last stock market boom. At one point it looked like law firms and investment banks might also be indicted. Declining to indict Ernst & Young may be a sign that the Justice Department is now aiming at the individuals involved with the allegedly abusive tax shelters rather than their employers.

At least one of those indicted today is not going quietly. A lawyer for Ernst & Young tax partner Richard Shapiro said today that his client was “disappointed that the Department of Justice and the United States Attorney’s Office have decided to go forward with the prosecution of an innocent man.” He went on to describe the charges against Shapiro as “baseless.”

Shapiro is a well known figure in tax circles. His views have been quoted widely in the press, and he has authored a booklet on taxes and investing.

How the Super Rich Avoided Taxes; Despite Making Millions [ABC News]

Ernst & Young Partners Charged in Tax Fraud [SmartMoney.com]

It is apparently still news to some that the Securities and Exchange commission is very deferential to the securities industry. This morning the Wall Street Journal reported that “the agency has been publicly and noisily pressured by a congressman, a union leader and a Democratic presidential candidate, amid increasing consternation the agency is favoring business interests in its decision making.”

The focal point for the attention is a Supreme Court case that will decide on whether shareholders can sue investment banks for the fraudulent activities of their clients. The question is whether the SEC will file a brief with the court supporting the plaintiffs position that investment banks can be held liable. Prominent (some would say, notorious) plaintiff’s lawyer Bill Lerach is lobbying the SEC to take the side arguing that banks can be sued. Merrill Lynch, which is a defendant in a class-action lawsuit filed by lawyers representing former Enron shareholders, asked the SEC to take the opposite side.

Both sides, of course, claim that their position best protects investors. The plaintiff bar claims that holding banks liable will make banks better police their clients and avoid aiding or even looking the other way when companies engage in fraud. The banks see this opening the flood gates to a torrent of lawsuits.

Who’s right? That’s probably entirely besides the point. These things are rarely, if ever, decided on the basis of wise policy.

[After the jump, we pull back the curtains on what really decides these kind of public policy issues. Hint: it's not a great and all-knowing wizard.]

There were 116 financial restatements in corporate public filings in 1997. Almost ten years later (2006), that number has grown over 15 fold to 1,876. Hank Paulson wants to know why. Paulson has ordered a Treasury study of restatements, their predominant causes, and effect on investors that will be headed by former SEC chairman Arthur Levitt and former SEC chief accountant Donald Nicolaisen.

The main reason restatements are thought to have increased so dramatically in number is because of tougher accounting oversight, and the fact that accounting firms have become increasingly aggressive in the face of so much exposure to litigation. Projected recommendations of the study include reducing the liability of public accountants and diluting the auditing industry so that it isn't as dominated by the same few firms.

A restatement explosion seems an odd justification for a major deregulatory push. This would assume that companies are not using dodgy accounting tricks to mask true performance and that financial restatements are somehow onerous to companies that misstate financials in the first place. One would think that tougher accounting rigor in audits followed by a spike in restatements is a sign that a lot of violations were going unnoticed, not that accouting firms are creating unnecessary restatements through nit-picking.

Treasury Targets Financial Fixes [Wall Street Journal]