Wednesday, July 9, 2008

More on Einhorn

"Einhorn spent the next six years investigating Allied, uncovering more accounting problems and presenting his findings to the SEC. Instead of cracking down on Allied, however, the SEC and then-New York attorney General Eliot Spitzer decided to investigate Einhorn, on the basis of Allied's allegations of stock-price manipulation (an investigation that has since been dropped). The experience left Einhorn convinced that somewhere along the line, securities regulators stopped doing their jobs. As his book tells it, the SEC has become accustomed to prosecuting fraud only after companies have already imploded and the money is gone; but when it discovers fraud in progress, it is hesitant to act. ... Einhorn [said] 'Unfortunately, the regulatory regime we have now represents the worst of both world: "There's the appearance of protecting the people, but in fact people are not actually protected".' ... 'The topic of the book is a lack of law enforcement,' he says. 'Someone breaks the law: Are we going to penalize them for breaking the law or are we going to decide that it's OK?' Fixing the problems in out financial markets 'would not require any act of Congress, would not require any rulemaking by any agency. It would require a different philosophy toward dealing with rules that currently exist.'", Stephen Spruiell (SS) at, 23 June 2008.

"Yet there turned out to be a crucial difference: Einhorn was actually doing something about it, betting that the gig would soon be up at Bear and Lehman by selling the shares short. ... But in the case of Lehman Bros., Einhorn engaged in a riveting public relations campaign to goad the firm into confessing its short-comings. In mid-June, it more or less did. ... After Lehman weathered the Bear scare, Einhorn began to speak out. ... For weeks, Lehman battled Einhorn's assertions. Some of the Wall Street analysts who follow the firm dismissed him as a half-informed dabbler. Then Lehman disclosed that it had lost $2.8 billion in the second quarter. ... Chief Executive Richard Fuld got on the company public-address system and declared, 'Einhorn didn't lose us $2.8 billion. We lost it.' ... But nobody else--not the SEC, not the Fed, not the analysts, not investors, not Lehman's board--was putting public pressure on the firm's executives to come clean", Justin Fox (JF) at Time, 30 June 2008.

The SEC's problems include: employing economically ignorant and innumerate lawyers, SEC employees' private interests frequently are adverse to the public interest and many SEC staffers are mediocre and cannot apply concepts like "substance over form" and various accounting rules. They are like first-year Big 87654 staff accountants, strictly "check the box" guys. The SEC has operated the way Einhorn decries since Einhorn was in kindergarten. To change the SEC's modus operandi, you much change the SEC staffers' incentives. Prohibit any SEC attorney from working for any law firm which has represented any SEC registrant in any securities matter for five years. What? This might make say Chris Cox form his own plaintiffs' law firm after leaving the SEC. Such rule would have kept Harvey Pitt out of Fried, Frank, Harris, et. al. The SEC is like the US State Department, full of Saudi apologists looking for a big payoff after they leave State.

JF asks, "How in the world did a hedge-fund manager become our top crusader for financial probity?" Easy, JF, Einhorn has a personal financial interest in it, unlike say an SEC or DOJ staffer looking for a sinecure when going into industry.


Danny said...

Have you read Einhorn's book? It's worth your time. Fits into the libertarian/mises view that I think you might follow based on your blogroll and your comments. It's amazing that people don't see shortsellers as the best regulators out there!

I am going to have to stop by your site more often, you and I frequent many of the same blogs.

Independent Accountant said...

You are correct, I am a Misean, having read 17 of von Mises books. I've also read: Hayek, Rothbard, Bohm-Bahwerk, O'Driscoll and other Austrians.
I will read Einhorn's book sooner or later. You might want to read some of my posts like "31 Years of Failure" to see how regulation has failed in the CPA industry. I mention the Ray Dirks fiasco a few times at this blog. The SEC's refusal to do anything effective to punish miscreants is an old story.
What kind of business are you in?