Friday, September 25, 2009

Open letter to Ken Feinberg re: the purpose of compensation and its nexus to fiduciary duty

The guiding and ONLY principle in establishing a compensation policy for the financial services industry including securities, banks and insurance companies and entities like GE Capital should be priority then alignment of interests of parties thereto. It helps to begin and include the social, industry, entity, vendor levels for and on behalf of whom? The customer which in many cases includes beneficiaries of fiduciary accounts; trusts, IRAs, 401k and pension plans, eleemosynary organizations charities, non profits, foundations, endowments and homeowners associations.

Friday, September 25, 2009

Dear Mr Feinberg,

From the early 1980’s thru today my fiduciary expertise stems from deep analysis, design, supervision of a major securities firm's compensation plan and internal accounting policies including proprietary trading at the “firm” entity level through distribution by a financial adviser, then into the customer’s account. Profitability to the firm is implicit every step along the way until we recognize – THE CENTRAL QUESTION - where does the fiduciary duty to the customer begin? You might be interested to know that in the past some firms’, not all, trading desks were agency – not profit centers; but clearly that was the past.

Also not all derivatives nor entities which invest in them are "bad" (as one measure only, over 90% of FDIC insured institutions are NOT on the watch list) rather I focus my remarks on professionals at certain institutions including traders, managers, executives, boards, outside auditors and primary regulators which implicitly or overtly sanctioned massive leverage; compounded by the utter failure to diversify collateral; however this stands in stark contrast to the similarly massive cash bonus paydays enjoyed by same during the "hockey stick era."

As such I am keenly interested in your process as “Pay Czar”, upcoming proposals and potential clawbacks of previous cash compensation. In some instances, in addition to my comments to the NY Times see below (which the moderator did not post) there may be instances of past fraudulent “conversion” as detailed below but summed up here:

Proprietary asset valuation models and parties thereto had motivation to do what? Over mark assets, add significant leverage, such that leverage both blessed such marks and signaled other market participants that asset marks were fair and thereby caused the conversion of same into what? It appears that traders and related parties created and inflated a set of assets (one form of currency) (RMBS, CDO's, etc.) knowing their compensation was payable in what? CASH, legal tender. CASH Compensation; when other means and forms make for better alignment and are preferred – for instance, compensating traders in the currency of the particular asset or index based upon same.

Secondly – although “legal” as per the SEC’s April 2004 decision to permit CSE’s to use proprietary valuation models in determining minimum net capital, seems to have gone off track causing certain, not all, off balance sheet, special purpose entities’ proprietary traders to improperly mark assets. Only traders can know or feel liquidity at the position level especially when nearly all of the subject securities are / were ‘created, issued, traded and valued” where? In the privacy and privilege of darkness of certain over the counter markets.

Third – if banks, broker dealers’ charters of authority are based upon serving public customers’ interests FIRST then the existence of “proprietary” trading in ANY security or market seems contrary. Flash trading seems only the most recently revealed, publicized example; hijacking of information. Proposed solution – dislocate proprietary purposes from agency intent – many principal agent conflicts as relates to the public customer will be a thing of the past – so that public customers can have “reason” (firewalls or Chinese walls are ineffective, rather tangible organizational separation) may be the solid evidence, not just hope, to again reasonably believe, rely upon and repose their full faith and trust in the institution of the capital markets, Wall St, the entity and individual adviser in particular.

Four – CASH compensation resulted for traders, managers and executives yet what is the purpose of such off balance sheet special purpose entities; how were public customers or the public in general benefiting from such private arrangements. Among other considerations the UK minister's "socially useless" theory is applicable here.

Five – LEVERAGE – explicit and implicit leverage should (and should have been) be reported to a public, observable market clearing entity. Such reporting can be best done at the entity level through trade level – on a generic asset level basis; similar to some of the long used conventions used to mark retail customers’ option order tickets – opening, closing, long, short, cash or leveraged which attach to and remain with the trade as it clears in addition to certain CFTC trade reporting conventions; additional thoughts are too long to write here.

Six – LEVERAGE – in off balance sheet vehicles, special purpose entities seems to have caused an unmonitored “stealth” money supply enabled by proprietary traders’ inflated asset marks and valuations; that disease was then transmitted into the money markets including commercial paper, asset backed commercial paper and repo's.
(a cut and paste from the NY Fed website) -
Major Change to Outstanding Calculations (April 10, 2006)
On April 10, 2006, the Federal Reserve Board made major changes to its CP outstanding calculations.

Seven – extensive research from public records including AIG’s (and Travelers and Radian) 2003 (not a typo) to exit broker dealer excess SIPC, after 30 years of NEVER having paid out on a claim, a quote from the AIG, yes AIG spokesman “It’s too much exposure” yet at the same time AIG Financial Products Group was doing what? Underwriting more and larger credit default swaps and related counterparty insurance; we know now lacking adequate underwriting capacity. As to why the primary regulators including the NASD (now FINRA), the SEC or state securities administrators failed to inquire or investigate remains to be seen; with the essential inquiry being “what is ANY / NEW too much exposure?” The link to the NY Times article from August 9, 2003 is here:

Eight – subject to proof, certain broker dealer entities may have improperly benefited at public customers’ expense by shifting customers' monies from money market mutual funds into entities’ affiliated banks’ deposit accounts then “loaning” it out not to public, arm’s length third parties but perhaps proprietary and/or controlled entities. It is believed that the emergency, extraordinary CASH infusions were necessitated due in part by the hidden UNregulated actions of certain sponsors of SIV's (structured investment vehicles). As a result – you might be interested to reference certain non, yes non FDIC insured affiliates of certain Banks and Thrifts have received support through the FDIC’s TLGP program; for which my office submitted a FOIA request #09-1132 which was denied by FDIC office of general counsel.

Link to the FDIC TLGP table here
32 such institutions including Banks, Thrifts and NON FDIC insured affiliates of same received $248B over 52% of outstanding program support as of August 2009.

Nine – FiduciaryALERTS™ one pagers, were issued annually by my office since 2004 urging review and caution with hedge funds, fixed income and real estate due to concerns not limited to explicit and implicit leverage and lack of transparency. Including one from May 2006 entitled "What do Johnny and Elvis have in common?" (Johnny being the deceased Johnny Carson) - both their estates announnced plans to do what? Sell, yes sell certain real estate holdings.

February 22, 2009 comment to NY Times:
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February 22, 2009 5:10 am

There may be two additional ways to seek recovery of "executive pay" and other types of Wall St. distributions; 1)it's possible that some broker dealers - in the past, may not have met minimum net capital requirements had their assets been marked to "true markets" rather than their own proprietary models; hence, at least dividend payments to shareholders (including executives) would have been disallowed. 2)Subject to proof, it's possible that some parties to transactions of what are now deemed "toxic assets" may have engaged in less than transparent or fraudulent acts. Today some banks, if not for taxpayer dollars, would be insolvent' and in the absence of private buyers, forced into BK. and we were reminded that BK trustees' claims or clawbacks for prior and proven fraudulent conveyances can go back 6 years - correctomundo! Clawback - it's music to my ears and may provide the US taxpayer much needed relief that ultimately justice will have been served. Last - let me be the first to raise my hand to volunteer to help in any and all recovery.
— fiduciaryexpert, Los Angeles, CA

PS: The entities themselves are and have been in the “know” as the annual estimated IT budgets for the Financial Services Industry is over $350 Billion (not a typo) and I believe that may not include GE Capital. Among other questions, what is the proprietary trading IT spend over the past several years? See link here

PPS: Hedge Funds and similarly unregistered and unregulated entities must be part of some form of at minimum generic but descriptive position disclosure in addition to disclosing valuations of same as proprietary, public market or derived. Only one example of a present UNFAIR advantage is that over mutual funds. Mutual funds MUST disclose holdings and amounts thereof every 6 months; hedge funds do not and are not required to disclose their playbook. Since both vehicles compete, sign and signal in the same capital markets they should be regulated more evenly.

PPPS: When will the securities industry and regulators prominently disclose to public customers that year after year the majority of active investment strategies fail to deliver even bench mark return, risk or diversification benefits? See the SPIVA study at S&P.

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