As you may remember, we blogged the hell out of Reserve Primary Fund's breaking the buck last fall. Now the SEC has charged its operators with fraud. As far as I can tell, their big crime is talking up their own health--claiming that they were less exposed to Lehman than they turned out to be.
What's interesting to me about this is that as I understand it, the fund didn't take in much new money on these claims; the talk was to existing investors, who didn't flee because they thought their money was safer than it was. But on a social level, this did no harm. It changed the distribution of the losses, but there were few-to-no extra losses as a result of their claims. For every person they made worse off, someone else recovered more than they otherwise would have. Yet we punish them as if they'd actively defrauded new investors, in order to maintain confidence in the system.
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It's interesting, but I hope you'll agree that it's hardly a defence of their actions.
Is there a legal difference between lying to current investors vs new ones?
Megan's correct that the consequence is nothing more than a transfer. So that means it's okay if I steal your car?
So a criminal enterprise is made less criminal by virtue of not being successful?
I suppose this really goes back to the argument of punishing crimes by intent vs result. Should the perpetrator of a financial crime, who wiped out the savings of thousands of people by fudging a few numbers be punished more or less than a thug who robbed a single person at gun point?
If you consider intent, then the financial criminal should receive less punishment, since morally his actions are much less heinous. Also, the fund in question is equally guilty no matter if it tried to dupe new investors, or keep existing ones.
On the other hand, if you consider consequences, then the financial perpetrator should receive a much heavier sentence than the armed robber, since he caused so many more to be poor, and the fund in question should escape virtually Scott free, since overall the consequences are nill.
I'm not sure I understand. At the end of the day, they broke the buck because of their exposure to Lehman. So at best they just forestalled for a day or two a run on the fund, without actually doing anything to prevent the eventual losses. That nobody invested new money in the fund just means that new investors didn't quite believe their stories. I'm not sure I understand how this makes this not a disclosure violation.
I disagree with this claim. It affected investor confidence in other funds. If this fund is lying about its exposure to Lehman, other funds may be as well. This causes everyone to pull out of their funds, potentially causing otherwise solid funds to break the buck as a result of massive redemptions. In addition, it shakes the publics' confidence in the securities market in general if issuers are permitted to intentionally lie about their financial condition.
In response to MDF, there may be a defense of truth on the market available, which could make their misstatements immaterial. Fraud claims require that the misstatement relate to a material fact. Essentially, if everyone knew the operators were full of it when they claimed there was little Lehman exposure, then the operators claims were not materially false, and thus were not fraudulent.
Y'all are reading too much into my claim. I'm simply interested in teh fact that this is, in some sense, not a net crime. That doesn't mean I think they shouldn't be punished, or that they didn't do anything wrong. But the moral intution is somewhat interesting.
I don't think this is correct. If they had been computing their net asset value honestly they would have broken the buck much earlier before their Lehman paper became completely worthless.
The netting problem is not limited to cases in which there are no new investors because, at least for diversified investors, everybody is at least as likely to be a seller as to be a buyer. This doesn't mean there's no harm, but it means there's a lot less than you'd get by calculating the sum of the losers' losses. For every loser, there's a coresponding winner. This is discussed in Easterbrook & Fischel, Optimal Damages in Securities Cases, 52 U. Chi. L. Rev. 611, 641 (1985). Essential reading for anyone interested in the issue.
I can see why you find it interesting, but I think that the way that you framed it has caused the audience to miss the point.
It is not interesting that we would have a moral reaction to a "no net loss" crime. As has been pointed out, a lot of crimes are "no net loss," and distribution between the innocent and the evil has just as much a moral claim over us, ethically and emotionally, as does efficiency. Almost everybody in every culture recoils when the big bully steals the weak kid's lunch money.
Rather, the interesting point here is our moral reaction at a redistribution of the loss amongst entirely innocent parties. As I understand your explanation, the fraud only led some innocent investors to stay in longer, thus distributing the pain of the fraud slightly more widely amongst the innocent than it otherwise would have been. So, it is not a redistribution from an innocent to a thief, but to two innocent people losing half their possessions rather than one person losing everything. We normally don't consider it better for one innocent party to bear the burden when the pain could be more widely shared, so from that perspective, as a discrete case, it is a bit morally counterintuitive.
Of course, as has been pointed out, a lot of actions take on a different moral character when considered discretely rather than in the aggregate. For instance, favoring junior creditors over more senior ones in a bankruptcy really doesn't change much if it occurs once, but if done systematically it wrecks your financial system.
This gets to the reason that this is a civil action brought by an administrative agency. The ultimate purpose of agency regulation is to ensure system integrity, even at the expense of justice in any individual action. As a common example, for deterrence purposes, executives of polluting companies can be held criminally liable for their companies' actions even though they are, in the individual instance, entirely non-culpable. It's an uncomfortable aspect of the regulatory state and the subject of extensive constitutional, economic, and moral debate.
I am curious as to what people would expect to solve, or curtail, the abuses on Wall Street?
Maybe its me, but their is a whole culture of people that live in NYC and DC. This culture does not see a problem or a fault in skewing perceptions of their businesses. It sees it as your problem, and by you I mean the potential investor. Its like painting and cleaning a house, nobody really knows the state of the house unless they really open it up and take a look. Something that as the salesman, this culture doesn't want you to do.
So some people lost, and some people gained? It isn't especially outrageous when taken in its context. I agree with Megan on this point. Where we disagree is this: regulation is merely a form of leverage. She sees regulation as a sort of leveling playing field, small, and minimal. I see regulation as the further extension of negotiation, quite powerful, punitive when gross violations occur, and ultimately designed to be neutral. Why? Well, for Megan I think it has to do with a bit more philosophy. She sees it as an inhibitor (which it is). Regulation to her seems to always be serving an interest (usually it does) to the detriment of another. As such, "as little as possible" is her prescription. Quite a few people agree with her analysis.
For me however, I can't help but see regulation in much the same light, but I think that the underlying assumptions behind Megan's view are derived from thoughts, and not actions. In short "what should be" versus "what is and has been". Now I have to shut up because I'm already late.