Sunday, March 16, 2008

The Wrongheaded Bear Stearns Bailout

Gretchen Morgenson has an acerbic commentary on the Fed-guaranteed bailout of Bear Stearns today. She writes:

. . . why save Bear Stearns? The beneficiary of this bailout, remember, has often operated in the gray areas of Wall Street and with an aggressive, brass-knuckles approach. Until regulators came along in 1996, Bear Stearns was happy to provide its balance sheet and imprimatur to bucket-shop brokerages like Stratton Oakmont and A. R. Baron, clearing dubious stock trades.
Gretchen actually understates the case. Bear was full partners with Baron in its ripoff of customers, and never paid the price.

Here's a New York Times story, also by Gretchen, on the SEC's settlement with Bear and Richard Harriton, head of its trade clearing operations in the 1990s. (My own Business Week stories on this wretched affair are, alas, unavailable on the Internet.)

In a separate civil suit, the S.E.C. accused Bear Stearns of helping A. R. Baron commit securities fraud by financing its operations even in the face of overwhelming evidence that the smaller firm was defrauding its customers. Bear Stearns settled the suit without admitting or denying the accusations and paid $38.5 million in fines and restitution.

In yesterday's settlement order, the S.E.C. said that Mr. Harriton's actions had caused certain A. R. Baron customers to be defrauded and substantially assisted the overall fraud conducted by the smaller firm by allowing it to stay in business when it lacked the necessary capital to operate.

Also worth reading is this report on the role of clearing firms in microcap fraud by the pre-Spitzer New York State Attorney General's office. Note that Bear Stearns plays a starring role:

The most frequent and inexplicable complaint is the refusal by clearing firms to halt unauthorized trades in customer accounts. These investors usually only receive a "Dear John" letter referring the investor back to the introducing, micro-cap broker (who, most likely has already been unresponsive to the investor) and to the boiler plate contained in their new account form that purports to set forth that the clearing firm is not responsible for anything and need not take instructions from the owner of the account.

Some investors even believe, mistakenly, that the clearing firm itself is, in actuality, their brokerage firm. This misapprehension is often planted by the brokers of the introducing firm who, in their scripted "spiel," emphasize their relationship to the clearing firm while omitting their own less-prestigious firm. For example, a Stratton broker stated, "You may not know the name of my firm, but we're backed up by some of the best firms on Wall Street -- like Bear Stearns."

Similarly, in the Bear Stearns approved welcome letter that was sent to customers of A.R. Baron & Co., Inc. ("Baron") in July, 1995, the public was told that Bear Stearns has $5.8 billion in capital, has been in business since 1923, and provides clearing clients with "$25 million insurance protection" for their accounts and that Baron was "confident that this relationship will provide you with a deep feeling of security."

It's outrageous that the Fed would bail out a company such as this. Bear finally was snared by its own greed and recklessness, and, if it was destined to die, it should have been allowed to die.

UPDATE: Bear Stearns has gotten a comeuppance of sorts. It is now a penny stock, having cut a deal to sell itself to JP Morgan at $2 a share.

© 2008 Gary Weiss. All rights reserved.

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