Arbogast resisting corporate corruption; cases in practical ethics from enron through the financial crisis, 3e (2017)

Resisting Corporate Corruption Scrivener Publishing 100 Cummings Center, Suite 541J Beverly, MA 01915-6106 Publishers at Scrivener Martin Scrivener (martin@scrivenerpublishing.com) Phillip Carmical (pcarmical@scrivenerpublishing.com) Resisting Corporate Corruption Cases in Practical Ethics from Enron Through the Financial Crisis Third Editon Stephen V Arbogast Kenan-Flagler Business School, University of North Carolina, Chapel Hill, U.S.A This edition was first published in 2017 by John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, USA and Scrivener Publishing LLC, 100 Cummings Center, Suite 541J, Beverly, MA 01915, USA © 2017 Scrivener Publishing LLC For more information about Scrivener publications please visit www.scrivenerpublishing.com All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, except as permitted by law Advice on how to obtain permission to reuse material from this title is available at http://www.wiley.com/go/permissions 1st edition (2006), 2nd editon (2013), 3rd edition (2017) Wiley Global Headquarters 111 River Street, Hoboken, NJ 07030, USA For details of our global editorial offices, customer services, and more information about Wiley products visit us at www.wiley.com Limit of Liability/Disclaimer of Warranty While the publisher and authors have used their best efforts in preparing this work, they make no representations or warranties with respect to the accuracy or completeness of the contents of this work and specifically disclaim all warranties, including without limitation any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives, written sales materials, or promotional statements for this work The fact that an organization, website, or product is referred to in this work as a citation and/or potential source of further information does not mean that the publisher and authors endorse the information or services the organization, website, or product may provide or recommendations it may make This work is sold with the understanding that the publisher is not engaged in rendering professional services The advice and strategies contained herein may not be suitable for your situation You should consult with a specialist where appropriate Neither the publisher nor authors shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages Further, readers should be aware that websites listed in this work may have changed or disappeared between when this work was written and when it is read Library of Congress Cataloging-in-Publication Data ISBN 978-1-119-32334-1 Cover images: Dreamstime.com and company websites Cover design by Russell Richardson Set in size of 10pt and Minion Pro by Exeter Premedia Services Private Ltd., Chennai, India Printed in the USA 10 Contents Foreword Sherron S Watkins xiii Preface xvii Note to Faculty: How to Use this Book xxi Acknowledgements xxv Section The Enron Cases Part Demolishing Financial Control, Neutering the Gatekeepers Case Enron Oil Trading (A): Untimely Problems in Valhalla Natural Gas Pipelines in Crisis Considering the Options The Meeting with Internal Audit Author’s Note Notes 14 15 Essay How to Do an Ethics Case Study The Solution Framework: Defining the Ethics Issue Tactical Planning and Alternative Business Plans Personal Considerations A Final Word About Financial Control 17 18 20 23 24 Case Enron Oil Trading (B): An Opening for Enron Audit? Author’s Note Notes 25 26 26 Essay 27 How a Corporation Becomes Corrupt Case Enter Mark-to-Market: Exit Accounting Integrity? Jeff Skilling’s Association with Enron Serge Goldman Prepares to Meet Jeff Skilling v 31 33 35 vi Contents Author’s Note Notes Necessary Ammunition: Economic Rationales for Financial Control Financial Control at the Heart of Business Success: Personal Experience Summarizing the Controls/Business Success Intangibles The Economic Consequences of Sound Financial Control Notes 43 44 Essay 45 45 50 51 59 Part Business Struggles, Accounting Manipulations Case Adjusting the Forward Curve in the Backroom Conversation with T.J Malva Ethics Assessment and Tactical Options Author’s Note 65 66 68 74 Case Enron’s SPEs: A Vehicle too Far? Enron and Special Purpose Entity (SPE) Vehicles Chewco Investments Author’s Note Notes 75 76 81 90 92 Case Court Date Coming in California? California Decontrols Electricity Enron’s ‘Star Wars’ Gambits Political Fallout in California Enron Legal Investigates SR Produces a Legal Opinion Author’s Note Notes 93 94 96 98 98 99 105 106 Part Resisting Corruption at Enron 107 Case New Counsel for Andy Fastow Determining a Course of Action Author’s Note Notes 109 111 120 121 Case Nowhere to Go with the ‘Probability of Ruin’ The Enron Companywide Risk Management Report Kaminski and LJM Meeting with Ben Glisan 123 123 126 128 Contents vii Elsewhere in Enron Author’s Note Notes 129 138 138 Case Lay Back … and Say What? Problems Deciding What to Say Skilling Decides to Call it Quits Assessing the Broader State of Enron Focusing on the Task at Hand Author’s Note Notes 139 140 141 143 144 153 154 Case 10 Whistleblowing Before Imploding in Accounting Scandals Welcome Back; Now Meet the Raptors Pondering an Approach to Ken Lay A Decision to Go Forward Author’s Note Notes 155 157 159 161 169 171 Essay Resisting Corporate Corruption: The Enron Legacy Tactical Lessons for Internal Resistance Tactical Lessons for Taking Ethics Issues Outside the Firm Implications for the Financial Crisis Cases 173 173 177 179 Essay Underappreciated Origins of the Financial Crisis – A Personal Memoir Jack Bennett Shakes Up Wall Street Wall Street Restructures, Consolidates, and Innovates Trading Dominates Banking and Client Relations Change Prelude to Financial Crisis Section 181 182 185 189 191 The Financial Crisis Cases Part New Business Models Undermine Standards and Controls Case Seeking a Sustainable Business Model at Goldman Sachs Banking vs Trading at Goldman Sachs Competitive Pressures Change Wall Street’s Business Models Embarrassment and Unprecedented Losses Hank Paulson Decides on a ‘Counter to Corzine’ 197 199 201 202 204 viii Contents Author’s Note Notes Case Juggling Public Policy, Politics and Profits at Fannie Mae Origins of a Conflicted Government Entity New Law, Politics and the ‘Housers’ Complicate Fannie Mae’s Mission Reconciling Wall Street Performance and ‘Affordable Housing’ Beating Back the Privatizers Wall Street Mounts an End Run, and Fannie Lowers its Standards The Year 1998 Guidance for Franklin Raines Author’s Note Notes 212 213 215 216 219 221 222 223 225 225 232 233 Case Should Countrywide Join the Subprime ‘Race to the Bottom’? Nature and Structure of the U.S Mortgage Business, 1940–85 Wall Street Develops Collateralized Mortgage Obligations (CMOs) ‘Subprime 1.0’ Temporarily Sobers the Market Countrywide’s Strategy in the 1990s AmeriQuest Launches a Subprime ‘Race to the Bottom’ Mozilo Reconsiders Countrywide’s Subprime Strategy Author’s Note Notes 238 240 241 242 243 251 252 Case Subprime Heading South at Bear Stearns Asset Management Hedge Funds Develop on Wall Street Bear Stearns Forms its Own Hedge Funds Mortgage Market Trends and HGF Disclosure Financial Control Issues at HGF Cioffi and Tannin Respond to Growing Pressures February 2007: ELF Performance Turns Negative Matthew Tannin Considers His Response to Barclays Bank Author’s Note Notes 253 254 255 258 260 261 261 262 272 273 235 236 Contents ix Part Consequences for Gatekeepers and Firms Case Ratings Integrity vs Revenues at Moody’s Investors Services RMBS/CDO Ratings: Kolchinsky Protests and is Transferred Moody’s Becomes a NRSRO Moody’s Culture Changes, and the Firm Goes Public Subprime Mortgage Debt: The Ratings Methodology Challenge The Subprime Market Begins to Unravel Summer 2008 – Moody’s Prepares to Resume Ratings Author’s Note Notes Case Admission of Material Omission? Citigroup’s SIVs and Subprime Exposure Citibank’s Subprime Product Flow and its SIVs Citibank Structures and Launches Subprime SIVs Citibank’s SIVs Finesse the VIE Rules Conditions Worsen in the Mortgage and RMBS/CDO Markets Citibank Reports Second Quarter Results Third Quarter Events Hammer Citi’s Results Considering Citi’s 3Q Results and IR’s Proposed Pre-Announcement Author’s Note Notes Facing Reputational Risk on Goldman’s ABACUS 2007-AC1 From Subprime RMBS to CDOs to SCDOs Goldman’s Trading and its Clients, 2006–07 Fabrice Tourre Constructs ABACUS 2007-AC1 Tourre Prepares for the MCC ABACUS Review Author’s Note Notes 277 278 280 282 284 285 287 294 295 297 298 300 301 302 303 304 305 314 315 Case Case Time to Drop the Hammer on AIG’s Controls? Innovation and Controls on Wall Street Management and Controls at AIG Greenberg Takes a Fall for AIG’s ‘Cooked Books’ AIG-FP Confronts a Subprime Market Decline 317 319 321 323 324 329 330 331 333 336 338 340 x Contents FP Faces Collateral Calls on Subprime CDS Ryan and PWC Approach a Decision Author’s Note Notes 340 342 349 350 Part Financial Firms and Resisters Case Write to Rubin? – Pressure on Underwriting Standards at Citigroup National City Bank Becomes a Giant Financial Conglomerate Citi Demolishes Glass-Steagall Organizational Challenges at Citigroup Growth and Controls within Citigroup’s Mortgage Operations Bowen Considers His Next Step – Write to Rubin? Author’s Note Notes Case 10 Lehman Brothers Repo 105 Lehman Gets in Trouble Repo 105 to the Rescue Weighing Ethics, Career and Courses of Action Author’s Note Notes Essay Wall Street and the Crisis – Causes, Contributions and Problems to Fix 353 354 355 356 357 359 371 372 373 374 375 377 385 386 387 Section The Post-Crisis Cases – Reforms, Resistance, Continuing Realities Part The Dodd-Frank Act: A Primer Case Morgan Stanley Seeks a Sustainable Business Model after the Financial Crisis John Mack Returns, Big Trading Comes to Morgan Stanley Mack Guides Morgan Stanley into and Through the Financial Crisis Mack Analyzes the Financial Crisis and Revamps MS Compensation Mack Weighs Strategic Alternatives for Morgan Stanley Author’s Note Notes 397 399 402 403 405 422 423 550 Resisting Corporate Corruption Finally, various former Enron employees were willing to be interviewed and to read draft cases of which they had some personal knowledge In particular, Jordan Mintz, Vince Kaminski, David Woytek, Jeff McMahon and Sherron Watkins reviewed the cases that involved them, providing factual corrections and enhancements The Financial Crisis Cases Two accounts of the financial crisis provided invaluable details about specific financial institutions and events Bethany McLean and Joe Nocera, All the Devils Are Here: The Hidden History of the Financial Crisis; Portfolio/Penguin, New York, 2010 Gretchen Morgenson and Joshua Rosner, Reckless Endangerment; Times Books, New York, 2011 All the Devils Are Here is a comprehensive guide to the financial crisis It begins at the beginning, with useful accounts of the invention of mortgage-backed securities and the evolution of subprime lending on the backs of “securitization.” It then examines each link in the chain of causation that led to catastrophe Countrywide, Fannie Mae, the rating agencies, AIG Financial Products and the unwise leaders at Merrill Lynch and Bear Stearns are all carefully scrutinized Important but often forgotten developments, such as the late 1990’s failure of many subprime mortgage lenders (Subprime 1.0) and the resurrection of subprime lending led by AmeriQuest, are ably recounted McLean and Nocera usefully and correctly depict the financial crisis as the end result of a chain reaction of greed, hubris, errors and regulatory failures The evidence they present is incorporated into many of this book’s case studies, most especially those involving Countrywide, Fannie Mae, Moody’s and Goldman Sachs Reckless Endangerment has a narrower, deeper focus Morgenson and Rosner concentrate on Fannie Mae and mortgage lenders like Countrywide By pursuing these stories in depth, the authors compile powerful indictments against key leaders at those firms To a lesser extent it also provides useful information on how the investment banks persuaded the rating agencies to bestow such high ratings on securities that ultimately proved toxic Reckless Endangerment’s special contribution is its detailed account of how Fannie Mae, under Jim Johnson, “gamed” its regulator and developed irresistible political influence in Washington This information and its implications for the subsequent regimes of Franklin Raines and Daniel Mudd are incorporated into the Fannie Mae case study Four books about individual investment banks are also valuable for understanding the financial crisis in its entirety: Gillian Tett, Fool’s Gold: The Inside Story of J.P Morgan and How Wall St Greed Corrupted Its Bold Dream and Created a Financial Catastrophe; Free Press, New York, 2009 A Note on Sources 551 William D Cohan, House of Cards: A Tale of Hubris and Wretched Excess on Wall Street; Doubleday, New York, 2009 William D Cohan, Money and Power: How Goldman Sachs Came to Rule the World; Doubleday, New York, 2011 Lawrence G McDonald with Patrick Robinson, A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers; Three Rivers Press, New York, 2009 Tett, a reporter for the Financial Times of London , tells how derivatives ended up contributing to the financial crisis J.P Morgan is the location for her story, as the Morgan bank was the First Mover in both collateralized debt obligations and credit default swaps Her account of the careful financial control environment within Morgan provides a useful contrast to the rest of the Street, and her explanation of how CDO/CDS products work technically is fundamental to understanding the role these products played in the crisis Cohan’s two books are almost as useful a guide to the crisis as the broader accounts of McLean and Morgenson Cohan is a former investment banker He has a feel for the culture inside investment banks and contacts in all corners of the Street Consequently, he gained access to a great deal of nonpublic information His account of the two Bear Stearns hedge funds that went bust in July 2007 conveys the chilling sense of bankers slowly waking to the avalanche bearing down on them Cohan explains how these funds were able to generate attractive returns for 40 straight months, only to scare their investors into fleeing for the exits over the subsequent months Cohan’s detailed story, including the questionable disclosure practices of fund managers, Ralph Cioffi and Matthew Tannin, are incorporated into the Bear Stearns case Cohan also provides many of the nonpublic specifics critical to the two Goldman Sachs cases His history of the firm provides an account of the Arrowwood conference, where Jon Corzine and Hank Paulson debated the firm’s ability to manage conflicts of interest The reported details of their speeches show how Corzine directed the firm onto a path of more aggressive trading and an almost inevitable Goldman IPO Paulson pushed back rhetorically, but seems to have changed little in substance, even after displacing Corzine as CEO The outcome of this debate and the seeds it planted show up in Goldman’s “Abacus” deal Cohan ably recounts this story in his Goldman book Both Goldman Sachs case studies rely heavily on Cohan’s research Charles Ellis’ work, The Partnership: the Making of Goldman Sachs; Penguin Books, New York, 2009, reads more like an ‘authorized account.’ It is more useful for its history of Goldman’s days as a partnership than for understanding what went wrong after it became a public company Lawrence McDonald’s book on Lehman provides a useful account of how that firm tried to “grow” its way out of its subprime mortgage mistakes McDonald reports how Dick Fuld and Joe Gregory paid top dollar for high-end commercial real estate and private equity funds in the year preceding Lehman’s bankruptcy In the process, the firm’s financial structure, levered 44:1, became hugely vulnerable This account provides the context within which Matthew Lee tried to correct poor 552 Resisting Corporate Corruption financial practices and manipulative accounting like Repo 105 McDonald’s book itself makes no mention of these issues or of Matthew Lee Other helpful Financial Crisis works include Michael Lewis’ The Big Short: Inside the Doomsday Machine; Norton, New York, 2010, Monica Langley’s Tearing Down the Walls: How Sandy Weill Fought His Way to the Top of the Financial World .and Then Nearly Lost It All; Free Press, New York, 2004, and Andrew Ross Sorkin’s Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System –and Themselves; Viking/Penguin, New York, 2009 Lewis’ book focuses on how a small group of outsiders saw the mortgage crisis coming years in advance, and then tells the story of how Goldman figured this out before the rest of the Street Lewis also offers views and some information as to how the rating agencies were rendered malleable by their investment banking clients Langley’s work is an account of how Sandy Weill overturned Glass-Steagall and converted Citibank into Citigroup Langley’s telling of the story is helpful for understanding how difficult it then became to manage the Citigroup conglomerate Sorkin’s book was the first high profile account of the financial crisis causes and the fateful events of September 2008 As such, it was a valuable work for later authors and especially useful as regards AIG Hank Paulson’s book, On the Brink: Inside the Race to Stop the Collapse of the Global Financial System, Business Plus, New York, 2010, gives his version of the critical events of 2008, but sheds little light on crisis causes or on his time at Goldman Sachs Internet articles provide a wealth of technical information about developments on Wall Street and the specifics of individual episodes A good example of the former is David Freidland’s article, About Hedge Funds, http://www.magnum.com/ hedge funds/ Friedland’s piece provides both a basic outline of what hedge funds and examples of the wide variety of strategies they use Excerpts are attached to the Bear Stearns case as background to that story The internet is also a great source for specific documents and technical explanations of transactions This proved very helpful in the Lehman Brothers case where the internet provided the text of whistleblower Matthew Lee’s letter, Letter to Lehman Brothers financial management; dealbook.nytimes.com, March 19, 2010 It also provided the explanation for Lehman’s controversial Repo 105 transactions, The Origins of Lehman’s “Repo 105”; dealbook.nytimes.com/ /the-british-origins-of-lehmans-accounting-, March 12, 2010 Watchdog blogs are a relatively new and useful resource This is especially the case when they are written by well-connected industry experts One such blog is Francine McKenna’s re: The Auditors, http://retheauditors.com McKenna, a former Price Waterhouse CPA, understands both the accounting technicalities and the political relations between CPA firm and client Without fail she was able to shed light on the accounting manipulations at AIG, Citigroup, Fannie Mae and Lehman In the process, she raised many valuable questions about the conduct of the public accounting firms For example, several accounts of Price Waterhouse’s conduct towards AIG are largely positive McKenna pointed out the firm’s failure to uncover former CEO Greenberg’s years of manipulation, and that PW knew A Note on Sources 553 about AIG-FP’s subprime exposures six months before it finally forced an AIG admission of “material controls weakness.” Lawsuits brought by regulators were especially valuable for understanding the ethical and financial control lapses at financial firms The Securities and Exchange Commission’s Complaint, Goldman Sachs and Fabrice Tourre, Defendants; Washington, DC, April 16, 2010, contains many key facts about Goldman’s Abacus 2007 deal These include, for example, the fact that Tourre never disclosed to the outside portfolio selection agent that John Paulson would be shorting rather than investing in the CDO Similarly, the SEC’s complaints against Citibank provide critical data about its recurring violations The SEC’s Order Instituting Cease and Desist Proceedings in the Matter of Gary L Crittenden and Arthur H Tildesley, Jr.; July 29, 2010 documents the bank’s use of SIVs to window dress its balance sheet and then its failure to adequately disclose the firm’s subprime mortgage exposure The information contained therein is so convincing as to leave one wondering why the SEC’s action was limited to Gary Crittenden and Arthur Tildesley as opposed to CEOs, Charles Prince and Vikram Pandit, who were also legally liable under Sarbanes-Oxley The U.S Department of Justice’s action against CitiMortgage sheds great light on the Sherry Hunt-Citigroup case Most of this information can be found in Bharara, Preet, United States Attorney for the Southern District of New York, United States of America ex rel and Sherry A Hunt, Plaintiffs Against Citigroup, Citibank NA Inc and CitiMortgage Inc., Defendents; 11 Civ 05473, New York, February 14, 2012 The DOJ’s settlement announcement, wherein CitiMortgage did not contest Justice’s findings, corroborates Hunt’s testimony to third parties and journalists Bankruptcy examiner reports are excellent, largely unbiased sources of financial analysis for trouble firms The report by Anton R Valukas, Report of the Lehman Brothers Bankruptcy Examiner, Volume 3; March 11, 2010, leaves little doubt as to Lehman’s high risk leveraging strategy and its attempt to disguise this exposure through the use of Repo 105 Interviews with whistleblowers provided information for the Moody’s and Citigroup cases McLean and Morgenson’s accounts of the crisis leave little doubt that the rating agencies were major contributors to the debacle Thus, it was very useful to have access to a Moody’s insider who could describe what was happening inside that firm before and during the crisis Eric Kolchinsky was a Moody’s Managing Director In August, 2007, he was in charge of rating subprime mortgage CDOs He had personally experienced Moody’s retreat from a quality ratings process, its deferral to the Wall Street banks on critical methodology matters, and its reluctance to face the consequences of its mistakes Kolchinsky provided long interviews and personal documents covering events at Moody’s from 2007-09 All of this is incorporated into the two Moody’s cases Similarly, Richard Bowen provided copies of his testimony before the Financial Crisis Inquiry Commission, Hearing on Subprime Lending and Securitization and Government Sponsored Enterprises, Testimony of Richard M Bowen III, April 10, 2010 This material shaped the Citigroup Underwriting Standards case and contributed to the Sherry Hunt-CitiMortgage case 554 Resisting Corporate Corruption As a final comment, the financial crisis continues to reverberate with new revelations and legal actions Gretchen Morgenson’s weekly column in the Sunday The New York Times Sunday edition is a rich source of continued scrutiny for past problematic events CBS’ 60 Minutes pursued financial crisis stories for some time, asking the question why more major figures have not been prosecuted In the process it interviewed Lehman’s Matthew Lee and CitiMortgage’s Sherry Hunt These interviews were made available online The Post-Financial Crisis Cases The post-crisis cases were derived in part from press accounts and articles detailing these recent events Of these, several were especially detailed and revealing The Street’s “How Did the Fraud Against Citi’s Banamex Work?” was especially helpful in describing exactly how the bribery was effected via false invoices to Pemex, while Business Insider’s “Citi’s Banamex, regulator clash over who played key role in loan fraud” shed light on the complex web of misconduct among higher level Banamex officials Gillian Tett’s Financial Times article “Libor’s value is called into question” and Carrick Mollenkamp’s “Bankers Cast Doubt On Key Rate Amid Crisis” helped unpack the particulars of how bankers cooperated to move the benchmark rate in directions that earned them profits The Wall Street Journal’s “How One Goldman Sachs Trader Made More Than $100 Million” triggered my interest in its implications for the Volcker Rule and resulted in the “chipping away at the Volcker Rule” case A range of semiofficial sources provided detailed accounts of key leaders or firm perspectives at specific points in time Of these, Morgan Stanley CEO John J Mack’s testimony before the Congressional Financial Crisis Inquiry Commission was especially helpful in outlining his (and maybe Wall Street’s) self-assessment regarding that crisis The Report of the Business Principles and Standards Committee at Goldman Sachs shed light on how that firm analyzed its conflicts of interests and what it was prepared to do, and not do, to address said conflicts This was instrumental to considering CEO Blankfein’s options as he weighed specific conflicts inherent in Goldman’s advisory relationship with El Paso Since several of these cases resulted in enforcement actions, the published official complaints/settlement agreements proved an especially comprehensive and valuable form of source materials The particular complaints/settlements and the cases they pertained to are listed just below: Case Complaint/Settlement Goldman Sachs/El Paso Memorandum Opinion, Chancellor Strine, February 29, 2012, http://online.wsj com/ public/resources/documents/ ElPasoOpinion03052012 A Note on Sources 555 MF Global REPORT OF INVESTIGATION OF LOUIS J FREEH, CHAPTER 11 TRUSTEE OF MF GLOBAL HOLDINGS LTD., et al., United States Bankruptcy Court for the Southern District of New York, In Re: M.F Global Holdings Ltd CitiMortgage Bharara, Preet, former United States Attorney for the Southern District of New York, United States of America ex rel and Sherry A Hunt, Plaintiffs Against Citigroup, Citibank NA Inc and CitiMortgage Inc., Defendents Although the post-Crisis cases are of recent vintage, several published books provided valuable accounts and/or background Patricia Beard’s Blue Blood and Mutiny: The Fight for the Soul of Morgan Stanley offers an excellent account of John Mack’s departure from and return to that firm As such, it sets the stage well for the actions Mack will take in the wake of the financial crisis Jonathan Macey’s The Death of Corporate Reputation: How Integrity Has Been Destroyed on Wall Street provides an excellent account of the negotiating back-and-forth among Kinder Morgan and El Paso, and of Goldman’s efforts to cope with its advisory conflicts This work also quotes at length from Chancellor Strine’s Opinion, which served to direct this author to review that document in its entirety Chancellor Strine did not find for the plaintiffs in this case, largely on technical grounds However, his expressed opinions on the conflicts and conduct of Goldman Sach’s and El Paso CEO Doug Foshee leave little doubt that the Chancellor does not believe that many issues which surfaced in the Financial Crisis are settled and behind us Index Arthur Andersen (AA) investigation of Enron oil trading (EOT), 27 mark-to-market accounting (MtM), 35–36, 39–40 professional standards group (PSG) discussion of MtM, 35, 38–42 Borget, Louis president of EOT, 3, 5–6, discussion of EOT financial irregularities, 9–10 details of alleged irregularities, 11–12 trading controls breach, 25–26 Causey, Rick assurances to Enron board when Jeff Skilling resigned, 144 assurances to Skilling prior to resignation, 142 California power market attorney-client privilege, DOJ attack on, 94, 101–102 deregulation of, 94–95 Enron manipulation of: Enron’s liability, 98–100 political fallout, 99 trading strategies, 96–98 Silverpeak incident, 97 Stoel Rives legal opinion, 93, 103–104 Ceconi, Margaret Enron electricity services financial losses, decision to contact SEC, 129–130, 177–178 Chewco investments, 102–104 Chewco transaction diagram, 89 Controls breach—remedial actions, 7–8 Enron California business disruption, 93, 96–98 candidates to become president/ COO following Jeff Skilling’s resignation, 167 diagrams of SPEs: Cactus, 84 Chewco, 89 JEDI, 85 prepays, 86 RADRs, 88 Raptor I, 164 total return swap, 137 Whitewing, 87 ethics policy, 61–62 financial statements 1985–1986, 13, 1999–2000, 131–133 excerpts: notes 1999–2000, 134–136 1H 2001, 148 formative years, 4–6 Resisting Corporate Corruption, (557–559) 2017 © Scrivener Publishing LLC 557 558 Index Gas bank, technical explanation and diagram, 37–38 implications: financial crisis, 179 internal audit, 9–12 lessons: internal resistance, 173–176 lessons: ‘Going Outside,’ 177–178 oil trading irregularities, 11–12 oil trading losses, 25–26 Skilling resignation announcement, 152 ‘Star Wars’ gambits, 96–98 stock price during Jeff Skilling’s tenure as CEO, 147 troubled business lines mid-2001, 165–166 use of special purpose entities (SPEs), 96–97 accounting treatment of SPE transactions, 101, 106–111 Exxon and ExxonMobil corporation Cazzaniga incident, 47 ethics policy, 47, 60 financial control, 45–51 foreign corrupt practices act, 47 safety, 45–47, 49–50 Valdez litigation, 46 Fastow, Andy attitude toward SPE accounting, 80 background at Enron, 76–77 Cactus formation, 76–77 conflict of interest justification, 114–116 early Enron career, 76 LJM compensation, 111, 176 LJM formation, 109–111, 126–127 role in Chewco investments, 81–83 role in SPEs, 76–83 Financial control Contribution to business success, personal experience at Exxon, 45–50 Financial control defined,50–51 economic rationale for, 50–51 theft prevention, 51–53 judicial and administrative judgments, 53–54 business disruption, 54–55 accurate information, 55–57 culture of accountability, 57–58 Glisan, Ben career background, 102–103 dilemma on Chewco transaction, 96, 102–105 meeting with Kaminski on companywide risk assessment, 128–129 How to an ethics case study: alternate business plan, 20–23 defining ethics issue, 18–20 early stages of ethical decomposition, 20–22 advanced stages of ethical decomposition, 22–23 Integrated commodity forward Buy/Sell with integrated interest Rate hedge, application of MtM, 65–66 Summary of transaction structure and accounting, 72–73 Irregularities at Enron oil trading, 11–12 Kaminski, Vince Companywide risk assessment, 123–126 Meeting with Ben Glisan, 128–129 Problems with LJM1 and Jeff Skilling, 125–126 Total return swap, 124–125 Trigger events, 125–126 Index Lay, Ken assessment of Enron’s business problems 2001, 142–143 background, becomes CEO of Enron, 4–5 involvement in Enron’s California issues, 94, 99 Jeff Skilling’s resignation, 141–143 Major Enron involvements 1999–2001, 149–151 Meeting with internal audit on EOT, 9–10 Options on EOT, 6–8 Public disclosure legal liability, 149–141, 146 Personal financial issues, 141 Valhalla EOT financial irregularities, 3–4, 6–10 Legal guidelines for comments by senior executives, 184–185 Legal status of whistleblowers in Texas circa 2001, 167 Mark-to-market accounting (MtM) Arthur Andersen meeting with Skilling, 48–50 At Enron finance, 35–40 Justification for, 36 Technical explanation, 42–45 Use for forward sale/purchases of commodities, 87–89, 93–94 Mintz, Jordan: history with Andy Fastow and LJM, 109–111 Move to global finance, 109–110 Options for resisting Fastow, 111–113, 117–119 Natural gas pipelines in crisis, 4–6 Powers committee report Chewco accounting charges, 56 Glisan’s Chewco role, 90 559 Raptor transactions Background to Raptor, 157–158 Diagram of Raptor, 164 Sherron Watkins’ assessment of Raptor I accounting, 157–158 Transaction summary, 163 Sabine pilot claim, 167 Sarbanes-Oxley act,170 Skilling, Jeff Assurances to Enron board when resigning, 139–140 Creation of Gas bank, 31–35, 37–38 Decision to join Enron, 33–34 Decision to resign, 141–143, 152 Demand for MtM, 31, 35–36 Enron (Draft) official resignation announcement, 152 Enron stock price performance during tenure as CEO, 147 Justification of mark-to-market accounting, 36 Watkins, Sherron approach to Ken Lay, 155–156 career prior to and at Enron, 157 decision to write anonymously to Ken Lay, 159–162 Raptor’s analysis, 157–158 text of draft anonymous letter to Ken Lay, 162 view of whistleblowers, 160–161 whistleblowers, Legal position of, 168 Woytek, David comment on MtM, 44 comment to Ken Lay on EOT irregularities, 9–12 Enron oil trading financial irregularities, 9–10 Memo on EOT financial irregularities, 11–12 The Financial Crisis Cases ABX Index 279, 320–322 AIG Accounting Scandal, 338–339 Cassano, Joseph, 338, 340–343 Controls, 336–338 Collateral Disputes, 340–342 Credit Default Swap Exposure, 340 Financial Products (FP), 336–337 Firm History, 336–337 Greenberg, Hank, 336–339 “Material Controls Weakness”, 331–333, 341–344 Price Waterhouse Coopers (PWC) Audit Findings, 341–342 Ryan, Tim, 331–333, 341–344 Sullivan, Martin, 331, 339–341 AmeriQuest Arnall, Roland, 242 Business Model, 242–243 Loan Criteria Products and Standards, 242–243 Bear Stearns Asset Management, 253, 260 Financial Control Issues with Hedge Funds, 260 Firm History and Financial Performance, 255–256, 268 High Grade Fund, 256–261 Organization, 260, 269 Subprime Mortgage Business and Strategy, 256–257, 259–261 Bennett, Jack F., 182–185 Blogs, Watchdog re: The Auditors, 378, 539 Bowen, Richard Conflict with CitiMortgage, 353, 358–359 Internal Resistance Options, 359–360 Underwriting duties, 358–359 Warning to Robert Rubin, 361–363 Cioffi, Ralph At BSAM Hedge funds, 253–254 Hedge Funds Strategy, 256–257, 259–263 Client & Lender Disclosure, 259–260 Citigroup CitiMortgage,356–358 Legal Guidelines, Executive Communications, 308, 313 Controls, 356–357 Crittenden, Gary, 297–298, 303–306 Firm History, 353–356 Glass-Steagall, Role in Repeal, 355 Organizational Structure and Challenges, 356–359 Prince III, Charles, 303, 353, 359 Quarterly Subprime Disclosure, 301–302, 305–307 Rubin, Robert, 353, 359–363 Scandals and Settlements, 367–369 Resisting Corporate Corruption, (561–564) 2017 © Scrivener Publishing LLC 561 562 The Financial Crisis Cases SIV usage, 302–308 Weill, Sandy, 355–357 Collateralize Mortgage Obligation (CMO) 218–219, 238–239 Construction of, 325 Collateralized Debt Obligation (CDO) ,326 Synthetic CDO, construction of, 327 Controls on Wall Street Value at Risk (VAR) and Other Controls, 325, 335 Countrywide Mortgage Business Model, 241–244 Competition with AmeriQuest, 235–236, 242–243 Controls, 241–242 Financial Performance, 245 Mozilo, Anthony, 235–236 241–244 Subprime Mortgage Business Evolution, 239–243 “Subprime I”, 240–241 Credit Default Swap (CDS) Collateral Calls, 340–341 Construction of, 319–321, 327 Fannie Mae Affordable Housing Requirements, 216, 219–220 Capital Requirements, 220 Conforming Mortgage Requirements, 217–218 Financial Performance, 218, 221, 225, 227–229 Firm History, 216–219 Incentive Compensation, 220–221 Maxwell, David, 218–219 Political Pressures on, 280–281, 284–288 Raines, Franklin, 215, 225 Role in Mortgage Market, 216–218 Safety and Soundness Act, 219–220, 223 Subprime Mortgage Lending, 223–224 Glass-Steagall Act, Description of, 199, 480 Repeal of, 355 Goldman Sachs Abacus 2007-AC1, 317–318, 323–324 ACA Portfolio Selection Agent, 317, 323–324 Arrowwood Conference, 197 Core Principles, 208–209 Corzine, Jon, 197–198, 204, 206–207 Firm History, 199–204 Mortgage Capital Committee (MCC), 317–318, 324, 328 Paulson, John, 317–318, 321–324 Reputational Risk, 317–318, 323–324 Subprime “Big Short”, 318, 321–324 Hedge Funds Accounting, Mark to Market, 255, 270 As Resistance Option, 377–378 Description of, 254–255, 264–267 Disclosure Requirements, 271 HGF/ELF Disclosure, 251–254, 259–261, 263 LTCM Collapse, 255 Johnson, Jim Accounting Concerns, 225, 230–231 Affordable Housing Strategy, 219–222 at Fannie Mae, 215–216 Business Strategy, 219–223 Compensation, 215, 220, 223 Lobbying Strategy, 221–223 Kolchinsky, Eric at Moody’s, 277 Conflict Over CDO Ratings, 278–280 Internal Resistance Options, 287–288 ‘Key Points’ to former group, 292 The Financial Crisis Cases Rating Abacus 2007-AC1,286 Ratings Methodology for CDOs, 284–285 Lee, Matthew At Lehman Brothers, 373–374 Conflict over Repo 105, 373, 377–378 Letter to Top Financial Management, 382–383 Resistance Options, 377–378 Lehman Brothers Causes of Financial Distress, 376–377 F inancial Performance, 384 Firm History, 374–375 Einhorn, David: Criticism of Lehman, 377–378 Fuld, Richard, 375 Repo 105 Description,375–376, 382 Usage, 375–376 Moody’s Investors Service As Public Company, 282–283 Business Model: Evolution, 282–283 Firm History, 280–283 Clarkson, Brian, 282–283 McDaniel, Raymond, 282–283 Ratings Integrity of, 281 NRSRO, 277, 280–281 “No Friends” Statement, 283 Role in Capital Markets,280–281 Subprime Securities Downgrade, 285–286 Subprime Securities Methodology, 284–285 Structured Finance, Impact of, 284, Mortgage Market Affordability Products, 243 Corruption of, 243–244 Development and Evolution, 236–240 563 Impact of Securitization, 240, 258, 284 Residential Mortgage-Backed Security (RMBS), 238–239 Role of Fannie Mae, 216–219 Role of Wall Street, 223–224, 238–240, 284–285 Subprime “Hard Money” lending, 238 “Subprime I”, 240–241 Coming Collapse Foreseen, 262, 318, 321–322 Paulson, Hank Arrowwood Conference Remarks, 210–211 At Goldman Sachs, 198–199 Attitudes on Client Conflicts, 204–205, 210–211 Sarbanes-Oxley law Auditor Independence, 332, 345–346 Liability for CEO, CFO, 298, 308 Material Controls Weakness, 332 Restrictions on CPA Conflicts of Interest, 345–346 Whistleblower Protections, 168, 170, 505–506 Securities and Exchange Commission (SEC) Rule 10b-5 General Provisions, 146, 313 Hedge Fund Reporting Requirements, Applied to Rating Agencies, 279 Tannin, Matthew At BSAM Managing Hedge Funds, 253–254 Client and Lender Disclosure, 256, 259 Options to Save Hedge Funds, 262–263 Tourre, Fabrice At Goldman Sachs, 317–318 564 The Financial Crisis Cases Constructs Abacus |2007-AC1, 323–324 ‘Key Points’ for MCC Review, 328 Prepares for MCC Review, 324 Variable Interest Entity (VIE) Rules, 301, 310–311 Wall Street Causes of Financial Crisis, 387–391 Competitive Evolution, 185–192 Consolidation, 185–186 The Post-Financial Crisis Cases Banamex Business Model within Mexico, 478–479, 484–485 Citigroup as Financial Supermarket, 480–483 Corbat, Michael, dilemmas as CEO, 477–478, 484–485 Foreign Corrupt Practices Act, 492 Medina-Mora, Manuel, as CEO Banamex, 478, 484 Oceanografía, 478–479 Receivables Scandal, 477–478, 490 Bank of England History, 461–462 Role in LIBOR Scandal, 461–462, 465–466 Suggested LIBOR reforms, 463–464 Tucker, Paul, 461–462, 468–469 Foshee, Doug, 425–426, 433–435 Corzine, Jon Becomes CEO at MF Global, 447 Investment Strategy at MF Global, 447–449 Role in MF Global Client Account Scandal, 447–451 Sovereign Debt Strategy, 447–449 Dodd-Frank Law A Primer on Key Provisions, 393–396 Legislative outlook, 408–409 Volcker Rule, 511–514, 516–520 Barclays Bank Diamond, Bob, 461–462, 472 LIBOR Submissions, 466–468 Role in LIBOR Scandal, 461, 466–469 El Paso-KMI Merger Doug Foshee as EP CEO, and personal ambitions, 427–429 El Paso Firm History, 426–428 Goldman Sachs Conflicts of Interest (COI), 429, 431 Judge Strine analysis of Goldman COI, 441–442 KMI Takeover strategy, 427–428 Blankfein, Lloyd Compensation, pre-Financial Crisis, 390 Conflict of Interest options in EP-KMI Merger, 425–426, 432 Conversation with El Paso CEO Goldman Sachs Board Committee Report: Business Standards, 425–426, 430, 436–438 Reputational Risk Concerns, 425–426, 431 Strategy to resolve Conflicts of Resisting Corporate Corruption, (565–566) 2017 © Scrivener Publishing LLC 565 566 The Post-Financial Crisis Cases Interest in El Paso-KMI merger, 429, 431, 432–435 Trader Makes $100 M profits postVolcker Rule, 511, 514–515 Hunt, Sherry Citi Disputes & Settlements, 500–501 CitiMortgage/FHA False Representations, 497–498 Conflict with CitiMortgage, 495–498 False Claims Act, Provisions, 499, 507–508 Legal advice and options, 499–500, 503–504 SEC Bounty Provisions, 506–507 Whistleblower risks, 502–504, 505–507 LIBOR Scandal Evidence of Banks Colluding, 465–466 Geithner Reform Suggestions, 470–471 History of LIBOR, 463–464 Mack, John Compensation Changes, 403–405, 416–417 Compensation pre-Financial Crisis, 390 Guides Morgan Stanley through Financial Crisis, 401–402 Return to Morgan Stanley as CEO, 397, 399–401 Testimony re: Financial Crisis, 397 MF Global Broker Dealer History, 446–447 Client Segregated Accounts, 444–446 Edith Obrien dilemma, 443–444, 452–453 Repo-to-Maturity, 447, 455 Morgan Stanley Business Models, Strategic Alternatives, – , 420–421 Financial Performance, Pre-Crisis, 401, 406, 410–416, 418–420 Financial Performance, Post-Crisis, 405 Firm History & Reputation, 399–401 Purcell, Phillip as CEO, 397, 399–401 Note on Blogs & Law Firms, 539–543 Note on Sources, 544–554 Proprietary Trading Differences from Market Making, 512–514 Distinguishing Characteristics, 514, 518–520 White, Mary Jo SEC Role enforcing Volcker Rule, 511–512, 515 ... retained the valuable lessons from Enron, but was updated to include real life examples from the corporate and financial scandals that continued throughout the decade of the 2000s, culminating in. .. Citi-Banamex cases offer amazing insights into just a few of the complicated and ethically challenging issues facing those in finance today In reading these cases, including the incredible documentation/evidence... 547 Index 557 The Financial Crisis Cases 561 The Post -Financial Crisis Cases 565 Foreword I first met Stephen Arbogast in 2006, when he was doing research on the first edition to Resisting Corporate