Corporate Governance

The SEC, Bear Stearns and the Failure of Regulatory Oversight: The Unredacted Version (Part 4)

By J. Robert Brown

What is going on at the top levels of the SEC?

As we have discussed, the Office of Inspector General at the SEC published a report on the SEC's Oversight of Bear Stearns and Related Entities. The report was relatively sharp, taking the Commission to task for a failed process. The publicly disseminated version was redacted, with apparently over 130 deletions. The redactions didn't seem to raise serious concern. After all, the report presumably contained some commercial information that could be confidential or proprietary and could be deleted without significantly harming the content.

This turns out to have been only a part of the explanation for the redactions. Senator Grassley released a copy of the unredacted version. As a result, the redactions can be compared to the actual language in the report and the results are disturbing. It turns out that while some of the redactions were commercial/proprietary information, many went directly to the role of the staff in the supervision of Bear Stearns. In other words, the public received a doctored report designed to understate the Commission's role.

An example? Below, we have two paragraphs from page 12 of the report. The bold print shows what was deleted. Note that a majority of the references, particularly the footnotes, were deletions to references to the staff.

• From April 2006 to March 2008, Bear Stearns? Basel Capital ratio decreased from 21.4 percent to 11.5 percent.77 TM memoranda suggest that in March 2008, TM inquired about whether Bear Stearns was contemplating capital infusions, but the memorandum does not suggest that TM exerted influence over Bear Stearns to raise additional capital.78 The OIG exper was unable to find TM memoranda indicating that TM had formally required or informally pressured Bear Stearns to raise additional equity capital prior to March 2008. In this sense, TM acted as though it did not believe it had a mandate to compel Bear Stearns to raise additional capital as long as its Basel capital ratio was greater than 10%. In fact, Bear Stears did not raise additional capital during this time in 2207 or 2008.
  

• According to TM?s documentation of its meetings with Bear Stearns, in November 2006, Bear Stearns initiated a plan to increase its availability of secured funding at the holding company level.79 One component of this plan involved a tri-party repurchase agreement80 with secured lenders, giving Bear Stearns access to $1 to $1.5 billion from each lender.81 Bear Stearns? secured borrowings were initially for terms of 30 days, with the goal of extending the terms to six months to one year.82 By May 2007, Bear Stearns? short-term borrowing was 60 percent secured and by September 2007, it was 74 percent secured.83 Finally, by March 2008, Bear Stearns? short-term borrowing was 83 percent secured.84 Nevertheless, Bear Stearns was still unable to obtain adequate secured funding to save the firm in March 2008.

• 77 Source: Bear Stearns monthly Commission filings.
  

• 78 ?We (Eric Sirri I believe) inquired about any discussions they were having at the moment in terms of capital infusions. Allan [sic] [Schwartz, the President and Chief Executive of Bear Stearns] said there were no ?terribly current discussions?. They had hired Lazard to advise them but that was on ?slow burn? and that with the time it would take to get that done it wouldn?t held (rumors would cause more damage in the meantime).?
  

• 79 Source: TM?s internal quarterly meeting memoranda with Bear Stearns for the 4^th quarter 2006, 1^st quarter 2007, 2^nd quarter 2007, and 3^rd quarter 2007.
  

• 80 In a tri-party repo arrangement, a third party (in this case JP Morgan) acts as a custodian for loans between Bear Stearns and other lenders. The custodian holds Bear Stearns assets as collateral for the loans from the other lenders. Bear Stearns used this tri-party repurchase agreement (repo) facility to finance assets which were otherwise difficult to fund.
  

• 81 Source: TM?s Internal quarterly meeting memorandum with Bear Stearns for the 4^th quarter of 2006.

• 82 Source: TM?s Internal quarterly meeting memorandum with Bear Stearns for the 4^th quarter of 2006.

• 83 Source: TM?s Internal quarterly meeting memoranda with Bear Stearns for the 2^nd quarter 2007 and 3^rd quarter 2007.
  

• 84 Source: TM?s Internal memorandum (file name: BS Monthly Liquidity Call_03-06-08.doc).
  

Over and over the report deletes references to staff notes, staff memoranda, and staff conclusions. Almost every footnote that refers to an internal memorandum was deleted (but not all, footnotes 142 and 143 refer to TM's internal credit meeting memorandum with Bear Steans dated July 2007).

In the next post, we'll offer some observations.

Full post as published by The Race to the Bottom on October 09, 2008 (boomark / email).