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Wall Street--The Effect On You.

By John Dietz - Email Editor

Date : August 19, 2008

Dear Valued Reader,

If there is one thing that we may have accurately predicated with the subprime-mortgage and loan problem, it was that it was only a matter of time until litigation made its way to the surface. The latest is that the Attorney General of New York, Andrew Cuomo, has issued Martin Act subpoenas to Bear Stearns, Deutsche Bank, Morgan Stanley, Lehman and Merrill Lynch. The pending investigation vests in the issue of whether the underwriters failed to disclose relevant information to investors in subprime deals.

The interesting aspect of this happening is that the plaintiff in the Martin Act does not need to prove the intent to defraud, or need to prove that a fraud occurred, but instead must only prove incompetence or negligence to achieve a judgment. Though you may be unfamiliar with the “Martin Act”, I am sure you recognize “Blue Sky Laws”, and the accused companies such as Enron, World Com, Tyco, Merrill Lynch and Citicorp who have all had to face the fierce sword and command granted to the Attorney Generals of New York by The Martin Act.

The Martin Act is known as the swiftest sword on Wall Street. Coupled with the Sarbanes-Oxley Act of 2002, the sword is hasty and powerful; all the AG has to do is threaten criminal prosecution and the money pay-offs will roll. It has happened in the past. It is as if the drawbridge is down in the castle as the Attorney General charges in. Subsequent surrender by companies occurs by those who do not want to be indicted.

In 1911, states started passing “Blue Sky Laws”, meaning that stock schemes had no more merit than the blue sky above because brokers tried to sell shares of the “blue sky”, which were considered fraudulent and without value. These laws controlled all stock sales until the Securities Act of 1933 and 1934, which was passed in response to the Crash of 1929. Regarding the Martin Act, just after the Great Depression, in People v. F.H. Smith Co., the court took a blank check approach by saying that the act should "be liberally and sympathetically construed in order that its beneficial purpose may, so far as possible, be attained." Things were quiet on Wall Street until Jacob Javits (Representative and Senator in the 1960s) used the act for a political tool and had an attorney fresh out of Columbia Law School rewrite the act with all of the “piss and vinegar” he could muster to cover “cheats and swindles” and Ponzi Schemes. Eventually Governor Eliot Spitzer and the SEC evolved into power and active involvement in broker regulation and enforcement.

*Sarbanes-Oxley amends the Securities Act of 1933 and 1934 concerning auction –rate securities (ARS) to require the SEC or market self-regulatory organizations to adopt rules addressing self-interest and conflicts of interest and to report within one year.

Bringing the sword with a vengeance, Spitzer went after several companies, which you are certainly familiar with. You probably remember District Attorney Morgenthau’s case against Tyco, Jack Grubman’s $15 million dollar settlement for Citicorp, Enron and just about every security firm you can think of to the tune of $1.4 billion dollars in settlements.

So where will the new Martin Act subpoenas lead? Herein lies the importance for all of us who have portfolios and keep our eye on Wall Street. We have been following the intertwining of all these stories for months now; we have predicted closed door solutions, settlements and changing legislation. What we cannot predict is how this will wash out in the criminal courts.

I believe that we will see new evidence and documentation that will lead to further and deeper investigation of even more Martin Act subpoenas, more civil suits and settlements of companies whose names we have not yet heard. We will not see the betterment of the economy before the Feds analyze the blame. Many believe that the sword is so powerful that it leaves the defendants defenseless.

Will the conquistadors conquer again with the swift sword of the Martin Act? The acts, (as well as the actors), have been criticized quietly and publically for their overreach of power. As the blame trickles down, with new brilliant waves of New York attorneys, well trained in accounting, taxation, securities and business, will come new challenges to the conflicts of power given by the Martin Act and Sarbanes-Oxley. Could the two acts possibly be in conflict with each other?

At 30,000 feet it, looks like more legislation is needed. At a closer glance of 100 feet, it looks like the two acts are after the same villain: fraud. Perhaps what the sword and the pen should be concerned with is not the people as villains, but the methods used by Wall Street.

For example one could affix blame on market accounting. When markets are extremely inefficient and a void is created, the result can be that there is no market. How does one value an asset, marking the asset to the market valuation when there is no market?

These two similar, but uniquely different factions of law were designed to protect our Wall Street interest. Whether your money is in the form of a pension, pure stocks or cash in the bank, Sarbanes-Oxley and the Martin Act are having an effect on all of your assets.

Protection does come at a price; in these times, we are asking our legislators to be mindful of Excalibur wielding its power and costing the rest of us mucho dinero.

Until next time,

John Dietz
Senior Advisor
TrustMakers.com

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