August 7, 2018
News broke last week that the feds decided to stop torturing Jesse Litvak. Jesse, you may recall, was a mortgage-backed securities sales-trader charged with criminal securities fraud. Jesse, in selling to an institutional customer, told the customer that he was flipping the bond to it after just having bought it himself at the customer's price. Instead, Jesse had it in inventory at a much lower cost. Jesse was twice tried, twice convicted, and twice freed on appeal. The government announced it won't try him a third time. Jesse persisted, won, and I say, good for him.
There's a lot of technical stuff in the Second Circuit Court of Appeals' May 3rd decision in Jesse's favor. United States v. Litvak (Opinion, 2Cir, 17-CR-1464 / May 3, 2018)
But the image I got reading it was of the judges rolling their eyes at the SEC and the Department of Justice for being so priggish to even charge him. I imagined a bubble over the Judges' heads saying, "You mean to tell us that you guys were shocked -- Shocked!! -- to learn that salespersons bullshit when they sell???" After all, Jesse Litvak's institutional buyer (a) had independently determined the price it was willing to pay for the bond, (b) had not relied on Litvak for any information in setting that price, and (c) asked only to acquire it at or below that price. Litvak delivered the bond at the customer's price. All the rest -- Litvak's prattling about how hard he had to work to get the bond, how lucky the buyer was to get it at its price, and how worthy Jesse was to earn a commission -- could have made no difference. In legal terms, Jesse's lies were not "material," because how and when he got the bonds didn't matter to the customer's internal investment decision to buy them at a certain price. The price mattered; the rest of Jesse's shtick was just bullshit.
In a neat little book entitled, appropriately, On Bullshit, Princeton philosopher Harry Frankfurt actually defined it. Bullshitting, Prof. Frankfurt argues, is different from lying. A liar knows the truth and intentionally conceals it. The bullshitter, on the other hand, doesn't care what the truth is. The bullshitter's objective isn't to spread lies, it is to achieve something else. He will say whatever he needs to achieve his objective. The bullshitter doesn't care if what he says is true, false, both or neither, so long as it serves his goal. Jesse's goal was to sell that bond. He used the art of the bullshit in doing so. Anyone shocked by this has led a more sheltered life than is healthy.
Bullshitting and selling securities are so conjoined that I question the point of many efforts to regulate it. The problem stems from the very nature of financial instruments. Securities are not like computers or locomotives. Having no "use" as such, securities cannot be measured by their real world function, performance or quality. The value of a security embodies only a prediction of what someone else might pay for it for in the future. And no one can predict the future well enough. Oh, we try. Once, we used crystal balls and chicken entrails. Today we are more comfortable using spreadsheets and probabilistic modelling. Whether we've progressed much is anyone's guess. But no one should be surprised that bullshit is in the very DNA of selling securities. If I want to sell Facebook stock, I can give you dozen reasons why it will rebound in a year; if I want to buy it, I can give you a dozen reasons why it won't. I can make all those reasons convincing. But either way, I'd be bullshitting to get the order I want, because, in truth, I have no idea what Facebook will be a year from now and neither does anyone else.
Does this mean that bullshit should always be legal? Not quite. Consider the Supreme Court's 2015 decision in Omnicare, Inc., et al. v. Laborers District Council Constr. Ind. Pension Fund, et al.
Omnicare's management was held liable for making false and misleading statements in SEC filings. Management stated its "opinion" that certain of its major contracts were valid and legally compliant. They weren't. Management's excuse? It was just their opinion!
The Supreme Court -- unanimously I should add -- didn't buy it. Omnicare's management was liable because it had no rational basis for its "opinion." It hadn't even consulted its own counsel. Management's opinion was nothing more than its own wishful thinking foisted on its unsuspecting shareholders. Pure bullshit!
So no, bullshit is not always legal in the securities field. It depends on the listener. Omnicare's shareholders had a right to management's honest and reasonable opinion. However, Jesse Litvak's bullshitting was just what salespersons do, and we all know it.
So, good for Jesse. Securities salespersons will bullshit. That is in their nature and to try to control it is a fool's errand. Under its new leadership, the SEC says it is focusing on the most vulnerable, main street investors. If so, it should start with the first of the great lies, broadcast unceasingly in the media ads of every large firm, that one's "future financial security" can be ensured by listening to a stock broker. Regardless, it's a right step away from the creeping paternalism of the past. A few years ago I heard an SEC official argue that sophisticated institutional investors needed as much protection as everyone else because, with so much to read, they had "limited bandwidth." Puh-leeze! Yes, there is fraud on Wall Street. There are schemes designed to cheat even sophisticated investors in ways so obscure the victims don't even know they are being cheated. But to unearth those frauds, the SEC will need to dig deep. It can't afford to wallow in the shallow mires of salespersons' bullshit.
ABOUT THE AUTHOR
Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice
380 Lexington Avenue
New York, NY 10168
Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters. Mr. Frumento has also represented clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents.
Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.
He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.
NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of BrokeAndBroker.com Blog.