February 29, 2008

How the SEC is Tackling the Subprime Crisis

Recently, SEC Chairman Cox delivered a speech about the subprime crisis. The SEC’s efforts include:

– Enforcement has created a Subprime Task Force to investigate possible fraud in connection with collateralized debt obligations and other subprime vehicles, as well as looking at whether bank holding companies and securities firms fully disclosed the risks of their CDO portfolios and valuations (and whether brokers followed suitability requirements in selling these securities).

– Market Reg (ahem, Trading Practices) is ramping up its “Consolidated Supervised Entity” program, which focuses on the quality of risk controls and liquidity for the largest banks, including the strength of their internal risk management and accounting issues related to off-balance sheet and CDO-related liabilities. I’m sure the newish Office of Risk Assessment will be providing input here.

– Corp Fin is reviewing the adequacy of disclosures by companies implicated in the subprime crisis.

If you want to brighten up your day with a little humor, take a look at this “Subprime Primer” that we have posted in our “Subprime” Practice Area.

Subprime Crisis: Congressional Pressure on the SEC

As noted in this article, Senator Jack Reed (D-RI) sent this letter to the SEC asking what is being done to increase transparency in the capital markets in light of the subprime, in particular why banks are not fully disclosing the risks posed by securitized loans. A few weeks ago, as noted in this article, Sen. Reed sent a similar letter to the FASB – and a letter to the IASB. These letters are posted in our “Subprime” Practice Area.

In response to a query in our “Q&A Forum” a few days ago, I breezed through some bank disclosures to review their “Risk Factors” and was surprised how few were tailored – even now – to what is happening in the markets and to each institution. Even though Kevin LaCroix reports in the “D&O Diary Blog” that the first subprime lawsuit filed has been dismissed, there are hundreds of credit-related lawsuits already filed (with undoubtably more to come) – so full disclosure would seem to be the wisest course.

Lynn Turner on the Recent Banking Crisis

Below are some thoughts from Lynn Turner, former SEC Chief Accountant, on what has been revealed recently at financial institutions:

Interesting that after the fiasco with the lack of controls at SocGen, we now have a control problem at AIG. And Merrill Lynch announced they didn’t even have a chief risk officer, and CitiGroup has been sued over the lack of transparency in their financial reporting. It appears this is somewhat of a systemic problem among financial institutions that the banking and securities regulators failed to regulate and get fixed.

The amazing and stunning run of articles on SocGen raise questions as to whether:

1. SocGen and certainly its investors could have benefitted by increased transparency with respect to its internal controls and assurance on whether they were operating effectively (which clearly they were not).

2. Did SocGen notify its independent auditors, which are two of the Big 4 firms, when SocGen was tipped off as per below to the concerns? And did SocGen have a risk officer, that when they were tipped off, should have stopped these risky activities with a lack of internal controls?

3. Whether a similar situation could/does exist with a US financial institutions given the concerns cited with respect to a lack of timely settlements of derivatives around the globe. This would seemingly be a material weakness that should be reported to investors if it did exist. Certainly it is a major risk so let us hope independent auditors have examined closely and carefully controls over such transactions, along with the federal banking regulators.

4. Why SocGen called the trader a “rogue” when the bank was tipped off to concerns about his strategy in November, but allowed him to continue trading while he was apparently generating gains. It appears only when the trades turned to huge losses that he became a “rogue” and someone to be throw under the bus to save others.

The Role of Boards in the Subprime Crisis

In this podcast, Ken Daly, President of the NACD, addresses the role of directors in the unfolding subprime crisis, including:

– Does responsibility for some of the elements of this debacle lie with the audit committees of companies only or does it lie with the entire board?
– Is government regulation vs. self-regulation by directors the answer to this crisis?
– What did the boards know and were there reasons why the quality of information going to the boards was inadequate to assess the risks of subprime mortgages?
– Do directors need different training, background or communications to prevent repeats of the credit crisis?

– Broc Romanek