Infectious Greed

by Frank Partnoy

  54 Jerry Hirsch, “Andersen Fires Executive Who Oversaw Enron Audit,” Los Angeles Times, January 16, 2002, p. A1.

  55 Kurt Eichenwald, “Enron’s Collapse; Audacious Climb to Success Ended in a Dizzying Plunge,” New York Times, January 13, 2002, p. A1.

  56 Loren Steffy and Russell Hubbard, “Enron Letter Shows Executives Knew of Partnership Accounting,” Bloomberg News, January 17, 2002.

  57 Enron 2000 Annual Report, p. 27.

  58 Mark Pittman, “Enron’s Fall Prompts Moody’s to Focus on Triggers,” Bloomberg News, December 7, 2001.

  59 Paul Chivers, “Empowering Enron,” Project Finance, June 1, 2000, p. 23.

  60 Richard Oppel Jr., “Enron’s Many Strands: The Hearings; Credit Raters to Explain Enron Role,” New York Times, March 20, 2002, p. C1; Alex Berenson, “Enron’s Collapse; The Rating Agencies,” New York Times, November 29, 2001, p. C7.

  61 James Higgins, “The Real Decade of Greed,” Weekly Standard, July 15, 2002, p. 27.

  62 Enron Form 8-K Filing, November 8, 2001, p. 9.

  63 Stephen Fidler and Vincent Boland, “Debt Mountains Threaten Avalanche,” Financial Times, May 31, 2002, p. 18.

  64 Mark Lake and George Stein, “Dynegy Saved Enron Merger with Last Minute Pact,” Bloomberg News, November 13, 2001.

  65 William Roberts, “Citigroup, J. P. Morgan Chase Offered Enron Packages,” Bloomberg News, July 23, 2002.

  66 Roberts.

  67 Roberts.

  68 Richard A. Oppel Jr. and Kurt Eichenwald, “Citigroup Said to Mold Deal to Help Enron Skirt Rules,” New York Times, July 23, 2002, p. A1.

  69 Oppel Jr. and Eichenwald, p. C4.

  70 Richard A. Oppel Jr., “U.S. Studying Merrill Lynch in Enron Deal,” New York Times, July 27, 2002, p. C1.

  71 Oppel Jr., “U.S. Studying Merrill Lynch in Enron Deal,” p. C1.

  72 Jathon Sapsford and Paul Beckett, “Enron Rival Used Complex Accounting to Burnish Its Profile,” Wall Street Journal, April 3, 2002, p. A1.

  73 Matt McGrath is not the trader’s real name.

  74 Jack Duffy, “Enron Collapse Destroyed Pensions, Prompts Calls for Change,” Bloomberg News, December 7, 2001.

  75 Enron Form 8-K Filing, November 8, 2001, p. 10.

  76 Spiegel.

  77 Loren Steffy, “Enron Insiders Sold More Than $1.2 Billion in Stock Since 1990,” Bloomberg News, December 3, 2001.

  78 “BusinessWeek Digitization Conference,” Darden School of Business, December 16, 2001.

  79 Richard W. Stevenson and Jeff Gerth, “Enron’s Collapse: The System; Web of Safeguards Failed as Enron Fell,” New York Times, January 19, 2002, p. A1.

  80 Malkiel, p. A16.

  81 Enron 2000 Annual Report, p. 30.

  82 Enron 2000 Annual Report, pp. 32-33. Assets from “price risk management activities” were $2.2 billion in 1999 and $12 billion in 2000. Liabilities from “price risk management activities” were $1.8 billion in 1999 and $10.5 billion in 2000.

  83 Ronald H. Coase, The Firm, the Market, and the Law (University of Chicago 1988), pp. 5-9.

  84 Michael Jensen and William Meckling, “Theory of the Firm: Management Behavior, Agency Costs and Ownership Structure,” Journal of Financial Economics, Volume 3 (1976), p. 305.

  Chapter 11: Hot Potato

  1 Robert Lenzner, “Someone Knew,” Forbes, March 4, 2002, p. 78.

  2 John Cassidy, “Comment: High Hopes,” The New Yorker, August 5, 2002, p. 21.

  3 Simon Avery, “Global Crossing Head Shows Passion for Making Money, Bending Rules,” Associated Press, March 5, 2002.

  4 http://www.cwpost.liunet.edu/cwis/cwp/but11/2001/ps/1.html.

  5 Julie Creswell, “The Emperor of Greed,” Fortune, June 24, 2002, p. 106.

  6 Edward J. Epstein, “Junk Bond King’s Next Step,” San Francisco Chronicle, October 9, 1987, p. C4.

  7 Laurie P. Cohen, “U.S. Appears to Intensify Campaign Against Milken,” Wall Street Journal, November 13, 1989, Sec. 2, p. 2.

  8 “Business Briefs,” Sydney Morning Herald, December 13, 1989; Kurt Eichenwald, “Prosecutors Said to Shorten Milken’s Pre-Sentencing Case,” New York Times, October 16, 1990, p. D1.

  9 Anthony Bianco, “Little Drexels Are Popping Up All Over,” BusinessWeek, October 6, 1986, p. 79.

  10 “One Man’s Junk,” Financial World, March 10, 1987, p. 20.

  11 Creswell, p. 106.

  12 Creswell, p. 106.

  13 Creswell, p. 106.

  14 Geraldine Fabrikant and Saul Hansell, “At Global Crossing, Deals with Son of Executive Raise Questions,” New York Times, February 18, 2002, p. C1.

  15 Global Crossing Ltd. Form 10-K for the fiscal year ended December 31, 2000.

  16 Creswell, p. 106.

  17 Paul Chivers, “Empowering Enron,” Project Finance, June 1, 2000, p. 23.

  18 Simon Romero, “Memo Indicates Global Crossing Chief Knew of Troubles,” New York Times, October 1, 2002, p. C6.

  19 David Barboza and Simon Romero, “Enron Is Seen Having Link with Global,” New York Times, May 20, 2002, p. C1.

  20 Barboza and Romero, p. C5.

  21 Barboza and Romero, p. C5.

  22 Dennis K. Berman and Deborah Solomon, “Optical Illusion?: Accounting Questions Swirl around Pioneer in the Telecom World,” Wall Street Journal, February 13, 2002, p. A12.

  23 Karen Kaplan and Elizabeth Douglass, “Global’s Exec with the Inside Knowledge,” Los Angeles Times, February 20, 2002.

  24 Berman and Solomon, p. A1.

  25 Dennis K. Berman, “Global Crossing’s Capacity Swaps Were of Little Value, Study Says,” Wall Street Journal, February 19, 2002, p. B6.

  26 Creswell, p. 106.

  27 Berman and Solomon, p. A1.

  28 Elizabeth Douglass and Tim Rutten, “Accounting Worried Global Crossing Exec.,” Los Angeles Times, January 30, 2002, p. A1.

  29 Laura Pearlman and Paul Braverman, “Unbillable Time,” American Lawyer, May 2002.

  30 Global Crossing Ltd. Form 10-Q for the quarter ended June 30, 2001.

  31 Douglass and Rutten, p. A1.

  32 Al Lewis, “Global Crossing’s Revolving Door Pure Platinum,” Denver Post, February 17, 2002, p. K-1.

  33 Creswell, p. 106.

  34 Specifically, Casey’s employment agreement omitted October 11, 2001, as a vesting date. According to the terms of the agreement, 34 percent would vest in 2000, 22 percent in 2002, and 22 percent in 2003. The agreement should have included 22 percent vesting in 2001, but did not. I am grateful to Andrew Kimmel for spotting this mistake.

  35 Elizabeth Douglass, “Global Eased Loan Terms,” Los Angeles Times, February 7, 2002, Part 3, p. 1.

  36 Rebecca Blumenstein, Deborah Solomon, and Kathy Chen, “As Global Crossing Crashed, Executives Got Loan Relief, Pension Payouts,” Wall Street Journal, February 21, 2002, p. B1.

  37 “Global Crossing Marine Unit Responds to Russian Submarine Rescue Effort,” Cambridge Telecom Report, August 21, 2000.

  38 Tim Cook, “Ebbers Recalled As Just One of the Guys,” Toronto Star, June 30, 2002, p. C3.

  39 Shane Holladay, “WorldCom Boss Recalled,” Edmonton Sun, July 28, 2002, p. 6.

  40 Scott Canon, “Telecommunications Mogul Is in a World All His Own,” Kansas City Star, October 4, 1999, p. A1.

  41 Holladay, p. 6.

  42 Cook, p. C3.

  43 Canon, p. A1.

  44 Holladay, p. 6.

  45 Gretchen Morgenson, “Despite Access, Star Analyst Missed WorldCom Trouble Signs,” New York Times, July 9, 2002, p. C1.

  46 Jack Grubman, Congressional Testimony, July 2002.

  47 Charles Haddad, Dean Foust, and Steve Rosenbush, “WorldCom’s Sorry Legacy,” BusinessWeek, July 8, 2002, p. 38.

  48 Haddad, Foust, and Rosenbush, p. 38.

  49 Charles Gasparino, Susanne Craig, and Randall Smith, “Two Congressmen Want to Know If WorldCom Executives Received Hot Shares in Bid to Curry Favor,” Wall Street Journal, July 10, 2002, p. C1.

  50 W
orldCom Revised Statement Pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934, July 8, 2002, pp. 2-6.

  51 WorldCom Revised Statement Pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934, p. 6.

  52 WorldCom Revised Statement Pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934, p. 6.

  53 WorldCom Revised Statement Pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934, p. 2.

  54 Michael E. Kanell and Russell Grantham, “WorldCom Scandal; CEO Had Great Run, Hard Fall,” Atlanta Journal-Constitution, July 1, 2002, p. 1A.

  55 WorldCom Revised Statement Pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934, p. 2.

  56 WorldCom Revised Statement Pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934, p. 4.

  57 WorldCom Revised Statement Pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934, p. 5.

  58 Morgenson, p. C1.

  59 Creswell, p. 106; Melvyn Westlake, “Surviving the Credit Crisis,” The Banker, May 1, 2002, p. 109.

  60 Westlake, p. 109; Stephen Fidler and Vincent Boland, “Debt Mountains Threaten Avalanche,” Financial Times, May 31, 2002, p. 18.

  61 Lenzner, p. 78.

  62 Nina Mehta, “Stress Test,” Institutional Investor, February 2002, p. 73.

  63 Mark Parsley, “Credit Derivatives: You Ain’t Seen Nothing Yet,” Euromoney, December 1997, p. 72.

  64 Federal Reserve Supervisor Letter SR 97-18, Application of Market Risk Capital Requirements to Credit Derivatives, June 13, 1997.

  65 Tom Kohn, “WorldCom Bankruptcy May Spark Payout on $10 Bln of Derivatives,” Bloomberg News, July 22, 2002.

  66 International Swaps and Derivatives Association, “Enron: Corporate Failure, Market Success,” April 17, 2002, p. 12.

  67 Shawn Tully, “Risky Business,” Fortune, April 15, 2002, p. 116.

  68 Ed Blount, “Can You Still ‘Know Your Counterparty’ in the Age of Enron?” ABA Banking Journal, April 2002, p. 41.

  69 Phillip L. Zweig, “Dizzying New Ways to Dice Up Debt,” BusinessWeek, July 21, 1997, p. 102.

  70 Grant Ringshaw, “Banks Pass the Bonds Buck,” Sunday Telegraph, June 30, 2002, p. 8.

  71 “Financial Fault-Lines,” Financial Times, March 2, 2002, p. 14.

  72 Westlake, p. 109.

  73 “Financial Fault-Lines,” p. 14.

  74 Westlake, p. 109.

  75 Greg Ip, “Credit Window: Alternative Lenders Buoy the Economy But Also Pose Risk,” Wall Street Journal, June 10, 2002, p. A8.

  76 Andy Serwer, “Dirty Rotten Numbers,” Fortune, February 18, 2002, p. 74.

  77 “The Jack and Jeff Show Loses Its Lustre,” The Economist, May 4, 2002, p. 58.

  78 “The Jack and Jeff Show Loses Its Lustre,” p. 57.

  79 Ip, p. A1.

  80 General Electric Form 10-Q, July 23, 2001, Item 1.

  81 Martin Mayer, “The Dangers of Derivatives,” Wall Street Journal, May 20, 1999, p. A20.

  82 “Global Financial Stability Report,” International Monetary Fund, March 2002.

  83 Stephen Fidler and Vincent Boland, “Debt Mountains Threaten Avalanche,” Financial Times, May 31, 2002, p. 18.

  84 Andrew Webb, “Four Questions Facing the Credit Derivatives Market,” Derivatives Strategy, April 1999, p. 31.

  85 John Ferry, “J. P. Morgan Refutes Credit Derivatives Wrongdoing,” http://www.risknews.net, February 27, 2002. In October 2002, I was retained to testify on behalf of a Korean party to a dispute with J. P. Morgan Chase related to credit derivatives based on Argentina’s debt.

  86 Tully, p. 116.

  87 Westlake.

  88 Jenny Wiggins, “Growth of Structured Finance Sector Set to Slow,” Financial Times, July 1, 2002, p. 26.

  89 Rebecca Bream, “Moody’s Expects Pressure on CDOs,” Financial Times, July 10, 2002, p. 31.

  90 Bream, p. 31.

  91 Britt Tunick, “Williams’ Boomerang: Should Merrill and Salomon Have Known before Pricing Convertible?” Investment Dealers’ Digest, February 11, 2002.

  92 David Barboza, “Complex El Paso Partnerships Puzzle Analysts,” New York Times, July 23, 2002, p. C1.

  93 Carol J. Loomis, “El Paso’s Murky Magic,” Fortune, July 22, 2002, p. 206.

  94 David Barboza, “Ex-Executive Says Dynegy Asked His Help to Cook Books,” New York Times, August 5, 2002, p. C1.

  95 Dan Colarusso, “Derivatives Under Fire,” Investment Dealers’ Digest, May 20, 2002.

  96 Heather Landy, “AOL Bonds Decline,” Bloomberg News, July 8, 2002.

  97 Wachtell, Lipton, Rosen & Katz, “Report to the Board of Directors of Allied Irish Banks P.L.C., et al.,” March 12, 2002.

  98 Deborah Solomon and Susan Pulliam, “Adelphia Off-Balance Sheet Debt Is Put Higher,” Wall Street Journal, April 3, 2002, p. A10.

  99 Gretchen Morgenson, “I.P.O. Plums for Titans of Telecom,” New York Times, August 4, 2002, Sec. 3, p. 9.

  100 Serwer, p. 74.

  Epilogue

  1 Frank Partnoy, “Financial Derivatives and the Costs of Regulatory Arbitrage,” Journal of Corporation Law, Volume 22 (1997), p. 211.

  2 Frank Partnoy, “Adding Derivatives to the Corporate Law Mix,” Georgia Law Review, Volume 34 (2000), p. 599.

  3 For an excellent article assessing the limits of the “rational actor” approach to thinking about the relationship between brokers and sophisticated customers, see Donald C. Langevoort, “Selling Hope, Selling Risk, Some Lessons for Law from Behavioral Economics About Stockbrokers and Sophisticated Customers,” California Law Review Volume 84, May 1996, p. 627.

  4 NASD Rule 2310.

  5 James D. Cox, Robert W. Hillman, and Donald C. Langevoort, Securities Regulation: Cases and Materials, 3rd ed. (Aspen Publishers, Inc. 2001), pp. 1146-1148.

  6 Frank Partnoy, “The Shifting Contours of Global Derivatives Regulation,” University of Pennsylvania Journal of International Economic Law, Volume 22 (2001), p. 421.

  7 Jeff Madrick, “Enron: Seduction and Betrayal,” New York Review of Books, March 14, 2002, pp. 21, 24.

  8 Enron’s 2000 annual report stated, “In 2000, the value at risk model utilized for equity trading market risk was refined to more closely correlate with the valuation methodologies used for merchant activities.” Enron 2000 Annual Report, p. 28.

  9 Partnoy, “Financial Derivatives and the Costs of Regulatory Arbitrage,” p. 211.

  10 Floyd Norris, “Accounting Reform: A Bright Line Vanishes,” New York Times, June 7, 2002, p. C1.

  11 Robert E. Litan, “Accounting and Disclosure after Enron,” Testimony before the Senate Committee on Banking, Housing, and Urban Affairs, March 2002, p. 17.

  12 United States v. Simon, 425 F.2d 796 (2d Cir. 1969).

  13 Floyd Norris, “An Old Case Is Returning to Haunt Auditors,” New York Times, March 1, 2002, p. C1.

  14 Frank Partnoy, “Barbarians at the Gatekeepers?: A Proposal for a Modified Strict Liability Regime,” Washington University Law Quarterly, Volume 79 (2001), p. 491.

  15 Frank Partnoy, “The Siskel and Ebert of Financial Markets?: Two Thumbs Down for the Credit Rating Agencies,” Washington University Law Quarterly, Volume 77 (1999), p. 619.

  16 Frank Partnoy, “The Wrong Way to Prosecute Fraud,” The San Diego Union-Tribune, May 11, 2002, p. G-3.

  17 Frank Partnoy, “Why Markets Crash and What Law Can Do about It,” University of Pittsburgh Law Review, Volume 61 (2000), p. 741.

  18 Frank Partnoy, “Multinational Regulatory Competition and Single-Stock Futures,” Northwestern School of Law Journal of International Law & Business, Volume 21 (2001), p. 641.

  19 Dirks v. SEC, 463 U.S. 646 (1983).

  20 James Grant, “Bargains Everywhere but on Wall Street,” New York Times, March 4, 2002, p. A27.

  21 Bridget O’Brian, “Enron Backer Gets $2 Million for 2001,” Wall Street Journal, April 3, 2002, p. C15.

  22 Grant, p. A27.

  ACKNOWLEDGMENTS


  I could not have written this book, or even imagined it, without the encouragement and vision of John Sterling at Henry Holt. Thank you, John, for your wisdom in directing this project, for your trust in me as a writer, and for your brilliant last-minute counsel. I also am very grateful to David Sobel of Times Books. Thank you, David, for your insistence that this book be broad in scope, for your uncanny ability to focus my thinking, and for your keen insights into how a reader best understands technical material. It truly was an honor to work with both of you.

  I am grateful to the staff at Times Books and Henry Holt, and especially Robin Dennis and Heather Rodino, for their skill in shepherding the manuscript through the editing process. I also want to thank Chris-tine Ball and Elizabeth Shreve for their untiring efforts in making this book a success.

  I especially want to thank my agent, Theresa Park. Thank you, Theresa, for taking me on as a client, for believing in my ability to pull off a “big picture” book, for being a hardnosed negotiator and lawyer, and for being a good friend and adviser. Yes, I am thinking about our next project.

  I received invaluable comments on drafts from Laura Adams, Rex Adams, Laurence Claus, Anna Coppola, Michael Devitt, Michael Greenberger, Peter Huang, Henry Kaufman, Donald Langevoort, George Needham, Helen Parry, Shaun Martin, Michael Rieke, Gregg Shapiro, John Tishler, Adam Winkler, and several others. Thanks to all of you for important insights, which greatly improved this book. Thanks to Andrew Franklin for helping me keep perspective. I owe special thanks to Dean Dan Rodriguez and the University of San Diego for their unwavering support.

  In researching this book, I conducted more than 150 interviews of traders, regulators, corporate executives, and others, most of whom—understandably—wished to remain anonymous. I have honored those wishes, and I do not cite these individuals directly; I am grateful to each of you. I am especially indebted to Andy Krieger for agreeing to do interviews on the record. I also want to thank the many business reporters who agreed to share information with me about their various investigations.

  Finally, thanks to Alan Greenspan for coining the phrase “infectious greed” in July 2002, just as I was abandoning hope of finding a pithy title that captured both the financial theme and viral metaphor of this book.