Tag Archives: Private equity

The Dirty Little Secret Of The Dodd-Frank Legislation

“The dirty little secret of the Dodd-Frank legislation is that by failing to curtail the worst abuses of the OTC market in structured assets and derivatives, a financial ghetto that even today remains virtually unregulated, the Congress and the FED are effectively even encouraging securities firms to act as de facto exchanges and thereby commit financial fraud,” the Institutional Risk Analyst writes in its recent news letter.

“No more QE thank you please.¤

Institutional Risk Analyst


“With the passage of the Dodd-Frank Wall Street reform legislation, many financial analysts and members of the press believe that investment banking revenues and resulting earnings are in danger, but nothing is further from the truth,” the Institutional Risk Analyst writes.

The Volcker Rule and other limitations on the principal trading and investment activities of the largest universal banks do nothing to address the true cause of the crisis, namely the creation and sale of fraudulent securities and structured assets based on residential mortgages, toxic waste which was sold over-the-counter (OTC) as private placements and without SEC registration, according to the Institutional Risk Analyst, know for its regular publication of the IRA Bank Stress Monitor.

Here’ some more from the rather harsh commentary:

It is not own account trading but the derivatives sales desks of the largest BHCs whence the trouble lies.

Even as the big banks make a public show for the media of implementing the new Dodd-Frank law with respect to limits on own account trading and spinning off private equity investments, these same firms are busily creating the next investment bubble on Wall Street – this time focused on structured assets based upon corporate debt, Treasury bonds or nothing at all – that is, pure derivatives.

Like the subprime deals where residential mortgages provided the basis, these transactions are being sold to all manner of investors, both institutional and retail.

The Perverse Structure

It is the perverse structure of the OTC markets and not the particular collateral used to define these transactions that creates systemic and institution specific risk.

One risk manager close to the action describes how the securities affiliates of some of the most prominent and well-respected U.S.

BHCs are selling five-year structured transactions to retail investors.

These deals promise enhanced yields that go well into double digits, but like the subprime debt and auction rate securities which have already caused hundreds of billions of dollars in losses to bank shareholders, the FDIC and the U.S. taxpayer, these securities are completely illiquid and often come with only minimal disclosure.

The Dirty Secret

The dirty little secret of the Dodd-Frank legislation is that by failing to curtail the worst abuses of the OTC market in structured assets and derivatives, a financial ghetto that even today remains virtually unregulated, the Congress and the FED are effectively even encouraging securities firms to act as de facto exchanges and thereby commit financial fraud.

Allowing securities firms to originate complex structured securities without requiring SEC registration is a vast loophole that Senator Christopher Dodd (D-CT) and Rep. Barney Frank (D-MA) deliberately left open for their campaign contributors on Wall Street.

But it must be noted these same firms have a captive, client relationship with the FED and other regulators as well, thus a love triangle may be the most apt metaphor.

Of course retail investors love the higher yields on complex structured assets. Who can blame them for trying to get a higher yield than available on treasuries, while the FED keeps rates at historic lows to, among other things, re-capitalize the zombie banks.

The Only Trouble

The only trouble is that the firms originating these ersatz securities, as with the case of auction rate municipal securities, have no obligation to make markets in these OTC structured assets or even show clients a low-ball bid. And because of the bilateral nature of the OTC market, only the firm which originates the security will even provide an indicative valuation because the structures and models behind them are entirely opaque.

In fact, we already know of two hedge funds that are being established specifically to buy this crap from distressed retail investors as and when rates start to rise.

The sponsors expect to make returns in high double digits by making a market for the clients of large BHCs who want to get out of these illiquid assets. But the one thing that you can be sure of is that nobody at the FED or the other bank regulatory agencies knows anything about this new bubble.

As with the early warnings brought to the FED about private loan origination and securitization activities as early as 2005, the central bank and other regulators are so entirely compromised by the political pull of the large banks that they will do nothing to get ahead of this new problem.

Consider a specific example:

Shall We Reward Incompetence?  – The Case of Sarah Dahlgren and the FED of New York.

Read the rest at IRA’s homepage here.

Related by the Econotwist:

So, You Thought BP Was An OIL Company?

Webster Tarpley: The Financial Reform Is A Failure

Transantlantic Bailout Buddys Agree To Disagree

Civil And Criminal Probes Against JP Morgan For Silver Manipulation

Two Thirds of Americans Support Stricter Financial Regulations

Living In A Derivative World

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Geithner Warns E.U.

The U.S. Treasury Secretary Timothy Geithner warns the European Commission not to regulate hedge funds and private equity funds. In a letter he sent to the EU Commissioner for the Internal Market, Michel Barnier, Geithner criticizes the  proposed Directive which introduces tougher restrictions on investment funds.

“These new rules could harm U.S. hedge funds, private equity funds and banks and their ability to work in Europe. It could lead to conflicts between the U.S. and EU.”

Timothy Geithner


In a letter he sent to the EU Commissioner for the Internal Market, Michel Barnier, Geithner criticizes the proposed Directive which introduces more stringent restrictions on investment funds, the Financial Times reports.

“These new rules could harm U.S. hedge funds, private equity funds and banks and their ability to work in Europe,” he writes in the letter dated March 1th.

“It could lead to conflicts between the U.S. and EU,” he warns.

The changes, as proposed, would restrict European investors access to invest in funds outside the EU, and funds from other places would have to deal with new rules to operate within the EU.

According to the directive, EU-based funds would also be required to use local banks for parts of its business.

Other areas that can lead to conflicts are the rules on bonuses and fees, loan restrictions and the abandonment of sensitive information.

EU diplomats will meet Thursday to discuss the new proposal.

Inside the E.U. there’s also skepticism towards the new regulations, particularly in Britain because the directive could threaten London’s position as a financial center.

Here’s a copy of the full letter from U.S Treasury Secretary Timothy Geithner.

Related by the Econotwist:

Top 10 Risks of 2010

Central Bank Of Norway Call For A New “Global Order”

Bernanke: “We Welcome A Review Of The FED’s Management”

Financial Fetish

Ordnung muss sein

77% of Senior Bankers Expect Another Financial Crisis by 2015

The Bailout Package Under The Christmas Tree

ETF Investors Increase 1673%



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The Ethics of Financial Services in Europe

Doing business in Europe? Then you should read this blog post by CEO of Euro-Phoenix, Les Nemethy. The European business veteran provides unique and valuable insight of the regions financial advisory industry. And it’s not all reassuring.

“The ethics of your advisors are at least as important as their knowledge and technical skills.”

Les Nemethy


Over the past decade of operating my advisory firm, Euro-Phoenix, I have encountered relatively few instances where a financial advisory firm knowingly breached laws, industry or ethical standards; instances of overt contravention are relatively few and far between.

That does not mean that users of corporate finance advisory services should just assume that the issue of ethics is not important. Ethics are of paramount importance. Allow me to mention some areas where ethical issues can arise:

Potential Conflicts of Interest

Several years ago, Euro-Phoenix was working on the buy side of a cable TV mandate in Bulgaria. We uncovered some hidden liabilities on the target company. We did not hesitate for a second to disclose this to our client, knowing full well that we were eliminating the possibility of a success fee, but if you think about it, any advisor on the buy side of a mandate has a similar potential conflict.

Setting Fees

Fee structures agreed with advisors should be fully aligned with the interests of their clients. For example, if you hire an advisor to buy a company for you, and offer him a success fee based on a percentage of the purchase price, your advisor may have a conflict of interest. The higher the purchase price he negotiates, the higher his success fee will be, which is likely to produce an undesirable result. In my experience, a pre-defined lump sum fee works best in such circumstances.

Collecting Fees

Euro-Phoenix was once engaged in selling a major asset for a multinational corporation. We received four offers. Three of those offers came with an explicit bribe from the offering investors: help ensure that a particular investor obtains the asset, and work on driving the price down rather than up—and the investor would be willing to pay us a success fee even larger than that offered by our client. (When we expressed our concern to one particular investor, he hastened to add, “Don’t worry—you can collect the success fee from your client as well”!) Are you sure that your advisor will resist temptation? Some jurisdictions (e.g. the UK) specifically forbid financial advisors from collecting fees on both sides of a transaction.

Financial Advisors is also in the Private Equity Business

Can you be sure that there are strong Chinese walls in place? I am aware of one situation where a private equity firm related to a particular financial advisory firm made an acquisition in the cable TV area. Whereas previously the advisory firm had had a vibrant business in the cable TV sector, to the best of my knowledge it never achieved another mandate in that sector, because the owners or managers of cable TV firms could not be fully confident that their confidential information would not end up in the hands of a competitor.

Financial Advisors Provides Audit or Other Services to a Client

In a number of Central European jurisdictions (e.g. Croatia), it is forbidden by law for a firm that provides audit services to a client to provide financial advisory services or any other services to the same client. (The US, UK, and France, also have restrictive regimes, preventing audit firms from deriving non-audit fees from audit clients). The potential conflicts of interest are numerous. Obtaining a generous success fee on a corporate finance mandate could just provide the right incentive to be more “flexible” with respect to some sticky points in the audit.

I hope that the five illustrations above have at least given you pause for thought. The ethics of your advisors are at least as important as their knowledge and technical skills.


Les Nemethy is the CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on Mergers & Acquisitions.

Follow him at: http://twitter.com/lesnemethy

More blog posts by Les Nemethy.


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