Rick to your point on Enron. We agree that insiders committed fraud and the shareholder are entitled to file a derivative suit to force the insider to disgorge their profits to the corporation. But their ill gotten gains are tiny in comparison to shareholder losses. Consider the raptor transactions; they faked trasactions and booked huge profits. A couple guys stole a few million as commission, a few others sold stock and netted a few million. But the profits convinced investors wage hundreds of millions on the company. How do they collect those hundreds of millions? Insiders don't have it and didn't steal that much. If the auditors perpetrated the fraud, they can be sued too, but that hasn't been shown; Auditors are entitled to rely on the data provided them (they were convicted of Obstruction of Justice, after all the hooplah had occured). Plus they BKed. So no one who committed the evil deeds has the funds to bring shareholders their lost investment. So they are, and will continue to be, screwed.

I think Ari's point, but I'm not sure, is that something must be done and my answer is "not legislatively." This is simple fraud that aggregations of wealth are always subject to. The Economists has a funny article on Corporate reform, how British, American and German boards are structured differently, but all of their business communities get sucked in by fraud. The point being that no structure weeds out that most base of human impulses.

[RM requests clarification: When you say "Not legislatively," are you saying (1) the feds shouldn't insure against these kinds of losses, (2) additional criminal lor civil liability for such wrongdoers is not appropriate, (3) new federal regulation isn't warranted, or (4) something else? I would start my amoral diatribe now but I'm all drunk and would hate to waste my muse on a misunderstood position. Also, what does "BKed" mean?]

Sony tries to clarify, but his thinking is admittedly loose (1) yes, (2) yes (since they're pretty hefty now, as long as the prosecutors don't take the short cut and deal, like they did with Milken and Boesky) (3) yes and (4) my point is that litigation & existing rules will handle the current mess and that nothing will prevent fraud, so lets not punish/burden the innocent. Sorry, BK is short for bankruptcy- so much of it going around we developed a short hand. I assume your SOU drinking game went well? Are you able to tell me how I should feel? Was he robust and strong? Did Elizabeth Dole get moist?

Rick mostly agrees: I'm with you on points 1 and 2, but disagree on point 3 and partly disagree on point 4. Existing laws and litigation aren't handling the current mess because they will fail to (1) make whole those who were wronged and (2) restore the average persons confidence in the equity markets. The second part is the larger problem. I think you would agree that over the last 10 years or so for a number of reasons the average American has become more heavily invested in equities. This has been good for a number of reasons, not the least of which is that it resulted in a robust IPO market which in turn made financing available to new and innovative companies that created jobs and economic growth, both delicious things. The current crisis is really the first crisis in that new reality. I think that what the average investor has learned is that you can't rely on financial statements, that financial advisors, auditors, and corporate managers don't necessarily have the same interests as public investors, and that when you get burned that money is gone forever, even if the loss is caused by outright fraud. And the average investor isn't going to have the resources or sophistication to, say, interview company management or scour companies' books. The proper response to this crisis would have been to both introduce legislation and fund enforcement to restore the average investor's confidence in the reliability and transparency of financial statements and to align the interests of the average investor with the interests of financial advisors, corporate managers and auditors. It's simply not enough to tell Joe Sixpack that he needs the knowledge of a CPA or JD to be able to make informed equity investment decisions and that if things go wrong he's SOL because he can't afford to litigate against an Enron (granted he could join a class action, but that rarely fails to make any investor whole) and even if he could, there's nothing left to take from them. All that says to me is stuff your money in a mattress, and that belief isn't going to do anybody any good.

[Erik wonders: Wasn't it federal tinkering with the tax code that encouraged companies to give out lavish stock options as benefits to senior management, thus setting the stage for the corrupting of corporate goals to the point where the day's stock price was the only thing that mattered to them? [Don't know what exactly you're referring to. Anyone? - RM] I could be wrong, and often am on these matters, but it would seem that some minor legislation to fix this problem would be in order. I'm not sure, though, that I like what Rick seems to imply, that the government should protect Joe Sixpack from his own bad investments.] [Insuring against loss, or prohibiting overly risky investments would undoubtedly be protecting JS from his own bad investments. Enacting and enforcing rules requiring that financial statements acurately and completely reflect the financial health of a company and also requiring independent auditors be actually independent isn't, IMHO. The later measures do, however, dramatically reduce transaction costs and help to ensure that equity prices reflect business risk rather than the risk that company management is a bunch of lying bastards. I suppose one could argue that securities regulation is a bad thing altogether. For an example of how that works, see, e.g., Russia and its thriving financial markets.]

[Erik blockquotes from some thinktank:]

One fast-growing tax break that had a very significant effect in lowering taxes involved stock options. When stock options are exercised, corporations can take a tax deduction for the difference between what employees pay for the stock and what it’s worth—even though in reporting profits to shareholders, companies don’t treat stock-option transactions as business expenses. ITEP found that 233 of the 250 companies lowered their taxes from stock options, by a total of $25.8 billion over the three years. Microsoft led the pack with $2.7 billion in stock-option tax benefits—reflecting the fact that stock option tax benefits are dependent on how much a company’s stock has gone up in value, and thus the tax savings were especially large in high-tech industries whose market valuations zoomed during the three-year period.

[Oh, dats what dey is. Personally, in my tiny, tiny, mind, that's not telling me that that has any impact in the recent wave of corporate scandals, although I do think that it's a lame-ass tax subsidy. I mean, there are other reasons to favor stock options as compensation. Most importantly, for example, is that they are taxed much more lightly in the hands of the employee than ordinary cash compensation would be, so the employee gets a better net return. Another is that the options aren't cash out of pocket for the employer. Even if the tax subsidy were the primary motivation for this type of compensation, I don't see why it's bad. I mean, if the corporate managers are shareholders, then doesn't that align their interests with the other shareholders. If on the other hand, their compensation were solely in cash, wouldn't they be mostly interested in extracting cash from the company? But perhaps I'm not seeing the arguments on the other side, which perhaps you will kindly provide me. - RM]