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INVESTING: Candid e-mails chip away at Wall Street's credibility

August 11, 2008

E-mail, today's ubiquitous form of communication, is proving to be the smoking gun in a number of recent financial fiascos.

The Securities and Exchange Commission recently released a draft of its investigation into the behavior of bond-rating firms during the subprime-mortgage-securitization craze. The report highlighted e-mails expressing the sentiment of the authors during the period-a sentiment in conflict with the Wall Street sales pitch being used to sell these securities to investors.

One e-mail a Standard & Poor's analyst sent to a colleague called a particular mortgage deal "ridiculous" and said, "We should not be rating it." The employee emailed back, "We rate every deal," and added, "It could be structured by cows and we would rate it."

In another e-mail, an S&P analyst wrote a senior manager that rating agencies continue to create an "even bigger monster-the CDO [collateralized debt obligation] market. Let's hope we are all wealthy and retired by the time this house of cards falters."

E-mails were instrumental in a civil complaint filed by New York Attorney General Andrew Cuomo accusing UBS AG of fraud in its dealings with clients in auction-rate securities.

The complaint alleges that seven UBS executives sold $21 million of their personal holdings in auction-rate securities based on their knowledge of problems in that market. During an exchange of e-mails between the executives last December, UBS' chief risk officer outlined the distress in the auctionrate market. Massachusetts regulators have sued Merrill Lynch for unloading collapsing auction-rate securities on unsuspecting customers. In this case, a Merrill analyst had issued a report in August 2007 suggesting that auction-rate securities might encounter problems. The director of Merrill's auctionrate desk sent an e-mail to company executives complaining that the report could undermine the auction-rate market.

According to the complaint, Merrill's research department retracted the original report and replaced it with a report alerting investors that auction-rate securities were "a buying opportunity for investors who are looking for short-term investments." Later that year, the same director sent an e-mail to an associate saying Merrill had to slash prices to sell its inventory of auction-rate securities, writing, "Gotta move these microwave ovens!!"

It was e-mails that contributed to the arrests of the two Bear Stearns hedge fund managers whose bad bets on subprime mortgage securities caused the loss of $1.6 billion in investor assets. The government claims the managers attempted to keep worried investors from fleeing their hedge funds, and deceived them by not disclosing how badly the funds were doing.

The moral of the story? Well, a cynic would say: Don't put what you really believe into your e-mails. Sadly, this latest round of hypocrisy has left investors once again questioning Wall Street's integrity.



Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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