Introduction
The world economy is facing its worst economic crisis in decades since the last one in 1945. Among the overall slow world growth, recession, laid off employees and high commodity prices, the United States, being the only world superpower and the central economy of the world, is faced with a huge number of problems. Amidst growing dissatisfaction in investors, both internal and external, over the state of the economy is resulting in precautionary mode of actions resulting in falling stock prices.
Likewise, high amounts of initial investments in home mortgage schemes and the overall US economy resulted in good growth in the years 2006 and the beginning of 2007, causing inflation and hence an increase in the overall basic commodity prices.
Growing dissatisfaction due to decreased confidence in the policies of the last US administration, a very high investment in supporting war on two fronts, the energy and fuel dependence on external sources and a large US current account deficit resulted in reduced investments in the economy.
High commodity and raw material prices resulted in increased, and highly unmanageable cost of operations for the businesses reliant on the US economy, specifically due to the failure of the Bretton Woods II system (Global Research Canada, 2008) (of US dollar as the world’s central currency), resulting in bankrupt businesses, loss of jobs and a stark increase in overall unemployment, standing at 7.2% in December 2008. (The Economist, 2009). Keeping such an economy moving, in the times of the great recession like the current one, supporting those unemployed, keeping up with the growth is a cumbersome task that has a large number of complications surrounding it.
Among organizations that are the first to be affected by the economic and financial crisis of the US have been major investors, brokerage houses, equity traders that have had large amount of investments from the public sector. Companies like Citibank, Morgan Stanley, JP Morgan Chase and Bear Stearns faced the worst of financial instability, and suffered losses amounting in billions of dollars. Failure of organizations to cope with the problem has been in part due to the failure of regulatory policies and procedures that govern the financial system of the economy, and on the other side, has also been due to bad practices of organizations to follow processes, identify and mitigate risks.
Some of the major names in the capital markets have faced defeat in face of operations performed in an unethical, illegal manner and failure to adhere to practices. For our analysis, we have chosen Bear Stearns to identify the list of possible behaviors contributing to its failure and subsequent acquisition by JP Morgan, the legal and ethical problems faced by the company in wake of the approaches of doing business followed by the company.
Background
Bear Stearns, an 85-year old company at the time of its sale to JP Morgan Chase, was one of the largest global investment institutions, securities trading and brokerage firm, formed by Joseph Bear, Robert Stearns and Harold Mayer with an initial investment of US $ 500,000 in capital. Through different subsidiaries, Bear Stearns provided asset management, lending, and merger and acquisition services (Sheldon Liber, 2008) to its clients.
The company was headquartered (Answers.Com, 2006) in New York, and a major share of the firm’s business was focused on providing services in three principal areas: capital markets, wealth management, and global clearing services. With offices in major cities all over the globe, a major reason of the company’s inception was clearly in response to the booming investment climate of the early 1920s. Tremors post-World War I resulted in heavy demand for capital, influencing general public towards entering the securities market, giving way to Bear Stearns to prosper and take advantage of the public’s interest in this area. Soon, the company also started catering in government securities, soon gaining ground in this domain as well.
Bear Stearns was among only the few companies that survived the NYSE crash of 1929, amidst setbacks such as stark decline of trade. In wake of the present crisis, Bear Stearns had accumulated enough capital to survive quite well: no employee was laid off by the company. The company soon forged a reputation of entering into the bond market through promotion, in an answer to President Roosevelt’s call for renewed development.
In the period after the initial realization of Roosevelt’s reforms, a large amount of cash had accumulated in the nation’s banking system, due to lower demand of loans. Simultaneously, bonds were very cheap. Bear Stearns cashed in for its first share of substantial profits by selling bonds to banks high in cash.
Bear Stearns’ operations were highly influenced by its chairman, Salim L. “Cy” Lewis, who built the company into a large, influential firm. Lewis’s outspokenness and drive had made him a legend in Bear Stearns as well as other business circles, and these qualities were what gave Bear Stearns the style that made it stand out on Wall Street for decades to come.
Opportunities came in the way in 1940s from an uprising revolution in the freight and transportation industries. With engineering excellence in auto manufacturing sectors and the cost-effectiveness of the aviation industry, this directly impacted the railways industry. The company saw it as a major bright prospect to capitalize on its services of mediating between railways companies going bankrupt and playing an effective role in their subsequent mergers and acquisitions.
The 1950s saw, that, under the leadership of Lewis, the origination of block trading which, by the next decade, was the only option of survival for most of the Wall Street. Before the SEC’s Security Act amendments became fully effective in 1975, Bear Stearns was among the few companies that benefitted to greater extents.
Bear Stearns soon developed reputation of being the frontrunner by beginning to expand retail business operations in the late 1960s. The company extended its operations to facilitating the management of investments for individuals, businessmen and corporate investors, as well ultimately laying foundations for margin operations, the company’s successful new area of business. Margin trading allows for brokerage houses to loan their clients’ securities to short sellers, while comparing funds with their own capital and using the entire amount to finance trade, paying interest on the amount loaned.
1975 proved to be another pinnacle for Bear Stearns, when it invested $ 10 million in New York’s securities, to save the city from bankruptcy. Although the risk was very high when compared against the losses amounting to millions of dollars, the company eventually came off as a winner placing stakes on this dark horse.
They say that with each risk comes a dose of overconfidence. Same was the case with Bear Stearns. It’s passion to take risks no matter what brought it into a new arena to try itself, corporate takeovers, voluntary and hostile. The company was often dubbed as “masterful at disguising takeover maneuvers” that also earned it negative publicity and dislike among different business sectors.
The company became highly unpopular in its practice to engage in “mock battles” with clients, as happened with GNR (Global Natural Resources), once the company determined that GNR’s management had undervalued its assets and that greater profits could be appreciated. In a surprising move to help with corporate takeovers, the company introduced and encouraged an “option agreement” allowing clients to buy stock in the company’s name, which was later put to a forced shameful end in an act by The Department of Justice and Securities & Exchange Commission, through the filing of lawsuits against several clients, all of which were eventually settled.
The 1987 crash of Wall Street devastated the company, resulting in involuntary vacation and elimination of various posts in the organization. However, with the economy eventually stabilizing, this change helped in increasing brokerage commissions and revenues from its investment banking division, to a significant extent. Finally, the company had achieved the position of becoming the top equity underwriter in Latin America. By 1992, the company had successfully included capital industry, biotechnology, and machinery stocks in its ever-expanding analysis of the corporate sector.
In 1992, the company included new industries into its fleet of providing consultation and analysis services to its clients, machinery stocks, biotechnology and the capital industry. The company also became a dominant party in the clearance of trades for other brokers and brokerages.
One of the company’s major strategic targets was to ensure its presence in major markets across the globe, which resulted in its focus towards new emerging economies in Asia and Latin America. The company started its operations in Asia with a representative office in Beijing in 1994, the addition of which, being close to Bear Stearns’s Hong Kong headquarters was recognized as an important milestone and a show of respect to China as a formidable challenge to the US stance as the sole world economic superpower.
The company again faced the music when it became the face of negative publicity due to a SEC investigation initiated to determine its role as a clearing broker for A.R. Baron, already gone bankrupt in 1996 and later defrauding its customers of $75 million (Larry Allen Bear, 2007). Bear Stearns was accused of crossing its boundaries in its role by continual processing of trades, loaning money, and extending credit to its client although knowing through piling up evidence that the firm, already in serious financial jeopardy, was behind stock prices manipulation and unauthorized trading while marauding customer’s accounts
Bear Stearns eventually agreed to pay a total of $ 42 million in fines and restitution, to settle all civil and criminal charges filed by the SEC and the Manhattan District Attorney, in summer of 1999, respectively. Nevertheless, the scandal adversely affected the image of the company as a result of which, shares of its stock were generally traded at discounted prices for the next two years.
The dawn of the new century arrived with a weakening economy, alarming Bear Stearns of its insecure position. Unexpectedly and almost abruptly, the company’s stock price was in a two-year slump; it was one of the last independent financial services firms on Wall Street, by the mid of 2000, in the midst of high incidence of mergers and acquisitions in the securities industry. It was indeed a challenge competing with companies, gaining ground through mergers with globally “sound” companies; however Bear Stearns was in no hurry to reply.
Rumors were that Bear Stearns would turn itself in the hands of a larger financial group in order to gain a place in the international markets as well. This had been the case previously with Donaldson Lufkin and Jenrette, PaineWebber, J.P. Morgan, and Wasserstein Perella. These rumors served their purpose, appreciating Bear Stearns’s stock value, and later, the company’s earnings reports proved the company’s capabilities as well.
Post 9/11, amidst high distress in context of national security, and badly shaken consumer confidence, the economy appeared to be spearheaded into a recession. Bear Stearns, had to bow down to the need to reduce expenses by laying 800 of its bankers, making up about 7 percent of the workforce.
The company continued to operate differently than the rest of Wall Street, and this paid off to the company’s advantage in the early 2000s. The company had lost much of its competitiveness in providing consultation to clients on mergers and acquisitions thereby being among the few ones to avoid major losses while the entire industry was facing a sharp decline. Even more, the company, through its focused vision on operating primarily as a clearing house, perfecting itself by increasing focus on productizing mortgages, reported first-quarter profit increase in 2002, demonstrating its resilience and its competitive edge once again, the only securities company to do so.
Bear Stearns came into crisis during 2006-7, in wake of the subprime mortgage crisis. The company was eventually sold to JP Morgan Chase in 2008 to divert the risk of sudden failure of the firm, after approval from the shareholders, while the company had been fighting off various legal issues, investigations, probes and ethical issues raised by different bodies / individuals over time. The company was finally sold at a share price of $ 10 per share, after shareholders’ (Money-Rx Blog, 2008) outcries resulted in a changed decision from $ 2 per share.
Ethical Analysis
The financial and investments managers at Bear Stearns engaged in unethical practices through ignorance and failure to follow procedures in the rule book that ultimately resulted in affecting millions of people, through breach in communication, while abusing the mortgage markets, leading to its collapse in March 2008.
The most significant ethical breach (Ryan Bryner, 2008) for Bear Stearns came in the face of its negligence to adhere to standards / guidelines of business. For example, there are specific guidelines specifying criteria that must be met for a home to be mortgaged. A home in the United States cannot be mortgaged if its sale price is more than four times the combined household income of all earning members, simply disregarded by Bear Stearns executives and continual of operations.
Another source of ethical failure on Bear Stearns’ part was to incorrectly anticipate the gravity of the situation and relying on false assumptions to carry out its business operations and future investments, resulting in insurmountable losses to the company. Bear Stearns carried out future loan product decisions based on the assumption that there would always be appreciation in the prices of homes, the economy would always be in growth mode, the US is the sole economic superpower, and dollar would prevail Euro as the international currency, and oil prices would increase at normal inflation rates, incomes would be rising and jobs will show significant growth.
Failure to communicate the potential risks and aversion strategies was also one of the major breaches of ethical performance by Bear Stearns to its borrowers. This was done at multiple stages. Firstly, Bear Stearns failed to disclose risks to borrowers in case of the failure of these assumptions. Secondly, in case of failure, which was quite likely in light of these unrealistic assumptions, the role of Bear Stearns was not defined.
Executives at Bear Stearns failed to communicate the same high risks to the board of directors and the stockholder, when sub-prime mortgage industry started to evolve, risks that were associated with the previously listed assumptions if they did not hold true. When the market collapsed because of the mortgage failures, these same executives implemented their plan without communicating the potential risks and, yet, accepted and received excessive compensation and golden parachute agreements. Decisions that created problems were not stopped or examined for appropriateness, nor was any accountability or responsibility accepted in this context.
Ethical Philosophies
In light of the seven philosophies discussed, we find the discussion of the following, in light of the Bear Stearns case suitable:
- Operations of the firm, aimed at serving their own interests, exhibit a high amount of egoism in the company’s culture. It was the perseverance to serve one’s own interests that resulted in Bear Stearns’ failure to communicate the risks to their own stakeholders, the contributing members of the firm that had a high involvement in the advancement and growth of the company.
- The firm’s dealings with customers and failure to realize the aftereffects of its negligence, also show a lapse of the failure of justice of an organization towards its significant parts, portions that form a large part of the organization, in supporting what the organization does and the future direction of its operations.
- The company during its 85-year history has been involved in attempts to coerce smaller companies to ensure easier acquisitions, in an attempt to become leader in that industry as well. Hostile takeovers have resulted in earning negative reputation for the company. The end result of this could be more success and business for the firm, however the means created for such acquisitions were not justified, pointing towards the failure of deontological ethical systems.
Legal Analysis
The company has been overshadowed by legal issues during its lifetime. One of the first major legal issues came in face of Bear Stearns’ as a clearing broker for a small brokerage firm, A.R. Baron that filed for bankruptcy in 1996 and later defrauded its customers of $ 75 million. Bear Stearns was the first company to be accused of supporting over and above its head as a clearing house by continuing to process trades, loan money, and extend credit to Baron in the face of mounting evidence that the firm was in serious danger, and was simultaneously busy in manipulating stock prices and conducting unauthorized training.
The company was also fined by National Association of Securities Dealers (Lisa Roner, 2004) in association with Deutsche Bank and Morgan Stanley, a staggering $ 4.95 million fine for Bear Stearns on the allegation that the bank broke rules by taking unusually high commissions from certain customers on routine trades “within one day of allocating shares in ‘hot’ IPOs to those same customers.”
Later on, in 2008, the firm was faced with a SEC probe Bear Stearns trading data to determine any unauthorized trading, constituted manipulation or actions contributing to the firm’s collapse. SEC’s probe report stated that trading records (Reuters, 2008), which were reviewed by The Wall Street Journal, open a window into the frenzied selling amid a bank run on Bear Stearns in March.
Weeks before Bear Stearns collapsed, “Goldman, Citadel and Paulson exited about 400 trades”. An important thing to note in this regard is that Bear Stearns was the trading partner in these cases, higher than any other firm, as shown by data, according to the Journal report.
The SEC then asked Bear Stearns to highlight any unusual activity in the trading documents, as expected. However, no misgivings on part of the company were discovered on examining the documents, the report said.
Factors to Consider
The company’s failure could be attributed to a variety of reasons, ethical, legal as well as policy governance. But the company’s failure is more of a failure of phenomenon rather than an individual’s failure. Failure could be averted by communication at all times with the major shareholders in the firm, with the businesses, with the regulatory authorities.
- Identification and mitigation of risks associated with the investments should have been identified and communicated to appropriate stakeholders
- Trading with other companies should have been performed with caution.
- Adherence to regulatory standards should have been maintained and monitored on a regular basis.
Conclusion
Bear Stearns had long been the favored company in the market, with formidable reputation and presence. However, its willingness to push itself to the limits, taking unmanageable risks and failure to manage it resulted in the company’s downfall and subsequent failure.
Works Cited
Answers. (2006). Bear Stearns. Web.
Bear, Larry Allen (2007). Managing ethical risk: The securities industry and the law. Stern School of Business, New York University. Web.
Brookins, H. C. (2006). An Overview of the Global Economy: Markets, Competetiveness and Trade Facilitation. (O. A. Oyewumi, Interviewer).
Bryner, Ryan. (2008). Economy Awareness Seminar 2008. Web.
Finlay on Governance. (2008). Outrage of the Week: Leadership Fiddles While Bear Stearns Burns. Web.
Global Research Canada. (2008). Breakdown of the Global Monetary System by Summer 2009. Web.
Liber, Sheldon. (2008). Companies that vanished: Bear Stearns – A lesson learned?. Web.
Money-Rx Blog. (2008). Bear Stearns Shareholder approve JPMorgan sale. Web.
Reuters. (2008). SEC to probe Bear Stearns Trading Data.. Web.
Roner, Lisa. (2004). NASD fines three banks $ 15 million over floatation prices.. Web.
The Economist. (2009). Human Capital and the Crisis – Swinging the Axe. The Economist , pp. 88-89.