A Matter of First Impression
In a matter of first impression in Puerto Rico, and applying Delaware law, District Judge Gustavo Gelpi dismissed all the claims against 11 defendants, all of whom were the most senior executives at Westernbank, formerly Puerto Rico’s second largest bank. Westernbank, a $10 billion bank with hundreds of branches scattered throughout the island, was closed by the FDIC in 2010 for reasons unrelated to the lawsuit.
The derivative lawsuit, brought by a shareholder of the bank, alleged that the majority of the board of directors and senior management purposely ignored the warning signs of a massive, $200 million structured fraud initiated against the bank’s asset based lending division by a significant client of the bank. The shareholder claims included breach of fiduciary duties as officers and directors of the bank, waste of corporate assets, unjust enrichment, Sarbanes-Oxley violations, and violations of numerous Puerto Rican statutes.
Attorneys Carlos F. Concepcion, Manuel A. Rodriguez and Scott A. Burr, and Forensic Investigator and CPA Francisco Gomez, assisted the Special Litigation Committee of the board of directors in determining the viability of multiple derivative claims initiated against the bank’s officers and directors.
The investigation involved a review and analysis of over 100,000 documents related to the fraud and interviews of nearly 40 bank officials, directors and officers with knowledge of the events leading to the fraud. The Committee’s report, a nearly 200 page single-spaced report detailing its factual and legal analysis, was ultimately filed with the court along with the Committee’s motion to terminate or otherwise dismiss the case. The factual investigation also required detailed analysis of Westernbank’s internal control systems and their remediation that resulted from nearly a dozen third-party reports and analysis.
Resolution of the derivative claims required a full and thorough investigation, however, as the Committee had to be careful not to enhance or otherwise fuel the parallel class action case that was asserted concurrent to the derivative claims.
The Committee and its counsel also had to be very careful not to waive claims of privilege or otherwise divulge sensitive or confidential proprietary information.
The forensic investigation was conducted through the prism of the legal claims being asserted, and the investigators and attorneys had to understand the factual significance of the events and legal elements of the claims. This interplay would have been very difficult without attorneys who were also experienced forensic investigators themselves.
The Special Litigation Committee had no subpoena power, and sought the cooperation of the corporation’s inside counsel, whose ultimate allegiance was to the corporation.
The Special Litigation Committee, while comprised of members of the board of directors, had to maintain its independence, both in appearance and in fact, while adjudicating the claims. This tightrope dictated that the Special Litigation Committee not permit either the corporation’s counsel or plaintiff’s counsel to dictate or otherwise manage the investigation and its conclusions. The Special Litigation Committee, though, sought the cooperation of plaintiff’s counsel, the corporation and its counsel.
In its lengthy order, the Court held that:
The Special Litigation Committee members did not have such significant commercial ties to the defendants to render them impartial to their duties;
Formation of the Special Litigation Committee did not raise serious questions as to their ability to independently assess the shareholder’s claims;
The Special Litigation Committee acted in good faith and conducted a reasonable investigation upon which it based its conclusions, and
The Special Litigation Committee’s recommendation that the derivative action be summarily terminated was reasonable.
The court declined to exercise its own independent judgment because the result reached by the Special Litigation Committee was not “irrational or egregious”.
In reaching its conclusions, the District Court validated several years of independent research by Francisco Gomez and Manuel Rodriguez. Both Mr. Gomez, who lead the initial factual investigation, and Mr. Rodriguez, are Certified Public Accountants and Certified in Financial Forensics. Additionally, Mr. Rodriguez is also an attorney.
Ultimately, Westernbank became a victim of the excesses of the national banking industry this decade. It’s irrational commercial real estate lending practices, coupled with a severe economic downturn in Puerto Rico led to its demise. The fraud perpetrated against it in this instance was but a drop in the proverbial bucket. Mitigation of this fraud, even at the onset, would not have stemmed the flood of losses that it eventually would realize and that doomed the stricken bank.
The Guy in the Gray Range Rover
The US has begun a long slog into the cycle of decay and vacuum of leadership that characterizes all great empires whose suns are fading.
We have witnessed the hubris of endless cycles of war and conquest that have characterized the Roman, Greek, British and Spanish empires, and more recently, the German Reich and the Soviet Union. Nearly every continent and empire has held unbridled power briefly, but none has been able to hold it for long. The Romans succeeded chiefly because of the relative weakness and tribal instincts that characterized their vanquished enemies, but even they were ultimately defeated by their own demons and internal failings.
These failings were principally characterized by an inability to recognize the unsustainable nature of their societies and the economic models on which they were premised. Marching vast armies through multiple continents became economically and politically unsustainable for the Roman Empire, which entrusted its unceasing demands for territory and power to professional armies that would spend years abroad and far removed from the Roman homeland. The German Army would march its Panzer units abroad for years, virtually requiring that these specialized army units reposition themselves as occupiers, rather than conquistadors.
Meanwhile, the local populace, ignorant of the back-breaking cost of these armadas, continued to cheer the endless conquests and territorial expansion of their homelands. Nationalistic fervor and pride, bordering on nihilistic self-approbation, continued unabated. No sacrifice was required, no penalty or tax was paid for this unceasing expansion, until virtually the end of their empires. The populace was ultimately deluded into a vision of guilt-free expansion, politically and economically, that required no excessive or burdensome levy on their current lifestyles.
We have witnessed a similar paradigm of empire-building and decay in the United States in the last 30 years. We have fought wars, namely the Korean, Vietnam, Iraq 1, Iraq 2 and Afghanistan wars. These wars have required little to no participation, tax or pain by the general American public, socially, politically or economically. Indeed, most Americans have come to believe that these wars have been relatively painless and have cost little in blood, sacrifice and economic contraction.
While these wars were fought, serious economic and political challenges occurred at home. American’s have inured themselves to the severe economic challenges facing this country. A duopoly of two political parties, both entrenched by extremists within their own ranks, contributes to a toxic environment of extreme political correctness. No major reforms are possible and public discourse is reduced to the merely inane. Vacuous platforms have numbed and desensitized our citizenry. Outside of the Beltway, no one really pays attention anymore.
Who is the Guy in the Gray Range Rover? He is every upper-middle-class individual who continues to ignore the symptoms of failing empire. He uniquely characterizes the suburban class in this country. He is every man enamored of his own image, enthralled by his economic self-sufficiency and independent means. This is the group that stands to lose the greatest in this seemingly unending downward spiral, and yet remains blissfully oblivious to its decay. The Guy in the Gray Range Rover is a white, suburban male, in his 40’s, married and has children. He owns his own business, has children who are in private schools, his wife drives a BMW, and his house is heavily mortgaged. He is quite likely Republican, drinks scotch, and is rabidly anti-tax. He is the perfect portrait of a contented, domesticated, upper middle-class existence. He is satisfied with his life, rejects any substantial social or political changes, and views the inertia favorably. He and his wife have little sex, so he satisfies this sexual deficit through clandestine affairs, refuses to disrupt his marriage, and is largely content with the status quo. He ignores the epochal changes enveloping him, society and his family. He is the epitome of upper and middle class America, immune, smug, and satisfied.
This characterization could have been repeated in ancient Rome, Greece, the German Reich, or any other empire facing systemic struggles. The fact remains that change is uncomfortable, destabilizing, stressful and filled with unknown and unintended consequences. As selfish as past generations and empires, the Guy in the Gray Range Rover is intent on preserving his social and economic well-being at the expense of future generations. The Guy in the Gray Range Rover has faced no serious consequences from these wars and the deficits they’ve occasioned, in fact, his overall tax burden has likely been lowered. His businesses continue to cater to crowds much like himself, oblivious to the impending schism occurring throughout society, and not caring much about its impact, as long as he and his family’s lifestyle remains unaffected.
The chasm occurs between the Guy in the Gray Range Rover and the rest of America. The reality of American life is such that a growing polarization between the Range Roving elite and the rest of the country is quickly occurring. Those that still hold power and the economic strings remain largely unaffected by the economic malaise affecting working class Americans and the backbone of our own reich. The costly wars, endless bailouts, and near-constant money printing have yet failed to impact the Guy in the Gray Range Rover, but have decimated the working class existence of middle and lower class America. These groups will find themselves burdened by permanent and structural 10% unemployment for the foreseeable future. No longer will young Americans look forward to rising prosperity as part of the social contract resulting from years of acquiring costly and increasingly meaningless student loans. No longer will future generations enjoy a heightened standard of living.
The very rich and merely rich will always remain unaffected by economic strains and discontent, their real living standards largely unaffected. The lower classes, never having acquired much in even the best of economic circumstances, will merely work harder to subsist. The greatest impact will occur to the Guy in the Gray Range Rover and his family, as his customer base is whittled, his taxes inevitably rise, and his savings and investments are consumed. For at least the near-term future, we will increasingly begin to resemble the Latin American continent, which has long exhibited a shrinking or insubstantial middle-class. Increasing wealth concentration among a substantially smaller upper class will create havoc for the Guy in the Gray Range Rover, who has long aspired to join the more elite class. His ability to seek alternative means of income, a simple re-calculation and re-calibration in the last decade, will be permanently impaired.
For now, the upper middle class will remain pliant, content in its bohemian excess and business-as-usual attitude. The Guy in the Gray Range Rover will remain blissfully unaware of the changes enveloping his life and society, the destruction of his customer base, and the political indecision and toxicity of our leadership. The Guy in Gray Range Rover has noticed the social upheaval, but his lifestyle choices and intellectual laziness render him incapable of any drastic change. He will blame the masses for their unending entitlements, blame our leadership for their failure to relieve his regulatory burdens, and seek relief from those in social classes superior to himself. In the end, all empires implode from their inability and unwillingness to seek social and economic justice and re-direct their resources to justifiable and meaningful goals. The goals of a few select classes eventually conflict with those of the greater majority, resulting in social strife and turmoil. Let’s hope the Guy in the Gray Range Rover understands this, soon.
The Failure of Predictive Modeling and Irrational Thinking
Can human behavior be accurately predicted, or is it too complex and nuanced to quantify and discern through modeling?
Predictive modeling, the process by which a model is created or chosen to try to best predict the probability of an outcome, has lost credibility as a forecasting tool. Overly simplistic models have failed to account for the sheer complexity of human interaction and the degree to which most people behave irrationally. Most predictive economic models presume that people behave rationally most of the time, a premise which is terribly flawed but which serves as the intellectual foundation of many current economic models (See the Wall Street Journal article on this issue, here).
Predictive modeling has seeped into nearly every facet of our decision-making. It has been the cornerstone for most economic models for decades, and lately it has even attempted to predict consumer behavior. Companies like Amazon use predictive modeling to determine what consumers will purchase, and even suggest purchase alternatives based on what other consumers have purchased after reviewing the same item that the consumer initially looked at.
These models are quite good at predicting outcomes provided that the input variables, or human choices, are extremely limited. Thus, Amazon’s ability to predict what a consumer might purchase after having reviewed a particular item on its website is quite good, because the range of inputs and variables necessary to make that prediction is low.
The models, though, are poor predictors of behavior once the range of variable inputs is high. The models also fail to incorporate the nearly endless human capacity to behave irrationally, behavior which cannot be neatly reduced to an algorithmic equation. These factors underpin the failure of most economic models to predict the current housing crisis. Because models are simply mathematical equations and struggle with variability, economists developed them assuming that people would act rationally and make informed choices, and ignored extreme variability. They populated their models with rational people who would calculate the variables and make informed and optimal decisions.
These economic models failed completely in the current economic crisis due to their inability to accurately predict extreme variability. Human behavior, whether economic or personal, is populated by irrational decision-making. Human beings, according to many studies, systematically overestimate or underestimate risk. They also engage in fantasy thinking, placing unreasonable valuations on objects because of the difficulties inherent in their valuation. When engaged in fantasy mode, humans will overvalue anything from Dutch tulips to dot.com stocks to houses. Add to this irrational behavior the daisy-chain of decision making and the confluence of events that occurs in complex economies and it’s no wonder that these models bear no relation to reality and are poor prognosticators of the future.
Another study, by the journal Current Biology (reviewed by the Wall Street Journal, here), concludes that human decision making is even more complex and potentially poorer than originally thought: the study suggests that investors often move in herd-like fashion because conformity feels good. It provides pleasure. This explains why contrarian behavior is often dismissed and ignored.
The study notes that humans consistently seek to reach consensus and agreement with others, and that areas of the brain associated with pleasure react intensely when agreement is reached and others feel identically. This “pack” behavior demonstrates why contrarians are frequently rejected or maligned, and often marginalized to the fringes. Moving with the herd and rationalizing what may be a poor choice supports the notion that humans often behave irrationally and make choices that are clearly against their own self-interest.
Ultimately, these studies suggest that human behavior is not susceptible to easy compartmentalization. Western culture has traditionally struggled with the concept of dualism and the need to interpret behavior along rigid boundaries and remove all ambiguity. Eastern cultures have long accepted the duality inherent in human nature, and have never struggled in living with the muddled middle. As long as predictive models continue to evolve simplistically and along a linear trajectory, they will continue to fail and offer no relief from cyclical periods of boom and bust. If these models cannot be embedded with enough variability to mimic human behavior, then perhaps they should be scrapped as bygone relics of an age where hubris defined our thirst for knowledge.
The New Normal
Jobs: 1998, Commerce: 1999, Housing: 2002, Tourism, 2005, Mood: 2003.
Those are the years to which the Great Recession has propelled South Florida’s economy. In a series entitled Economic Time Travel, The Miami Herald, here, and here, recently provided evidence of the stark reality that many businesses and consumers face.
The Herald study tracked 60 different monthly indicators, from revenue generated by hotels, building permits, home re-sales, unemployment, cargo volume, taxes, and many others, all weighted based on their relative importance to the economy as judged by economists, analysts and industry leaders.
Collectively, the Great Recession sent the South Florida economy back to 2002. Individually, many sectors have fared much worse, such as commerce and the overall business climate. The jobs market slid back to levels unseen since 1998. Only tourism and trade, two sectors that support lower level, service sector jobs, have prospered and bounced back.
60 economic indicators can’t be wrong about what we’ve all intuitively felt for a few years: we’re crawling backwards, not forwards economically. Our standard of living, earnings and our purchasing power have declined significantly, yet prices continue to march forward. Commodity prices have surged, and gas is poised to surpass the record levels reached in 2008. Nearly every family has been directly or indirectly affected by this economic malaise.
As a consequence, this recession feels different. It feels permanently regressive, disconcerting, and disorienting. No longer do we see the light at the end of a tunnel, most of us can’t even find the tunnel. No longer do we believe that our children’s standard of living will ever reach our own. Cynicism has bred contempt and disdain for the acknowledged pillars of our economy: Wall Street, the banks, the Federal Reserve, government, insurance companies.
Collectively and individually, we no longer know whom to trust and which institutions in which to place our faith. Now, the Herald has merely confirmed our worst fears, our local economy has statistically regressed to points not seen in a decade.
How does this Great Recession feel to most people? The feeling is akin to standing on quicksand. No stability or permanence, and always wondering when the other shoe will drop. We’ve begun to feel like economic mercenaries, selling ourselves to whomever, for whatever length of time, knowing this too will end.
What impact will the Great Recession have on our future? Most of us will have to learn to live within our means, control our impulses, and limit our desires. This New Normal will fundamentally re-order how we think, how we spend, how we entertain, and where we work. The long-term vision that financial planners demand of their clients will be replaced by short-term survival skills. Evidence of this is that few workers have the means or wherewithal to budget for retirement planning. No longer will we trust institutions, whether government or otherwise, to provide for our future. Absolute self-reliance will become the norm.
How has the Great Recession impacted our collective psyche? A profound sense of distrust will replace the hopeful idealism that has been the hallmark of American capitalism. A sense of betrayal, from bankers, Wall Street, government, big-business, etc. will erode confidence in these institutions, leading to deep cynicism and ambivalence. This destructive attitude bodes poorly for a country fast slipping from economic prominence.
Unless our leaders collectively acknowledge the utter sense of chaos and destruction occasioned by the Great Recession, no healing will take place. The wound is still very much open, just covered. The fact that civil disobedience has not occurred as a result of Wall Street’s grand theft does not mean that people have failed to notice, and that a return to business as usual is likely. Our institutions will return to business as usual, our psyche’s will not. Unlike past recessions, the wounds and memories will run very deep for generations to come.
Jackson’s Institutional Incompetence
Miami-Dade County’s Jackson Memorial Hospital is Adrift in a Sea of Incompetent Executive Management
The utter contempt that Jackson Memorial Hospital’s managing board, the Public Health Trust, and the Miami-Dade County Commission, have displayed for the residents of Miami-Dade County and the Jackson health system has reached a new high.
The Miami Herald reports, here, that the treasurer of Jackson Health System’s governing board noted this week that cash is getting “dangerously low” and that major cost cuts may be needed. Currently, Jackson will likely end the month of January with only 16.7 days of cash on hand. Hospital’s median day’s cash on hand is closer to 90 days cash, making Jackson’s days cash on hand ratio abysmal, and a true operating emergency.
Additionally, Jackson experienced a 7 percent drop in patient revenue, a material and significant decrease to any business entity. The impact on Jackson, though, is pronounced, given its already weakened financial condition and its primary mission of serving the uninsured.
Jackson’s real problems are the result of institutional ignorance and complacency. This author was briefly involved in the nomination process to sit on the Public Health Trust, and met with a panel of Miami-Dade County commissioners, Florida legislators, Public Health Trust members, and other important local politicians.
A 3 hour panel discussion ensued regarding Jackson’s status, and it became painfully obvious that the current Public Health Trust Board and the Miami-Dade County Commission are truly ignorant of the financial status of the hospital. This author reviewed over 1000 pages of material in preparation for the discussion, much of it dense financial data. It quickly became apparent that most of the people sitting on that panel had little knowledge of the contents.
The questions posed to this author were mostly superficial and chosen to deflect attention from the institutional incompetency that has seized Jackson for much of the last 2 decades. The issues being confronted by Jackson were merely magnified by the current economic crisis, but were certainly not caused by it.
The author reviewed a “stop-gap” financial proposal to immediately enhance revenues and reduce costs at the hospital, and noted that the nearly 100 planned initiatives should be vetted for reasonableness and predictability. Institutional initiatives aimed at closing financial shortfalls frequently fail due overeager management’s failure to account for the many inherent pitfalls.
Regrettably, the Herald notes that many of the 94 initiatives, worth $200 million in reduced costs or increased revenue, are already behind schedule. Is it any wonder, though, that the board and county commission, largely comprised of non-financial laypeople, are sufficiently competent to make complex business decisions in a vacuum? This author noted that at least 4 prospective Public Health Trust candidates had significant financial statement and business modeling experience. Of those 4 highly qualified candidates, how many were chosen: Zero.
Past boards and county commissions have largely applied super-sized Band-Aid’s when dealing with Jackson’s problems, including accounting gimmickry, financial speculation with new revenue streams, and other one-time financial gambits designed to kick the deep, structural problems to new generations, including Jackson’s onerous labor costs. Unfortunately, that day of reckoning has begun arriving. Like the leading edge of a large hurricane, the gail force winds of this impending crisis have already swamped management’s coping ability. The resulting financial hurricane could cause the residents of Miami-Dade County to feel unimaginable pain, as care will likely have to be significantly reduced to uninsured residents.
Jackson’s institutional incompetence not only impacts Miami-Dade County’s bottom line, but very difficult and highly controversial quality of care decisions are forthcoming, and none of them will likely enhance care provided to the most impoverished of this community. How such an important institution has been allowed to decay into this abyss is criminal, how no one has noticed the contempt demonstrated by its leaders is frightening.