Image from xkcd
In a great scene from the classic film, The Wizard of Oz, Dorothy and her friends have — after some difficulty and fanfare — obtained an audience with “the great and powerful Oz.” When, during that audience, Dorothy’s dog Toto pulls back a curtain to reveal that Oz is nothing like what he purports to be, Oz bellows, “Pay no attention to that man behind the curtain,” in an unsuccessful effort to get his guests to focus their attention elsewhere.
Like the Wizard, the great and powerful on Wall Street would have us pay no attention what is really there — “behind the curtain.” Yet once in a great while the Street rats itself out so that we get to find out, beyond a shadow of doubt (if you still had any), what the big investment houses really think about what they do and who they do it to.
The now-defunct Bear Stearns won a noteworthy 2002 legal decision involving former Fed Governor and then-Bear Chief Economist Wayne Angell over advice he and the firm gave to a Bear Stearns client named Count Henryk de Kwiatkowski (really) after the Count lost hundreds of millions of dollars in a just a few weeks (really) following that advice by trading currency futures on margin (really). The Count had been born in Poland, escaped invading Nazis, been banished to Siberia by the Soviets, escaped and travelled across Asia on foot to Tehran, talked his way into the British Embassy, became a renowned RAF pilot, moved to Canada, became an engineer, and made a fortune trading used airliners, most famously selling nine 747s to the Shah of Iran over a game of backgammon in the royal palace (really). He also became the owner of the famous thoroughbred racing institution, Calumet Farm (really).
Bear offered the Count “a level of service and investment timing comparable to that which [Bear] offer[ed its] largest institutional clients” (which is not to say that they were any good at it). The key trade was a huge and ultimately disastrous bet that the U.S. dollar would rise in late 1994 and early 1995. At one point, the Count’s positions totaled $6.5 billion nominally and accounted for 30 percent of the total open interest in certain currencies on the Chicago Mercantile Exchange. The jury awarded a huge verdict to the Count but the appellate court reversed. The appellate judges determined, quite conventionally, that brokers may not be held liable for honest opinions that turn out to be wrong when providing advice on non-discretionary accounts.
But I’m not primarily interested in the main story. Instead, I’m struck by a line of testimony offered at trial by then-Bear CEO Jimmy Cayne that does not even show up in subsequent court opinions, despite extensive recitals of the facts of the case. The generally “cocksure” Cayne apparently thought that his firm could be in trouble so he took a creative and disarmingly honest position given how aggressive Bear was in promoting Angell’s alleged expertise to its customers. Cayne brazenly asserted that Angell was merely an “entertainer” whose advice should never give rise to liability. Continue reading