August 26, 2016
What We’re Reading this Week
For a long time I have been convinced that the United States was on a steady march towards absolute and complete insanity. Finally, we have a light where there was once darkness. The insanity seemed to reach a fever pitch when McDonalds was sued for making hot coffee that was just the right amount coffee but too much hot. Well, everything old is new again and Starbucks was sued for…doing the opposite? The case brought to Los Angeles courts states that Starbuck’s cold beverages “contain significantly less product than advertised,” because an iced tea has both some tea and some ice. The plaintiff thought there was too much ice, or at least, not enough disclosures on exactly how much ice is in the cup. “Put another way, when a Starbucks employee fills a Venti Cold Drink cup to the top black line, they are only pouring about 14 fluid ounces of Cold Drink into the cup, not 24 fluid ounces.” That’s a direct quote from the complaint. Seriously though, the cups are clear. I really like the court’s response. Instead of just choosing to throw out the case and say, “this is stupid,” they opted to elaborate a little. “If children have figured out that including ice in a cold beverage decreases the amount of liquid they will receive, the Court has no difficulty concluding that a reasonable consumer would not be deceived into thinking that when they order an iced tea, that the drink they receive will include both ice and tea and that for a given size cup, some portion of the drink will be ice rather than whatever liquid beverage the consumer ordered.” They go on like that for a little. On a side note, I felt compelled to do a little research at home and try this experiment with my children. I showed them a 24 ounce cup and filled it with juice and ice. When asked how much juice they thought was in the cup they all said 24 ounces. Obviously I was disappointed but I persevered. “What if I take out the ice, how much juice is in the cup? It will be less than 24 ounces right?” I asked. They thought about that and concluded that if I removed the ice, they would like to have it. They also decided that if it couldn’t be divided evenly, the extra cubes would be given to the oldest children. Magnanimously they elected to give the remaining juice to the baby. I think the take away is that Starbucks should consider offering cups of ice to children. They really like ice.
It can feel as though all the chips are stacked against individual investors: large financial institutions and global investment banks have the manpower, money, and resources to lobby the government to further their agenda (higher fees, less disclosures, etc.), while the public at large has very few options for affecting change. Until now. The people’s hero, “paper manufacturers,” has stepped up to the plate. Mutual fund companies and the SEC are working together to cut down on your unread mail by allowing you to access mutual fund reports on the internet. Every quarter, mutual fund investment companies are required by law to print a portion of the internet and mail it to you for you to throw it away; this is known as a quarterly report. The president of Twin Rivers Paper Co. states, “After the nightmare of the meltdown in 2007 where millions of shareholders watched their holdings evaporate, Wall Street must remain accountable with paper statements and printed information.” Mutual funds responded with, “Yeah, but no one reads them.” I’m paraphrasing; what they really said was, “While they contain important information, many shareholders likely find the contents and length of these reports quite daunting.” Basically what I said. These reports can be as long as 651 pages. However, the company did think it was worthwhile to hire someone (a lawyer?) to write the darned things. Ostensibly, the same someone was tasked with writing to the SEC to advocate not printing them because they are a huge waste of time. I assume after that they started working on next quarter’s report. That sounds like a lonely job. Mutual fund companies are like, “Here, do this incredibly boring, monotonous job.” The writer says, “I think this might be a waste of time, no one reads this. Is there something else I can do?” The funds company then says, “Yes, please write a letter to the SEC explaining how meaningless your job is.” Ugh.
The case against Bank of America was recently thrown out based on the finding that the government has not proven the bank’s actions amounted to fraud. The Justice Department asked them to reconsider as the prior decision resulted in a $1.27 billion dollar fine. The courts said “no” and just sort of stopped there, which has to be a clear indication to the Justice Department that there isn’t much wiggle room. If you don’t recall, here’s the story. Bank of America had an agreement with Fannie Mae and Freddie Mac to sell them packaged mortgage debt (very normal). The agreement was penned with the understanding that the mortgages would meet certain underwriting standards (still normal) and the contract would extend for a certain period of time. Specifically, the contract stated that the mortgages would be “acceptable investments” as defined by Fannie and Freddie per the terms of the agreement. The mortgages were acceptable…until they weren’t. Bank of America (really, Countrywide, who was later bought by Bank of America) set up a mortgage origination program that they affectionately called the “High Speed Swim Lane” or HSSL, pronounced “Hustle.” These mortgages were not “acceptable investments” and the financial crisis hit in 2008 and the wheels fell off so to speak. Based on the absolutely inexplicable name “High Speed Swim Lane” and the nature of the program itself, I have suspicions that the program was called “Hustle” first and then they tried to find an acronym that would work. Seriously, they called it “Hustle.” I mean come on. Legal action was taken and the courts fined the mortgage company over $1 billion for fraud. The case was appealed and thrown out. That was repealed and the court said no. Now we are here. The courts decided that because the bank honored the contract initially and then just stopped honoring it, they were guilty of breach of contract, not fraud. Fraud in a contract requires material proof that one party of the contract never intended to follow through on their promises in the first place. In review, the bank had every intention of honoring the agreement, they just changed their minds later. They didn’t tell Fannie and Freddie but Fannie and Freddie also didn’t ask, so no actual fraudulent claim was made. The bank kept quiet and never had to look them in the eye and say, “Yes, these mortgages are still acceptable.” Many contracts like this require additional certification at the time of delivery that the mortgages still comply with the contract. This one didn’t have that and the debt was basically purchased on auto-pilot. There is a lot of legal side stepping here and it’s basically a perfect storm for BofA to avoid fraud charges. My stance is that they should still be fined if only because they called the program “Hustle.” If you’re doing something called “Hustle” and you work in finance (not dancing) you’re probably doing something illegal.
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