One thing is certain about the collapse of Bear Stearns (BSC): It will generate hundreds of millions–if not billions–of legal fees. Some of the fees will likely go to attorneys for CEO Alan Schwartz, as he defends the inevitable allegations that he lied about the firm’s financial condition on CNBC two days before it collapsed.
Did Alan Schwartz actually lie? Or was he just as blindsided by the sudden Bear collapse as shareholders, employees, and everyone else?
Here are the key parts of the transcript and published statement. (The full video is available here at the New York Times)
“Bear Stearns’ balance sheet, liquidity, and capital remain strong…
Our liquidity position has not changed at all, our balance sheet has not changed at all…”
Two days later, Bear Stearns effectively went bankrupt.
We realise this will be an unpopular conclusion, but in the absence of other evidence, we think there is almost zero chance that Alan Schwartz actually lied on CNBC. We think, at the time of the interview, he actually believed that Bear Stearns was in fine shape (a colossal mistake, but not lying). Why? Two reasons:
1. Jeff Skilling, the former CEO of Enron, is serving a two-decade jail sentence for lying to investors before the collapse of a similarly leveraged business. Alan Schwartz, like all of today’s CEOs, has to have understood what was at stake. Today’s CEOs don’t just “go on TV”–especially when their firms are under fire. Before talking to CNBC, Schwartz would have been lawyered and PRed up the wazoo. He would have had the latest information available to the firm. Unless he was brain dead, he would not have made anything he believed could be construed as a “false and misleading statement.” (Yes, he would have known that it was important to be decisive and confident about a moving picture, but if you’re going to start throwing CEOs in jail for being decisive and confident in the face of changing conditions, we might as well close up capitalism.)
2. It is entirely plausible to us that, at the time, Schwartz did believe Bear Stearns was fine. What killed Bear Stearns was third-parties suddenly demanding their cash. This reduced the firm’s liquidy and forced it to demand cash from its own counter-parties. (Voila–a run on the bank.) As Bear insiders tell it, the sudden withdrawals started in earnest after Schwartz’s CNBC appearance, not before. It is possible that Schwartz’s interview helped cause the collapse (perhaps he wasn’t firm enough), but, again, this is not evidence that he knew the collapse was coming.
Our initial read, therefore, is that, on March 12, Schwartz described the Bear Stearns world as he believed it to be. That he thought the firm was in solid shape is evidence merely of naivete, not of an attempt to deceive.
WILL SCHWARTZ BE ABLE TO PERSUADE THE SEC, et al, or WILL HE HANG?
Alan Schwartz is in a tough spot. A psychological phenomenon called “hindsight bias” tends to persuade people that future events were more obvious in the past than they actually were at the time. Given the shocking and total collapse of Bear Stearns only 48 hours after Schwartz CNBC interview, therefore, we think it will be tough for Schwartz to persuade regulators–let alone jurors–that he believed Bear Stearns’ balance sheet, liquidity, and capital remained “strong.”
Even if the relatively sophisticated SEC commissioners and Justice Department officials can be convinced, therefore, Bear JP Morgan (JPM) ill likely be on the hook for hundreds of millions in civil lawsuit settlements.
Fair? Not if Schwartz was describing the world as he saw it. But also a cost of doing business in today’s corporate world. And another reason why CEOs like Schwartz make the big bucks.