Cowell Facebook Fiasco: More Questions That Demand Answers

As the old saying goes, when looking at politics always follow the money.

Having just scratched the surface looking into the Janet Cowell Facebook fiasco, that’s just what I decided to do. The results are unsurprising, and intriguing.

To recap, North Carolina State Treasurer Janet Cowell invested about $26 million of state pension fund dollars in the Facebook IPO. As we all know by now, Facebook stock has dropped significantly, thus the pension fund has lost an estimated $4 million on that risky investment. The losers in this, of course, are taxpayers who will need to continue to finance the now insufficient pension fund. Cowell, in turn, has decided to join a class action lawsuit against Facebook, and the NC pension fund stands to be the lead plaintiff due to the size of its losses.

But there were some big winners in this ordeal, and certainly some connecting of the dots of the major players in this scenario should raise the eyebrows of government watchdogs, taxpayers, and retired teachers and government employees across the state. Following are the most relevant details:

As reported previously, Erskine Bowles sits on the Board of both Facebook and Morgan Stanley – two companies that were winners in this deal. FB of course raised billions from investors on quite possibly overvalued stock, and Morgan Stanley  earned millions as the chief underwriter of the IPO. As reported in the Wall Street Journal:

The deal was lucrative for the lead underwriters. In large IPOs, it is common for fees to be split relatively evenly between several lead underwriters. On the Facebook deal, Morgan Stanley stands to collect $68 million in fees—38.5% of $176 million slated to go to about 30 underwriters, public filings indicate. J.P. Morgan will get about 20%, and Goldman, 15%

And, in spite of the fact that FB stock prices have plummeted, Morgan Stanley made even more money off of the stock through a practice known as “stabilization.” The Wall Street Journalexplains:

Profits made by banks underwriting Facebook Inc.’s initial public offering as the stock fell were distributed this past week from a pool of about $100 million, say people with knowledge of the deal.

The banks together made the money through a process known as stabilization, which is a standard procedure in IPOs, though Facebook’s deal size made the profits larger than normal, these people said.

……

Stabilization works this way, people familiar with the process say: If investors are selling the stock after the IPO launches, pushing the price lower, bankers can step in and buy shares at the IPO price in an attempt to keep it from falling below its issue price. This also serves to cover their short positions. If a short position remains on their books and the stock keeps falling—which was the case with Facebook on subsequent trading days—the underwriters can continue to cover their short positions by buying back shares at prices below the IPO price, netting a profit.

There is no risk to the banks in this effort. If the stock only trades up, the short position is covered when banks exercise what is known as an overallotment option, buying more shares from the newly public company at the IPO price. The banks don’t lose money, and the new public company makes more money when the overallotment is exercised.

So there was no risk to Morgan Stanley as part of this deal, and in fact the drop in FB stock meant Morgan Stanley was able to make tens of millions more on the deal.

Now recall that Erskine Bowles and his wife hosted a fundraiser for Janet Cowell. Any conflict of interest there? Bowles raises funds for Cowell, then Cowell throws millions at the FB IPO in which Bowles sits on not one but two boards of companies standing to reap millions.

But wait, that’s not all.

Representing the North Carolina pension fund in the lawsuit – and jockeying to become lead counsel in the case – is the firm Bernstein Litowitz Berger & Grossmann. The New York based firm stands to make a lot of money in legal fees if they are chosen lead counsel.

An examination of political contributions to Janet Cowell’s campaign since 2008 courtesy of the NC State Board of Elections shows that employees of Bernstein have donated nearly $75,000 to Cowell in the last two elections cycles.

Interestingly, the donations include three in-kind donations for room/lodging in New Orleans. The contributor of this in-kind donation is Anthony Gelderman III, who is highlighted in this 2004 Forbes article as one who has “used political ties to turn Louisiana’s pension funds into a profit center for his New York law firm, Bernstein Litowitz.” Indeed, the article discusses a previous class action suit in which Bernstein tried to bill its clients (including major public pension funds) more than $10,000 per hour. The article also notes that Bernstein’s business model seems to include cozying up to politicians and then leverage that relationship for lucrative class action suits:

Despite its New York roots, Bernstein Litowitz is especially influential in Louisiana. The state’s public pension funds have retained the firm for at least 15 class actions. Bernstein Litowitz has contributed more than $90,000 to Louisiana politicians since 1996. It gave $38,000 last year, 83% of its contributions nationally.

Now it appears they are bringing that shady practice to North Carolina.

Every step in this story involves the politically-connected (Bowles/Morgan Stanley, Bernstein Litowitz) reaping major financial rewards, with taxpayers and perhaps NC state retirees on the hook. And Janet Cowell is squarely in the middle of it.

This whole Facebook fiasco begs a number of questions:

  • Was the risky Facebook investment a quid pro quo deal between Cowell and Bowles?
  • What about the selection of Bernstein as counsel in the class action suit, given their generous donations and cozy relationship with Cowell?
  • What was Cowell doing in Louisiana multiple times in the last few years?
  • What is a New York based law firm with much of its business in Louisiana doing donating to the North Carolina State Treasurer, if not sniffing an opportunity to someday milk the pension fund for outlandish legal fees by representing the fund in a class action suit?
  • Will NC taxpayers be on the hook for $10,000 an hour legal fees?
  • Should retired teachers and state and local government employees be comfortable with how their pension is being managed?
  • Does anybody else see any conflict of interests in this whole ordeal?

State and local government retirees – and taxpayers –  deserve some answers.

UPDATE: This original post included an erroneous spreadhseet of Bernstein, Litowitz Berger & Grossmann employees’ contributions to Cowell – it mistakenly listed several donations from earlier election cycles twice. The total came to nearly $100,000. The corrected spreadsheet is now available at the link provided above, and reflects what should be the correct total amount of nearly $75,000. Civitas regrets the error.

The Washington Monument Strategy or Reality?

Have you heard of the Washington Monument Strategy?  Erskine Bowles may have used it when he said recently that the UNC System may be forced to consider closing a campus if the General Assembly goes forward with large budget cuts.  Or perhaps Bowles was simply being forthright with the public.

The Washington Monument Strategy is simple: when budget cuts are on the way, bureaucrats and interest groups decry the cuts and whip up anger by saying that some popular program will be eliminated.  The name is derived from the National Park Service threatening to close the Washington Monument, obviously a popular tourist destination, if their budget was cut.

Of course, given the possible size of the budget cut facing the UNC System, Bowles is right to say that closing down a campus should be considered.  The alternative is to cut funding for each university in the system – cuts that might compromise the quality of education at universities that rely heavily on state appropriations.

Bowles may also have floated a political “trial balloon” to gauge public reaction to a campus closure for future reference.  As a current UNC System student, I have been surprised that the mention of a closure has not been a more toxic issue on campus and in the public at large.

A more in depth discussion of the issue can be read here.