Firm Investment Bank Supervision
This paper explores the tellativeness of short selling on finding short selling fraud, identifying institutional investors who adjust their positions before the release of a company’s fourth quarter financial statements, and using their knowledge to offset short seller profits on company stock price. We also consider the role of regulators in addressing these issues. Finally, we address the question whether short selling can be categorized as an appropriate investment strategy. The paper concludes by looking at two related topics, the relationship between stock price fluctuations and news releases, and the likelihood that the Securities and Exchange Commission will enact new rules to address these issues.
As with previous articles, this one relies on a limited number of primary sources to make its analysis. First, it relies on publicly available information from GAAP (Generally Accepted Accounting Principles), which it defines as “a method for accounting policies used to determine the measurement of financial data for the reporting of the value of assets and liabilities as well as the preparation of the audited financial statements.” The ten companies that GAAP define as public market firms include Enron, Ameriquest, Everglades, Learjet, Omega Advisors, Paine Financial, State Street, Sun Trust, and Wachovia. To borrow from the language of the GAAP definition, a company’s financial documents must “show at least the minimum expected cash flow and the fair value of the underlying assets as of the date of the transaction.” Although the GAAP definition is widely understood, not all of its terms are familiar to most investors.
Second, the authors rely on regression analysis in support of their analysis. Regression allow a comparison of the performance of a firm in the presence and absence of bank supervision to the performance of similar firms in the absence and presence of bank supervision. The book describes a set of related concepts including the concept of dynamic pricing, profit-at-the-risk (PAIR) and cost-at-the-risk (CAIR). The methods of regression depend on the assumption that the sample is normally distributed with mean and standard deviation estimates.
Next, Figsler & Rudnick claim that their proposed solution to the problems of investment bank supervision is to introduce a single supervisory mechanism, a pan-regional clearinghouse. Their proposal would require banks to submit all relevant information on activities in the context of their operations to a single European clearinghouse. In essence, each bank in the euro area would become a member of a “common pool” of resources. This would, they argue, make the regulation of investment more uniform.
Finally, the European Centre for Law and Regulation (ECLR), headed by Prof. Dr. Giampietro Vidotto, attacks the purported disadvantages of the Single Supervisory Mechanism as follows. Firstly, it is argued that the proposed regulation is economically harmful because it would result in fragmentation of the banking system and the increase of costs of implementation. Secondly, it is argued that the regulation is technically deficient as it fails to provide a satisfactory solution to the problems of capital management, bank ledgers and credit risk management. Lastly, it is argued that the proposed regulation would amount to an erosion of the market economy and political decision making power of the euro area countries.
The paper has many merits, but some criticism is necessary. Firstly, the proposals are theoretically incorrect as the results of a hypothetical model are entirely dependent on an assumptions made in the real world. In addition, the proposal does not provide an effective solution to the problems of capital management, bank ledgers and credit risk management. Moreover, although the proposal puts forward a novel way of regulating the banking system, it is unrealistic to expect such a system to be adopted in the euro area countries without further reform of the banking system. Overall, however, the authors do offer an innovative way to regulate firms in Europe without replacing the existing regulation with a new one.