In a settlement with the Securities and Exchange Commission (SEC) and
New York's Attorney General, ten of America's biggest investment banks
and brokerage houses agreed to pay a record $1.4 billion in fines, compensation
for investors, and a research and education fund. By agreeing to this
unprecedented settlement, they admitted that their research analysts
and investment brokers had colluded for years and on a large scale in
deceiving their investing customers.
Salomon Smith Barney, Credit Suisse First Boston, and Merrill Lynch
received the heaviest penalties because they not only tolerated conflicts
of interest but actually committed securities fraud. Two analysts, Jack
Grubman and Henry Blodget, were fined $15 million and 4 million respectively
for publicly promoting stocks they privately ridiculed as junk. Both
were banned from the securities industry for life.
Considering the income and the wealth of the companies involved, the
$1.4 billion penalty is not substantial. It amounts to only 7 percent
of the investment industry's profits last year. The $300 million fine
for Citigroup's transgressions amounts to less than one percent of the
$92 billion the company earned in 2002. Credit Suisse First Boston made
$56 billion and faces a $150 million penalty.
An angry Ralph Nader charged: "This settlement is an insult to
the millions of investors who lost hundreds of billions of dollars because
of the misleading information from these bank and brokerage analysts
who, for their own collateral profits, continued to issue 'buy' recommendations,
even as companies' shares plummeted."
None of the ten defendant companies had to make a formal admission of
wrongdoing. Duped investors therefore will find it difficult to win
civil judgments in their favor. Unless Congress changes the tax law,
banks and traders may be able to write some of their costs off as tax
deductions, or they may be covered by liability insurance. The Citigroup's
CEO even won a guarantee that he will not face criminal charges.
Some of the chief executives ultimately responsible for the damage done
to investors issued apologies, others preferred to keep quiet, while
a few belittled the whole affair. "I don't see anything in the
settlement that will concern the retail investor about Morgan Stanley,"
said this company's CEO. "We are the beneficiaries of our predecessors'
actions over many years in putting the interests of our clients first."
This is the same Morgan Stanley that paid millions to rival investment
banks for routinely producing glowing reports on companies whose shares
it was peddling.
New York's attorney general countered: "We believe that the allegations
set forth in the Morgan Stanley document establish a record that should
deeply trouble retail investors because the document reflects that the
supposedly neutral analytical work was indeed subservient to the investment
banking needs of the company." The CEO of Merrill Lynch, Stanley
O'Neal, was even more cynical: He warned that "regulatory attempts
to remove risk from the marketplace threatened the very nature of capitalism."
Since when are the risks caused by worthless or false recommendations
from researchers and traders an integral part of capitalism?
To prevent the kind of collusion between analysts and brokers exposed
by the SEC's investigations, the regulators enacted several new precautionary
rules. From now on, separate in-house organizations are required for
research and investment banking operations. Analysts' compensation may
no longer be tied to the business they produce for investment banks.
Analysts, moreover, may no longer be used as rainmakers pitching clients
in road shows.
Nevertheless, it remains unclear how the SEC can eliminate all conflicts
of interest, as long as researchers' compensation remains dependent
on the revenues of investment banks. Analysts who honestly produced
only negative evaluations on securities would soon be useless for the
sales efforts of the brokerage houses.
To spot phony recommendations, the SEC would have to assume the unpleasant
task of policing the industry much more energetically than in the past.