Worry More About Lawyers
by Alan Reynolds
December 23, 2002
Alan Reynolds is a senior fellow with the Cato Institute.
A gang of prosecutors, led by New York Attorney General Eliot Spitzer, managed to extract $1.4 billion from the stockholders of ten banks and securities firms using press leaks, smears and threats. According to Spitzer, this loot is being transferred to government coffers to "restore the confidence. .. in the marketplace." That confidence game rests on the legend that stocks fell because of depressed psychology, not depressed profits. Yet from late September 2000 through the end of June, earnings per share of the S&P 500 fell by 50%, while those stocks fell 31%. It was only after Spitzer and Congress set out to fix things that stocks fell much further even as profits improved.
The sweeping accusation in this case was conflict of interest. Analysts supposedly jeopardized their reputations and their firms' stock commissions to attract relatively modest banking fees. The evidence consisted of excerpts from e-mails, usually torn from context. The illogic in Spitzer's complaint about Merrill Lynch was that, "as previously covered stocks. .. plummeted. .. retail customers and the investing public were never advised to sell. The reason for this failure is at least in part the substantial unrevealed conflict of interest." Yet analysts could not possibly advise the public to sell a "previously covered" stock, and there could be no conflict over an uncovered stock.
This prolonged diversion will just lower the quantity and quality of research for small investors. Prudential already announced it will confine research to institutional investors. The 10 companies did agree to waste half a billion on outside research, but such subsidized and regulated paperwork will be sanitized, wordy and bland. Meanwhile, analysts have been publicly humiliated and threatened for, as one reporter put it, "overly positive research reports." The obvious message is to keep future reports timid, indecisive and useless.
It is time to stop assuming investors are gullible dupes and to start worrying more about protecting the companies we invest in from the costly escapades of ravenous lawyers and ambitious state prosecutors.
This article originally appeared in USA Today on December 22, 2002.