The aftermath of the $1.4 billion shakedown of Wall Street brought a new batch of media‐hungry politicians and regulators trying to upstage each other. Leaders of the Senate Finance Committee rushed into a ritualistic witch trial, rehashing old news to get free political publicity.
The new bit players read their lines from a script written by New York’s self‐appointed czar of stock market research, Elliott Spitzer. Commenting on remarks by the CEO of Merrill Lynch, Spitzer said: “Do they get it yet? You see the Stan O’Neal op‐ed piece and you think they don’t get it. … What we have alleged about your company is that you committed fraud.”
That “don’t get it” remark was imitated ad nauseum by people who obviously don’t get it. Democratic Sen. Paul Sarbanes of Maryland discovered, “Some CEOs on Wall Street just don’t get it.” Stephen Cutler of the SEC warned, “We’re not going to assume they do get it.” Robert Glauber of the NASD promised, “Those who don’t get it are going to get it.” And Dick Grasso of the NYSE said, “If people fail to get it, they won’t be in the business.”
I began to wonder if anyone would ever get it. Then I appeared on a Wall Street Week panel with Hedrick Smith, who said, “If there’s really fraud then somebody should go to jail.” He almost got it. But what if there isn’t really fraud? The Economist got that just right: “It is still not clear what the investment banks have done wrong, legally speaking. If the law was broken, then firms and their employees should have been prosecuted. If it was not, then the fines and bans seem hard to justify.”
If Spitzer really believes what he says — that entire corporations are guilty of fraud — then he has failed in his primary duty. A prosecutor’s main job is not to campaign for governor but to prosecute criminals. Failure to prosecute, in turn, proves Spitzer and his lackeys never had any evidence they dreamed might stand up in court. If there really had been fraud, prosecution would not be optional. No prosecution proves either there was no fraud or the prosecutor is incompetent. Since Spitzer cannot prove fraud through legal due process, he is obligated as a matter of minimal professional ethics to stop making fraudulent allegations.
Spitzer was prudent enough to use the word “alleged” — not accused. His April 2002 affidavit against Merrill Lynch did not accuse the company of fraud. Those trumped‐up charges were based on the state’s 1921 Martin Act, which as the affidavit explained, “proscribes a wide array of practices” such as “misrepresentation.” And “unlike the federal securities laws, no purchase or sale of stock is required, nor are intent, reliance or damages required element of a violation.” A company may be found guilty of something as vague as failure to disclose a conflict of interest without the prosecutor being required to demonstrate any intent to deceive or offering evidence that anyone was damaged. The Martin Act redefines rule of law to mean being ruled by lawyers.
The settlement proved two things. It proved it possible for state prosecutors to raise large sums for state governments without the nuisance of a trial and virtually rewrite national securities law without bothering to involve elected representatives. What it did not prove was fraud.
Spitzer’s agreement with Merrill Lynch on May 21, 2002, was entered into without “the court making any findings of fact or conclusions of law.” Nothing in that settlement “may be deemed or used as an admission of, or evidence of, the validity of any alleged wrongdoing or liability.” The case against Merrill is officially one with no accusation of fraud, no admissible facts, no legal findings and no evidence of wrongdoing. Yet Spitzer continues to talk as though his public allegations of fraud have a higher legal standing than, say, the ravings of some homeless lunatic shouting on a New York City street.
Reporters have been woefully negligent in questioning tidbits prosecutors feed to them. A Washington Post reporter dutifully transcribed Spitzer’s demonic interpretation of two pages of handwritten notes that “stood out among the thousands of documents in his investigation.” In reality, that note shows Salomon’s chief of research preparing to lecture underlings in support of “research integrity” and warning against “conflict between investment banking, equities and retail.” That tension between banking, institutional equity trades and retail brokers has been totally misunderstood.
First quarter commissions accounted for $1.1 billion of gross revenue at Merrill Lynch and asset management, and portfolio service fees added another $1.1 billion. But investment banking brought in only $368 million. Commissions on trades by managers of pension and mutual funds are huge. Merrill Lynch also has 14,000 financial advisors who handle accounts worth more than $100,000. To hand these clients bad investment just to please investment banking clients would be to abandon a giant brokerage business in favor of small banking fees. Ironically, emailed complaints about analysts from institutional investors and retail brokers were offered as evidence that banking interests always win. That was more evidence that prosecutors know nothing about finance.
I spent two decades consulting with a couple of dozen institutional investors. They are not easily fooled (not that I didn’t try). If any non‐discount brokerage firm earned a reputation for putting out terrible investment advice, institutional investors would quickly flee that company and trade with another.
Despite the fuss recently made about analysts hyping IPOs to professional money managers, they are big boys who can take care of themselves. IPOs are the way corporations are born — births far too vital to be aborted by the smothering maternal affection of prosecutors and regulators. If Spitzer & Co. make it too costly and too risky for financial firms to supply institutional investors with costly information about young companies hoping to go public, creation of new U.S. corporations will never revive and the economy will stagnate.
Since the crusade to regulate stock research has sunk to pretending to protect professional investors from IPO salesmanship, it is obviously time for Spitzer’s gang to find some other hobby. With each job in New York financial services tied to about five others, and with Merrill and the others slashing the employment of everyone except lawyers by 20 percent or more, Spitzer seems increasingly unlikely to find that new hobby in Albany.