We've dodged the recession bullet. The worst is past. Everything's coming up roses.
At least that's what Washington wants you to believe, even as Wall Street stubbornly refuses to shake off its doldrums. Bad news arrives almost daily: Monday's sell-off that sunk the Dow Jones to its grim post-9/11 low, more CEO scandals and more corporate execs unloading company stock at a frenzied pace, But each revelation is greeted with surprise. Isn't it time the designated mouthpieces of the political-financial complex wiped that look of incredulity off their faces?
On Wednesday, Goldman Sachs CEO Henry Paulson sounded a rare and welcome note of realism and alarm. "I can't think of a time when business overall has been held in less repute," he told a luncheon. And he blamed this year's spate of corporate scandals -- Paulson only named Enron, but it's hard not to think he was referencing Global Crossing, Andersen, Merrill Lynch and all the others -- for the stock market's refusal to validate the supposed economic recovery with a new surge. "I think this speech is a month or two late," Paulson admitted with rare candor.
Paulson is right: Why should battle-scarred investors return to their bullish ways when next to nothing has been done to restore their trust in the smooth and efficient (not to mention fair) functioning of our free markets? In the last two years, 433 public companies have declared bankruptcy, 2 million Americans have lost their jobs and $4 trillion in market value has been lost on Wall Street, leaving the NASDAQ looking like the tech bubble never existed. Every day brings more reasons for shellshocked investors to hide their money in the mattress.
And yet unlike other eras of corporate corruption, our own hasn't spawned much of a political movement for reform. We can't expect the Bush administration to act -- Bush, Cheney Inc. is a wholly owned subsidiary of corporate America, and President Bush likes to be known as "the MBA president." While his do-nothing anti-regulation approach to business might have gotten him more criticism when Enron imploded in scandal, he was able to use the Sept. 11 attacks and the war on terror to hide from blame. On Thursday Bush acted belatedly to reorganize his messed-up homeland security apparatus; don't hold your breath to see him take on the SEC and other agencies that are botching their regulatory responsibilities.
But as Paulson's warning shows, someone needs to reform those agencies, before the stock market finds a new bottom. The latest blow to investor confidence is the revelation that conflicts of interest among supposedly impartial stock market analysts are even more widespread than first believed. Last week brought word that, over the last year, the Securities and Exchange Commission has opened 10 separate inquiries into analyst wrongdoing, five of which have been upgraded to formal investigations. In addition, the in-house securities watchdogs -- the New York Stock Exchange and the National Association of Securities Dealers -- have launched 37 investigations into analyst misconduct.
It turns out that Merrill Lynch was just the appetizer to a smorgasbord of greed, corruption and insider dealing. Many on Wall Street and in Washington may be ready to quickly move on, but the bill for this banquet is far from settled.
Over the last decade, an unsettling number of Wall Street analysts morphed from highly professional researchers offering investors independent and objective advice into highly paid marketing machines, stopping at next to nothing to help generate huge investment banking fees for their firms. Trying to sign a client and need a positive research report to close the deal? No problem. Need a "buy" recommendation to keep a company's share price from dipping? You got it.
And since the shares of these companies go through the roof after you appear on television telling people to buy them, why not line one's own pockets by buying and selling shares of the companies you tout? Who's it going to hurt? I mean, other than ordinary shareholders not in the loop, in other words, the public.
Not surprisingly, the more investment-banking dollars analysts helped generate for their firms, the bigger their paychecks grew. At Smith Barney (now Salomon Smith Barney), for instance, analysts were given an end-of-the-year statement that showed just how much of their income was "earned" the new-fashioned way -- by blowing kisses across the Chinese Wall that theoretically, and only theoretically, separates the firm's banking and research departments. The amount was euphemistically labeled a "helper fee." It should have been called a "help yourself fee."
One analyst who most certainly did was Salomon Smith Barney's Jack Grubman, the high-flying telecom power broker whose fence-straddling efforts netted him $20 million a year. He must have been very helpful indeed. "What used to be a conflict is now a synergy," Grubman helpfully explained before the telecom bubble he helped create burst. "Someone like me who is banking-intensive would have been looked at disdainfully by the buy side 15 years ago. Now they know I'm in the flow of what's going on."
Last week, we learned just how "in the flow" Grubman was, with reports that he acted as an unofficial -- and undisclosed to investors -- consigliere to Global Crossing chairman Gary Winnick. Apparently, at the same time that Grubman was telling investors how bullish he was on Global, he was advising the company on everything from merger deals to major hiring decisions.
This check-to-cheek relationship paid off handsomely for Grubman, Winnick and Salomon, but cost investors who relied on Grubman's opinion $57 billion when the company went belly up in January. Would a more objective analyst have maintained a "buy" rating on Global Crossing, as Grubman did, even as its stock price plummeted from a high of $61 to $1.07, at which point he finally cut his evaluation to "neutral"? Of course, back when he was Master of the Telecom Universe, Grubman had derided the very notion of objectivity, scoffing: "Objective? The other word for it is uninformed." Translation: Only fools, suckers and outsiders play fair.
The truly shocking thing is that what Grubman did, while certainly sleazy, isn't against the law. He tiptoed along the edge of illegality by refraining from writing about Global Crossing during the times he was counseling them on specific deals. But, as with so many of the rules governing Wall Street, those concerning so-called blackout periods are filled with loopholes and open to wildly divergent interpretations. Of course, everyone knew what the spirit of the policy was and what kind of behavior it was intended to stop, but that, you know, was for the "uninformed."
For example, Grubman's own employer felt he should wait at least six months after advising Global on its merger with another telecom company, Frontier Corp., before issuing new research reports on Global. This didn't sit well with Winnick, who hated the idea of losing his most enthusiastic tout. So he complained to Salomon, which, not wanting to disappoint its big-fish client, reconsidered the rules and decided that Grubman only needed to lay low for two months.
The relationship between Grubman and Global Crossing has been described in press reports as "unusually cozy." In fact, as we find out more and more about what really happens on Wall Street, "typically cozy" seems much more like it. The time has come to change that to "unacceptably illegal."
But that's never going to happen if we leave it up to the SEC and the industry's self-regulating organizations. Nor will it come about solely on the efforts of crusading reformers like New York Attorney General Eliot Spitzer, whose groundbreaking investigation of Merrill Lynch ended disappointingly when the company was allowed to settle without having to admit guilt or wrongdoing or liability of any kind. I guess the banking giant forked over that $100 million out of the goodness of its heart.
The only thing that will end the abuses of the current system is a new wave of public outrage -- fueled by a constant stream of disclosures detailing the sordid goings-on in corporate America. But even the awful truth isn't coming out on its own. For instance, we never would have known about the latest SEC investigations had it not been for the efforts of Rep. Ed Markey, D-Mass., a senior member of the House Energy and Commerce Committee, who prodded Harvey Pitt to provide a report on what the commission was doing about conflicts of interest among stock analysts.
You can rest assured that the public, and even members of the press, would not have been given the same information -- no matter how hard they begged Harvey Pitt's minions for it. That's why we have to count on our elected representatives.
"Mark Twain," Markey told me, "used to say, 'Sure enough a cat that gets burnt on a hot stove will never get on a hot stove again but won't get on a cold one either.' And tens of millions of scorched investors are now sitting on the sidelines, afraid that the books are cooked and that only insiders can win at this game. The government needs to step up and give the public confidence that the game isn't fixed."
And it's essential that Markey and his cohorts on the Hill start enacting tough new laws immediately -- especially because, historically, there has been a significant lag between efforts to reform the financial system and the restoration of public trust -- which is the sine qua non of a thriving economy. Yet just last week, I wrote about the shelving of Sen. Paul Sarbanes' accounting reform bill, a muscular measure that would strengthen the SEC, restrict accounting firms' ability to double-dip as consultants and auditors for the same client and impose stringent conflict-of-interest rules on the investment banking world. Extra-strength lobbying by the accounting industry shoved the bill off course, and it's not expected to be revived anytime soon.
Now Goldman Sachs CEO Paulson has added his voice to the cries for accounting reform, which ought to strengthen the spine of Congress. Paulson also wants limits on when corporate execs can sell their stock, to prevent the scandalous cashing out that made Enron leaders wealthy while the company's workers lost their retirement savings. Let's see if the CEO works with legislators to do more than talk about reform, but make it happen.
Still, even his words are welcome. But Paulson isn't saintly; he's smart. He knows we need to create a system in which the Merrill Lynches of the world have to admit guilt and liability, where the Jack Grubmans do not hold all the cards (including the "Get Out of Jail Free" one), where Enron execs don't fleece energy consumers and their own workers. And we need to do it now, before investors completely give up on the market.