[Not as good as Nomi, but better than anything else in the Times. Of course this is from a visitor, admitted for the sake of balance.]
New York Times December 27, 2002
Settling for Less
By LUCIAN BEBCHUK
C AMBRIDGE, Mass.
One week ago regulators and the nation's top investment firms
announced what they described as a historic settlement. To settle
government claims that they misled investors, the country's 10 largest
securities firms will pay $1.4 billion and will make certain changes
in how they operate. Industry regulators said the settlement
represents "the dawn of a new day on Wall Street" and is a "vital step
in restoring investor confidence."
It might be more accurate to regard the settlement, announced by
federal, state and industry regulators, as a slap on the wrist. By any
standard measure its punitive value, its deterrence effect or the
extent to which it will bring about structural change on Wall Street
the settlement is rather modest.
One goal of regulatory action is to provide deterrence by imposing
costs for past misdeeds. For deterrence to be effective, players must
anticipate penalties that would exceed any gains they would make from
the misbehavior. While more than $1.4 billion in fines and future
payments is hardly trivial, it is not large given what is at stake and
the potential gains to the firms from this type of misconduct.
Consider Citigroup, on which much of the recent investigation has
focused. Jack Grubman, its star analyst, is alleged to have painted an
excessively rosy picture of telecommunications firms in order to help
Citigroup get underwriting business. The total cost of the settlement
to Citigroup will be $400 million. Is this price steep enough to
discourage thoughts of similar misdeeds in the future? Hardly.
According to a complaint filed by New York Attorney General Eliot
Spitzer against five telecom executives who received shares in
companies brought public by Citigroup's investment banking unit, the
unit has underwritten $190 billion in the telecom sector alone since
1996, pocketing hundreds of millions in underwriting fees. Moreover,
according to its 2001 annual report Citigroup made $4 billion from
underwriting fees in 2000 and 2001 10 times the cost of its part of
Aside from monetary penalties, another way to discourage corporate
misconduct is the threat of criminal sanctions for corporate
executives. Thus far, however, regulators have not announced any plans
to indict any of the individuals involved in the scandals over
analysts' research and banks' conflicts of interest.
Perhaps the value of the settlement lies in neither its punitive
effect nor its deterrence value but in the structural changes it will
bring to Wall Street. The terms of the settlement require the firms to
sever direct ties between their research divisions and their
investment banking businesses. By preventing analysts from
accompanying investment bankers when they make sales calls, for
example, and by prohibiting any linking of analysts' compensation to
the investment banking business they bring in, the settlement tries to
ensure that analysts will render objective investment advice.
But even without such direct links, analysts will still be influenced
by how their actions affect their firm's other profit centers, like
investment banking. The settlement does not permit the fate of
analysts to be directly determined by the investment banking unit. But
the success and compensation of analysts will continue to depend on
the management and decisions of the firm's top executives, for whom
investment banking fees remain an important source of profits.
There is strong empirical evidence that analysts tend to issue more
favorable reports about companies with which their firms have an
underwriting relationship. There is little reason to expect that the
settlement will eliminate this pattern.
Analysts have substantial discretion in choosing which recommendation
to issue. We might expect their recommendation to be influenced if,
for example, their firm brought public the company they are covering.
And we might expect the head of the research department to try to
please the firm's executives with a department that makes "buy"
recommendations rather than "sell" recommendations for the companies
the firm underwrites.
In fairness to the regulators, they had to take into account other
considerations in fashioning the settlement. Tougher action on the
nation's top investment firms could have dealt a terrible blow to
important institutions at a difficult time for the capital markets. It
is also true that the reputational costs and public embarrassment
caused by the scandals, coupled with the private suits many investors
are bringing, will provide some measure of deterrence. And perhaps
there are no realistic structural reforms that would work better than
the moderate ones adopted.
Still, the settlement is better characterized as "business as usual"
than as "the dawn of a new day." We should not exaggerate the extent
to which the settlement will restore investor confidence.
Lucian Bebchuk is a professor at Harvard Law School and a research
associate of the National Bureau of Economic Research.
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