Corporate Ethics. August 15, 2002.
Given recent events, it is clear that significant equity market reforms are needed. But, one market analyst suggested, "It is time to praise the equity culture, not to bury it under laws and lawsuits." This is nonsense.
In several high impact cases, ethical principles were abandoned in the pursuit of material well being. That this behavior has taken place in the most materially advantaged country extant suggests a culture of greed, arrogance, and envy has flourished, propelling standards of behavior downward.
Institutions that once helped insure the long term well being of equity market institutions have been pushed aside. Allowing analysts to give "investors an unprecedented amount of bad advice" was incompetent; "that those dispensing it often had an inkling that the firms they touted were probably overvalued" was illegal; "that (Wall Street analysts) had strong incentives to err on the bullish side" was immoral. A "go slow" approach to market malfeasance is fundamentally flawed. Justice, and markets, can not and will not wait.
Market participants are voting with their dollars: they are leaving en masse. This is a constructive, not destructive force: it shows that markets work. The factors that have come "together to cast America's capital markets..in a peculiarly unfavorable light and to fuel calls for wholesale reform" have little to do with markets falling, specific and continuing revelation of corporate malfeasance, or the imagined assault on Wall Street "by regulators, politicians and lawyers." Markets themselves are impartial resource allocation mechanisms. They are blameless. Market institutions, on the other hand, peopled by imperfect human actors, have been shown to be systemically flawed.
As the head of one large investment bank noted, "There is an air of cynicism surrounding every institution that underpins our capital markets." The same person suggested "This cynicism has gone beyond reasonable questioning, and could easily turn destructive." While the first claim is accurate, the latter concern is unjustified. We should worry about the destructive possibilities a lack of ethics and integrity on Wall Street might have on the future of democratic capitalism. Many calling for significant market institution reform are simply seeking to preserve democratic capitalism. As Federal Reserve Board Chairman Alan Greenspan noted on July 16, 2002,
"Well-functioning markets require accurate information to allocate capital and other resources, and market participants must have confidence that our predominately voluntary system of exchange is transparent and fair..Falsification and fraud are highly destructive to free-market capitalism and, more broadly, to the underpinnings of our society."
We agree.
The real issue is this: market institutions charged with protecting the public interest, specifically investment analysts, accounting firms and the SEC, have been compromised. As recently as January, 2002, according to one magazine, the head of the U.S. Securities and Exchange Commission (SEC) said: "There is nothing rotten in the accounting profession." This is no mere appearance of a conflict of interest. The "speed with which scandal leaps from company to company" is indicative of the systemic nature of the problem. The investigations launched by New York state's attorney-general were entirely appropriate. No other institution charged with protecting the public interest was able to act.
In response to mounting, uncontroverted evidence of systemic problems, several have called for improved disclosure standards. This is like offering a glass of water to a drowning man. It is more important to recreate standards of trust and integrity. The public has a right to demand that market institutions act in ways consistent with principles of fairness and justice. These institutions are, after all, not above the laws of society. To suggest that calls for equity market reform are simply a "search for someone to blame" ignores the serious long-term impact these incidents have on markets, the economy and society and decreases the likelihood of honest reform.
Several things can be done to restore public faith in the markets:
The Initial Public Offering (IPO) issue
Members of the public pay, unfairly, for the privilege of purchasing IPO shares. They can only purchase shares at an excessively high price in the after issuance market. At some point, to protect the economy, the markets and the investing public, the SEC should do what it knows it must, by "ordering investment banks to use auctions to allocate shares in IPOs to the highest bidders." Internet technology was specifically designed for this type of problem. Auctions could be conducted on-line, via a secure, tamper resistant, SEC monitored (or managed) website. The network of prescreened buyers, already well known to Wall Street, could easily be moved to this system. The system would be designed to meet certain security and performance standards.
I suggest this system be phased in over a six year period. In the first two years, IPO issuers would simply be offered the option of issuing stock via on-line auction. After two years, companies seeking capital in the IPO market would be required to describe why they chose to use or not to use the system. They would have to report certain information to shareholders. For example, I expect an auction system would be cheaper (resulting in lower stock issuance cost) than the current non-auction system. Corporate management would be required to report the cost differential between the auction system and other methods. Over time, say, after six years, all IPOs would be issued through the on-line auction system.
If Ebay can successfully implement this technology, so can Wall Street.
"Requiring full disclosure of any other relationships that managers of companies going public have with their underwriter" is a second-best solution: a complicating rather than simplifying half measure, more likely to generate revenue for law firms than to help the investing public.
The Research Issue
Investment research should be viewed as a public good. It is important, costly to obtain, with significant externalities. The SEC should take over portions of the investment research function by providing standardized investment reports to the public. The SEC has the devices and data it can use to do so - the erstwhile 10K and 10Q reporting forms, sanitized and made ready for public use. The SECs website already provides this information. The data simply needs to be scrubbed and made easier for the public to interpret.
The Integrity Issue
Most of the laws needed to restore public confidence in the markets are already on the books. As the U.S. Supreme Court recently noted, "Section 10(b) of the Securities Exchange Act makes it 'unlawful for any person ..[t]o use or employ, in connection with the purchase or sale of any security .. any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe.'" Investment research departments have been used as a "manipulative or deceptive device." Investment bankers and brokers used this device as part of "a scheme to defraud" the investing public. Current laws simply need to be enforced.
Further, I suggest the SEC create a confidential hotline to field calls from corporate insiders who have concerns about accounting practices. We have been asking the wrong people to look out for the shareholders interest. Many mid-level corporate staff people are anxious to report any fraud and abuse they might see. After all, they need to keep their jobs: most don't have golden parachutes or million dollar stock option packages to fall back on.
The Corporate Governance issue
For the benefit of shareholders, we should open the "Salotto buono." Public companies should be required to conduct Board elections via the Internet. Candidates would be nominated on-line and a fair, efficient procedure for screening candidates could be established. They could be vetted in any number of ways. Proxy voting and board elections could be conducted on-line, using a secure, tamper resistant, management-independent website. Votes would be tabulated on-line, in real time. Again, internet technology was specifically designed to further this type of collaboration. This system will be fairer, cheaper and more efficient than the current system.
Privatization of Social Security
It is entirely appropriate that we postpone discussions about the privatization of Social Security while we reexamine the institutions entrusted with the future of democratic capitalism. To do otherwise is to invite new players to take part in a rigged game of chance. Postponing this discussion will also give Wall Street additional incentive to resolve the issues noted above.
It is time to create a just, fair and ethical equity culture, one worthy of praise. If laws and lawsuits are required to do so, then so be it. In the long run, we will all be better off.
Corporate Malfeasense. January 27, 2003.
Deceptive and fraudulent activities carried out by corporate officers, investment banks, brokerage firms and investment analysts have cost investors billions.
Trusted financial market professionals abandoned ethical principles (repeatedly, in both bull and bear markets, in the most materially advantaged country ever) as they pursued excessive material well being. Laws and regulations designed to protect shareholder interests failed to do so.
Strong reform measures targeting Wall Street's stock analysts are clearly needed. Biased investment advice serves to misallocate capital by moving investment dollars from deserving companies to unworthy companies. The investing public no longer trusts Wall Street. According to a survey conducted by the Securities Industry Association, ? Investors' levels of satisfaction with their individual brokers (have) declined to new lows.? The Federal Reserve Board recently estimated that $8 trillion in stock market wealth has been lost over the past two and a half years. Wall Street itself is responsible for some portion of this decline and stock analysts must take their fair share of the responsibility for the loss of both capital and confidence.
Investors have a right to expect ethical behavior. No one expects perfection. Recent disappointments with American capitalism have more to do with a betrayal of ethical and social principles, and with a failure to learn from recent history. Apparently, regulators and politicians learned little from the S&L, junk bond and treasury market scandals of the 1980?s. These incidents were precursors to the biggest fraud yet: the systematic looting of shareholder value by people who didn?t really need the money and really should have known better.
Not all of us were blindly cheering the market on. Even during the height of the new economy market mania, we called for diversified stock portfolios comprised of old economy stalwarts ? utility companies, and new economy companies whose businesses you could understand, specifically Netscape and AOL.
(See: https://www.creativeinvest.com/research/netnoir.html)
Expensing stock options, appointing independent directors who meet regularly with or without executive directors, more disclosure..these ?reforms? will not help. Given the complexity of business life today, determined thieves will succeed, especially if their efforts are bankrolled by shareholders, sanctioned by politicians, protected by regulators and hidden from the public by a distracted media.
There is simply no substitute for honesty and common sense.
A (Very Brief) History of Corporate Irresponsibility and Malfeasence
It is entirely appropriate that we seek to determine just how irresponsible companies have been in the past. As James Baldwin noted, "the past is what makes the present coherent." But Mr. Baldwin also noted that the past "will remain horrible for exactly as long as we refuse to assess it honestly."
Determining how irresponsible companies have been in the past cannot be done without revisiting what has been called "one of the largest and most elaborate maritime and commercial ventures in all history," the Atlantic slave trade. This venture was financed and implemented by Anglo-Saxon companies.
Further, determining how irresponsible companies have been in the past requires we review their behavior on the other side of the Atlantic. As early as 1831, the US Government recognized, in Cherokee Nation v. Georgia, that "The Indians are acknowledged to have an unquestionable, and heretofore an unquestioned, right to the lands they occupy." These rights meant little to corporations, like railroads, so prominently cited as good corporate citizens in the past.
Until we can truthfully incorporate these facts into the analysis, the criticism of those who seek to make corporations (and markets) more responsible will remain incoherent and tragically flawed. In other words, horrible. A fairer, more just society is in everyone? best interest over the long term. History has shown us that.
Recent Media Coverage of Corporate Malfeasance
Some have indicated that politicians were not focused on corporate malfeasance. This may be true, but the media also missed the boat. On May 16, 1996, the Clinton Administration sponsored a conference on Corporate Responsibility. The conference was held at Georgetown University.
Most of that days news focused on the Whitewater scandal.
Politicians on both sides of the aisle have tried to focus on corporate responsibility. Representative Richard H. Baker, R-Baton Rouge, chairman of the House Subcommittee on Capital Markets, repeatedly called for increased standards of corporate responsibility. His efforts, too, were ignored, drowned out by the sound and fury of scandal.
Major media outlets were busy making celebrities of CEOs, too busy to reporting the latest scandal or to investigate company fundamentals. And, make no mistake about it; the information was there, right below the surface. According to an article published in the Washington Post on Monday, July 15, 2002, "As far back as 2000, WorldCom Inc. employees challenged the company's accounting and in at least one case raised those concerns with auditor Arthur Andersen LLP, according to internal documents released yesterday."
When a company becomes publicly traded, it also becomes subject to short term market pressures. Senior management at these companies become reluctant to criticize Wall Street for fear that investment banks and analysts will drive their stock price down, or, worse yet, cut them off from the capital market entirely. More importantly, management becomes so focused on cutting costs (so that they can report growing quarterly earnings) that they do not make the long term investments in people that might allow them to investigate complicated business stories. In so doing, they ?joined in the game of stoking short term stock price increases, regardless of long term consequences for the company and its shareholders? or the country. Some media companies, thus become ?entrepreneurial agent(s)? of Wall Street investment banks, not objective, independent observers.
?All Whitewater, all the time? indeed. Now we know what we missed.
Frequently Asked Questions about Corporate Malfeasense
A quick overview.
What's the deal with corporate malfeasance and crime?
It seems a growing number of major corporations conducted deceptive and fraudulent activities. These activities were carried out by corporate officers, accountants, investment banks, investment analysts, mutual funds and brokerage firms.
What, exactly, does this mean?
These people stole from you. They lied to you and then they stole from you. They conspired to rip you off.
Why should I care?
If you are an investor, these actions cost you money, either through increased fees or through losses caused as a result of, among other things, corporate bankruptcies.
Firms issued misleading and erroneous financial statements. They manipulated earnings reports in an effort to control stock prices. Investment analysts issued fraudulent reports. These were the big lies.
But, I'm not a big time investor. So, why should I care?
Even if you are not an investor, these actions had an impact on you. For example, if you live in California, one company found to have engaged in corporate malfeasance, Enron, cost you a lot of money. The company unfairly raised energy prices. Again, they ripped you off: they charged you more money than they should have. They circumvented the marketplace.
Need proof? Consider the following fact: "Within days of Enron's bankruptcy California's energy prices returned to normal levels." Energy prices fell.
I don't live in California. I'm not an investor, at least, not a big one. So, again, why should I care?
There are other reasons to be concerned. As these events have shown, greed and other unethical behavior is, like a virus, quick to spread. Accountants, CFO's, CEO's, investment banks and investment analysts, have all been contaminated. Even mutual funds. Unless inoculated, all sectors of the economy will be infected.
Just as a virus may bring about a general decline in the health of an organism, this type of infection will result in a general decline in the health of the economy. Societal fairness and justice will fall.
Oh, come on. Societal fairness and justice? Yada, Yada. Bottom line it for me.
. Here's the bottom line: unless checked, this type of behavior, this "virus" will result in higher prices and fewer jobs.
This is why you should care.
Oh. But, I don't have the time (or the knowledge) to keep track of these things. Who was supposed to look out for me?
All kinds of people. The Securities and Exchange Commission, mainly: "the primary mission of the U.S. Securities and Exchange Commission (SEC) is to protect investors and maintain the integrity of the securities markets."
In addition, there are these things called Self Regulatory Organizations. They include market exchanges themselves, like the NYSE: "The New York Stock Exchange is the leading self-regulatory organization in the U.S. securities industry."
Other organizations, like the National Association of Securities Dealers (NASD), are also supposed to protect investors: "As the world's leading private-sector provider of financial regulatory services, NASD has helped bring integrity to the markets..and confidence to investors for more than 60 years."
These people were supposed to look out for your interest.
They did not. They looked our for their own.
How about the politicians?
They only act when things go bad.
At the US House of Representative, the Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises"..watches over the U.S. capital markets, securities and insurance industries and government-sponsored enterprises, such as Fannie Mae and Freddie Mac. It oversees the Securities and Exchange Commission as well as the self-regulatory organizations that police the securities markets."
They depend upon the SEC, the NYSE and the NASD to do their jobs.
Yeah, but this is the first time this has happened, right?
Uhhh, no. There were the S&L, junk bond and treasury market scandals in the 1980?s. See: Top 100 Corporate Criminals of the 1990's. The problem is growing.
What can I do now?
Well, you can start by expressing displeasure with mutual funds, investment banks, brokerage firms and investment analysts tied to fraudulent activities. See: What you can do now.
Let others know you are concerned - write to the Federal Reserve Board (https://www.federalreserve.gov/feedback.cfm), the SEC (enforcement@sec.gov), Congress (U.S. Rep. Richard Baker, R-Baton Rouge, Chairman of the House Subcommittee on Capital Markets, has done more to protect the investing public than anyone else on Capitol Hill. Contact him at 2129 Rayburn House Office Building, Washington, D.C. 20515, (202) 225-7502 or at http://www.house.gov/baker/).
"If you have lost money due to WorldCom's or another company?s fraudulent practices, or if you suspect fraud on behalf of your brokerage house or analyst, seek the advice of a securities fraud attorney."
Also, if you've got a retirement plan and think you have been ripped off or impacted by these events, see: ERISAFRAUD.COM
For more information, google:
Corporate Crimes, Wall Street, Corporate Scandals, Enron, Accounting, U.S. v. Arthur Andersen, Email from Andersen attorney Nancy Temple