June 13, 2002
The Economist discourses on the issue of trust and the three key issues of: "the role of the research that is published by investment banks; ... the way in which shares in IPOs are allocated; and ... the use of accounting rules to mislead investors."
The issue of integrity to the system is a vital one and the question of what new rules and regulations should be added must be addressed. But it is important that, just as we need to consider the civil liberties issues when addressing national security, we consider the unintended consequences from regulation, the long-term impact on business, investors, and consumers, and avoid a "slippery slope." As well, business and finance have not been lightly regulated industries--the problem has been in many cases the credulity of the investors and the absence of critical thinking. No matter what laws and regulations are put in place, there will always be fraud--just as there will always be bank robbers, despite laws against it--and the effort to create a flawless system (an impossibility) can become counter-productive by creating a moral hazard. Excerpts from The Economist:
As for better corporate governance, the NYSE's new rules are a step in the right direction. Much will depend on how committed the exchange is to ensuring that the rules are honoured in the spirit as well as by the letter. Greater independence of non-executive board directors is certainly desirable. Too many American bosses fill their boardrooms with yes-men who have neither the character nor the financial incentive to challenge the boss's grandiloquence. Ultimately, however, governance is unlikely to improve much until the institutions that own large chunks of corporate America start acting as real owners, by keeping a sharper eye on their boards and their management.
There is no doubt that Wall Street gave investors an unprecedented amount of bad advice; that those dispensing it often had an inkling that the firms they touted were probably overvalued; and that they had strong incentives to err on the bullish side. On the other hand, every piece of advice issuing from a Wall Street firm comes couched in caveats. If the oldest rule of the marketplace, caveat emptor—“buyer beware”—is to apply in such cases, then anybody slavishly following the advice of a Wall Street analyst has only himself to blame for his future losses.
Ominously for Wall Street, however, on June 3rd a Supreme Court ruling—in favour of an SEC action against a broker—stated that the securities markets' regulations introduced in the 1930s “sought to substitute a philosophy of full disclosure for the philosophy of caveat emptor, and thus to achieve a high standard of business ethics in the securities industry”. Caveat emptor does not go far enough, it seems. Analysts may have a legal duty of care for their retail customers, which means, for example, offering them only such advice as they would give to themselves.
Also, see Jason Pontin's post on this subject in R21, where he notes remarks from Hank Paulson, the chairman and CEO of Goldman Sachs.