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Spitzer's Settlement: Who Actually Wrote This Deal?

Could it be that the recent $1.4 billion slap on the wrist to investment banks was inspired by those it was designed to punish? In any event, one can practically hear Wall Street executives' collective sighs of relief from sea to shining sea. And as far as solving problems go, this is unlikely to do much good--introducing ambiguity seldom does.

First off, the settlement on a per-investment-bank basis represents a couple days' revenues or one good sized underwriting fee per institution. And no admission of guilt on the part of the abusers, either. Little wonder the executives have, in SEC Chairman Donaldson's words, a "troubling lack of contrition."

Add to that the possibility that 2/5ths of the settlement costs may be met by insurers or be tax deductible. The independent research portion ($425 million) is payable over five years. The words "big deal" immediately pop to mind. Not the stuff of classic deterrence.

Let's go on: NASDAQ and the NYSE were spared censure yet didn't exactly jump into this fight eagerly or early. And their own enforcement arms (self-regulatory) stand to receive some of the penalty money. The foxes, guarding the hen-house, it seems, are supplied with sterling silverware in which to feast off all of us investing chickens.

That only analysts were at the center of the regulatory attack is another confusing ingredient in this flat settlement soufflé. What about bankers who determined analyst pay? What about corporations (and they seem to have had no finger yet pointed at them) who insisted that the entire underwriting syndicate issue buy recommendations (they held the purse-strings, after all, and had direct input into who they wanted in and who they wanted out of their deals)?

Were research analysts the only ones to make money--lots of it--of off these deals? Not even close. Salesmen who pushed lousy stocks on their clients understood, more often than not, that the research was biased. Syndicate Managers knew this. Bankers insisted on it. And senior management knew it as well. When something near 100% of the companies with new banking end up with a "Buy rating" that amounts to prima facie evidence that the system is fraudulent. Finally, I'd like to point out another major culprit who seems to have skated free and clear in this: the in-house compliance officers. They knew. They either approved these tactics or closed their eyes to it. Why is it that high-paid attorneys whose only role is to administer "compliance" aren't held accountable? At least disbarred or sued for incompetence?

So, where does this leave us? Analysts cannot pitch to potential clients. They are not to be rewarded for investment banking deals. Yet bankers and salespeople are still rewarded for deals done? Surely there is conflict of interest in that. After all, who does mom and pop investor listen to? Do they ever speak to an analyst anyway? No. They listen to their salesperson. Only difference now is that the salesperson won't have such an easy time blaming the research analyst for advice he or she knew all along was lousy.

Research analysts will now be paid according to performance. What the hell does that mean? Are we talking about stock performance in a quarter? A year? Two years? Three years? What of an analyst whose advice is correct for a quarter or a year only to have put investors into a stock that ultimately goes out of business? Do they make a ton of money for a year and then get fired? If a year is the criteria, then Mary Meeker did quite well for her clients within that time frame. The net of this rule: only an idiot would become a research analyst. And what if good ideas generate no revenues (i.e. commission business)? What if bad ideas (like internet stocks for a time) generate massive amounts of business? Does anyone think that Wall Street will ignore the business generators with the bad ideas?

And then there are all the unanswered additional questions like how is this independent research money to be allocated? What does investor education mean and how is that money to be spent? Some might argue that some of that money should have gone to training Wall Street analysts more so than the public. Even sincerely held bad advice--of which there has been an abundance--is still bad advice.

My own hope is that simple solutions (or at least partial solutions) aren't lost in this mess. Solutions exist, just not here.

Eliot Spitzer said: This will change the way Wall Street does Business." I happen to agree. From now on, Wall Street will not put any true sentiment into an email.