You, The Market, and Risk

Now that so many investors have felt so much financial pain as their stocks have collapsed, there are many who are looking for someone to blame. Lying companies, conflicted analysts, and crooked auditors are good places to start. But at some point the finger needs to point back at us. The only reason Henry Blodget could move the market with his utterances is because a bunch of people listened to him.

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By Bill Mann (TMF Otter)
May 10, 2002

I will be one of the panelists for a unique program being put on by the Securities and Exchange Commission this week: the Investor Summit. This program will focus on the various ways in which the mechanisms of the public market are not serving individual investors as well as they should. Whether or not anything good comes from this will in no small way be dependent upon the determination by Harvey Pitt and the other SEC Commissioners to make the U.S. markets safer for individual investors.

To do so will require that they stand up to some pretty well-entrenched interests. Since the beginning of this month, The Motley Fool has been featuring on its main page some of our suggestions and prescriptions for improving the market. This document, The Motley Fool Manifesto, was presented to our community prior to being taken to the SEC and the media. We did this for one very important reason: No matter how much we here at Fool HQ think we know about the operations of the public markets, there are scores of people who participate in our online forum who know much, much more. And the feedback we received on this document improved it substantially. This is what happens when the collective brainpower of a large group is put to work.

Unfortunately, there are few avenues for individual investors to act as a unified front. Companies can do it: There are the industry associations, they have their own lobbyists, and they can organize some big resources to protect their interests. But although more than 50% of all American households own stock in some form, we are so dispersed as to be hidden. And, unfortunately, there are probably about as many agendas as there are investors, not all of them healthy. In political discourse, this can be a problem: Legislators and regulators get tremendous, organized feedback from lobbying groups whenever they consider proposed changes or problems, but from the individuals they get, what, a letter or two? Not exactly enough to tilt the scales, even when the cause is just.

One of the smartest pieces of advice that we received during the comment period on the Manifesto came from Lokicious (one of my faves), who urged us to take dead aim at a real weakening in the concept of company ownership by shareholders. We have long argued against the tendency of some to think they're accomplishing much by trading little pieces of paper back and forth. We Fools mock mutual funds for their general tendency to trade in and out of positions -- their average holding time for a company is 335 days, less than a year. Is it any wonder that mutual fund managers are generally no-shows when it comes to voting their shares? What do they care, as likely as not they'll have sold the company before long.

They ripped us off, and we let them
Laissez-faire shareholders in an environment where ownership is widely dispersed give managements carte blanche to vote themselves massive compensation packages, manage earnings for the short-term, make misguided capital deployment decisions, and so forth. Compliant inattentive shareholders allow an Enron to happen. Gullible investors make the distortive influence of a Henry Blodget or a Jack Grubman, or even a Maria Bartiromo a near inevitability. The only reason these people can "move the market" is because others listen to them. Thousands of others. All of these things make for an unstable market, one that will attract less capital than if these pernicious influences did not exist. And they are our fault.

Every scam needs a sucker in order for it to work. Wall Street analysts, in what should be a surprise to no one, have been offering conflicted stock analysis for years. And yet people are suddenly angry now that they have been deceived. There is a simple reality in deception -- it takes two participants for it to work. Anyone who bought a company because they wanted to believe that the guy on television was giving them a hot tip in some ways gave the guy his power. They let down their guards out of pure, unadulterated greed. Wall Street analysts were able to set up the largest chain-letter scam in history, and they were able to do it because there were millions of people who were willing to be marks.

I love the fact that the Attorney General of New York, Eliot Spitzer, is going after the big investment banks and waving their dirty laundry for all to see. I really do. I like the fact that banks are left with the Dickensian choice of turning over e-mails and internal documents and looking like charlatans, or to claim that they "lost" the damning evidence, looking like incompetent buffoons. Either way, this does more damage to the sell-side analyst community than any official sanction ever could; it rips away the veneer of respectability from a profession that descended into prostitution long ago. The jury of public opinion will be brutal.

The problem is that it takes two to tango. Remember, back in 1999, people were screaming at investment banks that it was unjust that they would allow only a select few to get in on IPOs. It was not that long ago that there seemed to be no speculative leap that individual investors were not willing to take. They would take a leap of faith not only with companies that had no history of positive earnings or cash flows, but also with companies that had no history of earnings. This was not the fault of the analysts. Nor was it the fault of the analysts that people actually went out and bought companies like iTurf,, Arial, and Microage, absolute pieces of dreck, and held on to them. Yes, they fanned the flames, but the desperate mob was already out in force, looking to get rich yesterday.

And now we're looking for someone to blame. Well, there were situations, such as Enron, where people were defrauded out of their money. There were also people who turned over their portfolios to financial advisors, who placed them in completely inappropriate investments. These victims are guilty of little more than trusting the wrong people. Unfortunately in investing, that's enough to get you the maximum punishment. Santa Claus doesn't keep a list of naughty and nice investors. There is no one whose job it is to make the blameless whole again.

Investing entails risk -- it always has, it always will. Some people will lose lots of money by doing dumb things, some people will make money in spite of doing dumb things, and some will lose money in spite of doing things that were pretty smart. You just never know. But your best interest lies in trying to do smart things. This means not following the crowd. This means not listening to Maria Bartiromo list out all her hot tidbits without doing what she fails to do -- be very skeptical of the source. That means thinking like a business owner -- not buying any part of a company unless you could see yourself owning the whole thing. And it means understanding that risk cuts both ways, that someone who engages in high-risk activity should in no way be surprised when he loses everything.

And this also means that we, as participants in the stock market, must do our part to make it a more equitable place. Fifty percent of all market capitalization of the world's public companies calls the U.S. exchanges home. There are myriad reasons for this; after all, the American economy is the world's most dynamic. But one reason that foreign investors choose to place their money in the U.S., sometimes preferring it to their home markets, is that they trust it -- they trust our regulators, they trust our laws, they trust the corporate leadership. Anything, be it fraud, conflicted auditing, poor accounting for germane items such as employee stock options, milquetoast boards, or so on, that tilts the balance away from outside investors weakens the overall system, and eventually will keep money away. A healthy market benefits all of us.

We at The Motley Fool urge you to make your voices heard. When a company is doing something that is puzzling to you, demand an explanation. If none is forthcoming, sell the stock. Companies practicing poor disclosure and corporate governance habits deserve to be shunned. Even if your voice doesn't sway them to do better, rest assured that the voices of thousands will.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards

Bill Mann's profile can be viewed online, as can The Motley Fool's disclosure policy.