FOOL ON THE HILL
The Perils of Selfish Gain

It has come to pass that every participant in the giant U.S. stock market experiment is in it for self-interest. Selfish gain is a noble goal of investing, but it shouldn't be everything. When considered the be-all, it brings us such eventualities as faked financials, poor corporate oversight, and regulators asleep at the wheel. Our markets demand better supervision by all parties.

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By Bill Mann (TMF Otter)
August 23, 2002

Here's a question: Is the point of investing to make as much money as possible?

At first glance, the answer for many of us is "yes." We believe the most successful investors have managed to turn small amounts of investment capital into vast fortunes. Warren Buffett. Charlie Munger. Oseola McCarty.

Certainly, the stock market doesn't care whether its participants come by fortune (or demise) through moral or illicit means. A point gained in a company due to a manipulation by one or many participants adds a dollar per every single share held by each member. And that is, in fact, the goal of most people who invest -- to grow their money.

But I've been thinking about what happens when the stock market is expected to police itself. There are, of course, many regulatory forces checking in on the stock market: the exchanges, the Securities and Exchange Commission, the Southern District of New York, the Federal Bureau of Investigation, the Federal Trade Commission, state and local authorities in every jurisdiction where a market participant exists. But there's another regulatory force -- the market itself. In the efficiency theory, stocks eventually track to the appropriate level for the underlying economic return of the company. But in the most recent corporate crises, some insiders have done whatever possible to keep the illusion of economic growth up far longer than the company's performance actually warranted.

This is wrong. It's not unprecedented, but it's still wrong. What troubles me are the number of incidents, the sheer dollar figures in consideration, and the fact that there was a significant surge of this type of activity over the last six years or so. Perhaps it has to do with the fact that, as Benjamin Graham noted, hidden just below the surface of every bull market is a rising tide of fraud. Whenever there's the sniff of easy money in the air, people get greedy. When greed is the prevailing sentiment, people get careless. When there's carelessness, people take advantage.

Don't believe me? How, at the height of the Internet boom, did a teenager from New Jersey bilk people out of close to $1 million by hyping penny stocks on message boards? And why, in 1999, was a lack of democratic access to hot IPOs the biggest injustice in investing? In that year, the Fool wrote plenty about stock option abuses by companies, and no one cared. Why would they? Everyone was getting rich. Twenty years from now, people will be gossiping in country clubs about members who got rich by "tanking an Internet company." We didn't just reward success -- we awarded failure as well. There is, and should be, a greater need for some restraint by all participants, where their actions may harm the overall fabric of the stock market. Thus, the commonwealth can and should be a supreme concern for each and every participant.

I'm a true free market adherent, but I fully believe the pursuit of self-interest by the stakeholders cannot be the only driver in the market. There has to be an understanding that actions that enrich some at the cost of harming the institution must not be tolerated. I've spent a great deal of time in places that I'd prefer not to go back to. I could not believe the petty and not-so-petty corruption permeating business life in places like Pakistan. It never made sense, because the corruption created a severe disincentive for people to attempt gainful economic activity. The whole place was poorer due to the self-interest of the few -- there was no concept of the commonwealth.

At some point in the 1990s, the stock market and our public institutions took on this same veneer. At one time, professional standards were the main drivers of accountants, lawyers, analysts, bankers, and even government regulators. But in the '90s, these groups, the hitherto protectors of outside shareholders, began to serve an entirely different master -- the chase of big profits among the professionals and political expediency among the regulators.

Company executives were only so happy to push the envelope to keep up the impression of success, and individual and institutional shareholders reinforced all of this activity by helping to bid stocks to the sky, regardless of company fundamentals. Every single entity had a disincentive to turn out the lights on what became a really great party. "Maximizing shareholder value" replaced "corporate responsibility." "GAAP compliant" took over for "an accurate portrayal." "Eight years of economic growth" superseded protecting shareholders.

All of these were done out of self-interest. And self-interest in the stock market is good. But a market that is only about self-interest creates a moral hazard that many simply can't resist. Thus we have Enron, WorldCom, Cendant (NYSE: CD), Sunbeam, and many other frauds. Did former Enron CEO Ken Lay act out of self-interest? You bet, and it cost people billions -- and it cost the market a great deal of trust. The harm Enron's insiders caused far outweighs the gains they enjoyed.

Some of the new laws in place, particularly those that open up executives, directors, and professional consultants to prosecution and liability, will assist in recreating an equilibrium of good behavior, where self-interest in these constituencies includes avoiding jail time for misdeeds.

Raw self-interest must be tempered, particularly by those in power, for the overall good of the market. If you think about it, the market has already spoken on this regard -- people are afraid; they feel they've been ripped off; and now they're leaving (and may never come back). I suppose the people who "got theirs," who are on a beach somewhere sipping boat drinks based on their ability to flip some overvalued piece of dreck to the suckers, don't care. But a market with a preponderance of this type of person, operating solely in self-interest, isn't going to remain healthy for long.

And more's the pity if we let it happen.

Bill Mann, TMFOtter on the Fool Discussion Boards

The burger is in the cow. Bill Mann does not hold any of the companies mentioned in this article. He does have a bodacious dictionary, though. The Motley Fool is investors writing for investors.

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