FOOL ON THE HILL
Wall Street Gets Off Light

A consortium of regulators and prosecutors settled with a dozen Wall Street firms on a $1 billion fine and an agreement on how the companies will run their stock-analysis operations. This comes six years after a settlement of $1 billion against Wall Street firms for colluding on Nasdaq stock pricing. Not to worry -- there's too much money floating around for these settlements to be the last.

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By Bill Mann (TMF Otter)
December 20, 2002

Late last night regulators and investment banks agreed to a series of fines and sanctions in response to Wall Street's mistreatment of individual investors through bastardized, conflicted research.

The total tab in fines is $1 billion. Citigroup (NYSE: C), parent of Salomon Smith Barney, took the largest hit, at $325 million, but a baker's dozen of other Wall Street firms got fines, including Credit Suisse First Boston (NYSE: CSR) at $150 million, and Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MWD) at $50 million apiece. On top of these fines the companies will be required to fund a trust as seed capital for an independent stock-analysis entity.

This is the largest fine since Wall Street firms agreed to pay $1 billion in 1996 to settle charges of price fixing in Nasdaq stocks. Yep, that's right, a little more than six years ago Wall Street was facing a landmark fine and a change in the way it did business. Yet here we are again -- the companies didn't even need to cut back on their coffee services last time to meet those fines. Rest assured that the java train isn't endangered this time either. And therein lies the problem.

Let's list out the changes really quickly. On top of the fines -- for which Merrill Lynch (NYSE: MER) doesn't have to pay because it settled six months ago -- all of the parties agree that:

  • Stock analysts will be barred from sitting in on investment-banking pitches to client companies;
  • "Spinning," or giving choice initial public offering (IPO) shares to executives at other investment banking clients, is banned;
  • A database will be created to show the public brokerage analysts' latest calls;
  • Research and investment banking activities will be separate.

The fallout is wide ranging. eBay (Nasdaq: EBAY) CEO Meg Whitman quickly resigned her position on the board at Goldman Sachs over questions about her receiving preferential access to shares in Goldman-managed IPOs. 

Perhaps more illustrious, former Salomon analyst Jack Grubman is to be fined between $10 million and $15 million for putting out deeply conflicted stock research. That certainly hurts, but knowing that Salomon paid him more than $15 million a year to produce his research, one begins to understand that, even after a $1 billion hit, the conflicted-advice game was extremely lucrative. Grubman is barred from ever working in the securities industry again. I'm sure he'll pick some small island to buy so he can go into proper exile. Maybe he'll buy Singapore.

In other words, Wall Street got off easy. Worse, just like the big fine in 1996, these changes and sanctions may have the opposite effect of what was intended. One thing that is plenty obvious is that analysts no longer have the power and authority they once did. Even the slowest, most naive investors finally began to realize that analysts did not have their interests at heart -- and began to ignore them.

But an agreement to reform may actually help rehabilitate the reputation of Wall Street stock analysts by giving them once again a veneer of credibility. It's sort of like when the French thought that the best way to take care of its prostitution problem was to regulate them. Yeah, sure, it helps in some way, but it also gives the impression that such activities are somehow safe.

One problem -- they're still prostitutes, and those who patronize them play a dangerous game.

Wait, was I talking about Wall Street, or Paris? I guess it doesn't matter.

Do you think that the gaming of Nasdaq stocks stopped just because Wall Street companies were fined? No, it didn't. Perhaps they changed how they did it, but a fact is a fact. Gaming the markets, playing to the one who pays the big bucks, nets the investment banks billions of dollars a year. The losses paid by individual investors are not even collateral damage. The money put into the market by individual investors was the fuel -- they were the target of the malfeasance.

So while New York Attorney General Eliot Spitzer stands before God and country and crows about the dawning of a new day in Wall Street, we should be happy that a few got their just desserts, and we should be pleased that some of the $1 billion in fines will be used as payouts to legitimate fraud victims. But we should also be deeply, deeply cynical.

What Spitzer just did, once again, was legitimize the Mob. They broke the public trust, in some cases they broke the law, and for the most part they get to keep the money. That, in my mind, is no cause for celebration. Remember: The term "Chinese Wall" -- the division between research and banking -- is nothing new. The firms are agreeing to a bunch of conditions that were already part of their contract with their brokerage customers. And that, in a word, is despicable.

Rest assured, the money flow on Wall Street is too big for a piddly billion or two every few years to slow it down. The big media, when they need good soundbites about companies, will still go to Wall Street analysts to get them. Maria Bartiromo will still babble about some analyst "expecting earnings to come in higher than expected" (is there any surprise that "Market Wrap with Maria Bartiromo" has lost 42% of its viewership since August?), and that analyst will still have many, many masters to consider other than individual investors, truth, or other noble sentiments.

Wall Street is built on money. Never, ever forget that. Some of the money that they hope to use to keep the fire fueled is yours. I'm sure it seems like I'm trying to take lemonade here and turn it back into lemons, but sometimes the truth is sour.

You are the best person to decide how to manage your money. If you choose to buy individual stocks (and believe me, getting into an index fund is a great way to go!), then by all means, whenever anyone makes a specific stock recommendation, ask the question "What's in it for you?"

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

Bill Mann would like everyone to know this important information: The Indonesian word for "bird-of-paradise" is "cenderawasih." Thank you. Bill owns none of the companies mentioned in this article. Bill is managing editor of The Motley Fool Select, where you can find his best Foolish stock ideas you won't find anywhere else. The Motley Fool has a disclosure policy.