The Enron mess, coming on the heels of last year's analyst scandals — in which the public was shown just how Wall Street research was subverted to win investment-banking fees — has eroded investor confidence. Throw in some broker shenanigans, like the case of the Lehman Brothers broker who allegedly stole from his clients and covered up by creating false account statements, and pretty soon the public will think it's smarter to park money in the mattress than in the market. If they do, your lifestyle will change dramatically, and by that, I mean you may want to consider a career change.
These scandals are typical of the end of an investment boom. The inevitable next step is regulation. While many brokers resist regulation for fear that it will inhibit their ability to make money, the right regulation can restore faith in the markets. It is up to us, then, to influence the outcome of post-Enron regulation.
To start, let's look at how the Securities and Exchange Commission arose out of the 1929 crash. This is from John Kenneth Galbraith's “The Great Crash 1929,” which appeared in 1954 and laid out just how things got so out of hand in the '20s and why almost nobody noticed until it was too late.
To speak out against madness may be to ruin those who have succumbed to it. So the wise in Wall Street are nearly always silent. The foolish thus have the field to themselves. None rebukes them. There is always the fear, moreover, that even needful self-criticism may be an excuse for government intervention. That is the ultimate horror. So someday, no one can tell when, there will be another speculative climax and crash. There is no chance that, as the market moves to the brink, those involved will see the nature of their illusion and so protect themselves and the system….
Some enlightened individuals working in the industry in the 1930s did “rebuke” the “evildoers.” In fact, the founding fathers of securities regulation confronted conditions that were very similar to todays. Thomas K. McCraw in his 1985 “Prophets of Regulation” made the following observation:
Here was an industry that seemed hopelessly divided among warring groups of practitioners: investment bankers on the one hand and speculators on the other; the exchanges, dominated by the New York Stock Exchange…; an over-the-counter [market] with its diffuse hordes of brokers and dealers held together only by telephone lines and a loose set of unenforceable rules. And everywhere in the securities industry, there prevailed a tradition of nondisclosure and nonstandard accounting practice.” (Emphasis added.)
Despite such obstacles, Landis [an early SEC chairman] and his cohorts had some powerful ad hoc allies. These included the most progressive elements among brokers and dealers within the stock exchanges and a larger number of professional accountants, who found good reasons to cooperate with the government. Already accountants had benefited more from government regulations than from any source of support among business groups. (Emphasis added.)
This progressive approach stamped out many abuses and restored investor confidence. However, it has long been clear that the SEC was no match for aggressive accountants and unprincipled CEOs. As Professor Joel Seligman wrote in 1982 in “The Transformation of Wall Street,” the “bible” of securities regulation:
Historically, the breadth of the SEC's jurisdiction and the vagueness of pivotal provisions of the Commission's enabling statutes have contributed to the SEC's relative inattention to accounting and corporate governance…. Lacking commissioners with training or interest in the accounting field, the SEC's Office of Chief Accountant, consistently underfunded and understaffed, has not made studies of leading accounting problems, and has rarely proved able to attract outstanding theorists. (Emphasis added.)
Since then, I maintain, the securities industry has successfully lobbied Congress to underfund the SEC so that it has been unable to perform its duties according to its mandate — “to be the investors advocate.” Further, Congress has made it more difficult to prove fraud by the “Enrons” and “Andersens” of the world with laws passed since 1995. I will address these new laws in next month's column and propose some possible solutions.
T. Sheridan O'Keefe is president of the National Association of Investment Professionals.