Holdings of Analysts Just a Sideshow
Commentary. Michael Lewis, the author of ``Liar's Poker'' and ``The New New Thing,'' is a columnist for Bloomberg News. The opinions expressed are his own.
By Michael Lewis
New York, July 27 (Bloomberg) -- Some months ago I had a weird encounter with the then head of enforcement at the Securities and Exchange Commission, Richard Walker.
I was visiting his boss, then SEC Chairman Arthur Levitt, to learn what I could about the agency's prosecution of a 15-year-old New Jersey boy named Jonathan Lebed.
The kid had bought shares in small-cap companies and then posted messages on the Internet telling other people they should buy them too. Every time he did this, he drove the stock price up and got out with a profit. The SEC had found this investment technique offensive, and so set about putting him out of business.
I wanted Levitt to explain to me how what the kid did was ethically different from what Wall Street analysts did every day. He couldn't -- at least not to my satisfaction -- so he called Walker into his office.
No sooner had I repeated my unpleasant question than Walker became upset with me. He said my point was ridiculous, because Wall Street analysts didn't own stock in the companies they recommend.
Plausible, Just Wrong
I didn't call him on this as a) I assumed he knew what he was talking about, b) it sounded like a reasonable enough claim, since most journalists are prevented from owning stuff they write about and c) there was a more insidious conflict of interest on Wall Street, one that much more successfully corrupts analysts' willingness to tell the truth: Every analyst knows that if he offends a big company with a negative recommendation, he puts in jeopardy his employer's ability to rake in huge investment banking fees from that company.
Now it turns out that, in addition to the primary source of corruption, the analysts indeed owned the stocks they plugged. A few days ago, Credit Suisse First Boston followed the lead of Merrill Lynch & Co. and announced that from here on out its analysts would no longer be allowed to own stock in the companies they cover.
This was a weird case where the news of the reform came bundled with the news of the original offense. A CSFB spokeswoman named Victoria Harmon told Bloomberg News, apropos of its old code of ethics for analysts, that ``we didn't do anything that everyone else wasn't doing.'' Allowing analysts to invest in companies that the firm was taking public, and that they would later cover, ``was a bigger deal than dress-down Fridays, but it was really just another incentive to stem the tide of employees leaving for dot- coms,'' she said.
So They Were Clueless?
It's fiercely tempting to make Richard Walker's -- and the SEC's -- idiocy the point of this column. It's amazing to me that the SEC's director of enforcement would be as clueless as everyone else about what appears to have been standard practice on Wall Street. (At what point do investigators investigate themselves, and explain how on earth they remained blind to all of the financial activity that occurred right under their noses during the Internet Boom that they now claim to find so sinister?)
But the truth is, I didn't know myself that Wall Street analysts owned the stocks they told investors to buy. (Did you?) So perhaps Walker was just ordinarily stupid rather than extraordinarily so.
No, the real point of this story is that analysts eating their own cooking is beside the point, which is why CSFB and Merrill are so ready to make rules against it.
Making Matters Worse
CSFB and Merrill Lynch would like you to believe they've cleaned up that little apparent conflict of interest. They've probably just made matters worse.
Preventing analysts from owning what they recommend to others will only further untether Wall Street analysis from reality. As one investor intelligently pointed out, if you wanted to clean up the system, and compel analysts to say what they actually think, you would require them to invest a big chunk of their bonus money into the stocks they plugged, and insist that they hold that stock for at least a year.
But that sane idea has no chance in the currently insane world, where every Wall Street boss is scrambling to find ways to appear to reform his business without actually doing so.
Brain Drain
Henceforth any analyst at CSFB and Merrill Lynch who actually possesses real insight into the future value of a company or an industry will be much more inclined to quit his job and go work someplace where he is permitted to eat his own cooking. The colleagues they leave behind will be the only people on the planet who are allowed to invest in anything except what they actually know about.
The end result will be to lower the quality of Wall Street analysis, and so to raise the relative importance of their natural competitors for public attention, mainly journalists and financial pundits.
The people who run CSFB and Merrill must know this, so we may assume that they don't much care, and that they are resigned to the slow but sure whittling away of their influence on everyday financial public opinion. Meanwhile the serious conflicts of interest -- the ones that actually cause analysts to fudge their opinions -- go largely unaddressed. That's because the serious conflicts of interest generate the serious profits. |
