What makes Wall Street's brand of bribery such a big deal?
by James Surowiecki
The New Yorker
THE FINANCIAL PAGE
THE BRIBE EFFECT
Issue of 2002-10-07
newyorker.com
Salomon Smith Barney, like so many firms on Wall Street, seeks to please its clients. On June 24, 1997, when it was still Salomon Brothers, it offered one of those clients, Bernie Ebbers, the C.E.O. of WorldCom, the opportunity to buy more than two hundred thousand shares in the initial public offering of a telecommunications company called Qwest. At the time, the I.P.O. market was lucrative, and a bet on Qwest was a virtual lock, so Ebbers bought in. Three days later, Qwest's stock price was up twenty-seven per cent, and Ebbers began selling. In the end, he cleared almost two million dollars. Clients appreciate this sort of thing, especially when it happens more than once. Between 1996 and 2001, Salomon helped Ebbers earn eleven million dollars flipping I.P.O. shares.
As it happened, while Salomon was making Ebbers richer, he was sending a lot of business its way. Between 1997 and 2001, according to Thomson Financial, WorldCom paid Salomon a hundred and forty million dollars in fees for its underwriting of the company's debt and equity, and another seventy-six million in fees for its advice on mergers and acquisitions.
Salomon insists that the transactions had nothing to do with each other—that there was quid and quo, but nary a pro in between. You'd have a hard time finding anyone who believes this. It sure looks as though Wall Street investment banks, in the hope of winning future business, routinely doled out cheap I.P.O. shares to corporate executives, who then sold them for quick, hefty profits—a process known as "spinning." That practice has occasioned a predictable chorus of outrage, from editorial writers and politicians alike. Representative Michael Oxley, the chairman of the House Financial Services Committee—which is currently investigating I.P.O. allocations at Salomon, Goldman Sachs, and Credit Suisse First Boston—calls these gifts to executives "another example of how insiders were able to game the system at the expense of the average investor." Massachusetts Secretary of State William Galvin put it more bluntly: "The problem with I.P.O. spinning is that it's bribery."
But what of it? The lavishing of gifts and favors on prospective or valued customers is generally considered smart salesmanship. Potential advertisers and clients get free Knicks tickets. Maître d's give regulars and bigwigs the best tables. Las Vegas casinos comp high rollers. Movie studios take journalists on junkets. For that matter, most civilians get the Ebbers treatment every day, barraged as they are with offers of free stuff in exchange for their patronage. Buy a Chevy Malibu and get three thousand dollars in cash up front. Join Columbia House and get twelve free CDs. In all these cases, companies are giving away "something that serves to induce or influence," which is Webster's definition of a bribe. So what makes Wall Street's particular brand of bribery such a big deal?
It's a big deal because the deals are so big. When it comes to bribery, size does matter. A free Linkin Park CD is one thing; eleven million bucks is another. Even so, the real scandal on Wall Street isn't the deals themselves but the system that the investment banks rigged to pay for them. Here's how it worked. In the late nineties, most companies that went public sold their shares for much less than fair market value. In other words, when they could have sold ten million shares for thirty dollars apiece they sold them for twenty dollars apiece. As a result, they left a hundred million dollars on the table. And who advised them to do this? The very investment banks that were using those cheap shares as goodies for lucky gents like Bernie Ebbers. In effect, the hundred million dollars that should have gone to the company that was going public went instead into the pockets of privileged customers. Banks were making bribes with other people's money.
What was insidious about this was that it gave investment banks an incentive to keep underpricing I.P.O.s. According to a recent study by the finance professors Jay Ritter and Tim Loughran, in the nineteen-eighties I.P.O.s rose, on average, seven per cent on the first day of trading. Between 1990 and 1998, they rose fifteen per cent. And in the dot-com heyday, between 1998 and 2000, they rose sixty-five per cent. One of the main causes for this surge was Wall Street's desire to keep itself supplied with baksheesh to hand out to coveted clients.
This, in turn, deprived small companies of money that might have made the difference between life and bankruptcy. It corrupted the efficient allocation of capital, which is supposedly the whole reason that Wall Street exists. And it allowed the biggest investment banks to insulate themselves from competition, by creating a self-reinforcing pattern: the more business the banks did, the more bribes they could hand out, and the more business they got. "If you owned a big chunk of the I.P.O. market, you had more I.P.O. shares to hand out," Ritter said last week. "It was a rich-get-richer situation." All of this was far more destructive to the well-being of the capital markets than a little payola for a few telecom C.E.O.s.
The irony is that if Salomon had written Bernie Ebbers a check for two million dollars, instead of offering him shares of Qwest, it would have been clear that the firm was breaking the law. (At the moment, no firm or executive has been charged with anything related to I.P.O. spinning.) All things being equal, writing a check might have been less egregious. Bribery is no good, but if we're going to have it on Wall Street at least let it be in cash.
— James Surowiecki |
