The game's not rigged. it's not crooked. But we have to prove that to you by showing toughness toward those who tried to rig it and did their best to screw you. There, that's the mantra that Bill Donaldson, the new head of the SEC, had better have if he is going to be successful taking on the job of top securities regulator. He's going to have to have that attitude, because, as someone who speaks to or e-mails literally thousands of investors a week, I can tell you that people have lost all faith in the stock market as an honest place to make money.
The industry itself is in total denial. Actually, it's worse than total denial. The average "leader" in the stock business says that if it weren't for Eliot Spitzer, the New York State attorney general, and his ridiculous crusade, we'd be back to normal by now. That's preposterous, because "back to normal" would simply mean that we had restored investor stupidity instead of restoring investor trust.
Donaldson comes in at an awful time. The head of the SEC under President Clinton, Arthur Levitt, is barnstorming the country telling everyone that he was powerless to clean things up when, to be honest, he spent more time promoting the stock market than he did regulating it. Harvey Pitt didn't even regulate it at all. There's been a common theme at the SEC for years, which is, to put it bluntly: Caveat emptor.
Now, maybe you believe that the buyer should be more wary and maybe you believe that the government should be hands-off when it comes to the stock market, but, as someone who has been in the business for three decades, I can tell you that there's plenty that's just plain crummy on Wall Street, and the market's not about to take care of it.
First, understand that the business has always been full of conflicts, but it has served the business well to keep those conflicts hidden. You have made more money exploiting the conflicts than resolving them or pointing them out. There has always been a bias in favor of investment-banking clients; it just got exacerbated at the end of the nineties, because the merchandise was so bad and the bills were so big that it was, quite frankly, worth lying about it and hoping no one would find out.
Second, retail investors have always gotten a later call on research and sloppy seconds on IPOs, because Wall Street has always favored the biggest bill payers and the institutions pay bigger than individuals. In fact, you can trace all of the ethics problems to money issues. The investment banks have always sold their best efforts to the highest bidders. The corporate-finance clients pay the most, so they get lied for and hyped up the most. The institutional clients pay the second-most, so after the bankers are done favoring the corporate-finance clients with favorable pricings on merchandise, positive research reports, and large cuts of hot deals to the principals at the firms, they then try to bone the institutions with good calls on research and hefty dollops of good IPOs. Retail, the lowest payer, gets mostly lousy deals, gets the paid-for research without the call underneath it saying to ignore it, and gets lied to routinely if it suits the larger clients.
Don't believe me? Take the incident that started all of this hullabaloo: Henry Blodget's shameless hyping of InfoSpace, a company he knew sucked, because the investment-banking types at Merrill wanted to earn a big banking fee from InfoSpace. Do you think that I, when I was at my hedge fund, got the call from Blodget to buy Info-Space? No way. He knew that as a sophisticated investor, I would just ignore his InfoSpace claptrap. But not so the doctor who did a small amount of commission with Merrill and held on to it, much to his own detriment. That's why when the doctor sued, Merrill had to pay. Merrill's bankers showed total fealty to InfoSpace but didn't extend the fealty to institutional investors -- no sense in wrecking them on something like InfoSpace -- and showed no duty of care at all to retail. The really corrupt research was meant for the hungry, trusting, and unknowing individual, because the institutions wouldn't eat it.
That's what Eliot Spitzer recognized: There was no duty at all to the individual investor. And believe me, that hasn't changed one whit despite the publicity generated by Spitzer's one-man crusade. Recently, Morgan Stanley priced a terrible IPO for Seagate, a disk-drive company, that assured the banking client -- the venture capitalists behind the Seagate deal -- a hefty profit but showed total contempt for the stock's buyers. They lost money immediately. That's typical of the pecking order.
Bill Donaldson knows all about this double standard. His old firm even dabbled in it, according to Tom Brown, a fine banking analyst who lost his job at Donaldson, Lufkin & Jenrette when he criticized management at Wachovia's predecessor bank, First Union. Brown says DLJ tried to force him into saying positive things about First Union to the brokerage clients of the firm so DLJ could get some juicy, big-fee First Union business. When he wouldn't because he knew First Union's stock was a stinker, he was sacked. Spitzer has met with Brown and is familiar with the whole story. (Donaldson was not at the firm at the time.) If I were on the Senate committee vetting Donaldson, I'd ask him what he would have done if he were still running DLJ when Brown was canned for saying that First Union's stock was a loser.
Donaldson will need all of his skills and experience to figure out a way to make sure that one client isn't screwed to make hay for another. And if he can't, he needs to break up the investment banks so research isn't under the same roof as corporate finance. Until he does restore the appropriate duties, Main Street will stay away from Wall Street, and the game will forever seem rigged to the very investors who have supported the market for so long. If you favor higher stock prices, as I do, that's an unacceptable outcome. We need those investors to return to the market instead of staying sidelined in cash. It won't do them or the market any good given the paltry returns cash now generates. If Donaldson embraces Spitzer, then I know he will restore investor trust; if he disses him, score one for restoring investor stupidity.