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As prepared for the National Press Club - PDF Version (Printable) Executive Summary A crisis of confidence is shaking Wall Street to its core, as investors, already shell-shocked by deep market declines, realize that a series of deceptions by many institutions they trusted may have played a significant role in their losses. A deeper understanding of the crisis can be achieved through an analysis of "buy," "sell," and "hold" ratings issued to companies that have gone bankrupt this year -- a total of 50 investment banking and brokerage firms issuing ratings to 19 companies that filed for Chapter 11 in the first four months of 2002. Among these, the results show that:
To address these issues, the power and will of government is limited. Instead, the best regulators and dispensers of financial justice are investors themselves. They cannot exercise this function, however, in the current environment of uneven disclosure, secrecy and even duplicity. In order to help investors make constructive, informed decisions in the selection of a broker and brokerage firm, brokers should disclose significant data on stock ratings, past legal actions, and the financial stability of each firm. The disclosure must be accompanied by more complete education on the risks associated with specific investments and with the failure of a broker-dealer. Disclosure questionnaires and procedures are offered to help investors protect themselves against future abuses. Introduction A crisis of confidence is shaking Wall Street to its core. Investors have suffered losses of as much as $5 trillion since 2000. Now, adding insult to injury, they are learning that a complex series of deceptions by many institutions they trusted -- major corporations, accounting firms and investment bankers -- may have played a significant role in their losses The bankruptcy of large, well-respected companies in 2002 are a case in point. In the first four months of 2002, 87 publicly traded companies filed for Chapter 11, wiping out what was once a total of $185 billion in investor wealth at peak market prices. What steps, if any, did Wall Street firms take to warn investors of these bankruptcies? How will these and similar bankruptcies impact the brokerage industry in the future? What steps can be taken to improve the industry's ability to warn of future troubles? In this paper, each of these questions will be answered based on a broad analysis of the nation's brokerage and investment banking firms, encompassing their stock ratings, history of investor abuses and financial stability.
Each section is designed to help investors defend themselves with practical, user-friendly information, while providing guidelines for regulators and legislators. Part I. Wall Street Firms Fail to Warn of Failures in 2002 Typically, only the largest or most interesting companies catch the attention of Wall Street research analysts. So it is not surprising that only 19 of the 87 companies failing in 2002 received ratings. It is also typical that a relatively large number of brokerage and investment banking firms take an interest in the same company, and, in this case, there were 50 firms issuing ratings on at least one of the 19 failed companies. Thus, the scope of the analysis in Part I is restricted to the 19 failed companies and the 50 firms that covered them. It excludes companies that were not rated. It excludes brokerage firms that did not issue ratings on these failed companies. Plus, it excludes any ratings that were not available at four major public sources -- Bloomberg, Yahoo.com, Zacks, and First Call. (A more detailed discussion of the definitions and scope of this study can be found in Appendix A.) The analysis was undertaken from two perspectives, as follows:
Perspective A. Track Record of the 50 Firms Issuing Ratings on Failing Companies In reviewing the stock ratings available on major public sources, a careful analysis demonstrates that the brokerage firms displayed a consistent pattern of conscious neglect and even deliberate disdain for the individual investor, with few exceptions. It shows that:
In all of the above situations, the firms either continued to recommend the failing companies, or they quietly walked away from their earlier recommendations, neglecting to inform the public that their opinion might have changed. In its complaint against Merrill Lynch, the New York State attorney general's office put it this way:
Many firms seek to shirk responsibility for this disparity of reporting by pointing fingers at the news media. However, in most cases, it appears that the firms are to blame. They often viewed their earlier "buy" ratings for failing companies as a source of embarrassment and a potential threat to their reputation. In addition, some may have feared that a public warning could hasten the demise of corporations to which they had loans outstanding. Therefore, although most made every effort to publicize the positive ratings, it appears they made little or no effort to publicize the withdrawals of those ratings or to notify major public sources. In response to an inquiry about their policy for removing investment ratings, Bloomberg states:
However, by the date this analysis was completed, May 30, 2002, Bloomberg had not yet removed the ratings included in this analysis, implying that it had not received notification regarding a change in the employment status of the analysts or in the coverage status of the companies. Similarly, Yahoo.com continued to disseminate the ratings included in this study, with no indication of a change in their status. Table 1 lists the 50 brokerage firms included in this analysis along with a breakdown of the ratings available from these firms through major public sources, at the date of failure and six months prior to failure. Table 1. Brokerage Firm Ratings on Companies Filing Bankruptcy in 2002
On the date the companies filed for Chapter 11, there were six "buy" ratings from Lehman Brothers, as well as eight "hold" ratings from Salomon Smith Barney. There were also "buy" ratings from Bank of America Securities, Bear Stearns, CIBC World Markets, Dresdner Kleinwort Wasserstein, Goldman Sachs, Prudential Securities, and many other firms. Only the ratings from Credit Agricole Indosuez Cheuvreux, Edward Jones and HSBC Securities excluded any positive ratings on failing companies, while at the same time, including at least one "sell" rating at the time of failure. Ratings disseminated by major public sources from another five firms -- A. G. Edwards, Credit Lyonnais, Merrill Lynch, Prudential Securities, and U.S. Bancorp Piper Jaffray -- included "sell" ratings by the date of the bankruptcy filing but also included at least one positive rating on other bankrupt companies. Table 2 below summarizes the data listed in Table 1. Table 2. Ratings Issued by the Brokerage Firms on Companies Filing for Bankruptcy
Of the 121 ratings available from major public sources six months prior to failure, 95.9% were "buy," "hold" or equivalent, while only 4.1% were "sell" or equivalent. By the date of failure, the percentage of "buy" and "hold" ratings available from major public sources had declined to 90.9%, while the percentage of "sell" ratings had risen to 9.1%. However, given the many warning signs and news announcements that foretold of impending bankruptcy, the change in the ratings distribution over the six-month period is surprisingly small. Perspective B. The 19 failing companies and the ratings they received At the time of their failure, hundreds of thousands of individual investors owned shares in the 19 failing companies covered by the brokerage and investment banking firms, either directly or through mutual funds and other institutions. Many of these investors used major public sources to locate research and recommendations available on the companies. Moreover, when using these sources, it is fair to assume that they typically vest a high level of trust in the firms that produce the research, especially those with well-respected names and reputations. This confidence is further reinforced when more than one analyst or firm provides positive recommendations. Like a patient consulting various doctors and specialists, investors' confidence tends to be higher when second and third opinions are mutually supportive and even higher when they can find few or no dissenting opinions. Indeed, an analysis of the investment ratings available through major public sources and issued to the 19 bankrupt companies reveals that unanimity and mutually reinforcing opinions were the most common situation: among the 19 failing companies for which ratings were available, 12 continued to receive strictly positive ratings on the date of bankruptcy filing. Thus, even diligent investors who sought out possible dissenting opinions on their shares would have run into a virtual stone wall of unanimous, "don't-sell" advice from the firms. For example, on the day the company filed for Chapter 11, Global Crossing still boasted five "buy" ratings, nine "holds" and no "sells" at major public sources. Adelphia Business Solutions still received two "buys," three "holds" and no "sells." In addition, 10 other failing companies received exclusively positive ratings. In contrast, only one company received exclusively a negative ("sell") rating. The balance, six companies, received a mix of positive and negative ratings. Table 3 lists the 19 failing companies for which ratings were available through major public sources at the date of bankruptcy and six months prior. Table 3. Companies That Filed Chapter 11 in 2002 with Their Ratings from Major Brokerage Firms
Table 4 summarizes the data from Table 3. Table 4. Ratings Received by 19 Companies Prior to Bankruptcy
Six months prior to bankruptcy, 78.9% of the companies received exclusively positive ratings, while 21.1% received at least one negative rating. On the date of failure, the percentage of companies receiving exclusively positive ratings declined to 63.1%, while those receiving at least one negative rating rose to 36.9%. As stated earlier, however, given the many warning signs and news announcements that foretold of impending troubles, the weakening of Wall Street's unanimously positive support for the companies is surprisingly modest. Moreover, even when companies received a mix of positive and negative ratings, typically the positive ratings represented the overwhelming majority. Thus, the portrait painted for investors continued to encourage a high, but false, sense of confidence. This was in stark contrast to the dire realities that the failing companies were facing, as illustrated by the case studies that follow. The Case of Kmart Kmart filed for Chapter 11 on January 22, 2002. On the very same day, three of the firms included in this analysis issued new ratings reaffirming their existing "hold" recommendations on the stock, thereby continuing to discourage investors from selling their shares. Plus, nine "hold" ratings issued earlier were still available on major public sources. It is not known what specifically motivated each firm to actively or passively maintain its "hold" ratings on Kmart. However, the chronology of events leading up to the company's failure sheds light on the complex relationships among the firms, the companies and others in the industry:
The Case of Global Crossing Global Crossing filed for Chapter 11 just six days after Kmart, on January 28, 2002. Unlike the situation with Kmart, no new stock ratings were issued. However, five "buy" ratings and nine "hold" ratings continued to be displayed at major public sources. Most surprisingly, none of the ratings posted were "sell" or equivalent, leaving the clear impression that Global Crossing was still enthusiastically and unanimously recommended by Wall Street. Nevertheless, the firms had abundant advance warning of troubles from numerous reputable sources, and ample opportunity to notify major public sources of a rating change, as illustrated by this sequence of events:
The Case of McLeodUSA McLeodUSA followed Global Crossing into bankruptcy court 48 hours later, with an even larger number of positive ratings than Global Crossing's: four "buys" and 16 "holds." Unlike the situation for Global Crossing, major public sources also displayed two "sell" ratings on the company, indicating at least some dissenting opinion in the public domain. As with the chronology leading to Global Crossing's demise, however, analysts would be hard pressed to defend any assertion that they were caught by surprise:
From these and other case studies, the following patterns are evident: First, despite abundantly available and strikingly clear information that the company was sinking into bankruptcy, the firms rarely warned investors. The data show that the analysts could not have been ignorant of the fact that they were leading thousands of investors directly into severe losses. Second, while credit rating agencies periodically lowered their letter grade ratings on the company and its bonds, research analysts failed to lower their "buy" and/or "hold" ratings on the same company's stocks. The rating assigned by the credit agencies represented warnings of an increasing probability that the company would fail. Inasmuch as common shareholders are last in line for the available funds and have much more to lose from such failures than bondholders, one would expect the research analysts to be more pro-active in announcing downgrades than their counterparts at the credit rating agencies. However, the chronologies show the opposite to be the case. While the credit agencies were pro-active, the research analysts often took no steps, even retroactively, to correct past errors of judgment. Third, the business and financial ties between the firms and the failing companies may have played a significant role in influencing the stock ratings. Some examples follow:
Fourth, there was no special operational difficulty preventing the firms from issuing a warning to investors or preventing them from reporting the warning to major public sources. This is evidenced by the fact that at least some firms did downgrade the stocks to "sell" or equivalent, and those few "sell" ratings were clearly displayed by major public sources. Business as Usual In its settlement with New York State's attorney general, Merrill Lynch has promised to make significant changes in its ratings business. Other firms are under increasing pressure from the states and the Securities and Exchange Commission (SEC) to follow suit. Private investor lawsuits are also adding to the momentum. However, for individual investors seeking objective opinions on their shares in failing companies, very little has changed so far. For example,
Although these companies may recover, it is clear that the opinions from major firms are still overwhelmingly weighted to the positive side, despite growing signs of financial difficulties, much as was the case for the companies that have already filed for Chapter 11 in 2002. Part II. Investor Reaction and the Impact on the Brokerage Industry The aggregate market value of all the companies listed on the Nasdaq fell from $7.6 trillion on March 10, 2000, to $2.4 trillion on April 6, 2001, a decline of $5.2 trillion. This was the equivalent of almost half the nation's gross domestic product and the largest percentage decline of any major market index since the bear market of 1929-32, all in just 13 months. Today, there has been no recovery and the Nasdaq continues to trade at less than one third of its peak value, leaving millions of investors with sweeping losses. Initially, most investors blamed themselves for their misfortune. More recently, however, in the wake of widely publicized revelations about accounting manipulations and broker conflicts of interest, investors are increasingly turning their ire against the companies, their accountants and their investment bankers on Wall Street. This raises three urgent questions for the industry, regulators, and investors:
1. The Rising Tide of Arbitration Claims Filed against Brokers Long before the most recent revelations about conflicts of interest on Wall Street by the attorney general of New York and others, the number of arbitration claims filed against brokers and their firms was increasing rapidly, as shown in Table 5, based on National Association of Securities Dealers (NASD) data. Table 5. Arbitration Filings
Claims surged by 24.4% from 2000 to 2001. In the first three months of 2002, they have again risen by 17%, compared to the equivalent period one year ago. The rise appears to be due to a combination of factors:
All of these seem to have played a role in the rising tide of arbitration claims against brokers. However, even the most recent surge recorded for 2002 does not yet reflect the revelations regarding the conflicts of interest among research analysts. These are likely to accelerate the pace of arbitration claims and other legal actions, emerging as a potentially significant threat to the financial stability of many firms. 2. Which firms are subject to the most legal actions? It is difficult to predict which firms are going to suffer the brunt of the legal actions. However, it is fair to assume that those firms with the worst past record of investor abuses are likely to continue to be among the most frequent targets of future actions. In order to evaluate the past history of the firms, Weiss Ratings has analyzed 13,232 arbitration cases and regulatory or legal actions recorded by the NASD against 612 brokerage firms. For the purposes of this paper, the analysis was further narrowed to the 18 most prominent retail-oriented brokerage firms in the United States during the five-year period from 1997 to 2001. Larger firms devoted primarily to institutional clients were excluded. Also excluded were smaller firms with total assets of less than $5 million and less than 700,000 customer accounts. Further, to arrive at a relative measure, the number of legal actions against each firm was compared to the number of customer accounts reported in the Securities Industry Association Yearbook 2001- 2002. Findings
Table 6 summarizes the results of the study for the 18 largest retail brokerage firms. The data represent only those actions reported on the firm's public record, excluding the many investor complaints that are settled before they are judged. The NASD may expunge from a broker's record court-ordered arbitration settlements, court decisions and other complaints against brokers from its public disclosure database if agreed to in a settlement with a customer. Nevertheless, with most firms registering scores or even hundreds of actions over the five-year period under study, it is reasonable to assume that the NASD database provides a more-than-adequate representative sampling for analysis. Table 6. Record of Abuses by Top Retail Brokerage Firms 1997-2001
Two brokerage firms have responded with commentary, as follows:
Table 7. Prudential Securities: Arbitration Cases, Regulatory and Legal Actions By Year
3. Which firms are the most vulnerable financially? Many major firms were able to accumulate a substantial amount of capital from large profits earned from their initial public offerings and other investment banking operations during the booming 1990s. However, there are two disturbing trends which, when combined, imply the growing possibility of failures by some large brokerage firms: First, among the 57 brokerage firms that have failed in the past seven years, the single most common cause of failure was large arbitration awards or other legal actions against the firm. Second, even among the large firms, there are some that have demonstrated signs of weakening finances.[3] For example:
Table 8 below shows the 20 largest brokerage firms, with their Weiss Safety Ratings. Table 8. Twenty Largest Brokerage Firms Based on Asset Size
The Weiss Safety Ratings of brokerage firms are based upon an analysis of a brokerage firm's capitalization, leverage, earnings, liquidity, and stability. The latter category combines a series of factors including arbitrations, regulatory and legal actions, size, growth, strength of affiliate companies, and risk diversification. The data are obtained from public information, including reports offered by the SEC and NASD. Although companies with a rated C-, C or C+ are currently stable, many could become vulnerable should their financial performance deteriorate from current levels. Their stability would be of particular concern if they suffer a further increase in the volume of investor legal actions, along with steeper declines in the financial markets. As of the latest data available, 13 of the 20 largest firms are in the C range, with only seven believed to have the financial wherewithal to withstand a severely adverse business environment. Thus, it is possible that failures in the brokerage industry could emerge as a major future challenge for investors, legislators and regulators. Part III. Recommendations for Protecting Investors and Restoring Confidence in Financial Markets Recent recommendations by the industry and regulators include a more efficient separation between investment banking and research, changes in compensation for research analysts, and better procedures for informing the public of dropped coverage, all to be supported by stronger legislation and/or stricter regulation. To the degree that they are implemented fairly and universally, most of these proposals can contribute to positive reforms. However, recent history demonstrates that it is not possible to achieve a desired level of integrity in our financial system through legislation and regulation alone. For example:
In light of this history, it is clear that the regulators of the financial markets need help badly. They don't have -- and probably never will have -- the funding or the staff to micro-manage thousands of brokerage firms, hundreds of thousands of individual brokers, and trillions of transactions in an ever changing financial system, where new relationships and new financial instruments are created daily. The best defenders of investors are investors themselves; the best regulator of markets is the marketplace; and the most efficient dispenser of financial justice, the crowd of customers. Investors need not hire lobbyists or pound on the desk of faceless bureaucrats. They don't even have to wait for the next election to make their voices heard. In the case of dishonest companies or deceptive ratings, all they have to do is pick up the phone or click a mouse, putting through a simple instruction: SELL. Their actions, multiplied manifold, immediately punish any CEO, investment banker, or broker who may be perceived to be acting amorally, unethically or illegally. At the same time, buy orders reward those who demonstrate integrity. Investors can also vote with their dollars by closing accounts with firms that have a track record of skewed advice and investor abuse, while opening accounts with those boasting a solid record. Unfortunately, investors will not be able to exercise this function without specific, objective information presented in an easy-to-understand, standard, comparable format. When the information is not comparable, the policing power of the market is stifled. When the flow of information is slowed, filtered, or blocked, that power is snuffed out. Worst of all, when the information is skewed and misleading, as it has been in recent years, the marketplace can emerge as a powerful force that diverts society's precious capital to ill-conceived, poorly managed ventures, while leaving worthy enterprises struggling to raise funds. Instead of capital and business flowing to those companies that are most skilled at efficient production, it winds up instead in the hands of those most adept at destructive deception. Later, instead of disclosures building confidence, they are the cause of anger, frustration and even panic. Indeed, a key reason confidence in the financial markets has floundered in recent months is precisely because information has been withheld from the public for so long, and is now coming forth so quickly, in a torrent of shocking revelations. Ironically, many Wall Street executives still believe that the investor's loss of confidence is justification for even more attempts to talk up the market or erect darker shrouds of secrecy to protect the public from what they believe the public need not know. These proponents of corporate secrecy seem to forget that the public has a great capacity to absorb bad news in small doses. It's the backlog of bad news, hidden in dark closets for years and suddenly bursting into the sunlight, that is so damaging. What is most unfortunate is that the shroud of secrecy is perpetuated not only by the corporations, financial vendors, and intermediaries with the most to hide, but, frequently, also by the regulators with the most to gain from uncovering their secrets. The NASD refuses to disclose its data on the overwhelming majority of investor complaints, and the data it does provide is largely unusable by individual investors. The SEC provides financial data on brokers, but severely limits the number of requests from the public, while failing to disclose certain key financial aspects from the Focus Reports submitted by broker-dealers. Broker-dealer data held by states is difficult to acquire and even more difficult to compare. Even professional researchers are often stumped. This is especially unfortunate given the regulators' dire need for investor assistance in monitoring vendors and intermediaries, and given the fact that investors can only exercise that function when they have the needed information that some regulators are now holding closely to their vests. The Urgent Need for True Disclosure Investors lack the single most important element they need to help cut through much of the distortions and dislocations discussed in this paper: clear, full, and specific disclosure of accurate, unbiased, comparable information. The term "disclosure," however, is often misused. Many in the industry believe that partial and selective disclosure is adequate. For example, to address allegations of conflicts of interest, industry players would be glad to consent to a disclaimer footnoted in research reports along the lines of "analyst compensation may sometimes be related to the sale of recommended securities." A noncommittal and vague footnote such as this would become standard, investors would learn to dismiss them, and the firms would be free to go about business as usual. Sometimes, industry leaders consent to broader disclosures, but only because they know they can overwhelm investors with reams of relatively useless information. As an illustration, investors can log onto the NASD website, enter the name of a firm, and receive a report with a partial list of legal actions. However, even for sophisticated investors, the data is next to worthless. Due to wide variations in a firm's size and volume of business, it is impossible for the investor to judge what is normal and what is excessive; there is no facility available for comparing firms; and the data is provided in a text format that creates still another roadblock to analysis. Some regulators go as far as to view disclosure as dangerous in certain circumstances. They seem to believe that their primary mission is to protect Wall Street firms from the potentially angry backlash of the mass of investors, rather than protect the public from demonstrably egregious acts of the firms. Thus, details of settlements with brokers may often be sealed, investors are left in the dark, and problems endemic to the industry continue to fester. The New York State attorney general's complaint against Merrill Lynch was one of the first to thrust analyst conflicts of interest squarely into the public domain. Indeed, the events that ensued demonstrate that public outrage can often play a more effective role in driving positive change than legal sanctions. Full-service firms like Merrill Lynch may have legal departments that are well equipped to negotiate with regulators, but their advertising gurus may not be so well prepared to combat the likes of Charles Schwab, which is deploying a massive ad campaign overtly designed to capitalize on Merrill's bout of bad publicity. In response, Merrill is taking steps to restore its reputation. Indeed, as the first major firm targeted by the attorney general, Merrill may have the opportunity to be one of the first to regain public confidence. In the final analysis, the more public exposure, the better it is for both investors and the firms themselves. Three Types of Disclosure Needed From Brokers and Brokerage Firms When consumers take out a loan, they are required to sign disclosure statements mandated by Truth in Lending legislation. However, when doing business with a broker-dealer, there is no equivalent "Truth in Brokerage" disclosure. Moreover, the primary risk of a loan is shouldered by the lending institution, whereas the primary risk of investing through a broker is shouldered by the investor. Therefore, in addition to the terms of the transaction, Truth in Brokerage disclosures must reveal critical information about the individual broker and the firm, covering the following three areas: 1. The nature of stock ratings and the track record of research analysts. Currently, when reports and ratings from brokerage firm analysts are distributed, there is:
This is not only dangerous to the investor; it can also damage the reputation of the analyst and his or her firm. Even if an analyst issues a "sell" rating of the stock in a timely manner, if the information is not disseminated in the same venues as an earlier "buy" recommendation, investors may blame the analyst for losses that he or she sought to prevent. 2. The legal history of the individual broker and the firm. In the current environment, when customers open an account, they are given little or no information on:
3. Financial stability of the firm. It is often next to impossible for a consumer to obtain relevant information on the financial stability of a brokerage firm because:
Thus, even the most sophisticated analysts are often unable to gain a clear and complete picture of a broker-dealer's financial stability, while for consumers, the task of evaluating a firm's security and the consequences of a possible bankruptcy is practically impossible. Standards and Procedures Needed For Full Disclosure As indicated above, in order to fill these gaps and help investors select an appropriate broker, disclosures should include complete information regarding the nature and history of stock ratings, the legal history of brokers and their firms, plus the financial security of each firm. Further, the information provided must be: (1) Presented in context, and in comparison to other brokers and brokerage firms. Industry defenders often claim that disclosures would be unfair because consumers would take the information out of context. However, it is the industry's own resistance to full disclosure that has lead to partial release of bits and pieces, making it extremely difficult for investors to put those pieces into a proper context. For example, if an investor retrieves a report on an individual broker from the NASD website, it is likely that almost any information in the report, no matter how benign, will hurt business. In contrast, more complete disclosure will give the investor the ability to compare the broker to industry averages and view it in the context of that broker's overall volume of business. Comparative measures could include (a) the number of legal actions per customer account, (b) the total dollar value of awards and fines against the firm as compared to the total value of securities held for customers, and (c) the number of complaints settled compared to the total number of complaints filed. (2) Clear and easy to understand. Disclosure opponents will also react with the common refrain that most financial concepts are too complex for the average person to comprehend. But this attitude is perceived as an insult by most investors. They will readily admit that they may not be as sophisticated as industry insiders, but they rightfully insist that they are no less intelligent. Indeed, the overwhelming majority of investors have both the ability and desire to grasp virtually any concept that impacts their personal finances, provided it is explained in language that is straightforward and clear. (3) Presented at the point and time of sale. Many so-called disclosures are theoretically available on request but, in reality, difficult to acquire. Most customers have no inkling of what information exists or where to get it, and most brokers are also in the dark. The disclosures need to be made to the customer whether requested or not, before a customer opens an account. (4) Accompanied with consumer education programs that disclose and explain all significant points of risk and drawbacks. Investors are generally aware that stocks can go down in value. What they often fail to realize is that the stocks of well-established, household-name companies can decline very significantly and swiftly, often wiping out billions in market capitalization in just hours of trading, as shocking revelations are made. These events demonstrate the need for a broader education on real risks, which, until this day, typically remain unknown or misunderstood: the risk of earnings manipulations, the risk of ratings exaggerations, the risk of fraud, and the risk of failure. (5) Based on standard questionnaires used industry-wide. Some sample questions are offered in Appendix B as a basis for disclosure legislation or regulations. It is anticipated that the industry will put up stiff resistance. In that event, more specific measures, including a full separation of the research and investment banking businesses, would be mandated. Separately, these and other similar documents are offered gratis to investors to be used as instruments to facilitate their own requests for disclosure. Investors can print them from the Weiss Ratings website (www.WeissRatings.com), present them to existing or prospective financial intermediaries or vendors, and use them as tools to help get specific answers. The website also provides benchmark data for comparison purposes. Investors will be encouraged to demand adequate responsiveness before opening accounts or doing additional business, and it is hoped that other investor protection organizations will offer similar consumer-friendly tools. (6) Distributed to the public in a standard format with standard procedures. In its settlement with the State of New York, Merrill Lynch has agreed to develop procedures for notifying investors when coverage is dropped on a stock. This is a good beginning. However, where does it leave investors who bought the shares based on earlier "buy" recommendations and who now need to know what to do next? The firms should:
(7) Complete, including all information currently available to regulators and self-regulatory institutions regarding the past conduct of firms or individuals, made readily accessible in a user-friendly format. The regulators do disclose a significant amount of information, but there remains a wealth of information that is either not publicly available or is very difficult to acquire. Prime examples include data on arbitration complaints filed and not settled, or claims settled before a decision is made, plus other data held by the NASD, SEC, New York Stock Exchange, and regulatory bodies of the 50 states. (8) Strictly enforced and backed up by severe penalties. Currently, to open broker accounts, investors must sign away many of their legal rights by consenting to arbitration. However, the ugly secret of the arbitration system is that it is designed primarily to protect the firms, with few advantages for investors. Rules of evidence favor the firms, and even when a customer prevails, less than one fourth of the money awarded is paid, according to the U.S. General Accounting Office. Thus, new federal and state legislation is needed to grant investors better access to data and to improve enforcement of arbitration awards with measures such as pre-award attachment procedures and fidelity bonding of brokers. In addition, investors with large or complex claims should be restored the right to sue in court. The Role of Government and Self-Regulatory Bodies Rather than getting bogged down in the micro-management of daily transactions, business models, or strategic plans of Wall Street firms, the primary role of the authorities should be to standardize, facilitate, and strictly enforce the complete disclosure of critical information to consumers. State regulators, the NASD, and the exchanges can play a particularly constructive role by placing complaints against firms into the public domain and alerting investors to any present abuses or dangers. Using questionnaires such as those presented in Appendix B, it is proposed that:
If this level of disclosure had existed in the 1990s, along with equally good disclosure from the nation's public corporations and accountants, it would have been extremely difficult, if not impossible, for trillions in investor funds to have been diverted to shaky corporations. Some speculative funds may have flowed into high-risk ventures, where failures and even accounting shenanigans would have still been possible. But the overwhelming bulk of investment money would have naturally been directed to well-managed, stable companies with accounting integrity. The great anomaly of our era -- chicanery at some of the nation's most respected large institutions -- would have been next to impossible. Looking ahead, the very fact that big names have been embroiled in the melee provides a powerful catalyst for change and a unique opportunity for reform. However, without a broad, sweeping reform -- to unlock the floodgates of information and truly empower investors to defend their personal interests -- we are doomed to perpetuate the current crisis of confidence and, sooner or later, repeat the blunders of the 1990s. Some small steps are already underway, but they have barely scratched the surface. Moreover, backsliding is already a present danger. In early June, the CEO of Goldman Sachs, in a speech at the National Press Club, boldly placed the blame for Wall Street's crisis of confidence on corporate CEOs and their accountants, including some of his firm's top customers. But in the process, he minimized the responsibility of his own firm and the industry. Similarly, on the CNBC program, "Louis Rukeyser's Wall Street," the chief executive of Merrill Lynch, fresh out of a settlement with New York State, brushed off the entire conflict-of-interest matter by asserting the offenders were just a "few bad apples." These approaches are nonproductive, calculating, and disingenuous. Until the industry leaders fully recognize their own offenses, real solutions will continue to elude them. Appendix A. Definitions and Scope of Research on Broker Stock Ratings
Scope of the Analysis
Appendix B. Proposed Disclosure Questionnaires for Brokers and Analysts Disclosure questionnaires for research analysts can include questions such as:
Disclosure questionnaires for brokers and firms can include questions such as: To be answered by individual brokers:
Note to brokers: If you are not certain, it is your responsibility to determine what information does exist. For a list of state agencies that may pertain to you, see http://www.nasaa.org/nasaa/abtnasaa/find_regulator.asp
To be answered by a compliance officer, or equivalent, of the firm:
[1] Affidavit in Support of Application for an Order Pursuant to General Business Law Section 354 by Eliot Spitzer, Attorney General of the State of New York with regard to the acts and practices of Merrill Lynch & Co et al., submitted to the Supreme Court of New York County of New York, http://www.oag.state.ny.us/press/2002/apr/MerrillL.pdf. [2] Email communication from Bloomberg to Weiss. [3] Based on data reflecting strictly the brokerage subsidiaries or operations, as of year-end 2000, the latest available from the SEC. |
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