Memo to the SEC: Have Mercy on Investors


Instead of publicly barbecuing a few big-name crooks, the Securities & Exchange Commission should punish systemic corruption

Why is the Securities & Exchange Commission considering using its rather limited resources to bring charges against former AIG (AIG) chief Hank Greenberg? Are there no more pressing concerns on the docket?

To be clear, I am no apologist for Greenberg, but prosecuting the 83-year-old insurance executive amounts to the proverbial beating of a dead horse and is an egregious waste of limited SEC resources—particularly given that he was ousted from AIG three years go (since then, another CEO, Martin Sullivan, has come and gone).

The SEC's prosecution of Greenberg underscores its reluctance and failure to pursue systemic wrongdoing at the major Wall Street firms. Our financial system is broken, and individual investors must once again pay the price for Wall Street's unbridled greed. Someone needs to speak for these wronged investors, and the SEC is failing them.

Could the SEC Have Saved Bear Stearns?

A case in point is the love tap the SEC imposed on more than a dozen Wall Street firms when it was discovered they were rigging the auction rate securities market. As countless investors are now painfully aware, the paltry SEC fine did nothing to curb the widespread wrongdoing, which is a reason the market ultimately failed.

It's also quite possible the SEC could have prevented the collapse of Bear Stearns (BSC). The failure of Bear's subprime hedge funds revealed serious weaknesses in the firm's finances and business practices, but the agency chose to remain on the sidelines until after Bear imploded.

Then there's the issue of Wall Street's questionable research. How is it that some dozen Wall Street analysts were so completely wrong in their estimates of Lehman Brothers' (LEH) second-quarter losses, particularly when short-seller David Einhorn repeatedly and very publicly questioned the quality of the company's earnings? One must have substantial net worth to invest in a hedge fund like Einhorn's (which undoubtedly reaped a tidy profit from being short on Lehman), so an individual investor who relies on the research of a brokerage firm is clearly at a disadvantage.

Investment Bankers Unscathed

The SEC should target investment banking as well. Wall Street firms are allowed to peddle their dubious M&A advice with reckless abandon, as witnessed by Wachovia's (WB) disastrous acquisition of Golden West Financial (a Lehman-sponsored deal). Although there is compelling evidence that most large mergers don't work in the long run, investment bankers manage to rack up millions of dollars in fees arranging corporate marriages doomed to failure. When the botched unions fail, the CEOs are—rightly—forced out, but their investment banking matchmakers live it up in the Hamptons.

Finally, the credit default swaps market has been transformed into a trillion-dollar market that remains essentially unregulated despite the fact that its collapse could spark a major global crisis.

What to do? I say: Hit 'em where it hurts—in their wallets. Wall Street's compensation structure encourages conflicts of interest. The broker makes commissions on what he can sell to John Q. Public, whether it's suitable or not. The investment banker gets paid whether a deal is successful or not. And Wall Street CEOs have iron-clad contracts guaranteeing millions even after they cut shareholder equity in half.

A Better Compensation Structure

Wall Street and its regulators need to devise a more prudent compensation structure that aligns their interests with those of individual investors. One example might be to pay executives on a rolling three-year basis so they have no incentive to goose earnings in a particular year.

To be sure, there will always be those who game the system. Therefore investors should be able to more easily recover investment losses that are due to dubious practices. A first step would be to reform the securities arbitration process. Currently regulations stack the deck in Wall Street's favor because one of the arbitration panelists must represent the securities industry. The rules should eliminate industry people from the panel and require the presence of three individuals representative of the U.S. population.

These measures, and a regulatory environment laser-focused on the individual investor, could go a long way toward protecting Main Street's nest egg from Wall Street's greed.


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