But, one market analyst suggested, "It is time to praise the equity culture, not to bury it under laws and lawsuits."

This is nonsense.

Lets look at the facts. In several high impact cases, ethical principles were abandoned in the pursuit of material well being. That this behavior has taken place in the most materially advantaged country extant suggests a culture of greed, arrogance, and envy has flourished, propelling standards of behavior downward.

Institutions that once helped insure the long term well being of equity market institutions have been pushed aside. Allowing analysts to give "investors an unprecedented amount of bad advice" was incompetent; "that those dispensing it often had an inkling that the firms they touted were probably overvalued" was illegal; "that (Wall Street analysts) had strong incentives to err on the bullish side" was immoral. A "go slow" approach to market malfeasance is fundamentally flawed. Justice, and markets, can not and will not wait.

Market participants are voting with their dollars: they are leaving en masse. This is a constructive, not destructive force: it shows that markets work. The factors that have come "together to cast America's capital markets..in a peculiarly unfavorable light—and to fuel calls for wholesale reform" have little to do with markets falling, specific and continuing revelation of corporate malfeasance, or the imagined assault on Wall Street "by regulators, politicians and lawyers." Markets themselves are impartial resource allocation mechanisms. They are blameless. Market institutions, on the other hand, peopled by imperfect human actors, have been shown to be systemically flawed.

As the head of one large investment bank noted, "There is an air of cynicism surrounding every institution that underpins our capital markets." The same person suggested "This cynicism has gone beyond reasonable questioning, and could easily turn destructive." While the first claim is accurate, the latter concern is unjustified. We should worry about the destructive possibilities a lack of ethics and integrity on Wall Street might have on the future of democratic capitalism. Many calling for significant market institution reform are simply seeking to preserve democratic capitalism. As Federal Reserve Board Chairman Alan Greenspan noted on July 16, 2002,

“Well-functioning markets require accurate information to allocate capital and other resources, and market participants must have confidence that our predominately voluntary system of exchange is transparent and fair…Falsification and fraud are highly destructive to free-market capitalism and, more broadly, to the underpinnings of our society.”

We agree.

The real issue is this: market institutions charged with protecting the public interest, specifically investment analysts, accounting firms and the SEC, have been compromised. As recently as January, 2002, according to one magazine, the head of the U.S. Securities and Exchange Commission (SEC) said: "There is nothing rotten in the accounting profession." This is no mere appearance of a conflict of interest. The "speed with which scandal leaps from company to company" is indicative of the systemic nature of the problem. The investigations launched by New York state's attorney-general were entirely appropriate. No other institution charged with protecting the public interest was able to act.

In response to mounting, uncontroverted evidence of systemic problems, several have called for improved disclosure standards. This is like offering a glass of water to a drowning man. It is more important to recreate standards of trust and integrity. The public has a right to demand that market institutions act in ways consistent with principles of fairness and justice. These institutions are, after all, not above the laws of society. To suggest that calls for equity market reform are simply a "search for someone to blame" ignores the serious long-term impact these incidents have on markets, the economy and society and decreases the likelihood of honest reform.

Several things can be done to restore public faith in the markets:

The Initial Public Offering (IPO) issue

Members of the public pay, unfairly, for the privilege of purchasing IPO shares. They can only purchase shares at an excessively high price in the after issuance market. At some point, to protect the economy, the markets and the investing public, the SEC should do what it knows it must, by "ordering investment banks to use auctions to allocate shares in IPOs to the highest bidders." Internet technology was specifically designed for this type of problem. Auctions could be conducted on-line, via a secure, tamper resistant, SEC monitored (or managed) website. The network of prescreened buyers, already well known to Wall Street, could easily be moved to this system. The system would be designed to meet certain security and performance standards.

I suggest this system be phased in over a six year period. In the first two years, IPO issuers would simply be offered the option of issuing stock via on-line auction. After two years, companies seeking capital in the IPO market would be required to describe why they chose to use or not to use the system. They would have to report certain information to shareholders. For example, I expect an auction system would be cheaper (resulting in lower stock issuance cost) than the current non-auction system. Corporate management would be required to report the cost differential between the auction system and other methods. Over time, say, after six years, all IPO’s would be issued through the on-line auction system.

If Ebay can successfully implement this technology, so can Wall Street.

"Requiring full disclosure of any other relationships that managers of companies going public have with their underwriter" is a second-best solution: a complicating rather than simplifying half measure, more likely to generate revenue for law firms than to help the investing public.

The Research Issue

Investment research should be viewed as a public good. It is important, costly to obtain, with significant externalities. The SEC should take over portions of the investment research function by providing standardized investment reports to the public. The SEC has the devices and data it can use to do so – the erstwhile 10K and 10Q reporting forms, sanitized and made ready for public use. The SEC’s website already provides this information. The data simply needs to be scrubbed and made easier for the public to interpret.

The Integrity Issue

Most of the laws needed to restore public confidence in the markets are already on the books. As the U.S. Supreme Court recently noted, "Section 10(b) of the Securities Exchange Act makes it ‘unlawful for any person … [t]o use or employ, in connection with the purchase or sale of any security … , any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe.’" Investment research departments have been used as a "manipulative or deceptive device." Investment bankers and brokers used this device as part of "a scheme to defraud" the investing public. Current laws simply need to be enforced.

Further, I suggest the SEC create a confidential hotline to field calls from corporate insiders who have concerns about accounting practices. We have been asking the wrong people to look out for the shareholders interest. Many mid-level corporate staff people are anxious to report any fraud and abuse they might see. After all, they need to keep their jobs: most don’t have golden parachutes or million dollar stock option packages to fall back on.

The Corporate Governance issue

For the benefit of shareholders, we should open the "Salotto buono." Public companies should be required to conduct Board elections via the Internet. Candidates would be nominated on-line and a fair, efficient procedure for screening candidates could be established. They could be vetted in any number of ways. Proxy voting and board elections could be conducted on-line, using a secure, tamper resistant, management-independent website. Votes would be tabulated on-line, in real time. Again, internet technology was specifically designed to further this type of collaboration. This system will be fairer, cheaper and more efficient than the current system.

Privatization of Social Security

It is entirely appropriate that we postpone discussions about the privatization of Social Security while we reexamine the institutions entrusted with the future of democratic capitalism. To do otherwise is to invite new players to take part in a rigged game of chance. Postponing this discussion will also give Wall Street additional incentive to resolve the issues noted above.

It is time to create a just, fair and ethical equity culture, one worthy of praise. If laws and lawsuits are required to do so, then so be it. In the long run, we will all be better off.

August 15, 2002.

Frequently Asked Questions about Corporate Ethics

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