Tattered Standard of Duty on Wall Street
WITHOUT trust, there can be no free-market capitalism. Capitalism took root in Europe when wealthy families had excess income to invest, and they entrusted their money to managers who would treat their funds with due care.
Such standards of care required that those handling someone else’s money behave with extreme rigor and honesty. The standards, which came to be known as fiduciary duty, were the same duty a court required of, say, a trustee dealing with the property of a widow or a child.
Trustees always had to behave with the interests of the trustor uppermost — there could be no conflict of interest or even the appearance of one. Every relevant fact about an investment and a trusteeship had to be disclosed. As the law came to be interpreted in the United States, the trustee had to disclose every fact or belief that might influence an intelligent, reasonable investor.
These laws were codified in state and federal courts after revelations of stock market corruption before and during the crash of 1929. There could be no material deception and no “scheme or artifice to defraud.” The investor’s interests always had to be superior to those of the investment bank, financial adviser or broker.
For a good long time after World War II, the laws of fiduciary duty were observed. But by the 1980s, the law started to break down in a major way. There had been small scandals in the 1950s and ’60s. But by the end of the 1980s, the Drexel Burnham/Michael Milken junk-bond scandals had exploded, revealing that deception was routinely practiced against the buyers of junk bonds.
Then came the closely related savings-and-loan scandals, leaving taxpayers defrauded in a major way. Then we weathered the high-tech scandals of the late 1990s, in which the bluest of the blue-chip brokerage firms and investment banks placed excessive valuations on companies that they peddled to investors. These investors were often in a trustor-trustee relationship, they suffered losses on a scale never before seen and yet almost no one was punished.
Now, we have the collateralized mortgage obligations and their attendant losses in the subprime mortgage mess. The problem is a familiar one: basic hocus-pocus about what the securities were worth. Of course, there was boilerplate in all of the offerings saying that anything could happen. But that boilerplate is so ubiquitous, and covers so much, that it has come to mean nothing. What did mean something was the name of the underwriter selling the securities. If it was a big name, a name redolent of power and antiquity, a buyer could assume that it could be trusted.
Of course, as we know now, that turned out to be wrong.
The biggest of the big names were among the most aggressive in betraying their clients’ trust, as I see it. Some of the biggest names were selling securities that they — apparently — barely understood themselves. In so doing, they exposed their buyers, and their stockholders, to immense losses. (Think Merrill Lynch, Bear Stearns, Lehman Brothers and many others.) Other major players, including Goldman Sachs, were aggressively shorting the very same sort of products they were underwriting.
Now, Goldman can spin this as “risk management” and insist that it was doing it to protect its stockholders. (Remember, though, that Goldman’s lushly compensated traders and executives get a far larger share of the pie than we pitiful stockholders do.) But selling short the same securities or very similar ones that they were peddling to the clients is extremely hard to reconcile with basic fairness.
Goldman asserts that it did nothing wrong in its handling of C.M.O.’s, saying that most of the entities that bought them were highly sophisticated and capable of making their own investment decisions. Goldman declined to show me a list of its large buyers. It also offered no opinion on what its duties might be to small investors who were ultimately exposed to the C.M.O.’s it sold to larger entities.
Goldman emphatically says its short sales and similar trades were normal hedging operations. The firm declined to show me a chart of the scale of its short sales over the past several years.
After talking to Goldman, I was very impressed with how sure it is of its position. The people there are the ultimate salesmen. But the enviable and phenomenal self-assurance of any one investment bank is not the point. The point is this: Don’t expect the securities firms, or the securities laws, to help clients who suffered huge losses.
BASICALLY, a crossroads was passed in the Drexel/Milken scandals. Although hundreds and perhaps thousands of men and women were profiting from misconduct, only a few people, including Mr. Milken himself, went to prison. And even he emerged from prison a very rich man (and by what I see here in Los Angeles, a model citizen).
Today, in the midst of the mortgage mess, we see people breaching their fiduciary duty and getting away with it. A few may lose their jobs and wander off to a wealthy retirement. But the ordinary stockholders of the banks and mortgage companies are staggered. Entities that sought a marginally better return on their money and were sold exposure to the C.M.O.’s are pauperized because of the losses. And there are reports that Wall Street is expecting $38 billion in bonuses this year.
I keep hearing well-meaning people say that America is not a nation if it doesn’t have control over its borders. But are we a nation if there is no meaningful restraint on what people can do with an offering statement and a computer screen inside our borders? We surely cannot remain a republic under law if there is no law except the axiom from “Richard II” that “they well deserve to have, that know the strong’st and surest way to get.”
It's an old story, handed down from long ago.
Might makes right. Those of us who would destroy the ring of power are terra'ists. The Battle of Evermore never ends.