When I was a kid I ate a lot of cereal.  Sometimes I ate the stuff because I liked it, but more often than not it was because there was some toy at the bottom of the box.  Of course, once you took that first mouthful of the noxious garbage in the box --- well --- poor old dad usually wound up eating the rest of it.  Which eventually lead your parents to impose the dreaded rule:  If you don't finish this cereal you made me buy, you don't get to pick out anything again. In time,  youngsters realized that the cheap toy wasn't worth eating a pound of sugary sawdust.  Similarly, many of you are probably familiar with the dreaded sour-milk fiasco.  You know what I'm talking about.  That wonderful spoonful of cereal encased in sour milk --- which you promptly spit out amidst much gagging and yelling.  This too taught us a valuable lesson:  Smell the milk before you pour it.

In following the recent so-called historic settlement of the biased research practices on Wall Street, I was struck by the vainglorious self-promotion by the industry's regulators.  What geniuses we have entrusted with the protection of public investors!  No, they didn't know any of the improper practices had been going on.  No, they didn't know how pervasive those practices were.  But, once they saw an opportunity to make some headlines, well --- gee --- they just lined up before the television cameras like so many pigs at the trough.  If this is the best investor protection securities industry regulators can provide, we don't need the expense.

Consider this quote from William Donaldson, the current Chairman of the United States Securities and Exchange Commission:

[O]ur unified action brings to a close a period during which the once-respected research profession became nearly unrecognizable to earlier generations of investors and analysts. As many of you know, I helped found an investment firm that bore my name and which was originally dedicated to research.

For that reason, I speak very personally, when I say that I am profoundly saddened - and angry - about the conduct that's alleged in our complaints. There is absolutely no place for it in our markets and it cannot be tolerated. When an analyst signs his or her name, and places the firm's name, on a research report expressing strong support for an issuer, while admitting privately to doubts about the company's viability, the only appropriate reaction is outrage. . .

(Speech by SEC Chairman: Prepared for Delivery at SEC Press Conference Regarding Global Settlement by Chairman William H. Donaldson April 28, 2003)http://www.sec.gov/news/speech/spch042803whd.htm).

With all due respect to Chairman Donaldson, is he kidding?  Hasn't anyone regulating Wall Street gotten it yet?  The "once-respected research profession" was a figment of the imagination --- it was the premium in the bottom of the box of junk food and it was there for all the wrong reasons.  It wasn't there to entice an educated buyer into purchasing a healthy product; no, it was there to lure the unsophisticated investor into buying something of little, if any, true value.  Earlier generations . . .that's right Mr. Chairman, the scam perpetrated by the major firms wasn't new; it was going on for generations. 

Chairman Donaldson says he's profoundly saddened.  He's angry.  He's outraged.  But, still, I wonder.  He is no newcomer to Wall Street.  By his own admission, he founded one of the industry's leading firms.  He headed the New York Stock Exchange. Is he suggesting that for years and decades he was unaware that broker-dealers often issued reports at odds with the truth --- or at least the true feelings of the analysts who prepared the pieces?  He worked within the inner sanctums of Wall Street but he never, ever knew that research was being perverted for improper means? 

Similarly, the current head of the North American Securities Administrators Association (NASAA), Christine Bruenn, made the following statement:

[O]n a personal note: what dismayed me most about this investigation was how so many firms with otherwise good compliance programs could’ve allowed this tainted culture to grow up with its systemic problems and exist for so long without doing anything about it . . . 

(Remarks for Christine Bruenn, NASAA President and Maine securities administrator Given at the Securities and Exchange Commission on April 28, 2003) http://nasaa.org/nasaa/abtnasaa/display_top_story.asp?stid=363

You know how in your hometown there's this one place where everyone knows drugs are being sold, but, for some odd reason the police never seem to have a clue?  Why does NASAA --- an organization of every state securities regulator --- seem clueless as to the existence of fraud among Wall Street's largest firms?  How could the head of that organization be dismayed about the pervasive and long-term research abuses?  Could it be that the big boys make all those huge campaign contributions? Could it be that many regulators eventually secure employment at the national broker-dealers?

And what are we to make of regulators who complain that the very industry under their regulation isn't cleaning itself up?  Umm . . . Ms. Bruenn . . . let me try to put it politely --- that's your job, not the firms on Wall Street.  Sure, we can all pretend that the so-called first line of defense should be self-policing by the industry.  But that's nonsense.  Never has worked.  Never will work.  And, frankly, what's there to debate about at this point?  Self-regulation clearly failed in regards to industry research.  You said as much.  So, why did the state regulators also fail?  And let's all stop crowing about New York Attorney General Spitzer's efforts.  Yes, give the man his due.  Great job.  However, let's not lose sight of the key point.  What was needed was a stake-out to prevent the commission of misconduct.  What we got was an autopsy.

My suggestion to Wall Street's regulators is fairly simple.  You shouldn't have allowed the ten largest broker-dealers to have gotten off so lightly --- and, please, don't tell me about the $1.4 billion dollar fine.  Read Mr. Purcell's comments about Morgan Stanley's conduct if you think the big boys really got the message.  What you should have done is what my folks did when I bought one too many boxes of cereal for the wrong reasons.  You should have said that first you clean up this mess and then we'll see about the future.  Sometimes you have to punish  mischievous children.  They get time-outs or they get grounded.  Think of it this way:  If your teenage son were brought home by the police for  underage drinking and crashing the family car (which he wasn't supposed to be driving to begin with), would you simply tell him to write you a check for $100 and to promise not to do it again?

What were all the regulators doing for all these years?  Every day a new deal came out.  Analysts became media stars on cable television.  The kid bagging your groceries was buying stocks.  Companies with no earnings and quarter after quarter of bloating losses were being touted in research reports as "buys" --- and, wasn't it odd that those same companies just happened (by the merest of coincidences!) to be an investment banking client of the broker-dealer issuing those glowing recommendations?  And not a single state regulator, not a single federal regulator, and not a single industry self-regulator noticed that the milk was sour and curdled?  Anyone think of smelling the milk every once in a while?  

SINGER’S DISCORDANT NOTES
  Copyright 2003 by Bill Singer