December 22, 2015
by Bob Veres
In his first-quarter letter to investors of Greenlight Capital, David Einhorn lashed out at regulators. He claimed that the market is "fractured and possibly in the process of breaking completely." Q1 2021 hedge fund letters, conferences and more Einhorn claimed that many market participants and policymakers have effectively succeeded in "defunding the regulators." He pointed Read More
Ladies and gentlemen of the jury, we are here today to consider the case of a defendant who ought to be familiar to anyone who has watched its many advertisements on TV, or seen its iconic brands marketed in magazines and on the Web – the bull, the rock, the interlocking trapezoids that form a kind of circle with a square in the middle. It goes by many aliases, but whenever I point across the room at the defendant, I will refer to two of the defendant’s many names interchangeably: the brokerage industry, or simply Wall Street.
The defendant is charged with a number of crimes: of deliberately and systematically employing deceptive business practices; operating a cartel; deliberately (and successfully) undermining consumer protections; engaging in anti-competitive behavior against the emergent financial advisory profession; exerting undue and improper influence on Congress and the regulators; raking in excess profits and thereby harming the American economy that it originally was created to benefit.
I will ask you to find it guilty of acting as a detriment to society itself. And at the end, I will propose a penalty, should you find the brokerage industry guilty of these various acts of creative mischief based on the evidence I am about to present.
As we consider this evidence, I will ask you to suspend much of what you think you know about this defendant. Month in, month out, the financial services trade press launches articles detailing the lobbying battles between advisors and the large Wall Street brokerage houses, about fiduciary versus sales-related suitability standards and manifest customer confusion about regulatory oversight and the misleading titles (financial advisor, investment advisor, vice president of investments) their sales reps put on their business cards. We read about shifts in market share, Financial Industry Regulatory Authority (FINRA) efforts to take over regulation of advisors, and “harmonized” regulation.
These articles give the impression that two parties – the advisory profession and Wall Street – are roughly equal parties simply engaged in a battle for market share. They leave us with the false impression that the brokerage industry is nothing more than a competitor in the economic landscape.
Ladies and gentlemen of the jury, I hope to convince you that all of these individual skirmishes between Wall Street and the emergent advisory profession are part of a much bigger picture that must now be exposed.
I intend to make the case that the large brokerage firms are blocking – in the financial services world – the consumer revolution that has long since swept through the rest of the American economy. I will show that the defendant’s attempt to strangle the emergent advisory profession in its cradle is part of a much larger effort to stifle evolutionary impulses which have created price competition and broader choice for consumers in virtually all other sectors, from the decline of the large retail brands (Sears, Woolworth, Montgomery Ward etc.) in the late 1900s to the more recent broadened consumer access to competitively-priced products and services provided through the Internet.
At the same time, I hope to show that an industry that ought to be functioning like a public utility – aggregating capital so it can be allocated where it is needed in the U.S. economy – is actually shuttling money where it will benefit Wall Street the most, creating financial instruments that exist purely to serve Wall Street’s profit margins, placing itself aggressively between investors and entrepreneurs so that it can exact tolls over and over again whenever money flows, siphoning an alarming percentage of the all the profits of all corporations into its bonus pools while providing, in many cases, nothing productive or beneficial in return.
I hope to show that today’s defendant functions like a cartel. Ladies and gentlemen of the jury, I hope that at the end of our proceedings, you will agree with my premise that if these activities were conducted anywhere else in our economic system, they would be considered illegal and predatory.
I also hope show that the scope of this enterprise is enormous, and so, too, is the scale of the achievement. You will see that Wall Street spends many orders of magnitude more than consumer advocates on Congressional campaigns and lobbyists. It exerts so much influence on regulators that we can plausibly talk about regulatory capture by the industry – or, as you will see in the case of FINRA, direct control of its board of governors. At the same time, the industry exerts a remarkable degree of influence on the U.S. presidency itself.
Our proceedings today will provide you with a big picture review of an industry’s largely successful effort to maintain the ability to benefit itself at the expense of competitors, consumers and the American economy.
I call it The Case against Wall Street.
In the lobbying debate, it is sometimes forgotten that there are three sides to the Wall Street industry – and Wall Street lobbyists use this to their great advantage. They ask with a hint of incredulity in their voices how the dreaded fiduciary standard can be applied to brokerage firms because this would then extend to their IPO sales activities. They would be forced to benefit their retail investment customers rather than the companies for which they’re raising capital. On the second side, they would no longer be able to sell creative pooled investments and derivatives under the “buyer beware” standards that apply to retail manufactured products.
And on the third side, when Wall Street firms are trading for their own accounts, they ask whether their professional traders and flash boys should be required to make trades that benefit the counterparties in their transactions. Preposterous! After all, we don’t require day traders or lay investors to adhere to a fiduciary standard when they buy and sell securities
Ladies and gentlemen of the jury, let’s first of all be clear. No lobbyist for the emergent advisory profession has ever proposed that fiduciary standards, or even standards of plain decency, be applied to any part of Wall Street other than its retail-facing brokers. Trying to apply consumer protections to the other Wall Street activities is purely a straw man for brokerage lobbyists to trot out at their convenience.
But as I build my case, let’s take a moment to delve into the alleged value that Wall Street provides the economy with these activities, and see whether there’s a strong case to be made that they ought, after all, to be prohibited or at least controlled more closely than they are today.
Start with IPOs and capital formation. To bring a substantial company public in the U.S., you have little choice but to work with one of the larger Wall Street firms, which package the product for sale to the public. Ideally, one might expect this to be a very efficient balancing act that raises as much money as possible for the company without overpricing the offering and ripping off consumers.
Ladies and gentlemen of the jury, I invite you to consider: How well has Wall Street passed this simple, intuitive test of its effectiveness on behalf of our economy, investors and companies that require capitalization?