Editor's note: A version of this post originally appeared on LinkedIn.
"It's a crime what's legal on Wall Street," is a phrase we used to invoke frequently during my years at Forbes. The topic came up so often because in finance so many practices that are just plain wrong persist for years, and decades, directly under the noses of the financial cops.
Then on occasion, when nobody's expecting it, something snaps. Too many people lose money. An ambitious government official goes on the rampage. All of a sudden, practices that have been so wrong in so many ways forever suddenly become unacceptable.
That's what happened with mutual fund market timing and late trading a decade ago. For years, Securities and Exchange Commission officials acknowledged that the once-a-day setting of prices made international mutual funds an easy mark for those who gamed the system at the expense of small, long-term investors. Yet SEC officials did nothing but make speeches. Then along came Eliot Spitzer, who fingered the practices as scams and shut them down in a sweep that even led to a few criminal convictions.
Over the past few years, Wall Street's collapse has led to a crackdown that's put more wrongful practices off limits. Banks, for example, face a much tougher time selling worthless credit card "payment protection" plans and can no longer sue delinquent credit card customers en masse with little or no evidence to support their demands.
Companies that service mortgages can no longer connive with property insurers to foist exorbitantly priced "force-placed" policies on struggling homeowners who've let their standard coverage lapse. Likewise, the securities markets are getting more hostile for high-frequency traders, who've counted on receiving market-moving news before the rest of the public to profit at its expense.
Good stuff all, but Wall Street remains a place where a lot of very bad behavior continues to take place out in the open. Here are some of the most egregious examples.
Financial Advisor Chicanery: Imagine a two-tiered health care system in which some doctors were legally obligated to do what's right for their patients and others, like snake-oil salesmen of yore, could recommend whatever treatments made them the most money, as long as they didn't kill patients outright. Now imagine that the shysters did all they could to blend in with the real doctors. That's effectively the type of system we have today among the people Americans count on to tell them how to invest their life's savings. Registered investment advisors must, by law, put clients' interests first. Many thousands of other "advisors" at places like Morgan Stanley, Merrill Lynch and smaller shops are held to a much lower "suitability" standard. In essence, even though these people often refer to themselves as "financial advisors" or by some other comfort-inducing title, they're really glorified salesmen. Some do a great job serving their clients. Others don't. It's up to them. Under the law, as long as they avoid putting an 85-year-old widow into an exotic derivative with a 20-year lockup, they're bulletproof. Few clients know this fiduciary-suitability gap exists. The suitability crowd has worked tirelessly to keep the standard low and the distinctions murky. The cost to the public is incalculable but huge.
Pension Official Payola: Across the country public officials have been funneling growing slices of their trillions of dollars of public pension assets into hedge funds and private equity partnerships that boast high risks and high costs, but not necessarily high returns. It just so happens that their fund managers often show their appreciation by investing in the political success of the public officials who favor them. I wrote about one such egregious example in North Carolina a half-dozen years ago. Matt Taibbi took a pass at the story in a Sept. 26 Rolling Stone story titled "Looting the Pension Funds." The muni bond market is hardly a symbol of propriety. But at least there underwriters have been banned since 1994 from contributing to public officials' campaigns. SEC chairman Arthur Levitt tried to impose a similar ban for pension managers in 1999 but lost out to the lobbyists. Now would be a good time for Mary Jo White to try again.
Chairman-Equals-CEO Absurdity: A corporate board of directors is legally obligated to represent shareholders. A chief executive is the leader of the hired help. But in over half of U.S. corporations, the chairman and CEO are one in the same. The practice has many fervent defenders, like former JPMorgan Chase chairman and CEO William Harrison, who argue that it creates greater cohesion. But it also creates an unjustifiable conflict of interest in which investors are the victims. Is there a chairman in the country who's going to fire himself as CEO, no matter how dismal his performance? Enough said.
Management Buyout Mess: The top managers of public companies have a fiduciary duty to maximize shareholder value. Yet sometimes those occupying the boardroom and C-suite get it in their heads that they'd like to buy the company they're managing. In such cases, the lower the share price falls, the bigger their potential gains. So their fiduciary duty and personal financial interests are diametrically opposed. The answer to this one is simple: ban officers and directors of public companies and their families from participating in management buyouts with no ifs, ands or buts. If you want to buy your employer, quit first and do it from the outside.
SRO Conflict: Think of foxes guarding a henhouse. That's essentially the franchise the New York Stock Exchange and Nasdaq enjoy as "self-regulatory organizations" with the authority to write market rules and supervise trading activity, along with Wall Street's self-funded watchdog, the Financial Industry Regulatory Authority. Even back in the days when exchanges were nominally not-for-profit, the SROs failed to prevent a steady stream of scandals, including some that indicated the very core of the exchanges' trading operations were rotten. That included price fixing by Nasdaq market makers and improper trading by New York Stock Exchange floor brokers. Now that the exchanges are themselves publicly listed, the SRO structure is even more suspect and poses new perils. Following the debacle that was the initial public offering of Facebook, Nasdaq sought to invoke its SRO status as form of legal immunity from traders who lost money at the hands of its technological mistakes. Bottom line: Cops and robbers should never live under the same roof. That's a truism new SEC boss White may be taking to heart.
Fairness' Opinion Unfairness: When corporate boards are trying to convince the world that a merger or acquisition is "fair" to shareholders, they turn to their investment bankers to render an opinion. You might as well ask a barber if you need a haircut. The problem with fairness opinions is twofold: the investment bank rendering the opinion typically has a financial interest in seeing the deal get done; and the directors seeking it may also be looking forward to a change-in-control or other payday that investors aren't. Bottom line, fairness opinions are a bogus exercise. Tear down the facade and leave boards to face the legal ramifications of their actions sans the fig leaf.
Revolving-Door Debacle: It's hard to swing a cat without hitting a financier/regulator who hasn't profited from the incestuous ties between Wall Street and Washington. Treasury Secretary Jack Lew hails from Citigroup. Former SEC boss Mary Schapiro moved to uber-connected advisory firm Promontory Financial. White, her SEC successor, has made a round trip from government to Wall Street and back again. Sometimes such people do a great job of swapping sides. But in aggregate the result is a blurring of the line between regulators and the regulated. Sheila Bair, the former head of the Federal Deposit Insurance Corp., put it best: "The capture, a lot of people say, is bipartisan. And when I say capture, I'm talking about cognitive capture. It's not so much about corruption. It's just listening too much to large financial institutions and the people who represent them and not enough to the people out on Main Street who want this fixed." In a free country there's no way, thankfully, to prevent people from job-hopping. Prohibitions on lobbying former government employers are of some value. But what would really help is for the revolving door to swing less between Wall Street and Washington. Imagine the difference if the SEC and other regulators put honest-to-goodness consumer advocates in positions of power to balance out all those Wall Streeters.
Neil Weinberg is the editor-in-chief of American Banker. The views expressed are his own.