Crawling Across Broken Glass for a Fee: Fining Wall Street
In 2002 Wall Street entered into a settlement with the SEC and New York State Attorney General in which Wall Street agreed to create a clear separation between investment banking and Wall Street research. Research analysts could no longer participate in investment banking pitches. Their compensation could not be based on helping to reel in investment banking client, and their research reports had to detail any relationship their firm had with a subject company. The settlement was borne out of extraordinary emails that documented research analysts touting the grossly overvalued stocks of their firm’s banking clients. Wall Street paid over $1 billion in fines, agreed to put new compliance procedures in place, and promised that their analysts wouldn’t aid and abet investment bankers in soliciting investment banking work.
The Financial Industry Regulatory Authority (FINRA), which regulates broker-dealers, ,just fined ten investment banks $43.5 million for violating the rules promulgated as the result of the previous transgression. All ten firms were making a pitch for an initial public offering for Toys R Us, which is owned by KKR, Bain, and Vornado Realty. All ten firms made sure their investment banking and research presentations were aligned, so that so-called “independent” research would support the valuation being pitched by the bankers. FINRA found that many of these firms had poor or non-existent oversight, oversight that is specifically required by FINRA’s rules.
The fine is a pittance. For example, Citigroup, Goldman Sachs, and JP Morgan paid $5 million apiece to settle the matter without admitting or denying that they did anything wrong. Gretchen Morgenson of The New York Times wrote about the settlement last Sunday. While she captured the extent of the misconduct in the body of her article, her headline, “At Big Banks, a Lesson Not Learned,” is completely wrong.
Wall Street learned its lesson well. The rules don’t really matter because the fees generated as a result of bending or even breaking those regulations far exceed any fines. In other words, there isn’t a meaningful consequence to bankers and analysts colluding in direct contravention of the law, and it isn’t a one or two rogue firms (the “a few bad apples” theory). All ten firms did precisely the same thing. It’s the regulators, politicians, and the general public who haven’t learned the lesson about big banks. As I’ve written before, Wall Street culture is corrupt.
Ms. Morgenson quoted Needham & Company’s (an investment banking boutique) analyst in order to give her readers a flavor of the Wall Street mentality. Either she was too polite or constrained for space, but she didn’t report the entire statement. Here’s what FINRA cited in its settlement with Needham:
The Needham analysts sent an email to a colleague stating that the firm’s initiation of coverage was “[s]hameless positioning to get a certain upcoming toy IPO and that he “would do it too. I would crawl on glass dragging my exposed junk to get this deal.
The Toys R Us transaction never happened, so no one collected the big fee for managing the IPO. However, the FINRA settlement is a window into how Wall Street works on a day-to-day basis. If Wall Street can generate a fee without breaking the rules, it will stay within the law. However, if the law gets in the way, Wall Street will most certainly bend, if not break, the rules. That’s how the business works, and how bankers and analysts generate their big pay packages.