Can shareholders, management and boards change bank attitudes that continue to draw penalties?
A decade ago, 12 investment banks coughed up more than $1.4 bn as reparation for issuing compromised equity research that was deeply entangled in investment banking deals. The Global Analyst Research Settlement forced a hard separation between research and banking, killing the business model that much of equity research had, until then, been operating under.
As I’ve argued before, the settlement changed the IR landscape more significantly than any single regulatory action since Reg FD by fundamentally altering the research process, both for good and for ill. In a quest for more sustainable business models, non-bank independent research boutiques, issuer-sponsored research, expert networks and management access operations all blossomed. With the shrinking of research departments, many small and mid-cap firms saw coverage decline or disappear altogether. And – post-tech bubble – banks aggressively sought revenue beyond the IPO market.
At the time, the size of the settlements seemed significant enough to get the institutions’ attention. The original ‘dirty dozen’ essentially said ‘I get it!’ as they revamped research and moved on. Now, multi-billion-dollar settlements stimulate as much comment as a brief rainstorm on a summer day. But if you step back and look at just the headline numbers, they look more like a steadily rising deluge.
In the past decade, the 12 institutions caught up in the research settlement (or their post-acquisition incarnations), have been hit with about $45 bn in additional fines. These subsequent penalties cover a smorgasbord of regulatory and legal issues ranging from seemingly ancient fiascoes such as collapses at Enron, WorldCom and Global Crossing or the market-timing mutual fund scandals to abetting the Madoff Ponzi scheme and deceptive marketing of flawed mortgage-backed securities (MBS). Recent media reports cite estimates as high as $50 bn that may be imposed on upward of 17 institutions, including several of the remaining dirty dozen, to settle future MBS-related charges. And that’s not counting the more than $40 bn that five of the dozen agreed to shell out in 2008-2010 to repurchase auction ratesecurities from clients, settling SEC allegations of deceptive marketing practices.
Now we have a new fandango emerging: the unfolding LIBOR rate-setting scandal that has, to date, ensnared eight institutions (including three of the research settlement banks) that have been fined $6 bn and counting by seven different legal and regulatory authorities in the US and Europe.
In the late 1990s, following several years of restructurings and downsizings, particularly by high-tech companies, US GAAP rules were changed to eliminate ‘big bath’ reserves suspected of feeding future upside earnings surprises. As a result, companies now recognize charges as incurred, sparking the argument that booking a series of charges as part of a major structural realignment is not legitimately a one-time event, but the cost of doing business. One could argue that recurring restructuring charges signal strategic missteps, board and management incompetence or just being in the wrong industry at the wrong time. If so, what then do the billions in actual and potential penalties and payouts detailed above mean? Are they, too, the cost of doing business?
If banks laid out a track record of fines and legal costs going back even five years, as well as reserves against anticipated future judgments and legal costs, investors and the public could more readily judge for themselves. Maybe then shareholders, management and boards of firms paying recurring one-time fines would seek to change behavior that continues to draw penalties for actions that arguably degrade the integrity of the very markets that have so enriched them.
People are attracted to careers in business and finance to make money. I get it. They’re not social workers feeding the poor, teachers educating the young or nurses comforting the sick. But like soup kitchens, schools and hospitals – or even airports, grocery stores and sewage treatment plants – markets serve an important good that extends beyond the people who work in and profit from them. I hope, for all our sakes, they start to get it
