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Finally Someone Says It: Investors Are Responsible for Losses / mises.org

verfasst von - Elli -, 15.07.2003, 21:42

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http://www.mises.org/fullstory.asp?control=1271
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Finally Someone Says It: Investors Are Responsible for Losses

 

By James M. Sheehan

[Posted July 15, 2003]

[img][/img] You
buy a stock and the price goes down. Who accepts the liability for losses? The
purchaser of stock, of course, who must always bear in mind that stocks are
never foreordained to go up or down. Even so, regulators and politicians have
been using the great bubble and bust of the late 90s to extract billions from
securities companies, under the implied assumption that the mere fact of
losses is evidence of fraud.

"The record of Merrill Lynch’s
fraud is overwhelming," said <st1:State>
<st1:place>
New York</st1:place>
</st1:State>
state attorney general Eliot Spitzer. “That is the record I established in
an affidavit admitted to court on April 8 of last year…The issue of the
fraudulent advice is beyond dispute."

At
least, two federal court judges have correctly disputed Spitzer's bold
contentions. <st1:State>
<st1:place>
New York</st1:place>
</st1:State>
federal judge Milton
Pollack rejected two suits against Merrill Lynch,
with prejudice. Separately, Judge
Harold Baer Jr., rejected similar
claims against Goldman Sachs, Credit Suisse First Boston, and Morgan Stanley.
In these suits, Spitzer’s affidavit had been submitted as evidence of
securities fraud.

The
rulings came after a regulatory settlement of Wall Street conflicts of
interest, conceived by Spitzer and federal regulators. In that settlement, the
securities industry was fined $1.4 billion and forced to further separate
stock research and investment banking business segments. A portion of the
money was slated to subsidize independent research firms.

In
light of the courts' findings that a bursting Internet bubble was solely
responsible for investor losses in the stock market, it is time for the
government to return that money and repeal the settlement. There is no
justification for maintaining legal penalties against businesses whose conduct
was not illegal.  

In
the federal suits, Merrill Lynch and other firms were faulted for recommending
the shares of investment banking client companies whose share prices later
declined in value. Investment banking relationships were posited as evidence
of a sinister conflict of interest that impaired published opinions on stocks.
Had the brokerage firms disclosed their banking relationships, investors would
not have lost money in the tech bubble, or so the plaintiff's attorneys
alleged.

In
line with Spitzer's widely publicized accusations, plaintiffs obliquely
asserted that"some, and perhaps much, of the Internet bubble was a
classic stock market manipulation engineered by Wall Street’s investment
bankers and research analysts."

Judge
Pollack responded that federal securities laws only fault those who intend to
defraud by misrepresenting or omitting material facts, thus causing a
plaintiff’s losses. But the circumstances surrounding the case clearly
showed that brokerage firms were not defrauding anyone. The stock market was
"in the throes of a colossal bubble of panic proportions," the judge
observed, in which"speculators abounded to capitalize on the
opportunities presented."  The plaintiffs got caught up in the
general euphoria over the Internet that gripped so many people at the time.

The
brokerage firms' investment advice and target price forecasts"were both
correct and incorrect," points out Pollack,"depending on the timing
of the mercury level in the market thermometer." Investors who acted on
such prognostications were either rewarded with outsized returns or
disappointed during the collapse of the fever, depending on the timing of
their actions as the bubble ran its course. Regardless, none of the plaintiffs
to the class action ever admitted to having seen or read an analyst research
report before making a purchase or sale of stock.

The
judge's conclusions were devastating to the entire conspiracy theory dreamt up
by Spitzer:

The
record clearly reveals that plaintiffs were among the high risk speculators
who, knowing full well or being properly chargeable with appreciation of the
unjustifiable risks they were undertaking in the extremely volatile and highly
untested stocks at issue, now hope to twist the federal securities laws into a
scheme of cost-free speculators’ insurance. Seeking to lay the blame for the
enormous Internet Bubble solely at the feet of a single actor, Merrill Lynch,
plaintiffs would have this Court conclude that the federal securities laws
were meant to underwrite, subsidize, and encourage their rash speculation in
joining a freewheeling casino that lured thousands obsessed with the fantasy
of Olympian riches, but which delivered such riches to only a scant handful of
lucky winners. Those few lucky winners, who are not before the Court, now hold
the monies that the unlucky plaintiffs have lost—fair and square—and they
will never return those monies to plaintiffs. Had plaintiffs themselves won
the game instead of losing, they would have owed not a single penny of their
winnings to those they left to hold the bag (or to defendants).

 

Investment
banking considerations, a possible factor in a firm’s general market outlook,
were adequately disclosed to the market. Merrill Lynch’s role as lead
underwriter in initial public offerings for Internet companies was fully
disclosed on the cover of the prospectus for each IPO, as well as in research
reports on the companies. Moreover, Judge Pollack cited numerous press
reports as early as 1995 cautioning investors about possible banking conflicts.
The issue of conflict of interest, said Judge Pollack,"was a matter of
public knowledge for years before the amazing boom of the market initially
rewarded those who disregarded such caveats."

Judge
Pollack found that Merrill Lynch and its Internet analyst, Henry Blodget, did
not trick investors into placing bets on risky Internet companies. Mr.
Blodget’s research opinions on stocks were replete with risk warnings about
price volatility, and included detailed explanations for why stock prices
could disappoint. Had the investors actually read Blodget’s reports,
they would have been fully apprised of the potential for declining share price
performance.

The
unavoidable implication of these court findings is that the Spitzer regulatory
settlement was a sham. All the hype about Wall Street conflict of interest was
a politically convenient excuse to take money from Wall Street investment
houses.

The
$1.4 billion in fines were funneled improperly into the coffers of state and
federal governments. They must be returned.

The
continued existence of the Wall Street research settlement, and its fallacious
public verdict that biased research caused stock market losses, is a moral
hazard to the investing public. The legal reprimand of brokerage houses
misleads investors into thinking that investment losses are somebody else’s
fault. In addition, it promotes the harmful perception of cost free investment
insurance via government intervention. This makes investors likely to take on
more investment risk than they would otherwise be willing to tolerate, leaving
them more vulnerable to share price declines. The same phenomenon would
accompany a government plan to give away magic hangover pills. Drinkers would
tend to become more intoxicated on the assumption that the next day’s pain
would be anesthetized.

Kudos
to federal judges Pollack and Baer for not bending to the victimology and
sentimentalism of the times. The entire basis for a market system of finance
is undermined if investors are not forced to realize losses that are the
consequence of their own failed investment strategies.

As
painful as they are, investment losses are necessary to work off the excesses
of a bubble, and to re-allocate capital to more promising business ventures.
In addition, steep post-bubble investor losses engender a healthy skepticism
that prevents new market bubbles from forming. In this era of unprecedented
monetary turmoil under Federal Reserve chairman Alan Greenspan, investor
caution is more critical than ever.

<o:p>
 </o:p>

---------

James
M. Sheehan works in the financial services industry in <st1:State>
<st1:place>
New York</st1:place>
</st1:State>
. jsheehan2000@yahoo.com


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Finally Someone Says It: Investors Are Responsible for Losses / mises.org - - Elli -, 15.07.2003, 21:42