By Jonathan Macey, FT Press, 304 pages, $39.99
Reading Jonathan Macey’s provocative new book "The Death of Corporate Reputation: How Integrity Has Been Destroyed on Wall Street," I was reminded of Winston Churchill’s famous dictum about democracy being "the worst form of government except all the others that have been tried." Macey, who is the Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale Law School, and one of America’s most prolific writers on and analysts of corporate governance issues, takes his readers on a comprehensive tour of the country’s capital markets structure; and what he finds there is an utter disaster zone.
Macey’s most interesting thesis is that Wall Street’s reputation and the regulation of Wall Street should work in an inverse relationship. If Wall Street firms were to be viewed as having impeccable reputations, then the need for regulation would be (at best) de minimus; conversely, where the regulatory scheme is viewed as comprehensive and working well, then firms have little incentive to invest in their reputation. Unfortunately, Macey posits that we have the worst of both worlds—Wall Street’s reputation is in tatters and the extant regulatory scheme (in particular, the SEC) is even worse, the latter working under a system of perverse incentives. In short, he concludes, "we are in quite a pickle"; and this makes capital formation "very difficult and expensive."
Unlike many who would have the collapse of Wall Street ethics start with the 2008 worldwide financial crisis, Macey goes back a few decades and starts the decline by highlighting a number of Wall Street’s "greatest" mishits (e.g., Bankers Trust’s trades with Gibson Greetings and Procter & Gamble; Salomon Brothers’ rigging the U.S. Treasury markets; Drexel’s junk bond rise and fall). While these are important parts of Wall Street history, I found this part of Macey’s book least helpful in explaining our current problems. First off, Wall Street has always been a media and political piñata, dating back to days of Jay Gould. (Of course, in the era of the 24-hour news cycle, this phenomenon has been magnified exponentially.) Second, the corporate behavior focused on by Macey involves complex financial transactions between institutions and/or sophisticated individuals; whether "reputation" and "trust" have ever been important factors to such parties (well represented by top-notch legal talent) is surely open to question. Third, and most importantly, his attempt to make the point that we have reached a nadir by singling out Goldman, Sachs, & Co. rings hollow. Giving credence to the much bally-hooed letter in the New York Times by a mid-level employee who had been passed over for a promotion (and later wrote a book that apparently was read only by his parents) seems misplaced. As to the credit-default swaps sold to two European institutions, which ultimately led to Goldman paying $500 million to settle an SEC civil action, Macey appears to want to have it both ways. On the one hand, Macey recognizes (i) that the transactions had sophisticated counterparties who had different views of the market (as is the case in all such transactions); (ii) that the counterparties were not "trusting" Goldman (again, the participants in the transactions structured by Goldman all had their own views of the market); (iii) that a firm like Goldman under attack by the SEC cannot fight the "allegations" but must settle such cases (thus rendering the reputational impact of such SEC cases as doubtful, at best); and (iv) that the settlement was viewed by virtually every knowledgeable industry participant as a win for Goldman. On the other hand, Macey says that Goldman’s handling of the imbroglio "is at the heart of what [his] book is about," and that Goldman’s reputation "has been tarnished seriously by this series of very public body blows."
That the public/body-politic demanded scalps after the near death experience of the 2008 financial crisis is simply a truism. But the mere fact that the SEC can extract huge settlements from companies it regulates tells us essentially nothing about Wall Street ethics. What the Goldman/SEC settlement really helps us to understand is the flawed regulatory scheme, and this is where Macey’s insights are particularly acute.
When FDR was asked why he chose Joseph P. Kennedy—the legendary Wall Street manipulator­—to be the SEC’s first chairman, he famously replied: "Takes one to catch one." It turned out to be an inspired choice, and the SEC quickly became a well-respected regulator of the securities industry.
Fast forward to today, however, and its reputation is at an all-time low. Why? Macey identifies many reasons, but the key ones are: (1) "protecting small investors does not appear to be high on the SEC’s list of priorities"; (2) the SEC’s failure to discover the Madoff fraud was because it has "no interest, experience, or expertise in uncovering simple frauds"; (3) SEC officials have incentives "to focus on enforcing the most technical rules because doing so maximizes their career prospects both inside and outside the agency"; (4) the SEC may be suffering from "a bit of Stockholm syndrome" with respect to the firms it regulates; (5) although Macey ascribes the "lion’s share of the blame" for the 2008 financial crisis to the flawed work of the credit agencies, the SEC’s response thereto has been a "complete capitulation" to those agencies; and (6) notwithstanding all of those failures (and a near tripling of the SEC’s budget between 2000 and 2010), the SEC’s skewed "metrics of success" (i.e., a numbers game, stressing the number of enforcement cases and settlements) mean that the Commission is caught in an eddy from which escape seems highly unlikely (even with a very well qualified new leader). Not a pretty picture.
While Professor Macey sees some hope from new compensation structures on Wall Street (e.g., bonuses consisting of long-term restricted stock), he offers little other substantive proposals to pull us out of the dismal muck he so well depicts. There is, for example, no comparative analysis of whether America’s capital markets—with all of their problems—are suffering more than European or Asian markets (or, conversely, whether we are, in Churchill’s words, still better than "all the others"). Macey also does not take on the issue of whether Wall Street firms, with the demise of Glass-Steagall, have simply gotten too big and complex. With even Sandy Weill—the impresario of Congress’ tearing down of the Depression era firewall between commercial and investment banking—urging the law’s resuscitation, not to mention JPMorgan’s recent "London Whale" debacle, we surely need analysts like Macey to weigh in on whether such action would be helpful, harmful, or something else. Similarly, with the Volcker Rule (sort of) in place, will the drive to limit firms from engaging in proprietary trading lead to "better" Wall Street ethics, or perhaps to a whole host of unintended consequences? This reviewer would love to hear what Macey thinks on that particular topic, as well. But even without addressing those topics, Professor Macey has given us a lot to chew on if we hope to recapture our ethical standards and maintain our economic standard of living.
C. Evan Stewart is a partner at Zuckerman Spaeder.