Sobering Lessons from Arthur Levitt

The former SEC chief's new book, Take on Wall Street, is a must-read (even if depressing at times) for individual investors

By Christopher Farrell

Every individual investor should have certain books on the shelf. Among them: Against the Gods and Capital Ideas by Peter Bernstein, A Random Walk Down Wall Street by Burton Malkiel, The Only Investment Guide You'll Ever Need by Andrew Tobias, and Where Are the Customers' Yachts by Fred Schwed. I'd recommend adding to that collection Arthur Levitt's Take On The Street.

And that's what Levitt does. As head of the Securities & Exchange Commission from 1993 through early 2001, Levitt championed individual investors during the great bull market and the emergence of mass investing. Yet a powerful money triangle of Wall Street, Big Business, and Capital Hill thwarted much of his crusade for greater transparency and disclosure.

Swayed by lush campaign contributions from the accounting profession, Congress blocked an SEC initiative to ban auditors from consulting with the same client. Corporate lobbyists, especially from Silicon Valley, got Congress to condemn a plan requiring the expensing of stock options. "There is no one, in fact, that represents individual investors full time," says Levitt. "They are the most overlooked and underrepresented interest group in America."


  Of course, no regulatory or legislative initiatives could have prevented the alleged brazen fraud at Enron, WorldCom, Global Crossing, Adelphia Systems, and Tyco. Arthur Anderson, Merrill Lynch, Citigroup, Credit Suisse, and other financial firms, it appears, ignored blatant conflicts of interest for profit during the bubble market. The SEC could have been a tougher cop during the '90s. Still, the scale and scope of corporate corruption and executive wrongdoing might have been far less if Levitt's initiatives for protecting the rights of individual investors had garnered more support from America's power elite.

Take on the Street is a depressing read. The nation's power centers have rigged the money game against the individual. Yet Levitt remains surprisingly optimistic. He believes in the power of democratic capitalism to reform predatory capitalism. The capital markets will work for the people if individual investors do their homework.

In the short term, though, Levitt believes the odds remain heavily stacked against the individual investor, despite a brief burst of post-Enron reforms. Levitt writes, "The increasing power and sophistication of the special interests through Congress have thwarted the SEC. Conflicts plague the self-regulatory organizations -- the New York Stock Exchange and the National Association of Securities Dealers -- whose revenue come from the companies they list and the order flow of brokerage firms, the very groups the exchanges are supposed to oversee. Adverse legislation and court decisions have limited aggrieved investors' access to the judicial system."


  Take the mutual-fund industry. In 1950, Americans invested about $1.2 billion in 98 mutual funds. Last year, some $7 trillion was entrusted to over 8,300 funds. In one sense, it's a great American success story. But this business has a seamy side. Levitt attacks the industry for its "seven deadly sins" in a chapter that should be mandatory reading for all fund shareholders.

According to Levitt, the fund industry's transgressions include: high fees that strangle returns; ignoring the impact of frenzied trading and other tactics on tax liabilities; keeping the basics of the business opaque, such as not revealing how much fund managers earn; burying the industry's dirty little secret that actively managed funds never do as well as their benchmark index; the cult of performance that hypes recent returns even though the industry knows the information is deceptive; fund managers that preach the benefits of long-term investing even though the typical fund manager sells every stock in her or his portfolio at least once a year; and misleading fund names.

Considering the huge sums of savings the fund industry manages, the most worrisome sin is poor corporate governance. The mutual-fund boardroom defends management, not shareholders. "Warren Buffett likes to say that mutual funds choose their directors from the kennels of Chihuahuas, not Dobermans," says Levitt.


  Levitt was well qualified to be Wall Street's overseer. Raised in the Crown Heights section of Brooklyn, his father was New York State's Comptroller for 24 years. After a brief stint in cattle and ranch tax shelters, Levitt became a founding partner of the scrappy, legendary brokerage house Cogan, Berlind, Weill & Levitt (derisively called Corned Beef With Lettuce by the then WASP-dominated Wall Street).

The firm grew through acquisitions into a national brokerage house and is now part of the Citigroup empire. His other partners included Sandy Weill, chairman of Citigroup; Roger Berlind, a Broadway producer; and Wall Street investor Marshall Cogan. Levitt also ran the American Stock Exchange and published Roll Call, a newspaper that covers Congress. In other words, he knew well the workings of both Wall Street and Washington.

One of the most appealing features of the book is that big-picture discussions are complemented with practical manifestos. A primer on how to read a financial statement follows a searing portrait of the accounting industry exercising raw power and self-interest in Washington. An indictment of boardrooms is coupled with insights on judging a company's corporate governance. The failures of the current 401(k) retirement savings system lead to a discussion on getting a 401(k) plan into shape. Information and knowledge are power.


 Take On Wall Street lacks the verbal verve and intellectual energy of other classic Wall Street works. It's also somewhat self-serving at times. Yet Levitt, with the help of Paula Dwyer, BusinessWeek's Washington bureau deputy manager, has written a sober, rational analysis of what went wrong in the '90s and what individuals can do about it in the '00s.

He's right: A more informed and diligent investor is a better and more successful investor. But when I finished the book -- in the air somewhere between Minneapolis and Boston, staring out the window -- it was hard to shake the feeling that crony capitalism in America is far too entrenched for meaningful reform.

Even after all the corporate scandals, a fight has erupted in Washington over the potential appointment of John H. Biggs, the former head of TIAA-CREF, to lead the new board overseeing the accounting profession. The fear is that he'll be too aggressive. The current proposal to create a "Chinese Wall" between Wall Street research and investment banking is little more than a conflict-of-interest band-aid. Until reform takes deeper hold, Caveat Investor.

Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over Minnesota Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BusinessWeek Online

Edited by Beth Belton

Before it's here, it's on the Bloomberg Terminal. LEARN MORE