When Kim Schmitz was convicted in 2002 of manipulating shares in online retailer LetsBuyIt.com, it marked the end of Germany's biggest insider-trading case ever and exposed just how easy it was to profit at other investors' expense. The self-styled Internet entrepreneur's previous conviction for computer fraud didn't stop him from announcing a spurious rescue effort for the online retailer that temporarily goosed the stock -- and gave him the chance to sell his shares at a profit of $1.5 million. Worse, when it came time for sentencing, Schmitz got a slap on the wrist: a 20-month suspended sentence after five months in jail awaiting trial.
Yet the fact that Schmitz was prosecuted and convicted at all is a sign of progress in Germany. Insider trading wasn't even a crime until 1995, and until 2002 prosecutors had to prove the accused had criminal intent, a difficult burden.
The Schmitz case was just one of a series of events starting in 2000 that soured the German public on buying stocks. Since then, a raft of legal and administrative reforms have been adopted. But is it really safe to go back into these shark-infested waters? As far as the investing public is concerned, the jury is still out. "Investors are deeply shaken," says Munich lawyer and shareholder advocate Daniela Bergdolt. "Tougher regulation," she says, "is the only way to restore trust."
German stockbrokers, fund managers, and investment bankers, however, sense that the time is right. Stocks are off their recent lows, and shares are seen as reasonably priced. And some investors are gingerly returning to the markets. One sign that the national mood is now turning more bullish: Deutsche Post plans to float just short of 50% of its stake in its Deutsche Postbank banking unit on June 21, which would end an almost two-year drought in German initial public offerings. Bankers are hoping that the estimated $7 billion IPO will be a small-scale Deutsche Telekom (DT ), whose 1996 privatization instantly turned millions of Germans into first-time shareholders and helped touch off the stock-buying frenzy of the late 1990s. "Postbank will be a catalyst, no question," says Georg Hansel, who is responsible for German IPOs at Deutsche Bank (DB ), which is one of the lead banks for the listing.
FEWER SHAREHOLDERS. Still, few believe that Germans will return to the markets with their former zeal. The bursting of the tech bubble in 2000 scared many away permanently. Trading in Internet, tech, and startup companies fell so drastically that the Neuer Markt, Germany's answer to NASDAQ, closed in 2002 after losing more than 90% of its value from the peak of the boom. The Neuer Markt was done in partly by its reputation as a haven for speculative stocks and unscrupulous managers. The scandals, combined with a precipitous plunge in all markets, reduced the number of German adults who own shares from 21% in 2001 to 17% today. That's still nearly double the 1997 rate of 8.9%, but well below levels in the U.S., where more than half of all households own equities. Such low participation poses a problem for Germany Inc., analysts say, because the market ought to be a primary source of corporate finance.
Lawmakers have started to respond to the concerns. To help restore confidence, in 2002 Parliament merged the nation's banking, insurance, and stock market regulators into a single agency with broader powers to investigate securities fraud and impose fines. The government also strengthened Germany's insider-trading law in 2002 by easing the standards for proving the crime.
In addition, Deutsche Börse Group, the private company that operates the Frankfurt Stock Exchange, now requires companies to be more open about their finances if they want to be listed on the prestigious "prime standard" indexes such as the DAX. More protections are on the way. This year, Parliament is expected to pass laws tightening requirements for company prospectuses and providing for outside audits of companies when there is suspicion of faulty accounting.
Despite such measures, investors remain wary. In March, Munich-based Siltronic, a maker of silicon wafers for the semiconductor industry, postponed indefinitely a planned listing because of poor demand. The delay was particularly discouraging for Germany's financial community, considering that other European IPOs, such as Belgian national phone company Belgacom, were successfully launching shares at the same time. Belgacom showed that investors will buy shares in a company with a track record of profits but remain wary of companies such as Siltronic that are still in turnaround mode. "When it comes to retail investors, the sophistication has grown," says Rainer Riess, director of stock market business development for Deutsche Börse. "It was a painful learning process for all sides."
A vibrant stock market depends on companies that take shareholder interests seriously. Few doubt that new corporate governance guidelines, which encourage companies to be more open about such information as executive pay packages, are giving German investors a better picture of how companies are run. But that hasn't necessarily improved corporate behavior, notes Reinhard H. Schmidt, a professor of international banking and finance at Goethe University in Frankfurt: "Now, people know where their interests are hurt, but nothing is being done about it."
One need only look at recent headlines for an example. On Mar. 25, Ulrich Schumacher, the CEO of Infineon Technologies (IFX ), Europe's biggest chipmaker, was unexpectedly fired from his post. The Munich company has been a pioneer in adopting international standards of openness, listing on the New York Stock Exchange, giving detailed financial information and communicating frequently with bank analysts and the financial press. Yet when Schumacher was ousted, the company failed to provide an explanation and waited until the next day to quash rumors of a financial scandal. In the meantime, Infineon shares lost as much as 7% in intraday trading before recovering in the following days. In terms of good corporate governance, "that was an example of how it shouldn't be done," says shareholder advocate Bergdolt.
That's why the Frankfurt financial community is pinning its hopes on Deutsche Postbank, Germany's largest retail bank and a stable, well-known company, as an example of how a company should treat investors in a stock offering and beyond. "I have no doubt that when the Postbank deal comes out that the market will be ready," says a banker involved in the deal. But he also has no illusions that the glory days of the mid-1990s are returning soon. "I don't think we'll ever again have a popular share like Deutsche Telekom. There's a more discerning buyer." In the end, no matter what new rules are put into place, the most important rule for German investors is the same as anywhere else: Caveat emptor.
By Jack Ewing in Frankfurt