Wall Street Can't Serve Two Masters

Listen up, Wall Street. It's bad enough that the spreading scandal has inflicted pain on investors who lost billions in telecom and tech stocks. But corruption on Wall Street is damaging the entire U.S. economy, which depends on financial markets to channel capital to deserving companies. It threatens an equity culture based on direct participation by citizens in the risks and rewards of capitalism. And it undermines the core conservative belief that individuals and families can take charge of their lives--including their pensions and social security--and manage them without excessive government help.

By corrupting analyst research and enabling companies to manipulate earnings during the bubble years, Wall Street contaminated the information flow on which so much of U.S. commerce depends. Sanford I. Weill, chairman and CEO of Citigroup (C ), which owns Salomon Smith Barney; Philip J. Purcell, chairman and CEO of Morgan Stanley Dean Witter (MWD ); John J. Mack of Credit Suisse First Boston; David H. Komansky, chairman and CEO of Merrill Lynch (MER ); and other financial leaders must now step up, recognize the enormity of Wall Street's transgressions, and commit to real solutions before it is too late. Silence and meek apologies are insufficient. Wall Street's corruption is an American crisis.

The Street has traditionally struggled with conflicts of interest. After all, the same institution serves two masters: client companies, for which it raises capital, and investors, whom it advises on placing money. But deregulation and consolidation have given Wall Street firms far more conflicts to deal with in recent years, as investment banking, brokerage, lending, and research have come together under one roof. The huge fees, commissions, and salaries generated in the tech bubble of 1998-2000 clearly overwhelmed the "Chinese walls" and self-regulatory mechanisms designed to manage these conflicts.

E-mails from within Wall Street make it increasingly clear that in the fat years investors were confounded by misleading information put out by analysts in search of investment banking business. It was the kind of scurrilous "pump-and-dump" action normally seen in tiny, penny-stock markets. But it hurt millions of Americans who put their childrens' education funds and retirement savings into "growth" stocks on the advice of brokers.

What's to be done? Efficient markets have always required information to make them work. When a small number of people ran the U.S. economy and invested in equities, reliable data needed to flow to a select few. In a fast-growth, innovation-based New Economy with millions of people taking on high risk investments, it is critical to get vast amounts of information into the marketplace. Financial statements must be transparent. And research must be honest.

Short-term, heavy fines and penalties should be imposed to punish the worst offenders. After all, Wall Street took in $10 billion in fees during the three golden years, while investors lost $4 trillion from declines in high-tech and telecom stocks.

Wall Street must move quickly to manage its conflicts of interest properly, or checks and balances may have to be introduced to contain corrupt behavior. If self-regulatory reform doesn't come soon, government may have to step in to deconstruct and separate the functions of research, investment banking, lending, and brokerage. The clock is ticking.

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