With the hullabaloo surrounding the latest Senate hearings regarding malfeasance by Wall Street’s finest, what part did our stock exchanges play in this financial fiasco? At first blush, it would appear that exchanges would be immune from the onslaught of public opinion and Senate questioning. Their job is to create liquidity for sellers of stocks and other financial securities, to put the buyer together with the seller, and then get out of the way.
Exchanges provide the “secondary market” for securities. Creating the primary market for the initial sale of securities rests with the large investment banks, like Goldman Sachs, our largest and most successful investment banking firm. Our major stock exchanges, the NYSE, the Amex, and the NASDAQ/OTC, enable trades in public stock offerings for registered companies. Each exchange has detailed listing requirements, the toughest being for the NYSE. For example, listing on the NYSE affords companies great credibility because they must meet initial listing requirements and also must comply annually with maintenance requirements.
Consequently, to remain listed, NYSE companies must keep their price above $1 and their market capitalization (number of shares x price) above $50 million. There are many other major differences, but each exchange enforces these requirements to protect the integrity of its respective exchange and the interests of the individual investor. The Securities and Exchange Commission, our industry watchdog, has the mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. The laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it.
To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public.The firestorm on Capitol Hill is not about typical company stock offerings. The type of security in question is called a CDO, or collateralized debt obligation, and it does not trade on any major stock exchange. It is referred to as a synthetic market created for the sale of bond-like securities by large firms like Goldman and Citicorp to large institutional investors like governments, pension funds and insurance companies. Almost all CDOs are sold in private placements, and their current values aren’t posted anywhere.
Satyajit Das, a former Citigroup Inc. banker who has written 10 books on debt analysis, says, “There is absolutely no transparency. It’s difficult to get current values or information about the underlying assets in the CDO.”
Financial regulators have effectively outsourced the monitoring of CDOs to the rating companies. No less an authority than the U.S. Office of the Comptroller of the Currency, which regulates banks, depends on the rating firms to assess the quality of CDOs. U.S. banks have invested as much as 10 percent of their assets in CDOs, and the OCC requires that all of those CDOs be investment grade, says Kathryn Dick, deputy comptroller for credit and market risk. “We rely on the rating agencies to provide a rating,” she says. CDOs have been a bonanza for the rating companies. In the past three years, S&P, Moody’s and Fitch have made more money from evaluating structured finance, which includes CDOs and asset-backed securities, than from rating anything else, including corporate and municipal bonds, according to their financial reports. The companies charge as much as three times more to rate CDOs than to analyze bonds, published cost listings show. The companies say these fees are higher because CDOs are so complex compared with a single bond. Once again, as in previous financial scandals, greed raises its ugly head.
Human nature just can’t seem to shake the beast anymore easily than removing the pressure of quarterly earning calls. At least it appears that our exchanges are operating independent of the latest malaise. However, private market behaviors often impact their major market brethren to some degree. The more complicated the transaction, the more transparency required seems to be the lesson.
As for our trusted credit rating agencies, they continue to hide behind their disclaimers that their ratings should not be relied upon when making any credit or purchase decisions. Be alert in your due diligence activities. For the time being we can follow the reform debate on Capitol Hill on our favorite cable news channel at home. The Enron debacle was the last great financial scandal back in 2001. The investment in time and controls to deal with reform legislation from that period has most likely run its course. Time to create a new type of compliance officer to ensure integrity in our financial system and stamp out greed. If the last attempt was any indicator, then we will revisit the subject long before 2020.