- Reviewed by David M. Kinchen
A good reputation is the most valuable thing we have—men and women alike. If you steal my money, you’re just stealing trash. It’s something, it’s nothing: it’s yours, it’s mine, and it’ll belong to thousands more. But if you steal my reputation, you’re robbing me of something that doesn’t make you richer, but makes me much poorer. — Iago to Othello, Act 3, Scene 1 in the play “Othello” in a modern English rendering of Shakespeare’s famous “who steals my purse steals trash” speech
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Right after I finished reading and absorbing Jonathan R. Macey’s “The Death of Corporate Reputation” (FT Press, Financial Times, an Imprint of Pearson, 304 pages, $39.99) I came across a story by New York Times financial reporter Gretchen Morgenson offering a word or two of advice to incoming SEC chief Mary Jo White (link: http://www.nytimes.com/2013/04/14/business/dear-sec-chief-clock-is-ticking-on-mortgage-cases.html?nl=todaysheadlines&emc=edit_th_20130414)
Morgenson echoed Macey’s criticism of the U.S. Securities and Exchange Commission as a toothless lion, incapable of scaring anyone, and said the clock is ticking on cases brought in the wake of the 2008 economic meltdown, that “For a lot of cases involving questionable practices and disclosures arising from the mortgage bust of 2008, time is running out.
“A February ruling by the Supreme Court made this crystal clear. In a case called Gabelli v. S.E.C., the court ruled that the commission has no more than five years from the occurrence of a fraud to file enforcement actions. It cannot wait until it uncovers a violation to start that clock.
“How many S.E.C. cases are up against that five-year limit? Outsiders have no way of knowing. But one whistle-blower complaint involving potentially misleading disclosures by SunTrust Banks, a regional bank holding company in Atlanta, serves as an example. Filed with the S.E.C. more than a year ago by a former SunTrust employee, it appears to be languishing even though time’s a-wasting.”
Morgenson’s article also delves into Fannie Mae and Freddie Mac, two neither fish nor fowl agencies that Macey doesn’t discuss. I have strong feelings about these two so-called government sponsored enterprises (GSE) and I hope Macey devotes his next book or paper to them.
Macey argues that this change — dare I call it a “sea change?” — was a result of three factors:
• The growth of reliance on regulation rather than reputation as the primary mechanism for protecting customers
• The increasing complexity of regulation, which made technical expertise rather than reputation the primary criterion on which customers choose who to do business with in today’s markets
• The rise of the “cult of personality” on Wall Street, which has led to a secular demise in the relevance of companies’ reputations and the concomitant rise of individual “rain-makers” reputation as the basis for premium pricing of financial services
Macey captures the essence of the almost unheralded — by the financial press and media in general — disappearance of the real reasons why we “can no longer trust Wall Street” — and offers suggestions on what to do about it,including how the SEC got captured — “and why it’s perfectly happy about that”.
Macey’s easy to read tome (yes, I know I reported on financial matters for many years as a real estate editor and reporter and was actually a business news editor for more than a year on a West Virginia daily newspaper, but trust me, I’m an English major at heart and I rank Macey with David Cay Johnston for ease of understanding). In relatively nontechnical language, Macey provides essential reading for every policymaker, financial executive, investor, and citizen concerned with well-functioning capital markets.
For more than a century, law firms, investment banks, accounting firms, credit rating agencies, and companies seeking regular access to U.S. capital markets made large investments in their reputations. They generally treated their customers well and occasionally even endured losses to maintain their reputations as faithful brokers, dealers’ issuers, and “gatekeepers.”
Almost without the general public noticing (except all those wondering why legal and accounting general partnerships today have converted to limited liability partnership (L.L.P) today’s leading capital market participants no longer treat customers as valued counterparties whose trust must be earned and nurtured but as distant “counter-parties” to whom no duties are required. The rough and tumble norms of the marketplace have replaced the long-standing fiduciary model in U.S. finance. The result has been unrelenting financial scandal.
In “The Death of Corporate Reputation”, Macey describes the disastrous transformation from the old reputational model to the existing buyer beware model in finance. Macey convincingly argues that the change can be attributed to several factors, including (1) the growth of reliance on regulation rather than reputation to protect customers and (2) growing regulatory complexity, which has made technical expertise more important to customers than reputation. After identifying the heart of the problem, he offers a better path forward–and a true “silver lining” in the age of Madoff.
Among the many topics Macey discusses are:
> Why traditional methods of fraud deterrence have failed in finance
> The unintended consequences of aggressive overregulation–and how to fix them
> It’s not just the banks: touring post-reputation Wall Street
> Failure of reputation in accounting and law firms, rating agencies, and exchanges
> Michael Milken and beyond: why “nobody goes down with the ship” anymore” or even gets damp! (Hint: they get to keep most of their ill-gotten gains).
> Why the employees of scandal-tarnished firms keep right on thriving. With apologies to the authors of “Evita”: ‘Don’t Cry for Me, Arthur Andersen” — especially all those partners in Milwaukee! The same good fortune doesn’t apply to the hapless members of an accounting firm’s support and administrative staff.
> And, apropos of Morgenson’s NYT piece: The perverse incentives that make the SEC so ineffective — and effective as a revolving door institution whose employees get great jobs on Wall Street.
In another piece dealing with similar issues covered in his new book, Macey writes: “Thus, ironically, it is good news is that investors trust the reputation of the S.E.C. and other financial regulators even less than they trust the reputations of the firms in the industry. The folks at the S.E.C. are too cozy with the businesses they are supposed to regulate, too slow, and too interested in getting themselves on the revolving door to Wall Street riches. A few firms like Morgan Stanley are changing their compensation scheme and bringing in highly trusted individuals in order to reestablish trust with their current and future customers. This sort of strategy is likely to be very successful because everybody in the market is looking hard to find somebody that they can trust.”
In a telephone interview on Monday, April 15, I asked Macey how Canada handles securities regulations. He says it’s in the hands of the provinces that make up Canada, not an S.E.C. type federal agency. In fact, as an expert witness he advised Canada NOT to establish an S.E.C. type agency!
Macey also responded to my Fannie Mae and Freddie Mac comments: “I do not cover Fannie or Freddie in my book is because they never had reputations to lose. Specifically, I did not cover Fannie Mae and Freddie Mac because, as government sponsored entities the only reputation they cared about was their reputation for buying mortgages from investment banks without fear and without distinguishing between good credits and bad. They poured good money after bad and continue to do so after they failed, and were placed into conservatorship by the federal government in 2008. The U.S. Treasury is permitted by law to spend up to the entire federal spending limit to bail out Fannie Mae and Freddie Mac. In 2008 this limit was increased by $800 billion, bringing the total taxpayer funds available to $10.7 trillion. Fannie and Freddie don’t need or care about their reputations because all people care about is their buying power, and they are backed by the federal government.”
Summing up: If you’re a financial professional, you’ll want to read this book. If you’re a general reader, you should read this book!
About the Author
Jonathan R. Macey lives in New Haven, Conn. and is Sam Harris Professor of Corporate Law, Corporate Finance and Securities Law at Yale University, and Professor in the Yale School of Management. He is a member of the Board of Directors of the Yale Law School Center for the Study of Corporate Governance, a member of the Faculty Advisory Group of Yale’s Millstein Center for Corporate Governance and Performance, and Chairman of Yale’s Advisory Committee on Investor Responsibility. He has served as an independent director of two public companies, and is a member of FINA’s Economic Advisory Council. His many books include Corporate Governance: Promises Kept, Promises Broken and Macey on Corporation Law.