Insecure Securities
Is Manning G. Warren III a prophet, a canary in a coal mine or an alarmist?
"I'm just a scholar who learns from the lessons of history," he says.
With Corporate America undergoing what Warren calls the "third wave" of recent fiscal scandals in the form of mutual fund fraud, Warren stops just short of saying, "I told you so."
Warren, the Harold Edward Harter Endowed Chair of Commercial Law in U of L's law school and a noted international scholar of securities law, makes no bones about his advocacy of strictly regulating business and securities markets.
"This is a fascinating time to be a securities scholar," he says.
Warren explains that throughout the 1990s, laws to protect investors that have been on the books since the 1930s were severely eroded. He says Congress replaced them with new laws pushed by business interests that made it more difficult for investors, their lawyers and government to sue or regulate companies engaged in alleged wrongdoing, including releasing false earnings statements.
Advocates of the laws said they were needed to stem frivolous lawsuits that hurt the profitability and reputations of companies and stifled stock activity in a bull market.
But to Warren they all amounted to one thing.
"These laws greatly restricted the remedies of investors to pursue companies and investment professionals for securities fraud," he says.
"And the result is that you have thousands of people who have been fleeced out of their retirement."
In recent investigations by New York's attorney general, for instance, it was found that securities firms such as Merrill Lynch were underwriting new stocks (for risky dotcoms in many cases) and then recommending them as sound investments. Research analysts were asked by the firms' investment banking side to give favorable ratings to these stocks even when the analyst thought the stocks didn't deserve them.
The incentive for pushing risky stocks and rating them higher than deserved was that the underwriter could get a commission of up to 10 percent when the offering went public. But that left investors holding the bag when the dotcoms tanked.
"There used to be what I call 'Chinese walls' separating the investment banking division from the research division, but those walls have been breached," Warren says.
"The walls were put there for good reason: to prevent conflicts of interest and to protect investors."
Warren is passionate about the subject of securities law and consumer protection, making a career out of following, analyzing, teaching and sometimes influencing the course of those laws. He has been called one of the nation's leading scholars in corporate and securities law and the leading scholar on European securities regulation. He also has written several books and more than 25 articles published in respected academic law reviews.
Warren wrote the Alabama Securities Act (1990), helped draft amendments to the Kentucky Securities Act (1998) and was appointed to the U.S. Securities and Exchange Commission (SEC) Federal Advisory Committee on Market Transactions from 1991 to 1997.
Well before the Enron, Merrill Lynch and other scandals began breaking, Warren was writing about his concerns.
In a 1997 issue of Law and Contemporary Problems, a Duke University School of Law journal, Warren wrote that the then-bull market was making regulators and investors complacent.
"The paradox is that this (market) success cyclically undermines the regulatory process. In a bull market…no one wants to hear about fraud and abuse."
Quoting another source, Warren added, "Only when the bull turns tail do these swindles come to light."
During the bull market and dotcom boom of the 1990s, Congress passed the Private Securities Litigation Reform Act of 1995, the National Securities Market Improvement Act of 1996 and the Securities Litigation Uniform Standards Act of 1998.
Each made it harder for investor plaintiffs to pursue legal or regulatory actions against companies.
"Laws like these get passed when everyone is making money," Warren says. "It would be political suicide to pass such things now, but at the time very few complained."
Warren, who testified in Congressional hearings on securities issues in the past, claims he was never asked to comment when the new laws were being considered.
"Traditionally," he says, "Congress establishes panels with diverse views so that legislators could hear all sides, pro and con, and make informed decisions."
"But these panels were stacked in favor of industry-supported bills. Neither me nor like-minded colleagues who believe investor protection is important were ever asked to address these three pieces of legislation."
In the meantime, the dotcom bubble burst, the market took a nosedive and what Warren calls "the crookedness and chicanery" started coming to light.
"First, you had abuses by publicly traded companies, including overstating revenues or claiming revenues that didn't exist in order to boost their stock value," Warren says.
"Secondly, and perhaps worse, you had securities professionals—people who are licensed and regulated and who should know better—behaving in the same atrocious manner."
Warren cites investigations by New York's attorney general Elliot Spitzer that found widespread fraud in major investment houses.
"Spitzer found that these major broker-dealers were providing their own retail clients false and misleading recommendations on the stocks that clients should buy."
As a result of the investigations of 1999 and 2000, Merrill Lynch paid a fine of $200 million to the state of New York. Then, Congress passed the Sarbanes-Oxley Act of 2002 to reinstate some of the protections it gutted in the 1990s.
Now mutual funds, which manage the retirement savings of millions of Americans, have been pulled into the scandals.
"We have various mutual fund companies allowing their shares to be traded at market prices after the market closed, giving certain large traders an advantage that you and I—who have to stick to the rules—don't have."
Warren is especially critical of the SEC for its lack of vigorous enforcement during these emerging scandals.
"Where was the SEC during all of this?" he asks. "Harvey Pitt [the SEC's first chair to be appointed by President George Bush] was there and left under a cloud. His career was spent representing corporate management and mutual funds, so he had very little incentive to detect and prevent these kinds of violations.
"We're lucky," Warren continues, "that we have state attorney generals such as Spitzer who will ferret out the things that federal regulators seem to pay little attention to."
Warren says he is writing papers analyzing the recent investment banking frauds, a study of the growing mutual funds scandals and an analysis of the Sarbanes-Oxley Act.
"What's really shocking to me," Warren says, "is the extent of these investment bankers' breaches of their fiduciary duties to their customers. It's a fairly straightforward breach, but the magnitude is greater than the securities markets have ever seen or experienced.
"And we have people in their 50s and 60s who cannot retire because their nest eggs have been devastated. "I'm afraid we haven't even scratched the surface. We don't really know the full extent of it all yet."
