The Blog Of The Securities Industry Professional Association

The Definition Of Insanity

Main Entry: in·san·i·ty
Pronunciation: in- san- t-
Function: noun Inflected Form(s): plural -ties
1 : the condition of being insane especially when serious enough to keep one from being convicted of a crime or from performing duties required by law
2 a : extreme foolishness or unreasonableness b : senseless conduct
Today is a very sad day on Wall Street. Lehman Brothers (LEH) has declared Bankruptcy and Merrill Lynch ( MER) has been bailed out in a fire sale to Bank of America. Two of the most well known names in Wall Street history have flamed out within a matter of moments and American investors have been shaken to their core. How could this all happen so quickly and how in the world did these two titans of Wall Street get into this mess to begin with?
The answers are long and arduous but in our eyes this has been a disaster that has been 20 years in the making. Let’s be honest, despite the fact that these companies have long been considered the standard bearer on Wall Street in terms of name recognition and power, these companies have been pushing the envelop for many, many years. Along with Bear Stearns, Smith Barney, Goldman and a host of other legendary names on Wall Street, these companies have repeatedly taken obscene risks, followed by unethical and ‘senseless conduct” over the last 20 years that has gone largely unnoticed and for the most part unpunished. In the mid 1990’s these firms were part of the greatest collusion and price fixing this country has seen since OPEC was formed. The market makers all colluded and had built in mark-ups and mark down’s on every single share of stock. Despite the fact that they already held most of the market share and would still receive the lion’s share of profits, these largest firms on Wall Street were still not satisfied. This insatiable greed and monopoly was punished by the regulators (NASD and SEC) in a manner that still leaves most confused. The regulators enacted things like OATS and decimalization and lowered the spreads. That was great in theory but most small market makers were driven from the industry and these same large Wall Street insider firms now had several times the volume they had before. In other words, they lowered the profit spread on each share of stock but also increased 10 fold the volume these firms now were able to get. Throw in the fact that they each bought their own ECN and now you have even more forced volume into these firms…..Some punishment.

In 2001 and 2002 The Wall Street Elite firms were fudging numbers and coming out with erroneous and false research reports in an effort to bolster stocks like WCOM and ENRON. One noted and trusted analyst was so brazen he sent an e-mail that stated “let’s put some lipstick on this pig” just moments after telling a National Audience that Citigroup “likes the stock at these levels and prices”. This act alone cost millions of Americans Billions of Dollars and destroyed many 401k plans and retirement accounts. The punishment for this brazen lie? They paid a fine and went back to business. In fact, it was the Attorney General of NY who actually put the feet of these firms to the fire…But the NASD and SEC? Nothing that would impact them or STOP THEIR BAD BEHAVIOR.
In 2003, once again The Attorney General of NY had to stop some of the madness on Wall Street and went after Firms for Market Timing Mutual funds and more disturbingly, Firm’s that were buying mutual funds YESTERDAY with TODAYS news. For instance, Bear Stearns had an actual software program made that would conduct these after hour trades and market timing trades!!
It was estimated that Bear made over ONE BILLION from these illegal activities….their Punishment however was a 250 Million dollar fine from the SEC.!!

How insulting that you could actually allow this type of behavior to take place and basically reward it! Imagine telling a crook that “if you steal 10,000 bucks from a gas station, we are going to fine you 2500??” Do you think Crime would go down from this type of attitude??
These elite Wall Street firms consistently pushed the limits on what was legal and ethical for the sake of making an extra buck. Each month NASD’s Notice to Members lists dozens of firms and individuals who were fined and sanctioned for their behavior or lack of compliance. Every month the largest firms on Wall Street would pay a petty fine and sign a settlement agreement and promise never to do it again. A quick glance of Lehman, Bear and Merrill’s public disciplinary history shows Lehman has 360 regulatory hits, while Merrill has 250 and Bear a paltry 114( Yes that was sarcasm!). Combined that’s 750 regulatory (from FINRA, SEC or a State) actions against them. Bare in mind that these firms have additional arbitration marks to the tune of thousands and this figure does not include the many additional marks on related companies that engage in Market Making, Investment banking and other securities related businesses. In other words, these firms and their sister companies had well over 1000 regulatory actions against them!!!

Not once in all this time were any of these firms ever suspended from trading, or ordered to cease doing business. Over 1000 regulatory actions yet not once were these firms told that they could only accept SELL orders for the next 30 days and must cease doing a particular line of business. Imagine the loss of revenue and the screaming of shareholders if Lehman or Merrill were told they could not do any investment banking for six months and could only accept unsolicited sell orders for 30 days as punishment for recidivist behavior and hundreds of regulatory violations? Imagine if Bear Stearns was told that it could not add any new clearing correspondents for one year due to egregious and habitual violations?

Shareholders would have demanded heads on a platter and a change in mental attitude toward rules and regulations. This immunity from the wrath of regulation however created a false sense of security because in the end these firms were not immune from ” Extreme foolishness and senseless conduct”

It boggles the mind to read where Lehman held over 600 Billion in mortgage debt…They are a Stock Brokerage firm first and foremost yet they were playing with the real estate house of cards. One has to wonder why Regulators never questioned why a stock firm put all its eggs in one basket. Merrill Lynch is even more disturbing in that only 3 years ago they boasted excess NET CAPITAL of 86 billion dollars! That is pure hard cash that they put to risk and destroyed for shareholders. Sure, Bank America bought them for ’50 billion in stock” but read between the lines. They paid in stock not cash. In other words, BA printed some extra shares from the vault for a company that once had 86 billion in CASH! Imagine owning a home outright that you paid 200k for and then the value goes to 1 million…rather then cash out, you decide to take out home equity lines and buy additional homes…then when the crash comes, you’re overjoyed because somebody gave you 200 shares of Google for your house!!! Merrill is essentially the same.

With billions and billions in liquidity these companies could have paid handsome dividends to shareholders, bought other companies, invested in other areas, spread the risk versus reward ration yet they put all their risk capital into real estate egg basket… Extreme foolishness and senseless conduct

When will this insanity on Wall Street end? It may be right now….because these extreme fools are being punished now by the markets and investors in a way they could have never imagined and in a way that regulators never dared think of before……they are out of business due to their Extreme foolishness and senseless conduct

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September 22nd, 2008


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