RATHER than playing the hero in tales of crime and punishment, with Wall Street’s titans cast as the villains, state Attorney General Andrew Cuomo has quietly filed cases and won investor restitution when the facts justify such outcomes. The contrast with the more sensational tactics of his predecessor, Eliot Spitzer, underscores how free markets and the justice system can complement each other – when used properly.
As part of his probe of the credit contraction, Cuomo has now won huge concessions from five investment banks – Citigroup, JPMorgan Chase, Merrill Lynch, Morgan Stanley and UBS.
Cuomo’s investigators uncovered evidence that the banks had misrepresented the risks of investments called “auction-rate securities,” assuring customers that they were as safe and easy to access as cash. They weren’t.
Judging from Cuomo’s lawsuit against UBS before the settlement, plus evidence gathered about Merrill by Massachusetts, it’s reasonable to believe those two banks, at least, at some point realized the securities were risky, but kept on misleading customers anyway.
These cases illustrate some key ways Cuomo’s approach differs from Spitzer’s:
* Cuomo’s chief aim seems to be to use the civil-justice system to help wronged investors retrieve funds, rather than using their cases as fodder for media circuses.
The banks settled his investigations by agreeing to buy back billions of dollars worth of the securities from customers and paying up to $100 million each in fines.
The banks will also reimburse customers who already sold their securities at a loss and pay customers for damages (set by independent arbitrators) suffered because they couldn’t access their money.
“Our goal is simple: to get investors back their money, and that’s exactly what this deal does,” said Cuomo. (Merrill’s case hasn’t closed, but it says it’ll do buybacks, too.)
Ask yourself: As a customer of these banks, would you rather have your “cash” back, or see Cuomo embark on a long, vengeance-fueled journey?
* The AG didn’t repeatedly wield the aggressive public threat of criminal charges to get the banks to settle – as Spitzer did with Merrill Lynch in a conflict-of-interest case six years ago.
Criminal prosecution has its place in the markets, and individuals at the banks could still face charges. But investors know that criminal indictment of a company can be a death sentence – witness how the feds’ case against Arthur Andersen led to the accounting firm’s demise.
If Cuomo had threatened corporate criminal indictment, the banks would’ve had no choice but to settle. (They might’ve made that point in the press, making Cuomo look unreasonable and weakening his case against them in the public eye.) Rather than make that threat, he calmly laid out a civil complaint against UBS – letting the evidence speak for itself.
Cuomo’s strategy does something invaluable: It lets the market gradually and rationally do the work that an indictment (or the threat of one) would’ve done suddenly and in a panic.
UBS and Merrill, for instance, will likely suffer because of their own apparent actions – now adequately disclosed – not because of outside threats of prosecution. If clients agree (by virtue of the information now uncovered) that their banks seemed to care about themselves more than their customers, they’ll take their money elsewhere. Such flight is especially painful for the banks now, when their other lines of business – like mortgage securitization – have dried up.
Cuomo’s settlements illustrate how Spitzer’s policing of Wall Street was a missed opportunity.
Spitzer was most active five to seven years ago, after the tech bubble burst. Investors then clearly had cause for complaint and for regulatory redress: Investment banks and employees had often put their own interests ahead of their clients’.
Some Spitzer-designed reforms had reasonable goals – like efforts to enforce the separation of big banks’ supposedly objective research departments from their sales and trading desks. But some details weren’t well thought-out – in part because Spitzer’s threats forced banks and government agencies to accede to the reforms in a panic. So the reforms failed to achieve their aims even as they gave people false confidence that everything had been fixed.
Of course, Cuomo’s gentler tactics might not have worked as well then as they are now: The banks weren’t as much in a settling mood. They hadn’t collectively lost hundreds of billions and weren’t depending on the federal government to stay afloat.
But, even so, Spitzer was far too eager to wield his greatest powers – the power to bring criminal indictments and the power to demonize and bully individual executives in the press – and to make himself the story.
Without Spitzer to serve as a handy common enemy, some financial institutions and their investors might’ve had to look inward instead and to acknowledge the risks of a brittle business model – as they’re now forced to do.
Nicole Gelinas is a contributing editor at City Journal, on whose Web site this also appears.
Nicole@city-journal.org