Wall Street regulations have a mixed record, at best
Just like it is now, in other words.
I say this because of the sobering track record that regulatory efforts have had in the markets. Well-intended though they are, they too often have failed to eliminate the very behaviors they were designed to check. It seems that regardless of what new rules get adopted, the small investor ends up getting the short end of the stick.
I’m afraid that means that there’s no substitute for doing the due diligence yourself.
Global settlement
This was the 2003 agreement with Wall Street firms to correct for their conflicts of interest, in particular their refusal to issue a downgrade or sell recommendation on a stock with which they had an investment-banking relationship. Among other things, the settlement required those firms to set up and fund independent research firms, and they were further required to distribute those independent firms’ research alongside their own. And yet analysts’ buy-side bias persists.
According to CFRA Research’s Sam Stovall, nearly half of all analysts’ recommendations on Wall Street now are higher than “hold”; only 2.9% are “sell” and just 4.6% are a so-called “hold/sell.” (Please see chart.) One particular research result is worthy of note in this regard: One academic study found that the stock recommendations issued by the independent firms were actually more positive than those of the big firms.
‘Reg FD’
This rule — short for Regulation Fair Disclosure — was adopted in August 2000, requiring companies to disclose material information to all investors at the same time rather than selectively and piecemeal to favored analysts or investors. But selective disclosure has not been eliminated, as any of us can attest by how stock prices “mysteriously” start rising before the release of positive information — and start declining before bad news. A December 2016 academic study confirmed that our intuitions in this regard are well-founded.
Attempts to prevent market crashes
I’m referring to a number of regulatory changes — circuit breakers, trading halts, etc. — that have been implemented over the years, prompted by events such as the “flash crash” of May 2010, the 2008 financial crisis, the bursting of the internet bubble and the 1987 Crash, among others. This long litany is your first clue to regulators’ dismal success at preventing big down days in the market. And Xavier Gabaix, a finance professor at New York University, predicts that all such attempts will be futile. In an interview, he told me that market crashes are caused by the largest players (institutional investors) all wanting to get out of the market at once — and that no regulation can stop them when they want to. That’s because they can inevitably find other markets in which to unload their positions.
Altering CEO compensation incentives
There have been a number of such changes over the years, all motivated by the belief that chief executive officers will do a better job running their companies when they have skin in the game. Yet those changes’ track record has been mixed at best. CEOs of financial firms had huge sums at risk before the 2008 financial crisis, and yet that didn’t prevent them from pursuing risky strategies that cost their pocketbooks dearly — and nearly brought down the entire financial system.
The CEOs of Bear Stearns and Lehman Brothers — two firms that failed to survive the 2008 crisis — lost close to $1 billion each, for example. Rene Stulz, chair of Banking and Monetary Economics at Ohio State University, told me: “If the prospect of losing those amounts was insufficient to induce the firms’ CEOs to pursue different policies, it’s extremely difficult to imagine any compensation reform package that contains incentives that would do the trick.”
One reason that changing compensation incentives may backfire: The CEOs can manipulate the flow and release of positive and negative news to gut the effectiveness of those incentives. This isn’t just a hypothetical possibility: Alex Edmans, a finance professor at London Business School, has found that company news tends to be unusually positive in months in which a CEO’s options become vested.
Conclusion
For the record, I should stress that I’m not saying all market-related regulations fail, or that regulators should give up in their attempts to make the markets a more level playing field. But skepticism is healthy at all times, and especially when it comes to your money.
In short: There is no substitute for doing your homework.
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