Is corruption in the financial markets a daily fact of life for investors, or are the occasional waves of scandal just aberrations in a generally honest marketplace?
The latest wave of scandal started two years ago with the Enron collapse. Tyco and WorldCom followed. Then came the Wall Street analysts' scandal. And now there's the "market timing" and "late trading" scandal in the mutual fund industry.
The corporate and analysts scandals had a common denominator -- the popping of the technology stock bubble in the spring of 2000.
The dot-com bubble isn't a direct factor in the fund problems, except that the analyst scandal got New York Atty. Gen. Eliot Spitzer into the business of investigating financial services.
Market historians point out that when bubbles burst, scandal often follows. Anytime there's a flood of money, crooks will find ways to siphon more for themselves.
Nobody gets too worked up about a little cheating when everyone's getting rich.
But after the bubble bursts, there's a wave of finger pointing, investigation and scapegoating -- scandal.
There's something soothing in this view, as it implies that corruption isn't such a problem during normal times.
But that's false reassurance. Greed is always with us. It's only the opportunity to make it pay that waxes and wanes.
Rich get richer
The reason we see more corruption after bubbles pop is that a collapsing market often causes a financial house of cards to tumble, exposing frauds such as Enron. Then we start looking harder for other cases.
Many -- probably most -- of the people accused of corruption in the past two years were already rich by any ordinary standard. In some cases -- Martha Stewart's, for example -- the winnings from the alleged corruption were relatively small compared to what these people already had.
Take Pilgrim, Baxter & Associates, the Wayne, Pa., fund company whose founders became mired in front-page scandal this month. One of those men, Gary Pilgrim, is accused of making $3.9 million through his involvement in improper market-timing trades.
That's a lot of money to you and me, but Pilgrim was already a multimillionaire many times over.
What drives corruption among the rich? A compulsive need to succeed? An obsessive desire to ring up a bigger score?
Whatever it is, it's psychological, and that type of drive is there all the time.
Scandals always bring calls for reform. But when it comes to white-collar crime, the reforms typically fall short.
Penalties fall short
The House recently adopted a set of watered-down measures to deal with market timing, the fast in-and-out mutual fund trades that make money for speculators but undercut returns for a fund's ordinary long-term investors. The centerpiece is a rule change that would allow funds to charge more than the current 2 percent maximum as a penalty for investors who make short-term trades.
But the measure would not require fund companies to impose this fee. Indeed, many of the companies now embroiled in scandal had such fees in their rules at the time, but they waived them for favored clients. The House measure would allow Washington to claim it had passed reforms, while leaving investors at the industry's mercy.
The Securities and Exchange Commission settled its market-timing case against Putnam Investments, another fund company accused of trading abuses, with a slap on the wrist that infuriated reform advocates like Spitzer.
And reforms proposed at the New York Stock Exchange, mired in an executive pay scandal since summer, fail to take the needed step of completely separating the exchange's regulatory and enforcement operations from the business side.
In short, we're just not seeing the tough approach we get with drug dealing and other ordinary crime. How come?
Consider for a moment the Investment Company Institute, the trade organization for the mutual fund industry. Last week, it issued a press release quoting its president, Matt Fink, telling U.S. senators he was "outraged by the shocking betrayal of trust exhibited by some in the mutual fund industry."
This is like the police chief in Casablanca who was shocked to learn there was gambling at Rick's.
It turns out market-timing strategies have been an open secret in the fund industry. Academics have been writing papers about it for years. If the ICI didn't know about it, the ICI is an incompetent organization, so who cares what its president thinks? If it did know, why wasn't he shocked before now?
Let's not be naive. The ICI represents fund companies, not investors. These companies' profits come from the fees paid by investors. For them to make more, you have to make less.
This is why mutual fund fees have gone up during the years, even though the enormous growth of the industry should have produced economies of scale that brought fees down.
And it's why the ICI lobbied to get its members exempted from some key provisions of the Sarbanes-Oxley Act of 2002, Congress' reform effort after Enron.
The ICI also vigorously, and unsuccessfully, opposed new regulations requiring funds to disclose how they had voted on proxies for the companies whose stocks they own. The ICI said fulfilling the requirement would be too expensive.
But critics pointed out that many fund companies have lucrative business dealings with corporations the funds invest in. Keeping proxy votes secret helps conceal this conflict of interest.
The financial services industry and its trade groups are not on your side. Big profits for the industry buy lots of lobbyists to block the reforms that could undercut future profits.
Don't blame the late '90 bubble: Greed is a permanent, everyday feature of the financial services industry. There's not much chance regulators and politicans will do more than paper it over.
Of course, if you yell at your member of Congress, it might help.
To be heard over the big-business lobbyists, you'll have to be awfully loud.