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Remember
the public outcry when the “Government” put Arthur Anderson out of
business? The
question that I could not answer at the time was, “What business did
Arthur Anderson have to lose”? And what would possibly motivate one
of their previous audit clients to still be an audit client after
all that had occurred? I
was especially entertained when after the verdict there was the last
rush by Arthur Anderson clients to the other “Big” accounting firms
and the hint that they were having to buy their way onto their audit
calendars with big dollars.
In the old neighborhood we referred to that as a “Stupid Tax”.
A neighbor of mine is on the board of an unusual company - unusual
in the fact that it makes money and is in an industry where that is
not the custom. They made a decision to leave Arthur Anderson after
the Sunbeam and Waste Management lapses.
In their minds the significant premium paid for the prestige
of a “Big Five” audit was no longer justified.
They moved to a second tier, non Big 5 accounting firm thinking
the risk of having some investors not recognize the auditors name
was better than having an investor recognize the name of an auditor
associated with two recent scandals.
The real question is, why didn’t every other Arthur Anderson client
do the same thing? When
you pay very large sums for an audit, all you get is one sheet of
paper that basically says “we believe that these statements prepared
by the company are substantially correct”.
A fairly expensive piece of paper if the signature does not
signify integrity and a reputation for excellence to current and potential
investors. Why was there
no rush of companies to find another auditor that did not have the
baggage of these scandals? Why
was there no ground swell of investors avoiding Arthur Anderson audited
companies? Why was there
no rush of employees searching for employment in auditing firms untainted
by recent scandals? Simply
put, there was no economic penalty, not for them and not for the companies
that stayed with them.
Recently we observed another situation where there were two
very high profile lapses exposed with no apparent economic pain.
In the past 60 days Merrill Lynch settled with the New York
State District Attorney with a payment of $100,000,000 regarding issues
of the research given to their clients not representing the true in-house
opinion of the stocks in question.
I personally was disappointed by the settlement, not because
the amount was very small relative to the actual amounts made on the
transactions, but rather, I wanted to know what the in-house proprietary
trading was doing in these instances.
It is my opinion that the clients of Merrill Lynch have the
right to know if the firm was unloading stock to them in these occurrences
identified in the settlement.
The next occurrence was when two top Merrill Lynch executives refused
to testify to Congress on the grounds of self incrimination, specifying
a criminal probe into the Enron matter.
The subject was whether Merrill Lynch was assisting clients
in establishing transactions that would hide substantial debt from
current and potential investors.
Due to the lack of testimony, once again clients of Merrill
Lynch do not specifically know what happened, what part if any did
Merrill Lynch play, and if, after these transactions were structured
the stocks were still recommended to clients - knowing that there
were unreported liabilities.
Also, what if anything, was the proprietary trading activity
doing at that time.
Why isn’t every Merrill Lynch broker fielding calls all day long from
clients demanding these answers or leaving or threatening to leave?
The simple fact of the matter is that these two widely discussed
issues indicate that the people that are telling the brokers what
to sell “may” not have the clients best interest as their first priority.
These issues are not conclusive proof, but if it happens again,
and if it happens to you, will the stupid tax apply?
The bottom line is that there is no real economic cost to companies
that have real or apparent ethical lapses.
How many of you would have been economically better off if
you would not have bought any Arthur Anderson audited stocks after
Sunbeam and Waste Management? It is difficult to feel smart when a problem is identified
and repeated - giving you enough time to act and you still fall for
it again. The guy that
taught me to trade on the floor used to say “If it looks, walks and
sounds like a duck, it just might be a duck”, and this little pearl
of wisdom was usually hurled my way when something occurred that indicated
I should have exited a trade, didn’t, and unfortunately paid the price.
As a nation we seem to be very adept at dealing with issues after
the fact – throw the bums in jail, file a lawsuit or file an arbitration
claim. What we are not
very good at doing is determining and avoiding high risk situations
before they become a problem.
We do not deal with potential risk and therefore we do not
economically penalize firms for certain types of behavior that cause
that risk. If
there was a substantial economic risk for perceived conflicts, I believe
that the firms would be extremely reluctant to push the moral envelope
- but there is no market driven economic penalty.
Furthermore, there should be, in a perfect world, an economic
benefit realized by competing firms that do not engage in anything
that even gives the perception of conflicts.
Unfortunately, I see no evidence that this is occurring, not
before the latest revelations occurred and not even now when these
events are fresh in everyone’s mind.
There is a website that kind of epitomizes this type of attitude called
2nd Swing Golf. They
don’t have anything to do with investing - they sell golf clubs.
The company motto is “it’s not you – it’s the clubs”. Pretty effective marketing cliché. The problem is, if you see warning signs and still do not act,
and the worst a case scenario does occur (as it will from time to
time) – it is you - not the clubs and no amount of after the fact
remedies can change that.
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