WEBVTT NOTE How the Government Subsidizes Stocks 1 00:00:00.000 --> 00:00:05.400 My topic today is how government subsidizes stocks. 2 00:00:05.400 --> 00:00:08.400 And I'll race to that conclusion in my 30 minutes this morning. 3 00:00:08.400 --> 00:00:11.700 The title kind of gives my hand away. 4 00:00:11.700 --> 00:00:14.500 I should have picked something a little more mysterious, 5 00:00:14.500 --> 00:00:17.700 like Jim Grant's phrase this morning, 6 00:00:17.700 --> 00:00:19.600 the suspension of disbelief, 7 00:00:19.600 --> 00:00:23.900 because that's really what I'll be getting into today. 8 00:00:23.900 --> 00:00:29.980 Another alternate title was unpalatable conduct. 9 00:00:29.980 --> 00:00:34.220 The relevance of that will shortly become clear. 10 00:00:34.220 --> 00:00:39.420 The questions I'm going to look at this morning are 11 00:00:39.420 --> 00:00:43.860 why and how is the government in the securities industry, what is it that they 12 00:00:43.860 --> 00:00:45.380 protect 13 00:00:45.380 --> 00:00:51.180 and does that affect market values. This third question I think will probably have to 14 00:00:51.180 --> 00:00:56.180 Wait to the panel tomorrow because it's a pretty big topic. 15 00:00:56.460 --> 00:00:59.380 As you can see, I mean subsidy in the title 16 00:00:59.380 --> 00:01:01.420 in the broadest possible sense 17 00:01:01.420 --> 00:01:03.900 and not really direct cash support. 18 00:01:03.900 --> 00:01:07.780 Specifically, I mean the government's indirect support 19 00:01:07.780 --> 00:01:09.380 of the securities industry. 20 00:01:09.380 --> 00:01:11.060 The form of subsidy, excuse me, 21 00:01:11.060 --> 00:01:14.340 the form of subsidy is protectionism, 22 00:01:14.340 --> 00:01:18.400 capturing a customer base that might not otherwise 23 00:01:18.400 --> 00:01:19.720 be available to them. 24 00:01:21.180 --> 00:01:27.780 The often stated rationale of the Securities and Exchange Commission is investor protection. 25 00:01:27.780 --> 00:01:35.780 There's a big difference between the motive of protection and the motive of protectionism, a big difference. 26 00:01:35.780 --> 00:01:45.580 Securities regulators seem to have won the propaganda battle by virtue of their steady drumbeat of press releases. 27 00:01:45.580 --> 00:01:55.580 This, I think, echoes Tom Villarenzo's point just a few minutes ago that Congress likes to create the perception of crises. 28 00:01:55.580 --> 00:02:01.580 They say, we protect you. We protect you, the little guy, the average investor. 29 00:02:01.580 --> 00:02:09.580 So if you, a member of the general public, are reading about how the SEC busts day trading firms, 30 00:02:09.580 --> 00:02:16.700 Sometimes flaky brokerages, how it punishes banks and other large institutions for managing earnings. 31 00:02:16.700 --> 00:02:27.700 If you read yesterday's paper about the Maytag case, you'll tend to think that there's a lot of hanky-panky out there and you'd be right some of the time. 32 00:02:27.700 --> 00:02:36.700 But what is the protection offered by the SEC? Does it over-protect? Does it under-protect? Does it create false hopes? What does it do? 33 00:02:36.700 --> 00:02:47.700 On net are they helping or hurting? They say they want to root out fraud, which undermines confidence and upsets smoothly functioning markets. 34 00:02:47.700 --> 00:02:56.700 So Congress awards the SEC very wide discretion to punish those people who upset markets. 35 00:02:56.700 --> 00:03:02.700 The frauds are only one part of this total, the total group that upsets markets. 36 00:03:02.700 --> 00:03:12.700 In some ways, there are people who upset markets who are not committing fraud. 37 00:03:12.700 --> 00:03:21.700 The SEC has a vision of the market that if you violate that vision of the market, you are in effect committing a crime. 38 00:03:21.700 --> 00:03:26.700 Ultimately, I guess this is the point I really want you to go away with this morning. 39 00:03:26.700 --> 00:03:41.700 Are the laws that govern securities markets geared to specific credible rules against fraud or are they geared to enhancing the securities industry's ability to attract investors? 40 00:03:41.700 --> 00:03:48.700 Again, that grant phrase, suspension of disbelief, I think, is pertinent here. 41 00:03:48.700 --> 00:03:57.700 If they do protect the industry's position and reputation, then that has some important implications. 42 00:03:57.700 --> 00:04:03.700 Do SEC rules create any kind of artificial preference for stocks as against other things? 43 00:04:03.700 --> 00:04:10.700 Are they in effect a branch of the Federal Reserve System promoting confidence in securities, 44 00:04:10.700 --> 00:04:27.700 Like bank regulators create confidence in banks or SNLs or farm credit with the same kind of disastrous results we've seen in those industries in the 80s, with potentially the same disastrous results. 45 00:04:27.700 --> 00:04:35.700 Artificial preferences for things like securities or other financial instruments are going to affect their public values. 46 00:04:35.700 --> 00:04:41.700 Public Values. So these are the questions that everybody is asking these days, not just Austrians. 47 00:04:41.700 --> 00:04:48.700 Is the confidence of investors out of sync with expectations? The SEC itself thinks so. 48 00:04:48.700 --> 00:04:54.700 They do public surveys on this and they are worried that public expectations are out of line. 49 00:04:54.700 --> 00:05:00.700 Arthur Levitt pretty much agrees with Alan Greenspan that there is such a thing as irrational exuberance. 50 00:05:00.700 --> 00:05:16.700 The aura of protection and safety for average investors may put them in over their head. 51 00:05:16.700 --> 00:05:23.700 Just to give a down-home example, my wife is attracted to stocks that are ready to split, 52 00:05:23.700 --> 00:05:29.700 and I try to tell her that's really not going to affect the value of the stock 53 00:05:29.700 --> 00:05:34.700 Because everybody knows it's going to split, so that's taken into account in the value of the stock. 54 00:05:34.700 --> 00:05:41.700 So she makes money, and I look like a curmudgeon for telling her that it's not going to work. 55 00:05:41.700 --> 00:05:47.700 So a large segment of investors are feeling pretty supercharged today. 56 00:05:47.700 --> 00:05:57.700 The cash that flows into retail brokerage accounts is turning into, if not, hot money, kind of pseudo-hot money, the kind that turns on a dime. 57 00:05:57.700 --> 00:06:04.700 Let me make just a side point here about asset values and that will be the only thing I'm going to say about that right now. 58 00:06:04.700 --> 00:06:15.700 For years mutual funds have been taking market share from banks, which is good in some ways because mutual funds are better competitors than banks. 59 00:06:15.700 --> 00:06:22.700 Banks were very slow off the mark for a long time. Is there any way to really know whether this is a healthy development? 60 00:06:22.700 --> 00:06:52.300 Banks value assets differently than securities markets, should all of the assets, excuse me, should all of the asset values that we observe be public market values trading in securities markets, or is there any room for bank lenders doing complex, subtle, private valuations, perhaps channeling the ghost of JP Morgan to figure out what the true value of this thing really is. 61 00:06:52.300 --> 00:06:56.300 Like I said, I want to reserve those questions for the panel tomorrow. 62 00:06:56.300 --> 00:07:06.300 The modern SEC though is like any other government agency that has industry cooperation and sponsorship. 63 00:07:06.300 --> 00:07:10.300 In some ways, it is the marketing arm of the industry that it regulates. 64 00:07:10.300 --> 00:07:15.300 That's no surprise given what we know about other government agencies. 65 00:07:15.300 --> 00:07:21.300 The industry does not want investors to believe that the market could be rigged or biased in any way 66 00:07:21.300 --> 00:07:35.300 Just like the FDA doesn't want its regulators, its food companies, to believe that processed food is tainted. 67 00:07:35.300 --> 00:07:41.300 Now, they preach that they want to make the market fair for the little guy. 68 00:07:41.300 --> 00:07:46.300 We live in the new era of democratic capital. Everybody gets a piece of the action. 69 00:07:46.300 --> 00:07:56.300 We're all investors now. Stock trading, which was kind of a naughty thing to do in the 20s, is kind of a nice thing to do here in the 90s. 70 00:07:56.300 --> 00:08:05.300 And the chaperone between investors and firms is the SEC. No dirty dancing. 71 00:08:05.300 --> 00:08:12.300 Their central activity is to regulate business speech between firms and investors. 72 00:08:12.300 --> 00:08:17.100 They ban insider trading and other wicked sounding practices. 73 00:08:17.100 --> 00:08:20.100 They promote disclosure and transparency. 74 00:08:20.100 --> 00:08:27.700 While at first these communications regulations sound innocuous and popular, 75 00:08:27.700 --> 00:08:32.300 kind of like consumer protection, they have very bad effects. 76 00:08:32.300 --> 00:08:36.700 By painting with far too big a brush, 77 00:08:36.700 --> 00:08:41.700 they undermine the very trade in information that they're supposed to protect. 78 00:08:41.700 --> 00:08:47.700 In some cases, but not all, insider trading is appropriate. 79 00:08:47.700 --> 00:08:56.700 There is such a thing as property rights in intangible things, and that seems lost on the SEC. 80 00:08:56.700 --> 00:09:03.700 In some cases, transparency is appropriate. Other times, it's not. 81 00:09:03.700 --> 00:09:10.700 There are business secrets that are proprietary, disclosures that are not cost effective 82 00:09:10.700 --> 00:09:15.700 in situations where investors could care less whether they get various facts. 83 00:09:15.700 --> 00:09:22.700 Earlier this year, the SEC was burdened by the problem of selective disclosure. 84 00:09:22.700 --> 00:09:27.700 Did anybody read the papers yesterday about Maytag, by any chance? 85 00:09:27.700 --> 00:09:34.700 Thank you. You'll know what I'm talking about. Let me explain. 86 00:09:34.700 --> 00:09:38.700 Executive managers are sitting on very valuable assets. 87 00:09:38.700 --> 00:09:46.700 They are banned from using inside information themselves, whether their corporate board would permit them to use it or not. 88 00:09:46.700 --> 00:09:53.700 It sort of depends on the charter they have and what state they're in. 89 00:09:53.700 --> 00:10:03.700 It's possible that firms could experiment with allowing some of their executives to trade, 90 00:10:03.700 --> 00:10:11.300 Trade. Just like in days of old before these practices were banned. So firms create valuable 91 00:10:11.300 --> 00:10:19.940 property, tangible and intangible. Who is it that assigns the right to use those? Jonathan Macy at 92 00:10:19.940 --> 00:10:26.820 Cornell University, a fairly prominent law and economics professor once said that banning insider 93 00:10:26.820 --> 00:10:32.980 trading is like a rule that says throw money out the window of corporate headquarters. In this 94 00:10:32.980 --> 00:10:48.980 In this instance, instead of throwing it out the window, executives reveal it strategically to favorite analysts hoping to either delay contrary opinion or hoping for a good response. 95 00:10:48.980 --> 00:10:55.980 So, how does the SEC approach this? This is instructive. There are a few options. 96 00:10:55.980 --> 00:11:04.980 They can recognize reality that some information is too complex to be synthesized by average investors 97 00:11:04.980 --> 00:11:12.980 or they can let firms experiment with assigning rights to the use of those intangible assets 98 00:11:12.980 --> 00:11:18.980 at the same time while not undermining the public participation in their stock 99 00:11:18.980 --> 00:11:24.980 or they can simply say to the public, okay, folks, this is obnoxious, bribing analysts 100 00:11:24.980 --> 00:11:30.980 It biases outcomes, but it happens all the time, so you should watch yourself. 101 00:11:30.980 --> 00:11:35.980 I think the last option is the more honest. 102 00:11:35.980 --> 00:11:40.980 Instead, they continue down the path of threats and punishment. 103 00:11:40.980 --> 00:11:47.980 Here are the words of a current commissioner talking about making rules that deal with the problem of selective disclosure. 104 00:11:47.980 --> 00:11:55.040 In drawing bright lines by rulemaking, we always run the risk of legitimizing conduct that falls just below the line, 105 00:11:55.040 --> 00:11:58.780 conduct that we may still find unpalatable. 106 00:11:58.780 --> 00:12:03.280 And given a compelling set of facts on this selective disclosure case, 107 00:12:03.280 --> 00:12:08.080 we are not averse to testing our legal theories in this area through an enforcement action. 108 00:12:08.080 --> 00:12:13.380 In other words, if we don't like it, we have the power to stamp it out, so watch it. 109 00:12:13.380 --> 00:12:18.980 And wouldn't that make Chairman Mao blush, am I? 110 00:12:18.980 --> 00:12:26.780 So the question is, do you think that this outlook improves the quality of corporate information or not, 111 00:12:26.780 --> 00:12:33.580 independent of what you think about CEOs who give tips to friendly analysts? 112 00:12:33.580 --> 00:12:38.980 Let's talk about the Maytag case for a second and the papers yesterday. 113 00:12:38.980 --> 00:12:48.140 Let me recount the facts here. Individual investors bought about $2.3 million on Maytag stock on Thursday. 114 00:12:48.140 --> 00:12:56.380 Institutional investors, not sure how many, the Connected View and some others, were dumping their stock on Wednesday, the day before. 115 00:12:56.380 --> 00:13:02.340 The news came out on Friday, so the individuals got soaked. 116 00:13:02.340 --> 00:13:08.180 Here's my take. See, if you agree with this, we'll have a show of hands. 117 00:13:08.180 --> 00:13:22.180 Thursday, a lot of swaggering little guys with high capacity internet connections thought they could outsmart or outguess the institutions, buying on rumors one day before earnings. 118 00:13:22.180 --> 00:13:29.180 So, one question is, who buys long term in the days before earnings are announced? 119 00:13:29.180 --> 00:13:37.180 Correct me if I'm wrong, I don't know if anybody who considers themselves a long term investor would buy under those circumstances. 120 00:13:37.180 --> 00:13:47.180 Since they were short-term investors trying to be big shots, how many people here think they got that they deserved in the sense that they took a fair gamble and lost? 121 00:13:47.180 --> 00:13:49.180 Could I just see a show of hands? 122 00:13:49.180 --> 00:13:51.180 We're all in agreement then. 123 00:13:51.180 --> 00:13:54.180 Well, some of you don't agree. How many do not agree with that? 124 00:13:54.180 --> 00:13:58.180 Okay, I've convinced them. 125 00:13:58.180 --> 00:14:07.180 So none of you then, I have another question here, none of you would agree in the affirmative. 126 00:14:07.180 --> 00:14:21.180 How many of you think that the law should intervene to make absolutely certain no divergence of information should ever occur again between institutional investors and these new hot shot internet investors? 127 00:14:21.180 --> 00:14:25.180 And I don't think we need to spend a lot of time on that. 128 00:14:25.180 --> 00:14:31.180 Last month the SEC redefined materiality yet again. 129 00:14:31.180 --> 00:14:41.180 In the past, accounting firms argued convincingly, I think, that misstatements or errors that were small as a percentage of earnings were irrelevant. 130 00:14:41.180 --> 00:14:46.180 And that's a good rule, I think. Don't sweat the relatively small stuff. 131 00:14:46.180 --> 00:14:54.180 Now they say you cannot hide behind a fixed numerical test. 132 00:14:54.180 --> 00:14:58.180 If we say 5% we might mean 4%. 133 00:14:58.180 --> 00:15:02.180 At 4% watch out too because we might mean 3% or 2%. 134 00:15:02.180 --> 00:15:06.180 In other words, it's material when we say it's material. 135 00:15:06.180 --> 00:15:14.180 Now this attitude arose in the wake of CUC, a conglomerate that lied to its accountants, 136 00:15:14.180 --> 00:15:26.180 The accounting firm thought it was an immaterial error and it would have been had the company not lied to them. 137 00:15:26.180 --> 00:15:37.180 But the result is that this fraud now, the rulings based on this fraud expand the scope of SEC powers and impose more costs on firms. 138 00:15:37.180 --> 00:15:40.180 The rule is now, sweat the small stuff. 139 00:15:40.180 --> 00:15:48.180 They even have really bizarre issues with internet distribution. 140 00:15:48.180 --> 00:15:51.180 The fine-tuning mentality is really beyond the pale. 141 00:15:51.180 --> 00:15:54.180 If you just go to some of their speeches on their website, 142 00:15:54.180 --> 00:15:56.180 I can refer you to a couple of them. 143 00:15:56.180 --> 00:16:03.180 They'll make your hair curl or straighten or grow, depending on your reaction. 144 00:16:03.180 --> 00:16:17.180 The reaction, 70 million people in the country have internet access, which is only 20% of households, and that's just not good enough for the SEC. 145 00:16:17.180 --> 00:16:28.180 They split hairs over when information is disseminated, when it's published, when it's available, at what time, if it's on the website, is it published, 146 00:16:28.180 --> 00:16:32.180 If Dow, Reuters, Bloomberg don't have it, does that mean it's not published? 147 00:16:32.180 --> 00:16:41.180 Fortunately, I have come up with what I consider to be the best and final technical solution to this problem 148 00:16:41.180 --> 00:16:47.180 to make sure that investor information in future generations is equal everywhere. 149 00:16:47.180 --> 00:16:52.180 It's like the V-chip. I call it the 10K chip. 150 00:16:52.180 --> 00:16:58.180 Everyone gets a wireless receiver and storage device implanted in their brain at birth. 151 00:16:58.180 --> 00:17:05.180 Later in life you can upgrade to the 10KAR, which is what? 152 00:17:05.180 --> 00:17:14.180 It's the 10K doubler chip that allows you to receive not only the 10K but annual reports with graphics and video. 153 00:17:14.180 --> 00:17:26.180 So other modifications are possible too. You can have it Buffettized. It'll select out the five or six things that Warren Buffett looks for. 154 00:17:26.180 --> 00:17:35.180 Anyway, the possibilities are endless here and I'm advising the Gore campaign this year. So watch for it. 155 00:17:35.180 --> 00:17:43.180 So back to the main theme. This issue, investor protection or industry promotion, is a bit confusing. 156 00:17:43.180 --> 00:17:55.180 There is a chicken and egg quality to it. In some high-profile cases, in the Michael Milken case, for example, the situation was totally unprecedented and unique. 157 00:17:55.180 --> 00:18:06.180 The establishment reacted to Drexel's extraordinary success by what? As Tom DiLorenzo was mentioning earlier, 158 00:18:06.180 --> 00:18:36.180 The late business historian Robert Sobel from Hofstra University told me the thing you have to remember about Drexel is that they had no friends on Wall Street, so Drexel is a very long and complicated story, not enough time to get into it, not enough time to get into it, not enough time to get into it, not enough time to get into it, not enough time to get into it, 159 00:18:36.180 --> 00:18:45.180 But in the end, the SEC was the instrument of the hostility of the industry, the public and the Congress. 160 00:18:45.180 --> 00:18:53.180 Now, banning Michael Milken from securities markets for life to protect the average investor 161 00:18:53.180 --> 00:18:57.180 should sound a little far-fetched, I think, to this audience. 162 00:18:57.180 --> 00:19:05.180 But remember, the head of the SEC at the time was very vicious, compared him to a mafia kingpin. 163 00:19:05.180 --> 00:19:16.180 and rationalize their actions against him by referring to the needs and the desires of small investors. 164 00:19:16.180 --> 00:19:22.180 Other lower profile issues the SEC deals with can be ambiguous. 165 00:19:22.180 --> 00:19:30.180 Earlier this year the floor traders were in trouble and I can't remember... 166 00:19:30.180 --> 00:19:42.180 The floor traders were in trouble. They charged a commission to their customers. Depending on the way the commission is structured, it can resemble profit sharing. 167 00:19:42.180 --> 00:19:53.180 That can bias the floor trader's decision on who to deal with and slide down the slope here. Commissions begin to look like bribery. 168 00:19:53.180 --> 00:19:57.180 This seems to be a common pattern in SEC enforcement. 169 00:19:57.180 --> 00:20:04.180 Traders and others become the victim of a new law applied to a conventional or aggressive practice. 170 00:20:04.180 --> 00:20:08.180 I'm going to go a little out on a limb here. 171 00:20:08.180 --> 00:20:15.180 There's some things I don't quite understand about the member exchange system, but I want to throw this out. 172 00:20:15.180 --> 00:20:18.180 Maybe someone can let me know. 173 00:20:18.180 --> 00:20:26.580 Well, traders who show utter indifference toward clients who basically act like computers showing no favoritism, 174 00:20:26.580 --> 00:20:31.980 that seems to me like a way of widening participation. 175 00:20:31.980 --> 00:20:43.780 My point here is simply to throw out a subtle case where the marketing effect of this SEC action against the floor traders 176 00:20:43.780 --> 00:20:48.780 is what is operative rather than the protections offered to investors. 177 00:20:50.780 --> 00:20:58.780 I want someone to explain to me why a floor trader cannot or should not distinguish between a good customer and a bad customer. 178 00:20:58.780 --> 00:21:02.780 Every other agent develops good relations. 179 00:21:02.780 --> 00:21:11.780 Why should new low-volume customers get the identical treatment of older, more reliable, high-volume customers? 180 00:21:11.780 --> 00:21:18.780 Customer relations seem to be a fact of life. Why not just let the new customers know the score? 181 00:21:18.780 --> 00:21:22.780 Again, correct me if I'm wrong on this interpretation. 182 00:21:22.780 --> 00:21:27.780 So also over the last year, there's been talk of regulation of electronic trading. 183 00:21:27.780 --> 00:21:34.780 One of the key features of electronic trading is that counterparties can simply bypass the member exchanges 184 00:21:34.780 --> 00:21:37.780 and trade anonymously and in large volume. 185 00:21:37.780 --> 00:21:45.780 Member exchanges fear disintermediation, which is just a big word for the money going someplace else. 186 00:21:45.780 --> 00:21:55.780 In the interest of market transparency, the SEC wants electronic exchanges to reveal information, 187 00:21:55.780 --> 00:21:59.780 but institutional investors do not want their positions known. 188 00:21:59.780 --> 00:22:05.780 That disclosure rule would push institutional investors back to the member exchanges or the phones 189 00:22:05.780 --> 00:22:12.780 The law that invokes the gospel of transparency. We want to furnish the public with the full size of the best buy and sell orders, denying the reality of the power of institutional investors and their ability to get what they want. 190 00:22:35.780 --> 00:22:46.780 The rule here clearly squashes electronic exchanges and benefits an SEC constituent, namely the member exchange. 191 00:22:46.780 --> 00:22:55.780 The market is not made better by regulation that promises protection, but more often lures the unwary. 192 00:22:55.780 --> 00:23:00.780 The fears of the little guy are not answered, but hijacked for special interests. 193 00:23:00.780 --> 00:23:05.780 These examples that I've just gone over show that the member exchanges benefit, 194 00:23:05.780 --> 00:23:10.780 the connected investment banks benefit, and the Congress benefits. 195 00:23:10.780 --> 00:23:16.780 It's a matter of the pork barrel politics that serves special interests. 196 00:23:16.780 --> 00:23:24.780 It's not clear that overall that reasonable investors or the amorphous investment community 197 00:23:24.780 --> 00:23:33.780 are better off by banning electronic exchanges, banning selective disclosure, banning floor traders with customer relations 198 00:23:33.780 --> 00:23:37.780 and banning or eliminating an investment bank like Drexel. 199 00:23:37.780 --> 00:23:43.780 One thing is clear that after these regulations that the money does flow. 200 00:23:43.780 --> 00:23:50.780 The stock exchange, the stock market makers and the investment bank trading units benefit from trading 201 00:23:50.780 --> 00:23:58.780 The more that trading is perceived to be fair, the more the general public will trade in stocks. That much is easy to understand. 202 00:23:58.780 --> 00:24:14.780 What is more complicated for the public to get is that fraud is defined not in the context of property rights, but in reference to the economic policy of wide, deep, liquid securities markets. 203 00:24:14.780 --> 00:24:18.780 If you violate that policy, you've committed fraud. 204 00:24:18.780 --> 00:24:25.780 The SEC and the member exchanges define healthy markets in a special way that serves their interests. 205 00:24:25.780 --> 00:24:33.780 They have the right to attract wide participation in the stock market and ensure its continuance by voluntary means. 206 00:24:33.780 --> 00:24:38.780 But wide participation is not the standard for evaluating the market. 207 00:24:38.780 --> 00:24:45.780 Markets with less participation are not imperfect, they're not inferior, they're not in need of correction. 208 00:24:45.780 --> 00:25:00.780 The member exchanges do not have the right to create or hijack an agency, especially an agency with extraordinary power to find and eradicate unpalatable conduct. 209 00:25:00.780 --> 00:25:07.780 No market can live up to the level of perfection demanded by the SEC. 210 00:25:07.780 --> 00:25:15.780 To create a false perception of fairness in order to attract capital is a public disservice. 211 00:25:15.780 --> 00:25:27.780 One foundation stone of a credit structure supported by, in Jim Grant's words, this suspension of disbelief. 212 00:25:27.780 --> 00:25:39.780 The alleged benefits of investor protection looked at in this light I think are far more sinister than the average investor realizes. 213 00:25:39.780 --> 00:25:48.780 And that's the end of my main remarks and I have a few minutes and I'd be willing to take a question or two, 214 00:25:48.780 --> 00:26:03.780 I don't want to be too long a question or two, but I also want to just throw out a couple of questions, a pop quiz for amateur stock market historians, just to see if anybody in the room knows this. 215 00:26:03.780 --> 00:26:08.780 So if you have a real pressing question, please interrupt me. 216 00:26:08.780 --> 00:26:13.780 I've got about five minutes. 217 00:26:13.780 --> 00:26:21.480 One obvious question is how the SEC started, what was the experience in the 20s and 30s, 218 00:26:21.480 --> 00:26:29.980 and what did the Congress really intend at the time, did the agency start out of hand, did it get out of hand, what happened? 219 00:26:29.980 --> 00:26:38.780 Were they answering the problems of speculation, fraud, how much fraud was there really? 220 00:26:38.780 --> 00:26:42.140 So let me throw out these questions to you. 221 00:26:42.140 --> 00:26:46.500 Does anyone know, excuse me, does anyone know 222 00:26:49.860 --> 00:26:53.140 what the widest held securities in the world were in the 20s? 223 00:26:54.020 --> 00:26:57.660 And in particular in the U.S. at the beginning of 1929. 224 00:27:00.100 --> 00:27:02.580 These were very popular, let me give you a couple of hints. 225 00:27:02.580 --> 00:27:04.380 They were wildly popular securities 226 00:27:04.380 --> 00:27:07.300 held by the most prestigious universities 227 00:27:07.300 --> 00:27:10.300 and investment banks and the stock investing public. 228 00:27:10.300 --> 00:27:13.100 Some also came in a novel form. 229 00:27:13.100 --> 00:27:18.300 These were the first B-share, class B securities. 230 00:27:20.300 --> 00:27:26.300 And it was a worldwide conglomerate, had lots of different interests. 231 00:27:26.300 --> 00:27:32.300 And as a foreign stock, think on that for a second. 232 00:27:32.300 --> 00:27:33.300 Let me go to the next question. 233 00:27:33.300 --> 00:27:40.100 Question. Does anyone know who was on the cover of Time magazine when the market crashed in 29? 234 00:27:40.100 --> 00:27:48.100 Was it a figure of hope, anguish, irony? 235 00:27:48.100 --> 00:27:52.580 In the few years that followed the crash and the real pain of the depression started appearing, 236 00:27:52.580 --> 00:27:59.940 the blame was directed toward speculators. The causes of the crash were not understood 237 00:27:59.940 --> 00:28:07.620 and speculators were the first targets of public outrage, but that actually subsided. 238 00:28:07.620 --> 00:28:14.620 Why did it take almost four years, October of 1929 to May of 1933, 239 00:28:14.620 --> 00:28:18.300 for the Securities Act of 1933 to be signed into law? 240 00:28:18.300 --> 00:28:19.900 What was Congress doing all that time? 241 00:28:19.900 --> 00:28:26.060 Securities laws had been on the back burner since 1918 in the Wilson administration, 242 00:28:26.060 --> 00:28:28.580 so it's very curious. 243 00:28:28.580 --> 00:28:46.580 So anyone has or to guess about what the wide securities were, who was on the cover of time, why the Congress reacted finally in 1933, no one knows. 244 00:28:46.580 --> 00:28:57.080 Well, I'll tell you, it was Kruger and Toll Securities, Ivar Kruger, the famous match king, Swedish match king, was on the cover of time that week. 245 00:28:57.080 --> 00:29:03.280 and in 1932 he committed suicide or was shot depending on who you believe 246 00:29:03.280 --> 00:29:10.580 and for the year before the Securities Act there were 300 articles in the New York Times 247 00:29:10.580 --> 00:29:16.680 on Ivor Kruger, on his empire collapsing, there were five books written about him 248 00:29:16.680 --> 00:29:23.080 and testimony before Congress, the Congressional Committee put out a report called 249 00:29:23.080 --> 00:29:37.880 Stock Exchange Practices in 1933 and 250 pages of it were devoted to the Kruger scandal and so the question is did he commit a fraud? 250 00:29:37.880 --> 00:29:42.880 Well I guess you're just going to have to come back next year and find out. 251 00:29:42.880 --> 00:30:06.880 I have a question. I was hoping you would talk to me about this. Could you give me a few words about how you came to this and how you came up with the contract for this? 252 00:30:12.880 --> 00:30:17.880 In his book, Economics and the Public Welfare, where he talks about, I think it was U.S. Steel, 253 00:30:17.880 --> 00:30:28.880 stocks getting, their stock was getting hammered for one reason or another, 254 00:30:28.880 --> 00:30:37.880 and they wanted to convey to the public that there was no reason to be worried about the condition of their company, 255 00:30:37.880 --> 00:30:53.880 and instead of saying that, they went out and said, we have a lot of confidence in our company, we personally are going to take on more risk, we're going to buy more stock, we're going to buy stock and put it in our own personal portfolios. 256 00:30:53.880 --> 00:31:14.880 And so that's the classic kind of example where they signal the outside participants in the stock market that they are confident in the future earnings of the company 257 00:31:14.880 --> 00:31:20.880 and they buy stock following waves of pessimism. 258 00:31:20.880 --> 00:31:24.880 I think that's a perfectly legitimate thing to do. 259 00:31:24.880 --> 00:31:39.780 ______________________________________________________________ 260 00:31:40.180 --> 00:31:49.980 Well, right, I mean there are times when there is such a thing as illegal, unauthorized insight trading, 261 00:31:49.980 --> 00:31:55.980 I don't know if I'm an executive and I've got an offshore account and I'm secretly buying up shares. 262 00:31:55.980 --> 00:31:58.980 I'm basically stealing company property. 263 00:31:58.980 --> 00:32:06.980 I'm not saying that there aren't serious cases where insider trading shouldn't be punished. 264 00:32:06.980 --> 00:32:10.980 I'm just saying that there are times when it's appropriate. 265 00:32:10.980 --> 00:32:25.980 The SEC has a very, very broad brush and they will go after it in a lot of different ways whether or not it makes economic sense, as in my first example. 266 00:32:25.980 --> 00:32:32.980 That to me makes perfectly good economic sense and if they go after something like that, they shouldn't. 267 00:32:32.980 --> 00:32:47.980 There are other examples where they've gone after people, you know, arbitrageurs, Ivan Boesky, people like that, and tried to hook them for insider trading when it didn't really even apply. 268 00:32:47.980 --> 00:32:50.980 yes 269 00:33:17.980 --> 00:33:24.980 The idea that if you are advantaged in any way, whether you have a fiduciary duty to the company, if you can move the market in mysterious ways, if you can upset it, you've violated this policy. 270 00:33:47.980 --> 00:34:03.980 The policy of having a wide deep liquid securities market because you undermine confidence and so they're willing to go after anybody who say overhears a couple of lawyers in a bar talking about the merger offer next week. 271 00:34:03.980 --> 00:34:09.980 They will go after that person even though that person has happened before. 272 00:34:09.980 --> 00:34:11.980 Yes, Tony. 273 00:34:39.980 --> 00:34:50.620 Yes, some economists would argue that who is it really harming if you're a long-term 274 00:34:50.620 --> 00:34:57.500 holder and insiders are buying up, you know, it's irrelevant to you, if they're buying 275 00:34:57.500 --> 00:35:03.340 up on good information because they think things are going up, if they're selling on 276 00:35:03.340 --> 00:35:07.840 bad information because they think things are going down, if you're in it for the long 277 00:35:07.840 --> 00:35:17.840 I think I just add to those comments that trading by an insider, per se, is not wrong. 278 00:35:17.840 --> 00:35:32.840 I think I just answered those comments that trading by an insider, per se, is not wrong. 279 00:35:32.840 --> 00:35:47.840 This guy or half of Boehm-Garrison's corporation and they want to sell for personal use, or they want to buy and further invest in it, this is a very normal thing to do. 280 00:35:47.840 --> 00:35:48.840 Right. 281 00:35:48.840 --> 00:35:53.840 It's for the basis of some future information. 282 00:35:53.840 --> 00:35:57.840 Right, or it's timed around earnings announcements. 283 00:35:57.840 --> 00:36:21.840 It is persistent, and I think that even if you were able to define it very carefully, it still would persist, it would be throughout the market, always, anyway. 284 00:36:21.840 --> 00:36:29.840 I work for a company, I'm not allowed to inside trade, a week before earnings, a week after earnings, 285 00:36:29.840 --> 00:36:34.840 but I don't know what our earnings announcements are going to do to the stock. 286 00:36:34.840 --> 00:36:39.840 I have no idea how people react to what we're going to say. 287 00:36:39.840 --> 00:36:46.840 It's not clear to me at all, but I'm in 401k plans and stuff like that, and so I can move money around that way, 288 00:36:46.840 --> 00:36:49.840 but those are long-term holdings, and I've got an advantage. 289 00:36:49.840 --> 00:36:55.720 I know a little bit more I know when when to buy and when to when to sell but 290 00:36:55.720 --> 00:37:00.240 that's that's just the nature of the market and take one more question before 291 00:37:00.240 --> 00:37:02.240 for Lunch, Burt? 292 00:37:02.240 --> 00:37:09.240 I want to just give a comment to you about what you think the parents and members of the car are of the period of fraud. 293 00:37:09.240 --> 00:37:14.240 When you talk about what is not, I think you need to look at the big picture. 294 00:37:14.240 --> 00:37:25.240 I want to just give a general outline of what you think those kinds of criminal fraud are in the period of fraud. 295 00:37:25.240 --> 00:37:32.240 Well, remember I was mentioning the... I can't obviously be exhaustive, but let me give you an example. 296 00:37:32.240 --> 00:37:41.240 Well, you know, I'm not a lawyer, so I can't get disbarred for this. 297 00:37:41.240 --> 00:37:54.240 Well, in the case of... I would say the rule of, you know, material misrepresentation is a pretty good principle. 298 00:37:54.240 --> 00:38:03.240 Faking trades, in the case of this floor trading scandal, was actually triggered by a real scandal. 299 00:38:03.240 --> 00:38:09.240 The Oakford Corporation was just giving blank tickets to the floor traders. 300 00:38:09.240 --> 00:38:14.240 The floor traders were just trading on their own account and then going back 301 00:38:14.240 --> 00:38:21.240 and sort of backdating the documents to make it look like the client initiated the trade 302 00:38:21.240 --> 00:38:41.240 Yeah, like I said I'm not a lawyer I don't know the penalties whether double or triple damages or being banished from the securities industry for life. 303 00:38:41.240 --> 00:39:02.240 I'm not sure about the proportional punishments for things like that, but if it's bad, it's bad on some scale, and then you would calibrate the appropriate punishment. 304 00:39:02.240 --> 00:39:10.240 But let me think on that, because I don't know, like I said, material misrepresentation and faking money. 305 00:39:10.240 --> 00:39:23.240 faking, faking trades, things like that. I mean, there are genuine cases of securities frauds and there are subtle and complex securities frauds. 306 00:39:23.240 --> 00:39:37.240 You know, Michael Milken was alleged to have done and still is alleged to have done by many people a very subtle form of securities fraud. 307 00:39:37.240 --> 00:39:40.240 So, one more, last one, I'm hungry. 308 00:39:59.240 --> 00:40:02.240 Are you talking about silicon graphics? 309 00:40:02.240 --> 00:40:04.240 Compact, okay. 310 00:40:04.240 --> 00:40:34.240 I'm not familiar with the Compaq case but it sounds almost like the silicon graphics where the silicon graphics executives were actually putting out really positive reports for months and months at the same time they were getting internal reports about how sales were down so they were actually putting out disinformation it's one thing so you can say okay if they just kept silent and not said anything and 311 00:40:34.240 --> 00:40:38.880 did not answer questions from analysts and analysts would say we think there's something 312 00:40:38.880 --> 00:40:44.240 rotten in Denmark here, so we can't recommend the stock, they're not telling us the truth, 313 00:40:44.240 --> 00:40:50.080 but the fact that the Silicon Graphics executives actually gave out this information about how 314 00:40:50.080 --> 00:40:56.360 rosy things were going to be, I think there's a genuine case of, and at the same time we're 315 00:40:56.360 --> 00:41:04.160 selling their stock, I think that the crime is only one part insider trading, I mean what 316 00:41:04.160 --> 00:41:11.880 What they did was give out disinformation in order to sell their stock at a good price 317 00:41:11.880 --> 00:41:16.000 before it was going to go down, when they put out other information. 318 00:41:16.000 --> 00:41:20.080 So I think that would, you know, if I were an attorney and I were suing someone on the 319 00:41:20.080 --> 00:41:26.720 basis of that, a reasonable lawsuit I would think would say you were putting out disinformation, 320 00:41:26.720 --> 00:41:29.240 putting out one thing doing another. 321 00:41:29.240 --> 00:41:31.240 Thanks.