Noisy Code Of Silence

Chapter Two A Noisy Code of Silence

Americans pay sincere homage to free speech as few other nations ever have. They feel its vital importance to their way of life deep down to their bones. And they are justifiably proud that such freedom is not only enshrined in the Constitution, but widely practiced as well. In this land of free speech, securities investment is one of the most discussed and written about topics. There is, to say the least, intense competition in the field. Thousands of firms compete for every investment dollar. Numerous newspapers and magazines, cables channels and radio shows, academic tomes and popular pamphlets, evening seminars and business school and Ph.D. programs of a very wide rage of specificity and sophistication are dedicated to the topic. And yet this is one of the relatively few areas of public discourse where the unobtrusive hand of censorship or, if that word bothers you, a code of silence, exerts its strongest hold. Most readers will find this sentence controversial, if not downright nonsensical. The code of silence one sees in the financial arena is very loud and noisy and a very American form of silence and censorship. Skeptics are permitted to cry wolf as much as they want. Their books and articles are published, and they even manage to get onto the major broadcast media once in a while. But their numbers are far, far fewer than those of cheerleading optimists. Authors and publishing houses have always found it lucrative to cater to the acquisitive instincts of human beings. There is much greater demand for optimistic, how-

to-get-rich-quick-and-painlessly books, than there is for the cautionary tales of the “nay saying nabobs” who do not offer easy hope. There is no better example as popular books that made the New York Times bestseller list in the 1990’s. Books like “9 Steps to Financial Freedom” by Susan Orman, where the advice is based on emotional and spiritual steps one needs to take to accomplish financial freedom, and where concrete advice, like most other financial specialists contains a few simple steps: Step 1. get out of debt, Step 2. put money equivalent to few months in the saving account and last put monthly money in mutual funds and let the power of compound return and market average rate of return do their magic in ensuring that your money is working for you. Such writers justify their advice to put money in the stock market through mutual funds, IRA, or 401(k) on a “conventional wisdom” on the basis of the power of compound return. Many take as given assumptions such as a 10%stock market rate of return. They tell us over and over that the stock market is the best alternative to the saving account, money market, or bonds. Of course, the 10% rate of return assumption is just a wishful and artbitrary number with no real empirical foundation, but such assumptions repeated over and over have reached the status of conventional wisdom or even an axiom. This “axiom” is appealing as it requires little work from investors. The investor just has to choose a mutual fund or the strongest company in a sector, put his or her money every month, an presto--PE, Cash Flow, Income Statement, sound business fundamentals etc become secondary because in the long run the market rate of return is 10%

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History and facts do not support such an “axiom”. In fact, between 1831 and 1861 the stock market underperformed bonds. Since 1861, the market hascompleted only for 30 years cycles. Four cycles is too few to make a valid inference on the stock market performance. If you throw a coin 4 times and it is head 3 times, you cannot conclude from such observation that likelihood of heads is 3/4. The reality is that both events—head and tail—are equally likely. Stock market statistical model is infinitely more complicated than throwing a coin. Table 1. Current and High Values of the Major Market Indices

Dow Jones SP500 Nasdaq

Date of Highs in 2000 th January 14 th March 9 th March 24

Highs in 2000 11,723 1,527 5,048

As of October 2005 10407 1198 2,090

Percent Change -11.23% -21.54% -58.61%

Even though the stock market is not that old you can still find extended periods where it barely performed and even underperformed. After the stock market peaked in 1926, and 1966, it underperformed short-term interest rate for 10years. In the seventies, inflation averaged 8.3% a year, and the total return from equities, even after reinvesting dividends, was just 5.8%--on average investors lost 2.5% a year during this period.1. It is true that when examined over 20 year periods one can find only one period 1901 to 1921 where the market underperformed short-term interest rates, but between September 1929 and 1949 the real rate, i.e. the rate after inflation, of return was 0.4%, and for the period 1966 to 1986 it was only 1.9%2. Unfortunately, since its peak in 2000, the stock market as of 2005 has still not reached its previous peak. Dow is still 11.23% lower than its

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high, S&P500 index is still -21.54% lower than its high, and Nasdaq index is still 58.61% (Table 1) Hence, the supposedly convention wisdom that the stock market will give you with certainty a solid rate a return in the long run is a fallacy, even if the financial media, investment houses, and brokerage firms want to make you believe otherwise. Unfortunately, a lot of individual investors are not aware of this, and invest without doing adequate due diligence. They hear about a litany of new baseless “paradigms” and interpret them as proven theorem, and no one, especially not the financial media is going to dampen belief.The financial media have a strong interest in the game continuing undisturbed and have no incentive to pick up on cautionary tales, especially in bull markets like the one we have witnessed in the 90’s, and which was based largely on phantom revenues. There is no compelling incentive for them to seriously dull the enthusiasm of individual investors for the markets and their resulting hunger for investment advice. As more and more of individual investors rely on the stock market performances for their retirement—through IRA, and 401(k); (as of 2004, $3.00 of every $4.00 put aside for retirement went to 401(k)or IRA)3 In fact, in 2004, individual investors have invested more than $2.1 trillion in their 401(k), and $3.4 trillion in their IRA.The trillions of dollars that come into play predispose the tight relation between the financial community and the press to become even closer. Sometimes the influence of money managers on the press is starkly illustrated, such as in the case of Fidelity Capital which not only owns the popular financial magazine, Worth, but 117 newspapers in its home region as well. At other times the links are more subtle: through advertising

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budgets, influence on publishers and editors, and control over primary sources of information that the media rely on. The market cheerleaders get disproportionately more air time than the skeptics. Pessimism is frowned upon on Wall Street, in the field of investments as a whole, and among the canons of capitalism. They are all based on optimism, optimism that things will go, or you can make them go--in the direction you think they will within a time horizon that is relevant to you--or the optimism that the market always recovers from a downturn. Financial media did extremely well during the nineties bull market when optimism was at its peak. Kiplinger’s saw its ad revenues up by 19% in one year, Smart Money by more than 30%, Worth by 35%. Even the laggard Money magazine was up by 5%, a respectable growth rate in many other fields of publication4.

The financial

information provider Reuters’ stock was up 800% in the space of a decade beginning in the mid 1980s. On the other hand, the effects of down markets and a bearish climate can be devastating for the financial media. The Wall Street Journal saw its financial advertising revenue, which constituted almost one third of its total, and declining, advertising revenue, almost dry up in the aftermath of the crash of 1987. The Journal’s total ad revenues in 1987 were down by $85 million (to $325 million) from the previous years5. Similar effects appeared in 2001 with the demise of Silicon Alley, and Industry Standard, as well as thinning out of early venture capital rags such as Red Herring. The financial services companies have made two important changes in advertising in recent years. First, they increased advertising budgets. In 1990 and 1995 these

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companies spent $1.1 billion, and $1.6billion, respectively, on advertising in all media. By the end of 1996 financial companies rate of advertising spending was estimated at up to $1.8 billion. These companies recuperate these expenses from fees and commissions that they impose on their clients—individual investors. From a survey conducted by Investment Company Institute in July 2003, 53.3 million households own mutual funds, and of those 70% have income higher than $50,000.6 Second, to reflect the new reality that more companies have been moving retirement risks to their employees through 401(k), they have shifted their advertising from financial professionals (advisers and brokers) to the consumers. In the process the financial services industry’s advertising campaigns have begun to look like those of mass consumer marketers with talk of brand identification and brand loyalty. Ads that taps on consumers emotions are aimed at getting the well tested message across to the consumers that they must use the advertised product to keep or attract love (“Love is expensive” said a Merrill Lynch ad) or face dire consequences (“Where in the food chain would you like to fit in?” asked Dreyfus as the image of a lion grabs your attention; “Time is running out” implied Fidelity as images of clocks impress themselves on your retina and an old rock tune Time Has Come To drums into your ear and reminds you - particularly if you are an aging baby boomer - that your time is running out). The investment houses 1995 advertising budgets tell us all we need to know about their perceived necessity and importance in his brave new world of consumer finance: Merrill Lynch: $61 million; Fidelity: $5 million; Dean Witter: $22 million; Dreyfus: $15 million. Smith Barney: $11 million. Such spending was worth it, by 1995,

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Fidelity Magellan, the largest equity fund, received 87% of fresh money for its retirement funds.7 From the amount of money they spend on marketing it is evident that financial giants are urgently trying to impress upon the consuming public. They have seen the handwriting on the wall. They know Americans don’t trust Wall Street, especially after the Technology Bubble debacle. So, most financial services companies emphasize trust and dependability in their advertisements, not specific funds or products. This, according to Kevin Allen, Senior Vice President of the prominent ad-agency McCann-Erickson8 There is empirical evidence that consumers (which is what retail investors really are: consumers of financial services and advice) are being subjected to hype and even fraudulent advertising. A detailed empirical review of the evidence would be outside the scope and patience of a book like this. The following is what one ad actually reads: “You would have turned $10,000 into $ 39,160,394 since 1980 by using Dr. Stephen Leeb’s Master Key.” The ad fails to mention that the returns were notional returns calculated based on historical market moves that were analyzed after the fact--wth 20/20 hindsight that is. 9Some of you must have heard the radio ads for seasonal investment products, like the ones that claim that every year the price of heating oil goes up from August to February and that there is an 85% chance of making money, sometimes up to several times the amount of the original investment, using futures and options on heating oil. As convincing as it is, the truth, according to regulators, is that 75% of investors drawn in by these ads lose money10 you won’t hear any mention of that in the ads.

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What’s important is that inflated claims are not the exception. “That’s the thing it’s very important for investors to be aware of: They should know that exaggeration has now become the norm for most advertisers” says Mark Hulbert whose newsletter, the Hulbert Financial Digest, analyzes and reports on what other financial newsletters say and claim.11 David Weiss, the president of the Better Business Bureau of Cleveland (an organization that knows a thing or two about detecting exaggerations, frauds, and scams perpetrated on the public) has most succinctly summarized the situation. This is what he had to say during a panel discussion on Financial and Investment Advertising at a national conference sponsored by the Federal Trade Commission, the Food and Drug Administration, the National Association of Attorneys General, and the American Association of Advertising Agencies on the subject of financial advertising: “I have seen an awful lot of ads running in all of the media that are clear indications that dollars sometimes speak louder than ethics when it comes to advertising acceptance.12 And no amount of endorsements, from no matter how distinguished a source, let alone paid actors, should provide you any comfort. In a Barrons’ article Tyco’s CEO Dennis Kozlowski was hailed as the next Jack Welch.

In 2005, he was found guilty of fraud and sent to prison.13 Early 2002, few

months before fraud disclosure, Mr Ebbers, ex-CEO of WorldCom, painted a rosy picture for his company at an interview on CNBC. He said: “We have been a sound financial company. We have been very conservative in our accounting.” He added that the dividend the company was paying on its MCI group tracking stock wasn’t in any danger.

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However, such statements were untrue as 2 weeks earlier the ex-CFO of WorldCom Mr. Sullivan had told him that the dividend was at risk. Advertisements can at least be approached and evaluated on their own terms. More disturbing are the multitude of tips and stories in the media that are no more than industry press releases. Tips are planted by companies, and one must never forget that even respectable analysts have their salaries paid by securities firms that often have a direct interest in the pushing out to the public stocks that they have underwritten. Regrettably many analysts’ reports are in the end little more than disguised advertisements.During the bull market in the 1990’s while some analysts at Merrill Lynch were praising to investors the companies they were following, they were sending internal emails recommending Merrill Lynch to unload its holding of these companies14. Mr. James Grant in his July 19, 1999 Financial Times article “Talking Up the Market” summarized the nineties security research as follows: “Honesty was never a profit center on Wall Street, but the brokers used to keep up appearances. Now they have stopped pretending. More than ever, securities research, as it is called, is a branch of sales investors beware” What better example than Enron, the seventh largest energy company in the world: one month before it declared bankruptcy, 16 out of 18 analysts rated it a “buy”. During 1983 according to Zacks Investement Research, analysts issued 24.5% “buys”, 48.7% “holds” and 26.8% “sells” recommendations. By 1999 according to Zacks Investement Research some 6000 companies’ analysts rated only 1.0% “sells” while they rated 69.5% as “buys” and 29.9% as “holds”15. In fact, at the height of the 1990’s bull market less than 1% of analysts reports recommended investors to sell stock despite serious allegations of accounting irregularities and overpriced stocks.16 They

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justified their recommendation on the “new economy” paradigm—companies do not have to make money they just need to have a flashy name and dot com after the name. To name few star analysts whose research harmed investors during the techbubble are: Mary Meeker, Henry Blodget, and Jack Grubman. Ms Meeker, who became an analyst at Morgan Stanley in 1995, is famous for 300-page optimistic report about the internet. She had no problem recommending AOL, Ascend Com, Cascade Com, Cisco System, Intuit, and in the process helped Morgan Stanley rise cash for these companies either through IPO or secondary offerings1. It appears not to have mattered that some of these companies had weak financial statement, and an unproven business model. By 2003, SEC had fined, and banned both Henry Bloget and Jack Grubman from the financial industry. Both of these men were star analysts during the Tech-Bubble. Henry Blodget while at CIBC Oppenheimer in 1998 stated that Amazon.com stock price will reach $400.00; how he reached to this number, only he knows. Mr. Blodget spent more time courting companies to attract corporation finance business than in analyzing the companies. His goal was to generate money for his institution and himself. In fact, from 1999 and 2000 his compensation quadrupled from $3 million to $12 million per year.17 Finally, Jack Grubman, who was a star analyst for Citigroup’s Salmon was aggressively promoting Global Crossing and WorldCom Inc. until just a month before they filed for Chapter 11.

Their respective companies appear to have known that their

recommendations were questionable, but still supported them, the money they were generating was too important to have more penetrating analyses and to let the public know about evaluations and recommendations, that would let these stocks price go to 1

M. Mahar, “BULL!”, pp. 101

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their fair, and hence much lower, value.

It is not only in broadcasting and magazines

where a marked faintness of the critics’ voice can be observed. It is surprisingly true of books as well, an arena where there should be more time to reflect and report on some obvious and troublesome patterns. Books on frauds are few and mostly written for a small audience of specialists. You would think that after Enron, Waste Management, Boston Chicken, WorldCom, etc. more books will be written about financial shenanigans.

We decided to search

Amazon.com website to find out how many books have been published since the Bubble bust.

We searched for books published in or after 2002 using keywords “Finance

Shenanigans” and “Financial Fraud”. As suspected, we found in total only 20 books: 15 of them expensive and written for security professionals. Out of the five left, one of the books written for the larger public which is a very good one: “Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports” by Howard Schilit is in its second edition. The peculiar fact is none of these books made the New York Times Best-seller list—implying that either the public has total faith on the equity markets fairness, does not care, is not aware, or is in denial and does not want to know. The very one sided nature of information is the first and perhaps most important of the very un-leveling aspects of this particular playing field. The exception to this is when things get out of hand (as in the Enron, S&L Crisis, or the Orange County California Scandal). However, even in these instances a strong case can be made that the financial press have failed miserably in adequately discharging their duty to inform and warn the public. Even though the numbers of such “headline” stories are not few, the right lessons are not widely drawn from them. They are usually

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stories of “big” investors. The eventual fate of those involved even gives the public a perverse sense of satisfaction that the rascals are being caught, the watchdogs are vigilant, and everything is going to be all right again. The media spot light has a purging and reassuring effect in all but the most extreme of these cases. What happens, day in and day out, to individual investors, usually well within the boundary of the law, does not merit mention because it is business as usual and a very lucrative business as usual at that. This talk of censorship and a code of silence, or more precisely, of the truth getting lost in the hype and the babble is not fantasy. There are real testimonials to it by very credible individuals. No less an authority on money and economics than Harvard Professor John Kenneth Galbraith is one prominent witness to this censorship. In his invaluable little book (or long essay) entitled A Short History of Financial Euphoria18 he relates two personal experiences that are instructive on this matter. The first one occurred in 1955 when he testified before the Senate Banking and Currency Committee at a hearing called to consider a modest speculative build up on the market. Galbraith did not predict a crash in those hearings, limiting himself to a reminder of the Crash of ’29, and calling for an increase in margin requirements on the purchase of stocks. The market fell considerably during his testimony whether because the whole country knew and listened to him, or because Wall Street had implicit faith in his infallible judgment or, as is more likely, because a correction was due. The good professor was subjected to some very democratic hounding by loads of letters condemning his remarks, offering prayers for his demise and even threatening him with death.19

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The second incident was milder and more “civilized” but significantly more disturbing in that it showed the institutional censorship in stark fashion. In the autumn of 1986 the New York Times requested Professor Galbraith to write an article on the financial and speculative fever gripping the country in the Reagan years. He complied and predicted (quite correctly as it turned out) that the markets were in a classically euphoric mood and that a crash was inevitable. This was more in the nature of pointing out systemic problems of the market rather than simply offering a bearish forecast. The Times editors refused to print the article they had requested in the first place because in their view it was too alarming. Another publication with a much more limited influence, the Atlantic, published the article early in 1987. The response to the article and a subsequent interview on the topic with the Times were classic example of what we have called censorship American style. The reviews of his article were “both sparse and unfavorable”, and he was accused of not liking to see people make money. A few months later, Black Monday occurred and suddenly almost everyone Professor Galbraith met told him they had read and admired the article.20 In 1998, Christopher Byron a writer of a syndicated column called Observer had his column syndicated to the Go2Net Network, San Francisco Web operation that owned the “Silicon Investor” site. When Go2Net Network went public, Mr. Byron decided to study its financial statement.

His findings brought him to conclude Go2Net was

worthless and overvalued. When he published he conclusions in his column, Go2Net ordered him to retract his statements; when he refused his contract was canceled.21 In

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October 2000, Go2Net merged with InfoSpace a cross-platform merchant and consumer infrastructure services on wireless and other platforms. Go2Net was not the first company about which Byron had warned his readers in. In 1996, he wrote that Boston Chicken, a publicly traded fast-food chain, “basically boils down to a clever new way to lose money” and its fate is bankruptcy. He advised his readers to take out a second mortgage and short Boston Chicken stock. Boston Chicken officials demanded that the Observer retract the story, which the Observer declined. Two years later Boston Chicken filed for bankruptcy and closed 16% of its restaurants. In 1997, he wrote about Livent, a publicly traded movie-theater. He showed his readers that the company’s costs were growing faster than its revenues. The founder Grath Drabinsky threatened to sue the Observer. Subsequently, Livent declared bankruptcy in 1998, and federal persecutors charged Drabinsky with hiding more than $60 million.22 It is not only the professor and other financial outsiders who are subjected to a ruthless and effective code of silence and censorship. Individuals at the very pinnacle of the financial hierarchy are also not immune. In fact these captains of finance will be hounded with even greater vengeance should they ever threaten the common meal ticket. Galbraith relates the fate of two leading men of finance, one a practitioner and the other an academic, at the very top of their careers to illustrate the consequences of challenging the “vested interest in error that accompanies speculative euphoria”. He illustrates how “speculation buys up, in a very practical way, the intelligence of those involved”, and how the personal interest in the euphoric belief of further riches and the pressure of public opinion and “superior” financial opinion is brought to bear against individuals who question the mass credulity that is there for every one to observe if they

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would only open their eyes.23 The first is the story of what happened to Paul M. Warburg, a founder of the Federal Reserve System and the leading banker of his time. All Mr. Warburg had to do early in 1929 was to speak critically of the “unrestrained speculation” gripping the markets, and warn of a collapse and economic depression if this speculation continued. The reaction of other bankers and financiers to this sensible and, in hindsight prescient, warning was swift and brutal. This most respected banker of his time was subjected to malicious attacks; everything from being accused of talking his own short book and sandbagging American prosperity, to anti-Semitic attacks were hurled at him. A few months later, in September 1929, just before the Great Crash one of the leading market theorists of the time, the prominent economist and market observer Roger Babson, made the same predictions (a market crash and “serious business depression”). Attacks on him were even more vicious and personal. The financial press, Wall Street, and academia all went for the jugular. Barron’s declared him “notoriously inaccurate” and not to be taken seriously. The great investment house Hornblower and Weeks warned its clients not to be “stampeded” by this “gratuitous forecast”. And, for good measure, the leading economist of the day Professor Irving Fisher of Yale, put the figurative last nail in the coffin, pronouncing his strong disagreement with Babson’s prediction.24 The reigning professional, academic, and public sentiment was well summed up by Joseph Stagg Lawrence of Princeton; “The consensus of judgment of the millions whose valuations function on that admirable market, the Stock Exchange, is that stocks are not at present overvalued....Where is that group of men with the all-embracing wisdom which will entitle them to veto the judgment of this intelligent multitude?”25.

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Who can argue with democracy, the market, and expert financial and academic opinion, not to mention mass euphoria and greed, all at the same time? The lesson, repeated many more times over the decades since, has not been lost on potential dissidents. This censorship is not limited to the individual. There is ample history to show that it very much has been practiced at the institutional level as well and that even the country’s highest financial authority, its central bank, is not immune from it. The First Bank of the United States, which was the country’s first central bank and which was created to impose a degree of financial discipline on the state chartered banks that were issuing paper money, and which made the mistake of taking its mandate seriously, was subject to an ultimate silencing campaign: in 1810 its charter was not renewed! Wiser heads prevailed though and the country realized the need for a central bank and so the Second Bank of the United States was formed in 1816 to carry out its required central banking duties. That bank initially joined in feeding the post war boom that began in 1812 and it extended many real estate loans. It also began discharging its other duties including calling on the regional banks to make payments on their notes. When the boom ended (as all booms eventually must) instead of blaming the speculators for creating an unsustainable bubble, those very speculators, along with the public, and even President Andrew Jackson, blamed the central bank and its regulatory efforts for the end of the boom and the bust that followed. As a result, and for the second time, the central bank of the United States was subject to the ultimate censorship. Its charter was not renewed and it was totally silenced.26

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It would nearly be one hundred years before the cautionary voice of a new central bank would be heard again in the United States. Maybe not so incidentally, though little publicized—the fact that the current central bank of the United States—the Federal Reserve, is not owned by the U.S. Government or some other representative of the people of the United States; It is owned by the country’s banks! In the words of the late Chairman of the House Banking Committee, Texas Representative Wright Patman “…constitutionally, the Federal Rreserve is a pretty queer duck” ”…a dictatorship on money matters by a bankers club”27. Actually, that’s not totally accurate. The Federal Reserve System is owned by the twelve regional Reserve Banks. The presidents of these Reserve Banks share power with the seven governors of the Reserve Board who are appointed by the President. The presidents of the Reserve Banks are elected by nine directors, six of which are chosen by commercial banks. Not a straightforward system, to say the least. Even the Chairman of this largely privately controlled central bank, the presidential appointee Alan Greenspan, is not immune from a huge amount of implicit and sometime explicit pressure to alter and influence what he says. Witness his comments regarding the “irrational exuberance” of the stock market in December 1996 and subsequent cautionary words of early 1997 and the reaction to it, including widespread media criticism bordering on derision, of what was essentially a bold and well justified warning. In short, expressing skeptical views regarding the stock market’s fundamental character and long term prospects (though not necessarily of its short term and intermediate prospects) can be a dangerous, and often fruitless, endeavor that has to be

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contend with the greed of the public and the power of the financial princes. Those who embark on it flirt dangerously with the consequences of having to bear the scarlet letter of an ideological, almost theological, heretic. A good example of the implicit censorship of facts is when, after the crash of 1987, the public was bombarded with advertisements (like the one bearing the signatures of the most reputable individual in the world of finance and industry including former secretaries of treasury and chief executives of major corporations), and studies by the New York stock exchange, the SEC, and a specially appointed Presidential Task force (a la the Warren Commission) chaired by Nicholas Brady28 all of which tried to shift the blame away from the market’s inherent speculative nature to such things as computer selling, and budget deficit. The underlying mechanism were not, as indeed they could not, be examined or challenged. To do so would raise a storm of financial McCarthyism. History repeated itself in 2001, where the blame for the crash was put on few accounting frauds, overcapacity build up of fiber optics by telecom companies, and the terrorist attack on 9/11. It is the bankruptcy of Enron, a $110 billion in revenues a year company, that prompted the SEC, in 2002, to take action which resulted in Congress passing Sarbanes-Oxley Act to returning confidence to the investors, whom some of them lost their retirement savings after the bubble burst, and unveiling of accounting frauds committed by some generously paid executives of well respected publicly held companiesWe will come back to the law after we show the effect of hidden important news. However, perhaps the best example of the failure of the media in this age of information to discharge its duty to adequately inform the public on fundamental and

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systemic financial problems, is to look at what happened when the biggest financial scandal of human history met the most influential and powerful financial publication there ever was, and how the latter utterly failed to give the public adequate warning regarding the impending $ 500 billion disaster. If you ask most people who care they would say that the Wall Street Journal played a leading role in covering and exposing history’s greatest financial scandal. The scandal cost to every man, woman, and child in the United States has been almost $2,000 (that’s $2,000 a person). No other financial scandal in history--including Enron, or WorldCom fraud--begins to approach this in magnitude. While in 1983 the tiny (circulation 5,200) Russian River news of California got on trail of the story, the fact is that the Journal published its first two part series on this well concealed, because ill understood, colossus of the scandal in November 1990. Stephen Pizzo, the editor of the News, did his best to interest the Journal in the scandal that was brewing and the scent of which he had picked up from the goings on at his local savings and loan. Pizzo approached the Journal’s San Francisco bureau chief Greg Hill, who happened to be the Wall Street Journal S&L expert, and was rebuffed. So he and two others went on to write a book, Inside Job: The Looting of Americas Savings and Loans29, which led to the scandal being exposed. In the words of Susan Burkhart, writing in the San Francisco Examiner on June 24, 1990 “Three little guys, including an ex-housewife, uncovered one of the great scandals of the century. They scooped the establishment press who were too big and too corporate ever to notice much less expose, what’s been happening across America in the last eight years”30

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Francis X. Dealy, Jr., a former Vice President of Dow Jones and Co. (publisher of the Wall Street Journal) who has written a superb and eye opening book on the Journal31 mentions some truly startling statistics: His review of the Wall Street Journal news index and Dow Jones News Retrieval Systems found no stories about the savings and loan scandal until late 1989 about six years after the crisis was in full swing.32 That’s almost five years after Pizzo brought the story to the Journal’s attention and was rebuffed. During the first three years of the Reagan administration 439 S&Ls failed the highest rate since 1941 (when 13 S&L failures occurred) but the Journal never even ran a first page story on the alarming failure rate (never mind the associated scandal that was brewing) during that time period. The Wall Street Journal also missed the biggest of the S&L stories, the goings on at Charles Keating, Jr.’s Lincoln Savings of Irvine, California. It never ran a leader on California’s Savings and Loan commissioner, Leonard Taggart, who had given the go ahead for two hundred new thrifts, all of which failed in two years or less. It did not run leaders on the politicians who were ultimately responsible for the crisis by championing the deregulation of the industry, the result of which was a lightening change in the number of the S&L and the nature of the business they do. By 1983 there were 4100 S&Ls and only 634 Federal Savings and Loan Insurance Corporation examiners (less than when the S&Ls were fully regulated and had much less possibility for making mischief), who made $14,000 a year on average and were expected to police this brave new world of high stakes deal making.33 The results were almost inevitable and the American public was saddled with on of the biggest fraud bill in human history. The Wall Street Journal, with all its high powered reporters and unparalleled contacts in

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government and the financial world, failed in its duty of informing the public, a duty that if correctly discharged would likely have nipped the scandal in the bud and probably saved the public hundreds of billions of dollars. The Journal’s San Francisco bureau chief Greg Hill, who happened to be the Wall Street Journal S&L expert, and was the very same man who rebuffed Pizzo’s attempt to interest the Journal in the breaking scandal: “No national publication did a good job uncovering the savings and loan scandal. With us, it was a question of territorial imperatives. The balkanized structure of the bureaus didn’t allow for national cooperation and coordination”34. This excuse is less a defense of the Wall Street Journal than an indictment of the national media when it comes to covering the really sensitive issues in the financial markets, and their evident reluctance at antagonizing friends and powerful interests, and breaking the code of loud silence that exists. Was this glaring, and unforgivable, failure a single and exceptional lapse by the Journal. The answer is that, regrettably, it is not. The Journal failed to expose the crimes being committed by the junk bond kings of the 80s, and in particular Michael Milken and Ivan Boetsky, until it was, again, too late. It was Fortune magazine that first picked up the scent of the junk czar’s wrong doings and wrote about them in it August 6, 1984 issue, and Connie Bruck book’s, The Predators Ball,35 and a 1988 cover story by Fortune that widely exposed the crimes that were being perpetrated in the junk bond market. Yet, interestingly, and revealingly, the nature of power and old boys’ networks being what is, the Pulitzer Prize in 1988 went to a Journal reporter, Jim Stewart for two retrospective articles, one on Marty Siegel’s insider dealings (written five months after Siegel had

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turned himself in), and the other on Black Tuesday (written a month after the fact). Both were too late to help investors. Why have these journalistic failures occurred? Is it, as the Journal’s Greg Hill claimed, really just because of a balkanized bureaucratic structure? Writing about former Journal Managing Editor Norman Pearlstine—current editor-in-chief at Time Inc.—and former and present Dow Jones CEO and Wall Street Journal publisher Warren Phillips and Peter Kann, this is what Francis Dealy, Jr. has to say in his book about why these things could have happened at a Wall Street Journal the journalism of which he characterizes as “permissive, celebrity-oriented journalism”: “Unfortunately, throughout the eighties, Pearlstine’s fraternization with Wall Street tycoons, tacitly endorsed by Phillips and Kann, sapped the Journal’s will to investigate and expose business conduct contrary to the public interest.” Others are less charitable. Spy magazine in an article entitled “Pearlstine Before Swine”36 quotes Stephen Schwazman the president and CEO of the elite and highly prestigious investment banking firm, the Blackstone Group, as has having this to say about Pearlstine when he was still running things at the Wall street Journal: “We all know Norm is a star-f…., and the way to get to him is to take him to lunch”. The prominent Wall Street public relations maven, Davis Weinstock, says the same thing in a slightly different fashion: “It is absolutely true, that anyone of public note in the business world can call Pearlstine, either through intermediaries or direct, have dinner with him and, as a result get a Journal story about them either killed, postponed, or ameliorated”.37

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This was the publication that the American public and the non-financial media, too, counted and relied upon to keep them informed of the goings on in the financial world and to act as their watchdog over the greed and power of the money men. Spy magazine indeed sums it up best: “The Wall Street Journal was not a cold observer of the cynicism on Wall Street in the 1980s but part of it”.38 Unfortunately, it was still true during the 1990’s Bull market. It is Fortune magazine, not the Wall Street Journal, that had an article questioning Enron’ business practices. InMarch 2001 issue of Fortune, Bethany McLean wrote an article called “Is Enron Overpriced?” . In there she quoted Chris Wolfe, the equity market strategist at J.P. Morgan private bank: “And the inability to get behind the numbers combined with ever higher expectations for the company may increase the chance of a nasty surprise. Enron is an earning-at-risk story”. She stated that even the quantitatively minded from Wall Street and whose job is to analyze the company for a living did not understand the company’s business model or its financial statements. As Todd Shipman a credit risk analyst at Standard and Poors said: “If you figure it out, let me know”39. This article did not stop 16 out of 17 analysts to recommend Enron as a “Strong Buy” or a “Buy” in October 2001, one month before the company filed for bankruptcy. Little wonder then that the financial media neglected to inform the American public of the biggest fraud that was about to be purported on then. To caveat emptor of stocks one must add caveat reader of financial publications, even the most high brow and prestigious of them. Don’t always believe everything you read. Not in the Journal and

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not in another financial publication, or any place else where human beings and money interact. One might fairly ask at this stage whether the Journal and its management have a monopoly on such shortcomings and failures. This answer is that of course they don’t. According to Bill Kovach curator of the Nieman Foundation at Harvard University, former editor of the Atlanta Journal Constitution, and former bureau chief of the New York Times in Washington: “None of us did a good job monitoring the eighties. Newspapers in this country tended to react to news and events long after that was sufficient” and he goes on to say about the Wall Street Journal: “Because most of us focused on general news, we essentially looked to the Wall Street Journal to help us spot trends in the world of finance and business”(emphasis ours). He faults the Journal with not flagging the S&L and junk bond market developments in a timely fashion. At the end one is left with only one logical conclusion: that the U.S. media failed the U.S. public by not adequately warning them, until in was too late, of two of the biggest financial scandals that affected the pocket books of every family in this country no matter how poor of how rich. Unfortunately, it was still true in the nineties where the Wall Street Journal, and CNBC appraised a stock not on fundamentals or news that may have a impact the company bottom line but on possibility that someone might make a bet the next morning.40The stock of Novell, a computer networking company, jumped 15% after Maria Bartiromo mentioned that Barron’s was going to write an article about the company stating that stock price will quardruple in 5

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years. Dell stock increased by 6% after Ms. Bartiromo said that Dell was expected to make an “upbeat presentation”.41 Editors at other publications have been known to be fired when what they wrote jeopardized the bottom line of their owners. One well knows alleged example is that of the Andrew Neil, the editor of the Sunday Times. Mr. Neil claims in his autobiography, “Full Disclosure”, that after the paper in 1994 published some articles alleging kickbacks to Malaysian government officials by British construction firms he was fired by Rupert Murdoch the media tycoon whose News Corp owns News International PLC which publishes the Sunday Times, because the Malaysians’ displeasure with the article put Mr. Murdoch’s Star TV operations at risk in that country.42

Does this mean that these

publications’ reporting is influenced by non-journalistic considerations? The answer, it seems, is obvious. Even when there is no ill intended on the part of the journalist, the advice is often flawed because of

the journalistic need to write something splashy, something

interesting enough to capture a headline, and that means something atypical and on the extreme (like how somebody fleeced a widow of her life’s savings, or, more often how $1,000 invested in such and such a start up, or commodity, or piece of land could have made you rich, or why you should change your investment strategy because of the latest economic number releasedwhich will probably be forgotten by the time the government prints the final revised number, or before that by another number pointing to a different direction of economic activityor how such and such a thirty something mutual fund manager is so hot the seat of his pants sizzle neglecting to mention that last year’s golden boy or girl is more likely than not doing not much better than average). None of which is

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the right stuff to lay the foundation of your life’s financial strategy on.We don’t mean to say that people in the financial media are any less ethical than the rest of us. Only that they are no better. And they are subject to powerful temptations posed by their privileged position and, not being infallible, some of them succumb to these temptations. Therefore, few bad apples in the media should be enough to make us all be extremely wary, even if most members of the financial media will not violate the letter and the spirit of the law. Here is another example meant to shake any complacency that you may still have regarding people in the media. The example I want to present to you is the case of Earl Brian, Chairman and Chief Executive Officer of the now defunct cable channel, FNN (The Financial News Network). This was one of the new and major sources from which the public was supposed to receive unbiased financial information in this golden age of information of ours. On October 17, 1996 Dr. Earl Brian, the former Secretary of California’s Health and Welfare Agency under Governor Ronald Reagan, was convicted by a federal grand jury on 10 counts of conspiring to cover up the FNN’s true financial situation. Federal prosecutors claimed that Dr. Brian and a colleague had inflated FNN profits by some $50 million over a period from 1988 to 1991 via drafting hundreds of false invoices to help obtain $70 million in bank loans for the network and its parent company. In the process, the federal prosecutors claim, they managed to fool auditors, financial underwriters, and even the Securities and Exchange Commission. The chief financial officer of FNN and its former controller had previously pleaded guilty to conspiracy, bank fraud, and securities fraud.43

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The media link in this fraud case doesn’t end there. FNN was owned by Infotechnology, Inc. The latter also owned controlling interest in the famous wire service United Press International (UPI). The chief financial officer of UPI, Gary Prince, has also pleaded guilty to conspiracy, bank fraud, and securities fraud. These are the people who were supposed to bring you untainted and financially disinterested and objective investment and business reporting. Is it likely that they did? Mark Hains, co-anchore of CNBC’s Squawk Box sums up what the role of the media in propagating financial news in

2001 PBS interview on Media Matters :

“Investors who didn’t understand that the “experts” who appeared on CNBC would be biased were simply “too naive” to be in the game. It never occurred to us that anyone was sitting home, watching this, thinking it was totally unbiased advice.”44 We are not really revealing anything new here. All that we are saying is that the mere fact that a reporter or financial commentator works in the financial media is no guarantee, not even a mild assurance that he or she will rise above being average human beings, subject to average human self-interests and temptations. We must all carefully consider and draw our own conclusions as to whether, financial considerations can affected ethics in general, and journalistic ethics in particular, and then consider whether examples of lapsed journalistic ethic are unique situations the repeat of which is impossible, or whether lapses in the financial ethics of the media is something we should always be concerned about and on guard against. It has been claimed that just prior to the Crash of ’29 nearly every financial journalist was on the take. Even if journalism ethics and/or oversight have improved

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since then, there is still room for a great deal of caution and concern indeed, even when it comes to the most reputable of financial media. Even the purportedly most prestigious and most respectable and solidly and conservatively researched of publication must be read with reasonable degree of caution when it comes to financial matters. A case in point is the Encyclopedia Britannica which declares the Scotsman John Law, who came up with the scheme to make payment on France’s borrowings by selling shares in Louisiana gold mines (gold mines that never existed), the same John Law who fled from a jail he was in on a murder charge, who went to the Continent and lived a life of luxury as a gambler, this very John law who held the title of Duc d’Arkansas (present Arkansas nobility take note), this very swindler, gambler, and murderer is called an honest man and a financial genius in the august encyclopedia45. Don’t trust what you see in print or see on television, or in the lecture hall! It goes without saying that you cannot expect the financial firms themselves to promote a critical view of their operations and an open discussion of their failings. As elsewhere in society whistle-blowers are treated very harshly. One example is the case of Michael Lissack, who was a managing director in Smith Barney’s public finance department. In February 1995 he was fired after he accused the firm of cheating Dade County, Florida out of several million dollars in an interest rate swap transaction. Lissack went on to set up a Web site called “Municipal Bond Scandals” with an area called “The Smith Barney Page”. Smith Barney reacted by threatening him with a lawsuit for trademark infringement because of the manner he used the name of the firm on his Web site. The two sides have also filed multimillion dollar

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lawsuits against each other. A trade mark infringement issue or an attempt to make life difficult for a whistle blower, that’s for the courts to decide, but it is not difficult to surmise the effect on other potential whistle-blowers in the industry that Mr. Lissack’s woes have, irrespective of whether his claims against Smith Barney have any merit or not. James Chanos, an analyst who gave sell recommendation to deserving companies such as Enron, WorldCom, and Baldwin-United, is one of those rare analysts who triedto bring to the public’s attention companies that “gamed” their books.

His

recommendations did not come without headaches to him. In 1983, while at Gilford Securities, he put a sell signal on Baldwin-United, which was the market darling at that time, after his report the stock still doubled, but Chanos knew that the financial statements were manipulated and he reported it. Baldwin threatened to sue, but in March 1983, admitted that it could not pay its short-term debts, and on August 1983, it filed for bankruptcy.

$6 Billion of stock market wealth evaporated and holders of Baldwin

annuities were left with nothing.46 And this type of behavior is not limited to one financial organization. The late Swiss banker, Edmond Safra, who ran Republic Bank of New York was smeared by no less venerable an institution than American Express after he stopped doing business with that company. Stories in three newspapers (in Paris, Mexico City, and Peru) linked him to illicit drug trade. All three stories were traced back to the same operative hired by American Express.47 The point is that where large sums of money are concerned all kinds of unexpected behavior cannot be ruled out from even the holiest than thou institutions and

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individuals (Remember the Washington Mandarin and confident of presidents, Clark Clifford?). The rush to grab the trillions of dollars individuals have to invest is a prime candidate for tempting otherwise honest men. It is best to assume that financial professionals will help you if they can, but they will put their interest way above yours. No contest. It may all be very elementary and obvious, but the implications are frightening, given that, as we will see later, there is currently very little refuge for the individual investor. They promote riskier investment vehicle,s stocks, to the detriment to safer ones: savings and bonds. They scare the individual investor into thinking that he or she will be destitute if they do not put their money in riskier investments. The reality, investment, and brokerage houses make their money from your risky investments, hence the existence of self censorship and codes of silence should come as no surprise and should be fully expected.. No better example exists than the late 1990’s go-go era, when the market’s performance diverged from the real economy and the small investors were assured repeatedly that the stock always paid in the long run, whilethe insiders were rushing to the exits. Top telecom executives captured $14.2 billions in stock gain between 1997 and 2001. By 2003, in this industry only, hundred thousand workers lost their jobs, and sixty firms went bankrupt.48 In fact, Fortune magazine found out through analyzing 1035 companies, whose stock price fell at least 75% between 2000 and 2002 and whose top executives and directors sold their companies stocks, that these executives and directors took roughly $66 billion49. This discrepancy was possible thanks to the code of silence. There is one very key point that needs to be made here: When we talk about censorship and codes of silence, we do not in any way mean to say that bearish views on the market

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get censored, although it is debatable whether there is a tendency to underplay these sentiments. The censorship that we are talking about kicks into action when there is an attempt to warn the average retail investor about systemic problems, non-level playing fields, individual investor disadvantages, the lack of expertise of experts and their nonimpartiality, and the questionable value and quality of the advice that financial professionals provide to the public, i.e. some of the very topics addressed in this book.

1

Maggie, Mahar, Bull!, New York, HarperBusiness p. 109 Robert J Shiller, Irrational Exuberance, Broadway, p. 193 3 Ellen Frank, The Raw Deal, Boston, Beacon Press, p.48 4 Ibid. 5 Francis X. Dealy, Jr, The Power and the Money: Inside the Wall Street Journal, New York, Birch Lane Press, 1993. 6 http://www.ici.org/shareholders/us/03_news_households.html#TopOfPage 7 Ellen Schultz, “Tidal Wave Of Retirement Cash Anchors Mutual Funds,” wsj, September 17, 1995, p. C1 8 Dottie Enrico, Investment companies invest in ads, USA Today, November 18, 1996. 9 David Ward with Matt Rees, Free Advice—And just about Worth the Cost, Bloomberg, June 28, 1996. 10 Aaron Lucchetti, Alarm sounded Over radio, TV Pitches, Wall Street Journal December 16, 1996, p. C1. 11 Ward and Rees, Ibid. 12 Proceedings of the Conference on Preventing Fraudulent Advertising , April 21, 1995. 13 The Fortune Teller, pp.92-93 14 Raw Deal, p. 34 15 Irrational, p 30 16 Ellen Frank, The Raw Deal,Beacon Press, Boston, 2004 17 “How Corrupt is Wall Street,” Business Week, May 13, 2002 18 Galbraith, John Kenneth, A Short History of Financial Euphoria, Whittle Books in Association with Penguin Books, New York, 1994 19 Ibid., pp. 8-9. 20 Ibid. p. 10. 21 The Fortune Tellers, p. 82 22 Howard Kurtz, The Fortune Tellers, NY, The Free Press, 2000, p. 83 23 Ibid. p5. 24 Ibid. pp 6-8. 25 John Kenneth Galbraith, The Great Crash, 1929 , 1988. 26 Galbraith, A Short History..., Ibid. pp. 58-60. 27 Quoted in William Greider, Secrets of the Temple, Touchstone, Simon and Schuster, New York 1989, pp 50-51. 28 Galbraith, Ibid., pp98-100. 29 Pizzo, Stephen, Mary Flicker, and Paul Muolo, , Inside Job: The Looting of Americas Savings and Loans, New York, McGraw-Hill, 1990. 30 Susan Burkhart, San Francisco Examiner, June 24, 1990, p. D1. 31 Francis X. Dealy, Jr, The Power and the Money, Ibid. 32 Ibid., p. 362, Footnote 1. 2

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Ibid. Chapter 22 Ibid., p.300 35 Bruck, Connie, The Predators Ball, New York, Simon and Schuster, 1988. 36 Spy, June 1993, pp 42-53. 37 Ibid. 38 Ibid. 39 Bethany Mclean, “Is Enron Overpriced?” Fortune, March 5 2001. 40 Bull!, pp. 21-22 41 The Fortune Teller, p. 53 42 “Book say Ex-Editor was fired to protect Murdoch’s Interest”, Wall Street Journal, October 18, 1996, p A7. 43 Associated Press, “Ex-Chief of Wire Service Convicted of Fraud Conspiracy”, Washington Post, October 18, 1996, p. A4. 44 Mark Havis,”Busting the Bubble,” Interview by Alex Jones, Media Matters, September 2001. 45 Galbraith, Ibid, pp. 35-36. 46 Bull!pp. 55-56. 47 Ed Leefeldt, The Economical Truth” Bloomberg Magazine, September 1995, p. 11. 48 Raw Deal, p. 42. 49 Mark Gimein, “You Bought, They Sold,” Fortune, September 2nd 2002, pp. 64--74. 34

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