Deal or No Deal: Why Settling With Wall Street Is a Mistake

Last Updated May 14, 2010 1:22 PM EDT

Talk is heating up that the numerous investigations into Wall Street might lead to a "global settlement" with investment banks akin to a federal agreement struck in 2002 over tainted stock market research:
"I would be stunned if any of these cases go to trial," said Frank Partnoy, a professor of law at the University of San Diego. "I think Wall Street needs to put this scandal behind it as quickly as possible and move on."
Several factors weigh in favor of a deal. First, the fissures running through Wall Street are multiplying, with a battery of federal, local and industry officials looking into banks' mortgage finance practices, relationship with credit rating agencies and other activities. Especially threatening are the probes into whether Goldman Sachs (GS), Morgan Stanley (MS) and other firms committed crimes -- no financial firm has survived a criminal prosecution.

Second, targeting Wall Street as a whole would deflect criticism that federal officials are waging war on a specific firm. Third, such investigations are dauntingly complex and amount to a huge drain on legal and regulatory resources. Federal agencies such as the SEC and DOJ, along with local prosecutors like New York Attorney General Andrew Cuomo, likely lack the budgets and manpower to pursue individual cases against the big banks.

"The government doesn't have the personnel to simultaneously prosecute several investment banks," Columbia Law School professor John Coffee told the NYT.
A consolidated settlement might be a boon for Wall Street, limiting litigation risks for individual firms and ending uncertainty over what penalties the government might have in store. Whether such a deal would be good for the larger financial services industry -- and the country -- is less clear. That's because such agreements often don't work exactly as planned.

Under the $1.4 billion deal signed seven years ago, 10 investment banks agreed to pay fines and pledged to separate their stock research and banking business. The monetary penalty amounted to a slap on the wrist. By contrast, evidence suggests that the move to sever connections between research and investment banking did result in less biased analyst reports.

Yet a team of academics concluded in a 2005 study that the "overall informativeness" of banks' stock recommendations "significantly decreased" as a result of the global settlement and related regulations. The finding underlines a well-documented difficulty in regulating Wall Street: It's hard to land a punch. Especially if the puncher isn't trying that hard. A U.S district court in March weakened parts of the global stock-research settlement after the SEC failed to develop certain industry-wide rules originally called for under the pact.

In other words, settlements may settle nothing. A deal that fell short of, say, banning synthetic CDOs, which appear to contribute little by way of broader economic value, might confer a false sense of security for a financial system crying out for fundamental reform.

Image from Flickr Related:

  • Alain Sherter On Twitter»

    Alain Sherter covers business and economic affairs for