Merrill Lynch is once again in a heap of trouble. But this time,
the Wall Street monolith is feeling the heat from Congress, the SEC and the
In May, Merrill paid $100 million in conflict-of-interest
charges to New York Attorney General Elliot Spitzer after it was found that
research analysts at the firm had shilled for investment bankers. This time,
it's the investment bankers who shilled for Enron. They provided loans for a
sham transaction designed to avoid proper debt scoring and inflate profits.
Now all hell is descending on the fine old firm of Merrill
Lynch. It may turn out that Merrill is charged with willful fraud.
Individuals may well go to jail. Undoubtedly, the reputation of this great
company will be badly besmirched. And the sad fact is, the folks at Merrill
You can call it another case of moral amnesia in the financial
world. Yet so much of life is a tug-of-war -- you're pulling on one end of
the rope, while somebody else is pulling on the other. In Merrill's case,
bankers knew full well that big fees could accrue from the Enron
transactions. But these very same bankers also knew they would get big
bonuses from those fat transaction fees. This, of course, is the age-old
dance of seduction.
Who seduced whom? It really doesn't matter. Both sides were
wrong. The off-the-books Enron partnership was part of Enron's pump-and-dump
corporate scam. And the structured finance loan from Merrill Lynch should
have never been made to Enron in the first place. Merrill financial chief
James Brown made this clear in handwritten notes that labeled the
transaction a "reputational risk that aided and abetted Enron income
Plenty of Wall Street's big investment houses have been offered
transactions structured around various tax and accounting benefits. But
those firms who have maintained their ethical compass have always asked the
key questions raised by the IRS and the SEC. Namely, they ask if a
transaction has any material economic value or benefit.
Of course, many accounting issues are neither black nor white --
there's a gray area that will ultimately be vetted by accounting or
law-enforcement agencies. Honest disagreements are possible. People do not
go to jail if their intent was good -- if they were creating something of
economic value that would benefit the public.
Grown-up banking houses, however, set up
numerous management controls to separate the wheat from the chaff, the
ethical from the unethical, the legal from the illegal.
Well-managed firms force their staffs to jump through numerous
hoops before final sign-offs are made on unusual deals. One firm I know of
recently created a special investment-banking committee to rule on
structured-finance transactions. This same firm also forces its executives
to get clearance from a commitment committee, a tax committee, a compliance
function and a credit panel. I'd call this a grown-up, well-managed firm.
Sure, that sounds like a corporate bureaucracy. But the well-run
houses know full well that their reputations are on the line and that
business has been very good to them. So they work hard to preserve what they
have built over time.
Still, this system broke down somewhere in the Merrill Lynch
line of command. Clearly, there weren't enough managerial hoops to jump
through and clearly too many senior execs looked the other way. Merrill
Lynch will have to replace senior management in order to change its badly
battered and much-abused culture. Shareholders will demand no less.
The firm can survive this, the jobs of the thousands and
thousands of honest employees can be maintained, and its equity value can
prosper in a new world. In the aftermath of the new securities and
accounting legislation recently passed by Congress and signed into law by
the president, American business can be revived through more honest
accounting, greater information disclosure and independent corporate
Adam Smith's ethical epicenter that is required of a free market
system will be resurrected. Along the way, however, those who chose the
wrong path will bear the responsibility for that miscreant decision. Perhaps
they, too, may rise again.