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Chronicle of the Conspiracy
Join us as we discover, document, expose and challenge the bad people, the bad institutions and the bad ideas that stand in the way of wealth creation -- and show you how to fight back!
Friday, December 19, 2003
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Here's the newest antitrust threat from the Bush administration. It seems the
Federal Trade Commission has decided to declare war on intellectual
property, specifically patents. The FTC recently released a report that
concluded patent laws are too generous -- meaning they protect patent holders
rather than consumers. Some of the FTC's specific criticisms have merit, but
ultimately it's Congress's job to decide what the patent laws are. But
the FTC has never been an agency that waits for Congress to act. Thus, the
Commission is already using its broad antitrust authority to go after patents
they don't like. Today this battle took a potentially nasty turn.
In 1997, Schering-Plough, a drug company, sued two generic drug companies
that allegedly infringed S-P's patents in developing a generic version of S-P's
K-Dur 20 drug. These patent suits are routine in the pharmaceutical
industry. At the urging of the trial judge, the companies settled their dispute.
S-P made payments to the two competitors in exchange for agreements to defer
introduction of the generic drugs. The court approved this deal, and that should
have been the end of that.
In 2001, the FTC filed an administrative complaint, charging the deals violated
the antitrust laws because they denied consumers immediate access to generic K-Dur
20. In June 2002, the administrative law judge assigned to the case dismissed
the FTC staff's complaint on all counts. Today, nearly 18 months later, the five
FTC commissioners unanimously reversed the judge and held the court-approved
settlements were illegal.
You have to question the integrity of the decision making process. A neutral
judge finds the FTC staff's arguments baseless. Then the five commissioners,
political appointees having recently stated their personal agenda in opposition
to intellectual property rights -- overrule the judge in favor of the position
taken by staff appointed by the same commissioners. And we're supposed to tell
the Iraqis how to try Saddam?
The timing of this decision is curious for another reason. Andrx
Pharmaceuticals is currently fighting a class-action lawsuit challenging an
agreement it made to settle patent litigation with Aventis. In this case,
the Sixth Circuit held an interim settlement violated the antitrust laws.
Andrx has filed a petition for review with the Supreme Court, and the
plaintiffs must file a response by December 29. My group, the Center for the
Advancement of Capitalism, is filing an amicus brief at Andrx's
invitation. I have to think the FTC is trying to send a message with today's
decision.
Posted by Donald L. Luskin at 10:12 AM | link
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You think the mutual fund industry's "late trading" and "market timing" abuses are scandalous? Well, I never quite saw what all the fuss was about. But now the mutual fund industry is doing something that's really scandalous. It's engaged in a campaign to put America's best securities analysts out of business.
I know it sounds incredible, but I'll prove it. But first, let's talk about who America's best securities analysts are.
They're not the lavishly compensated -- and vastly over-rated -- superstars who work for the big Wall Street investment banks. No -- the analysts I'm talking about are very different. Their firms don't have any conflicted investment banking relationships with the companies they cover. So these analysts don't have permanent "buy" ratings on every stock.
I'm talking about independent securities analysts. The ones who make a living not by being superstar salesmen for investment banking services, but by making investors money by being right. And a lot of the time, that means making tough calls that are very different than the happy-talk that radiates endlessly from Wall Street.
For instance, there's Mark Roberts, of Off Wall Street Consulting Group. Roberts has become famous for being just about the only analyst to have had a sell rating on Enron as early as May 2001, well before the bottom fell out.
How about Howard Schilit of the Center for Financial Research and Analysis. Schilit warned about Microstrategy in October 1999, and the stock fell by 95% -- the first of the major corporate scandals. He pointed to dubious accounting at Biovail last July, and the stock fell nearly 50%.
Or David Tice of Behind the Numbers. Tice nailed Tyco in October 1999, Lucent in November 1999, and Providian in July 2001 -- all major trainwrecks that Wall Street blithely ignored until it was too late.
Scott Cleland of Precursor is an ace telecom analyst who called Worldcom's business a "dead model walking" in January 2002, and predicted the company's bankruptcy. And right at the top in 2000 he warned investors against Global Crossing, Qwest and Level 3 -- because his research exposed the myth of hypergrowth in internet traffic, showing that actual growth was a only about 1/15th as fast as these companies were claiming.
Independent analysts have positive opinions sometimes, too, of course. But over the last three years it's been gutsy negative calls that have made investors the most money. And negative calls are calls that conflicted analysts at Wall Street investment banks just won't make.
Okay -- now back to the mutual fund industry's campaign to put these courageous analysts out of business. To see how that campaign works, you have to understand how these independent analysts get paid.
Most independent analysts are paid by so-called "soft dollar commissions." With soft dollars, clients don't write checks to the analysts directly, but instead instruct their brokers to pay them in exchange for an agreed amount of trading commission business.
At first it may seem unfair that an investment manager gets to pay for a business expense with his clients' trading commission dollars. But think again. Securities analysis and trade execution have been bundled in a single package for as long as there have been formal securities markets. For example, if you’re a Goldman Sachs trading client, you probably get reports from their famous software analyst Rick Sherlund. It may seem like the reports are free, but they're really not. You get the reports because of your trading commissions.
And US securities law gives explicit permission for this bundling of research and execution, in section 28(e) of the Securities and Exchange Act of 1934.
Despite the perfectly legal and honorable status of soft dollar commissions, now the mutual fund industry's Washington lobbying organization, the Investment Company Institute, has sent an open letter to the Securities and Exchange Commission urging the agency to ban them. It's a way for a scandal-plagued industry to do something to look like it's policing itself, by uncovering what can be made to seem like a tricky scheme by which shareholder money is employed to pay the investment manager's expenses.
But it's not so tricky that any fund company will get in any real trouble over it. A 1998 SEC investigation of soft dollar commissions established that there are virtually no abuses of it in the mutual fund industry. Get real: if this were any kind of even vaguely real scandal, don't you think Eliot Spitzer would have been all over it by now?
Scandal or not, it's going to put independent analysts out of business. Why? Because the ICI is only asking the SEC to ban soft dollar commission to pay for independent research like that of Roberts, Schilit, Tice, Cleland -- and my own firm. The big Wall Street brokers will be allowed to go on just as before. So how are the independents going to compete when clients have to dig into their own pockets to pay them -- but can still pay for their Wall Street competitors out of commission dollars that were going to get spent anyway?
Is it just a coincidence that the big Wall Street brokers come out on top, thanks to the mutual fund industry's attack on their independent competition? Maybe not: the big Wall Street brokers are the ones whose sales forces are responsible for the majority of mutual fund sales year in and year out.
The only good news is that what the fund industry is asking the SEC to do may, in fact, require an act of Congress to accomplish. At minimum, it will require a lengthy and very public review process at the SEC. So there will be plenty of opportunities for the truth to come out. And when it does, I hope that the mutual fund industry emerges even more covered in shame than it is today.
But now, that's not what the fund industry is thinking about. It's barely thinking at all. It's like a herd of zebras, under attack by a pack of hyenas -- seized by fear, and doing anything it can think of to try to survive. I'm not exaggerating. When I talked to ICI spokesman John Collins for this story, he told me he has been praying lately.
He said, "When they come, I pray they take the young ones. They're more tender."
Precisely. Throw the independent analysts to the hyenas. Maybe some of the herd will survive.
Posted by Donald L. Luskin at 12:51 AM | link
Thursday, December 18, 2003
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"All mutual fund shareholders deserve lower fees. Not just shareholders who invested in funds that engaged in questionable trading practices; not just shareholders invested in one fund family; but all mutual fund shareholders deserve relief from fees that continue to rise."
I've heard of congress legislating tax relief. I've heard of congress legislating regulatory relief. I've heard of congress legislating disaster relief. But since when is it any of congress' goddam business to give mutual fund shareholders "relief from fees"?
Posted by Donald L. Luskin at 11:18 AM | link
Wednesday, December 17, 2003
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The Investment Company Institute -- the powerful Washington lobbying organization that serves the mutual fund industry -- has come out with a public call for the Securities and Exchange Commission to outlaw the use of so-called "soft dollar" brokerage commissions. Of course it's all draped in grandiose rhetoric about how this "will benefit fund investors" and "restore trust and confidence in mutual funds, upon which tens of millions of Americans depend." And besides, anything called "soft dollars" just must be bad, right?
Wrong. "Soft dollars" may be an unfortunate name, but the reality is that the thing the fund industry wants to outlaw is one of the few remaining mechanisms that make it possible for independent investment research firms and small brokerage firms to compete against the Wall Street goliaths, and for smaller mutual funds and investment managers to compete against the behemoths of that industry. As usual for industry lobbyists, the ICI's initiative is all about entrenching the interests of the biggest players. And if it steals headlines from Eliot Spitzer for a couple of news-cycles, so much the better.
I know the soft dollar business intimately, because my company -- Trend Macrolytics LLC, a small, independent economics research firm -- depends on soft dollars for much of its revenues. Here's how it works.
An investment manager -- perhaps a mutual fund manager -- decides he'd like to receive our research, seeing it as an alternative or a complement to research he is already getting from the big investment banks like Goldman Sachs or Salomon Smith Barney. Instead of simply writing a check to my company, the investment manager instructs a broker to pay me instead -- promising to do a certain amount of trading business with that broker in compensation. That's soft dollars.
Critics say that's not right. Why should commission dollars -- paid for out of the investment manager's clients' money -- go to provide a research service that the manager himself ought to be paying for out of his own pocket? That's a fair question, but it begs a much bigger one: if that's not right, then how come the manager can get comparable research from Goldman and Salomon without paying for it out of his own pocket? That research is, in truth, being paid for by commissions too. There's no such thing as a free lunch, or a free research report.
Congress addressed this matter in 1975 when it enacted section 28(e), amending the Securities and Exchange Act of 1934. This statute makes it clear that investment managers may use clients' commission dollars to pay for services, like research, that lie beyond trade execution. The statute makes no distinction as to whether such services must necessarily come from personnel of the same broker that executes the trades. Indeed, any such distinction is entirely meaningless and arbitrary.
Yet the ICI wants the SEC to make this distinction -- and it's a distinction that would put me and other small firms like mine out of business, leaving the giants of Wall Street free of independent competition. Make no mistake about it: the ICI wants the SEC to ban soft dollars only for independent research. They say they "urged the SEC to limit the use of soft dollars to the narrow category of proprietary research that reflects unique intellectual content." ICI spokesperson John Collins confirmed to me that "proprietary" means research produced by brokers.
Would such an outcome serve investors? Hardly. It's independent research firms who warned investors about Enron, Tyco and Worldcom, while Wall Street maintained its "buy" ratings right up to the bitter end. And its independent research firms who, by definition, have no investment banking conflicts. Are they the good guys we should be trying to encourage?
So who, exactly, is served by the ICI's initiative? The Wall Street giants, of course. The abolition of soft dollars would not only destroy Wall Street's research competitors, but its smaller brokerage competitors as well -- many of whom specialize is soft dollar business.
And what a coincidence. Those Wall Street giants are the same firms whose sales forces sell mutual funds -- like the huge American Funds family, whose investment manager is Capital Research and Management, of which Paul G. Haaga, Jr., chairman of the Investment Company Institute, is executive vice president and director.
The big mutual fund families -- like the American Funds -- would also be winners, at the expense of their smaller rivals who have less influence in the corridors of power within the ICI. When the few surviving independent research companies must be paid out of investment managers' own pockets, only the largest managers will have deep enough pockets to pay them. Only the giants will have access to the best research. The little guys will be stuck with nothing but Wall Street's perpetual "buy" ratings.
What adds special irony to this adventure by the ICI in self-interested regulatory crusading is that -- unlike "late trading" or "market timing" or the other matters that have tainted the mutual fund industry of late -- soft dollars has received constant and intense regulatory scrutiny for years, and has always come up with a clean bill of health. Even the ICI has had to admit that a 1998 SEC study of soft dollars -- in what amounted to an industry-wide surprise audit -- "found no soft dollar abuses by mutual funds."
Perfect! The mutual fund industry, cowering under Eliot Spitzer's rubber hose -- and with so much housecleaning to do -- distracts the SEC and the public with a scandal in which there have been no abuses! It's scandal "lite": all the sensationalism with none of the guilt.
If the mutual fund industry gives a hoot about the welfare of the investing public, it really only has two choices. It should either take on Eliot Spitzer head-on and end the regime of this self-appointed regulatory czar, or confess its sins and put in place rigorous systems to make sure they'll never happen again.
But this tomfoolery with soft dollars is nothing but transparently self-serving grandstanding. It's no way for the mutual fund industry to restore public trust.
Posted by Donald L. Luskin at 5:29 PM | link
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Posted by Donald L. Luskin at 1:42 PM | link
Tuesday, December 16, 2003
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"I stumbled onto your December 11 piece on Krugman. Actually you could have attacked him far more forcefully, though you would have had to change your mind on some things that you wrote before. I do not have the initial pieces you wrote on the steel issue.
"You could have explained a temporary steel tariff as, yes, a mistaken policy -- but correcting a bigger blunder: Greenspan's mismanagement of the dollar since 1997, allowing it first to rise by 30% (when replacing the other disappearing reserve currencies at the time). And you could have then said that the protection should have been temporary -- at best (the US would have still given weight to international standing and reactions), until the dollar comes back to Earth -- where it is now, at roughly the 1997 level (with Euro threatening to become a reserve currency). You would have had the benefit of both explaining the origins, the timing of the tariffs and predicting its end. And if one asked why steel or textiles were singled rather than Microsoft, the answer is margins (survival), and, yes, no doubt about it, political calculation too. But the timing of both introducing the tariff and canceling the tariff was important to explain.
"As to your other points in the article: the reason Democrats are so furious at the Republicans is similar to why many Republicans were furious at Clinton: for giving credit to himself for what the Republican congress passed, and actually prevented the administration from doing.
"Last but not least: it is still beyond me why Krugman was ever considered to be a decent economist: I never found anything in his writings. Am still waiting to hear someone identify one insight (have you found it?). I looked into it when Washington-based Institute for International Economics (on whose board Krugman was sitting at the time), asked me to review his book, The Return of Depression Economics. I called it 'Depressing Krugnorance,' and it was reprinted around the world. Parts of it are included in my Force of Finance book. Others appeared long ago in my "Making Sense out of Nonsense" in my Educating Economists book, some 12 years ago."
Posted by Donald L. Luskin at 10:57 AM | link
Monday, December 15, 2003
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A number of my readers copied me on emails they sent to Daniel Okrent, the New York Times' new "public editor," concerning Paul Krugman's column Friday. One reader, David Skurnick, has shared Okrent's response -- and it is not encouraging. It's not just that Okrent disagreed with Skurnick's take on the way a front-page news story about the Halliburton over-charging scandal was handled (I see Okrent's point here). What's discouraging is that Okrent totally abdicated when it comes to the way Krugman handled the same material, telling Skurnick to email Krugman directly. This would seem to cut against Okrent's double-negative assurances to our friends at The National Debate that "I do not mean to suggest in any way that I am not interested in the paper's policy of holding columnists responsible for their own corrections." Sounds like it's business as usual on West 43rd Street.
Here's the exchange.
"Mr. Okrent:
"In his column today, Paul Krugman inaccurately implied that a Pentagon audit accused Halliburton of profiteering:
'Yes, Halliburton is profiteering in Iraq - will apologists finally concede the point, now that a Pentagon audit finds overcharging?'"http://www.nytimes.com/2003/12/12/opinion/12KRUG.html
"'profiteering' means making excessive profits on goods in short supply. However, the Times's news article today reported that the audit found the opposite: Halliburton's overcharge had not given them excess profits:
"'The officials said Halliburton did not appear to have profited from overcharging for fuel, but had instead paid a subcontractor too much for the gasoline in the first place.'
"http://www.nytimes.com/2003/12/12/international/middleeast/12PENT.html?pagewanted=1&hp
"I would also criticize the layout of the news article. The finding that Halliburton appeared not to have profited was important, but it didn't appear in the headline, nor in a sub headline, nor on the front page. The reader had to follow the article back to page A24 to learn that the Pentagon audit found that Halliburton had not profited from the overcharge.
"David Skurnick"
Okrent's reply:
"Dear Mr. Skurnick,
"It's an interesting point you make about the presentation of facts in the news article, but I think I disagree: the Pentagon spokesman's comment in the fifth paragraph indicates that as far as the government is concerned, overcharging is itself a misdeed, whether or not 'profiteering' is involved.
"As for Mr. Krugman's comment, I urge you to write him directly at his e-mail address, krugman@nytimes.com."
So Okrent is willing to discuss matters of emphasis in a news story, but he simply passes the buck and washes his hands when it comes to Krugman -- whose use of the word "profiteering" is flatly wrong. Off to a great start...
Posted by Donald L. Luskin at 12:18 AM | link
Sunday, December 14, 2003
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"GORE: As Paul Krugman has pointed out in the New York Times, George W. Bush is not only the worst president in American history, he is the worst leader of any nation on Earth going back more than 500 years.
"DEAN: Really, I -- I mean, I'm no fan of President Bush, but what about Hitler?
"GORE: Number three.
"DEAN: Pol Pot?
"GORE: Number six.
"DEAN: See, I'm not sure I buy that.
"GORE: Oh, no, that's accurate. It's in Tuesday's column."
Thanks to Bret Swanson for the heads-up.
Update 12/30/2003... Henry Hanks at Crooow Blog sends this link to the full transcript of the sketch.
Posted by Donald L. Luskin at 5:27 PM | link