Will settlement money reach bilked investors?

The chairman of the House Financial Services Committee wants to make sure defrauded investors get some of the money regulators will soon be raking in.

In a Jan. 15 speech to The Heritage Foundation, a free-market think tank in Washington, Rep. Michael G. Oxley, R-Ohio, said he will be “closely examining” a $1.4 billion-plus settlement between regulators and brokerage firms announced last month.

Noting that a provision in the Sarbanes-Oxley Act of 2002 is intended to help investors receive compensation when they are defrauded, Mr. Oxley said, “After all, isn’t that a critical part of restoring investor confidence?”

The Heritage Foundation sponsored a panel discussion titled “Retoothing the Tiger: Restoring Confidence in the Securities and Exchange Commission.”

The settlement was announced last month by the SEC, New York Attorney General Eliot L. Spitzer, state securities regulators, NASD and the New York Stock Exchange. It would require 10 top brokerage firms to insulate their research analysts from investment banking pressures.

Among other things, the brokerages also would have to contract with at least three independent research firms and provide clients with reports from those analysts for the next five years at a total cost of $450 million.

Others would also like to know how much of the $1.4 billion will get into the hands of investors.

At another recent Washington seminar on broker-dealer regulation, a lawyer representing some of the brokerage firms in the settlement questioned how much money investors would actually receive.

The largest share of the settlement money, $900 million, is slated to go to state regulators. Some of that may go to investors who lost money as a result of analyst conflicts of interest.

But Samuel Winer of the Washington law firm Foley & Lardner said it is “very much a big question mark as to whether that’s going to happen.” Mr. Winer made his remarks at a Jan. 9 Washington seminar sponsored by the American Law Institute-American Bar Association Committee on Continuing Professional Education.

In his speech, Mr. Oxley also said his committee would look at the use of soft dollars by mutual funds.

Mr. Oxley said the use of soft dollars may interfere with best execution and could be a disincentive for companies to get the best research. Using soft dollars also can lead to churning if the arrangements entail commitments for a certain level of trading.

“Soft-dollar arrangements may be acting as a disincentive for the funds to do a good job for investors, and that may rise to the level of a conflict of interest,” he said.

Mr. Oxley also reiterated his support for the SEC’s proposals to require funds to disclose to shareholders their proxy votes and provide information on their holdings quarterly instead of semiannually.

John J. Brennan, chairman and CEO of The Vanguard Group Inc. in Malvern, Pa., and his counterpart at Fidelity Investments in Boston, Edward C. “Ned” Johnson III, attacked the proxy-vote proposal in a rare joint editorial in The Wall Street Journal week before last.

For syndicated financial columnist James K. Glassman, who is a resident fellow at the American Enterprise Institute in Washington, the key to reinvigorating the SEC lies in more-vigorous enforcement by the agency.

“Why is WorldCom still walking around?” Mr. Glassman asked at the Heritage Foundation event. “Phony profits are now expected to total $9 billion, but in December the SEC announced a partial settlement that did not even require the company to admit any wrongdoing. What kind of example is this for investors and for other corporate managers?”

Mr. Glassman supports the notion of freer markets.

The SEC, he said, “has become obsessed with the wrong things, like proxy voting by mutual funds and forcing lawyers to rat on their clients.”

Lawrence E. Mitchell, a professor at The George Washington University Law School, said an overemphasis on short-term profits is the root cause of investor and SEC malaise.

Mr. Mitchell also attributed investor and regulatory woes to 1993 tax code changes that encouraged the compensation of executives with stock options, as well as compensating institutional money managers on the basis of short-term performance.

The bubble market of the 1990s further encouraged inexperienced investors to expect huge capital gains fast, Mr. Mitchell added.

His proposed remedy is to revise capital gains tax laws so that stocks held for less than three months would be punished with a 75% tax rate, while stocks held for at least 10 years would escape taxation.