Forty years ago, the richest professors at some of the world’s great
universities were the art historians, who were paid to certify that some
painting a dealer had for sale was indeed a Rembrandt or a Rubens or a Raphael.
Their fees were a percentage of the sale price of the painting. If they said it
was genuine, they got paid a lot; if they said it was the work of a lesser
artist (or a fake), they got paid very little. Villa I Tatti, art historian
Bernard Berenson’s great estate near Florence, stands as evidence of how
lucrative such commissions were.
The favourable opinion that enriched a professor also enriched an art dealer.
Indeed, it could be argued, and was argued, that the purchaser—whose money was
divided among seller, dealer and expert—lost nothing, because what he then
hung on his wall was a certified masterpiece.
Those old days in the art market are the proper reference for the latest Wall
Street scandal: the analysts whose pay is linked to the banking business their
firm does with companies whose stock the analysts recommend to the firm’s
This perverse incentive in finance was created when the individual who links
the brokerage client to the markets became a “registered representative”—
someone who works for the firm—rather than, as he had been, “a customer’s
man”: someone whose job was to care for the interests of the client.
From the firm’s point of view, the defect of the customer’s man was that he
could take his customers with him. In the 1970s, when the brokerage houses
became corporations that had to sell their own stock, they needed a structure
that tied the client to the firm. They wrote non-compete clauses into employment
contracts and sometimes went so far as to sue a registered rep whose clients
followed him to another firm. And they demanded that the rep declare a first
loyalty to his employer rather than to his customer. In practice, this meant a
willingness to tout the stocks and bonds the employer was underwriting or
distributing from its own trading inventory, regardless of personal views of
It was only a short step from rewarding the registered rep for his sales of
the firm’s Rembrandts to rewarding the research analyst for the report that
echoed the wish-lists of corporate executives choosing dealers for their own
Rembrandts. From that, much harm has followed.
The work of brokers is to resolve the conflicts of interest between sellers
and buyers, in a fair and honest way. There has always been an element of doubt
that brokers could maintain these standards if they were also dealers whose
profit depended on having the client pay more.
Writing the Securities Acts in the 1930s, Congress asked the new Securities
and Exchange Commission to explore conflicts of interest in the broker/dealer
combination. The SEC staff reported in 1935 that separation was feasible and
probably desirable but the Commission decided instead to raise Chinese walls
between the banking and brokerage areas of securities firms.
As a way to keep information confidential in departments of the firm, Chinese
walls never worked – the cant line on the street was that “grapevines grow over
Chinese walls”. But they at least expressed the industry’s recognition that a
financial firm has obligations to its clients as well as to its own bottom line.
Compensating analysts on the basis of the banking business that they attract
knocks a big hole in the wall.
What put a stop to the swindle in the art market was a combination of
publicity and the disgust of a new generation of art historians, most of whom
were not on the gravy train. Today, a historian asked to authenticate will be
paid the same fee whether it is thumbs up or thumbs down. Unfortunately, because
everybody is in the game, professional discipline will not do it for Wall
Street, though publicity helps and many analysts, having worked hard for their
degree as chartered financial analyst, are unhappy about the disrespect.
Securities regulation in the US was pioneered by the states, which still have
so-called blue-sky laws (to prevent stockbrokers from selling people the blue
sky). These laws survive, mostly to give state officials tools against
fraudsters who operate locally and never register with the self-regulatory
organisations that police the established markets for the SEC.
But if famous brokers sell the blue sky to their customers, they violate
state as well as federal law. Eliot Spitzer, New York attorney-general, was well
within his competence when he went after Merrill Lynch for inducing analysts to
help registered reps sell the securities of companies that gave Merrill banking
business, even when the analysts thought the stock was garbage.
Merrill’s subsequent settlement with Mr. Spitzer suggests that, just as there
was a purge in the art market 40 years ago, Wall Street will undergo a similar