‘Was It Stolen, or Did You Lose It?’

“The public feels that Wall Streeters ... are crooks and scoundrels and very clever ones at that; that they sell for millions what they know is worthless; in short, that they are villains.” -- Fred Schwed Jr., from his 1940 book on the brokerage business, “Where Are the Customers’ Yachts?”

Sixty-three years have gone by since Fred Schwed skewered Wall Street with his classic book, which derives its title from the question supposedly asked by a visitor to lower Manhattan who spied the brokers’ and bankers’ yachts moored nearby.

Reprinted in 1995, it’s a terrific piece of literature to read or reread at a time like this -- in the aftermath of financial scandals that have angered and disgusted Americans of every income level and political persuasion.

Schwed, who was a Wall Street veteran, provides great reading not just because he reminds us that public mistrust of the brokerage industry is the norm rather than the exception. He is captivating because he writes in plain English (1940s style) and with a wonderful sense of humor rather than with the vitriol that quickly can become tiresome.

For those who are moved to either lash out, cry or both because of the brokerage industry’s latest despicable conduct, Schwed’s book offers the opportunity also to laugh a bit -- at the often absurd nature of the securities business, and at human nature, which makes financial booms and busts possible.

Indeed, while lampooning Wall Street practices that fundamentally are no different today from a century ago, Schwed also reminds investors of their own probable culpability when portfolios go bad.

“The burnt customer certainly prefers to believe that he has been robbed rather than that he has been a fool on the advice of fools,” Schwed writes. “Was it stolen, or did you lose it?”

The magnitude of the scandal, which 10 big brokerage firms settled last week with federal and state regulators to the tune of $1.4 billion in fines and other payments, leaves little doubt in many people’s minds that Wall Street must be a vast criminal enterprise.

A year ago, investors were stunned by New York Atty. Gen. Eliot Spitzer’s revelations that analysts at Merrill Lynch & Co. in recent years had publicly touted Internet stocks that they privately believed to be overpriced, or worse. Spitzer asserted that the analysts lived to please the brokerage’s investment bankers, who wanted to keep their corporate clients happy with high stock ratings -- at the expense of the truth.

The settlement announced last week alleged far more of that kind of self-serving conduct up and down Wall Street by firms such as Goldman Sachs & Co., Morgan Stanley & Co. and Citigroup Inc.

In one example, regulators cited an e-mail from a Lehman Bros. analyst to an institutional investor: “Well, ratings and price targets are fairly meaningless anyway ... but, yes, the ‘little guy’ who isn’t smart about the nuances may get misled, such is the nature of my business.”

Nobody wants to feel like a chump, yet that’s how millions of small investors now feel about riding the market up in the late 1990s and down since. To paraphrase Schwed, the mostly yacht-less customers believe they were sold stocks that their brokerages knew were worthless, or nearly so. Many of those securities, at least in the technology sector, ultimately did become worthless as the market bubble burst.

It is cold comfort to consider how inherently dangerous it is to ask Wall Street for advice and believe wholeheartedly that it must be genuine. There is a quote attributed to former Columbia University finance professor Louis Lowenstein that provides a timeless warning:

“Wall Street gets paid for persuading people to change their minds. There are only a certain number of shares of GM and Wall Street gets paid for persuading some people to buy and other people to sell -- to play a game of musical chairs.” Thus, to ask for advice is “like asking the croupier whether you ought to go to the roulette table.”

The Outrage Zone

In any case, if people thought they were getting past the scandal wave, the details in the brokerage settlement last week may have pushed many back into the outrage zone. The settlement followed revelations the previous week about a New York Stock Exchange investigation of its own traders, and was itself followed by new indictments in the Enron Corp. debacle.

At The Times’ annual Festival of Books one week ago today, an audience of more than 1,000 packed into Royce Hall at UCLA to hear four authors discuss “America After Enron.” The crowd was raucous and clearly angry about what has transpired in corporate America. It was as if they were gathered for a trial of the town’s worst criminal. They wanted justice; some sounded as if they wanted blood.

Had Morgan Stanley Chief Executive Philip Purcell attended that forum, it might have made him think twice before uttering what he did Tuesday, one day after the brokerage settlement was announced.

Under the terms of the settlement, the 10 brokerages neither admitted nor denied the allegations. That left no room for any of them to suggest publicly that the government’s case was wrong or trifling. Yet at a conference in New York on Tuesday, Purcell said: “I don’t see anything in the settlement that will concern the retail investor about Morgan Stanley.”

His comment, reported in the New York Times and then widely disseminated, triggered a stinging rebuke from Securities and Exchange Commission Chairman William H. Donaldson.

In a letter to Purcell, Donaldson said the CEO’s statements “reflect a disturbing and misguided perspective on Morgan Stanley’s alleged misconduct.”

Purcell followed with an apology to Donaldson, saying, “I deeply regret any public impression that the commission’s complaint was not a matter of concern to retail investors.”

Unfortunately for individual investors, the attitude Purcell exhibited Tuesday showed what they will face if they attempt to seek damages for their bear market losses. Contrition has never been the brokerage industry’s strong point.

All investors sign agreements when they open a brokerage account, waiving their right to sue for damages. Instead, they must take disputes before a panel of arbitrators provided by the NYSE or NASD (formerly the National Assn. of Securities Dealers).

Lawyers are expecting many more investors to file arbitration cases alleging that they have been cheated by dishonest brokerage practices as detailed by the government. Because regulators did the legwork, the evidence -- or what investors hope will stand for evidence -- already is there.

But the brokerages aren’t likely to roll over.

An arbitration case filed in February by one Southern California investor shows what people are up against.

The investor, who asked that his family not be identified in The Times, took Merrill Lynch to arbitration, alleging that his Merrill broker of the last decade invested family assets in unsuitable stocks -- mainly technology issues recommended by Merrill’s former Internet analyst, Henry Blodget.

The complaint, obtained by The Times, asserts that as the investor saw the value of such shares as CMGI Inc., Ariba Inc. and InfoSpace Inc. plummet in 2000, he voiced his concern to his broker. The broker, in turn, “repeatedly advised him that Merrill Lynch analysts still maintained a very positive outlook” for all of the investor’s stocks, according to the complaint.

The investor said he decided to e-mail Blodget directly in January 2001. To his surprise, he said, Blodget e-mailed him back. The complaint includes what it says is Blodget’s reply, in which the analyst primarily states that he always rated Internet shares as “speculative” investments, and that “conservative investors shouldn’t have a cent in any of these stocks, precisely because we always knew and articulated that there was a risk this meltdown could happen.”

The complaint, which seeks payment of $215,933 in lost assets, attempts to pit the broker against Blodget, who last week was barred from the securities industry for life under an agreement with the SEC. The complaint also uses material from the New York attorney general’s investigation to assert that Merrill’s research reports were “compromised.”

Turning the Tables

In its reply to the complaint, Merrill turned the tables on the investor. The brokerage contends that the initial idea to buy tech stocks was the investor’s, not his broker’s. In 1999, as tech shares soared, “The lure of these returns proved irresistible for many individuals who previously had been content with the steady but less spectacular appreciation of diversified portfolios,” Merrill said.

The broker “reluctantly acceded to his client’s wishes,” Merrill said.

As for the complaint’s inclusion of the attorney general’s material regarding Merrill, the brokerage’s response is that “the allegations were never proven.”

Perhaps most intriguing is Merrill’s response to the assertion that the broker relied on Blodget’s research in recommending Net stocks to the investor. Not true, Merrill said. The broker “recommended stocks only if they received high ratings, not just from Merrill Lynch analysts, but also from Value Line and other analysts,” referring to the independent Value Line Investment Survey.

The “other analysts” aren’t identified in Merrill’s response.

Who’s telling the truth? The arbitration panel will have to decide that question.

For this investor, and for others burned by the long bear market, the experience is at once universal and intensely personal.

As Fred Schwed wrote, “There are certain things that cannot be adequately explained to a virgin, either by words or pictures. Like all of life’s rich emotional experiences, the full flavor of losing important money cannot be conveyed by literature.”

Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to: www.latimes.com/ petruno.