Death of Corporate Reputation How Overregulation Has Destroyed Integrity on Wall Street

“...a brilliant, provocative, and persuasive exploration of a root cause of the failure of modern financial market regulation, engendered by lawmakers, regulators and prosecutors, and their legal and accounting acolytes.... A must-read for anyone concerned about the health and well-being of our capital and financial markets.”

--Harvey Pitt, CEO of global business consultancy Kalorama Partners, formerly 26th Chairman of the U.S. Securities and Exchange Commission (2001-2003)

• The real reasons why we can no longer trust Wall Street and what to do about it
• How the SEC got captured--and why it’s perfectly happy about that
• Essential reading for every policymaker, financial executive, investor, and citizen concerned with well-functioning capital markets

Trust and reputation are central to the operation of capital markets. But in our generation, reputational mechanisms are failing, and when these fail, markets and societies will fail as well.

The conventional response is more aggressive regulation. But this only worsens the problem. In The Death of Corporate Reputation, one of the world’s leading experts in financial market regulation explains why. Yale Law School’s Jonathan R. Macey demonstrates how and why poorly considered regulation has undermined traditional trust mechanisms throughout financial institutions, accounting and law firms, credit ratings agencies, and stock exchanges alike.

Macey retells Wall Street’s recent history in a new and more productive light, revealing what has really happened--and offering a different and better path back to trust and integrity.

For more than a century, law firms, investment banks, accounting firms, credit rating agencies, and companies seeking regular access to U.S. capital markets made large investments in their reputations. They generally treated their customers well and occasionally even endured losses to maintain their reputations as faithful brokers, dealers’ issuers, and “gatekeepers.” This has changed. Today’s leading capital market participants no longer treat customers as valued counterparties whose trust must be earned and nurtured but as distant “counter-parties” to whom no duties are required. The rough and tumble norms of the marketplace have replaced the long-standing fiduciary model in U.S. finance. The result has been unrelenting financial scandal.

In The Death of Corporate Reputation, pioneering corporate law and governance expert and Yale professor Jonathan Macey describes the disastrous transformation from the old reputational model to the existing buyer beware model in finance. Macey convincingly argues that the change can be attributed to several factors, including (1) the growth of reliance on regulation rather than reputation to protect customers and (2) growing regulatory complexity, which has made technical expertise more important to customers than reputation. After identifying the heart of the problem, he offers a better path forward--and a true “silver lining” in the age of Madoff.

Why traditional methods of fraud deterrence have failed in finance

The unintended consequences of aggressive overregulation--and how to fix them

It’s not just the banks: touring post-reputation Wall Street

Failure of reputation in accounting and law firms, rating agencies, and exchanges

Milken and beyond: why “nobody goes down with the ship” anymore

Why the employees of scandal-tarnished firms keep right on thriving

The perverse incentives that make the SEC so ineffective

Responding to the wrong metrics, driven by the wrong politics

Why did the financial scandals really happen? Why are they continuing to happen? In The Death of Corporate Reputation, Yale's Jonathan Macey reveals the real, non-intuitive reason, and offers a new path forward. For over a century law firms, investment banks, accounting firms, credit rating agencies and companies seeking regular access to U.S. capital markets made large investments in their reputations.  They treated customers well and  sometimes endured losses in transactions or business deals in order to  sustain and nurture their reputations as faithful brokers and “gate-keepers.”  This has changed completely . The existing business model among leading participants in today’s capital markets no longer treats customers as valued clients whose trust must be earned and nurtured, but as  one-off “counter-parties” to whom no duties are owed and no loyalty is required .  The rough and tumble norms of the market-place have replaced the long-standing reputational model in U.S. finance. 

This book describes the transformation in American finance from the old reputational model to the existing laissez faire model and argues that the change came as a result of  three factors: (1) the growth of reliance on regulation rather than reputation as the primary mechanism for protecting customers and (2) the increasing complexity of regulation, which made technical expertise rather than reputation the primary criterion on which customers choose who to do business with in today’s markets ; and (3) the rise of the “cult of personality” on Wall Street, which has led to a secular demise in the relevance of companies’ reputations and the concomitant rise of individual “rain-makers” reputation as the basis for premium pricing of financial services. This compelling book will drive the debate about the financial crisis and financial regulation for years to come -- both inside and outside the industry.

Jonathan R. Macey is Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale University and Professor in the Yale School of Management. He is a member of the Board of Directors of the Yale Law School Center for the Study of Corporate Governance, a member of the Faculty Advisory Group of Yale’s Millstein Center for Corporate Governance and Performance, and Chairman of Yale’s Advisory Committee on Investor Responsibility. He has served as an independent director of two public companies and is a member of FINRA’s Economic Advisory Council and the Bipartisan Policy Center Task Force on Capital Markets. His many books include Corporate Governance: Promises Kept, Promises Broken and Macey on Corporation Law.

Introduction     1

Chapter 1: The Way Things Used to Work: Reputational Theory and Its Demise     7

Chapter 2: Thriving the New Way: With Little or No Reputation--The Goldman Sachs Story     29

Chapter 3: The Way Things Used to Be: When Reputation Was Critical to Survival     55

Chapter 4: Individual Reputation Unhinged from the Firm: Hardly Anybody Goes Down with the Ship     83

Chapter 5: Proof in the Pudding: Michael Milken, Junk Bonds, and the Decline of Drexel and Nobody Else     103

Chapter 6: The New, Post-Reputation Wall Street: Accounting Firms     123

Chapter 7: The New, Post-Reputation Wall Street: Law Firms     149

Chapter 8: The New, Post-Reputation Wall Street: Credit Rating Agencies     165

Chapter 9: The New, Post-Reputation Wall Street: Stock Exchanges     191

Chapter 10: The SEC and Reputation     215

Chapter 11: The SEC: Captured and Quite Happy About It     231

Chapter 12: Where We Are and Where We Are Headed: A Conclusion of Sorts     253

Index     277