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Is this any way to punish fraud?

Few have ever accused Morgan Stanley, the white-shoe investment bank formed in 1935 by partners of the imperial J.P. Morgan & Co., of being solicitous toward the investing masses. And that hauteur was on full display last week. On April 29, appearing at the UBS Warburg Global Financial Services Conference, at Manhattan's gilded Pierre Hotel, Morgan Stanley CEO Philip Purcell was asked about the $1.4 billion "global settlement" that Morgan Stanley and nine other firms had just inked with state and federal regulators. "I don't see anything in the settlement that will concern the retail investor about Morgan Stanley," Purcell claimed. "Not one thing." At another point, the 55-year-old former McKinsey & Co. consultant remarked, "So far, so good this year. We have maintained our standards in market share as well as our reputation, in my view."

The comments were so at odds with plainly visible reality that, for a moment, it seemed as if the bespectacled Purcell were impersonating former Iraqi Information Minister Mohammed Said Al Sahhaf. Not 24 hours before, Morgan Stanley and other leading Wall Street firms had agreed to settle charges that were exceedingly troubling to all investors. The bestiary of sins laid bare in the so-called global settlement were, by and large, familiar to most casual readers of The Wall Street Journal: Investment banks allocated shares of hot initial public offerings to executives in exchange for business, and research analysts routinely subjugated their better judgment to the mandates of their investment-banking colleagues. But the settlement also brought new revelations about Morgan Stanley. Not content merely to turn its own analysts into shills for the dodgy stocks of its investment-banking clients, the august firm paid other, smaller firms to issue absurdly positive reports and recommendations on the shares of Morgan Stanley clients as well.

Purcell's remarks, Securities and Exchange Commission (SEC) Chairman William Donaldson retorted, displayed "a troubling lack of contrition." And, indeed, one would think that, after being bludgeoned into a settlement, which included the publication of embarrassing internal e-mails and a ten-figure fine, Wall Street CEOs would treat us to a round of self-flagellation. But, so far, the bosses have shown no sign of trading in their Thomas Pink shirts for hair shirts. That's because, on Wall Street, settling charges with regulators is akin to advertising or paying rent: It's considered just another cost of doing business.

Even companies with the best images and records of corporate governance routinely face litigation from employees, business partners, competitors, customers, regulators, and governments. It's a fact of corporate life. Look through the 10-K filing of any large corporation, and you'll see a section reserved for "Legal Proceedings." Morgan Stanley's most recent 10-K mentions nine separate items. They range from an Equal Employment Opportunity Commission sexual discrimination lawsuit to actions taken by creditors of Sunbeam Corp., shareholders of a Turkish telecommunications company, and the Federal Energy Regulatory Commission.

It's also a fact of corporate life that most of these proceedings will be settled. Litigating lawsuits, with the $400-per-hour lawyers Wall Street firms favor, can be very expensive. And the deposition and discovery process can bring embarrassing information into the public realm that a defendant would just as soon keep quiet. What's more, settlements can bring their own financial advantages. For instance, to the extent that some of the $1.4 billion in global settlement payments fund investor education ($80 million) or pay for independent research ($432.5 million), companies may deduct them from their taxable income. (The firms promised that they would not try to take tax deductions or collect insurance coverage on the $487.5 million in penalties levied.)

More significantly, when Wall Street firms are investigated by the SEC or sued by a former client, they face something worse than shame; they face uncertainty, which is the great un-desideratum for any publicly held company. The prospect of a multibillion-dollar judgment, a verdict that could force changes in crucial business practices, or a ruling that unwinds a transaction can hang over executives' heads like a sword of Damocles. The easiest way to resolve litigation-induced uncertainty, of course, is to settle. And, when uncertainty is resolved—even if it's resolved by paying a huge fine—stocks tend to rise. (On April 28, the day of the settlement, financial stocks rose across the board.) Best of all, settling doesn't mean having to say you're sorry or that you did anything wrong. Generally, settlement agreements—whether they are with the SEC or the New York Stock Exchange (NYSE)—note that the party "neither admits nor denies these allegations, facts, conclusions, and findings."

As unsatisfying as such a wishy-washy, non-admission admission may be, regulators and law enforcers who deal with financial misdeeds don't particularly want to litigate either. The NYSE and NASDAQ—which are more akin to trade groups or professional membership organizations than corporations—certainly prefer not to take their members to court. And permanently underfunded SEC enforcers would rather notch quick enforcement actions than endure marathon trials. In Wall Street investment bankers, the government faces the rare class of defendants with the resources to bollix things up in court for years.

Indeed, trials in securities cases are reserved only for the most obstinate—like high-yield bond king Michael Milken—or the most venal and wily defendants. Robert Brennan, the notorious 1980s-era penny-stock swindler, was charged with fraud by the SEC in 1995 but not convicted until 2001. Rogues of the 1990s, such as Andrew Fastow of Enron and Dennis Kozlowski of Tyco, may similarly avoid justice for several years, primarily because their allegedly ill-gotten gains will finance a decade's worth of trials. "The alternative to the [global] settlement, which resulted from months of tough negotiations, would have been protracted litigation," New York State Attorney General Eliot Spitzer noted. And that "would have delayed industry-wide reform indefinitely and could have resulted in a badly fragmented regulatory approach." (Or, perhaps worse, it could have meant that, come the New York gubernatorial election of 2006, Spitzer would still be deposing the Lehman Brothers managing directors instead of campaigning in Buffalo.)

But, while settling may make practical sense, it's not necessarily the most effective means of reform. After all, virtually all the firms involved in the global settlement have previously settled charges that they violated rules promulgated by the SEC or the NYSE or that they abused customers. In April 2003, the NYSE disciplined four firms and 26 individuals, including employees or former employees of Salomon Smith Barney, Merrill Lynch, and Bear Stearns—all of which are parties to the global settlement—for everything from misappropriating funds to failing to supervise employees properly. Each month, The Wall Street Journal publishes the NYSE's disciplinary actions, often in tiny type so as not to take up too much space. Every sin has a price. And every sinner can get an indulgence. Last November, for example, Merrill Lynch paid $300,000 to settle NYSE charges (without admitting guilt or denying it) that it had violated regulations by knowingly hiring people with criminal convictions.

And here's the rub: In virtually every instance, it is worth it for the firms and individuals to pay the fine—because it was worth it for the firms to engage in the sort of behavior that earned the fine in the first place. The $1.4 billion in fines—which will be considerably less after taxes and potential insurance collections—amounts to only a tiny fraction of the immense profits companies earned as a result of the corrupt practices for which they are being sanctioned. Morgan Stanley's share of the global settlement amounts to $125 million (pretax). But that amounts to about 0.6 percent of its $19 billion in 2002 revenues. The ten firms in question probably clocked about $1.4 billion on a few good days in 1999. Even more objectionable, the settlement regime permits CEOs like Philip Purcell to parse the language in a self-serving manner. Purcell can stand up, with a straight face, and declare his firm a winner in this imbroglio. After all, Morgan Stanley was not deemed to have committed a crime; it was just forbidden to deny having committed one.

Is there a better way? Perhaps. A truly satisfying and perhaps more effective settlement would force not just the companies and a few of their employees to kick in, it would also force CEOs such as Stanley O'Neal of Merrill Lynch or Purcell of Morgan Stanley to part with some chunk of their massive fortunes. While a CEO levy wouldn't make investors whole, it would stand as recognition that the bosses were somehow responsible for the goings-on under their watch. It would make CEOs think twice about sanctioning future corruption. And it would be just. After all, the CEOs and other top executives profited far more from the corrupt research and other practices than did the lowly research analysts and investment bankers.

Because of their massive options packages and the performance of their shares in the late '90s, most CEOs took home tens of millions of dollars each year. In 1999, for example, Purcell's compensation package was worth $27.8 million, and he made $52 million exercising stock options. If Purcell—or any other Wall Street CEO—were forced to give up $10 million, or $20 million, of his after-tax fortune to an investor education fund, then we'd really see some contrition.

Daniel Gross is a senior editor at Newsweek and writes the "Moneybox" column for Slate.