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De-Brainwashing the Regulator

A former high-ranking SEC official told a group of advisors and journalists at the recent TD Ameritrade fiduciary summit that the SEC would never act against the interests of Wall Street. Why? Because the SEC regards Wall Street as the key to capital formation in the United States.

When I first read that, I thought it must have been a misquote, but others who were there assure me that this is what was actually said. Now I think it's an example of remarkable incompetence-or, perhaps, an even more remarkable example of brainwashing.

The term “capital formation” must have meant, to this person, the process of taking companies public via IPO and floating corporate bond issues. It could not have referred to venture capital, which is raised through a variety of independent partnershiips, many of them in proximity to Silicon Valley. I would argue that the real job of capital formation is creating effective financing for new business ventures, inventions and other innovations that move our society forward-things that Wall Street has only a peripheral interest in. So if I were organizing a rebuttal to the idea that Wall Street is the vital nerve center for allocating financial resources in America-if I were hoping to deprogram our brainwashed regulators-my first question would be: how involved is Wall Street in startups and mezzanine funding to nurture those startups to become viable businesses?

The answer? Wikipedia ( has compiled a list of the 133 largest venture capital firms, and only one of them, Intel Capital, is a corporation. None are Wall Street firms.

So we move on to IPOs, where Wall Street is the exclusive place to turn if you want to take your company public. The next stage of my deprogramming process is to ask a simple question: how do you define a cartel?

I think any reasonable definition would include the following characteristics: a small group of providers who have managed to collude on pricing of their product or service, the evidence being that they all impose the same price, without the price competition that you always find when market forces are at work. They do this because it's much more profitable for each cartel member if they, as a group, control total access to their product or service and are able to maintain obscene pricing as a result.

Obscene? Fees range from 7.5% of the total proceeds of the larger IPOs to as much as 25% of smaller ones. That's over and above the printing and other fixed expenses incurred by the investment banks, and it doesn't count the systematic underpricing of issues so the investment bank can buy shares and flip them, or sell underpriced shares to potential investment banking clients in return for their future business.

So I would ask the SEC to look at the value, to the enterprises, of underpricing shares, and to show any evidence at all of discount or competitive IPO pricing among Wall Street firms.

Finally, I would wonder aloud why we need to pay those fees at all. Yes, even without Wall Street's assistance, companies going public would need to register with the SEC and file a lot of paperwork, and get a formal valuation-ideally, unlike the current process, from a firm that doesn't directly benefit from deciding that the enterprise is viable and valuable. But once the paperwork is filed, the company could post its IPO on the Internet and give all investors a chance to bid on those shares, creating a true pricing mechanism, giving the enterprise all the money that is raised.

The bottom line of my argument: Wall Street doesn't participate in the most vital capital formation in our economy, and where it does participate, it acts as an overpriced cartel and chronically raises less money than could be raised. There are more efficient, market-based alternatives to its version of capital formation.

So why, again, should our chief financial regulator be looking out for Wall Street's interests? And if there is no good rebuttal to this discussion, we move to the next question: how can we deprogram the staffers at the SEC?