Struggle to clean up Wall Street

REGULATING the financial markets in the US was once an occupation for faceless bureaucrats, but no longer. The regulators have become the Caped Crusaders of the business world, patrolling the markets on behalf of a public disgusted by scandal and grasping executives.

Everywhere you look, there is some business-related investigation, prosecution or punishment going on. Regulation is a boom industry. The aim is to tame the greed of Wall Street once and for all. But a question hangs over all this activity: will it actually work?

One of the most vivid images of regulation at work was the glistening bald scalp of Dennis Kozlowski, former chairman of Tyco, bobbing up the steps of the New York State Supreme Court on a grey Manhattan morning earlier this month.

After an investigation lasting more than a year, he is being tried for the alleged theft of $600m (£354m) from Tyco. In another court house down the road, former investment banker Frank Quattrone was on trial for obstructing an investigation into corrupt banking practices. Meanwhile, Martha Stewart, the home-making diva, is due to be tried in January for insider dealing.

Eliot Spitzer, New York's aggressive young New York attorney general, has already upset the banking industry with an investigation into the conflicts of interest between investment banking and securities research that contributed to the stock market bubble of the 1990s.

And now he and the Securities and Exchange Commission are investigating illegal trading among mutual funds and hedge funds. This threatens to become the biggest, widest-ranging supervisory investigation ever conducted, rapidly spinning out across the $6.9bn mutual fund industry to engulf some of the US's biggest financial institutions.

Fund managers at several leading banks and money managers - Morgan Stanley and Prudential among them - have lost their jobs. Two managers have been prosecuted and Spitzer is promising many more. Angry investors have pulled $8bn out of mutual funds named in the probe during the past month alone.

In response, the SEC is hastily drafting new rules to supervise hedge funds. Funds will, for the first time, have to register with the SEC.

Many fund managers are angry. 'It's a huge administrative burden that isn't necessary and isn't sufficient, either,' says Robert Jaeger, a hedge fund manager in Connecticut and author of All About Hedge Funds. Registering with the SEC is not going to deter rogue managers, he says, and it would take more than a routine audit to catch the bad guys.

Meanwhile, specialist traders on the floor of the New York Stock Exchange are being fined by the exchange for breaking its trading rules. This is another body blow to the world's largest stock exchange already being turned upside down after the scandal over the $188m pay package awarded to its former chairman, Richard Grasso.

Suddenly, major investment institutions are questioning the role of the specialists, who act as middlemen to maintain an orderly market.

Indeed, some of the largest NYSE users, such as Fidelity, are saying publicly that it should switch to an electronic trading system such as London's. Only this can eliminate the transgressions among floor traders that occur with the current system.

But while they battle to keep Wall Street in line, regulators are hampered by infighting. It began when Spitzer launched investigations into matters that should have been handled by the SEC. Caught napping, the SEC reacted slowly but is trying to regain some ground with a flurry of new rules.

Its public image, however, is that of an institution that was asleep at the wheel through most of the 1990s and whose job has been done by Spitzer instead. In the wake of the Grasso affair, the SEC is questioning whether the NYSE should be allowed to continue to regulate itself. SEC chairman William Donaldson argues that the regulatory function should be performed by an independent body, as it is with the Nasdaq market. Interim NYSE chairman John Reed says it should stay inside the exchange. The battle lines are drawn and everything else is likely to take a back seat until the matter is resolved.

Perversely, it turns out that even during the economic downturn and despite pressure from regulators and investors, executive pay has continued to soar. One striking example is David d'Alessandro, head of John Hancock Financial Services, an insurance company, whose $21.5m package last year was seven times bigger than in 2000.

Although the reasons for this are unclear, the message is not: greed has a way of finding its way around the highest barriers. The current spate of regulation may be more of a bump in the road than a permanent structure to tame Wall Street.

How the watchdog broke the bonus pot

WHEN Eliot Spitzer struck a deal with the banks last year that was designed to separate their securities analysts from their investment banking business, he threw the analysts into turmoil.

It is unlikely they will ever again be paid the $15m-a-year bonuses the likes of former Citigroup telecoms analyst Jack Grubman used to get. Lower down the scale, an analyst who got $1m three years ago might be lucky to get half that now.

That's because they can no longer act as investment bankers, persuading the companies they cover to use their banks for major corporate finance deals. It is also because the investment banking divisions can no longer directly pay analysts as they used to. The bonus pot has shrunk dramatically.

Analysts have been leaving the business in droves, and the banks warn that the result may be that their smaller research departments will not cover many stocks, leaving swathes of the stock market with virtually no analysis.

Bankers, meanwhile, privately point out that there are plenty of ways to get round the Chinese Wall between research and investment banking.