Something strange has happened to our financial system over the past years. We have always prided ourselves on having well-supervised financial markets and sophisticated financial institutions. Yet despite the preeminent role of the U.S. financial and capital markets, we have in recent years seen a significant and worrisome increase in conflicts of interests in the world of financial intermediaries and advisers, when their own economic interests and benefits increasingly clash with those of their clients, whose interests the intermediaries and advisers are paid handsomely to represent.
Unfortunately, we have allowed these conflicts of interest to compromise the integrity of these very markets and to contaminate so many of the commercial relationships that form the core of our financial system -- to the point that many parties and participants in these markets have come to accept a financial universe riddled with conflicts of interest as business as usual.
To those who believe that financial markets can only survive and prosper in transparent, ethical and fair conditions, the pervasiveness of conflicts of interest indicates a serious and potentially fatal flaw in our economy. It is high time for us to address and correct this serious problem in the interest of reestablishing thriving financial markets that serve the legitimate capital raising and investment needs of its participants.
The Senate Permanent Subcommittee on Investigations, which I chair and of which Senator Tom Coburn is the ranking Republican, spent over two years investigating the factors and causes that have contributed to our financial crisis and recently released a 639-page bipartisan report (available at levin.senate.gov). In the course of four hearings and the review of countless documents and pieces of correspondence, we uncovered stunning evidence of rampant and blatant conflicts of interest. Time and again, we learned how financial professionals who were supposed to look out for their clients' interests violated those very interests and instead chose to enrich themselves.
Some of the structures we exposed were as impressive in their complexity as they were repulsive in their breach of the clients' trust. There are countless examples, such as investment vehicles set up to contain highly dubious assets sold with aggressive sales tactics to clients, while the financial institution that selected the poor assets made huge profits by secretly betting against these very assets with short positions. In one case, a $2 billion security called Hudson was marketed by Goldman Sachs to clients with promotional materials representing that the firm's interest was aligned with the security, when in fact Goldman had secretly held the short position, which resulted in Goldman enriching itself at its clients' expense when the security tanked.
When questioned about the obvious conflicts of interest, evidenced further by internal correspondence within the financial institutions describing the assets as worthless, financial industry representatives regularly claim that their clients are sophisticated investors and assume risks with open or semi-open eyes. This industry-wide retort to accusations of obviously bad and disloyal behavior is very troublesome. It seeks to establish that conflicts of interest are a necessary byproduct of complex financial transactions and that they can always be cured by means of disclosure to the client in the form of so-called risk factors or investment considerations, which most often tend to be grossly inadequate, vague, out of context and meaningless.
The Dodd-Frank Wall Street Reform and Consumer Protection Act finally puts to rest the myth of conflicts of interest as perhaps an unfortunate but nevertheless unavoidable part of our financial system, and gives a forceful mandate to our regulators to use their broad powers in order to clean the Augean stables that our financial and capital markets have become. In clear provisions, the law tackles these disgraceful practices that jeopardize our markets' integrity and long-term viability.
Sen. Jeff Merkley, D-Ore., and I successfully argued for explicit provisions in Dodd-Frank prohibiting conflicts of interest and granting necessary powers to the regulators to implement the prohibitions. Together with other Senate colleagues, we were determined to send a clear signal that this gross violation of ethical standards and this colossal betrayal of clients' trust is intolerable. Conflicts of interest are at the very core of abusive and fraudulent practices that are dangerous to effective and high-performing markets. Many existing prohibitions of dishonest or manipulative acts in the financial and capital markets are based on the same need to prevent and sanction unethical behavior. The Dodd-Frank Act has finally taken a major legislative step in addressing these appalling practices with the urgency they deserve.
The financial crisis has shattered the financial security of countless Americans, many of whom have tragically lost their life savings and are facing desperate fears and anxieties about their economic survival and their children's future. We all witnessed what happens when financial institutions entrusted with maintaining the safety and soundness of the markets fall short in their commercial and ethical duties, and we all received painful reminders that some people with the opportunity to enrich themselves will behave badly when they are not regulated and supervised.
Putting an end to this supervisory and regulatory vacuum, and making an unequivocal commitment to go after conflicts of interest, is not regulatory overreaching, as some have claimed. It is a critical and long overdue step toward economic healing and healthy financial markets. The cops on the Wall Street beat must take the mandate we gave them in the Dodd-Frank Act seriously and implement it forcefully to end these conflicts of interest.
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