Taking Stock / Just Ask Eli

A month before the cabinet begins debating the reform of the capital market and banks, the PR war is raging.

After the finance minister failed to extract clear-cut statements of support from the legendary Fed chairman Alan Greenspan, the director-general of the Finance Ministry, Joseph Bachar, managed to wring just that unqualified support from none other than the Nobel prize winner Joseph Stiglitz.

Greenspan and Stiglitz are two of the most respected personalities in the global economic sphere. But if ministers or even bankers want an even more weighty opinion, there's a man to supply it.

That man is Eliot Spitzer, the attorney general of the state of New York.

Nobody ever asked him to reform the American financial establishment but in the last three years, Spitzer has shaken it to the core, in ways that neither the U.S. Securities and Exchange Commission nor the Federal Reserve nor any other regulator managed to do. Maybe because they never tried, but nevertheless.

Last week Spitzer did it again, sending tremors up and down Wall Street. This time his target wasn't investment banking, it was insurance.

Announcing an investigation into possible kickbacks by the big insurance companies to agents and brokers, Spitzer accused brokers such as Marsh & McLennan from taking illegal payments from insurers, including the giant American International Group.

The broker's stock promptly lost 30 percent of its value and AIG dropped 15 percent, wiping out $20 billion in value.

Spitzer's move took Wall Street by shock, mainly because he broke with precedent and didn't give the accused executives a hearing, or hold negotiations. He discovered norms that he felt were not only wrong but illegal, and filed charges.

What did Spitzer actually find? He found America, more or less. He found that American insurance agents and brokers recommend their clients give their business to certain insurance companies because they got kickbacks. But nobody disclosed the "commissions."

Is that accepted practice only in insurance? Of course not. The entire American securities industry is riddled with kickbacks, undisclosed or even disclosed, but in a manner obscuring the real deal involved.

Spitzer's insurance probe is the third front he's opened against Wall Street. He began with the analysts defrauding their clients and moved onto the mutual funds. There he exposed methods by which fund managers were giving biased treatments to their various customers in after-hours trade. And from there, Spitzer leaped onto the real deal, the kickbacks that the mutuals were paying brokers for recommending their funds.

Kickbacks at home

Kickbacks are also central to the dispute between the Bachar team and the bankers. Joseph Bachar's panel concluded that if the banks are allowed to continue receiving kickbacks from provident and mutual funds, in the form of "distribution fees," the great reform they were designing would be largely nullified.

The kickbacks take away the incentive for bankers to grant genuinely objective advice to would-be investors. Allowing them to persist would merely push the bankers toward increasing their take from overt or covert fees.

The model that the Bachar team suggests, for banks to collect fees directly from clients, would render the entire financial arena transparent and simple. It would force the banks to provide genuinely objective advice. It would force the system to grant better service at lower prices.

Finance Minister Benjamin Netanyahu says he hasn't decided yet whether the prohibition against kickbacks is critical or not to the reform of the banks. He might smile upon allowing the banks to collect fixed distribution fees, instead of the floating varying method.

He is being influenced among other things by the banks' claim that nowhere in the world have business-steering agreements been banned.

Maybe instead of asking Greenspan, Stiglitz or other luminaries with a bird's eye view of the issues, Netanyahu should check what Spitzer is up to.

As the Herald Tribune wrote, money seems to have changed hands between brokers without their clients realizing what was happening, even though the insurance companies thought their disclosure was sufficient. Much the same was happening in the mutuals industry. If the fees were more transparent, pricing could become competitive. And competition doesn't do nice things for corporate bottom lines.

Look what Spitzer's been up to for the last few years. He's trying to do exactly what the Bachar team is trying to do, present a new model for the financial system, a model in which the customers know exactly what the interests of the person at the other side of the table are, and who's getting money for what.