Zbigniew Piekarski cautions investors about the motives of investment managers.

"Now is the time to get out of debt. We do not urge that you sell securities indiscriminately, but we do advise that you take advantage of present high (stock) prices and put your own financial house in order."

- Charles Merrill, head of Merrill Lynch, in a letter to his customers before the 1929 crash

Last month 10 Wall Street firms agreed to pay a settlement of €1.2 billion ($1.4 billion) to resolve accusations that they lured millions of investors into buying billions of dollars of shares in companies they knew were troubled and which either collapsed or sharply declined. The fines themselves are insignificant compared with the firms' annual profits and are either tax deductible or covered by insurance.

The Securities and Exchange Commission, state prosecutors and market regulators accused three firms in particular - Citigroup's Salomon Smith Barney, Merrill Lynch, and Credit Suisse First Boston - of outright fraud. Five other firms - Bear Stearns, Goldman Sachs, Lehman Brothers, Piper Jaffray and UBS Warburg - were accused of making unwarranted or exaggerated claims about the companies they analyzed. Salomon Smith Barney and CSFB were accused of currying favor with their corporate clients by selling hot stocks to senior executives, who could then turn around and sell the shares for virtually guaranteed profits.

In settling their cases, the firms neither admitted nor denied the allegations, following the standard practice in resolving such disputes.

Such conflicts of interest were entirely predictable when the Financial Modernization Act was passed in the autumn of 1999, which repealed the Glass-Stegal Act enacted in 1933 during the Great Depression in order to prevent a repeat of the fraudulent activities of the "mania" of 1929. The act separated commercial and investment banking services. Once the two services were linked again, however, the temptation for deceit was too strong.

In 1929, Charles Merrill strongly urged all his customers to sell their shares in the year before the Great Crash and actually pleaded with President Calvin Coolidge to speak out against speculation in stocks! Can you imagine this happening today?

I doubt you will ever see the chief executive of any financial services institution tell his customers to sell their stocks or to pay off their debts. The common practices of firms are nothing compared to what you really have to worry about. There is a very serious breakdown in the savings, investment and pension businesses today. The chain of accountability leads nowhere.

Mutual funds, investment funds, unit trusts and pension funds take your money, combine it with other people's money and invest it on your behalf. The investment manager who looks after the fund has only one objective - to keep his high-paying job. His job description is not to make you a profit; it is to beat a stock market index. So if his benchmark index (say the Nasdaq or the WIG20) is down 55%, and he's "only" lost 50% of your money, that fund manager gets a huge bonus for outperforming his benchmark. He keeps his high-paying job by not screwing up too badly. That's it. And how does he keep from screwing up too badly? By holding a portfolio that is almost identical to his benchmark index - so he will never do particularly well or particularly poorly.

For instance, Microsoft is the major stock in all three major indexes in the United States - the Dow Jones Industrial Average, the S&P 500 and the Nasdaq. Typical fund managers hold a heck of a lot of Microsoft - a ridiculously expensive stock (trading at nine times sales). When individual investors get tired of poor performance, they will start to sell their mutual funds. This selling will drive down share prices, as funds (having to meet shareholder liquidations) sell the easiest stocks to trade.

A fall in Microsoft's share price could then lead to a vicious downward spiral in the indexes, as the major stocks have the power to drag entire indexes down. (This is not a problem in Poland right now as most of the investments have been in government bonds. However, it will be in the equity markets.)

Most investment managers have to stay fully invested at all times. They also have to own the big stocks that made up their benchmark indexes. In essence, if the market were crashing, those fund managers would have to sit back and watch you lose money.

So how did we reach this point where the people that are supposed to be in charge of making you money sit aside and watch you lose it? Some of the blame lies with the regulators themselves who insist on standardizing and controlling only things that they understand. As their ranks consist mainly of failed accountants and failed lawyers, their level of comprehension is limited so that they concentrate on form to the exclusion of substance. "Percentage allocation" is their religion, as they can just about understand it.

Some of the blame lies with the Bandersnatchers, the salespeople who benefit most as soon as you make the investment and who are unaffected by its performance.

However, most of the blame lies with you, the public, who spend less time and thought in making financial decisions than deliberating on what color underwear to purchase and only complain when the anticipated benefits are not there. So what can you do? You can save yourself. Carry on learning.

On the WSE: The bureaucrats and state "workers" of other European countries are on the march. The Americans are ready to decimate the black economy and reduce their investments with smaller dollars. The anticipated "Referendum Rally" will not set new highs, although it may provide new lows.

Zbigniew Piekarski is a portfolio manager based in Warsaw. He can be reached at zbigp@bipnet.pl.