May 2006. Full Report >>

Executive Summary

Following the bursting of the “dot-com” and stock market bubbles of the late 1990s, and several widely publicized corporate-finance scandals, new federal regulations were put into place, most notably the Sarbanes-Oxley Act. At the State level, local regulatory institutions also focused new attention on the financial-services sector. In particular, the Office of the Attorney General (OAG) of New York State has been extremely active in investigating various financial-services firms in New York. These investigations resulted in a number of large financial settlements and some industry-level restructuring.

There have been concerns that actions taken by the New York OAG in the past few years regarding the investment banking, mutual fund, and insurance industries, have cost jobs in New York. This paper takes an early look at whether or not the new regulatory scrutiny hurt these sectors by introducing unwarranted penalties and restructuring, or fixed it, by restoring informational symmetry and investor confidence.

The earliest OAG regulatory actions in New York’s financial-services sector were made public in April 2002 with the investigation of a prominent investment bank. Investigations into mutual fund industry practices were initiated in September 2003, and insurance industry legal action got underway in October 2004.

The historical volatility of the financial-services sector has long been a factor in New York’s economic picture. The pronounced run-up in financial markets in the late 1990s ended with the bursting of the “dot-com” bubble in March 2000. New York City securities subsector employment peaked at the end of 2000, reflecting the peak levels of activity in mergers and acquisitions and initial public offerings. Financial-services employment retreated sharply through the middle of 2003, in New York and nationally. The financial markets, and New York financial-services employment, were also buffeted during this period by the September 11th terrorist attacks, corporate financial scandals affecting Enron, WorldCom and other companies in mid- and late-2002, and by the build-up to the Iraq War from the fall of 2002 through the spring of 2003. Nationally, investor, consumer and business confidence did not begin to rebound until mid-2003.

Econometric analysis was used to separate out macroeconomic factors from OAG regulatory actions in their effects on financial sector activity. Employment in investment banking and the securities subsector declined sharply in the wake of the dot-com crash, but the statistical analysis shows that there was no drop in employment following the OAG actions other than that predicted by market fundamentals and the macroeconomy. Investment banking employment has increased in recent years as the financial markets have rebounded and New York has maintained its share of national employment.

OAG enforcement actions may have benefited the mutual fund industry by restoring investor confidence. In the period since OAG actions, the inflow of funds into the mutual fund industry has increased relative to overall market performance. Because OAG enforcement action in the insurance industry has been more recent and is ongoing, it is premature to conclude anything about the possible effects of regulatory activity. It can be noted, however, that through consolidations and other developments, insurance brokerage employment in New York has experienced long-term structural decline since at least 1990, but that there has been a very slight up-tick in employment since the fall of 2004.

Although it is too early to make definitive judgments, the data and analysis presented here suggest that the financial-services sector is no worse off, and quite possibly better off, than it would have been absent OAG actions, because of improved confidence on the part of investors stemming from the more effective regulation and the corrective actions that followed widely publicized scandals.