New York, NY – Last week, President Obama signed into law the Jumpstart our Business Startups or JOBS Act. This new law, which received bipartisan support from Congress, was written to help small businesses and make it easier for startups to raise capital. However, most securities regulators have warned that the new bill will eliminate some important investor protections resulting from the 2003 Global Research Analyst Settlement which prohibited research analysts from improperly promoting stocks to help their firms drum up investment banking business.
Some Research Rules Relaxed for EGCs
To promote research coverage of emerging growth companies (firms with less than $1.0 bln in annual revenue) the JOBS Act relaxes restrictions on investment banks publishing research reports on these firms – either before and during a registered offering — whether an IPO or a follow-on offering of common equity. The JOBS Act provides that publication of a research report does not constitute an offer of securities, even if the investment bank that publishes the research is participating or will participate as an underwriter in the offering.
The JOBS Act also eliminates some of the restrictions previously in place prohibiting interaction between research analysts and investment bankers from the same firm in connection with the IPO of an emerging growth company (EGC). Previous limitations resulted from the Global Research Analyst Settlement (GRAS). The restrictions were designed to address perceived conflicts of interest involving analysts and investment bankers, particularly the perception that bankers sometimes promised their clients favorable research to win underwriting business.
The JOBS Act also prohibits the SEC and FINRA from adopting or maintaining restrictions on who can arrange communications between a securities analyst and a potential investor, or restrictions on research analysts and investment bankers meeting together with an EGC. Other restrictions resulting from the GRAS will remain in place, such as analyst certification requirements, limitations on compensation practices, prohibitions on analysts helping to solicit investment banking business, prohibitions on banker input into research, and provisions relating to budgeting and oversight of the research function.
Regulators Pan JOBS Act
As you might guess, many former and current regulators don’t support these aspects of the JOBS Act, as they feel the loosening of rules regarding research for ECG’s could lead to many of the same biases and conflicts of interest that plagued Wall Street research during the dot com boom.
“It is a bad sequel to a bad movie,” said Eliot Spitzer, the former New York attorney general. “It shouldn’t be called the JOBS Act, it should be called the Bring Fraud Back to Wall Street Act.”
Mary Schapiro, chairwoman of the S.E.C., recently warned that the JOBS Act will “weaken investor protection.” “We should not walk backwards here,” she said. “Collusive behavior between analysts and bankers cost investors huge sums, shattered confidence in the integrity of research, and damaged the markets themselves.”
Even CFAs Concerned
A recent survey of Chartered Financial Analysts reveals that these investment professionals are overwhelmingly opposed to the new legislation. Only 29% of CFAs are in favor of the JOBS Act, while 69% of CFA holders believe it would reduce investor protection and transparency.
One concern that CFA’s have with the new law is that it would allow analysts to evaluate IPOs of companies their own firms are underwriting. They believe that most analysts will feel pressured to give these companies favorable ratings due to the fact that their employers are bringing the company public. Certainly, these concerns are not without precedence. Investment banking conflicts of interest were clearly major factors which lead to the Global Research Analyst Settlement and all the related SRO regulations which followed.
Another reason many CFAs are against the relaxing of research rules included in the JOBS Act is that they are concerned that doing so could effectively put their client’s money at risk due to the proliferation of potentially biased and inaccurate research on emerging growth companies that could result.
Response from Wall Street
Wall Street firms, on the other hand, are trying to figure out whether the new research rules included in the JOBS Act creates an opportunity or a threat.
Davis Polk, a large law firm representing many Wall Street firms, wrote in a recent note to clients that the JOBS Act represented “the most significant legislative loosening in memory of restrictions around the I.P.O. process and public company reporting obligations.” Some on Wall Street acknowledge that the new law creates significant flexibility when providing research coverage for EGCs compared to large cap companies.
Despite the opportunities available in the new legislation, Wall Street is taking a cautious approach to doing research on emerging growth companies that are planning to go public. Part of this reticence is likely borne from the concern that investors can still sue them if they can prove that analysts drafted intentionally deceptive research.
In addition, the investment banks are unsure how the SEC and FINRA are likely to interpret the provisions of the JOBS Act relating to the interaction between research and investment banking. Market participants suggest that FINRA is likely to relax some of it rules to comply with the JOBS act, though they have not yet announced a timetable for finalizing any changes. The SEC, on the other hand, is unlikely to change any of its rules.