Compliance Considerations in a New Era


New York, NY – In the past, a number of clients have engaged Integrity Research Associates to conduct due diligence of the various research providers they want to conduct significant business with.  As part of this process, we have spent considerable time and attention reviewing and assessing research providers’ compliance policies and procedures.  Of course, different types of providers have different compliance concerns.  However, all research providers have to consider compliance issues in developing and implementing their business practices. The following article was written by an expert on the topic of research compliance issues — Ms. Susan Mathews.

Susan A. Mathews spent almost ten years as Senior Counsel and Deputy Ethics Liaison in the Enforcement Division at the SEC, following several years in private practice as a securities litigator.  Susan’s last few years at the SEC were spent overseeing the implementation of the independent research portion of the landmark Global Research Analyst Settlement.  Susan is currently advising firms on ethics, conflicts and compliance issues through her consulting practice, Madigail Consulting LLC.  Susan can be contacted at or 301-654-0406.

Tough times spawn creativity.  Sometimes beneficial innovation results.  But oftentimes corners get cut and put businesses at unnecessary risk.  No one can ignore that dollars for independent research are getting scarce.  The millions of dollars earmarked for independent research under the Global Research Analyst Settlement will be drying up this summer.  The big banks on the street are cutting back on their research budgets to stem the hemorrhaging of cash.  Where does this leave the independents?

Obviously, independent research firms may have to change their structures to generate revenue in varying ways.  For example, firms may move away from the independent research only model towards a combination model such as research/money management or research/broker-dealer model.  Some firms are morphing into expert networks and survey outfits.  It would be quite ironic if the independents moved back towards combining research with investment banking or a paid-for-research model.  Whichever direction the independents move will require heightened vigilance on management’s part to ensure that independence is not being compromised.  Conflicts, ethics and compliance are always more challenging when competition is steep.

Regulators are just beginning to focus on the conflicts that facilitated the recent melt-down on Wall Street.  Last week the SEC passed new rules to help reduce conflicts at credit-rating agencies.  This step is just the beginning – – and was a weak step at that.  I predict the new administration will take much stronger action with respect to conflicts and ethics rules in the financial sector.   Obama’s ban on lobbyists, extensive vetting questionnaire and insistence on an unprecedented level of transparency in his cabinet are signs that stricter standards will be the norm in the new administration.  Obama’s website refers to the new standards as “the strictest and most far reaching ethics rules of any transition team in history.”

What should independents focus on?  I recommend three areas that remain staples of regulators’ enforcement actions:  information control; personal holdings; and supervisors.

Information Control

Since many new business models involve gathering information that no one else in the marketplace has, the pressure to dig and find information that may be confidential has reached new heights.  Revenue generation may depend solely on access to professionals who have confidential information and expertise that is otherwise absent from the marketplace.  Compounding this already-dangerous structure is the fact that the incentives are skewed to encourage professionals to say more than they should.  For example, many professionals are paid based on how long they talk about a certain topic.  If you are paid more for talking longer, you will try to talk longer.  Consequently, it is virtually impossible to prevent someone from accidentally revealing information they should have kept quiet.  Even if your business model is not a stable of experts, the race to find “value-added” information has never been steeper.

Shockingly, industry professionals who should know better often commit the most blatant insider trading violations.  An executive director in UBS’ research department settled insider trading charges by the SEC that alleged that he illegally tipped material, nonpublic information regarding UBS analyst upgrades and downgrades to two traders.[1]  More recently, in October 2008, two registered representatives were barred from the securities industry for garden-variety insider trading – – tipping friends about an upcoming merger and buying shares the day before good news was publicly announced. [2]  Obviously, independents need to have checks and balances in place to prevent different kinds of violations that can result from the lack of control over information – – from confidentiality breaches to deliberate profiteering.

Personal Holdings

Research professionals need to be very careful about their personal trading.  The best way to destroy a client’s confidence in your research is to trade in the securities of a company that you cover.  Many firms have recently been fined or censured because their analysts or supervisors trade in the securities they cover. [3]  Analysts who make trades that are inconsistent with their ratings also lose their clients’ trust and risk regulatory action.[4]  Every research firm needs to have written securities holdings rules and reporting procedures that are closely monitored at all levels.


The vast majority of regulatory actions include an allegation that a firm’s supervisory systems were inadequate. [5] Research firms need to ensure they have qualified supervisors who follow a clear set of procedures when a violation is suspected.  Firms often make the mistake of relying on one person to detect and follow through on potential violations.  Rather, a separate system of follow-up should be in place, with supervisors who have increasing levels of authority designated to address a problem.  Sometimes firms have a great system in place that detects potential problems and issues exception reports.  However, many firms fail to include a written system for thorough follow-up on exception reports.  A common misconception is that supervisory mandates are basic and easily followed if you have good people working in your firm.  Unfortunately, even with great staff in place, it is only after a firm is in trouble that the holes in your supervisory system will reveal themselves.  Be proactive in this area.

These are just three areas that you would be wise to audit in the new year to ensure that the heightened conflicts and ethics genre of the new administration will not catch you off guard.

[1] SEC v. Mitchel S. Guttenberg et al., Lit. Rel. No. 20725(Sept. 18, 2008).[2] See FINRA Disciplinary Actions October 2008.

[3] See Johnson Rice & Company, LLC and Edward Douglas Johnson Jr., FINRA Case 2007007422001, Oct. 2008; Tradition Asiel Securities Inc., FINRA Case 2008013615401, Sept. 2008; Charles Michael Ronson, FINRA 2007009451201, Sept. 2008; David Wu, FINRA 20060037540-02, June 2008.

[4] See Gary Mark Ginlen, FINRA 2005001601001, Aug. 2008; Paul S. Kuklinski, FINRA 20070083155-01, June 2008; The Robins Group LLC and Marcus Whitney Robins, FINRA 2005001863901, Apr. 2008.

[5] Raymond James & Assoc., FINRA 2007009525901, Nov. 2008; OTA LLC, FINRA 2005000012501, Nov. 2008; SWS Financial Services, FINRA E062005006701, Oct. 2008.


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