New York – Valentine’s Day is a day for special gifts and the SEC did not disappoint Gradient Analytics when it dropped its investigation into allegations of biased research, brought by Overstock.com indicating that no enforcement action was recommended.
The news was contained in a letter from the San Francisco Office of the SEC to Scottsdale, AZ-based Gradient.
In 2005 Gradient (along with a number of hedge funds and research providers) was named in two lawsuits involving alleged conspiracies to profit from issuing negative research on two publicly traded firms, Bioval and Overstock.com. These lawsuits included the following accusations:
- Gradient allowed hedge funds to review research reports prior to publication and suggest material changes.
- Gradient selectively distributed its research reports, enabling some of its clients to take positions in a stock before the research was distributed to its full client base.
- Gradient did not make any disclosures about these activities.
There were also allegations that Carr Bettis, who was then CEO of Gradient, owned one of the hedge funds, Pinnacle Investment Advisors, which profited from the alleged activities. Since the lawsuit was filed, Mr. Bettis sold his interest in Pinnacle Investment Advisors to remove potential conflicts. Pinnacle no longer exists-its models were sold to Greenbook and then to Advanced Equity Strategies.
Overstock.com filed suit against Rocker Partners and Gradient in a stock price manipulation scheme. Biovail filed suit against SAC Capital, Gradient Analytics, Banc of America, BofA Analyst David Maris, Pinnacle Investment Advisors, Helios Equity Fund and Hallmark funds. The Biovail suit was profiled on 60 Minutes, in which previous employees of Gradient provided testimony that called in question many of the company’s practices.
In addition to these lawsuits, Gradient was also subpoenaed in an SEC investigation regarding alleged market manipulation. This is the investigation that has been dropped.
Gradient’s Proactive Response
Gradient did not simply arm itself for a lengthy legal battle. It also instituted a number of internal changes to address the existing charges and to limit potential future concerns. Most independent, non-broker/dealer, research shops are protected under the publisher’s protections under the First Amendment. As a result, these research companies do not need to adhere to rules instituted by the NASD that deal with how analysts must conduct themselves in public speaking engagements, rules regarding personal stock ownership of analysts etc, covered under NASD 2711.
- Gradient changed its CEO to Brad Forst, From Carr Bettis and Carr Bettis dropped his ownership in his hedge fund Pinnacle Investment Advisors.
- Gradient appointed a compliance officer and rewrote its policies and procedures documents, including:
- Securities Compliance Policy – 2006
- Analyst, Sales and Professional Practice Guide – April 2006
- And Code of Ethics and Conduct – April 2006
- Finally, Gradient stopped producing custom research
Gradient’s response reflects the seriousness with which the company views these charges and the need for best practices to be established even if they are not legally required. Integrity has long been a proponent of independent research firms under taking similar approaches in their policies and compliance processes.
The Way Forward
Obviously, the lawsuits are still in play for Gradient, but the SEC’s decision not to press charges is a very positive sign. While the SEC investigation is not connected to the lawsuits, per se, the fact that the SEC is not pursuing the charges is a positive for the defense in the Gradient cases.