Spitzer's Legacy to Equity Research


New York, NY – The stunning developments of last week have resulted in the disgrace and resignation of New York’s well-known democratic governor, Eliot Spitzer. As most involved in the research industry remember, former New York State Attorney General, Spitzer was a moral crusader who aggressively took on powerful opponents, including Wall Street, for knowingly promoting biased equity research to unwitting retail investors.

The consequences of Spitzer’s battle with Wall Street include rules separating equity research from investment banking departments, policies mandating that analysts publicly acknowledge that they personally stand behind their BUY / SELL / HOLD recommendations, and the implementation of the Global Research Analyst Settlement.

However, one question that remains is whether Spitzer’s attack on the sell-side will have any lasting impact on the investment research industry, or whether the industry will revert to pre-2000 practices where obvious conflicts of interest threatened the overall credibility of Wall Street research.

Some in the financial markets question whether the termination of the Global Research Settlement in 2009 will benefit or harm investors, as the government mandate to provide independent research to retail investors is no longer in force.

Certainly, the team at Integrity Research Associates often wonder if the Global Research Analyst Settlement was successful in moderating the conflicts of interest inherent in much sell-side research. However, we don’t disagree that, given the various trends in the financial markets, that retail investors could well be at an increasing disadvantage in the future as their access to unbiased research declines over time.

Consequently, we think it is appropriate to start a dialogue about how the benefits of the Settlement might be salvaged, even if the mandate comes to an end. The following is a recent letter to the editor of the Financial Times, written by Shane Smith, the CEO of independent research firm IIIR, that addresses this topic.


Benefits of deal must be saved

Published: March 15 2008 02:00 | Last updated: March 15 2008 02:00

From Mr Shane Smith.

Sir, With the 2003 settlement aimed at correcting abuses around flawed equity research reaching the end of its life next year, and in the light of Eliot Spitzer’s fall from grace this week, the time is right to consider his legacy in this area.

The key feature of the Spitzer settlement was that participating investment banks should provide research from independent sources alongside their own, as a sanity check and to rein in any unwarranted enthusiasm. Has this measure had the desired effect? By the most important measure – the absence of any scandals in sell-side equity research – the answer is a resounding yes. But what will happen when this moderating influence is withdrawn in 2009?

Every desk in every bank is under huge pressure to perform. Under such conditions, the checks and balances afforded by independent research are all the more important. At the same time, a study by Thomson Financial last year showed that as sell-side analysts have left the industry research produced by the investment banks is 20-30 per cent less than before the settlement. This decrease in coverage and competition between the banks will mainly affect retail investors. The institutional buy-side is again taking care of business by mopping up the best analysts from the sell-side, for continued access to the best research.

Mr Spitzer’s moral authority may have evaporated, but the benefits of his settlement must not be allowed to suffer the same fate. The independent research industry, despite an effective subsidy of $432.5m from the settlement over its five-year life, and sell-side research alike have struggled to develop a viable commercial model. Independent research cannot be funded by investment banking mandates, or by unsupervised payments from issuers without risking the same criticisms as those levelled at the credit rating agencies.

The greater part of the settlement subsidy went to existing research firms and drove a temporary fillip to earnings, rather than an enduring structural increase in capacity. Without further intervention, when the settlement ends there will be a return to the status quo in the industry but with less research produced by the sell-side and no “policing” to keep research practices in line. All independent research firms should be exploring business models that could avoid this outcome.

Shane Smith,
Chairman and CEO,
Independent International Investment Research,
London SE16 2XB


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