New York – The WSJ reported yesterday that the SEC joined 12 Wall Street firms in trying to change a portion of the 2003 global research analyst settlement, put in place after the tech-stock bubble burst. The portion of the settlement in question here was the ruling that prohibits employees in investment-banking and research departments at Wall Street firms from communicating with each other without a lawyer or compliance official present.
This particular facet of the settlement was put in place to help ease the pressure that research analysts felt from their banking brethren to put an optimistic report out on a stock despite the researchers actual opinion of the company. As the Journal states, “After the bust, it was revealed that many of those analysts were touting stocks at the behest of their firms’ investment-banking operations, which were profiting from initial public offerings.”
SEC spokesman John Nester was quoted as saying that he believes this particular aspect of the settlement is no longer necessary as there are other restrictions in place. One of the restrictions mentioned in the article is the fact that analysts and bankers are physically separated. It would seem that simply physically separating the two groups is a bit naïve however if there are no other restrictions placed on the communications between them.
Responses to the news that the SEC backed Wall Street in this endeavor were understandably split. On the one hand, some feel that the ability to use the expertise and knowledge of the analysts is a big advantage for bankers, which was lost as a result of the settlement. Others feel that the institutional investors whom the sell-side targets are smart enough to know when research is biased. They believe that the disclosure of conflicts which are now mandated are the meat of the settlement’s impact and that removing the chaperone’s from meetings is similar to throwing Wall Street a bone. Of course, the problem with this argument is that most Wall Street research is also distributed to retail investors who do not know the inherent bias contained in most reports. An article we wrote back in 2008 highlighted some of these concerns with the overall structure of GRAS nicely, and talked about the negative implications it had for everyone involved.
Of course, on the other hand the SEC’s backing of the repeal of this measure leads some to believe that the SEC is not truly looking out for investor interests. Comments on the WSJ article largely belied this belief as one refers to the SEC as a “fox guarding the chicken coop” while another commenter cites his experience as a manager of a Wall Street Research Department and states that this regulation is definitely necessary.
The truth of the matter probably lies somewhere in the middle of these two opinions. In all likelihood, not much would probably have changed with the absence of mandatory chaperones on banker/analyst interactions. As we’ve written recently, banks are still finding ways to pressure their analysts and removing chaperones wouldn’t theoretically give the two groups free reign to discuss any immoral topic they wanted (the wording of the change stated that the nature of the communications should be consistent with those that an analyst might have with investing customers). Nevertheless, the terms of the settlement were put in place for a reason and the SEC’s push to remove barriers put in place to protect investors could set a dangerous precedent at worst or at the very least undermine confidence in the institution.