SEC sets analyst rules
Agency moves to curtail conflicts of interest between brokers' analysts and investment bankers.
May 8, 2002: 6:52 PM EDT

NEW YORK (CNN/Money) - The Securities and Exchange Commission approved a new set of rules for stock analysts Wednesday in an effort to combat conflicts of interest between the investment banking and research arms of brokerage houses.

The new rules bar tying analysts' pay to specific investment banking deals; block analysts from issuing favorable opinions on stocks in return for banking business; and prohibit them from being supervised by the investment banking department.

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Other provisions would require more disclosure in reports, including a chart tracking analysts' recommendations in relation to stock price and restrictions on personal trading by analysts.

The issue of conflicts on Wall Street received wide attention in April after New York Attorney General Eliot Spitzer released e-mails showing Merrill Lynch analysts privately disparaging stocks that they praised in public to their clients. Merrill (MER: up $3.31 to $43.95, Research, Estimates) is currently negotiating a settlement of Spitzer's allegations that the firm's analysts were compromised by the investment banking operations.

SEC Chairman Harvey Pitt called the rules an "impressive first step" but stressed that the commission still is investigating analyst practices and more rules may be adopted. The agency, the nation's top securities regulator, is investigating other brokerage houses along with the National Association of Securities Dealers and the New York Stock Exchange.

SEC officials have said that along with determining if any laws have been broken by the brokerage firms, the investigation could lead to more reforms.

Appearing on Lou Dobbs Moneyline, Pitt declined to comment on the current state of the investigation, but said the SEC is trying to make it inclusive, working with the North American Securities Administrators Association (NASAA), Spitzer, the NYSE and the NASD.

"We're going to make sure we leave no stone unturned," he said.

The rules adopted Wednesday morning originally were submitted by the NASD and NYSE in March and modified by the SEC based on comments from various sources, including the brokerage houses themselves. The rules will be implemented over the course of this year.

The changes include a prohibition against analysts offering or threatening to withhold a favorable research rating or specific price target to gain investment banking business.

In research reports, firms would be required to clearly define their stock ratings, disclose the percentage of stocks receiving a "buy," "sell," or "hold" rating, and include a chart with historical prices of the stock and points where the firm initiated coverage or changed its rating.

Also among the proposed changes is a prohibition against analyst compensation being tied specifically to investment banking transactions.

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Wall Street firms have asserted that analysts are not paid for specific deals, but the Wall Street Journal reported Monday that several Wall Street employment contracts and accounting firm policies state clear rules for bonuses and compensation related to bringing in new business, including which deals would garner the most extra cash.

SEC Market Regulation Director Annette Nazareth said the new rules should "significantly mitigate" the problems of investor confidence with analyst research.

Nazareth said if an analyst does not believe what he or she is writing, "that is fraud, pure and simple, and it is actionable."

Also in the proposed rules is a stipulation that no research analyst may be supervised or controlled by the investment banking department. In addition they recommend a "quiet period," during which no firm acting as lead manager or co-manager for an initial public offering of a company be allowed to issue a research report on that company for 40 days.

Changes are also recommended for the personal trading of analysts and their households. The regulators propose that no analysts or members of their household be allowed to make stock trades contrary to the analysts' current recommendations or trade 30 days before a research report is issued.

In public appearances, such as on television and radio, analysts must disclose whether they own the stock they are discussing and also if their firms have a financial position in the company.

Proposed rules also would cover disclosure about the brokerage firms' banking relationships with companies they cover and the financial interest of analysts in companies, similar to those adopted by Merrill.

Will the rules have an impact?

A spokesman for Goldman Sachs (GS: up $4.65 to $79.50, Research, Estimates) said the firm has most of the rule changes in place already and reiterated that the firm continues to support efforts of regulators to restore investor confidence.

Credit Suisse First Boston said it "fully supports the regulations," while Salomon Smith Barney said it "applauds the rules" as an active participant in the process.

Morgan Stanley (MWD: up $3.59 to $48.49, Research, Estimates) declined to comment.

Henry Hu, corporate and securities law professor at the University of Texas, said that the rule likely to have the most effect is the requirement for brokerage firms to break down the percentage of "buy," "sell" and "hold" ratings.

"In terms of benefits there are lots of benefits for both unsophisticated investors, and in terms of costs (to the brokerage houses) there really are not costs," Hu said.

He said unsophisticated investors will be able to see how the majority of stocks receive a "buy" or "strong buy" while sophisticated investors will be able to use the information to compare different brokerage firms.

But Hu said the limits on communications between the research and banking sides could turn out to be excessively burdensome for smaller brokerage houses.

He also said that the rules do nothing to rectify "the bulk of the problems" raised by Spitzer and said those would not be worked out until Spitzer and the SEC come to some kind of accommodation on what reforms need to be implemented.  Top of page