Editor's note: TheStreet.com columnist Adam Lashinsky is testifying today before the House of Representatives Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises. The committee is
Some Obvious and Not-So-Obvious SolutionsThis committee seems to be taking the approach that its best role is to use its bully pulpit to get the market's participants to clean up their act rather than to propose structural reform. As a columnist and observer of the capital markets, I support that approach. Analysts should be encouraged to disclose their conflicts of interest. Reporters should be urged to be critical. Investors should be admonished to do their homework before buying securities. Investment banks should be embarrassed at the way they have misled the general public. But there are other, more radical, approaches Congress, together with the SEC, could take.
- Split investment banks from brokerages. This step flies in the face of the last decade of financial services reforms intended to allow consolidation of the industry. But if the government feels that the public is being hurt by the system as it exists today, take apart the system. Brokerages that didn't have investment banking arms no longer would be conflicted by investment banking pressures. Investment banks could distribute research to whomever they liked, but it would be clearer whose interests they serve. Brokerages, of course, would find it difficult to make money under such a scenario. Conversely, perhaps all that's needed is a semantic shift. Perhaps if investment banks somehow were more honest about the fact that their research arms already lack independence then the charade would be over and everyone would be happier.
- Allow fixed-rate minimum commissions. When Congress threatened the exchanges with price-fixing charges, it began the end to institutional investors paying for research. If trading isn't profitable, the brokerages will find other ways to make money. But if they could charge some clients more, those clients likely would be willing to pay for the privilege of receiving independent research. Research, after all, isn't public information the way the public filings of listed companies are. The way the system works today, however, brokerages don't try to make money on research, essentially because they are not allowed to.
- Require greater disclosure. This process is under way, led by a series of best practices suggested by the Securities Industry Association. These are guaranteed to be little more than palliatives. It will help a paying client to know the conflicts of an author of a report, but only so much. Similarly, firms restricting stock ownership by analysts will have little impact. The big money is in investment banking, not trading for one's personal account. These are matters properly addressed by a firm's own compliance department, not Congress.
- Support Regulation FD. The job of being a research analyst has become more difficult since October 2000, when the SEC promulgated Regulation FD, for "fair disclosure." Because public companies must disclose all material information simultaneously, analysts with good social skills or financial muscle with senior management no longer have an edge. This is a good thing. In order to be effective, analysts must analyze again. An analyst recently wrote me an email complaining that companies had to be allowed to supply him with a financial model. Otherwise, how could investors know what to expect? I reminded him that it is his job to build a model based on his research. Good modelers will make good money for their clients; bad ones will not. A dangerous move is afoot by the securities industry and some elements within the SEC to weaken FD. If Congress wants to do right by the individual investor and force analysts to analyze, it should throw its support behind Reg FD.