Here's a riddle: What's the difference between a Wall Street analyst and a real estate agent? Not much -- or at least there shouldn't be under the law, according to two legal scholars. In a soon-to-be published legal journal article, two corporate law professors argue that the best way to regulate the behavior of Wall Street analysts is to treat them as "quasi agents." In other words, they say, analysts should owe some fiduciary obligation to investors, in much the same way that an agent who sells real estate has an obligation to deal fairly with a customer.
Bad vs. Evil
The professors aren't saying that analysts should be liable to investors for simply making a bad stock pick every now or then. But an analyst who makes a bad stock call because of some conflict of interest or other "malfeasance" owes some sort of legal obligation to the investors who rely on his or her judgment, their argument goes. The professors contend that the problem with the current government effort at regulating Wall Street analysts is that all the emphasis has been on requiring analysts to disclose potential conflicts of interest. But there's been little discussion about the obligations of analysts and the need for a new regulatory framework that might make it easier for investors to sue analysts for dispensing faulty stock advice. "We're not articulating a precise fiduciary duty, but there is an expectation of reliance on the part of investors," says Jill Fisch, one of the authors and a securities professor at Fordham University School of Law. "It's naive to say that they don't rely." Fisch and her co-author, Hillary Sale, a professor at the University of Iowa Law School, say the fiduciary obligation arises because brokerage analysts are not just supposed to be salesmen for their employers and the companies they cover. Analysts also are supposed to be information providers that investors and the overall stock market can depend upon. That's a dual role that's fraught with inherent conflicts of interest, and one that cries out for regulation beyond simple heightened disclosure requirements, the professors say.
The conclusion reached by Fisch and Sale is sure to spark controversy and debate. The conventional view is that analysts are not agents and don't owe any legal obligation to investors or the companies they cover, since the primary relationship on Wall Street is the one between an investor and a broker -- not an investor and an analyst. That's why many legal experts say all those disgruntled investors racing to file lawsuits and arbitration claims against analysts face an uphill battle. While New York State Attorney General Eliot Spitzer's investigation into analyst conflicts of interest at Merrill Lynch ( MER) may have shone a much-needed spotlight on the issue, it didn't make it any easier for investors to prevail in a lawsuit against an analyst. Back in May, Merrill and Spitzer agreed to a settlement that required the nation's biggest brokerage to pay a $100 million fine and take steps to put more distance between the work of its analysts and that of investment bankers. For instance, investment bankers at Merrill may no longer evaluate the performance of the firm's analysts, nor may they have a say in how an analyst is compensated. The brokerage also must establish a committee to monitor the relationship between investment bankers and analysts and disclose any potential conflicts to investors. Scores of politicians have praised the Merrill settlement as establishing a blueprint for other Wall Street firms. But the professors are critical of the Merrill deal, saying it's fraught with "loopholes" and doesn't go far enough in eliminating potential conflicts or protecting investors. They say the settlement still allows room for analysts to participate in meetings with investment banking clients and even permits analysts to help solicit new business in some circumstances.
"The Merrill agreement is loaded with rhetoric about preserving the research process as one designed to protect investors, and it includes disclosure provisions, but it still does not prevent the actual conflicts from occurring," say the professors in their paper, which is called "The Securities Analyst as Agent: Rethinking the Regulation of Analysts." Not surprisingly, the securities industry is neither ready nor willing to embrace anything as sweeping as the change advocated by the professors. Industry executives say that before any new regulations and laws are enacted, investors need to allow time for the market to react to the terms of the Merrill settlement and additional analyst disclosure rules adopted by the Securities and Exchange Commission. The new disclose rules, among other things, require analysts to disclose whether they or a family member own a particular stock and whether an analyst's firm does any investment banking work for a company. "We need to take stock of these significant new changes that are just coming on line now," says Stuart Kaswell, general counsel for the Securities Industry Association, a Wall Street trade group. "The idea that we need a whole new brave new world is premature."