It's amusing to those of us who have been
writing about the inherent conflicts between investment banking and brokerage research to see the rest of the world paying attention now. At TheStreet.com, this has been a core issue of our coverage since we began publishing in 1996.
CNBC, a shill for so many analysts for so long, now routinely asks research analysts to disclose situations in which their employers have provided investment banking services (like underwriting an IPO or providing merger advice) to the companies whose stock they're touting. The New York Times also has been after analysts a handful of times recently, which is kind of like closing the barn door after the horses are gone. Where were they when the individual investor was entering the stock market, not exiting it? But perhaps the most interesting example of the new "conflict-free" concept is a print and broadcast campaign by Prudential Securities, which touts that "objective advice begins with objective research." The funny thing about Prudential's line is that it's a tacit admission of what no investment bank will publicly acknowledge: Wall Street research is driven primarily by a desire to provide services to banking clients, not brokerage customers. "In a market like this, what investors need most is objectivity," continues Prudential. "You'll know that our award-winning team has only one guiding interest: you, the individual investor." Whoa! "In a market like this?" Translation: It was OK to hype the heck out of our underwriting clients when times were good. Now the climate is so bad, we've got precious little to hype, so we'll give the straight dope again until things turn around. I've written before that research doesn't sell. There's no way a firm existing only by selling opinions and investment advice could generate the kind of revenue an investment bank gets from equity offerings or M&A deals. But there's also no question that the system is broken. "Analysts who recommend stocks on TV and radio rarely mention clear conflicts of interest -- for example, that their trading desk, or they themselves, own stock in the company, or that their firm has an underwriting relationship tied to their recommendation," said outgoing Securities and Exchange Commission Chairman Arthur Levitt, in a November speech. And yet Levitt, the most activist SEC chairman in memory, declines to suggest a solution, other than asking analysts to be clearer about their conflicts. "While conflicts are often unavoidable, meaningful disclosure shouldn't be," he says. While disclosure is good enough for companies issuing stock -- caveat emptor, or let the buyer beware, certainly applies here -- it shouldn't be good enough for Wall Street. The big brokerage firms have built up a sham system whereby the only companies that get significant attention are heavily traded issues (which every firm follows) and banking clients (which, not coincidentally, are followed only by the two or three banks that underwrote their offering). It's not all Wall Street's fault, of course. Savvy chief financial officers have learned how to keep naughty analysts on a short leash: Those who find themselves out of favor with the CFO for making negative comments suddenly don't get their calls returned, don't get invited to company meetings and aren't fed friendly information. Regulation FD, the rule that requires equal dissemination of material information, should mitigate the CFO's ability to bully. But the symbiotic relationship between issuer and investment banker remains a problem for the individual investor, who now understands that he's been had but doesn't know what to do about it. A common refrain from Main Street (I've read this in reader email and even heard it at the auto mechanic) is that analysts should be sued or put in jail for their irresponsible calls. Sorry, not possible. So long as the analysts have disclosed their conflicts, stupidity isn't against the law. Prosecuting analysts isn't the answer. Instead, perhaps it's time for the SEC and the National Association of Securities Dealers to consider something more radical: cleaving brokerages from their investment banking brethren. This, of course, is just the opposite of what's gone on in the investment banking world for the past 15 years. There never was any prohibition on retail brokerages and banks being married. But it's relatively recent that retail institutions such as Dean Witter and Smith Barney got together with investment banks like Morgan Stanley and Salomon Brothers, respectively. Moreover, Merrill Lynch and Prudential, both with big retail networks, have their own banking divisions. So, the web is very tangled throughout the major brokerage firms. And because of this entanglement, brokerage clients have lost out. If banks did move away from providing analysis to retail clients -- creating a class of investment banks and retail brokerage firms, again -- the banks still would need analysts to help analyze banking deals and other transactions. But it's unlikely those analysts would want to communicate with the public anymore, because there wouldn't even be a pretense of selling them stock. Several securities lawyers I've spoken to about this maintain my plan is highly improbable. It flies in the face of the past decade-plus of consolidating financial services under one roof, not carving out independent pieces. Another point: The market will take care of some of this. Analysts who've made particularly bad calls will have a tough time making it through the bear market. And perhaps the market will desire more independent advice, making room for nonbanking analyst companies to emerge. But when the market improves, the touts will return. And just because consolidation is a good trend doesn't mean the securities industry should stand by and do nothing when the individual investor isn't being served.
To solve the inherent conflict between investment banking and sell-side research: The government should socialize all research departments, employing government analysts to provide advice to investors. Analysts should be forced to wear pins on their clothing with the logo (or ticker) of any recommended stock, along with the recommendation and disclosure of any conflict. Nonsense. There is no conflict. Stupid investors should stop whining. The SEC should force investment banks to pay analysts based on the accuracy of their advice. Congress should prohibit investment banks from owning retail brokerages.
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