Brokerages Get a Billion-Dollar Crackdown

Physician's Money Digest, July31 2003, Volume 10, Issue 14

Securities regulators and self-regulatingorganizations, including the NationalAssociation of Securities Dealers, haveordered 10 Wall Street firms to pay $1.4 billionto settle charges that the firms' researchanalysts gave false and misleadingadvice to curry favor with investment bankingclients. The settlement included reformsin how analysts dispense advice. Despite itsefforts to make the firms isolate their stockanalysts from sales and banking influences,the settlement likely will raise investorawareness of the importance of independentsources of research and advice.


Under the financial terms of the settlement,in which the alleged wrongdoersdid not admit or deny misconduct, theWall Street firms are required to:

  • Pay $875 million in penalties;
  • Make payments totaling $432.5 millionto fund independent research;
  • Spend $80 million (7 firms only) onprograms to teach investors how tomake informed decisions; and
  • Not seek reimbursement, indemnification, or tax deductions for penalties paid.Among the reforms agreed to in thesettlement, firms will be required to:
  • Sever ties between research analystsand investment banking operations, includingphysically separating the departments;
  • Prevent compensation for investmentbanking activities or compensationor department budgets on investmentbanking revenues;
  • Prohibit analysts from solicitinginvestment banking business; and
  • Contract with at least 3 independentresearch firms to furnish customerswith independent research.

Additionally, an analyst's compensationwill be based in part on the quality andaccuracy of their research. On a quarterlybasis, each firm will publish on its Web sitea chart showing its analysts' performances,including each analyst's name, ratings,price targets, earnings-per-share forecastsfor each covered company, and an explanationof the firm's rating system.

The firms also voluntarily agreed torestrict allocations of securities in "hot"initial public offerings (IPOs). This practice,known as "spinning," involves givingkey executive officers and directorspreferred access to IPOs that begin tradingin the aftermarket at a premium.

Perhaps the most noteworthy amongthe reforms is the requirement to separateresearch analysts from investment bankingoperations. Independent research is of criticalimportance to an individual investorbecause it permits decisions to be madebased solely on the investor's interests. Asthe terms of the settlement imply, investmentadvice based on biased informationcan't possibly give priority to what is bestfor an individual investor. In the case ofthe Wall Street firms that were party tothe settlement, research and recommendationswere dispensed to benefit thefirms by influencing banking clients andprospects to give the firms their business.

Broker-dealers that offer unbiased,independent investment research don't offerproprietary products and don't engagein investment banking activities. This allowsrecommendations to include a broadscope of investment products that are inthe best interest of the individual investor.


Ironically, just days after the settlementwas inked but before its provisionstook effect, a Bear Stearns financial analystwas caught promoting a new stockoffering. Bear Stearns apologized forthe incident, postponed the IPO, anddisciplined the analyst. However, theincident reinforced concerns that thebig Wall Street firms have yet to takethe imposed reforms seriously.

It is unclear how long it will take forthe settlement provisions to change WallStreet's thinking and habits. Investorswho use reliable sources of unbiasedinvestment research and advice may notneed to wait to find out.

Scott J. Kleimanis an independent

advisor with Linsco/Private

Ledger, located in Elkins

Park, Pa. All securities offered

through Linsco/Private Ledger,

member SIPC. Past performance

is no guarantee of future results.The

information presented is the opinion of

Scott Kleiman and not that of Linsco/Private

Ledger. He welcomes questions or comments

at 800-242-1760 or