Near the Corner of Church and State (Update)

Efforts to insulate sell-side analysts from investment bankers will hurt some capital-raisers, but help others.


In a speech given in 1999, Arthur Levitt, then chairman of the Securities and Exchange Commission, spoke eloquently about a “web of dysfunctional relationships” which was inexorably undermining confidence in U.S. financial markets. During the speech, Levitt roundly criticized, among other things, the close ties between Wall Street investment bankers and their research analyst colleagues.

Since everybody on Wall Street — and Main Street — was making a killing in the market at the time, nobody much listened to Levitt. In fact, the issue barely made it onto the radar screens of market regulators

Three years later, the incestuous relationship between investment bankers and sell-side analysts has become fodder for supermarket tabloids, let alone market regulators.

In April, for example, New York State Attorney General Eliot Spitzer made national headlines when he charged that rain-makers at Merrill Lynch, Wall Street’s largest firm, had urged the bank’s research analysts to issue buy recommendations on potential banking clients.

Then, late last month, the National Association of Securities Dealers fined U.S. Bancorp Piper Jaffray $250,000 and managing director Scott Beardsley $50,000. The reason? The NASD claimed bankers at the firm threatened to drop coverage of Antigenics Inc. unless the biotech company hired U.S. Bancorp to underwrite a stock offering.

NASD’s dramatic actions came just weeks after the SEC had greenlighted Nasdaq’s new rules governing analyst independence. Those rules, which are now in force at the New York Stock Exchange as well, strictly prohibit sell-side analysts from promising favorable corporate coverage in exchange for investment banking business. The rules also bar investment bankers from overseeing sell-side analysts.

While the new prohibitions may help restore a sense of church-and-state in investment banking circles, the rules may not be greeted warmly by some finance chiefs. Wall Street, observers point out, is a two-way street, and corporate capital raisers often have benefited from investment bankers’ sway over analysts.

In fact, some observers say it’s not uncommon for a company’s CEO or CFO to demand positive stock coverage in exchange for the company’s banking business. The larger the prospective client, the greater the clout.

Says Sam Miller, a partner and chair of the market-regulation group at law firm, Orrick, Herrington & Sutcliffe: “There is no question that there has been a history of issuers strong-arming analysts and their firms.”

Off the Guest List

Take the case of BellSouth. According to information gathered by economic consultants A. Gary Shilling & Co. and published in CFO magazine, management at the Baby Bell apparently excluded Salomon Brothers from a $300 million bond issue in 1994 after analyst Jack Grubman criticized the company’s inefficiency. (Last month, Grubman appeared before the House Financial Services Committee to explain why he touted WorldCom two days before the telecom giant announced a $3.8 billion restatement.).

Another example: insurance company Conseco reportedly fired Merrill Lynch as the lead underwriter for the company’s $325 million debt offering after Merrill analyst Edward Spehar downgraded his stock rating for Conseco.


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