In addition, new internal policies adopted by Citigroup, and expected to be adopted by other banks, would bar analysts from attending road shows, traditionally another large perk in selling an IPO. Although some CFOs don’t think that losing these perks are a big deal, they do protest the intent of the changes–cutting analysts out of the IPO process.
“To exclude them from the process is a fundamental mistake,” says Ken Goldman, CFO of Siebel Systems. “It’s good for analysts to get involved in these deals. It’s the one time they can really get inside a company and understand what’s going on internally, because it’s still private. They can get information they couldn’t otherwise obtain.”
“This one was a tough pill for the analysts to swallow,” admits the NASD spokesperson. “It was one of the more controversial rules.” However, the new rules would do nothing to change the standard practice of underwriters offering to initiate analyst coverage as part of an underwriting deal. So why is one prohibited while the other is allowed? “If they didn’t have coverage [being initiated], it would be harder to sell the deal,” says the spokesperson. “But if the analyst hated the company, they wouldn’t take them on in the first place.”
Some experts say that the new rules would continue to allow clear conflicts of interest, while minimally affecting the investment bankeranalyst relationship. By agreeing to comply with the rules, investment-banking firms can crow that they have taken positive steps to ensure their analysts’ credibility.
Will analysts who have green-lighted an IPO suddenly become impartial once the offering is complete? It’s doubtful; analysts will still draw their salaries from investment-banking revenues, although bonuses for specific deals will be prohibited. “As long as research exists on the same P&L as banking, you’ll never get rid of this problem,” says Lavallee. Most of the corporate financial executives polled in the CFO survey would like to get rid of it: 71 percent say that the regulators should mandate a complete, legal separation between analysts and investment banking.
One can only speculate on what effect the new rules will have on the capital-raising process. “It’s possible that [the cost of capital] will go up,” says Jay Morse, CFO of The Washington Post Co., “but I think it will be very small.” Almost half of the survey respondents think a legal separation wouldn’t increase the cost of capital at all, but 29 percent think it would increase the cost. Meanwhile, the NASD and the SEC have both made it clear that they aren’t finished tinkering with the investment bankeranalyst relationship. While it’s hard to make predictions, some outcomes are less likely than others. For example, even though most respondents in the CFO survey think that analysts should be legally separate from banking, that probably won’t happen anytime soon, say experts.
“Lopping off research from the rest of investment banking firms is not a good idea, either in theory or in practice,” comments Dwight Crane, a professor at Harvard Business School and co-author of Doing Deals: Investment Banks at Work. “A full-service bank has a corporate finance department, a trading department, an institutional sales force, and a retail sales force. One analyst team serves all of those groups. They screen investment-bank deals, they provide content and ideas to the institutional and retail sides. We can imagine efforts to make the research team 100 percent credible with the public through a complete separation, but it would make it less useful to the rest of the bank.”