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Can Outside Research Clean Up the Street?

Critics say forcing brokerages to supply independent opinions won't end conflicts.

November 04, 2002|Josh Friedman | Times Staff Writer

Stock research by major Wall Street brokerages has been shown to be tainted by inherent conflicts of interest. So securities regulators have come up with a novel plan for reform: Force the brokerages to give their investors the research of outside firms that don't face the same kinds of conflicts.

Backers say the idea would benefit individual investors by making available to them a range of opinions on stocks -- specifically, the opinions of analysts whose firms aren't also pursuing fee-rich investment banking work from companies the analysts are covering.

Many so-called independent research firms are small, little-known operations that now primarily provide their work to institutional investors.

Critics say the idea would just create a new conflict of interest by aligning the independent research boutiques with the scandal-tainted brokerage giants.

"We're kind of scratching our heads," said Scott Cleland, chief executive of Precursor Group, a Washington-based independent research firm. "The word 'independent' means 'not of Wall Street,' and now the government's solution is to have Wall Street be a distributor of independent research. We don't see how you remain independent."

The Securities and Exchange Commission and New York Atty. Gen. Eliot Spitzer, along with other state regulators, have been negotiating with the big brokerages in recent weeks, seeking a "global" settlement of allegations of widespread misconduct by analysts during the late-1990s bull market.

Probes by New York, Massachusetts and congressional committees this year have shown that some analysts touted stocks of even the most fundamentally weak companies to help their firms win lucrative banking work, such as underwriting stock offerings.

As part of a settlement, it's expected that regulators would demand that the 10 to 12 biggest brokerages shell out $1 billion over five years to fund the work of independent research firms and make that research available to their clients in addition to in-house research.

The brokerages have endorsed the accord in concept, but they reportedly are bickering about how much each should pay. A deal could be struck any time in the next few weeks.

Under the plan, an oversight panel would set standards for independent research and decide which research firms would get contracts to supply the brokerages.

The panel would be expected to pick the "most accurate" research firms for different stock sectors, say people familiar with the negotiations. But the question of how to judge accuracy could become contentious.

For example, three firms might be picked to cover energy, so if a Merrill Lynch & Co. client sought information on Duke Energy Corp., his broker would have to make available reports from those firms along with reports by Merrill's in-house analyst, according to people who have been part of the discussions.

To be included, independent firms would have to swear they have no investment banking ties and would have to meet other standards yet to be determined.

"We hope this will put integrity back into the [Wall Street] research business and stimulate competition," said Darren Dopp, a spokesman for Spitzer.

Paul A. Volcker, a former Federal Reserve chairman, and John Biggs, former head of the pension giant TIAA-CREF, have been mentioned as possible nominees for the research panel.

Yet critics question the idea of government-appointed bureaucrats directing the process.

Said Cleland: "Does anybody think a quasi-government body would be good at picking stock pickers?"

"Why not give investors everything and let the marketplace decide?" said Samantha Topping, spokeswoman for Multex Inc., a New York company that provides research, for fees, from more than 250 independent firms as well as from the big brokerages.

Cleland said Precursor, for one, wouldn't compete for any of the contracts. "It's temporary money and it's tainted money. It would undermine our integrity," he said.

Dopp called the critics misguided. "It would not be the government doing anything. This would be an independent panel and the money would be escrowed," he said. "This is not going to be 'Eliot Spitzer-sanctioned' research."

Some independent firms concur, saying they don't believe distribution of their reports through brokerages would taint their work.

"Our research already is being distributed through brokerage Web sites as well as [financial] advisors and our investor newsletter," said Sandy Bragg, executive managing director at the Standard & Poor's Corp. investment services group in New York. "Wall Street firms license our research today -- it's part of how we've built a successful business model. We don't have any qualms about that."

Other firms are taking a wait-and-see approach, saying key questions need to be answered.

"I understand they will pick the research firms based on accuracy, but how do you define 'accuracy'?" asked John Eade, president of Argus Research Co. in New York.

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