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Wall Street in Separation Mode

Securities: Major brokerages are seeking to cut potential for conflicts by splitting investment banking and research units.


NEW YORK — A number of major securities firms have held discussions with regulators about separating their stock research and investment banking units as a key step toward resolving multiple government investigations of Wall Street, sources said Thursday.

In a meeting with regulators set for this afternoon in Washington, Citigroup Inc.'s Salomon Smith Barney brokerage will propose a division of its research and investment banking operations as a central component of a plan to settle probes by federal regulators, one source said.

Goldman Sachs Group Inc. also is among those holding discussions with regulators about more clearly separating the two functions, to reduce the potential for conflicts of interest, another source said.

Wall Street firms also are discussing with regulators plans to prevent investment banking departments from playing a role in the allocation of initial public stock offerings. The government is examining whether brokerages awarded coveted IPOs to corporate executives in the late 1990s to lure banking business.

It is unclear how a formal breakup of research and banking divisions would work at individual companies or whether all Wall Street firms would be willing to agree to such a plan, sources said.

There is supposed to be a "Chinese wall" separating research from banking. But critics say that wall crumbled during the bull market, as bankers increasingly influenced analysts' ratings of stocks in attempts to curry favor with corporate clients.

The brokerage industry was embarrassed in the spring when New York Atty. Gen. Eliot Spitzer released private e-mails from Merrill Lynch & Co. that showed some of its analysts privately disparaging Internet stocks while publicly recommending them.

This year the Securities and Exchange Commission approved new rules for analyst conduct, and the National Assn. of Securities Dealers and the New York Stock Exchange are considering additional measures.

But Wall Street has long opposed the idea of cleaving research from banking, in part because stock analysis is unprofitable on its own. The fact that such a plan is being seriously discussed demonstrates how political sands have shifted and how eager brokerages are to lay the multiple government investigations to rest, experts said.

In reaching a settlement with Merrill Lynch in May, Spitzer considered requiring that the firm formally segregate research from banking. But the idea was dropped, in part because of concern that it would be unfair to require a split for just one brokerage.

The Salomon proposal, which sources said also would include an offer to pay a large fine to settle allegations of misconduct, will be made to officials from the SEC, the NASD and the NYSE.

Salomon, which has aggressively sought to settle investigations of its research practices and allocation of stock offerings, has been told by regulators that it must propose a reform plan with "real change" to reach a deal, a source said.

The SEC said Thursday that it is considering "the full range of possible reforms" of Wall Street practices. SEC Chairman Harvey Pitt, who some critics say has been slow to respond to Wall Street abuses, is trying to position himself as taking a tough stance, analysts said.

"There is something of a regulatory competition underway and the SEC doesn't want to look like the laggard that is always defending the industry," said John Coffee, a Columbia University law professor.

However, completely dividing research and banking could lead to a major contraction of Wall Street stock research, some experts said.

"It's not clear whether research departments could stand on their own," said Chuck Hill, a brokerage-industry expert at Thomson First Call in Boston.

Also, a split that shrinks overall market research probably would mean less coverage of smaller firms, Coffee said. An information vacuum could make stock manipulation easier.

Through the 1990s, research and banking units became increasingly intertwined at many brokerages, with the highly profitable banking units often helping to subsidize money-losing analyst operations.

By contrast, stock research paid for itself in the 1960s and 1970s as firms charged high trading commissions to individual and institutional investors. That began to change in 1975 when deregulation caused commissions to plunge.

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