Sellside Analysts Suffer in Fallout from Scandals
Byline: Lynn Strongin Dodds
Ever since the first pop in the TMT sector was heard and the Enron accounting scandal broke, research analysts have been in the firing line. Once the darlings of the investment world, their crowns were knocked off by plummeting share prices and accusations that they misled investors with their cheerleading of troubled companies, especially in the technology, media and telecommunications sectors.The result has been a host of investigations and regulations that have stopped short of disassembling the integrated investment banking model. While the glare of attention has been aimed at US-based brokerage houses, most are global in nature and are implementing the slew of newly issued rules across their overseas operations.
European firms have not been blameless. They may not cater to the same large and litigious retail investor base as in the US, but analysts in Europe were swept away in the dot-com euphoria and wrote overly enthusiastic reports about fledgling firms. Europe has its own beleaguered companies, such as Vivendi Universal, that escaped many analysts' attention. Regulators and trade groups have reacted by publishing their own dictum and everyone wants to be seen toeing the line to win back investor approval.
The big question, of course, is will the new world order address the conflict of interest issues and restore investor confidence, especially in these turbulent markets?
The answer is mixed. While most in the industry agree that greater disclosure and transparency will help repair the analysts' tarnished images, few believe it will resolve the age-old tug of war between corporate finance and investment research departments. As one industry observer says: "The brokerage houses are being forced to make cosmetic changes that will make investors and companies happier. In many cases, the analysts have become the scapegoats because they were under internal and external pressure to make Buy recommendations, especially on internet stocks. It is interesting to note that the regulators did not go after the top investment bankers but have only gunned for the analysts. So far, it has been very one-sided. Also, if history is any guide, memories are short and all may be forgotten if the bull market returns."
Citigroup's brokerage arm in the US is the latest to dominate the headlines. Jack Grubman, Salomon Smith Barney's controversial telecoms analyst, was forced to resign earlier this month after being caught up in an investigation by Congress into SSB's relationship with the bankrupt WorldCom; he was also the subject of an investigation by the National Association of Securities Dealers (NASD). Senator Michael Oxley, chairman of the US House financial services committee, demanded that the investment bank produce all documents related to its relationship with WorldCom. Grubman's relationships with WorldCom and telecommunication firms in general are also being scrutinised by Eliot Spitzer, the New York Attorney General.
Spitzer's knock at the door is not a welcome sound. He is seen as taking a much tougher stance than the Securities and Exchange Commission (SEC), which has been accused of being too slow in its probe of investment banking practices. In early April, Spitzer released a set of e-mails which showed Merrill Lynch's internet analysts privately disparaging firms they were recommending to investors. The investigation led to a $100m (E102m) out-of-court settlement for allegedly misleading investors.
Merrill also agreed to simplify its rating systems to three categories - Buy, Neutral and Sell - and to implement a new performance-based compensation system with no direct input from investment banking. Many of the changes the firm announced were also part of the new New York Stock Exchange and NASD rules that were approved by the SEC earlier this year. …