Laura Unger, the acting chairwoman of the Securities and Exchange Commission, told Congress on Tuesday that the agency has found that conflicts of interest run deep and wide among analysts at almost all the nation's largest brokerage firms. And, in an interview following her testimony, she said that some of the analysts' actions may become the subject of enforcement cases brought by the regulator.
Testifying before Congress on the biases that have come to light, doing severe damage to the credibility of Wall Street research, Unger said her staff had studied research departments at nine major but unnamed brokerage firms that underwrote large numbers of initial public offerings recently.
Confirming investor fears that analysts are primarily salespeople for their firms, the SEC found that at all the firms, analysts helped their investment banking departments win stock underwriting deals by participating in road shows to drum up investor interest and by initiating research coverage in prospective banking clients.
According to Unger, 40, the examinations also determined that many analysts had significant involvement in startup companies before their shares were offered to the public and had acquired shares in private companies at a fraction of the price that public investors later paid. More than one-quarter of the 57 analysts reviewed had made pre-initial public offering investments in companies they later followed, initiating their coverage with a buy recommendation.
The commission also found that three of these analysts executed trades for their own accounts that were contrary to recommendations they made to the public. One analyst sold a security short while advising the firm's clients that the company was a buy.
Unger's testimony also belied the claims made by most Wall Street firms of vigilant compliance departments set up to scrutinize all their employees' personal stock trading. According to the commission's initial examinations, just one firm could accurately identify investments made by employees in companies the brokerage firm later offered shares in to the public.
This laxity came as something of a shock to Unger. "It surprised me that a number of firms that have very rigorous compliance procedures in other areas do not appear to be as conscientious in the area of analyst conflicts," she said in the interview. "Only one of the firms examined could provide any information on employees' ownership interest in companies they underwrote. That's pretty egregious."
The results of the SEC's examinations were presented to the House of Representatives subcommittee, chaired by Richard H. Baker that has been examining analysts' conflicts. Tuesday's hearings were the second of three hearings.
Baker called the most recent testimony very disturbing. "It has established in my mind that concerns about the bedrock of ethical conduct on Wall Street are totally justifiable," he said in an interview. "And we must make the effort to act with the self regulatory organizations and the SEC if necessary. If six months from now we have not seen significant change in industry practice, I am convinced that decisive action must be taken."
Indicating how closely analysts work with their investment banking colleagues, six of the firms examined by the SEC reported that their analysts had provided bankers with advance notice of a pending change in recommendations. The examinations also determined that current brokerage firms' disclosure of analysts' and firms' ownership in recommended securities varied widely. In some instances, the SEC said, analysts' ownership in a covered company was not disclosed at all in the research report.
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