Responding to an outpouring of complaints, the US Securities and Exchange Commission has issued an alert to investors not to rely solely on stock analysts' reports when they make decisions about buying and selling stocks.
Laura Unger, acting chairwoman of the SEC, said that the alert was needed because investors may not fully understand the many roles that analysts can play at their firms and the inherent conflicts in those activities.
"This alert gives investors a framework for what to look for and identifies key issues that could compromise the objectivity of the research," Unger said.
The SEC's office of compliance, inspections and investigations will expand its scrutiny of analysts to encompass not only whether research is an independent function at brokerage firms, but also whether conflicts result when analysts own stocks they write about or when they are paid by a firm's investment banking arm for their work. If the examinations turn up extensive problems, Unger said, the SEC could take enforcement action or create new rules.
The SEC reported a surge in letters from investors who said they had lost large sums of money, sometimes their life savings or their children's college funds, when they based investment decisions on analysts' reports.
Representative Richard Baker, a Republican, chairman of the recent congressional hearings on analysts' conflicts, applauded the SEC alert. The brokerage industry recently introduced best practices in response to its critics, and Baker has appointed a review board to examine these guidelines.
The 13-person board includes representatives from the SEC, the National Association of Securities Dealers and the New York Stock Exchange, and academics such as Amy Hutton and Samuel Hayes, both from Harvard Business School, and Andrew Metrick and Robert Stambaugh, both from Wharton Business School.
The review board also includes two former Wall Street analysts who now work on their own. Thomas Brown, chief executive officer of Second Curve Capital and formerly with Donaldson Lufkin & Jenrette, has criticized brokerage firms for such dubious practices as linking an analyst's pay to investment banking deals he helped generate.
Jonathan Cohen, managing partner of JHC Capital Management, was an Internet and software analyst at Merrill Lynch until February 1999. While at Merrill, Cohen had been cautious on Internet stocks, in contrast to his replacement, Henry Blodget, who heartily endorsed Internet shares at lofty prices.
Earlier this week, Blodget dropped coverage on several Internet stocks that he has covered and that he had recently rated a buy.
"Maintaining the legitimacy and the quality of equity research is vital to preserving investor confidence and the efficiency of the public markets," Cohen said. "I am very happy to be participating on this review board and in this process."
Baker said each member of the review board would put recommendations in writing by mid-August. Then Baker and his staff will open a second round of hearings on analysts in early September. A third hearing is planned for later in the fall. "Then we'll determine if further legislative action is needed next spring," Baker said.
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