Few Believe $1.4B Deal will Change Wall St.

By Thor Valdmanis, USA TODAY

NEW YORK — Goldman Sachs caused an uproar this month when it upgraded Allianz a day before leading a $4.8 billion offering of the insurer's stock.

After two years of almost non-stop Wall Street scandal, corporate governance gurus, not to mention rival bankers, were quick to accuse Goldman of dirty dealing. Never mind that Goldman analysts and investment bankers are no longer even permitted to exchange pleasantries without a lawyer present.

"Given everything that has happened, it beggars belief that anyone would think that banks conduct research these days at anything other than arm's length," says Goldman managing director Lucas van Praag. "But there is still a great deal of skepticism out there."

Talk about an understatement. Even with the Securities and Exchange Commission's aggressive move Monday to impose a record $1.4 billion in penalties on Goldman and nine other top investment banks in addition to a laundry list of structural reforms designed to end Wall Street conflicts of interest, most Main Street investors remain nonplused.

"I have no faith in Wall Street. There is no one there to protect you," says Joy Veit, a 62-year-old Minnesota real estate saleswoman who lost more than half of her retirement savings on tech stocks. "It's a nightmare."

While many applaud the effort to crack down on dishonest bankers and rebuild the "Chinese Wall" separating research and investment banking, few believe it will fundamentally change how Wall Street operates. The "settlement merely bandages a broken system," says former analyst Scott Cleland, who runs Investorside, an association of independent research houses. "We are glad for the enforcement action, but there is still a lot of work to do to clean this mess up."

Many critics fear that the settlement, hammered together after months of intense and highly politicized negotiations, will trigger a host of unintended consequences. Experts warn stock research could become less available and more expensive. Unknown companies could find themselves shut out of Wall Street and starved of cash.

"We fully agree with the separation of research from banking," says Louis Thompson Jr., president of National Investor Relations, which represents 2,400 public companies. "But this deal is going to make it more difficult for small and midsize companies to get analyst coverage and access capital markets. And investors are going to see less research."

Many Wall Street observers see more transparency as key. But there are concerns that more regulation will bring more problems.

If securities regulators harbor any worries, they were certainly not on display during the unveiling of the Wall Street settlement Monday at the Securities and Exchange Commission in Washington, D.C.

"I'm confident that this enforcement action has delivered a message that the firms will not soon forget," SEC Chairman William Donaldson said at an afternoon press conference.

New York Attorney General Eliot Spitzer, who was the first regulator to take on Wall Street two years ago, went a step further.

"We are at a rare moment," Spitzer said, expressing the hope that the deal would prove as pivotal as the trust-busting business reforms promoted a century ago by President Theodore Roosevelt.

What is certain is that the nation's biggest banks, struggling with the worst industry downturn since the Great Depression, have been humbled by the biggest settlement on record for violating securities laws.

Citigroup, Credit Suisse First Boston and Merrill Lynch faced the indignity of being accused of issuing "fraudulent" research. All the banks had to endure the disclosure myriad e-mails and internal memos that shed light on how Wall Street firms touted stocks to lure investment banking clients.

"Ironically, this is a settlement that the industry needed more than the regulators," says Columbia University law professor John Coffee. "Banks need to be able to say that they have put all this behind them. But in reality it could take some time."

Stephen Cutler, head of the SEC's enforcement division, held out the possibility that senior Wall Street executives could still face individual charges in the coming months. Firms have also put aside more than $3 billion to cover possible settlements in class-action lawsuits and arbitration cases brought by shareholders angry at heavy stock market losses.

"There are going to be a lot more arbitration actions filed on behalf of individual investors who lost billions due to fraudulent research," Indianapolis attorney Mark Maddox says. "Our office is gearing up to do hundreds of these cases."

Possible side effects

But the larger issue is whether the settlement will create a more transparent and investor-friendly Wall Street. Regulators argue the settlement will eliminate the main cause of the biased research by outlawing deal-related bonuses for stock analysts. Analysts will also be barred from initial public offering "road shows" and other pitches to lure corporate clients.

The danger, of course, is that investment banking has historically subsidized Wall Street research, which still accounts for 95% of all coverage. If banks are unable to use research as a marketing tool to lure clients, many experts believe they will simply exit the business.

That is already happening. While firms such as J.P. Morgan Chase are venturing to countries like India to hire lower-cost analysts, most are simply slashing staff. At the height of the dot-com boom in March 2000, there were 3,600 analysts covering 5,900 stocks, according to Zacks Investment Research. Today, there are only 3,000 analysts covering 4,498 stocks, a drop of 23%.

"If you are one of those companies without coverage, you are working around the clock trying to find an analyst," Mitch Zacks says. "You don't want to be an orphan."

With a universe of 8,000 publicly traded stocks, many companies are being forced to take extreme measures to get coverage and raise their profile — even paying for it. Small boutiques such as J.M. Dutton and Chatsworth Spelman Associates will initiate research coverage of a company for a five-figure annual fee.

Regulators say research houses will pop up thanks to settlement provisions calling on Wall Street to underwrite independent research to the tune of $432.5 million over five years and use it to complement their in-house product. A competitive marketplace could also be created. Firms will also have to publish the results of stock-picking prowess, much as Morningstar and Lipper now rank mutual funds.

But critics say high-quality research firms won't participate because their big institutional clients — pension funds, insurance companies and university endowments — will not want the reports shared with the public.

"We are not going to see many good independent research boutiques getting involved in this settlement program," says Chuck Hill, research director at analyst-tracking firm Thomson First Call. "I'm afraid the kind of independent research small investors get will be lacking in quality."

Other potential side effects: Many midsize and small companies are going to find it tougher to raise money now that analysts are prohibited from initiating coverage as part of an IPO deal.

Brad Hintz, the brokerage industry analyst at Sanford Bernstein and a former Lehman Bros. chief financial officer, says IPO volumes are down almost 60% from their highs three years ago as many private companies wallow in obscurity. The situation will likely worsen while big IPO issuers hang on to the little business being generated.

"Inadvertently, Spitzer will have locked in the market share of the big equity underwriters," Hintz says. "The Morgan Stanleys, Goldmans and Merrill Lynches of the world will come out as the winners because you can no longer compete on research anymore. You can only compete on distribution, which these guys have in spades."

Investors remain dubious

All of this, of course, is beside the point for shell-shocked individual investors, who witnessed more than $7 trillion in shareholder wealth evaporate over the past three years.

Despite the groundbreaking nature of the settlement, some investors said they would not change their methods much. Al Kondraschow, a 45-year-old systems engineer in Chicago, said that even before the settlement he never relied on Wall Street research. Instead he seeks investment advice from multiple sources before buying or selling anything. He has access to independent research from his account with Charles Schwab.

"I would never go by one person's opinion," Kondraschow says.

Richard Shade, a 53-year-old training consultant in Arlington, Va., says he's pleased to see the Wall Street investment banks finally have paid for issuing faulty research during the boom.

"During the late 1990s, there was a lot of disinformation promulgated by the analysts to convey misleading information to individual investors to inflate stock prices," says Shade, who reads Wall Street research.

But Shade admits his perception of Wall Street research is forever changed. "Rather than taking it at face value, I'm going to do more individual research," he says.

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