Regulators Announce $1.4 billion Settlement with Wall Street

USA Today

NEW YORK — Securities regulators Friday announced a $1.4 billion settlement with Wall Street investment bankers, aimed at protecting investors from brokerage firms' conflicts of interest.

"Every investor knows that the market involves risk," New York state Attorney General Eliot Spitzer told a news conference outside the New York Stock Exchange. "Nobody expects a guaranteed profit. But what every investor expects and deserves is honest investment advice — advice and analysis that is untainted by conflicts of interest."

The deal settles the largest case ever brought by regulators against the securities industry.

The nation's top 10 investment banks and brokerage firms will pay $900 million in fines, $450 million to pay for independent research and $85 million for what regulators called 'investor education.' Proceeds from the fines will be split among the investigating state regulators and the U.S. Securities and Exchange Commission.

It was not clear how much of the fines would go to a restitution fund for investors.

The payments are a drop in the bucket for most of the companies. Citigroup, for example, averaged about $65 million in profit each business day in the third quarter, meaning one good week would cover payments by its Salomon Smith Barney unit.

If the settlement payments turn out to be tax deductible, the companies are on the hook for considerably less money. The banks would have to show the IRS the payments are not fines, but compensatory damages to investors, which can be deducted.

New York Stock Exchange Chairman Richard Grasso would not comment on the tax status of the companies at the news conference announcing the deal.

The settlement excludes two smaller firms, US Bancorp Piper Jaffray and Thomas Weisel Associates, that had raised objections to the deal this week. Negotiations are continuing and those firms are expected to pay $20 million each, Spitzer spokesman Darren Dopp said.

The reforms establish a sweeping set of rules aimed at eliminating tainted Wall Street research and ending stock offering practices that investigators say were prevalent during the 1990s market boom.

Under the settlement, the firms' stock analysts will be barred from being paid for stock research by the firms' investment banking arms and won't be allowed to accompany investment bankers "on pitches and road shows" to lure investment banking clients. See details of the settlement terms in the box, right.

After months of back-room shouting matches and horse trading, the nation's top investment banks and brokerage firms reluctantly signed on to the settlement in an effort to buy peace after a punishing year of leaked e-mails and other internal documents purporting to show ugly behavior.

NASD Chairman and CEO Robert Glauber said the settlement "marks a vital step in restoring investor confidence. It underscores that the industry's highest duty is to investors. It makes plain that cleaning up research and IPO practices is not just good ethics, it's good business."

In agreeing to the fines, the firms neither admit nor deny charges that they had misled investors.

Firms led by Merrill Lynch and Bear Stearns feared that the inclusion of any wording in the final settlement that suggested they were admitting to wrongdoing would add to the mountain of shareholder arbitration and class-action lawsuits pending against the industry.

The companies could still face costly lawsuits from shareholders charging the brokerage firms slanted research to please corporations and win investment banking business for their firms.

Many critics say the regulators engaged in blackmail.

"Regulators rounded up the largest firms and fined them by height," says Roy Smith, professor of finance at New York University's business school. "It's arbitrary and unfair, and I can't see how that inspires confidence."

Debate is already raging about the long-term impact of the reforms. Will they improve transparency and level the playing field for small investors? Or will they reduce the quality and quantity of research as investment banks get out of a game that is costing them several billion dollars a year and independent boutiques pick up the slack?

Even advocates worry that the new rules will lead to a smaller universe of companies covered by stock analysts. At the moment, only a third of companies listed on the New York Stock Exchange are covered. Large fund managers might have to do more research, passing on costs in mutual fund fees.

"I would expect we would see a further shakeout in the securities analysts group, because there just isn't enough revenue to support the scale of research that we have seen in recent years," says Samuel Hayes, professor emeritus in finance at Harvard Business School. "The revenue on the retail investor side just isn't large enough."

But small, independent research houses, which don't have the investment-banking operations that regulators say create conflicts of interests for research analysts at big Wall Street firms, are positioning themselves to grab a piece of the business.

Thomas White, a former managing director at Morgan Stanley, just launched a consortium of independent research firms called Best Independent Research. "We're going to use third-party monitors to measure our performance, and that will ensure we are not infected by the investment banks that hire us," says White. "Small investors will pay higher commissions if they believe in the research."

Columbia University securities law professor Jack Coffee believes even small research boutiques will find remaining independent a challenge.

"The biggest problem is there must be sufficient controls to ensure that we don't simply convert independent research boutiques into very dependent economic satellites of the Wall Street firms that hire them," Coffee says.

What few debate, however, is that long-ignored conflicts of interest would not have been publicized without Spitzer's move this spring to take on Merrill Lynch and the rest of Wall Street.

But even Spitzer admits eliminating conflicts of interest on Wall Street is a tough task.

"Some banks have behaved more badly than others," Spitzer said this summer. "But they all suffer from the same ingrained industry conflicts."

Terms of the Settlement

Insulating research analysts from investment banking pressure.
Firms will have to sever internal links between stock research and investment banking, including stock analysts' compensation and the practice of analysts accompanying investment bankers when they call on companies to get business. This is aimed at ensuring that stock recommendations are not tainted by a company's effort to win investiment banking business.

A ban on "spinning" shares of initial public offerings (IPOs).
That is, firms can no longer set aside shares of lucrative IPOs for corporate executives who are in a position to give the firms their company's investment banking business.

Independent research.
For five years, each of the brokerage firms will have to contract with at least three independent research firms that will provide research to the brokerage firm's customers.

Disclosure of analysts' recommendations.
Each firm will make public its stock ratings and price targets, allowing the public to compare the accuracy of analysts' forecasts.

Fines (millions)Independent
research
(millions)
Investor
education
(millions)
Citigroup (Salomon Smith Barney)
$300
$75
$25
Credit Suisse FB
$150
$50
none
Merrill Lynch
$100
$75
$25
UBS Warburg
$50
$25
$5
Lehman Bros.
$50
$25
$5
Morgan Stanley
$50
$75
none
Bear Stearns
$50
$25
$5
Deutsche Bank
$50
$25
$5
J.P. Morgan
$50
$25
$5
Goldman Sachs
$50
$50
$10
Contact Us
Free Consultation: (800) 259-9010