The Securities Industry Association released its "Best Practices" report yesterday, intoning that firms should keep their investment banking and analyst businesses separate. This righteous statement came one day before the House of Representatives begins hearings on Wall Street shenanigans. Conflicts of interest have and will continue to occur, as long as money is to be made. Protect yourself from them, since no one else will.

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By Brian Lund (TMF Tardior)
June 13, 2001

"First, many in Wall Street -- a community in which quality control is not prized -- will sell investors anything they will buy."
    --Warren Buffett, chairman of Berkshire Hathaway (NYSE: BRK.A), in his 2000 Letter to Shareholders.

Wall Street firms, in the form of the Security Industry Association, came out with a strongly worded Best Practices for Research (.pdf document) yesterday. It declared that the investment-banking arm of securities firms "should not promise or propose specific ratings to current or prospective clients when pursuing business." There must, it said, be independence and integrity in all branches of the business, from sell-side analysts to research managers to investment bankers.

Thank goodness. Now we can all relax, secure in the knowledge that Wall Street will stop chasing top-dollar initial public offerings (IPOs) by promising to maintain positive coverage of companies. No more will sell-side analyst ratings be driven either by buy-side stock purchase decisions or possible future underwriting business. No more will the Street chase the quick buck. It's all about integrity now.

Coincidentally, this report comes just days before the House's financial services subcommittee on capital markets examines complaints about the potential conflicts of interest between ostensibly objective research analysts and the underwriting divisions of the investment banks that employ them. The House also wants to talk about "grade inflation" in research ratings, 98% of which fall between "strong buy" and "hold." With the Street's new commitment to integrity, though, these meetings are moot. Whew! Glad THAT'S over.

Don't bet on it, Pollyanna. Like most of Wall Street's public pronouncements, the Best Practices paper is high on form, low on substance. Much is blustered but little said, as every paragraph but one is peppered with the word "should," as in "I really should lose some weight," or "I should do something about this elephant in the room." (The one paragraph without "should" talks about "key responsibility.") The paper even has the look of propaganda. The first four pages are essentially wasted space, the text appears sporadically in a narrow band on each page, and the graphics are beautiful.

This is not the first time Wall Street has tried to convince investors of its integrity. During hearings on Regulation Fair Disclosure, Carlos Morales of Merrill Lynch (NYSE: MER) wrote rhapsodically about his firm's integrity. Bill Barker debunked that theory at the time.

Evidence to the contrary from other research first has continued to pile up. A note leaked from JP Morgan Chase & Co. (NYSE: JPM) showed that the company mandates that analysts get feedback from its investment bankers and corporate clients prior to changing stock recommendations. Fortune did a cover story about Morgan Stanley's (NYSE: MWD) Mary Meeker that demonstrated a strong tie between sell-side analysts and investment bankers.

And just today, Goldman Sachs (NYSE: GS), once one of Wall Street's most-respected firms, dropped Loudcloud (Nasdaq: LDCL) from its Recommended List after the stock dropped 30%. Was Loudcloud really one of the company's best investment ideas? Let's hope not. It is noteworthy, however, that Goldman was one of the co-managers of Loudcloud's IPO. Goldman similarly downgraded Webvan (Nasdaq: WBVN), a company for which Goldman was the lead IPO underwriter, on Dec. 18 after investors who took its advice had lost -- get this -- 97.5% of their investment. It's hard to strongly recommend a stock that does that badly.

As long as there is big money to be made for a company if one branch works with another, they will work together. However Wall Street or the House or The Motley Fool thinks they should act, securities firms will take advantage of opportunities to make big money. Perhaps the only way to stop this is to legislate against it. But with the deep pockets in New York, don't count on that anytime soon.

Instead, just be aware of the conflicts that exist. Don't buy and sell based on analysts' recommendations alone. If you have money with an asset manager that has an investment banking division, realize that it cares more about its financial health than yours, and may use you to its benefit as much as it reasonably can. Read the Best Practices paper so you know how manipulation can take place, and avoid it.

Don't count on the House or securities firms to protect your money. Do it yourself.

Brian Lund doesn't count on working on Wall Street anytime soon. Of the companies mentioned, he owns shares of Berkshire Hathaway. The Motley Fool is investors writing for investors.

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