In yesterday's show hearing about conflicts of interest on Wall Street, the players all played their roles well. Members of Congress were disturbed to learn that -- gasp -- the research arm of a brokerage also often works with the investment banking side. In fact, the SEC found that 30% of analysts in its study owned pre-IPO shares of companies the analysts eventually covered. Despite the outrage, though, expect no action.
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I'm here to report on yesterday's meeting of the U.S. House of Representatives Subcommittee on Capital Markets, which is investigating conflicts in Wall Street's research practices, and I'm having a hard time suppressing my inclination to be sarcastic. A few noteworthy items emerged in the hearing. Most notably, the Securities and Exchange Commission (SEC) revealed that 30% of analysts surveyed owned pre-IPO shares of companies they covered. I'll get to that in a minute -- I promise. First, though, I've got to blow off some steam. Quality tragic-comedy The play featured the SEC acting chair, Laura Unger, in the role of the embattled ambassador -- Horatio, if you will -- trying to provide a balanced solution for all. Appearing in cameo roles were: The greatest actors, though, were the Congressmen in the chorus, expressing disbelief. How could this kind of behavior be taking place? They were like outraged parents, who stumbled into their death-metal-obsessed child's room and exclaimed, "What's this? A basin of yak's blood? And have you been doing drugs? Can this be true?!?" No, wait, they were more like crooked cops, who've been getting kickbacks for years from a floating crap game, suddenly saying, "What's all this then?" when someone notes that the game may be illegal. Analysts' conflicts of interest But who would have guessed that 30% of the 57 analysts the SEC investigated owned pre-IPO shares of companies they later covered? While "friends & family" shares have been known to go to analysts before, that number is high. More disturbing, however, was Unger's testimony that only one of the nine major underwriting firms was able to supply the SEC with a list of analysts who owned pre-IPO shares. Unbelievable. Do firms think this is irrelevant information? Do the firms have no internal codes of conduct that require disclosure of such things? How about this: Several of the analysts, who held pre-IPO shares, sold them while maintaining their buy rating. One even shorted a stock he rated a buy. These things happened in 1999. According to Unger, firms were required to disclose this information under the regulations of the SROs, or self-regulating organizations, such as the securities exchanges and registered associations. The SEC is now looking into the matter, but it will take time to do so. Basically, Wall Street firms have been flouting SRO disclosure rules. Not surprising. They have also used sell-side analysts to obtain investment banking business. This is also not surprising; in fact, it's well known, and has been for some time. Fortune ran a cover story on it a few months' ago, which reportedly triggered the hearings in the first place. Look, research is not a business that pays for itself. As Lashinsky pointed out, the people who are upset about poor recommendations are mostly people who paid nothing for them. Market making has turned into a weaker business lately, too, with the advent of the Internet and of decimalization. The money is in investment banking, so it's no surprise that the big brokerages hold it as priority #1. Lashinsky proposes some potential solutions, such as splitting investment banks from brokerages, requiring greater disclosure, or actually supporting Regulation Fair Disclosure (Reg FD). Don't hold your breath for the first, which the likes of Merrill Lynch (NYSE: MER) and Morgan Stanley Dean Witter (NYSE: MWD) would fight tooth and nail -- just look at the stink raised over toothless ol' Reg FD. There is more hope for the second and third, but Wall Street has shown its contempt for regulations before. Without significantly more SEC oversight -- even during bull markets -- expect no change. And from Unger's testimony, it's not clear that she's interested in more work for the SEC. She thinks more investor education is the answer. Well, it certainly can't hurt. We're with her on that. Unfortunately, most people won't learn. All we can do, I guess, is educate ourselves, try to educate others, and deal with the consequences. The most likely result of this hearing, in my opinion, is that we'll be right back here, playing our familiar roles, the next time the market tanks. Brian Lund, it is said, hums old Genesis tunes in his sleep. His stock holdings can be viewed online, as can The Motley Fool's disclosure policy.
Are you a fan of mock drama? If so, I recommend that you tune into the hearings. You can hear yesterday's event on Hearings.com, but you'll want to watch the next meeting live, so that you can register the full pathos of the actors.
So it turns out that the big political donors on Wall Street have occasionally made their money in, well, less than forthright ways. Let's not say "illegal," though some of the committee members did use the "f" (for fraud) word.
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