In the offices of buysiders, regulators, marketmakers and corporate America, the debate continues: if investor confidence is to be restored in investment-banking firms-and the stocks they underwrite-should securities research be completely separated from the powerful influences of those firms' corporate-finance arms? Some bulge-bracket houses have taken the lead to dampen sentiment favoring such a split. To ensure the independence of its research team, Credit Suisse First Boston in July 2001 implemented a policy prohibiting its equity and fixed-income analysts from purchasing the securities of companies they cover. This May, the firm committed to completely separating the determination of analyst compensation from the company's investment-banking activities; to creating an internal committee to review the analytical basis for all initiations of, and changes to, stock ratings; and to institute a new system to monitor the electronic communications between investment bankers and research analysts. In a related move that month, Goldman Sachs appointed E. Gerald Corrigan, former head of the Federal Reserve Bank of New York, as investment-research ombudsman. Additionally, the company this summer announced a new stock-rating system-as did Credit Suisse First Boston-to ensure the objectivity and integrity of its investment research. And it established research-review committees to approve all stock ratings. "At this firm, research is a stand-alone division," stresses Andrea Rachman, a spokesperson for Goldman Sachs. "Analysts aren't able to own stocks in the sectors they cover, and they've never been compensated based on any formulaic percentage of investment-banking revenues." Notwithstanding these steps, one major Wall Street firm has opted to break ranks with its peers. Citigroup, recently under investigation by securities regulators and New York Attorney General Eliot Spitzer for its Enron and WorldCom dealings, says it's separating its equity research and investment-banking activities. A new Citigroup entity with a not-so-new name-Smith Barney-will handle stock research and retail brokerage operations. The head of the new group, Sallie L. Krawcheck, will report directly to Citigroup chairman Sanford I. Weill. The corporate-finance arm of the reorganized financial institution will become Citigroup Global Corporate and Investment Bank. Outspoken market observer Fadel Gheit, senior energy analyst for Fahnestock & Co. in New York, has long called for such a separation. "The revenue mainstay for most of the big Wall Street houses is the investment-banking side of the business," he says. "It dictates what the research side does. And analysts at those firms are under pressure to support that business because a big chunk of their compensation comes from it." Indeed, in August 2001, one analyst put a Sell rating on Enron at $38 per share and was reportedly dumped by his investment-banking firm which, coincidentally, had corporate finance ties to Enron. Two months later, another analyst issued an unbelievable Buy recommendation on Enron, after its share price had toppled to $15. This had the ring of selling deck chairs on the Titanic. "The system has to be drastically reengineered, and that means forbidding major investment banks from owning research organizations," says Gheit. But if investment banking is severed from research, who picks up the tab for the latter's efforts? "There are pure research firms like Argus Research in New York that have been successful for many years," contends the analyst. While pure research firms may not be all that plentiful, discussion is under way of creating a special pool-as much $1 billion-that would be funded by large investment banks and brokerages to back such independent equity researchers. That said, does it really make sense to separate investment banking from research? Given the market jitters that now exist, it might allay investor fears in the short term. But in the long run, analyst independence will be best achieved by stronger financial corporate governance, greater regulatory oversight and stiff jail time-not "Club Fed"-for bankers and analysts who betray investor trust. It's a cinch that simply fining Wall Street firms $100 million isn't going to make them blink. Says Gheit, "They can make that up in one deal."
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