Sunday, November 1st, 2009
goodbye to all that

Yesterday marked the end for me of more than six years of direct involvement in one of the biggest regulatory actions in financial market history, the Global Research Analyst Settlement.SEC | This is a link to the SEC’s series of documents on the settlement.  For the record, throughout the settlement the Wikipedia entry has been inaccurate as to the monetary penalties paid by the settling firms.  I’m waiting to see how many years it takes for it to show up correctly. For a man of a certain age (today), looking back wistfully on the experiences of life can become something of a habit.  In this series of postings on the settlement, I will try not to veer into that sort of reflection, but to focus on the unique views of the business that my window provided.

Born of conflicts of interest in investment research that came to light after the bursting of the dot-com bubble, the settlement started with a bang of publicity and piece by piece is ending with a whimper, overshadowed by an even bigger crisis that posed an alarming risk to the financial system and further eroded confidence in Wall Street.  The settlement had several components, including mandated operational changes at the firms and penalties levied to fund investor education, restitution, and the provision of independent research to clients of the firms.  It was an independent research program that I ran on an arms-length basis for one of the settling firms.

I am not well versed in the investor education or restitution programs, but published commentaries have disparaged their lack of effectiveness.Securities Law Prof Blog | Judge Pauley, who presided over the settlement, also expressed his displeasure with the execution of those elements of the order. Of more impact were those operational changes.  It is hard to sort out the effect of the settlement from everything else going on at the time, since other regulations that came into being shortly before it, such as Reg FD (fair disclosure) and Reg AC (analyst certification), also targeted the abuses that had been uncovered.  Interestingly, some of the operational strictures that applied to the firms that settled were never required more broadly throughout the investment banking industry, so that practices outlawed at some firms were not outlawed at others.  Nevertheless, the spotlight caused changes in the relationship between investment research and investment banking at sell-side firms, whether they were subject to the settlement order or behaviorally affected by the attention that it generated.

One of the most noticeable effects of all of this activity was the change in the distribution of ratings on stocks by brokerage analysts, there being far fewer buy-rated stocks and more “holds” and “sells” than had been the case.  (This has subsequently reversed to a great degree.)  One other phenomenon that occurred was a migration of investment research talent from the Street, with experienced and well-known (read “expensive”) analysts going off to hedge funds, traditional buy-side shops, or, in some cases, starting their own firms.  It is hard to ascertain the degree to which the settlement contributed to those movements, but there is no doubt that it played a key part in them.  Other effects could be seen in the IPO process, sales trading, and elsewhere throughout the business.

As for the independent research component of the settlement, some wags have said that its primary benefits flowed to the independent research firms that won the business and the independent consultants (like me) that ran the programs for the twelve investment banks.  For obvious reasons, I’ll leave that assessment to others.  Quite apart from the money, it was an enriching experience for me.

When I received the phone call out of the blue during which I was asked if I was interested in serving as an independent consultant,the research puzzle | You’re right, the word “independent” comes up a lot when talking about the settlement:  “independent research,” “independent consultant,” “independent monitor,” etc.  I touched on this a bit in a Fourth of July piece called “celebrating independence.” I responded that the assignment sounded like it was “right up my alley,” but I had no idea how well in practice it would fit my interests and expertise. Almost perfectly, I am pleased to report, since it was a blend of the theoretical and the practical, required good due diligence skills, concerned a range of investors and investment firms, dealt with the nature of the investment process employed by the creators and users of research, and involved the operational issues in delivering investment information in an accurate, timely, and revelatory way — all things I have worked on during my career.  Add the fact that I had complete authority and responsibility to create and operate the research program within the regulatory framework that existed, and you have what could be called a dream job description.

There were important developments, intriguing considerations, and interesting people galore along the way, which I’ll touch upon in posts to follow in the coming days.