Spitzer's Plan: What's the Rush?


By Amey Stone New York State Attorney General Eliot Spitzer and the Securities & Exchange Commission have come up with an intriguing solution to the vexing problem of how to protect individual investors from conflicts of interest between research and investment banking divisions at brokerage firms.

The firms are being asked to spend millions each year to fund independent research and to create an oversight board that will ensure the quality of the research and that the research is distributed free to individual investors. The case for moving now: Quick action would restore faith in Wall Street and help the sagging stock market, Spitzer and regulators say (see BW Online, 10/25/02, "Spitzer's Solution: Team Research?").

CHOOSE OR LOOSE. This plan could limit, if not prevent, Wall Street from promoting a stock because the company is a lucrative investment-banking client rather than because the stock is a good buy. Yet despite the plan's surface appeal, it's being met with a barrage of cynicism and unease for one simple reason: Regulators seem to be rushing things.

That criticism seems more than justified. Wall Street firms, which met with securities regulators behind closed doors on Oct. 24, have only until Oct. 30 to agree to the new plan and thus settle the probe into possible misconduct in their research and investment-banking divisions.

A solution to a crisis that was years in the making can be formulated in a week? Doubtful. Investors are left guessing about the details -- and wondering if the regulators and securities firms genuinely care if they come up with something workable as long as they get headlines saying they've solved the problem.

LINING UP. The proposal initially caught the securities industry by surprise. Firms were expecting regulators to try to force them to spin off research divisions. That would have been hugely disruptive to Wall Street and probably would have resulted in inferior research for individual investors (see BW Online, 10/14/02, "A Chinese Wall -- or Several Fences?").

Yet after weeks of damaging headlines as the investigations drag on, the brokerages are so eager to put this public-relations nightmare behind them that they're expected to line up behind the plan. Says Terry Bird, a partner at Los Angeles law firm Bird, Marella, Boxer & Wolpert: "I'm afraid the firms are going to end up agreeing to changes in the system that may or may not work just to get on with life."

Even firms that don't do much business with individual investors, like Lehman Bros. (LEH) and Goldman Sachs (GS) may support the plan. If there's any opposition, it would likely come from the institutional players, which might not want to spend millions to fix a problem they don't have, says Reilly Tierney, an analyst with Fox-Pitt Kelton.

"BIG WINNER." Spitzer, who many believe has higher political aspirations, also benefits from a quick resolution, partly because he gets to proclaim a victory and then move on to other issues. "He won't go away unless you make him a winner, so you have to make him a big winner," says Richard Bove, an analyst with research boutique Hoefer & Arnett. Bove expects brokerage firms to initially agree to the settlement but then subvert it by bogging down the implementation process.

Would the proposal benefit from more time on the drawing board? "If they were serious, it would, but they're not serious," he says. "Now the issue is to get the thing gone." While Bove thinks the proposal for firms to fund independent research makes sense conceptually, "in terms of practical application, all I see is a big waste," he says.

He's not alone in his skepticism. "This was sort of a bizarre turn," Tierney says of the proposal. "Unfortunately, I don't think it's going to do much to restore investor confidence."

SLOW DOWN, OPEN UP. Indeed, where's the opportunity for public comment? Because the plan would be part of a legal settlement it wouldn't be subject to the SEC's usual rule-making process, which involves giving the public 30 to 60 days to review and comment on a proposal. And the SEC's only public comment on the process has been an Oct. 3 press release in which it said it would be working with state and securities regulators in hopes that "swift and appropriate resolution of these investigations" would protect investors and help restore confidence in the markets.

The emphasis on speed may be misplaced. A stronger economy and healthier corporate profits would be more significant factors in quickly restoring faith in the markets. Rather than rushing, regulators would do far better to slow down and open up the process, creating a forum in which as-yet-unanswered questions could be addressed. Transparently fine-tuning the myriad details of implementing such a sweeping measure could help win it more support.

The message investors and analysts are taking from the haste to reach a settlement is that neither regulators nor brokerage firms are sufficiently concerned about getting it right. If they would move more deliberately and get more input, the plan might not only get improved but would earn far more respect. And that could actually go the longest distance toward restoring investor confidence. Stone is an associate editor of BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column


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