Thursday, February 14, 2008

Will Wall Street ‘Misremember’ the Lessons of the Global Settlement?

It’s safe to say that not much good came out of yesterday’s Clemens vs. McNamee battle on Capitol Hill. Both parties seemed to be on a crusade to display the most loathsome qualities of humanity, as Congress (having no more pertinent matters to tend to) refereed the clash.

If nothing else, the one good thing that came out of yesterday’s battle royale was that Mr. Clemens, in his infinite wisdom, pulled out his finest Bush-ism, and reminded us all that sometimes people simply “misremember.”

This got us thinking – misremembering is not a plight suffered solely by fallen heroes representing our national pastime. Misremembering runs rampant in our financial markets as well. We won’t delve deeply into this topic (we think you can probably recall enough instances on your own) but as one example, the brilliant financial wizards putting together subprime loans (as well as the mindless lemmings who jumped into this market with both feet) must have ‘misremembered’ the tale of The Junk Bond King. You get our gist.

With the global research settlement set to end in April 2009, we couldn’t help but wonder: Will Wall Street ‘misremember’ its lessons from 2003?

A Journey Back in Time, To Avoid Misremembering

To briefly recap history, the global settlement was the result of Spitzer’s investigation into Wall Street research which found that many (primarily bulge bracket) firms were providing tainted/conflicted research to their investors. The firms were forced to pay fines, and also to offer independent (i.e. outside) research in addition to ‘cleaning up’ their own research offerings.

Much has changed in the research world since 2003, as many new Independent Research Providers (IRPs) have jumped into the market – if for no other reason than to capitalize on the terms of the global settlement. With so many IRPs in the market, the definition of an IRP has expanded greatly as well. From expert networks, to quants and research tools, to traditional research providers – these offerings all fall under the IRP banner.

While it is a very positive move for firms to utilize and offer more independent research, it seems they may misremember the problem at hand. In-house research at the large firms has not made any great strides to improve quality or be less tainted. As a matter of fact, in December, the Wall Street Journal reported that Wall Street research hadn’t cleaned up its act at all – there were still only 7% ‘Sell’ ratings in Street research as of then.

Given the current state of the markets, we find it hard to believe that only 7% of stocks deserved sell ratings as of last December. So, either the analysts a) are in a stranglehold by their trading desk or investment banking counterparts, or b) they’re incompetent. As much as we do not believe the waffling accounts of either McNamee OR Clemens, we also do not believe Wall Street analysts are incompetent. We do believe, however, that many are the puppets of their bullying investment banking and trading brethren.

So, the question remains what will happen as of April 2009? Will Wall Street immediately drop its IRP counterparts, and open itself up to closer SEC scrutiny of their internal research? It wouldn’t seem to make sense, but, as firms look to eliminate any and all expenses that can help alleviate some of the pain of the subprime woes, it’s not entirely out of the question.

The SEC plays a major role as well, as they still have not issued guidance to require unbundling that mirrors the requirements in the UK. Although unbundling has steadily gained traction in the past couple of years, this key driver to the ongoing success of independent research has not yet been pushed through.

So, much like the Clemens/McNamee case, it’s hard to tell which way things will play out for the post-global-settlement research world – but we can only hope that the eventual outcome includes cleaner, clearer policies and programs designed to avoid these stumbling blocks in the future.