Bankers would rather face the SEC than a raging attorney general
Richard Thomson in New York Sunday May 5, 2002 The Observer
It is hard to overstate the effect on Wall Street investment banks of the hand-grenade lobbed into their midst by Eliot Spitzer, the New York Attorney General. There is fear, panic and a desperate scramble to comply with tighter rules governing securities research before they have even been written.
Yet Spitzer's assault on Merrill Lynch and the deeply embedded conflicts of interest that bedevil securities research and investment banking has brought him into head-on confrontation with the Securities and Exchange Commission, the federal regulator, and the US Congress. Wall Street is playing a guessing game: what new rules will come from this process and which agency will take the lead in framing them?
In a letter to Harvey Pitt, the SEC chairman, last Monday, Richard Baker, chairman of the House capital markets subcommittee in Congress, pressed the regulator to get involved. Baker, a Republican who wants mild Wall Street reform, appears to be worried that Spitzer is driving a more radical agenda. So he has pushed the SEC into a full-scale turf war with the New York attorney general: he and the SEC insist the issue should be handled by federal, not state, regulators. Inconveniently for them, Spitzer is not backing away: 'This is not going to muffle, stifle or inhibit me.' He has strengthened his hand by forming a task force of 11 other states intent on targeting banks for fraud.
Superficially, the SEC is in the stronger position. As lead securities market regulator, it can impose industry-wide solutions while Spitzer can only make individual deals with individual banks, as he is trying to do with Merrill Lynch. The SEC has, for instance, been working on new disclosure rules for all analysts that it will unveil this week.
But the federal regulator's advantage is something of an illusion. The truth is that any deal Spitzer makes with Merrill on greater disclosure of potential conflicts of interest by banks and analysts is likely to be adopted by the rest of the industry. Sources say he has already forced Merrill to go further than the SEC's new disclosure rules. More important, neither Congress nor the SEC can stop Spitzer if he wants to go to court. If he feels the industry is not changing enough, he may issue indictments.
'Big Wall Street names, starting with Henry Blodget, the former Merrill internet analyst, would be forced to take the Fifth Amendment to avoid incriminating themselves, like some big racketeer or Mafia don. It would be a big reputational loss to the industry,' says John Coffee, Columbia University's professor of securities law.
This is the outcome Wall Street fears most, and explains why the big banks would far rather have the SEC than Spitzer handling the problem. It is virtually certain that the turf war will lead to a more significant change in the rules governing analysts than anyone expected even a month ago. It is already a given that banks will have to provide better information about banking interests that could bias their equity research, but an eventual solution may go well beyond this. Spitzer's own preference is to force banks to spin off their research departments into separate entities. Most bankers say this is impractical, as few research departments would be viable as stand-alone businesses.
Yet many bankers see a different, but nearly as radical, outcome looming. 'Sooner or later we'll have to put all our star analysts into the investment banking division so they don't have to pretend to be independent any more,' says a senior equity analyst. The 'independent' research role on the broking side of each firm would then be carried out by junior number-crunchers. This would almost emasculate the broking research side of many banks. At a stroke, they would lose the star analysts that their biggest institutional investment clients rely on for investment ideas.