Settlement the first step toward reform

Monday, May 5, 2003

NEW YORK -- Winning back the trust of investors will require more than education classes and warning labels on stock-research reports.

Those are among the many mandates detailed Monday in the $1.4 billion settlement between regulators and investment firms accused of conflicts of interest in their company research.

Let's face it: The settlement itself is more ceremonious than anything else. But it's an important starting point for the sweeping changes needed on Wall Street.

"Change isn't going to come from paying fines, but from showing investors that you will treat them honestly," said Charles Elson, director of the Weinberg Center for Corporate Governance at University of Delaware.

Investors' view of the Wall Street community matters because they need to trust who handles the buying and selling of their stocks. If investors have doubts, they won't invest.

That's part of what's happening now. On top of a rash of corporate accounting scandals and the weak economy keeping investors sidelined, they've had reason to be uneasy about both investment firms and stock exchanges.

Research trickery

Part of that stems from the stock-research trickery that took place in recent years.

As investors became increasingly reliant on analysts' stock reports during the late 1990s, what they didn't know was that the analysts were giving out rosy reviews of companies so that their firms could win lucrative investment banking business to do merger deals and stock offerings. And the positive recommendations often came although many of these businesses were crumbling.

So unknowing investors were buying stocks not worth a fraction of what they cost and were left holding on to the stocks when they should have sold.

It's that conflict of interest in stock research that's behind the global settlement announced Monday by state and federal regulators. It named 10 of the nation's largest investment firms, including Citigroup, Merrill Lynch and J.P. Morgan Chase, though none admitted or denied allegations that they had misled investors.

Among the many changes that the settlement requires: a complete separation of stock research and investment banking at the firms and the offering of independent research services to investors in addition to the research provided by the investment firms themselves.

Every analyst report will spell out for investors what investment banking relationships a firm might have with a given company and will warn investors to not just use the research as the basis of their investment decisions.

While the settlement should keep Wall Street bankers and analysts on their best behavior for at least the short term and hopefully longer, still more work needs to be done to restore investors' trust.

"There have been trillions of dollars lost by investors," said Jacob Zamansky, a New York attorney who represents investors. "Try telling someone in their 60s that has lost their entire life savings that this is enough."

Beyond just changes at the investment firms themselves, reform is needed at the New York Stock Exchange, too. It has come under fire for its own corporate-governance shortcomings and is investigating trading practices within its own organization.

Markets need investors to grow, but investors won't come back until they are more confident in markets. The settlement should start them down that road.

Rachel Beck is the national business columnist for The Associated Press.

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