Risk & Compliance

SEC to Analysts: Beware of ‘Reg LT’

What's next after Reg FD?
Ed ZwirnMay 4, 2001

Analysts better end their conflict-ridden relationships with issuers or face SEC regulation. That’s the message increasingly coming out of the regulatory body these days.

With the report card for Regulation FD (Fair Disclosure) mixed at best after being in effect just over six months, critics both inside and outside the SEC are saying that that rule, which regulates “material” disclosure of information to analysts, is besides the point when it comes to eliminating analyst conflicts of interest.

Now, there is the possibility the agency will go further.

Speaking recently to a New York audience of CFOs and other corporate professionals, Lynn E. Turner, the SEC’s chief accountant, urged banks, brokerage houses, and other firms employing analysts to take steps to improve disclosure of conflicts of interest.

Turner’s speech, which he made before a joint Financial Executives International/American Institute of Certified Public Accountants “summit” in New York on April 26, drew sharp comments from analysts and financial professionals in attendance and echoed similar remarks made by Acting SEC Chairman Laura Unger the week before.

Pressure On Analysts

The SEC accountant began by citing newspaper accounts depicting the pressures on analysts to soften the impact of unfavorable buy/sell recommendations.

“And to think I was worried about the independence of auditors,” he said, referring obliquely to auditor independence rules established by the SEC last November.

He also noted the overwhelmingly positive assessments of companies being offered by analysts.

Of 27,978 recommendations in effect as of March 1, 2000, “just 10 days before the market started a major downturn,” all but 220, or 0.8 percent, were either in the Strong Buy, Buy or Hold categories.

“How many of you believe that analysts today offer independent, unbiased research?” he asked those assembled at the meeting.

“The firms employing them should just remove the word ‘analysts’ and acknowledge they are salespeople,” Turner said after no hands went up in response.

Turner called for the firms and the securities industry itself to take the lead in establishing standards and disclosure requirements for analysts.

“If not, I believe it would be time for regulation ‘LT,’ which stands for ‘lots of transparency,’” he said.

Unger Takes Umbrage

Turner’s boss has also been active on the analyst issue.

Speaking to an audience at Northwestern University School of Law on April 19, Unger, who was made acting chair of the SEC after the resignation earlier this year of Arthur Levitt, spoke of her dissent from Reg FD when it was approved in February 2000 and took note of disagreements over “whether [it] will serve to minimize the conflicts that arise as analysts ‘walk the tightrope’ with corporate officials.

Unger also noted similar statistics showing the overwhelming majority of positive analyst assessments and cited a survey showing that one out of five CFOs “acknowledged that they have withheld business from brokerage houses whose analysts issued unfavorable research on the company.”

“Last year, while the Nasdaq was dropping 60 percent, less than 1 percent of analyst recommendations were ‘sell’ or ‘strong sell’ recommendations,” she said.

“What happens when an issuer, its investment firm, and the firm’s analysts all have a common financial interest in seeing that the company performs well? How can analysts provide independent research when they are part of a marketing team?” the SEC chief asked rhetorically.

Not surprisingly, the SEC’s criticism of analysts and their relationships with the firms they cover have met with some sharp responses.

Patricia McConnell, senior managing director of Bear Stearns & Co., spoke at a panel discussion following Turner’s address to the FEI/AICPA summit and criticized the SEC chief accountant for having “expressed amazement that a research director should consider a suggestion from management [of a firm being analyzed].”

“If they did not consider that suggestion and have a well-thought-out response to it that would be negligent,” she said.

Roger Trupin, vice president and controller at Citigroup, expressed concern that the SEC call for “transparency” might be a back door to even more stringent regulation.

“I cringe at the use of the word ‘transparency,” he said, accusing the SEC of “requiring disclosure to control behavior.”

“The idea [is] that if the company has to be disclosing this information, then they wouldn’t be doing the wrong thing,” he argued.