Who Should Pay For Independent Research?

The crisis of the conflicts of interest faced by research analysts came to the notice of the outside
world last year when Merrill Lynch decided to pay a fine of $100m to the attorney-general of New
York State and others. The accusations stemmed from the incriminating e-mails that revealed
analysts privately ridiculing certain stocks as "dogs" while publicly commending their virtues in
their research reports. Of late, information has come to light that Jack Grubman, Citibank's star
analyst, released positive research so as to persuade his chief executive to lend him a hand in
gaining admission to pre-school for his kids.
Conflicts of interest pervade investment banking, mainly because investment bankers and
research analysts stay under the same corporate ceiling. Fresh revelations imply that for years
analysts' research has been influenced by demands to give out positive research to draw
investment banking and underwriting business. Understandably, retail investors consider these
past practices to be despicable and have been outrage. Unfortunately, they have now come
around to the outlook that Wall Street has manipulated the system against them.
In October, the Securities and Exchange Commission, along with state authorities and stock
exchanges, declared a combined effort to harmonize investigations into the conflicts of interests
faced by analysts and to arrive at a wide-ranging resolution with 12 investment banks.
Irrespective of the results of this effort, the SEC may need to contemplate if new regulations
would assist in creating an enduring, industry-wide answer. However, we must decide first how
imperative it is to have more extensively accessible "independent" research.
If you do not think that more impartial research is required, you presumably will support a
resolution that leaves it more-or-less in the same state as it is today, with the supplementary
defenses directed under the Sarbanes-Oxley Act and now planned by the exchanges. The new
system will entail analysts to confirm the honesty of their research and will preclude them from
being remunerated for drawing underwriting and other investment banking business for their
employers.
Many also espouse an extra obligation that all sell-side research should be clearly and
prominently labeled as "promotion materials". Supporters of this status quo style contend that this
is enough to protect investors. Others maintain that no set of policies or firewalls will ever get rid
of the facade that analysts will favor the investment bank's clients. They think it would be
healthier to ensure that independent research is done outside the banks.
This method raises two primary questions:
Who, eventually, will have to shell out money for the impartial research?
Who will choose the research sources?
One remedy would be to compel all listed stocks to be evaluated by an impartial analyst. The
meaning of "impartial" would be defined by the SEC and implemented by the stock exchanges.
Under this proposal, independent research would be financed by the exchanges, which would
pass on these expenses to the issuers of stocks as a component of their listing fees. Since the
issuers are gaining from access to the capital markets, it is fitting that they should bear the costs.
In due course, the investment banks may split these costs through reduced underwriting and
other investment banking charges in return for the issuers business.
Any income from an arrangement with the investment banks could sponsor the costs of this type
of "external" remedy for a period - say, for three years - after which the issuers would be
completely responsible for them, through their exchange listing fees.

An "external" remedy along this outline would not differentiate among exchanges since the
system would pertain to all of them. In an ideal world, the exchanges would vie to provide the
highest quality research. Thought also would have to be given to if autonomous research would
be offered to smaller companies not on national exchanges or a part of the national market
structure.
If the SEC decides to seek an enduring, market-wide solution through new regulations, it would
be wise to contemplate this "external" solution. There is a lot to be gained from eradicating
possible conflicts of interest in a manner that reinstates trustworthiness among small retail
investors.

Aayamtathaghat Banerjee