Stock research practices need overhaul

NEW YORK -- It might be hard to understand how cleaning up Wall Street research would end up costing you money. Didn't biased research already cost you enough?

It sure did. During the stock-market boom, analysts seemed more interested in winning investment banking business than giving investors accurate information. And many people lost big following their tainted advice.

But, that said, there's now a push to make research independent. It's not about just building walls between analysts and bankers, but taking more drastic steps to completely cut ties between the sides.

That would surely provide investors with more objective data, but there is a downside: You might have to pick up the tab, and it won't be cheap.

It seems like every week brings more revelations of conflicts of interest in stock research.

During the late 1990s, analysts handed out lots of positive recommendations of the companies they covered so their firms could then win lucrative investment banking business. And the rosy reviews came even though many of the businesses were falling apart. So investors continued to hold on to these stocks, unaware that the system was really rigged.

The mounting evidence of rampant abuse has prompted calls for a major overhaul of stock research.

A new federal law, passed this summer, forbids bankers and analysts from discussing their business dealings. But the details of how this will actually work is still being ironed out by the Securities and Exchange Commission, state regulators and the stock exchanges.

It's up to them to decide whether to let the investment firms police the situation themselves, or to implement more stringent rules.

Many Wall Street firms have started erecting barriers between bankers and analysts. That's a direct result of hefty fines that some have paid for publicly pumping stocks that they privately bad-mouthed.

But what is and isn't allowed is still somewhat ambiguous.

For instance, in the $100 million settlement with Merrill Lynch, New York Attorney General Eliot Spitzer told the investment firm it had to build walls between the sides, but he didn't spell out how to do it.

And without detailed standards to follow, critics say, there's always room for abuse.

"It is hard to maintain a wall unless management makes a serious effort to do so," said Kathy Waldron, dean of Long Island University's School of Business. "There is still room for conversation between the sides, when they work in the same building, eat in the same cafeteria."

That's why there's some push to take even more radical steps to clean up stock research.

Just this week, Massachusetts' Secretary of State Thomas Galvin called for a complete separation of research from banking, and federal regulators as well as officials from other states are said to be mulling the same.

If firms were required to create research-only subsidiaries, that would cut out any potential ties between the sides. Firms might also choose to get out of research entirely, instead hiring outside rating agencies to do their work.

Both ways promise more objective analysis and independent thinking, something that investors say they want given all the recent controversy.

But such changes might be very costly.

Research costs have generally been paid for by investment banking fees, and firms basically give out the research for free to investors. So if they spin off their research into separate units, it is likely that they would start charging investors to cover the expense.

Firms could potentially save billions of dollars if they got out of research completely, much of that coming just from cutting out huge analyst salaries. But buying research from independent contractors also would be expensive, and chances are that most of those costs would be passed along to investors.

So the conflict of interest would be gone and investors would have access to unbiased research. But now there's concern that research might only be available to those who are willing to pay for it.

"Are investors really inclined to pay for research?" asks Kent Womack, associate professor of finance at Dartmouth College's Tuck School of Business. "My worry is that we'll fire all the analysts, but in the end, investors will end up getting much less research."

Just more proof that it's not so easy to clean up this mess.

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck@ap.org.