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Wall Street's $1.5B Reform On Precipice of Settlement

Dec 20, 2002 | USA Today Swimming with the sharks on Wall Street could get safer for small investors. Securities regulators, at least, are expected to make that case today once the finishing touches are completed on a controversial $1.5 billion package of fines and reforms of Wall Street practices.

While cautioning that an announcement could be delayed until next week, people close to the talks were optimistic Thursday night that last-minute objections by investment banks to the wording of some final documents would be resolved.

New York Attorney General Eliot Spitzer's office has scheduled a press conference at the New York Stock Exchange on Friday at 1 p.m. ET.

A deal would settle the largest case ever brought by regulators against the securities industry.

The nation's top 10 investment banks and brokerages are expected to pay about $1 billion in fines and $500 million over five years to finance the distribution of independent research to small investors. The fines will be split among the investigating state regulators and the Securities and Exchange Commission.

The reforms also would establish a sweeping set of rules aimed at eliminating tainted Wall Street research and stock offering practices that investigators say were prevalent during the 1990s market boom.

After months of back-room shouting matches and horse trading, the nation's top investment banks and brokerages are reluctantly signing on to the settlement in an effort to buy peace after a punishing year of leaked e-mails and other internal documents purporting to show ugly behavior.

"We're very, very close to a settlement," Chris Bruenn, head of the North American Securities Administrators Association, said Thursday night. "A settlement will help restore faith in our markets if it changes the corporate culture, metes out meaningful penalties and gives investors independent research and the facts they need." The NASAA is the state securities regulators' group.

Those facts were the center of a last-minute dispute Thursday night. Firms led by Merrill Lynch and Bear Stearns fear the inclusion of any wording in the final settlement that suggested they were admitting to wrongdoing would bolster the mountain of shareholder arbitration and class-action lawsuits pending against the industry.

Banks are unlikely to win the debate, particularly because regulators plan to release more incriminating e-mails and other documents next year as part of a final "record of finding." Cases against individual bankers, such as former Citigroup telecoms analyst Jack Grubman, Credit Suisse First Boston high-tech dealmaker Frank Quattrone and former Merrill Lynch Internet analyst Henry Blodget, are still being pursued.

Many critics say the regulators are engaging in blackmail.

"Regulators rounded up the largest firms and fined them by height," says Roy Smith, professor of finance at New York University's business school. "It's arbitrary and unfair, and I can't see how that inspires confidence."

Debate is already flaring about the long-term impact of the reforms. Will they improve transparency and level the playing field for small investors? Or will they reduce the quality and quantity of research as investment banks get out of a game that is costing them several billion dollars a year and new independent boutiques pick up the slack?

Even advocates worry that new rules will lead to a smaller universe of companies covered by analysts. At the moment, only a third of companies listed on the New York Stock Exchange have coverage. Large fund managers might also have to do more research, passing on costs in mutual fund fees.

"I would expect we would see a further shakeout in the securities analysts group, because there just isn't enough revenue to support the scale of research that we have seen in recent years," says Samuel Hayes, professor emeritus in finance at Harvard Business School. "The revenue on the retail investor side just isn't large enough."

But small independent research houses, which don't have the investment-banking operations that regulators say create conflicts of interests for research analysts at big Wall Street firms, are positioning themselves to grab a piece of the business.

Thomas White, a former managing director at Morgan Stanley, just launched a consortium of independent research firms called Best Independent Research. "We're going to use third-party monitors to measure our performance, and that will ensure we are not infected by the investment banks that hire us," says White. "Small investors will pay higher commissions if they believe in the research."

Columbia University securities law professor Jack Coffee believes even small research boutiques will find remaining independent a challenge.

"The biggest problem is there must be sufficient controls to ensure that we don't simply convert independent research boutiques into very dependent economic satellites of the Wall Street firms that hire them," says Coffee.

What few debate, however, is that long-ignored conflicts of interest on Wall Street would not have been publicized without Spitzer's move this spring to take on Merrill Lynch and the rest of Wall Street.

But even Spitzer admits "eliminating conflicts of interest" on Wall Street is a tough task.

"Some banks have behaved more badly than others," Spitzer said this summer. "But they all suffer from the same ingrained industry conflicts."

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