Unilateral disarmament doesn’t work on the geopolitical stage and it probably won’t fly on Wall Street either.
And that’s why few expect Citigroup’s Salomon Smith Barney to unilaterally separate its investment banking and stock research businesses unless the other big Wall Street firms are forced to follow suit.
Yes, Citi officials may be talking to the SEC and other securities regulators about a plan for decoupling stock research from investment banking work. And Citi officials might even be talking about paying a big fine in the hopes of putting its regulatory woes behind it, as The Wall Street Journal reports.
But the feeling on Wall Street is that Citi is unlikely to sign a sweeping deal with the SEC unless it knows its main competitors — Merrill Lynch Goldman Sachs J.P. Morgan Chase Morgan Stanley and Credit Suisse First Boston also will have to do the same.
And while industry sources say Citi’s competitors might be receptive to the idea mainly because Wall Street has grown weary of the government investigations into stock-touting analysts those other firms aren’t yet on board with the plan.
In fact, the other firms haven’t been invited to take part in the negotiations said to be going now between Citi, the SEC and other regulatory agencies. Indeed, New York Attorney General Eliot Spitzer, who is conducting his own investigation into conflicts of interest at Salomon, may not even be on board with the plan, sources say.
Citi officials will neither confirm nor deny that they are talking to the SEC about a plan to separate investment banking from stock research. Spitzer’s office also won’t talk about the reported negotiations.
But the main reason a unilateral separation is unlikely is because it would place Citi at an unfair disadvantage to its competitors.
Spitzer’s office says that’s why it didn’t force such a drastic remedy on Merrill, even after its investigators found evidence that its analysts often hyped the stocks of the firm’s investment banking clients. Spitzer, instead, opted for a plan that imposed a $100 million fine on Merrill and forced it to erect more barriers between investment banking and research.
In the Cold
The problem with forcing a Wall Street firm to unilaterally disarm is that revenue generated from investment banking deals still help a firm pay the salaries of all those analysts. And investment banking dollars enable a firm like Citi to hire the hundreds of analysts it needs to cover thousands of stocks each year.
If Citi were forced to operate its stock research division as a separate business, it might be forced to employ fewer analysts, reduce its coverage of midsized companies, alienate some of its brokerage customers and possibly lose out on some investment banking deals. In other words, the nation’s biggest financial services firm could suffer a loss in revenue at a time that every firm on Wall Street is scrambling for every buck it can make.
But while a unilateral settlement may be unlikely, a mutual disarmament package does appear inevitable. That’s because it’s becoming increasingly clear to regulators and industry critics that the only sure way to prevent investment bankers from influencing the work of stock analysts is to put them under different roofs.
“Right now we are going through a situation where an awful lot of people have felt burned, and it’s not surprising that some fairly draconian solutions are being considered,” says Kenneth Froewiss, a professor at New York University’s Stern School of Business.
Also feeling burned are the Wall Street firms, many of which have seen their stocks get scorched this year because all the negative publicity caused by the government investigations into analyst conflict of interest.
One reason Citi is so eager to find a way out of its regulatory mess is because of the big hit its stock has suffered as a result of the many scandals stemming from Salomon’s past business practices. Citi’s stock, now trading around $29 a share, has fallen 38% this year, a drop that’s shaved nearly $100 billion from the bank’s market capitalization.
Indeed, it’s becoming increasingly clear to Wall Street executives that the days of the star analyst are over and any kind of working relationship between investment bankers and analysts must be fraught with inevitable conflicts.
“I don’t think Wall Street executives were ever real excited with analysts gaining power and holding them up for big contracts,” says David Trone, a brokerage analyst at Prudential Securities, a brokerage that rates stocks but doesn’t do any investment banking business. “The problem is when people get star power they also get bulls eyes on their heads.”
In fact, Trone says the idea of separating investment banking and stock research is really nothing more than a return to the way Wall Street operated two decades ago.
Back then, analysts were anonymous and played second fiddle to brokers. Trone says it was unheard for an analyst to be paid $1 million a year, let alone $20 million. An analyst’s salary, he says, largely was subsidized by trading commissions generated by a firm’s retail brokerage division.
A return to that kind of system will mean the big Wall Street firms will employ fewer analysts and cover fewer stocks. But Trone says it also will mean that the firms will have to pay a lot less money in salaries.
And it could even present an opportunity for smaller brokerage firms to pick up coverage of the midsized companies that the big Wall Street firms will stop paying attention to. That could be a benefit, he says, to smaller research firms that charge a bundle for independent research reports.
Of course, the downside of all this change is that individual investors who can’t afford to pay for stock research might have fewer places to turn for information on small- to midsized public companies.
But that’s the price of change.