SEC Sends Latest Jolt to Analysts’ Credibility

In the latest blow to the image of Wall Street stock analysts, federal regulators said Tuesday that more than one-quarter of analysts they surveyed had purchased shares of companies at low prices before recommending the stocks to investors.

Of 57 analysts surveyed by the Securities and Exchange Commission, 16 acquired shares in so-called private placements at attractive prices that were unavailable to the general public.

The analysts later recommended the stocks to investors when the companies went public. In three cases, analysts sold their shares even while recommending them publicly, earning from $100,000 to $3.5 million, regulators said.

The SEC data were released Tuesday during the second in a series of congressional hearings examining the objectivity of stock analysts and the role they played in whipping up investor enthusiasm during the late-1990s bull market.

In the aftermath of last year’s stock market collapse, critics have argued that analysts’ credibility has increasingly been compromised by a web of conflicts of interest.

Though the general issues surrounding stock analysts had been debated in Congress’ initial hearing in June, a presentation Tuesday by Laura Unger, the SEC’s acting chairwoman, underscored the breadth of potential conflicts.

One of the biggest, Unger said, is that analysts’ compensation is increasingly tied to the profitability of their brokerage firms’ investment banking units. “It has become clear that research analysts are subject to several influences that may affect the integrity and quality of their analysis and recommendations,” she said.

Investment bankers handle the lucrative business of underwriting fledgling companies’ initial public stock offerings. There is supposed to be a “Chinese wall” in brokerages separating investment banking from the research departments that suggest stocks to investors.

But in recent years, analysts have become deeply involved in recruiting companies to issue IPOs through their firms and in enticing investors to buy shares of those companies.

Critics say that has created huge incentives for analysts to issue favorable reports on companies, even if the stocks are overvalued by traditional measures.

Hoping to defuse the criticism, Wall Street has tried to eliminate the appearance of conflicts. In June, the Securities Industry Assn., Wall Street’s main trade group, issued a set of voluntary guidelines for analyst conduct. Among other proposals, it called on firms to disclose the personal financial holdings of analysts and to decouple their pay from investment-banking operations.

In July, Merrill Lynch & Co. and Credit Suisse First Boston said they will bar analysts from owning shares of companies they cover.

“We’re on the same page” as regulators calling for changes, James Spellman, an SIA spokesman, said Tuesday.

Part of the problem, Unger said in her testimony, is that there are “gaps and inconsistencies” in the rules governing disclosure of analyst conflicts to investors. She indicated that recent proposals could improve disclosure.

The SEC did not go into details about the methodology of its survey. The agency said it examined nine brokerages that underwrite IPOs, especially those of technology firms. The agency did not name the companies or analysts in its survey. But Bloomberg News reported that the agency is conducting further investigations of the three analysts who sold stock while recommending the shares to investors.

The survey found that analysts at some brokerages report, at least indirectly, to the investment banking divisions of their firms in addition to the research units.

The SEC also found, in some cases, that analysts issued what the agency called “booster shot” recommendations that coincided with periods in which analysts or their firms could sell stock after an IPO.

When analysts or brokerages owned shares of companies whose IPOs they underwrote, they often agreed to so-called lockup periods that typically barred them from selling shares for several months after the IPO date. Of the 97 lockups the SEC reviewed, 26 analysts issued recommendations within a week of the lockup expiration, Unger said.