A paper presented by ASIC Deputy Chairman Jeremy Cooper to the Securities & Derivatives Industry Association, 26 May 2006, Melbourne.
Broad overview
Investment banks have innovated at a furious pace and changed the mix of their businesses. While banks like to say that they still rely on traditional investment banking, their profits increasingly come from other activities such as trading and principal investment. As The Economist rather cheekily noted 'the sharp suited investment bankers act as a sales force for less well dressed colleagues who work out how to make money from swaps, operations and direct investments'.
Innovation has created a world often riddled with conflicts of interest. In some cases, it is difficult to tell whether a bank is looking after its own interests or the interests of its clients. In simple terms, a conflict of interest happens when an adviser can't really go into bat for a client because some other duty or interest is pulling them in another direction. An example includes competing with a client for an investment opportunity.
New York Attorney-General, Eliot Spitzer, turned the heat on investment banks when he investigated their management of conflicts of interest in 2001–2002. The investigation netted a $1.4 billion dollar settlement and was started after Spitzer became aware that research analysts at Merrill Lynch had downgraded stock from a company, not because there was a change in opinion about the company, but because the company did not do business with Merrill Lynch.
Following action against Merrill Lynch, Spitzer spearheaded a joint investigation by state and federal regulators to examine whether other investment banks had also failed to manage conflicts of interest between their research and investment banking divisions. The widened investigation found that 10 banks had failed to manage conflicts.
In addition to paying a cash settlement, the investment banks the subject of investigation agreed to a number of structural reforms including:
- severing the link between compensation for analysts and investment banking;
- prohibiting investment banking input into analyst compensation and company coverage choice;
- creating a review committee to approve all research recommendations;
- requiring that upon discontinuation of research coverage of a company, firms will issue a final research report discussing the reasons for the termination;
- disclosing in research reports whether a firm has received or is entitled to receive any compensation from a covered company over the past 12 months; and
- establishing a monitoring process to ensure compliance with the terms of the settlement.