Under the Global Settlement, the firms were required to reform their  structures and practices to insulate equity analysts from investment  banking pressures. SEC and FINRA have asserted that analyst conflicts can harm investors. Data and Stakeholders’ Views Suggest That Regulatory Actions Have Helped Address Conflicts Faced by Equity Analysts

We reviewed empirical studies, analyzed examination and enforcement  action data, and interviewed market participants and observers to assess  the extent to which regulatory actions have addressed equity analysts’  conflicts of interest. However, these results generally were mixed. In addition, FINRA officials and SEC staff told us that they view the  regulatory reforms as effective—citing their examination findings and the  limited number of enforcement actions involving conflicts between  research and investment banking as evidence of the reforms’  effectiveness. Similarly, FINRA’s examination findings indicate that the Global  Settlement firms generally have complied with the Global Settlement. SEC staff said that they do not have an examination module  specifically designed to cover the SRO research analyst rules or the  Global Settlement but have reviewed whether broker-dealers were  complying with such requirements in some of their examinations of  broker-dealers examined by FINRA. Specifically, the  recommendations included:  changing the definition of “research analyst,” “research report,” and  other terms used in the rule, to codify exceptions set forth in previous  interpretive material and to align with SEC Regulation Analyst  Certification and the Global Settlement; eliminating a provision that permitted investment banking personnel to  review research before publication (to verify factual information),  because SRO staff believed that such a review raised concerns about  the objectivity of the research and noted that such a review was not  permitted under the Global Settlement’s terms; amending the disclosure rules to provide more effective disclosure by  allowing, in lieu of disclosure in the research report itself, a prominent  warning on the cover of research reports that conflicts exist and  information about how investors could obtain more details about those  conflicts of interest on the firm’s website, because staff were  concerned that the volume of disclosures in the reports could obscure  their overall message; and amending the provision that prohibited investment banking personnel  from retaliating against research analysts as a result of unfavorable  research to include all of a firm’s employees. According to FINRA  officials, their tentative plan is to seek comment on a regulatory notice on  a revised debt research proposal and then package the final debt and  equity research rule proposals together and submit a single proposed  consolidated research analyst rule to SEC in the first half of 2012. SEC and FINRA Have Not Formally Assessed and Documented Whether Any of the Global Settlement’s Remaining Terms Should Be Codified

Although the Global Settlement has been in place since 2003 and  includes a provision that allows for it to be modified or superseded, SEC  and FINRA have not proposed codifying the Global Settlement’s  remaining terms. Although SEC staff and FINRA officials periodically have discussed and  analyzed the Global Settlement’s terms, they have not formally  determined and documented the benefits and costs of adopting rules  based on the Global Settlement’s remaining terms. However, as long as the Global  Settlement remains in effect, the Global Settlement firms continue to be  subject to the requirements of the Global Settlement and the SRO  research analyst rules, while other firms that provide the same services  are subject only to the SRO research analyst rules. As a result, investors  may not be provided the same level of protection. We have previously  reported that a regulatory framework should include investor protection as  part of its mission to ensure that market participants receive consistent,  useful information, as well as consistent legal protections for similar  financial products and services. In addition, NASD and NYSE encouraged firms to consider  adopting industry-developed principles to address such conflicts. At the time, BMA did not support the adoption of SRO rules designed to address fixed-income conflicts. To the extent that any of the  Global Settlement’s remaining terms provide an effective way of  furthering investor protection, by not assessing their codification SEC may  be missing an opportunity to provide consistent investor protection. Recommendation for Executive Action

To help ensure that investors consistently are protected from potential  conflicts of interest between research analysts and investment bankers  employed by the same broker-dealers, the Chairman of SEC should  direct the appropriate divisions or offices to formally assess and  document in a recommendation whether any of the Global Settlement’s  remaining terms should be codified. SEC staff  noted that the agency has been working to promote the objectivity and  independence of securities research analysts. Appendix I: Objectives, Scope, and Methodology

Section 919A of the Dodd-Frank Wall Street Reform and Consumer  Protection Act requires us to identify and examine potential conflicts of  interest between investment banking and research staff in the same firm.To address this mandate, we examined (1) what is known about the  effectiveness of the regulatory actions taken to address research analyst  conflicts of interest and (2) what additional actions, if any, could  regulators take to further address research analyst conflicts.
Why GAO Did This Study

In 2003 and 2004, the Securities and Exchange Commission (SEC), self-regulatory organizations (SRO), and others settled with 12 broker-dealers to address conflicts of interest between the firms research and investment banking personnel. The regulators alleged that the firms allowed their investment bankers to pressure equity research analysts in ways that could cause them to issue misleading research to the harm of investors. Under the Global Research Analyst Settlement (Global Settlement), the firms had to undertake reforms designed to sever links between research and investment banking. The SROs also adopted equity research rules to address analyst conflicts across the industry, but these rules were not as stringent in some areas as the Global Settlement. The Dodd-Frank Wall Street Reform and Consumer Protection Act required GAO to study these issues. This report discusses (1) what is known about the effectiveness of the regulatory actions taken to address analyst conflicts and (2) what further actions, if any, could be taken to address analyst conflicts. GAO reviewed empirical studies and SEC and SRO rules, examination findings, and enforcement actions. GAO interviewed SEC and Financial Industry Regulatory Authority (FINRA) staff, and market participants and observers.

What GAO Found

Existing research and stakeholder views suggest that the Global Settlement and other regulatory actions have helped to address conflicts faced by equity research analysts. The results of the empirical studies that GAO reviewed generally suggest that the Global Settlement and equity research rules adopted by the SROs were associated with improvements in analysts stock recommendations. FINRA officials and SEC staff told GAO that the regulatory reforms have been effective, citing minor deficiencies in their examinations and the limited number of enforcement actions involving conflicts between research and investment banking as evidence of the reforms effectiveness. Independent monitors, which were required as part of the Global Settlement, also found that the 12 firms generally were complying with the Global Settlement. Finally, broker-dealers, institutional investors, and others told GAO that the regulatory actions have helped insulate equity research from investment banking influence, although some noted that not all conflicts can be eliminated and certain restrictions can be circumvented.
Although SEC and FINRA have been taking regulatory action to further address conflicts faced by research analysts, additional action is warranted. FINRA has been working to finalize a rule proposal designed to broaden the obligations of firms to identify and manage equity analyst conflicts and better balance the goals of helping ensure objective and reliable research with minimizing regulatory costs and burdens. FINRA also has been working to finalize another rule proposal that would address conflicts faced by debt research analysts. The current SRO research rules do not cover debt research analysts, although these analysts face conflicts of interests similar to those faced by their equity analyst counterparts. In the absence of an SRO debt research rule, the SROs have relied on antifraud statutes and SRO rules requiring ethical conduct. They also have encouraged firmswith limited successto comply voluntarily with industry-developed principles designed to address debt analyst conflicts. FINRA plans to package its two rule proposals together and submit them to SEC in the first half of 2012. In contrast, SEC and FINRA have not proposed codifying the Global Settlements remaining terms. At the request of the broker-dealers, a court modified the Global Settlement in 2010 and eliminated settlement terms where, for the most part, comparable SRO rules existed. Nonetheless, some of the Global Settlements terms that serve to protect investors have not been codified. As a result, the Global Settlement firms continue to be subject to the requirements of the Global Settlement and the SRO research analyst rules, while other firms that provide the same services are subject only to the SRO research analyst rules. As a result, investors may not be provided the same level of protection. GAO has previously reported that a regulatory framework should ensure that market participants receive consistent and useful information as well as consistent protections for similar financial products and services. SEC staff told GAO that they periodically have discussed and analyzed the Global Settlement terms but have not formally assessed and documented whether any of the Global Settlements remaining terms should be codified. By not formally assessing whether codifying any of the Global Settlements remaining terms provides an effective way of furthering investor protection, SEC may be missing an opportunity to provide the same level of protection for all investors.

What GAO Recommends

GAO recommends that SEC formally assess and document whether any of the Global Settlements remaining terms should be codified. SEC agreed with the recommendation.