Equity Research

In the past few years, compliance controls over equity research has been strengthened as a result of enhanced regulatory standards. Beforehand, we can find many cases where research integrity is compromised by conflicts of interest. Last week SEC settled enforcement action against Banc of America Securities LLC (BAS) for failing to safeguard its forthcoming research reports and for issuing fraudulent research.

During 1999 through 2001, in breach of the firm's stated policies, BAS sales and trading employees were on multiple occasions able to obtain access to forthcoming BAS research (including analyst upgrades and downgrades) before the public release. BAS failed to track the actual release times and monitor for potential misuse of such information.

Prior to mid-1999, BAS traders received advance access to material non-public research information but were prohibited to establish or accumulate proprietary positions while unreleased research information were pending. Subsequently BAS erected an information wall between research and trading departments and thus allow BAS traders to trade notwithstanding that research changes were pending. However the above breakdown of research dissemination lead to "front-running" by the proprietary traders.

In BAS, there was a Marketing Director who acted as a "sounding board" for the firm's analysts (therefore in possession of material non-public information concerning forthcoming research), liaised with sales department and regularly provided trading advice to the traders. BAS knew that he was one of the most active personal traders at the firm but failed to address the conflicts created by his multiple roles.

Also during 1999 through 2001, BAS intertwined research with investment banking and rewarded analysts for their support of investment banking activities. By compromising independence and objectivity, the firm's analysts published research reports on three companies (Intel, TelCom and E-Stamp) that did not reflect their true views.

Each BAS research report included an investment rating. In early 1999, BAS utilized a three-tier rating system of Buy, Hold and Sell. In mid-1999, BAS changed to a five-tier system of Strong Buy, Buy, Market Perform, Underperform and Sell. During 1999 through 2001, BAS analysts rarely rated companies an Underperform and almost never a Sell, in part to avoid aggravating current or prospective investment banking clients.

Don't you think the above story you are so familiar with? Yes, of course, the same story happened in so many firms during 1999 through 2001.