TOPICS > Economy

Chairman of the Securities and Exchange Commission: William Donaldson

April 29, 2003 at 12:00 AM EDT


RAY SUAREZ: After months of investigations into one of the largest scandals in Wall Street history, regulators announced yesterday they had reached a settlement with ten of the nation’s largest securities firms. The investigations included conflict of interest charges, and found that several firms, such as Merrill Lynch and Citigroup’s Salomon Smith Barney, had violated investors’ trust by giving overly optimistic advice.

Regulators also uncovered numerous e-mails showing some Wall Street analysts promoted stocks of lesser quality, just so their companies could win investment bank business.

Yesterday’s settlement includes a number of reforms designed to change the way those firms conduct business in the future. They include paying a collective penalty of $1.4 billion to the government; mandating that stock research and analysts are kept strictly separated from the influence of investment bankers at Wall Street firms, which must also be monitored independently; and requiring the firms to provide investors with three sources of independent research.

We get more on this deal and its impact from the chairman of the Securities and Exchange Commission, William Donaldson. Welcome to the program.


RAY SUAREZ: At the announcement of the settlement, the chairman of the New York Stock Exchange, Dick Grasso, said investors do not expect a guarantee of profit but they expect and deserve a guarantee of fairness. Does this get us closer?

WILLIAM DONALDSON: Well, I think it does. I think that as a result of this settlement hopefully we’re going to get a restoration of the integrity of investment research that is aimed for the benefit of investors and not for the internal benefit of the investment banking divisions.

RAY SUAREZ: Once a lot of this wrongdoing was turned up, how was the decision made to go after the offenders in this way, with civil rather than criminal proceedings, with a solution where nobody had to admit any wrongdoing, for instance?

WILLIAM DONALDSON: Well, the admission of wrong is a normal or rather the lack of admission of wrong is a normal thing in a civil suit. These are not criminal suits. I think that when the malfeasance was uncovered, you know, investigations began on a number of firms and we found a number of infractions.

RAY SUAREZ: Two analysts in particular came up and their names were mentioned often during the whole trajectory of this case – Henry Blodgett and Jack Grubman. They were named again in the settlement but didn’t the problem with analysis and its relationship to other parts of these investment houses go much further than these two analysts?

WILLIAM DONALDSON: Well, the issue here is that the analysts were basically putting out recommendations that they didn’t believe in. In other words, they were putting out recommendations to buy the stock when, in fact, they did not think the stock was a good investment.

Why did they do that? Because they were trying to incur favor with the investment banking side of the business and trying to develop investment banking business. They were not serving the public in their recommendations.

RAY SUAREZ: But by concentrating on these two particular cases, does that let off the hook the many other analysts who were found to be involved in the same kind of behavior?

WILLIAM DONALDSON: No, no, no, no. There were ten firms where the infractions were found, and the infractions were different in different firms. But the total net effect of the thing was that the integrity of research was compromised.

RAY SUAREZ: How was the amount of the fine arrived at? Some people writing and commenting on this latest settlement say that $1.4 billion is tiny compared to the amount that these buy recommendations drove up the market and tiny compared to the cumulative loss of people who bought the stocks on these recommendations.

WILLIAM DONALDSON: Well, $1.4 billion is not tiny in anybody’s language. I think the thing to remember is that these are the largest fines that have ever been adjudicated by the SEC in the whole history of the SEC, Number One.

Number Two is that the varying amounts depended upon the seriousness of the infractions.

Number Three is I think that this may not be the end in terms of people going after these firms in terms of civil suits outside of the regulatory mechanism.

RAY SUAREZ: So the information that was generated in the course of this investigation is now available to other parties who want to sue?


RAY SUAREZ: How do you break up parts of companies that had become pretty chummy and pretty close to each other, trading, investment banking and research weren’t seen as separate islands in a big ocean but rather enmeshed in many of these companies —

WILLIAM DONALDSON: Right. Well, there are a whole series of rules that have now been put into place having to do with the way research analysts are compensated. They will now be compensated strictly based on their own performance and by the management of the research division. They will not… the investment banking divisions will have no say in how an analyst is compensated. There will be independent monitors inserted in each firm who will monitor the quality of the research and make judgments on that.

Research analysts will sign their research. The research materials that will go out will have at the bottom the fact that the company may be doing investment banking business with the company being researched.

And last but not least, the research will offer research to clients from independent sources so that if the client wants to get research on the same company from an independent source, that will be made available to him. $400 million of the settlement will be devoted to paying for that independent research.

RAY SUAREZ: So it sounds like the investor, the individual investor sitting in front of a computer screen at home will be able to find out about more of these relationships, have more transparency but a year from now, how will you know whether these new rules are working?

WILLIAM DONALDSON: Well, we will monitor this very closely. I think that the… hopefully in addition to having eliminated the conflicts inherent in research under the current system, the quality of research will improve as it’s an independent entity, unrelated to being a handmaiden to the investment banking side of the business, hopefully the quality of research will go up and the payment for research will really be worth something as opposed to being used for other purposes.

RAY SUAREZ: Do you expect to see a few more sell ratings now that some of these relationships will be prohibited?

WILLIAM DONALDSON: Yes I do. I think there will be much more unbiased research that will call it either way, good or bad.

RAY SUAREZ: Are there new rules involving the relationships of executives in these companies to their own departments?

WILLIAM DONALDSON: Yes, there are. The reporting relationship is such that the research group will report to its own management and the structure will be totally encased so that there’s no… the only thing influencing the compensation of the research analyst will be the quality of his research, his or her research.

RAY SUAREZ: And are there new rules also involving initial public offerings because some shenanigans had been found involving those, new stock issues that people were interested in buy?

WILLIAM DONALDSON: Well, the rules have been carefully revised and defined so that the research analyst will be able to assist the company in determining the quality of the company to be underwritten, but the research analyst will not be allowed to be a promoter of that company. The research analyst won’t be able to go on a so-called road show and help sell the product. The only relationship will be helping the underwriting team to determine the quality of the company but it stops there.

RAY SUAREZ: And this will empower the individual investor how?

WILLIAM DONALDSON: Well, it will empower the individual investor hopefully in terms of the quality of the research and the independence of the research. Of course the real important thing at the end of the day is the quality of the research. In other words, we’ve taken away the conflicts that were inherent in the processes that exist right now, but then the quality of what’s said remains to be seen. I hope that this will result in a much higher quality of research.

RAY SUAREZ: And to the companies that cheated, is the possibility of further regulation always there as sort of a warning? Is there something probationary about this agreement?

WILLIAM DONALDSON: Well, I think the financial penalties are, as I said earlier, extreme and high. The potential penalties coming from the private sector are there. I think perhaps one of the greatest things that this will result in is the hurt to the reputation of these investment banking firms. And I think that the people who manage those firms are going to be very much interested in rebuilding their own reputation. So I think there’s sort of a moral overtone that’s inherent in this whole process.

RAY SUAREZ: Chairman Donaldson, thanks for talking with us.

WILLIAM DONALDSON: Nice to be with you.