WASHINGTON In the first of a series of hearings on the integrity of investment banking firms equity analysts, lawmakers on Thursday rejected an industry argument that investors who exercise sufficient due diligence can recognize and account for the analysts biases.
Testifying before the House Financial Services Committees capital markets panel, Gregg Hymowitz, founding partner of EnTrust Capital, admitted that during the recent boom in Internet stocks, investment banking firms frequently took companies public that would not have been considered for stock sales in the past.
Analysts on the sell side of those firms were pressured to give positive recommendations to help their institutions cash in on the Internet stock craze, he said.
However, in the culture of Wall Street, the inherent bias of the sell-side analyst is well understood, Mr. Hymowitz said. Individuals who make their own investment decisions, rather than delegating that responsibility to a money manager or a mutual fund, should bear the responsibility of doing their own research, he said.
Any investor could have just picked up the prospectus and read it, Mr. Hymowitz said. All they had to do is look at the financial statements of these companies, and you would have seen the warnings. You would have seen that these companies were profitless.
That is not a reasonable mans standard, said Rep. Richard H. Baker, the Louisiana Republican who chaired the hearing. What I am saying to you is that the reasonable man, the working families who are providing the capital, are comforted by the analyst.
Rep. Baker and other members of the committee said that it is not realistic to expect individual investors to be able to read and understand disclosure documents filed with the Securities and Exchange Commission. Further, they said, any recommendation with the imprimatur of a large investment house carries enormous weight with the unsophisticated investor.
Rep. Baker reiterated his belief that a set of voluntary guidelines for equity analysts, issued on Tuesday by the Securities Industry Association, was insufficient.
The guidelines, which suggest that firms separate analysts compensation from any connection to investment banking deals and encourage more disclosure of their own stock holdings, will not ensure investors trust in Wall Street analysts unless they are altered to include a mechanism for regularly assessing compliance them and penalties for failing to do so, he said.
Marc E. Lackritz, president of the broker-dealer trade group, urged lawmakers to give the voluntary guidelines a chance to work. He noted that the chief executive officers of 14 of the largest securities firms had committed to the agreement.
Lawmakers were unmoved by his arguments.
I am not a regulator, Rep. Baker said. I dont think the federal government is the answer. But I urge you very strongly, in terms I hope are clearly understood: I believe the sentiment has been expressed in the committee today that if we dont get this fixed, probably someday the Congress is going to fix it in a way the markets wont like.
Among Democrats, Rep. Paul E. Kanjorski of Pennsylvania said the industry needs to produce a self-regulatory regime that convinces Congress and the public that the industry is being run by people who are credible, with integrity, and not to the disadvantage of the average person.
He said he agreed with Rep. Baker that if the industrys reform efforts fail, the regulatory agencies or Congress will impose a solution.
In an interview after the hearing, Mr. Lackritz said: We think the proof is going to be in the quality of the research. The real proof is if the research is getting better, and if it is, then obviously we are doing a better job, and best practices will be a large part of that.
Instituting a system for monitoring compliance would be equivalent to piling more regulation onto an already heavily regulated industry, he said. We have the SEC, state regulators, self-regulatory organizations, and everyone else. Creating yet another compliance mechanism doesnt strike me as being something that is necessary.
Rep. Baker assured the witnesses that while the committee is serious about investigating the issue and plans to hold more hearings, legislative action is not an immediate threat.
The committee will move very slowly, he said. We are hopefully not going to demagogue this important issue.