In the wake of a regulatory “global” settlement that last week began requiring the largest Wall Street investment banks to supply independent research free to their retail brokerage customers, some second-tier investment banks may follow the lead of companies like Wachovia that have done so voluntarily for years.
Michael Jones, the manager of Wachovia’s advisory services group, said his company has offered independent research from six firms for the past six years.
“No one had to make us, and we didn’t have to write a check for millions in order to provide independent research,” Mr. Jones said. “We looked at it from the standpoint that this was something that professional money managers want. They want multiple sources of research.”
Alvi Abuaf, a vice president and the head of North American financial services at Capgemini U.S. LLC, said other large and midsize investment banks may voluntarily comply in order to remain competitive.
“Right now only the top 10 have to comply, but we are projecting that many firms will look to make changes,” Mr. Abuaf said. “If an investor can get third-party research from one provider and they can’t get it from another, the firm that provides additional research will have a competitive advantage.”
Mr. Abuaf said other second-tier companies, including the brokerage unit of Fidelity Investments and the investment banking unit of Toronto-Dominion Bank, already were providing free third-party research.
The settlement reached last year with NASD Inc., the Securities and Exchange Commission, the New York Stock Exchange, and the New York attorney general’s office required each of the 10 investment banks that participated to make available three third-party research firms by July 28.
Analysts agreed that more large and midsize investment banks would want to match what the largest are required to do.
“I think that, since the leading firms in the industry are in a position that they have to provide a second source of research, others will want to do this,” said Burton Greenwald, a Philadelphia-based analyst. “I think that independent research will be looked at very favorably by investors.”
Denise Kazmier, a spokeswoman for the TD Waterhouse unit of Toronto-Dominion, said the firm has been supplying independent research for 25 years. Fidelity expanded its equity research for individual investors and broker-dealer clients on July 15.
The Boston fund giant is offering analysis from independent researchers Prudential Equity Group, Reuters Co., Best Independent Research, Columbine Capital, Thomas White International Ltd., Callard Research; Channel Trend; and Ford Equity Research.
Adam Banker, a spokesman for Fidelity, said it has been working for years to develop the independent research it offers retail customers and did not increase its offerings because of the settlement. “We heard from customers that they wanted a broader range of research,” he said. “We will continue to look at research requirements for customers and try to meet our customers’ needs.”
Mr. Abuaf said the industry will change dramatically in the next few years. The settlement will stimulate research firm start-ups, he said, and nudge second-tier investment banks that aren’t offering independent research to do so.
Second-tier “investment banks will not be able to keep their current research model intact,” Mr. Abuaf said. “They will have to outsource and contract boutique firms to work with them.”
Mr. Abuaf said companies like Morningstar Inc. and Standard & Poor’s that already have a reputation as researchers have the most to gain. Morningstar announced Wednesday that it had research agreements with the investment banks Goldman Sachs & Co., J.P. Morgan Chase & Co., Merrill Lynch & Co., Piper Jaffray & Co., and Citigroup’s Smith Barney pursuant to the settlement. These five are among the 10 participants in the global settlement. The others are: Bear Stearns, Lehman Bros., UBS AG, Morgan Stanley, and Credit Suisse First Boston.
Margaret Cohen, a spokeswoman for Morningstar, said she could not comment on whether Morningstar is in talks with second-tier firms.
Wachovia’s Mr. Jones said it is not enough for companies just to offer independent research. It can be difficult for retail investors to weed through the plethora of very different opinions, he said, and Wachovia has an equity strategy team that takes research and filters it for retail financial advisers.
“We take a very open architecture approach to this,” he said. “We have a tremendous platform of research … the client gets to decide how deep into the process they want to go.”
Mr. Jones said this “filter” is not required by the settlement. Too many companies are doing “just enough” to comply, he said.
“If you look at what our competitors are doing, they are slapping their research against independent firms’,” Mr. Jones said. “I am not sure that you have really advanced the cause of providing more research to the client by doing that. I think you’ve provided them a lot of paper, but I don’t think you’ve helped them find answers.”
Mr. Jones said a lot of competitors are worried about research costs. A Capgemini study said Wall Street firms have slashed their proprietary research teams by 40% and further cuts of 20% to 30% are expected because of the settlement.
Petrina Dolby, a vice president and securities industry consultant at Capgemini, said each company in the settlement contributed to a $432.5 million fund to help pay for research over the next five years. But the costs will exceed what was set aside, she said.
“Companies are downsizing their research staffs and restructuring to cover these costs,” she said.
Mr. Jones said that in the end companies will have to fundamentally change the way that they do business in order to satisfy the regulators’ intent.
“I don’t know where it will wind up,” he said. “You may find when the settlement expires they will go right back to their old ways. To adopt our model requires some fundamental cultural changes in the way you do business … Merrill Lynch and Smith Barney are a long way from being able to do that.”
