[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]

                         ANALYZING THE ANALYSTS



                               BEFORE THE

                            SUBCOMMITTEE ON
                    CAPITAL MARKETS, INSURANCE, AND 

                                 OF THE

                              COMMITTEE ON
                           FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION


                         JUNE 14; JULY 31, 2001


       Printed for the use of the Committee on Financial Services

                           Serial No. 107-25


73-368                     WASHINGTON : 2001

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                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Ohio                  JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD, Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSELLA, New York               JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missiouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         

             Terry Haines, Chief Counsel and Staff Director
            Subcommittee on Capital Markets, Insurance, and 
                    Government Sponsored Enterprises

                 RICHARD H. BAKER, Louisiana, Chairman

ROBERT W. NEY, Ohio, Vice Chairman   PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER COX, California          NYDIA M. VELAZQUEZ, New York
PAUL E. GILLMOR, Ohio                KEN BENTSEN, Texas
RON PAUL, Texas                      MAX SANDLIN, Texas
SPENCER BACHUS, Alabama              JAMES H. MALONEY, Connecticut
MICHAEL N. CASTLE, Delaware          DARLENE HOOLEY, Oregon
EDWARD R. ROYCE, California          FRANK MASCARA, Pennsylvania
FRANK D. LUCAS, Oklahoma             STEPHANIE TUBBS JONES, Ohio
BOB BARR, Georgia                    MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, North Carolina      BRAD SHERMAN, California
JOHN B. SHADEGG, Arizona             JAY INSLEE, Washington
DAVE WELDON, Florida                 DENNIS MOORE, Kansas
JIM RYUN, Kansas                     CHARLES A. GONZALEZ, Texas
BOB RILEY, Alabama                   HAROLD E. FORD, Jr., Tennessee
VITO FOSSELLA, New York              RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois               KEN LUCAS, Kentucky
GARY G. MILLER, California           RONNIE SHOWS, Mississippi
DOUG OSE, California                 JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania      STEVE ISRAEL, New York
MIKE FERGUSON, New Jersey            MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania

                            C O N T E N T S

Hearing held on:
    June 14, 2001................................................     1
    July 31, 2001................................................    63
    June 14, 2001................................................   115
    July 31, 2001................................................   208

                        Thursday, June 14, 2001

Bowman, Thomas A., CFA President and CEO, The Association for 
  Investment Management and Research.............................    51
Cleland, Scott C., Chairman and CEO, The Precursor Group.........    49
Cole, Benjamin M., financial journalist and author, ``The Pied 
  Pipers of Wall Street: How Analysts Sell You Down the River''..    47
Glassman, James K., Resident Fellow, American Enterprise 
  Institute, Host, www.TechCentral.com...........................    15
Hymowitz, Gregg S., founding partner, EnTrust Capital............    12
Lackritz, Marc E., President, Securities Industry Association....    18
Silvers, Damon A., Associate General Counsel, AFL-CIO............    53
Tice, David W., Portfolio Manager, Prudent Bear Fund, publisher 
  of the institutional research service ``Behind the Numbers''...    10


Prepared statements:
    Baker, Hon. Richard H........................................   116
    Oxley, Hon. Michael G........................................   126
    Jones, Hon. Stephanie T......................................   118
    Kanjorski, Hon. Paul.........................................   120
    LaFalce, Hon. John J.........................................   122
    Ney, Hon. Bob................................................   124
    Bowman, Thomas A.............................................   195
    Cleland, Scott C.............................................   184
    Cole, Benjamin M.............................................   181
    Glassman, James K............................................   166
    Hymowitz, Gregg S............................................   160
    Lackritz, Marc E.............................................   172
    Silvers, Damon A.............................................   199
    Tice, David W................................................   128
                         Tuesday, July 31, 2001


Byron, Christopher, syndicated radio commentator, columnist, 
  MSNBC.com......................................................    90
Glantz, Ronald, former Managing Director, Tiger Management, 
  former Director of Research and Chief Investment Officer, Paine 
  Webber.........................................................    87
Hill, Charles, Director of Research, Thomson Financial-First Call    95
Kianpoor, Kei, CEO, Investars.com................................   100
Lashinsky, Adam, Silicon Valley columnist, The Street.com........   102
Unger, Hon. Laura S., Acting Chairman, U.S. Securities and 
  Exchange Commission............................................    70
Winkler, Matt, Editor-in-Chief, Bloomberg News...................    98


Prepared statements:
    Baker, Hon. Richard H........................................   209
    Oxley, Hon. Michael G........................................   225
    Castle, Hon. Michael N.......................................   211
    Hinojosa, Hon. Ruben.........................................   214
    Israel, Hon. Steve...........................................   215
    Kanjorski, Hon. Paul.........................................   217
    LaFalce, Hon. John J.........................................   219
    Byron, Christopher...........................................   245
    Glantz, Ronald...............................................   241
    Hill, Charles L..............................................   248
    Kianpoor, Kei................................................   261
    Lashinsky, Adam..............................................   266
    Unger, Hon. Laura S..........................................   227
    Winkler, Matt................................................   253

              Additional Material Provided for the Record

LaFalce, Hon. John J.:
    Letters to Securities and Exchange Commission's Acting 
      Chairman, Laura S. Unger, July 5, 2001, July 30, 2001......   221

                         ANALYZING THE ANALYSTS


                        THURSDAY, JUNE 14, 2001

             U.S. House of Representatives,
       Subcommittee on Capital Markets, Insurance, 
              and Government Sponsored Enterprises,
                           Committee on Financial Services,
                                                    Washington, DC.
    The subcommittee met, pursuant to call, at 10:00 a.m., in 
room 2128, Rayburn House Office Building, Hon. Richard H. 
Baker, [chairman of the subcommittee], presiding.
    Present: Chairman Baker; Representatives Oxley, Ney, Shays, 
Paul, Castle, Royce, Barr, Weldon, Biggert, Miller, Ose, Hart, 
Kanjorski, Bentsen, J. Maloney of Connecticut, Hooley, Mascara, 
Jones, LaFalce, Capuano, Sherman, Inslee, Moore, Hinojosa, 
Lucas, Shows, Israel and Ross.
    Chairman Baker. I would like to call this hearing of the 
Capital Markets Subcommittee to order. We're starting promptly 
on time this morning. We like to have the ability to start 
trading as soon as the opening bell rings around here.
    First, by prior agreement with Mr. LaFalce and Mr. 
Kanjorski, opening statements today will be limited to Chairman 
Oxley, myself, Ranking Member LaFalce, and Mr. Kanjorski, who 
is on his way, to expedite the proceedings of the hearing this 
    All other Members' statements will be incorporated into the 
    I am appreciative for the courtesies extended by Mr. 
Kanjorski and Mr. LaFalce in facilitating this meeting this 
    As we all know, this is an issue of some importance and 
volatility. There was a question on a recent magazine cover 
that struck me as particularly appropriate: ``Can We Ever Trust 
Wall Street Again?''
    The simple answer to that question is, we must. That is, we 
must find a way. It's simply not a choice. America's 
prosperity, as always, is intrinsically bound to the influx of 
capital investment that fuels business expansion, job growth 
and technology.
    To the extent that American consumers have been temporarily 
shaken by the recent market downturn, our first goal today here 
is to begin a process of rebuilding that confidence, not only 
to reaffirm American consumers' faith in the fairness of the 
market, but actually to have their trust.
    Clearly, I am a pro-market conservative legislator and I am 
going to be one of the last on the subcommittee, I think, to 
suggest Federal intervention to solve every problem.
    However, the foundation of the free market system is based 
on the free flow of information which is straightforward and 
unbiased. I believe this subcommittee has a very high 
responsibility to safeguard this principle.
    I am deeply troubled by the evidence of the apparent 
erosion by Wall Street of the bedrock of ethical conduct.
    It's a new and continually changing marketplace. Since 
1995, on-line trading has resulted in enormous growth of 
investment by working families, some 800,000 trades a day, I am 
told, with a typical demographic profile of a $60,000 annual 
income with net worth less than 50.
    These individual investors rely on and believe what they 
think is objective, professional advice from sophisticated 
    There's a message here. These investors are the future of 
the dynamic growth of the market place. They deserve fair 
treatment not only for their best interests, but for the growth 
of the market.
    Folks who work hard to pay the house money, pay their 
taxes, and the grocery bill don't have luxury to be able to 
speculatively gamble. Over the last few years, Wall Street's 
insiders have whispered knowingly about a grade inflation, as 
it's called, resulting in what I think is a very coded language 
in analysts' recommendations.
    A goal of this hearing is to begin speaking openly about 
what has apparently been unspoken in the past. I'm amazed. I'm 
the chairman of the Capital Market Subcommittee in the United 
States Congress. I learned this yesterday. Strong buy does not 
mean buy, but actually out-perform.
    It really makes you wonder what out-perform or accumulate 
must mean. I am concerned not only about the potential for 
significant losses by the unwary and misinformed individual 
investor, but the possibility of overall market volatility that 
results when a more rational view does return.
    Today, we are going to inquire into disturbing media and 
academic reports about pervasive conflicts of interest, which 
appear to be compromising the integrity of current market 
    In fact, I want to enter into the record at this time, a 
study from the Harvard and Wharton Business School study 
entitled ``The Relationship Between Analysts' Forecasts of 
Long-Term Earnings Growth and Stock Price Performance Following 
Equity Offerings.''
    I want to quote from that report one paragraph: ``Our 
evidence suggests that the coexistence of brokerage services 
and underwriting services in the same institution leads sell-
side analysts to compromise their responsibility to brokerage 
clients in order to attract underwriting business. Investment 
banks claim to have Chinese walls to prevent such a conflict. 
Our evidence raises questions about the reliability of the 
Chinese walls. We document that analysts officiated with the 
lead underwriter of an offering tend to issue more overly 
optimistic growth forecasts than unaffiliated analysts. 
Furthermore, the magnitude of the affiliated analysts' growth 
forecasts is positively related to the fee basis paid to the 
lead underwriter. Finally, equity offerings covered only by 
affiliated analysts experience the greatest post-offering under 
performance, suggesting that these offerings are the most over-
    I have to say this in my own words, as I basically 
understand it. Maybe there hasn't been a complete erosion in 
the Chinese walls that traditionally shield analysts from 
investment banking interests. But I have to say that I believe 
there are some folks out there manufacturing a lot of Chinese 
ladders for people to climb back and forth over those walls as 
they deem appropriate.
    A market bubble that bursts is the time when people look 
for someone to blame. I believe it rather should be an 
opportunity for all concerned in the activity to step back, 
take a deep breath, and reexamine their own accountability to 
make sure it doesn't happen again, and all parties have some 
shared responsibility.
    Today, we focus on the analysts' conflicts. At some point, 
we will take a look at the investment banks and the 
institutional investors.
    And I must say a word about the financial press. They have 
much greater impact than many have given them their allocation 
for. It is irresponsible reporting to quote unquestioningly 
irresponsible analysts' reports and put them on the cover of 
magazines and make them into rock stars.
    There is some examination due in this area as well. 
Consequently, while I appreciate the effort of the Securities 
Industry Association with their best practices proposal, put 
forward only 2 days ago, I am not yet convinced we have a 
remedy to our problem.
    I take the very drafting of them as a positive sign that 
the industry accepts that problems may exist and I am naturally 
going to take a very careful look at any document that, on its 
face, has a disclaimer, which I'm paraphrasing here, 
respectfully, we're going to do our best to be honest and 
straightforward unless of course circumstances dictate we must 
do something different.
    Today is not the end of our discussion, but the beginning. 
In the next few months, we will access recommendations, 
converse with regulators and, at the end of the process, the 
subcommittee, I hope, will come to a bipartisan agreement as to 
the best practices standard. Make the recommendations to 
regulators, and only if necessary, in my view, propose 
legislation, particularly for the sake of the growing number of 
$200 investors who are out there this morning on the job, 
working trying to make the next dollar.
    It is far more important to do this very carefully, 
thoroughly, rather than do it quickly. Therefore, this hearing 
this morning marks the beginning.
    It is my intention to have several hearings over the coming 
months. At the suggestion of many, we will hear from 
regulators, we will hear from academicians, we will hear from 
all those concerned who have a financial interest in seeing 
trust become the bedrock of our financial marketplace again.
    [The prepared statement of Hon. Richard Baker can be found 
on page 116 in the appendix.]
    Mr. Kanjorski.
    Mr. Kanjorski. Thank you very much, Mr. Chairman.
    We meet today to consider the issue of analyst 
independence, a subject of great significance to our nation's 
vibrant capital markets. I congratulate you on your diligence 
in convening this very important and well-timed hearing.
    I would make, at this point, two observations, however, Mr. 
Chairman. As I walked down the hall, it is the first time in my 
memory that the line is down to the corner and around the 
corner, and down the other hallway. It reminds me that when I 
was a little boy, I read the 50 years of the New Yorker cartoon 
book, which asked a very pungent question: Where are the 
investors' yachts? I think today's crowd brings that cartoon 
back into play. Maybe that is why we are meeting here.
    The second observation is one of internal process. I do 
want to register my great disappointment with the House 
leadership in convening a very important bill involving SEC 
revenues that is on the floor today at the precise moment we 
are having this hearing. As you know, Mr. Chairman, several of 
us on this side of the aisle are opposed to the passage of the 
bill in its present form, and intended to argue that position 
on the floor today, as well as offer amendments in accordance 
therewith. And, as a result of the importance of this hearing, 
and the conflict with that bill on the floor, we are really put 
in an impossible situation either to miss our opportunity here 
and the intelligence we can gather, or to have a bill go 
through without comment. I hope this scheduling was not 
intentional, and I hope it never happens again.
    With that said, it is a well-timed hearing. I am not 
attempting to be facetious when I say that. Over the last 
several years, the perceived immortality of the U.S. economy 
and the emergence of the Internet have contributed to 
extraordinary interest and growth in our capital markets.
    Investors' enhanced access to financial reporting and their 
new-found ability to trade electronically also helped to fuel 
this dynamic expansion. Unlike some other sources of investment 
advice, the vast majority of the general public has usually 
considered the research prepared by Wall Street experts as 
reliable and valuable. With the burst of the high tech bubble, 
however, came rising skepticism among investors concerning the 
objectivity of some analysts' overly optimistic 
recommendations. Many in the media have also asserted that a 
variety of conflicts of interest may have gradually depreciated 
analysts' independence during the Internet craze and affected 
the quality of their opinions.
    We have debated the issues surrounding analysts' 
independence for many years. After the deregulation of trading 
commissions in 1975, Wall Street firms began using investment 
banking as a means to compensate their research departments, 
and within the last few years the tying of analysts' 
compensation to investment banking activities has become 
increasingly popular.
    As competition among brokerage firms for IPOs, mergers and 
acquisitions grew, so did the potential for large compensation 
packages for sell-side analysts. These pay practices, however, 
may have also affected analyst independence.
    While some brokerage houses suggest that they have erected 
an impenetrable Chinese wall, which you mentioned, that divides 
analyst research from other firm functions like investment 
banking and trading, the truth, as we have learned from many 
recent news stories, is that they must initiate a proactive 
effort to rebuild their imaginary walls.
    The release of some startling statistics has also called 
into question the actual independence of analysts. A report by 
First Call, for example, found that less than one percent of 
28,000 recommendations issued by brokerage analysts during late 
1999 and most of 2000 called for investors to sell stocks in 
their portfolio. Within the same timeframe, the NASDAQ 
composite average fell dramatically. In hindsight, these 
recommendations appear dubious. Furthermore, First Call has 
determined that the ratio of buy-to-sell recommendations by 
brokerage analysts rose from 6-to-1 in the early 1990s, to 100-
to-1 in 2000.
    Many parties have consequently suggested that analysts may 
have become merely cheerleaders for the investment banking 
division of their brokerage houses. I agree. To me, it appears 
that we may have obsequious analysts instead of objective 
    Today's hearing will help us better understand the nature 
of this growing problem and discover what actions might restore 
the public's trust and investors' confidence in analysts. Like 
you, Mr. Chairman, I generally favor industry solving its own 
problems through the use of self-regulation whenever possible. 
But in this instance, the press, regulators, law enforcement 
agencies, and spurned investors have also begun their own 
examinations into these matters. I suspect that these parties 
may demand even greater reforms than those recently proposed by 
the Securities Industry Association, including the need for 
full and robust disclosure of any and all conflicts of 
interest. To address these concerns, the industry may 
eventually need to come forward with a way to audit and enforce 
the best practices it now proposes. If not, others may seek to 
impose their own solutions to resolve this problem.
    We will hear today from eight distinguished witnesses 
representing a variety of viewpoints. I am, Mr. Chairman, 
particularly pleased that you invited a representative from the 
AFL-CIO to join in our discussions. I would have also liked to 
learn from the concerns of SEC and NASD, among others.
    I was, however, heartened to learn yesterday that you plan 
to hold additional hearings on this issue in the upcoming 
months with the concerned parties.
    As we determined last year during our lengthy deliberations 
over Government sponsored enterprises, a roundtable discussion 
is often the most appropriate forum for us to deliberate over 
complex issues. In the future, I urge you to convene a 
roundtable over the matters related to analyst independence. A 
roundtable discussion would force the participants to challenge 
each other's assumptions and assertions in an open environment. 
It would also provide us with greater insights than testimony 
that has been scrutinized and sterilized through the clearance 
process. A roundtable debate would further allow us to more 
fully educate our Members about the substantive issues involved 
in this debate.
    In closing, Mr. Chairman, let me caution all Members of 
this subcommittee, and particularly Members on my side. This is 
an issue that evidently is somewhat sexy and popular just by 
evidence of the amount of television here today. To people in 
public office and, quote: ``politicians,'' it may be a great 
temptation to be a demagogue.
    I join you in urging our fellow Members and others in our 
society to hold back their fire and their conclusions. We have 
the most successful financial and capital markets in the world.
    Because we are in some difficulty economically in the 
markets, this is not the time to grab a club and take personal 
advantage by playing the role of lead demagogue. We cannot 
afford that, and the American economy cannot afford that.
    So I look forward to hearing the testimony today. I think 
that over the next several months, if we use more open fora, we 
may be able to find a solution to a problem that is self-
regulation by the Association and the industry itself. I would 
join you in that effort and hopefully, that is the best 
conclusion that we could reach.
    Thank you, Mr. Chairman.
    [The prepared statement of Hon. Paul Kanjorski can be found 
on page 120 in the appendix.]
    Chairman Baker. Thank you, Mr. Kanjorski.
    Just by way of assurance, the subcommittee's hearing date 
was established some time ago without knowledge of the floor 
consideration. Your point concerning the fee reduction bill on 
the floor today and the subcommittee hearing simultaneously is 
a matter of concern, but I assure you it was not an intentioned 
effort to create difficulty.
    I happen to have some interest in the opposite side on that 
matter, and would like to be there to watch you on the floor 
very carefully.
    Mr. Oxley. Thank you, Mr. Chairman. Let me commend you for 
holding this hearing.
    One of my goals, as the Chairman of this new Committee, is 
to help investors by improving the way they get information on 
which they base their investment decisions. Due in large part 
to the advances in technology that have brought to us the 
Internet, we've become not only a Nation of investors, but a 
Nation of self-taught investors.
    No longer do investors have to rely on the information they 
obtain from their broker to make their investment decisions. 
Today, there is a veritable smorgasbord of information about 
the marketplace available to the public through financial 
websites, print publications, television, and virtually every 
media outlet.
    There is a wealth of data available to investors. I 
launched this subcommittee's inquiries into improving the way 
stock market quotes are collected and disseminated into the 
impact of Regulation FD with an eye toward assuring that 
investors have broad access to the highest quality information 
about the marketplace.
    Today's hearing continues our work toward that goal. I 
commend you, Mr. Chairman, for your work on each of these 
issues and for holding this important hearing today. I heartily 
agree with the Supreme Court's characterization in the Dirks 
case of the importance of analysts to investors to the 
    And I quote: ``The value to the entire market of analysts' 
efforts cannot be gainsaid. Market initiatives are 
significantly enhanced by their efforts to carry it out and 
analyze information. Thus the analysts' work rebounds to the 
benefit of all investors.''
    Yet the important work of analysts is not to the 
marketplace or investors any good at all, if it is compromised 
by conflicts of interest. There has been a great deal of 
concern raised by the media by regulators and by market 
participants about the perception that analysts are not in fact 
providing the independent, unbiased research that investors and 
the marketplace rely on.
    We are here today to learn whether the Chinese wall that is 
long cited as the separation between the research and 
investment banking arms of securities firms has developed a 
crack or is completely crumbling.
    I am encouraged that Wall Street has recognized that this 
is not a phantom problem, and has proposed industry best 
practices guidelines to address these conflicts about which we 
will hear today.
    But I must emphasize that if that Chinese wall is in need 
of repair, wallpaper will not suffice.
    While I am a strong proponent of free market solutions, I 
and the subcommittee plan to examine these industry guidelines 
very closely to ensure that they are tough, they are fair, and 
they are effective.
    I am distressed by the statistics that as the markets were 
crashing last year, less than two percent of analysts' 
recommendations were on the sell-side.
    It is no wonder there is public outcry about analysts' 
independence when the statistics are so stark. But it seems to 
me that the problem is not simply biased analysts. The firms 
that employ these analysts tie their compensation to the 
analysts' success in bringing in investment banking business.
    Then the firms are undermining the independence of their 
own employees' recommendations.
    Similarly, companies that pressure analysts through either 
the carrot on the stick or of increased or decreased investment 
banking business in turn for favorable reports exacerbates the 
    Likewise, institutional investors also exert pressure on 
analysts to issue rosy reports about the stocks those 
institutional investors hold in their own portfolios.
    We intend to examine every angle of this issue in order to 
best determine how to resolve it. Our subcommittee's goal here 
is to improve industry practices and I call on the industry to 
eliminate the conflicts of interest created by compensation 
structures and insufficient separation of investment banking 
and research, and I call on them also to provide meaningful and 
understandable disclosure to investors that will enable 
investors to evaluate, for themselves, what weight they should 
give the recommendations of any particular analyst.
    Mr. Chairman, this hearing is this subcommittee's first 
step in a long-term effort to ensure that the Nation's 
investors have the best possible information about the stocks 
in which they invest. Ensuring that investors could rely on the 
expertise of analysts, without any doubt as to their integrity 
or independence, could not be more fundamental to that effort.
    I yield back the balance of my time.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page 126 in the appendix.]
    Chairman Baker. Thank you, Mr. Chairman. I certainly 
appreciate your leadership on this issue as well.
    Mr. LaFalce.
    Mr. LaFalce. Thank you very much, Chairman Baker.
    Today, our subcommittee confronts the very important 
question of whether investors are receiving unbiased research 
from Wall Street securities analysts.
    I don't think they are, and I commend the Chairman for 
holding these hearings. I'm very concerned that investors have 
become victims of recommendations of analysts who have apparent 
and direct conflicts of interest relating to their investment 
    So I think this morning's hearing is extremely important. 
It is anomalous that as our subcommittee considers this 
extremely important hearing, the bill that was reported out of 
our subcommittee is on the floor of the House of 
Representatives either now or in a matter of moments, reducing 
the fees of the SEC by approximately $14 billion over the next 
10 years, without regard to the capacity of the SEC to 
effectively enforce the laws and regulations responsible for 
investor independence and objectivity, responsible for 
accounting independence and objectivity, responsible for so 
many of the other problems which are probably just the tip of 
the iceberg of problems existing for investors in this multi-
trillion marketplace that the individual citizen is 
participating in today in the United States in a manner 
unparalleled in American history.
    That's very regrettable, but in any event, I'm glad for the 
hearing. It's clear that sell-side analysts work for firms that 
have business relationships with the companies they follow. 
Most analysts are under increased pressure to look for and 
attract business and to help the firm keep the business it has.
    The analyst is asked to be both banker and stock counselor 
and these two goals often live in conflict. The individual 
investor is often unaware of the various economic and strategic 
interests that the investment bank and the analysts have that 
can fundamentally undermine the integrity and quality of 
analysts' research.
    The disclosure of these conflicts is often general, 
inconspicuous, boiler plate, meaningless. In addition, current 
conflict disclosure rules do not even reach analysts touting 
various stocks.
    For example, on CNBC or CNN, as former Chairman of the SEC, 
Arthur Levitt noted, I wonder how many investors realize the 
professional and financial pressures many analysts face to 
dispense recommendations that are more in a company's interest 
rather than the public's interest.
    I believe it is precisely these pressures that moved many 
analysts, during the technology boom over the last several 
years, to recommend companies and assign valuations beyond any 
relationship to company fundamentals.
    In a recent article, a very well-known technology analyst 
was quoted as responding to questions concerning the legitimacy 
of the valuation of a particular company, and the analyst said, 
we have one general response to the word ``valuation'' these 
days. Bull market. We believe we have entered a new valuation 
    The article to which I refer, and many, many, many others 
like it, make the case that these conflicts may have profoundly 
undermined analysts' integrity and possibly misled investors. I 
think possibly should be almost certainly misled investors as 
analysts held fast to companies, as the market eroded out from 
under them.
    The Securities Industry has suggested new guidelines to 
address some of the conflicts we will discuss in today's 
hearing. Their initiative is an important first step. I do not 
believe, however, that these voluntary guidelines go far enough 
to address the problem.
    I am pleased therefore that today's hearing will begin a 
process whereby our subcommittee and the regulators can begin 
to take a hard look at these troubling questions affecting the 
American investing public.
    I look forward to the hearings where the SEC and the NASD, 
amongst others, where academic analysts, where investors, 
attorneys, and others can testify on the question of analyst 
    In my view, the Securities regulators' perspective is 
especially critical. We cannot fulfill our oversight 
responsibility if the Government and quasi-government entities, 
charged by Congress with the protection of investors, have not 
been heard.
    Not only do the Securities regulators have an important 
perspective on the magnitude of the problem, they also have a 
view on how the industry is complying with current regulations 
on information barriers, so-called Chinese walls and the 
disclosure of conflicts.
    In sum, I am increasingly concerned that industry self-
regulation may not be sufficient to guard against the problems 
and abuses we are seeing, and that more disclosure of these 
conflicts, in itself, may not suffice to protect the individual 
    So I hope today's hearing is only the first step in 
confronting these very troubling issues of securities analysts 
conflicts of interest that mean trillions of dollars to people 
in neighborhoods across America.
    I thank you.
    [The prepared statement of Hon. John J. LaFalce can be 
found on page 122 in the appendix.]
    Chairman Baker. Thank you, Mr. LaFalce.
    By prior agreement, we had hoped to limit opening 
statements to the Members previously recognized, and I intend 
to do so, but I have been requested by Ms. Jones to be 
recognized for 30 seconds to explain her necessity for 
departing from the hearing this morning.
    Ms. Jones.
    Mr. Jones. Mr. Chairman, Mr. Ranking Member, Colleagues, I 
appreciate the opportunity to submit my statement for the 
    This morning, the National Institutes of Health will be 
naming a building after the Honorable Congressman Louis Stokes, 
my predecessor. I must go out there and congratulate them. 
Thank you very much. I submit my statement for the record.
    [The prepared statement of Hon. Stephanie T. Jones can be 
found on page 118 in the appendix.]
    Chairman Baker. Thank you very much, Ms. Jones.
    At this time, I would like to proceed with the introduction 
of our panelists.
    Our first to participate this morning, we welcome, is Mr. 
David Tice, Portfolio Manager, the Prudent Bear Fund, and 
publisher of the institutional research service known as 
``Behind the Numbers.''
    Welcome, Mr. Tice.
    For the record, all witness statements will be made part of 
the record. Please feel free to summarize. We will have a 
number of questions for the panel during the course of the 
morning, and we would like to maximize that time as best we 
    Please proceed, sir.

                     ``BEHIND THE NUMBERS''

    Mr. Tice. Thank you very much, Mr. Chairman. David W. Tice 
& Associates operates two different businesses. We publish 
``Behind the Numbers,'' an institutional research service, and 
serve as investment advisor to two mutual funds.
    I started ``Behind the Numbers'' in 1988 because I realized 
institutional investors did not receive independent, unbiased 
research from their traditional brokerage firms, which almost 
never issued sell recommendations.
    To our knowledge, there are now fewer than six other 
significant firms that concentrate on only sell 
    We like to call ourselves ``The Truth Squad'' with regard 
to individual Wall Street recommendations. The truth is, this 
lack of analyst independence has been great for our business. 
Currently, more than 250 institutional investors purchase our 
service. Our 15 largest clients manage more than $2.3 trillion.
    David W. Tice & Associates, Inc., is a modest-sized 
organization of 17 professionals, yet every 2 weeks we butt 
heads with the best and brightest from Wall Street's biggest 
firms with our assessment of company fundamentals.
    Of nearly 900 sell recommendations issued between 1988 and 
2001, 67 percent have under performed the market with about 
half declining in price in the biggest bull market in this 
    Usually our analysis makes our research clients 
uncomfortable as well as potential mutual fund shareholders 
because it differs from the Wall Street consensus.
    However, our research has earned respect because of its 
quality and because people realize that our conclusions are 
free of the biases that affect traditional Wall Street 
    Our job is not to be pessimistic or optimistic, but to be 
realistic and to help protect clients' capital. In this spirit, 
and with the benefit of our insight into hundreds of U.S. 
companies that we analyze, the U.S. stock market and economy, 
we concluded that we had a bubble stock market and a bubble 
    So we organized the ``Prudent Bear Fund'' in 1996, the same 
year that Alan Greenspan made his famous ``irrational 
exuberance'' speech.
    We believe the individual investor should be warned and 
should have access to a vehicle to hedge himself in a market 
decline. Some will question our objectivity since we manage 
this bear's fund, and say that I'm just talking ``my book.''
    But I believe passionately in every word of my testimony, 
and it's all based on fact, rigorous analysis, and solid macro-
economic theory.
    There is no question, Mr. Chairman, that Wall Street's 
research is riddled with structural conflicts of interest. 
Compounding this problem, according to a recent study, those 
who closely follow Wall Street's stock recommendations have 
suffered abysmal investment performance as this study showed 
that from 1997 through May 2001, only 4 out of 19 major Wall 
Street firms would have generated positive returns over the 
4\1/2\ year period in the biggest bull market in this century.
    In our testimony, we've provided many examples of 
conflicts. Generally, our perception of this situation today 
coincides with the Chief Investment Officer of Asset Allocation 
of a multi-billion dollar asset manager who said, and I quote: 
``Research analysts have become either touts for their firm's 
corporate finance departments or the distribution system for 
the party line of the companies they follow. The customer who 
follows the analysts' advice is paying the price.''
    Today, the power structure of most Wall Street firms is 
simply concentrated too much in investment banking; and even 
with the supposed Chinese walls, there are still multiple cases 
of analysts reporting to investment bankers.
    This is an outrage. This conspicuous lack of objectivity in 
research is indicative of what we see as a general lack of 
responsibility on Wall Street today, one that's having a 
corrosive effect on the marketplace.
    The main emphasis of our testimony has addressed the 
consequences that arise when capital markets lack integrity, 
stemming largely from this lack of objectivity. This problem is 
much larger, Mr. Chairman, than whether or not individual 
investors are disadvantaged or have suffered losses, or if 
analysts receive over-sized bonuses.
    What's at stake we believe is that a sound and fair 
marketplace is at the very foundation of capitalism. It is the 
functioning of the market pricing mechanism that determines 
which businesses and industries are allocated precious 
resources, and it is this very allocation process that's the 
critical determining factor for the long-term economic well 
being of our nation.
    When the marketplace regresses to little more than a 
casino, the pricing mechanism falters and the allocation 
process becomes dysfunctional. When the marketplace's reward 
system so favors the aggressive financier and the speculator 
over the prudent businessman and investor, the consequences 
will be self-reinforcing booms and busts, a hopeless 
misallocation of resources, and an unbalanced economy.
    We believe that in an environment of more independent 
analysis, it would have led to a more efficient capital 
allocation where we would have financed fewer internet 
companies less fiber optic bandwidth, and instead perhaps built 
more refineries in California power plants.
    When credit is made readily available to the speculating 
community, failure to rein in the developing speculation risks 
ponzi-type investment schemes. Such an environment will also 
foster a redistribution of wealth from the unsuspecting to 
those most skilled in speculation.
    Such an environment creates dangerous instability, what we 
refer to as financial and economic fragility.
    The financial sector is creating enormous amounts of new 
debt that's often being poorly spent. Sophisticated Wall 
Street, with its reckless use of leverage, proliferation of 
derivatives, and sophisticated instruments, is funding loans 
that should not be made.
    While such extraordinary availability of credit certainly 
does foster an economic boom, it must be recognized that 
history provides numerous examples of the precariousness of 
booms built on aggressive credit growth that are unsustainable 
and dangerous.
    Goldman Sachs' Abby Joseph Cohen has used the phrase ``U.S. 
Supertanker Economy,'' but the problem is Wall Street has 
created a ship that has run terribly off course. Wall Street's 
lack of independence has fostered this misdirection and 
camouflaged the fact that our U.S. economy is in danger because 
of our capital misallocation and credit excess.
    This may sound ridiculous to most of you with nearly 
uniform optimism among traditional economists. But if you doubt 
me, I'll quote ex-Fed Chairman Paul Volker, who more than 2 
years ago said, quote: ``The fate of the world economy is now 
totally dependent upon the U.S. economy, which is dependent 
upon the stock market whose growth is dependent on about 50 
stocks, half of which have never reported any earnings.''
    If I could go to our potential solutions. We do not pretend 
to be experts in the area of Securities Law and Regulation. We 
have presented a list of nine solutions in the spirit of 
general directions to take, not specific laws to change.
    Not included in our list of solutions are proposals that 
try to tinker with analysts' compensation schemes or require 
some type of peer review. We believe the problems are so 
significant and so critically important, bold solutions, not 
incremental change, are required.
    Tremendous political courage will be needed to effect 
change in this area. Those who have benefited from the current 
broken system have enormous financial resources.
    The raw political power of those who favor the current 
system cannot be underestimated.
    The voice of those favoring change will be faint, but well 
worth listening to. However, we must remember that trust in our 
institutions is the cornerstone of a vibrant capitalist 
society, and lies at the heart of a healthy democracy.
    Chairman Baker. Can you begin to wind it up, sir?
    Mr. Tice. Yes. We commend the subcommittee and Chairman for 
tackling such a difficult and timely issues. The stakes are 
    Thank you for the honor of appearing before this 
    [The prepared statement of David Tice can be found on page 
128 in the appendix.]
    Chairman Baker. Thank you, Mr. Tice. I appreciate your 
courtesy, sir.
    Our next witness to appear is Mr. Gregg Hymowitz, founding 
partner, EnTrust Capital.
    Welcome, sir.


    Mr. Hymowitz. Mr. Chairman Baker, esteemed Members of the 
subcommittee, I'm Gregg Hymowitz, a founding partner in EnTrust 
Capital. It's a pleasure to share with you this morning my 
summarized thoughts and observation.
    My comments today represent solely my personal views and 
not necessarily the views of EnTrust Capital.
    Is there a conflict of interest among sell-side analysts 
and the companies they cover? In my opinion, the answer is yes.
    But the relationship between analyst, issuer, and the 
investing public is a complex network of checks and balances.
    Typically, the analyst works for an investment bank whose 
bankers are attempting to move business from the issuer, often 
in the form of a capital market transaction. Therefore, most 
analysts recognize it does not behoove their firm's self-
interest to have a negative view on the issuer.
    Additionally, most analysts's compensation at investment 
banks has historically been partially determined by the amount 
of high margin capital market transaction revenues for which 
each analyst was responsible.
    The communication between analyst and issuers is symbiotic. 
The issuer needs the analyst's coverage to get potential 
investors interested in buying, and the analyst's life blood is 
an open communication channel to the issuer.
    One can surmise that communication is easier and more open 
between parties when they are aligned. The pressures and 
conflicts on the sell-side analysts during the recent equity 
bubble were exaggerated by the compressed period of time the 
capital markets were accommodative.
    Investment banks, due to the demand from the investing 
public, and the supply created by venture capitalists, took 
hundreds of companies public that, in historical terms, would 
never have made it out the door.
    The need for new valuation metrics became apparent. Free 
cash flow and earnings metrics were replaced with multiples of 
sales, developers, and my favorite, web hits.
    Now while many of these metrics have turned out to be just 
plain silly and will continue to remain just plain silly, we 
need to remember 20 years ago, a now widely recognized metric 
called EBITDA was created to analyze certain profitless 
    Investment banks have been recommending stocks to their 
clients roughly since the 1792 Buttonwood Agreement. 
Historically, however, the Morning Call was the province of the 
institutional money manager, who understood where this 
information was coming from and was able to evaluate its 
relative importance.
    With the rise of the Internet, Wall Street calls are 
everywhere, rich with a frenzy day trading analyst calls took 
on exaggerated importance. Often the trading public seized upon 
these calls and stocks would move significantly. Remember, 
there was little or no public uproar over analysts' rosy 
coverage in 1999, when many investors were making in the market 
    For years, the institutional money manager understood from 
where the sell-side research held, and as it became more 
dispersed, the individual investor has now caught on.
    In this age of information overload, the individual has the 
responsibility to perform his or her own due diligence. For 
decades now, the institutional investor has been ranking equity 
analysts, and today there are dozens and dozens of free 
websites, which rank analysts.
    These resources are doing an excellent job of informing 
those investors who are willing to invest the time on doing due 
diligence, and which analysts to follow.
    But for the individual who merely sees the stock market as 
a craps table, without doing any of his or her own research on 
either the issuer or the analyst, does so at one's own peril.
    One idea that may coerce analysts to be more thoughtful in 
their recommendation is for investment banks to actually urge 
analysts to own the stocks they suggest, with proper internal 
safeguards to prevent such things as front running in addition 
to appropriate disclosure, analysts actually owning the stocks 
they recommend actually may help ameliorate the biases that 
    The old Wall Street adage to analysts is, don't tell me 
what you like, tell me what you own. Many individuals want to 
find a causal relationship between the market's crash and the 
lack of sell recommendations among sell-side analysts.
    I believe no causal relationship exists. While there have 
been many buy ratings on the steel, food, and retail stocks, 
with little if any sell recommendations, they did not 
experience the meteoric rise many tech stocks had over the past 
couple of years, incorrectly many believe that there are few 
sell recommendations on Wall Street.
    There are, however, numerous firms, including Mr. Tice's, 
that specialize in providing only sell recommendations. 
Unfortunately, much of this research is not widely circulated 
to the individual investor because, quite frankly, it is very 
costly. There are also many countervailing pressures on 
analysts that work toward providing a balanced view, first and 
foremost. On Wall Street, reputation and record mean 
    The analysts over time who are the most thoughtful, 
responsible and correct earn the respect of the investment 
community. This institutional pressure for analysts to be 
correct is the largest force compelling unbiased work.
    Another clear way of holding analysts accountable is for 
the investment bank to publish each analyst's performance 
record. This will provide more information to the investors and 
aid those who are superior stock pickers.
    Investment bankers should improve the materiality of 
disclosure statements. It is more important from a potential 
conflict standpoint to know if the bank is currently engaged by 
the issuer or is pitching the firm new business, rather than 
the typical historical disclosures.
    The disclosure statement should consist of whether the 
analyst personally owns the security. Equity ownership by 
analysts is a positive occurrence, not something to be shunned.
    I will sum up. The new information age, combined with 
Regulation FD, Fair Disclosure, is impacting the role of the 
analyst, with companies now severely limited to what they can 
say to analysts.
    Prior to generally released news, the importance and edge 
that analysts have over the investing public has significantly 
diminished. Unfortunately often, and I know this from personal 
experience, the only way to learn this business is from 
mistakes. That costs money.
    Investors have learned a hard lesson. With huge rewards 
come equally huge risks, the bubble has burst. There will be 
other manias with new and probably evermore fanciful evaluation 
metrics in our future.
    Investors should not believe everything they read, hear, or 
see. In the new Regulation FD Internet age, the playing field 
has been leveled, possibly lowered. And therefore the 
responsibility accordingly must be shared.
    Thank you, Mr. Chairman.
    I'd be honored to attempt to answer any questions the 
subcommittee may have.
    [The prepared statement of Gregg S. Hymowitz can be found 
on page 160 in the appendix.]
    Chairman Baker. Thank you very much.
    Just by way of notice to Members, we have a 15-minute vote 
on the floor pending, followed by two 5-minutes. It would be my 
intention to recognize Mr. Glassman for his opening statement, 
and then recess the subcommittee at that moment to proceed to 
the votes. We'll be out for about 15 minutes. We will try to 
get back as quickly as possible.
    Mr. LaFalce. Parliamentary inquiry, Mr. Chairman.
    I understand what you just articulated. I wonder if we 
might consider--I suppose this depends upon the schedule of the 
witnesses of panel one and panel two. The bill that we are 
considering deals with the SEC and the fees that are being 
charged. Section 31, Section 6, Section 13, Section 14, peg to 
parity capacity of SEC for enforcement, and so forth.
    I'm wondering if we couldn't recess until completion of 
debate and passage of that bill, and then return. I suspect it 
would be about 2:00 o'clock. But I don't know what the schedule 
of the witnesses is.
    Right now, we have two responsibilities; one here and one 
there. We can't bi-locate, so either we have to give short 
shrift to one of our responsibilities and they are both great.
    Chairman Baker. I understand the gentleman's point. 
Ordinarily, if we had prior notice to try to make arrangements, 
we would have just convened at a later hour today, but given 
the witnesses' traveling arrangements, I respectfully suggest 
we proceed as announced with a brief recess, come back, and we 
will do all we can to accommodate appropriate consideration.
    I intend to be in the subcommittee most of the day and will 
miss most of the debate on the floor myself, which I deeply 
regret. But I think in deference to the eight people who've 
made arrangements to be here, we need to proceed as we 
    At this time, I'd like to recognize Mr. James Glassman, no 
stranger to the subcommittee, who is a Resident Fellow at 
American Enterprise Institute and Host of 
    Welcome, Mr. Glassman.


    Mr. Glassman. Thank you, Mr. Chairman, Members of the 
    My name is James K. Glassman. I'm a resident fellow at the 
American Enterprise Institute, author of financial books and an 
investing columnist for many years. I've devoted much of my 
professional life to educating small investors.
    This hearing sheds light on an important subject, but I 
urge restraint in two ways. First, analysts should not be seen 
as scapegoats for the recent market decline.
    Second, this subcommittee should resist the urge to pass 
legislation in this area.
    Analysts and firms have enormous incentives to do their 
jobs well. The marketplace weeds out the bad from the good as 
long as the public has the information. That is the function of 
a hearing like this, and I commend you for holding it.
    Many analysts were caught off guard by the recent decline 
of the stock market, which represented the first bear market in 
a decade. Some of them were accused of allowing personal 
financial interests and a desire to cater to the investment 
banking side of their firms to distort their judgments.
    Let me make three comments about this criticism.
    First, conflicts of interest pervade the securities 
industry because they pervade life. You Members, yourselves, 
cope with conflicts all the time. You have allegiances to 
family, to donors, to party, but you try to surmount them.
    Or consider journalists. Surveys show that most journalists 
lean to the left of the political spectrum. For example, a 
study by the Roper Center of 139 Washington bureau chiefs and 
correspondents found that in 1992, 89 percent of them voted for 
Bill Clinton, 7 percent for George Bush, yet every journalist 
to whom I've ever spoken claims that his professionalism 
overrides these conflicting political leanings.
    Does it?
    Well, the answer is that we can judge for ourselves by 
reading the articles that they write or the TV segments in 
which they appear.
    A similar situation prevails for stock analysts, except 
that their judgments are clear and more easily accessed by the 
    The essential problem with a conflict of interest of any 
sort is that it leads to poor decisions. In the case of 
journalists, bias may suddenly color reporting and be difficult 
to discern.
    In the case of stock analysts, it could mean that a company 
with poor fundamentals is given a high recommendation.
    In this case, however, the analysts' judgment is assessed 
quickly by the public. An analyst who consistently gives bad 
advice will be rejected as not useful, either to investors or 
ultimately to the firm that employs her. An analyst cannot hide 
for very long.
    Second, I favor voluntary and extensive disclosure by 
analysts of personal holdings and other affiliations that might 
color decisions. But don't exaggerate the benefits of 
disclosure. What, for example, should an investor make of the 
disclosure that an analyst owns shares of stock that he 
    Is it that the stock may not be all that good, but the 
analyst is pushing it for personal gain?
    Or is it the opposite. That the stock is particularly good 
because the analyst owns it?
    I am not really sure that disclosure is all that helpful. 
Yet, I do favor it, and I do it myself.
    Third, the essential critique is that analysts biased by 
conflicts have made poor recommendations. Now we can test that 
theory by looking at the actual performance of analysts.
    How well do they do? This question has been examined at 
length in a study published in the April 2001 issue of the 
Journal of Finance, a highly regarded publication for scholars.
    In the article, the articles, Brad Barber of the University 
of California at Davis and three of his colleagues found that 
analysts' recommendations were in fact prescient and 
profitable. This research reinforces earlier studies that have 
found that professional securities forecasters have acted 
rationally, that is, with proper judgment.
    The authors of the new study looked at a database of 
360,000 pieces of advice from 269 brokerage houses and 4,340 
analysts from 1986 to 1996. They found that investors buying 
portfolios of the highest rated stocks by these analysts 
achieved average annual returns of 18.8 percent to compare with 
a stock market benchmark return over this period of 14.5 
    The lowest rated stocks by analysts achieved a return of 
only 5.8 percent.
    These results are truly exceptional. Rare, for example, is 
the mutual fund that can beat the Standard & Poor's 500 Stock 
Index by four points over 10 years. In fact, the benchmark has 
beaten the majority of funds over the past two decades.
    I should add that Mr. Tice likes to criticize analysts, but 
his own fund, the Prudent Bear Fund, has, according to 
Morningstar, produced a total return of minus 47 percent from 
its inception in 1996 through April 30th, 2001.
    The S&P 500, the benchmark, produced a return of positive 
120 percent.
    The results of the Barber study suggest that analysts are 
truly able to pick winners.
    Now last month, the researchers published an unpublished 
follow-up for 1997 to 2000. In the first three of those years, 
the results were even better than they had been in the previous 
10 years. But in the final year, 2000, the results were 
terrible. The most highly recommended stocks fell sharply while 
the least favored stocks did the best.
    Those results of course are at variance with the previous 
13 years and certainly we should watch analysts closely, but 
the longer term results show that, on the whole, analysts do a 
good job for their clients.
    Finally, I worry that this hearing could send three wrong 
messages to investors, to small investors. The first is that 
bad stock picks are the result of corruption and bias. In the 
vast majority of cases, they are not.
    Poor picks usually happen because the market in the short 
term is impossible to predict. No one is right all the time or 
even much better than half the time.
    The second wrong message is that short-term stock 
recommendations are all that important to investors. Again, 
they are not. The best advice to investors always is to own a 
diversified portfolio for the long term.
    Concentrating on the day-to-day judgment of analysts is not 
a profitable pastime for small investors, whether those 
analysts are pulled by conflicts of interest or not.
    And the third wrong message is that the paucity of sell 
recommendations is a scandal. To the contrary, smart investors 
buy stocks and they keep them; they don't sell.
    Despite the past year, as I said earlier, the benchmark is 
up 120 percent in 5 years. Investing is a long-term endeavor; 
done best, it is boring. If I could change anything that 
analysts do, it would be to encourage them to tell us the best 
stocks to own unchangingly for the next 5 to 10 years, not the 
next 5 to 10 weeks.
    However, I congratulate this subcommittee for airing such 
an important issue.
    Thank you.
    [The prepared statement of James K. Glassman can be found 
on page 166 in the appendix.]
    Chairman Baker. Thank you, Mr. Glassman.
    We stand in recess for approximately 15 minutes.
    Thank you.
    Chairman Baker. I'd like to begin the effort to reconvene 
our hearing. The good news is we only had two votes instead of 
three and Members are on their way back. I expect them to be 
coming in as we proceed.
    In order to facilitate the progress in the hearing, I'd 
like to go ahead and recognize our next witness. It's my 
expectation that we will have at least another hour before we 
get interrupted again unless of course things change.
    With that caveat, I would like to, at this time, recognize 
Mr. Marc Lackritz, President of the Securities Industries 
    Welcome, Mr. Lackritz.


    Mr. Lackritz. Thank you, Mr. Chairman. Mr. Chairman, I'm 
really pleased to be here this morning to have this opportunity 
to meet with you and the subcommittee.
    The subject of today's hearing concerns how this industry 
fulfills its obligations to its customers, to the nearly 80 
million Americans who directly or indirectly own shares of 
    Our most important goal as an industry is to foster the 
trust and confidence of America's shareholders in what we do 
and how we do it.
    And we succeed as an industry only when we put investors' 
interests first, period.
    I will refer you to my written testimony for a detailed 
description of who analysts are and how they help investors and 
our markets. The value added by securities analysts has been 
widely appreciated.
    For example, both the Supreme Court and SEC have said in 
the Dirks case, as Chairman Oxley indicated earlier, that the 
value to the entire market of analysts' efforts cannot be 
    Market efficiency and pricing is significantly enhanced by 
their initiatives to ferret out and analyze information. Thus, 
the analysts' work redounds to the benefit of all investors.
    How good a job you can ask do securities analysts do? As a 
group, they do a pretty good job. As my colleague, Mr. 
Glassman, said earlier, the recent academic paper that he cited 
reviewed approximately 500,000 analysts' recommendations from 
1986 to 2000, and concluded that the consensus recommendations 
that analysts make on specific stocks prove both prescient and 
    The authors found ``sell-side analysts' stock 
recommendations to have significant value.'' Aside from this 
comprehensive study, it's quite notable that 71 percent of 
recommendations listed in First Call are buys or strong buys.
    This seems appropriate, considering that the 12 years from 
1988 through 1999 saw the Dow Jones Industrial Average and the 
Standard & Poor's 500 Index both post an average gain of 16 
percent a year.
    Critics of analysts were much less vocal then. To be sure, 
in the past year or so as the market declined and the Internet 
bubble burst, it seems that securities analysts have a few 
bloody noses. They certainly do and they are not alone. Just 
about everyone working, reporting on, and commenting about 
securities recently has tripped at least a few times.
    The question before this subcommittee is whether these 
analysts can be subjected to direct or subtle pressure to skirt 
objectivity and shade their conclusions one way or another.
    It's a very legitimate question. The answer is, yes, they 
can. We in the industry, as well as those who regulate us, long 
have been aware of this. For this reason, there are strong 
legal mandates in the Securities Exchange Act of 1934. And 
similar regulations and laws are on the books to ensure 
research integrity and objectivity.
    These are tough regulations as are the internal safeguards, 
yet is clear that some doubts may now be clouding the 
perception of how securities analysts operate. That's why we're 
meeting today, just to banish these clouds.
    The Securities Industries Association has formalized and 
bolstered the safeguards by endorsing and releasing earlier 
this week, these best practices for research. In these, we 
articulate clearly the means to protect the independence and 
objectivity of securities research and the securities analysts.
    We reaffirm that the securities analyst serves only one 
master, the investor, not the issuer nor the potential issuer.
    Let me offer some examples from its main points:
    One. The integrity of research should be fostered and 
respected throughout a securities firm. Each firm should have a 
written statement affirming the commitment to the integrity of 
    Two. The firm research management, analysts and investment 
bankers, and other relevant constituencies should together 
ensure the integrity of research in both practice and 
appearance. Research should not report to investment banking. 
The recommendation should be transparent and consistent. A 
formal rating system should have clear definitions that are 
published in every report or otherwise readily available, and 
management should support use of the full rating spectrum.
    Three. An analyst should not submit research to investment 
banking nor to corporate management for approval of his or her 
recommendations or opinions, nor should business producers 
promise or propose specific ratings to current or prospective 
clients while pursuing business.
    Four. A research analyst's pay should not be linked to 
specific investment transactions.
    Five. Research should clearly communicate the relevant 
parameters and practical limits of every investment 
recommendation. Analysts should be independent observers of the 
industries they follow. Their opinions should be their own, not 
determined by those of other business constituencies.
    Six. Disclosure should be legible, straightforward and 
written in plain English. Disclaimers should include all 
material factors that are likely to effect the independence of 
specific security recommendations.
    Seven. Personal trading and investments should avoid 
conflicts of interest and should be disclosed whenever 
relevant. Personal trading should be consistent with investment 
    There are a number of other important points to best 
practices, copies of which have been submitted to the 
    In addition to these best practices, Mr. Chairman, we will 
also continue and renew our efforts to educate investors on the 
risks and rewards inherent in the market, as well as basic 
investment precepts.
    We have a number of publications that we've put out over 
the last couple of years. They are available on our website, 
and we're renewing our efforts to distribute them through our 
own members to investors directly.
    Successful investing is a partnership between securities 
professionals and the investor. Therefore, just as the 
securities industry is renewing its commitment to do its part, 
we ask investors to be educated, informed, and prudent in their 
investment decisions.
    The long-term interests of investors, the securities 
analysts and the securities firms for which they work are best 
served by analysts using their most skilled powers of research 
and best judgment.
    The market is a very powerful and unforgiving enforcer. 
Flawed projections lose customers.
    All of us in this industry know only too well the truth of 
the adage that it takes months to win a customer, but only 
seconds to lose one.
    No securities firm wants to give advice that will hurt a 
client. Firms that offer bad investment guidance penalize 
    We believe the best practices endorsed by so many major 
firms and continuing throughout our Association demonstrate a 
vigorous renewed commitment to the investor. We hope they will 
go a long way toward ensuring that the public maintains and 
increases its trust and confidence in our markets and our 
    Thank you very much, Mr. Chairman.
    [The prepared statement of Mark E. Lackritz can be found on 
page 172 in the appendix.]
    Chairman Baker. Thank you, Mr. Lackritz.
    I'll start my questions with you and the recitation of the 
best practice summary you just concluded. One element of that 
that I believe I understand, and want to clarify, that the 
compensation for an analyst should not be tied to a specific 
transaction, so that a recommendation that leads to a client is 
an example of something, a favorable recommendation would not 
be compensated by bringing that client into the bank.
    However, I believe this to be accurate, and this is the 
reason for the question. Either on a quarterly or on an annual 
basis, the bank may declare bonuses for all affected parties 
and therefore reimburse or reward the analyst for the year-long 
effort, as opposed to the specific transactional activity.
    That is correct, is it not?
    Mr. Lackritz. Yes. But the specific best practice says that 
competition is not to be directly tied to any specific banking 
transaction or trading revenue or sales practice, but should be 
based on the overall performance of the analyst including the 
quality of the recommendations that the analyst has made.
    So the notion is to make it a merit-based compensation 
system. Of course, if the firm does better, everybody is going 
to get some of the rewards from that.
    Chairman Baker. I understand that. I'm just reading it 
critically from a legislative perspective.
    I would seem to me that rather than Fed-Exing the reward, 
we're going to send it by bus. That's my problem. There still 
is a correlation between the recommendations and bringing 
business in, as opposed to doing pure analytical work.
    I'm merely making that point to say that the best practices 
are indeed an appreciated step and I want to acknowledge that.
    As I told you and others, when it was presented, one of the 
elements that I believe is missing that we need to figure out 
how to resolve is the way to confirm or audit the compliance. 
It's one thing to have a nice book and put it on a shelf; it's 
another thing for it to actually be utilized.
    I think what you have presented there represents the 
absolute minimum standard for reasonable professional conduct.
    I also understand my criticism about the disclaimer. I've 
been provided with information in the interim that was intended 
to preclude potential civil cause of action for someone finding 
that a particular standard was not complied with and therefore 
creating unwarranted legal liability.
    I respect that, but I have to honestly say I don't believe 
that disclaimer would get you where you want to be. I think in 
fact there would be very creative efforts to say that that 
means nothing.
    If we are going to go that route, I'm simply offering this 
today as a matter for later discussion that really would have 
to be the subject of legislation to provide for a safe harbor 
from civil liability in the event that's where we think we need 
to go in order to get the quality of conduct that we think is 
    Do you have any comment?
    Mr. Lackritz. Maybe I could discuss that from two 
perspectives. One, your concerned about attracting long-term 
business to the firm because of these recommendations, and 
second with respect to the footnote.
    The goal of these best practices is to raise the quality of 
research throughout the industry, not to create a sub-structure 
of lots of different rules and regulations, but clear standards 
of behavior for what we can control.
    In the long run, firms are going to succeed by the quality 
of their advice. They will attract business because of the 
quality of their advice.
    Chairman Baker. I think that's true at a modest growth or 
certainly in an environment where people are worried about 
losing money. But in a bull market we've just come through, 
people are going to throw money without regard.
    They're going to watch the evening commentators figure out 
who the hot guys are. I mean, I've watched it. I've had yahoo 
finance web page and I watch and I say, this is going to be a 
real comer.
    You can see almost instantaneously the level of volatility 
that comes as a result of that guy's hip-shooting, and I can't 
say that that's appropriate for the investor to do it, but I'm 
saying that's what's happening.
    And people don't want to miss out on the opportunity to see 
their wealth increase. It's just logic.
    So we look to this analyst group to be the guys who really 
make sure that we're not being led in the wrong direction.
    Mr. Lackritz. I think that's a very good point, and it's 
part of the reason we're renewing our efforts toward investor 
education, because that's so very important to advise investors 
to get a second opinion, to do the research, to not just 
immediately buy something.
    Chairman Baker. Let me jump, because I've got a couple of 
other things I want to try to cover before I run out of my own 
    I just can't fathom going through the list you read, which 
is outstanding, that there would be a circumstance in which any 
of those minimal requirements would not always be applicable. 
In other words, what circumstances would I not do this, 
applying the Louisiana Real Estate Code to my practice?
    In all honesty, we've got a way to go here to catch up to 
    Mr. Glassman, let me address your comment about journalism 
and matters in political office and their ethical conflicts. If 
you are suggesting that the measure of congressional ethics 
ought to be the standard, which I think would shock most people 
in America, let me quickly add, we have to disclose every 
nickel of public income, every nickel of outside income, which 
is also limited. We have to disclose what boards we serve on if 
we choose to serve on boards. We have to disclose what 
charitable contributions are made to our credit by third 
parties. We have to report what trips we take if we're not on 
our own time, where we go. Then we are precluded from eating 
anything unless we're standing up.
    The political contributions, we're limited in what we do. 
If you're suggesting we should subject the analyst community to 
the same standards of disclosure as the Congressman, I'm on.
    Mr. Glassman. In fact, as you may know, Congressman, first 
of all, I lived in Louisiana for many years myself, and I know 
what you're talking about.
    Chairman Baker. Ethics is always the number one concern in 
Louisiana. I'm sure you know that.
    Mr. Glassman. When I was editor of Roll Call, the newspaper 
that so diligently covers Congress, I editorialized many, many 
times against these nitpicking kinds of disclosure rules to 
which Congress is now subjected.
    I think at least there's a certain consistency in my view. 
The only thing I can say is that there are many other 
conflicts. They have to do with family, and in some cases they 
have to do with donors, that really are not covered by any 
rules. And the fact is, you surmount them day after day.
    For example, it's no secret, and it's not necessarily 
terrible that Members of Congress who have Members of their own 
families who are suffering from a specific disease will 
advocate more research money for that disease.
    Chairman Baker. Sure, but that's only subject to getting 
219 votes to make it happen.
    Mr. Glassman. Exactly right. These conflicts are surmounted 
I think in most cases by you, because you have to publicly 
vote. And if you take a vote, and people say, oh, well, he did 
this because of this donation or because of this conflict or 
that conflict, it's out on the table.
    That's the analogy that I wanted to draw.
    I think with journalists, it's the same thing, but 
basically in spades. The journalists lean to the left based on 
studies. I think it would be hard to argue with that. And yet 
every journalist says that he or she is a professional who 
surmounts those conflicts.
    Chairman Baker. But if the journalists was writing about a 
stock in which he had a financial interest and put it in the 
paper, that would be grounds of dismissal, would it not?
    Mr. Glassman. It depends on the publication, frankly. I 
think that journalists should disclose their holdings, but I 
think that's really up to them and to the publication. I don't 
think the Congress should pass a law that says that every 
journalist must disclose holdings.
    When I worked for the The Washington Post, I was not even 
allowed to own stocks, and I thought that was a good rule.
    Chairman Baker. My point is that you don't have to have a 
public disclosure. There is a professional standard which says, 
you don't play in this game, period.
    Second, if you do play in the game and you write about what 
you own, which is self-serving, you're gone. I don't think that 
needs to be subject of a rule or regulation. I think that's 
professional standards, which is what we are trying to pursue 
here today.
    And I'm way over my time. I assure you I'm going to be 
    One caveat that I think, in fairness, I should make an 
announcement. After discussion with Mr. LaFalce, Mr. Kanjorski, 
and Chairman Oxley, what we do intend to do with the Fair 
Practices Standard, not to make a political determination here 
today, is to, between now and the next hearing, circulate the 
Best Practices Standard for review and comment by regulators, 
NASD, the SEC, academic review, to get professional response to 
us from appropriate interested parties.
    Convene a second hearing, at which time we will receive 
those comments, and a second panel. I spoke last night with Ron 
Ehsara concerning media concerns was on the air, and he wanted 
to know if anybody in the media had been invited, and I said, 
yes, we hadn't had anybody take us up, and he wants to come 
    So we will have a media panel to get their involvement in 
this. We cannot shoot specific minnows in the barrel. There are 
a number of people who are in the tank who have shared 
    Before we're done, we're going to look at everybody, and I 
just wanted to make that announcement for the subcommittee as 
    Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman. Thank you all for 
being here. I apologize for missing some of the testimony.
    This is an interesting hearing, but I can't think of a time 
and I would ask the panel when there was a time that you had a 
run up in the market and then you had a correction, that the 
fingers didn't start being pointed at one another.
    Particularly, it's one thing with retail investors and I 
think you have to differentiate between retail and 
institutional investors. But I happen to think of institutional 
investors as so-called ``big boys'' as being ones who 
theoretically and under the law are considered as being 
sophisticated and know what they are getting into.
    And yet I can't think of an instance where there's a 
correction and sophisticated investors don't turn around and 
say, why didn't you tell us this? We weren't aware of this.
    And yet, there is, under the law, a least in some practice, 
there's a great deal of disclosure. I guess from my 
perspective, I'm kind of shocked to find out that stock 
analysts or equity analysts might well be giving subjective 
advice as opposed to objective advice.
    I would bet that the retail public would be equally shocked 
to find out that somehow that analysts who work for brokerage 
houses may well be interested in helping promote some of the 
stocks or bonds that are being sold by those houses.
    You know, I understand if there is an issue that relates to 
manipulation, but on the other hand, I think we might be erring 
a little bit in trying to think that analysts employed by firms 
which are underwriting stocks and bonds are somehow supposed to 
be auditors and not people who give a subjective viewpoint, and 
that we don't take this with a grain of salt.
    But I would ask anybody, is there a period of time that 
there hasn't been a correction where people haven't come back 
and said, things were not done fairly.
    Mr. Hymowitz raised the issue of EBITDA went on after the 
crash of the job market, and people were saying that there 
wasn't appropriate disclosure, that these deals were oversold, 
and yet you had some very sophisticated investors who were 
involved in buying those deals.
    Mr. Hymowitz. Unfortunately, I've had the finger pointed at 
me by my clients when I lost their money, so your point is 
well-taken. Obviously, when the market starts going down, 
people start loosing money, you learn very quickly that people 
take their money very, very seriously.
    This is not a perfect business. In a sense, investing is 
not a science. David does an excellent job and we subscribe to 
his research, but quite frankly all of our records are mixed. 
It is not a science.
    I will say one thing to a previous question, Mr. Chairman, 
that you asked. We all have to understand that in the 
underwriting process, the analyst is extremely important in 
that process as it relates to the investment banks decision 
whether or not to proceed with taking a particular company 
public. It is crucial for the investment banker to get the 
input of the firm's supposed expert in a particular industry 
sector or, to use a term of art now, space.
    If you want to see a public uproar, divorce the analyst 
from that role, then have the investment bank take the company 
public. Then, after the quiet period, have the analyst issue a 
sell recommendation on that stock, and you will see a public 
    It's impossible. I've been in meetings at my previous firm 
where the analyst with a private company decided, based upon 
the qualities of a particular company, that it would be unwise 
to take that company public.
    The fact of the matter is, during the most recent bubble, 
the pressure on banks, the pressure on investment banks to meet 
the demand of the investor for paper of Internet companies was 
extreme. That is why, unfortunately, a lot of companies that 
should never have made it out the door, went out the door and 
in many respects, as I say in my written testimony, the public 
equity markets became second-stage venture capital.
    And if anyone's ever looked at the venture capital markets, 
the risk involved is enormous. And that, in many respects I 
believe, is what happened and what ultimately caused the market 
correction that we have, besides a whole host of monetary 
issues also.
    Mr. Glassman. Can I respond to your question, Congressman 
    I think we are telling the American public the wrong thing 
if the idea they get from this hearing is that the reason that 
stocks have gone down, or their own accounts have declined, is 
because of some sort of manipulation that's been going on by 
    That's not it at all. The truth is that markets go up and 
they go down. And in the history of the stock market, one out 
of every 3 or 4 years, the markets go down.
    This is an important lesson for people to learn. In fact, 
this has not been a particularly rough bear market. The Dow was 
down, which I think is a very good reflection of the market as 
a whole. The Dow-Jones Industrial Average was down five percent 
last year; it's up a little bit this year.
    That doesn't mean there's not a lot of pain out there. 
There is, and I think a lot of people unfortunately have 
learned a tough lesson, and there may well have been and I know 
there were some people who exaggerated and led them down the 
wrong path.
    That's why this hearing is good. But investors have got to 
understand that markets go up and markets go down and the way 
to smooth them out is by holding diversified portfolios for the 
long term.
    Mr. Bentsen. My time is up. But investors, I think, also 
need to understand that analysts who work for investment firms 
are not independent auditors and were never intentioned to be 
independent auditors.
    And I think Mr. Hymowitz makes a very important point, that 
there is another role that applies that analysts play within 
the firms for credit concerns, underwriting concerns that 
affect the ability of the firm to function in the future and 
the risks that it may take.
    And I think that all of this needs to be taken into 
    Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Bentsen.
    Let me make just one comment.
    Mr. Hymowitz, I want to acknowledge your comment. I will 
get back to that subject at a later time.
    Mr. Paul.
    Mr. Paul. Thank you, Mr. Chairman
    I want to direct my comments and questions to Mr. Tice and 
follow up on his testimony.
    This is, to me, a very important subject, but for some 
reason I think we are really missing the whole point, because 
we are dwelling on the analysts and the advisors.
    That's very important, but I think there's a much bigger 
problem than the best analysts may be giving the bad advice. 
But if you added up all the advice of the analysts and the 
advisors last year, I guess they gave pretty good advice. They 
told somebody to sell, so I guess more people were selling than 
buying. Somebody was giving the correct advice.
    But, I'm surprised that people are surprised at what's been 
happening for the past year. Free market economists who 
understand the business cycle and understand monetary policy 
knew this stock market correction was coming and anticipated: 
and they anticipate even more problems down the road.
    I see this as more of an attempt to scapegoat, find out 
who's been causing this problem because people lost some money.
    If we had not had a stock market crash, we wouldn't be 
here. If the bubble kept growing, you know, we would have been 
blissfully nonchalant about what was happening.
    But what we don't ask is, why did we have the bubble? Where 
did that come from? Was it the analysts that caused the bubble? 
They were a participant, but they don't cause bubbles; analysts 
can say a lot of things, but credit causes a bubble, excessive 
credit, not analysts.
    Where does credit come from? Do we go to the bank and 
borrow money that someone loaned to the bank? No. Nobody saves 
any money. Credit comes out of thin air from the Federal 
Reserve System, and we need to concentrate on that.
    When the Fed does this, the Fed artificially lowers 
interest rates and this causes people to do dumb things. It 
causes people who used to save money not to save. It causes 
consumers to borrow more money than they should. They cause 
investors to invest irrationally. And then all of a sudden, we 
have this bubble.
    And then, on top of this, this has been around for a long 
time, this is nothing new, everybody knows about this, but this 
time around, of course, it was different. It was unique, 
because we had a ``new era'' economy, just like Japan had in 
1980, and just like we had in the 1920s, a ``new era,'' a new 
paradigm. And therefore all the rules were thrown out.
    And who pumped this up? Who really said the new paradigm 
was here? The central bank, the same central bank that created 
all the credit. The Fed creates the credit, it created all the 
distortion, and then it says, ``Oh, there's so much 
productivity increase that it's going to solve all our 
    Therefore, the analysts become the victims. They're victims 
of bad information and not good judgment, but they're not the 
cause. They are the symptom of the problem.
    So my question is, is this not what you were alluding to? 
Should we not pay more attention to monetary policy? And is it 
not true that just regulating analysts is not the answer, 
because they're doing what they see in their own rational self-
interest, under the circumstances. Yes, for 10 years, they made 
a lot of money, and they made a lot of money for other people.
    It's just when the bubble burst that it happened. But it 
seems to me that regulating analysts is not the answer; it is 
paying more attention to how we regulate and rein in the power 
of the Fed to create money and credit excessively out of thin 
air that we should be dealing with.
    Mr. Tice.
    Mr. Tice. Thank you, Mr. Paul. I agree with you completely. 
However, I also do believe that there is a Wall Street problem. 
I believe that Wall Street has been a cheerleader for the 
    I share your view that our economy is where it is today due 
to excessive credit growth. If you look at the telecom and 
Internet mania that occurred, that was really the first stage 
of excessive credit growth.
    We essentially have financed a number of businesses that 
should not have been financed, as I talk about in my written 
    We kept the cost of capital too low. I'm a believer of the 
Austrian school of economics, as you are, Dr. Paul, and I 
believe that the interest rate has been kept too low and that 
we essentially financed a number of CLEC and Internet 
companies. We essentially misallocated capital in the Nation 
that will have a tragic cost to the country.
    Currently, we are over-financing the financial sector. We 
are growing MZM at nearly a 20 percent rate over the last 6 
months in an attempt to keep the bubble going. We believe that 
this bubble is not yet over.
    There've been a number of comments as though the bubble has 
burst, the decline is over, we can get back to fun and games 
again. We don't believe that. The NASDAQ is still selling at 
nine times sales. The S&P 500 is still selling at 30 times 
    Mr. Glassman will of course disagree with me. He has a book 
out talking about the Dow 36,000. You know, we think that's 
absurd. Nobody will pay 100 times earnings for a company like 
Bank of America, as he's talked about in his book by assuming 
that the discount rate is going to be five-and-a-half percent.
    We believe that there's still a great deal of danger in the 
economy going forward. It is due to excessive credit growth. If 
you look at some of the numbers recently, asset-backed 
securities growth is growing at 42 percent. Credit card 
securitization is growing at 70 percent. Home equity loans 
growing at 63 percent.
    So I think it's important to understand that Wall Street is 
complicit in this credit growth and essentially seeking out 
asset inflation. And they sought out Internet companies and 
telecom companies in the first stage.
    Now it's the financial companies, but we have an asset 
bubble and unfortunately there's more pain ahead.
    Chairman Baker. Mr. Paul, your time has expired. We'll come 
back for another round.
    Mr. Capuano, why don't you be next by time of arrival, sir?
    Mr. Capuano. Thank you, Mr. Chairman.
    I too want to congratulate you for conducting this hearing. 
I think it takes a fair deal of courage to raise these issues 
in a public forum.
    I'm not a big time investor. I don't really understand some 
of the things, the details of how all this works. But I try to 
draw analogies.
    The analogy I draw is, I don't think there's a big 
conspiracy on the part of Wall Street to somehow control the 
world. There is certainly not one that I'm aware of in the 
Congress to over-regulate anybody. I don't do any of those 
    All I'm interested in really is transparency. We talk about 
it all the time when it comes to financial issues. We did it 
last year in the banking bill. We do it on international issues 
all the time.
    Transparency is honesty and honesty is if you're making 
analysis of anything, tell them who you're working for, and 
then a reasonable person can make a decision.
    Fair enough. I guess, though, I didn't get a chance to look 
it up, but a few months ago, I read a pretty interesting story 
about a young teenage boy who was dealing on the Internet on 
penny stocks, basically giving an analysis of the penny stocks 
to lots of people. They would drive up the market, and he would 
all of a sudden buy or sell or do whatever he was doing, and 
made billions of dollars as a young teenager.
    He got caught. He got a slap on the wrist, but it was a 
lack of transparency. It has nothing to do with a teenage kid 
dealing with penny stocks who cares; that's good. But that's 
what I think is missing so far is all this concern about what's 
going on. I want honesty, that's all I want, so that investors 
can make honest decisions.
    I guess I was going through a whole litany of examples, and 
I just wonder, what's the difference between what's going on 
and the old payola scandals of the radio days when people, 
allegedly independent DJs would be on the payroll of a record 
company, and all of a sudden, out of nowhere, this record was 
going to number one with a rocket. Why? Who knows why? Gee, it 
just so happens they're on the payroll of the record company.
    What's the difference between this and the S&L scandal? 
Don't worry, this company, this investment is stable, it's got 
good credit, trust me. Oops. I didn't want to tell you that we 
have an investment in that. I didn't want to tell you that my 
cousin is the owner.
    What's the difference between this and Michael Milken's 
situation? Trust me, we don't have any inside information, no 
one on Wall Street does that, that is wrong. What's the 
    What's the difference between this and the cable 
oligopolies who tell me, as a consumer, don't worry, everybody 
wants the 14 history channels, and in order to do that, we have 
to raise everybody's rates a buck-and-a-half. What's the 
difference. And gee, we didn't bother to tell you that we own 
all 14 of the history channels.
    What's the difference between that and what's going on 
right now with our energy oligopolies? I'm not quite sure what 
they're doing just yet, but I know one thing. All of a sudden 
it is costing us a lot more money and it seems like it's all 
going to one group of people who keep telling me that there is 
only one problem; that they need to be able to drill.
    All I see is a complete and utter--not by everybody--but, a 
significant lack of honesty and transparency. If someone is an 
analyst who works for somebody who pays them, and then there is 
money to be made, so be it. Just tell me what's so hard about 
that? What is so difficult about that? Why can't Wall Street 
just do it, as opposed to simply coming up with, and again I've 
only just gotten them today, but, you know, the best practices.
    They sound awfully nice, but I don't see teeth in them, and 
I'm sure we'll have further discussions. I do want to talk to 
the SEC to see what's going on with it.
    I don't believe there is any conspiracy, I really don't, 
but I do believe one thing; money makes people do crazy things. 
And I'm no different; we all do it.
    And if there's money on the table to be made by someone who 
holds themselves out, either publicly or by innuendo, as an 
independent analyst, simply tell us the truth. Are they 
independent or are they not. And I would like to know what the 
difference is in any of your minds between any of the analogies 
that I just drew and what apparently is going on as apparently 
a relatively accepted practice on Wall Street that it's OK to 
try to burn both ends.
    Mr. Tice. I'd like to respond, Congressman.
    I agree with you completely that the system is broken. I do 
not see that much difference between what goes on commonplace 
on Wall Street versus what happened with this Internet 15-year-
old boy. There's been a lot of discussion so far, as if we can 
fix this around the edges.
    We think we have a broken system, and I would like to read 
you a couple of quotes from our written testimony. This is from 
a former research director at Lehman Brothers. He said an 
analyst is just a broker who writes reports.
    Another gentleman, who was an analyst, said he explained 
his reasons for recommending a company. I put a buy on it 
because they paid for it. We launched coverage on this company 
because they bought it fair and square with two offerings.
    Another case, an analyst at Morgan Stanley, who followed 
Cisco Systems, analyzed his rationale----
    Chairman Baker. Excuse me, Mr. Tice. I would like to have 
everybody have an opportunity and my time is running out. I 
apologize for interrupting.
    Mr. Hymowitz. Congressman, I would add that disclosure is 
everything. You are absolutely correct. I think the problem, 
one of the problems with current disclosure today is often the 
disclosure statements are longer than the actual research 
    You get an early morning note from an investment bank, 
it'll be a paragraph long, and the disclosure statement is 
three pages long. Disclosure statements need to be, as I guess 
the SEC has tried to make prospectuses more in plain English, 
disclosure statements need to be more in plain English.
    Furthermore, I think that if you really examine this issue, 
where the crux lies is that many investment banks, as is the 
nature of the business, are constantly trying to get more 
investment banking business. So people have grown skeptical of 
whether or not the analysts are trying to aid the investment 
bank in getting that business.
    So one suggestion I have is possibly, as long as it doesn't 
interfere with the commercial practicabilities of the 
industries, for the investment banks, for issuer to disclose 
whether or not they are currently engaging in any publishing 
investment banks on them, or whether or not there is the 
potential that they are seeking investment banks.
    Then you'll know really whether or not--or at least as to 
your point--the public will then be informed that possibly if 
Investment Bank X is issuing a positive report on Company Y, 
well maybe it's due to the fact that there is a beauty contest 
going on for capital markets transactions.
    The disclosure needs to be more relevant, shorter, more 
succinct, and in plain English.
    Mr. Glassman. Congressman, I'm definitely in favor of 
transparency. I think the question is the role that this 
Congress should play. It seems to me that all industries, all 
businesses have a tremendous incentive to tell customers what 
they're doing, because customers will shun businesses that are 
either dishonest with them or opaque.
    I also just want to say that I do take exception to a 
number of the things you said about energy oligopoly and some 
of your comments about Michael Miliken, but in general, I would 
also say that the S&L crisis had definitely presented a role 
for the Federal Government to play because of insurance.
    This area I don't think there's a role for you to play 
except to have hearings like this and air these issues 
publicly. That's very important.
    In general, I want to associate myself with your comments 
about the importance of transparency.
    Mr. Lackritz. Congressman, I would also associate myself 
with those comments and with your comments about transparency. 
We have always favored transparency. That's at the crux of the 
securities laws in this country.
    Where I take issue is when you compare the situation to a 
number of other scandals in the past. I think if you take a 
longer perspective of what the securities industry has done 
over the last decade, the securities industry raised more 
capital in 10 years to build plants, to build schools, to 
create new jobs, to create new products and services than in 
the entire 200 years before that combined.
    So we are very proud of what we've accomplished and the 
opportunities that we have created for millions and millions of 
investors who, if you look at over time, have done extremely 
    Last year, we had a terrible year. And we could have either 
said, well, it was just a bad year and we're going to get back 
on track, or we could say, look, let's see if we can fix some 
behavior here and assure that going forward, there will be no 
questions whatsoever about the independence and objectivity of 
    And that's what we've done with these best practices and 
transparency really is at the core of these best practices.
    Chairman Baker. Your time has expired, Mr. Capuano.
    Mr. Castle, you'd be next.
    Mr. Castle. Thank you, Mr. Chairman.
    Let me thank you for holding these hearings. Let me 
encourage you, although I don't think you need encouragement, 
to continue this. This is big time business we're talking 
about. It's covered by a lot of national magazines, by national 
television every night, by a lot of financially focused 
    It involves the assets of most of America today, and these 
questions should be asked and we should get some answers. I'm 
not sure that we should legislate in this area, and I'm all for 
best practices, I think that's great.
    I don't know how much good disclosures do unless somehow 
you all are regulating that. I started to get my privacy 
notices in the mail recently. I don't even understand what the 
heck they mean half the time. And I'm not convinced at all that 
either we, as average investors--and that's what I consider 
myself to be--would really, truly understand all disclosures 
    And I would be the first to tell you that stocks are 
unpredictable and always will be. And when you get into the 
timing of the stock market, it becomes even more unpredictable, 
and when you get into the timing of particular sectors, such as 
the high tech sector, it becomes even less predictable yet.
    Having said that, I am absolutely, totally convinced there 
are conflicts out there. I think anyone who dismisses that out 
of hand is off base and I do agree with something Mr. Tice 
said, something along the lines of Wall Street has been the 
cheerleader for the bubble, and I think that is essentially 
correct. And I think it really needs to be looked at. I 
honestly believe it needs to be looked at, and hopefully you 
will all look at yourselves and tell us something so that we 
don't have to do something here.
    I've been here for most of this hearing and I don't think I 
heard this; maybe I did. But I think Mr. Hymowitz, you said 
something to this effect, maybe you or Mr. Glassman can help me 
with this.
    But you stated that many believe there are few sell 
recommendations on Wall Street. Maybe you question this fact, 
but how do you reconcile that statement with a study by First 
Call indicating that the ratio of buy-to-sell recommendations 
by brokerage analysts rose from 6-to-1 in the early 1990s to 
100-to-1 in the year 2000.
    I don't even know what half these expressions mean. Out-
perform, strong buy. I've never seen a sell recommendation on 
anything frankly. All I see are these recommendations of a buy 
nature, which is part of being the cheerleader for the bubble, 
as far as I'm concerned.
    I'd be interested in your views on that. I think we have a 
problem out there and I think we need to admit that and 
determine how we're going to fix it.
    But I get the idea that you don't necessarily agree that 
there is a problem; maybe you disagree with those facts or 
don't think it's relevant or something. I would like to hear 
from the two of you on that.
    Mr. Hymowitz. Congressman, to answer your question, I'm not 
familiar with the First Call Survey. But we utilize First Call 
in my firm, and typically First Call covers mainly the well-
known broker/dealers. That's only if, I believe, those 
companies submit their research and their analysts' estimates 
to First Call.
    When I said there's plenty of sell recommendations----
    Mr. Castle. I don't mean to interrupt you, I'm sorry, but 
let me go on. Maybe that's important. If Merrill Lynch is 
giving bad recommendations, if Dean Witter's giving bad 
recommendations, instead saying out of 100 securities firms, 
which are also analyzing stocks, so many of them gave us bad 
recommendations, I think we need to look at the number of 
people they are impacting and the total number of dollars 
they're impacting.
    We might dismiss this on the basis of some three-man shop 
doing it incorrectly, but the big boys aren't.
    Mr. Hymowitz. I understand that.
    My point about the fact that there are as many sell 
recommendations on Wall Street as there are is the way I define 
Wall Street. As an institutional money manager, we have the 
resources due to the fact that we do commission business all 
over the street.
    To get private research, meaning companies like Mr. Tice's 
here and others who specialize in providing a counterbalance to 
the sell side research. There are different types of analysts 
on Wall Street.
    In my written testimony, I define them. One is what we have 
mainly been talking about today, the sell side analyst that's 
mainly related to a large investment bank.
    But there are numerous other kinds of analysts on what I 
call Wall Street, and many of them work at research houses 
only. And those analysts also provide buy recommendations and 
sell recommendations.
    Although there has been the creation of a niche business 
recently where specifically research analysts look at 
accounting issues and sometimes just fundamental business 
issues, and recognize that certain companies are possibly 
candidates for shorting. So many of the institutional money 
managers who subscribe to these services, they tend to be very 
costly, you know. I think in the range of some of them cost 
roughly $100,000 a year.
    And we subscribe to these services and we use these 
services to counterbalance the sell side research. Just let me 
add one other thing, and I said this in my written testimony. 
The most important thing, though, is for the investor to do 
their own research.
    How many people do we know that spend more time with the 
Consumer Reports magazine trying to determine what DVD player 
to buy. Then they do in time on due diligence of what stock 
they should buy, and ultimately----
    Mr. Castle. Let me cut you off, because my time is running 
out. I don't know what you expect some of us, as investors, to 
do. I imagine most people you're dealing with have other jobs, 
have a heck of a lot to do and are dependent upon people who 
are supposed to be professionally trained in that job to do it, 
which are these analysts. If they're not getting good advice, 
they're in a degree of difficulty, and I don't disagree with 
    I wish I had the time to do it. I wouldn't probably be such 
a loser on the stock market.
    Mr. Hymowitz. Could I touch on that one last point?
    You have to remember the analysts are not buying the 
securities. You're right. Many of the individuals do not have 
the time to manage money. That is why I'm in business. Without 
the fact that you all don't have enough time, I'd be out of 
business. So that's why people are very wise to give money to 
mutual funds, money managers, hedge funds, index funds. That's 
why this business exists, because many people don't have the 
time, nor should they spend the time because you're right.
    There are professional money managers out there who 
understand what sell-side research is all about.
    Mr. Castle. Hopefully, individual investors could depend on 
those people who have the expertise, without conflict, to have 
their good advice.
    Mr. Glassman.
    Mr. Glassman. I just wanted to comment on selling. There 
are 7,000 listed stocks in general. Analysts follow stocks that 
have good prospects, because it doesn't make a lot of sense for 
them to spend a lot of time on the others, and there are 
specialty firms that follow some of these other stocks if they 
think there might be a chance to short them.
    I just also want to say that the idea that individual 
investors should be preoccupying themselves with selling, which 
is basically market timing that you talked about earlier I 
think is a mistake.
    Generally, the way to be a good investor is to buy good 
companies and hold onto them for a long time. The paucity of 
sell recommendations, as I said earlier, is a reflection, in 
part, of what companies' analysts are following, and also the 
market itself, which, despite the year 2000, has gone from, if 
we just look at the Dow, from 777 in August 1982 to over 10,000 
    So if you're spending a lot of your time selling, you 
weren't doing very well.
    Mr. Castle. My final statement, Mr. Chairman, if I may. I 
don't disagree with what you've just stated and I don't mind 
buy-and-hold as a theory of investing, which I think makes a 
lot of sense.
    But if you're getting a preponderance of buy 
recommendations, the ratio of 99 to one, and a lot of these are 
going down as much as 50-, 60-, 70-, or 80 percent of the 
course of a year or two, that's a problem as well for the poor 
devil who's trying to buy and hold it in that circumstance.
    It's not just looking for sell recommendations, it's 
knowing what not to buy. And I don't think the average investor 
knows, looking at these reports, in many cases what not to buy.
    You cited figures earlier. We can't go into them. I'm just 
not as optimistic about all those figures.
    Chairman Baker. Mr. Castle, if you will, it looks like 
we'll be able to do another round and we'll come back to you.
    Mr. Kanjorski.
    Mr. Kanjorski. Thank you very much, Mr. Chairman.
    I think the issue boils down to the fact of whether any of 
the alleged conflicts of interest are in real existence, and if 
they are, to what percentage they are.
    I am sort of disappointed, looking at the analysts' 
problem, at a time when the stock market has not reacted well. 
Sometimes we get bad law out of responding in times like these. 
And, we ruin reputations and injure a lot of people who have 
been paid to make estimations that have not got any basis, 
other than a lot of their own intuitive senses, once they study 
a situation.
    But I do think, from my own experience, something I would 
like to posit to the panel. Would any of you like to play on a 
professional football team where the referees' salaries were 
dependent on which team won the game? I think we would have a 
tendency to wonder whether every call of the referee was sound.
    I will give you an example in Pennsylvania. Up until about 
30 years ago, when we reformed our Constitution, the lowest 
judicial court in Pennsylvania was the Magistrate's Court. We 
saved a lot of money in Pennsylvania because we never paid 
magistrates. The way they got paid was by collecting the fees 
on the convictions.
    It was amazing how many convictions there were in 
Magistrate Court, somewhere around 90 percent. When we changed 
the Constitution and directly paid Magistrates a set salary 
without a fee attachment, suddenly convictions fell 
    I think in my analysis of this situation, it is somewhat 
similar to what happened in the late 1920s and the early 1930s 
in the boiler room operations.
    There were a lot of people who said, ``No, you do not have 
to pass the SEC legislation, we can self-regulate ourselves. I 
particularly look at the analysts that appear on the network or 
cable programs that are prognosticating 24 hours a day of how 
to get instantaneously wealthy.
    Investors are 50 percent of the American population, and I 
think probably 95 percent of which do not have an MBA from 
Harvard or Wharton. So, in a way, they are responding to this 
guy in the Brooks Brothers suit, who looks smart, talks smart 
and works for a very prestigious named investment house. And 
they are relying that these analysts are honest people.
    A I mentioned in my opening remarks, the point I want to 
make is that we should find whether or not there is any 
evidence of actual problems out there.
    I would say if we do find literal abuse of position to gain 
personally, it is going to be in the smallest percentage of 
instances. I think in most instances, the failure to predict 
accurately what to do is the exuberance of the market. Who 
wants to call contrary to the trends of the market? That is 
probably what most analysts did.
    This is not necessarily a bad time to raise this problem. I 
guess the question I would like to have answered concerning the 
best practices as put out by the industry, which are nice, but 
are they not a little late and probably fortuitous in timing, 
because the hearing was coming up? That is my impression 
    But without any enforcement, do you four witnesses, any one 
or all of you, feel that the industry and the private sector 
itself cannot only put out standards and have best practices, 
but also develop an enforcing mechanism and a mechanism of 
disqualification, fines, penalties, and so forth, that will 
really work and take the unethical behavior out of the 
business, or is that beyond the private industry to do? Does 
this matter instead require SEC regulation or acts of Congress 
to accomplish that?
    Mr. Lackritz. Could I address that first, Congressman? I 
think that these best practices that we've come up with are 
going to be very effective, and are going to work extremely 
    The reason for that is because they've been endorsed not 
only by the 14 largest firms representing 95 percent of the 
underwriting business, but all the CEOs of those firms down 
through the directors of research.
    In addition, you've got an incredibly powerful and 
unforgiving enforcer in the marketplace. These practices are 
designed to help improve the quality of research.
    To the extent that the quality of research doesn't improve 
for clients, they go other places. To the extent that 
competitors see that their competitors may not be following 
some of these rules, they're going to be quite aggressive.
    Already you see a fair amount of competition in the 
    Mr. Kanjorski. Wait a second. I love the marketplace. I 
think it has a lot of regulation to it that is imposed by the 
natural forces, but I think to make the argument that the 
marketplace itself is going to take care of things is quite 
    Let me give you an example. Just recently in a fraud case 
involving GSEs, as a matter of fact----
    Chairman Baker. I am shocked.
    Mr. Kanjorski. ----Perhaps thousands of mortgages were 
improperly sold at an inflated value. And, when you look at it, 
it is alleged that the perpetrators of the fraud were really 
two appraisers who were going in and appraising these homes 
over their real value.
    And in the preliminary investigation, after identifying 
something has been maybe millions of dollars of potential 
fraud, these two appraisers were fined just $10,000. Woowhee, 
big deal.
    I mean, if you guys are going to self-regulate by fining 
somebody or slapping them on the wrist, and shuffling them off 
to Buffalo, if you will, we will not receive any real reform. I 
have just met with the State regulators and they tell me that 
there are brokers selling intrastate that have been fined and 
convicted in three and four and five other states and the State 
regulators have no capacity to find out who these people are. 
They are just moving around the country, one State by one 
State, knocking it off.
    And honestly, with the industry coming forward now and 
saying, wow, we have got to find a way to make sure this 
information gets out to all the regulators so that these 
investors are warned that there are these bad actors out there, 
it seems questionable.
    Look, when you can make millions of dollars by perpetuating 
frauds like this one, and you only lose your license, or you 
get a penalty of $10,000 on a multi-million dollar fraud, I do 
not know any con artists that are going to turn down that deal. 
That is a pretty good deal.
    Mr. Lackritz. Congressman, I would take issue with that. 
Industry has no tolerance for bad actors. We want to do 
everything we can to get fraudsters out of the industry.
    Mr. Kanjorski. Why, under best practices, do you not have 
transparency, enforcement, and penalties that are just like the 
Bar Association?
    If you have a bad lawyer, you can disbar him and throw him 
    Mr. Lackritz. We have transparency in these 
recommendations. There's mandatory clear language and mandatory 
disclosure of holdings of conflicts that go beyond these best 
practices, Congressman, go beyond the regulations that are on 
the books now.
    They take the regulations on the books now and go beyond 
that. In fact, part of the reason it took us a while to come to 
relesae these was because it was a long process of negotiating 
among the firms.
    The firms took it quite seriously because they realized in 
some cases they might have to change the way they did business 
in order to comply with this They took it extremely seriously.
    As a result, that's what held this process up a little bit, 
but from the standpoint of their effectiveness, I'm quite 
confident that they are going to be effective and I think time 
is going to be the test. The proof is going to be in the 
    Chairman Baker. Mr. Lackritz, and Members, if I can, we 
would like to recognize Mr. Inslee for these questions. We are 
nearing the end of debate time on the next vote. I would like 
to get him in and perhaps conclude this panel before the vote 
starts. You probably would like that idea.
    Mr. Inslee.
    Mr. Inslee. Thank you, Mr. Chair.
    We don't have a rule that we just shoot the analysts here 
when the market goes down, if that's any relief to you, but I'm 
intrigued by a thought that Mr. Cole, who was an author, I 
assume you are familiar with, who has been critical of the 
industry in various ways.
    Basically as I understand his approach, he believes that 
there's been such a radical change in the structure of the 
industry toward an investment banking oriented part of the 
industry that it's changed dramatically the problems that 
analysts have internally in their own structure.
    For instance, he quotes a statistic. I don't know if it's 
accurate or not, that says that 60 percent of industry revenues 
before 1975 were trading commissions. Today, that's less than 
16 percent.
    As I understand his argument, he's basically saying that 
analysts now have this much greater incentive, if you will, to 
deal on the investment side, and that's what skewed judgments 
perhaps or at least created a concern in the public about that.
    And I just want to read--and he's going to testify later--I 
want to read something I want to get your comments on, if I 
    He said, where the role of analysts has changed 
dramatically in the last 25 years, the regulatory environment 
has little changed from 1975 or even 1945.
    Analysts have safe harbor under the law, even to the extent 
that they can tell their larger clients that a stock is really 
a dog, while keeping the buy signal on for the public. That is 
entirely legal.
    It is even legal for an analyst to tell their trading 
departments that a buy signal will be out on the morrow. If the 
analyst is influential, the trading department can bulk up on 
the stock and then sell it to retail demand then generated by 
the buy signal all legal.
    Brokerages call this, quote: ``building inventory to 
satisfy demand, just serving our customers.''
    Others might call it a license to print money.
    I read in your best practices. As I read it, it sounds like 
your best practices were designed somewhat to address some of 
the issues that he's raising here.
    But I guess what I'd like you to do is if you could respond 
to his argument that the dominance of the investment side of 
the industry has become such that we now need to take another 
cut at looking at the regulatory aspects on analysts, 
particularly some of the issues that he raised.
    I'll leave this open to any of you.
    Mr. Lackritz. I would just say, first of all, I disagree 
completely with some of the things that you read that he's 
    Clearly, an analyst that's giving some recommendations to 
one side of clients and not to others, that's not currently 
appropriate and obviously that's not a good business practice.
    Second, the business is changing dramaticaly, but I suggest 
that it's changing from a transaction-based business that it's 
been historically, to an information and advisory business more 
and more and more. This means that the quality of our 
information is the most important product that we're offering.
    The quality of our advice is the most important product 
that we're offering, which is why we put forward these best 
practices. We think these will help to continue to improve the 
quality of the advice that we are offering and in the long run, 
that's what's going to be successful for the business.
    Mr. Hymowitz. Congressman, I would also add I would not be 
that concerned about the shift in fees investment banks earned 
from commissions to advisory fees. I will tell you things have 
changed once again back. One would have to wonder what 
investment bankers are doing these days. Even the fact that the 
capital markets are effectively shut down, there hasn't been, 
other than the Kraft IPO yesterday, I don't remember the last 
    It's a natural cycle in the business. When the markets are 
going up, the investors are looking for companies to take 
public. Therefore, the percentage of revenues in the investment 
banking department goes higher, the commission and manaegment 
fees goes lower. But the cycle changes.
    And today, if you took a snapshot of any investment bank, 
I'm sure commissions, asset management fees are gaining in the 
preponderance that they represent in the total revenues of the 
companies. And in investment banking fees, you can see it by 
Wall Street. Look at the layoffs that are occurring. They're 
not laying off asset managers, they're laying off investment 
bankers, because that portion of he business is suffering due 
to hte fact that the capital markets are shut down.
    Mr. Glassman. Congressman, I'd like to respond to this 
issue of best practices and what the SIA has done. Also, this 
addresses something that Congressman Kanjorski asked.
    I'm not so sanguine about it, because I think the way to 
solve this problem is by individual firms stepping up to the 
plate and saying that, at our firm, we have a real Chinese 
wall, and if we find anyone breaching it, that person is out. 
That's our rules at this firm.
    Now another firm will then compete and say ``No, no, we can 
top that.'' We can have even more objectivity among analysts. 
There are good things about industry groups, but one of the 
problems is that they all get together and decide what the rule 
is going to be.
    That's also the problem, by the way, with legislation. It 
takes away the competition, which really ends up giving you the 
best kind of rules and the best protections for consumers. 
That's what I worry about.
    Mr. Inslee. Let me tell you abuot a concern I have. 
Obviously what it sounds like, your best practices are designed 
to build a Chinese wall. My concern, however, is if you build a 
Chinese wall, but you leave it under the control of the Chinese 
about where the gates are going to be and how high the wall is 
going to be, I'm not sure it gives enough confidence to the 
people in this regard.
    So let me just ask you this. In contrast to the legal 
profession or the accountancy profession, or the physicians' 
profession, is there any reason to have Americans trust the 
industry to be self-regulatory on this issue as to analysts 
where Americans demand some independent source, to some degree, 
to control the behavior of lawyers and doctors and accountants.
    Mr. Lackritz. Can I address that?
    I think, first of all, the quality of our professionals has 
never been higher. We in the securities industry have a 
mandatory continuing professional education requirement, as I 
understand that no other profession even has.
    We have to have mandatory retesting your fifth year and 
tenth year after receiving a license. So that, in and of 
itself, makes it different and the quality has gone up 
    I also think that it is fairly easy for customers to see, 
because they get their statements every month how they are 
    With other professions, sometimes it's not as clear; it's a 
much more subjective kind of judgment.
    So we have a real bottom line I think that really serves as 
a very effective accuntability mechanism, which is one of the 
reasons that the quality of the research is so important. Which 
is why our firms have an incentive to give out the best quality 
advice they possibly can to their investors.
    Mr. Tice. Congressman, if I could just add that I do 
believe that you hit a hot button issue as far as the magnitude 
of dollars that are involved in the investment banking. And the 
fact is that people are people and money motivates people. And 
the structure of these firms is that the investment bankers are 
still too powerful within these firms, because that's where 
money is made.
    Now as Gregg said, the IPO and the investment banking 
revenues are down currently. However, paying 6 cents a share or 
4 cents a share, which is what institutions are paying for 
research today, the profitability is much greater in investment 
banking, and therefore investment banking drives it.
    We don't believe the industry can regulate this from 
within. The dollars are just too big.
    Another problem is, the industry, in my opinion, has not 
even admitted that there's much of a problem. There's talk 
about there's a perception of a problem, rather than admitting 
that there is a problem.
    Mr. Hymowitz. You're not arguing for higher commissions, 
are you?
    Mr. Tice. I would pay higher commissions, sure.
    Mr. Inslee. Thank you, gentlemen.
    Chairman Baker. Your time has expired, Mr. Inslee. Thank 
you very much.
    I want to pick up with a point that I failed to make 
accurately perhaps.
    Mr. Hymowitz, in your answer to a prior question, talking 
about the demand in the market to get paper out, and that as a 
result perhaps some of the dot coms move to public offerings 
that weren't, in all circumstances, mature for that position. 
That is extremely troubling to me.
    What is the role of the analyst? Maybe that's where there's 
a miscommunication. I want to take you to the days of LTC, and 
I'm not making a parallel, I'm not making accusations, merely 
to understand my level of concern.
    We had 3 years of back-to-back trading without 2 days of 
concurrent loss. There were extraordinary levels of 
profitability. You had bankers, you had folks in the 
international community, literally throwing money at them.
    You were told a million dollar minimum, 3 years. Don't pick 
up your phone and call me. I'll let you know what's happening. 
Extraordinary types of information, lack of exchange.
    Now what drove that was the desire by the individual to get 
a piece of the action and make a quick buck. I understand that.
    In my view of market responsibility, the single person who 
should have been in that room when the credit was being 
extended by the bank was the credit risk analyst. The little 
guy sitting in the corner with the glasses, reading the 
complicated sheets. Who says, wait a minute, guys, there may be 
something wrong here.
    If the management overrides him, I understand, but it's 
that analyst who should be the one to have the professional 
standard to stand in that door and say, no.
    What you're telling me is, because the investor's demand to 
get in on the run up of the market, it was almost embarassing 
to go to a cocktail party or a birthday party, or you're in the 
back row of the church, and people saying, man, have you seen 
my 401K lately, and if you weren't in it, there was something 
wrong with you.
    So the public pressure was to get a piece of it, and within 
the firm, deciding what they were going to market and what they 
would not, because of the demand for paper.
    Because the community was asking for it, the investor 
lowered his bar and said, let's put this out, because we've got 
to get something for people to buy and keep this moving.
    Am I wrong?
    Is it not the analysts' obligation to reach a professional 
opinion and express it, notwithstanding market conditions and 
consumer demand?
    Isn't it a professional responsibility to say, no, now is 
not the time? People can disagree, but the board can override. 
But somewhere in the record, that analyst's view should be 
noted. Is that wrong?
    Mr. Hymowitz. I don't think it's wrong, but I think the 
answer is very complicated. I'm sure we don't have enough time 
for it, but let me just make a couple of comments.
    The capital markets changed dramatically when companies 
like Netscape and Yahoo were able to be taken public without 
    Investment bankers realized, unlike years past, the 
investor was willing to take the chance, and risk, and look, 
that's what investing is about.
    Chairman Baker. But on that point, I hate to interrupt, but 
it's so critical and pivotal to the understanding.
    The investor was willing to take the risk because the 
analyst was telling him it was a good risk to take. You're 
telling me the analyst was saying, don't invest in this? I 
didn't hear that.
    Mr. Hymowitz. I didn't say the analysts, I'm not saying 
that. But I think it's more complicated than that. A company is 
taken public. We all recognize that the Internet was, a few 
years back, something completely new.
    Let's remember, I see many Congressmen using their 
Blackberries. You weren't doing this 3 or 4 years ago. Without 
the capital markets financing these companies, we wouldn't be 
able to do it.
    So there's lots of tremendous positives that have come from 
this, thousands and thousands and hundreds of thousands.
    Chairman Baker. I agree with you. I think that's great.
    What I'm saying to you is, the huge capital flows that 
appeared since' 95 to the current day, come from less-than-
sophisticated pension fund managers in some cases, you now, 
some school teachers' retirement fund, they are under critical 
pressure from their owners of that fund.
    Wait a minute. Everybody else is getting 18, 21 percent, 
why aren't you? He goes further out on the risk profile. He is 
listening to his analyst.
    My point, I want to be focused on, I'm not disputing that 
the capital markets don't perform a wonderful function. I am 
not a regulator. I don't think the Federal Government is the 
    But I am suggesting very strongly in terms that I hope are 
clearly understood, I believe the sentiment's been expressed in 
this subcommittee today, if we don't get this fixed, probably 
some session of Congress is going to fix it in a manner the 
market won't like.
    That's what we are about here, is trying to not have that 
occur. And if you're telling me the role of the analyst is not 
to be direct and forthright, and to tell people what they don't 
want to hear in an environment when it's not popular to say it, 
that's a very disturbing thing. We've got to find a way to fix 
    And I want to say to Mr. Lackritz and the SIA, I appreciate 
what you have done, but we have now recognized we have a 
problem. We have entered the 12-step process. We are step one, 
maybe two. We are all getting in a room together and comforting 
one another. We haven't really decided where we're going to 
wind up in a few weeks.
    We're shaking it a little bit and we are a little bit 
worried, but there is a problem. And in my view, although I 
fault the media for hyping the stuff, I fault the investment 
bank for pushing the analysts, I fault the investor for not 
doing the due diligence that they ought to do.
    At the end of the day when I get my call from a broker 
saying, boy, you don't want to miss this train, it's a sure 
bet, who am I to disagree?
    I rely on their professional judgment to tell me when it's 
advisable. Should they be right a hundred percent of the time? 
Heck, no. I'd like them to be, you now, 51/49, but at some 
point we have to realize the standard of conduct which a 
reasonable man should expect from the Street has not been 
utilized, and the formulation of the best practice standard I 
think is evidence there was a recognition of a problem. And 
we're now about addressing it.
    I don't think we need to skirt around it anymore. I think 
we've got to figure out what do we do. That's the last piece. I 
don't see a lot of recommendations beyond the best practice 
    Mr. Tice, you had a few?
    Mr. Tice. Yes. If I could respond briefly to Mr. Hymowitz' 
point, I don't think it is that complicated and you're exactly 
on target that the analysts should be objective. He should not 
be looking at what the customers demand for a product or an 
investment service.
    That's the problem. The analyst most often serves as a 
sales person. He's looking at the customers out there and 
saying, what can I sell to them; therefore how can I promote 
this stock so that he will want to buy it, rather than being 
independent and saying, is this good for the customer.
    That truly is the problem today.
    Chairman Baker. Let me give Mr. Hymowitz equal time, 
because we have a couple of more Members who want to come back 
with another question.
    Mr. Hymowitz. First, I would say if the whole problem was 
just analysts had a lot of buy recommendations on stocks, and 
that was it then the railroad stocks would have gone to the 
moon, the drug stocks would have gone to the moon, the food 
stocks would have gone to the moon. That's not what happened.
    What happened is the public at large, and I don't know who 
is to blame, and I'm not smart enough to figure it out, the 
public at large had a very short period of time, 12 months, 
maybe 18 months where they got completely enthused with the 
Internet and anything dot.com, and that's it.
    You know what? Ultimately a lot of these companies will be 
good companies. Many companies will employ hundreds of 
thousands of people years from now.
    The fact is, as I said earlier, for a moment, and I'm not 
necessarily saying this is a good thing or a bad thing, but for 
a moment, a short period of time, the capital markets that 
historically were mature markets, were funding what I have 
called and many other people have called ``second stage venture 
capital businesses.''
    Chairman Baker. I agree with you.
    Mr. Hymowitz. There's nothing wrong with that.
    Chairman Baker. We don't have a dispute about that. My 
point is that there was no public discussion that we were into 
venture capital as opposed to long-term investments. When a 
dot.com only lost 6 cents instead of seven, they were rewarded. 
And when a brick and mortar, who has a 50-year history of 
profitability, made 6 cents instead of 7 cents, they were 
    I can't explain that either.
    My point is that the rational, calm voice in the midst of 
turmoil should be the analyst.
    Mr. Hymowitz. Mr. Chairman, could I just comment on that 
last thing.
    I actually respectfully disagree with you that we weren't 
warned. We were of course warned. Any investor should have just 
picked up the prospectus and read it, and all you 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. 
There were plenty of warnings out there that these companies 
that were being funded were immature, often very young 
    Chairman Baker. I respectfully understand your disclaimer, 
but it would take someone fairly committed and fairly clever to 
read through the 86 pages of disclaimer. It's the only thing 
that I've seen that's more complicated than the first mortgage 
loan closing document package. That is not a reasonable man 
    What I'm saying to you is the reasonable man, the working 
family was providing the capital for all this wonderful 
activity. The analysts comfort him and say, yes, I think in the 
long haul, you know, don't buy for today, buy for the long 
haul. It will be a wise investment. They did.
    And when things go south, understandably, the investor is 
    But if the analysts had done the job at the outset in 
saying, look, this is a ten percent shot. If you want to do it, 
I'll be happy to service your account, but I would strongly 
recommend you get over here with this long record. It'll be 
slower growth, it'll be more stable growth, less risk. And I 
don't think a lot of those conversations were held is my 
    Mr. Castle, I'm sorry I've taken so much time.
    Mr. Castle. I'll try to be brief too.
    If this was asked, somebody cut me off because I had to be 
out of the room for a little bit.
    But, Mr. Tice, you apparently in your testimony, according 
to our staff, cited the tremendous competitive disadvantages 
that independent research firms actually face.
    I think a few of them, such as where is the revenue coming 
from and whatever, and I can think of a few of them.* But if 
people who are investors believe that Wall Street firms are not 
giving good advice, then why don't the market forces send more 
people to the outside. Why don't the market forces sort of rise 
up and say, you're not giving us good advice. We have to look 
someplace else for it. And give the independent firms greater 
strength than they presently have. What's the marketing problem 
there. I don't follow the dynamics of all that.
    Mr. Tice. One of the issues there, Congressman, is the fact 
that we believe that Wall Street research should be priced. 
Currently, Wall Street research is essentially being given away 
in order that the big investment managers could have access to 
their trading, to their IPOs, and so forth.
    Therefore, it's very difficult for a small, independent 
firm, such as mine, to be able to garner fees and commissions 
in order to get paid. It's very easy to continue to get the 
First Boston, the Goldman Sachs, and Merrill Lynch research, 
because it's essentially free.
    What we would like to see occur, and we've pointed this out 
in our solution to a very complicated issue that I can't get 
into today, is to have Wall Street price their research.
    Mr. Hymowitz. Can I just make one comment?
    Wall Street research is priced. You do not get Wall Street 
research if you're a client or an institutional money manager 
unless you have some relationship with the bank in the form of 
commissioned business. There's a price you pay for it.
    Mr. Castle. Just a final comment. We are sitting here 
talking about analysts and Wall Street firms, and securities 
firms, and whatever. But the average person out there is 
usually dealing with a broker who is then handing them that 
information. They don't know who the analyst is. They don't 
even know if the firm that's handing them the information is 
the one who did the analysis or whatever it is.
    There's sort of a disconnect here between what happens in 
public and what we're discussing.
    Mr. Glassman. Not only that, Congressman, they are dealing 
in many cases with mutual funds. Forty percent of Americans own 
mutual funds. Three trillion dollars are in equity funds, and 
these are professionals who are getting advice from lots of 
    I don't think we need to have laws passed to protect these 
    And also let me just say, I really think it's important to 
put in perspective what has happened in the markets over the 
last few years.
    Over the last 5 years, the stock market as a whole has gone 
up 120 percent despite what happened in the year 2000. The 
NASDAQ, which is the high tech index, has just about tripled 
over the last 10 years.
    So the idea of passing legislation, which in fact, if it's 
the wrong kind of legislation, will have a devastating effect 
on the market itself, because of a problem that has occurred in 
stock prices over the last year, I think that may be going a 
little bit too far to say the very least.
    Mr. Castle. I'll close with this. I don't disagree with you 
perhaps, at least at this point, in passing any kind of 
regulatory legislation or anything of that nature with respect 
to Wall Street research or whatever, but I remain adamantly 
convinced that you have not made the case that we have unbiased 
research on Wall Street.
    I think a lot of the conflicts and problems that have been 
mentioned at this hearing do exist, and I think it is up to you 
all, meaning the broad securities industry as a whole, to 
really take a good look at this.
    I think factually that can be demonstrated and I believe 
something has to be done, maybe away from Congress, but 
something should be done.
    I yield back.
    Chairman Baker. Thank you, Mr. Castle.
    For the record, Mr. Glassman, I don't think anyone today is 
suggesting further legislation on the matter. This is an 
opportunity to share thoughts and hopefully see some positive 
results without legislation.
    Mr. Kanjorski.
    Mr. Kanjorski. Mr. Hymowitz, you made some interesting 
comments about reading the prospectus, the profit-and-loss 
statement, and the balance sheet of some of these corporations. 
You suggest that people are able to ascertain and make a 
judgment on their own.
    Unlike Congressmen, you probably spend more time at the 
club than you do at the gas station. We are about to decide a 
public policy on whether or not Social Security should be 
invested in the stock market. The proposal would allow people 
to have the voluntary election to do that.
    There are about 150 to 160 million workers covered by 
Social Security. If you know something about the statistics on 
level of education, I think it is more than 20 percent of the 
American population that is functionally illiterate. That would 
be 35-, 40-million adult Americans that cannot even read and 
understand what would be in a business prospectus.
    I hope therefore, people are listening to this broadcast 
that are going to be deciding whether or not we should open up 
Social Security money to go into private accounts managed by 
private individuals for investments. In part of your testimony, 
I was under the impression that we were going to have a very 
high standard of professionalism. You should have taken into 
account one out of four people's total incapacity to understand 
and comprehend these things. Without the professionals of Wall 
Street, they would not have to.
    But you are telling me, you are saying to all Americans 
now: It is up to you to understand these things, to read these 
statements, and to comprehend these statements. So the 
Congress, under that argument, should say look, we know there 
is more than 20 percent of the population that is functionally 
illiterate, who cannot even read and fill out an employment 
form, much less read a prospectus.
    Should we not protect them and say that is the craziest 
issue in the world? Are you not one of the greatest witnesses 
against privatizing Social Security?
    Mr. Hymowitz. Congressman, let me answer the question. What 
I was responding to was Chairman Baker's question about why 
wasn't the public informed when the capital markets switched, 
in some respects, to start funding secondary venture capital 
companies, young, immature enterprises.
    And my answer was that prospectuses that this Government 
requires companies to file hopefully are meant to be read. And 
the individual who does not want to spend time and the effort 
to read the prospectus then should do what millions and 
millions of Americans do every day, and that is give their 
hard-earned investments to mutual fund companies to index 
funds, to brokers, to money managers to hedge funds.
    Look, I don't know anything about automobiles, so if I go 
in and I attempt to figure out what car to buy, I'm going to 
get some expert advice on what kind of car I should buy.
    Mr. Kanjorski. The average American does not do that. He 
does not hire an engineer to evaluate an automobile. I do not 
know where the heck you are living, but you are not going to 
the gas station to which I go to pump my gas. I talk with 
people every day.
    I want to give you an anecdote. In a coffee shop 2 weeks 
ago, I saw a friend of mine, injured seriously on his job, and 
who settled out his Workman's Compensation case at $250,000 
about 3 years ago. He got caught up in the hysteria of the 
stock market, and made some investments in early IPOs. These 
stocks really ran up at first.
    He thought Christmas had now arrived 365 days a year. That 
$250,000 is, however, now worth less than $19,000. When he told 
me what he was doing, I could not believe it. I recommended 
against it. I said, ``Don't you ever play this game with this 
money. This is your livelihood.'' But he could not resist that 
temptation. Everybody else was doing it.
    Mr. Baker made the point. Having all my 401(k) in 
Government securities, I have to say over these last 5 years, 
sometimes I have kicked myself when I look at that bottom line, 
and I look at my neighbor's bottom line. But knowing that I 
neither have the time nor the expertise, I just cannot. I may 
also have a conflict of interest, so I just stay out of it.
    But there are an awful lot of American people who are not 
capable of doing that. We try to open up hope and opportunity 
to everyone, and there is not any question, as I said in my 
opening statement, that the American capital markets are the 
envy of the world. We are not trying to cast aspersions on all 
analysts, even the majority of analysts, and certainly not on 
all investments.
    I know these people. They are mostly exceptionally 
talented, bright, and highly ethical. Do they police everything 
or are mistakes made? Yes. But our problem is that we have to 
respond and try to protect in some way, even the foolish and 
the functionally illiterate. What I think we are asking this 
panel to do, and the industry to do, is put your heads together 
and come up internally within your industry with standards that 
are acceptable, and enforcement that is acceptable. We need 
standards that leave us with the belief that the markets are 
being handled by people that are credible with integrity, and 
not to the disadvantage of the average person.
    And if we cannot do that, I agree with my colleagues: there 
will be a time when either the regulator, or this Congress, 
will act precipitously if conditions continue.
    Chairman Baker. Thank you, Mr. Kanjorski.
    If no other Member wishes to ask a question of this panel.
    Congressman Shays.
    Mr. Shays. Mr. Chairman, I consider this a very important 
hearing and I was chairing the National Securities Subcommittee 
and I just apologize for missing what I was told was an 
outstanding dialogue with this panel and the Members and I look 
forward to the next panel.
    Thank you.
    Chairman Baker. Thank you, Congressman Shays.
    I want to thank each of you for your perspectives. I assure 
you, the subcommittee will move very slowly. We are, hopefully, 
not being viewed as demagoguing an important issue. We want to 
understand it. We want to know how markets function, the role 
of the analyst and all participants.
    We would welcome your further comment pursuant to your 
appearance here today. If you have answers responsive to any 
Members' questions, we would welcome them.
    I specifically would like further analysis on if we are to 
proceed with the best practices model, in whatever form that 
finally is contemplated, I feel it appropriate to have some 
confirmation of compliance, whether that is by the Congress, 
the regulator or some other activity by contract. But we need 
to have some assurances that the standards that are being held 
up, as in all other professions, there's some level of 
accountability for assuring those practices are being followed.
    I don't sense, from the Members of the subcommittee here 
today, that we feel like we're near resolution, but that we can 
reach an understanding with professional leadership from the 
investment community that I think can be acceptable to all 
parties, and most importantly, we all fully understand that the 
huge growth in our economic ability and our quality of life in 
America has been very positively effected by the activities 
over this past decade.
    We wish to do nothing to impair the efficient flow of 
capital markets, but we also have a new political 
responsibility. People who are working families that had no 
access to the markets to speak of are now on-line, as we hold 
this hearing, making investments because they want to have part 
of this dynamic growth and that is creating a new level of 
    As I quoted earlier in the week, I said it may be one thing 
for one shark to eat another; it is quite a different matter 
for the shark to eat the minnows, and we're about making sure 
that everyone who's in the tank has equal access to 
opportunity, a free flow of information that's unbiased, that 
will result in the restoration of unquestioned truth and faith 
in our capital market system.
    That really is our purpose and I really do appreciate your 
participation. It was not easy to get folks to come and talk 
about this and frankly it wasn't easy to call the hearing, but 
I think we served an important purpose and I thank you for it.
    At this time, I'd like to call our second panel, please. 
I'm told, just as an update, we're getting to a point in debate 
on the floor where we're expecting a vote within a few minutes. 
I'd like to go ahead and proceed. If need be, we will 
temporarily suspend. I think it may be only one vote and I can 
run over quickly and be back just to give you an advisory.
    We will start first with welcoming Mr. Benjamin Mark Cole, 
Financial Journalist, author of the ``Pied Pipers of Wall 
Street: How Analysts Sell You Down the River.''
    Thank you, Mr. Cole.


    Mr. Cole. Thank you, Mr. Chairman, for receiving my 
testimony today. With the NASDAQ cut in half from 2000 and 
Internet stocks trading for pennies on the dollar, many 
Americans are asking themselves what happened.
    How come no major securities house predicted you might lose 
half your dough on the NASDAQ in less than a year, or lose 
almost all your money on an E-toys price line, or an I-Village.
    It reminds me of that old joke of the 1970s, made fresh 
again by recent events. ``How do you end up with a million 
bucks on Wall Street? Start off with two million.''
    What the public doesn't realize yet, though it is catching 
on, is that Wall Street research has become hopelessly corrupt. 
Today's so-called analysts are more akin to lawyers in court. 
They regard their job as one of advocacy to make the best case 
why a stock is a terrific buy.
    Ask an analyst if what they are doing is dishonest, and 
they will answer that you don't understand their job 
    What happened to analysis? Why does a sell signal make up 
less than one percent of analysts' recommendations?
    The answer lies in the way Wall Street makes money today 
compared with 1975. Twenty-five years ago, Wall Street made 
money in ordinary retail trading commissions which were fixed 
by regulation. That environment, something of a cross between 
Shangri-La and Fat City, made Wall Street a clubby place of 
almost assured profits. The prized customer was a wealthy 
individual or family that liked to trade stocks and the prized 
employee was a stockbroker with a good book of business.
    But the SEC erased fixed trading rates in 1975, an action 
then fought tooth and nail by the industry, which wanted no 
part of free enterprise and competition.
    In the years since, if inflation is taken into account, 
retail trading commissions have fallen to a penny on the 
    If you look at a thrifty investor using a discount on long 
brokerage for securities firms, the downward plummet of trading 
rates raised a serious problem.
    How do we make lots of money like we all came to Wall 
Street for?
    Wall Street, after 1975, had to come up with a new way to 
make lots of money and they found it, happily for them in their 
own corporate finance departments, also known as investment 
    Investment banking is the business of underwriting initial 
public offerings of stock, secondary offerings, bond 
underwriting, or advising companies on mergers and 
    Increasingly, brokerages have moved upstream in the 
financing cycle of companies, often providing private equity, 
also called venture capital, to a company before they take it 
    This activity can be extremely lucrative. CIBC Oppenheimer, 
now CIBC World Markets, invested $30 million in private equity 
into Global Crossing Limited, the Telecom giant. After the 
company went public and the stock surged, that stake became 
worth $4.3 billion.
    Goldman Sachs invested $36 million private equity or stock 
in Storage Networks, Inc., pre IPO. That stock became worth 
$1.6 billion after Goldman took Storage Networks public.
    Some quick numbers illustrate the changed nature of Wall 
Street. In 1974, the U.S. securities industry underwrote $42 
billion worth of stocks and bonds. In 1999, the industry 
underwrote $2.24 trillion of stocks and bonds, more than 50 
times the pre-1975 level.
    Trading commissions today made up 60 percent of industry 
revenues before 1975, but today make up less than 16 percent.
    The simple story is this: Wall Street makes its money on 
investment banking, not retail trading commissions. With this 
change, came a change in who held power within the brokerage.
    In days of yore, as quaint as it may seem today, the 
stockbroker with his book of business was the power employee 
within the brokerage. Sometimes they were referred to as 
customers' men.
    When an analyst wrote a report, he looked over his shoulder 
at the customers' men who would hold him accountable.
    Today, things have changed. Today, analysts look over their 
shoulders at investment banking and trading departments, the 
new profit centers.
    The results of this switch in loyalty are obvious to all 
within the industry, so much so that brokerage analysts are 
referred to often dismissively as sell-side analysts. Perhaps 
not surprisingly, numerous industry and academic studies have 
found that analysts' recommendations as a group under perform 
the market.
    Investors would be better off tossing darts at the Wall 
Street Journal than following analysts' recommendations.
    Although the role of analysts has changed dramatically in 
the last 25 years, their regulatory environment is little 
changed from 1975 or even 1945. Analysts have safe harbor under 
the law even to the extent that they can tell their larger 
clients that a stock is really a dog while keeping the buy 
signal on for the public. That is entirely legal.
    It is even legal for analysts to tell their trading 
departments that a buy signal will be out on the morrow. If the 
analyst is influential, the trading department can bulk up on 
the stock, and then sell into the retail demand generated by 
the buy signal, all legal.
    Brokerages call this ``building inventory to satisfy 
demand.'' Just servicing our customers. Others might call that 
a license to print money.
    What is disturbing in the last 25 years is to see that many 
practices once limited to regional and one-branch brokerage 
shops, the so-called schlock shops have become commonplace in 
Wall Street proper.
    In particular, when a brokerage finances a company before 
an IPO and then has an analyst issue a buy recommendation, it 
is mimicking practice commonplace off Wall Street for 
    Some quick stabs at solutions here.
    One, I would increase the budget of the SEC for enforcement 
actions and beef up the U.S. Attorneys Office for securities 
industry prosecutions.
    Two. I would require the brokerages to create a uniform 
standard for rating the accuracy of analysts' recommendations 
and that analysts' batting averages, if you will, be constantly 
published on an industry website maintained by the National 
Association of Securities Dealers.
    As an aside, I find it somewhat amusing that we know Marc 
McGuire's batting average day-by-day, how many home runs he's 
hit, but we don't know what the analysts' batting average is 
day-by-day, yet we are investing based upon their 
    In the 1930s, the SEC examined whether brokerages should 
even have underwriting and retailing operations under one roof. 
It may be time to reexamine that situation.
    In care and feeding of short traders, in a nut shell, allow 
short traders to have contracts specifying terms for returning 
borrowed shares. Short traders can be a tonic on the market.
    Lastly, better mandatory disclosure of analysts' conflicts 
of interest in both broadcast and print media.
    Thank you very much, Mr. Chairman.
    [the prepared statement of Benjamin M. Cole can be found on 
page 181 in the appendix.]
    Chairman Baker. Thank you very much, Mr. Cole.
    The next witness is Mr. Scott Cleland, Chief Executive 
Officer of the Precursor Group.
    Welcome, Mr. Cleland.


    Mr. Cleland. Thank you, Mr. Chairman, for the honor of 
testifying. I'm Scott Cleland, Founder and CEO of the Precursor 
    We provide investment research to institutional investors. 
We've aligned our business interests solely with investor 
interests so we've avoided the common financial conflicts of 
interest. We do no investment banking. We don't manage money. 
We trade stocks but we never own them.
    And all Precursor researchers may not own individual 
stocks. We are a pure research firm because we believe that a 
company cannot serve two masters well at the same time. You 
can't serve investors and companies together.
    We think conflicts undermine research. We think 
independence improves research.
    We saw a real market opportunity to be a pure research 
    Our interest in testifying is clear. We are worried that 
the powerful investment banking and trading interests that have 
suffocated independence within a firm are at work within the 
industry at large, and can suffocate the independent research 
views at large.
    That's because the firms that have conflicts control well 
over 90 percent of the market for research commissions, 
according to our best estimate.
    So what we're calling for is more competition to conflicted 
research, not less. The less regulation of pure research and 
more disclosure and regulatory oversight of conflicts of 
interest, the freest and the most competitive flow of 
information is what best serves investors and helps the markets 
operate efficiently.
    A system that's 90 percent or more dominated by companies 
that have inherent conflicts of interest profoundly distorts 
the type of information that the market receives. We think that 
more competitive research is the answer.
    Recently, American shareholders and pension plan 
beneficiaries lost over $4 trillion when the NASDAQ fell, and 
at that time, there were only one percent of analysts 
recommending a sell.
    I'm not saying that the problem is the analysts. I think 
they are being made the scapegoat.
    The problem is the regulatory system that is favoring 
companies over investors. The analysts and the firms work 
primarily for companies, so it's unrealistic to expect that 
they are going to bite the hand that feeds them.
    So what are our recommendations for you? We have four.
    The first recommendation is, encourage fuller and more 
practical useful disclosures of financial conflicts of 
interest. Who does a researcher work for? Is it the companies 
or is it the investor.
    My second recommendation is encourage the alignment of 
interests, encourage research that is aligned with investment 
and with investor interests.
    Let me tell you a little fable in a sense. This is a 
classic case of the fox in the hen house. Today, the investment 
research assumes that the investor hens will be just fine in 
the same hen house with the investment banking fox as long as 
the regulator, the farmer, makes sure there's enough chicken 
wire to keep the fox away from the hens.
    My question to you is: Why not encourage more hens seeking 
out hens and why does the system always encourage that a hen 
must deal with a fox? It makes no sense, but that's what the 
system encourages.
    It encourages the hens to live right next to the fox all 
the time.
    Now what's my third recommendation? Reduce regulatory 
barriers to people who want to do pure investment research like 
we do. Do you realize that in order to become an independent 
research broker/dealer, we had to be licensed and regulated and 
audited to do investment banking and all the trading.
    There are over 900 pages of regulations that we are 
subjected to and only ten apply to research. We essentially in 
the regulatory system, why you have so little independent 
research is the regulatory system powerfully discourages it. We 
have to take a regulatory exam called a Series 24. We took it 
and we passed it.
    However, it was a very difficult exam. We spent over 150 
hours studying for that in order to pass it. And there were 
very few questions, a very small percent that applied to what 
we are trying to do in our business, which is to provide 
investment research to improve investors' performance.So we 
think you can do a little bit of deregulating. The last 
recommendation I have is ensure a full and diverse competition 
for ideas and information in the marketplace.
    More specifically, watch the institutional commission 
lists, because right now the folks that have 90 percent share 
of those research commission lists are trying to get 100 
percent. That's the reason why we're testifying here today. If 
you want to have more independent research, if you want to fix 
the solution, allow the marketplace to compete with conflicted 
    Thank you for the opportunity to testify today.
    [The prepared statement of Scott C. Cleland can be found on 
page 184 in the appendix.]
    Chairman Baker. Thank you very much, sir. We appreciate 
your appearance.
    Our next witness is Mr. Thomas Bowman, CFA, President, 
Chief Executive Officer, Association for Investment Management 
and Research. Welcome, Mr. Bowman.


    Mr. Bowman. Good afternoon, Mr. Chairman, and other Members 
of your subcommittee. My name is Thomas Bowman, President and 
Chief Executive Officer of the Association for Investment 
Management and Research, a non-profit organization with the 
mission of advancing the interests of the global investment 
community by establishing and maintaining the highest standards 
of professional excellence and integrity.
    Thank you for the opportunity to and privilege to speak on 
behalf of more than 150,000 investment professionals worldwide 
who are members of AIMR or who are candidates for AIMR's 
Chartered Financial Analyst designation.
    For more than 30 years, CFA charterholders, candidates and 
other individuals who are AIMR members have adhered to a 
standard of practice that requires them, among other things, to 
achieve and maintain independence and objectivity in making 
investment recommendations and to always place their clients' 
interests before their own.
    Although AIMR members are individuals, not firms, AIMR has 
succeeded in developing other ethical and professional 
standards that require firmwide compliance and have been 
globally adopted. Based on our experience, ethical and 
professional standards are most effective when voluntarily 
embraced rather than externally imposed.
    To provide analysts with an environment free of undue or 
excessive pressures to bias their work, we must understand that 
these pressures come from many sources, not simply investment 
banking activities, and not all of them internal to their 
firms. None of these pressures is new, but their impact has 
escalated in an environment where penny changes in earnings per 
share forecasts make dramatic short-term changes in share 
price, where profits from investment banking activities outpace 
profits from brokerage and research, and where investment 
research and recommendations are now prime time news, or as 
some would say, entertainment.
    Let me elaborate a bit on some of these pressures. Analysts 
need to work with their investment banking colleagues to 
evaluate prospective clients. Although we do not believe that 
this relationship is inherently unethical, firms must have 
procedures in place that minimize, effectively manage and 
adequately disclose the conflicts to investors.
    Firms should foster a corporate culture that supports 
independence and objectivity.
    They should establish or enforce separate and distinct 
reporting structures so that investment banking can never 
influence a research report or investment recommendations.
    They should have clear policies for analysts' personal 
investment and trading.
    They should implement compensation arrangements that do not 
link analysts' compensation to work on investment banking 
assignments; and
    Make prominent and specific, rather than marginal and 
boilerplate, disclosure of conflicts.
    Analysts also have been pressured by companies to issue 
favorable recommendations. Companies have been known to take 
punitive action against analysts and their firms for negative 
    Some institutional clients also support ratings inflation. 
Portfolio managers' compensation may be adversely affected by a 
rating downgrade of a security in their portfolio. 
Consequently, they may retaliate by shifting brokerage to 
another firm.
    These and other conflicts are discussed at length in a 
position paper that AIMR will soon issue for public comment. 
This paper will form the basis for the development of AIMR's 
Research Objectivity Standards, which will be specific and 
measurable practices addressing each conflict.
    Finally, we must address how research recommendations are 
communicated. Increasingly, private investors get research 
recommendations through brokers, the media and the Internet. 
Typical research reports are lengthy, but are often condensed 
to earnings forecasts or buy, hold or sell recommendations when 
communicated to the investing public. This makes a good sound 
bite, but investors should know that headline ratings do not 
provide sufficient information for buying or selling a 
    Investors or their investment managers should study the 
entire research report to assess the suitability of the 
investment to their own situation, their own investment 
objectives, and their constraints.
    Although the analysts we are addressing are a small 
fraction of AIMR members, and the investment profession at 
large for that matter, I would like to impress upon the 
subcommittee that AIMR and its members appreciate the 
seriousness and also the complexity of this problem. We 
recognize that the reputation of the entire investment 
profession has been called into question. But a precipitous 
solution is not the answer.
    AIMR is committed to work with the profession to develop 
effective, long-term solutions. I'll be happy to answer any 
questions you may have. And again, Mr. Chair, thank you very 
    [The prepared statement of Thomas A. Bowman can be found on 
page 195 in the appendix.]
    Chairman Baker. Thank you, Mr. Bowman.
    Our final witness today is Mr. Damon Silvers, Associate 
General Counsel, AFL-CIO. Welcome, Mr. Silvers.

                    ORGANIZATIONS (AFL-CIO)

    Mr. Silvers. Thank you, Mr. Chairman. The AFL-CIO and its 
member unions--there are 13 million members--believes today's 
hearings on investment analyst independence is of vital 
importance to working families and their pension funds.
    We would like to thank the Subcommittee for its efforts in 
this area. In particular, Mr. Chairman, let me express our 
appreciation to you for your concern for the interests of 
working families as investors.
    Defined benefit pension funds that provide benefits to the 
AFL-CIO's 13 million members have approximately $5 trillion in 
assets. Through 401[k] plans, ESOPs, and union members' 
personal savings accounts, there are further extensive 
investments in equity markets by America's working families and 
union members.
    Most of our members and the trustees of our pension funds 
rely on a variety of professionals for their information about 
the equity markets. America's working families have an enormous 
stake in the accuracy of this investment analysis.
    In addition, many of the largest pension funds, whose 
beneficiaries account for hundreds of thousands of working 
families, have placed the majority of their equity investments 
in index funds. This decision is driven by index funds' lower 
fees and the difficulty of obtaining consistent above-market 
returns in active trading.
    However, the funds who invest in indexes are placing their 
trust in the transparency and honesty of our markets and have 
no defense against systematic distortions such as those created 
by conflicted analysis.
    In that context, what are we to make of the data that's 
been cited here frequently today that in December of 2000, 71 
percent of all analysts' recommendations were buys and only 2.1 
percent were sell?
    In the remainder of my testimony, I would like to suggest 
that what has happened here is the collapse of what used to be 
called the Chinese Wall between investment banking and 
analysis, and that only regulatory action can rebuild it.
    There is substantial statistical evidence that analysts' 
decisions whether or not to recommend that investors buy a 
stock are influenced by whether their firm is an underwriter 
for that issuer or considering becoming one.
    CFO Magazine reported last year that analysts who worked 
for full service investment banks have 6 percent higher 
earnings forecasts and close to 25 percent more buy 
recommendations than analysts at firms without such ties.
    And in the last few months, analysts have been quoted by 
name in the financial press saying such things as, quote: ``a 
hold does not mean it's OK to hold the stock''. And, quote: 
``the day you put a sell on a stock is the day you become a 
    This data is not surprising given the relationships that 
have developed between analysts and the investment banking side 
of the full service securities firms. It has become a common 
practice for analysts to accompany teams from their corporate 
finance departments on underwriting roadshows, and most 
importantly, analyst compensation has become tied at many firms 
to analyst's effectiveness at drawing underwriting business.
    In addition, the consolidation of the financial services 
industry puts issuers in a position to withhold business from 
the firms of critical analysts across a wide array of markets, 
including commercial loans and commercial banking services, 
pension fund and Treasury money management and insurance 
    For example, the same CFO Magazine article reported last 
year that First Union cut off all bond trading business with 
Bear Stearns in response to negative comments by Bear Stearns' 
analyst, and Bear Stearns then ordered the analyst to be more 
    Just yesterday morning there was an account of how an 
analyst report critical of the Kraft offering that was 
mentioned here today was effectively suppressed by Goldman 
Sachs. They had their reasons, they reported in the press. The 
fact is, the report was suppressed.
    On the eve of this hearing, the Securities Industry 
Association announced a voluntary set of principles governing 
analysts at their member firms. We would urge the subcommittee 
to look closely at this code to see if it leaves room for 
continued linkage of analyst compensation to investment banking 
activity or continued participation by analysts in marketing 
securities underwritten by the analysts' firms.
    The problem of conflicted analysts is driven by extremely 
powerful financial pressures, and it will not be halted or 
reversed by either general statements of a desire to be honest 
or subtly crafted principles that on closer examination leave 
room for a continuation of business as usual.
    Rather, we think Congress ought to assist the Securities 
and Exchange Commission, the NASD and the national exchanges in 
continuing the course toward greater market transparency and 
integrity promoted by the SEC's recent regulatory initiatives.
    Already in Regulation FD on selective disclosure, the 
subcommittee has taken an important step toward combatting 
conflicting analysts' reports. The disclosure targeted by Reg 
FD gave issuers power to punish and reward analysts with 
information that warped the behavior of those analysts who 
actually got the selective disclosure.
    Unfortunately, despite the improvements wrought by FD, we 
believe that there is a need amply demonstrated by this 
morning's hearing for this Subcommittee to work with the 
regulatory agencies, including the industry itself, in the NASD 
and the SROs to develop new regulatory approaches.
    Some measures this subcommittee ought to consider and raise 
with the Commission should include bars on any form of linkage 
between analyst compensation and investment banking 
performance. And in addition, bars on analyst participation in 
marketing activities by their firms, most importantly, 
underwriting roadshows.
    The subcommittee should also consider whether in view of 
the pressures at work here a more comprehensive ban on analysts 
from issuing reports to the public on companies which their 
firms are underwriters for should be appropriate. One thing 
that has not come out in this discussion very much this morning 
is that analysts and broker-dealers are fiduciaries for their 
clients here. And they owe a duty to those people under law 
currently. Unfortunately, it seems to be somewhat 
    Working with the Commission on these new initiatives, 
however, will take time. In the meantime, we think this 
subcommittee would do a great deal to protect investors and the 
analyst community if at a minimum it used its influence with 
the SEC to protect Regulation FD and ensure it continues in its 
place in current form.
    In conclusion, the AFL-CIO believes the question of analyst 
independence is vital for the retirement security of America's 
working families. We thank this subcommittee for its work in 
this area, and we look forward to working with you in the 
    [The prepared statement of Damon A. Silvers can be found on 
page 199 in the appendix.]
    Chairman Baker. Thank you, Mr. Silvers.
    Mr. Bowman, I'd like to start my questions with you, sir. 
In your capacity representing AIMR and secondarily as to the 
content of your statement, I found it most helpful. You 
centered on a number of concerns that I have had, and I express 
my great interest in the release of the paper, which I assume 
will address all of those issues raised.
    Have you had occasion to review yet the Best Practices 
standard of the SIA?
    Mr. Bowman. Very briefly, sir. I think they came out 
earlier this week. And I had not had any advance--I had not 
discussed that with the SIA prior to their coming out with it. 
So I'm vaguely familiar with them, but I have not read them in 
    Chairman Baker. And you're not in a position to make a 
comment today?
    Mr. Bowman. Well, I found one thing very interesting. As I 
read through those, in fact I had an e-mail from one of our 
members who had seen it, and if you read through those Best 
Practices, while we agree with them all, it's very interesting 
to see that most of what was included in that report has been 
in our Standards of Practice handbook for 35 years--analyst 
independence, clients first, you know, conflicts.
    Chairman Baker. I was expecting that looking at that manual 
for 35 years of practice it would appear to me on first blush 
from a distance of about 40 feet, it contains a bit more than 
the Best Practices Standard recommended by the SIA. Is that a 
    Mr. Bowman. Well, in fairness it does, but there's case 
studies in here too. So this is not all the standards.
    Chairman Baker. Are there significant elements of its 
content which you would deem advisable for the subcommittee to 
consider in the application to the Best Practices of the SIA?
    Mr. Bowman. Very much, sir.
    Chairman Baker. What I will suggest, since I have a 
suspicion this will get inordinately complex very quickly, is 
to request--and I'll follow up in writing--your organization's 
review of those Best Practices as recommended, and particularly 
a contrast between your Manual of Best Practice and that which 
is proposed to help the subcommittee better understand where 
deficiencies might exist or where we find something of value in 
the SIA's proposal.
    At least my view, and I think the view of most Members of 
the subcommittee is there is not a desire to legislate in this 
matter, but we certainly want to encourage the best possible 
standard to be self-implemented, but to view the best way to 
confirm, as Mr. Silvers had pointed out, a way to ensure that 
the conformity with the standards is in place. Is there such an 
audit or enforcement provision with regard to the AIMR 
    Mr. Bowman. Again, sir, as I mentioned in my testimony, we 
are an organization of individual professionals. We do not have 
corporate membership, and therefore no authority over some of 
the firms that we're talking about here this morning.
    So we do have enforcement mechanisms over our members.
    Chairman Baker. Right. In other words, if you find somebody 
not complying with your rules, they're out?
    Mr. Bowman. They're out.
    Chairman Baker. But my point is that there's accountability 
at least within the organization, and where there is evidence 
of inappropriate conduct, there are consequences?
    Mr. Bowman. Absolutely.
    Chairman Baker. Well, see, that's something that's lacking 
I think in the SIA proposal. There's not even the beginning 
suggestion of a consequence for your failure to act 
    Mr. Cleland, did you want to jump in there?
    Mr. Cleland. Yes, if I could. It's always important to put 
things into context. And the SIA Best Practices, everyone 
should support. I just would like to put it into context that 
there's nothing really new here; that this is boilerplate.
    If you look at the National Association of Security Dealers 
self-regulatory manual that was first published in the 1950s, 
this language would be very similar to what the preamble was 
    Chairman Baker. So you would characterize this as not a 
particularly bold step, in other words?
    Mr. Cleland. This is probably a needed refresher course. 
But it's been the standard for 45 years.
    Chairman Baker. And by the way, just for the record, it was 
stated earlier that perhaps the organization was one of the few 
that had continuing education. I can confirm from my own 
personal experience there. Annual education requirements for 
most professional affiliations with annual testing. And I can 
speak to that from only the real estate perspective. But it is 
not an abnormal activity for a professional organization to 
require continuing education and examination, and I think 
that's highly appropriate.
    Did you wish to jump in, Mr. Silvers?
    Mr. Silvers. Yes, Mr. Chairman. I think that you have a way 
of avoiding the dichotomy that I think you wish to avoid 
between purely voluntary self-policing of the sort that the SIA 
code suggests, and legislation. Congress is fortunate that in 
its wisdom it created the structures of the self-regulatory 
organizations and the NASD, which are industry structures, 
controlled by the leaders of the securities industry who have 
the authority to enact structures of accountability in this 
    It's our view that the proper role for this subcommittee 
here is to work with those bodies and encourage them to use the 
authority they have to address this problem and create the 
kinds of accountability, Mr. Chairman, that you are concerned 
    Chairman Baker. Thank you. I'm going to jump to Mr. 
Bentsen. I don't know how soon we'll get to a vote, but I'd 
like to try to at least get Mr. Bentsen and Mr. Shays' 
questions in before then. Mr. Bentsen?
    Mr. Bentsen. Thank you, Mr. Chairman. let me just restate 
and make sure it's clear what my opinion is on this so no one 
is confused. I think there is some move here to try and treat 
financial analysts in the same way that we treat auditors and 
to link their positions. And I just continue to believe that 
those are two different professions and we ought to be cautious 
in our approach.
    And in a couple of the testimonies that were given, there 
seems to be an extrapolation of not just fiduciary 
responsibility--and I agree that analysts, because they have 
contact with investors, are required to take their Series 7 and 
I don't know whatever series tests they have to take through 
the SROs.
    But no one yet has shown me in the law where analysts' 
reports fall under the same guidelines that offering documents 
for securities do in terms of providing objective disclosure. 
And second of all, no one has yet fully provided for me some 
widespread pattern of manipulation of the market on the part of 
the analyst corps that creates some real and present problem 
that needs to be addressed through regulation or legislative 
    Now at the same time, as I said to the earlier panel, and 
maybe I'll try and be less subtle, that it comes as no great 
surprise to me that analysts who work for investment banking 
firms or brokerage firms may well be, particularly on the sell 
side, may well be trying to add in the pitch of the sale. And I 
think there is a risk to the brokerage firms that they be 
cautious in how subjective they want to be, because they are 
trading ultimately on trust. And then if they cross that line 
into what is manipulation through false disclosure, even though 
they are not under the Security Act or other disclosure laws.
    I mean, can anybody here give me a pattern that has 
occurred? And the other thing I would just add, and I'd ask Mr. 
Cole, you talk about the fact that the NASDAQ has been cut in 
half from 2000, but this is not the first time we've seen 
market corrections in the 20th century. I mean, you had in 
1900, in the 1920s, in the 1950s. You had a brief correction in 
the 1980s.
    And if there's a correlation between analysts saying sell 
versus hold versus buy, is it to say--I mean, how did you get 
that 50 percent correction in the first place? Had they all 
said ``sell,'' would it have been a 100 percent correction in 
the market? Or does the market move on information other than 
what analysts provide to them?
    And finally, I'd just say, in many respects I think there 
is a herd mentality that occurs in the market, and I think the 
excess capacity of media outlets amplifying what analysts are 
saying, which heretofore used to be a subscription-type 
business sort of amplifies what their real worth is.
    But basically, I'd like to know where is the pattern? Where 
is the empirical evidence? Because I don't think that case has 
been made today.
    Mr. Cleland. If I could jump in, I wouldn't necessarily say 
that--I wouldn't try and answer it that way. What I would say 
is the entire structure, the economics, the structure, the 
regulation, the compensation structures, are all mutually 
reinforcing that put company interests ahead of investor 
    The SIA's Best Practices said the investor interest comes 
first. Well, if you look through the regulation, the structure, 
the economics of the industry and the compensation, it all 
rewards companies over investors.
    Mr. Bentsen. Now Mr. Cleland, do you support Reg FD?
    Mr. Cleland. I think that Reg FD is OK. I think what it 
means is that most research has to happen in a stadium, and 
that generally isn't how research is done. Research is done day 
by day, tough, you know, digging and getting different nuggets 
at different times.
    Mr. Bentsen. But wouldn't it, if we had a Reg FD, isn't 
there a school--I think there's a school of thought if we had 
Reg FD that when a company tells an analyst that they have a 
cozy relationship with they also have to disclose to the rest 
of the world. I mean, isn't that what you want to see happen?
    Mr. Cleland. I have no problem with that.
    Mr. Bentsen. Isn't that what we're saying in part here 
    Mr. Cleland. Yes. And I don't think there's any--I'm not 
quibbling with FD.
    Mr. Bentsen. We had a hearing a week ago, or 2 weeks ago, 
where some were trashing Reg FD and saying that it was going to 
lead to less disclosure and contort the market and all other 
sorts of things.
    Mr. Cleland. And I'm not quibbling with FD. I'm trying to 
tell you that there is a systemic bias toward representing 
company interests over investor interests throughout the 
system. And you will get biased research, because that's what 
the system is geared to do.
    Mr. Bentsen. In the laws governing offering documents, I 
mean, issues you raise about companies taking positions, the 
brokerage houses taking positions in companies that they're 
also writing research for, when they are actually pitching a 
stock through an offering document is a material item that has 
to be disclosed in the document.
    And I think what you are arguing is perhaps we need to 
apply disclosure standards, legal disclosure standards to 
research, which is a pretty far step to take.
    Mr. Cleland. No, I'm not saying that. I think the rules as 
I know them that research reports are classified as sales 
material. So at least that's what the current rules do say. 
They treat research as--they call it sales material.
    Chairman Baker. If I can, Mr. Bentsen, I'm going to jump to 
Mr. Shays, and hopefully we can release our witness panel. Mr. 
    Mr. Shays. Thank you. I'm intrigued with all your 
testimony. Mr. Cole, you start out very clearly and say Wall 
Street has become hopelessly corrupt. And I'm interested in you 
trying to give me the two or three best examples of why you 
think it's hopelessly corrupt, and then I'd like a response by 
the rest of the panel.
    Mr. Cole. Well, when you look at a Planet Hollywood 
underwriting or Playboy secondary offering and you see the 
quality of research which was released in either of those 
companies. Planet Hollywood went bankrupt shortly after it went 
public. Or if you consider the role of analysts at a brokerage 
where the brokerage actually provides venture capital to a 
company, helps create the company, then takes it to an initial 
public offering and the company does go public, the brokerage 
itself has a stake in the company worth from hundreds of 
millions to billions of dollars.
    What analyst is going to come out with a sell 
recommendation when the brokerage itself owns billions of 
dollars of stock in that company? If the analyst's sell 
recommendation only knocked 10 percent off the value of that 
stock, it could hurt the brokerage to the tune of hundreds of 
millions of dollars.
    Mr. Shays. I'm struck by the fact, though, I don't know how 
a brokerage firm does well if its analysts are constantly 
telling people to do something that's not in their best 
interest. I see the built-in bias, but in the end, it seems to 
me that analysts----
    Mr. Cole. The day of reckoning may come, as I said in my 
statement. I think the public is catching on. And if you want 
to be a little bit dramatic, what happens when the public does 
catch on and loses faith in Wall Street?
    Mr. Shays. What about all the other analysts who work for 
other companies who will express an opinion about a particular 
area where one company has a vested interest in? In other 
words, doesn't the fact there are so many analysts out there 
ultimately modify, provide additional information? So one 
brokerage firm says buy and another one says sell.
    Mr. Cole. I wish that it did modify it, but it seems to 
magnify it since as we've heard, 99 percent of recommendations 
are buy, it seems to have a reinforcing effect rather than a 
moderating effect.
    Mr. Shays. I guess my question is, other firms that don't 
have a vested interest in it. Therefore, I don't see where 
their bias is.
    Mr. Cole. They may seek business in the future. They may be 
owned by a commercial bank which has a commercial banking 
relationship with the company in question. It never pays to 
make enemies.
    Mr. Shays. Let me just hear the response of others. Mr. 
Cleland, I want to just say, the way you organize your 
statement tells me it's based on your training as an analyst. 
I'd love to show my staff how clearly you organize your 
statement. It's intriguing.
    Mr. Cleland. Thank you.
    Mr. Shays. But I'd love you all to just respond to Mr. 
Cole's comments.
    Mr. Cleland. Well, I think I wouldn't use the word 
``corrupt''. I would use the word ``conflicted''. I mean, 
there's nothing wrong with representing companies. The problem 
in the system is, is people think the system represents 
investors. And the structure, the economics, the compensation 
and the regulation is all biased toward helping company 
interests subordinate investor interests. That's the system. 
That's the problem is that it's not transparent that the system 
is so skewed.
    Mr. Shays. Mr. Bowman?
    Mr. Bowman. With all due respect, I categorically disagree 
with Mr. Cole's statement. As I think Mr. Glassman and the 
earlier panel indicated, life has conflicts, as does any 
    As I mentioned, I represent an organization of 150,000 
investment professionals and I deal with thousands of 
investment professionals every day, and I can tell you that in 
99.99 percent of the cases, all they want is for the investing 
public and for us to be able to demonstrate that these people 
are honest, forthright and are putting their clients first.
    In fact, since this whole issue arose several months ago, I 
have probably never been inundated with e-mail, mail and fax 
from members about the concern that they have and the black eye 
that they're receiving over what is really an isolated set of 
conflicts. And that is a relatively few number of sell-side 
firms who have these potential conflicts.
    So I can tell you that over 30 years of investment 
practice, all the investment professionals that I've ever run 
into and at least those who are members of our organization, 
are honest, forthright and only interested in serving their 
    Mr. Shays. Thank you.
    Chairman Baker. Thank you, Mr. Shays.
    Mr. Royce.
    Mr. Royce. Thank you, Mr. Chairman. I missed a little bit 
of the testimony here, because the Investor and Capital Market 
Relief Act is on the floor and I was speaking to that bill. But 
I caught some of the earlier testimony.
    And I have yesterday's Wall Street Journal with me here. 
And I just want to read for the panel here a comment made in 
yesterday's Journal: ``Investors increasingly are blaming 
analysts for helping to pump up the dot.com bubble by issuing 
favorable research reports in recent years on companies handing 
out fat investment banking fees and not warning investors of 
the problems at these companies until long after the bubble 
    And what the Journal does is just give a short example 
here, which I'd like you to comment on. It says: ``A week ago 
Credit Suisse First Boston was appointed lead underwriter on a 
new stock deal for GoTo.com, a Pasadena, California Internet 
search engine. And Credit Suisse First Boston beat out Merrill 
Lynch and Company for the lucrative position. A few hours 
later, Merrill's high profile technology stock analyst, Henry 
Blodgett, who had been bullish on GoTo.com shares, did a 
turnaround on the stock. He downgraded the stock to a neutral 
from accumulate.'' And the Wall Street Journal asks the 
question, a coincidence? And that's the question I want to ask 
you. Is that a coincidence?
    Chairman Baker. If I may suggest, gentlemen, respond very 
quickly, and here's the incentive. If we get through this round 
of questions in time, we will adjourn our hearing. If not, 
we'll come back. It's your choice.
    Mr. Royce. Those types of examples. Are they a coincidence?
    Mr. Silvers. Congressman, I think that if you look at the 
academic studies in this area which were cited extensively in 
my written testimony, you'll see that not only is that not a 
coincidence, but that it preceded the bubble. That those people 
at the leading business schools of this country who have taken 
a look at the relationship between whether or not an analyst's 
firm has an investment banking relationship with the company 
that analyst is looking at has an effect on their reports, the 
answer time and time again has been yes in the 1990s.
    It's a matter I think of statistical proof. And in addition 
to the academic studies that were done all through the 1990s 
that are in my testimony, the Journal had reports yesterday on 
a study that showed someone who followed the recommendations of 
conflicted analysts would have had a 50 percent grater loss 
than one who did not. And furthermore, there was a study in CFO 
Magazine that I mentioned earlier. And there is to my knowledge 
no contradicting studies.
    I think that there is ample data for the proposition that 
you're asserting here and that regulators' inaction, frankly, 
at this point is inexplicable to me.
    Chairman Baker. If I may suggest, we're down to probably a 
couple of minutes left, Mr. Royce on the vote.
    Mr. Royce. Thank you, Mr. Chairman.
    Chairman Baker. Thank you very much. I would enter into the 
record, Mr. Silvers, the document you were referring to is the 
Investars.com study in which 53.34 percent--investors lost an 
average of 53.34 percent when they followed analysts employed 
by firms as opposed to independent analysts lost 4.24. Now both 
were losing. I mean, there's nothing to brag about in this 
message. But the point is that it seems to have been 
exacerbated by the affiliation.
    To that end, I think the testimony given here today has 
been very helpful.
    I'm sorry, Mr. Bentsen. Very quickly.
    Mr. Bentsen. If I could clarify very quickly, on a point 
Mr. Cleland made, talking to counsel, the 33 Act for disclosure 
purposes does not cover analysts' reports. And I think we're 
again being very confused here that analysts' reports are not 
offering documents. And at the end of the day, people who are 
buying stocks and bonds should read the offering document where 
the disclosure is in and we are now extrapolating that, 
expanding that to cover analysts reports. And I think we need 
to think long and hard before we make that assumption.
    Chairman Baker. We're down to a minute, Mr. Bentsen. And I 
don't dispute your point. Investors should have some 
responsibility. But this complicated matter, I hate to close 
our hearing in this fashion, but I must. We will address the 
remaining issues in hearings that are yet to come. I would 
welcome your written comments and suggestions, and certainly 
Mr. Bowman, I eagerly await the findings of the paper and look 
forward to working with each of you toward appropriate 
    Our hearing is adjourned.
    [Whereupon, at 1:25 p.m., the hearing was adjourned.]

                         ANALYZING THE ANALYSTS


                         TUESDAY, JULY 31, 2001

             U.S. House of Representatives,
       Subcommittee on Capital Markets, Insurance, 
              and Government Sponsored Enterprises,
                           Committee on Financial Services,
                                                    Washington, DC.
    The subcommittee met, pursuant to call, at 2:05 p.m., in 
room 2128, Rayburn House Office Building, Hon. Richard H. 
Baker, [chairman of the subcommittee], presiding.
    Present: Chairman Baker; Representatives Castle, Royce, 
Oxley, Fossella, Toomey, Kanjorski, Bentsen, J. Maloney of 
Connecticut, LaFalce, Sherman, Inslee, Moore, Gonzalez, Ford, 
Hinojosa, Lucas, Shows, Crowley, Israel.
    Chairman Baker. I'd like to call this hearing of the 
Capital Markets Subcommittee to order. I'm advised Members are 
on their way to the subcommittee, but to try and keep our 
proceedings on a timely basis, I will open our hearing.
    This is the second in a series, and I expect a long series 
of hearings over the concerns of market practice and the free 
flow of unbiased information to investors.
    Many people have expressed concern over the under-
performance of the market over the last few weeks, and 
individual investors have seen portfolios shrink rather 
dramatically. That is not the basis on which the subcommittee 
conducts its review today.
    As always, investors have the ultimate responsibility to 
make their own determinations based on their own best judgment. 
However, it has become increasingly clear that market practices 
are not what they used to be, and, in fact, there will be 
today, I believe, testimony to indicate that the scope of 
concerns the subcommittee has had are fully warranted and, in 
fact, may be more pervasive than originally contemplated.
    The purpose of the hearing will be to determine the breadth 
of those problems and to begin the initial process of assessing 
the appropriate steps that are responsive to the problems that 
are identified. As everyone is aware, we have appointed a peer 
review committee which now has under advisement the best 
practices standards as issued by the Securities Investment 
Association, (SIA).
    It is our hope that with the information provided in the 
hearing today, that we can properly assess the effectiveness of 
those rules and determine what enforcement mechanisms may be 
appropriate in light of the difficulties that have been 
determined to date.
    I'm particularly grateful for those who are participating 
on today's panels. There's pretty clear agreement among all the 
witnesses as to the fact that a problem exists. I suspect there 
may be some differing opinion as to the remedies that might be 
appropriate, but I very carefully reviewed all the witnesses' 
testimony and think the hearing today will be very helpful for 
the subcommittee in understanding what will be an appropriate 
remedy to our concerns.
    To put a fine point on that process, the subcommittee will 
conduct a hearing in the fall, after the August recess. We will 
develop recommendations for the industry to consider, and we 
will develop a mechanism by which those recommendations can be 
verified as to the level of compliance.
    However, I should make it fairly straightforward, at least 
in my opinion, that should there not be an appropriate or 
adequate response by the industry to the identified public 
policy concerns, I am not turning my back on the question of 
providing a legislative remedy should we fall short of 
achieving the desired goal.
    With that, I would like to recognize Mr. Kanjorski, the 
Ranking Member, for his opening statement.
    [The prepared statement of Hon. Richard H. Baker can be 
found on page 209 in the appendix.]
    Mr. Kanjorski. Thank you, Mr. Chairman.
    We meet today for the second time to consider the issue of 
analyst independence, a subject of great significance to our 
Nation's capital markets. Increasing the transparency of 
analysts' work should make it easier to detect faulty research 
and should enable investors to more easily evaluate the 
differing views of analysts who cover a particular stock.
    Increased transparency should also help restore confidence 
in Wall Street's research. Since we last met on this subject in 
June, a number of developments directly affecting the subject 
of analyst independence have occurred.
    Therefore, I will summarize some of these events before we 
begin today's hearing. First, the National Association of 
Securities Dealers (NASD) recently proposed changes to its 
disclosure rules. These amendments propose, among other things, 
to include common stock as a financial interest that firms and 
analysts must disclose.
    More importantly, the proposal would also require 
abbreviated disclosures during public appearances on radio and 
television shows. When implemented, these changes should help 
retail investors to better understand analyst conflicts.
    Officials with the NASD have also personally assured me 
that this rulemaking is not the last step that their 
organization will take to enhance analysts' capabilities. A 
number of securities firms have additionally announced 
revisions of their existing policies to manage analysts' 
conflicts. These changes exceed the recommendations for best 
practices announced by the SIA at their last hearing.
    For example, Merrill Lynch, Edward Jones, and Credit Suisse 
First Boston have announced plans in July to prohibit their 
analysts from owning securities in companies they cover in 
their research. In the coming weeks, I expect other firms will 
follow the lead of these companies by announcing changes in 
their own policies and practices designed to increase the 
independence of research.
    Furthermore, the Nation's largest brokerage firm announced 
that it has agreed to pay $400,000 to a pediatrician in Queens, 
New York. This doctor claimed that he lost more than one-half 
million dollars following the advice of his broker who 
regularly cited the bullish research of a prominent Wall Street 
    Although this settlement establishes no legal precedent by 
itself, it does raise important ramifications for the brokerage 
business, especially if other investors, in the weeks and 
months ahead, pursue similar cases.
    I predict that just one or two more settlements of this 
type will create an incentive for the investment banks to take 
further action to improve the quality and trustworthiness of 
their research. Although each of these actions demonstrates 
that the marketplace has begun to self-regulate on the issue of 
analyst objectivity, we must still do more.
    Mr. Chairman, in the week since our last hearing, the 
debate has intensified about whether we should privatize Social 
Security. Social Security presently covers about 160 million 
persons. Because more than 20 percent of the adult American 
population is functionally illiterate, we can estimate that 
about 35 to 40 million Americans cannot read or understand a 
business prospectus. Yet, we would be asking these very same 
individuals to make decisions about their retirement funds 
under Social Security privatization schemes. If they cannot 
read and comprehend a business plan or an accounting statement, 
it seems likely that many of these individuals would become 
reliant on the advice of Wall Street researchers when making 
their investment decisions.
    Therefore, industry has an obligation and a responsibility 
to comprehensively address the issue of analyst conflicts and 
resolve all related concerns before we begin any public policy 
debate on the future of Social Security.
    With that said, Mr. Chairman, today's hearing will further 
our understanding of the nature of this growing problem and 
help us to discover other actions that might restore the 
public's trust in analysts.
    As you know, I generally favor industry solving its own 
problems through the use of self-regulation whenever possible. 
And I was pleased to join you in recent weeks in creating a 
review board to assess the adequacy of the industry's reform 
proposals. I will also listen carefully to today's testimony 
and continue to encourage our subcommittee to move deliberately 
on these matters in the months ahead.
    As I advised at our last hearing, we should not demagogue 
on the issue of analyst objectivity to score political points. 
Only cautious action on this subject will help to ensure that 
our capital markets remain strong and vibrant.
    In closing, analyst independence is an issue of the utmost 
importance for maintaining the efficiency of and fairness in 
our Nation's capital markets.
    Thank you, Mr. Chairman, for having this hearing today and 
raising these concerns.
    [The prepared statement of Hon. Paul E. Kanjorski can be 
found on page 217 in the appendix.]
    Chairman Baker. Thank you, Mr. Kanjorski.
    Chairman Oxley.
    Mr. Oxley. Thank you, Mr. Chairman. I commend you for 
holding this important hearing, part of a series of hearings on 
issues of Wall Street research practices. These practices have 
come under fire in the past year for some good reason. As we 
learned at our first hearing on analysts last month, and as 
even the trade group for analysts acknowledged, conflicts of 
interest do pervade Wall Street's research machine and taint 
the recommendations of equity analysts.
    There's one reason institutional investors pay little 
attention to sell side analysts, relying on their own research 
professionals instead.
    Robert Sanborn, a former portfolio manager of the Oakmark 
Fund says that anyone who follows a recommendation from a sell 
side analyst is an absolute fool. Most investment advisors 
caution investors to consider analysts' recommendations not as 
definitive in any way, but rather as a single factor in making 
a buy or sell decision. That is good advice, but even as a 
single factor in an investment decision, an analyst's 
recommendation should, at the very least, be free from the 
taint of bias.
    The financial media has played an important role in 
elevating the profile of Wall Street analysts. Mary Meeker and 
Henry Blodgett are now familiar names to a large number of 
American investors. Many have criticized the news media for its 
failure to hold analysts accountable for wildly wrong 
predictions. I would urge the news media to require sources to 
disclose whether they hold any interest in stock, long or 
short, and whether their firms have business relationships with 
the company. Then let investors weigh that information. Some 
news media already take these steps, but it should be 
    Having said all that, as a free market Republican, I am 
loathe to legislate in this area. My preference is for industry 
to clean up its own mess. I'm encouraged by steps that some 
companies have taken to address the issue. I will continue to 
work with the industry to make sure sufficient steps are being 
taken to resolve the problems and to restore confidence in Wall 
Street research practices.
    This subcommittee has established a peer review board of 
industry practitioners, money managers, academics, and 
regulators to comment on the industry's proposals for reform. 
That group will present its findings to the subcommittee at a 
hearing this fall.
    I look forward to our distinguished witnesses today who 
will provide new perspectives on the issue including 
Commissioner Laura Unger, the Acting Chairman, who has done 
considerable work on this matter as Acting Chairman of the 
Commission, and on our second panel, a variety of esteemed 
experts in research and investment banking, and the financial 
    Welcome, Ms. Unger, it's good to have you back before the 
    Mr. Chairman, I yield back the balance of my time.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page 225 in the appendix.]
    Chairman Baker. Thank you, Mr. Chairman.
    Mr. LaFalce.
    Mr. LaFalce. Thank you very much, Mr. Chairman. And thank 
you, Mr. Kanjorski, for the fine work the two of you have been 
doing in the hearings you've had thus far on these very, very 
important securities issues. They, along with the many meetings 
that I've had with market participants and regulators and 
academics have increasingly convinced me that analyst conflicts 
have seriously eroded confidence not only in the capital 
formation process, but in the way stocks are evaluated by 
investors who seek objective advice in a very complex 
    It's also become clear to me that the analysts have a role 
in boosting and supporting the stock price of certain 
companies. That is but one piece in a series of activities that 
contributed to the market exuberance of the late 1990s and the 
early months of this century. We must redress these practices.
    The centrality of the market, as both the measure of a 
company's success and a fundamental source of wealth creation 
for insiders especially, has tilted companies' attention toward 
their stock price and away from the fundamentals of their 
    Executive compensation is now most often intertwined deeply 
with the performance of a company's stock. The stock price, in 
turn, is very much affected by the expectation of the 
securities analysts and the investor community. Companies live 
and die by meeting analysts' predictions each and every 
quarter. Missing the estimates by as little as a penny can send 
a company's stock price plummeting, even when there has been no 
substantive change in the firm's condition or prospects.
    Since the last hearings, the SIA, in an effort to stem the 
public and vocal tide of criticism, released its voluntary 
guidelines, and shortly after its release much of the industry 
claimed they were already following these guidelines.
    In response, Ms. Unger was quoted in the press as saying 
that this would, quote: ``Suggest that perhaps the guidelines 
need to be enforced more stringently.'' Perhaps so, if you can 
enforce guidelines.
    In any event, shortly following those remarks, in a very 
positive but telling step, Merrill Lynch, Credit Suisse First 
Boston, amongst others, barred their analysts from owning the 
stocks that they cover. Now I think that was a clear indication 
that something was very wrong. I also think it's a clear 
indication that the wrong can be righted. As a result, I've 
communicated with Ms. Unger, and the NASD on two occasions to 
call for a rulemaking that goes beyond the enhanced disclosure 
recently proposed by the NASD to amend Rule 2210.
    We know that the role of the analyst is both a mechanism to 
win business and a voice to speak objectively about the 
business fundamentals of the companies they cover. This advice 
is relied upon by small investors and by large investors alike.
    What is at risk is often a person's entire future, a 
person's retirement, a person's financial security, a person's 
fortune. Conflicts are not simply facts to be disclosed. 
Conflicts of interest undermine the objectivity of the analyst 
and the efficacy of the work that they do.
    Like any profession that requires trust by the public, 
conflicts need to be minimized or eliminated, not simply 
disclosed. Therefore, I have suggested to Ms. Unger, and I 
invite her to respond today, if not on behalf of the Securities 
and Exchange Commission (SEC), on behalf of Laura Unger 
personally, to the following recommendations.
    First, to affirm through regulation the actions of 
companies such as Merrill Lynch and Credit Suisse by banning 
securities analysts from owing or having an interest in the 
stocks that they cover.
    Second, to engage the academic community, the NASD and 
market participants to arrive at a workable construct that will 
alter the present compensation structure of analysts to 
separate analysts' compensation from their investment banking 
function, and reward them based on the quality of their 
    Third, to require securities firms to disclose on each 
research report or recommendation, how many issuers they cover, 
and an aggregate breakdown by category of the ratings assigned 
to these issuers. For example, xyz investment firm covers 200 
public companies. Of these companies, 50 are strong buys, 100 
are buys, 49 are holds, and one is a sell or two are sells or 
three or four or whatever it may be. But that might put the 
recommendation in perspective.
    I made additional suggestions to the Commission in late 
June following this subcommittee's first hearing. Without 
objection, I would ask that they also be made a part of the 
    Chairman Baker. Mr. LaFalce, without objection, but I hate 
to ask if you could begin to close.
    Mr. LaFalce. Yes, I do support many of the modest changes 
supported by the NASD in its proposed rulemaking. But I'm 
increasingly concerned that industry self-regulation may not be 
sufficient and that more disclosure of these conflicts in 
itself will not suffice to protect the American investor.
    So I urge the regulators to act quickly to eliminate these 
conflicts, because if the regulators do not, Congress must.
    [The prepared statement of Hon. John J. LaFalce can be 
found on page 219 in the appendix.]
    Chairman Baker. Thank you, Mr. LaFalce.
    I go next to Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman.
    Ms. Unger, it's good to have you and the rest of our panel. 
Mr. Chairman, I appreciate that you are having the second round 
of hearings on this important issue, and I think the panel that 
you have today, Ms. Unger from the SEC, and our other, broader 
panel will be very helpful for both the Congress as well as the 
public, who is watching this, to get a better understanding of 
both how the process of research analyst works as well as what, 
if any, the response from the Federal Government should be.
    However, I would caution my colleagues, and I would caution 
the Securities and Exchange Commission to be careful in our 
attempt to, as we look for a culprit for the collapse--or I 
don't want to use the word collapse--but the rapid decline in 
the value of certain markets, that we shouldn't try and go and 
pin it, in this instance, on the case of the research analyst 
and try and sterilize the research business.
    I would remind my colleagues that on the books we have 
existing securities laws, existing disclosure laws which, 
whether or not people are actually looking at what is being 
disclosed, is something that we should not ignore.
    Second of all, I think we have to be realistic and 
understand that this is a problem that the industry not only 
has a responsibility to the general public, but has a 
responsibility to their own shareholders and their own partners 
to fix. I think that any firm which gains a reputation of 
irrational research will soon find that reflected in their 
bottom line.
    So I would hope that we gather as much information as we 
can, but that we proceed very cautiously in this approach, and 
that we do not try to equate the research business in the same 
way as we might equate the auditing business. Because, in this 
Member's opinion, those are two very, very different things.
    I thank the Chairman for calling this hearing.
    Chairman Baker. Thank you, Mr. Bentsen.
    Mr. Fossella.
    Mr. Fossella. Thank you, Mr. Chairman.
    To follow up on my colleague, Mr. Bentsen, it's a great 
thing that more Americans have become investors. I think it's a 
healthy thing. I think what is important, as well, is to remind 
all Americans who want to become investors that it's in their 
interest to become educated for their own good.
    We acknowledge the critical role I think that research 
analysts play in developing the markets and maintaining the 
integrity of the markets, and ultimately providing a service 
not only to their companies and firms, but to ordinary 
investors across this country.
    I think that what's happened in the last several weeks is a 
positive thing, that is, the industry, I think, has identified 
that there seems to be a problem. While the vast majority of 
individuals who work for these firms I think are of the utmost 
integrity, they have to comply with their own firms' standards, 
and deal with the SEC, among other regulatory entities, to 
comply with the law, there seems to be a strong belief that 
something needs to change.
    Some firms I think initially have thought that the best 
practices in events recommended by the SIA are necessary. It is 
healthy and good that some firms have said, no, I think we need 
to make some changes and modifications to our practices.
    What's left to be asked, however, is how much time should 
the industry have in order to change the way they go about 
these practices. There are different firms. Each firm has a 
different standard. How is it that the SEC is going to look 
upon the implementation of these best practices to ensure that 
as many firms as possible, if at all, are going to comply? You 
look at a Merrill Lynch, it has a different standard than a 
First Boston and a different standard than Salomon.
    I think over time it's up to the SEC to put a timeframe on 
those, is it 3 months?; is it 6 months?; is it after bonuses 
are given in December, to see if these things are working?
    I share Mr. Bentsen's views, and I believe my other 
colleagues who have said let's not jump to legislative remedies 
for this, because ultimately it's up to the investor to beware. 
But there is a degree, and a large degree of questions at stake 
with those few research analysts who compromise not only 
themselves, but their firm's integrity, as well as that of the 
individual investor.
    There are going to be conflicts always. There's no question 
about it. You have the responsibility, and I think you would do 
well to ensure that those conflicts and compromises are kept at 
a minimum. As the market decreases, it did so rapidly in less 
than a year, people are going to start pointing fingers and 
looking for someone to blame.
    I don't think that's the right thing to do in the long 
term. The right thing to do in the long term is to bring all 
these firms as close as possible to the best practices as 
recommended by the SIA and try to take another snapshot, in say 
6 months' time to see what's happened. But the rush to judgment 
may just be a big mistake.
    I yield back.
    Chairman Baker. Thank you, Mr. Fossella.
    Does any other Member have an opening statement?
    [No response.]
    Chairman Baker. If not, it would be my intention to recess 
pending the floor, Ms. Unger. I'll come back very quickly. My 
best guess is that that will take me about 10 to 12 minutes, 
and then we'll get started.
    Thank you very much.
    Chairman Baker. I'd like to reconvene our hearing. We had 
two votes instead of one so we were detained a little. The 
other Members will be returning as soon as possible.
    I'd like at this time to recognize our first witness for 
today's hearing, The Honorable Laura Unger, Acting Chairman of 
the Securities and Exchange Commission, certainly no stranger 
to the subcommittee.
    Welcome, Ms. Unger.


    Ms. Unger. Thank you very much, Chairman Baker, and others 
who may be returning to the hearing. A lot of what was said 
really resonated with me, and I think you'll find that what I 
say today will resonate with you.
    I thank you for the opportunity to address the subcommittee 
today concerning analysts' conflict of interest. The Commission 
commends the subcommittee for its continued attention to this 
important issue. I thought I would spend my time this afternoon 
addressing three issues.
    The first is, what conflicts affect analysts and why do 
these conflicts exist? The second is, what have we observed 
about analyst conflicts as a result of our staff's recent exams 
of brokerage firms? The third is, what is being done to address 
these conflicts?
    Before I turn to these particular questions, I think a 
preliminary remark is in order. It is fair to say, as others 
have said today, that it has not been a banner year for 
analysts. The profession has been the subject of intense public 
scrutiny. In many respects, analysts are a victim of their own 
success. The longstanding bull market and the record number of 
Initial Public Offerings (IPOs) made research--and the positive 
impact on stock price that research could have--a basis on 
which investment banking firms competed for underwriting 
    But I think it's important for us not to lose sight of the 
important role that analysts play in our securities markets. As 
the Commission recently stated, in adopting Regulation Fair 
Disclosure (FD), analysts provide a valuable service in sifting 
through and extracting information, the significance of which 
might not otherwise be apparent to the ordinary investor.
    We should also not forget that the overriding majority of 
analysts operate on the highest ethical plane. In other words, 
the issue of analysts' conflicts is largely structural and not 
    With that preface, I will begin by identifying a few of the 
more acute conflicts. Most stem from the blurring of the lines 
between research and investment banking that I just alluded to. 
This blurring can be seen in a number of ways. First, an 
analyst's salary and bonus may be linked to the profitability 
of the firm's investment banking business, motivating analysts 
to produce favorable research that will attract and retain 
investment banking clients for the firm.
    Second, at some firms, analysts are accountable to 
investment banking for their ratings. Third, analysts sometimes 
own a piece of a company that they cover, mostly through pre-
IPO share acquisitions.
    SEC staff has conducted on-site examinations of several 
full service brokerage firms, focusing on analysts' conflicts 
of interest. The staff, in its examinations, selected nine 
firms that underwrote significant numbers of IPOs, particularly 
internet and technology-related IPOs. These examinations 
focused on the three areas that I just mentioned: compensation 
arrangements; analysts' accountability to investment banking; 
and analysts' financial interest in companies they cover.
    Today, I will share with you some of the preliminary 
observations. The first is that the line between research and 
investment banking, has indeed blurred. Seven of the nine firms 
inspected reported that investment banking had input into 
analysts' bonuses and the analyst hiring process. In at least 
one of those firms, 90 percent of the analyst's bonus is based 
on investment banking revenue.
    The staff inspections found that the investment banking 
department does not formally supervise the research department, 
but that analysts assist investment banking by consulting on 
IPOs, mergers and acquisitions, participating in pre-IPO road 
shows, and initiating research of prospective investment 
banking clients.
    Second, interviews with former analysts revealed that it 
was well understood that they were not permitted to issue 
negative opinions about investment banking clients.
    Third, about one-quarter of the analysts inspected owned 
securities in companies they covered.
    The staff found that 16 of 57 analysts reviewed made 39 
investments in a company they later covered. All of the 
investments were pre-IPO. Moreover, the examiners found that 
three of these analysts traded contrary to their research 
report recommendations. Examiners also found that in 26 of 97 
lockups reviewed, research analysts may have issued ``booster 
shot'' research reports. These reports reiterated buy 
recommendations shortly before or just after the expiration of 
the lockup period.
    As you know, a lockup is the time period during which 
insiders and others who have obtained pre-IPO shares are 
prohibited from selling those shares. In each of these 
instances, the firms underwrote the IPO of the company in which 
the firm's analysts owned stock. So, you may ask what is being 
done to address these conflicts?
    As has been noted today, the industry, the Self Regulatory 
Organizations (SROs), and the Commission have taken action to 
improve the objectivity and independence of research analysts. 
Both the SIA and the Association for Investment Management and 
Research recently issued a set of best practices in this area. 
These best practices provide a basis or foundation for on-going 
discussions about managing conflicts.
    Firms are reviewing their internal policies and procedures. 
Several securities firms have already taken some initiatives to 
revise their existing policies and procedures to manage 
conflicts. As reported in the press, at least three securities 
firms have recently adopted policies that prohibit analysts 
from owning securities in companies they cover.
    The NASD recently proposed for member comment changes to 
enhance and harmonize its conflict disclosure rule. The 
Commission has two roles in managing analyst conflicts. The 
first is making sure that disclosure is adequate and effective. 
The second is educating investors.
    So far, we have worked with the SROs to improve and more 
diligently enforce the disclosure of conflicts of interest. Our 
Office of Investor Education and Assistance has also issued an 
Investor Alert to explain to investors exactly what conflicts 
analysts may face and how investors should interpret 
disclosures about these conflicts.
    I believe investor education is particularly vital to 
managing analyst risk. I say this because we can really only 
manage the conflicts. Some conflicts will always exist, such as 
pressure from institutional investor clients protecting their 
portfolio value, and pressure from issuers who put analysts in 
the dog house for downgrading their stock.
    It is my hope that with a little help from the regulators, 
the industry will resolve these issues. The recent industry 
initiatives are a step in the right direction. But I would be 
remiss, especially as a former enforcement attorney, if I did 
not emphasize that the industry and the SRO initiatives will 
only succeed with vigorous enforcement.
    The SEC staff inspections revealed that firms had policies 
on the books that were virtually ignored and rarely enforced in 
practice. For example, one firm approved an analyst's pre-IPO 
investment 3 years after the fact. In another example, only one 
firm could identify accurately all pre-IPO investments by 
analysts. This situation cannot continue. The firms, the SROs, 
and the SEC must work together to ensure that we have 
information with integrity out in the marketplace.
    I look forward to continuing this partnership. Thank you, 
Mr. Chairman. I will now be happy to answer any questions.
    [The prepared statement of Hon. Laura S. Unger can be found 
on page 227 in the appendix.]
    Chairman Baker. Thank you very much. I was optimistic that 
your testimony would satisfy all the concerns of the 
subcommittee and I think you've done an outstanding job of 
energizing the subcommittee's concerns.
    Ms. Unger. Thank you.
    Chairman Baker. There is considerable content to your 
testimony that I would like to question you about, but I'm 
going to focus on two or three things that I think are 
particularly disturbing.
    Examiners found that three analysts executed trades for 
their personal accounts which were contrary to the 
recommendations in their research report. That's from page 6, 
footnote 8. It goes on to say, and this is what really got me 
concerned, that the analysts' profits generated by acting in 
what I think is at least unethical if not a violation of some 
rule somewhere, between $100,000 and $3.5 million for each 
transaction by selling their shares while continuing to 
maintain buy recommendations. One analyst sold securities short 
while maintaining a buy recommendation on the subject company.
    What was the scope time-wise of your inquiry in the market? 
How recent are these examinations that led you to this 
    Ms. Unger. The examinations occurred in 1999 and 2000. What 
we saw as far as the scenario you just mentioned in terms of 
analysts deriving significant profits from selling activity 
contrary to their recommendations is something that we are 
taking a very close look at. And in fact, in those cases, it's 
possible that the analysts violated not only firm policies, but 
also the Federal Securities laws.
    Chairman Baker. That really was my next question. Was there 
a regulation, a professional standard of conduct, or a statute, 
and if not, I would welcome, once your review is finished, 
advising the subcommittee as to what, if needed, any steps 
might be taken. I find it frankly appalling that someone could 
tell me to buy while they're selling in the back room profiting 
from my investment.
    If that's not a bedrock of necessity to correct, there is 
nothing in this marketplace that we can correct. I just found 
that very troubling.
    The staff found instances in which the analysts' ownership 
in stock of the covered company was not disclosed in the 
research at all. Now I have trouble with the boilerplate that 
says we may have an interest, but to not say it at all is not a 
violation of current practice or regulation or is there any 
rule that says you have to disclose at least that the firm may 
have an interest?
    Ms. Unger. Well, this is part of the problem. The New York 
Stock Exchange has rules, as does the NASD. There is a 
disparity between what each of the SROs require in terms of 
disclosure. For example, one SRO requires that the firm 
disclose the common stock position, and the other doesn't. One 
SRO requires that there be a disclosure of the investment 
banking relationship that's more detailed than another.
    And so what we really need to do as a first step is 
harmonize the existing SRO rules to make it easier for firms to 
comply with those rules.
    Chairman Baker. I think the subcommittee would be 
interested. Again, one of the footnotes, page 8, footnote ten, 
despite the language of the rule, the NASD has stated that it 
does not interpret the disclosure requirement to apply to media 
appearances by analysts. So the SRO doesn't see anything wrong 
with someone getting on the television set saying what a great 
investment opportunity this is and there are no consequences. 
In fact, it doesn't violate the code of conduct.
    Again, I commend you for great testimony, but you've just 
increased our workload here for the considerable future. If we 
don't now have rules sufficient to govern practice from the 
SRO, I think we have a long struggle to get the industry to get 
where I believe you think they ought to be without significant 
    Ms. Unger. Well, the Commission, as you know, has been 
engaged in a dialogue over at least the last year with the NASD 
about their interpretation of what disclosures must be made by 
analysts in media appearances.
    Chairman Baker. Well, for what it's worth, I'd like to see 
a Surgeon General's warning that says, ``Warning. I have an 
interest in this thing I'm talking about,'' kind of flashes on 
the screen.
    Ms. Unger. Well, we have taken the position that the 
disclosure requirement applies irrespective of the media.
    Chairman Baker. Absolutely. Just because you whisper it 
instead of standing up and saying it in public is no different, 
you still have to disclose.
    Ms. Unger. I think the NASD is coming around to that 
    Chairman Baker. Well, for what it's worth, I hope we can 
encourage them.
    I have one more point I want to make, but my time's coming 
to an end, and so I'll do it real quickly. This is a what-if, 
and you may not be comfortable to comment today. But let's 
assume we had a standard of conduct which we all would 
prescribe as being good, and that we were able to get the 
industry to voluntarily implement that standard. We don't have 
it and we're not there yet. But assume for the moment we had 
    The other point of your testimony was many of the 
organizations have very well written, very well thought out 
codes of conduct, but they're also ignored. So we have pretty 
books sitting on the shelf that nobody reads.
    What we need, no matter what the standard may look like, is 
someone to determine compliance and a consequence for not 
having compliance. It seems to me there is a great deal of non-
compliance and there's no consequence. For example, the fellows 
who are trading against their public position.
    What would be the effect of having just a grading system, 
A, B, C, for example, real simple. A you comply with 
everything, B you're pretty close, but you're not there, and C 
you better really get your stuff together or bad things are 
going to happen.
    Now I don't know whether that would be the role of the SEC, 
the NASD, the SRO, but there has to be some measure of 
performance of your conduct, because without that, the market 
can't act and bring about the discipline we all want.
    Can you comment generally on the idea?
    Ms. Unger. You are correct. I would like to see the SROs 
first make the disclosure requirements crystal clear and 
consistent. I would next like to see the firms adopt policies 
across the board that would make disclosure with the 
requirements an everyday practice, and then I think we need to 
ensure a way for firms to enforce those rules.
    And what you've described is certainly one way and a 
powerful incentive, I'm sure, for the firms to comply with 
their own internal policies which in turn comply with the 
existing SRO rules, or soon to be existing SRO rules.
    I'm not sure what the extent of the SEC's involvement would 
be in something like that. I would prefer the Agency not to 
have any type of merit review, because we are traditionally not 
involved in merit review, and this would be something like 
that. I think we could be helpful in the process of developing 
standards and certainly we'd like to be engaged in the 
    Chairman Baker. But do you see merit in the public 
disclosure of outcomes? That's really my point, that today 
there are--although we all wish for self-discipline in the 
market--there is are consequence if you do not, and you can't 
make an informed judgment as an investor unless you know how 
the company functions. And it appears to be a very difficult 
determination to make today.
    Ms. Unger. The Commission often uses disclosure as a means 
of discipline.
    Chairman Baker. Thank you. I've exhausted my time.
    Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman.
    Ms. Unger, let me ask you this at the outset, because of 
how this is being portrayed and I want to make sure that I 
don't dig myself in too deep in the situation, because I'm a 
little worried that we're on a little bit of a witch hunt here.
    But do you believe that given the current situation and the 
concerns about conflicts of interests with analysts, that this 
is something akin to--there was a movie called ``Game Show'' 
about the 1950s and the hearings in Congress, long before you 
and I were born.
    Ms. Unger. Yes, I know what you're talking about.
    Mr. Bentsen. But it was sort of a rigged market. Is that 
your perception?
    Ms. Unger. No. And I think maybe you missed my opening 
comment where I said that, in fact, analysts perform a critical 
role in today's market, and in large part, they are victims of 
their own success.
    I think what's happened is that the market was so strong 
for so long and with the huge influx of IPO activity, firms 
looked for ways to compete to get that IPO business. Part of 
the way they began competing was to include analysts in the 
mix. The ability to provide favorable analyst coverage became 
part of the mix of services the investment banking firm offered 
    Mr. Bentsen. Let me ask you this. I mean, hasn't the 
analyst position always been part of the mix of investment 
banking and the mix of the trading and underwriting? I mean, 
haven't brokerage houses always relied, at least for internal 
purposes, for their own internal credit risk purposes, on the 
work of their research analysts?
    Ms. Unger. Well, I hate to do this, because it always seems 
like we point to the deregulation of commissions as the pivotal 
point for changes in the industry, but I do think that had some 
impact on the underwriting business. Commissions were where 
most of the money was being made by Wall Street at that time, 
and deregulation changed the focus of that business and how 
that business was conducted, and what made it profitable.
    I think analysts have probably always been involved in the 
deals, but not to the extent that they are now, and not to the 
extent that they have become so idolized in some respects.
    Mr. Bentsen. Well, they have become the masters of the 
universe, I guess, of the 1990s, as opposed to the investment 
bankers of the 1980s, at least in the media's eyes.
    Let me ask you this. Is there anything under the existing 
securities laws that subjects analysts' documents, analysts' 
reports or whatever, to the same disclosure requirements that 
are required of offering documents. And if not, should there 
    And furthermore, didn't the Commission, just a few years 
ago, pass--I can't remember what the colloquial term was for 
this--but a plain English approach to the writing of offering 
documents so that they would be more easily understandable and 
possibly used by the public?
    Ms. Unger. Well, it's interesting, because you raise, I 
think, a critical point in the discussion which is not only 
have the dynamics of the marketplace changed the role of 
analysts, but the role of research reports themselves and the 
extent of their availability have also changed. Investors can 
now access research reports that they were not able to before, 
as a result of the internet.
    So what does this mean in terms of how the Commission needs 
to educate investors about the conflicts, and what investors 
need to know in using these research reports? Yes, there are 
the offering documents; yes, they are subject to review by the 
Commission, but we don't have the resources, nor would we want 
to be engaged in merit review with respect to the contents of a 
research report.
    Mr. Bentsen. Well then, in fact, the law doesn't cover the 
research documents in the same way, I don't think, as it does 
the offering documents.
    Let me ask you one more question.
    Ms. Unger. Well it's slightly different, because Section 11 
is strict liability for what is contained in a registration 
    Mr. Bentsen. Right.
    Ms. Unger. Section 10(b), the anti-fraud provision, applies 
to everything.
    Mr. Bentsen. Let me ask you this, because my time is up, 
but I want to ask you this. Can you be concerned about 
conflicts of interest between analysts and companies and be 
opposed to Reg FD, and be consistent?
    Ms. Unger. I'm sorry, can you repeat that?
    Mr. Bentsen. Can you be concerned about potential conflicts 
of interest between research analysts and the companies that 
they review and the relationship with the investment banks, and 
also be opposed to Reg FD and be consistent?
    Ms. Unger. Me personally?
    Mr. Bentsen. In general.
    Ms. Unger. Yes, I think you can, because I think you can 
note that the conflicts exist, but I believe that Regulation FD 
does not cure the conflicts. Reg FD goes to communications 
between an issuer and an analyst and not to insider trading, 
which was purported to be the original objective or reasoning 
for Reg FD's adoption.
    So it depends how far you want to go with the conflicts. 
The conflicts are the underpinnings of the discussion on both 
Regulation FD and today's hearing, but in a very different way.
    Mr. Bentsen. Thank you. Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Bentsen.
    Mr. Castle.
    Mr. Castle. Thank you, Mr. Chairman. I have an opening 
statement which I would like to submit for the record.
    Chairman Baker. Without objection.
    Mr. Castle. Thank you.
    Ms. Unger, I have some questions. I've got to tell you that 
this whole practice bothers me a tremendous amount. And I, in 
my opening statement that I've just submitted, state that I 
don't think we should legislate in this area. But I'm just not 
sure anymore. I mean, I'm becoming more and increasingly 
concerned. I mean, there could be anything from just bad 
analysis which of course should not be punishable by anything 
to the classification situation, to the so-called ``hold'' 
business, which apparently is a red flag to sell which most of 
us never understood, except for the analysts owning the stock, 
to the firm for which the analyst works owning the stock and 
the retirement accounts or otherwise, or other individuals just 
having big placements in that particular stock that the analyst 
is recommending or the investment banking side of the firm 
owning it, or the analysts' compensation being tied to overall 
profits of the firm for which the analyst works, or the analyst 
being involved in the early IPOs at a lower price than the IPO 
is going to come out, and then huckstering it in some way or 
another, either verbally or in writing some way or another.
    Are there any situations such as that where the SEC does 
step in now?
    Ms. Unger. Step in and do what?
    Mr. Castle. Step in and enforce, do something about it?
    Ms. Unger. There are instances----
    Mr. Castle. Are any of those things violations of laws or 
regulations at this point?
    Ms. Unger. I wish you had asked me that before you 
enumerated them. None of them jumped out at me as violations of 
the law, but I will say that the Commission looks very closely 
at what's disclosed, whether there was material information 
that was not disclosed by an analyst and the firm's involvement 
in recommending and selling. But sometimes you can't just look 
at one particular activity--you need to look at the whole 
picture to really get a sense of whether it's an area for an 
enforcement action or not.
    But yes, we brought cases involving analysts.
    Mr. Castle. You have brought cases that just involve the 
analyst side of it, is that?
    Ms. Unger. Well, we've brought cases where an analyst was 
making reckless statements----
    Mr. Castle. Are these penny stock-type cases or are these 
major firms that may have these conflicts in which you've 
brought the cases?
    Ms. Unger. There's a handful of cases that I could get you 
more information about if you're interested.
    Mr. Castle. I mean my judgment is there have been billions 
of dollars put on the table as a result of a lot of these 
practices and which probably occasion losses of a tremendous 
amount. Do you trust the industry itself to be able to do this 
as a self-regulatory matter, or does the SEC have to get 
tougher with its enforcement in order to back that up? Or 
should we be passing laws up here which frankly I'm loathe to 
do, but is that something we should be considering?
    Ms. Unger. Well, I think there are three prongs. One is 
compensation, one is the accountability of analysts to 
investment banking, and the third is the stock ownership. And I 
think you need to look at each one of those individually in 
determining whether or not there are issues that need to be 
    I think there are disclosures that apply in each of these 
areas and there are existing rules that, as I said earlier, 
need to be harmonized and clarified and followed. And I think 
we need to do a better job, the industry and the SROs need to 
do a better job in inspecting firms to make sure that they 
comply with rules that are on the books and rules that are 
about to be improved that will be on the books.
    I also think that the firms need to do a better job of 
ensuring compliance with their existing internal policies and 
procedures, most of which exist at the firms that were 
inspected, most of which are not being enforced adequately 
    Mr. Castle. Well, and you're right. I mean, there's a whole 
level of enforcement in various ways. But do you believe that 
the SEC should change its rules and regulations or specifically 
its enforcement mechanisms to address some of the problems 
which you have spoken to in your opening statement, which we've 
had another hearing, which I'm sure you're familiar with, and 
which is going to be continued later today by another panel 
involving a number of the different situations that I have set 
forth, all of which you're familiar with in terms of different 
practices that are at least questionable.
    Or do you think the SEC is fine the way it is?
    Ms. Unger. The SEC has broad antifraud authority. We have 
ample authority to bring cases involving fraud and violations 
of Section 10(b) and Rule 10(b)(5). The first line of defense 
in this whole discussion about managing analyst conflicts 
really are the SROs whose rules deal with this more directly 
than the Commission.
    Again, I think we all need to do a better job. I think of 
course the Commission is doing a great job, but we need to do 
more in our oversight of the SROs in making sure that they 
conduct the inspections and examinations that are needed to 
determine whether the firms have the appropriate policies and 
whether the policies are being followed.
    I think that's really the first step that we need to take 
in this discussion which I think is why the Chairman of this 
subcommittee is asking about ways to improve enforcement 
efforts and make the firms accountable to the public in terms 
of what they're doing internally.
    Mr. Castle. Well, my time is up, but I mean, this won't be 
a question but, you know, I think it's our job to worry about 
the consumer out there. I can't worry about the big firms, I 
can't worry about the practice of the SEC, but I think a 
consumer should be able to look at an analyst's recommendation 
on a stock and it could be wrong, but at least it should be 
done with integrity and honesty and they get a pretty good idea 
of what they're dealing with.
    Until we've gotten to that point, it seems to me we all 
haven't done our job. And I yield back the balance of my time.
    Chairman Baker. Mr. Castle, just to finish up on your 
point, in earlier questions to Ms. Unger, I've made reference 
to her footnotes of her own document. In just one transaction, 
the fellow profited $3.5 million by selling his interest while 
publicly telling his clients to buy. On its face, unless it's 
the gentleman's estate--that's the only reason I could see it 
would be OK--that in itself is a serious problem, and yet that 
is under advisement at the moment for determination as to 
whether action is appropriate or not. That is a very large 
concern. Your point is right on target.
    Mr. Kanjorski.
    Mr. Kanjorski. Thank you, Mr. Chairman.
    I wanted to follow up. Did I hear you respond to Mr. 
Bentsen that you don't have the resources to do some of the 
things you'd like to do?
    Ms. Unger. We would always like to have more resources, but 
I don't think that merit review of analyst research reports is 
something that's appropriate for the agency, given our mandate 
as it exists today.
    Mr. Kanjorski. So in order to have you do something, we 
would have to enact statutory law to give you greater authority 
or direction to do that?
    Ms. Unger. I guess you would, but I also don't think it's a 
good idea. With all due deference to this subcommittee, I think 
the problem is in managing the conflicts. Whether the 
Commission reviews the substance of the research or not, you 
still have the issue of the conflicts and managing those 
    Mr. Kanjorski. Let me direct ourselves to some of those 
conflicts. The Chairman and I were talking when we went over to 
the vote, particularly about these transactions that you 
mention in your testimony. One example is that of pools of 
analysts that were investing and giving advice to buy when, in 
fact, they were selling, and, in fact, they were making single 
transactions in the range of $100,000 to $3.5 million.
    I think the Chairman made the observation that if this 
activity happened in Louisiana real estate, there'd be somebody 
in jail.
    Chairman Baker. That's a pretty bad comment too. You know, 
when you think about it, when we put anybody in jail in 
Louisiana, they've got to really be out of it.
    Mr. Kanjorski. And I tend to agree with him. Doesn't that 
constitute fraud? Forgetting conflicts, isn't that just out and 
out fraud?
    Ms. Unger. I did say we were reviewing these particular 
    Mr. Kanjorski. How long ago did these transactions happen, 
Ms. Unger?
    Ms. Unger. 1999 and 2000.
    Mr. Kanjorski. So they are almost 2 years old and we're 
still reviewing those transactions? The reason I asked you how 
long is because I recall from law school that most of the court 
decisions on bills and notes were around 1934, 1935 and 1936. 
It seems to happen that we want to find somebody at fault or 
responsible when the market crashes.
    What I am wondering is why these transactions were going on 
when the market was pretty healthy in 1999 and 2000. Are you 
intending that we realize that you didn't know at that time? 
Did you just found out recently? Or did you know in 1999 and 
2000 before the market crashed?
    Ms. Unger. Well, no, we did just find out last month, and 
in fact, I think it would be highly unlikely that anyone would 
be making that kind of money in today's market.
    Mr. Kanjorski. OK, but when did you find out about it, I 
    Ms. Unger. Pardon me?
    Mr. Kanjorski. When did you find out?
    Ms. Unger. We have just been conducting these reviews about 
analyst conflicts.
    Mr. Kanjorski. So there isn't any reporting or any way that 
you could pick that up without doing these reviews?
    Ms. Unger. No. There are inconsistent requirements that 
exist currently, SRO requirements, about the firms' disclosure 
of stock ownership.
    Mr. Kanjorski. Did they make the proper disclosures in a 
timely manner?
    Ms. Unger. This is what I'm trying to explain to you. Of 
the firms we inspected, which were nine firms that account for 
the majority of the IPO and technology underwritings, only one 
of the firms was able to give us a list of employees who 
invested pre-IPO in a company that the firm had as a client.
    So in fact, the internal controls at the firms apparently 
did not require this information.
    Mr. Kanjorski. And you have no regulations that require 
that internal information?
    Ms. Unger. They are required to make the disclosure.
    Mr. Kanjorski. Under your regulations they're required to 
make it?
    Ms. Unger. No, under the SRO regulations, they're required 
to disclose in the research report, depending on which 
regulation you're looking at, the firm is required to disclose 
certain ownership positions.
    Mr. Kanjorski. I understand that. I have limited time, and 
I'm trying to rush you along.
    What I understand is they didn't make the disclosure, and 
they may not have had the internal controls to do that. 
However, neither do you have the internal controls to know that 
they weren't doing that.
    Somebody here is responsible at the end to know whether or 
not these SROs are doing what they are supposed to do, or 
whether or not you have a requirement to find that out in a 
reasonable time: I think 2 years is beyond a reasonable time.
    And then for you to tell me you're reviewing these things; 
these guys may retire or die before you get all done with those 
reviews. And I think the Governor made a good point. You know, 
we're not worried about the big, the conflict, quote: ``that 
may exist between the analyst and his own company.'' I don't 
know if there is a clear conflict with those ten million people 
who are watching nightly television and listen to this guy 
saying, ``Oh, this is a great buy.'' And I watch them every 
night. And I have yet to hear anybody telling me to sell. And 
they're still doing it. And every now and then they do say, 
``Oh, our company does have stock in them or represent them in 
some stock offering.'' I don't understand it.
    I want to get to the point. What I'm indicating to you is, 
if you don't have the authority to test whether the SROs have 
internal controls and are properly reporting or having 
transparency back to the SEC, then you should be up here asking 
us for that authority.
    But second, I'm worried about another thing that I brought 
up in my opening statement. You're sitting back here and there 
is a public policy decision that's going to be made probably in 
the next 6 months or a year, but certainly within the next 18 
months, to privatize Social Security. We're going to throw 160 
million consumers into the marketplace, 25 to 30 percent of 
which are functionally illiterate. That 25 to 30 percent are 
going to be guiding their own accounts.
    Has the SEC started to enlarge its structure and anticipate 
what is about to happen, which could cause massive fraud and 
conflict of interest if all these billions of dollars and 
millions of people come into the marketplace? Or are you just 
going to wait around and have this happen and then come in and 
say--2-3 years after the fact, that you have a problem?
    Aren't you anticipating that if we, as a matter of public 
policy, decide to privatize Social Security, then we are 
putting at least another 80 to 100 million people into the 
market that have never been there before? And aren't a good 
portion of these people not qualified to read financial 
statements and understand this information? Many certainly are 
not qualified in ``newspeak,'' and I think that is what we are 
talking about here. We're in 1984. These people are using terms 
that are not standardized. The language that sometimes is only 
understood within their own house or within a limited number of 
houses, but certainly not by the general public.
    And it just seems to me that the SEC ought to be proactive 
in anticipating what is about to occur, what may occur. Looking 
back at these experiences that you have been reviewing for the 
last 2 years and anticipating how they will be compounded if we 
put another 50 or 80 million people into the marketplace.
    Instead, 2 years after we do that, we are going to have a 
hearing within the halls of Congress filled with a lot of 
middle-aged and older people that will claim that we led them 
down the primrose path. They will say we drove them to take 
their 2 percent of Social Security and invest in these 
horrendous start-up entities that weren't regulated, weren't 
controlled, and didn't have transparency: and they will claim 
``people were telling us to buy and we bought, and then some 
people who were telling us to buy were selling and cleaning up 
and making $3 million per transaction.''
    What is your response to that?
    Ms. Unger. Are we talking about Social Security or 
analysts' conflicts now?
    Mr. Kanjorski. I'm talking about looking at what we've 
already seen in a hyper market in 1999 and 2000.
    Ms. Unger. Just the market generally?
    Mr. Kanjorski. With analysts and anticipating what may 
happen if we enlarge this market by 80 million more customers?
    Ms. Unger. Well, as part of my testimony, I said I thought 
the SEC's role in analyst conflicts was disclosure and 
educating investors. We have put out a very comprehensive and 
well-received ``Investor Alert'' about analysts' conflicts so 
that investors would understand exactly what we're talking 
about and to highlight for them what analysts' conflicts are 
and how they should approach interpreting a research report.
    I would never counsel, and I think many people have said 
that no investor should rely exclusively on an analyst research 
report or recommendation in making an investment decision. The 
Commission generally is very proactive in terms of investor 
    I presume that if Social Security were privatized and there 
were special needs presented to the marketplace and to the 
Commission, we would attempt to fulfill those special needs by 
outreach in further investor education.
    With respect to the analysts' conflicts we're talking about 
today, it was the SROs' responsibility to supervise and monitor 
and inspect for the private investments by the analysts and the 
firms at which the analysts work.
    Mr. Kanjorski. I love the terminology education and I do 
appreciate it and I hope you're very successful in educating 
all the people that are in the marketplace today. However, I 
doubt that you are going to give them the equivalency of a 
working understanding of the marketplace and terminology, but 
I'm not talking about those people. I'm talking about knowledge 
that there are 20 to 25 percent of the American people that are 
functionally illiterate. They cannot even fill out an 
application form, let alone read a profit and loss statement or 
a balance sheet.
    Are you suggesting to me that you're going to put together 
an investor educational program that are going to take 25 
percent of the American population's functional illiterate and 
have them understand what they need to understand to be 
privatized and investors in the marketplace and not have to 
rely on analysts or security house recommendations?
    Ms. Unger. Well, if they are functionally illiterate, 
they're not reading research reports either, are they?
    Mr. Kanjorski. No, I doubt it. That's why I'm suggesting 
    Ms. Unger. Just checking.
    Mr. Kanjorski. Well, that's the next question. Have you 
been asked for, or have you been given by either the Commission 
or this Administration, recommendations as to whether or not we 
should privatize Social Security and put 160 million more 
Americans in the stock market? And are they qualified by basic 
learning and education to manage their accounts, or are we 
setting them up for a tremendous let-down?
    Ms. Unger. Commissioner Carey, who recently passed away, 
was the Commission's expert on Social Security privatization 
and he did a lot of work on that. And I commend him for that 
work. He, however, is no longer with us, and we have not yet 
determined who will take on that responsibility at the 
    Mr. Kanjorski. Are you prepared though to make a 
recommendation to the Congress?
    Ms. Unger. We have not adopted a Commission position yet on 
Social Security privatization. There've been numerous different 
permutations of how that could occur. We would be happy to 
participate in any discussions about Social Security 
    Mr. Kanjorski. Could you succinctly tell me, though, have 
you made a recommendation, positive or negative, on that 
particular issue? Are we prepared to see 40 million 
functionally illiterate Americans put into the market?
    Ms. Unger. We have not adopted a Commission position.
    Chairman Baker. We'll have to move on.
    Mr. Royce.
    Mr. Royce. Thank you, Mr. Chairman.
    Chairman Unger, one of the things I was going to ask about 
is the interviews that we have with people who are analysts, 
the information that we've received indicate that one of the 
things that's changed on Wall Street is the business model. One 
of the things that used to drive profitability was revenues 
from research and trading, and as that began to decrease, it 
was supplanted instead by enormous revenue gains from initial 
public stock offerings. As you saw a 15-fold increase over a 
decade in the fees coming into the firms, then the business 
models changed.
    And the allegation here is that included in that change was 
a change in the way the analysts were compensated. In the past, 
bonuses were given to analysts based on research quality, or on 
the brokerage arm's profitability.
    Now it is common for those bonuses instead, and typically 
this would be the bulk of their annual compensation at most of 
the firms, to be tied to the amount of banking business that 
they generate for the firm. And that change in business model 
could explain a lot. It certainly could explain the disparity 
between positive and negative recommendations. Could it be that 
analysts are fearful of offending their banking colleagues and 
fearful of those existing underwriting clients or potential 
underwriting clients? I mean, why would it be that only two 
percent of the stocks covered would have that sell rating? I 
mean, that's one of the things I wanted to ask you.
    Another question that I had, we have a witness coming on to 
the next panel and he submitted his testimony in advance, Chris 
Byron. And he calls this an outrageous situation. He says IPOs 
are offered to investment bank clients at cheap pre-market 
prices even as the bank's analysts engage in non-stop 
commentary designed to pump up demand for the stock in the 
    And I wanted to ask you also what is your view of that 
practice, OK?
    Ms. Unger. OK. I will try to address those questions in 
    Mr. Royce. Thank you.
    Ms. Unger. I agree that there has been a change in the 
business model which has led to a lot of what we're talking 
about today. It's not just the investment banking client that 
applies the pressure though; it's also the institutional 
investors who don't want their investments downgraded. Firms 
are competing for underwriting business, and favorable analyst 
coverage is part of the package.
    No investment banking firm will take a company public that 
its analysts couldn't issue favorable research about. Why would 
they? Nor would a company want to have an underwriter like 
that. So, in a sense, they become intertwined at the very 
beginning, which accounts for why you see a large number of 
favorable research recommendations. The business itself demands 
that, and it makes sense. Many firms do not bring many deals 
for that reason.
    Mr. Royce. Should we then rename them from analysts to 
    Ms. Unger. Well, that's sort of the gatekeeper function of 
the firms and the analysts that have become part of that. Once 
the company goes public, the analyst issues a report, which we 
know is going to be favorable, 25 days later. Then the firm 
begins putting its clients into that stock, a lot of which are 
the institutional investors with sizable portfolios.
    As you can imagine, the research is favorable, there may 
come a point when the analyst says, ``Gee, this company's not 
doing as well as I thought it was going to, I'd like to change 
the rating.'' Well, consider all of the pressure that's applied 
by the company with the investment banking relationship, the 
institutional investors where the firm has a stake in its 
commissions and with its relationship, and perhaps stock 
ownership on the part of the firm or the analyst.
    I don't know that you can ever eliminate these conflicts 
and I'm sure there is some good in all of it in terms of 
understanding the company and the dynamics and everything else.
    What I do think you can do is manage the conflicts, and the 
way I think you can manage the conflicts is to have the 
investment banking firm disclose the analyst's involvement in 
the deal, and to have disclosure if the analyst owns stock in a 
particular company that it's issuing research reports about, 
and have that all be very clear to the investors, so that the 
investor understands any potential conflicts and can take that 
into account.
    I think we're not even seeing that threshold disclosure at 
this particular point. I think we're seeing that stock 
ownership exists, that the pre-IPO share allocations exist, and 
that there's considerable influence exerted over the analyst by 
the investment banking part of the firm, but we are not 
managing all of that very well right now, in terms of 
    Mr. Royce. And I guess for the SEC and for us, one of the 
critical questions is, how is that disclosed in a way that the 
small investor really comprehends, really sees that disclosure, 
as opposed to the institutional investors? How do we do this in 
a way that the market really understands?
    Ms. Unger. And that question really takes us full circle, 
because the reason that this is a discussion that many people 
are having now is because of the broad dissemination of 
research reports and the fact that they are reaching the 
individual investor who may not be as experienced in 
interpreting the documents and knowing what the conflicts are.
    So that is the challenge of the SEC in terms of educating 
investors, and that's what we try to address in our Investor 
Alert that we released last month.
    Mr. Royce. We have a long way to go.
    I thank you, Chairman.
    Chairman Baker. Thank you, Mr. Royce.
    Mr. Toomey, you're up.
    Mr. Toomey. Thank you, Mr. Chairman.
    I'd like to first follow up briefly on a line of 
questioning that my good friend and colleague from Pennsylvania 
made earlier about Social Security accounts and his concern 
that 25 percent of the American public is insufficiently 
literate to accumulate savings in personal accounts.
    I would point out that most of these people have jobs, they 
buy homes, they raise their children, they do lots of things in 
life, and I think if we suggest that they are not competent to 
invest their savings, we may not be giving them the credit they 
    Furthermore, I would observe that any mechanism by which 
investments would be made in personal accounts within Social 
Security has yet to be defined. It's entirely possible that it 
would consist of choosing from a range of funds in which the 
individual investor would never have the occasion to actually 
attempt individual stocks. So I, for one, hope that you won't 
suggest any major new policies and initiatives in anticipation 
of what I do hope will be a significant move to allow personal 
accounts within a reformed Social Security.
    But my first question for you, I'd like to harken back to 
an example that's been referred to several times and the 
suggestion that an analyst who sells a stock, while 
recommending a buy, has prima facie committed fraud and that 
this is outrageous. Now I'm not defending any particular 
individual or circumstances that I'm not familiar with. But 
perhaps you could comment. It seems to me that one could 
recommend a buy on a stock while selling it into one's personal 
account, and that there might not be anything wrong with that 
    There are a lot of reasons a person might choose to sell 
stock. It could be the individual simply needs to raise cash 
for any number of reasons. It could be that the person's 
portfolio is too concentrated in a particular industry or too 
concentrated in that particular company. It could be a function 
of the profit that's been accumulating in a particular holding, 
and the person's own personal investment criteria.
    But would you agree that selling a stock while recommending 
a buy in that stock is not necessarily evidence prima facie of 
fraud or even any nefarious activity on the part of the analyst 
by itself?
    Ms. Unger. And I'm glad you raised that point, because I 
would hate for this subcommittee to walk away today thinking 
that it is prima facie evidence of wrongdoing. We would need to 
conduct a very fact-intensive review of exactly why the analyst 
was acting contrary to the recommendation. There are firm 
policies that have very specific times and circumstances under 
which an analyst can buy or sell contrary to a recommendation.
    I'm not sure that in this case, or these couple of cases 
that we're talking about, that was done. If it was so clear and 
it was prima facie, we would have brought those cases. So that 
I'm sure we are assessing exactly what you are describing and 
that is whether there other reasons for the selling in the 
    I have heard anecdotally that firms have very strict 
procedures in terms of looking at the overall portfolio. I'm 
confident that firms are able to make and develop internal 
policies to make sure that it happens under the proper and 
appropriate circumstances.
    Mr. Toomey. Thank you. Perhaps you could comment on this 
idea, that there are no consequences for firms which would 
engage in inappropriate compensation or creating incentives for 
analysts that they ought not to have.
    I disagree with that. First of all, I think there's a very 
competitive marketplace out there. There are a lot of 
alternatives for any investor, and we've seen the industry take 
many steps already. The securities industry has put forward an 
industry best practices guideline, there are rating agencies 
that assess the performance of analysts' recommendations, 
individual firms disclose their underwritings, and it is public 
information what kind of under-writings are going on.
    As you pointed out, the SEC has done an alert which strikes 
me as the obvious, that investors should not rely solely on the 
advice of a particular analyst. And when I look at all this in 
a cumulative sense, it strikes me that certainly most 
investors, the overwhelming majority, it's going to occur to 
them that they ought to have a certain amount of skepticism 
about what an analyst recommends, and that that should be one 
of various factors that they would include.
    But there are alternatives for investors. There are 
consequences imposed by the marketplace and we ought not go too 
far in trying to impose regulations on this.
    Ms. Unger. I think you're right, we ought not go too far, 
but I think all we're talking about today or all I'm 
recommending today is that we follow the existing rules and 
actually improve the existing rules to make clear what the 
disclosure obligations are of the firm and the analyst and to 
follow those rules. For firms to either follow the best 
practices or their own internal procedures that they've already 
established and to actually enforce those.
    And I think that's the first area that we need to focus on 
in terms of managing the conflicts.
    Mr. Toomey. Thank you. I yield the balance of my time.
    Chairman Baker. Thank you. Just for the record's sake on 
whether or not folks trade inappropriately, I think I recall 
you making the comment that of the firms you surveyed, only one 
could tell you all the positions of every analyst. It would 
make it rather difficult, I think, to make the judgment that 
the firms are therefore making appropriate disclosure over 
these matters when they don't know what the investments are. 
That's my point.
    And second, the statement that there are perhaps adequate 
rules in place, but I believe, in accordance with your own 
observation, that they are not being followed, is the core of 
the problem. And if we don't bring enough attention and focus 
on it, practices are not likely to change.
    I do appreciate your appearance here. There are a number of 
questions that I would like to follow up with. For my own sake, 
and for any of the subcommittee, we'd like to hold the record 
open for a few days and perhaps submit additional inquiries for 
the record. And we do very much appreciate your courteous 
participation today. Thank you, Ms. Unger.
    Ms. Unger. Thank you very much.
    Chairman Baker. We'd like to have our second panel come 
forward, please.
    Welcome. I'd like to get started with our panel. I regret 
we have so much territory to cover and such a distinguished 
panel of witnesses here today. Without further ado, I'd first 
like to call Mr. Ron Glantz, former Managing Director, Tiger 
Management, former Director of Research and Chief Investment 
Officer of Paine Webber. Incidentally, in light of your written 
testimony, I think I need to say you're rated by Institutional 
Investor for seven consecutive years as the top investor. So I 
particularly appreciate your willingness to appear here today, 
sir. Welcome.

                     OFFICER, PAINE WEBBER

    Mr. Glantz. Chairman Oxley, Chairman Baker, Ranking Members 
LaFalce and Kanjorski, and Members of the subcommittee, thank 
you for inviting me to testify on Wall Street's research 
    My name is Ronald Glantz. I was in the investment business 
for 32 years before retiring last year. I began my career on 
Wall Street as an equity research analyst. Money managers 
polled by Institutional Investor Magazine selected me the top 
analyst in my field for seven consecutive years. I then became 
Director of Research, Chief Investment Officer, Director of 
Economics and Financial Markets and a member of the Management 
Board of Paine Webber, one of the largest brokerage firms in 
the United States.
    I ended my career as a Managing Director of Tiger 
Management, one of the largest hedge funds in the world. This 
has given me a good perspective on how the role of analysts has 
changed over the last three decades.
    When I began in the business, the top-rated equity research 
firm was named Laird. Within 5 years it failed. So did most of 
the other top-rated firms. What happened? When I began, the 
average commission was over 40 cents a share. A few years 
later, institutional commissions became negotiated, almost 
immediately falling to less than six cents a share. The only 
way for research firms to survive was to merge with someone 
that could spread research costs over a larger base, usually 
brokerage firms whose main clients were individual investors.
    Retail commissions had remained fixed and retail brokerage 
firms discovered that good research helped them gain retail 
clients and stockbrokers. By the end of the 1970s, the largest 
number of top analysts were at Paine Webber, which had bought 
the top-rated research firm, and Merrill Lynch, which hired 
talent from failing research firms.
    Meanwhile, as analysts became more influential, companies 
increasingly pressured analysts to recommend their stocks, 
since a higher price means fewer shares have to be issued when 
raising new funds or acquiring another company, they are less 
vulnerable to being taken over, executives make more money when 
they cash in their options, and shareholders are pleased.
    It is easy to reward favored analysts. They are given more 
access to management, ``helped'' in making earnings estimates. 
They'll even call you up and tell you that your estimates are 
too high or too low, and invite you to resorts for 
``briefings.'' And most important, their firm receives 
lucrative investment banking business.
    Companies penalize analysts who aren't sufficiently 
enthusiastic. Let me give you a personal example. When I was a 
brokerage firm analyst, I downgraded a stock. The company's 
chief financial officer called my firm's president to say that 
unless I recommended his stock, he would cease doing investment 
banking business with my firm, and would order the bank which 
managed his company's pension fund to stop doing any business 
whatsoever with my firm.
    I have seen top analysts removed from company mailing 
lists, their telephone calls left unreturned, and even 
physically barred from company presentations. Once I was doing 
a reference check on an analyst I was considering hiring. A 
chief financial officer told me that the analyst was disliked 
so much that he was deliberately given misleading information.
    In 1980, top analysts made just over $100,000 a year. 
Today, top analysts make up to $20 million a year. How is this 
possible, considering that institutional commissions have 
fallen even further and brokerage firms now discount retail 
commissions to avoid losing customers to such firms as Schwab 
and e-Trade?
    What happened is that brokerage firms discovered that 
highly rated research helped them gain investment banking 
clients. Soon the largest number of top analysts were at 
investment banking goliaths such as Morgan Stanley and Goldman 
Sachs. They could pay considerably more because investment 
banking transactions were much more lucrative than trading 
stocks. The institutional commission on trading $300 million 
worth of stock was only $300,000, of which less than $25,000 
would go to the research department. This barely paid for 
printing and mailing research reports on that company. However, 
underwriting a similar dollar value of a new issue would bring 
in at least $10 million, and bankers thought nothing of giving 
a million dollar fee to the analyst responsible for the 
business. A merger or acquisition could bring in even more. 
Soon, firms were including anticipated investment banking fees 
in the contracts they offered analysts. The huge fees earned by 
investment banking gives them the ability to influence and, in 
some cases, even control the equity research department. As we 
all know, whoever ``pays the piper'' names the tune.
    Analysts used to view retail customers and investment 
managers as their clients. My first boss told me ``widows and 
orphans depend upon you to give good advice.'' Now the job of 
analysts is to bring in investment banking clients, not provide 
good investment advice. This began in the mid-1980s. The 
prostitution of security analysts was completed during the high 
tech mania of the last few years. For example, in 1997 a major 
investment banking firm offered to triple my pay if I would 
join them. They had no interest in the quality of my 
recommendations. I was shown a list with 15 names and asked, 
``How quickly can you issue buy recommendations on these 
potential clients?''
    Let me pause here to assure you most analysts still want to 
give good advice. Not only is it the right thing to do, it 
helps their reputation, which brings in investment banking 
business. Nevertheless, the pressures are enormous.
    When I was Director of Research, analyst compensation was 
based upon the performance of his or her recommendations, 
commissions generated, and ratings by institutional clients and 
the retail system. Today, name analysts are given guaranteed 
contracts, whether or not their recommendations are any good. 
Every year, The Wall Street Journal lists the analysts who have 
provided the best investment advice. These analysts are rarely 
the best paid in their field.
    Why is that? Investment banking. It is an open secret that 
``strong buy'' now means ``buy,'' ``buy'' means ``hold,'' 
``hold'' means that the company isn't an investment banking 
client, and ``sell'' means that the company is no longer an 
investment banking client.
    Mr. Glantz. Less than one percent of all recommendations 
are ``sell.'' Some analysts call their best clients and tell 
them that their real opinion differs from their published 
opinion, even though this is illegal.
    But what about the individual investor? No one told my 86-
year-old widowed aunt that the internet stocks she was buying 
in 1999 had no hope of ever earning any money, or that the 
analyst recommending purchase was being paid by investment 
    Investment banking now dominates equity research. Bankers 
often suggest and are usually asked to approve hiring analysts 
from other brokerage firms. Investment banking provides the 
bulk of proven analysts' pay package. Some analysts report 
directly to investment banking. Analysts routinely send reports 
to the companies and to bankers for comment before they are 
    Three years ago, Tiger was able to hire the top-rated 
analyst in his field from a Wall Street firm. This analyst had 
consistently been negative on one company, a major source of 
investment banking fees, because of its many acquisitions. Then 
his firm hired an investment banking team from another 
brokerage firm. As reported in the Wall Street Journal, the 
analyst was fired so that a more ``compliant'' analyst could be 
hired, one who would recommend potential investment banking 
clients. Disillusioned, this analyst moved over to money 
management where the quality of recommendations was still more 
important than the quality of relationships with potential 
buyers of investment banking services.
    To give one of many personal examples, 4 years ago I came 
up with some extremely negative information on a company, 
including bribery, defective product, accounting 
irregularities, and serious pollution problems. I called the 
three most visible analysts recommending the stock, one of them 
the top-rated analyst in his field, and gave them my evidence. 
Every one of them continued to recommend the stock. Why? This 
company was an investment banking client. Incidentally, within 
a year, every member of top management was thrown out and, of 
course, the stock plummeted.
    The genie has been let out of the bottle. As long as 
investment banking is the most profitable part of the firm, 
then investment bankers will find a way to pay analysts who 
bring in business. Money managers can hire their own analysts. 
But my elderly aunt will never know whether the advice she is 
receiving is unbiased or not. That's not only bad for the 
average investor, it undermines one of the primary reasons for 
having a stock market--the efficient allocation of investment 
    My proposals can only address part of the problem. At the 
least, brokerage firms should list in large type on the first 
page of all buy recommendations any investment banking business 
they have had with the company over the last 3 years and any 
equity ownership by the analyst, members of his or her 
immediate family, or the firm.
    Second, no buy recommendation should be permitted if the 
analyst, members of his or her immediately family, or the 
brokerage firm purchased stock or options for their own account 
in the month preceding the report, nor should they be permitted 
to sell stock until 3 days after a sell recommendation is 
    Third, any shares purchased of a new issue by the analyst, 
members of his or her immediate family, or a money management 
arm of a brokerage firm should be held for a minimum of 1 year.
    Thank you, I would be happy to answer any questions.
    [The prepared statement of Ronald Glantz can be found on 
page 241 in the appendix.]
    Chairman Baker. Thank you very much, Mr. Glantz.
    Our next participant is Mr. Christopher Byron, Syndicated 
Radio Commentator, Columnist for MSNBC.com.
    Welcome Mr. Byron.

                      COLUMNIST, MSNBC.COM

    Mr. Byron. Thank you very much, Chairman Baker, 
distinguished Members of the subcommittee.
    Chairman Baker. I should make a special notation. As our 
MSNBC.com and also our Bloomberg News participant, you are our 
first media-related types willing to stand in front of the 
subcommittee in a public forum. I welcome you for that reason.
    Mr. Byron. Before I go any further, I want to thank the 
subcommittee enormously for inviting me to appear before it and 
give me this opportunity to do just that. It's an enormous 
personal honor and a pleasure to be able to appear before you 
and give testimony on a subject that I've written about in one 
form or another for a number of years now in various 
publications that I write for.
    You've asked me for some brief biographical information 
about myself, and I'll give you that very quickly. I'm a 
magazine, newspaper, and internet columnist and radio 
commentator. My columns appear weekly in the New York Observer 
newspaper, on MSNBC.com interactive on the internet, where I 
host a daily webcast radio show called ``High Noon On Wall 
Street.'' I also do a radio show called ``Wall Street Wake Up 
with Chris Byron'' that's syndicated on 40 AM radio stations 
around the country, and I write a monthly column for Red 
Herring magazine as well.
    Over the years, I've written for a great number of 
newspapers and magazines. They are listed in my submitted 
testimony. I won't bother you with them now.
    The subject that we are about here today is enormously 
important to me personally, because it affects what I do for a 
living. The changing role of financial analysis and journalism 
on Wall Street is a very important topic for a whole variety of 
    I have a long perspective on this subject. When I came to 
Wall Street as a reporter in 1968, the beginning of 1969 was at 
the tail end of the go-go 1960s bull market. Three decades 
later, I'm still here covering essentially the same material 
that I covered then. A lot of the money and equity markets of 
America, now the world, a lot has changed in that time. When I 
came to Wall Street as a reporter in 1969, not a single person 
I knew, including myself, owned a computer. I had never seen a 
computer. Today, I know of no one who doesn't work with a 
    When I came to Wall Street as a reporter, it took days, 
sometimes a week or more, to get my hands on the most single 
valuable asset that any writer in this subject area, any 
investor, any financial analyst or reporter can have, and 
that's an audited financial statement from a company.
    Today, that information is instantly available to anybody 
with a desktop computer, a telephone connection, and a dial-up 
service on the internet. There's also been an enormous 
explosion in the public's interest about financial information 
itself. When I began covering financial markets at the end of 
the 1960s, The Wall Street Journal was generally viewed by 
people in my profession as kind of a second tier publication. 
There was no CNBC, no CNFM, there was no internet. Now The Wall 
Street Journal is regarded as one of the world's premier 
newspapers. Electronic media likes CNBC, MSNBC.com on the 
internet all have global audiences on every continent.
    I'll give you one personal illustration of this, and I 
think it is sort of revealing about the kind of thing that 
we're talking about here. I do, as I said before, a daily noon 
time webcast radio program called High Noon On Wall Street With 
Chris Byron. It's carried from my home office in Connecticut 
via a distribution system provided by Microsoft in Redland, 
Washington to 24 time zones around the world simultaneously. I 
must tell you, it is pretty daunting to sit in my den at noon 
every day and start to offer opinions and commentary on 
whatever happened in the market in the last 3 hours, and 
instantly receive back from every continent on the earth, 
emails from people listening to what I'm saying and saying 
``Byron, that's a great point,'' or ``You're an idiot, you 
don't know what you're talking about.''
    It's really a very, very large audience that reacts 
instantly to financial information all over the world.
    There's one thing, however, that hasn't changed in the 30 
years that I've been doing this job, and that is fundamentally 
Wall Street remains what it has always been: the place you go 
to get the money. That's where the money is.
    You may hear discussions from time to time about socially 
responsible investing and phrases like that. But the reality is 
people go to Wall Street to get the money and the promotion of 
concepts like socially responsible investing, and phrases like 
that are simply another way to enable them to get the money.
    The financial markets of Wall Street are, in my personal 
opinion, the single most successful self-regulatory arena the 
United States has had, at least in my life time. I think that's 
because people are, generally speaking, honest by nature and we 
have the oversight capacity of the Securities and Exchange 
Commission hovering in the wings over the self-regulatory 
bodies that we've been talking about this afternoon.
    But there's something different now. There's a huge, huge 
amplification of voices provided by the digital age. This is 
creating what I think are really important new difficult 
challenges for the self-regulators and for the SEC. I think you 
can make a convincing case that this entire tech sector bubble 
that we saw begin in the mid-1990s, swell over the following 4 
years, the last two of which the NASDAQ composite index nearly 
tripled in value, and then popped like a champagne bubble and 
just disappeared in the glass, was caused by, and I think the 
responsibility lies directly at the feet of the amplifying 
megaphones of the digital age, the internet, the world of cable 
television, and the access to them that financial analysts and 
compliant journalists have which reaches investors all over the 
    This has huge and obvious policy ramifications for 
Congress, in my opinion, because the collapse of the market, 
the NASDAQ national market is in collapse and we would be 
remiss to call it anything other than that. It has lost over 75 
percent of its value from its stock. Some of it's come back, 
but it is still way, way off.
    This has brought an end to the longest running bull market 
we've known in this country's history. It now threatens to tip 
the entire economy into recession. No one has any clear idea 
what to do with it. Trillions of dollars have vanished from the 
economy by the implosion of what Federal Reserve Chairman Alan 
Greenspan referred to as the ``wealth effect'' created by this 
bubble and the dot.com stocks that were in effect the miner's 
canary of that bubble.
    The Bush Administration and the Federal Reserve are now 
engaged in efforts to replace it with a combination of tax 
rebates, lowered short term interest rates. No one is entirely 
clear whether this is going to work or not. But if prices 
hadn't been pumped up to the levels they reached in the first 
place, they wouldn't have fallen as far as they have, and we 
wouldn't now be groping for a way to pump them back up again.
    This bubble was financed largely by individual investors. 
And it is the Wall Street analysts and the media voices that 
helped turn the analysts into pseudo-celebrities whom I believe 
now have to bear the consequences for their actions, the 
responsibility for their actions. In some cases, we've seen 
what I thought I would never see in my life time in this 
business which is the spectacle of professional investors, who 
simultaneously wear a hat purporting to be an analyst, an 
investor and a journalist simultaneously.
    I think is just a circle. You can't square and you can't 
put any kind fine line, fancy talk around it. Those three 
things don't go together. For nearly 4 years from the Yahoo IPO 
in 1996 to the deluge of IPOs that spread across Wall Street in 
the first 3 months of 2000, the analyst community, Wall Street, 
and the media organizations that covered them engaged in what I 
would call nothing less than a massive, shameless, totally 
irresponsible free-for-all riot in the pursuit of money.
    I have included with this testimony a collection of stories 
and columns I wrote during this period that attempted to call 
the public's attention to the colossal pocket picking that they 
were being subjected to. Most particularly, I wrote repeatedly 
about the outrageous situation in which IPOs would be offered 
to investment bank clients at cheap, pre-market prices, even as 
the bank's analysts and the firms engaged in non-stop public 
commentary designed to pump up demand for the stock among 
individual investors in the after-market.
    There are dozens of billion dollar examples of this in the 
public record before us today. Then when the stock would come 
public, the insiders would instantly dump their shares into the 
waiting and outstretched arms of individual, after-market 
investors at four, five and sometimes ten times the price they 
paid for them, often within hours.
    You can call that what you want, but I call it fraud. You 
may review the trading histories of dozens of tech sector IPOs 
and dot com IPOs during this period and find precisely this 
pattern repeating itself over and over again. To that end, I 
would thus respectfully call the subcommittee's attention to 
the following IPOs which are simply illustrative of the process 
I've described.
    VA Linux Systems, Inc. The insider price in this deal was 
$30, the first price to an after-market investor in the public 
market, $320.
    TheGlobe.com, Inc., a deal that failed the first time 
around and couldn't even be gotten off, because the underwriter 
couldn't even find a market for it. The second time around at a 
mark-down, Cy Sims' basic sale price of nine bucks. This deal 
got off at $9. First sale to individuals in the after-market, 
    WebMethods, Inc., sale price to the insiders, $35; first 
sale to the after-market individual investors--everyday 
citizens, $336.
    All these stocks have since collapsed. There are dozens 
more like that. These stocks and countless more were pumped to 
wildly supportable prices by impossibly grand claims from 
analysts regarding their potential as businesses. We all knew, 
as journalists, that these claims were absurd, and we would 
constantly talk with each other about that. Not often did our 
private opinions about what we were seeing make it into public 
print. The fact that these claims echoed through the megaphones 
of TV and the internet to reach individual investors from every 
corner of the globe simply underscores how much capital can be 
raised on Wall Street now that the whole world is watching.
    And this is only the first instance of this in which this 
unexpected alliance of analysts and the electronic media has 
come to bear on the marketplace. Unless efforts are undertaken 
to prevent this recurrence, I think we can look for even more 
disruptive recurrences of this in the future.
    To that end, I would respectfully suggest the following:
    Without going into the specific Sections of the 33 and 34 
Act, because I'm not entirely certain, in the amount of time 
that I had to prepare this testimony, I have the correct 
references in my written submission.
    Chairman Baker. To that end, please feel free on reflection 
to forward that information in writing at a later time. That 
will help you in your presentation.
    Mr. Byron. I would simply say Section 17(b) of the 
Securities and Exchange Act of 1933, which I understand it in 
laymen's terms, requires anyone who is paid by an issuer to 
circulate, publish, or otherwise disseminate stock 
recommendations, be augmented to require, as a matter of law, 
that anyone publishing or disseminating that information 
disclose on that document in which the dissemination takes 
place, any financial interest, either direct or indirect, he or 
she holds in the stock in question, and I would wholly endorse 
the vivid image that the Chairman offered before of I want to 
see the surgeon general's warning stamped across the front of 
these things. It says ``Caution! Investing in This Deal May Be 
Hazardous To Your Financial Health'' in big red letters.
    In this particular area, I think that volunteerism just 
hasn't worked. And I don't think that the' 33 Act, I live by 
the First Amendment. I say things that anger lots of people so 
the First Amendment is very important to me, and I don't feel 
that the 1933 Act, as it's written now, violates my First 
Amendment rights, and I don't think that the augmentation in 
the way I'm saying, you might want to consider augmenting it, 
would violate them either.
    Second, I think that Section 10(b) of the 1934 Act, which 
deals with the general concept of fraud of the market, could be 
aggressively enforced by the SEC Enforcement Division. For 
example, the black letter law we all know well in my line of 
work, the Foster Wynans case. This is a case that the Wall 
Street Journal reporter ran afoul of the act by using 
information that he had obtained in the course of his work to 
trade on stocks before putting it in the paper, in violation of 
his agreement that he signed with the Wall Street Journal not 
to do that.
    I think the essential holding in that case boils down to 
this: He promised not to do something that he went ahead and 
did anyway. While I think the basic principle there can be 
expanded to find an implied covenant, not just with your 
publisher, but with the whole world of your consumers, 
particularly when you're disseminating financial information 
that is offered to the public under the color of impartiality.
    Nobody is going to believe what you write if it comes 
stamped all over it and says ``I make a buck so long as I get 
your money,'' but if it's stamped on the front of it, if it 
comes representing itself to be this is unbiased material, in 
that case I think when you don't deliver unbiased material, you 
ought to be held to account with a sanction that hurts.
    I think we shouldn't be looking at the minimum amount of 
disclosure necessary to find adequate disclosure, but the 
maximum possible disclosure to protect the individual investor, 
a completely different orientation.
    I've probably run over my time. I thank you for your 
    [The prepared statement of Christopher Byron can be found 
on page 245 in the appendix.]
    Chairman Baker. Thank you very much, sir. We appreciate 
your remarks.
    Our next witness is Mr. Charles Hill, Director of Research 
at Thomson Financial/First Call. Welcome.


    Mr. Hill. Thank you. Good afternoon, Chairman Baker. I 
would like to thank you and the Members of the subcommittee for 
the opportunity to espouse my views on this important subject. 
Let me first mention the usual disclaimers. The views expressed 
here today are my personal ones, and are not necessarily those 
of my employer, Thomson Financial/First Call, where I'm 
Director of Financial Research, or those of the Boston Society 
of Securities Analysts, where I'm a Vice President and a 
    I'm a chartered financial analyst and proud of it. My only 
aim today is to uphold and improve on the quality and integrity 
of my profession.
    The problems we are talking about today are not new. They 
tend to wax and wane with each stockmarket cycle. The only 
difference this time is that some of the problems may be worse 
than in past cycles. There does to be some secular trend 
underway that may have been exacerbated by the cyclical swing 
in the market and that needs to be corrected.
    Any prolonged corrections in stock prices tend to wring out 
some of the excesses we're talking about today. Nevertheless, 
some of the underlying secular trends are disturbing and it may 
take more than just a market correction to remedy the 
    Let me point out that in this market downturn, as in past 
ones, investors always look for scapegoats. The broker/analysts 
are an easy target. There is no doubt some basis for this, but 
it is most probably over done. Let the record show that at the 
time of the market's frothiest peaks, there were many broker/
analysts doing very thorough and objective research.
    The problem was that there were not enough in this 
category. There were too many whose work was shoddy and/or 
biased because of naivete, laziness or outside pressures.
    But let's not paint all the analysts with the same brush. 
As a former sell side analyst for 18 years, I shudder at the 
thought of returning to that field and having to compete with 
some of the top analysts today with all the technology tools 
available. There is no question in my mind that today's stock 
research for the top sell side analysts is better than from the 
top analysts of 25 years ago.
    What we need to improve is the quality and objectivity of 
the work from the rest of today's sell side analysts that are 
not currently doing their job as well as they should. Before we 
turn to the causes of deteriorating stock research quality, it 
is worth looking at how the problems of quality and bias can 
manifest themselves. There are four data items by which 
analysts can distort an investor's perceptions of a company's 
stock or leave the investor confused.
    The first is recommendations, the second is target prices, 
third is earnings estimates, and fourth is earnings basis. On 
recommendations, this subcommittee has previously raised this 
issue and has cited bar data, first calls data. The rough rule 
of thumb is that about one-third of all broker recommendations 
are in the positive category, strong buy, or whatever the 
broker's equivalent term is.
    About one-third are in the second most positive category 
buy or whatever the broker's equivalent term is. About one-
third are in the third most positive category, hold or the 
equivalent, with only about one percent in the two bottom 
categories, sell and strong sell or their equivalents.
    The individual investor needs a decoder that would put all 
the brokers' various terminology for their recommendations on a 
common scale. The brokers are doing a better job of putting in 
each research report a definition of what their recommendation 
terminology means, making it easier for investors to compare 
one broker's recommendation with another. However, not all are 
doing this. A better answer might be if the brokers could agree 
on a common scale with common terminology.
    Let me digress from my printed text for a minute to refer 
to something Congressman Kanjorski was talking about. When you 
mentioned about the confusion of the terminology, let me just 
read you the different terms that the brokers used for the 
third category. We've gone to all the brokers and said, you fit 
whatever your scale of terminology is to a common scale from 
one to five where one's a strong buy, two's a buy, three is a 
hold, and so forth.
    Here are the terms that are used in category three: 
Accumulate, attractive, hold, average, hold/neutral, long-term 
accumulate, long-term attractive, maintain, market average, 
market perform, neutral, neutral/hold, no action, out perform, 
perform in line, speculative buy, trading buy, market out 
perform, stock pick.
    Now what is the individual investor to do without this 
    But let me go on. Unfortunately, the investor needs a 
second level in their decoder to adjust for the over-optimism 
of the broker analyst recommendations. Since the better 
companies get more analyst coverage than do the weaker 
companies, there is a justification for somewhat of a positive 
bias to the recommendations. As of the end of July, yesterday, 
this data was run. 27.6 percent were in the strong buy 
category, 36.9 in the buy, only 1.1 percent were sells and 0.4 
percent were strong sells. That means the number of buys of all 
kinds were 47 times the number of sells of all kinds. That much 
of a positive bias is hard to justify.
    Last year when the market was at peak levels, the spring of 
2000, and many stocks were substantially overvalued, the ratio 
was even worse. On 1 March, it was 92-to-1. As the market crept 
up to a bigger peak on May 1st, it was 100-to-1. As the market 
began falling, the ratio was still a very high one, 99-to-1 on 
the first of August. By October it was 78-to-1. Today, as I 
mentioned, it's 47-to-1. It's a bid harder to understand why 
the recommendations were even more positively biased than 
normal at the market peak.
    Second issue, target prices. Target prices are another area 
where the analysts have the opportunity to put their naivete or 
biases to work. Target prices became the rage of the 1990s, but 
their popularity seems to have abated slightly. Many were 
unrealistic, but many of the analysts that were providing those 
target prices have lost considerable credibility.
    Earnings estimates. Most analysts, most of the time, tend 
to start out too high with their estimates at the earnings 
report time. On average, the analysts start out too high ahead 
of the reporting period. They bring the estimates down, but 
take them down too far at the end of the period. More than half 
of the companies in the S&P 500 beat the final estimates every 
    Whether the analysts have been misled by the company's 
guidance or whether they knowingly went along with that 
guidance is debatable, but there does seem to be too regular a 
pattern of companies beating the estimates, particularly at 
some companies.
    Now Regulation FD hopefully will diminish that problem. Now 
the fourth one is earnings basis. One of the problem areas that 
is mushrooming, but is often overlooked is the determination of 
the earnings basis used to value the stock. The SEC requires 
companies to report earnings on the basis of Generally Accepted 
Accounting Principles, (GAAP). Most everyone would agree that 
those numbers often need to be adjusted to exclude non-
recurring and/or non-operating earnings.
    The problem is that what one person considers non-recurring 
or non-operating, another may not. There is no right answer. It 
is all in the eyes of the beholder. A big part of the analysts' 
job is to determine the appropriate basis for earnings as used 
in the price earnings ratio or other earnings-based valuation 
    A company's earnings can often be enhanced by excluding 
items that normally would not be excluded or by including items 
that normally would be excluded. The excesses in this area have 
been most common in the technology sector where the use of the 
cash earnings or pro forma earnings have taken on a wide 
variety of special meanings that have greatly enhanced some 
companies' earnings.
    Chairman Baker. Mr. Hill, if you can begin to wrap up, I 
want to get all of our panelists in before we get interrupted 
by a vote. I hate to do it.
    Mr. Hill. OK. There's a growing trend for companies to put 
out releases that emphasize an earnings number that has been 
adjusted to a basis the company espouses, sometimes to the 
almost total exclusion of the GAAP results. What this is 
amounting to is a way for companies to gild the lily on their 
earnings reports, and it's an issue that Lynn Turner did bring 
up before his leaving the SEC.
    But, let me just quickly say that the four ways that the 
analysts are being pressured is first, themselves, in that the 
analysts have fallen in love with the industries they cover, or 
they'd be covering some other industry. So they start out with 
what I call an honest bias, come to the table looking through 
rose colored glasses. Second is the investment banking issue 
that we've talked quite a bit about today. The third is the 
public companies, the companies themselves putting pressure on 
the analysts or they'll be cut off communications-wise.
    Last, the institutional shareholders who also can pressure 
the analysts not to put out a sell when they own the stock.
    [The prepared statement of Charles L. Hill can be found on 
page 248 in the appendix.]
    Chairman Baker. Thank you very much, Mr. Hill. Your 
testimony and all the witnesses' testimony will be made a part 
of the record in full, and I'm sure--I know I do--we'll have 
further questions in writing as well. Pleased don't feel 
dispossessed if you don't get through your entire prepared 
    Our next witness to appear is Mr. Matt Winkler, Editor-In-
Chief of Bloomberg News.
    Welcome, Mr. Winkler.


    Mr. Winkler. Thank you very much, Mr. Chairman. I'm 
delighted to appear before the subcommittee as part of your 
continuing discussion of analyzing the analysts. My name is 
Matthew Winkler. I am the Editor-In-Chief of Bloomberg News, a 
global news service with 1100 reporters and editors and 80 
bureaus in 50 countries.
    Bloomberg News produces more than 4,000 stories daily on 
the economy, companies, governments, financial and commodity 
markets, as well as sports, politics, and policy. Many of these 
stories are published in more than 350 newspapers including the 
New York Times, The Washington Post, Los Angeles Times, Le 
Monde, and the Daily Yomiuri.
    Since its inception in 1990, Bloomberg News has received 
more than 50 awards and citations for the quality of its 
journalism, including awards from the Overseas Press Club, the 
Gerald Loeb Foundation, the Society of Professional Journalists 
and the Society of Professional Business Editors and Writers. 
Bloomberg News is the main content provider for Bloomberg print 
and broadcast media. These include several magazines, a New 
York-based radio station and network, and a 24-hour television 
network operating in the U.S. and in a dozen languages in 
countries in Europe, Asia, and South America.
    Financial stories are both complex and critically 
important. As someone who is passionate about providing the 
public with the context and analysis necessary to make sound 
decisions, I want to salute this subcommittee for its 
extraordinary commitment to ensuring that investors have broad 
access to the highest quality information about the 
marketplace. When this subcommittee greets with skepticism 
efforts to create a property right in stock market quotes, or 
highlights the question of whether investors are getting 
unbiased research from Wall Street, you are taking a step 
toward ensuring public access to information. In the 
information age, that is no small accomplishment.
    It may take a bear market for investors to realize that 
many stock analysts have never been anything more than fancy 
pitch men for the firms that sell securities. As long as shares 
went up, as they did in the 1990s, analysts rarely had to say 
``sell.'' In their lingo, the stocks were never ``fully 
priced.'' Now that the NASDAQ composite, the symbol of the 
greatest bull market ever, is down about 50 percent from a year 
ago, it is easy to attack the analysts because the few 
occasions when they might have said sell came long after the 
damage was done.
    Analysts always will have a conflict of interest as long as 
the firms that employ them participate in initial public 
offerings, arrange stock and bond sales, and use analysts' 
research to help win new business. In such circumstances, it's 
hard to find any analyst on Wall Street who met a stock he or 
she didn't like. Analysts are part of the sales team.
    Analyst conflicts of interest are a symptom of something 
much more sinister. Until the Securities and Exchange 
Commission late last year approved Regulation FD, public 
companies routinely invited analysts and some of their 
shareholders to private meetings as they discussed sales, 
profits and losses. Until adoption of Regulation FD, analysts 
were protected under law from insider trading liability and 
liability for ``tipping'' if they did not have a special 
relationship with the corporate officials that fed them insider 
information--a monetary or other quid pro quo.
    That protection was designed to shield analysts from 
unlimited risks of liability for attempting to ferret out 
information. It quickly became perverted, however, as issuers 
figured out they could punish analysts that did not give them 
good ratings. The punishment came in the form of exclusion from 
the inside information gravy train which was provided to their 
competitors. Inside information was thus joined with analysts' 
recommendations in a troubling form of barter. It was as if a 
student could punish the teacher for giving him or her a bad 
grade by withholding the teacher's pay.
    In short, this practice of selective disclosure 
increasingly made the stock market a financial ``Animal Farm'' 
in which some shareholders were more equal than others. The 
sloped playing field created by selective disclosure during the 
1990s was so common that many analysts and publicly-traded 
companies assumed it was the price of capitalism. Analysts 
equipped with inside information, they argued, were needed to 
grease the wheels of the market, even if they could trade on 
that information before Aunt Betsy and the rest of the 
company's shareholders.
    The SEC disagreed because in too many instances, trading in 
a company's shares turned out to be rigged, undermining the 
integrity of the stock market. I believe the SEC got it right. 
What precisely does Regulation FD have to do with analyst 
conflicts of interest? Everything. Conflicts and bias breed in 
the dark. The more information that is available to the public 
the greater our collective ability to assess independently 
whether the analysis we are receiving is potentially biased.
    Does Regulation FD solve the problem of analyst conflicts? 
Of course not. I repeat, as long as firms employ them to 
participate in initial public offerings, arrange stock and bond 
sales, and use analyst research to help win new business, 
analysts will always have a potential conflict of interest. 
Initiatives that enhance broad dissemination of information to 
the public will have a salutary impact.
    Justice Brandeis is remembered for observing ``publicity is 
justly commended as a remedy for social and industrial 
diseases. Sunlight is said to be the best of disinfectants. 
Electric light, the most efficient policeman.'' Like seeing a 
policeman in the rear view mirror or knowing a Congressional 
Oversight Committee is looking over your shoulder, the 
availability of information enhances accountability. That 
serves as a catalyst that sometimes prods better behavior, and 
that is very much in the public interest. Again, I commend you 
for your willingness to explore this important issue.
    Thank you very much.
    [The prepared statement of Matt Winkler can be found on 
page 253 in the appendix.]
    Chairman Baker. Thank you very much for your remarks.
    With apologies, Mr. Kianpoor, Chief Executive Officer for 
Investarts.com, also a media panelist of sorts, I have been 
informed that I have overlooked as well TheStreet.com also 
being an internet site. Thanks to both you gentleman for your 
willingness to appear today.


    Mr. Kianpoor. Speaking on behalf of the Investars.com team 
and our co-founder, John Eagleton, I'm honored to have the 
opportunity to contribute to these hearings. Investars.com was 
founded in October 1999 to give investors tools to better 
interpret stock recommendations made by Wall Street Analysts. 
With the huge growth in the number of individual investors in 
the mid-1990s, Investars.com sought to measure the track 
records of Wall Street's research providers, thus giving 
investors the tools that would allow them to sift through 
dozens of stock recommendations made daily. Investars.com 
degree of success system calculates the hypothetical return an 
investor would have made if he or she had traded based on each 
brokerage's recommendations.
    Investars currently ranks more than 200 research firms, 
based on their overall hypothetical returns for every stock 
since January 1997. Hindsight has made it clear that the boom 
and bust of the past 4 years did not leave lasting benefits for 
anyone. Investors have suffered, businesses built on 
unrealistic have collapsed, and the brand equity of many 
brokers whose businesses depend on public trust is being eroded 
as we speak.
    We must join forces to implement common sense reforms that 
will benefit all parties. Respectfully, we'd like to propose 
three basic reforms.
    One, to make historical recommendation and earnings 
estimate data public; two, to encourage disclosure of 
investment banks relationships with covered companies; three 
push for a common recommendation language.
    In the interest of saving time I've pared down some of my 
testimony on subjects that have been mentioned before. I would 
like to focus on some of the more important things. Historical 
Wall Street recommendations and earnings data is not available 
only to institutional investors. Individual investors suffered 
in the recent boom and bust cycle, because they lacked these 
key facts. They lacked these facts, because there's a virtual 
monopoly on the distribution of analysts' historical data, 
namely, financial data distributors who agree with investment 
banks not to make historical ratings information available to 
the public.
    This is the single most important, most absurd, and least 
addressed issue affecting the individual investor today, that 
investment banks can prevent the release of their historical 
recommendations data to the public. Historical recommendations 
and earnings estimate data must be made available to all 
investors and preserved in the public venue, such as the SEC 
    Please refer to the statements made by other analysts 
ranking sites, such as Validea.com and MarketPerform.com in our 
written testimony.
    The second issue is the disclosure of investment banking 
relationships. Our IPO bias feature compares the track records 
of investment banks based on their recommendations for 
companies that they underwrote to their track records in 
companies that they did not.
    Overall, since 1997, the returns in the first case are 
approximately 50 percentage points lower than the returns on 
the second. Due to the lack of availability of historical 
information, the possibility of conflict of interest was not 
previously quantifiable for investors.
    As their second reform, Investars proposes that investment 
banks disclose to an SEC database their historical underwriting 
relationship with any company which they cover. I believe 
that's been brought up before. Disclosure is not an end in 
itself. We call on the media on-line brokers, financial 
advisors, research firms, and sites such as Investars, to 
educate and protect the people. By placing this information in 
context with current technology, we can explore investment 
banks' track records and conduct a detailed peer group 
analysis, and the media should avail itself of these new tools. 
If it proves impossible to obtain full disclosure, the media 
should emphasize the implications of its absence.
    The third issue we need to address is Wall Street's 
language. Again, that has been mentioned before. We need a 
common scale. It's just common sense. In that case, our 
conclusion is that we cannot lose sight of the average investor 
who must be equipped to assess the quality and integrity of 
market analysts.
    It is common sense when you buy a car, you check consumer 
reports. When you buy a house, you have it inspected. To make 
such assessment possible, we need to establish a standard 
language and break the investment banks' control over factual 
historical recommendation data. Investars also suggests that 
the media start to delve into more detail when reporting on 
analysts' recommendations to the public.
    We now possess the technology to refer to analysts' batting 
averages and provide play-by-play commentary on their ratings. 
We can publicize the good and transparent and underscore the 
deficient, heighten investor awareness that will self-enforce 
industry compliance with higher standards.
    I'd like to end my testimony with a statement. There's a 
greater fool theory in the market. It states that no matter 
what a stock is worth, investors buy it, because they believe 
there will be a greater fool willing to buy the stock from them 
at a higher price. As long as brokers and financial data 
providers can block the distribution of factually historical 
data to the public, the average investor will ever remain as a 
greater fool in the market. That's just common sense.
    I'm grateful for this opportunity to share our views with 
you today.
    [The prepared statement of Kei Kianpoor can be found on 
page 261 in the appendix.]
    Chairman Baker. Thank you very much, sir. I appreciate your 
willingness to appear.
    Our final witness today is Mr. Adam Lashinsky, a Silicon 
Valley columnist, and employed by TheStreet.com.


    Mr. Lashinsky. Thank you very much, Mr. Baker. I had the 
privilege of interviewing you recently for an article that I 
was writing, so turn about seems fair play. I'm happy to give 
you my thoughts today.
    When I first started out as a business reporter, I was 
handed a large book called the Nelson's Director of Investment 
Research. I was told there are lists of analysts in this book. 
Call them if you need comments for the stories you're writing 
on public companies.
    I knew nothing about what the individual analysts did, the 
importance of their firms, whether some were better than 
others. All I knew was that the ones who returned my phone 
calls were more valuable than the ones who didn't return my 
phone calls. If they said something germane on the record, they 
were even more valuable because they could go into my articles.
    I think that as we entered the bull market, the individual 
investor found him or herself in a similar position. They were 
told in either the newspaper article or on television that an 
analyst had something good to say about a stock. They had no 
ability to judge whether or not that analyst was good or bad. 
They knew that an expert was speaking and that information was 
good enough.
    The news media plays a role in this, and I'd like to 
address that. The point is that professional investors have 
understood the games that have been played on Wall Street all 
along. The individual investor didn't understand what the 
conflicts were, came into the game cold, if you will, just as 
if having been handed a big book.
    One thing, Congressman Baker, that I think hasn't been 
addressed in the hearings yet is who is entitled to the 
information that we're discussing and how they should be using 
it. There's been discussion today of research reports being 
entered into historical records or indeed being regulated like 
a securities offering.
    The fact remains that at least for now, these are not 
public documents, these are proprietary pieces of research for 
which investors pay. So Fidelity understands that it is a 
client of Goldman, Sachs, to choose one example.
    To the person watching on CNBC, it's not typically a client 
of Goldman, Sachs. It they act on the research that Goldman, 
Sachs has produced, in a sense, they're taking a shot there on 
their own; they're not the client, they didn't pay for it. But 
what is the media role here?
    TheStreet.com has had a policy since its founding in late 
1996 of always stating a conflict of interest that an analyst 
has. So if we quoted an analyst whose firm was the underwriter 
of the IPO of the company that we're discussing, we simply say 
so. It doesn't mean that the analyst is good or bad, it means 
that we're cluing our readers in that there's a potential 
conflict here.
    I would point out that sometimes those analysts are the 
best informed because they spend more time with the companies, 
but an investor has to have his or her eyes open to the fact 
that there may be a conflict here. Thus, Street.com is not 
immune from some of the criticism that the financial news media 
    Over the past few years, we had, for example, something 
called the ``Red Hot Index'' where we participated fully in the 
momentum of the era. However, I'm proud of what TheStreet.com 
has done in terms of outlining analysts' conflicts. I don't 
think the rest of the media has lived up to the same standard, 
in particular the broadcast media has been particularly harmful 
in putting analysts or putting fund managers on television 
without explaining to the overage viewer at home what the full 
story is behind the recommendations that they're making.
    I would offer to you several solutions that you're 
addressing, not all of which I necessarily endorse, but I offer 
them as food for thought.
    One, you could write legislation to split investment banks 
from brokerages. This would solve the problem. It would be very 
painful. It would fly in the face of the last 10 years of 
consolidation in the financial services industry, and of course 
brokerages wouldn't be able to make much money in that 
scenario, because trading is not a particularly profitable 
endeavor, but it would solve your problem. Then you could allow 
fixed rate minimum commissions again, so that brokerages could 
run a profitable business. That flies in the face of Congress' 
concerns about price fixing.
    You could require, and you are discussing requiring greater 
disclosure as the industry itself is discussing. My personal 
opinion is that these are palliatives. They will have little 
impact on the conflicts. They simply will make people more 
aware of what the conflicts are and perhaps make people feel 
    Lastly, you can rigorously support Regulation FD. There is 
an undercurrent that isn't stated loudly that there are 
elements with in the SEC and certainly on the Commission and 
certainly in the securities industry to diminish the effects of 
Regulation FD, because it makes the industry uncomfortable, and 
it is requiring the industry, in my opinion, to work harder.
    In my reporting, it's my opinion that Regulation FD is one 
of the best things that has happened for individual investors 
in recent history, and Congress can do its part by standing 
firmly behind Regulation FD and not give in to some of the 
demands that it be weakened.
    Thank you, sir.
    [The prepared statement of Adam Lashinsky can be found on 
page 266 in the appendix.]
    Chairman Baker. Thank you very much, Mr. Lashinsky.
    Let me say to the whole panel, thank you very much. This 
has been again very informative, but also very troubling. From 
the first hearing, when there were some observing, wow, 
Congress is looking at the conflicts of interest on Wall 
Street, isn't that news?
    Obviously we all know that there are conflicts and firms 
have assured us of their ability to manage those conflicts. But 
the further we have gone in looking at the divergent list of 
individuals who have unique perspectives of market actions, 
there is no doubt that the character and nature of the market 
has changed over the last decade.
    Unfortunately, I think there is reason for most investors 
to have great concern about the independence of the information 
flow when they make such significant investment decisions 
coupled with the advent of online trading, and now what many of 
us in political life call the working moms and pops investing 
on line and, to some extent, using media appearances. Look at 
what's happening here in this sector today, the type of 
analysis in order to make all those small individual 
transactions in the aggregate responsible for the huge inflows 
of capital to the market. We have a very volatile circumstance.
    In speaking with most members, we are all reticent to act 
legislatively. But it would be my intention, based on the 
support of the subcommittee, that we would move forward from 
this point with some recommendations through the fall and 
winter and perhaps come back with the assistance of the NASD, 
the SROs and the SEC, and determine whether our actions and 
recommendations have not only been implemented, but there is 
actual day-to-day practice and consistent following of the 
recommendations that appear to be warranted.
    Let me make a couple of statements and then kind of get the 
consensus, yes or noes. My view is everybody thinks there's a 
problem. You all may not see the same problem, but generally 
there's a problem that we need to fix. Nobody objects to that?
    Second, that it would be better, if possible, for the 
industry, itself, to craft the remedy, but have that remedy be 
subject to the light of day. For example, additional committee 
hearings, SRO insight, that's maybe in the middle of the pack.
    Are there those who agree with that sort of general context 
that we ought to do something, look to the industry, and then 
    The next question is much more difficult. Let's assume 
we've gotten through those first two steps. We've prepared a 
list, we've gotten the industry to look at it, but there's 
still not consistent uniformity in compliance. What should be 
the enforcement mechanism? Is it sufficient, as I suggested to 
Ms. Unger earlier, to have just a rating mechanism; a, you're 
complying with all the rules; b, you're trying, but you're not 
quite there; c, you've got a problem. Will the publication of 
you being on the c list have a consequence in the market? Is 
that a point of discussion?
    Yes, sir?
    Mr. Winkler. Mr. Chairman, I think the greatest impact on 
the market is disclosure and the more disclosure there is, just 
as you yourself said earlier today, a warning on a package of 
cigarettes is a very powerful way of letting people know that 
they are about to use something that's possibly fatal. Reg FD 
goes a long way toward that kind of goal.
    And I do think that if this subcommittee were active in 
doing everything it can to promote and enforce Reg FD, that 
would be very helpful.
    Chairman Baker. Thank you for that. I do have some concerns 
about Reg FD, but not from the perspective of the industry 
having a difficult time complying. I just want to make sure it 
functions in the intended fashion. And further to the point, it 
would have no implication on an analyst making a recommendation 
to buy when he's selling his own interest.
    I think we have to get not only at the flow of information 
but the personal conduct issue of the individuals. For whatever 
reason, it makes no difference; are they being pressured by the 
firm or is it the opportunity to make four or five million 
dollars on a deal. If they do it, it's wrong. That's where we 
have to have, I think, significantly more involvement by the 
SROs than we have today.
    For example, it troubles me greatly that, at least 
according to Ms. Unger, the NASD does not look at an analyst or 
require disclosure, if he makes a television appearance, if 
he's got an interest in the stock which he's talking about. I 
find that unfathomable from a regulator's perspective.
    Mr. Lashinsky, did you have a comment?
    Mr. Lashinsky. Yes, sir. I was going to say that in every 
instance I know, the compliance department of any firm would 
not allow the type of department that Ms. Unger described 
earlier. Without being a lawyer, that strikes me as fraudulent 
behavior and bad ethics, so there's a break down in how the 
SROs are regulating the compliance departments of their own 
    Chairman Baker. Ms. Unger also stated that in the short-
term audit they conducted, there was only one firm that could 
give her an accurate reporting of all the analysts' interests 
within the firm. How could you possibly have any capacity to 
govern analysts' practice if you don't know what they own?
    There's a fundamental structural problem here that is going 
to take more than one hearing and one simple piece of 
legislation to fix. To that end, we will get back to each of 
you with additional questions and insights for you to give us 
your educated opinion on.
    But we would very much welcome, over the course of the 
August recess, your best thinking along the idea of here are 
the elements we think would be important as we have a peer 
review group now looking at the SIA's best practices.
    By the way, just a show of hands, how many of you think the 
SIA's best practices recommendations are sufficient?
    [No response.]
    Chairman Baker. That's what I thought.
    Over the August recess, if you'll give me your insights 
into those, as well as additional steps from your various 
perspectives, it would be very helpful to us in trying to 
construct very carefully a package for us to suggest to the 
SROs that they review, and our process would be very slow. 
We're not going to rush to judgment. But to take the fall and 
winter and come back next spring and make an assessment about 
the effect and consequences and recommendations that the 
subcommittee may make this fall. It's just by way of process.
    I don't want to go on at length because Mr. Kanjorski and 
Mr. Crowley have been very patient sitting here.
    Mr. Kanjorski.
    Mr. Kanjorski. Thank you, Mr. Chairman.
    Mr. Kianpoor, you made an observation that the value of a 
stock will be whatever the next idiot will pay.
    Mr. Kianpoor. That's right. It shouldn't, but it did for 
the last 2 years.
    Mr. Kanjorski. And after the excellent testimony of the 
entire panel, each one of you added a great deal of insight 
into some of the problems in analysis on Wall Street.
    I don't think any of you are my age, but I'm going to 
relate a story. You may remember my favorite program when I was 
a young man in the late forties, was Captain Midnight. Captain 
Midnight was sponsored by Ovaltine, you'll remember.
    I was just about able to read, write, and figure out how to 
do things, and I was pressed at 5:00 o'clock every day to 
listen to Captain Midnight. And Captain Midnight started this 
process of the secret code and secret information, and every 
day you would write down the numbers. They were useless to you 
if you didn't have a decoding device, but Captain Midnight 
offered a decoding ring with ten bottle labels of Ovaltine and 
a dollar.
    And as a dutiful follower of Captain Midnight, I bugged the 
hell out of my mother to get those ten bottles of Ovaltine. By 
hook or crook, I got that dollar and I wrote in, and at that 
time, nothing was instantaneous like the internet; thus, with 
bated breath every day, when I'd come home from school, I'd 
look for my package from Captain Midnight. It wasn't there. It 
took weeks. But every day at that program at 5:00 o'clock, I 
copied down all those numbers so that when my ring came, I'd 
know what Captain Midnight was saying to me.
    Finally, the day arrived and it came, and I remember it 
very well. I tore that box open. I immediately ran in and I 
couldn't wait for the program to be over when the message would 
be given, and finally it was given. And I took my ring and I 
decoded the message. It was probably the best lesson I ever 
learned in my life, because the message was----
    Mr. Hill. Congressman, that was the information for my 
reference. I had my Captain Midnight Decoder.
    Mr. Kanjorski. Do you remember what the decoded message 
was? ``Buy Ovaltine.''
    Mr. Kanjorski. Well, it taught me a lesson. We can't 
encourage Americans to necessarily buy decoder rings when 
they're not available. Somebody's got to do something with this 
decoding. We have to move out of the Orwellian world. I think 
the Chairman and I both agree we would least like to do it by 
Government action. But clearly, I was disappointed. I listened 
to the testimony of the SEC today. And I got the feeling that 
it's not our fault, it's somebody else's responsibility if they 
are not doing something.
    It didn't strike me that the proper attention was paid, but 
then I thought about listening to all of you six gentlemen 
here. I want to compliment you. You are all competent and very 
successful in your field, but you have to answer this question 
for me.
    Why wasn't there anyone that did investigative work in 1998 
and 1999 and 2000 to tell the American people and most of us 
about these terrible analysts when the market was going up?
    Mr. Kianpoor. As I said before, the data was not being made 
available to individual investors. That means to do this 
investigative work, you need to get the historical data for 
what these analysts and investment banks have been recommending 
for the past 10 years.
    Mr. Kanjorski. You mean that there is nobody?
    Mr. Kianpoor. The data is being provided by investment 
banks to certain financial data providers which will not 
    Mr. Kanjorski. Then, we are going then through a fog, is 
that it?
    Mr. Lashinsky. Mr. Kanjorski, there were plenty of people 
during that period who did research and said repeatedly ``this 
is madness, this stock is not worth what you say it's worth. 
There are ways to fundamentally value this stock, and it's 
highly over-valued.'' And those people were laughed at for 
roughly 3 years because the stock kept going up and kept going 
up and kept going up. That was the period we just came through.
    Mr. Kanjorski. Would it have made any difference if we had 
the historical knowledge?
    Mr. Kianpoor. It would have, Mr. Kanjorski, and it will in 
about 4 or 5 years. As early as now, people are looking at our 
site and finding out what people's track records are instead of 
having a Surgeon General's warning on TV coming up, you could 
have the person's track record and see either the guy is a 
complete crook or a complete idiot. It's far more effective.
    Mr. Kanjorski. It strikes me as something like Monday 
morning football reporting, how well we played the game that 
was played on Saturday. We are the greatest analyzers of why Al 
Gore lost the election. But I don't think anybody could have 
told you that or would have told you that beforehand.
    And I'm just wondering, are we chasing a phantom?
    Chairman Baker. Let me jump in too, because I think Mr. 
Byron wanted to make a comment in response to that question.
    Mr. Byron. Yes. I would simply say, Congressman Kanjorski, 
that the data on which you can base informed judgments with 
respect to the value of a stock, given that no one can foresee 
the future, at least makes some reasonable guess about the 
likely course of a stock's value. It's available to everybody, 
whereas 20 years ago, it wasn't. And I mean by that, the 
instant access to audited financial statements, balance sheets, 
income statements, cash flow statements, shareholder equity 
statements from publicly traded companies via the filing system 
of the SEC. That stuff is all available and usable by anyone.
    Most people have neither the time nor the expertise to dig 
into that stuff and understand it. That's where the role of the 
media is critically important, because in my respects, we're 
the unelected, self-anointed proxies for public understanding 
of what these documents are.
    Mr. Kanjorski. How am I going to know, though, if I'm 
listening to you on the radio, and you're paid for by Exxon or 
American Express? How do I know whether or not that's 
influencing what you're saying to me?
    Mr. Byron. There is an inherent problem in that with 
everything in the capitalist system obviously. At some point, 
we all need to pay the rent.
    The question that I want to get at is when the conflict 
becomes gratuitous, particularly in the media, when media 
voices begin to have a demonstrable self-interest in the 
outcome of their own opinions and their own reporting at the 
same time the entire system tends to break down, because 
there's no place left for the public to go unless a investor 
wants to take the time to learn how to read a 10K statement 
from the SEC. Most people don't want to do that.
    So in my opinion, a very important part of this equation 
has to be the role of the media and financial journalists. When 
we start thinking of ourselves as superstars in the same way 
that the analysts do, we have a really serious problem on our 
hands, because who stands to inform the public when you have a 
situation like that?
    Chairman Baker. If I can recognize Mr. Crowley, do you have 
a comment or question, sir?
    Ms. Crowley. I do, Mr. Chairman. Thank you very much.
    It's funny. If I close my eyes, I think I'm listening to 
election reforms sometimes, some of the comments that are made. 
I appreciate that, because there are some analogies I think you 
can draw between the two in terms of the sharing of information 
by electoral analysts or financial analysts in terms of 
expertise dealing with election results or, in this case, maybe 
before the bell rings, what they hope would be the market 
results for a particular product.
    Mr. Glantz, I have a couple of questions, and first of all, 
let me thank you for being here. It's good to have, from a 
retired analyst, insider information basically on how some of 
this may work.
    The Henry Blodgett case put the analysts into the forefront 
for millions of small investors. While this case was before the 
SEC and Mr. Kanjilal--I hope I'm pronouncing that right--of 
Queens, my hometown, went to arbitration, and it first looked 
like that was going to be the road we were going to be going 
    This event brought to light a serious issue that when small 
time investors, who are the bulk of the American public, set up 
a brokered deal, many of these firms require that that 
individual agree to arbitration as opposed to going to the 
courts to address any wrongdoings down the road.
    In your view, do you think the current law should be 
overturned or reviewed so that private plaintiffs are provided 
with the right of action against analysts?
    And with respect to the current arbitration system, do you 
believe that the arbiters should be outside the securities 
industry and that they rather be from the American Arbitration 
Association or some other outside firm to oversee the 
    Mr. Glantz. Yes. I agree that investors should be able to 
sue in courts. I believe that any arbitration should be done by 
people outside of the system.
    If I can also add a response to a previous question. One of 
the problems with the rating systems is that the greatest 
excesses are made by people who have no track record. Whoever 
heard of Henry Bodgett before the internet stocks went up? It 
would have taken until the stocks fell that you would know that 
he had been over-enthusiastic. I think the basic problem is not 
the analyst, but the pressure on investment banking.
    If you tell the investment bankers, ``Gee, I think this is 
a terrible company,'' you get fired. If you don't support the 
stock, you get fired.
    Ms. Crowley. Today, but not in the past.
    Mr. Glantz. Right.
    Mr. Hill. Back in the days when I was an analyst, I could 
put a sell, as I did on investment banking clients, and I did 
not hear anything from the investment banking side of the firms 
I worked for or from the companies involved. But that's changed 
    Mr. Kianpoor. Mr. Crowley, that's why we are looking for 
historical information on investment bank recommendations. We 
don't go by analysts, because we believe that going by analysts 
would be like saying that the tail is wagging the dog. We go by 
Merrill's recommendations or CFSB's recommendations. Every time 
they make one, they put their equity at stake, and the public 
should know what their track record in different stocks and 
different sectors is when they're making those decisions. 
That's a market-based solution to the problem.
    Ms. Crowley. In the interest of time, I yield back, but 
before I do, I thank the Chairman. I believe this is the second 
hearing on this and there are going to be more hearings. I look 
forward to it because this is a very interesting issue. The 
whole concept of an analyst being rewarded for information that 
he or she gives over the mass media is troubling to me. It's 
substantial dollars. We're talking in the range of $100,000 
plus dollars for every time they give a bump to a product over 
the media, the mass media. That's troubling, because it affects 
my constituents, the general public that is more involved and 
more interested in the market than ever before, those are the 
people that we have to look out for.
    And that seriously troubles me. So I thank you all for your 
testimony today.
    Chairman Baker. Thank you, Mr. Crowley, and yes this is 
only the second, but it really is the beginning of this 
subcommittee's jurisdictional responsibility. I don't see even 
the passage of legislation as the end of our responsibility. If 
there's anything I've learned from pass excesses, the Long-Term 
Capital Management and others, there has to be outside constant 
review of business practice in order for the system to work 
without distortion.
    Ms. Crowley. I agree with you, Mr. Chairman. In fact, I 
think the hearings you're holding are doing in many respects 
just that.
    Chairman Baker. Thank you, sir.
    I believe that it's an important responsibility in light of 
the way the market has changed, technology has opened up the 
world to the small dollar investor, they may even, despite FD, 
be flooded by information they can't even understand. So I 
don't know that folks today have the confidence that the people 
they pay for information are necessarily giving them the 
unvarnished truth.
    That's what this is all about. I would like to return to 
the remedy aspect. I don't think it's that difficult. I think 
it's difficult because it may change business practices in 
certain areas and cause difficulty in securing the IPO client 
for the investment bank. But if you have the research 
department not reporting to the investment bank, where their 
compensation package may be based on the quality of their work, 
is it facetious to be believe that, as a research analyst, that 
if you do your work, and go out and say this is a dog and say 
this one is so-so, and this one is where we want to put our 
money, and based on those recommendations at year end, if you 
did identify the dog, you did tell them where to put their 
money properly, isn't that a mechanism which could work with 
reasonable support from professional management?
    Mr. Hill.
    Mr. Hill. It could work if the compensation system was 
changed. It did work in the past, but the problem is, and this 
is where the buy side institutions have to look in the mirror. 
They have been one of the big complainers about the 
deterioration and the objectivity of quality of sell side 
research, but they've driven commissions down to extremely low 
rates. There's more of a premium today on trading execution so 
it's difficult to get paid the way the brokers used to be able 
to for their research.
    When I was an analyst, I was incentivized monetarily to do 
good fundamental research. Once a quarter, the institution sent 
a letter in saying, we did X amount of commissioned business 
directed to your firm in return for research services provided 
by the following analysts.
    If my name appeared on more of those letters than my 
compatriots did, I got a bigger share of the research 
department bonus pool. In those days, the research department 
generated enough commission business to have a bonus pool. If I 
did something for investment banking along the way, there may 
be a little sweetener in there for that, but it was the 
frosting on the cake.
    The problem today is it's the cake, because they can't get 
paid for research and they've had to return to investment 
banking to compensate the analysts.
    Chairman Baker. Let's take that point. Let's assume for a 
moment that business practice has changed. We can't undo it and 
it's a fact of life. The conflict of interest will continue. Is 
merely the disclosure of the relationship somehow doing 
something about the IPO problem that was referenced, I believe, 
by Mr. Glantz in your testimony. Is that going to be sufficient 
along with Reg FD-like disclosure requirements sufficient to 
bring back or to establish credibility in analysts' work with 
the average investor.
    If we can't unwrap the investment bank research problem, 
where do we go from there?
    Mr. Glantz. You have asked two question. One question that 
you asked earlier, if I have an investment banker who is making 
the firm hundreds of millions of dollars, I don't care what the 
formal relationship is, he runs research. The second is to 
restore investor credibility. Unfortunately, the investors who 
are hurt the most are not paying for the research, they're 
trading on AmeriTrade.
    Chairman Baker. A network.
    Mr. Glantz. They're trading on the internet. Every once in 
a while I used to go into one of these chat rooms to find out 
what people were saying. I was amazed at the illiteracy, the 
lack of knowledge, ``So-and-so's stock is going to go to a 
hundred,'' and that's not the analysts' fault.
    The criticism I make of analysts is conflict of interest 
and I think that should be on the first page. But is that going 
to cure the problem of the reputation of analysts? No.
    Chairman Baker. Any other comment on the next step?
    Mr. Lashinsky. I would just disagree with one thing that 
Chuck Hill said to get to Ron Glantz's point. Typically, the 
buy side is not particularly upset with the situation. They see 
it as an unfortunate situation, but they know that they can't 
rely on the sell side for buy and sell recommendations. So they 
take the sell side for what it's worth. It's expertise, it's 
knowledge, it's analysis, not its recommendations on the 
stocks. They have their own research teams for that.
    Chairman Baker. Would you like another round, Paul?
    Mr. Kanjorski. I was going to confess something. I gave up 
holding equities when I got elected to Congress. But I have to 
tell you, I gave up going to cocktail parties about 5 years 
ago, because I just couldn't stand to go to them and listen to 
all my friends making 30 and 40 and 50 percent return on their 
investments knowing I'm in Government bonds.
    Now I appear absolutely brilliant, but I want to make the 
point that what some of you were talking about here goes to the 
question of ethics and business. These investment banking 
houses are very substantial houses employing very substantial 
people. It seems to me they are prostituting, as I think the 
word was used, their analysts to help that side of the 
    Am I to believe that Wall Street is so much different than 
say the journalistic area where Katherine Graham stood behind 
her investigative reporters even against the President of the 
United States. Have we lost that standard of ethics in the 
business field? Has capitalism gotten to the level that money 
and money alone is the determining level of what ethics exist 
in the business?
    Mr. Byron. Congressman Kanjorski, I would simply say that 
we're at the end, or we were in March of the year 2000, to the 
longest sustained bull market in the Nation's history. We saw 
levels of premium value attached to stocks that really turned 
people's heads around.
    I think that it's really possible to lose your moorings 
when you can go from $30,000-a-year to $2- or $3-million 
dollars a year in 2 years in a job. So, yes, I think that the 
correction that you're now seeing in the market is likely to 
correct a lot of that.
    Nobody was complaining. Nobody ever complains about the 
stock market when it goes up. It's only when it stops going up 
that people start wondering, well, why didn't you tell me 
before. So the ethical question I think is likely to disappear 
as values return to their historical norms.
    Mr. Kanjorski. With the market coming down, everybody's 
going to get ethics and morals?
    Mr. Byron. You'll find ethics returning to their mean, yes.
    Mr. Kanjorski. I had the one question that I brought up in 
my opening statement. Maybe if you could just individually 
respond if you have a comment on it. I have a great fear on the 
public policy question of privatizing Social Security and 
turning those millions of investors and billions and trillions 
of dollars over to what you describe as an ``unethical, ethical 
or egoistic omen market.''
    What are your feelings on this as individuals? Are we 
prepared to do that?
    Mr. Glantz.
    Mr. Glantz. I think this has to be extremely well thought 
out or we're going to have a repetition of the S&L problem. 
With your constituents saying, ``I just lost half my money, 
make me whole.''
    Mr. Lashinsky. I work for a website that is committed to 
informing the individual investor and I think your concerns are 
extremely valid.
    Mr. Kanjorski. I just want to congratulate you two. Are you 
the last two existing dot com companies?
    Mr. Lashinsky. I'm not sure how to respond to that.
    Mr. Kanjorski. Going back to what I said before, when I was 
growing up in a rather conservative investor home, we used to 
think of real estate investments the way you figure out the 
value of property was ten times earnings rentals: That was a 
pretty good mix of whether the profit was going to be there and 
the real estate investment, a maximum of 12 to 20 percent 
profits or earnings to price.
    Then, of course, I went to these cocktail parties 5 years 
ago and I heard 100-to-1. You didn't worry about companies even 
making earnings. It was what do we call it, a new market, a new 
    Chairman Baker. Stupidity, I think is what it was.
    Mr. Kanjorski. We do not want to go into overkill. I, for 
one, would like to see more Americans have the capacity to 
participate in equities. I think that is a major positive 
feature of America today and the world today, but we cannot 
allow unrestrained exposure of the fox in the hen house, and 
I'm even worried about H.R. 10.
    Now we have allowed these securities companies to become 
part of huge banks and huge insurance companies. If they are 
willing to pollute and prostitute any measure including the 
media, maybe we have some fear out there. Unfortunately, maybe 
we need Government restraint, even though so many of us would 
like to have less regulation. Maybe we are starting down a 
trail that we have created our own monster.
    How is H.R. 10 treating this? I talked to a banker the 
other day and he expects the world to have six multi-trillion 
dollar banks in the next 10 to 20 years and that will be it. 
The rest will be little mom and pop operations out there. 
That's an awful lot of economic power to put in the hands of 
single people. The questions are what will they do with it, and 
what will the people that work for them do with it, and how 
willing will they be to surrender their ethical standards or 
    Anyway, Mr. Chairman, again, great panel, great discussion. 
I think we can take back to our membership a great transcript. 
Thank you.
    Chairman Baker. Thank you very much, Mr. Kanjorski. I too, 
like Ranking Member Kanjorski, don't have any investments in 
the market. Given my responsibilities, I don't think that's 
appropriate. But my son asked me some time ago, ``Dad, when 
should I get out of the market?'', and I told him ``About 3\1/
2\ years ago.'' This thing can't last. He just started speaking 
to me a couple of weeks ago now that things have gone in a 
different direction.
    There is no doubt that the individual investor shares a 
great deal of responsibility in the current market 
circumstance. People don't make you put your money in the 
market, you have to make a conscious decision to write the 
check, to add the debit to your account. But I think our 
concern, properly focused, is when you make that decision that 
the information you are receiving is unbiased, accurate, and 
any interest in the party that is giving you the information 
material to your investment decision should be made clear.
    There's nothing wrong, and I've used it numerous times in 
prior hearings, in Louisiana real estate law, if I'm going to 
represent buyer and seller, I must have a written disclosure by 
both that that is OK, and then I am not allowed by law to give 
any information about the buyer to the seller or conversely 
that would prejudice the ability of the other to get full 
market value, or for the seller to get the best price.
    I become basically a letter carrier at that point, and can 
no longer espouse a particular party's interest in that 
transaction. We have got to get our standards and the 
consequential effects for violating the standards in a position 
where I can have the same confidence in the analysts that my 
constituents are utilizing that I think my constituents can 
have in a Louisiana realtor.
    I don't think that is a standard that's too high to 
achieve. So from my perspective, with your good help over the 
coming months, we hope to be able to encourage the private 
market to see the advisability of this effort to be cooperative 
and to perhaps lead us in the right direction.
    But, as some have indicated, if we are not successful and 
the problems do not appear to be remedied, then I certainly 
would not at this time rule out the possible further actions of 
this subcommittee, given the Members' interest expressed here 
    With that, I thank you for your courteous and lengthy 
participation and we look forward to hearing from you further.
    Our hearing is adjourned.
    [Whereupon, at 5:15 p.m., the hearing was adjourned.]

                            A P P E N D I X

                             June 14, 2001