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SEC approves new rules to curb analysts' conflicts of interest

| Thursday, May 9, 2002

WASHINGTON (AP) — That analyst on television praising some stock to the heights is going to have to let you know if he has a financial interest in the company.

Seeking to restore investor confidence shaken by Enron's collapse, federal regulators approved rules Wednesday requiring analysts to clearly disclose, in research reports and TV and radio interviews, their interest in companies whose stock they tout.

Financial analysts can reach millions of households on television and their advice was heeded by investors during the bull market of the 1990s. Yet critics say they have compromised their power by holding significant positions in stocks they recommend.

The rules, designed to curb conflicts of interest among analysts, also prohibit securities firms from tying their analysts' compensation to some investment-banking business the firms do for companies.

Proposed by Wall Street's self-policing bodies and approved by the Securities and Exchange Commission, the rules have been criticized by consumer advocates and some lawmakers as not going far enough.

The SEC action came a few days after the agency opened an investigation into whether analysts at big Wall Street brokerages rated certain stocks highly so that their firms could obtain lucrative investment-banking business. That business includes arranging and financing companies' first sales of stock to the public.

Several prominent analysts touted high-tech stocks while their firms financed the companies' initial public offerings.

If an analyst knowingly makes a false recommendation on a stock, "that is fraud, pure and simple" and it will be prosecuted, Annette Nazareth, director of the SEC's market regulation division, said at an open meeting before the vote by the three SEC commissioners.

For about a year, New York state's attorney general, Eliot Spitzer, separately has investigated alleged conflicts and possible fraud by analysts at big brokerage houses, including Merrill Lynch & Co.

Spitzer recently released documents and e-mails showing that Merrill analysts privately used profanities to describe some stocks and the words "disaster" and "dog" for others while publicly recommending that investors buy the companies' shares.

"In light of the recent revelations, it's clear that the rules they (the SEC) came out with today don't go far enough," said Juanita Scarlett, a spokeswoman for Spitzer. "We hope our investigation will serve as a catalyst for much-needed reform."

At yesterday's meeting, Nazareth said the rules for analysts were urgently needed because "strengthening investor trust and confidence is critical to our markets."

The potential conflict of interest arises because the brokerage firms for which analysts work often invest in the companies being scrutinized, and can profit from the analysts' recommendations.

Firms that tie analysts' pay to their success in attracting investment banking business for the firms may compromise the analysts' independence and objectivity, critics say.

In the case of Enron, 10 of 15 analysts who followed the company still rated it as a "buy" or "strong buy" as late as Nov. 8, two weeks after the SEC announced it had opened an inquiry into the energy-trading giant. Enron slid into the biggest bankruptcy in U.S. history on Dec. 2.

Even before the Enron disaster, critics of analysts' conduct said investor confidence was eroded by analysts who issued rosy stock recommendations as the market plummeted in 2000. At one point during the slide, when the Nasdaq composite index was down 60 percent, fewer than 1 percent of analysts recommended selling stocks.

SEC Chairman Harvey Pitt said yesterday that the rules for analysts, proposed by the New York Stock Exchange and the brokers' group that operates the Nasdaq Stock Market, "will go a long way toward addressing concerns that Congress and others have raised."

"Our efforts are not concluded," he said.

The SEC will review the rules within a year to see how well they are working. Some take effect immediately; others will be phased in during the next six months.

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