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December 1, 2002

Research and Reform

By John A. Byrne

Before signing off on the last issue in this year, I have a confession. The Feds may be about to blow another big hole in your golashes. I can't think of anything more ridiculous than the current debate on conflicts of interest in research. The proposed reforms in the "global settlement," which stem from the discovery of financial fiction passed off as research, could be costly. If the reformers succeed and enact new laws that change the dynamics of the trading markets, these new laws won't be the last. Sure enough, the reformers will have an insatiable appetite for more. Will the reformers then submit each analyst to regular lie detector tests so that we can be absolutely certain analysts are not illegally using your commission dollars for free passes to Yankee games? Will the reformers unveil amazing schemes to bring peace on earth and good will among all trading men and women, all the time, everywhere? Will the reforms, if enacted without common sense, backfire?

"If I have a trader looking at a group of stocks and he is spotting a trend, he can call our analyst today and ask what's happening," said the head of one Nasdaq dealer desk. "The analyst can now tell the trader whatever is public information on this stock." But under the logic of the proposed plans, the free flow of information between an analyst and a trader could be impaired. Who wants to be accused later of having intentions, words and recommendations read out of context? "What happens if a stock goes down two bucks and the analyst didn't see the price change?" asked the same head trader. "I want my trader to call the analyst and say the stock is down two bucks. I want the analyst to say, hey thanks,' I am going to call the company and find out what is happening."

Then there is the question of commissions. One view is that commissions rates will rise. That's to pay for the heavy cost of so-called independent research. Another view is that more institutions will start abandoning sellside research. "I expect to see a wave of consolidation and brokers abandoning research that is perceived as a commodity," Harold Bradley, the outspoken executive at American Century, told me. Bradley, referring to Web-based research services, makes an even more tantalizing comment. "I expect to see a number of ECNs hook up with independent analysts who see no compelling proposition in remaining with brand name firms...when ECNs can do an immediate soft conversion based on a single analyst's intellectual contribution as measured in paid views." Bradley's analysis is broadly in line with trends in the institutional markets since fixed commissions were abolished in 1975. On the other hand, the proposed reforms could take us in another direction - a step backwards to the days when commissions were fixed. In that case, the usual suckers will end up having to pay the bill. Have a Happy Holiday and a prosperous New Year.


John A. Byrne