The NYT, the SEC and Insider Trading (Part 3)
We are discussing the piece in the NYT about alleged "insider" trading at Lehman Brothers. See Is Insider Trading Part of the Fabric?.
The article contained allegations suggesting that pressure had been placed on analysts at Lehman to write more favorable opinions in order to garner additional investment banking business. This raised possible concerns under NYSE Rule 472 and the global settlement with brokers designed to separate their investment banking and analyst functions. Lehman was one of the firms subject to the global settlement.
What ever concerns exist over the relationship between investment banking and analysts, the JOBS Act just put in place a provision designed to make the separation far more difficult to maintain. According to Section 105 of the On Ramp provision, Section 2(a)(3) of the Securities Act was amended to provide that, in connection with a public offering for equity securities (and not just the IPO) for an "emerging growth company," the publication of an analyst report will:
not to constitute an offer for sale or offer to sell a security, even if the broker or dealer is participating or will participate in the registered offering of the securities of the issuer.
This presumably means that the SEC cannot restrict the distribution of analyst reports (even those issued by the underwriter) during the offering process. It probably sets aside the restriction in NYSE Rule 472 that prohibited analysts at firms involved in the underwriting from circulating reports until 40 days after the offering. See Id. ("A member organization may not publish or otherwise distribute research reports regarding an issuer and a research analyst may not recommend or offer an opinion on an issuer's securities in a public appearance, for which the member organization acted as manager or co-manager of an initial public offering within forty (40) calendar days following the offering date.").
Moreover, Section 15D of the Exchange Act has been amended to provide that with respect to an emerging growth company engaging in an IPO, neither the SEC nor the exchanges can adopt rules that restrict:
based on functional role, which associated persons of a broker, dealer, or member of a national securities association, may arrange for communications between a securities analyst and a potential investor;
The provision presumably overturns the prohibition in NYSE Rule 472 on analysts participating in road shows and may overturn the prohibition on communcations with prospective customers "in the presence of investment banking department personnel or company management about an investment banking services transaction."
Likewise, the SEC and exchanges cannot adopt a rule that restricts:
a securities analyst from participating in any communications with the management of an emerging growth company that is also attended by any other associated person of a broker, dealer, or member of a national securities association whose functional role is other than as a securities analyst.
Analysts can, therefore, attend meetings in which management of an emerging growth company is "pitched" for investment banking business, overturning yet another requirement of NYSE Rule 472. See NYSE Rule 472 ("A research analyst is prohibited from participating in efforts to solicit investment banking business. This prohibition includes, but is not limited to, participating in meetings to solicit investment banking business (e.g., "pitch" meetings) of prospective investment banking clients, or having other communications with companies for the purpose of soliciting investment banking business.").
All of this suggests that analysts can, with respect to emerging growth companies, have a much greater connection to the efforts to sell shares and to pitch management. It will likely be difficult to ensure that this involvement is limited to emerging growth companies. Moreover, it will likely be difficult to ensure, given this involvement, that analyst reports are uninfluenced by the needs of the investment banking arm of the firm.
Thus, for example, it is hard to imagine an analyst for a managing underwriter issuing an unfavorable report during the offering. This will be true even where the analyst is not subject to direct pressure from the investment banking side of the firm. Investors, therefore, will always get a positive spin on the company, at least from the analysts connected to the underwriter.
As the tumbling Facebook shares illustrate, investors benefit not from a rosy forecast but from the truth. It is not at all clear that the provisions of the JOBS Act governing analyst reports have advanced that possibility.