Broker-dealers may provide a range of financial services to clients, including corporations, financial institutions, governments, and individuals. A full-service broker-dealer (or a related subsidiary or affiliate) may employ (1) investment bankers to assist clients with raising capital through underwritings and private placements of equity and debt securities and by offering advisory services on mergers, acquisitions, and restructurings; (2) investment advisers who provide investment advisory and financial planning services to clients; (3) brokers who facilitate client transactions in fixed-income, equity, currency, and commodity products; and (4) securities research analysts who provide equity and fixed-income research services. Securities research analysts play an important role in providing investors with information that may affect their investment decisions. Analysts typically research the current and prospective financial condition of publicly traded companies in the particular industry or sector of the economy in which they specialize. They then make recommendations (e.g., buy, sell, or hold) about investing in the securities issued by the companies the analysts cover in their research. To develop judgments about the future prospects of a company and its securities, analysts may evaluate the company’s expected earnings, revenue, and cash flow; operating and financial strengths and weaknesses; long-term viability; and dividend potential. Analysts often specialize in equity or fixed-income (debt) securities research. Sell-side analysts typically work for full-service broker-dealers and make recommendations on the securities they cover through their research. In contrast, buy-side analysts typically work for institutional money managers, such as mutual funds, hedge funds, or investment advisers, which purchase securities for their own accounts. Finally, independent analysts typically are not associated with firms that underwrite the securities they cover in their research. The securities industry generally is regulated under a combination of self- regulation (subject to oversight by SEC) and direct oversight by SEC. Securities industry SROs primarily are responsible for establishing the standards under which their members conduct business; monitoring the way that business is conducted through regularly scheduled compliance examinations; bringing disciplinary or enforcement actions against their members for violating applicable federal statutes, SEC rules, and their own rules; and referring potential violations of nonmembers to SEC. In 2007, NASD and NYSE’s member regulation, enforcement, and arbitration functions merged to form FINRA, the primary securities industry SRO responsible for overseeing broker-dealers.November 2011, FINRA’s membership included nearly 4,500 broker- dealers. According to FINRA, as of November 2010, approximately 220 firms conduct both investment banking and research. SEC’s oversight of FINRA includes inspecting its operations and reviewing and approving its rule proposals. SEC also directly regulates broker-dealers by conducting As of examinations; taking disciplinary actions against broker-dealers; and interpreting, implementing, or changing its existing regulations. A series of actions involving various federal and state entities culminated in the Global Settlement. SEC reviewed industry practices and conducted targeted examinations regarding analyst conflicts in 1999 and reported the preliminary findings of the examinations to Congress in 2001. In April 2002, the New York Attorney General’s office announced an enforcement action against a broker-dealer based on evidence that analysts were pressured to issue positive stock recommendations to please investment banking clients. Soon after, state regulators, SROs, NASAA, and SEC formed a joint task force to investigate the undue influence of investment banking interests on securities research at broker-dealers. Analyst conflicts allegedly found by the investigations included the following examples. Research analysts supported investment banking by pitching business to prospective clients and marketing investment banking deals to institutional customers through road shows. Equity research analysts’ compensation was determined partly by the degree to which they assisted investment banking or their contribution to investment banking revenue. Investment bankers evaluated research analysts’ performance, influencing research analysts’ compensation. Investment bankers implicitly promised their potential clients favorable research, with analysts participating in the sales presentations. Investment bankers influenced whether analysts would start or continue research coverage on existing or potential investment banking clients. Based on evidence compiled in their investigations, the joint task force members determined the conditions of a settlement to resolve the allegations of misconduct. In April 2003, 10 broker-dealers agreed to the Global Settlement, concluding the joint investigation. In 2004, enforcement actions were commenced against two other broker-dealers involving analyst conflicts, and the firms settled substantively under the same terms as the Global Settlement. Under the Global Settlement, the firms were required to reform their structures and practices to insulate equity analysts from investment banking pressures. A three-part addendum to the Global Settlement constitutes its operative portions (see app. II for a complete description for the separation of research and investment banking, and the disclosure/transparency and other issues sections). Section I of the addendum set forth the structural reforms designed to separate equity research from investment banking. For example, the firms had to physically separate research and investment banking departments; not base research analysts’ compensation, directly or indirectly, on investment banking revenues or input from investment banking personnel; prohibit investment bankers from having a role in company-specific prohibit research analysts from participating in efforts to solicit investment banking business; and create and enforce firewalls restricting interaction between investment banking and research personnel, except in specifically designated circumstances. Section II of the addendum includes disclosure requirements that serve to inform investors about potential analyst conflicts and the performance of analysts’ recommendations. It also includes a provision that allows any Global Settlement term to be superseded by an SEC or SRO rule that expressly purports to do so. With regards to any term that was not superseded in this way within 5 years from the entry of the final judgment of the Global Settlement, the firms could move to amend or modify any term (other than the terms relating to independent research), subject to court approval, unless SEC believed that such amendment or modification was not in the public interest. Section III required the Global Settlement firms to provide customers with independent research. Firms also had to make various payments under the Global Settlement— totaling more than $1.4 billion. Specifically, each firm had to pay civil penalties and disgorgements, in part to establish distribution funds to recompense harmed investors, and other monies to create investor education funds and provide customers with independent research. Views about what harm, if any, analyst conflicts cause investors vary. SEC and FINRA have asserted that analyst conflicts can harm investors. For instance, because of a conflict, an analyst could issue a misleading recommendation on which investors rely and suffer a loss. In a 2003 report, the International Organization of Securities Commissions similarly noted that the conflicts faced by sell-side analysts can result in biased research that harms investors and undermine the fairness, efficiency, and Also, some investors claimed in lawsuits that transparency of markets.biased analyst recommendations artificially inflated market prices of the covered stocks. In turn, they claimed that they bought stocks or held onto stocks that they otherwise would have sold based on the biased recommendations and suffered losses when the stocks returned to their true value. Finally, some academics have suggested that institutional investors may be able to trade strategically to take advantage of misinformed individual investors that naively follow biased analyst recommendations. In contrast to such views, some economists and others have questioned whether biased analyst recommendations, such as overly optimistic recommendations, can lead to investor harm. For example, one economist has argued that SEC enforcement actions against the Global Settlement firms did not establish a clear connection between the analyst conflicts and losses suffered by investors. he noted that in private litigation against one of the firms involving analyst conflicts, the judge found that the plaintiff’s attorneys were not able to craft an argument to show that investor losses could be attributed to the allegedly conflicted research reports issued by a broker-dealer. In addition, some evidence from empirical studies indicates that market prices anticipate and incorporate analysts’ biases, suggesting that biased analyst recommendations do not artificially inflate stock prices to the harm of investors. Erik Sirri, “Investment Banks, Scope, and Unavoidable Conflicts of Interest,” Economic Review, Federal Reserve Bank of Atlanta, Fourth Quarter 2004. We reviewed empirical studies, analyzed examination and enforcement action data, and interviewed market participants and observers to assess the extent to which regulatory actions have addressed equity analysts’ conflicts of interest. In addition to the Global Settlement, regulatory actions taken to address conflicts faced primarily by equity research analysts include the following SEC, NASD, and NYSE rules issued between 2002 and 2005: In May 2002, SEC approved NASD and NYSE proposals to address analyst conflicts. NYSE’s proposal amended NYSE Rule 472, and NASD’s proposal established NASD Rule 2711. These rules (SRO research analyst rules) were substantively similar and designed to restore public confidence in the validity of research and the veracity of equity research analysts, who were expected to function as unbiased intermediaries between securities issuers and investors. The SRO research analyst rules require clear, comprehensive, and prominent disclosure of conflicts in research reports and public appearances by equity analysts. The rules also implement basic reforms to separate research from investment banking. These include prohibiting investment banking personnel from supervising analysts or approving research reports, members from offering favorable research to induce investment banking business, and analysts from receiving compensation based on specific investment banking transactions. In February 2003, SEC adopted Regulation Analyst Certification, which requires, among other things, equity and fixed-income analysts to certify that the views expressed in their research reports accurately reflect their personal views and disclose whether they received compensation or other payments in connection with their views. In July 2003, SEC approved amendments to the SRO research analyst rules. The rule amendments were designed to further promote analyst objectivity and transparency of conflicts in research reports and implement changes mandated by the Sarbanes-Oxley Act of 2002.