Time to Move On: The SEC Was Right to Retire the Global Research Analyst Settlement

By Robert Cook, President and CEO, FINRA

The Global Research Analyst Settlement (GRAS) was an important enforcement response to misconduct over 20 years ago by 12 firms that had published biased research to curry favor with investment banking clients during the dot-com era. In addition to fines and other sanctions, the GRAS imposed special undertakings on these firms to address conflicts of interest between their research and investment banking functions.

Recently, the SEC consented to amendments to the GRAS that terminated these undertakings in recognition of changes that have been made to the regulatory regime for equity research.¹

The SEC made the right decision. Like most enforcement undertakings, the GRAS restrictions were never meant to last in perpetuity. Indeed, express language in the GRAS presumed they would eventually be retired once an enhanced regulatory framework was established that would apply to all firms, not just the original 12 subject to the GRAS. And in fact, actions by Congress, the SEC and FINRA have accomplished just that: creating a robust regulatory regime to safeguard the integrity of equity research that amply justifies retiring the GRAS.

Most of this regime was built through FINRA rulemaking under the supervision of the SEC. Over several years, FINRA added a suite of new requirements into what is now Rule 2241 that were approved by the SEC over two administrations.² These requirements were designed to manage the same conflicts as the GRAS by separating research and investment banking and prohibiting conduct that could compromise an analyst’s objectivity. Moreover, these rules apply not only to the remaining GRAS firms (several of the original 12 firms have since merged, been acquired or are no longer in business), but also to over 250 other firms that engage in some research activities.

Congress and the SEC have also weighed in. The Sarbanes-Oxley Act (SOX) prescribed conflict management requirements for research that were effectuated through FINRA’s rules. And the SEC’s Regulation Analyst Certification complemented FINRA rules by requiring analysts to attest to the veracity of their research and confirm they have not been compensated for specific recommendations.

A recent opinion piece³ by former SEC Chairman Arthur Levitt critical of the SEC’s action on the GRAS suggests that this regulatory regime is inadequate, and that the GRAS remains necessary to defend against tainted equity research. Chairman Levitt’s piece focuses particularly on the GRAS requirement that every communication between research and investment banking—no matter the form or content—must be chaperoned.

Setting aside the fact that the GRAS applied only to a small subset of firms engaged in research, treating its undertakings as indispensable ignores the efficacy of these other requirements whose broad scope and detailed obligations provide layers of protections for investors even in the absence of a one-size-fits-all chaperoning requirement. FINRA’s rules in particular include many specific mandates that address this issue, along with core principles that must be implemented in a manner best suited to the complexities of different business models and unique fact patterns.

For example, these rules explicitly prohibit certain potentially problematic interactions and, as required by SOX, expressly mandate information barriers and other safeguards reasonably designed to insulate analysts from investment banking. Such barriers and safeguards are commonly used to manage various conflicts across the industry, and firms may utilize chaperoning as appropriate to the circumstances. Moreover, investment bankers cannot review draft research, supervise research analysts or influence their compensation; analyst pay cannot be based on contributions to investment banking; and analysts cannot solicit investment banking business. The rules also require prominent disclosures of conflicts in research reports and public appearances.⁴

FINRA rules actually exceed the GRAS restrictions in key respects. For example, they prohibit selective dissemination of research, require proactive identification and management of any material conflicts impacting research—not just investment banking conflicts—and mandate enhanced disclosures that help investors assess the accuracy of analyst recommendations.

While Chairman Levitt’s opinion piece offers an example of problematic behavior to illustrate the purported dangers of retiring the GRAS, the example instead demonstrates its obsolescence. As the piece notes, an analyst at a non-GRAS firm competing for a proposed IPO in 2014 engaged in improper solicitation activities. But this behavior violated FINRA’s rules and resulted in an enforcement action by FINRA. FINRA concurrently brought enforcement actions against several GRAS firms whose analysts also engaged in impermissible solicitation activities in connection with the same offering. The GRAS did not prevent any of this conduct from happening at GRAS firms, nor was its absence (with respect to non-GRAS firms) an obstacle to prohibiting and sanctioning the relevant behavior. More broadly, since the GRAS, the SEC and FINRA have consistently brought enforcement cases under their rules to support the integrity of equity research; none of these cases were brought under the GRAS.

Objective and reliable equity research plays a critical role in assisting investors with making informed capital allocation decisions. And the risks to investors and markets of unregulated conflicted research are very real. But research is a dynamic and complex business. Unfortunately, as a 2022 SEC staff study confirmed, there is a shrinking universe of research coverage, particularly for smaller issuers, to the detriment of our public markets. This trend, caused by a variety of factors, underscores the need for regulators to carefully consider and periodically revisit policies that may impact research.

Regulators can do this most effectively by following a transparent process that includes engagement with market participants, the opportunity for public comment and an open debate about the trade-offs inherent in any policy choice—like the process FINRA followed in developing its rules—not by perpetuating enforcement undertakings for some firms that were meant to be a temporary bridge to comprehensive rules for all firms.

While FINRA’s research rules have proven effective, they are not immutable. As part of the FINRA Forward initiative,⁵ FINRA has been engaging with market participants about how FINRA can improve its capital formation rules, including with respect to research.⁶ This work is ongoing, and FINRA will be hosting a roundtable of its members in the near future to further explore challenges and opportunities with respect to research. As the research business and investor preferences evolve, FINRA will continue to work with the SEC and interested parties to ensure the relevant rules enable firms to produce the quality and objective research that investors deserve and that will facilitate vibrant capital markets in which everyone can participate with confidence.