The Securities and Exchange Commission charged an investment bank’s research analyst with publishing a rating on a stock that was inconsistent with his own view. Charles P. Grom gave a public “buy” recommendation to the retailer Big Lots, but privately expressed his concerns about the company.
“We just had them in town so it’s not kosher to downgrade on the heels of something like that,” he said on an internal conference call, according to the S.E.C.
Regulation Analyst Certification (Reg AC) came out of the Dot Com bubble burst. Investment banks were handing out favorable public analyst recommendations to their clients, but providing conflicting advice to their institutional clients. Sarbanes-Oxley required the SEC to adopt a rule addressing analyst conflicts.
The most famous case under Reg AC was Henry Blodget. In 2003, the former Merrill Lynch tech stock analyst paid $4 million in fines and disgorgement and was permanently barred from the industry. (Mr. Blodget neither admitted nor denied wrongdoing as part of the settlement.) Ten investment banks paid $1.4 billion in fines for publishing analyst recommendations that conflicts.
It’s been quiet under Reg AC for a decade. I assume banks took steps to correct the conflicts.
I also assume that they enforced the “Fight Club Rule.” The First Rule and Second Rule being that you do not talk about Fight Club. Analyst should not speak about any conflicting advice.
Mr. Grom broke the rule and revealed that investment banks may not have taken Regulation AC to heart.
On March 2, 2012, Mr. Grom published a “Buy” rating on Big Lots.
On March 28, Mr. Grom and the bank hosted Big Lots executives and spent most of the day with them.
Over the course of the day Mr. Grom told a trader to sell 25,000 shares from the bank’s proprietary account.
Over the course of the same day Mr. Grom spoke with four of the bank’s top priority “Global Research Service Level 1” hedge funds. Each of those funds then sold all of their positions in Big Lots.
Then on March 29. Mr. Grom issued a research report on Big Lots entitled “Not All Is Good In Buckeye Land,” in which he reiterated his BUY rating.
On that same day he said on a conference call with the bank’s research and sales personnel: “We just had them in town so it’s not kosher to downgrade on the heels of something like that.”
Then on April 24 he revealed that he had violated Reg AC on a call with the bank’s research and sales personnel
“[F]ortunately we told many clients a few weeks back to sell the stock.. . . I think the writing was on the wall [that] we were getting concerned about it, but I was trying to maintain, you know, my relationship with them. So, that’s why we didn’t downgrade it a couple of weeks back.”
Oops.
The question that comes to mind: how did Grom get caught? Perhaps it was internal compliance who reviewed the internal call. That would be a double face palm event for violating Fight Club Rule 1 and Rule 2. Maybe it was SEC or FINRA examiners reviewing a recording of those conference calls. It’s an easy win for them.
Sources:
- SEC: Deutsche Bank Analyst Issued Stock Rating Inconsistent With Personal View
- SEC order
- Regulation Analyst Certification
- Ex-Deutsche Bank Analyst to Pay $100,000 Over Ratings by Liz Moyer in DealBook
- SEC dusts off Reg AC to charge former Deutsche Bank analyst by Bruce Carton in Compliance Week
