THE 2003 ALL-EUROPE RESEARCH TEAM

European firms crowd the top slots. UBS stays in first place for overall team strength. Deutsche Bank repeats in third. Of American firms, Citigroup/Schroder Salomon Smith Barney lands at second overall.

Click here to view the entire 2003 All-Europe Research Team results available in the Research & Rankings section of this site.

On December 20, U.S. regulators gathered at the New York Stock Exchange to announce a landmark $1.435 billion settlement with ten securities firms that were under investigation for allegedly issuing biased research reports to unknowing investors. The deal capped months of probing by investigators and a punishing flurry of bad press for Wall Street, as its seediest policies and practices were laid bare for public viewing. With the flash-bulbs popping, nine months of fierce and unpleasant negotiations had come to an end, and the industry could leave the scandal behind it. Right?

Not exactly. The all-important details of this landmark agreement-in-principle are still being frantically hammered out by regulators and the firms involved. And one of the most contentious issues to be decided pits the firms against each other, not the Securities and Exchange Commission or New York State Attorney General Eliot Spitzer, who led the research inquest. Basically, the tiff concerns how -- or if -- the terms of the U.S. settlement should be applied elsewhere. The issue is of particular concern in Europe, where U.S. investment banks spent much of the past decade establishing beachheads in competition with local firms.

The press conference inside the stately boardroom of the NYSE had barely ended when a group of U.S. firms with significant European business -- Goldman Sachs Group, Morgan Stanley and Salomon Smith Barney among them -- began pushing for the settlement terms to be applied to operations around the globe, not just in the U.S., say people close to the matter. Credit Suisse First Boston, owned by a Swiss bank but run from the U.S., is siding with the U.S. firms, these people say.

“It’s kind of difficult for us to imagine how you don’t apply the structure and compensation globally,” says CSFB vice chairman Gary Lynch, speaking of analysts. The former SEC enforcement director was recently given responsibility for stock research and legal and compliance issues at the firm.

But other European houses, led by UBS Warburg and Deutsche Bank, are vehemently resisting the idea. They argue that the problems and conflicts surrounding research were not nearly as pronounced in Europe as they were in the States and that adopting all of the proposed U.S. reforms there could have drastically negative consequences for European capital markets.

The dispute is likely to get more contentious -- and public -- this month. The U.K. Financial Services Authority is expected to issue a consultation paper outlining proposed regulations that, say people following the issue, are similar to much of what has been introduced in the U.S. Brokerage firms would be encouraged, for example, to publish in research reports their firmwide breakdown of buy, hold and sell recommendations. But the agency is expected to stop short of mandating that securities firms distribute to their retail clients research from other firms that are deemed independent of investment banking conflicts, as U.S. regulators did. The FSA regulations will likely outline best practices, not specific requirements and prohibitions.

FSA chairman Sir Howard Davies described the agency’s aims to delegates at the World Economic Forum last month in Davos, Switzerland: “All the things that were dealt with in the Spitzer settlement we will deal with in a U.K.-compatible way.”

The firms themselves will not comment about the dispute, but in private each side accuses the other -- surprise! -- of trying to lever the settlement negotiations to its own advantage. The U.S. firms snipe that their European rivals would be willfully skirting the spirit of the agreement to flout it outside the U.S., while the European firms counter that the New York banks want to extend the settlement across the Atlantic to compensate for declining clout in Europe. As recently as 2000 Merrill Lynch and Morgan Stanley were ranked first and second, respectively, by investors voting in this magazine’s All-Europe Research Team survey, and the year before four of the top five firms were domiciled in the U.S. But the tide has turned, as the results of this year’s team indicate.

European firms crowd the top slots, led by UBS, which repeats in first place for overall team strength. Deutsche Bank, eighth as recently as 1999, repeats in third; CSFB takes fourth place. Among American firms, Citigroup/Schroder Salomon Smith Barney turns in the strongest showing, climbing to second overall from fourth last year. Merrill Lynch and Morgan Stanley repeat in fifth and sixth places, respectively. Goldman Sachs International falls to ninth from seventh (in 1999 it ranked fourth).

U.S. firms do fare relatively better in rankings of industry and macroeconomic sector coverage -- and excluding country-focused research -- which we break out in this year’s poll to reflect the increasingly pan-European nature of research coverage. CSFB takes top billing in the industry and macro coverage rankings, followed by Citi/SSSB and UBS in a tie for second. Merrill and Morgan Stanley tie for fourth, followed by Deutsche Bank in sixth.

There is clearly a growing split among firms with regard to country coverage. Some houses, principally American, have scaled back or abandoned their country coverage, seeing it as an unjustified expense that industry-focused clients value less and less. Others, mainly European, say that the changing coverage reflects not fundamental shifts in investor needs but severe cost-cutting brought on by sour markets and that institutions still value the combination of sector research and country strategy.

“We’ve made a deliberate business decision to address our clients that way,” says Nicholas Pink, a member of the research management team at UBS. “Other firms are taking different decisions, perhaps because of cost pressures or perhaps because they have a different view. But our clients tell us they want a comprehensive offering, so we are orienting ourselves that way.”

Investment banks had better get it right soon, because their institutional clients say that the quality of the research they produce is declining rapidly. In 2001 we asked voters in the All-Europe survey to rate for the first time the quality of sell-side research on a scale of one to ten, with ten being the highest. The average score that year was 6.45. That declined to 6.17 in 2002 and to 5.93 this year. On the brighter side, respondents to a supplemental survey point to some positive changes during the past 12 months. Sixty-two percent of this group say that analysts are more likely to issue sell ratings than before the recent raft of corporate scandals, and half say that analysts have become more skeptical about the quality of corporate earnings (for complete details, visit www.institutionalinvestor.com).

Many forces are pushing for change in the way that European research is conducted. Apart from the FSA, the European Commission, as part of a larger effort to create a single European securities market, is also considering whether to include language addressing research conflicts in pending legislation.

Additionally, the U.K. Treasury is scheduled next month to complete a two-year review of the fund management and brokerage industries, in which it will judge whether the private sector has gone far enough in heeding the recommendations set out in the Myners report on institutional investment that it published in March 2001. The report, written by former Gartmore Investment Management chairman Paul Myners, concluded that the management of U.K. pension assets required sweeping changes to root out conflicts and inefficiencies.

The government is expected to push money managers to pay brokerages separately for research and trade executions, which for decades have been bundled together and paid for with brokerage commissions. Separating the two -- by essentially mandating that commissions cover only trading services and that research costs carry a separate bill -- will either raise costs dramatically for the buy side or squeeze the revenue and margins of the sell side (Institutional Investor, November 2002).

But European regulators are unlikely to go as far as their U.S. counterparts. Far fewer individuals invest directly in the stock market in Europe than in the U.S. Most pension schemes as well as other institutional investors have only begun to broadly embrace stocks over bonds and other more conservative investments. And, historically, investment banks have been less likely to try to curry favor with corporations by touting their stocks to individual investors. As such, Europe lacks the masses of blame-slinging retail investors that helped fuel the political and regulatory inquisitions in the U.S.

Still, uncertainty about what changes may come in Europe is unsettling some research officials. “With everything we’ve got going on -- the Spitzer business, the FSA and the European Commission doing their bit, Myners -- nobody knows exactly what’s going to happen. But everyone worries it’s going to be big. You are talking about long-term winners and losers here. If you’re not paying attention and planning for the various contingencies, you could be left out in the cold,” says one European sell-side research chief.

One likely change: less research, largely because there will be less money to pay for it. Brokerage houses already have been slashing their ranks. CSFB has cut 100 people from European research in the past two years. Citi/SSSB is down to 225 people from 300 about 18 months ago. These cuts have come as revenue from underwriting and advisory fees has dried up. But if regulators decide that this revenue, even when it flows again, cannot fund research because it fuels a conflict of interest -- or if the U.K. government prohibits brokerages from accepting trading commissions as payment for research -- more cutbacks are certain.

In the end, though, the biggest concern of many sell-side officials is that their competitors will come out of all the regulatory churning with an unfair advantage. U.S. regulators had targeted the end of January for ironing out the settlement details, though that goal appeared unlikely to be met until later in the year. Even when the ink is dry, research officials say it will take several months before the agreement’s real effects can be assessed. In Europe the various regulatory projects under way aren’t expected to yield anything concrete for quite a while. In the meantime, a lot of eyes previously trained on New York will turn to the new European front in the ongoing conflict between regulators and investment bankers over stock research.

Click here to view the entire 2003 All-Europe Research Team results available in the Research & Rankings section of this site.

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