When the Wall Street research scandal drew to its close last July — as the SEC exacted a “global settlement” from the top investment banks — many reps wondered how it would change their lives. In addition to coughing up a total of $875 million in fines, the firms agreed to new rules on how sell-side research would be conducted and presented to clients.

The thrust of the reform was to separate research from investment banking, a smarmy arrangement that, during the 1990s boom, helped firms like Merrill, Morgan and Salomon Smith Barney use research to generate demand for shares in unproven, unprofitable telecom and dot-com companies. In the words of SEC Chairman William Donaldson, the settlement was intended to restore “the integrity of investment research,” ensuring that it would exist “for the benefit of investors and not for the internal benefit of the investment banking divisions.” The firms were required to spend $432 million on independent research.

Brokers were particularly concerned about one specific requirement of the settlement: The SEC had demanded that brokerage firms provide clients with independent research as well as their own. So, if a rep were telling a client about how bullish the firm was on, say, Exxon Mobil, he would also have to trot out an independent research report, which might present a different view. Even if the indie research supported the firm position, there was, as one Morgan Stanley rep points out, a new, awkward process that threatened to bog down his practice and cut into the number of transactions he could complete.

But those concerns proved unfounded. Clients, it seemed, weren't interested — in the new independent assessments or in the newly sanitized firm research. “I felt like a teacher giving a boring lesson to a class,” says the Morgan rep. “They had absolutely no interest in it, and they just tuned me out.”

Word of Mouth

The SEC requires “oral notice” that research is available whenever an order is placed for clients with less than $10 million in assets. Clients who have between $1 million and $10 million can send a form to waive the notice; those with under $1 million cannot waive it. Reps say their firms have given them clear instructions to make certain that clients know about the independent research and to ensure they have easy access to it. But many say they are finding precious few takers, regardless of how diligently they promote it. “I have a hard enough time letting them know about our research,” one advisor says. “It's something that's over a lot of their heads.”

There is no industrywide data that measures compliance with the new rules, but some brokers who spoke to Registered Rep. for this story indicate that they don't feel compelled to push independent research. “I have to tell you, I very rarely use that stuff,” one Merrill broker says. “It's not that it's bad or good or anything. It's just that it's just one more piece of information that my clients eventually just shut out.”

“It's difficult to see a widespread change because of that settlement,” says an executive at a regional brokerage with an in-house research department. “We tell our reps to make sure the clients know they can access that research, but we don't get the sense that clients are falling over themselves to get at it.”

A representative at one wirehouse acknowledges that his firm has no specific mechanism for measuring client interest in indie research, but he says, “I don't think it's much different than before.”

Lack of Demand

Indeed, reps say that the real lesson to be gleaned here is that research — independent or in-house — long ago ceased to be an effective lure for retail clients. Even before the market crash revealed conflicts of interest that pushed analysts to continue recommending shares, no matter what the real-world prospects were, investors were tuning out. Much of that, some say, is because of the prevalence and accessibility of the research; with most research reports available online, the notion of receiving free research is old news to many clients — and advisors.

So, the reforms seem to have had far less impact on the lives of reps than had been feared. Still, the new rules have certainly changed how Wall Street pays for, executes and uses research. The SEC required that firms contract with at least three independent research firms (the contracts are to last five years before the rules are revisited), that they let their clients know about the available research on the cover of all in-house research reports and that they hire an independent consultant to oversee the third-party research.

Morgan Stanley uses eight companies to fulfill its independent-research needs: Alpha Equity Research, Argus Research, The Buckingham Research Group, Fulcrum Global Partners, IPOfinancial.com, Soleil Securities Group, Standard & Poor's and Zacks Investment Research. The firm declines to say why it chose those firms, saying only that they “met with our requirements and value systems.”

Smith Barney uses five companies: Argus Research, Morningstar, Renaissance Capital, Standard & Poor's and Thomson Financial. Merrill Lynch offers a total of 23 indie research firms.

More of the Same

Is the independent research any better at identifying good buys (and sells)? Indeed, research by Investars, a company that tracks the performance of research, shows that independent research has done “only slightly better” than Wall Street in-house research since the settlement was reached; independents have beaten established market benchmarks by 1.3 percent in 2004, compared to 1.1 percent for in-house research, on average. At the same time, the quality of in-house research may have improved: According to Chip Roame of Tiburon Strategic Advisors, the ratio of sell recommendations to buys has risen from one in 33 since the year before the settlement to one in eight in the year afterwards.

Whether that's a direct result of the reform is not clear. What is clear is that research is no longer the moneymaker it was when it was supported by investment banking.

Last year, according to New York-based research experts Sanford C. Bernstein, research brought in $172 million in revenue for the major Wall Street firms, down more than 50 percent from three years earlier. A Thomson Financial study suggests that this may be because of falling use of firm research by institutional investors. According to the study, 60 percent of money managers prefer independent research to analysis generated by a brokerage firm.

As a result of falling demand, and because of the slowdown in underwriting in 2002 and 2003, many of the big Wall Street research operations have downsized. Smith Barney, for instance, shed a handful of technical analysts and six stock analysts. Merrill Lynch has yet to release the number of analysts let go, but observers say, “there's blood-letting to come, for sure.” And the average senior analysts salary is down a whopping 50 percent from four years ago. Roame predicts further cutbacks in firm research. “My guess is that the full-service brokerage firms will pull back on their research offerings, much as they may with proprietary asset management,” he says. And, he says, that's a good thing for advisors: “Relying on third-party products and research is a return to the concept of a broker, after all.”

And that might be, in the long term, the lasting effect of the research settlement. Whether clients want it or not.