September 23, 2002
Jonathan G. Katz, Secretary
RE: Proposed Regulation AC (File No. S7-30-02)
Dear Mr. Katz:
Goldman, Sachs & Co. is pleased to have this opportunity to comment on proposed Regulation AC. We believe that the Securities and Exchange Commission must address the issue of the objectivity and integrity of the research function in broker-dealers and we believe that the basic approach taken in the proposed rule is an appropriate measure in that regard. We do, however, believe that the proposed Regulation should be modified to take account of certain legitimate concerns which firms such as our own and analysts in such firms have with the current terms of the proposed Regulation.
We wish, first and foremost, to focus on two fundamental issues. They stem, we believe, from the lack of recognition in the proposed Regulation and proposing release of two basic realities. First, notwithstanding that proposed Rule 501 begins "A broker or dealer...that publishes...a research report prepared by a research analyst," - that is, that the broker or dealer, not the individual analyst, publishes the research - the wording of the certification as to personal views does not take account of the fact that the firm may legitimately influence the views of the analyst in a report for one of several reasons. Second, research analysts are entitled to be compensated by their firms in part for the accuracy and profitability of their research views. That is the legitimate incentive held out to analysts, and it is in the interests of markets and investors that it be so. Yet the proposed certification relating to compensation is so broad as to implicate such compensation as well as compensation arrangements designed to produce inflated recommendations and overly favorable views due to other business relationships of the firm.
We are therefore concerned that the certification in proposed Rule 501 (a) does not acknowledge the fact that an analyst's work will be subject to a number of supervisory checks that are entirely appropriate, beneficial to investors and indeed required by the rules of the New York Stock Exchange and the NASD. First, an analyst's work is subject to review by supervisory analysts. Second, most firms, to our knowledge, have some sort of ratings review or stock selection committee which must review either all ratings changes or the selection of stocks for certain ratings. An analyst may seek to have the committee approve a certain rating for a stock but fail to persuade the committee; arguably, therefore, the resulting report does not contain the analyst's personal views. Further, a number of firms have policies that either limit the publication of research or limit the content of research published in situations where the firm represents a company involved in a merger or other fundamental corporate event. This is done to guard against the appearance of a breach of the Chinese Wall. Our policies, for example, among other things, require that both companies involved in a merger transaction in which we are involved to be "Not Rated" for the duration of the transaction. Again, given unfettered discretion, an analyst would choose to rate the stock, rather than carry the "NR." Finally, certain of the Commissions own regulations limit the ability of analysts to increase their ratings prior to a public offering. For any and all of these reasons, it may be that the research report which the firm clears for publication does not reflect the analyst's own unreviewed "personal views."
We realize that one possible response to the points raised above is that the analyst be allowed, under the Regulation, to make a "negative certification" - i.e., state that the report does not represent his or her personal views because the firm policies have prevented it. This we believe would overstate the case and would be potentially confusing to investors. Rather than allowing for this possibility, we suggest below an amendment to the wording of the Regulation to accommodate this ongoing management of individual analysts by their firms. We would suggest that this must be a reality of all firms and all analysts from time to time and that is better addressed as a general matter in the Regulation.
As to the second part of the basic certification required, that dealing with compensation in proposed Rule 501(b), we believe that it is worded much too broadly and as such it causes concern both for our firm and our analysts. We believe that the wording of the proposal suffers from being too general and not specifically addressing the underlying issue of concern. That is, in the words of the proposing Release, "analyst compensation may be based significantly on generating investment banking business." While we agree that such a compensation arrangement is improper, we are concerned that the wording of the proposal could be read to call into question the analyst being compensated either for the accuracy of his or her views as to the subject company's prospects or for service to investing clients in understanding the subject company. While we in fact question whether the certification as to compensation is really needed if the first certification is understood, as it must be, to mean that the analyst has arrived at his or her conclusion independently, assuming that the Commission will require the second certification in order to clarify the matter for investors, we believe that the second certification should be much more directly worded, as we suggest below.
We believe that our concerns should be addressed by redrafting the Regulation. We do not believe that the Regulation should be left as is, with only language in the adopting release addressing such issues. We would submit that it is important going forward to have clarity in the Regulation itself, particularly given that the certifications of analysts will use the wording of the rule and that investors will therefore read that certification, not the release.
We submit the following modification of the proposed Regulation for the Commission's consideration as a means of addressing our concerns:
(a) A statement attesting that, subject to supervision policies of the broker or dealer applicable to all research published by it, the views expressed in the research report....
(b) (1) A statement attesting that no compensation arrangement related to the investment banking business of the broker or dealer was, is or will be, directly or indirectly, related to the specific recommendations....
The foregoing matters as to the substance of the certifications to be made under
Regulation AC are our primary concerns. However, on further consideration of the proposal, we are puzzled as to the somewhat elaborate and indirect manner in which the proposal deals with the matter of public appearances. While we do not think that repeated on air certifications are necessary or useful, unless the Commission were to clearly enunciate a permitted shorthand - "I meet the standards of Reg AC," for example - the proposal's approach of requiring no statement at the time of a public appearance but then imposing after the fact record keeping and "corrective" disclosures in print strikes us as overly complicated and missing the point. First, presumably the vast majority of analysts making public appearances will have been making the certifications in their published research and that record will be available to regulators or investors if needed. Second, if an analyst has not and cannot make the certification, the listeners deserve to know at the time of the public appearance. A series of disclosures as in published research perhaps several months later, and a belated notice to an examining authority, hardly addresses that issue. Finally, firms are already obligated under the new SRO rules to keep records of public appearances; thus additional listing of public appearances by analysts is not necessary and a quarter end certification by analysts would only reconfirm, in virtually every case, the certifications the analysts have been making in their published research. The sum of all the foregoing is that the requirement ought to be that, if an analyst making a public appearance would not able to make the Regulation AC certification at that time if publishing research, he or she is obligated to disclose that state of affairs in the public appearance. If that were the rule, the 120 day "corrective" publication thereafter would be unnecessary; listeners would have heard the disclosure and any published research by the same analyst thereafter would have to deal with the compensation arrangements at issue, as per Rule 501(b)(2). We would submit that this approach is much simpler, addresses the issue head on, and avoids both unnecessary "corrective" steps of dubious efficacy and unnecessary and duplicative record keeping.
We do not propose to comment on all the issues raised by the Commission in the proposing Release. However, we do have the following views:
Goldman, Sachs & Co. appreciates the opportunity to comment on proposed Regulation AC. We hope the Commission will address our fundamental concerns in the Regulation as adopted.
If you have any questions about our letter, please contact me at 212-902-6268 or at firstname.lastname@example.org.
Very truly yours,
/s/ John W. Curtis