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The Analyst as Fiduciary: A Misguided Quest for Analyst Independence?Jill E. Fisch
*
 
Abstract
The role of the research analyst has come under extensive scrutiny. Analyst conflicts of interesthave been blamed for distorting analyst reports and recommendations, and undermining theanalyst’s role as an information conduit for investors and a gatekeeper of the integrity of thesecurities markets. The regulatory response has been a call for mandated analyst independencefrom conflicts of interest, particularly those relating to investment banking.This Article challenges the regulatory goal of analyst independence. The Article questions theextent to which so-called analyst business relationships are inconsistent with their clientobligations and the degree to which the supposed conflicts reduce the quality of analystinformation. The Article also demonstrates that the independence requirement can only bepredicated on a conception of the analyst a fiduciary – a conception that is inconsistent with thenature of the research industry. More importantly, the Article argues that the costs of imposingfiduciary status on research analysts are too high. By removing viable sources of funding analystresearch, mandated independence is likely to be counter-productive and to reduce marketefficiency. As an alternative, the Article identifies several more limited regulatory changes thatare likely to increase the value of analyst research to the market while maintaining its financialviability.
Introduction
Several years ago, New York Attorney General Eliot Spitzer revealed widespreadmisconduct by research analysts including disseminating recommendations to the investingpublic that were inconsistent with their true opinions. In response, Hillary Sale and I argued thatanalysts should face increased liability exposure for releasing recommendations and reports forwhich the analyst had lacked sufficient supporting information, either because of a failureadequately to investigate or because the analyst’s private information was inconsistent with theposition taken publicly.
1
We premised our position on the analysts’ role as information
*
T.J. Maloney Professor of Business Law and Director, Center for Corporate, Securities & Financial Law,Fordham Law School. Copyright 2006 Jill Fisch. A prior version of this paper was delivered as the keynoteaddress at the 2005 Corporate Law Teachers’ Association Conference at the University of Sydney Faculty of Law.I am grateful for the many helpful comments and suggestions I received at that conference and for the thoughtfulcommentary provided by Tony D'Aloisio, Managing Director and CEO, Australian Stock Exchange. I am alsograteful for helpful comments from Hillary Sale, Rob Sitkoff, and the participants in the Eugene P. and Delia S.Murphy Conference on Corporate Law at Fordham Law School.
 
1
Jill E. Fisch & Hillary Sale,
The Securities Analyst as Agent: Rethinking the Regulation of Analysts
, 88 I
OWA
L.
 
R
EV
. 1035, 1040-43 (2003).
 
 
2intermediary in the securities markets. Our recommendation was somewhat akin to the state lawduty of candor imposed on corporate insiders by decisions such as
 Malone v. Brincat 
2
and
Shamrock Holdings v. Iger.
3
 Regulatory reforms generated by the analysts scandals extended well beyond requiringanalysts to be honest. Focusing almost exclusively on analyst conflicts of interest, regulatorshave mandated a variety of disclosure requirements and structural safeguards designed to assureanalyst independence. This independence is designed to reestablish the analyst’s role as agatekeeper of the integrity of the securities markets.
4
In so doing, the regulations have the effectof placing the analyst in the position of a fiduciary for the investing public.At the same time, courts have been not bought into the quest for analyst independence.Resisting the view that investor losses resulting from the bursting of the technology bubble canbe laid at the feet of unduly optimistic analyst reports and recommendations, the courts havebeen reluctant to treat analysts as fiduciaries.
5
Judges confronted with shareholder litigationhave repeatedly questioned the extent to which investment banking conflicts tainted analystresearch or defrauded investors. Unlike Congress, the SROs and the SEC, courts appear to valuethe analysts’ role as information conduits and to question the extent to which that role isconsistent with the stringent mandates of the fiduciary model.
6
 The characterization of the analyst as a fiduciary is a key element in mandatingindependence. The core component of a fiduciary relationship is the duty of undivided loyalty.This loyalty is compromised by the other business interests possessed by the analyst and theanalyst’s firm, including investment banking operations, generating brokerage commissions
2
722 A.2d 5, 9-12 (Del. 1998) (articulating duty of disclosure as a component of the fiduciary duties of care andloyalty).
 
3
2005 Del. Ch. LEXIS 83, *16 (2005) (describing director duty “to communicate honestly with shareholders”).
 
4
Securities & Exchange Commission, Statement Regarding Global Settlement Related to Analyst Conflicts of Interest, Apr. 28, 2003,http://www.sec.gov/news/speech/spch042803com.htm(describing the analyst’s role as a“gatekeeper”) (hereafter Global Settlement Statement).
 
5
 
See
Jill E. Fisch, Cause for Concern: Loss Causation and the Analyst Scandal (working paper 2006) (describingsecurities fraud litigation against analysts).
 
6
The best known example, of course, is the Supreme Court’s decision in
 Dirks v. SEC,
463 U.S. 646, 658 (1983).
 
 
3through securities transactions, the operation of mutual funds, and so forth. If the analyst owesfiduciary obligations to investors, these other business interests create conflicts of interest.Hence independence from such conflicts is an essential element of fiduciary status.This article questions whether imposing fiduciary obligations on analysts and theresulting quest for analyst independence make sense. The article evaluates the extent to whichanalyst independence is logical, based on the business structure that underlies equity researchand the nature of the analyst’s relationships with those to whom analyst research is disseminated.The article argues that so-called conflicts of interest are an inherent part of the industry becausethe public good nature of research requires firms to subsidize its cost through other relatedbusinesses. The conflicting demands of these related businesses – investment banking,brokerage, and asset management – preclude the analyst from acting with undivided loyalty toretail investors. Moreover, the article questions the value of mandated independence, citingempirical research demonstrating that even potentially biased research provides information tothe market.Given that regulators have already decided to address the analyst scandals by requiringstructural separation of research from investment banking, do these concerns continue to matter?They do, in part because of the substantial costs of mandated independence.
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Absent financialincentives for analysts to supply research, investors, particularly retail investors, are unlikely toreceive it. If they cannot recover the cost of research through other activities, analysts are likelyto limit themselves to serving institutional investors who are willing to pay substantial fees –increasing information asymmetry in the markets. Alternatively, analysts may simply abandontheir positions as sentinels. Consequently, mandated independence may have the perverse effectof reducing the quality and quantity of available information. Indeed, early market responses tothe new regulatory restrictions on analyst conflicts of interest suggest a dramatic reduction inmarket information. This reduction threatens the efficiency of the financial markets andincreases the cost of capital, particularly for small and mid-cap issuers.
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In addition, regulators outside the United States are evaluating the U.S. reforms and considering whether to adoptsimilar measures.
See
Pauline Skypala,
Robeco Chief urges EU to back independent research,
F
IN
.
 
T
IMES
, Feb. 14,2005, at 2
 
(describing call by Independent Research Think Tank for the European Union to boost independentresearch because of concern over investment banking conflicts). The concerns identified in this article offer reasonsto question the appeal of the U.S. approach.
 
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