.COM Pump & Dump Penalties
July 3, 2017
of the primary functions of investment banks are company and
market analysis, and traditional investment banking with capital
raising services. Analysts provide research covering growth
opportunity, earnings outlooks, and provide buy, sell or hold
ratings. Meanwhile, the investment bankers are responsible for
selling securities, providing loans, mergers and acquisitions,
as well as other fee-related activities. When an investment bank
is trying to acquire a business and its' analysts are rating the
same business, the opportunity for bias becomes apparent.
"It's well documented that banks that have relationships with
firms provide biased coverage. So if I have a lending
relationship with you, and I provide analyst coverage, my
analysts are on average a little more optimistic than the
average analyst," Associate Professor and Chair of the
Department of Finance, Insurance & Real Estate Mike Stegemoller
said. "It's very much like me convincing someone to come to
Baylor… I'm a little biased."
In the late 1990s, during the tech bubble, bias was prevalent.
In what was referred to as "pumping and dumping," analysts would
bolster ratings for the betterment of the investment banking
side of the company.
"Before the stock went public, the analyst coverage would be,
‘Oh, this is going to be a great stock! You should buy, buy,
buy.' And then, the same firm who was providing that analyst
coverage would take the firm public, and then these analysts
would tell their best clients to dump the stock. So it's pump it
up, take it public, then dump," Stegemoller explained.
Led by the then New York Attorney General Eliot Spitzer, Wall
Street conflicts of interest were uncovered and put to an end
with the 2003 Global Analyst Research Settlement, which required
12 of the top investment banks and analysts to be heavily fined
($1.2 billion amongst them). Simultaneously, new regulations
designed to separate analysts from bankers were put into place.
Now, nearly 15 years later, Stegemoller sought to examine the
prevalence of bias before and after the settlement.
"After the settlement, the bias in those top 12 banks,
essentially, disappears," he said. "They don't provide overly
optimistic coverage. The other banks, that didn't have to pay
out penalties, they get worse. They get more biased, actually."
With co-authors Shane Corwin and Stephannie Larocque of the
University of Notre Dame, Stegemoller found the evidence
consistent with the financial penalty for the 12 creating a
change in their company culture. The expected costs of biased
coverage outweighed the expected benefit, so they adapted. The
effect increased over time as new analysts and bankers were
hired and trained according to the new regulations imposed by
the Securities and Exchange Commission (SEC).
But, with smaller firms that were not given consequences for
biased policies, the researchers found there was little to no
behavioral change. Without discipline, the evidence suggested,
those investment bankers and analysts who were not penalized
continued their questionable tactics and mutually beneficial
"What we're saying is, you can't just give people rules if
they're doing something wrong, you have to penalize them,"
Stegemoller said. "Our paper basically shows that the expected
benefits of this biased coverage didn't outweigh the expected
costs for those 12 firms because they knew what the costs were."
article, "Investment Banking Relationships and Analyst
Affiliation Bias: The Impact of Global Settlement on Sanctioned
and Non-Sanctioned Banks," was published in the Journal of
The article utilized a relationship measure created by
Stegemoller and Corwin, which provides a comprehensive
evaluation of banks' relationships with debt, mergers and
acquisitions, equity and other factors. The measure itself has
been a labor of love; Stegemoller remarks that the duo began
work on it before his now 9-year-old twins were born.
"Our relationship measure is a very comprehensive measure," he
said. "I'd say it is the best measure of the relationship
between banks and firms."
He plans to continue in this line of research, with the aid of
the robust relationship measure, looking into how the investment
banking industry has changed over time and how it continues to
change as the industry consolidates.