Conflicts of Interest in the Financial Services Industry

by Crockett, Andrew; Harris, Trevor; Mishkin, Frederic S.; White, Eugene N.

• ISBN13: 9781898128793
• ISBN10: 1898128790
• Format: Paperback
• Copyright: 2004-06-01
• Publisher: Centre for Economic Policy research

Summary

In the recent stock market collapse, confidence in the financial industry was shaken by numerous scandals. Beginning with Enron in 2001, scandals brought about the demise of prominent financial figures, damaged the reputation of premiere firms and destroyed the global accounting giant Arthur Andersen. Central to this crisis was the exploitation of conflicts of interest. Research analysts at investment banks were found to be distorting information at the behest of underwriting departments eager to promote new issues. Auditors appeared to sanction misleading accounting in order to gain business for the consulting side of their firms. Policy response in the United States was quick. Large fines were levied and regulators compelled the separation of financial activity by function, constraining financial conglomerates.

Author Biography

Andrew Crockett: Former General Manager, Bank for International Settlements, Basel Trevor Harris: Morgan Stanley, New York Frederic S Mishkin: Graduate School of Business, Columbia University, New York Eugene N White: Rutgers University, New Jersey

Table of Contents

List of Conference Participants	ix
List of Figures	xiii
Acknowledgements	xv
Foreword	xvii
Executive Summary	xix
1 What Are the Issues?	1	(12)
1.1 Introduction	1	(1)
1.2 Information and financial markets	2	(1)
1.3 The role of financial institutions in financial markets	3	(2)
1.4 What are conflicts of interest?	5	(1)
1.5 Why conflicts of interest are important	5	(1)
1.6 A framework for evaluating policies to remedy conflicts of interest	6	(3)
1.7 The types of conflicts of interest studied in this Report	9	(2)
1.8 Plan of the study	11	(2)
2 Investment Banking: Conflicts of Interest in Underwriting and Research	13	(14)
2.1 Information synergies and conflicts of interest	13	(1)
2.2 The problem of analysts' compensation	14	(2)
2.3 The IPO boom of the 1990's	16	(1)
2.4 Analysts 'excessive' optimism	17	(4)
2.5 Evidence of increasing conflicts in the 1990's	21	(3)
2.6 Remedies for the underwriter/analyst conflict of interest	24	(3)
3 Accounting: Conflicts of Interest in Auditing and Consulting	27	(14)
3.1 Introduction	27	(1)
3.2 The evolution of auditing, standards and regulation	27	(2)
3.3 The value of the audit opinion	29	(2)
3.4 Conflicts of interest	31	(4)
3.5 Separation of auditing and related services	35	(1)
3.6 The multi-product audit firm and auditor independence	35	(2)
3.7 Litigation risk and rules-based audits	37	(2)
3.8 Remedies	39	(2)
4 Rating Agencies: Conflicts of Interest in Credit Assessment and Consulting	41	(14)
4.1 Introduction	41	(1)
4.2 The role of rating agencies	42	(1)
4.3 Beneficiaries of an effective rating mechanism	43	(1)
4.4 The evolution of the rating industry	44	(2)
4.5 Do rating agencies add value?	46	(2)
4.6 Vulnerability to conflicts of interest	48	(2)
4.7 Remedies to conflicts of interest	50	(4)
4.8 Conclusion	54	(1)
5 Conflicts of Interest In Universal Banking	55	(22)
5.1 Introduction	55	(1)
5.2 American universal banking before Glass-Steagall	56	(1)
5.3 Investments banking and insurance	57	(2)
5.4 Commercial and investment banking	59	(6)
5.5 Testing the myths	65	(3)
5.6 Contemporary universal banking in the United States	68	(1)
5.7 Universal banking and conflicts of interest outside the United States	69	(2)
5.8 Remedies for conflicts of interest	71	(6)
6 Overview and Conclusions	77	(10)
6.1 When are conflicts of interest a serious problem?	77	(2)
6.2 Evaluating remedies	79	(2)
6.3 Recommendations	81	(6)
Discussion and Roundtable	87	(1)
Session 1: Analysts and underwriters	87	(4)
Session 2: Auditors and rating agencies	91	(5)
Session 3: Universal banking	96	(5)
Session 4: Remedies	101	(8)
Endnotes	109	(6)
References	115