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WHAT HAS BEEN DONE TO REMEDY CONFLICTS OF INTEREST?

Two major policy measures have been implemented to deal with conflicts of interest in financial markets: the Sarbanes-Oxley Act and the Global Legal Settlement.

Sarbanes- Oxley Act of 2002

In 2002, the public outcry over the corporate and accounting scandals led to the passage of the Public Accounting Reform and Investor Protection Act, more commonly referred to as the Sarbanes-Oxley Act after its two principal authors in Congress. This act has four major components.

1. The act increases supervisory oversight to monitor and prevent conflicts of interest:

•It establishes a Public Company Accounting Oversight Board (PCAOB), overseen by the SEC, to supervise accounting firms and ensure that audits are independent and controlled for quality.

• It increases the SEC's budget to supervise securities markets.

2. Sarbanes-Oxley also directly reduces conflicts of interest:

• The act makes it unlawful for a registered public accounting firm to provide any nonaudit service to a client contemporaneously with an impermissible audit (as determined by the PCAOB).

3. Sarbanes-Oxley provides incentives for investment banks not to exploit conflicts of interests:

• It beefs up criminal charges for white-collar crime and obstruction of official investigations.

4. Sarbanes-Oxley also has measures to improve the quality of information in the financial markets:

• It requires a corporation's chief executive officer (CEO) and chief financial officer (CFO) to certify that periodic financial statements and disclosures of the firm (especially regarding off-balance-sheet transactions) are accurate.

•It requires members of the audit committee (the subcommittee of the board of directors that oversees the company's audit) to be "independent"—that is, they cannot be managers in the company or receive any consulting or advisory fee from the company.

Global Legal Settlement of 2002

The second policy arose out of a lawsuit brought by New York Attorney General Eliott Spitzer against the ten largest investment banks (Bear Stearns, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, J. P Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, Salomon Smith Barney, and UBS Warburg). Spitzer alleged that these firms allowed their investment banking departments to have inappropriate influence over their research analysts, thereby creating a conflict of interest. On December 20, 2002, the SEC, the New York Attorney General, NASD, NASAA, NYSE, and state regulators reached a global agreement with these investment banks. The agreement includes three key elements:

1. Like Sarbanes-Oxley, the Global Legal Settlement directly reduces conflicts of interest:

• It requires investment banks to sever the links between research and securities underwriting.

• It bans spinning.

2. The Global Legal Settlement provides incentives for investment banks not to exploit conflicts of interests:

• It imposes $1.4 billion of fines on the accused investment banks.

3. The Global Legal Settlement has measures to improve the quality of information in financial markets:

• It requires investment banks to make public their analysts' recommendations.

• It requires investment banks for a five-year period to contract with no fewer than three independent research firms that would provide research to their brokerage customers.

 
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