We are discussing the piece in the NYT about alleged "insider" trading at Lehman Brothers.  See Is Insider Trading Part of the Fabric?.  The implication of the piece was that the alleged facts sustained a case for insider trading but that the SEC somehow dropped the ball.  In fact, as we discussed in the last post, most of the alleged misbehavior (tipping analyst reports in advance of public disclosure to the Lehman trading test and to select clients) may not even be insider trading.  

The article spends a great deal of time on the purported insider trading.  Far less attention was given, however, to the separation of the investment banking and analyst functions at the firm.  As the article describes:   

Lehman bosses, he contends, told him to write research that would support investment banking business — a violation of the Spitzer settlement. He says he was warned not to make negative comments about companies, even when he thought they were merited, lest he antagonize corporate executives. In 2003, he says, he was chastised for downgrading a company that was a corporate finance client of Lehman’s.

The alleged facts suggest the lack of separation between the research arm of the firm and the investment banking arm.  This raises a number of concerns. 

First, NYSE Rule 472 specifies that brokers are to keep separate the analyst and investment banking function.  Under the Rule, analysts may not be "subject to the supervision, or control, of any employee of the member organization's investment banking department."  In addition, the analyst reports must not be "subject to review or approval prior to publication by Investment Banking personnel."  In other words, the analyst writing process must be independent of the investment banking function.  The quote above, if true, suggests that this may not have been the case.

Second, the SEC (along with the NY AG's Office) brought actions against ten brokers alleging that research analysts were subjected to "inappropriate influence by investment banking at the firm."  The firms entered into a global settlement.  One of those firms included Lehman.  According to the Release:  

Lehman has agreed to sever the links between research and investment banking, such that: research and investment banking are physically separated with completely separate reporting lines; analysts' compensation cannot be based directly or indirectly upon investment banking revenues; investment bankers may no longer evaluate analysts; investment bankers will have no role in determining what companies are covered by the analysts; and research analysts will be prohibited from participating in efforts to solicit investment banking business, including pitches and roadshows. In addition, Lehman must disclose on the first page of each research report whether the firm does or seeks to do investment banking business with that issuer, and when Lehman decides to terminate coverage of an issuer, Lehman must issue a final research report discussing the reasons for the termination.

For a list of the specific undertakings, go here.  In other words, the article in the NYT does not make out a clean case for insider trading but it does raise concerns over the obligations of large brokers to keep their investment banking and analyst functions separate. 

Having said that, it is likely not an easy violation to prove.  It would probably have to be shown that reports were altered as a result of pressure from the investment banking arm of the firm.  The allegations quoted above suggest the importance of business considerations in writing research reports but stop short of stating that the approach resulted from pressure by the investment banking arm.