Toy Wall

When a Chinese Wall Is Not Something to Toy With

Toy Wall

In the wake of the dot-com bust of the early 2000s, you may recall how we were promised that going forward there would be a “Chinese wall” or a “firewall” between the research and investment banking departments of the Wall Street investment banks that so badly led clients astray into now defunct companies like,, and many others. One consistent problem identified was the entanglement between the research analysts (who set unrealistic price targets with enthusiastic buy recommendations) and the investment bankers who made insanely large amounts of money on the IPOs (initial public offerings). Perhaps the most ridiculous of these excesses was symbolized by Jack Grubman, the former lead research analyst for Salomon Smith Barney’s telecommunications sector, who admitted to changing his research recommendations in order to increase his chances of having his twin daughters accepted into a coveted Manhattan pre-school program. During this time, he was the highest paid research analyst on Wall Street, raking in a cool $25 million per year. The Securities and Exchange Commission (SEC) banned Grubman from the financial industry for life and nailed him with a $15 million fine for his admitted misconduct.

Of course we could not simply rely on the good graces of the Wall Street banks to maintain the integrity of the firewall, so it was enshrined into law as part of the 2002 Sarbanes-Oxley Act (Title V). As cynical as we are about Wall Street, even we were surprised to see this press release from the Financial Industry Regulatory Authority (FINRA) stating that not one, not two, not three, but ten firms were fined a total of $43.5 million for allowing their equity research analysts to solicit investment banking business and for offering favorable research coverage in connection with the 2010 planned IPO of Toys “R” Us. The list of companies (shown below) basically includes all the major players. 

  • Barclays Capital Inc. – $5 million
  • Citigroup Global Markets Inc. – $ 5million
  • Credit Suisse Securities (USA), LLC – $5 million
  • Goldman, Sachs & Co. – $5 million
  • JP Morgan Securities LLC – $5 million
  • Deutsche Bank Securities Inc. – $4 million
  • Merrill Lynch, Pierce, Fenner & Smith Inc. – $4 million
  • Morgan Stanley & Co., LLC – $4 million
  • Wells Fargo Securities, LLC – $4 million
  • Needham & Company LLC – $2.5 million

It appears that all ten companies systematically made the exact same calculation that the potential IPO profits were large enough to break the law and risk having to pay a fine. Well, they thought wrong because the IPO never materialized, and although the investing public suffered no actual harm, FINRA saw fit to ding them with the fines shown above. We can’t resist saying that when you play with a firewall, you sometimes get burned. Unfortunately, those amounts of money aren’t even pocket change to those firms, so we don’t expect to see any changes in future behavior. It is important to remember that unlike the SEC, FINRA is not a government regulator but rather the industry’s self-regulatory organization, so we should not be surprised by the relatively small penalties it levies.

So why do we bring up this story, considering that we have long advised our clients not to have brokerage accounts with the firms mentioned above and to steer clear of IPOs in the secondary market? We just want to remind investors that when they come across a research report with a “strong buy” or other such recommendation, they should not assume that the researcher is operating in a “clean room” environment and is providing purely objective and unconflicted information. We also want to re-emphasize the importance of having a fiduciary for your investments who is paid only by you and is obligated to act in your best interests at all times.