Judge Rejects SEC and Bank Proposal to Remove Firewall

Editor’s Note: A recent Davis Polk & Wardwell LLP Client Newsflash describing the modified Global Settlement discussed below is available here.

U.S. District Judge William H. Pauley III recently rejected a proposal by the Securities and Exchange Commission and a group of securities firms to modify the terms of their 2003 Global Research Equity Settlement (“Global Settlement”). Among other things, the Global Settlement, which binds 12 securities firms, including Goldman Sachs, JP Morgan, Merrill Lynch, Citigroup, Credit Suisse, Morgan Stanley and Deutsche Bank, puts in place limits on the interaction between the research and investment banking arms of the firms – a so-called “firewall”.

The SEC and the firms had agreed on a proposal to loosen some of the restrictions contained in the Global Settlement, including the firewall. The proposal would have permitted:

“Research personnel Investment Banking personnel to communicate with each other, outside the presence of internal legal or compliance staff, regarding market or industry trends, conditions or developments, provided that such communications are consistent in nature with the types of communications that any analyst might have with investing customers.”

Judge Pauley rejected the proposal. His ruling stated that:

Such a proposed amendment is counterintuitive and would undermine the separation between research and investment banking. On May 7, 2003, SEC Chairman William H. Donaldson emphasized the importance of that separation to the Senate Committee on Banking, Housing and Urban Affairs when he testified: “[T]here will be no overlap between the jobs of investment bankers and research analysts … To ensure that the separation between investment banking and research is comprehensive, firms will create and enforce firewalls between the two operations reasonably designed to prohibit improper communications between the two.” … The parties’ proposed modification would deconstruct the firewall between research analysts and investment bankers erected by the parties when they settled these actions. This Court declines to approve the proposed modification to Section I.10.a because it would be inconsistent with the Final Judgments and contrary to the public interest.

Judge Pauley’s full order is available here; the brief of the firms seeking the order is available here.

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One Comment

  1. Corporate Lawyer Christopher Neufeld
    Posted Friday, April 2, 2010 at 6:53 am | Permalink

    The Securities and Exchange Commission either needs to be more stringent with its membership or its leadership really needs to be re-orchestrated, as this early willingness to support a position change that would have allowed for the weakening of the firewalls is entirely unacceptable. Much of the financial crisis was the result of a weakening and elimination of regulated separations within the financial industries. While practicing in the securities arbitration field in New York City, we saw how the removal of regulated separations (including firewalls and chinese walls) adversely impacted individual investors, while the financial crisis reflected the grander scale of things. As such, the judiciary needs to stand firm and the SEC needs to get its act together.