SEC Settlement Shows Shameful State of Wall Street Research

February 18, 2016

After a while, it all just gets tiring -- enervating. Cut by cut. Inch by inch. Whatever alleged honesty and integrity was once believed to have existed on Wall Street is lessened. Frankly, long ago it got to the point where many investors concluded that the exchanges and markets were simply rigged casinos. Along with that ongoing erosion of investor confidence in the trading venues, we also had doubts about the honesty of the securities industry's research. Talkin' their book. Bought and sold puffery. For much of the last twenty or so years, the headlines were filled with allegations, charges, and convictions about insider trading and compromised research. Sadly, it seems that it's still not safe to go back into the muddied waters of Wall Street.

Case In Point

From June 2011 through February 2013, Charles P. Grom, age 41, was a managing director and senior equity research analyst at Deutsche Bank Securities, Inc. ("DBSI"), where he covered about 20 public companies in the consumer retail sector. In anticipation of the institution of proceedings by the Securities and Exchange Commission ("SEC") but without admitting or denying the findings, Grom submitted an Offer of Settlement, which the federal regulator accepted.  In the Matter of Charles P. Grom, Respondent (Order Instituting Administrative And Cease-And-Desist Proceedings, Making Findings, And Imposing Remedial Sanctions And A Cease-And-Desist Order; '34 Act Rel. No. 77150; Invest. Adv. Act Rel. No. 4335; Invest. Co. Act Rel. No. 31997; Admin. Proc. File No. 3-17119 / February 17, 2016).

A Name In the Biz

As the OIP alleges:

7. During his tenure at DBSI, Grom was one of the most prominent and influential research analysts covering the consumer sector. In 2012, he was ranked by Institutional Investor magazine as the number one "broadlines / department stores" analyst on its "All-America Research Team" and by Greenwich Associates as the number two "broadlines / retail analyst" on its "Greenwich Research Team Survey." DBSI clients, as well as sales and trading personnel at the firm, closely followed his research and sought his views on the companies that he covered, including Big Lots.

Consequently, Grom's opinion on the retail sector was not merely of interest within the walls of DBSI but carried great weight among professional and retail investors who followed the retail sector. 

Maintaining a Relationship

As alleged in the OIP, Grom had issued a March 29, 2012, research report on discount retailer Big Lots, Inc. that rated the company's stock a "BUY." The OIP asserts that, in fact, at the time of that rating, Grom personally believed that Big Lots should be downgraded but declined to issue that opinion in order to maintain his relationship with the retailer's management. 

Following  a March 27, 2012, conference at which Big Lots' Chief Executive Officer and its Senior Vice President of Finance appeared and made a presentation and also following a March 28, 2012, Non-Deal Roadshow ("NDR") by Grom and DBSI for the Big Lots' CEO and SVP of Finance. The OIP asserts that:

17. Before the NDR, Grom was bullish on Big Lots: he believed the company's first quarter financial performance, particularly its first quarter comparable store sales, would be strong, with comparable store sales "up four or five, maybe six percent." At some point early during the NDR, Grom's view changed and he ultimately concluded that Big Lots' first quarter comparable stores sales would increase by only two to three percent, a significant shift in Grom's view. Grom believed, and his financial models reflected, that even a one percent change in Big Lots' comparable store sales could significantly impact its earnings per share. Grom became particularly concerned during the NDR when Big Lots' executives made what Grom believed to be cautious comments about Big Lots' consumables business, which comprised approximately twenty-five to thirty percent of Big Lots' total sales at the time.

18. At 8:51 a.m. on March 28, 2012, shortly after the first NDR meeting had ended, Grom called the DBSI trader responsible for trading Big Lots' stock. At 9:31 a.m., within a minute of the market opening, the trader placed an order to sell 25,000 shares of Big Lots' stock, which he had purchased the day before in a firm proprietary account.

19. In the early afternoon on the day of the NDR, Big Lots' Chief Executive Officer abruptly asked Grom whether he was going to downgrade Big Lots stock. At 1:23 p.m., Grom emailed one of his junior analysts back in New York, simply stating, "this is gonna be hard." Three minutes later, the junior analyst responded, "uh oh." At 1:26 p.m., Grom sent the junior analyst another email, stating, "[p]retty clear that biz is just ok."

20. Beginning within minutes after the NDR had ended, Grom communicated with several DBSI clients, including Hedge Fund A, Hedge Fund B, Hedge Fund C, and Hedge Fund D. After talking to Grom, all four of these DBSI clients subsequently sold their entire positions in Big Lots stock. . .

The OIP asserts that on March 29, 2012, Grom reiterated a BUY rating in a Big Lots research report, notwithstanding the report's title: "Not All Is Good In Buckeye Land." The OIP then asserts that:

23. On March 29, 2012, at 7:30 a.m., roughly two hours after his Big Lots research report had been publicly disseminated, Grom spoke about Big Lots on the DBSI morning  conference call with firm research and sales personnel. Grom said that he had maintained a BUY rating on Big Lots because "obviously that we just had them in town so it's not kosher to downgrade on the heels of something like that." Grom also said, "[B]ut more importantly than that, I think there's obviously time left in the quarter" and that he and his team was "gonna do our homework on it" and "gonna be in front of 'em."

In formulating its proposed case, the SEC apparently believed that Grom should have downgraded his rating for Big Lots in his March 29, 2012. The SEC apparently concluded that Grom did not undertake the downgrade based upon what the federal regulator deemed as inappropriate considerations towards maintaining a business relationship with Big Lots' management. That conflict rendered the research report inaccurate because it failed to truly represent Grom's personal views in violation of Rule 501 of Regulation AC of the Exchange Act.

Big Pain

In settling the OIP, the SEC deemed it in the public interest to Censure Grom; and order him to pay a $100,000 civil money penalty and to Cease-And-Desist from committing or causing any violations and any future violations of Rule 501 of Regulation AC of the Exchange Act. Moreover, the SEC ordered that Grom be:

  • suspended from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization for a period of twelve (12) months, effective on the date of entry of this Order;
  • prohibited from serving or acting as an employee, officer, director, member of an advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company or affiliated person of such investment adviser, depositor, or principal underwriter for a period of twelve (12) months, effective on the date of entry of this Order; and
  • suspended from participating in any offering of a penny stock, including: acting as a promoter, finder, consultant, agent or other person who engages in activities with a broker, dealer or issuer for purposes of the issuance or trading in any penny stock, or inducing or attempting to induce the purchase or sale of any penny stock for a period of twelve (12) months, effective on the date of entry of this Order.
Bill Singer's Comment

Compliments to the SEC on an informative and articulate OIP. This is certainly an important warning to the investing public and raises very, very troubling questions about what integrity is left, if anything, among research analysts at Wall Street's investment banks and brokerage firms. 

Separately, note that this is nearly March 2016 and the underlying conduct at issue took place about four years ago in March 2012. Some may argue that it takes time for the SEC to learn about misconduct -- and, yes, that's a fair point; however, the OIP notes that "DBSI terminated Grom in February 2013 for 'conduct not consistent with firm standards.'" Consequently, the SEC was on notice for at least three years that something was amiss with Grom.  Given the substantial record presented in the OIP and the dates involved, one must wonder why things moved at such a glacial pace, particularly since the SEC's allegations resulted in a settlement and did not require a lengthy trial or hearing.