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Toys 'R' Us runs afoul of investor rules

12/12/2014

A $43.5 million fine has been levied against 10 Wall Street firms for doing what they were asked by Toys “R” Us as the retailer prepared an ill-fated public stock offering in 2010.



The Financial Industry Regulatory Authority (FINRA) levied the $43.5 million fine against the 10 investment banks – but not Toys “R” Us – for allowing their equity research analysts to solicit investment banking business and offer favorable research coverage in connection with the retailer’s planned IPO in 2010.



"FINRA's research analyst conflict of interest rules make clear that firms may not use research analysts or the promise of offering favorable research to win investment banking business,” said Susan Axelrod, FINRA’s Executive Vice President of Regulatory Operations. “Each of these firms used their analyst to solicit investment banking business from Toys "R" Us and offered favorable research. This settlement affirms our commitment to policing the boundaries between research and investment banking to ensure that research is not improperly influenced."



FINRA may be committed, but the size of the fine when spread across 10 banks is inconsequential and unlikely to be a deterrent to behavior the regulatory group deems inappropriate. For example, Barclays Capital, Citigroup Global Markets, Credit Suisse Securities, Goldman, Sachs & Co. and JP Morgan Securities were each fined $5 million. Deutsche Bank Securities, Merrill Lynch, Pierce, Fenner & Smith, Morgan Stanley & Co., and Wells Fargo Securities were each fined $4 million. Needham & Company was fined $2.5 million.



In April 2010, Toys “R” and its private equity owners invited the 10 firms to compete for a role in the company’s planned IPO. FINRA found that each of the 10 firms used its equity research analyst as part of its solicitation for a role in the IPO and more specifically that Toys “R” Us asked equity research analysts from each of the 10 firms to make separate presentations. According to FINRA, the objective was to ensure that the analysts' views on key issues, including valuation factors, were aligned with the views expressed by the firms' investment bankers.



“Each firm understood that the performance of their analysts at the presentations would be a key factor in determining whether the firm received an underwriting role in the IPO,” according to a FINRA statement announcing the fines. “As detailed in the settlement documents, each of the firms implicitly or explicitly at these meetings or in follow-up communications offered favorable research coverage in return for a role in the IPO. Throughout the course of the solicitation period, Toys “R” Us made clear to the firms that the purpose of these requests was to vet the analyst's views to determine their consistency with the valuation provided by its investment bankers.”



"The firms' rush to assure the issuer and its sponsors that research was in synch with the pitch being made by their investment bankers caused them to overstep the prohibitions against analyst solicitation and the promise of favorable research,” said Brad Bennett, FINRA’s Executive Vice President and Chief of Enforcement. “Today's actions reaffirm the importance of these prohibitions to maintaining the integrity of the research function against whatever pressures may exist to monetize the reputation and work product of the analysts."



Toys "R" Us and its sponsors offered each of the 10 firms various roles in the IPO but the retailer eventually decided not to proceed with the offering.




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