It looks like déjà vu all over again on Wall Street. Get ready for a classic play by investment banks; conflict rich reports on companies by analysts who are hustling to generate fees.
This dark mark on Wall Street was supposed to be a memory of the past. In 2003, Wall Street firms and securities regulators entered into a $1.4 billion global settlement seeking to eliminate conflicts of interests between Wall Street research analysts on one side of the house and investment bankers at the other.
At the time, the securities industry was finally forced to recognize the enormous conflict of interest in its business model and how it contributed directly to the dot.com market crash in 2000. With investment bankers on the 32nd floor generating fat fees from listing initial public offerings, how objective could analysts sitting on the 33rd floor be when writing research reports consumed by brokers selling hot stocks to Mom and Pop clients?
After the tech meltdown, new rules and policies were put in place to separate these two functions – investment banking and research – so that retail investors could get access to honest and independent analysis.
Let’s be clear. The $1.4 billion paid in 2003 by a group of Wall Street firms was chump change compared to the billions that the firms make from fees on investment banking deals and brokerage commissions.
The passage of time, however, has eroded this critical investor protection and conflicted research appears to be back again in full force.
According to a recent Wall Street Journal article, companies like Coach will not allow analysts who issue “sell” ratings to attend events with clients, namely money managers who work at hedge funds or mutual funds. Indeed, companies of all stripes are limiting access to analysts, according to the Journal report.
Is the securities industry headed back to the dark days of the roaring nineties when investment bankers would berate analysts to improve their ratings on companies in order to cut deals?
“Analysts who want top executives at Coach Inc. to attend private events with their investor clients have to show they are ‘brand ambassadors,’ as the luxury handbag retailer dubs it,” wrote Journal reporters Serena Ng and Thomas Gryta. “You can’t be a brand ambassador if you have a sell rating on Coach’s stock.”
“Coach investor-relations chief Andrea Resnick says it takes that approach because of ‘the sheer volume of requests’ from analysts to have its management meet mutual funds, hedge funds and other clients,” the Journal noted. “Coach can’t say yes to everyone, Resnick adds, so it has to decide who gets access—and who doesn’t.”
The 2003 Wall Street settlement saw superstar analysts from Merrill Lynch and Salomon Smith Barney barred for life from the industry because of conflicted research. That was largely due to the fact that analysts’ compensation was based on the amount of investment banking revenue their ratings generated, not whether the research was valuable and honest.
Recall the infamous internal emails disclosed in the settlement. It was revealed that analysts privately viewed some stocks as “pieces of junk” and “pieces of s**t”, which they then publicly touted to Mom and Pop investors as “screaming buys.”
The Journal reported that, as in yesteryear, analysts’ compensation is tied not to their objectivity but the coziness of the relationship they have with the companies they cover. Many Wall Street firms “tally the number of times their analysts take company executives on the road to meet clients and use the number to help decide analysts’ annual bonuses,” according to the Journal. As much as “one-third of analysts’ yearly pay can be tied to corporate access.”
Other signs point to a dangerous level of cooperation between stock analysts and companies they cover. The number of current “sell” ratings on company stocks are minuscule, with the Journal reporting that “just 6% of the roughly 11,000 recommendations on stocks in the S&P 500 Index are sell or equivalent ratings.”
Makes you think back to 2003 and the conflicts of interest the regulators highlighted, doesn’t it?
Yogi Berra once famously said, “It’s like déjà vu all over again.” The late, great Yankees catcher was talking about playing baseball, but he could have been easily speaking about the securities industry and the embedded conflicts between its bankers and analysts. It’s like 2003 all over again.
Zamansky LLC are investment and stock fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.