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Commentary: Why Research Reform Won't Help the Little Guy


Wall Street's analyst woes are finally nearing an end. On Nov. 23, New York State Attorney General Eliot Spitzer, together with regulators from other states and the Securities & Exchange Commission, began briefing a dozen big investment banks on how much they'll have to pay to settle charges that their analysts biased stock ratings to win lucrative initial public offerings and other banking business. Regulators are hitting Citigroup (C) for $500 million and Credit Suisse First Boston (CSR) for around $200 million.

But what benefit will Mr. and Mrs. 401(k)--the victims of the boom-and-bust excesses that analysts helped create--reap from the settlement? Unfortunately, not much. In addition to money, the deal will create greater separation between the banks' research analysts and their investment banking co-workers, and it will force the banks to invest in independent research. But those moves will do little to help the average individual investor make more informed decisions about buying and selling stocks than he or she did before.

Regulators wouldn't agree with that assessment. They're imposing stricter rules on analysts' pay and contacts with investment bankers in hopes of reducing the temptation to bestow glowing ratings on companies being courted for banking business. Those rules will help clean up the market, but so long as banking pays the bills, they can't eliminate research biases.

The SEC and the states also figure that individuals will benefit from independent research by Wall Street boutiques. For the next five years, each of the Street's big banks will be required to employ an SEC-approved monitor who'll buy independent analysis whenever the bank issues a report on a company whose stock it underwrote. If the two recommendations differ widely, SEC officials say, the banks' brokers must inform clients of the disparity.

But even some regulators view this idea with skepticism. "I'm not sure who ever looked at any of these reports anyway," says one SEC doubter. Forcing the banks to buy independent research "may be creating a product for which there's no demand," admits another regulator.

There might not be much supply, either. "The high-value research boutiques won't bid on this business," predicts Charles L. Hill, director of research for Thomson Financial/First Call. Independent researchers thrive by selling insights to sophisticated institutions such as mutual funds and pensions. Before a research shop makes its wisdom available to Merrill Lynch & Co.'s (MER) thundering herd, the firm has to worry about damaging its standing with the investing elite. Those analysts who appear on CNBC have no obligation to back up their recommendations by providing reports to viewers. Individuals should not kid themselves: They'll never get the same insights as the big guys.

Even clients can have a hard time getting research unless their balances meet the brokerage's minimums--and that situation will persist. "Anyone who hears a recommendation should be able to get the underlying report at a reasonable price," says Patricia D. Walters, senior vice-president of the Association for Investment Management & Research, a professional society for analysts and money managers. "But that's not on the table."

Would complete access to research make for a smarter investing public? Probably not. Studies show that few individuals ever read past the buy or sell rating to get to a report's details. That's not the only reason why complete access to research wouldn't help most individuals to become better investors. Studies by Brad M. Barber, a finance professor at the University of California-Davis, shows that Wall Street research tends to focus on small-cap growth stocks. That's the most fertile sector for IPO business, but it's hardly the basis of a well-rounded portfolio. Small-cap growth has been a quagmire since the market peak in March, 2000: Analysts' lowest-rated stocks outperformed their top picks by 20 percentage points in 2000 and 2001, according to Barber's studies.

None of these objections is likely to stand in the way of the analyst settlement. Both Spitzer and his Wall Street foes are eager to wrap up before Christmas. The SEC, too, wants to finish the case so that the commission can take a longer look at how analysts operate in the fevered world of IPOs and stock-pushing. Commissioner Harvey J. Goldschmid, who'll head that effort, would be well advised to study how individual investors make their buy and sell decisions. The market's most vulnerable players deserve better. By Mike McNamee


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