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October 24, 2005

Good news for independent analysts?

Amey Stone

Wondering why brokerage-house analysts usually have so much more stock-moving muscle than independent analysts? One big reason is that brokerage firm trading services are often bundled with research. Large institutional investors want to be tops on the list of best clients at places like Goldman and Lehman to ensure that they get the best service on trades. That means they get a lot of brokerage house research thrown in with the deal.

If institutional investors want independent research, they usually pay for it by trading with a firm that has a relationship with the independent analyst they are following. That trading firm then pays the independent analyst a rebate (known as "soft dollars") as compensation. Confusing right?

Now the Securities and Exchange Commission is looking at this web of relationships more closely to make sure that the investors who are the clients of money managers (i.e. mutual fund shareholders) are getting the best trading and execution services.

Last week the SEC issued long-awaited guidance on soft dollar relationships (it now calls them "client commission practices") which found it is okay for money managers to pay for research with trading commissions. There's still more guidance coming on how these payments should be disclosed.

Here's what John Meserve, president of BNY Research, Commission and Payment Services (a division of Bank of New York which aggregates and distributes independent research), told me about the latest news on Oct. 20:

"There had been some ambiguity about whether or not it was appropriate to use commissions to acquire research both from Wall Street and from independent third parties. Today the SEC clarified that it was in fact something that was lawful."

"We expect to see some of the [fund] managers that swore off using soft dollars to pay for research come back into the marketplace."

"This was pretty consistent with what we expected," he says. "It is similar to new rules created in London."

"The next shoe to drop is the whole issue of disclosure and transparency. That will shake out in the next 12-18 months."

"Now there is more of a jump ball for independent research firms to garner some of the traditional research spend won by proprietary firms."

04:54 PM


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Brokerage analysts frequently comment on and sometimes recommend companies that their firms have recently taken public. We show that stocks that underwriter analysts recommend perform more poorly than “buy” recommendations by unaffiliated brokers prior to, at the time of, and subsequent to the recommendation date. We conclude that the recommendations by underwriter analysts show significant evidence of bias. We show also that the market does not recognize the full extent of this bias. The results suggest a potential conflict of interest inherent in the different functions that investment bankers perform.

Posted by: Beale_J at October 29, 2005 07:56 AM

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