Study Cites Bias at Brokerages

Wondering whether to buy or sell? Don’t count on your brokerage firm for objective advice, according to a study of more than 8,000 stock evaluations made by investment firms.

Brokerage firms routinely pressure their securities analysts to give overly optimistic assessments of securities sold by client companies of the brokerage, suggests the study, conducted by Columbia University’s business school and released Monday.

Although the allegations are not new, the study bills itself as the first to extensively document the problem by looking beyond anecdotal evidence.

The Securities Industry Assn., the main U.S. trade group for brokerage firms, questioned the study’s conclusions and denied any pervasive bias in the industry. Stuart Kaswell, the SIA’s general counsel, said the study “doesn’t begin to prove” that firms pressure stock analysts and that internal controls at brokerages help prevent this.

And though the study did not mention individual firms, brokerages generally have denied that they pressure their stock analysts to make recommendations, saying the analysts are independent of the securities sales staff.

The study’s authors dismiss as ineffective the safeguards that brokerage firms have in place to prevent abuses, including in-house rules limiting communication among investment bankers and analysts about pending deals.

“It raises the possibility that investors who are acting on the advice can suffer losses,” said Mathew Hayward, the study’s lead author and a doctoral candidate in business administration.

“In our view, there is not nearly enough being done by the regulatory authorities to, one, protect investors against this type of loss and, two, ensure this doesn’t happen.”

Hayward and his co-author, professor Warren Boeker, urged stricter regulation by the stock exchanges and the federal Securities and Exchange Commission.

The study looked at 8,169 assessments of 70 companies made by stock analysts between 1989 and 1993. It compared recommendations by the 525 analysts at firms that worked for the stock issuer with the remaining 7,644 analysts who did not.

The study found that 93% of the analysts working for firms that did work for stock issuers rated the stock higher than analysts at firms that did not work for the stock issuer.

The ratings were issued within the 12 months before and after a transaction. Most of the brokerages working for the stock issuer had helped the companies issue securities, whereas a lesser number gave advice to the client companies about mergers and acquisitions.

The study also found that the bigger the corporate finance client, the higher the recommendation by the securities firm. In addition, the closer in time the rating was made to the client’s financial transaction, the higher the rating by the client’s investment bank.

Investment analysts are required to disclose in writing whether their firm has worked on any deal involving a company they rate, but the authors said such requirements aren’t adequate because most investors get their advice by telephone. In addition, information about pending mergers and acquisitions is not public and therefore can’t be disclosed beforehand to investors.

The authors looked at figures supplied by Zack’s Investment Research and Securities Data Co., two data research firms.