Brokers Set to Pass Along Advice From Outsiders
Later this month, investors nationwide will start getting something unusual from their brokers: stock advice that may run counter to what the brokerage thinks.
It could be confusing. Your brokerage may rate Microsoft Corp. a “buy,” but the same envelope that delivers that guidance to your mailbox may include a recommendation to sell the stock.
The second opinions from independent research firms, due to start flowing on July 27, are mandated by last year’s $1.4-billion settlement of conflict-of-interest charges involving analysts from 10 of Wall Street’s biggest brokerages.
Proponents tout the program as a way for individual investors to get unbiased opinions, some of them from small “boutique” research firms that until now have worked exclusively for hedge funds, pension funds and other institutional investors.
In fact, what started as a regulatory smackdown of wayward brokerages may end up giving them a competitive edge, since they’ll be giving customers research once reserved for big clients. Perhaps to blunt this advantage, rival firms not involved in the settlement have begun scrambling to add outside stock reports to their in-house research.
For investors, more information is supposed to be better. But for brokers, the new landscape may be tricky to navigate. What do you tell your customer, for example, when your firm’s analyst loves a stock but the outside analyst hates it?
While the brokerage firm can meet its legal obligation by simply making sure the customer receives the outside research, many investors will turn to their brokers to make the call when one report says “buy” and the other says “sell.”
“The broker’s in a tough spot when the opinions conflict,” said Steven B. Caruso, a securities-arbitration lawyer based in New York. “This seems to be shifting the burden from the firm to the broker.”
Skeptics point to another problem. Noting that investors won’t be charged for the expanded research menu, they say free stock picks tend to be worth exactly what you pay for them.
Some critics also fear that the outside research will be stale or watered-down compared with what the institutions are seeing.
“The idea you’re going to get high-quality boutique research out of this is pie in the sky,” said Charles L. “Chuck” Hill, an Ipswich, Mass., consultant who tracks analyst recommendations. “If somebody’s really good, they ain’t going to stay in this arena very long. They’ll work for the institutions, where the money is.”
The legal settlement came after investigators -- led by New York Atty. Gen. Eliot Spitzer -- dredged up cynical e-mails and other compelling evidence of analysts shading their stock picks to help their firms land investment-banking business. The so-called Chinese wall separating research from investment banking turned out to be more like a screen door.
The solution worked out by regulators, in addition to fines and court-enforced promises to sin no more, was for each of the 10 firms to appoint an independent consultant who would hire outside research firms to supply reports on each of the stocks covered by the brokerages’ in-house analysts.
The consultants are a seasoned group that includes former mutual-fund and hedge-fund executives, plus a former commissioner of the Securities and Exchange Commission. They have been at work since November lining up independent research firms and negotiating the format and content of their reports and the prices to be paid for them.
Michael A. Dritz, consultant for UBS Warburg, said he met with representatives of more than 70 research firms. Bridget Macaskill, Merrill Lynch’s consultant, said she met with at least 50.
The outside firms are to be certified as conflict-free, meaning they don’t do any investment-banking business. Their reports are to be made available at the same time and on the same basis as the in-house reports. That is, if a customer has an online account, both reports are to be available electronically; if the customer prefers hard copies, both reports must be sent in the mail.
The brokerages were ordered to set aside a total of $432.5 million to be spent on the independent research over the next five years. The firms’ individual budgets range from $7.5 million to $75 million -- again, spread over five years.
BNY Jaywalk Inc., a unit of venerable Bank of New York Co., has emerged as the most popular vendor, chosen as an independent research provider by four of the six brokerages that have announced their selections so far. Four brokerages have yet to announce, but sources involved in the process said that one of them -- Credit Suisse First Boston -- also has picked BNY Jaywalk. Credit Suisse First Boston declined to comment.
BNY Jaywalk calls itself an “aggregator”: It doesn’t have analysts of its own but contracts with more than 100 independent research firms that together cover some 6,000 stocks, or practically every U.S.-listed stock. Its affiliates include such large and well-established firms as Argus Research as well as boutiques such as retail-industry specialist Tiburon Research Group and banking authority NAB Research.
Jaywalk’s original business plan was to sell research mainly to institutional investors, but when the settlement came about, the firm recognized it as an opportunity, John D. Meserve, Jaywalk’s president, said in an interview last week.
Several of the brokerages’ independent consultants said they found Jaywalk’s one-stop-shopping approach more convenient than signing contracts directly with multiple firms.
Yet Citigroup, with $75 million to spend, signed directly with five well-known firms: Argus, Morningstar, Renaissance Capital, Standard & Poor’s and Thomson Financial.
Dritz, former chief executive of securities trading firm Smith Newcourt, said he probably would end up using about 25 firms through Jaywalk to match UBS Warburg’s coverage of 950 stocks. He also has contracted with a separate consulting firm affiliated with Syracuse University to evaluate how well the private research is performing.
Part of his intensive negotiations with the research firms was aimed at obtaining reports that have the same general format as UBS Warburg’s -- bullet points, buy-hold-sell ratings and so forth -- so that investors won’t be overly confused.
Macaskill, former chairwoman of OppenheimerFunds, took a similar approach with Merrill Lynch. Research firms that mainly work for institutional investors sometimes produce extremely long and technical reports that would be of little use to individual investors, so she worked to get them to reformat and streamline their reports.
Does this mean the research will be watered down, as some critics have charged?
Retail customers, Macaskill said, will get “what I hope is the same quality of thinking and the same ratings, although a shorter synopsis” compared with what an institution would get.
And if the outsiders’ views sometimes contradict those of Merrill’s analysts, let the chips fall where they may, she said. “Merrill Lynch has absolutely no say in whose report gets chosen and whose doesn’t.”
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Second opinions
Under a $1.4-billion settlement, 10 Wall Street securities brokerages face a July 27 deadline to give customers independent stock research. Here are the brokerages, the amount each must pay over five years for the outside research, and the vendors each has chosen.
*--* Brokers Budget Research providers (in millions) Bear Stearns $25 BNY Jaywalk Citigroup $75 Argus Research, Morningstar, Renaissance Capital, Standard & Poor’s, Thomson Financial Credit Suisse First $50 Not announced Boston Goldman Sachs $50 Morningstar, Renaissance Capital, Standard & Poor’s J.P. Morgan Chase $25 Not announced Lehman Brothers $25 BNY Jaywalk Merrill Lynch $75 BNY Jaywalk, Morningstar Morgan Stanley $75 Not announced Piper Jaffray $7.5 Not announced UBS Warburg $25 BNY Jaywalk
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Source: Times research
