Wall Street analysts finally are facing tougher scrutiny in their actions, words

By DAVID MOON, Moon Capital Management
July 15, 2001

Since I first addressed the horrible problem of Wall Street analysts and research over a year ago, it seems to be a more popular topic these days. The State of New York threatens to launch an inquiry, as have a couple of members of the US Congress. I suspect some politicians/investors got the short end of an analyst recommendation and are ready to swing that stick at someone. Too bad the guilty parties are still dodging the stick.

There are two problems with Wall Street research: it is often terribly biased and almost always difficult to decipher. Words on Wall Street mean something different than they do on Main Street. Only on Wall Street could a highly paid professional make an 'aggressive hold' recommendation on a stock. Only on Wall Street could only 2 or 3 percent of the stocks under coverage receive a 'sell' recommendation. And only on Wall Street, it seems, could the 'solution' to this problem actually add to the problem.

Because many Wall Street brokerage firms make a substantial portion of their money selling investment banking services or executing client transactions, the research reports they produce are often criticized for merely supporting those two goals. Why would a firm produce a negative report on a company for which the broker would like to raise money in a secondary offering or handle their next acquisition? It seems that many people on Main Street are finally waking up to this conflict and the implications for the reports produced by these firms.

The Securities and Exchange Commission recently warned individual investors not to rely solely on analysts' research reports when deciding whether or not to buy a stock. If you are paying your broker for the value of her research, what value is it if you can't use it to make your decision?

The financial news network, CNBC, has started trying to force analysts to translate their doublespeak into real American English. During the daily barrage of analyst interviews, every time an analyst gives a rating on a stock, the network commentator will ask for an interpretation. 'We have an 'Accumulate' rating on the stock,' an analyst might say. To which the network host will reply, 'just exactly what does that mean? Should our viewers buy, sell or hold the stock?' This simple question will result in a 60 second gibberish meandering about near-term this and intermediate-term that and moderate or conservative investment postures. The recommendations often have no practical value. But these exchanges make for entertaining television.

When we buy a stock for Moon Capital Management clients, our money goes into that stock, too. My money is invested identically to our clients. Seems to make sense to me; when I go home at night and think about my money, I am thinking about my clients' as well. In an effort to "further ensure the objectivity and independence of its research," one Wall Street firm announced this week that its analysts are now prohibited from buying stock in any of the companies they research. Presumably, this removes the risk that an analyst might sell his shares while still maintaining a 'conservative intermediate-term moderate hold' recommendation on a stock. To me, it seems a better policy would be to force an analyst to invest his money identically to his investment recommendations and at the same time. If an analyst covers a stock and refused to own it, he should have to put a 'sell' recommendation on it. It might make for more clear research reports.

The professional organization for analysts, the Association for Investment management and Research, announced a plan to solicit comments and produce a report outlining the problem of conflicts and (ideally) clarity of research reports. Hopefully, the results will be thorough, client-oriented and understandable.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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