By DAVID MOON, Moon Capital
May 12, 2002
A running joke in the investment industry is the difference between what
stock analysts say and what they actually think or believe. For a large
Wall Street firm to issue anything other than a "buy" recommendation is
rare. Occasionally, a firm might issue "hold," signaling a horrible
distaste for a specific investment. Until recently, "sell" recommendations
were about as common as pickup trucks in brokerage firm parking lots. I
have previously written and joked about firms making clearly silly stock
recommendations like "aggressive hold' or downgrading their opinion after the
price of a stock has fallen from $90 to $6.
It may not be a joke any longer. The New York state attorney general,
Eliot Spitzer, is investigating brokerage firms for various misdeeds within
their research departments. Spitzer says, that while investment
professionals know the distinction between what research analysts say and what
they actually mean, individual investors have not been privy to that running
gag. Spitzer alleges that the citizens of New York were damaged when,
among other things, analysts touted stocks during television interviews they
were trashing in private discussions back at the office.
As is the case with much in the financial industry, this is about knowledge
and trust. What knowledge do individual investors have about the people
advising them? Do they understand all of the conflicts of interest
involved? Too often, an individual is swayed by sophisticated terminology
or an expensive suit. A nifty television interview on CNBC might do
wonders to create the appearance of legitimacy and competence. But that
interview will do very little to tell you if the interviewee's firm has multiple
business relationships that could cloud the analyst's opinion. Worse,
these types of interviews normally tell you nothing about how that specific
analyst invests her own money.
The Securities and Exchange Commissioner recently joined the New York
attorney general in his probe. This will likely apply more pressure to the
industry. Only last week, Merrill Lynch CEO, David Komansky, apologized
for some of the actions of his analysts. I am sure the apology means a
great deal to the Merrill Lynch customers who, on Merrill's recommendation,
purchased Amazon.com at $240, and still own it today at $17.
Apology? How about some actual information and knowledge? Why not
disclose the personal investments of every analyst who makes public
pronouncements or manages client funds?
The brokerage industry response might be funny if it wasn't so tragic.
When pressed about the natural conflicts that arise when firms produce research
reports on companies with which they also have other, more lucrative
relationships, Wall Street captains are quick to offer that analysts will no
longer be allowed to own stock in the companies they recommend.
I would prefer that the analysts be required to own the stocks they recommend
' not that they be precluded from doing so. And they should buy those
stocks on the same terms and at the same prices at which they encourage their
customers to buy.
Individual and institutional investors are
actually responsible for this situation - not the brokerage firms. We
allow these firms and individuals to continue these practices without demanding
proper disclosure. Without this information, we make decisions about whom
to trust with our eyes partially closed. The New York attorney general may
motivate some people to action, but the investment public deserves the
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).