Investment analysts play us for suckers; in not demanding disclosure, we let 'em

By DAVID MOON, Moon Capital Management
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 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 blame.

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

Add me to your commentary distribution list.

MCM website