Independent analysts run out of funds

Amy Scott Jun 11, 2009

Independent analysts run out of funds

Amy Scott Jun 11, 2009


Kai Ryssdal: The federal budget deficit is $79 million smaller today, thanks in no small part to Wall Street’s last big scandal six years ago. A federal judge has ruled that the balance left in a fund from a settlement over fraudulent stock research has to be turned over to the Treasury Department. He said nobody can figure out a way to get it into the hands of investors that were wronged by Wall Street analysts. They’re the ones who make those buy, sell and hold recommendations on various companies you hear about.

It turned out that the investment banks those analysts worked for, they were often trying to win business from some of the same companies that were being raided. And the analysts were hyping stocks to customers, telling them to buy those stocks that they were secretly panning in conversations with their colleagues inside the bank. As part of a settlement the banks wound up paying more than $450 million toward a fund for independent stock research. That fund that is set to expire next month. Marketplace’s Amy Scott reports that could wind up costing investors.

AMY SCOTT: When regulators first announced their settlement with the big Wall Street firms, New York Stock Exchange chairman Dick Grasso made a proclamation.

DICK GRASSO: It is time to close this, perhaps one of the darkest chapters in the history of modern finance.

It sounds almost quaint, given this latest dark chapter. But at the time, it was a big deal.

The brokerage houses agreed to split their investment banking and research divisions to limit conflicts of interest. And they promised to provide their clients with a second opinion on stocks from independent research firms. That is, firms that don’t do investment banking.

Michael Mayhew tracks the research industry at Integrity Research Associates. He says the money from the settlement helped several independent firms get off the ground. But as of next month, they’ll have to stand on their own.

MICHAEL MAYHEW: There were 60-70 independent research firms that received monies as part of the settlement. And that will go away. And the big question is whether or not those independent research firms have discovered a business model that will enable them to stay in business.

One of the biggest winners in the settlement was Morningstar, in Chicago. You may know it for its mutual fund ratings. Morningstar’s analysts also research 2,000 companies. That research helps institutions and individuals figure out how to invest their money.

Catherine Odelbo heads the equity research group. She says settlement money made up 4 percent of Morningstar’s revenue last year. That’s $21 million Morningstar may have to do without.

CATHERINE ODELBO: It’s certainly a hole, but not one that we weren’t aware of. And as you can see, 4 percent of Morningstar’s total revenue, it’s not a huge number from a total company perspective.

Odelbo says her firm has been preparing for this day. It’s developed other lines of business. This week the company announced a deal with Nasdaq to provide research on companies listed on the exchange. Indy firm Argus Research and two others struck a similar deal with the London Stock Exchange.

Analyst Michael Mayhew says independent firms will live on beyond the settlement, by charging institutional investors, like hedge funds and mutual funds, for their research.

MAYHEW: The problem I see is what happens to retail investors.

People who still own individual stocks. Mayhew says most of them still get their information from the big Wall Street firms. He says that research appears less biased than it used to be. The firms are much more likely to recommend selling a stock than they were before the settlement.

But Mayhew says the downturn has led the big brokerage houses to cut back their research departments. Some of the firms in the original settlement don’t exist anymore.

MAYHEW: Right now they’re under a lot of pressure. And we’re seeing a lot coverage decline as a result. And who does that hurt? That hurts the guys who can’t afford any other kind of research. Retail investors.

Some Wall Street firms say they’ll offer their clients an independent second opinion even after the settlement expires. Morgan Stanley Smith Barney is one of them. If your broker doesn’t, there are places you can go, like investing newsletters and Web sites. For a price.

I’m Amy Scott for Marketplace.

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