In the unseemly and increasingly desperate scramble by the leaders of Wall Street firms to do a deal with the SEC, Eliot Spitzer and the whole posse of state prosecutors pursuing them over bent research and IPO spinning, common sense was ditched long ago.
It’s been apparent since the summer that the senior executives of the leading American investment and universal banks will agree to just about any imposition: they’ll sacrifice any part of their firms, adopt almost any new business model no matter how idiotic – just to get the vengeful lawmen off their trail.
They’ll separate research from investment banking, abandon research entirely, whatever it takes. These men are living in fear – fear of huge fines and civil suits, fear that rivals will somehow shape a settlement with the legislators that will better suit their own firms, fear that some senior Wall Streeters could yet go to jail.
It’s riveting, dramatic stuff. But the obsession with freeing research reports from the taint of the investment banking pitch book re-inforces the absurd notion that fund managers were being duped all along by the wicked sell-siders.
That’s a complete distortion. Yes, some retail investors may have been mis-led. But fund managers themselves weren’t innocent bystanders in the inflation of the stock market bubble. They were at the heart of it, they encouraged it, they boosted it and they were enriched by it. They had just as much incentive as any Wall Street spiv or greedy corporate CEO in keeping the whole sham running.
By making it clear to corporate executives what kind of behaviour they were ready to reward, fund managers encouraged excessive leverage in pursuit of fantastical earnings growth. And when managements rigged the figures to make it look like they were indeed delivering, fund managers didn’t care to examine them too closely.
Five years ago, this magazine interviewed the head technology analyst at a top three investment bank on the day after Alan Greenspan had suggested that technology shares were becoming over-valued by any sensible measure. What did he have to say about it? “Alan Greenspan is absolutely right.” So what rating was he going to put on leading technology shares, now? “Buy.” And how could he justify making this call to his clients? “Because they’re still going to go up. Everybody else is buying them.”
Go back and read the financial pages in the late 1990s. They were filled with warnings against buying shares in newly-listed business plans with no revenues. Investors didn’t want to listen. And any settlement over equity research which ignores fund managers’ complicity in the excesses of the age is fundamentally flawed.
It’s often said that fund managers won’t pay for research and that securities firms can only pay analysts with subsidies from investment banking fees. If that’s true then independent research firms have no future.
Well, let’s see. Plenty of small, independent research shops are now being set up by analysts leaving the top firms. And fund managers are using them. Often they put resulting trades through full-service brokerages and demand that the brokers’ re-imburse some of their commission to the independent shops.
The truth is that fund managers do need research. It’s just that most would rather not absorb the cost of it. For years they have bundled payments for research up with transaction charges that can be passed on to their end clients. This is what the Myners report in the UK strove to uncover. Let’s lay it bare.
It would be interesting to see how fund managers that use outside research perform versus those employing their own analysts; interesting to see what fund managers will pay – openly – for research and which independent research firms will thrive.
Right now, we’re supposed to marvel at Citigroup’s giant step in hiring Sallie Krawcheck to run equity research in a new unit called Smith Barney which is to be kept separate from investment banking and underwriting. She will report directly to chairman and CEO, Sandy Weill.
So what?
