New rules may temper stock 'touts'
Cheer up, stock market investors. Brokerage analysts may be starting to give more straightforward recommendations on corporate stocks.
"It's the silver lining behind the dark clouds," says Roderick Powell, an analyst with Weiss Ratings Inc., a Palm Beach Gardens, Fla., company that rates brokerages and other financial firms. "I have even been seeing more sell recommendations."
One that stood out to him occurred June 26, when WorldCom announced a $3.8 billion accounting error. An analyst at Credit Suisse, a major investment-banking firm, actually immediately recommended the sale of WorldCom stock, predicting its price would fall to zero.
Sell recommendations have been rare among the thousands of stock-research reports turned out by Wall Street 1 to 2 percent of all recommendations. Investment-banking firms have preferred that analysts sound positive or at least not firmly negative.
Wall Street firms are keen to get investment banking business, such as the issue of new bonds or stocks, from corporations. It is usually more lucrative than the ordinary sale or purchase of stocks, where competition has dramatically driven down brokerage fees. A bad research report can kill a business deal.
A Weiss study found that among 50 brokerage firms covering companies that have gone bankrupt this year, 47 continued to recommend that investors buy or hold shares in 13 of 19 failing companies even as they were filing for Chapter 11. Global Crossing, for example, received five "buys," nine "holds," and no "sells" on the day it filed for bankruptcy.
That excess optimism could be changing.
Reasons include the downturn in the stock market and the financial scandals. They make some buy recommendations transparently ridiculous.
Another is the $100 million settlement that New York Attorney General Eliot Spitzer won from Merrill Lynch & Co. in May. Merrill pledged to reform its stock-research process, including the separation of analysts' pay from the firm's investment-banking business. The deal came after Mr. Spitzer released dozens of embarrassing internal Merrill e-mails in which research analysts derided stocks Spitzer said the firm was recommending in hopes of getting investment-banking fees.
Spitzer and other state regulators are continuing investigations of 12 other firms.
Criminal charges against Wall Street firms or their executives could result, he has said.
A third element in change results from new regulations put out by self-regulatory organizations the National Association of Securities Dealers and the New York Stock Exchange with approval from the government's Securities and Exchange Commission.
Some elements of the new regulation dealing with conflicts of interest between research and investment banking or personal trading by analysts take effect tomorrow. For instance, an analyst can't buy or sell a security for his own account for 30 days before or five days after issuing a report. And he can't act contrary to the recommendation in that most recent report.
Another provision prohibits a firm from basing an analyst's compensation on a specific investment-banking transaction.
More visibly significant to investors, as of Sept. 9 each research report must include a chart showing the price of the security for as long as three years, with the dates the analyst assigned a rating to the stock (buy, hold, sell), any price target, and the date of any change in the recommendation.
If, for example, an analyst put a buy recommendation on Enron at $60 a share and didn't change the buy until bankruptcy last fall, that would be clear in the chart, notes Joseph Price, NASD's director of corporate financing.
Another rule coming into effect Sept. 9 requires a brokerage firm to publish in its research reports a summary of all its stock recommendations. If covering a total of 100 companies, say, it might note that it has a buy on 70 stocks, a hold or neutral on 20, a sell on 10. It will have to do the same separately for companies with which it has an investment-banking relationship.
If, in its total coverage, it has 70 percent buys, and in its second smaller list of investment banking clients, the ratio is 98 percent buys, "that probably provides some information to investors," says Mr. Price. In other words, it would reflect on the honesty of the recommendations.
Some brokerages have already been reevaluating their research. Since February, 22 percent of Morgan Stanley reports have been sells.
"This is the kind of distribution ... we will see eventually," says Charles Hill, research director at Thomson First Call, a group that keeps track of investment research.
If so, the goal of the new regulations, a restoration of "investor confidence," should be boosted.