Commentary: The Trouble With Free Investing AdviceJeffrey M. Laderman
The Internet is overflowing with bad investment advice, from tipsters planting stories in chat rooms and on message boards to stock-touting Web sites operating out of Panama. That has given the major brokerage firms an opportunity to bring in new customers who trade on the Net by offering access to their proprietary research reports. While this investment advice may have a better pedigree, it should be taken with a ton of salt.
Wall Street research reports are more sales documents than disinterested analyses. Most professional investors understand this and treat the research accordingly. But do newer investors, who arrived on Wall Street via cyberspace, grasp it? They certainly need to if they want to avoid putting their dollars in jeopardy.
At most Wall Street firms, the fabled Chinese wall between investment banking and research isn't much more than a paper partition. Analysts assigned to follow companies are encouraged to get friendly with managements, in the hopes of helping the analysts' employers land a fat fee for arranging an acquisition, securing financing, or underwriting stock. And even if there are no investment banking fees to be had, getting close to a company's top executives means improving the chances they'll get the "guidance" they need to be able to make on-the-money earnings estimates.
Either way, the tendency is for analysts to play up the good and sugar-coat the bad. During the long bull market, sell recommendations have all but vanished. At the end of October, 66.7% of stock recommendations were buys, and only 2.3% were sells, according to Bloomberg Financial Markets. The rest were holds, many of which are considered to be sell recommendations in disguise.
NO LIMIT. "Putting the research up online allows a brokerage firm to build their brand and get leads," says James M. Tousignant, president of Multex.com Inc., a public company whose Multex Investor site is a big online distributor of brokerage research. Through Multex, you can get 30 days of unlimited access to research from Merrill Lynch, Salomon Smith Barney, or Prudential Securities. The trade-off? Before the month is out, you'll be solicited by a broker.
With the big firms promoting inhouse research, those that don't have it are scrambling. "We will expand the research offerings dramatically," says Charles Schwab President David S. Pottruck, who declined to fill in the details. Schwab's site offers reports from Credit Suisse First Boston and Hambrecht & Quist, and some Schwab-watchers think the broker will strike a research deal with Goldman, Sachs & Co.
Multex itself is emblematic of the burgeoning business of distributing investment research on the Net. Multex, which started six years ago as a service aimed at institutional investors, launched its individual investor site a year ago. Tousignant says the site has 850,000 registered members and is adding new members at a rate of 80,000 to 100,000 per month. The company went public in March at $14 a share and now is around $23, though in its first month it topped $71.
The Multex Investor site contains research from 300 brokerage firms, but only about one-third of the content is free; some analyses are "sponsored reports," meaning visitors can get them in exchange for giving data about themselves. Even more reports are available by purchase, costing as little as $10 for a two-page earnings revision update to $150 for a thorough review of an industry. Tousignant says most of the reports purchased go for less than $25.
ASK A PRO. The problem with all the research, whether free, sponsored, or purchased, is that it's created for institutional investors, who know the jargon. An analyst dropping a stock's ratings from "buy" to "market performer" may not seem like a sell order to an individual but it certainly does to a pro. The best warning on this point is at Zacks.com, which, like Multex, distributes others' research: "You should assume that all research is written and prepared for experienced institutional investors who have the highest degree of financial sophistication and knowledge, and the capacity to withstand any financial losses."
Wall Street investment research doesn't go from the analyst to investors without some scrutiny. Supervisory analysts and compliance officers scour every word and follow guidelines set by regulators. Yet following the rules doesn't necessarily result in effective disclosure. Just look at Merrill Lynch's Nov. 15 report on World Wrestling Federation Entertainment Inc. The investment bank rated the stock a "buy"--its highest rating--for the long term and "accumulate"--the second highest--for the intermediate term. No surprise, since Merrill was one of the four underwriters of the company's Oct. 19 initial public offering. The others also issued buy recommendations on Nov. 15, the first day that the underwriters could do so.
The problem is, if the investor wasn't already aware that Merrill did the WWF deal, then it would be hard to learn that from the report. The underwriting connection is not in the boldfaced Investment Highlights section of the four-page report, nor even in the body. The only mention is in a boilerplate disclosure section at the end of the report, which is printed in 5 1/2-point type. That's about 40% smaller than the typeface in which this story is written. Says Raymond T. Abbott, director of global research compliance at Merrill Lynch: "We've talked to regulators about our formats, and they never said the disclosure was too small to be legible."
Or consider Merrill's Nov. 12 report on Tyco International Ltd., a once-hot conglomerate whose stock dropped by 23% last month when a non-Wall Street research firm raised questions about its accounting. Merrill, like most of Wall Street, dismissed the accounting criticism and gave Tyco a rousing endorsement. But Merrill had managed three secondary stock offerings for Tyco within the past four years, a fact not mentioned in the boilerplate. The disclosure says merely that Merrill may "from time to time" perform investment banking for this company or solicit such business from it.
The statement, while true, is so broadly written that it's meaningless. Merrill's Abbott says it meets the New York Stock Exchange rules: A more specific disclosure is only needed if Merrill is the last firm to do a public offering. Merrill did lead a bond offering in August, but since the deal was not to the public, no disclosure was required.
None of this is unique to Merrill. It is typical of how Wall Street presents conflicts that could affect the credibility of investment advice. Current practice might suffice for institutional investors. However, if the big firms are going to use investment research to lure newly minted Internet investors, they owe them a better and higher standard of disclosure.