Commentary: Investment Banks: Let Analysts Do Their JobsHeather Timmons
If you're an investor, it's no secret that stock analysts at big investment banks aren't always your friend. All too often, if you follow their advice, you'll lose your shirt. That's because those analysts, instead of recommending stocks on their merits, more and more push stocks to butter up companies and win underwriting or acquisition business for their firms. No wonder: If analysts are negative about a client, they sometimes risk losing their jobs.
It was not always so. The classiest investment banks used to be proud of the intellectual wattage of their research teams, who once turned out some of the most penetrating reports in the world. That's not to say all analysts just issue valentines to the companies they cover. But as the 1990s bull market grew, banks became increasingly obsessed with piling up deals and fattening profits. Now, the market is tumbling out from under them, touching off a spate of controversies about self-interested stock recommendations that spew out of Wall Street.
In short, it's time for investment banks to clean up their act. Banks that pressure analysts to make "buy" recommendations and cover only companies their employers do business with may get multimillion-dollar fees up front. But in the long run, these analysts and their firms are creating a mountain of ill will.
Analyst Gary R. Craft left Deutsche Bank Securities early in October because, he says, he "didn't have the opportunity to do solid long-term research" on the whole e-finance industry. Instead, he says, he was pressured to cover just the companies Deutsche Bank was working with, which gave an incomplete picture of the industry as a whole. Craft says he's not going back--and has rejoined Financial DNA, an independent research firm he started in 1999. Craft predicts that the big banks' research departments will become a costly albatross as disillusioned investors turn to more reliable sources of information. Many investors in recent years have used big bank trading desks just to get access to shares of initial public offerings. As IPO volume drops, why would they bother to pay the banks' higher trading commissions?
Investment banks need to restore integrity to their research efforts by holding their analysts to stricter standards. Instead of giving them a slice of banking fees they've helped win, banks would be smarter to award bonuses for good calls. And research departments should report to someone other than the heads of investment banking.
It needn't be a struggle. "Doing honest research is not incompatible with generating business for your firm," insists Michael Mayo, a highly regarded bank analyst who has been among the most bearish on the banking industry. Mayo and his team were unceremoniously booted from Credit Suisse First Boston early this month after it took over Donaldson, Lufkin & Jenrette. CSFB chose to go with DLJ's lower-ranked banking team. Some say that consolidation in the industry is giving firms an excuse to dump troublesome researchers.
BURNED. In fact, an analyst who issues a positive call to curry favor with clients could ultimately lose his firm business. On Oct. 9, Jack Grubman, Salomon Smith Barney's telecom analyst, dropped AT&T from a "buy" to an "outperform," a lesser rating in Wall Street's lexicon, after news reports claimed he issued the better recommendation to win Salomon an underwriting role in the IPO for AT&T Wireless Group. Some observers say Grubman's buy rating so angered Wall Street that Salomon has been kept out of other upcoming telecom deals.
Securities & Exchange Commission Chairman Arthur Levitt has scolded investment banks several times for their research, calling the ties among analysts, investment bankers, and companies a "web of dysfunctional relationships." To date, though, regulators have done little more than complain. The SEC and Wall Street firms would be wise to form a joint committee to hold the industry to stricter standards.
As the bull market wanes, angry investors with big losses are sure to scrutinize the relationship between analysts' buy recommendations and their firms' investment-banking business. Neither private litigation nor SEC action is out of the question. Indeed, if investment banks don't start fixing the problem now, they might have changes they don't like forced on them later.