Rating for Sale? Brokerage Charges Company for Analyst Coverage

  • Natixis says Transgene paid for its analysts’ report
  • EU ban on commissions to pay for research takes effect 2018

The bullish stock recommendation came with a warning: the company paid us to write this.

With brokers increasingly unable to subsidize research with indirect payments, France’s Natixis SA is pioneering a novel approach: charge clients for coverage, a model that has proved fraught with conflicts for debt-rating companies.

Analysts Jean-Jacques Le Fur and Philippe Lanone at Natixis published this month their first piece on Transgene SA, a French biotechnology company that’s worth $125 million, with a two-page note recommending that investors buy the shares. At the bottom of the first page, in bold italics, is a disclaimer that roughly translates to “Natixis has been paid by Transgene to produce financial analysis.” The stock soared 7.8 percent on the highest volume since January.

“I find the whole concept a little odd,” said Ian Gordon, head of banks research at Investec Plc in London. “It would potentially taint the brokerage’s product. My perception is that investors only value truly independent research. I don’t really understand why any company would be willing to write a check to commission such research if it is not valued.”

A spokeswoman for Natixis declined to comment on the agreement with Transgene. External representatives for Transgene did not return calls and e-mails seeking comment.

While providing paid promotions may undermine credibility and raise concerns about potential conflicts of interest, there aren’t too many alternatives, especially for mid-sized shops. Trading commissions to pay for research will be banned under European Union rules in 2018, and banks are looking for ways to pay for the service without passing costs onto their buy-side clients.

“It’s an industry trend,” said Sarah Jane Mahmud, a Bloomberg Intelligence analyst. “We’re likely to see banks moving to a more a la carte pricing structure for their research ahead of the new rules. It’s precisely the medium-sized players who are squashed. A lot of them are even exiting the business.”

The contract is perfectly legal as long as it’s disclosed loud and clear, according to French market regulator AMF. For small companies that may suffer from a lack of analyst coverage, it’s a way to increase exposure and get on the radar of investors, potentially increasing the liquidity of their stock. A handful of analysts provide investment research on Transgene, compared with more than 30 for Total SA, France’s biggest listed company, according to data compiled by Bloomberg.

“Of course, such contracts create concerns in terms of conflicts of interest,” Christele Fradin, communications director for AMF, wrote in an e-mail. “Market-abuse regulation requires a clear disclosure of such agreements in the research documents.”

The need to squeeze more money from research has prompted rivals such as Bank of America Corp., Morgan Stanley and Citigroup Inc. to limit access and make it more difficult to share files. While Natixis’ model is comparable to how debt-rating companies like Moody’s Investors Service and S&P Global Ratings produce reports for fixed-income investors, it’s far less common in the equities market, according to Michael Woischneck, a money manager Lampe Asset Management.

Credit-rating firms were blamed for lowering standards to win business in the lead up to the financial crisis. In response to the lapses, the Dodd-Frank Act of 2010 directed the U.S. securities regulator to prevent conflicts of interest from creeping into ratings decisions. While in the U.S. issuers pay a firm of their choosing to assess their debt, those in Europe are required to hire a different rating company every few years.

As a manager of a European small-cap stock fund, Woischneck says he has read commissioned research reports from small brokerages, but never from a larger bank like Natixis.

“A paid note can’t be completely neutral,” said Woischneck, who manages about $180 million as senior equities manager at Lampe in Dusseldorf, Germany. “It might be a good way to find out about the company and to get a first impression, but it’s marketing. I’d be careful with the conclusions, and I wouldn’t take a buy rating seriously.”

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