Investors Should Consult the Independent Stock Research Now Available
rokerage firms now must provide investors with independent stock research. That is one of the requirements of last year's $1.4 billion global analyst research settlement with securities regulators, who believed that the brokerage firms had issued misleading stock research due to their investment banking conflicts of interest. This independent research will "ensure that individual investors get access to objective investment advice" regarding stocks, according to a press release that the regulators issued.
Should investors pay any attention to this independent stock research? A new study confirms that investors indeed should pay very close attention.
The August, 2004 study by three academics, Brad Barber, Reuven Lehavy and Brett Trueman, compares the stock recommendation performance of investment banking brokerage firms versus the stock recommendation performance of independent research firms. The trio makes three especially notable findings.
First, on the buy side (that is, for recommendations to buy a stock), the study shows that, from 1996 through 2003, the performance of the independent firms' stock recommendations exceeded that of the investment banking brokerage firms by nearly 8% annually. More particularly, since the bear market began (measured from March 11, 2000) through 2003, the performance of the independent firms' stock recommendations exceeded that of the investment banking brokerage firms by more than 17% annually. Most strikingly, during this bear market period, the academic trio finds that, subsequent to an initial public offering (IPO) or follow-on stock offering, the investment banking brokerage firms' recommendations trailed the independent firms' recommendations by almost 22% annually! The authors conclude that, "Taken as a whole, these results suggest that at least part of the underperformance of investment bank buy recommendations is due to a reluctance to downgrade stocks whose prospects dimmed during the early 2000's bear market, as claimed in the SEC's Global Analyst Research Settlement."
Second, the academic trio finds "a much different picture" on the sell side (that is, for recommendations to sell a stock, or the industry equivalent, the euphemism to "hold" a stock). The sell (and hold) recommendations of investment banking brokerage firms were better than the sell (and hold) recommendations of the independent firms for all periods. In fact, the investment banking brokerage firms' sell (and hold) recommendations fared the very best, outperforming independent research firms by 22% annually, during the bear market period for IPOs and follow-on stock offerings. Of course, those findings are not good news for investors. Why? The authors conclude:
"The performance differences …[are] consistent with a reluctance on the part of these [investment banking brokerage firm] analysts to downgrade stocks during the market downturn, in particular those that had recently generated investment banking business. Apparently, a very negative expected return was required, in general, for a banking analyst to issue a downgrade under these circumstances."
Third, the researchers find that the underperformance of investment bank buy recommendations extends not only to the ten investment banking brokerage firms that securities regulators sanctioned, but also to the non-sanctioned firms as well.
Thus, the study demonstrates that investors should pay close attention to the independent stock research now available to guard against investment brokerage firm bias, stemming from conflicts of interest, as well as against proven stock recommendation underperformance.
Moving forward, investors at the ten sanctioned firms (Bear Stearns, CSFB, Goldman, J.P. Morgan Chase, Lehman, Merrill Lynch, Morgan Stanley, Piper Jaffray, Smith Barney and UBS) will have access to various independent research reports. The July 27, 2004 Wall Street Journal has a helpful summary of what investors at those firms can receive. Additionally, further information regarding the global analyst research settlement, including restitution funds for investors, may be found at http://www.sec.gov/spotlight/globalsettlement.htm.
As always, it pays to do one's (independent) research!
_______________________________________________________________________
James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.
|
Download Acrobat Reader
