Tuesday, July 2, 2002
by Marc J. Lane

Reprint permission from the July 2, 2001 issue of Crain's Chicago Business.

Too many Wall Street stock brokerage firms pressure their securities analysts to hype the stocks of companies they've landed - - or hope to land - - as lucrative investment-banking clients. The public pays the price, and so do emerging companies which count on a legitimate market to raise capital and grow.

The most influential analysts work for firms that sell stock to the public, but also provide investment-banking services to the very companies the analysts cover. Favorable research reports buoy stock prices of companies which gleefully go on to issue more shares and enrich the investment bankers who curry their favor.

Each analyst's pay can be specifically tied to the investment-banking income his firm earns from the companies he follows. No wonder analysts are less than independent in their judgment.

Amazingly, some analysts have even been encouraged by their bosses to collaborate with the companies they rate, which sometimes help them write their research analyses. The head of equity research for one of the world's largest investment houses is reported to have instructed his analysts to seek his approval - - and solicit feedback from both his firm's investment-banking client and the client's investment banker - - before changing a recommendation on its stock.

It gets even more insidious. Investment firms often earn equity stakes in early-stage companies in exchange for the financing services they provide. When the firm's analyst writes a glowing research report - - a "booster shot," in industry parlance - - the client's stock rockets and the underwriter can sell its shares into an inflated market, realizing a huge, but unjustified profit.

So, everybody seems to benefit from a positive analyst's report or a "buy" recommendation on a company. Everybody but the investor who should have been advised to sell, or the issuing company which is shut out of the game or exploited by its rules.

The analyst has become an advocate, out to make the best case he can that any stock he studies is a compelling "buy." And brokerage firms back their analysts even when they set wildly unrealistic price targets or base recommendations on phony "metrics" like Web site visits.

Investment firms' research activities used to be separated from their investment-banking work, and regulators are starting to realize that the Chinese wall between them needs to be rebuilt. The SEC, state attorneys general - - and even Congress - - are finally taking notice that securities analysts just aren't accountable to investors anymore.

Last month, only two days before the U.S. House's financial services subcommittee on capital markets examined complaints about biased stock analysts, the Securities Industry Association decided to weigh in. It issued a set of voluntary "best practices" intended to address concerns about the independence of analysts. Of course, the SIA didn't admit that any analyst ever did anything wrong, but it did take aim at the most flagrant of abuses.

Obviously looking to forestall any legislative initiative, the Association half-heartedly suggested that analysts should not report to deal makers. That analysts' pay shouldn't be "directly" linked to transactions. And that analysts shouldn't sell stock they urge their investors to buy.

The SIA's approach is long on rhetoric, but short on substance. And it has no teeth.

The industry's self-righteous attempt to hold off mandatory regulation comes too late. Just before the Nasdaq started to implode in the spring of last year, there were 100 "buy" ratings recorded for every "sell" rating on technology stocks. Now we know that millions of unsuspecting investors relied on the advice of securities analysts who played both sides of Wall Street - - and that the public continued to buy unprofitable dot-coms, even after their prices soared to unsustainable levels.

Analysts should serve only one master - - the investor. They should be required to disclose their conflicts of interest to the public, and absolutely prohibited from owning shares in companies they cover.

Nothing less will restore the integrity of the financial markets and save investors from the conflicted analysts they've been trained to trust.


Marc J. Lane ( is a Chicago lawyer and financial planner and an adjunct professor of law at Northwestern University School of Law. His recently published book is Advising Entrepreneurs: Dynamic Strategies for Financial Growth (John Wiley & Sons, Inc.). 


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Copyright © 2001 by Crain Communications Inc.

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