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Source: Wall Street Journal, January 19, 2017 article

THE WALL STREET JOURNAL.


Markets

New Wall Street Conflict: Analysts Say ‘Buy’ to Win Special Access for Their Clients

Securing face time for investors with top executives has become a vital revenue source for securities firms; ‘brand ambassadors’ at Coach

 

Coach’s headquarters in New York City in May. The luxury handbag maker doesn’t let analysts who have a sell rating on its stock host private meetings between their investor clients and top Coach executives. PHOTO: MICHAEL NAGLE/BLOOMBERG NEWS

 

By Serena Ng and Thomas Gryta

Updated Jan. 19, 2017 11:31 a.m. ET

Analysts who want top executives at Coach Inc. to attend private events with their investor clients have to show they are “brand ambassadors,” as the luxury handbag retailer dubs it. You can’t be a brand ambassador if you have a sell rating on Coach’s stock.

Coach investor-relations chief Andrea Resnick says it takes that approach because of “the sheer volume of requests” from analysts to have its management meet mutual funds, hedge funds and other clients. Coach can’t say yes to everyone, she adds, so it has to decide who gets access—and who doesn’t.

In 2003, a $1.4 billion settlement between Wall Street securities firms and regulators sought to eradicate conflicts of interest that led analysts to issue overly positive research on companies, a phenomenon designed to help win investment-banking deals. More than a decade later, the impact of the settlement has helped exacerbate another set of potential conflicts.

Securities firms have struggled ever since the settlement to make their research profitable. As a result, analysts’ relationships with company executives, including the ability to line up private meetings for investor clients, have become an increasingly vital revenue source. And that is increasing the pressure for analysts to be bullish on the publicly traded companies they follow.

U.S. investors paid $2 billion in brokerage commissions for corporate access in 2016, or more than a third of all the money spent on stock research and related services, according to consulting firm Greenwich Associates.

Many securities firms tally the number of times their analysts take company executives on the road to meet clients and use the number to help decide analysts’ annual bonuses.

At some firms, as much as one-third of analysts’ yearly pay can be tied to corporate access, says James Valentine, the founder of training and consulting firm AnalystSolutions LLC. Analysts generally earn in the six figures a year, but pay ranges widely by experience and securities firm.

Current and former analysts say those forces can cause them to err on the side of producing rosy research reports rather than jeopardize lucrative relationships with investor clients.

“It’s a decision I have to make on my sell-rated stocks: whether I will forgo the opportunity for corporate access, which clients will explicitly pay for,” says Laura Champine, a retail analyst at Roe Equity Research. Some previous bosses at other firms told her to “just drop coverage” instead of putting out sell ratings, she says, while declining to comment on where that happened.

“When your compensation is in part based on how many meetings you set up in a given year, it’s really tough to stick to your guns,” says Eric Hollowaty, a former analyst at Stephens Inc. who covered consumer companies.

Warren Stephens, the securities firm’s chairman, president and chief executive, says in a statement that analysts at Stephens “are encouraged to stay true to their convictions…even if it means less access for us.”

Analysts’ ability to arrange private events with management for clients is just a “minor aspect of compensation,” he says, adding that “turnover is very low among our analysts.”

A federal rule bars companies from selectively disclosing material nonpublic information but doesn’t prohibit private conversations with investors. Companies also are allowed to control how analysts and investors get access to corporate executives. Mutual funds and hedge funds, meanwhile, are happy to pay for the opportunity to pepper top executives with questions out of earshot of rival investors, possibly gleaning information to inform trading decisions.

Coach’s Ms. Resnick says any analyst may meet one-on-one with management, even if the analyst has a sell rating. About 50 analysts currently cover Coach, she adds, and it has held investor events with analysts who have buy or neutral ratings. Such analysts make up the vast majority of those with a rating on the stock.

Just 6% of the roughly 11,000 recommendations on stocks in the S&P 500 index are sell or equivalent ratings, according to research firm FactSet.

Last year, Deutsche Bank AG agreed to pay a $9.5 million penalty to settle civil charges that the firm “published an improper research report” from an analyst who kept a buy rating on Big Lots Inc. despite telling some traders and hedge funds he had new concerns about the discount retailer, according to the Securities and Exchange Commission.

 

A Big Lots store in Alhambra, Calif., on Thanksgiving morning. Regulators suspended an analyst who kept a buy rating on Big Lots despite telling some investor clients that he had new concerns about the discount retailer.PHOTO: FREDERIC J.BROWNAGENCE FRANCE-PRESSE/GETTY IMAGES

Those qualms were based on information from investor meetings with Big Lots management hosted by the analyst.

The SEC said Deutsche Bank’s performance-evaluation system for analysts “assigned significant weight to analysts’ access to and relationships with the senior management of the companies they covered and the feedback that the firm received from its clients.”

Analysts received additional credit for securing meetings with chief executive officers and chief financial officers, the SEC said. The enforcement action didn’t conclude that the practice of investors paying analysts for corporate access creates a potential for conflicts of interest or other problems.

The Financial Industry Regulatory Authority says securities firms need to be proactive about identifying and defusing conflicts of interest that could affect the objectivity of their research analysts.

Amanda Williams, a spokeswoman for Deutsche Bank, says the firm “takes its research analyst communications and conduct very seriously and has a robust policy and control framework.”

The analyst, Charles Grom, paid a $100,000 penalty to the SEC, was fired by Deutsche Bank and is serving a one-year suspension from the securities industry. Mr. Grom and Deutsche Bank didn’t admit or deny wrongdoing. The analyst’s lawyer, Patrick Smith, said Mr. Grom had no comment.

 

Analyst recommendations often carry weight with small investors, says John Bajkowski, president of the American Association of Individual Investors, a nonprofit group with 180,000 members. Most retail investors tend to lack sophisticated financial data and seldom dig through corporate filings, he says.

Some hedge funds and smaller money managers also get trading and investment ideas from analysts. “As much as we can screen the fundamentals of a company, those analysts are going to know far more than me and my colleagues,” says Kevin Mahn, president of Hennion & Walsh Asset Management Inc., which oversees $800 million in investment trusts held mostly by retail investors.

Upgrades and downgrades by analysts often move stock prices, says Mark Bradshaw, a Boston College accounting professor who has researched the securities industry. That is one reason why top executives care deeply about what analysts are saying, investor-relations officials say.

Mr. Valentine of AnalystSolutions, a former analyst and managing director at Morgan Stanley, now coaches analysts across the industry.

Many of them have a goal of increasing the number of “non-deal roadshows,” or marketing trips that aren’t tied to specific corporate transactions or stock sales but feature analysts taking executives to the offices of current and potential investors. The meetings allow executives to pitch an analyst’s clients on the company’s strategy and investment value.

More than 90% of companies go on such roadshows, according to a 2014 survey conducted by the National Investor Relations Institute trade group.

Banks and brokerages often poll large investors on the services they value most highly. Private meetings arranged by analysts are cited among the top reasons why investors steered trades through the banks and brokerages.

That decision is important because commissions from such trades are part of the lifeblood at many financial firms. Competition has intensified since the financial crisis because the pool of available commissions is shrinking from price cuts and the rise of automated trading.

Christopher King, a former Stifel Financial Corp. analyst, recalls asking Sprint Corp. for meetings with clients when he had a hold rating on the wireless telecommunications company a few years ago. He says a Sprint investor-relations officer asked why it should oblige when he didn’t have a buy rating.

Two analysts who still follow Sprint say their investor-meeting requests also were been rebuffed when their ratings were negative. Twenty analysts have a buy or hold rating on Sprint, while nine rate the stock a sell, according to Thomson Reuters.

Sprint’s head of investor relations, Jud Henry, says he doesn’t recall telling analysts that they wouldn’t get corporate access because they didn’t have a buy rating on the company. He says Sprint executives recently attended conferences hosted by analysts with neutral and sell ratings.

Meredith Adler, a longtime retail analyst who retired from Barclays PLC in early 2016, says companies sometimes reacted to sell ratings by cutting analysts off, which was “a hardship because your questions go unanswered and you’re deprived of information,” she adds.

The former analyst recalls that Family Dollar Stores Inc. wouldn’t let analysts with negative ratings take executives on the road to meet with investors, though the discount retailer would still maintain contact with those analysts.

Family Dollar was acquired by Dollar Tree Inc. for about $9 billion in 2015. Randy Guiler, Dollar Tree’s head of investor relations, says the company considers executives’ availability, analysts’ ratings and other factors when making decisions about corporate-access events.

Media analyst Richard Greenfield of BTIG LLC says his emails, phone calls, and a request for an investor meeting with Walt Disney Co. have gone unanswered since he issued a sell rating on the company in December 2015.

The rating went out on the same day as the world-wide release of “Star Wars: The Force Awakens.” Before then, when Mr. Greenfield had a buy rating on the stock, he was regularly invited to Disney events and once hosted a meeting between a group of investors and a Disney executive, the analyst says.

“Everything changed when we went to a sell,” says Mr. Greenfield. When Disney invited more than 50 analysts and investors to the opening of its Shanghai Disneyland resort last summer, Mr. Greenfield was left out.

Disney did invite Barclays analyst Kannan Venkateshwar, who had an “underweight” rating on Disney last spring, according to people familiar with the matter.

In November, Mr. Venkateshwar boosted his Disney rating, and he is scheduled to hold an investor meeting with Disney next month, one of the people says.

David Strasser, a former retail analyst at Janney Montgomery Scott LLC, says some investors told him they had little interest in his research and were only paying for meetings he could set up with companies.

“I wanted to be valued for my analytical abilities, but arranging meetings became such a critical part of the job,” says Mr. Strasser, adding that he was sometimes asked to sit outside the room so investors could ask questions without him. In 2015, he left the research industry to join a venture-capital firm.

When Steve West was an analyst covering restaurants and grocery chains, many companies did roadshows only with analysts who had buy ratings, he says. Corporate access “became part of the overall calculus,” he adds.

Mr. West is trying to change things now that he is Panera Bread Co.’s vice president of investor relations. He says Panera’s policy is that all analysts can get their clients face time with management regardless of their rating on Panera’s stock.

“It shouldn’t be a popularity contest,” he says.

Write to Serena Ng at serena.ng@wsj.com and Thomas Gryta at thomas.gryta@wsj.com

 

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