much of this. Photographer: Spencer Platt/Getty Images
Matt Levine is a Bloomberg View
columnist writing about Wall Street and the financial world.
Levine was previously an editor of Dealbreaker. He has worked as
an investment banker at Goldman Sachs and a mergers and
acquisitions lawyer at Wachtell, Lipton, Rosen & Katz. He spent
a year clerking for the U.S. Court of Appeals for the Third
Circuit and taught high school Latin. Levine has a bachelor's
degree in classics from Harvard University and a law degree from
Yale Law School. He lives in New York.
Wall Street Analysts Give Investors What They Want
It's just not what regulators think they
Jan 20, 2017 7:00 AM EST
while back I
Here are two models of sell-side equity research.
Sell-side analysts are in the business of finding out what
stocks will go up and then telling you.
They tell you to Buy stocks that will go up, Hold stocks that
will stay flat (why?), and Sell stocks that go down.
You believe them, and do that.
Sometimes they lie to you, but it is always a shock when they
Sell-side analysts are in the business of helping
institutional investors get access to corporate management
They flatter management teams by giving most companies good
ratings, to maintain access.
They help their clients, because investors who meet
with management tend to outperform investors who
The clients aren't too worried about the Buy/Sell/Hold stuff
I more or less believe Model 2, though I recognize that it is
imperfect and incomplete. But there is plenty of
empirical evidence for
Today's Wall Street Journal has a
terrific article demonstrating, beyond any real doubt, that
Model 2 is right and Model 1 is wrong. If you believe that the job of
a sell-side analyst is to tell people which stocks to buy and which
ones to sell, you need to stop believing that right now, because it is
not true. You shouldn't be embarrassed about getting this wrong; lots
of people did. For instance, this guy thought that, and he actually
was a sell-side analyst:
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
But now he knows better ("he left the research industry to join a
venture-capital firm"), and so do you. The evidence is overwhelming:
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.
mean, look. To be fair: That leaves another two-thirds. Analysts
aren't just schedulers. They do analyze. They go to the meetings
themselves -- usually! -- and listen to what the managers say and then
try to find useful insights for their readers. They put together
financial models, and project companies' earnings and stock prices.
And yes, yes, yes, they put out Buy and Hold and -- rarely -- Sell
ratings. And that stuff can be useful to investor clients. A clever
insight from an analyst can give a client a good trade idea. An
industry background piece from an analyst can help a client get up to
speed on a new sector. An analyst's model can help the client think
about how the company makes its money. There is a lot of potential
value there, beyond just the scheduling.
But there is also just the dumb simple narrow question of: Which is
more important, the corporate access, or the Buy/Sell/Hold
recommendation? And on that question, there is just no doubt. Clients
want the access, and are willing to sacrifice Buy/Sell/Hold accuracy
to get it:
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
This makes sense: The investors are in the business of making
investment decisions. They want information -- management meetings and
analysts' research -- that will help them make those decisions. They
don't particularly want someone
else to make the investment decisions for them.
If you run a big mutual fund, your job is to decide which stocks to
buy. You might use a research analyst for background or insight or
management meetings, but you're not going to buy because she says Buy.
And investors do have
to sacrifice some Buy/Sell/Hold accuracy for the access, because some
companies will explicitly refuse to do client meetings with research
analysts who have Sell ratings on their stocks.
“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.
Notice that the analysts don't really have to sacrifice anything else.
They can still write insightful industry background pieces, and have
thoughtful conversations with clients about a company's future, and
summarize their takeaways from management conversations. They can even
write negative reports, really. They
just have to slap the word "Buy" on top. And so "just 6% of the
roughly 11,000 recommendations on stocks in the S&P 500 index are sell
or equivalent ratings."
Now, one potential reaction here is: This is terrible. The analysts
are lying to people. Instead of telling investors their true feelings
-- that they think investors should sell a company's stock --
they tell investors to hold, or even buy, that stock, just so they can
get the investors a meeting with the company's management. The
investors are deceived. They are losing money because of this conflict
But it isn't exactly a conflict of interest, is it? This isn't a story
of analysts lying to investors in order to win investment banking
business from big companies. This
is a story of analysts (maybe) lying to investors because that's
what the investors want.
The investors want the corporate access. You know that because they
tell the analysts that, and because they explicitly pay for it. The
investors don't care so much about the Buy/Sell/Hold stuff. You know
that because they tell the analysts that (sometimes), and because
their demand for corporate access has led to more bullish research. If
they cared more about ratings accuracy, you'd see less bullish ratings
and less corporate access. But
the reverse is true.
the investors are asking to be lied to, then they probably aren't
deceived, and we shouldn't feel worry about them. They are getting
what they want, and pay for: access to corporate managers. The fact
that they are also getting pieces of paper with "Buy" written on top
of them is irrelevant.
But of course those aren't the investors that anyone is worried about.
The worry is that small-time investors don't understand this system,
and don't benefit from it. Big institutional investors get to meet
with corporate management, which they like, because it is useful; they
discount the Buy recommendations. Small-time retail investors -- and
even small institutions -- don't get the benefit of corporate access,
so they just assume that the research is about the Buy/Sell/Hold
recommendations, and that they should buy all the stocks labeled Buy.
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.
own view is that buying individual stocks in your spare time based on
research analysts' recommendations is an incredibly weird niche
leisure activity and that there is no reason to organize any part of
our capital markets around it, though I am aware that that is a
minority view. But,
yes, those retail investors may be deceived, if they think that a
"Buy" recommendation represents the
deepest convictions of a research analysts with profound
insights into which stocks will go up, rather than a compromise to
give that analyst's big clients what they really want, a meeting with
corporate management. And it isn't just retail investors who think
that. It's also the Securities and Exchange Commission, which ...
doesn't so much think that as mandate it. Regulation
AC requires analysts to certify "that the views expressed
in the report accurately reflect his or her personal views," which is
awkward if you are censoring your personal views to improve management
One simple solution here would be to just
tell retail investors about Model 2,
which solves the problem of them being deceived, though it doesn't
really address the SEC problem. Really, while you're at it, you might
want to tell retail investors that they are very unlikely to beat the
market by trading individual stocks based on analysts' published
recommendations, and that if that was their plan they should probably
just index. It seems unlikely that the current research-analyst system
works well for retail investors, but: What system would work
well for them?
There is a lot of Wall Street stuff that looks sort of dumb and shady,
and it is tempting to point at it and say "this is dumb and shady" and
think that will make it go away. But I prefer to assume that most of
it comes from some rational economic place, and to try to understand
the rational economic explanation rather than write it all off as
shady nonsense. People have been crowing for years about
the fact that research analysts rarely give Sell ratings. It is a very
well-known fact. If it bothered investors, they could easily do
something about it. They could sit down with the analysts' bosses and
say: Look, we need better ratings; we need at least a third of your
ratings to be Sells, and if you can't do that, we are going to stop
giving you commissions. But they didn't do that. Instead, they sat
down with the analysts' bosses and said: Look, we need more meetings
with corporate managers; your analysts need to get us those meetings,
and if they can't do that, we are going to stop giving you
commissions. The market demanded a product, and the banks responded by
supplying it, and the market is happy with it. It's
just that the product -- the actual value provided by research
analysts -- is an access/analysis melange, not just a bunch of Buy and
Sell recommendations. It's a little different from, and a little more
complicated than, what regulators, and the press, and retail investors
think it is.
am fond of the
wrote a report titled "Not All Is Good In Buckeye Land," slapped a Buy
recommendation on it, and was fined by the Securities and Exchange
Commission for not saying what he meant. He meant "Not All Is Good In
Buckeye Land." He didn't mean "Buy."
That story happened!
It led to the big analyst
research settlement of 2003.
but I am fairly confident that that conflict is mostly gone.
way of allocating commissions to banks that provide them more access.
"U.S. investors paid $2 billion in brokerage commissions for corporate
access in 2016," reports the Journal, "or more than a third of all the
money spent on stock research and related services, according to
consulting firm Greenwich Associates."
Or, I don't know, maybe all companies are good now and so you should
buy them all? Something like 84 percent of the S&P 500 stocks were up
over the last 12 months, according to Bloomberg data, which is
not that far off the 94 percent of ratings that are Buy or Hold.
This exaggerates. Analyst recommendations do matter. "Upgrades and
downgrades by analysts often move stock prices," notes the Journal.
But that is in part just because most
ratings are so bullish, and Sells are so rare. If everyone has a Buy
rating, and you move to a Sell, it's news.
More disturbing is that some small professional money
managers also may rely too uncritically on sell-side research
recommendations: "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 a guy who runs "$800 million in investment trusts
held mostly by retail investors."
When bond-rating firm Standard & Poor's
paid $1.5 billion to the Justice Department to settle charges that it
"engaged in a scheme to defraud investors by knowingly issuing
inflated credit ratings for CDOs that misrepresented their
creditworthiness and understated their risks," I
pointed out that
S&P had never really lost any market share despite the exposure of
that scheme. Why is that? Shouldn't investors have stopped trusting
it? My own guess is that investors -- many investors, anyway -- wanted inflated
ratings on collateralized debt obligations. They wanted to own
AAA-rated stuff, but they wanted it to have high yields. They weren't
idiots, and they knew that higher yields came with higher risks. They
didn't really think that AAA-rated CDO-squareds were as safe as
Treasuries. But they wanted the AAA rating to show their regulators,
or their board of directors, or whomever, and so they were happy that
S&P helped supply it.
This column does
not necessarily reflect the opinion of the editorial board or
Bloomberg LP and its owners.
To contact the author of this story:
Matt Levine at
To contact the editor responsible for this story:
James Greiff at
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