Archive for the ‘ResearchWatch’ Category

Estimize Caps Off Three Big Wins With $1.2 mln Funding

Monday, March 31st, 2014

Last week saw some great upsets in the NCAA Division I Men’s basketball tournament (Go Flyers and Huskies!). However, crowd-sourced earnings estimate provider, Estimize, experienced its own March Madness last week, with three notable wins, capped off by a $1.2 mln funding round reflecting the numerous advances the firm has made over the past eighteen months.

Company Background

Founded in June 2011, Estimize is an open financial estimates platform based on the belief that the “wisdom of the crowds” is more accurate then estimates provided purely by sell-side analysts. The firm was established by Leigh Drogen, a former quantitative hedge fund analyst, who felt that Wall Street analysts are not correctly incented to provide accurate and unbiased earnings estimates due to inherent conflicts within the investment banking business model.

Currently Estimize collects revenue and earnings estimates from 4,232 contributors, including professional analysts from the buy-side and sell-side, as well as private investors and even students.  The consensus estimates collected by Estimize cover more than 900 U.S. publicly traded stocks on a quarterly basis.

The core consensus data set generated by Estimize is open and free to everyone, regardless of an individual’s contribution level.  The firm currently generates revenue by selling access to their dataset via an API for professional investors.  At present, a handful of clients pay for access to its API, with almost two dozen more who are testing the data now.  The company is also in talks to feed its data to a few financial media platforms. Management explains that Estimize’s revenue has grown 100% each quarter.

Deutsche Bank Report Validates Estimize Data

One of the first wins experienced by Estimize last week was an extremely encouraging report published by Deutsche Bank’s Quantitative Research Group validating the use of Estimize data in quantitative research models.  Following are a few of the findings from the Deutsche Bank report:

  • DB found that the Estimize consensus forecasts more accurately identified earnings surprises than the less timely IBES estimates – a factor that led to capturing more of the stock price move post earnings announcement.
  • DB also found that as the number of contributors to the Estimize consensus increased, the forecast accuracy relative to IBES also increased.  For example, EPS estimates for stocks with more than 20 Estimize contributors are more accurate than the IBES consensus 2/3rds of the time.
  • DB also found, much to their surprise, that the EPS prediction accuracy of Estimize contributors who were finance professionals underperformed the accuracy of non-professionals.
  • In addition, DB found that combining the Estimize estimates of professionals and non-professionals increased the accuracy of these estimates above the accuracy of any one of the groups alone.

In wrapping up, the quantitative group at Deutsche Bank agreed that, “In conclusion we found multiple benefits to using the Estimize dataset; especially in the case of short-term applications in which accuracy is essential. Another interesting byproduct of the analysis was the power of crowdsourcing. We found that some of the value-added in the Estimize dataset was due to the ‘wisdom of crowds’ effect as more predictions give way to greater accuracy. Moreover, the diversity of the contributors provides a greater spectrum of information which can potentially improve investment strategies based on estimates.”

Launch of Mergerize.com

Another major development for Estimize last week was the launch of a new financial information product called Mergerize which provides crowd-sourced expectations for mergers and acquisitions.

At its most basic, Mergerize (www.mergerize.com) is a platform where people can guess whether a company will get bought by another company, or whether they will buy another company, and at what price.  Drogen explained, “It’s all the same set up as Estimize, but it’s more about if Company X will buy Company Y for X dollars.”  The platform will eventually provide M&A expectations on more than 4,800 public companies, private companies, and even start-ups.

Drogen, a former buy-side quant analyst explained the potential value of this M&A expectations data, “How might the resulting data be used by traders? Well for the quants, I expect that they will use Mergerize data to exclude certain stocks from their trading at certain times given that there is outsized risk associate with M&A transactions in their models. If Mergerize data can mitigate this risk by putting a “no trade” tag on certain stocks, it should be very valuable. For discretionary traders, specifically of the event driven persuasion, having a set of M&A expectations should allow them to take advantage of their own beliefs if they see that they are significantly different from the crowd. If the market feels a deal will take place, and you believe there’s a premium built into a stock because of that expectation, but you don’t think that deal is going to happen, then you probably believe at some point that premium is going to come out, and you should be short. My bet is also that there will be a high correlation between the velocity of people predicting a certain deal and the implied volatility of the target in the deal. I’m sure traders will figure out how to utilize that correlation.”

Of course, Mergerize.com is a brand new expectations service and doesn’t offer many of the features found on Estimize.com, nor does it have the volume of estimates of that site.  So far, a total of 38 predictions have been made, focusing on 26 predicted targets and 28 potential acquirers.  However, Drogen is hopeful about the new service, explaining “Over time as we see the platform grow more resources will be put towards it.”

$1.2 mln Funding Round Completed

Capping off a great week, Estimize closed a $1.2 mln Series A-1 funding round, at approximately 3 times the valuation it received in its previous funding round 18 months earlier, reflecting the progress the company has made on building out its the product, data set, and team.

The financing round included the firm’s current venture investors from Contour Venture Partners and Longworth Venture Partners.  It also included a syndicate of angel investors put together by ValueStream Labs, along with individual angels Brian Finn (former CEO of Credit Suisse), Mike Towey (Director of Research at Susquehanna), and Jason Finger (Founder SeamlessWeb).

Drogen explained his excitement about the angel syndicate put together by ValueStream Labs, “It has always been my goal to do a “crowdfunding” round at Estimize. Our platform is reliant on a network effect, and we want as many people as possible who use Estimize to be incented to grow our community with us. And while our government has made strides in opening up the legal framework for crowdfunding, it’s still touch and go in many respects when it comes to accredited vs non accredited investors. The AngelList syndicate structure gets us half way, and has allowed us to bring in 20+ amazing investors from across the financial ecosystem in a clean way for our cap table.”

Summary

The past few weeks have been particularly noteworthy for “crowd-sourced” investment research sites, including SeekingAlpha, and now Estimize.  While few firms have fully embraced the view that the “wisdom of the crowds” can be even more valuable to investors than traditional investment research and analyst estimates, a small but growing number of studies have shown that this clearly could be the case.

In our mind, what is particularly exciting is the extension of the “crowd-sourcing” model to quantify new areas of “investor expectations” like M&A activity.  Only time will tell if this data will be accurate and useful for investors.  However, whether the Mergerize product is successful or not, we think professional investors will become increasingly more willing to consider using non-traditional research data from “crowd-sourced” investment research businesses like Estimize, Seeking Alpha, StockTwits, or other new data and research vendors that are likely to spring up in the next few years.  Clearly, “crowd-sourcing” is here to stay.

 

Gerson Lehrman 2.0

Wednesday, March 26th, 2014

Earlier this month, Gerson Lehrman Group, the world’s leading expert network, introduced a new logo and revamped its website. The change is symptomatic of the resurgence of expert networks since the onset of the insider trading investigations.

Gerson Lehrman, reportedly coming off a year of record revenues in 2013, is rebranding itself as GLG, not to be confused with GLG Partners, the $30 billion hedge fund based in London. Besides a state-of-the-art new website, it will be moving its headquarters into state-of-the-art new offices at One Grand Central Place in Manhattan this summer. And it is hiring furiously. It would not be surprising if the long deferred IPO were announced later this year.

GLG Tech

With the new website comes a new url: www.glg.it. Note the .it domain. No, Gerson Lehrman has not moved to Italy. It doesn’t even have an office in Italy. More likely the domain is meant to evoke ‘Information Technology’, seeking to position GLG as a tech company.

Aspiring to be viewed as a tech company is not a new phenomenon for GLG. During its last rebranding in 2011, the firm launched a social media site named G+ which was going to be the new social media face of Gerson Lehrman: a LinkedIn with gravitas or, more accurately, a business-oriented version of Quora. However, Google did not take kindly to the G+ brand, and GLG changed it to ‘High Table’ in 2012. With the latest rebranding this month, GLG has quietly killed www.hightable.com, redirecting the url to its main site.

The GLG research website still lives on (www.glgresearch.com) highlighting GLG’s events, offering website information in 12 different languages and featuring GLG’s research store which allows purchase of one-off reports and conference transcripts. However, parts of the GLG research site already redirect to www.GLG.it so it may just be a matter of time before it goes away also.

Expert Membership Network

The other key facet of GLG’s rebranding is to distance it from being an expert network. Gerson Lehrman is no longer an expert network, it is a membership: “GLG is building the world’s largest membership for professional learning and expertise, so clients in every sector can interact with experts to gain insight.” Oops, experts slipped in there. The guideline for writing GLG’s copy appears to require sparing references to experts or networks and never ever put the two words together.

The irony here is that being an expert network, and more especially being an expert network during the insider trading investigation, has ultimately been good for Gerson Lehrman. After its planned sale to Goldman Sachs cratered over liability issues in 2004, GLG began aggressively beefing up its compliance platform. By 2008, the stringency of GLG’s compliance platform was becoming a competitive issue, with smaller, nimbler expert networks touting their quicker response times (and implicitly their laxer compliance regimes).

Consolidation

Gerson Lehrman had an even bigger problem as pricing was pressured by greater competition. GLG created a large price umbrella, typically charging over $1000 per hour for consultations, and there were few barriers to entry for new expert networks. By 2010, there were around 50 expert networks globally, and the consultation fees were dropping to $800 per hour. Then in late 2010, the insider trading investigations went public and an expert network competitor, Primary Global, was deeply implicated in the scandal.

Suddenly, the words ‘expert network’ raised the blood pressure of buy-side compliance officers and GLG became the safe choice. GLG was not immune from the overall decline in expert networks by asset managers immediately following the Primary Global scandal, but it picked up market share. And the number of competitors shrank by more than half. Now, as usage of expert networks has rebounded, GLG is a key beneficiary.

Going forward

GLG is hiring aggressively. With a staff of 850, it is already an order of magnitude larger than most other expert networks. It is advertising over 70 new jobs as it continues to scale. Three quarters of the new jobs are in the US, reflecting in part the centralization of many of its back office operations in Austin Texas, but it is also hiring in China, India (where much of its expert sourcing occurs), UK, Ireland and Singapore.

Overall, we think the new rebranding is more successful than its previous brandings, and reflects the confidence engendered by the resurgence of its business (and big bucks spent on high end designers). The end goal is an IPO exit for its private equity investors, Silver Lake Partners and Bessemer Venture Partners. The exit was delayed by the insider trading scandals, but now that GLG has resumed a growth path it is just a matter of time before GLG files, perhaps later this year.

 

Earlier this month, Gerson Lehrman Group, the world’s leading expert network, introduced a new logo and revamped its website. The change is symptomatic of the resurgence of expert networks since the onset of the insider trading investigations.

Gerson Lehrman, reportedly coming off a year of record revenues in 2013, is rebranding itself as GLG, not to be confused with GLG Partners, the $30 billion hedge fund based in London. Besides a state-of-the-art new website, it will be moving its headquarters into state-of-the-art new offices at One Grand Central Place in Manhattan this summer. And it is hiring furiously. It would not be surprising if the long deferred IPO were announced later this year.

GLG 2.0

With the new website comes a new url: www.glg.it. Note the .it domain. No, Gerson Lehrman has not moved to Italy. It doesn’t even have an office in Italy. More likely the domain is meant to evoke ‘Information Technology’, seeking to position GLG as a tech company.

Aspiring to be viewed as a tech company is not a new phenomenon for GLG. During its last rebranding in 2011, the firm launched a social media site named G+ which was going to be the new social media face of Gerson Lehrman: a LinkedIn with gravitas or, more accurately, a professional version of Quora. However, Google did not take kindly to the G+ brand, and GLG changed it to ‘High Table’ in 2012. With the latest rebranding this month, GLG has quietly killed www.hightable.com, redirecting the url to its main site. http://www.integrity-research.com/cms/2011/05/10/rebranding-gerson-lehrman/ http://www.integrity-research.com/cms/2012/05/15/gerson-agonistes/

The GLG research website still lives on (www.glgresearch.com) highlighting GLG’s events, offering website information in 12 different languages and featuring GLG’s research store which allows purchase of one-off reports and conference transcripts. However, parts of the GLG research site already redirect to www.GLG.it so it may just be a matter of time before it goes away also.

Not an expert network

The other key facet of GLG’s rebranding is to distance it from being an expert network. Gerson Lehrman is no longer an expert network, it is a membership: “GLG is building the world’s largest membership for professional learning and expertise, so clients in every sector can interact with experts to gain insight.” Oops, experts slipped in there. The guideline for writing GLG’s copy appears to require sparing references to experts or networks and never ever put the two words together.

The irony here is that being an expert network, and more especially being an expert network during the insider trading investigation, has ultimately been good for Gerson Lehrman. After its planned sale to Goldman Sachs cratered over liability issues in 2005, GLG began aggressively beefing up its compliance platform. By 2008, the stringency of GLG’s compliance platform was becoming a competitive issue, with smaller, nimbler expert networks touting their quicker response times (and implicitly their laxer compliance regimes).

Consolidation

Gerson Lehrman had an even bigger problem as pricing was pressured by greater competition. GLG created a large price umbrella, typically charging over $1000 per hour for consultations, and there were few barriers to entry for new expert networks. By 2010, there were around 50 expert networks globally, and the consultation fees were dropping to $800 per hour. Then in late 2010, the insider trading investigations went public and an expert network competitor to GLG, Primary Global, was deeply implicated in the scandal.

Suddenly, the words ‘expert network’ raised the blood pressure of buy-side compliance officers and GLG became the safe choice. GLG was not immune from the overall decline in expert networks by asset managers immediately following the Primary Global scandal, but it picked up market share. And the number of competitors shrank by more than half. Now, as usage of expert networks has rebounded, GLG is a key beneficiary. http://www.integrity-research.com/cms/2013/11/11/resurrection-of-expert-networks/

Going forward

GLG is hiring aggressively. With a staff of 850, it is already an order of magnitude larger than most other expert networks. It is advertising over 70 new jobs as it continues to scale. Three quarters of the new jobs are in the US, reflecting in part the centralization of many of its back office operations in Austin Texas, but it is also hiring in China, India (where much of its expert sourcing occurs), UK, Ireland and Singapore.

Overall, we think the new rebranding is more successful than its previous brandings, and reflects the resurgence of its business. The end goal is an IPO exit for its private equity investors, Silver Lake Partners and Bessemer Venture Partners. The exit was delayed by the insider trading scandals, but now that GLG has resumed a growth path, it is just a matter of time before GLG files, perhaps later this year.

Expert Membership Network

Crowd Sourced Stock Ideas Beat Wall Street Analysts

Monday, March 24th, 2014

A recent academic study revealed that the stock market ideas published on internet investor forum Seeking Alpha outperformed the research written by Wall Street analysts and articles published by financial news services over the past seven years supporting the belief in the “wisdom of the crowds”.

Background of the Study

Last week, the Wall Street Journal wrote an article highlighting a recent academic study called Wisdom of Crowds: The Value of Stock Opinions Transmitted Through Social Media which found that stock market recommendations published on internet-based investor forum SeekingAlpha.com predicted individual stock returns, as well as earnings surprises, in excess of what is provided by Wall Street analyst reports and financial news articles.

The study, which will be published shortly in the Review of Financial Studies, was written by Hailiang Chen, Prabuddha De, Byoung-Hyoun Hwang, and Yu (Jeffrey) Hu of City University of Hong Kong, Purdue University and Georgia Institute of Technology.  The researchers analyzed the sentiment of approximately 100,000 articles and related comments posted on SeekingAlpa.com between 2005 and 2012.

The study evaluated the percentage of positive or negative words in SeekingAlpha articles and the associated comments on a particular stock, and tracked the performance of that stock after the article and comments were posted.  In order to eliminate the short-term impact of investors immediately responding to published articles, the researchers started tracking the performance of these share prices 48 hours after the article was published.

In addition, the researchers tried to determine whether the articles on SeekingAlpha were primarily moving the market rather than predicting it.  They did this by also analyzing whether the sentiment of SeekingAlpha articles or the associated comments were highly correlated with earnings surprises.

Findings of the Study

What the researchers discovered was the more positive the articles and comments were on a specific stock, the more likely that stock was to perform better than similar stocks over the next several months.  They also found that negative articles and comments also underperformed similar stocks in the future.

In fact, the study concluded that on average, someone investing according to the sentiment of the articles and comments and holding positions for three months would consistently beat the market.  This finding held up even when a number of variables were controlled for, including Wall Street analyst recommendations, upgrade/downgrades, earnings surprises, and the sentiment of traditional financial news articles.

In addition, the study found that the aggregate opinion of SeekingAlpha articles and comments had a strong correlation with earnings surprises, suggesting that the articles did not merely move stock prices, but they had some predictive power.

“We find that the fraction of negative words in SA articles and comments strongly predict subsequent scaled earnings surprises,” says the study. “The earnings-surprise predictability suggests that the opinions expressed in SA articles and comments indeed provide value-relevant information (beyond that provided by financial analysts).”

The study also found that SeekingAlpha articles and comments predicted stock returns over every time-frame examined: three months, six months, one year and three years.

Lastly, the study concluded that in cases where there is broad-based disagreement between the authors of articles and the community’s comments to these articles, the sentiment of the community was more accurate than the authors in predicting future stock price performance and earnings surprises.

Some Issues with Seeking Alpha

Despite the support that SeekingAlpha and crowdsourcing of investment ideas received from this recent academic study, a few have been quick to point out the dangers that sites like SeekingAlpha could create for individual investors.

In an article published this past weekend in Barron’s, called Seeking Alpha Needs to Take Stock of its Policies, John Kimelman wrote that several of SeekingAlpha’s policies could lead to sloppy analysis or even market manipulation by its contributors.

Kimelman wrote, “But Seeking Alpha has also received some troubling press in recent weeks, exposing problems inherent in the site’s policy of allowing anonymous contributors. The problems, I contend, also stem from less than stringent editorial standards that need to be tightened up so that Seeking Alpha can do a better job resisting stock manipulators who see the site as an easy mark.”

In the article, Kimelman discusses a recent instance when SeekingAlpha removed at least a half  dozen favorable articles about Galena Biopharma after concluding that the anonymous writers of these articles weren’t being truthful about their identities.  After investigating this issue, SeekingAlpha discovered that one individual wrote five articles under different pseudonyms.

Unfortunately, a number of Galena insiders sold shares of the stock which may have gained value, at least in part, due to the favorable articles.

Kimelman concludes that the by protecting the anonymity of the authors, SeekingAlpha is overlooking the dangers that could result from this policy, like enabling a writer to publish sloppy or one-sided analysis, or even allowing a single writer to try and manipulate stock prices by publishing overly bullish or bearish articles by making up phony aliases.

The second troubling policy Kimelman highlights is the fact that SeekingAlpha asks its writers to disclose whether they are long or short the stock when they write an article.  Unfortunately, the forum has no way to tell if the writer is telling the truth, an issue which could call into question whether the article is biased or not.

Kimelman concludes his article by explaining, “In response to some of my questions, [Eli] Hoffman [the Editor in Chief of SeekingAlpha] says that his site is taking steps to improve the quality of the site, including a new compensation system that rewards quality rather than just page-views. But no steps are being taken at this time to limit the use of anonymity.  I would urge them to reconsider that point.”

Summary

In our mind, the recent study clearly points out the value that crowd sourcing of investment ideas from a site such as SeekingAlpha, can provide to individual investors.  In fact, Yu Jeffrey Hu, associate professor at Georgia Tech’s Scheller College of Business and one of the authors of the academic study, pointedly explained that, “Seeking Alpha is the only platform to date that we have shown can predict individual stock returns.”

However, the recent Barron’s article also highlights how sites like SeekingAlpha can be abused by bad actors trying to profit from the impact the site has on stock prices – a fact that could put some investors at risk of being manipulated.

Given this, perhaps the most important role that SeekingAlpha, and other crowd sourced investment research sites, should play (at least at present) are they are great sources to find interesting ideas which investors can use to start their research process.

 

Readership Survey Results

Wednesday, March 19th, 2014

A big thank you to all who completed the readership survey we conducted in January of this year.  ResearchWatch will celebrate its 10-year anniversary later this year, and the feedback from readers is helping us prioritize future improvements.

Reader Profile

Most readers are directly involved with research, either on the sell-side (68%) or the buy-side (15%).  More readers are in a management role (39%), followed by research (35%), sales (16%), trading (3%), commission management (2%) and other (5%).

Nearly half of readers (48%) are with independent research providers, 10% with investment banks, another 10% with agency brokers, 15% are on the buy-side, 5% with market data vendors and 12% with other types of firms.

Three-quarters of readers are U.S. based, with the remainder primarily comprised of readers from the UK (9%), continental Europe (5%), Asia (4%), Canada (2%), Latin America (2%) and rest of world (2%).

Most readers read the blog on Mondays when the weekly summary email is sent.  Readers use a wide variety of news sources, with the most popular being Bloomberg, the Wall Street Journal, Financial Times, and Institutional Investor.

Interests

Readers are interested in most varieties of research, but those of most interest are fundamental equity research (18%), industry research (15%) and expert networks (12%).

Readers prefer topics involving general research industry news, acquisitions involving research firms, and commissions related to research payments.

Guidance

We asked readers for feedback on what they valued about ResearchWatch.  Generally, readers like the consistent coverage of a specific niche, investment research, which is only periodically covered by the broader media.  Readers appreciate that ResearchWatch is relevant to their business, that it has an understanding of research industry dynamics, and they value the commentary (although they don’t always agree with it.)

We also asked for advice on improvements.  Overall, readers would like to see more content more frequently.  Many responders asked for more coverage of the UK, Europe and Asia.  There were excellent suggestions for specific topics, such as people moves, business models, sales and marketing activities, pricing, what buy-siders want, and more.

Some readers feel ResearchWatch has been too negative about the business environment and trends in the industry while others have the view that we hold back in our commentary at times.  All very helpful!

Going forward

The reader input has been tremendously valuable to us and we are taking it all on board.  We have started working on ways to expand the coverage and content of ResearchWatch, without disrupting what readers currently value.

Part of this will involve encouraging readers to contribute ideas, thought pieces and success stories with the broader community of readers.  If you have interest in contributing, let us know.   ResearchWatch can be a forum for a more diverse set of voices besides ours.

We will revert with more specific plans as they congeal.  In the meantime, thanks to our loyal readers for all their great feedback.

SEC Strikes Again With New SAC Insider Trading Charge

Monday, March 17th, 2014

Last week the Securities and Exchange Commission filed civil charges against yet another former SAC Capital analyst for insider trading, suggesting that the government is not done with its investigation of Steven Cohen’s hedge fund.

Background of the Case

In its recent complaint, the SEC alleged that Ronald N. Dennis, a former analyst at SAC affiliate CR Intrinsic Investors, traded on material nonpublic information he received from two other hedge fund analysts in the shares of Dell (DELL) and Foundry Networks (BRCD) during 2008 and 2009.

Dennis purportedly received illegal inside information about Dell’s financial performance from former Diamondback Capital analyst Jesse Tortora.  Separately, Dennis received an illegal tip about the impending acquisition of Foundry Networks by Brocade Communication Systems from Matthew Teeple, an analyst at a San Francisco-based hedge fund.  Both Tortora and Teeple have been previously charged by the SEC for insider trading.

The SEC also alleged that Dennis traded in Dell before earnings announcements in 2008 and 2009, enabling CR Intrinsic and SAC Capital to either generate profits or avoid losses of $3.2 million on its positions in Dell stock.

In addition, the SEC alleged that Dennis received information from Teeple about Brocade’s upcoming acquisition of Foundry Networks in July 2008, prompting him to purchase Foundry stock for CR Intrinsic before the news of the acquisition was made public.  This trade enabled CR Intrinsic to generate approximately $550,000 in profits.

Steve Cohen Identified

In the SEC’s complaint, a number of SAC employees were mentioned who Dennis reportedly shared the inside information he had received.  This includes “Portfolio Manager A” who the SEC alleges, purchased 120,000 shares of Foundry stock for CR Intrinsic after Dennis gave him the tip; “Portfolio Manager B,” who the SEC alleges traded Dell shares based on inside information Dennis provided; and “Portfolio Manager C,” who the SEC alleges, bought 500,000 shares of Dell in August, 2009 after speaking with Portfolio Manager B, who had received inside information from Dennis.

While the SEC complaint did not identify the three SAC employees Dennis allegedly shared his illegal tips with, people familiar with the matter say that Portfolio Manager A is likely to be Alec Shutze, Dennis’s former boss at CR Intrinsic; Portfolio Manager B is Eric Gerster, who became Dennis’s boss after Shutze left the firm; and Portfolio Manager C is SAC founder Steven Cohen.

Settlement Agreed

In response to the SEC’s allegations, Dennis agreed, without admitting or denying the charges, to pay $95,351 in disgorgement of profits, $12,632.34 in prejudgment interest, and a $95,351 penalty.  Dennis also agreed to be permanently barred from working in the securities industry.  The settlement is subject to court approval.

Sanjay Wadhwa, senior associate director of the SEC’s New York Regional Office explained this settlement, “Like several others before him at S.A.C. Capital and its affiliates, Dennis violated the insider trading laws when he exploited confidential information about public companies, in this case Dell and Foundry, to unjustly benefit the firms and enrich himself.  His actions have cost him the privilege of working in the hedge fund industry ever again.”

The case is SEC v. Dennis, U.S. District Court, Southern District of New York, No. 14-01746.

Summary

Almost exactly one year after the SEC announced a record $600 million insider trading settlement with SAC Capital affiliate, CR Intrinsic Investors, the SEC brought yet another civil case against a former CR Intrinsic analyst for insider trading.  While the settlement of this case was not surprising, what the case clearly proves is the SEC is far from done with its insider trading investigation of the firm, or the hedge fund community in general.

As we have mentioned numerous times in the past, the federal criminal and civil authorities collected hundreds of hours of wiretaps, have thousands of e-mail communications, and have dozens of cooperating witnesses on hand as part of its “Perfect Hedge” investigation.  Most experts we have spoken with believe this alone is sufficient evidence for the DOJ and SEC to continue bringing insider trading cases for the next few years.

In our minds, this should be sufficient legal pressure for the asset management industry to continue to clean up its act.  It probably also means that hedge funds will continue to hire legal and compliance professionals to help protect the firms from bad actors and potential insider trading risk.

 

Financial Sector Job Cuts Surge Last Month

Wednesday, March 12th, 2014

Despite the modest improvement in the jobs outlook seen across much the economy recently, Wall Street continued to slash jobs last month as weakness in mortgage applications, weakness in trading, and general rightsizing was seen at many of the nation’s largest banks.

Challenger, Gray & Christmas February Report

According to Challenger, Gray & Christmas’ monthly Job Cuts Report released last week, the financial services industry announced the most planned layoffs of any industry in the US economy during February with plans to cut 9,791 jobs in the coming months.  This is almost double the 4,817 planned job cuts announced in January, and is the largest number of monthly layoffs announced since the 21,724 total seen in February 2013.

Over the first two months of 2014, Wall Street firms have announced 14,608 planned layoffs.  While this is significantly higher than the total seen in recent months, it still represents a 52% drop from the 30,302 planned job cuts announced in the first two months of 2013.

John Challenger, CEO of Challenger, Gray & Christmas explained this weakness, “While some of the cuts in the financial sector were related to cutbacks in mortgage lending operations, a large portion of the banking workforce reductions in February were due to the ongoing shift away from branch banking toward increased mobile banking.  This is a trend that is gaining momentum and undoubtedly will have a profound impact on banking employment levels in the coming years. The number of bank tellers and traditional banks will continue to shrink as more people manage their bank accounts over their phones, on their laptops, and at ATMs and kiosks.”

Planned hiring at financial services firms did rise slightly in February to 400 jobs from a meager 129 new jobs seen in January, however this is considerably weaker than the 1,130 new jobs announced in February 2013.

JP Morgan Cutting ???? Jobs

One of the Wall Street firms that announced the biggest spate of layoffs in February was JP Morgan Chase & Co which reported 3,500 expected job cuts.  In recent months, JP Morgan has announced it will slash over 10,000 jobs in its business globally, primarily because its mortgage business (like so many other banks) has slowed to a trickle.

Interestingly, the Financial Times has written that it expects that JP Morgan may reduce headcount by as many as 15,000 jobs, and the number of layoffs could reach close to 20,000 if the firm’s mortgage business continues to worsen.

Mortgages Not Only Reasons For Layoffs

However, weakness in the mortgage business is not the only factor prompting higher job cuts at JP Morgan and other Wall Street banks.   Clearly weak trading revenues in the first quarter continue to prompt layoffs at many banks.  For example, JP Morgan Chief Executive Officer Jamie Dimon recently said that revenue from the firm’s equities and fixed income businesses was down about 15%, consistent with the decline expected from Citigroup’s finance chief.  This could presage the fourth straight drop in trading revenue during the 1st quarter.

Additionally, the increased adoption of technology and changing customer behavior is also having a substantial impact on most banks’ employment plans – particularly in the bank branch network.

Speaking about JP Morgan’s layoff plans, Challenger said, “According to reports, most of these will come from its branch network. However, these are not cuts from a weakening economy or a struggling bank. These are proactive moves by CEO Jamie Dimon in recognition of the coming sea change in the way people bank. The bank has shifted from a ‘branch-building strategy to an optimization strategy.’ In other words, Chase will have more places to bank, but technology will replace tellers for day-to-day banking. Meanwhile, the bank promises to provide more personalized asset-management services for those seeking more financial planning guidance.”

Other large banks, including Wells Fargo and Bank of America already responded to the declining relevance of the bank branch, as they have both been closing branches for the past few years.

Relevance for Research Industry

While most of these trends won’t have a direct impact on the research business, the continued weakness in equity and fixed income trading won’t help business prospects or hiring.  Clearly, sell-side and independent research firm revenue will be impacted by weak commission flows.  In addition, many large banks with both struggling mortgage units and over-sized bank branch networks may try to keep a lid on hiring across their firms – including in their investment research businesses.

 

CFA UK Opposes Proposed Regulations

Monday, March 10th, 2014

The CFA Society of the UK (CFA UK) registered opposition to new guidelines for research commissions proposed by UK regulators.  In its 32-page comment letter, which included a white paper on the research market, the CFA UK criticized the Financial Conduct Authority’s (FCA’s) content-based approach to regulating what research is eligible to be paid with client commissions, arguing for a use-based approach permitting anything that contributes to investment decision-making.  However, it agreed with the proposed ban on commission payments for corporate access with the proviso that the volume of corporate access should not be diminished by the new regulations.  The CFA UK recommended against a total ban on the use of client commissions for research.

Eligible Research

The CFA UK, whose membership comprises approximately 10,000 investment professionals from both the sell-side and buy-side, took issue with the FCA’s definition of research eligible to be paid with client commissions.  The FCA and its predecessors have maintained a tighter research definition than U.S. regulators, requiring that research contain ‘original thought’.  In its new proposed regulation articulated in Consultation Paper 13/17, the FCA underscores its definition by characterizing it as requiring ‘substantive research’.

The CFA UK attacks the FCA’s content-based approach to eligible research:  “…we do not support a content-based approach to the definition of research. We favour a use-based definition requiring investment managers to make reasonable, evidence-based assessments of the extent to which different research products and services have contributed to investment decision-making across specific investment vehicles.”

The awkward fact, however, is that the UK definition of research has been content-based for the last 8 years.  As we have noted previously, the specific research definitions in CP 13/17 are no different from the previous definitions.  Rather, what CP 13/17 is doing is clarifying what the FCA believes meets its previous standards.  CP13/17 reflects the FCA’s umbrage that asset managers have been largely ignoring the existing standards, most blatantly with corporate access but also through payments for expert networks and other forms of primary research.

The CFA UK argues that the FCA’s definition is too restrictive:  “By focusing only on the content of the material, the proposed definition may inappropriately narrow the scope of services available to be obtained by commissions to only research reports and conclusions in their final form. This approach ignores the use of commissions to obtain building blocks of information or raw data that can be used by investment managers to form their own independent strategies or analysis.”

Corporate Access

Although corporate access is an important building block to investment decision-making, the CFA UK wavers in its support for corporate access.  Tucked away in an appendix is the CFA UK’s admission that it agrees that paying for corporate access from dealing commission should be disallowed.  The CFA UK’s tepid support is preceded by an extensive ode to the virtues of corporate access and caveated with the proviso that the FCA’s payment ban should not diminish the volume of corporate access.

It is unlikely that the volume of corporate access in the UK will diminish because, as the CFA UK points out in its paper, the investment banks will be quick to game the new regulation.  The CFA UK (many of whose members work in investment banks) expects that banks will continue to arrange meetings with company management as a ‘free’ service for their largest clients.  “Corporate access will persist in all but name, but will be managed as a ‘free’ service’”.

We suspect that the banks’ response will be more subtle, incorporating analyst input into the corporate access process and leveraging the eligibility of conferences in order to ensure that corporate access services are ‘substantive’.

As we have noted, there are also new startups offering innovative responses to the proposed regulation.  One example is Ingage, a brand new cloud-hosted platform designed to intermediate corporate investor relations with institutional investors.  While the CFA UK supports new initiatives like Ingage, it cautions that asset managers will be loath to pay for corporate access from their own wallets:  “However, it is worth noting that the general anxiety about being seen to pay for any form of corporate access – even where payment is made exclusively from an investment firm’s own resources – means that investment firms are cautious about subscribing for such services.”

Other

The CFA UK also cautions the FCA against a total ban on research commissions, arguing that it would be disruptive to markets, uncompetitive for the UK asset management industry relative to other domiciles, and disadvantage smaller asset managers and independent research providers.  While it acknowledges that smaller asset managers and research providers might recover, it raises the risk of permanent damage to competition within the asset management industry and the research market.

The submission also includes a review of academic literature on the value of research and the results of the survey on research the CFA UK conducted last fall.  The survey provided strong support for improved disclosure of research costs and more explicit pricing of service levels by research providers (something over which the FCA has little control).  Interestingly, the survey was most negative about two of centerpiece recommendations made by the CFA UK: better benchmarking of external research costs and research budgeting.

Conclusion

The CFA UK’s submission is substantive and, given the organization’s stature, will be given close scrutiny by the FCA.  Its arguments against a content-based research definition are forceful and well-reasoned.  Nevertheless, it is unlikely the FCA will move to a use-based definition as the CFA UK proposes.

First, there is the matter of regulatory inertia.  The current content-based research definition has been in place since 2006.  Further, the FCA is incensed that asset managers have effectively ignored the rules with regard to corporate access.

Second, a use-based research definition opens the gates widely to a variety of services that the regulators do not consider research, most notably market data.  Market data vendors can rightly argue that their services are valuable inputs to investment decisions and therefore should be eligible to be paid through commissions.  However, the FCA explicitly cited examples where asset managers were paying in full for market data services with client commissions as abuses of the current regime.  The CFA UK wisely glossed over this issue in its submission.

Corporate access is also problematic for the CFA UK’s position.  The submission states that there is common agreement that corporate access is valuable.  If so, why not support it under a use-based definition?  The reasons given (lack of transparency, difficulty in determining value) are no different than for any other bundled research product.

Which leads to a further question: if the CFA UK supports a ban on commission payments for bundled corporate access, why not support a ban on commission payments for all bundled research?  The CFA UK’s answer is that a total ban would be too disruptive.  However, if the proposed ban on commissions for corporate access goes smoothly, perhaps the FCA will be emboldened to move to a broader injunction.  In other words, CP 13/17 is a test case for a broader ban.  To be continued.

Corporate Access Startups Hoping to Profit from FCA Ban

Wednesday, March 5th, 2014

The proposed ban on payment for corporate access with client commissions by the UK’s Financial Conduct Authority (FCA) promises to be a boon to firms hoping to benefit from the regulatory change.  Ingage is a brand new platform to facilitate non-deal roadshows.  At the same time, video conferencing platform OpenExchange has partnered with Ipreo to offer virtual roadshows and conferences to Ipreo’s customer base.

Ingage

Ingage is a cloud-hosted platform designed to intermediate corporate investor relations with institutional investors.  The system allows investors to view the company roadshows and one-on-one meetings available while companies can select the investors they most want to meet.  Companies can host webcasts directly on the platform to reach a wider audience.

Ingage was founded in January 2014 by Michael Hufton, a former Cazenove partner and fund manager at Polar Capital.  The firm says its platform is in trial with key players including Fidelity International, Nestlé, Tullow Oil, and National Grid, the operator of the UK’s electricity system.

The business model is a user-based subscription model charged to participants, whether they be publicly traded companies or investors.  Companies will pay £6,000 (US$10,000) a year, discounted to £3,000 at first. Companies will also be asked to cover the cost of hiring rooms and providing refreshments. Asset managers will pay between £6,000 and £120,000 (US$200,000) a year, depending on their size.

As we have noted in the past, the fees for corporate access have tended to average between US$7,500 to US$10,000 for each non-deal roadshow, and can range as high as US$20,000 per access for particularly hard-to-get corporate officers, as mooted by the Financial Times.

By these standards, Ingage’s fees are reasonable, but the reality is that investors have been paying corporate access fees with client commissions, not money out of their own wallets.  Their appetite for paying for what was previously free to them remains to be seen.

OpenExchange

Particularly since investment banks, for whom corporate access is currently a major source of commissions, will not be standing still.  Banks are adept at finessing regulation, and we think the FCA’s ban will be no exception.  Although facilitating vanilla one-on-one meetings will not eligible to be paid with client commissions under the proposed regulation, conferences are anticipated be eligible since they better meet the “substantive research” standard.  Expect to see more conferences, including virtual conferences.  Also we will see more analyst involvement in corporate access, moderating meetings and providing perspective, thereby providing grounds for payment with client monies.

OpenExchange is more likely to be a beneficiary of such a trend.  OpenExchange is a B2B video collaboration platform targeted to investor communications.  In June of last year the firm began collaborating with Ipreo to integrate its video capabilities with Ipreo’s investor relations product.  In September, the two firms announced they were adding OpenExchange’s platform to products targeted to the sell-side.

OpenExchange’s collaboration with Ipreo coincided with a $6 million Series B financing led by Ipreo and Barclays.

Conclusion

While it is virtually certain that the FCA will implement the rules proposed in its Consultation Paper 13/17, it would be simplistic to expect the estimated £500 million (US$833 million) UK corporate access market to simply evaporate.  Ingage intends to disintermediate investment banks by allowing corporates and investors to interact directly.  Larger asset managers inclined to do-it-themselves may find this attractive.  However, if Ingage fails to gain a critical mass of corporates and investors, its appeal will be weak.

More likely, investment banks will retrofit corporate access to meet the standards dictated by CP 13/17.  Tools such as Ipreo and OpenExchange, which already have traction on the sell-side, are better positioned to succeed in this environment.

 

 

 

 

 

Brokers Ban Controversial Surveys

Wednesday, February 26th, 2014

In the wake of BlackRock’s settlement with the New York attorney general over its surveys of security analysts, eighteen brokerage firms have agreed to bar their analysts from participating in asset manager surveys.  Separately, the quantitative hedge fund firm Two Sigma suspended its analyst survey earlier this month.

Brokerage agreements

The eighteen brokerage firms agreed to stop answering analyst surveys by “certain elite, technologically sophisticated clients at the expense of others,” according to New York Attorney General Eric Schneiderman. The interim agreements were part of the NY AG’s efforts to combat trading advantages secured by investors that win early access to potentially market-moving data.  The agreements cover all research on equities listed on US exchanges. The brokerages did not admit or deny wrongdoing.

Firms included in the deal are Goldman Sachs, JPMorgan Chase, Citigroup, Bank of America Merrill Lynch, UBS , Barclays Capital, Credit Suisse, Morgan Stanley, Deutsche Bank Securities, Jefferies LLC, Sanford C. Bernstein, Macquarie Group, FBR Capital Markets, Stifel Nicolaus and its units Keefe, Bruyette & Woods, Thomas Weisel Partners, plus two independent research boutiques, Vertical Research Partners and Wolfe Research.

BlackRock’s settlement

BlackRock settled with the NY AG in January, agreeing to suspend surveys that “allowed it to obtain information from analysts that could reveal forthcoming revisions to their published views” according to the settlement. The firm agreed to pay $400,000 to cover costs of the investigation.

According to BlackRock’s NY AG settlement,  BlackRock administered surveys from March 2009 to January 2013.  During that period the surveys collected 60,000 analyst answers indicating a corporate earnings surprise, either up or down. For the year ending March 2010, BlackRock collected almost 8,000 answers regarding potential acquisitions, the attorney general’s investigation found.

Information gleaned from these and other questions was fed into trading algorithms designed by BlackRock’s Scientific Active Equities unit, a quantitative investment group acquired when BlackRock bought Barclays Global Investors in 2009.

Two Sigma

Earlier this month, Two Sigma, an $18.1 billion hedge fund, agreed to suspend its analyst survey program which it had originated in 2008.  Two Sigma said its survey was intended to obtain public information rather than nonpublic information about the companies the analysts cover. It was considered to be one of the largest such surveys.

The program had been developed with the help of lawyers and included mechanisms intended to ensure it complied with securities laws. As part of the survey, analysts’ responses went to compliance personnel at both the analysts’ firms and at Two Sigma. The hedge fund viewed its survey program as a more transparent alternative to unstructured and unmonitored communications with analysts.

The surveys were sent to about 1,300 analysts, and Two Sigma paid the firms of participating analysts.

Conclusion

Academic studies have suggested that selective research dissemination has been a rampant practice among major brokerage firms.  The SEC fined Goldman Sachs $22 million in 2012 for its ‘trading huddles’ after a Wall Street Journal article highlighted the practice.  Otherwise, selective dissemination has been a low regulatory priority.

NY AG Schneiderman, who first learned of the BlackRock survey through a New York Times article, has labeled the survey practices “Insider Trading 2.0” and has vowed to continue investigating.   However, absent additional media exposés, it is likely this topic will now revert to the regulatory back burner.

UK Asset Managers Promise Reform

Tuesday, February 18th, 2014

The UK trade association for asset managers, the Investment Management Association (IMA), released its long-anticipated report on research procurement earlier today.  Not surprisingly, the report opposes a ban on the ability to pay for research with client commissions, arguing that a restriction would disadvantage UK asset managers, reduce coverage of smaller capitalization stocks and erect barriers to entry for new asset managers.  The IMA urges UK regulators to coordinate any such ban globally, preferably through the International Organization of Securities Commissions (IOSCO).

In an effort to persuade UK regulators that a ban on research commissions is unnecessary, the IMA proposes a set of reforms to current research procurement practices, improving oversight, research budgeting and more transparency.  The report also calls on investment banks to more explicitly price bundled research.

Notably absent is any defense of corporate access, which will not be payable with client commissions under proposed UK regulation.  The IMA told Reuters that its recommendations did not mention corporate access because the regulators had already made their position clear on the issue.

While the IMA report contains no major revelations, it does signal the intent to reform current research procurement practices. Whether this will be sufficient to deter a ban on research commissions remains to be seen.  The comment period for CP 13/17 ends February 25, 2014.   The FCA intends to implement CP 13/17 later in the spring of 2014 and expects to release the results of its thematic review after the implementation of the changes proposed in CP 13/17.

The following is an outline of the IMA paper provided courtesy of Frost Consulting. Neil Frost was a member of the advisory panel that provided input to the IMA in the preparation of the report.

Initial Thoughts – IMA White Paper on Commissions

Overview

1. Rigorous defense of current system

2. Definitive call for any changes in commission to be in an international context through IOSCO

3. Clearer definition of research including sub-categories (SUBSTANTIVE)

4. Rejects that research producers cannot value research

5. Calls for price transparency from producers – threatens sequential declines in payment if they do not.

6. LACK OF DATA POINTS on relative research pricing. – PARTICULARLY RELATIVE TO EXECUTION

7. Risk of regulation impeding global flow of research

Risks of Banning Commissions

1. Lack of UK competitiveness in asset management.

2. UK research job losses

3. Reduction of asset manager competition through damaging smaller managers

4. Reduction in available research

Recommendations:

Research

1. Research budget setting – independent review (not portfolio managers) and internal consistency checks – CFO oversight, end of year audit.

2. That compliance not portfolio management should oversee the process

3. Oversight of the research commission allocation be substantially expanded, to the board level if research expenditures are as large as other expenditures which have to get board approval – increases risks to asset manager boards around commission allocation.

4. Keep appropriate (far better) records of research consumed.

5. Check research budgets against whatever quantitative measures exist.

6. Provide greater and more consistent feedback to research providers as to what products/ services are valued.

CSAs

1. Asset manager reconciliation of CSA balances.

2. Re-papering of agreements to clarify FX and unused balances