New York-Merrill Lynch has implemented new controls on the distribution of its proprietary research, as announced yesterday in a letter to clients. Candace Browning, who heads Merrill’s global research reporting directly to CEO Stan O’Neal, announced a new digital distribution strategy that 1) terminates research access to non-clients on Merrill’s proprietary site and external vendor platforms; 2) further restricts and delays media access to selected content; 3) eliminates existing licensing arrangements that erode the value of our written product and 4) establishes licensing agreements at market prices competitive with services offered by other providers.
Swatting the Fly
Browning’s letter makes a thinly veiled reference to theflyonthewall.com as a motivation for implementing the new strategy. Merrill, along with Lehman and Morgan Stanley, filed suit against theflyonthewall.com last June for copyright infringement of its proprietary research reports. The suit, filed in U.S. District Court, seeks $150,000 in damages for each report infringed.
The flyonthewall.com offers a news feed providing synopses of analyst upgrades and downgrades which it says provides an average of 600 stories a day. The news service is $25 per month (there is also a separate calendar service at $15 per month and a syndication news service at $25 per month.) Theflyonthewall claims its information is sourced “from Wall Street traders, brokers, and institutional investors” but Browning’s letter implies that Merrill believes that theflyonthewall is getting access from one of Merrill’s redistributors.
Napsterization
Merrill’s concern that its content is being pirated is only part of the story, however. The broader issue is the value of the research. Merrill and other bulge bracket firms have long railed against Thomson, Reuters and other redistributors of its content for a lack of stringent entitlement controls over who accesses the research. As CSAs/CCAs accelerate the dialogue with institutional clients about the value of proprietary research, it becomes even more urgent to know specifically who is using the research, how they are using it, and how often. It is very difficult for research directors like Candace Browning to gauge what is most useful about their research when they don’t even know who is using it.
Most existing distribution platforms were built to reflect the original “fire hose” distribution model of Wall Street research. In the days when research was heavily subsidized by investment banking, the major sell-side firms had an incentive to blast out as much research as possible. This model has changed since the Global Research Settlement, which decoupled investment banking and research operations and raised the cost-structure of sell-side research.
The current research distribution systems-including First Call, Bloomberg and Reuters-are designed to broadcast research. These systems are well suited to the old Wall Street business model, but not to the new one. Making them work in an unbundled world is a big re-engineering task, almost as difficult as asking TV stations to customize their content.
Conclusion
Merrill’s new distribution policies reflect the new reality of unbundling research from execution. The new policies help Merrill’s negotiating position with clients, as it tiers clients based on their trading relationships with Merrill and seeks to eliminate “free riders” clients which do not maintain a minimum threshold of commission volume. Certainly piracy is a concern as well, as the suit against theflyonthewall.com illustrates. As Merrill and other bulge firms increasingly place a value on their research, market efficiencies begin to come into effect increasing the competitive pressures on all research-both proprietary and alternative. Getting control of distribution is a necessary first step.
The letter is reproduced below:
March 22, 2007
Dear Client,
Not long ago, something very disturbing happened to me while I was sitting at my desk listening to our morning call. That morning, we featured a contrarian upgrade of a major U.S. company’s common stock – which went on to generate over a 40 percent return for our clients. What happened was that within 60 seconds of releasing our opinion change, this same information we had just sent out on our private platforms was being replicated with plagiaristic precision by a New Jersey-based digital financial news source. This is a website that purports to provide its paying customers with research it compares to “having a seat at Wall Street’s best houses and learning what they know when they know it.”
The heart and soul of what sell-side analysts do is to provide well-grounded investment ideas to individual and institutional clients to support them in making timely and (we hope) profitable investment decisions. But that day I realized that, much like the music and film industries before us, Merrill Lynch Research is in the throes of being Napsterized. I also realized that like every other content provider – from the Walt Disney Company to obscure news outlets – Merrill Lynch Research needed to regain control of our distribution channels in order to preserve and protect our hard-earned intellectual capital for you.
So, starting this month, we have begun to take a number of aggressive steps to ensure that we can continue to provide premium products and services for the exclusive use of our clients. We are rolling out a digital distribution strategy that 1) terminates research access to non-clients on our proprietary site and external vendor platforms; 2) further restricts and delays media access to selected content; 3) eliminates existing licensing arrangements that erode the value of our written product and 4) establishes licensing agreements at market prices competitive with services offered by other providers.
For a number of years, I have been listening with mounting frustration to a never-ending litany of statements that erroneously predict the demise of sell-side research, labeling it as virtually without value in the digital era. Certainly the ease and speed with which the fruits of our efforts can be posted on the web for the world to review has pointed yet another arrow at the chests of sell-side research organizations. Yet, when I listen to these predictions, I feel like Tom Sawyer covertly present at his own funeral: perversely proud to be there while basking in an inviolable certainty that sell-side research is alive and well.
Sell-side research is not only surviving but thriving in today’s global marketplace, because it plays a critical role in ensuring that corporate, fixed income and other securities are priced as fairly as possible in the primary and secondary markets, thereby delivering one of the most important functional elements of a market economy: efficient capital allocation. Sell-side research turns information into insight – both in the form of investor education and specific recommended investment ideas. Merrill Lynch currently employs 750 analysts who follow more than 3,000 stocks and other securities for institutional and individual clients. The educational value and investment recommendations produced by those analysts is not only broad, it is exceedingly valuable: Last year, our recommendations produced a total global return (calculated in local currency) of 19.5% versus the MSCI’s 16.2%.
Fortunately, clients grasp the value of sell-side research. According to a recent poll of more than 2,000 institutional clients by Greenwich Associates, U.S. respondents reported that they effectively allocated nearly half (42%) of their total commission spend on high-quality sell-side ideas. And, the much-bandied-about notion that hedge funds value research less than other money management firms is further contradicted by the same poll’s finding that U.S. hedge funds allocate 55% of their commissions for research, as opposed to 33% at mutual funds.
There is little doubt that sell-side research continues to be highly valued by those in the know, yet at the same time it is incumbent upon us to nimbly adjust to the ever-shifting exigencies of the digital era. By continuing to deliver alpha and eliminating access to research by non-clients, we can and will regain the recognition that the sell-side research profession deserves, and we will also better serve you.
Sincerely,
SVP, Head of Global Securities Research & Economics
Merrill Lynch
Comment by Bill George:
For those readers who are interested in other recent structural changes to Merrill Lynch’s, and other major full-service brokerage firm’s, research offerings or are interested in understanding other recent changes in full-service broker’s research distribution policies, you might want to read details of the 2003 Global Analyst Research Settlement.
and / or read Chairman of The SEC William Donaldson’s Testimony Concerning The Global Analyst Research Settlement, given before the Senate Committee on Banking, Housing and Urban Affairs on May 7, 2003.
Comment by Bill George:
Today’s article about Merrill Lynch’s new Research Distribution Policy is very interesting on several levels.
For one thing it seems Merrill Lynch’s Candace Browning is, to some degree, breaking ranks with the traditional claims by most full-service brokers that it’s impossible to separate the costs of research from the costs of execution. By quoting published reports on surveys about advisor’s brokerage commission allocation to research costs and specifically to “high quality sell-side research” she is raising the question, again, about the ability to separate research costs from execution costs and the costs of other brokerage ‘services’. The full-service brokerage industry has always claimed this is an impossible accounting task, now a representative of the industry is quoting surveys reporting these costs. Can they have it both ways?
Be that as it may, I believe the surveys Ms. Browning quotes generally underestimate what institutional investment advisors spend on research and ‘other services’. Such under-reporting is caused, partially, by a reluctance to admit what portion of institutional clients’ commissions is spent on research & ‘other services’, and partially because some commenters really don’t know how much of their clients’ brokerage commissions are used for ‘research’.
It seems safe to assume that if institutional executions can be accomplished at an average of 1.5 cents per-share advisors who are paying 5 cents per share are paying three and a half cents per share for other service including ‘research’. That means that about 66.66% of the commission pays for research and “other unidentified services”.
Another interesting point that Ms. Browning’s statement brings to mind, she says, “The educational value and investment recommendations produced by those analysts is not only broad, it is exceedingly valuable: Last year, our recommendations produced a total global return (calculated in local currency) of 19.5% versus the MSCI’s 16.2%.” This statement ignores the fact that it’s one thing to calculate an expected return from the instant one announces investment recommendations, it’s quite another thing to implement the recommendations and achieve that rate of return in an actual investment strategy. I would not dispute her claim about the educational value of Merrill Lynch’s analyst recommendations. “Educational value” is far too subjective to debate.