New York, NY – This past summer, a significant portion of the Global Research Analyst Settlement officially came to an end as ten of the world’s largest investment banks stopped providing independent research to their retail customers. Many commentators agreed that the Settlement had successfully pressured sell-side investment banks to provide more objective investment research that was unbiased by investment banking conflicts of interest. However, a Wall Street Journal article published last week reveals that one sell-side analyst faced considerable internal and external pressures to reverse a “SELL” rating on a stock that he covered – despite the fact that that stock plunged 75% after he made that call.
The Facts of the Story
In a research report published on April 24th, Jefferies & Company equity research analyst Brian Kennedy put a “SELL” rating on Conshohocken, Pennsylvania based medical device manufacturer CardioNet, Inc. Kennedy’s negative rating was based on weeks of discussions with Medicare reimbursement experts, insurers and physicians.
This led Kennedy to the view that CardioNet was likely to experienece a drastic cut in the price Medicare would be willing to pay the firm for their remote heart monitoring system. It is important to note that Jefferies had not underwritten CardioNet, though they did make a market in the stock.
After Kennedy’s report was published, CardioNet’s stock fell 13% in heavy volume. Most other Wall Street analysts had rated CardioNet a “BUY”, according to the Thomson Financial consensus data. Not surprisingly, several of the most bullish analysts worked for companies that had underwritten CardioNet’s initial public offering, including Citigroup and Leerink Swann.
Analysts for both Citigroup and Leerink Swann publically disagreed with Kennedy’s assertion that Medicare was likely to reduce the amount it paid for CardioNet’s heart monitoring system. In addition, CardioNet’s CEO Randy Thurman publically stated that Kennedy’s assertions were false, and that he had failed to do proper due diligence in his researching the company.
Even some analysts inside Jefferies were unsupportive of Kennedy’s call on CardioNet, suggesting he was “rocking the boat” by rating the company a “SELL”. Fortunately, some of Jefferies’ analysts encouraged him, including the firm’s head of research. In addition, an internal review by Jefferies’ legal department cleared him of any wrongdoing.
Despite this support, in early June Mr. Thurman wrote letters to the Securities and Exchange Commission and the Financial Industry Regulatory Authority (FINRA) complaining that Kennedy’s “SELL” rating was part of a plot to help CardioNet short-sellers profit by manipulating the price of the company’s share price lower. Mr. Kennedy denied this allegation.
Fortunately, on June 30th, Mr. Kennedy was vindicated when CardioNet announced that some private insurers were cutting their reimbursement rates to the firm. This was followed on July 12th when Medicare reported that it was reducing the amount it was reimbursing CardioNet for its heart monitoring system by 33% — the exact amount that Kennedy forecast was possible when he published his initial SELL rating on April 24th.
Unfortunately, this story doesn’t end happily. Kennedy quit his job as an analyst with Jefferies & Co. in early July and is currently looking for a research analyst position with an independent research firm that has no investment banking conflicts.
The Importance of this Case
The CardioNet case is an example of how much pressure Sell-Side analysts can face, both from public company management, from other Wall Street analysts, and from internal critics (like investment banking departments) when they try to publish “SELL” ratings on the companies they cover.
These pressures are also why in 2003 the SEC approved NYSE and NASD rule changes addressing various research analyst conflicts of interest including separating analyst compensation from investment banking influence, prohibiting analysts from participating in investment banking pitches, prohibiting firms engaged in investment banking activities from directly or indirectly retaliating, or threatening to retaliate, against research analysts who publishes research reports that may adversely affect the firms’ present or prospective investment banking relationships.
In fact, some might argue that these internal and external pressures are some of the principle reasons that sell-side analysts publish so few “SELL” ratings on the companies they cover. According to Thomson Financial, as of November 1, 2009 only 7% of North American sell-side analyst reports had “SELL” ratings attached to them. This compares to 48% of sell-side research reports that included “BUY” ratings, and 45% which included “HOLD” ratings.
It is important to remember that in the CardioNet case, Jefferies & Company did not participate in the underwriting for the firm, nor did Jefferies management try to pressure Kennedy to raise his “SELL” rating. Rather, CardioNet management, and other sell-side analysts employed by firms that were part of the underwriting syndicate, attempted to bully Kennedy into changing his negative rating.
In fact, one of the unfortunate lessons learned in this case is that sell-side analysts have few, if any protections against harassment from company management or other sell-side analysts who have more reason to be biased in their assessment of the company’s prospects. This lack of protection could be one important reason why analysts don’t “stick their necks out” and making difficult “SELL” ratings, even if they are warranted.