The Dark Side of the Odd Couple


New York, NY – Yesterday, we posted an article on the growing partnership that some investment banks are looking to establish with alternative research firms.  As we expected, this article elicted strong opinions from a variety of readers.  The following are comments, posted by two readers, William George of BlueSky Research Services and Mr. David Miller CEO and co-founder of Biotech Stock Research.  They are both interesting and insightful.



In my opinion the comment below, by David Miller, is right-on the money.

It’s sort of amazing to me that investors can’t come to the conclusion that was reached by the regulators who put together the Global Analyst Research Settlement. Under that penalty arrangement the regulators felt it necessary to mandate rigorous safeguards and strict regulatory oversight to insure that the independent research to be distributed by the firms being punished would remain independent.(1) Why doesn’t the market understand the risks of compromised independence?

Admittedly Goldman’s distribution network and marketing approach are different from most bulge bracket firms. Most of other bulge bracket firms have significant retail distribution resources which Goldman doesn’t have; but, everybody should see the problems of believing that independent research providers can maintain their independence once they have whiffed the heady vapors of fame and fortune delivered by serving the sometimes conflicted interests of investment banking brokers with powerful distribution networks.

It’s very odd to see the market’s reaction to emerging paradox of “captive independent” investment research. Perhaps what seems to be wide acceptance, by professional investment advisors, of this “captive independent research” concept is caused by the more or less natural interdependence of institutional advisors and broker dealers (an interdependence which is described, in part, by David Miller’s post above). For years, after 1932, the interdependence and collusion between advisors and broker dealers was made difficult by The Glass-Steagall Act. However, the Glass-Steagall Act was emasculated during the late stages of the 1990’s Tech Bubble; so now it seems professional investment advisors and brokerage firms are eager to marginalize, (or compromise) independent research and get back to the business of trading favors for their mutual benefit to the detriment of the investing public. (2)


(1) See Wikipedia entry Global Settlement >

(2) See Glass-Steagall Act >


When we’re talking about the value of research to Wall Street firms, I wish we’d quit prancing around the elephant in the room.

Any firm that depends on hedge fund trading revenue (excepting those that compete solely on price) will not last long as a business without a research arm. The more dependent the firm is on trading revenue, the more necessary a trading arm is.

Research arms of these firms are now expected to assist their clients’ positions. Have a major client buried in a long position? Research sends out an aggressive buy recommendation. Have a major client buried in a short position? Research sends out an aggressive sell recommendation. Since financial media outlets are conditioned to report such things, especially the more outrageous they are, these conflicted research notes will have the desired effect in the market, partcularly in the small cap stocks where these Wall Street firms make their living. used to have an application where you could watch the trading volume for different market participants over time for a particular stock. When it was updated monthly, it was a great dentiment indicator for how hedge funds thought about a company. If you saw an unusual research opinion, watch the volume to that firm. If it jumped, then that’s the way the hedgies were leaning.

I’ve had people argue that this is the way the sell side is supposed to work. People are just “voting” with commission dollars for the research. I give that the same weight I give to people who tell me the earth is flat. Write the research your clients need to make their positions more profitable and you’ll be rewarded.

If any of us “independent” research firms *choose* to play this game, we can be equally successful as sell side research.

Pick any moderately successful independent firm and you’ll discover all their top people could be making much more money at a sell-side firm. Some of us, however, put more weight on being able to look at ourselves in the mirror each day. We want to write what we actually believe about a company instead of worrying about whether the head of trading will have us on the carpet for writing something counter to a major client’s book.

Comment by Bill George:
Current Events: A Recent Example of the problem.

In today’s Wall Street Journal (7/11) there is a very interesting article that highlights a justifiable suspicion of conflicted goals and biased research, when captive research analysts working for full-service brokerage firms make predictions that might be interpreted as effecting other revenue opportunities (investment banking and portfolio holdings) at the firm that employs them. The article is titled, “Behind Bear Analyst’s Sub-prime Call” by Kate Kelly page C-1


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