Upbeat Note on the Paid-For Model


New York – In response to our last week’s blog about the paid-for or issuer sponsored research model. Because of the article we were referring to, the news about the model was fairly negative. And while we did indicate that there were providers of issuer-paid research that do a good job, we would like to clarify that further in this blog. There are currently 41 paid-for equity research providers in the Integrity Research database.


After the blog was posted we received some communication from a paid-for model shop, called Fundamental Research Corporation.  Fundamental Research Corp. is a Vancouver-based issuer-paid research shop that recently wrote an article in the CFA Institute Magazine about the proper process to abide by to provide value to investors within this model. They also point out that there are conflicts within the sell-side model (or any model), if they are not managed properly.


One indictment against the model is the fact that the majority of the recommendations made are buy recommendations. We note, however, that while this is an issue, there is almost certainly a biased towards small cap companies buying coverage when the results are likely to be favorable (self-selection), rather than negative.


The often heard reason for paid-for research is that it provides information on the small cap stocks that would otherwise have no coverage, owing to their low levels of trade volume. This argument is entirely appropriate, since algorithmic and high-frequency trading seem to be pushing the trend toward ever larger, higher volume stocks. This is because these investment styles all depend on highly liquid securities to avoid liquidity risks inherent in the lower volume stocks.  So having established that there is a place for paid-for research the real question is whether the policies and procedures are sufficient and if so whether they are being enforced diligently.


Here is a listing of the rules and regulations that are listed in the article. Certainly, there are a number of other compliance issues which apply to any research shop, but these are the policies that relate specifically to the paid-for model. First, the research firm must get paid up front in cash (not stock). This payment needs to be disclosed in the research disclaimers on every report. Additionally, the contract for coverage should be for at least 4 quarters, so that any change in conditions can be freely divulged by the analyst. Second, the covered firm must sign an agreement protecting the analyst’s independence, meaning that the analyst will not be interfered with by the covered company in any way over the coverage contract period. Third, research providers should employ full time analysts. This is an internal guideline related more to the quality and consistency of the reports than to the conflicts. Fourth, the research firm should have paid subscribers to its research. When the research firm is being judged on the quality of the recommendations they provide to investors, they are likely to be more analytically critical of the covered firms. Fifth, the research firm should be transparent about the percentage of buys, holds and sells it has issued.


Even if the research provider has a large number of buys in its portfolio, it does not necessarily mean that the investor is being disserved. As such, it is important from a transparency perspective for research firms, particularly those with a paid-for model maintain an independent assessment of their overall research performance. If one invested in every recommendation the research shop made, what would have been the return to the investor.


As part of its transparency efforts, Fundamental Research Corp. is being tracked by a third-party performance evaluation service called Investars. Investars allows investors to compare the performance of research providers by taking their buy, sell and hold positions and tracking performance across a universe of research providers. This allows all research firms that issues buy, sell hold recommendations to be compared to each other on an apples-to-apples basis.


So while there are flaws in the paid-for model, there are a careful few research providers that maintain strong policies and procedures to counteract those potential conflicts.


Note: Integrity Research has not conducted any analysis of the actual practices of Fundamental Research Corporation and is relying on the published policies and procedures on an as stated basis.



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  1. Bill George on

    Research Independence and Conflicts-of-Interest: Follow The Money ~ One of the great debates relating to the role of the Nationaly Recognized Statistical Rating Organizations (NRSRO’s) in the housing bubble and the financial crisis is the payment methodology used by those credit rating agencies (Moody’s, S&P and Fitch). Years ago the credit rating agencies moved from an ‘investor pay’ model to a ‘issuer pay’ model. In investigations and hearings [sponsored by Congressional Committees, regulators, and the Financial Crisis Inquiry Commission (FCIC)] there has been a lot of discussion about whether the ‘issuer pay’ model used by the rating agencies exposed the rating agencies to conflicts of interest because revenue and market share in the ‘issuer pay’ model forces the organization to curry favor with the issuer (investment bank, securitizer). It’s fairly obvious that this factor played a major role in the break down of the reliability of the credit ratings of securitized debt in the late stages of the housing bubble.

    Recently, I was watching a June 2, 2010 hearing conducted by the Financial Crisis Inquiry Commission (FCIC) which has been published in the C-SPAN video library. In the hearing Warren Buffett provided testimony and answered questions posed by FCIC commissioners. One of the commissioners, Heather Murren,* asked Mr. Buffett a question about the issuer pay business model used by the Nationally Recognized Statistical Rating Organizations (NRSRO’s) and if, in his opinion, the structure of the NRSRO’s business model might have influenced their ratings.

    As someone who is personally interested in independently produced investment research, institutional ‘third party’ agency brokerage, and institutional soft dollar commissions – used as payment for independent research – I found Mrs. Murren’s follow-up (to Mr. Buffett’s answer) very interesting. Her follow-up:

    “I would hate to differ with you. If you look at, for example, equity research, there are a number of boutique shops that are specifically known for the quality of their research. And, they do not engage in investment banking activities, so they don’t have as much of a stake in the origination process. And, to me, there’s some parallel between this area of research and some others. So, I guess my question really is, if you change the way people get paid, do you end-up getting a different outcome? So, that was really the nature of where I was headed with this.”

    * In April 2002, Mrs. Murren retired as a managing director, Global Securities Research and Economics, of Merrill Lynch where she was group head for the Global Consumer Products Equity Research effort. Also noteworthy, Mrs. Murren is married to James Murren, who before becoming the CEO of the MGM Grand, Inc., was a managing director and director of U.S. Equity Research at Deutsche Bank. Both Heather Murren and James Murren are Chartered Financial Analysts. (Heather Murren and James Murren both have biographical information published at Wikipedia).

    I’m wondering if the Murren’s activities working for large full-service investment banking brokerage firms, which produce proprietary investment research, may have influenced Heather Murren’s positive comments about the quality of independently produced research produced by some independent investment research boutiques.

    If you would like to watch a video-clip of this portion of the FCIC hearing you can do so by copying and pasting this url in your browser address line: http://www.youtube.com/watch?v=gB9YEfn6D2I

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