Apparently FINRA is looking into whether sell-side research analysts are doing some naughty things, which is an evergreen topic, though you might almost imagine that the current round is being prompted by the return to public life of Eliot Spitzer, who gets a quote in the DealBook article. Eliot Spitzer: not a fan of research-analyst naughtiness.
It’s hard to tell if the analysts are doing naughty things but, probably, right? Basically the analysts are meeting with potential issuers before those issuers’ IPOs, which is fine. But at those meetings, which tend to be arranged by “so-called I.P.O. advisers” like Solebury, Rothschild or Lazard,1 they might be talking about the IPO and the analysts’ views of the issuers, which is not fine. They’re “supposed to discuss only broad industry trends at these meetings” and defer to their bankers for “specific views on a company, like earnings models or potential I.P.O. pricing,” because the idea is that the analyst meetings are not supposed to be used by the issuers to select underwriters. They’re just a chat! It’s like, hey, I’m in this industry, you cover this industry, let’s talk about broad industry trends! For my general education! Because while, yes, me and my IPO advisers sitting next to me are picking underwriters for our IPO, and while your bankers are pitching us “within hours” of this meeting, right now I’m entirely focused on a general chat about broad industry trends. That’s all this is. Read more »
Investment banks are in large part in the business of creating and selling products to customers. So are lots of other companies. Kia dealers, for instance, sell cars to customers, and part of the job of a Kia salesman is to say to customers “this Sorento is awesome and you should buy it.” This can cause problems because the Sorento may not be awesome and you maybe should not buy it, but these problems are not large because everyone knows about them and so nobody buys Kias solely on the salesman’s representation that they’re awesome.
On Wall Street this dynamic is complicated by at least two factors that don’t exist for Kia. One is a veneer of objectivity that comes from treating finance like physics: “commercial mortgage-backed securities will decline in value over the next 12 months” is at least as subjective an opinion as “Kia Sorentos are not in fact awesome,” but a ton of apparatus – much of it created by banks themselves – has grown up around the notion that it is not. So expressions of personal opinion are often treated as statements of fact, which can then be right or wrong, particularly in hindsight: 12 months later, you can look back and actually see if the CMBS actually declined in value, whereas you have no more access to the Sorento’s awesomeness or lack thereof than you did 12 months ago.
The other is the research settlement, which requires Wall Street research analysts to certify that what they say about stocks really is their personal opinion. That is not a requirement that applies to other industries: a Kia salesman can’t tell you that the Sorento’s top speed is 350mph and that its exhaust smells like bacon, but I’m not aware of any car salesman ever getting in trouble for saying “you look really cool driving that lime-green SUV” even when, in his heart of hearts, the salesman actually thought the customer looked like a tool.
The settlement is awkward because banks are more in the business of selling products than they are in the business of Being Right About Stuff. So banks sometimes market stock offerings where their research analyst has a Sell rating on the stock, and there’s no real conceptual difficulty in that: the research analyst has one opinion, and the salesperson calls the client and offers counter-arguments. But, given the veneer of objectivity, clients don’t just want a salesperson saying “Facebook is great,” they want something that looks like research or fact or analysis to support that pro-Facebook view. So banks like to have people hanging around the sales desk who are not pure golf-and-handshakefulness “salespeople” but something else – “desk analysts” or “strategists” or whatever. They work for the sales and trading department, not research, and they give clients ideas in the hope of generating business for the bank. This can create controversy* when their ideas are not exactly the same as those of research, but of course that is rather the point.
So let’s take a look at this lawsuit filed yesterday by a UBS commercial mortgage strategist named Trevor Murray. He seems not to have gotten along with his boss Ken Cohen, a former Lehman guy now in charge of UBS’s CMBS business. From the complaint: Read more »