Hank Boerner
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Boerner's Corner - Financial Research & Analysis Update - (07-27-04) FUTURE OF INDEPENDENT RESEARCH -- GLOBAL SETTLEMENT (SPITZER-TOP 10 FIRMS) EFFECTIVE JULY 26 - AND NOW WHAT FOR BROKERAGE CUSTOMERS-INVESTORS?



FINANCIAL RESEARCH AND ANALYSIS
July 27, 2004 post

FUTURE OF INDEPENDENT RESEARCH -- GLOBAL SETTLEMENT (SPITZER-TOP 10 FIRMS) EFFECTIVE JULY 26 - AND NOW WHAT FOR BROKERAGE CUSTOMERS-INVESTORS?

When New York Attorney General Eliot Spitzer settled charges with the Big 10 Wall Street investment banking / full-service brokerage firms, after the AG attacked the firms' faulty or allegedly misleading research reports (no guilt was admitted), it was agreed that [as part of the historic settlement] the banking-brokerage firms would make available to their customers "independent research." This would be purchased from qualified third parties that had no compensation coming to the firm from investment banking or brokerage businesses.

The plan was to be put in action by the Big 10 on July 26.

On a practical basis, if Morgan Stanley or Merrill Lynch et al now provide sell-side research for a specific issuer - say, a General Motors or Microsoft - then the firm would also have to make available up to three or more independent reports on the covered company. These would be the work of outside, independent research organizations working at arm's length and compensated by fees for their services.

Institutional investors do have the choice to opt out of the offer. Presumably, individual investors and small institutions will now welcome the offer of receiving independent non-banking or non-brokerage related research and recommendations - alongside the brokerage's sell-side report.

Confusing? Well, consider that in theory, if a broker offered a report on GM, it would also offer up to three (or more) independent reports...if all 10 firms covered GM, there could be 10 analyst reports plus 30 or more independent reports - on all GM!

Each of the Big 10 appointed an independent monitor to select outside research firms and arrange for purchase of research for covered companies, to be provided "free" to customers if they request such reports. (Brokerages are now notifying their customers of the availability of research. They must also make these reports known to prospective customers if they are using sell-side research as a marketing tool.)

"Free" bothers some of the leading independent research organizations - this is commoditizing their work, they feel.

The Investorside Research Association (Washington DC), organized two years ago by about two dozen research organizations, including Precursor and Argus, now has 76 member organizations. John Eade (head of Argus Research) is the group's chair. Keith Kennebeck is the executive director.

The association screens financial research organizations and licenses the "Certified Provider" seal for use in advertising materials - this is to assure investors that the analyst is working free of investment banking conflicts. (Members must pledge they provide no investment banking services and can lose the seal if they do.)

An unintended consequence of the corporate governance revolution has the potential to derail this noble sounding effort: The recent mutual fund scandals created a more intense focus by media, investors, regulators and Congress on investment company practices. "Soft dollar" transactions (the amounts paid by mutual funds above the cost of the trade for services such as research) are now in the focus of SEC staff and the mutual fund industry.

The Investment Company Institute (the trade association of mutual funds) is opposed to the use of soft dollars to purchase research.

The Securities & Exchange Commission has an internal task force looking into what should be done about soft dollar compensation. If mutual funds are prohibited or discouraged from paying for research from investors (the dollars held in trust within the fund, which belong to the mutual fund investor), and must pay fees out of the Advisors' own fees / income, this will chill business for independent researchers. A report is due by year-end.

Already, according to the Investorside Research Association, mutual fund managers have expressed reluctance to purchase independent research.

Congress had looked at the soft dollar issue (when the mutual fund scandals broke) and ultimately referred the matter over to SEC. So, we should consider that payments to the independent firms might be in danger of being cut back or eliminated.

Back to the Big 10 - what is going to happen now that (in theory) you can receive up to three independent reports on a company (issuer) covered by one of the 10 major brokerages?

Have you as a customer of these houses received any news regarding the availability of the independent research reports and recommendations?

We're interested in hearing from you, and about your experience as the terms of the Spitzer-Wall Street settlement are supposed to become action steps (this week). And your views on the role independent research can play in investor decision-making. What do you think?

We'll continue to report on independent research in the weeks ahead.

For more information:

Investorside Research Association at www.investorside.org

Sources/Interviews: Keith Kennebeck, Executive Director of IRA and John Eade, Chairman of Association and head of Argus Research

Send me an email via hb@hankboerner.com


Copyright 2005 H.L. Boerner. All rights reserved.

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