After Scandals, Big Investors Snub Street's Stock ResearchMay 3, 2003 | Boston Globe Citigroup Inc. recently sent Sallie Krawcheck, its new executive in charge of stock research, to Boston to schmooze clients at some of the city's biggest mutual fund houses. The reception was chilly. Senior managers at MFS Investment Management, for example, said they had no plans to pay for Wall Street research anymore.
While New York's biggest securities firms agreed Monday to pay $1.4 billion to settle charges they had tainted their stock research, the bigger question for many of them is what role if any their stock research will now play. Some firms are expected to scale back their efforts dramatically, while others aim to track a narrower niche of companies. Either way, the traditional purveyors of analyst reports are finding that large investors now have little use for their stock opinions.
At Putnam Investments, executives recently sent several representatives from Wall Street research groups away empty-handed. "They've come to ask us, more than ever, what kind of services we're looking for," said Stephen Oristaglio co-head of investments at Putnam, a Boston fund manager. He declined to name which companies he sent away but said they complained, " 'Wow, it's tough earning a dollar off you.' "
The change in attitude following last year's research scandals is sparking a huge shift in the way business traditionally was conducted on Wall Street. In the past, research analysts were extensions of a firm's sales team, paid handsomely for their work as rainmakers. The star power of such analysts as Merrill Lynch & Co.'s Henry Blodget and Salomon Smith Barney's Jack Grubman helped attract new corporate clients. Their reports were widely watched, and their "buy" recommendations during the bull market could propel a stock sharply higher.
Analysts who became experts in their fields learned of hot companies before their rivals, and often had contacts with venture capitalists who were funding the next big thing. Blodget and Grubman were among the group Monday that agreed to settle conflict-of-interest charges, as were Citigroup, Merrill Lynch, Credit Suisse First Boston, and seven other firms.
Over the years, executives at Boston's largest mutual fund firms and hedge funds say they have taken Wall Street research but would often regard it skeptically. The mutual fund firms believed securities firms were conflicted when they rated current or potential clients, companies for which they'd arranged stock offerings or merger deals. Most fund groups rely on their own research staffs for stock calls.
But now that federal and state regulators have found evidence that some analysts touted high-flying technology stocks at the direction of their bosses to win investment banking fees, money managers have become bolder about telling Wall Street firms how much their research is worth to them: Not much, and in many cases, zero.
"Their importance to us has been declining," said Ed Haldeman, Putnam's co-head of investing. "There will be shrinkage on Wall Street in research."
Jocelyn Cunningham, an expert on brokerage firms with Deloitte Consulting in New York. said, "Research is not a revenue-generator anymore. It's become a commodity." Over the past several years, Wall Street has been able to charge less and less for research, she said. Some firms began giving research away as a perk to garner stock-trading business with mutual funds and other institutional investors.
As Wall Street firms try to figure out what role their stock research plays in today's new environment, it's difficult to identify exactly how much revenue their analyst operations bring in, Cunningham said. With the market for stock offerings in the doldrums for a fourth-straight year, no one is drumming up IPO revenues these days. In fact, the regulatory crackdown on research comes as Wall Street is already under pressure to cut costs in these high-paid units.
Citigroup hired Krawcheck, 38, last October to overhaul its analyst ranks in the wake of the investigations. As chief executive of Smith Barney, she runs a newly separate unit of 13,000 brokers and analysts. Krawcheck formerly was chief of independent Wall Street research group Sanford C. Bernstein, and in the late 1990s was ranked an all-star analyst by the widely watched trade paper Institutional Investor.
She declined to discuss the MFS rejection, as did Citigroup and MFS.
Boston's mutual fund executives do not want to offend Wall Street brokers outright because the funds rely on brokers to sell their products. But a senior executive at Fidelity Investments said the firm depends on its own analyst staff and pays for outside research mainly from specialists. Similarly, a prominent hedge fund manager in Boston said he pays only researchers who "work to eat," meaning they make their money by analyzing stocks, not on investment banking fees.
For Wall Street, that's causing upheaval beyond the regulatory agreement, which calls for a solid wall between a firm's research and investment banking departments. Bankers can't oversee analysts or weigh in on their pay. And analysts may no longer solicit business or accompany bankers on pitches to win clients. Under the accord, researchers may not even help identify prospects a measure some smaller investment bankers say is unfair and even unenforceable.
Most rules should always have been in place, Cunningham said. But times, and the market, have changed. Now, she said, even Wall Street firms are saying, "Research is not a sacred cow anymore."