Some in the media has done a tremendous job with an assist from the SEC trying to confiscate private property for the public use without the benefit of due process enshrined in the Constitution. It almost sounds like eminent domain and it is playing out like that, though what I am referring to is not taking physical property to build a road. It is who owns investment analysts opinions? In two articles, in the past two months Gretchen Morgenson of the New York Times has written two provocative articles centering on analyst opinions and who gets them when. Most of the media has lined up in chorus to support her basic thesis that analyst opinions are material non-public information that influence stock market prices and hence should be made available to all on an equal timely basis. The New York Times even just ran an editorial in support of this position: http://www.nytimes.com/2012/07/18/opinion/not-all-investors-are-equal.html?smid=pl-share
Analyst opinions unfortunately do influence stock market prices for about one day though rationally they shouldn’t. But that they influence security prices for 24 hours or so does not make them material information, in fact they are not information at all as explained so well here by Felix Salmon:
Now the SEC is partially complicit in this attempt to confiscate private property In April, Goldman Sachs paid $22 million to settle charges about “analyst huddles” where their own traders and select clients were given heads ups on analyst insights and presumably rating changes. The SEC has taken the position that all Goldman clients must be treated equally, while the New York Times has expanded that to Goldman treating the general public which pays it nothing on par with it clients. But the situation at Lehman described in Morgenson’s May article on Lehman seems similar enough to Goldman to raise questions why the SEC took no action in the Lehman case. Perhaps Lehman’s lawyers raised objections that Goldman’s didn’t as to what were the SEC’s powers here anyway.
Most inside trading cases and there is no specific law on “inside trading”, rely under rules and laws about misappropriation and violation of fiduciary duties. But you can’t steal or misappropriate from oneself. Lehman and Goldman should be free to use the work product they produce as they see fit, to use it internally or to disseminate early to better paying clients. Most businesses including banks and brokerage firms treat better paying customers better than lower paying ones. When an online trading firm charges less commission if you do more trades with them or have more assets, they are not treating all customers “equally”.
There is a difference or should be between a government report like unemployment numbers that influence security prices being timely disseminated to all because taxpayers pay for that. But Goldman and Lehman are private companies, most market participants are not their clients and pay them nothing, so why are they entitled to anything? This is their work product produced at their cost not the public’s. Should everyone get a free card from GM or Ford? It is the same concept. What would happen if leaks were to develop or the media would seek out internal recommendations from buyside firms like Fidelity or Trow Price? These would presumably influence market prices too if they were reported. If these recommendations were leaked without authorization that is one thing, but what happened if busyide firms wanted to share some internal research with its own clients and some of those clients leaked it as would be expected on that scale – would these firms be obligated to share them with the public on a timely basis? Can a buyside firm have research “huddles” with its biggest customers but not all of them? The top institutional clients of buyside firms get access to the firm’s portfolio managers and often one on one meetings. Retail clients who buys those firms products through mutual funds do not get this access – is that some form of violation?
The business model for investment research is becoming extinct. First the SEC in the aftermath of the internet bubble meltdown in conjunction with Eliot Spitzer stopped or cut substantially the ability of the investment banking divisions to pay for “research”. Ok, it really wasn’t research often – it was paid for advertising and the “fix” should have been to have it labelled as such, so it would not be perpetrating a fraud on its users that it had an intellectual unbiased basis. But that didn’t happen and now the SEC and apparently many in the media are suggesting even using trading commissions is problematic because everyone should get the product even if they don’t pay any commissions. Meaning if you are day trading from home using Scottstrade you should be able to get word on Goldman rating changes as soon as the people trading through Goldman? Really?
What the SEC should do is put out a public warning about sellside “research”, that the public should ignore analyst recommendations because they are either tainted or because they are getting the information late and also because even when done on the most ethical basis are often wrong. The SEC should formally state that anyone who buys or sells a security solely based on an analyst opinion is a fool and perhaps the public would stop doing it. If the public stops following these analyst changes, the hedge funds and the banks own traders will have no reason to front run them because there won’t be a fool behind them willing to pay a higher price on the buys or sell at a lower price on the sells or downgrades. I won’t hold my breath waiting from this kind of candor from the SEC.
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