Suppose you were in the market for a new automobile, and further suppose that, because you had very little time, you wanted to hire an agent to find the best car for your circumstances at the best price. Would you hire someone who was also being paid a commission by Ford to sell their cars?
This is precisely the situation many investors, perhaps unknowingly, are often in. The fact is, many Wall Street “full service” brokerage firms regularly publish research and directly advise their clients to buy certain securities while at the same time the firm’s investment banking branch is competing to sell new stock issued by corporations. Firms claim to have a “Chinese wall” which separates research departments from their investment-banking unit, but in fact analysts’ compensation is often related to the firm’s ability to woo corporate clients.
Evidence of this conflict is obvious. “Sell” recommendations by analysts are virtually unheard of, we suspect partly because of concern for offending potential investment banking clients, and down grades of a company often appear as euphemisms, such as a change from “strong buy” to “buy”, or “market outperformer” to “market performer.” We have seen evidence in our role as investment advisors as well. From time to time we encounter a wave of prospective clients who have been using a full service broker, whose holdings include the same obscure security, often inappropriate for the investor’s circumstances, that, sure enough, had been underwritten by the broker’s affiliated banking firm.
This issue has gained a great deal of attention recently. In the aftermath of the Nasdaq’s fall from grace, politicians and regulators have increased their scrutiny of financial firms. The Securities Industry Association (SIA), the trade association for these Wall Street firms, responded by endorsing certain “best practices” that SIA’s member firms should follow. These included guidance for corporate governance (reporting among business units), adoption of consistent and transparent recommendations, prohibition of direct ties between analysts’ compensation and investment banking revenues, and full disclosure of personal interests.
Several of SIA’s member firms agreed, generally, but explained that no real changes were needed because these practices were already being followed. Is regulation the answer? We do not think so. Instead investors should consider the many alternatives provided by the market place. We recommend that investors pay only for objective investment advice, provided by an entity whose compensation is derived solely from the investors they serve.
The same would apply to individuals seeking financial or estate planning. As a reader of the INVESTMENT GUIDE, you receive one of the lowest-cost independent investment newsletters available. Clients of our advisory services similarly benefit from unbiased supervision of their accounts, held with well-established discount brokers at a cost that is among the very lowest in the industry.
Also in This Issue:
Quarterly Review of Investment Policy
Hate to Say We Told You So…
Barrick to Acquire Homestake
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
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