Unfair Shares 

Unfair Shares 

Unfair Shares 

Policy made plain.
July 13 2001 3:00 AM

Unfair Shares 

Any journalist who's been involved in an ethical controversy or two must follow the current discussion of ethics among securities analysts with amazement. Wall Street and Washington are urgently chewing over the question of whether the advice these people give investors is corrupted by conflicts of interest. In theory, this question was just as pressing when share prices were going up. In practice, no one cared until prices turned down. What's amazing is that there is anything to discuss.

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American journalism's obsession with conflicts of interest—others' and its own—is overwrought. For example, the Washington journalist Andrew Sullivan this week was pressured into giving back money the pharmaceutical industry had paid for a commercial sponsorship of his Web site. Sullivan is HIV positive and has admitted, if that is the word, that he is grateful to the drug companies for keeping him alive. It is hard to believe that his views about an industry that is saving his life will be affected by a few hundred or even a few thousand dollars.

One pretty standard rule in journalism is that journalists shouldn't own shares in companies they write about, or companies that might be affected by what they write, or possibly financial journalists shouldn't own stocks at all. The concern here is obvious and legitimate, but even so the rule is a bit odd. Most financial journalism—in print, on the Web, and on television—consists of journalists transmitting the views of finance professionals: fund managers, brokers, analysts. And one reason people want to know what the professionals think is precisely that they have money on the line. If a financial columnist strings together a bunch of quotes from a hedge fund manager, he's got a column. But if a hedge fund manager writes the column herself, she's got trouble with the ethics cops.

That said, consider (as the SEC and Congress are now doing) what's standard operating procedure for securities analysts. Analysts are like journalists—their job is to investigate and report—except that they're paid a lot better (millions, often) and their judgments matter a lot more. People actually invest money based on what stock analysts say. This is a thrill generally denied to political commentators. And during the 1990s, stock analysts stole a lot of the televised glamour from political journalists, which makes the comparison even more galling!

Analysts routinely own the stocks they analyze—even get shares as party favors from companies before they go public—but that's just the beginning. Most of the top analysts work for firms that also bring shares to market. This investment banking function is how these firms make their serious bucks. And analysts' compensation is tied, often directly, to how well the investment banking division does—or even how well particular stock issues do. Analysts plot strategy with their investment-banking colleagues, and even get paid for bringing in deals. Then they are supposed to supply objective analysis to the public about whether these same shares are worth buying.

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It is as if the Washington Post were being paid by the Republican or Democratic National Committee to help that party win elections, in a deal brought in by the Post's chief political correspondent, whose salary and bonus are based on how successful that party is. And the ethical controversy is not about the propriety of this arrangement but about how much of it the chief political correspondent ought to mention when he or she goes on television.

The current controversy started with a superb Fortune cover story in May about Mary Meeker, the locally legendary Internet analyst for Morgan Stanley. The story described Meeker waving a favorable report on eBay in front of eBay's CEO in an effort to snare that firm's initial public offering. It traced her remorseless puffing of stocks her company had brought to market even as their prices tanked. It quotes her ingenuously owning up to a "keen sense of responsibility" not to be "really aggressive on the downside" about companies she had helped bring public. It may actually be possible, in that world, to see nothing troublesome about all this.

So, Merrill Lynch announced on Tuesday that it will forbid its analysts to own the stocks they cover. Skeptics have pointed out that this addresses the least of the problems. But it's not just that the investment-banking connection is a bigger deal. It's that the ownership by analysts of stocks they cover is less objectionable. There actually is a lot to the argument that it's good for people being paid for their advice to have "skin in the game." The problem is not when analysts own shares—the problem is when they sell them. And this could be handled, if not completely solved, with rules to forbid selling within some period during and after a positive recommendation (and analogous rules to prevent talking down a stock and then buying it). But the investment-banking business is all about selling shares, and it creates an unambiguous incentive to tout the stock.

Meanwhile the SEC has issued a warning to investors. Before you buy any stock recommended by an analyst, the agency recommends, you should check the company's registration statement to see if that analyst's employer is an underwriter. You should investigate whether the analyst or the employer owns a large chunk of the company's stock. Check out Schedules 13D and 13G, the agency suggests. Don't miss Forms 3, 4, and 5—and Form 144. Scour the SEC's electronic database for "lock-up agreements." And so on.

Heck, if you could do all that, you could be a stock analyst yourself. Beats working.