NCPA - National Center for Policy Analysis

Will Security Analysts Take The Fall?

June 20, 2001

Financial analysts are in the doghouse with many investors, says Bruce Bartlett. Most of them missed the Internet boom. And those who warned the tech-heavy NASDAQ market was in the midst of a classic bubble lost favor with their clients. The fact they ultimately turned out to be right didn't redeem them.

Then the Securities and Exchange Commission issued a regulation limiting analysts' ability to get "inside" information from corporate executives. Henceforth, all important financial information had to released to everyone, including the general public, simultaneously. This meant the information financial analysts had was little better than anyone else's, thus diminishing their value.

There is an unfortunate side effect of the SEC's Fair Disclosure rule.

  • Corporate financial information now tends to come out in large globs, rather than being dribbled out, so instead of being able to gradually absorb bad earnings news, markets get it all at once.
  • This has tended to exaggerate the impact of negative earnings announcements, increasing volatility and driving stock prices lower than if the same news had been released through analysts who could interpret the figures before they became public.

Now financial analysts are being accused of fudging their analyses to benefit the investment banks most of them work for. No doubt, there are some analysts who have felt pressure to boost their ratings to help banks get or avoid losing business.

Even if the incidence of actual biased research is small, the perception is deadly. The Securities Industry Association is working to strengthen the wall between analysis and investment banking. But it may be that only a full-blown separation will restore the analysts' reputation.

Instead of paying for analysis indirectly through commissions, investors ultimately may be forced to buy it directly. Only that way can they be sure they are getting an analyst's true opinion.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, June 20, 2001.


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