Wednesday, September 2nd, 2009
back at it

The last week of summer (as practiced) is upon us and soon most of the players will be back in force, acting their parts in the market drama.  That doesn’t mean that the weeks preceding Labor Day have been devoid of action — certainly the returns have been interesting, especially in equities, and there have been some notable stories as well.

One of interest is the discussion of the “huddles” at Goldman Sachs.This terminology is quite timely as well, with the impending start of the football season, which this year features dazed and confused Minnesota Vikings fans cheering for the guy with the funny name that they used to shout epithets at. On the heels of a Rolling Stone article that blamed the firm for pretty much everything (a former intern’s mother, upon reading it, wondered if the job he accepted at Goldman meant he was going to work for the devil), the Wall Street Journal examined the practice of using research analysts to generate trading calls for top clients.Wall Street Journal | This is a subscription article, but there are a variety of summaries available on market blogs.

It’s hard to know where to start with this story, since there are so many angles to it.  Almost all of the articles I have seen about the huddles have mentioned the Global Research Analyst Settlement and one of its core goals, to ensure that research analysts aren’t publishing one opinion and saying something else again to favored clients.Disclosure:  I have been an independent consultant under the settlement, the final reports of which are now being written.  I guess that means I have some available time should this trigger another regulatory action. As I have written before, research reports are “frozen in time” in more ways than one,the research puzzle | This posting focused on how little progress there had been in creating better reports during the electronic age. with the stated view of the firm from a research standpoint often being different from how the firm is trading and even from what an analyst is thinking day to day.  That is why institutional investors like to talk to analysts on the phone or in meetings and why they like to get the signals from these huddles:  they are accessing what is changing at the margin and trying to get an inkling as to the probability that an analyst’s opinion is going to change “officially.”

We can debate the worth of such activities and whether any lasting value is created from them, but they are common features of the business, yet at odds with the regulatory framework for published research opinions.  (I’ll leave enforcement considerations to the regulators and engage in other sorts of idle speculation.)  In years past, when the operating decisions of the big brokers were questioned, someone would always say that they were the smartest people around and knew what they were doing (with the implication that the questioner did not).  Surely the events of the last two years put the lie to that, so it’s a bit more comfortable to doubt their wisdom.

The Rolling Stone article talked of Goldman’s stated interest in being “long-term greedy,” and I’m sure that it believes it is doing so by adopting policies that favor its most important clients, thinking that some version of the 80/20 rule applies and that it makes sense to cater to the few with the greatest economic heft.  My advice:  If you want to restrict services, fine, but be upfront about your actions, distinguish the differences among the services, and tell clients why they are or are not eligible.  Otherwise, if you have clients entitled to research, a push of the button makes it available to all instantaneously.  Pretty simple stuff.

The practice of skirting the edges of regulations, client relations, and possible conflicts of interest, so much a part of the Wall Street model of yore, needs rethinking, even at the cost of near-term profits.  It simply hasn’t worked, other than to allow for outsized payoffs for the edge-pushers (until the inevitable retrenchment due to enforcement action or market failure).  It’s not long-term greedy, it’s long-term stupid.

It also puts a strain on spokespeople for the firm, who have to do semantic gymnastics when the stuff inevitably hits the fan.  In defense of its selective disclosure of the signals called in its huddles,  a Goldman representative said it doesn’t want to “overload” its clients — do they really believe that?  Let the clients decide what’s important and how to filter it.  And, while you’re at it, please don’t use price targets in an ill-conceived way to talk about why the short-term ideas from the huddles aren’t in conflict with the long-term published outlook.  Those targets are usually meaningless (a topic for a future posting) and no one believes that they provide an explanatory blanket for anything.

All of this is not to say that I think that today’s system of regulation regarding research and its relationship with trading and investment banking is the best one possible or reflects the changes over the last couple of decades in communications technology and the investment business.  It isn’t and it doesn’t.  But I do believe the game of cat-and-mouse that brokers play with regulators and clients is the wrong way to improve things.  Yet that is the game that they are taught to play and, in this case, Goldman and those that copy it are back at it again.