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Apr 30, 1999

The great information crunch

The complex world of stock surveillance

If chief executives are the generals and IROs their lieutenants in the capital markets campaign, who is the secret service? The market intelligence firms, of course – aka stockwatch or stock surveillance. Snooping up and down the Street, leaving no stone unturned, decoding the myriad signals emitted by fund managers, stock exchange specialists, analysts and traders, stockwatch analysts are today's IR intelligence officers.

Admittedly, it is a disservice to the stockwatch folk to liken them to spies – at least nowadays. But it wasn't so long ago that diplomatic stinks regularly rocked the community as sometimes underhanded methods came to light. Witness the ire of Bear Stearns over DF King's stockwatch operations twice this decade. The brokerage accused the surveillance team of impersonating Bear Stearns employees to get snippets of back office trading information, of bribing bank personnel with booze and hockey tickets. That ignominious episode ended with a settlement of millions and the sale of DF King's stockwatch division to Thomson Financial Investor Relations.

Today stockwatch has shed its sleazy image, in part due to that very scandal. 'It was good for our business,' says one stockwatch executive. 'The murk has been cleaned up because no-one wants to go through the same ordeal. It can't be worth it.'

Info evolution

As described by Walter 'the Shoe' Schuplak of Shareholder Communications Corp's Kissel-Blake, a stockwatch veteran of 18 years who has worked for Morrow & Co, DF King and Georgeson & Co, today's sophisticated stock surveillance evolved out of 'sharkwatch' in the 1980s. 'Originally clients would retain us to keep an eye out for movement in their stock,' he recounts. 'They really weren't focused on which large institution bought the stock; they were just happy for us to report to them that the million share block that crossed was purchased by a Fidelity or Putnam and not a Carl Icahn.'

Back then, stockwatch was not an IR tool but a service used by the general counsel or corporate secretary. Then in the late 1980s and early 1990s, with the break-up of Drexel and resulting relief from hostile raiders and greenmailers, stock surveillance became the domain of the IRO. 'It has now evolved to a bigger picture, long-term perspective. As we have accumulated databases and background on what makes institutional investors tick, clients could see the trends which would then dictate what type of investors they could go to and get the best bang for the IR buck,' remarks Schuplak.

'We've seen a continuing increase in the use of stock surveillance, not only because more companies are becoming aware of it, but because they're finding more uses for the kinds of intelligence we provide,' says David Geliebter, chairman of the Carson Group. 'The latest trend is companies using it as a competitive intelligence tool. There's a tremendous amount of information out there not only on how their stock is performing and how they're perceived in the marketplace, but on how they're positioned versus their competitors. Any company today worth its salt is interested in understanding that as much as why their stock is going up or down.'

But some of stockwatch's current popularity can be marked down to a resurgence of swashbuckling M&A activity. John Grau of Beacon Hill Partners says companies now want information on a more frequent basis. 'Every day our clients are calling and asking about aggressive trading by arbitrageurs and hedge funds,' he comments. 'They're worried about being taken over again. In the past month we've had three public utility companies become involved in fairly large merger transactions. There is certainly an increased awareness of M&A activity, especially among the hot companies in technology, pharmaceuticals and biotech.'

Grau also remarks on the growing sophistication of some clients. 'Five years ago we had around 100 companies in our technology area and they were all entrepreneurs. Now they have matured to the point where they're starting to think more about corporate governance and M&A issues, and how keeping their stockholders happy goes far beyond having pleasant phone calls when they call in. It has to do with how they're managing their company and whether their company will actually survive.'

New tools?

Geliebter admits he would like to say Carson had found all kinds of new tools for analyzing basic stock surveillance information, but it's just not the case. 'The methods that have been in place for some time still exist today. There are ways to automate certain parts of the process, but by and large it's getting on the phone, talking to the Street, and trying to understand why a stock is trading the way it is. The basic mechanics of finding out who's buying and selling are pretty scientific; it's everything we do afterward – analysts getting on the phone and doing the legwork – that produces the information that companies really value.'

'As long as companies have their shares traded every day, our process of identifying changes in ownership, being the analyst to the IRO, explaining our take on what's happening with their stock and their peers' stocks, will not change,' concurs Grau.

He says the nuts and bolts of stock surveillance are the beneficial ownership lists provided weekly by the Depository Trust Company. Based on experience of which institutions hold their shares with which brokers, the surveillance analysts can get a good picture of movements in clients' stocks.

'It's real roll-up-your-sleeves analysis comparing changes in DTC lists from one week to the next, looking at Nobo lists (non-objecting beneficial owners) and lists from banks and brokers. We try and limit our contact with the actual back offices of banks and brokerage firms as much as possible,' adds Grau.

'At its core stock surveillance is simply explaining movements in stock price and volume,' recaps Tom Bloom, just named global head of Thomson Financial Investor Relations' stock surveillance unit (see People, page 83). 'In the early 1990s it was still seen as a luxury item. But by the middle of the decade the market expanded further to the point that companies see it as a necessity.'

There is one branch of the data pipeline that has tightened over the last year, however. And it is a sticky subject for the stockwatch firms. The upshot is that a handful of custody banks have ceased to sell 'bank lists' – daily lists of the share amounts of their largest holders and corresponding account numbers. Based on such lists, which are a foundation of stockwatch, analysts can do detective work to uncover near real-time changes in ownership. But now these lists are under threat.

'It has become tougher and tougher to get information out of the custodial banks,' says Edelman Financial's Ed Kuhlenkamp, who was at Carson before heading up Georgeson's stockwatch division. 'A lot of the analysts are in a tough predicament: the service is sold to clients on the basis that they can find out ownership positions as soon as possible; but they have difficulty getting the information, so they're trying to guess or figure out what's happening in other ways.'

Clearing the crunch

While most stockwatch players steer clear of this issue (concerned more custody banks will crack down) they do say they're largely unaffected by the information crunch. 'The top stockwatch firms have found ways around it,' says one. 'Everything in this business is contact-based relationships. You have established contacts on the Street who recognize you're not misrepresenting them, and they're going to continue to give out information. They know we're not running to a broker with the information, but going straight to the IRO who uses the information for internal purposes. They know there's nothing untoward going on.'

Bloom explains that Thomson intensively collects trading information directly from the exchanges – whether it's a market or limit order, however aggressive the buying or selling. 'How the order is executed often indicates who could be behind it. So by the time we get to the settlement process we have a short list of who is ultimately behind that trading, even if the stock flows into a particular custodian where the relationship with the surveillance firms is limited. We're trying to be less reliant on the custodial relationships because of what's going on in the industry.'

Light years ahead

'The business of gathering information day-to-day has not become tougher because of the availability of information,' says Paul Hebert of Corporate Investor Communications (CIC). 'It's become tougher because of the client's instant, value-added analysis of that information. The advice and tools provided to our clients now, in terms of shareholder intelligence and ability to analyze it, are light years beyond what there was in the 1980s. All we did then was assess vulnerabilities for takeover threats and hostile accumulations. Now we're using similar intelligence to counsel our clients on what shareholder reaction is likely to be to spin-offs, earnings revisions, financial strategies and M&A activity,' explains Hebert. 'That entails considerably more in-depth analysis on our part. We're gathering data, using tools to analyze it and building tools for our clients to do their own analytics.'

He sums up: 'Market intelligence providers are much more actively involved in counseling clients on long-term objectives. Meanwhile, demand for information delivered more quickly and electronically has risen.'

Hebert admits that there still is a need to know what's going on day-to-day for curiosity's sake. 'Large block trades are still under the skin of the CEO and CFO,' agrees Cort Gorham, Beacon Hill's stock surveillance chief. 'They want to know who's pushing them up or down, and they want to know right now.'

As underlined by Kissel-Blake's Schuplak, traditional stockwatch is relied upon to add value to the IR effort. 'It's having another set of eyes and ears on the Street, getting the facts back quickly to the IR effort. It's timely information on who's driving share value; understanding perceptions and motivations of investors in the current climate; and even delivering feedback to measure the success of investor communications. Basically it's getting the client answers – that's pure stockwatch.'

That said, he notes that the trend continues toward sophisticated targeting techniques. For instance, more pre-IPO companies are targeting particular investors as they prepare their roadshows, striving to attract long-term investors. And last year's increasing market volatility, while ringing alarms at the SEC and stock markets, is ringing cash registers at the surveillance firms. 'We love it,' exclaims Geliebter. 'If the market was flat and nothing was happening, it might be difficult justifying a service like ours. But when it's going up or down, investor relations officers need us to interpret what impact that's going to have on their company or the stock. That's what we thrive on.'

'Clearly day trading and the amount of trading electronically – not only by individuals but by institutions – is increasing marketplace volatility,' Bloom remarks. 'And anything that creates more volatility creates more questions about who is behind that activity. IROs want to be able to go to the chairman more quickly with the answer.'

Over at Beacon Hill, Gran says companies are placing much more attention on individual investors with some shareholder compositions becoming drastically more retail oriented. 'Everyone is jumping on the online trading bandwagon.' There's also a lot more focus on foreign ownership, for overseas as well as US clients. Gran remarks on the increase in US-style proxy fights and mergers in Europe, for example.

IPO interest

Geliebter adds that the biggest change he has observed in the last year has been an increase in new IPOs knocking on the stock surveillance firms' doors. 'These are smaller cap companies very interested in how they're perceived in the marketplace, how their stock trades and how they're valued.'

A major priority for stockwatch firms is client access. Kissel, like the other major stockwatch players, now offers stock surveillance reports over the internet. 'Rather than lug around a huge book of institutions, they can log on, find out how many shares are held by a specific institution they're going to visit, and what their most recent movements have been,' Schuplak explains.

Adds Jason Alexander of Shareholder Communications Canada, 'As the economy becomes more and more global and the search for investors broadens to Europe and the Far East, having that internet accessibility is crucial for an IRO.'