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Aug 31, 1998

Honest analysts

Going in search of unbiased research

Most IROs spend a lot of their time talking to analysts, those tireless window-cleaners of capitalism who ensure that everything is crystal clear and transparent for the world’s investors.

But is all this research quite so limpid? Can the sell-side carry out independent research, or is the Chinese Wall all too permeable, and the research clouded by the leak of self-interest from the revenue generating operations? Two prominent and renownedly independent researchers, independent unto this last, come up with two completely different answers. Credit Suisse First Boston’s director of banking research, Michael Mayo, thinks that there is independent research life on the sell-side. Marvin Roffman, famously and formerly of Janney Montgomery Scott, but now with his own investment management firm, Roffman Miller, cites his own experience to prove that sell-side research is about selling stock, not seeking truth.

‘Keep your mouth shut, or you’ll never work in this business again,’ Roffman was told in 1990 after he had been sacked at Donald Trump’s insistence for suggesting that the Taj Mahal in Atlantic City would not be hitting the jackpot. Roffman did – hit the jackpot that is – and received a New York Stock Exchange arbitration award of $750,000 from JMS and an undisclosed but assuredly large settlement from Trump for defamation.

Starting as an analyst in 1961, he worked for 17 years for a small boutique brokerage in his native Philadelphia before joining JMS – from where he was fired in 1990. Investor Relations magazine reached him working from home and guffawing at the star analysts on MSNBC as they answered viewers’ questions with ‘Buy, hold or sell.’

‘If these are some of the 10,000 companies they don’t follow, then what are they saying?’ Roffman wonders. ‘If they are following 40 or 50 names, then forget it, it’s virtually impossible.’ In today’s financial services environment he is pessimistic about the chances of independence for sell-side researchers. There are just too many conflicts of interest. ‘It’s very difficult on the sell-side of the Street to really be honest. In July 1990, Institutional Investor interviewed analysts and found 61 percent of them had been asked to temper or modify a negative opinion – and I reckon the other 39 percent of them are probably liars,’ he condemns sweepingly.


Selling sizzle

‘If you look at the typical analyst, his bonuses are bigger than his salary, and they’re based on the business he’s generated, not on how accurate his earnings estimates are,’ continues Roffman. ‘All you have to do is to talk to the average registered representative. They don’t even read the reports; the aim is to create ‘sizzle’, which is how the sell-side makes its money.’ A major culprit is, he says, ‘rotation – new names, new ideas for the sales force,’ citing many examples from his own experience. For example, at JMS he was told that he could not have the same favorite stock for consecutive years, no matter how good it was.

However, it is only indirectly, by persuading clients to buy new stocks, that the sell-side can tell people to unload old ones. Analysts are ‘scared of the four letter word.’ No one wants to risk business by putting a ‘sell’ on their reports.

Roffman stresses that he is still a researcher, but on the buy-side, ‘I’m really a very happy person now. Seven years ago, I didn’t have a job. It’s like a breath of fresh air, not having to worry about telling the truth any more. And actually that’s what an analyst’s job is. To tell the truth.’ He also found that the pressure to keep getting the sizzle on new stocks was counterproductive when it came to due diligence. ‘You can’t cover many more than a dozen to 15 stocks properly. And now, the sell-side has its analysts constantly going out on the road to talk to the buy-side. They don’t have time to do any research, so they have assistants to do the number-crunching and report writing.’

In contrast, Roffman now finds time to do the research ‘and make money for my clients, which is what my job should be.’ Putting no faith in Chinese Walls, his company eschews all conflicts of interest. It takes no commission, doesn’t sell any products, and runs by the conservative but successful investment philosophy he outlined in his post-Trump book, Take Charge of Your Financial Future.


Noble goals

CSFB’s Michael Mayo would have no problems with these noble goals. ‘I approach the job with a sense that we have a fiduciary responsibility to investors,’ he remarks. ‘I do regard bank analysis as a career, not as a pretty stunt to make a lot of money – although I hope that in time those objectives should converge. I want to be known for making investors money, for being objective and for calling a spade a spade.’

However, that does not always warm the hearts of those being researched, as he discovered earlier this year when he was actively disinvited from Mellon Bank’s analyst dinner at New York’s plush Metropolitan Club. It was of course, the lack of access rather than the food that he found unpalatable. He hadn’t even put a sell on the stock, but stuck to the euphemistic ground rules with a ‘hold’.

He takes the snub in his stride. ‘As an analyst, it’s part of your normal course of doing business that you will occasionally have confrontations with the people that you are doing business with. You try not to take it personally; sometimes it’s a business decision by the company you cover. And sometimes it’s a wrong decision.’

He adds, ironically: ‘Banks are at the forefront of floating capitalism outside the US, and to the extent that they don’t themselves disseminate proper information it’s a bad example of how to promote free markets.’ A graduate in computer science, Mayo cut his teeth as an analyst working with the Federal Reserve in Washington, analyzing bank mergers in the tumultuous late 1980s and early 1990s. He counts this as the equivalent of Marine Corps training for an analyst.

‘At the Fed, every word was scrutinized, even where the however was positioned in the sentence.’ He left the Fed in 1992, and spent two years with UBS, and then three years with Lehman Brothers before joining CSFB. However, his reason for leaving each time was in search of promotion, not as a refugee from dictated research. Even so, he agrees that, ‘Once a year in my experience there’s been some kind of confrontation based on where the cards may fall.’


Stepping up to the plate

Despite that, he says, ‘Generally I’ve been fortunate in the amount of independence I’ve had. At Lehman my predecessor had put several sell recommendations which gave me confidence. Here, when I was being interviewed, I said to Al Jackson, head of research, that occasionally I made comments that upset management. His reply was, So did I when I was an analyst.’

His research now covers CSFB banking clients, potential clients, and some banks that CSFB would never do business with. ‘I simply treat everyone the same, and present factual, thorough research that’s as balanced as possible.’ He does not court a reputation as a nay-sayer and thinks that knocking stocks too often is as bad as offending no-one. ‘It’s wrong to say that management is stupid, or has lied, or is incapable. But if a stock has underperformed then simply say that, and let the facts speak for themselves.’

The subjects of his research, ‘even if they disagree with the conclusion, understand the thought process.’ Except perhaps for Mellon Bank, and the source of his rejection. He would rather not say who was responsible, and Mellon’s IRO, Don McCleod, also prefers a ‘no comment.’ However, Mayo allows, ‘Most IR departments have a good relationship, and try to be open. If I’ll say it to an investor, I’ll say it to the IR department. I try to stay away from conjecture.’ He concludes: ‘Clearly there’s a balance: to do a comprehensive analysis based on the facts, and come to a conclusion, and that’s where I find that CSFB and Al Jackson are very supportive. I feel I can do independent research.’

More importantly, he adduces, so are those who reap the reward of his buy recommendations. ‘The investors who’ve owned those bank stocks for the last four years know who stepped up to the plate.’