Wall Street is giving its detractors yet another reason to complain about the way business is done.
The New York Times is reporting that "a handful" of large hedge funds have been getting early access to research analysts, enabling the recipients to factor those views into their trading models before the information is disclosed publicly. According to the report, the information isn't a research report of the type that's issued daily on any number of stocks. Nor does it appear to be an overt call such as buy or sell. Instead, the analysts are passing the information along to the privileged clients by way of answering questionnaires that would ask, for instance, an opinion about a potential upcoming earnings period.
Specifically, The Times said questionnaires have been provided to a few firms, including hedge funds run by BlackRock and the U.K. hedge fund company Marshall Wace. While the funds say the only information that's been sought is in fact in the public sphere, the Times cites documents that call that contention into question. "[I]n at least four cases, documents from Barclays Global Investors, now a unit of BlackRock, state the goal is to receive nonpublic information," the article says.
Jim Rickards (@JamesGRickards), author of Currency Wars: The Making of the Next Global Crisis and partner at JAC Capital Advisors in New York, addressed the report in the accompanying video. While he doesn't support the practice described, he does caution against getting overly worked up about it.
"Based on what we know, it's not illegal," he tells Aaron Task. "It might be material nonpublic information. That's kind of the classic definition of insider trading. But it's important to know that not all insider trading is illegal. It's only illegal if you steal the information or abuse a trust."
If the information is obtained "through your own research, you generated that information -- that's your property," he says. "You can trade on it."
The key question of course is whether there's anything wrong with giving potentially special access to some, when that access isn't being given to all. Not being illegal doesn't exactly make it entirely above board, either.
"I don't think the hedge funds are breaking the law by using this information, but I question the ethics of Wall Street in giving it to certain customers over others," Rickards says. "They ought to be a little more transparent about that so the little guy knows he's getting the shaft."
Rickards says his own firm does its research in house and hasn't been privy to the type of early views into analyst thinking as described in the article. "We consider a lot of that to be noise," he says. "The less of that the better in terms of our funds."
Analysts have been pilloried for several years, going back at least to the days following the dot-com bust. In general, the press and the general public hold them in fairly low regard. So why should anyone care what they say and when they say it?
"It does matter if you get [information] early," Rickards says. "It may not have the impact that it used to ... but it can move markets."
Early Bird Gets the Worm
The Times article does in fact cite a fascinating study, albeit from 2004 and using data from 1999 through 2002, that looked at the impact of analyst recommendations on stocks. In sum, it found that buying and selling around research reports can pay off handsomely if done skillfully.
"Tens of millions of dollars trade at favorable prices following recommendation changes, and a calendar based trading strategy that purchases following upgrades and sells short following downgrades results in average annualized excess returns of over 30%," the study says.
The paper, titled "The Value of Client Access to Analyst Recommendations," by Emory University's T. Clifton Green, also found that "market participants who purchased stocks in the morning following a pre-market recommendation change were able to obtain positive and significant two-day returns. Purchasing within the first five minutes of trading and selling the next day from 2:00 to 4:00 results in an average return of 1.02%."
For investors, the rate of profit potential fell over the next several hours before dissipating around noon Eastern time, the research found. "Overall, the findings indicate that exclusivity is an important component of the value of analyst research," the Green study states. "Efforts to delay the dissemination of analyst recommendations to other market participants may enhance their value to brokerage firm clients."
So what do you think? Is this business as usual or should something be done about the practice described in The New York Times? Share your thoughts below.
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