This is a disturbing trend. Bloomberg BusinessWeek reports that some companies are now paying brokerage clients to cover them. This is similar to the credit rating agency model that has been criticized so often for the conflicted advice it produces, but this is worse, much worse. Here’s more from BusinessWeek (emphasis is mine)
With brokers increasingly unable to subsidize research with indirect payments, France’s Natixis SA is pioneering a novel approach: charge clients for coverage, a model that has proved fraught with conflicts for debt-rating companies.
Analysts Jean-Jacques Le Fur and Philippe Lanone at Natixis published this month their first piece on Transgene SA, a French biotechnology company that’s worth $125 million, with a two-page note recommending that investors buy the shares. At the bottom of the first page, in bold italics, is a disclaimer that roughly translates to “Natixis has been paid by Transgene to produce financial analysis.” The stock soared 7.8 percent on the highest volume since January.
“I find the whole concept a little odd,” said Ian Gordon, head of banks research at Investec Plc in London. “It would potentially taint the brokerage’s product. My perception is that investors only value truly independent research. I don’t really understand why any company would be willing to write a check to commission such research if it is not valued.”
This “novel” approach isn’t all the fault of the brokerage community. Regulators share in the blame. .
While providing paid promotions may undermine credibility and raise concerns about potential conflicts of interest, there aren’t too many alternatives, especially for mid-sized shops. Trading commissions to pay for research will be banned under European Union rules in 2018, and banks are looking for ways to pay for the service without passing costs onto their buy-side clients.
The practice is perfectly legal (though it probably shouldn’t be) as long as it is disclosed, but as investors have learned time and again with the credit rating agencies, the model incentivizes the analyst to bias his research.
As a manager of a European small-cap stock fund, Woischneck says he has read commissioned research reports from small brokerages, but never from a larger bank like Natixis.
“A paid note can’t be completely neutral,” said Woischneck, who manages about $180 million as senior equities manager at Lampe in Dusseldorf, Germany. “It might be a good way to find out about the company and to get a first impression, but it’s marketing. I’d be careful with the conclusions, and I wouldn’t take a buy rating seriously.”