Wall Street is driven by information. In the asset management business, information is the lifeblood. Superior information translates to superior investment results, and superior investment results mean big paydays. As illustrated by the guilty verdict in the Raj Rajaratnam insider trading case, some investors will stop at nothing for information.
It wasn’t that long ago that the so-called “information edge” was readily available, and large investors viewed it as an entitlement. Companies routinely would make selective disclosures of non-public, market moving news directly to large investors or brokerage firms. I spent the bulk of my career marketing investment research for one of the world’s largest investment banks. We would take the information and repackage it as “research.” Many clients felt that they had no choice but to do business with us because we had the inside track on information.
Early in my career, one of my accounts requested an earnings model from one of our highest profile analysts, and the analyst refused to send the model to my account. I brought the situation up with management. It came to me as a surprise that the reason he wouldn’t send out the model was because he didn’t have a model. It seemed counterintuitive—how could this guy be the top rated analyst in his space and not have an earnings model?
The answer was that he didn’t need a model—he was the go-to guy in his space. If a company had news to release, in many cases they’d just call our analyst and he’d put out a research comment, which was then conveyed to our largest clients first, hence the term “first call.” Everyone knew this analyst was very tight with the managements of the companies that he followed and so naturally they coveted his research.
Then in 2000, the SEC adopted Regulation Fair Disclosure, or Reg. FD, which put an end to selective dissemination of non-public, market moving news. In a nutshell, Reg. FD requires issuers to provide everyone with the same information at the same time. It was the beginning of the end for Wall Street research. Overnight, we went from marketing juicy market moving scoops to marketing hunches, industry surveys, and rehashed corporate press releases.
Not long after Reg. FD, investment research took another body blow when in 2003, the SEC entered into a settlement agreement with major Wall Street firms relating to conflicts of interest arising from the way investment banking and research departments interacted. Our analysts’ windows of insight into their respective industries were slammed shut, research budgets were slashed as they could no longer be subsidized by investment banking fees, and many talented analysts moved on to pursue other interests.
The era of the information edge was regulated away and Wall Street research lost its fastball. Yet amazingly, I never received a single call from a client questioning the value of our research. I guess it’s a testament to the fact that the asset managers don’t pay for the research, their clients do.
Of course the research story doesn’t end there. Enter “alternative research” firms, also known as expert networks, matchmakers, etc. These firms operate on the regulatory fringe. They generally recruit mid-level corporate executives to moonlight as “industry consultants.” Unlike senior corporate executives who are trained to deal with inquiring investors on a daily basis, these mid-level executives usually lack the training found in the corporate suite, making it far more likely that they’ll spill the beans and give away secrets. Raj Rajaratnam apparently put together his own web of experts and paid them handsomely.
Most of these third-party research firms claim that their consultants, or experts, will not disclose any non-public or market moving information. Naturally this begs the question, why would a savvy investor pay these steep research fees if all the information is already in the public domain?
Much to the chagrin of active investment managers, the days of the information edge are behind us. As regulators have discovered the power of wiretaps, investors who want to roll the dice with these alternative research outfits should have a back-up career ready to go.