Research Renegades

Fed up with conflicts at big banks, equity analysts are striking out on their own and winning over jaded investors. Not all of the fledgling firms will make it.

By Edward Robinson
Bloomberg Markets, November 2009

When Credit Suisse Group analyst Ivy Zelman refused to turn bullish on homebuilding stocks during a rally in the fourth quarter of 2006, the blowback was intense.

She says investors told her that some housing industry executives were ridiculing her analysis as a “jihad,” and several of the bank’s sales representatives pressed her to upgrade “hold” ratings to “buys” on companies to appease bullish institutional-investor clients. One sales manager even sent her an e-mail warning that analysts who stayed bearish too long often lost their jobs.

Zelman was furious. She’d spent 16 years dissecting the home construction business and wasn’t about to ditch her analysis and join the bulls’ party. On Dec. 7, 2006, she slapped a “sell” call on the entire group, and during the next 12 months, the Standard & Poor’s Supercomposite Homebuilding Index plunged 53 percent as the real estate market collapsed.

Stefano Natella, Credit Suisse’s global head of equity research, says that while debate between the sales team and research staff over their calls is normal and healthy, the e- mail from the manager crossed the line and he was reprimanded. Even though Zelman had Natella’s support, she grew fed up with a culture that prized irrational exuberance over sober analysis.

“It was no fun being the bear,” Zelman, 43, says. “I’d come home from work and just be so upset. So I started thinking, ‘If I believe in my work, why not do it on my own?’”

Going Solo

In May 2007, she resigned from Credit Suisse. After weighing whether to start a hedge fund, a buyout boutique or a research firm, she settled on the latter and opened Zelman & Associates, in Cleveland and New York, five months later.

Zelman is one of a rising number of equity analysts who’ve quit large banks and gone solo. They’re joining a wave of investment bankers and traders who’ve moved off Wall Street to set up mergers and acquisitions advisory firms and work at mid- size brokerages as the financial world reconstitutes after the credit crackup.

Independent research firms are popping up in New York, Silicon Valley and London, where Stuart Graham, the former head of Merrill Lynch & Co.’s European banking stocks team, unveiled Autonomous Research LLP in July with the motto “Free from external control and constraint.” The number of independent research firms in the U.S. has soared to 2,667 from 1,012 in 2006, according to Integrity Research Associates LLC., a New York-based consulting firm.

Outflanking Wall Street

Zelman and her fellow independents are taking aim at Wall Street banks by selling research to institutional investors, ranging from PNC Capital Advisors Inc., an investment firm in Philadelphia, to hedge fund firms such as Passport Capital LLC in San Francisco and Vardon Capital Management LLC in New York.

Independent shops will have a hard time outflanking resurgent securities firms, which possess huge advantages. Their underwriting and allocation of equity offerings motivates money managers to preserve their relationships with brokerages, says Jay Bennett, a consultant with Greenwich Associates, a Stamford, Connecticut-based firm that advises institutional investors.

Today, Bank of America Corp., JPMorgan Chase & Co. and other giant securities firms receive almost 70 percent of the commissions institutional investors dole out for research. That compares with 3 percent for independents and the rest for mid- size firms, according to Greenwich.

“There is a symbiotic relationship between the bulge- bracket bank and the typical institutional investor, and I can’t see that being displaced,” Bennett says.

Analysts Marginalized

In 2002, then-New York Attorney General Eliot Spitzer and the Securities and Exchange Commission began investigating the research industry in the midst of conflict of interest scandals that erupted after the dot-com bubble imploded in 2000. Rock star analysts like Jack Grubman, the telecom specialist at Citigroup Inc. who earned $67 million from 1999 to 2002, and Henry Blodget, Merrill Lynch’s dot-com guru, had issued glowing recommendations of companies to win investment banking business, according to lawsuits filed by the SEC.

In 2003, the SEC prohibited the analysts for life from associating with a broker-dealer or investment adviser. Grubman and Blodget didn’t admit or deny wrongdoing in their settlements.

In 2003, Spitzer and the SEC struck a settlement with Goldman Sachs Group Inc., Merrill and eight other major banks that permanently barred them from using investment banking revenue to compensate research staffs and fund their work. Analysts became marginalized on Wall Street, losing thousands of jobs and their seven-figure salaries: Annual pay for top performers fell to about $600,000 by 2008 from a peak of $2.5 million in 2000, says Alan Johnson, president of Johnson Associates Inc., a New York-based compensation consultant.

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