The State of Independent Research, at NY Society of Security Analysts

Nitron Advisors’ COO, Scott Lichtman, took detailed notes on last Thursday’s panel on “The State of Independent Research” at the New York Society of Security Analysts. It was a well-attended event that covered questions ranging from how independent research firms are capturing value through new delivery models to the impact of Elliot Spitzer’s global research settlement and prospects for research jobs on the buy-side and sell-side.
NYSSA notes that, ‘These are the opinions of speakers at NYSSA’s Career Chat on Independent Research and do not necessarily reflect the opinions of NYSSA or its members. NYSSA does not endorse or promote any of the opinions or products mentioned.’

Eric Alexander, President, Institutional Services, Wall Street Access
Michael W. Mayhew, Founder and CEO, Integrity Research Associates, LLC
Paul Spillane, President and CEO, Soleil Securities Group, Inc.
David Teten, CEO, Nitron Advisors
David Weild IV, President and CEO, The National Research Exchange
CHAIR: Richard G. Lipstein, Boyden Global Executive Search


Eric Alexander is president, institutional services, for Wall Street Access, which offers research and execution to hedge funds and money managers. He is responsible for strategic development of the firms research offering, including coverage of mergers and acquisitions, energy, healthcare, and special situations. Previously, he served as director of marketing, and was instrumental in forging strategic relationships that helped the firm grow over the next decade. Prior to joining Wall Street Access, Alexander was a vice president with the public relations firm Burson Marsteller, where his clients included AT&T and American Express.

Michael W. Mayhew is founder and CEO of Integrity Research Associates, LLC, a ratings, analysis, and consulting firm for the equity research industry. Prior to founding his firm, he was CEO and president of Garban Information Systems, the financial information division of Garban/United News & Media. Previously, he was director of strategic planning and business development for Standard & Poors Financial Information Services Group. Mayhew has been quoted widely by various newswires, newspapers, and industry magazines, including Reuters, Investment Dealers Digest, Institutional Investor Magazine, Bloomberg News, Forbes, The Wall Street Journal, The New York Times, Financial Times, and Business Week. He is a member of the Board of Directors of Investorside, the nonprofit trade organization for the independent research community, and chairs a committee of the board to establish best practices for the research industry.

Paul Spillane, president and CEO of Soleil Securities Group, Inc., has been in the securities industry for over 25 years. He started his career at Goldman Sachs. where he worked in fixed income, foreign exchange, commodities, futures, and options products. He then moved to Deutsche Bank, serving as managing director and head of global market sales for the Americas. Spillane subsequently transferred to global equities as a senior member of the executive team responsible for building the global equities businesses. Most recently, he was responsible for establishing Deutsche Banks Global Relationship Management program.

David Teten is CEO of Nitron Advisors, a unique research firm that provides hedge funds, private equity funds, venture capital funds, and law firms with direct access to a global network of carefully selected frontline industry executives, scientists, academics, and consultants. David also is the coauthor of The Virtual Handshake: Opening Doors and Closing Deals Online, the first business book describing how to take full advantage of blogs, social network sites, online networks, and other “social software. ” He runs, a resource site and blog, and co-writes a monthly column for Teten was CEO of an executive recruiting firm that he sold to Accolo, and CEO of GoldNames, an investment bank focusing on serving the internet domain name asset class. He has worked with Bear Stearns Investment Banking division as a member of their technology/defense mergers and acquisitions team, and was a strategy consultant with Mars & Co.

David Weild IV is president and CEO of The National Research Exchange (The NRE), an innovator in products and services that support capital formation. The NRE provides patent-pending analytics and facilities that enable the systematic evaluation and long-term funding of research and related services. Weild served as vice chairman of The NASDAQ Stock Market and spent fourteen years at Prudential Securities, where he served as president of, head of corporate finance, head of technology investment banking, and head of equity capital markets. He also chaired Prudentials Equity New Issues Commitment Committee.

The entire research industry is undergoing a seismic shift that will produce both winners and losers in the coming years. Some of the more innovative research providers will continue to experience growth, while the total number of independent research firms is to expected to fall almost two-thirds by 2009. The need for good research, however, will never go away. Learn the reasons for the coming shakeout and how you can be among the success stories.

Scott Lichtman’s notes:

Richard Lipstein Question: Please describe your business models for independent research.

David Weild IV: We are a utility for Wall Street to get research paid for explicitly, while achieving coverage and liquidity for smaller public firms. Coverage continues to be shed across the industry. Fewer IPOs are symptomatic of this. There were < 200 IPOS in each of last 3 years. Pre-bubble, there were 460 IPOs/year avg. We have 14 patents. David Teten: We provide access to frontline industry experts who can provide deep insight into the companies and industries you are analyzing. There is a circle of economic agents around any company  suppliers, customers, regulatory observers-- who are in an appropriate position to provide fresh information to investors. We provide access to that circle. This means your analysts are drawing conclusions and making the buy/sell recommendations (not us), while you benefit from ready access to unique sources. There are three trends that drive the fast growth of our model: 1) The destruction of credibility of sell-side research. 2) Trend towards more people, including senior executives, who are managing their careers individually, without assuming they are wedded long-term to a given firm. These "corporate alumni are an exceptional base of knowledge. 3) A trend towards people having a public, articulated virtual identity, through personal web sites, bios and resumes online, social network sites, and software that is aggregating peoples backgrounds into a chronological whole. I discuss these technologies in more depth in The Virtual Handshake: Opening Doors and Closing Deals Online.

We are actively seeking out consulting firms and individuals who would like to consult through our platform.

Paul Spillane, Soleil Securities. Our goal: Premier aggregator and distributor of intellectual content. We are a registered broker dealer. We have a significant distribution platform, analysts all around the country and an agency trading desk in New York. Covering 320 stocks, 32 analysts, 3-5 alternative products. Analysts work when they want, get paid based on deliverables. Incorporating Fixed income, Commodities, Equities, and commentary on data sources. If you can think of a new idea, you can provide content in our model. We are looking for employees, firms to partner with and new sources of content.

Michael Mayhew: Integrity is the leading provider of information assessment and evaluation on the research industry. We publish research on the industry including a blog, web-based tools, due diligence on 436 research firms. Now adding 60 firms in Europe to the database. We help funds find research to add alpha, and mitigate risk in using research. Very little due diligence is typically done on hiring a research firm, especially compared to investing in a fund or fund-of-funds. We help funds reduce their risk in hiring a research firm.

Eric Alexander: We offer clients an integrated service, including access to a team of leading analysts in M&A, special situations, oil and gas, utilities and agribusiness. We also offer clients access to a proprietary network of healthcare experts. Also have a trading desk  important for clients to gain a full range of service and for us to get paid appropriately. We customize offerings for each client.

Richard Lipstein Question: What are challenges facing independent research firms.

David Teten: Research has a very unusual economic model: You usually get paid well after the service is delivered, you usually don’t know how much you’ll get paid, and neither seller nor the purchaser knows the exact value of the service. The value of research varies enormously from highly negative to many millions of dollars, yet it’s not common to define, let alone track, the metrics to place a value/price on it. Also, declining commissions on a per trade basis are putting pressure on the economic equation.

Michael Mayhew: 2 major trends.
1) Biggest challenge is proving value, day in and day out. The kind of research that could be sold 20 yrs ago has changed. Today folks want trading ideas and proprietary data points. Very large % of research firms have a tough time proving value, and probably shouldnt be in business.
2) Getting paid is hard, even if you prove value.

David Weild IV: A rough statistic: He took all research analysts, divided by (monthly) trading volume, and got 20,000 shares/analyst. If 50% is program-based, 50% of what’s left is algorithm based, and therefore there’s only 5,000 shares traded to pay each analyst. That’s roughly 250 shares/day. At 5c/share that is not a lot of money to spread around, and 5c is a high figure by current trading standards. The business is fundamentally bankrupt at some level.
Clients want 3 things  1) access to management, (2) experts, (3) traditional research. People want things that no one else has.

Eric Alexander: A lot of what the industry does is a commodity. Some of the forms of compensation are a thing of the past. Its much more entrepreneurial now.

Richard Lipstein Question: Buyside firms are decrying the lack of research but cutting back on # of research suppliers. How did we get in this contradictory situation?

David Teten: The buyside is not seeing enough compelling research from the sell-side. However, the number of buyside analysts is way up, which shows a commitment to proprietary sources.

Michael Mayhew: Other trends are happening too. There will be a significant reduction in # of firms getting paid. Firms will separate research fees and execution fees. You may only have 20 firms getting commissions, but hundreds getting research checks.

Richard Lipstein Question: Paul, how does one manage a virtual corporation?

Paul Spillane: Everything about the decline in research firms/getting paid is music to our ears. This is the only industry Ive seen that has no idea of COGS (cost of goods sold). We love a value-driven model. If you can add value, clients will pay you unlimited amounts. So good analysts in their virtual workspace are making 2-3x what they did in a bulge-bracket environment. “We manage by compensation.”

The industry needs to get away from the lack of connection between quality and reward  casual votes on who should get what. We have the same regulatory framework that any registered broker-dealer has, with the analysts being registered 86s or 87s. Our good analysts work “24×7” at times because they love the work and get paid well, and other times take a break.

“Its an absolutely fantastic time to be an analyst. The bottom is here.” The # of stocks covered by bulge-bracket firms is going lower and lower. The bottom line is here, there will be less people around, but those who are good will be making money. Like Nitron, we only pay an expert when they get a phone call.

Eric Alexander: Research revenues might go from $3.9bn to $3.6bn, but it’s still a big opportunity.

David Weild IV: Wall St research firms are getting smart that they do get paid. Roughly 50-70% of bulge bracket revenues for an offering are for the deal, and 30% is to provide coverage, but the funds arent always allocated to that purpose. It seems like Reuters and Thompson want to know who is consuming their research and cut out people who are drinking for free. The tide is turning on getting paid.

Eric Alexander: We are still committed to trading desk model. Its hard without a desk; it’s integral. The buyside sees their traders as integral to their team and so do we.


Q to Soleil: What does it mean for an analyst to “deliver” value and get paid commensurately?

Paul Spillane: There are many ways to signal how to pay: a voting mechanism, # of visits set up, commissions paid. Clients now are responsible, e.g. Via the UK’s regulations, to say how research is allocated. More hedge funds have a formal voting mechanism due to regulatory requirements. Checks come in with specific analyst names on them to us.

Michael Mayhew: All about producing good research. To one client thats management access, to another it’s industry expertise, and to another it’s performance recommendations. Issue is that if you produce me-too maintenance research, models that dont outperform, you have to worry.

Question: What about outsourcing research to India and other places.
Eric Alexander: This question is symptomatic of how much has become commoditized. Reg FD has commoditized information.

Michael Mayhew: Couple years ago, the avg cost of wall st to cover a company was $192K  per company. There was an absolute need to lower that cost, so moving some research oversees made a lot of sense. But value-add of a research firm cant be outsourced.

David Weild IV: But you can create new value by leveraging offshore resource. It may become a necessity to have competency in offshore inputs.

Paul Spillane: The last mile is where the value is. We get 7 calls/month from Indian firms to provide us with outsourcing. Most of those analysts dont have 86s/87s and dont talk to management. Offshores wont complete with mainline analysts, they will focus on filtering through existing data in more conventional ways, at least for now.
Offshore wont be a huge threat. We think $8bn will be paid out, over time, in hard research. If you look at outsourcing initiatives in the technology world, JPM outsourced their platform to IBM in a multi-billion deal, but brought it back in-house when the deal expired. Well all experiment with it, but when cost goes up for offshore it will lose competitiveness. We used to pay $25K for an associate abroad, now its $50K.

Richard Lipstein: One bulge analyst I know is having increasing quality issues, exacerbated by language barriers, time differences. They didnt see benefit anymore.

Michael Mayhew: Im concerned about long term risk. If we outsource associates, when do future senior analysts come from? Are we going to hire the offshore people and bring them here?

David Teten: All of this gloom & doom is great news for Nitron. Offshore people working off same public data further commoditizes publicly available analytics. Basic Yahoo! finance data is free. There are so many hedge funds out there, and they’re all obsessed with chasing alpha, which they can’t do with the same tools as everyone else. (The hedge fund incubators, incidentally, remind me of the dot-com incubators we used to see, which is a sign that there is a surplus of hedge funds. 2006 is the first year when we’re on track to see more hedge funds shut down than open up.)

Audience Question/Observation: In the last few years, lot of great info free on internet has become available in forms of blogs. Incredible corporate-experience types, speaking their minds and providing insights while going after eyeballs. They are getting paid $550K/year monetizing eyeballs (Editor’s note: I know extremely few bloggers earning that type of money!).

Paul Spillane: This industry has to recognize that as a threat. The audience member asking the question has worked in tech  so she’s better able to know where to find quality information. The insights arent there for (isolated) associates to make money.

Michael Mayhew: There is a model thats been developed over a few years, for readily available info: Research that is restricted to small # of clients (and which delivers alpha). Hedge funds will pay lots and lots of money for restricted access, which means 30,40, or 60 clients. Hedges wont trade off blog content because it’s available to thousands/millions of people. Also, most hedge funds dont want to say: “if this deal blows up, Ill tell my manager I got the info free off the internet. ” Give me a break!

David Teten: If I have really good info, am I giving it for free on a blog? Publicly-available information (on a blog, New York Times, etc.) is designed to be relevant to the average person. If you want customized analysis for your portfolio/your situation, then you typically pay the person who produced the analysis that’s broadly relevant. He proves his credibility with his general analysis.

Eric Alexander: Blogs are a threat. Collaborative relationships deliver distinct ideas. You need a talented, experienced analyst with an expert network to find the alpha idea. Blogs dont work standalone but they are a valuable contribution.

Paul Spillane: Most investors have an overload of info. We have a product to grade blog: Collective Intellect. Using AI to sort through hundreds of millions of blogs a day to rate for accuracy. This product is on desks of some of the largest prop trading desks in the world. It can be a CYA, but you cant sort through all the available info and it becomes more productive.

Audience observation: Great bloggers are identified and filtered by word of mouth. Experienced people dont read every single blog.

Paul Spillane: But imagine if you can also grade them all. Were excited about the prospects.

David Weild IV: In my west coast conversations, a lot of funds are using expert networks. One guy I spoke with was a well respected 1990s internet analyst. Widely followed. He said that one key problem with Wall St research is deteriorated quality. Because of Reg FD, executives are uncomfortable with sharing corporate info. Sourcing of independent experts has become very important. One guy is using expert networks to do due diligence on potential portfolio cos. Wont replace need for direct access.

Audience Question: Whats the career opportunity and income oppty for sell-side analysts. Do you see migration to buyside? What about buy/sellside relative compensation?

Eric Alexander: Its important to be part of an organization with a regulatory structure, so the analyst can focus on the work. Theres an opportunity to be more entrepreneurial these days. Locked in salaries and guarantees are much less available.

Richard Lipstein: The top of the Internet bubble skewed compensation and demand for analysts. Comp for internet analysts gone down significantly. They used to be able to make 7-8 figures. Compensation has bottomed out because of disappearance of guarantees and extreme salaries. Not easy for sell-side analyst to move to the buyside because theyre viewed as a salesperson. However, hedge funds hire more sellsiders, young ones, than mutual funds.

Its worth noting that a typical analyst will make more than 98% of the US population rather than 99.9% in the past.

Paul Spillane: You summed it up perfectly. Its not easy to move to the buyside. But everyone is still paying people 6-7 figures. A lot of doctors, lawyers, fireman who dont get paid that  who arguably provide critical value to society.

David Teten: I saw a talk by a prominent person in the research industry, who said, “If you meet an analyst thats been on sellside for more than 5 yrs, theyre not good at picking stocks, because if they were, they’d get a job on the buy-side.”

There is increasingly a disaggregation of analyst’s responsibilities. Management access is highly valued by the buy-sidebut thats a concierge service firms like ours (Nitron) do more effectively than generalist research firms.

Richard Lipstein Question: The typical independent research firm is much smaller than bulge bracket dept. There have been problems, eg took a research firm to court for allegedly being part of a plan to devalue and short sell the stock. How can small firm deal with intimidation of big corporation, particularly when issuing negative research?

Paul Spillane: Associate yourselves with a firm with strong compliance. Reputation of your employer is important to focus on when you are an analyst. Unless you commit fraud, you are in a good position to make clear statements – your opinion is your opinion. One analyst whose opinion dropped a stock 50% (is rumored to have) received death threats  from a retail firm!

Richard Lipstein: I think its more an issue of small research firms can’t cover legal costs to defend themselves.

Paul Spillane: Agencies like SEC, NASDAQ wont allow that intimidationand the First Amendment.

Eric Alexander: Be clear who the customer is. It’s not the company covered, its the investor.

Paul Spillane: WSJ or NYT would love to defend the small guy with strong opinion. The court of public opinion doesnt cost much. And it’s great PR.

David Teten: Most of time, the analyst is doing right thing. Owen Lamont research showed that, the more a corporation fights a critical analyst, the more likely it is later on that the analyst is correct. Jeff Skilling said “Theyre on to us,” in response to a certain piece of independent research. That’s a great ad for independent research! (As Jim Chanos pointed out in a recent talk).

Audience Question: Given internet bubble, do you see another shakeout?

David Weild IV: Theres a rationalization, but other models are flourishing. The big shoe that dropped wasnt the bubble, it was decimalization in 2001. That cuts 95% of the commission flow. The internet brought direct transaction models and commission compression  commission went from $350 avg to 5 bucks.

David Teten: Creative destruction is a benefit, not a bug, of capitalism. Net net, people are making a lot of money in finance. The industry is always evolving, companies change, people move around, but the quality people do just fine.

Michael Mayhew: For sell side research, unbundling will have a big impact. When asst mgr has ability to select research and broker independently, that will really impact someone like Goldman Sachs. If they charge 4c/sh, how much is for research and how much will get they for this

Question: Whats the track record of Spitzer agreement to channel $s to indie firms?

Eric Alexander: Some large firms got huge funds channeled to them. Were not in that space at all. Im hopeful this is over soon, it hasnt been effective at all.

David Teten: Spitzer uses lawsuits effectively for gubernatorial campaigns, but not necessarily in the pursuit of justice.

Someone asked a panel I participated on earlier this year “where should I invest, as a retail investor?” Look, you as a retail investor have the worst information and the worst prices. You’re much better off hiring a professional, by putting your money in a mutual fund, hedge fund, or hiring a Financial Advisor.

Spitzer agreement was a solution in search of a problem. The retail investor will almost inevitably have inferior returns to the professional, because of the nature of the industry.

Richard Lipstein: The Wall St. Journal said you cant legislate against greed.

David Weild IV: Ive talked to many of the NASD regulators. All agreed that the Spitzer agreement has been an “absolute disaster”. Jack Coffee, of Columbia, on their board, calls it a new form of government. It has created a level of paralysis  3 years left, and firms are afraid to innovate. Every bulge bracket says behind close doors wont pony up again. It hasnt expanded coverage to new names. It was a grand experiment that failed. “This is a drug.” Has failed to expand coverae.

The audience member asked what are usage statistics for the independent research that had to be posted. 5% of retail hits are on the indie research, the rest is from the main provider. The only success from the agreement is focusing people on the problem  Wall St research has greater integrity today.

Teten: There is one pressing, highly important public policy goal that the Spitzer settlement achieved: Spitzer won the primary.

Question: Comment on future consolidation in independent research firms. Is pace likely to quicken? A panelist said there are over 400 firms today.

Michael Mayhew: 450 firms in N. America. We certainly believe in consolidation but not across the board. Restricted providers will do quite well. Fundamental data-based research will consolidate. My partner has argued that research is frankly a lifestyle business for many. If you have a dozen clients paying $100K each, you can have a nice business for a few analysts. I suspect the number therefore will be unusually high, but fundamental traditional research will find it increasingly difficult to get paid.

David Teten: Consolidation per se doesn’t concern us. I would be worried if the overall pie shrinking dramatically. But to my knowledge, expert networks are the fastest growing sector in the research business. Consolidation means we buy or get bought, and there are worse things that can happen.

Eric Alexander: For full disclosure, my business partner in the audience asked the consolidation question. The alternative to a lifestyle approach to making some money in research is being part of collaborative effort. When someone like Monsanto wants to do a deal, they can turn to one of our deal specialists.

Richard Lipstein Question: What about the idea of a corporate rollup, e.g. how Eric Alexander got Foresight.

Eric Alexander: That wasnt an acquisition but a subset of analysts were attracted to our platform.

David Weild IV: Question for Michael–What # of firms have > 5m revenues?

Michael Mayhew: Quite small, < 10% of 450. Lot of folks with $1m revenue. Some consolidation when firms go out of business, other when firms get bought. Question: Going back to the value of research, how is the way investment firms are compensated linked to value? In an unbundled world, mutual funds are asset-based profit-makers, not performance based, so they should worry less about costs. Hedge funds are compensated by assets and performance, so they are looking for research value. Would mutuals prefer bundled research? Michael Mayhew: The audience member asks analysts how they judge good research. They say, "Ill know it when I see it." This means, many buy-side people dont know what makes good research to them. That only has a chance of working if they get research for free, use it, then decide later on if they liked it, but its still subjective. David Teten: There are 3 reasons why hedge funds are desirable clients. They have a lot of money compared to cash/overhead requirements, they don't usually have an easy way to measure the value of your unique product (compared with tools available to measure ROI if you are selling, e.g., bottled water to them), and they are paying with soft dollars, i.e., other peoples' money. I have problems with how soft dollars are used when applied too broadly, but the system works to the benefit of research firms. Eric Alexander: Its a lot harder for a research firm to penetrate/develop business with large mutual fund. "Im sitting with a fire hose of info" says one large-fund portfolio manager. They need barriers to access, not more info. Question: What are new models on how to pay for research: Is it arbitrary or still predominantly through trades? Paul Spillane: 85-90% is still via soft dollar. It will take a lot longer to wean off than anyone thinks. If a large mutual fund company wanted to separate costs, it could be 3% of their management fee. For a smaller firm, its entire management fee could be allocated to research cost. Richard Lipstein Question: Last question. For someone looking to get in the research business, what does this business mean for the up-and-coming professional? Eric Alexander: Paul Spillane and I say same thing. Be good, and be entrepreneurial. If you have been a salesperson, bone up on analytics. If you are an analyst, participate in selling. Michael Mayhew: Ample opportunities for good and great analysts. A lot of analysts have spun off with high expectations. Paul Spillane: If you love it and are passionate about it, theres never been a better time. If you dont love it, join a bulge bracket firm. You get real motivated when you wake up thinking "how am I going to make money for my family?" David Teten: Be focused to add value. There is a story, true I believe, of one analyst making over 2 million covering one stock (McDonald's). Pick a domain you can own, then become the recognized expert in that domain. David Weild IV: 1) Being a research analyst is a wonderful thing, whether starting independent and or bulge bracket. You learn a real discipline in a dynamic market (securities). You can switch to private equity or corporate side. Its a great training ground. Id like my kid to do this. 2) Just to mention separately, this is anniversary of 9/11. There is a wonderful organization on that was on 60 Minutes called Tuesdays Children, which provides services to kids who lost parents. Helps them get through college. Annual event at Ciprianis 9/27. They placed kids on take-your-child-to-work day. Im on the board of directors. Please consider supporting them.