For the dwindling number of mom-and-pop investors still active in the stock market, an analyst with a big-name investment bank issuing a "buy" rating on a stock implies that, maybe, it's time to buy that stock. But an order from the SEC today illustrates, yet again, how rigged the system can be in favor of hedge funds and big investors.
A former Deutsche Bank analyst was charged by the SEC for telling some hedge fund clients to sell shares of discount retailer Big Lots, in 2012, while publicly maintaining a "buy" rating on the stock to stay on good terms with company management. Chuck Grom, the analyst, agreed to pay a $100,000 penalty to settle charges and will be suspended from the securities industry for a year, according to a statement.
Analysts like Grom study the financial state of companies, and try to get regular access to top management to better understand the business. They produce research notes and recommendations for their clients, which are often spread widely through the investment community and financial media.
Wednesday's SEC order underscores the pressure on such analysts to provide special access and information on companies to preferred clients, and how this has watered down the meaning of "buy" and "sell" ratings on stocks in recent years.
Here's how this particular incident went down: Grom and Deutsche Bank hosted a day of meetings between their clients and Big Lots' CEO and senior vice president of finance on March 28, 2012, according to the SEC. Comments there made Grom, who had a "buy" rating on the stock, believe sales would grow by less than he previously expected.
Later that day, he had phone calls with four unnamed hedge funds, who collectively sold almost $40 million worth of Big Lots shares after talking with him, as per the order.
Despite all that, Grom reiterated his "buy" rating on Big Lots in a report published the next day. He told Deutsche Bank research and salespeople on a call that morning that he maintained the "buy" recommendation because "we just had them in town so it's not kosher to downgrade on the heels of something like that," the SEC said.
After Big Lots reported disappointing earnings the next month, he allegedly said on a separate call, "I think the writing was on the wall [that] we were getting concerned about it, but I was trying to maintain, you know, my relationship with them. So, that's why we didn't downgrade it a couple of weeks back."
The SEC said he made a similar comment in response to a compliment from the Deutsche salesperson who worked with one of the hedge funds that sold shares based on his information.
Deutsche Bank declined to comment.
The SEC said the comments showed Grom violated the legal duty of analysts to "issue research reports that accurately reflect their personally-held views." As part of the settlement, Grom didn't admit or deny the SEC's findings. He was fired from Deutsche in February 2013 for "conduct not consistent with firm standards," as per the SEC's order, and was most recently an analyst at Sterne Agee. He could not immediately be reached for comment.
While the SEC said such violations "undermine public confidence in the integrity" of analyst research, it's not clear how intact that integrity is.
"Sell" ratings are on the decline as stock analysts fear upsetting colleagues in other parts of a bank and losing access to the companies in question, according to the Financial Times. What you'll see more often is analysts telling executives, "great quarter, guys," even when it wasn't really, as Bloomberg News wrote last year.
The Wall Street Journal has outlined how analysts and brokers are expected to arrange special access to company executives for certain investors, and the benefits provided by such meetings.
That role was reinforced in the SEC's order today. Deutsche Bank's performance evaluation system for stock research analysts "assigned significant weight to an analyst’s access to and relationships with the senior management of the companies they covered and the feedback that the firm received from its clients," the SEC wrote.
Almost 10% of an analyst's internal performance rating was tied to "the frequency and level of contact that the analyst was able to arrange for firm clients with management from the companies they covered," according to the order. Analysts got extra credit for "arranging contact" with CEOs and CFOs.
“When research analysts tell clients to buy or sell a particular security, the rules require them to actually mean what they say," said Andrew Ceresney, director of the SEC's enforcement division, said in today's statement. "Analysts simply cannot express one view publicly and the opposite view privately."