According to an article in the New York Times, some of the biggest brokerage firms are giving a few major hedge funds an early look at views from their research analysts, enabling them to feed the information into their algorithms and trade ahead of other investors.
These elite hedge funds – which the Times says include those run by BlackRock; Marshall Wace, a large British hedge fund company; and Two Sigma Investments, a United States hedge fund concern - are receiving results from surveys that analysts answer and submit electronically every month or every quarter.
According to the Times, analysts who have participated in the program include those at Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Merrill Lynch and UBS. Of particular interest to hedge funds are analysts’ responses to questions about possible unexpected earnings or losses at the companies they track.
From the New York Times:
What analysts tell investors about the companies they follow — and when — is central to the concept of a level playing field on Wall Street. When disseminated, analyst downgrades and upgrades can make a stock sink or soar. Getting that information early can be very profitable for traders. As a result, regulatory rules require brokerage firms to restrict the information flow from research departments to prevent the potential for trading ahead of research reports.
Questions about the selective release of analysts’ views came up when the brokerage firms charged with selling Facebook’s initial shares were found to have warned large buyers about some analysts’ doubts regarding the company’s prospects. That irked many small investors who had not received the guidance and sustained losses in their Facebook shares. The Securities and Exchange Commission is investigating these disclosures.
The Times says the practice is “systematic and growing” on Wall Street, according to documents the newspaper has obtained.
The funds themselves say they ask only for public information. But Times journalist Gretchen Morgenson claims that in at least four cases, documents from Barclays Global Investors, which is now a unit of BlackRock, state that the goal is to receive nonpublic information.
“Two documents state that the surveys allow for front-running analyst recommendations,” Morgenson writes.
Reports of the early dissemination of analyst research to hedge funds is incendiary given that firms officially state that research is distributed to all its clients at the same time.
James Badenhausen, a BlackRock spokesman, told the Times that “the language in the Barclays Global Investors internal memos is sloppy and inaccurate and totally inconsistent not only with the stated purpose of the survey but also with the high ethical standards by which BlackRock does business. The survey explicitly states that it requests only information that sell-side research analysts have already disseminated publicly and an analyst cannot even take part in the survey without first clicking a button to confirm that answers would be based solely on public information.”
Representatives for Citigroup, UBS and JPMorgan Chase told the Times they have strict policies in place for analysts participating in client surveys, which require that their comments are consistent with their publicly held views.
Despite these denials, the Times reports that it has seen various confidential documents describing the surveys, where company officials clearly state that nonpublic information is what they are after. From the Times:
“We expect the earnings surprise direction to be able to capture the information not released to the market,” stated a confidential BlackRock memo from November 2008, detailing its analyst surveys of nine brokerage firms in Asia. “The question may give the clue on the direction of the analyst’s future revisions.”
Morgenson notes that a 2009 document on the firm’s analyst surveys is even more explicit: “We are trying to front-run recs,” the document says, referring to trading ahead of analysts’ recommendations.