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Wall Street has an alarming number of shady practices geared to transfer your money to itself. Main Street investors are outgunned and ill-equipped to deal with its chicanery.
Conflicts of interest abound
There's a reason Wall Street doesn't want to be legally obligated to put your interests above its own. Brokers can (and often do) have conflicts of interest when it comes to the investment products they sell, allowing them to enrich themselves at your expense. But that's apparently not enough to satisfy Wall Street's greed. It persists in engaging in questionable conduct that harms investors.
The peril of relying on analysts
Many investors rely on research and "target prices" set by analysts employed by major brokerage firms. Their assumption is that knowledgeable analysts are able to uncover information about a particular stock that has eluded millions of traders looking at the same publicly available information. The author of one study observed that "analysts' recommendations don't add much value and investors know it." Actually, many investors don't "know it."
The Securities and Exchange Commission (SEC) notes that investors "should not rely solely on an analyst's recommendation when deciding whether to buy, hold, or sell a stock" and warns of the many conflicts of interest analysts may have (which should be disclosed).
Even if you believe the views held by analysts are worthy of consideration, you should know that some don't abide by what many investors would consider rules of unbiased fair play. Sometimes, they have an interest in the stock they are recommending which is either not disclosed or marginally mentioned.
An article by Gretchen Morgenson in The New York Times is illustrative of the latter. It discusses a report from Longbow Research recommending the purchase of shares in Tempur Sealy International. The analyst was Mark Rupe, who formerly was head of the company's investor relations unit. His background, and the fact that he or a member of his family owned stock and options in Tempur Sealy, was disclosed in his report. The report also disclosed that Mr. Rupe would receive incentive compensation from Tempur Sealy if the company met certain performance hurdles.
It's likely some investors would either miss these disclosed conflicts of interest or fail to appreciate their significance and assume this report is unbiased. If so, the potential for harm is evident.
More troubling is the case of a Deutsche Bank research analyst who issued a stock rating inconsistent with his personal view. According to a press release issued by the SEC, an investigation found that Charles Grom certified that his March 29, 2012 research report on a discount retailer, Big Lots, accurately reflected his personal views about the company. This turned out not to be true. The SEC found he didn't downgrade Big Lots from a "buy" recommendation because "he wanted to maintain his relationship with Big Lots management."
Grom agreed to settle the charges by paying a $100,000 penalty and will be suspended from the securities industry for a year.
And what about the investors who relied on Grom's flawed report and suffered losses? Presumably, they will be left to pursue claims from Grom and Deutsche Bank in court proceedings. The outcome likely will be uncertain and the cost of obtaining redress will be a significant deterrent.
A game you're unlikely to win
Conflicted analyst reports are a small part of a much larger problem. Wall Street's arsenal of weapons geared to lower your returns and enhance its profits range from outright deception to expensive and confusing investment products. Its basic value proposition is that entrusting your money to its "experts" is a responsible and intelligent way to invest.
Don't be fooled. The only way to avoid being harmed by Wall Street is to opt out of a game you'll probably lose. Shift your focus to capturing global market returns, keeping your fees low and minimizing or avoiding taxes. Above all, don't rely on an advisor who won't agree in writing to place your interests above theirs.
Dan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read and his latest, The Smartest Sales Book You'll Ever Read.
The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.