WASHINGTON - Conflicts of interest may still be rampant on Wall Street, with a new study showing that nearly two-thirds of investment-firm analysts received favors from executives of companies they cover and suggesting that the companies get favorable ratings in return.
The academic study published Friday outlines a culture of blatant back-scratching on Wall Street as company executives bestow professional and personal favors on analysts - putting them in touch with top executives of other companies, recommending them for a job - and their companies receive positive ratings and evade stock downgrades. At the same time, executives punish analysts for negative reports by refusing to answer their phone calls or their questions.
For their study, management professor James Westphal of the University of Michigan and accounting professor Michael Clement at the University of Texas sent 4,500 questionnaires to financial analysts between 2001 and 2003 and follow-up surveys to hundreds of executives at the large and mid-size public companies covered by the analysts.
The 51-page study, to be presented at the Academy of Management's annual meeting next month, found that the more a company's earnings slipped below analysts' consensus forecasts, the more favors the company's executives showered on the analysts covering it - especially at big investment firms.
The study comes four years after a crackdown by the Securities and Exchange Commission, then-New York Attorney General Eliot Spitzer and other state regulators exposed Wall Street conflicts that skewed analysts' research, and forced the big investment firms to alter their research practices and pay a total $1.4 billion in a landmark settlement. The regulators found that analysts at the powerhouse investment firms - including Citigroup, Merrill Lynch and Credit Suisse - misled investors with stock recommendations designed to win their firms investment-banking business and lucrative fees.
As part of the settlement, the investment firms agreed to sever the links between analysts' research and investment banking, and to pay hundreds of millions of dollars for independent stock research for their customers and to compensate them for losses caused by biased recommendations.
Wall Street's biggest lobbying organization, the Securities Industry and Financial Markets Association, on Friday downplayed the significance of the new study.
Its authors "are using old data from a survey conducted before many of the new rules on analysts' behavior had been fully implemented," said spokesman Travis Larson. He cited a December 2005 study by the New York Stock Exchange and the NASD, the brokerage industry's self-policing organization, which found the analyst conflict-of-interest rules that came after the crackdown have been effective and brought more accurate research for investors.
"Therefore we don't think this is a systemic issue, but where individual problems are found we expect the regulators to vigorously enforce the rules," Larson said.
Kurt Schacht, executive director of the Center for Financial Market Integrity at the CFA Institute, which represents financial analysts, said the sort of favor-trading depicted in the study "would be a flat-out violation of our standards and our code of ethical conduct."
The organization has not heard of many instances of such behavior, Schacht said, noting that many securities analysts are not members of it.
Spokesmen for the SEC had no immediate comment.
The new study found that doing two favors for an analyst after a company released lower-than-forecast earnings reduced by half the likelihood of the analyst downgrading the company's stock. Sixty-three percent of the analysts surveyed received favors from CEOs, chief financial officers and other top executives.
Frequent favors done by corporate executives for analysts, according to the study:
Putting the analyst in touch with a top executive of another company, the most frequently reported favor representing 28 percent of all favors.
Giving the analyst career advice, 20 percent.
Offering to meet with an analyst's clients, 13 percent.
Providing advice to the analyst on a personal matter, 11 percent.
Providing industry information to the analyst, 10 percent.
Recommending the analyst for a job, 8 percent.
Helping the analyst gain access to a private club or non-professional organization, 6 percent.
"Our findings provide multifaceted evidence for social influence and reciprocity in relations between top executives and the analysts who cover their firms," Westphal and Clement wrote. "The results suggest that favor-rendering is used as a social-influence tactic by top executives in their relations with (securities) analysts."
In addition, they say, bestowing such favors brings more positive stock recommendations from the analysts who receive them. Negative recommendations lead to retaliation by executives - which in turn deters such "non-cooperative behavior" on the part of other analysts.
"Our theory and supportive results contribute to an understanding of how corporate leaders influence the behavior of external constituents toward their firms," the two experts wrote. "In some respects, the social-influence process examined in this study could be likened to an act of bribery."