The U.S. Congressional subcommittee reviewing analyst independence got a good overview on the gradual degradation of analyst integrity in yesterday’s testimony from Ron Glantz, former managing director of Julian Robertson’s Tiger Management, one of the largest hedge funds in the world.

In his testimony to the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises of the Committee on Financial Services, he referred to analysts as prostitutes.

Glantz said that when he began in the business the top-rated equity research firms began failing as institutional commissions started falling. He says top analysts started moving to big retail shops that could support them by serving retail investors. By the end of the 1970s, he says, the largest number of top analysts was at Paine Webber and Merrill Lynch.

At that time top analysts made just over US$100,000 a year, now they can make up to US$20 million a year. While retail commissions have fallen, “brokerage firms discovered that highly-rated research helped them gain investment banking clients. Soon the largest number of top analysts was at investment banking goliaths such as Morgan Stanley and Goldman Sachs. They could pay considerably more, because investment banking transactions were much more lucrative than trading stocks. The huge fees earned by investment banking gives them the ability to influence and, in some cases, even control the equity research department As we all know, whoever ‘pays the piper’ names the tune.”

Glantz said that most analysts want to do good work, but the pressure not to is tremendous. “Today, name analysts are given guaranteed contracts, whether or not their recommendations are any good. Every year the Wall Street Journal lists the analysts who have provided the best investment advice. These analysts are rarely the best paid in their field.”

Glanz testified that these days, bankers often suggest and are usually asked to approve hiring analysts from other brokerage firms. He noted that investment banking provides the bulk of proven analysts’ pay packages, and that some analysts report directly to investment banking. He also said that analysts routinely send reports to the companies and to bankers for comment before they are issued.

Glantz stated that it is easy for issuers to reward favored analysts. He noted they are given more access to management, “helped ” in making earnings estimates, and invited to resorts for “briefings”.

“The genie has been let out of the bottle. As long as investment banking is the most profitable part of the firm, then investment bankers will find a way to pay analysts who bring in business. Money managers can hire their own analysts. But my elderly aunt will never know whether the advice she is receiving is unbiased or not. That’s not only bad for the average investor, it undermines one of the primary reasons for having a stock market – the efficient allocation of investment dollars,” said Glantz.