Banks skank stock market investors, again

Who is advising you, why are they advising you, and what’s in it for them?

After the dotcom bubble burst in 2000, people were angry and looking for someone to blame. They settled on Henry Blodget.

Blodget got famous in the 1990s as an internet analyst for investment banks. He used to go on TV making bold calls on internet stocks (specifically, making bold calls that internet stocks would go up).

He made his name while he was still a broker at Prudential Securities. In 1998, when the stock was trading at $240, he forecast it would reach $400. Merrill Lynch’s internet analyst thought it was ludicrously overvalued at $240. Shortly afterwards it passed through $400; the Merrill Lynch analyst was fired and Blodget took his job.

A paediatrician from Queens was Blodget’s undoing. After the dotcom bubble burst, the paediatrician filed a complaint against Merrill Lynch, saying that he’d lost a half a million dollars following Blodget’s advice on an internet stock.

When the Securities and Exchange commission looked into the case, it found that Blodget was highly dubious about the stock in question,… but still maintained a buy rating on it. The long and short of it was that was one of Merrill Lynch’s clients. Blodget and the other analysts were under pressure to keep a buy rating to keep happy, at the cost of ripping off retail clients like the paediatrician from Queens.

The New York Attorney General, Elliot Spitzer, didn’t hold back: Blodget was permanently kicked out the banking industry and ordered to pay a fine of two million dollars.

Who’s paying for your advice?

I was reminded of Henry Blodget’s story recently. The Wall St Journal reported last month that “Analysts Say ‘Buy’ to Win Special Access for Their Clients”.

According to that story, Blodget-style conflicts of interest are still going strong in the equity research business. Banks are recommending stocks to their retail clients not because they believe they’re good investments, but because they want to keep their real clients (the companies themselves) happy.

This kind of problem is inevitable, really. It’s baked into the banks’ business model. They pay teams of analysts to research stocks and issue recommendations, and then give that research away for free.

In theory its supposed to gin up extra trading. But in practice, there’s not much in it for the bank. Since the bank doesn’t make much money from the research, we shouldn’t be surprised when the research is contaminated by some other, more profitable part of the bank’s business.

In the financial industry, you always need to think very carefully about the advice you’re getting. Who is advising you, why are they advising you, and what’s in it for them? If it’s free, then who’s paying them. If you’re paying them a percentage of your own money, are you the only person paying them? And if you’re paying them a percentage of your own money, are their incentives being distorted?

Risk and Reward is free, but you understand why I publish this newsletter. I publish Risk and Reward to spread the word about The Penny Share Letter. In The Penny Share Letter I charge a flat fee for my advice, I give specific recommendations on how to grow your money, and nobody else pays me except the subscribers. If you’re happy, I’m happy. And that’s the way it should be.

To check out my latest investment research, click here to sign up for The Penny Share Letter. 

P.s. Thanks to all who came out to Southwark Cathedral last night for my first live event. It was great to meet readers in person. Look out in Risk and Reward next week for a video of the event.

P.s. In case you’re wondering – Henry Blodget’s doing okay for himself. He founded in 2008. In 2015 he sold the site to Axel Springer for $422m.

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