Why Wall Street Analysts Shouldn't Own the Stocks They Cover

The normally-astute Evan Newmark has gone a little crazy in his latest missive for Deal Journal: he's decided that it would be an excellent idea if Wall Street stock analysts were to start trading for their personal accounts in the very stocks and asset classes they cover.

This is what should interest investors: The true depth of a Wall Street analyst's or fund manager's conviction. When you place your chips on red, is your adviser putting a chunk on red, too?

Now with fund managers, I can see Newmark's point, although he's blind to the concept that a fund manager might be in charge of a fund aimed at investors who have a very different risk profile to his own. But analysts? They're not financial advisers. Their job is not to tell you where to put your money; their job is to analyze. The "buy" and "sell" recommendations on the front page are ignored by the clients who matter - the institutional investors. What matters is the quality of the analysis, not the future direction of the assets being covered.

Besides, if analysts had long or short positions in the companies they covered, that would inject a whole new set of unhelpful biases. Individuals who are long or short a stock often get wedded to their own thesis; that's a danger with analysts, too, but there's no point in making a bad situation worse. And what purpose in any case is really served by leaving analysts open to accusations of market manipulation and front-running? If analysts were allowed to own stocks, that would serve as an incentive to put out ever more extreme research reports, with the "buy" reports downplaying all the downsides, and the "sell" reports downplaying all the upsides. In other words, they would make the reports less useful.

Especially given the fact that asking analysts to put their own money on their own predictions isn't going to make those predictions any more accurate. Analysts don't know where stocks are going, any more than Evan Newmark does. If they were really good at predicting the future in that way, they would be fund managers, not analysts. The distinction is a useful one: let's not obliterate it.