The problem, Sidoti adds, is that many people view research as a commodity. He says investors often think they can easily obtain research from the Internet. Therefore, Sidoti asks, how can their advisors persuade them to pay for something that they believe is free?
The growth of the independent research movement comes at a time when Morningstar, for years a big player in rating mutual funds, is now expanding its ratings of individual stocks. Given its expertise in funds and its huge data bank, the Chicago-based Morningstar, which is in the process of going public, is expected to be a big player as the independent research business expands. A spokeswoman for Morningstar declined to comment, saying the company could not comment because its IPO is before the public.
The 75-member Investorside Research Association is a trade group representing new independent research businesses. Investorside officials estimate that there are now some 200 independents offering research services. For the near future, Investorside is not concentrating on attracting new members, but on helping current ones with what they say is a sometimes-hostile regulatory climate.
"Regulators, for years, have taken a one-size-fits-all approach to research," says Investorside Chairman Scott Cleland. But independents now are benefiting from last year's global settlement, which requires Wall Street's biggest firms to ante up some $1.5 billion to help fund the independents. The payment was, in part, a penalty for the large firms' conflicts of interest.
The regulators contended that "from approximately mid-1999 through mid-2001 or later, all of the firms engaged in acts or practices that created or maintained inappropriate influence by investment banking over research analysts, thereby imposing conflicts of interests on research analysts that the firms failed to manage in an adequate or appropriate manner," according to the Securities and Exchange Commission settlement.
Some of the firms cited and forced to pony up were Credit Suisse First Boston, Merrill Lynch, Goldman Sachs, Bear Stearns and Piper Jaffray, among others. Nevertheless, despite some $430 million of the settlement money going to fund independent research businesses, Investorside officials say independents still have many hurdles ahead of them.
Sidoti, who is also a member of Investorside, says he is surprised that the regulators have not taken some simple steps that would help independents. "They could suggest to pension funds that they get a periodic evaluation of how the funds are invested," Sidoti says.
He also is surprised that the regulators haven't opposed those in the fund industry who want to curtail or eliminate the use of soft dollars. Supporters of a bill in Congress to ban soft dollars have argued that the use of soft dollars drives up execution costs and results in high fund expense fund ratios.
"If they ban soft dollars, that would really hurt many independent firms," Sidoti warns. Cleland also contends that unfair government regulation is retarding the growth of independents. He says that is because regulators don't understand the nature of how these firms function.
For example, Cleland says securities rules now require a broker-dealer to be licensed to offer investment banking if the firm is collecting research commissions from funds and investors. And that, he complains, discourages new independents because a broker-dealer licensing exam requires the knowledge of some 900 pages of investment banking rules.