The Yin of Startups

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The Yang of Startups

  • It is not the critic who counts...the credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood...who knows great enthusiasms, and great devotions...who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat. - Theodore Roosevelt, 1910

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September 22, 2008


Doug Newkirk, BFKN

I've been mulling over Crovitz's argument. While it is certainly no surprise that a WSJ commentator would blame a government prosecutor and not any industry participants for the current crisis, and I'm no fan of Spitzer, I'm not sure I agree. Spitzer simply divorced analysis from deal-making, as too many banks (and issuers) had let the sell-side research become a way to win the investment banking business (and another way to support the stock in the after-market) and thus, the sell-side research had become corrupted (Spitzer would argue). (Even as to that point, I've had some reservations, since I saw sell-side analysts at my investment banking clients kill several IPOs, even after the process had started.)

However, if Crovitz believes that better research would have kept the Inv. banks, hedge funds, mutual funds and other proprietary traders from buying all this now-illiquid (and opaque and likely highly overvalued) junk, then he, as a free marketeer, has the burden of explaining the market failure. That is, why couldn't buy-side analysis solve Crovitz's problem? Even if Crovitz is correct that Spitzer's kicking research off the corp fin deal-making gravy train rendered sell-side analysis unprofitable (since the brokerage business could no longer support research (since the Feds had already got rid of fixed commissions (a pro-market reform)), nothing Spitzer did precluded any banks or other financial firms from hiring BUY-side analysts, as the article recognizes. Plenty of margin should have remained to pay for good research on the proprietary side of the business for all the institutional investors(since on the buy side, the stakes for good research are not a broker's pennies on the dollar of each trade, but the owner's $1.00 of each dollar on the asset purchased (or sold, or not purchased)). So, I'm not sure Elliot has to take the entire blame.

Dan Malven


Dan here. Good to hear from you. I appreciate you using the "sell-side" and "buy-side" naming conventions. Those in the industry understand them, for those not in the industry, "sell-side" refers to the type of research analyst that acts as a consultant/advisor to clients who take the financial risk of buying/selling securities. "Buy-side" is a research analyst who works at an entity (like a hedge fund or mutual fund) that takes the financial risk by buying/selling the security themselves, i.e. sell-siders advise while buy-siders put their money where their mouth is.

The issue with buy-side analysis is that if you see a buy-side short opportunity, you are guarded as to who you disclose it to because if everyone knows it then the market reacts and it's no longer an opportunity. So the buy-side shorts want to covertly build positions and then hope for disaster, which is what happened. The ones smart enough to see it became the "information haves". It is the sell-side analysts job to trumpet it to the world (generally speaking) and avoid disaster, thus educating the "have nots" and creating better information parity. But because sell-side became so unprofitable, the quality sell-siders turned into buy-siders, which helped create the disaster.

One other point about the regulations that were enacted is that they not only made it harder to make money from sell-side analysis, they also made it harder to perform high-quality sell-side analysis by altering the way that a sell-side analyst could communicate with management teams.

I admit the argument is not flawless, particularly is it only holds if one believes that only a small number of research analysts (either buy-side or sell-side) would have been smart enough to decode the complexity of the situation. If it's a small number, then having those people on the buy-side would not have moved the market enough to correct the problem (by design, because they didn't want to move the market slowly, they wanted to build big short positions slowly over time and then have disaster strike).


I think you give us way too much credit. In my opinion, the bigger issue is the lack of detailed financial disclosure that would allow analysts and investors to analyze these issues. I don't think financial disclosure currently is anywhere near adequate to allow proper insightful analysis--especially of complex issues such as these. I think that the vast vast majority of shorting is done based on rumor and innuendo, not on cold analytics.

Separately, I do agree that Spitzer eviscerated the sell-side, and has made the process of raising capital less efficient for companies and no more transparent or high-quality for investors. Even well-intentioned initiatives like the Fair Disclosure regulations in my opinion have resulted in less not more information being made available to investors. The playing field may be more level, but the level is lower than it was before.

Of course, the real issue with sell-side economics is deregulation of and competition on trading commissions, that in combination with the proscription against benefiting from investment banking activity means that you cannot afford to pay for sell-side analysts. I will tell you, however, that there still is no shortage of highly talented individuals wanting to join the sell-side. I am not sure it is the case that the best-and-the-brightest are avoiding the sell-side for hedge fund opportunities, and I do not think that has become worse since Spitzer.

For various compliance and other reasons I'd rather not attach my names to these comments on your blog.

Dan Malven


Thanks for your input. Always great to hear from people who are actually doing the job that is being discussed.

Again, for those not in the industry, he is talking about Regulation Fair Disclosure (or Reg FD). I refer to this in my post about how it is now much harder to perform high-quality sell-side is because of Reg FD.

Very good quote on how FD may have leveled the playing field, but the field is now much lower than before. This meltdown is a very real result of that lowered playing field.

Robb Hendrickson

crovitz concludes by making the case for private research firms, such as gerson lehrman, (at least partially) filling the information void. do you buy that? if so, how many such firms do you see playing that role? also, if not too off-topic: what path do you envision the corpfin side of IB taking...boutiques? ...and, as an early-stage investor, how do you foresee this market disruption playing-out for entrepreneurs and VCs? will it impact seed-stage financing? ...and do you see more opportunity or lack thereof as a result of recent events?

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