CAN Wall Street analysts be trusted these days? For a sizeable portion of the investing public, burnt by their experiences in the 1990s, the question might provoke a belly laugh. After the spate of revelations of conflicts of interest that battered brokerage houses, equity analysts have replaced lawyers as the butt of bitter jokes. Question: How can you tell when an analyst is lying? Answer: His lips are moving.

But things are supposed to have changed since then.

In 2002, as American capitalism was undergoing one of its periodic trials that made names such as Enron, WorldCom and Global Crossing bywords for corruption and fraud, regulators imposed a whole new set of rules on equity research.

These were designed to correct the problems that apparently arose from analysts’ conflicts. If the analyst providing you with research and investment recommendations worked for a company that earned hundreds of millions of dollars in investment banking fees from a company, his employer wasn’t generally too keen on the idea of him telling his clients that the company’s stock was a dog.

Famous cases of analysts such as Jack Grubman, at Salomon Smith Barney, happily pumping stocks to innocent clients even as they crashed cast a shadow over all of Wall Street. The outrage led to new regulations and a famous Global Settlement, orchestrated by the zealous and ambitious New York attorney-general (now candidate for governor) Eliot Spitzer. Under the settlement, the Big Ten Wall Street brokerages agreed to pay $1.4 billion (£790 million) into a fund to promote “ independent research” and clean up the way that they recommended investment decisions.

The new regulations said that analysts could not be compensated for any corporate finance earnings that the firm made from companies that they analysed, and brokerages were to advertise clearly potential conflicts of interest What effect have the new rules had? First, the good news. According to new research presented last weekend at the annual conference of the American Economic Association, by Leonardo Madureira, of the University of Pennsylvania, Wall Street has, indeed, cleaned up its act. Before the regulations, Madureira calculated that the odds of receiving a “buy” recommendation for a stock increased by 40 per cent if the analyst’s firm had handled an initial public offering or other juicy fee-earning business for the company in question. After the regulations, that bias disappeared.

Since 2002, analysts have been no more likely to issue “buy” recommendations on companies that the brokerage had a relationship with than they were with genuine third parties.

Yet there was something else. The research also discovered that analysts were still much more likely to avoid issuing “sell” recommendations for those firms than they were for others. In other words, analysts had stopped pumping stocks that their firm had a connection with, but they still could not quite bring themselves to advise clients to sell.

There was other good news. The Big Ten Wall Street brokerages — those that signed up to the global settlement — have become markedly less optimistic overall in their assessments of companies’ prospects. Before the settlement, the vast majority of recommendations by big brokerages were either “strong buy”, “buy” or at worst, “hold”. After the deal, the number of “buy” recommendations fell sharply. Other brokerages, not part of the Big Ten, changed much less dramatically.

So what does this amount to? Perhaps less than meets the eye. In another paper presented this weekend, researchers actually found very little evidence that this bias matters very much.

According to Mark Chen, of the University of Maryland, who analysed financial information from 232 companies, there was, indeed, a strong correlation between analysts’ recommendations and the degree to which the Wall Street firm was dependent on a company for fees. But there was no evidence that this had any serious misleading effects on investment behaviour.

Investors, in fact, generally knew about the relationships, and discounted the “puff” effect. They also knew very well that, because “sell” recommendations were so rare in a generally upbeat Wall Street, a “hold” recommendation was tantamount to a “sell”.

Investors who expressed outrage at the conflicts of interest then were a little like Inspector Renault in Casablanca, pronouncing themselves “shocked, shocked” at the very idea that analysts might be conflicted.

Of course, some casual individual investors probably did get ripped-off, not having the knowledge or experience of professionals or more serious traders. That, however, may just be another sad lesson to all of us, if we really needed it, of just how dangerous it is to wander into an activity dominated by people who have a lot more information than we do.

The main conclusion seems to be that Wall Street analysts have got more honest under the pressure of regulations. But, since most people knew when not to believe them in the first place, did it really matter?

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