When NY attorney general Eliot Spitzer and the Securities and Exchange Commission (SEC) cracked down on Wall Street investment research, they held up “independent” research as the ideal. Unbiased by conflicts of interest with an investment banking business, the independent research would offer more accurate, less bullish advice.
Regulators have now decided to harass independents for being too bearish. The SEC is investigating claims of possible stock manipulation and conflict of interest at independent research firm Gradient Analytics. Two companies, drug maker Biovail and internet retailer Overstock.com, have sued Gradient for issuing negative investment research on behalf of their “unregulated” hedge fund clients who were shorting the companies’ stock. The SEC is now investigating the hedge funds. The companies also allege that several business journalists were part of this conspiracy to drive down their share prices. The SEC initially demanded to see email and phone records of various financial journalists who reported negative stories on Biovail and Overstock. After a First Amendment outcry, an embarrassed SEC chairman Christopher Cox quickly reversed the journalist subpoenas.
Whether a conspiracy existed remains to be seen. While Biovail’s stock hardly moved following the publication of Gradient’s negative research, it tumbled following a class action investor lawsuit, an SEC investigation into its accounting practices, repeated financial disappointments, and a truck crash that destroyed a shipment of Biovail drugs. Perennial loss-maker Overstock.com’s shares too have been punished for its persistent underperformance. Patrick Byrne, the wacky CEO of Overstock.com, has made himself a laughingstock for blaming his company’s woes on a “Sith Lord” mastermind and for circulating to investors a flow chart of the vast anti-Overtock.com conspiracy (reminiscent of Hillary Clinton). Byrne claimed on an investor conference call that he made up stories about being a gay coke-head in a failed bid to discover the mysterious Sith Lord’s identity.
This looks like an effort to use regulatory power to silence journalists, intimidate short sellers and stock analysts, and prop up the stocks of underperforming companies.