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Analyst Back Dating Scandal: A Non-Random Walk through IBES analyst ratings

Blame the professors: Just as the option backdating scandal started with academic researchers noting mathematical anomalies, so too might the next brewing scandal: the I/B/E/S Analyst ratings back dating scandal.

According to a Barron's article by Bill Alpert (buried on page 39), several professors have discovered what they describe as 54,729 non-random, ex-post changes out of 280,463 observations -- a little over 19.5% of analyst recs (abstract below):

"The professors found almost 55,000 changes that had been made in the I/B/E/S database of stock-analyst recommendations maintained by Thomson, the Stamford, Conn., firm that is a leading vendor of financial data. The alterations made Wall Street's record of recommendations look more conservative -- hiding Strong Buy recommendations and adding Sell recommendations from 1993 to 2002. That is a period for which Wall Street has drawn heat and government sanctions for touting Internet bubble stocks.

As a result of the changes, the stock picks shown in the database would have created annual gains that were 15% to 42% better than the originally recorded recommendations, using a trading strategy based on analysts' recommendations."

The firms were the most significant participants in the data backdating were also the firms who had the closest relationship between banking and research and were the hardest hit by the Spitzer enforced settlement.

From page four of the academic working paper notes exactly how significant this was:

"Why do the historical data now look different than they once did? The contents of the database changed at some point between September 2002 and May 2004, a period that not only coincided with close scrutiny of Wall Street research by regulators, Congress, and the courts, but also saw a substantial downsizing of research departments at most major brokerage firms in the U.S.

The paper outlines four types of data changes: 1) non-random removal of analyst names from historic recommendations (€œanonymizations€); 2) the addition of new records not previously part of the database; 3) the removal of records that had been in the data; and 4) alterations to historical recommendation levels.

The net result of this was to make many specific trading strategies appear better in retrospect than they actually were.  Buying top rated stocks and shorting lowest rated stocks, based on the changed data, now perform 15.9% to 42.4% better on the 2004 revised data than on the 2002 tape, the professors state.

Further, the profs observe the career paths of many analyst recs: "Analysts whose track records are affected are associated with more favorable career outcomes over the 2003-2005 period than their track records and abilities would otherwise warrant."

According to communication received from Thomson Financial (the owner of I/B/E/S) in November and December 2006, the anonymizations were caused by a series of software glitches, introduced in 2002-2003.1 Surprisingly, despite the seemingly random nature of this type of shock to the data, the resulting patterns have apparently systematic components, rather than appearing random. For instance, bolder recommendations are more likely to be anonymized, as are recommendations from more senior analysts and Institutional Investor all-stars.

The characteristics of the additions and deletions are similarly unusual. Additions disproportionately consist of holds and sells; indeed, in the case of one prominent brokerage firm, 91.5% of its 234 additions are sells, and these increase the number of sells the firm has on the 2002 tape by a factor of 20. Deletions, on the other hand, disproportionately consist of strong buys, while alterations disproportionately consist of buys and strong buys (which are typically revised down). Perhaps most strikingly, all four types of changes correlate strongly with survival by both the brokerage firm and by the analyst.

Follow the correlation: 

"Brokerage firms associated with these changes are substantially larger, both in terms of the size of their investment banking operations and the size of their research departments. Most remarkably, they employ between eight and 16 times more analysts on average in 2002 than do unaffected brokerage firms. . . In fact, continuing to publish research appears to be a pre-condition for a brokerage firm’s recommendations to have changed: Not a single recommendation associated with one of the 89 brokerage firms that have ceased publishing investment research by 2002 has been anonymized, whereas an astonishing 85.4% of the 280 firms that continue publishing research had some recommendations anonymized. Similar, though slightly less extreme patterns hold for alterations, deletions, and additions.

And lastly, consider this: 

"A former Thomson executive with knowledge of the I/B/E/S database told me he was skeptical that Thomson's validation procedures could prevent a concerted effort by Wall Street to retouch its track record. The Thomson data are maintained by overworked, inexperienced clerks, said the former executive."

Ouch . . .

This may turn out to be the most overlooked financial story of the weekend. 
 

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DISCLOSURE: We have a modest short position in Thomson Corp (TOC)

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Sources:
Mysterious Changes in Key Wall Street Data
Bill Alpert
Barron's,  MONDAY, MARCH 5, 2007
http://online.barrons.com/article/SB117288153945425442.html

Rewriting History 
ALEXANDER LJUNGQVIST
New York University
CHRISTOPHER J. MALLOY
London Business School
FELICIA C. MARSTON
University of Virginia
February 20, 2007, AFA 2007 Chicago Meetings Paper http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID963981
_code97668.pdf?abstractid=889322&mirid=1

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Abstract: Comparing two snapshots of the historical I/B/E/S database of research analyst stock recommendations, taken in 2002 and 2004 but each covering the same time period 1993-2002, we identify 54,729 ex post changes (out of 280,463 observations), including alterations of recommendation levels, additions and deletions of records, and removal of analyst names. The changes appear non-random across brokerage firms, analysts, and tickers, and have a significant impact on the overall distribution of recommendations across stocks and within individual stocks and brokerage firms. They also affect trading signal classifications, back-testing inferences, track records of individual analysts, and models of analysts' career outcomes in the three years following the changes. 

Monday, March 05, 2007 | 12:52 PM | Permalink | Comments (23) | TrackBack (0)
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Comments

Ouch indeed. But does this amount to fraud?

What is the recourse? Is Thomson reversing the changes?

Posted by: Brooklynite | Mar 5, 2007 1:49:06 PM