A new gust of change is sweeping through Wall Street - for the better.

No, this change cannot stop the stock market from falling. Nor can it insulate investors from losses in overvalued stocks.

But for the first time in my lifetime, I see a realistic chance that average investors will get a fair deal in this sense:

Starting this summer, brokerage and investment banking firms on Wall Street are going to give you at least one independent, third-party opinion on every stock they cover. No charge.

You’ll get the opinion with detailed, independent research reports.

You will get the opinion in your monthly broker statements and confirmations.
 
You’ll get the research whether you’re buying, selling, or just holding.

And you’ll get the research even if it directly contradicts your brokerage firm’s own opinion.

 

Consider This Scenario ...

Your broker calls you one morning soon after the market opens, just like he used to in years past. He immediately launches into a sales pitch, touting the glories of a particular stock, just like before. But then, he does one more thing he never would have done in the old days. He informs you independent research is available and asks if you want it; if you reply “yes,” he then faxes you an independent report. Or he sends you an e-mail with an attached pdf file. You open it, and you read it. To your surprise, you see that it’s telling you to sell the very same stock your broker just told you to buy. No censorship. No withholding of the information you need to make an informed decision.

Think this will never come true? Think again. Because it’s one of the situations that you’re very likely to experience starting July 26.

Why July 26? Because that’s the deadline for the Wall Street firms to make these reports available, in compliance with the terms of the Global Settlement they signed with Eliot Spitzer and the regulators last year.

That’s when a huge network of independent analysts will be ready to start operations.

Could it be delayed a bit? Maybe. But not for long, and once it gets rolling, it will run for a full five years after the start date.

This is not a forecast I make lightly. I’ve seen too many smaller and less complex operations go afoul, falling months behind schedule. This time, though, it’s different. Nearly all of the ten brokerage firms are on schedule (or very close) for one simple reason: They have no choice - it’s the penalty they agreed to pay for past misdeeds.

 

How Do The Brokers Decide Whose

Independent Research To Give You?

 

They don’t. In fact, the decision is entirely in the hands of the brokerage firms’ independent consultants. And to my knowledge, all of these consultants are making decisions that are based on merit. No special favors. No good ol’ boys’ network.

 One of their primary criteria: Performance.

In other words, the consultants are seeking to give you a second-opinion report from THE single independent research firm that has had the best historical track record on the particular stock you have or you’re interested in.

Some of the brokerage firm consultants are seriously considering outsourcing the process of collecting and compiling the reports to a specialized firm in the field of independent research - a Bank of New York subsidiary called Jaywalk.

Essentially, here’s how Jaywalk’s system, the “meritocracy,” is designed to work:

First, each week, Jaywalk collects tens of thousands of research reports from scores of independent research firms, with a buy, a sell, or a hold rating on almost every stock listed on American exchanges.

Second, Jaywalk date stamps the reports and adds them to its database.

Third, another independent firm hired by the independent consultants tracks the performance of each independent research provider. (Note the threefold stress on independence!)

- If the rating is a buy and the stock goes down, it counts against the research firm.

- If the rating is a sell and the stock goes up, that also counts against them.

Conversely,

- If the rating is a buy and the stock goes up, it’s to the firm’s credit. Or ...

- If the rating is a sell and the stock goes down, it’s also to the firm’s credit.


Fourth, for each stock, all the research firms are ranked by their performance on that stock. For example, for IBM, the winner could be Research Firm A; for Intel, Research Firm B; for GM, Research Firm C; etc.

Last, based on these and a other objective criteria, the independent consultants decide which report or reports you will receive. That way, the goal is for you to get the best research available on each stock.

 

For Example ...

Let’s say you’ve got Costco shares in your portfolio. And let’s say there are a couple of smart guys in a small boutique firm in Idaho who have been doing a great job following Costco. When they said sell, Costco went down. When they said buy, it went up. When they said sell again, it went down again, etc.

Result: The Idaho research firm ranks #1 nationwide in providing signals for Costco. So that’s the report you should get.

I say “should” because performance is not the only criteria. The independent consultants also want to see some consistency in the kind of reports you get. They don’t want you to get a report on Costco from one research firm today and then another, entirely different report from another firm tomorrow.

Plus, they’re going to favor research firms that give you reports which are easy for you to use - not those that are mostly a bunch of technical mumbo-jumbo.

Moreover, there’s one thing in this whole program that has truly impressed me: The independent consultants truly have your interests paramount in mind.

Refreshing, isn’t it?

 

Three Warnings

I have little doubt this is going to make the stock market a much fairer place for investors in the long term. But I have three warnings:

Warning #1. Independence doesn’t guarantee objectivity. There are other biases that can creep into the research. (More on this in a moment.)

Warning #2. Objectivity doesn’t guarantee accuracy. Even researchers that remove 100% of the bias can still make mistakes. And I don’t have to tell you that those mistakes can cost you - either because of missed opportunities or outright losses.

Warning #3. Bear markets! Many of the research firms - even truly independent ones - may have an ingrained bullish bias. They often give more buy signals than sell signals. And even after a bear market is under way, they may be too slow to downgrade. Result: Despite the independence, you can still lose money.

How do you protect yourself?

The simple way is to get most of your money out of the market, and that may not be a bad idea. Like I said last week, we could be in for a rough ride.

Another is to hedge against losses with a reasonable allocation of your portfolio to a mutual or hedge fund that’s designed to go up when the market goes down (a reverse index fund).

But that’s my own bias. If you don’t agree with me, or you want an all-weather way to protect yourself, here’s an alternative:

Rely mostly on research that is driven LESS by human intellect or emotion (“qualitative”)... and MORE by disciplined, hard-nosed, number-crunching (“quantitative”).

In up markets, it’s too soon to say which approach is going to make you more money.

But in down markets, I believe the disciplined, quantitative approach is far better equipped to protect your capital.

We’ve looked at a lot of the research and we see this pattern frequently: The folks who crunch numbers usually have a healthy balance between buys and sells. If their model picks up something wrong with a stock, they tend to tell you promptly, and that should give you the chance to get the heck out before you suffer too much damage.

In contrast, the people who rely heavily on their intuition typically have too many buys and not enough sells. Why? One reason is that when they’re picking out which stocks to cover, they usually go for the ones they LIKE to begin with.

Then, once they start covering the stock, their inclination is to CONTINUE liking it. They can get away with that bias in a bull market. But in a choppy market or a bear market, investors following that approach can get hammered.

At this very moment, the independent consultants are hotly debating this vital issue. This debate may seem to be far removed from your daily concerns. But it’s not. The outcome could have a real impact on your investment success or failure.

So recently, I gave a speech about this debate in New York and I also wrote a white paper on the subject, Stock Research for the Global Settlement: Qualitative or Quantitative Approaches?

Click on it now, and I trust you’ll find it quite revealing.

The key points I make:

1. Quantitative research has historically beat qualitative research hands down, especially in unstable environments or down markets, and it’s down markets that can destroy your portfolio’s long term return.

2. Even if there are no investment banking pay-offs, qualitative research still leaves the door open to a Pandora’s Box of potential biases, including ...

* Business bias. The firm has other types of business ties with the rated company, such as consulting, credit ratings contracts, shared interests in other ventures, cross ownership of stock, directors in common, etc.

* Bias stemming from security transactions. The firm or the analysts buy, sell and hold securities in the same companies they are covering.

* Prestige bias. The prestige of the firm or the analysts is directly or indirectly tied to the results of the rated company.

* Preference bias. The analysts or the firm have special likes or dislikes for particular companies, based on past relationships and experiences, or based on current interactions in the procurement of information.

* Bullish/bearish bias. The analysts or the firm are influenced by their bullish or bearish views of the future. These, in turn, can be driven by their own commitments to personal finances or business strategies.

* Intellectual bias. The analyst develops an intellectual commitment to previously published opinions and is reluctant to change, typically out of concern that changes may be interpreted as an admission of error or a lack of conviction.

* Emotional bias. The analyst is emotionally driven by a particular fear or hope, such as fear of reprisal or hope for some future favors.

No matter how independent a firm may claim to be, analysts are human beings and are inevitably subject to some bias. The best protection: Quantitative approaches that help force the analyst to stay disciplined. I’ll send you a complete list of quantitative firms as soon as it’s available.

 

You Ask: “How Will I Get Access To The

Independent Research That Brokers Will Be Providing?”

 

One way is to simply maintain an account with one of the ten firms who are signers to the Global Settlement. They are:

Bear Stearns
Credit Suisse First Boston
Goldman Sachs
Lehman Brothers
J.P. Morgan Securities
Merrill Lynch
Morgan Stanley
Salomon Smith Barney Inc.
UBS Warburg
Piper Jaffray

Suppose your firm is not among these ten. Will you be shut out of the research? Should you switch firms to gain access?

No. Most of the mid- and even small-sized firms are very likely to provide a comparable service. They realize that if the big ten firms are the only ones giving away solid, independent research, they could lose business.

So, sure enough, many other brokerage firms - even those that are not required to provide independent research - are ALSO setting up special new facilities to do just that. And who knows? They may give you even more.

Which will be better - the big ten or the medium-sized firms? It’s too soon to say. But it’s also too soon to talk about switching. So sit tight. I’ll do my best to give you a thorough review as soon as the firms are closer to getting set up.

No matter how you slice it, this is good news. You are going to be the beneficiary of some of the highest quality research that’s ever been available to investors.

For free.

Well, almost free. You’re still going to have to be a customer at a brokerage firm. And you’re still going to incur the normal transaction costs associated with buying and selling. But for the next five years, there will be no charge for the research - whether it’s produced by the broker or by a third party.

Bull or bear, it’s a bonanza for you. So don’t be shy. Take advantage of it. This summer, start asking your broker for as many reports as you need as often as you need them.