Independent Research Pay Closes Gap on Wall Street

There was a time when equity research analysts wanting freedom, career satisfaction and a normal workday would have to work for an independent research firm. If you wanted money, on the other hand, you worked on Wall Street. Not anymore.

As Wall Street analysts see their ranks thin and their compensation erode, those working for independent research firms are seeing their salaries rise.

That's not to say independent analysts are now better paid than their compatriots at the large investment banks. Seasoned, well-known analysts, who rate high in the Institutional Investor rankings, can still earn multi-million compensation packages. A managing director at a major Wall Street firm, for instance, might receive $2 million a year. An independent research analyst is not likely to take home that kind of money unless he owns the firm.

"If you're a managing director at a Wall Street firm, you could be paid one of the top salaries at the firm," says Richard Lipstein, a principal at Boyden Executive Search in New York. "At an independent research firm, your base would be lower. The upside is limited."

Lipstein says a portion of the revenue base that is derived from trades in the stocks an analyst covers is given to that analyst as part of his or her performance-based bonus. So long as the large investment banks have their mammoth trading operations, they will always be able to pay research analysts better.

"A rising tide lifts all boats," Lipstein says.

Higher Pay Down to Analyst

Analysts also live and die on the strength of their recommendations. But if a tree falls in the forest and nobody hears it, so too goes an analyst's recommendations if nobody sees them. A large investment bank can give an analyst the exposure and the audience it needs to build a reputation, particularly among the asset managers who actually rate them in the Institutional Investor rankings.

"If you've got a large sales force, you deal more with the institutions that do the voting," Lipstein says.

Lipstein says compensation figures are all over the map, but in general, a junior or associate analyst fresh out of school might earn $125,000 to $150,000 at a Wall Street firm. Someone who's been a senior analyst for a year or two would earn between $250,000 and $350,000. Figures for independent analysts are somewhat lower, though more egalitarian. Particularly at MD level and above, investment banks tend to start at higher base salaries than their independent counterparts.

"In general, Wall Street is still paying more than the independent houses," says Edward Fleming, managing partner at Wall Street Exchange, a California-based financial services recruiting firm. But he notes, if analysts "have the distribution, the size, working on the independent side can be just as high."

It comes down to the backgrounds of particular analysts. If they were previously on Wall Street and developed a following there, with perhaps an II ranking, they can distribute more of their research out to the market, and that will translate into higher compensation.

Fleming says that the growing hedge fund market seems to have more respect for independent analysts. They value the absence of any conflicts, whether those conflicts still exist on Wall Street or not. "Nobody has forgotten," Fleming says. "It's only been a couple of years since the breakout of all the conflicts in research."

The Spitzer Effect

The biggest boost to independent research can be summed up in two words: Eliott Spitzer. His investigation into conflicts of interest between the research and investment banking operations at ten Wall Street investment banks resulted in $1.4 billion in settlement fees.

The firms (Bear, Stearns; Credit Suisse First Boston; Goldman, Sachs; Lehman Brothers; J.P. Morgan Securities; Merrill Lynch; Morgan Stanley; Citigroup Global Markets (formerly Salomon Smith Barney); UBS Warburg; and U.S. Bancorp Piper Jaffray) agreed to not only provide their clients with independent research but also to sever ties between their research and underwriting functions. The result is that Wall Street analysts are no longer privy to the lucrative investment banking revenues come bonus time. In fact, the settlement specifically states that their compensation must be based in significant part on the quality and accuracy of their research.

"The settlement created a great growth opportunity," says Andrew Schroepfer, president and founder of Tier1Research, an independent research firm based in Minnesota. "Each of the banks must provide an independent research report on all the stocks they cover. If Morgan Stanley covers 1,000 stocks, it must find an independent research firm for all 1,000."

Bank of New York provides that independent research for seven of the 10 firms involved in the settlement, and Schroepfer's firm is among the companies to which Bank of New York turns for that research. The result is that Schroepfer's business has grown 30% since the settlement, a figure that is expected to rise to 50% by the end of next year.

Many of those who landed in the independent research side wound up there because they were sent packing during one of the recent purges at the Wall Street firms. And as the economy has turned around and investment banks have begun hiring again, some of those same analysts are now returning to Wall Street firms, according to recruiters.

Hello Buyside

Others have used the opportunity to move over to the buyside, says Fleming at Wall Street Exchange. "They get tired of covering eight or 10 companies. They want to be able to pick stocks on their own, become more of a maverick instead of an order taker."

Fleming says some don't like being confined to one sector, nor do they like the sales aspect of the job, which entails distributing their research, going to road shows, meeting with companies. It takes a long time to put out a report and keep up with a company's endless stream of financial information. Some would rather just pick stocks.

"Some that go to an independent house didn't like the bureaucratic atmosphere you find at the big houses," Fleming says. "They want more control, more say in how they go about their research. Or they're just at a point where maybe they want flexibility, but from my experience, these guys are eager to get over to the buyside."

It's a good thing some analysts are leaving Wall Street voluntarily. Industry observers say the trend overall is shrinking research departments at the large investment banks and growing research operations at the independent firms. Now that the investment banking departments aren't "subsidizing" their research departments, the independent research firm model looks more cost effective.

For one thing, it doesn't have the large infrastructure to support, says Ken Dengler, chief operating officer for Soleil Securities Corp., a New York-based brokerage firm that provides independent research.

If It's Broke...

"Clearly, the model that a lot of us grew up with is broken, and some of that is a function of Spitzer," Dengler says. "Some of that is a function of natural evolution. But that model cannot exist without some sort of subsidization and that's why you're seeing significant layoffs. In a fixed cost model, without that subsidy, it's impossible to justify paying analysts rock star salaries."

Dengler says some Wall Street analysts made in the "multiple seven figures" in the past. Compensation is much more realistic today. "Total compensation at the traditional houses is heading downward at a time when compensation at independent houses is heading upward," he says.

Soleil's model is to connect its institutional clients with its growing network of independent analysts. The analysts work from home and are hired as subcontractors. But they are registered with the Securities and Exchange Commission through Soleil, their reports are published through Soleil, and their salaries are ultimately paid through Soleil's trading commissions.

An analyst's cut of this revenue-sharing agreement is based on performance; the more his or her research is utilized by the firm's clients, the more the analyst is paid. Dengler says.

"Our analysts don't get paid unless they are providing value. It's a very Darwinistic model."

Dengler, who worked at Goldman Sachs, Donaldson Lufkin Jenrette, First Boston Corp. and Deutsche Bank before joining Soleil last year, believes his firm's model is the way research operations will be structured in the future. The key, he says, is variable costs. Investment banks have huge fixed costs, which leads to layoffs. He says, "You can play around with the bonus at the investment bank, making your model somewhat variable, but at some point, you can't keep cutting the bonuses down or people will leave the firm."