A boutique brokerage based in New York is looking to go public, but Sidoti & Co features a rather unusual business model: analysts many not put out negative ratings on any of the stocks they follow.

To many, including the author of this article, this idea is patently ridiculous and morally bankrupt, as a marketing firm should not be allowed to call itself a brokerage. In fact, a former employee has filed a whistleblower complaint with the SEC, claiming that Sidoti & Co. has violated a variety of securities regulations. However, it is important to note that this practice is not that uncommon and Sidoti is not that different from other brokerage firms. Several former sell side analysts (including ones from Sidoti) told ValueWalk that the article merely underlies the numerous inherent conflicts of interest with sell side research.

As an example below is a screenshot from the disclaimer section in a Jefferies report (we picked JEF at random)

Screenshot_241

Boutique Brokerage Sidoti Does Not Allow "Sell" Ratings

An SEC spokesman had no comment regarding a complaint against Sidoti, and the current status of the former employee’s claim against the firm is unclear.

An outside law firm hired by Sidoti said that while the firm’s ratings system is “unconventional,” it has “carefully vetted policies and procedures” to guarantee quality research and analyst independence.

The news of Sidoti’s ridiculous business strategy makes it crystal clear how Wall Street research firms are inevitably tangled by conflicts of interest and how their recommendations are often influenced by financial incentives.

More on Sidoti & Co

Sidoti has a policy of only allowing analysts to issue “buy” and “neutral” research recommendations. Nearly all other brokerage firms have at least three ratings, including a “sell” or other negative rating. Keep in mind that equity research is already heavily weighted toward positive ratings overall.

Jenny Strasburg And  Julie Steinberg of The Wall Street Journal investigated by examining internal emails and other documents. These documents provided some support for the whistleblower’s criticisms, such as Sidoti executives pressuring employees to offer more positive assessments of companies in their reports. The WSJ notes that the emails also offer insight into Sidoti’s efforts to compete with larger Wall Street firms in a difficult business climate.

The legal team for Sidoti explained that the firm’s analysts express their changing views of companies by adjusting stock-price targets. In an IPO filing in May, Sidoti included a statement that it provides “relevant disclosure” in its research reports, but also said “because we do not have a ‘sell’ or ‘negative’ rating, there is the potential for investor confusion.”

The whistleblower complaint filed last summer said that Sidoti’s rating system had created issues in the past, according to WSJ sources familiar with the claims. In the emails, Sidoti management on several occasions specifically told analysts not to describe “neutral”-rated stocks using the words “sell” or “short,” but noted it was oj to use the term “overvalued”.

Sidoti filed the initial documents with the SEC to raise $35 million through an initial public offering back in October of last year. Sidoti execs would not comment to the WSJ, citing the required quiet period surrounding an IPO.