By November, with Apple stock in the midst of a precipitous decline, they were still bullish. Fifty of 57 analysts rated it a buy or strong buy; only two rated it a sell. Apple shares continued their plunge, and this week were trading at just over $450, down 36 percent from their peak.

How could professional analysts have gotten it so wrong?

It wasn’t supposed to be this way. A decade ago, Congressional hearings and an investigation by Eliot Spitzer, then the New York attorney general, exposed a maze of conflicts of interest afflicting Wall Street research. There were some notorious examples of analysts who curried favor with investment banking clients and potential clients by producing favorable research, and then were paid huge bonuses out of investment banking fees. Many investors and regulators blamed analysts’ overly bullish forecasts for helping to inflate the dot-com bubble that burst in 2000.

After a global settlement of Mr. Spitzer’s investigation by major investment banks and the Sarbanes-Oxley reform legislation in 2002, investment banking and research operations were segregated. Conflicts had to be disclosed, and research and analyst pay was detached from investment banking revenues, among other measures.

These reforms seem to have worked — but only up to a point. Other conflicts have come to the fore, especially at large brokerage firms and investment banks. And studies have shown that analysts are prone to other influences — like following the herd — that can undermine their judgments. “The reforms didn’t necessarily make analysts better at their jobs,” said Stuart C. Gilson, a professor of finance at Harvard Business School.

It may be no coincidence that the only analyst who even came close to calling the peak in Apple’s stock runs his own firm and is compensated based on the accuracy of his calls. Carlo R. Besenius, founder and chief executive of Creative Global Investments, downgraded Apple to sell last Oct. 3, with shares trading at $685. In December, he lowered his price target to $420, and this week he told me he may drop it even further, to $320.

Mr. Besenius founded his firm a decade ago after spending many years in research at Merrill Lynch and Lehman Brothers. “I saw so many conflicts of interest in trading, investment banking and research, so I started a conflict-free company,” he said this week from Luxembourg, where he was born and now lives. “Wall Street is full of conflicts. It still is and always will be. It’s incompetent at picking stocks.”

Since the passage of Sarbanes-Oxley, several studies have documented a decline in the percentage of analysts’ buy recommendations, albeit a modest one, while sell recommendations have increased. “Before 2002, analyst recommendations were tilted toward optimistic at an extreme rate,” Ohad Kadan, a professor of finance at Washington University in St. Louis, and co-author of one of the studies, told me this week. “That’s still true today, but it’s not as extreme. It’s a little more balanced.”

While investment banking conflicts have been addressed, “the most obvious conflict now is that research is funded through the trading desks,” Professor Gilson said. “If you’re an analyst and one way your report brings in revenue is through increased trading, a buy recommendation will do this more than a sell. For a sell, you have to already own the stock to generate a trade. But anybody can potentially buy a stock. That’s one hypothesis about why you still see a disproportionate number of buy recommendations.” That may be especially true for heavily traded stocks like Apple, which generate huge commissions for Wall Street.

Article source: http://www.nytimes.com/2013/02/09/business/following-a-herd-of-bulls-on-apples-stock.html?partner=rss&emc=rss