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At Precursor Group, Independent-Minded Analysts Shake a Legg

The big-picture stock-market analysis group splits from Legg Mason in a push for freedom from the appearance of banking conflicts.

Are Wall Street analysts really independent? With the following story,

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Skeptics often question Wall Street analysts' objectivity. Now one group of analysts hopes to prove its research isn't compromised by financial ties.

In the wake of its split-off last month from

Legg Mason

(LM) - Get Legg Mason, Inc. Report

, the

Precursor Group

telecommunications-research boutique is marketing itself by trumpeting its analytical independence. A lack of investment banking ties and strict employee stock-ownership policies enable the group to provide the unbiased research that's difficult to find elsewhere, it says.

The Precursor Group's public stance highlights the increasing challenge of avoiding apparent conflicts of interest among equity analysts working for Wall Street's

sell-side banks, given the firms' presumed desire to stay on good terms with past and potential investment-banking clients.

Objectivity Day

"We believe that people will value and pay for research independence and objectivity," says Scott Cleland, the Precursor Group's founder and CEO. "Wall Street is rife with huge financial conflicts of interest. Wall Street represents companies and competes with its clients on multiple levels."

Cleland and Precursor Group President Bill Whyman hope to make the firm's newfound independence a selling point. As a stand-alone, the firm won't do any banking, won't manage money and won't trade for its proprietary benefit, he says. "We don't have the usual research conflicts of interest," Cleland says.

In addition, the firm has established a strict stock-ownership policy for its research staff. Analysts and their editors aren't permitted to trade stocks personally. Rather, as a condition for employment, they may own mutual funds, or give a money-manager authority to buy and sell stocks on their behalf without giving them advance notice of trades. (Most of the firm's covered employees are taking the mutual-fund route.) "You can't be objective and daytrade at the same time," Cleland says.

That's a formalization of an informal rule to which Cleland held his team at Legg Mason. He says he himself has invested in no stocks, only mutual funds, since moving to Wall Street from a State Department post in 1993. Ordinarily, firms permit their analysts to hold stocks, including in industries that they cover.

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Free and Clear

Ira Malis, director of research for Legg Mason, says he was disappointed when the Precursor Group told the firm it was planning to break out on its own. "What do you when someone tells you that?" he says. "You wish them luck, and you hope that you can get together in the future somehow."

But he disagrees with Cleland on the issue of analysts' owning stocks in which they cover. In contrast with Cleland's approach, he says it's fine for analysts to buy stocks that they have rated buys or strong buys, as long as they follow rules such as not trading contrary to, or ahead of, their published research. "If you follow a stock, you can own it," he says. "But you're going to be the last one in and the last one out. Which is as it should be, because the clients go first."

In fact, he says, it can open up analysts to criticism if they don't own stocks they cover, because clients may question how strongly they believe in companies they recommend but don't own.

Despite his questioning of analysts' independence, Cleland insists that his own employment affiliations, at Legg Mason and previously with firms including

Charles Schwab

, never encumbered his own work. "We never were told by Legg Mason what to write," he says.

Says Malis, "I believe the work the Precursor Group did was high-quality work with full integrity. There was never any conflict, from our point of view, with our asset management side or investment banking side."

Making a Buck

Although the company hopes to use its independence as a selling point, that's not the major motive behind its departure from Legg Mason, Cleland says.

In fact, says Cleland, the employee-owned group of eight researchers wanted to control and profit from its own destiny, as opposed to "renting" the operation from Legg Mason. "We wanted to be independent so we could set the direction and the growth of the firm," he says.

Cleland says he's confident the firm will be able to find paying customers who previously might have gotten its research for free as Legg Mason institutional customers.

Indeed, the group has made some savvy predictions over the year: Most recently a report issued in mid-March said the government would likely block the merger of






. (Despite the firms' recent retreat from the merger, he still thinks the telecommunications sector is ripe for further global, cross-industry consolidation.)

Not every assessment has worked out. For example, the firm overestimated the speed with which the Baby Bells would break into the long-distance market. And the Precursor Group, by its practice of not picking individual stocks to buy and sell, avoids climbing out on the limb onto which sell-side analysts regularly venture.

Fans Are Legion

But calls like the WorldCom-Sprint prediction have generated rave reviews from research clients. Bob Unger, senior portfolio manager at

Columbia Management

, credits the Precursor Group with living up to its name. "They anticipate. They're ahead of the curve," he says. "It's an A-plus-plus, five-star service."

Another portfolio manager, who asked to remain anonymous, claims to have been a fan of Cleland's since 1993, when Cleland made a "huge call" on the cable industry. "He was the only one who was raising the flag that the FCC could start another round of rate regulation," the manager says. Cleland was right, and the renewed scrutiny caused the demise of 1994's merger of



Bell Atlantic

, says the manager.

And despite Cleland's commentary about the hazards of researchers' potential conflicts of interest, it doesn't appear that clients have doubted his and the Precursor Group's independence. "If you listen to him, it's clear he's not doing anything to keep the banking side of the business," says the anonymous


On the other hand, "People are not always allowed to say what they feel, because someone's a client on the banking side, and they want the deal," the manager says. "That's pretty well-documented."