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Equity Research Review

Articles in yesterday's New York Times and today's Wall Street Journal reported that a securities regulator was investigating pre-IPO meetings between analysts and companies planning to pursue IPOs. The essence of the stories was that there is concern in some circles that Wall Street might be slipping back toward the unsavory ways of the Henry Blodget/Jack Grubman era, when investment banking departments were alleged to have had undue influence on securities research. The objectivity of research produced by many Wall Street firm at the time was highly suspect, to say the least.

As a result of those investigations a decade ago, on April 28, 2003, the SEC and a handful of other regulators announced that they had entered into a settlement agreement, the Global Settlement, with 10 of the largest investment banking firms to settle charges alleging misleading or fraudulent research. The firms involved in the settlement were required to pay a combined total of $1.4 billion.

Earlier this year, we published a white paper (Analyzing the Analysts: A Survey of the State of Wall Street Equity Research 10 Years after the Global Settlement) that examined the problem of the "orphaned stock" which, in part, was related to changes wrought by the Global Settlement. The data were alarming.

As of December 31, 2012, we estimate that a staggering 1,443 out of 5,044 exchange-listed companies, or nearly 29% of all exchange-listed companies, had either zero or no meaningful analyst coverage of their stocks. We define "meaningful" as having at least one analyst from the approximately 100 firms included on either the Institutional Investor or StarMine list of ranked analysts. Of the 1,443 exchange-listed stocks without meaningful analyst coverage, 1,105 have market caps of less than $250 million, representing 55% of all listed companies with market caps under $250 million. Here are some of the key takeaways of our research:

· The 5,044 stocks have an aggregate market cap of approximately $18.2 trillion.

· There are 1,205 stocks (24%) with a market cap below $100 million.

· There are a further 816 companies (16%) with market caps between $100 and $250 million. (We define a "micro-cap" stock as one with a market capitalization below $250 million.)

· Cumulatively, there are a total of 2,021 micro-cap stocks (40%). Stated another way, two out of every five companies listed on a Senior Exchange is a micro-cap.

· On an aggregate basis, micro-cap stocks have a combined market cap of $190 billion-representing approximately 1% of the total listed U.S. market cap.

· We estimate that 1,443 out of 5,044 exchange-listed companies, or nearly 29% of all exchange-listed companies, have either zero or no meaningful analyst coverage of their stocks.

· And of the 1,443 exchange-listed stocks with zero/no meaningful analyst coverage, 1,105 are micro-caps, representing 55 % of all exchange-listed micro-cap companies.

In short, the dearth of analyst coverage for micro- and small-cap stocks is and remains a pressing problem. Moreover, we believe there are causal links between research coverage and liquidity, liquidity and equity capital formation, and equity capital formation and job creation. So ultimately this is an issue that goes beyond Wall Street to the heart of Main Street.

The central role of equity research in the job creation puzzle is now beginning to get the proper attention it deserves from Wall Street, the academic community, Congress and, very importantly, from the regulators. Let's hope the investigations reported by the Times and the Journal are part of a constructive solution to improve the state of affairs rather than a witch hunt to worsen an already dire