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If information "wants to be free," as one half of the famous aphorism goes, somebody forgot to tell Wall Street. This fall a federal appeals court in New York will weigh in on a long-running and widely watched legal dispute pitting Barclays Capital, Bank of America Merrill Lynch and Morgan Stanley against Theflyonthewall.com, a New Jersey–based web site that publishes sell-side analyst recommendations before the market opens — and often before the firms can distribute their own research to clients. The firms contend this hurts their commission revenue. This past spring a lower court judge ordered Theflyonthewall.com to delay publication of the firms’ stock calls until one half hour after the opening of the New York Stock Exchange, among other restrictions. The web site countered with an appeal and won a temporary stay.

Even if the brokerage firms prevail in their battle against Theflyowritnthewall.com, winning the war to preserve the primacy of their investment research won’t be easy. Bolstered by the low cost of online publishing and the rising popularity of blogs, discussion forums and commenting, a growing number of niche web sites are creating opportunities for new forms of investment analysis to emerge — and for buy-side professionals, even those at rival firms, to collaborate and learn directly from one another. These social media web sites are supplementing, and in some cases supplanting, the traditional Wall Street information ecosystem that transmits sell-side investment research and stock calls to the buy side. The sites’ popularity has been fueled by the limitations and shrinking coverage universe of sell-side research and the failure of establishment experts — from Wall Street analysts and strategists to the credit ratings agencies to the financial news media — to call the credit crisis.

“The sell side can often be slow to twist and turn with where the market is going,” says David Jackson, a former Morgan Stanley technology analyst and the founder and CEO of Seeking Alpha, a leading investment blog backed by blue-chip venture capital firms Accel Partners, Benchmark Capital and DAG Ventures. But crowd-sourcing investment ideas, he says, has its benefits: Throughout the rise and crash in the price of oil in 2007 and 2008, the unraveling of the housing market and the implosion of Bear Stearns Cos. and Lehman Brothers Holdings, Jackson’s more than 3,000 handpicked contributors and vocal readers were “uncannily on topic in terms of what was driving the market — at a macro level and an individual stock level.”

In mid-August, as part of the U.S. Treasury Department’s ongoing outreach to the financial blogosphere, seven bloggers were invited to a private meeting with a small group of senior officials, including Treasury Secretary Timothy Geithner, to discuss financial reform. As four of the seven bloggers regularly contribute to Seeking Alpha, the meeting was a nod to the site’s growing influence.

Finance pros have taken notice. According to audience tracker Nielsen Co., Seeking Alpha, which launched in 2004, now attracts more financial professionals than any other major financial web site. The site recently hit 540,000 registered users, and its opinion and analysis pieces, which are free, are read by more than 2.8 million people a month. Nielsen data suggest that more than 385,000 of these individuals are professionals: money managers, sell-side analysts, investment bankers, financial advisers, business leaders, entrepreneurs and sophisticated retail investors. Morgan Stanley’s sell-side research, by comparison, goes out to roughly 250,000 institutional investors, though the firm’s reach is much broader when you factor in its retail network of 18,000 financial advisers and their clients.

“Blogging is absolutely democratizing the investment business,” says Barry Ritholtz, who is CEO and director of equity research at independent quant research firm FusionIQ, and who writes The Big Picture, a well-regarded blog about macro investing themes. A Wall Street veteran and the former chief market strategist at New York boutique investment bank Maxim Group, Ritholtz says that 20 years ago the typical Wall Street strategist had an economics degree, went to one of a half dozen leading MBA programs and came up through the ranks at a big firm: “You’re talking about members of the same club — similar schools, similar background, working at the big Wall Street firms, quoted in the major media.” But these days, he contends, “that model is totally broken.”

For every form of investing, to tweak Apple’s catchphrase, “there’s a blog for that.” Naked Capitalism, which specializes in financial and economic commentary, is overseen by Yves Smith, the nom de plume of a former Goldman, Sachs & Co. and McKinsey & Co. executive, and is widely read by hedge funds. Footnoted.org, launched by journalist Michelle Leder, reports on the things that companies try to bury in their Securities and Exchange Commission filings and was recently acquired by Morningstar. And Jeff Matthews Is Not Making This Up, written by the founder of Greenwich, Connecticut–based hedge fund RAM Partners, delivers blunt analysis of everything from the sources of revenue growth at Hewlett-Packard Co. under former CEO Mark Hurd to Wall Street’s earnings coverage.

The explosion in socially generated investment analysis is both a blessing and a curse, especially when you consider the volume of short messages containing financial content that are transmitted every day via Twitter, the microblogging service that is especially popular among active traders (see sidebar, opposite). To manage what traders might call the high “signal-to-noise ratio” of public web sites, at least three private online communities now cater specifically to professional investors: Value Investors Club and Distressed Debt Investors Club, which were founded in 2000 and 2009, respectively, and each cap their membership at 250 investors, who are anonymous to fellow users; and SumZero, which launched in 2008, combines user-generated investment research with social networking features and now boasts a membership of more than 4,000 buy-side analysts and portfolio managers.

All three sites are rivals of sorts but share some members. Generally speaking, they screen applicants based on the quality of a sample investment thesis and require members to post write-ups on securities and regularly rate other community members’ ideas. The sites may also offer incentives to encourage participation; Value Investors Club, for example, awards a weekly prize of $5,000 for the best idea.

SumZero is betting that scale, transparency and Facebook-style networking features will set the site apart from its two smaller rivals. “The dynamic is that the bigger the idea database gets, the more compelling it becomes to contribute to,” says co-founder and CEO Divya Narendra, a 28-year-old former analyst at Boston-based hedge fund Sowood Capital Management who is running the site while pursuing law and business degrees at Northwestern University.

Networks are something that Narendra has spent a lot of time thinking about. As an undergraduate at Harvard University, he co-founded social network ConnectU, and he remains locked in a long-running legal battle with Facebook and its co-founder Mark Zuckerberg, a Harvard classmate whom Narendra accuses of stealing his idea. SumZero’s name and tagline, “The opposite of zero sum,” suggest a Facebook-like zeitgeist. It’s a cheeky riff on the idea — which seems out of place in the cutthroat world of money management — that investors can create value for one another by openly collaborating and sharing ideas.

And they are. James Kilroy, a portfolio manager at Gainesville, Georgia–based Willis Investment Counsel, which oversees about $1 billion in institutional and high-net-worth assets, joined SumZero when it was a third of its current size. He says that he often posts a detailed investment thesis to the site after completing his research and building a position. His goal is to stress-test his ideas — “I want to understand how I can be wrong,” he says — and to share them with an influential community that is prepared to act on a persuasive argument.

“You want to be early and first,” explains Kilroy, a former Bear Stearns analyst who covered multi-industrials, “but ultimately you need other investors to share your point of view for the stock to go up.” Kilroy likes the fact that SumZero members must disclose whom they work for and the type of funds they manage. “It forces you to a higher level of accountability,” he adds.

Access to contrarian investment thinking is also a key driver of investor interest in these social media sites. Jackson credits Seeking Alpha’s success to the diversity of viewpoints expressed by the site’s writers and commentators, who create a wide-angle view of a stock that he says is unmatched by traditional Wall Street research. SumZero’s Narendra agrees. “Somebody might put up a thesis [on SumZero] where a stock trades at $2 and the target is $10,” he says. “That’s the kind of stuff that the investment community needs — a divergence of viewpoints, as opposed to herd thinking.”

Still, investors must proceed with caution. In a 2007 study of 340 buy and 160 sell recommendations posted on Seeking Alpha, Veljko Fotak, a Ph.D. student in finance at the University of Oklahoma, found that the stock picks exhibited some value and market impact, as measured by returns in the 20 trading days after publication, but that the quality of the investment advice varied. He found scant evidence of any factors that could predict the quality of a blogger’s recommendations.

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Related Topics: social media· online networks· investment research