Heard on the Net

Motley Fool's New Research
Has Some Conflicts of Its Own

By JASON ANDERS
THE WALL STREET JOURNAL INTERACTIVE EDITION

Stock-chat site Motley Fool is hoping to one-up Wall Street with its own staff-written research reports on some of the most popular stocks.

The Fool says it has two goals. First, to write reports in plain English that teach novices something about investing while delving into the particulars on a hot stock. And second, to deliver that research without the same conflicts of interest that it believes color reports from traditional Wall Street firms.

The Motley Fool notes that many times, the firms issuing "buy" recommendations on stocks have investment-banking relationships with those same companies, and stand to profit from increased interest in the company's shares. It's a sort of "wink-wink, nudge-nudge" relationship, according to the Fool's Web site.

But despite its efforts to set itself apart from Wall Street research, the Motley Fool has some conflicts of its own.

Most of the companies that thus far have been the subject of Motley Fool reports are held in one of the Fool's much-touted model investment portfolios, which are the personal holdings of David Gardner, one of its founders. What's more, many of the Fool's analysts own shares in the companies they're writing about.

"On the surface, they have a good argument that this has the appearance of less conflict than you have with traditional research reports," says James Schrager, a professor of entrepreneurship and strategy at the University of Chicago Graduate School of Business and an expert on business ethics. "But look just below the surface, and you see that this is really just the same as Wall Street. There are still serious conflicts of interest."

Erik Rydholm, chief operator officer and co-founder of the Motley Fool, says he's confident the research reports are objective. "I don't think we're doing anything here that we haven't been totally upfront about," he says.

A disclaimer at the end of each research report alerts readers when the stock is part of one of the site's portfolios, and also says "the Fools associated with this report may own shares in the companies they write about."

The research reports were launched earlier this month, and subscribers pay a fee for access to them -- $12 a la carte, or $99 for all reports issued for one year. There are 10 reports available on the site now, with more on the way soon, the Fool says.

Wall Street firms have long been criticized for the relationship between their analysts and investment-banking operations. The firms argue that there's a so-called Chinese wall between the two sides, and say that aside from sharing the same employer the two groups don't work together. Critics point out, however, that firms regularly issue "buy" reports on companies they've had a hand in taking public, though they rarely issue "sell" reports if a stock heads south.

It's a "murky" relationship, says Mr. Rydholm. "Wall Street is motivated by other types of activities, things like the commission structures of retail brokers and the relationship between the investment-banking side and the analysts. We tried to make the first consumer-oriented stock research product sold directly to investors without a transaction component tacked onto the backside," he says.

Still, many of the Fool's analysts stand to directly profit from increased interest in stocks mentioned in the site's research reports. Of the 10 reports on the site, seven were written by analysts who own shares of the stocks being profiled.

Mr. Rydholm says he doesn't necessarily consider that a conflict of interest, and says in fact it can make the reports better. "One of our strengths is that we have investors writing for investors. These people can write about these companies from an investor's point of view," he says.

Mr. Rydholm says the Fool prohibits its employees from trading in a stock five days before or after they write about it.

There are other connections between the Fool and some of the companies being covered by research: Seven of the 10 reports available for purchase offer investment opinions on companies that are part of one of the Motley Fool's portfolios.

The Fool's two primary portfolios -- the Rule Maker and the Rule Breaker -- are a popular feature of the site, and are used to teach readers about investing. The site has frequently pointed out the strong performance of the two portfolios: It says the Rule Breaker portfolio is up more than 1,500% since its inception in 1994, while the Rule Maker portfolio is up about 80% from its start in early 1998.

Mr. Gardner and his brother Tom, also a founder of the site, have even written a book about the success of the portfolios and the trading strategies behind them.

Mr. Rydholm says the Fool never set out to write research reports about companies held in its portfolios, but rather looked for stocks that were popular with investors. "There was some natural overlap there," he says. The Rule Maker portfolio consists of 12 stocks; the Rule Breaker has seven.

A spokesman for the Fool notes that while the portfolios are "real-money" holdings, the company itself doesn't own the stocks. Both the Rule Maker and Rule Breaker portfolios were started and are owned by David Gardner, he says.

Regardless, Mr. Rydholm says he believes the Fool avoids the appearance of any conflicts of interest by gearing its reports toward long-term investors. He says the urgent nature of some Wall Street reports -- "strong-buy" recommendations and short-term price targets, for instance -- can raise questions about a firm's motivation in issuing them.

"We're trying to focus not so much on the stock price, but on more fundamental business analysis. We want to help people figure out if these are good investments, and why," he says.

Indeed, there are no "buy" or "sell" recommendations with the Fool's reports. Instead, each company is rated on four categories -- things like industry attractiveness and investment predictability -- to come up with an overall score. The ratings, not surprisingly, are presented using the Fool's trademark jester caps.

The reports spend a lot of time explaining a company's business plan and history. Terms like "price-to-earnings ratio" aren't thrown around without explanation, and the authors readily admit that they can't predict the future: "Trying to estimate Amazon's profits is much like trying to predict the weather weeks in advance," notes Paul Larson in his report on the online retailer. In-depth financials are presented at the end of each report for those interested in crunching the numbers.

A spokesman says there are plans to broaden the disclaimers at the end of the reports to disclose exactly which writers own which stocks. "We felt like it was the right thing to do," he says.

The University of Chicago's Mr. Schrager, who considers himself a "big fan" of Motley Fool, says the site's reputation and brand name may alleviate concerns over conflicts of interest, but won't erase them.

"If you stumbled on some other Internet site where people were writing about stocks they owned, you'd probably say, 'Yeah, right,'" he says. "Here, you're willing to give them some credit, but that doesn't mean they can escape these conflicts. They are still very much a matter of concern."

Write to Jason Anders at jason.anders@wsj.com²

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