Rumblings about the failings of securities analysts tend to reappear every time the bears begin to growl. Few people complain about duff investment advice when markets are rocketing upwards but they need someone to point the finger at when things become a bit stickier. Whose fault is it? It’s those pesky analysts, that’s who. They told us to ‘buy’ everything. Now we’ve discovered that they were also working for the guys they were wanting us to buy. Or just getting us to trade for trading’s sake. It’s just not fair.
It might not be fair but it’s not as if it’s anything new. Conflicts of interest between independent research and corporate finance work have existed for years – as has the need for analytical research to generate trades. It should hardly come as a shock revelation when the markets turn downwards. Mind you, last year’s optimism surrounding the dot-com boom has brought the situation home to an even wider, newly-converted investing audience. They are not used to such rotten practice and are baying for blood.
So what to do? This time round the securities analysts themselves know that it’s attracting some awfully bad press and that maybe they should get their house in order – before they get seriously slapped by government. Recent months have seen the Canadian Committee on Analyst Standards issue its first report on the issue, while the German society of investment analysts (the DVFA) is racing with its government to put a new hardline approach down on paper. The latest group to come out fighting are the Wall Street investment banks, who are reportedly negotiating a new code of best practice among themselves.
Will these new codes of conduct bring a halt to the conflict of interest problems and poor quality research of recent years? Probably not. After all, there would seem to be a few conflicts of interest inherent in the self-regulatory nature of many of these initiatives. They should, however, help move the debate forward by bringing more of the issues out into the open.
For example, the Canadian committee (‘independently’ drawn from members of the Toronto Stock Exchange, the Canadian Venture Exchange and the Investment Dealers Association of Canada) has tended toward greater disclosure where real or potential conflicts of interest exist. The DVFA’s proposals have also gone down the greater disclosure route, with the suggestion that research notes should state whether the bank publishing the research owns shares in the company covered, handled its IPO, or is acting as broker.
Greater disclosure is a move in the right direction, as any good investor relations officer will tell you. And it’s good to see the investment community practising more of what they preach for once. However, as the best investor relations officers will also tell you – the best disclosure is that which goes beyond the basic boundaries laid down in rules and regulations. Few companies really take this to heart and, one expects, even fewer analysts will be prepared to voluntarily disclose all relevant information. There’s just too much money wrapped up in keeping things under wraps.
The solution may lie in fund managers being prepared to walk away from research that does not toe the ‘open and honest’ line. Or, failing that, invest even more heavily in their own research operations, as has been the trend in recent years. In the same way that ‘closed’ companies are punished for failing to disclose information, institutional investors should begin to be a little bit more choosy about the type of research they buy or, at the very least, make it plain that they expect conflicts of interest to be openly revealed.
Unfortunately, a few self-regulatory initiatives on the part of analysts are unlikely to have the desired effect of calming exuberant recommendations next time we hit a roaring bull market. As in most walks of life, it’s only when clients or investors – in other words, money – really begin to kick up a fuss that anything is achieved.
