Two years after the global settlement between major Wall Street firms, securities regulators and New York attorney general Eliot Spitzer, some companies are ill at ease with the diminished influence investment banking has on sell-side research. Several management teams have waged war against sell-side analysts who downgrade their company’s stock or ask ‘sensitive’ questions by cutting off access or publicly berating them, or both.
In fact, nearly 40 percent of the 732 sell-side analysts who responded to our Investor Perception Study, US 2005 say they have felt cut off from a company following a rating downgrade. Common experiences include lengthier response times to analysts’ queries and being shut out from asking questions on the quarterly conference call. ‘One company I covered for two years refused to speak with me or allow me on its quarterly calls, even though I continued to cover it, after I rated the firm a sell,’ says one sell-side respondent. A more appalling finding of the US study is the 6 percent of analysts who say companies have threatened to suspend their banking relationship following a ratings downgrade.
In other extreme cases, analysts have been sued for their sell ratings. Last January LVMH’s suit against Morgan Stanley for publishing ‘damaging’ reports resulted in a $38 mn settlement. Julie Neiman, senior VP of equity research and portfolio management at St Louis-based RT Jones, has twice been threatened with corporate lawsuits in nearly 40 years as an analyst. ‘If someone threatens to sue me, I know I am hot on the trail,’ she says.
Neiman, who covers oil and gas, has also been frozen out of conference calls and had her calls go unanswered. ‘I would ‘disappear’ off mailing lists,’ she notes. ‘They didn’t want me on conference calls as I had a sell on the firm.’
A recent example of this type of corporate retaliation came in early February when a senior executive at Missouri-based NovaStar Financial called a conference call participant derogatory names after he questioned the accuracy of the firm’s dividend guidance. The executive assumed no-one was left on the fourth quarter conference call but some listeners remained and the incident earned NovaStar a disparaging story in the Wall Street Journal. It’s unclear who the participant or the senior executive was but this attitude and behavior has industry bodies up in arms.
The CFA Institute and the National Investor Relations Institute (Niri) released a set of best practice guidelines for analyst-issuer relations meant to safeguard sell-side objectivity in December 2004. The guidelines cover information flow, analyst conduct, corporate communication and access, corporate review of sell-side analyst reports, and issuer-paid research. Representatives of standard-setting and regulatory organizations observed the process and the SEC is interested to see whether these voluntary guidelines will quell vengeance against analysts.
‘There is still an attitude that if an analyst downgrades a stock it’s appropriate to cut him off,’ comments Lou Thompson, president and CEO of Niri. ‘It may make the CEO feel good temporarily but it’s a zero-sum game; our guidelines say everyone should have access to the firm.’
The IR angle
The IR person facilitates that access naturally, which is why it’s essential for IROs to be part of management’s inner circle. ‘We think companies should have a policy detailing who has access to senior management and how it addresses analyst and investor requests for information,’ says Jonathan Boersma, vice president of standards of practice at the CFA Institute.
In the UK, the Financial Services Authority (FSA) is following the outcome of the Niri/CFA guidelines with interest, and closely monitoring banks’ efforts to ensure analyst objectivity. Last August, as part of wider guidelines on company-analyst relations, the FSA issued a reminder to firms that ‘freezing out’ analysts is unacceptable.
The EU’s Market Abuse Directive will also affect analyst-issuer relations by forcing sell-side analysts to explain their research methodology more thoroughly. The FSA, however, is already moving to implement new rules designed to counteract conflicts of interest. ‘We currently require only that any headline recommendation, or anything that might explicitly indicate what a headline recommendation might be, should be removed prior to an issuer checking the facts,’ explains FSA spokesman David Cliffe. ‘But our new disclosure rules will also require analysts to disclose all material sources and explain the methodology used to evaluate a company.’
Why companies are so concerned with sell-side ratings befuddles the buy side, which isn’t focusing on these scores. ‘We pay attention to the ratings but we are more interested in the industry background and what [the sell side] is saying about product trends,’ explains Samuel Jones, chief investment officer and chief compliance officer at Trillium Asset Management Corporation, who headed the CFA side of the Niri/CFA guidelines task force. ‘Institutions now prefer to go through a Glass Lewis-type firm to have all the tough questions answered; people want to maintain anonymity rather than incur the wrath of management.’
For example, last year proxy advisory firm Glass, Lewis & Co held conference calls prior to Disney’s AGM in which institutional investors were invited to participate and questions were filtered through Gregory Taxin, head of Glass, Lewis & Co.
The bottom line, says Jones, is that management has every right to limit the amount of questions any one analyst asks but it can’t stop the hard questions. ‘If you answer the question correctly in a forthright transparent manner you will probably make sure the subject of that answer is discounted in your market price,’ Jones explains. ‘If the question doesn’t get asked, the answer won’t be there and there will be a continued cloud. Why put up with the whispers when you can deal with it upfront?’
Direct pressure
Some experts say corporate retaliation against the sell side is now coming directly from companies. ‘Investment banks are in a different position; if the company pressures them to do something about the analyst, they really can’t do that anymore,’ says Chuck Hill, president of Veritas et Lux and former director of research at Thomson First Call in Boston. ‘Even when relaying a complaint, banks have to have legal counsel present. I’m not saying it won’t happen but it’s more difficult for companies to retaliate now.’
‘The companies say, I am cut off from the banking route so I will just go to the analyst and pressure him directly,’ observes Boersma. This is not to say there aren’t times when a company has a legitimate complaint about a sell-side analyst’s research, but all too often the catalyst is a rating downgrade. ‘Part of the problem is the shift in focus to the short term – which is why companies are so concerned with negative ratings,’ adds Boersma.
Direct retaliation against analysts is by no means rampant, however. Firms generally respect the settlement’s terms and recognize there is nothing they can do about unfavorable reports, provided they’re accurate, says Rick Levitt, research manager at investment bank Dresdner Kleinwort Wasserstein (DrKW). ‘There could be companies that will occasionally overstep their boundaries and say, I don’t like the tone you’re using,’ he explains. ‘In these cases, the analyst has to say, I’m truly sorry but it’s not for you to discuss with me. That has never happened in the past because companies understand what’s going on and, should it ever happen in the future, our analysts know they can happily refer companies to me and I will advise them of the changes that have gone on in this industry.’
Communication breakdown
Some IROs are genuinely alarmed by the fallout of the Spitzer settlement. They say the quest for analyst objectivity is restricting dialogue between sell-side analysts and companies, sometimes leaving IR to iron out research mistakes after a report is published. And with European companies preparing to report under international financial reporting standards (IFRS) for the first time, IR feels it’s imperative to speak more with analysts to make sense of the new numbers. ‘I at least want to see the model they’re using for my own purposes because I run it through software that covers all the analyst models and makes the numbers comparable, but they won’t even let me have that anymore,’ fumes one IRO at a FTSE 100 company.
Kate Holligon, IR director at UK pubs operator Mitchells & Butlers, says the sell side is feeling the effects of restricted communications with companies. ‘Some firms complain analysts don’t check facts with them so much anymore, but the frustration is more acutely felt by analysts, who frequently run up against compliance, particularly at the big American banks,’ she notes. ‘You get the impression they would like to check certain facts but can’t because it’s against compliance.’
Levitt thinks it’s the type of dialogue between analysts and issuers that has changed post-settlement, not the amount. ‘All analysts are now extremely mindful of telling corporates,You are allowed to comment on matters of fact only,’ he says. ‘What we do is send corporates the note stripped of the investment thesis.’
Even as regulators and industry bodies zero in on the issue of safeguarding sell-side objectivity, some think it’s a losing battle. Peter Reynolds, IR director at London-based gaming and entertainment firm Rank Group, thinks no amount of Chinese walls or voluntary guidelines will overcome the contradiction that lies at the heart of sell-side research. ‘Clearly the sell side wants to have its cake and eat it,’ he says. ‘When sell-side people are on roadshows, who is the client? There is obviously still a conflict here.’
