• PAGE ONE
• INDEX
• HOME

Analyst objectivity

Glenn Cheney on the independence of investment analysts.

AMERICAN financial professionals often boast, and not without reason, that their country's financial reporting, auditing and independence standards are the best in the world. Transparency, accuracy and thoroughness are important to Americans, and certain ly to some extent, the overall openness accounts for the country's financial stability and economic growth.

No one, however, claims the system is perfect. As American stock markets assume the approximate angle of the Titanic when its passengers first thought about lifeboats, the buy-side of the securities industry is perceiving problems with the independence o f research analysts in Wall Street banks and brokerages. Today, with the Nasdaq at half its former average and the Dow Jones average not looking too good itself, decimated investors are wondering why, last year, less than 2 per cent of analysts' recommen dations were to sell.

As investing supplants baseball as the national sport, many investors are amateurs incapable of understanding the nuances of a research report. They are all too dependent on and uncritical of the basic buy and sell recommendations of analysts. They accep t a bottom-line `buy' recommendation but fail to notice a report's conflicting evidence of risk and dire prospects.

They might also be interested to know whether the analysts are taking their own advice. Often, they aren't.

Industry watchdogs claim that the contradictory ``buy it'' recommendation stemming from a ``be careful'' report may result from a conflict of interest. In some cases, the analyst may want to write an honest report, but his or her employer wants to sell s tock, and the latter may be willing to reward the former for a particular kind of recommendation.

The problem has aroused the attention of the US Securities and Exchange Commission. The prospect of government regulation in turn has prodded the Securities Industry Association, to which most Wall Street banks and brokerages belong, to produce a framewo rk for self-regulation. In mid-June, just a few days before a House of Representatives hearing titled Analyzing the Analysts, the SIA rolled out a set of guidelines called Best Practices for Research.

The guidelines call for SIA members to work together to ensure the integrity of research, to serve primarily investors by producing recommendations that are transparent and consistent. Analysts should not submit research to investment bankers or corporat e managements for approval or opinion. Analysts should be objective and independent, and their disclaimers should be clear and comprehensive. The analysts' investments should be consistent with their recommendations, and their personal interests should b e disclosed. Private investment or business interests should not conflict with securities analysis.

The SIA guidelines will not be backed by any power of enforcement. The association simply assumes, or at least hopes, that its 700-plus members will voluntarily adopt the recommended practices. Participating firms will be free to announce that they meet SIA best practices, but the association plans no formal certification or official statement of participation.

The National Association of Securities Dealers is also trying to help make investors more aware of conflicts of interest. In December of last year the NASD's board of governors announced their intention to develop rules on the disclosure of conflicts of interest by financial services professionals during scheduled public appearances, such as on television programs. The association will work in conjunction with The Securities and Exchange Commission and the New York Stock Exchange to develop common rules and language.

The House hearing elicited the opinions of several experts, though none were from the major Wall Street banks. Generally, they indicated serious problems with the independence and integrity of analysts.

Mr Benjamin Mark Cole, a financial journalist, told the House Committee on Financial Services that research analysts are similar in their approach to lawyers: ``They regard their job as one of advocacy,'' he said, ``to make the best case why a stock is a terrific buy. Ask an analyst if what he or she is doing is honest, and they will answer that you don't understand their job description.''

Among Mr Cole's recommended solutions was the creation of a system for rating the average accuracy of an analyst's recommendations.

Can we ever trust Wall St. again?

As the sell-side of the industry tries to clean up its act, the buy-side, represented most powerfully by the Association for Investment Management and Research, is setting the standards it would like to see analysts meet.

``I can't help but be frustrated and disappointed when I see magazine headlines like, `Can we ever trust Wall St. again?','' said AIMR president and chief executive officer, Mr Thomas A. Bowman, as the association announced its intention to issue researc h objectivity standards. ``Clearly we still have work to do to set a higher standard for investment professionals worldwide.''

Being a worldwide organisation, the AIMR would like to see worldwide standards. ``I've talked face-to-face with market professionals and regulators in at least 12 countries in the last 12 months,'' Mr Bowman said. ``They haven't been distracted by market volatility... Almost no matter what country I travel to, I get asked about two things: selective disclosure and analyst objectivity.''

The AIMR has developed a position paper on preserving research integrity. It found that research analysts are not always free to issue honest, unbiased reports, and it describes sources of potential influence on analysts, including investment banks, fund managers, and public companies. The report is supposed to serve as a `best practices' guideline of appropriate behaviour.

The AIMR is also is also developing ``Research Objectivity Standards'' which will provide measurable ``best practices'' that firms should take to protect the independence and objectivity of their analysts. The association hopes that firms will publicise their compliance to give themselves a competitive edge. A proposed set of standards will be released for public comment later this year.

The questionable independence of some research analysts can hardly be blamed for the tumble of American stock markets. Likewise, the establishment of industry guidelines will no more raise the market than new shipbuilding codes will raise the Titanic. St ill, investors can only be encouraged to know that at least the value of analyst recommendations is on the up. Maybe stocks will follow.

(Edited extracts from Accounting & Business. A journal of ACCA, London. www.accaglobal.com)