Poor Etiquette: Suggestions for Analyst Conduct Lack Teeth
After the annihilation of the New Economy bull market, research analysts have found themselves wedged somewhere between personal injury lawyers and reality TV cast members on the list of loathed professions.
Just as the government is turning its attention to the problem, the securities industry has come out with a list of remedies. The
Securities Industry Association
earlier this week came out with a list of 14 "best practices" for research analysts that try to draw a more distinct line between brokerage firms' research and their investment banking businesses.
They are merely suggestions, however, and pretty empty ones at that. Don't break your arm patting the industry on its back -- most of the suggestions are currently in place, reminding investors it will take a lot more to create an atmosphere where objective Wall Street research can happen routinely.
It's become an oft-cited statistic that only about 1% of all analyst ratings advise investors to sell a stock, a reminder that it was cheerleading analysts that helped hype and hawk a bull-market bubble. So what would turn things around? Force investment banks to make their banking and research arms totally separate. Not "Chinese Wall" separate, which is the "we don't influence each other" honor code currently in place, but a real division that makes research and banking two entirely different entities. It's the only real way to eliminate the suspicion that investors feel -- or should feel -- about analyst research.
The
Securities and Exchange Commission
last October enacted
Regulation Fair Disclosure
, known as Reg FD, to try to combat the problem of a small cabal having first crack at market-moving information. It was meant, in part, to put individual investors on an equal footing with Wall Street by requiring that all information disseminated from companies be made public within 24 hours.
Some brokerages, like
Prudential Securities
, have been touting that they now do better research. In December, the firm killed off its investment-banking arm, and last month it pared the number of its stock ratings to three -- buy, sell and hold. That's in contrast to the myriad ambiguous ratings, such as "intermediate-term attractive," firms typically have.
The industry's recent recommendations start with the most pressing concern that banking and research are now more than just strange bedfellows. SIA suggests "research should not report to investment banking." And if you ask any brokerage, officials will tell you that this is already true -- research does not report to banking. What the recommendations miss entirely is the issue of influence and pressure.
Wall Street's a competitive world -- and a close-knit one, at that. The pressure is often on researchers to make positive remarks about companies in a bid to encourage banking business -- the lucrative advisory, securities underwriting and other services investment banks offer.
"The investing client comes first," the report says. But often, the investing client does not really come first because analysts are concentrating -- directly or indirectly -- on corporate reaction, not investor reaction. An angry investor email, after all, can be quietly deleted. One from an officer at a big company cannot.
The industry group also suggests that brokerages institute a formal rating system with clear definitions, disclaimers written in real English and disclosure of conflicting interests. By and large, however, brokerages already do this. But nothing is standardized. The result is a tower of Babel, with one firm's market outperform equal to another firm's buy rating.
Don't fret, though. Brokerages define their ratings in the last paragraph on the last page of a research report -- often in hard-to-read, six-point type. The same goes for all disclaimers and disclosures, which end up being the typographic equivalent of the list of possible side effects given in a TV spot for prescription drugs. You'd think a possible conflict of interest was worth at least 12-point bold type.
Credit Where It's Due
The SIA is dead-on in one area: "A research analyst's pay should not be directly linked to specific investment banking transactions, sales and trading revenues, or asset management fees." Companies already do this. Or at least they say they do. In the same way that nepotism doesn't
really
exist and fired CEOs
resign
, it's easy to say compensation is not based on banking fees generated because of an analyst's work.
In reality, that is a true statement -- analyst compensation isn't based solely or directly on fees garnered by firms. But compensation is in many cases based on the analyst's ability to, among other things, get a good ranking in
Institutional Investor
and the ability to bring in more business as a result. There are reasons
Mary Meeker
is still employed, despite her fall from superstar analyst status. She makes money for her firm, even if she doesn't necessarily bring it home to her clients.
And that gets back to the SIA's groundbreaking idea that clients should come first. But in order for the investor to be placed first, research and banking have to be made into two entirely separate endeavors. They should not exist under the same roof.
If the two don't interact or influence each other, as firms say happens, then splitting them up should not be such a problem. Splitting them would eliminate much of the suspicion surrounding ratings and analysts' motives for liking or disliking a stock. Until there's a clean break, all of the suggestions in the world are an attempt to put a gauze pad on a gaping wound.
Source: Securities Industry Association