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| Opportunities & Exposures: Finance |
Independent Minded
By Jonathan Boersma, CFA
10/01/2005
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We are now nearly halfway through the five-year provisions of the Global
Analyst Research Settlement that the New York District Attorney’s office
announced in April 2003, designed to reduce equity analysts’ conflicts of
interest by separating investment banking from research. Yet there are still any
number of opportunities for conflicts of interest to distort the reports and
recommendations that research analysts produce.
In addition to the separation
of investment banking and research, the investment banks involved in the
settlement are required to provide clients with a report produced by an
independent research firm for every stock they cover in-house. The district
attorney hoped that this practice would create a permanent demand among
investors for independent research. In a strange turn of events, some investment
banks are now advertising that they “offer” this independent research as a
service to their clients. Turning a punishment into a marketing tool—now that is
innovative.
However, many of the groups that generate this “independent”
research are, in fact, still part of institutions that do business with the
companies that the research analysts follow. For example, a sell-side research
firm might be part of an institution that has an asset management division that
manages the pension fund assets of a company followed by one its analysts. If an
analyst issues a negative report, the company could threaten to take its pension
fund business elsewhere. There are also cases in which the investment management
divisions may pressure an analyst to issue positive research. Since an
investment manager’s pay is typically determined by the performance of his or
her portfolio—which can benefit from positive research reports—the manager may
bring pressure to bear on the research analysts.
One distressing precedent
for those who hope analysts will remain able to speak freely was a 2004 decision
in the French courts that forced Morgan Stanley to pay around v30 million ($38.5
million) to Moët Hennessy Louis Vuitton (LVMH), based on allegations that the
firm issued negative reports on LVMH and positive ones on Gucci because the
latter was a client. While this would certainly be unethical if proved true,
ultimately analysts need to be free to state their own opinions regardless of
which companies the firm has as clients.
Some companies may lobby for
favorable reports, especially because so many now tie executive compensation to
the performance of company stock. More often, companies employ the subtle
practice of denying access to those who have written negative reports or who are
known for asking tough questions in meetings. Such analysts frequently find they
have mysteriously been blocked out of a conference call or have not received
notice of the meeting at all. We have also heard of cases of companies
attempting to pressure analysts by refusing to trade through their firms’
brokerage divisions.
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