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Another perspective on analyst independence

By Paul Hocking

Friday 21st March 2003

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There is much discussion about, and some condemnation of, the apparent lack of research independence in the broking industry.

Much of the comment is based on an opinion that analysts are guilty in the main of purposefully delivering research reports that do not give an honest opinion of the outlook and consequent value of listed companies for whatever reasons or that when the occasion arises they will deliver biased reports.

This opinion is both incorrect and unwarranted for a profession that has worked hard in this country to deliver quality research.

It is also interesting that many commentators, particularly the media, when faced with unexpected share price movements tend to believe there is something fishy going on rather than accepting the fact that a good-quality piece of research by a respected analyst has just been published.

In much of the discussion seen locally and internationally on research independence there seems to have been one important aspect missing. While it is generally accepted that the shenanigans seen in the US were due to the bevy of IPOs that enabled favours to be given to corporate clients' executive staff there has been little said about the behaviour of these executives.

In New Zealand we have not experienced the same problems as we have not had a bullish market in IPOs.

What is missing in New Zealand is discussion of the role of corporate executives in the research process.

It is entirely appropriate where an analyst has misunderstood the information released or does not understand technical details of a corporates product or process that the CEO or CFO contacts that analyst to correct such errors.

Indeed, analysts often provide drafts of their research reports to companies to ensure that the reports are factually correct in these aspects.

But what happens if the analyst fully understands the information but interprets it negatively and writes a less than bullish report?

It is a widely known secret within the broking industry that some executives do put pressure on analysts to change recommendations or publish more favourable reports, even in cases where there is no investment banking relationship between broker and company.

This pressure can attempts at mild persuasion, demands on analyst's bosses for retribution or even threats of legal action.

Does this happen in New Zealand? You bet it does. Are any regulators or quasi-regulators addressing this?

Not that the Institute of Finance Professionals New Zealand Inc (Infinz) is aware of.

This highlights that attempts to build in bias to research reports can come from quarters outside the broking industry.

Executives have to accept that not all research will be favourable to their firms.

They also have to accept that a recommendation could be given to sell or hold not for any dislike of the company but merely because it isn't as good as its peers. In an ironic twist Forbes magazine reported last November that Morgan Stanley in the US was being sued by LVMH in a Paris court for issuing less than favourable research on LVMH due to alleged bias in favour of Gucci with which Morgan Stanley had a relationship.

This shows the lengths to which some disgruntled executives will take their dissatisfaction.

The call for more "sell" recommendations from brokers is being addressed via various techniques but corporates need to accept this and not try to influence research outcomes just because they feel hard done by.

The responsibility to remove bias and maintain integrity is not the preserve of analysts alone.

Sharebrokers are as concerned as anyone else with the negative opinion of research analysts.

They see it as a matter of vital importance that the investing public, whether they be retail investors or professional institutional investors, have good reason to accept the integrity of research analysts and the firms that employ them. The industry is not sitting idle waiting for regulators and quasi-regulators to address the issue.

Infinz has already held meetings with industry participants to discuss how the industry should address the lack of confidence in research and how to ensure that integrity, honesty and independence are seen as the norm.

The results of these discussions will be conveyed to the regulators once the common view has been properly established.

Interestingly the industry was open about current practice, was concerned to ensure that any shortcomings, perceived or real, were addressed and suggested ways in which confidence could be ensured through active participation of regulators and quasi-regulators where appropriate.

Looking forward, there is a responsibility on quasi-regulators such as the Stock Exchange to incorporate in their governance rules requirements for appropriate behaviour from listed company executives and directors with regard to analyst's research.

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