Regulators target sharebrokers' 'research' influence

Friday 3rd August 2001

Around the world, equity market regulators are zeroing in on the influence that sharebroking analysts have on company share prices and the potential conflicts that arise from it.

In the dotcom era, research analysts such as Henry Blodgetts of Merrill Lynch and Mary Meeker of Morgan Stanley, through their pronouncements on company prospects, could substantially increase the related stock price.

While these two individuals were probably the highest profile, there are dozens of other Wall Street analysts whose views would be keenly followed by both professional and amateur investors.

The influence of analysts could not only generate the meat and potatoes of broking firms - investors buying and selling stocks - but also the rich caviar through the creation of investment banking business.

It is no wonder that with these bigger prizes in mind that few stockbroking research analysts publicly recommend selling stocks (thereby infuriating existing or prospective corporate clients).

In a recent survey by Bloomberg, a financial markets information service, only 2.2% of analyst recommendations were "sell" ratings. Therefore 97.8% of ratings were "buy" or "hold."

It is no wonder, with many equity markets now at levels well below a year ago, investors have lost faith in the recommendations of sharebrokers' research analysts.

So much so that investors are grouping together to sue the larger stockbroking firms.

In response, a number of Wall Street brokers are seeking to shore up their credibility through a higher level of disclosure about their analysts' own stock holdings plus the fact that their firms may generate investment banking business from the company being researched.

These actions appear too little and too late, given it has been commonly known before now that analysts may buy stocks they research plus aid the creation of investment banking business. What would be a superior solution?

First, stockbroker research analysts should not also be able to promote or participate in the investment banking business of their employer.

Second, analysts' compensation structures should be transparent, with a component within it relating to how the analyst's stock recommendations perform, therefore offering an incentive to analysts to also place sell ratings on stocks.

What relevance does this have for New Zealand investors and are New Zealand-based regulators and stockbrokers responding to the winds of change? The simple answer is no.

The regulators have yet to put the issue on the agenda and New Zealand stockbrokers see no real need to move to a highly transparent environment that would overcome investor concerns of real or perceived conflicts of interest.

So while New Zealand was rated the third least corrupt country in the world, according to the latest global survey by Transparency International, it appears New Zealand's sharemarket and stockbrokers are less keen to clean up the risk of interests' conflict.

What can the ordinary investor do if they can't rely on the company research generated by stockbrokers?

One could compile one's own stock research, which for most is not practical, or alternatively invest through professional investors such as fund managers, especially those that invest in the required research resources to ensure minimal dependence on the "research ratings'"of stockbrokers.

David van Schaardenburg is executive chairman of FundSource, the investment strategy and funds management research company

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