Stock Analysts Rule Could Go Farther
By Christopher Faille, Reporter
Monday, May 13, 2002
WASHINGTON (HedgeWorld.com)—The stock analysts restrictions adopted by the Securities and Exchange Commission could have gone further, some in Congress and the industry say.
John J. LaFalce (D-N.Y.) offered his own plan to strengthen the Chinese wall between stock analysts and investment bankers beyond those adopted by the SEC. to the Securities Traders Association last Thursday.
Industry participants also voiced dissatisfaction with the SEC rules. William Fleckenstein, a short-seller who heads the hedge fund firm Fleckenstein Capital, Seattle, says the SEC rules still don’t remove the incentive for stock analysts to shill for the investment banking side of the business. And the head of the Association of Investment Management & Research, which offers the Chartered Financial Analyst designation, proposed added requirements regarding research analysts’ compensation.
Rep. LaFalce’s Proposal
Speaking at a morning session, Rep. LaFalce ranking minority member of the House Financial Services Committee, said the new rule adopted by the Securities and Exchange Commission was an important first step but didn’t go nearly far enough. The rules adopted were those proposed by the New York Stock Exchange and the National Association of Securities Dealers.
“Congress should adopt the approach taken in the legislation I have proposed,” the congressman said, “My bill would have ensured that analysts are compensated according to the quality of their research, rather than according to the investment banking business that they win for the firm. Moreover, my bill would have prohibited investment banking from having any input into the hiring, firing, promotion or compensation of securities analysts.”
Republicans defeated Rep. LaFalce’s bill, H.R. 3818, “The Comprehensive Investor Protection Act,” but in response to post-Enron furor the House on April 24 passed an alternative drafted by Rep. Michael Oxley (R-Ind.), H.R. 3763, “The Corporate Accounting, Responsibility and Transparency Act.”
In his speech to the Securities Traders, Rep. LaFalce said that H.R. 3763 not only failed in some crucial respects; it was actually a backward step in others. On the matter of analyst conflicts, the Oxley bill is silent. On other issues both bills address, Rep. LaFalce argued that his bill’s provisions were superior.
“The provisions included in the bill will make it more difficult, rather than less, for the SEC to bar officers or directors who have committed securities fraud from serving in other public companies, by codifying the most restrictive current case law standard. The bill also fails to implement the President’s proposal to require” chief executive officers and chief financial officers “to stand behind the financial statements they submit.”
And Mr. Fleckenstein says that barring analysts from owning stock of the company they own, as the rules dictate, won’t do a thing. “They completely missed the boat,” he said. Instead they should be forced to own the stock. “If they have their own money at risk, they’re less likely to be investment whores,” he said.
Mr. Fleckenstein acknowledged that the industry isn’t likely to adopt his approach, but said that market. forces have already begun the process of solving the problem. “Do you think anyone will listen to Henry Blodget anyway?” he said in reference to the former Merrill technology analyst.
In a similar vein, AIMR President and Chief Executive Thomas A. Bowman said in a speech to AIMR in Toronto that Analysts’ pay should be “dependent on, and directly attributable to, the quality of their research and the success of their recommendations over time.”
What the New Rules Do
However many steps they represent, the new rules prohibit analysts from offering a favorable research rating (or threatening to withhold one) to induce investment banking business; prohibits the supervision of analysts by the investment banking department; allow firms to tie an analyst’s compensation to a firm’s general banking revenues, but require disclosure of any such tie; and require that firms disclose in their research reports whether they’ve managed or co-managed a public offering for the subject company in the preceding 12 months.
The rules also bar analysts or family members from trading in a company’s stock around the time they issue reports thereon; require analysts to disclose whether they own shares of companies they recommend; require clear explanations in research reports of the meanings of all ratings terms used; and require disclosures from analysts during public appearances such as television or radio interviews.
Sen. Paul S. Sarbanes (D-MD), chairman of the Senate Banking Committee, shares Rep. LaFalce’s views of the analyst/banker conflict and related matters. His staff is now circulating a discussion draft of a bill that would impose new regulatory requirements on both sides of the relationship between accountants and their corporate clients, and that would protect stock analysts from retaliation should they make unfavorable stock recommendations. |
