"...a 'sell' recommendation from an analyst is as common as a Barbara Streisand concert." Arthur Levitt, SEC Chairman
The Economic Club of New York, New York City
October 18, 1999
sec.gov
Excerpt:
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A little over a year ago, I voiced concerns over a gradual, but perceptible, erosion in the quality of financial reporting. The motivation to satisfy Wall Street earnings expectations was beginning to override long established precepts of financial reporting and ethical restraint. A culture of gamesmanship over the numbers was not only emerging, but weaving itself into the fabric of accepted conduct.
I thank those in corporate America who took to heart the call for greater integrity and accountability in the financial reporting process. I also recognize and applaud the efforts of private industry groups that strive to "raise the bar" in the investment management industry through voluntary compliance with high ethical standards. Your commitment and your efforts have made a real difference. While we have made strong progress, the gamesmanship, unfortunately, persists.
A gamesmanship that says it's okay to bend the rules, tweak the numbers, and let small, but obvious and important discrepancies slide; a gamesmanship that tells managers it's fine to cut corners and look the other way to boost the stock price; where companies bend to the desires and pressures of Wall Street analysts rather than to the reality of numbers; where auditors are pressured not to rock the boat; and a gamesmanship that focuses exclusively on short-term numbers rather than long-term performance.
We've all seen what happens when a company misses an analyst's earnings target by just a few pennies. The stock plummets. It's remarkable, but today, a near miss is a miss by a mile. I can't tell you how many times an investor has come up to me ? incredulous and exasperated ? because a company's market capitalization dropped by millions of dollars simply because it was a penny or two shy of its earnings estimates. Unfortunately, there is no law of economics I can cite, no reasonable correlation from which investors can draw.
I can only point to what I see as a web of dysfunctional relationships ? where analysts develop models to gauge a company's earnings but rely heavily on a company's guidance; where companies' reported results are tailored more for the benefit of consensus estimates than to the reality of the ups and downs of business; where companies work to lower expectations when they fully expect they'll beat the estimates; and where the analyst attempts to walk the tightrope of fairly assessing a company's performance without upsetting his firm's investment banking relationships.
Our review of the relationship between companies and the analysts who follow them indicates that analysts, all too often, are falling off that tightrope on the side of protecting the business relationship at the cost of fair analysis. Analysts are a fixture on business pitches and investor road shows ? doing their bit to market their own firm's underwriting talents and to sell a company's prospects. What's more, analysts' compensation is increasingly based on the profitability of their firm's corporate finance division, and their contribution to the deals to which they are assigned.
Needless to say, you can see how an analyst who recommends selling a client's stock because it's overvalued would not be terribly popular. In many respects, analysts' employers expect them to act more like promoters and marketers than unbiased and dispassionate analysts.
An all too candid memo from a leading Wall Street firm's corporate finance department couldn't have framed the conflict more plainly: " . . . We do not make negative or controversial comments about our clients as a matter of sound, business practice. . . the philosophy and practical result needs to be 'no negative comments about our clients'."
An analyst who goes against the grain may find himself excluded from conference calls, or worse, as I recently read, even silenced by his own firm. Is it any wonder that today, a "sell" recommendation from an analyst is as common as a Barbara Streisand concert. And, is it any wonder that many Wall Street firms would prefer that analysts heed their mothers' admonitions: "If you can't say anything nice, then don't say anything at all."
How many times have we seen an analyst on television being asked to list his top five picks? And, how many times has that analyst taken the opportunity to caution viewers, "By the way, my employer recently underwrote three of these stocks?" More often than not, he hasn't. And that's because some firms claim that these recommendations are either "extemporaneous" or covered by a prior disclaimer, or that disclosure is just plain distracting or impractical. Frankly, I don't find any of these arguments very persuasive.
I think the time has come for the SROs to consider whether investors are told ? in a meaningful way ? when the analyst's employer has a recent investment banking or advisory relationship with the company that is being recommended. We cannot settle for boilerplate disclosure, cloudy language that masks a firm's position, or small type disclaimers at the end of the document. In addition, firms should reexamine their compensation practices for analysts and ask themselves this simple question: Do our payment practices ensure unbiased and quality information?
Let me turn to another important issue in the area of analyst communications: selective disclosure. The behind-the-scenes feeding of material non-public information from companies to analysts is a stain on our markets. This selectiveness is a disservice to investors and it undermines the fundamental principle of fairness.
In a time when instantaneous and free flowing information is the norm, these sort of whispers are an insult to fair and public disclosure. We've also all heard about those roadshows where the banker's analysts give some investors a select look at an IPO that's not available to ordinary investors. While roadshows obviously serve a valued purpose, they shouldn't be the vehicle for giving a very different look at the company that's not in the prospectus.
Unfortunately, there is no simple regulatory or legal fix to this problem. But the Commission is planning to take action where it can. Within the next few months, we will consider proposing rules to close the gap between those in the so-called "know" and the rest of us in the public. But edict can never replace ethic. I appeal to companies, in the spirit of fair play: make your quarterly conference calls open to everyone, post them on the Internet, invite the press.
Don't misunderstand me, analysts serve an important role in ensuring the efficiency of our markets by ferreting out disparate facts and offering valuable insights. In a market that increasingly demands that all participants add value to compete, analysts have positioned themselves well to do so. But if analysts continue to view the world through rose-colored lenses, they doom themselves to irrelevance. As more and more investors, even retail investors, recognize sell-side analysis as a marketing tool, they will increasingly turn elsewhere for reliable research.
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-Eric |
