Proposed Rules for Analysts Get Solid Marks
Some experts said they were pleasantly surprised by the scope of disclosure rules proposed Thursday to govern brokerage analysts--including a requirement that past ratings be plotted on a stock’s price chart in research reports. But they said the plan falls short of solving the industry’s inherent conflict-of-interest problem.
“It’s better than I was expecting, and it should do a lot for investor education,” said Jay Ritter, a finance professor at the University of Florida. “But let’s face it: As long as analysts are employed by [brokerages] there’s going to be a major league conflict. There’s still an economic incentive to be friendly to corporate management.”
The National Assn. of Securities Dealers devised the rules at the urging of Congress and the Securities and Exchange Commission, which have joined the debate over whether analysts are pushed to issue glowing research reports to win and maintain lucrative investment banking deals, such as stock underwriting.
The New York Stock Exchange on Thursday proposed similar rules for its member firms.
SEC Chairman Harvey L. Pitt immediately urged brokerages to abide by the proposed changes even before they are formally approved, a process that could take two months, after the agency invites public comment.
Many of the rules sought by the NASD, the industry’s self-regulatory agency, match those the Securities Industry Assn. trade group unveiled last summer--guidelines major brokerages say they already follow. But their adoption by the NASD and the NYSE would give the organizations enforcement power.
The NASD surprised some observers by telling brokerages to include charts in research reports showing a stock’s price trend and the points along the way when an analyst recommended that investors buy, hold or sell the stock, along with details about the firm’s rating system.
A common complaint is that Wall Street analysts are so biased that they often reiterate buy ratings on crumbling stocks, as with Enron Corp. last year. Performance charts would enable investors to see how astute an analyst’s earlier calls were.
That part of the plan, however, is likely to meet resistance, one observer said. “As an investor I’d be interested in seeing it, but I think broker-dealers will be averse to the idea unless they have spectacular records,” said Tom Carter, chief financial officer of StarMine Corp. in San Francisco, which evaluates analysts’ performance.
A proposed NASD requirement that brokerages define their stock ratings and provide data on how commonly each rating is issued would help individual investors who may be unable to read between the lines of research reports, experts said. For example, a brokerage’s “strong buy” rating might indicate that a stock is expected to rise 10% more than others in its sector during the next 12 months.
The true meaning of a “hold” rating has long been a sore point with brokerage critics. “Mom and Pop in Peoria might not know that ‘hold’ really means ‘sell,’” Ritter said.
A firm-wide breakdown of analysts’ ratings might show how inflated they can be, he said. Some observers, however, said a uniform stock rating system across the brokerage industry might be more helpful. Firms still use a hodgepodge of euphemisms such as “reduce,” “accumulate” and “market perform” when rating stocks.
“The proposal leaves a lot of room for ambiguity,” said Kei Kianpoor, chief executive of Investars.com, a New York company that tracks analyst performance. “What about brokerages that have two ratings on the same stock, like ‘near-term hold’ and ‘long-term buy’? Does that mean you should wait to buy, or buy and then wait?”
Ritter said he was pleased by proposals for a firewall that would prevent a firm’s investment banking department from reviewing or having veto power over analysts’ research reports before publication, and for disclosure of underwriting work done for a company “up front in big type rather than buried in the footnotes.”
But he and others said the overriding problem--pressure on analysts to accentuate the positive--remains. “Analysts who don’t cozy up to management [of companies they follow] will still have a hard time getting their phone calls returned,” he said.
Under the NASD and NYSE proposals, analyst compensation could not be linked directly to underwriting fees on a given deal, but bonuses could be tied to a firm’s overall underwriting success, Ritter noted.
“Companies choosing a [brokerage] to work with on a merger deal or a follow-on stock offering are still going to be starting from a list of firms whose analysts put out positive reports,” he said.
Carter noted that the NASD can’t regulate the behavior of corporate executives: “I hear of CFOs who tell the analyst community flat-out, ‘Here are the numbers, here’s the story and if you go out and say something different, your firm is not going to be getting any part of our investment banking business,’” he said.
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