The Risks that Securities Analysts face
July 30th 2012
The Delhi chapter of IAIP organized a Speaker Event in New Delhi on 30th July 2012. Jeremy Bolland, Head of Research Training and Best Practice, BNP Paribas Securities (Asia) Ltd, Hong Kong, delivered an extremely insightful presentation full of real world examples. Both members and non-members of IAIP attended and appreciated the event. The event qualified for 1.0 SER credit hours.
Jeremy organized the talk around the 3C’s of securities research – Compliance, Content, and Commerciality aspects. Regulators all over the world have increasingly focused their attention on the research work of securities analysts. As a result, analysts must meet ‘research specific requirements’ (such as disclosure of all conflicts of interest and relations with the companies covered) as well as comply with ‘Market wide laws’. The main risks for sell side analysts come from conflicts of interest, front-running, insider trading, defamation, and copyright / plagiarism. Often analysts are unaware of the breaches of compliance resulting in accidental wrong doing. Analysts must inform the employer or compliance department as soon as they become aware of their accidental wrong doing. In many civil settlements involving a variety of wrongdoings, Supervisory deficiencies were found to be a major cause.
Commercial implications of non compliance include fines, suspension of licenses to trade, and loss of business as clients take their business away. A case in point is US Global Research Analysts settlements from 2003-2007 in which most of the top US banks had to pay hefty fines. The same happened in 2008-2009 with CDOs. The regulator asked the research analysts to focus on reasonable basis for their opinions (valuation and risks) and provide detailed risk disclosures in their research reports. For risk disclosures, Jeremy advised that the analysts should include tables of sensitivity analyses and scenario analyses in every research report.
Jeremy pointed that it is extremely important to define what work is “research” and what work is not research. Research constitutes any analysis of “securities” for investment purposes that steers a client towards an investment decision. A historical analysis of “business” will not constitute research. Jeremy suggested that a company should separate “Research” (Published) from the “Non-research” (Emails, phone calls, Meeting Q&As).
Sell side analysts might face conflicts of interest due to their interaction with colleagues in Investment Banking / Corporate Finance, Sales teams, Proprietary trading desks and the management of companies they cover. Often, Front running occurs when the principle of fair distribution of research is violated. An example is “Trading huddles” (in which Goldman Sachs was fined USD 32 million in 2011/12) where the analyst gave a bullish view to traders and favored clients ahead of formal research.
Analysts also get accused of putting companies in play. An example would be an analyst identifying an M&A target (without any announcement from the company). Sometimes, the analyst might have actually done good research supported by verifiable facts and reasonable assumptions. And, it would be wrong to accuse the analyst in this case. Nevertheless, analysts are accused of spreading rumors and colluding. Analysts also get accused of collecting material price sensitive information and using this to indulge in Insider trading and Market manipulation. To avoid this, Jeremy suggested that analysts should represent M&A as risk to base case rather than base case. Also to prevent rumors, Jeremy suggested that analysts avoid pillow talk and not talk to spouses and friends about work. The US SEC also ruled in 2007 that not all pre-merger investments are illicit.
Regarding Content of research reports, Jeremy suggested that the research analysts should have reasonable basis for every opinion expressed in the research report. The report should answer the two key questions that clients ask: 1. Why should I buy/sell this stock? 2. What are my risks? So, the analyst should make detailed risk disclosures (sensitivity and scenario analysis tables). In addition, the analysts should also report Corporate Governance issues (for example: related party transactions, executive compensation, vote rigging, resignation of independent non-executive directors)
To avoid any defamation suits from the companies that analysts cover, the analysts should be careful about the language used in the research report especially that used in the title and the first paragraph. Jeremy suggested that analysts also qualify the sources of statements (for example: The company said…. or The court ruled….)
Jeremy concluded that analyst research is increasingly becoming the focus of regulators’ attention. It is important to define “research” by its content. There is potentially more risk in what’s not published (emails, phone calls, meeting Q&As). Fair distribution of research to all clients is important so that sales team is not the first client. Analysts suspected of putting companies in play might actually have done good research supported by verifiable facts and reasonable assumptions. A good research report can move the market. Therefore, it is important for analysts to maintain independence. Analysts should justify recommendations and highlight risks in their research reports. Last but not the least, analysts should follow all procedures and have employers support.
About the Speaker:
Jeremy Bolland is an Independent Securities Research Consultant. He had been Head of Research Training and Best Practice at BNP Paribas Securities (Asia) Ltd in Hong Kong. He is also the author of the book “Writing Securities Research: A Best Practice Guide”
Contribution by: Manan Agrawal, CFA, IAIP volunteer
Photographs by: Manan Agrawal, CFA, Parijat Garg, CFA, IAIP volunteers