The decision by the Society of Investment Analysts in Ireland to adopt new standards aimed at ensuring the objectivity and independence of its members raises an interesting question.
Is it a tacit admission that the Irish market is not immune to the sort of problems that have become apparent in the US? Recent months have seen the departure from Salomon Smith Barney of star analyst Jack Grubman, albeit with a $32 million (€32.7 million) pay-off. SSB, which is part of Citigroup, decided that Mr Grubman was a liability after the extent to which he blurred the distinction between providing investment analysis and merchant banking became apparent. His aggressive buy recommendations contributed significantly to the telecoms bubble from which his company made huge profits. In return he received remuneration - reportedly $20 million last year - that reflected the merchant banking fees he helped generate for the bank. We have also seen Merrill Lynch, one of the world's most highly regarded banks, reach a $110 million settlement with the New York attorney's office over allegations that its analysts pushed shares they privately trashed in order to help win business for Merrill's merchant banking arm.
It would be naive to claim that the conditions that gave rise to this phenomenon in the US don't exist here also. The market is dominated by two large brokers, Davy and Goodbody, both of which are owned by Bank of Ireland and AIB respectively. Both these banks seek to provide a range of banking and corporate finance service to the companies quoted on the Irish market. In addition several international merchant banks are members of the Irish Stock Exchange and have active Irish equity desks. They include Merrill Lynch, Commerzbank , CSFB and ABN-Amro.
Sell recommendations are no more common in Dublin than in London or New York, but there is a big difference between choosing not to highlight the bad news about a client company and ramping a dud company. Not surprisingly the society is emphatic in its denial that the new initiative is a response to an incipient problem. "There is no hint of any problem here," according to the society, which also claims that its members enjoy a "very robust, very good reputation".
IF this is the case then one has to ask: Why go to the trouble of insisting on a regime that will put a considerable voluntary regulatory burden on companies that are already regulated by the State? The society is proposing that the Irish market adopt the guidelines that have been proposed by the Association for Investment Management and Research, the professional body for US research analysts. The Research Objectivity Standards are a direct response to the credibility issues raised for the industry in the US.
In order to become AIMR-ROS compliant firms will have to have a written formal document on the independence and objectivity of its research which will be provided to all clients and staff. It will have to put in place procedures that ensure the policy is adhered to and once a year a senior officer of the firm will attest to the company's compliance with its own code. Other requirements are that any relevant employees who discuss research and recommendations in public must disclose any personal conflicts of interest and any conflicts that the company might have. Research reports and recommendations "must have a basis that can be substantiated as reasonable and adequate". To ensure this all reports and recommendations must be approved by an appointed officer.
Investment banking firms have to put in place policies and procedures to segregate research analysts and the investment banking department. These include procedures to prevent the investment banking side of the business reviewing or rejecting research reports.
The salaries, bonuses and other compensation of research analysts should be alined to quality and accuracy of their recommendations and not linked to any investment banking or corporate finance activities on which they collaborated. Other recommendations cover the sort of contact that analysts can have with companies and their own investments. In particular they are prohibited from trading in a way "contary to, or inconsistent with" their own recommendations or those of the firm. There is a also a section devoted to compliance and enforcement, which requires firms to put in place effective procedures and disclose conflicts of interest. There is a similar list of recommendations for investment management firms and also corporate issuers.
The final series of recommendations covers the media. It suggests that media organisations have a written policy on how they handle disclosures of conflicts on interest.
It is pretty obvious that these recommendations are aimed at large US investment houses and implementing them would be expensive and difficult for most Irish stockbrokers and other investment businesses. It would also be a waste of time if - as the society maintains - there is not a problem.
So why is it seeking their implementation? One suspects the answer is a mixture of good public relations and expediency. The society has just become a chapter of the AIMR, so in reality has little choice but to evangelise on its behalf. It must also realise that it does no harm to be seen to be unilaterally seeking to clean up its act in the current climate.
The test will be whether what at the moment is a glorified public relations stunt ever becomes a reality. Let's hope so. Regardless of the reasons behind what the society is doing, the introduction of the AIMR standards can only be in the interest of investors, both large and small, as well as anyone who has a pension.
jmcmanus@irish-times.ie
