Trade Secrets

It used to be that being a securities analyst was a pretty cushy job: Your followers were elite and educated. Few people understood what exactly you did for a living. Even fewer understood it enough to question or regulate your actions. Then came the tech boom, and lots of people made money. Then came the tech bust, and lots of people lost money. Now it's not so much fun being a securities analyst. "We saw along with everyone else that analysts and analysts' practices were becoming controversial," says Dan Michaelis, a spokesman for the New York-based Securities Industry Assn. (SIA), which in June published a list of "best practices" to ensure the integrity of analyst research. "I think the downturn had something to do with it." Indeed, following the ill-fated, turn-of-the-century trading frenzy predicated on "new economy" technology companies, it seems everyone from downtrodden investors to analysts themselves is calling for more disclosure among the professionals who follow corporate performance and determine via research and review the worth of public companies as investments. In addition to SIA's best-practices list, many major security firms have published their own guidelines for analysts in the last six months, and Rep. Richard H. Baker (R-La.) has been holding hearings in Washington to review -- among other market-related drivers -- analysts' influence on stock-price fluctuations. The attention focuses on two areas: analysts owning stock they are reviewing, and analysts' relationships with the investment-banking side of their businesses, specifically whether there is pressure for analysts to talk up certain stocks to better their employers' chances of landing lucrative investment-banking contracts from those companies. Among other things, the SIA guidelines recommend that analysts should not trade against their recommendations, they should disclose their holdings in companies they cover, and their pay should not be directly linked to investment-banking transactions, sales, and trading revenues. Michaelis says all 700 SIA member firms -- representing 95% of U.S. brokerage activity -- have endorsed the guidelines. Many firms have issued even more stringent rules for their own analysts, such as prohibiting them from owning stocks they cover. But these do not go far enough for some people. Baker has said outright that the SIA guidelines don't completely address the disclosure issue. "He felt he read into the [SIA] proposal a caveat that said 'We promise to be honest unless circumstances don't allow for it,'" says Michael DiResto, Baton Rouge, La.-based press secretary for Rep. Baker. "First, there are no sanctions. Second, there is no way for enforcement of their own rules. Third, when he hears language that analyst compensation won't be 'directly linked' to investment banking activity, he is concerned." Amy P. Hutton, an associate professor at the Harvard Business School who has researched analyst disclosure, also calls for more action. She was appointed by Baker to a review board of his House Subcommittee on Capital Markets. Hutton points out that securities analysts, unlike doctors and attorneys, can't be booted from their profession for misconduct. She calls for analysts to police their own profession with a system that allows for removal of bad apples. Right now, she says, there is a free-rider policy. "Regulators are not the ones with the biggest incentive to get this right. Any time analysts shirk on professional conduct, they are taking the profession a step lower." Others reviewing this issue warn against blanket regulations. Having a variety of policies at various firms would offer consumers more choice, they say. "There are those who would view an analyst owning his own stock as the ultimate endorsement," Michaelis points out. Despite the attention paid to analyst conduct, Baker and others say companies, the media, and even investors could share some of the blame for the speculative trading in technology stocks that has left many people broke. DiResto said that in Baker's second hearing (July 31) the congressman's message about analysts was: "There is a plethora of pressures on them, and they are not the ones who started this, but they are not exonerated." And both Hutton and Michaelis stress that more consumer education is needed, especially with the growth of self-directed investments such as IRAs and 401(k)s. Formerly, institutional investors were the primary audience of analysts. Now that audience includes retail investors -- regular working folk -- and they need to understand what makes for a good analyst. "We've made a strong point of telling investors [when SIA released its guidelines] that they should not rely solely on an analyst when buying a stock," Michaelis says. "They should comparison shop."