• AUGUST 10, 2001

Will SEBI follow SEC?

Analysts in the US have finally come under regulations after giving several what now looks to be biased stock recommendations. All the top investment bankers including Goldman Sachs, CSFB and Merrill Lynch have imposed strict disclosure norms on their analysts (a step in the right direction, although late)

To protect the investors’ interest, the Securities and Exchange Commission (SEC) has already warned investors not to rely solely on analysts when making an investment decision. This is due to the fact that there are possibilities of conflict of interest between analyst and companies they cover.

Take Mary Meeker (Internet analyst) of Morgan Stanley, for example, who was once dubbed to be the ‘doyen on wall street’. It was recently alleged that she provided biased research on media and Internet giant AOL-Time Warner. The lawsuit concerning AOL Time Warner alleges that Morgan Stanley and Meeker failed to disclose that their main job was to attract and retain investment-banking clients from Morgan Stanley. As a result her stock recommendations were allegedly based not on objective analysis but on her desire to retain AOL as a Morgan Stanley’s client. Analysts are generally perceived to offer unbiased reports. But with the boom in the IPO market in late 1990s, the line of separation (between investment banking and research) has narrowed.

SEC has issued a detailed set of guidelines for investors after a series of such cases. According to the guidelines, investors are required to do preliminary research such as reading the prospectus for new companies, annual reports and the press release filed with the SEC before making investment decision. The word of caution from the SEC is supported by the fact that the analyst’s firm might be competing to get underwriting or banking business from the company under coverage. Consequently, the recommendations are influenced significantly.

Apart from this, analysts’ also face conflicts because they may own stocks in the companies they research. Also, most of the time, their compensation is linked with the amount of money the investment bank brings in through deals with the covered companies. These concerns have forced the top investment bankers of the Wall Street to impose strict disclosure norms on analysts.

While Goldman’s analysts are required to disclose stock ownership in the companies they cover, Merrill Lynch has prohibited its analysts from owning stocks in the companies under their coverage. CSFB, which is facing the regulatory investigations, has instituted a similar policy for both its stock and bond analysts.

SEBI is in the process of implementing such policies. When we link the US markets with the volatility in the Indian markets, we forget to remember the fact that the policies are more stringent and decision making is much faster there than in India. SEBI needs to become even more proactive to prevent the scams and bring back investor confidence. The liquidity in the markets could only increase then. Not to mention that retail investors in India could be relatively safer while relying on the research reports of firms, which have no investment-banking interests. Preliminary analysis is the best way before making any investment decision. And this is also the first principle of investing.

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