Extend Reg FD to broking research

By R SIVANITHY, Published April 2, 2007

THERE'S no denying the profound impact stockbroking research has on daily trading these days. More often than not, a well-timed 'buy' report can send a stock flying, while a 'sell' report often brings its price crashing.

Unlike at the turn of this decade when houses heavily favoured employing day traders over analysts, brokers now recognise the value of sound research - and many have put strong teams in place. Together with the various officially sanctioned incentive schemes, this can only benefit the local capital market in the long run.

However, notwithstanding the advances made in the past 10 years, more can be done to upgrade the profession and offer investors an even superior product. The ultimate goal must be to serve the public to the best with independent insights backed by sound analysis, while bearing in mind the need for business practices to be consistent with a disclosure-based regime.

When trying to achieve this goal, why not then follow this reasoning: if companies are expected to make full disclosure of all material information all the time - known as Regulation Fair Disclosure or RFD in the United States - why not extend this same requirement to broking research?

Consider, for example, the disclosure of likely conflicts of interest between investment banking and research. Most foreign houses currently place a dubious and patently ridiculous disclaimer on page one of their company reports, stating that they may have an investment banking or other financial relationship with the company that could prejudice their analyses and recommendations. Beyond this, nothing more is said.

Local houses are only slightly better. Rather than draw attention to the fact that the report may be tainted, they include a sentence at the bottom of the first page referring the reader to the back of the report where roughly the same disclaimer appears.

Even if this practice is deemed acceptable, why not give full details of these potentially compromising arrangements between the broker and the company over the recent past, say six to 12 months, and put them on page one?

So if the broker played a role in the company's IPO or handled a share placement, the deal should be brought to the reader's attention and he can decide if it was significant enough to affect the report.

Then there is the distribution of new research. If an RFD-type rule were to apply to research, fresh reports would have to be given to all clients at the same time - and not selectively to the firm's own sales, proprietary traders and favoured customers.

In spirit, this is what houses are encouraged to follow. In practice though, anecdotal evidence from market sources suggests it is not always the case. Institutional and proprietary desks often receive the reports first, giving them an unfair advantage.

The slanted portrayal of past recommendations is another flaw in the reports put up by analysts. In his excellent book, titled Writing Securities Research (John Wiley & Sons 2007), ex-analyst Jeremy Bolland points out that analysts and brokers often only show clients successful calls and underplay failed recommendations.

He notes it is now a requirement in the US that research reports include the performance of all the recommendations over at least the previous one year. 'Whether or not this is a requirement in other markets, best practice would dictate that analysts not boast about their successes without giving a balanced portrayal of all their recommendations, including the unsuccessful ones,' says Mr Bolland.

There are many other areas where RFD can help advance the profession. For instance, in disclosing upfront whether or not the author of the report has immediate family members who own shares in the company being covered; and in highlighting the reasons for any change in recommendations and key investment risks pertaining to the company being covered.

RFD was formulated to ensure a level playing field - at least as far as possible - in a disclosure-based market. Most listed companies have already come to terms with it and have adapted accordingly. Perhaps it's time to extend the RFD to other areas where price-sensitive disclosures can be made, starting with broking house research.