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Thursday, 14 June, 2001, 14:14 GMT 15:14 UK
Wall Street analysts under fire
Analysts now have a new set of guidelines to follow
Analysts now have a new set of guidelines to follow
By BBC News Online's North America Business Reporter, David Schepp

Since the bursting of the dot.com bubble, the recommendations of Wall Street analysts have come under intense scrutiny, with investors wondering whether the share tips were truly objective.

The US Congress has now begun hearings to investigate the securities industry's behaviour.

The analysts, who take a critical look at a company's operations, stand accused of issuing rosy stock ratings in the hopes of gaining lucrative fees for underwriting stock flotations.

In recent months they have come under fire for their overly postive stock recommendations that have caused some investors to lose money when share prices fell.

On Tuesday, 14 of the largest Wall Street investment firms - including Merrill Lynch, Goldman Sachs and Morgan Stanley - stepped forward to back new guidelines for analysts set forth by the Securities Industry Association (SIA), an industry trade group.

But the guidelines are just that - guidelines - and there are those who are clamouring that more must be done to keep deep-pocketed investment banks in check.

Broken system

US Representative Richard Baker says the current system is broken and needs be fixed.

"We must have - as investors - confidence that markets are functioning properly," Mr Baker told the BBC. "Today, I don't think we can say that."

The Louisiana Republican is heading the hearings into analyst recommendations. His Subcommittee on Capital Markets will hear testimony from investors, brokerages and even members of the media, who are partly responsible for the "rock-star" status some analysts have achieved.

"There's obviously a natural pressure for the analyst to be more co-operative with the business community than perhaps their professional responsibilities would indicate," Mr Baker says.

It is a point not lost on analysts, who must balance the day-to-day pressures of issuing accurate ratings and not throwing away new business.

"There's always pressure on an analyst not to say 'sell'," says Michael Mayo, an analyst for Prudential Securities.

"The companies that you follow want you to say nice things. If you say nice things about the companies you cover, then they'll return the favours."

But Mr Baker says that is not the way it should work: "I think it inappropriate, for example, for an analyst to recommend 'buy' and have a personal portfolio where he may be selling that exact stock."

Mr Baker adds the current Securities and Exchange Commission rules already prevent an analyst from doing just that.

Tough issue

For investment banks, it can be a tough issue.

On one hand the firms want their research departments to appear unbiased and thorough. On the other, they must balance the recommendations made by research with the deals they wish to secure in underwriting stock deals.

As a result, they frequently encouraged investors to "buy" or "hold" stock and only infrequently encouraged them to "sell".

"The natural incentive is to avoid releasing an unfavourable report that might alienate the company and impact its future investment banking business," acting SEC chairman Laura Unger said in an April speech.

In issuing its guidelines on Tuesday, the SIA said analysts should adhere to a number of principals, including to not trade against their own recommendations and disclosing their holdings in the companies they cover.

Investing boom

The dilemma has been partly borne out of the '90s boom in investing.

Financial analysts achieved cult status, appearing frequently on cable financial news channels as investors salivated over rising stock prices.

While times were good and stock prices at all-time highs, analysts had little reason to fear their credibility would be called into question.

But when the bottom fell out of the market and analysts' buy recommendations on flailing dot.coms were suddenly under scrutiny.

The precipitous drop in share prices of internet-related companies contributed to the growing scepticism about analyst independence.

As one industry expert noted, the dot.com bubble exposed the dangers of ignoring fundamental analysis.

Frank Fernandez, chief economist at the SIA, says a change in the structure of the market has contributed to the scrutiny being foisted upon analysts and their recommendations.

"With the market downturn," he says, "you've exposed these analysts to this criticism."

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10 May 01 | Business
When not to believe the experts
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