An honest recommendation
It really is little wonder that investment research is lacking in credibility. Try explaining to a novice that when an analyst puts hold on a research note, more often than not it actually means sell.
'So why don't they just say sell in the first place?'
'Because,' you reply with a patronizing chuckle at the ridiculous naivete of your student, 'being so upfront would risk offending the companies that they are independently analyzing.'
In such circumstances, HSBC's recent announcement that it is to abolish hold recommendations and order its analysts to publish as many sell as buy notes, comes as a welcome breath of fresh air. The buy and sell tags will be based on likely performance relative to each company's sector, effectively forcing an overall sector ranking out into the open.
While HSBC's move is to be welcomed, it is hardly a behemoth of the investment-banking world and, as its larger rivals were quick to point out, it therefore has less to lose on the corporate finance side. Get this quote from an analyst at one of its competitors, obviously slightly amused by HSBC's stance: 'They do not have many corporate clients and have the luxury of being able to do this sort of thing.'
Remember - it's worth repeating once again - that 'this sort of thing' is simply saying 'sell' when you mean 'sell'. It's hardly radical, although in investment banking circles it is deemed just that.
This radical leap into the unknown is just the latest response to a number of legal challenges to analysts and their employers that have emerged since the bull market came to an end. Most of these have centered on the spectacular optimism of technology analysts in the last few years. HSBC's investment banking ally Merrill Lynch recently settled one dispute from a brokerage client against its analyst Henry Blodget for $400,000. And in late August a federal judge dismissed a case against Morgan Stanley and its star technology analyst Mary Meeker as 'gross and unrestrained.' The case had been brought by shareholders in Amazon.com and eBay.
Needless to say, the judge's comments caused relief to ripple through the investment banking industry in much the same way that fear had spread prior to the judgment. Still, there are plenty of other lawsuits remaining and rapid, yet weak, responses from industry organizations in the US, Canada and Germany (previously covered in this column - July 2001) have done little to dispel the negative sentiment.
The investment banking industry deserves to be hit hard for its long-standing lack of concern over biased analyst research, but corporate attitudes also deserve a good shake-up. Most analysts have stories to tell about being shut out of the corporate information loop because they have released reports that were deemed too negative by corporate executives - even if they were accompanied by a watered-down hold recommendation. Indeed, it is usually only the more experienced or respected analysts in any one sector that will happily talk on the record to journalists about the negative aspects of a company's story.
Despite Regulation FD, the practice of granting favored analysts (read positive analysts) extra snippets of information is still rife at some companies. Some would argue that such an approach is human nature; similarly, the investment banks might argue that not wishing to offend potential corporate clients with negative-sounding research is human nature.
If analysts really are expected to come clean with their recommendations then corporate investor relations departments have their part to play, too. Granting equal access to securities analysts, regardless of their research or comments, might help ease the process.