[sgmb id=”2″]Pity the poor equity analysts.
When faced with making their final formalized, profound analyst recommendations after extensive
number crunching and model analysis, the analysts only can make three conclusions: buy, sell or hold. Of course, this can be modified by a “strong” or “weak” recommendation, but maybe there are more choices that should be available in the new era of monopoly capitalism and errant corporate behavior.
Maybe equity analysts should also be able to recommend that a corporation that is so egregious and antithetical to the public good be nationalized.
That would be the recommendation of many average citizens for the recent Well Fargo Bank scandal that certainly will be cited in business school case studies for decades as the real impact of opening blatantly false new bank, credit and debit card accounts, PIN numbers, and emails all in an effort to meet sales goals.
And while the fraud was known to the bank’s top executives, of course the burden felt on those at the bottom of the totem pole, some 5,300 mostly low-level employees who were terminated because of the scandal, according to CNN Money.
Equity Analysts Need More Choices
So what does the current scandal have to do with equity analysts?
Equity analysts have tremendous power over the fate and fortunes of publicly-traded corporations.
A negative analyst recommendation can drive down a stock’s price just as sure as the missed reporting figures from the corporation itself. Earnings surprises and negative ratings are shocks to the company’s stock price and are eagerly awaited by traders who look for any price shock to the upside or downside that can be leveraged to make a profit.
The most famous equity analyst scandal was in 1999 to 2000 during the infamous Y2K conversion at the millennium that also overlapped with the tech bubble. At that time, analysts were involved in the tech bubble and some created blatantly false buy recommendations to supplement the investment banking activities of some of Wall Street’s largest banks.
By 2003, after the dust had settled on the offending investment banks and analysts, the Guardian newspaper (April 28, 2003) reported that the corruption on Wall Street during the late-1990s tech boom was serious enough for the SEC to hit the banks with an historic $1.4 billion settlement of conflict of interest allegations. “The deal, agreed in principle at the end of last year and presented by the SEC, NASD and the New York Attorney General, settles claims that analysts published fake research which was presented as objective, but was actually a sop to win investment banking fees for their firms,” the Guardian reported.
The scandal even cost two analysts – Henry Blodget, formerly of Merrill Lynch, and Jack Grubman, once with Salomon Smith Barney – individual fines of $4 million and $15 million respectively, the Guardian said. The two were barred from the industry. Blodgett’s fellow star tech analyst, Mary Meeker, got off much easier.
At issue was the conflict-of-interests between investment banking and the so-called independence of the banks’ equity analysts.
CFAs Have a Responsibility
With the current unprecedented Wells-Fargo scandal, equity analysts should have a new, more serious recommendation protocol for banks that have gone off the deep end in terms of ethical commercial corporate behavior. This new classification should call for their nationalization or dissolution, which would be the ultimate form of “sell” recommendation.
Equity analysts should have this option when a bank or other publicly-traded corporation engages in business operations that defraud the unsuspecting general public or impair the environment. It’s time for equity analysts to exercise their real power over corporations. This is one new 21st Century way of exercising their power.
According to the 1999 AIMR (Association for Investment Management and Research) Standards of Practice Handbook, fundamental and quantitative equity analysts both have to adhere to standard Section IV (A.1) when it comes to making recommendations. Analysts must have a “reasonable basis and representations” standard that includes having “a reasonable and adequate basis, supported by appropriate research and investigation, for such recommendations or actions.” This standard also says CFAs must “exercise diligence and thoroughness in making investment recommendations or in taking investment actions.”
So given the extreme corporate fraud of Wells Fargo, it’s hard to believe that CFA equity analysts who follow Wells Fargo should not initiate a “sell” recommendation based on the systemic fraud at the bank. Or maybe it’s time equity analysts had another choice to make against corporations and banks that are clearly operating outside the realm of ethical and legal bounds. Maybe analysts should be able to recommend that errant corporations be nationalized as an example for others in the industry.