Analysts' recommendations clouded by conflicts

RESEARCH analysts study publicly traded companies and make buy and sell recommendations on the securities of those companies.

Most specialise in a particular industry or sector of the economy. They exert considerable influence in today's marketplace.

Analysts' recommendations or reports can influence the price of a company's stock -- especially when the recommendations are widely disseminated through television appearances or through other electronic and print media.

The mere mention of a company by a popular analyst can temporarily cause its stock to rise or fall -- even when nothing about the company's prospects or fundamentals recently has changed.

Analysts often use a variety of terms -- buy, strong buy, near-term or long-term accumulate, near-term or long-term over-perform or under-perform, neutral, hold -- to describe their recommendations. But they rarely urge investors directly to sell the stocks they cover. One study showed that, in the 2000, less than one per cent of brokerage house analysts' recommendations were ``sell'' or ``strong sell'' recommendations. As a result, many industry professionals interpret a ``hold'' recommendation to mean ``sell.''

Investors should not rely solely on an analyst's recommendation when deciding whether to buy, hold, or sell a stock. Instead, they should also do their own research -- such as reading the prospectus for new companies or for public companies, the quarterly and annual reports filed with the SEC -- to confirm whether a particular investment is appropriate for them in light of their individual financial circumstances.

Who analysts are

Analysts historically have served an important role, promoting the efficiency of our markets by ferreting out facts and offering valuable insights on companies and industry trends. They generally fall into one of three categories:

*Sell-side analysts typically work for full-service broker-dealers and make recommendations on the securities they cover. Many of the more popular sell-side analysts work for prominent brokerage firms that also provide investment banking services for corporate clients -- including companies whose securities the analysts cover.

*Buy-side analysts typically work for institutional money managers -- such as mutual funds, hedge funds, or investment advisers -- that purchase securities for their own accounts. They counsel their employers on which securities to buy, hold, or sell and stand to make money when they make good calls.

*Independent analysts typically are not associated with firms that underwrite the securities they cover. They often sell their research reports on a subscription or other bases. Some firms that have discontinued their investment banking operations now market themselves as more independent than multi-service firms, emphasising their lack of conflicts of interest.

Potential conflicts of interest

Many analysts work in a world with built-in conflicts of interest and competing pressures. On the one hand, sell-side firms want their individual investor clients to be successful over time because satisfied long-term investors are a key to a firm's long-term reputation and success. A well-respected investment research team is an important service to customers.

At the same time, however, several factors can create pressure on an analyst's independence and objectivity. The existence of these factors does not necessarily mean that the research analyst is biased. But investors should take them into account before making an investment decision. Some of these factors include:

*Investment banking relationships: When companies issue new securities, they hire investment bankers for advice on structuring the deal and for help with the actual offering. Underwriting a company's securities offerings and providing other investment banking services can bring in more money for firms than revenues from brokerage operations or research reports. Here is what an investment banking relationship may mean: The analyst's firm may be underwriting the offering. If so, the firm has a substantial interest -- both financial and with respect to its reputation -- in assuring that the offering is successful. Analysts are often an integral part of the investment banking team for initial public offerings -- assisting with ``due diligence'' research into the company, participating in investor road shows, and helping to shape the deal. Upbeat research reports and positive recommendations published after the offering is completed may ``support'' new stock issued by a firm's investment banking clients.

*Client companies prefer favorable research reports: Unfavorable analyst reports may hurt the firm's efforts to nurture a lucrative, long-term investment banking relationship. An unfavorable report might alienate the firm's client or a potential client and could cause a company to look elsewhere for future investment banking services.

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(Source: www.sec.gov)