Securities firms are still debating a global settlement over equity research with New York state attorney general Eliot Spitzer, the SEC and other US prosecutors seeking to avenge investors’ losses. All the parties, though, seem to have lost sight of their true purpose. The changes proposed so far will neither restore faith in the system nor prevent future abuses. They are unworkable and thus irrelevant. Proposed reforms are targeted at the wrong level: at the institution not the individual.
If you really want to influence analysts’ behaviour, there’s only one route to follow – regulate their pay, focusing not so much on how much they are paid but what they are paid for.
These are the suggestions of Cary T Mills, managing director of an investment banking headhunting business who has specialized in the equity markets for eight years (Carytmills@aol.com).
First, tie analysts’ pay directly to the quality and accuracy of their work through a bonus formula imposed across the market. This might be divided into four chunks. Say 30% paid according to accuracy of work (a set amount that diminishes according to the falling percentage of accuracy on earnings, share price and other forecasts), the next 30% actually invested precisely according to analysts’ calls (watch those strong buys disappear), 30% on client reviews and 10% discretionary.
This not only symbolically but actually refocuses the analysts on producing accurate work. Further, by investing their money according to their calls, analysts effectively become their own clients. Their clients’ interests are quite literally their own and no matter how much covert pressure were applied, they would not risk up to 90% of their remuneration to gain a maximum 10% discretionary award from investment banking, the only room for illegitimate reward.
Secondly, establish a professional body globally that analysts must join if they are to practise (along the lines of lawyers’ or medical practitioners’ professional associations). This body would have a code of conduct that if broken would lead to analysts being struck off and thus unable to earn more from the profession.
This again would cause analysts to weigh a lifetime of earnings versus a little extra in one pay packet for touting a stock to curry favour with a CEO for an investment banking mandate.
Finally, in any future case where malpractice has been proven, the individual who had deliberately misvalued a stock should be personally fined for all earnings from the point of the indiscretion onwards. It’s draconian perhaps, but let’s not forget that they’re not supposed to do it in the first place and anyone who did do so, fully aware of the penalty, would frankly deserve to be punished heavily. Isn’t legislation supposed to discourage wrongdoing?
How would this be funded? By the equity department itself and a statutory levy on investment banking departments, say 10% of revenue. Bankers might protest, but the secondary business still provides ready access to clients for them to market their deals to. Indeed, remunerated as suggested, analysts would be far more effective at discouraging banks from taking on bad deals at the wrong time. You can’t imagine a bank marketing a deal that its analyst is slating or at least refusing to back. This is ultimately in the long-term interest of the bank, its reputation, clients, investors and market integrity, and thus confidence as a whole. The analyst’s role is thus transformed overnight into a market-wide institutional safeguard against poor deals.
Who could realistically object to such a proposal? Investors? They get better product and an effective filter on bad deals, for no more cost. The banks? They are prevented from carving up their businesses, given safeguards against bad deals, are able to maintain a valuable contact with clients, have their integrity enhanced. All this – through likely downward pressure on pay – at less cost.
Perhaps analysts themselves would object. Well, they are only being asked to be paid according to performance.
Let’s see if the regulators will go for it.
