FSA outlines options on analysts investment research

Howard Davies, chairman of the FSA said:

"Our analysis shows that the UK market is different from the US market in a number of ways. In particular there are fewer individuals who invest directly in the UK and might therefore respond to analysts recommendations and there is far less emphasis here on star analysts. We also have not had any specific examples of bias and corrupted advice."

"On the other hand, the market here is dominated by the same firms who operate in the US market. And there is some evidence both that analysts recommendations have been systematically more positive than market performance would justify and, more seriously, that analysts recommendations in relation to companies with which their parent house has a relationship are systematically more positive than the average. The proportion of buy recommendations made by firms acting as corporate brokers/advisors to the subject company is, at 80%, almost twice as high as the proportion of buys where the analyst does not work for the corporate broker. It is difficult to see how the differential in buy recommendations can be justified on any objective grounds."

"The differences between the UK and US markets mean that whilst US-style disclosure requirements coupled with mandatory qualifications for analysts might be one way of dealing with a perceived problem, letting the market find its own solutions, improving consumer education or even completely changing the approach to research are also worth considering. The Discussion Paper on which we are especially interested in comment from investors, both institutional and individual, canvasses all the viable options."

Examples of market-based solutions in the UK include moves by some investment houses to address the imbalance of buy and hold recommendations. If the FSA were to set disclosure requirements these could include requirements to explain the meanings of the ratings and give the percentage of buy/hold/sell ratings. Research reports could also include more detailed disclosures on any relationship an investment house has which may affect the conclusions of report.

The FSA will use the responses to this paper to assess need for change in the UK. Feedback will also support the FSAs contributions to the work of the Committee of European Securities Regulators (CESR) on the proposed directive on Market Abuse and to similar work by the International Organisation of Securities Commissions (IOSCO).

Comments should reach the FSA by 30 October 2002.

Notes for editors

1. The FSAs discussion paper 'Investment Research: Conflicts & Other Issues' is available on www.fsa.gov.uk/pubs/

2. Awareness of analysts conflicts of interest, as well as the conflicts of interests of their employers and clients, was heightened when the telecoms and technology stock bubble burst. In some well-publicised cases from the US, analysts were producing positive reports for their clients even while the values of those stocks were plummeting.

3. The nature of the work undertaken by analysts has changed. Analysts work now serves not only to gain information about individual stocks and sectors, but it also helps generate orders for the brokerage business of their company and is used to support bids for corporate finance business. Analysts knowledge is often used during such work and so the integrity of their reports may become compromised to improve the results of a deal.

4. All FSA-regulated firms have to comply with the 11 FSA Principles for Business. The most relevant ones in this context are: Principle 1 which requires a firm to conduct its business with integrity; Principle 6 which requires a firm to pay due regard to the interests of its customers and treat them fairly. Principle 8 provides that a firm should manage conflicts of interest fairly and Principle 9 provides that a firm must take reasonable care to show the suitability of its advice for any customer who is entitled to rely upon its judgement. The FSA can, if it is decides that it is necessary, take Enforcement action against firms and individuals based on these principles. This action can take the form of public censure, fines and even expulsion.

5. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection of consumers; and fighting financial crime

6. The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal.