New SEC rules for sell-side financial analysts do not adequately address the issue of compensation, says Thomas Bowman, president and CEO of the Association for Investment Management and Research. The new rules prohibit paying analysts based on their work on a specific banking assignment and require disclosure of compensation based on an analyst’s contribution to investment banking generally.

“We would propose going further,” Bowman said at the AIMR annual conference in Toronto. “We would propose requiring that research analysts’ compensation be dependent on, and directly attributable to, the quality of their research and the success of their recommendations over time.”

Bowman noted that the securities industry is under “unprecedented scrutiny,” because of the Enron scandal, the investigation by the New York Attorney General’s office, and other developments. He says most AIMR members are not subject to the conflicts of interest that have dominated news coverage of the industry. The conflicts are faced primarily by sell-side analysts who work for investment firms that sell stocks and bonds and investment banking services, he said, and are known popularly as “Wall Street” or “Bay Street” analysts. Most AIMR members work for the “buy-side” such as the bank trust departments, investment counseling firms, pension and mutual funds, and other
investment management firms that buy sell-side research.

AIMR strongly supports the reform efforts championed by the SEC and by Canada’s Securities Industry Committee on Analyst Standards, Bowman said. As examples of the new rules AIMR supports, Bowman cited “specific and meaningful new disclosures, not boilerplate legalese,” concerning stock holdings of companies under review, and rules barring analysts from trading against their public recommendations.

But AIMR fears that they indeed do not go far enough, he said. Besides facing internal conflicts, from their employers, analysts face external conflicts, from the companies they follow and frominstitutional investing clients. The current climate presents an opportunity to address those conflicts too.
AIMR is developing “Research Objectivity Standards” that will go beyondwhat has been proposed by the SEC and that will be relevant worldwide, not just in North America. “Through these standards,” Bowman said, “wehope to help fuel a marketplace that actually competes in part on independence and objectivity, rather than running from it.”

In addition, Bowman called on research firms to broaden their rating systems beyond the one-dimensional “buy,” “sell,” or “hold” to include a characterization of risk and a time horizon. “Adding these other dimensions would help the average investor make a more informed decision,” he said.