Writing Securities Research: A Best Practice Guide, 2nd Edition

Foreword xv

Preface xix

Summary points and recommendations xix

Background xxii

Background to the second edition xxii

Background to the first edition xxvi

The changing regulatory environment xxvii

Introduction xxx

More education rather than more regulation xxx

The need to identify investment risk xxxi

Target readership xxxiii

Commercial benefits to compliance xxxiii

Local differences and specific circumstances xxxiv

Summary xxxiv

Case studies and examples xxxv

Themes xxxvii

Research coverage xxxvii

Sourcing information xxxviii

Reasonable basis for recommendations and risk assessment xxxix

Conflicts of interest xl

Writing in general xli

Acknowledgments xlv

Abbreviations Used in This Book xlvii

Chapter 1: Principles of Research 1

Key points 2

Definition and supervision of research 2

Supervision and control of research 2

Marketing research to the U.S. by foreign broker-dealers 3

Stock-picking tips 8

Continuing education 9

Cheating in tests 10

The realm of research 11

Ambit of securities regulations (bonds) 12

Ambit of securities research regulations (equity and credit research analysts) 13

Ambit of securities regulations (swaps and other derivatives) 16

Ambit of securities research regulations (marketers of research, including hedge fund research) 19

Ambit of securities research regulations (analysts as experts on sales desks) 20

Ambit of securities research regulations (stock-tipping bloggers) 21

Ambit of securities research regulations (media commentators) 23

Minimizing approval and publishing risks 26

Honesty and fair treatment of clients 28

Common securities-related violations cited by the SEC and FINRA of the U.S. 28

Regulations tightening up around the world (Hong Kong) 29

Regulations tightening up around the world (China) 31

Regulations tightening up around the world (Japan) 32

Front-running and selective distribution of research 35

Front-running and selective distribution of research (huddles) 35

Front-running of research 36

Selective distribution of research 37

Selective distribution of research (fact-checking) 39

Selective distribution of research (greater conviction of view) 39

Insider dealing and selective disclosure 41

Use/dissemination of price-sensitive information (general) 44

Use/dissemination of price-sensitive information (U.S.) 47

Use/dissemination of price-sensitive information (U.K.) 48

Use/dissemination of price-sensitive information (Hong Kong) 50

Use/dissemination of price-sensitive information (serial insider trading) 53

Use/dissemination of price-sensitive information (pillow talk) 54

Use/dissemination of price-sensitive information (economists) 56

Specific requests and proprietary information 58

Definition of publishing 59

Unfair portrayal of past recommendations 60

Performance of past recommendations 60

Conflicts of interest and disclosure of interests 62

Catering to investors with specific investment criteria 62

Shari’ah law implications for securities research analysts (stocks) 64

Shari’ah law implications for securities research analysts (bonds) 65

The virtues of a vice portfolio 67

Analyst surveys 67

Playing the voting “game” 68

Sourcing information 71

Acknowledging the source 71

Gathering confidential information 72

Receiving confidential information 76

Rumors, speculation and M&A 79

Identifying M&A candidates (putting companies into play) 81

Short selling by hedge funds (abusive rumor-mongering) 84

Defamation—libel and slander 88

Defamation 89

Intellectual property—copyright and plagiarism 91

Intellectual property 91

Research integrity and consistency 95

The problem 95

Disgruntled clients 95

The principles 96

. . . be consistent or explain apparent inconsistencies 97

Sector/country weightings and universes 100

Consistency of views 101

Top picks (research requirements) 102

Consistency of views 104

Technical analysis 105

Useful qualifications (technical analysis) 106

Coverage universe—initiations, terminations and transfers 106

Accountability principles 106

Initiation of coverage 107

Transfer or re-initiation of coverage 107

Co-authorship liability 108

Termination of coverage 109

“Under review” 110

Publishing new research 111

No recommendation? 111

No recommendations 114

Chapter 2: Reasonable Basis, Valuations and Risk 119

Key points 120

Consistency of recommendations 121

Explanation for inconsistencies 121

Following the market 122

Valuation support 122

Forensic analysis of accounts 122

Channel-stuffi ng and other activities 123

Cross-industry antitrust issues 124

Disclosures and notes 126

Pro-forma accounting and use of selective data 128

Reasonableness of valuations 128

Highlight valuation changes 129

The appropriate valuation methodology 129

Unrealistic expectations or questionable bases for valuation 130

Excessive valuations 132

Highlighting risks and volatility 133

Appropriateness of sell ratings 134

Short-selling by hedge funds (pushing the envelope?) 135

Management’s reaction to negative research (legal action) 137

Management’s reaction to negative research (restricting information) 138

Mis-selling and not highlighting risks 139

Highlighting investment risks (credit crisis of 2007/08, U.S.) 139

Highlighting investment risks (credit crisis of 2007/08, global) 142

Highlighting investment risks (general) 144

Evaluating risks and catalysts 146

Catalysts and consensus 147

Market liquidity and contagion risks 147

Foreign exchange and interest rate risks 147

Currency risks 148

Earnings risks 150

Brand theft risk 151

Brand theft 151

Brand usurping 152

Cashflow and liquidity risks 153

Valuation risks 153

Modeling and miscalculation risks 154

Modeling risks 155

Mispricing risks 156

Information risk 157

M&A risks 158

Corporate governance risks 159

Gauging corporate governance risks 159

Social responsibility 161

Corporate governance (social responsibility—rankings) 161

Durability of brand names 163

Corporate governance (social responsibility—the mass-consumer market) 164

Corporate governance (social responsibility—corporate governance excellence) 165

Executive remuneration 167

Corporate governance (executive remuneration) 168

Corporate governance (executive remuneration—disclosures) 172

Executive insider trading 174

Corporate governance (executive insider trading) 175

Equal treatment of shareholders 176

Corporate governance (equal treatment of shareholders) 177

Corporate governance (related-party transactions) 179

Corporate governance (equal treatment of

shareholders—related-party transactions) 181

Corporate governance (vote manipulation) 182

Corporate governance (independent non-executive directors) 184

National interest 184

Corporate governance (national interest) 184

Corporate governance (national interest—strategic industries) 187

Corporate governance (national interest—sovereign wealth funds) 189

Risk management 189

Corporate governance (false statements by issuers) 190

Corporate governance (risk management and rogue traders) 191

Corporate governance (transparency of operations) 196

Ponzi schemes 197

Corporate governance (risk management and money-laundering, bribery and corruption) 199

Credit rating risks 201

Analyzing risk (credit rating agencies) 201

Due diligence by investment bankers 203

Due diligence (failures) 204

Chapter 3: Independence of Research and Conflicts of Interest 209

Key points 210

Summary 210

Separating research and banking 211

Conflicts of interest (global settlements) 212

Conflicts of interest (collateralized debt obligations) 214

Conflicts of interest (auction-rate securities) 216

Managing contacts between analysts and bankers 217

Disclosures of interests and relationships 219

Conflicts of interest (private trading contrary to recommendations) 220

Analyst certification 221

Conflicts of interest (disclosures) 222

Writing research on banking clients 223

Conflicts of interest (watch lists) 225

Confl icts of interest (managing apparent conflicts) 226

“Pre-deal” research 230

Conflicts of interest (pre-deal research) 231

Influencing of analysts by issuers 234

Conflicts of interest (bribes) 234

Conflicts of interest (favors) 235

Conflicts of interest (issuers guiding analysts) 236

Conflicts of interest (employment) 237

Independent research firms 238

Alleged conflicts of interest (independent research firms) 239

Paying for sell-side research 242

Transparency in paying for research (inappropriate payments) 245

Paying for credit ratings 246

Chapter 4: Non-research: E-mails, Blogs and Internal Communications 251

Key points 252

Approval of e-mail and media appearances 253

Objective commentary on non-rated companies 254

E-mails 256

E-mails as research 257

Retention of e-mails 259

“Internal Use Only” 261

Chapter 5: General Writing, Editing and Publishing Considerations 263

Key points 264

Introduction 264

Getting the message across 265

Headlines and covers 265

Standards of taste 266

Bullets, key points and executive summaries 267

Publishing and distribution 267

Writing the text 268

Writing rules 268

Use the right word 269

Vocabulary for attributing forward-looking comments (using “will”) 269

Measurements and direction/degree of movement 271

Vocabulary for describing movement and performance 272

Words to avoid or use carefully 273

Bullshit Bingo (vocabulary and phrases) 274

Clarity of communication 275

Clarity, consistency, conformity and continuity 276

Be consistent or explain inconsistencies 277

Editorial departments and style guides 277

Translations into different languages 278

Mistranslations 278

Publishing independent yet integrated reports 279

Sensitivity to politics and religion 280

Sensitivity to politics and religion 280

Correcting errors 281

Courses of corrective action 281

Materiality of the error 282

Publishing of out-of-date story 282

Retractions 283

Helping the reader 286

Index 287