Guidelines too little, too late

Up until a year ago, Mary Meeker was the highest-rated technology analyst in America, the “Queen of the Internet,” and Wall Street’s number-one cheerleader for the “new economy.” While the good times rolled, the dot-com diva was praised by business leaders and the media for her “vision” and “laser-like analytical skills.” Now that the party’s over, she’s the “lead villain” of the high-tech meltdown, “an incredible embarrassment to the investment-banking industry,” and just plain “nutty.” To add insult to injury, her fall from the pedestal has become cautionary-tale grist for business magazines, including one emblazoned with the headline “Can we ever trust Wall Street again?”

Good question, though the Securities Industry Association (SIA) is hoping to diffuse the answer and circumvent a potential public relations disaster. In mid-June, it rolled out “best practice” guidelines for research analysts as part of a broader effort to “maintain the public’s trust and confidence in capital markets and our industry.” The SIA proclaimed that “investors’ interest must come first” and that high professional standards are “a responsibility we incurred when we chose to manage other people’s money [OPM].”

It’s a smart move, given that the federal government is already investigating the cozy relationship between the research departments and investment banking divisions of major brokerage firms. It’s a necessary move, given the scorn being heaped on analysts these days. They are under fire for shoddy research and ludicrous valuations, for shamelessly touting overpriced shares that their investment banks underwrote, for almost never issuing sell recommendations, and for throwing the old rulebook out the window when it was needed most. As one investor sniffed, there’s more to being an analyst than trend-spotting and issuing a string of buy recommendations.

Indeed there is, which is why the SIA’s newly found commitment to “professional standards” and “best practices” won’t stop the barrage of criticism being levelled at the profession. It’s too little, too late for thousands of burned investors, and it’s a safe bet that those who lost big money will be seeking remedies other than industry self-regulation motivated by fear and self-preservation.

What’s more, the finger-pointing does not stop at the research community. Underwriters are accused of under-pricing initial public offerings (IPOs) for the benefit of favoured clients, particularly those who had promised to use their profits to buy more shares in the after-market, or to buy shares of other, less-exciting IPOs. And, rightly or wrongly, banks and brokerage firms are perceived as having been more interested in chasing lucrative commissions, underwritings and mergers than in preserving the wealth of investors.

High-tech corporations and their executives and auditors haven’t emerged unscathed either. Class-action lawsuits have been filed, and dozens of major investigations are under way, with many focused on allegations of insider trading, accounting irregularities and improper disclosure. In California’s Silicon Valley, the high-tech beat has become a crime beat for local reporters now that the Securities and Exchange Commission has added eight new attorneys to its 21-person staff. The U.S. Attorney’s office has seven lawyers working on securities fraud there, up from zero a few years ago.

Toronto’s Bay Street is feeling the heat too, now that high-flyer Nortel Networks has been grounded by massive losses and reduced demand for its products and services. JDS Uniphase and numerous other high-tech darlings came back to earth with a thud too, prompting dozens of analysts to slash their forecasts and price targets. Investors were not amused.

At last report, though, Queen Mary was staying the course. In late April of this year, she reaffirmed buy ratings for Yahoo! (even after it reported layoffs, losses, and a major collapse in advertising) and various other walking-wounded Internet stocks. Her rationale? “If we believe in the business, the last thing we’re going to do is downgrade it at the bottom.”

Meeker has few options but to believe. She built the case that a technology revolution would crush the pillars of the “old economy,” and create a new world order dominated by dot-coms. She created a new methodology for estimating companies’ value, based on how much a web visitor or a software user might spend in the future, and projected revenue and profits based on those estimates.

Now tossed about on stormier-than-expected seas, Mary Meeker is, at the very least, a captain willing to go down with her ship. The rest of Wall Street is merely promising to do better next time.

The SIA’s key recommendation is that research departments should not report to investment banking or any other business units that might “compromise their independence.” Analysts should be “encouraged” to indicate both when a stock should be bought and when it should be sold, and management should “support” the use of the full ratings spectrum. Analysts should not trade against their recommendations and should disclose their holdings in companies they cover. Pay should not be linked to investment banking transactions, sales, and trading revenues or asset management fees.

The member firms of the SIA believe that their commitment to best practices sends “a strong message to the investing public that serving their interests is our first priority.” It will be interesting to see what sort of “strong message” investors send in return.