expert_views

Who pays for Investment Research on small caps: The debate continues

• FROM: July 2006 |
• TAGS: faegre & benson, mifid |
• COMMENTS: Add yours

• Who pays for Investment Research on small caps: The debate continues
• | Printer-friendly version

DONALD STEWART believes MiFID will rewrite the rules making things much more difficult for small caps

The role of financial research is now a standard part of the AIM IPO process. In order to generate interest in a company, brokers will send out “research notes” well ahead of a scheduled IPO in order to whet the appetite of professional investors.

Not least because of the US$1.4 billion settlement reached between Eliot Spitzer, the New York State Attorney General and ten Wall Street investment banks, there has been an increased awareness of the potential conflicts of interest which arise in the dissemination of investment research by investment houses whose own corporate finance departments are trying to sell the issue. The FSA tightened up our domestic rules in 2004 and in June 2005 published a MORI report on the impact of those changes.

That survey showed that since the FSA rule changes the majority of sell-side firms have put in place a conflicts policy and make it available to clients. As a result there is much increased confidence on the buy-side as to the objectivity of research held out as impartial. However buy-side fund managers and analysts still depend to a very large extent on their own ability to identify bias in a research report. So the current system depends for its continuance on the sell-side being happy to admit that their research may not be impartial and on the confidence of the buy-side on relying on their own instincts and feeling that they are not being disadvantaged. So far so pragmatic, particularly when considering the costs of covering small companies.

The issue now is that the EU is about to impose its own revision of the existing rules as part of its Markets in Financial Instrument Directive (MiFID), currently scheduled to come into force in November 2007. While MiFID provides that investment firms “shall maintain and operate effective organisational and administrative arrangements with a view to taking all reasonable steps designed to prevent conflicts of interest…from adversely affecting the interests of its clients…”, the devil, as always, is in the detail in the form of the Committee of European Securities Regulators’ (CESR) advice to the Commission on implementation. Amongst CESR’s recommendations are that persons who produce investment research “must not acceptany payment or inducement from issuers, or others with a material interest in the subject matter of the investment research, other than minor gifts or hospitality…” and “must not be directly supervised by a natural person who has responsibilities or interests that might reasonably be considered to conflict with the interests of the client to whom the investment research is disseminated”. Furthermore the remuneration of investment researchers “must not be directly determined” by such a person or “create any incentive which is inconsistent with their objectivity …”.

The implementation of these new rules is likely to have a serious impact on the issuance of investment research to third arties, the structure of research departments and the remuneration and career prospects of individual analysts. The debate about who pays for small cap investment research is about to enter a new phase.

DONALD STEWART is a partner at Faegre & Benson LLP, who specialise in providing services to AIM companies, and a Director of the Quoted Companies Alliance. To find out more visit: www.faegre.co.uk

Have something to say?

Discuss this article: post your comment below. Please be polite. We reserve the right to delete any inappropriate comments.

Name: (required)

Email: (required)

Web address:

Your comment (required)

Remember my personal information
Notify me of follow-up comments?