Mark Hynes - thoughts on corporate disclosure

Opinions on changing rules, changing best practices, and their effect on investor relations officers.

Wednesday, July 04, 2007

Changes in soft dollaring will change companies’ analyst relationships

One of the key focus points for most IR professionals is relationships with their sell side analysts. Research and morning notes from these analysts can sway investors and affect share prices. So what to make of the latest reviews and commentary on the way of life of the sell side?

SEC Chairman Cox – in testimony this week to the House – commented “the SEC has intensified its focus on “soft dollars” that brokers receive from mutual funds”. In other words they are thinking of regulating. This is against a background of years of attempts by regulators on both sides of the Atlantic to end the practice of “soft dollaring”, or at least to ensure that the independence of the research (by separating it from the banks’ corporate finance activities) is protected.

Under soft dollaring, investment banks generate research and provide it to institutional investors. This research is supposed to be paid for by commission income, however the amount of commission spent by the buy side on sell side research is falling fast. And with institutions– especially long investors - increasing their spending on in house research, the value proposition for the sell side in producing the research is getting worse. Add in the compliance challenges for companies in dealing with the sell side as compared to the buy side, and on the surface, sell side research is doomed.

However many believe that however it is paid for, there will be a role for outside research in order to blow fresh air through the thinking at institutional fund managers. And emerging evidence suggests that independent research – certainly outside the US, where EPS guidance is almost non existent - is better at earnings forecasting.

So how does this changing world impact IRO’s? What could / should they be doing to address this brave new world?

The change needs to be recognised. Communications processes and relationships built up over years will need to be re-thought. As the influence of boutique research shops – paid in cash by institutional fund managers to produce innovative research – widens, resources at companies will need to be invested in identifying the influential boutiques and building new relationships. This at the same time as continuing to support the traditional sell side analysts.

There are – at least – 2 positives to come out of this situation.

First, the quality of research should get better. Investors paying hard – rather than soft – dollars for the research will demand quality.

And second, the knotty problem of coverage of smaller companies may be addressed. Independent analysts will not be hamstrung by the need only to cover the most high volume stocks to earn commission. Rather the reverse, they will be encouraged to identify winners outside the usual suspects. In fact, the numbers of analysts covering larger companies could even go down.

Is this purely a US phenomenon? By no means. Even though it is the SEC that has kicked the ball into play again, the transatlantic nature of the investment banking world will create a common standard.


  • At 2:35 pm, Blogger CrypticLife said…

    So, what kind of effect will this have on small to mid-sized sell side brokerages that already have highly regarded research arms such as Sandler O'Neill or Keefe, Bruyette & Woods? Do they get additional competition from the potential legislation? Or could this be a bonanza for them, as new fund managers seek them out for their historical expertise?

  • At 10:45 am, Blogger Mark Hynes said…

    Sorry for the slow reply - been on the road again!
    My view would be IF - and its a big IF - legislation comes, it will present those excellent research arms with an opportunity to sell that research for hard dollars. The focus will I suspect change from top index companies - where the buy side is already well researched - to smaller companies that present an opportunity even though they may be thinly traded to date.
    Love to know your view!

  • At 7:42 pm, Anonymous Anonymous said…

    You Stole my name you jerk. I'll be taking back my domain sometime soon!


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