When “Investment Research” is not Independent Research

City analysts are swamped daily with research of variable quality. The move from printed reports to electronic media has triggered an explosion of content. Amidst all this noise, can investment managers sift out the key information they need? Unfortunately, knowing what to trust is complicated by the loose way in which research is described. Terms like “independent” are not always what they seem. The FSA aims to separate genuine independent research from more questionable marketing material. But there is little sign of the regulations working as intended.

Standards for genuine independent research are exacting, and much of what is put out by the largest investment banks and brokers meets these rules. But the problem is that good reports are mixed in with substandard “research”. The FSA requires this to be labelled as “non-independent” or “marketing material”, but adherence to the rule is patchy. Buried in a footnote, in very small print, a report might say “a marketing communication under FSA rules”. But this can come after much more prominent statements such as “we are a leading independent research company, promoting the highest standards of research”. It seems almost designed to confuse.

Without clear labels, who would realise that there might be client conflicts, or that analysts might have been permitted to deal ahead of publication? The FSA would not permit retail communications to bury the warnings in small print or in the middle of a paragraph. Yet, institutional clients are denied the same protection. The non-independent material is thoroughly mixed in with good independent research, creating a minefield for investors. Compliance with the rules on independence is time-consuming and costly, but we are failing to give due recognition to the quality and value of the result. The confusion favours research firms that take short-cuts.

The problem is growing, as equity sales staff increasingly put out market commentary or blogs. Often these highlight that they are not official publications and should not be treated as independent research. But unfortunately, not all observe the rules, and for a few, these blogs are compliance-lite. Clients value the immediacy of quickly distributed views. There is little time before the market opens for applying the independent research rules, and sales staff have the task of co-ordinating lots of different early morning impressions from their research colleagues. There is a risk of misuse of this sales material, as it is mixed up with all the independent output.

Social media can be even more challenging, with Twitter feeds that might link to research, yet not reveal conflicts. The FSA initially thought of banning use of social media for financial promotions, but relented and set out guidance in 2010. This put the onus on financial promoters to ensure communications are fair, clear and not misleading on any type of electronic media. Since then, little has been heard. The FSA’s concept that the rules should be media neutral, does not seem to recognise the ease with which unathorised individuals can comment on investments or promote. Media, such as Twitter, set new challenges for regulators and promoters alike. How easy is it in 140 characters to strike the right balance and put advice in context?

US regulators seem more aggressive with this. Some US firms have banned the use of social media entirely, whilst others permit it for client contact, but with carefully controlled content. Typically, this is designed not to be interactive with clients, but is simply passive output of pre-complied messages. For example, one US investment bank has allowed its financial advisers to use Twitter, but with a library of authorised tweets. It does not sound like the Twitter most of us know.

The explosion in electronic communications seems to have caught regulators by surprise. Rules can be set for authorised firms, but this is now mixed in daily with emails or blogs that are unapproved comment. Many using new media who may not even be authorised. Investment banks and stockbrokers face a dilemma. Clients clearly value immediacy and personal contact – sometimes, it seems, even more than compliance and professional standards.

Clients think they can navigate through this minefield, and make the right adjustments for possible conflicts as the material arrives on screens or phones. But, amidst the daily noise, with data arriving from hundreds of sources, can we really adjust for conflicts? Investment managers must switch back and forth rapidly between different types of media, and will rarely scroll to the bottom for risk warnings or click-through to a separate page to deliver that.

One mid-tier investment bank has moved back from independent research to marketing communication, apparently under pressure from clients for speed. The cost of delivering independent research does not seem to be valued by clients; few may notice the difference. But lower standards weaken the City’s reputation. The danger for the industry is of further polarisation, with more of the medium sized firms being pulled away from the expense of full independent compliance as they battle with smaller, nimble operators.

We need a new approach from regulators, recognising the different ways in which social media are used, and the lack of boundaries between authorised and unauthorised commentators. If regulators believe there is a difference in quality between independent research and marketing material, they need to make this work in the marketplace. The current system is increasingly being compromised, giving investment managers an impossible task.

It is time for regulators to assess what is happening in the real world; setting unrealistic rules may not actually be promoting higher standards. Currently, the only winners are the “research” firms that have cut costs and are allowed to hide their warnings. Regulators must act; they should recognise the growing problem, and demand clear upfront labelling.

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