Should you buy a used share from your broker?

By NZPA

Friday 7th June 2002

Used car salesmen have a reputation for being economical with the truth, but should we expect the same from a share broker?

If the car dealer or broker wants return business then the product has to stand up. A car dealer may decide to make a killing on a one-off deal. For brokers that's a dangerous game.

The broking industry has come under scrutiny in recent weeks after Merrill Lynch paid a $US100 million ($NZ204 million) out of court settlement with New York Attorney General Eliot Spitzer for allegedly misleading investors.

This week, the Securities Markets and Institutions (SMI) Bill, designed to "ensure confidence in the New Zealand market by increasing the effectiveness and efficiency of the law governing securities markets", was reported back to parliament by the finance and expenditure select committee.

It is part of a Government package, which includes the Takeovers Code and planned tougher insider trading laws, aimed at bolstering investor confidence.

The Merrill case revolved around the No 1 United States brokerage and icon of American capitalism pushing stocks that it privately acknowledged were rubbish.

Mr Spitzer's probe uncovered e-mails in which Merrill analysts secretly mocked stocks to which they had given top ratings.

They were also accused of making overly bullish calls so the firm could win investment banking deals -- a charge levelled at many Wall Street analysts.

A closer look at Wall Street analysts' research shows broking firms have a huge bias towards `buy' or `strong buy' ratings -- 62 percent. The average for `sell' ratings is only 2.7 percent.

Mr Spitzer now has Credit Suisse First Boston and Salomon Smith Barney, the brokerage of one of the world's biggest banks, Citigroup, in his sights.

Because of the out of court settlement, Merrill has never admitted culpability. However, it, and other Wall Street firms have reluctantly agreed to new rules that will force investment banks to focus on potential conflicts of interest.

Analysts will be required to provide disclaimers on the front page of research reports instead of burying them in small print; disclose valuation methods; the exact meaning of stock recommendations; conflicts of interest; and provide price targets on a stock that have "a reasonable basis".

They will have to disclose a brokerage's percentage of `buy', `hold' or `sell' recommendations and provide charts detailing the performance of past recommendations.

Finally, they will have to reveal commissions and there will be prohibitions linking analysts' pay to a specific deal.

All strong stuff. Should the same measures be applied here?

Independent analyst Brian Gaynor said the problem of misleading recommendations has always prevailed here and was rampant in the 1980s, but is not so dire at present because of the dearth of new issues -- where most misleading recommendations originate.

"It was dreadful in the 1980s, and I experienced it myself in my organisation when analysts were being forced to write positive reports on new listings."

Brokers connected with a new issue write glowing reports, put most of their own clients into a stock and keep writing glowing reports for a year or two afterwards until most of those clients have a chance to get out of the stock.

"You have to remember that analysts basically are sales people," Mr Gaynor said.

He did a survey of three New Zealand broking houses last month. Of 81 recommendations, 52 percent (42) were buys, 42 percent (34) were holds and only five (6 percent) were sell. A recent survey by the Australian Financial Review came up with similar proportions across the Tasman.

"Are there only 6 percent of shares that go down?" said Mr Gaynor.

One of the problems in a small country like New Zealand is that if an analyst puts a sell recommendation on a company, then the company won't talk to the analyst.

Another issue is that the route up the greasy career pole to senior management for an analyst is to avoid being negative .

Mr Gaynor also notes that it is a myth that brokers make just as much money when shares go down as when they go up.

"They don't. Brokers actually only make money when the sharemarket is going up, because that's when you get the volume.

"You don't see the real estate institute ever saying the housing market is stuffed. People should recognise that brokers are in the business to promote shares."

Australasian head of research at UBS Warburg, John Deakin-Bell, said his firm already has full disclosure of any potential conflicts of interest.

"What has happened in the States hasn't changed our procedures a great deal," he said.

"In the States it was an issue of analysts' independence -- an analyst had a buy on the stock that he actually thought was a sell."

Warburg's policy is that if an analyst wants to change a recommendation, it has to go through a committee of sales and research staff who discuss the merits.

Mr Deakin-Bell argues that the percentage of sell recommendations is smaller because brokerages don't research companies they think are poor businesses.

He also argues that because the Australian economy has been growing strongly in the past five years there is a natural bias towards buy recommendations.

He would not disclose Warburg's proportion of sell recommendations.

"People generally are hesitant to put sells on stocks because it is such a strong call. If the whole market is going down it's easier because you have a negative environment. But the Australian economy has been growing at 4-5 percent so you would expect there to be a bias towards buys."

Mr Deakin-Bell also rejects allegations that companies are more likely to get a positive recommendation if it is a client.

"If you looked across the recommendations, it wouldn't be any truer than average," he said.

Overall, he believes reputation is the main control on brokers.

"If stock brokers are continually doing the wrong thing, then the clients aren't going to pay them, so they won't be around for long."

Michael Webb, acting chairman of the Securities Commission said the Merrill case had global and local implications.

The commission has made some recommendations to Commerce Minister Paul Swain regarding requiring advisers to disclose material benefits and commissions. Commission staff are preparing a report on the implications of the Merrill case.

The main measure of the SMI bill will be a requirement of continuous disclosure of price sensitive information by listed companies. It will also require directors to disclose share dealings within five days. The powers of the Securities Commission will be enhanced.

Market watchers hope new Stock Exchange boss Mark Weldon will bring a new attitude to the exchange and industry .

Shareholders' Association chairman Bruce Sheppard said it was crucial for Mr Weldon to change the monitoring and enforcement of market rules from a "slap with a warm wet towel to a bite from a pit-bull".

"The first thing Mr Weldon has to do is make a clear statement that listing rules will be reviewed and made more robust in line with our international peers," Mr Sheppard said.

"He needs to turn with the tide instead of swimming against it," he said of the former Olympic swimmer.

Mr Weldon believes the lack of new listings is the exchange's main problem. But the former New York business adviser acknowledges that perception of the market is important. He plans to follow the same disclosure principles he observed in the US -- that " sunlight is the best disinfectant".

The new Securities Bill would "go a long way" to improving confidence, he said.

Mr Gaynor said the New Zealand market's performance in terms of new listings, individual participation, share price and capital raisings has been at the bottom of the world. Mr Weldon's appointment will be a step towards improving things.

He is not expecting miracles but said the appointment was a symbol that the New Zealand broking industry was finally ridding itself of the attitudes of the 1980s.

Comments from our readers

No comments yet