New York, NY – The ResearchWatch article posted last night included Integrity’s view of the eight (8) of the most important trends or developments for the research industry in 2007. After careful consideration, we have identified three additional issues we would add to our list. This includes the following:
Research Best Practices
Over the past few years, the press, regulators, and retail investors have focused on eliminating the conflicts of interest associated with research produced by investment banks and NASD brokerage firms. As a result, various rules and regulations have sprung up to address these concerns, including the Global Research Analyst Settlement, Regulation AC, SEC Rule 2711, and other SRO rules.
It is important to note that many research providers, including a majority of the more than 450 independent research firms in North America, are not governed by these regulations. Instead these firms are legally seen as “publishers” rather than investment advisors. As a result, these research firms are protected by the Constitutional right of free speech.
This issue was highlighted in 2006 as Overstock.com and Biovail sued various hedge funds and an independent research firm, Gradient Analytics, accusing them of colluding to drive down the price of these firms’ shares. Of course, this is not the first time that a publicly traded company has tried legal scare tactics to pressure research providers into changing their negative ratings of the companies.
While the Overstock.com and Biovail lawsuits have move on to making more arcane legal arguments, the Gradient lawsuit has focused industry attention on the policies associated with producing custom research, the timing of distributing this research, and the conflicts associated with research firms (or their principals) also managing assets.
As a result, we suspect that one of the most important issues to impact the independent research space in 2007 will be the development and implementation of “best practices” to mitigate the potential conflicts of interest associated with producing and distributing investment research.
Reg NMS and MiFid
One regulatory development that is likely to have an impact on the research industry in the coming year is the roll out of Regulation NMS in the US and MiFid in Europe. While both of these proposed regulations are different in many ways, they are similar in that they attempt to ensure “best execution”. In fact, some commentators expect that Reg. NMS will ultimately lead investors to direct more of their execution volume either to electronic trading systems or alternative trading systems.
The reason we expect that Reg NMS and MiFid will impact the research industry is that these regulations could act to push equity commissions even lower, exacerbating the trend that has been in place over the past few years. This would mean even less commissions available to pay for third-party (sell-side and independent) research services.
One approach to pay for research using electronic trading systems would be for the buy-side to use an “execution plus” model, thereby directing their execution providers to add a specific amount to their commission to pay for their external research. Of course, we suspect that such a development would support the move to unbundling as execution and research costs will be more clearly defined.
Explosion in International Research
In the past five years, regulatory initiatives like the Global Research Analyst Settlement had a marked impact on promoting the independent research industry in the United States. Unfortunately, independent research outside the US did not have this benefit.
However, we expect that various trends including the use of CSAs overseas, unbundling, and the growing popularity of international equity markets, will help boost investor interest in independent research in these markets. As a result, we expect that the number of international independent research firms (domiciled outside of the US) will grow rapidly in the coming few years.
In addition to a gain in absolute numbers, we also expect that the European and Asian independent research industries will evolve much like it did in the US, with new research models growing up to meet the changing needs of the institutional investor community. For example, we would not be surprised to see a surge in the number of primary research, forensic accounting, quality of earnings, and other specialty research firms in Europe and Asia that are focused on serving the buy-side community.