The New Compliance Regime Challenges Analysts


Most security analysts were trained in an era when ethical issues centered on conflicts.  Now the ethical focus has shifted to information control, which poses new challenges for the analytic process.  Information control moves compliance into the center of securities analysis from the periphery where it has existed up until now.  This requires big adjustments for both analysts and compliance staff.

In the wake of the bust in 2000, regulators focused on the conflicts between investment banking and equity research.  The Global Research Analyst Settlement and related regulations in 2003 created a series of compliance activities designed to maintain analytic independence in the face of conflicts and internal and external pressures.

In the wake of the mortgage bust and ensuing financial crisis in 2009, the regulatory focus has been on controlling inside information (even though no one believes inside information was a cause of the crisis.)  Although there is no new regulation ensuing, aggressive enforcement and prosecution has prompted institutional investors to implement rigorous information controls.  Unlike the previous crisis, the new compliance processes are spreading from the buy side to the sell side instead of the reverse.

Analysts and portfolio managers at institutional investors now have to be acutely sensitive to the sources of their information, not only with respect to whether the information encompasses material non-public information but also whether it breaches confidentiality restrictions.  Further, information intensive analytic activities such as surveys, channel checks or speaking with outside consultants now require more compliance oversight and documentation than in the past.  Even casual conversations during industry conferences can trigger compliance concerns.

However, these new standards don’t just apply to buy side analysts.  Institutional investors are increasingly proactive in assessing the risks associated with the external research they are receiving.  The result is that the heightened compliance processes implemented by the buy side are now spreading to the sell side.

These new compliance processes will give analysts a strong incentive to rely more heavily on company guidance and publicly available information.  Doing so is easy and ‘safe’.  However, easy and safe also makes it harder to escape the gravitational pull of industry consensus.  How do you add value as an analyst if you are doing what everyone else does?

The new compliance regime also presents challenges for compliance professionals, who need to better understand analytic processes.  As compliance becomes more intimately involved in core analytic activities, it needs to cognizant of analytic priorities and objectives.

Many independent research firms have relied on their independence from investment banking conflicts as a proxy for compliance practices.  In the new compliance regime, this is not sufficient.  Independents have responded by increasing their compliance activities and adding additional oversight.

We have not seen the full ramifications of the new compliance regime.   Corporate access has been untouched, so far.  Although SIFMA has issued guidance for sell side use of expert networks, the full impact of the new regime has not yet impacted the sell side.  For investors, the priority has been independent research firms, and broker dealers have largely been given a pass up until now.  However, as regulators codify the new practices it is likely that the new regime will be fully extended to the sell side.



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