Every investor knows that the market involves risk. Nobody expects a guaranteed profit. But what every investor expects and deserves is honest investment advice, advice and analysis that is untainted by conflicts of interest.
It has been the clarion call of the financial services industry: Independent research that is truly independent.
Conflicts of interest pose significant dilemmas for research coverage, beginning with research analysts themselves. As analysts write research reports and make buy/sell/hold recommendations, their analysis may be influenced by financial (and career-related) incentives to directly or indirectly support investment banking business initiatives on behalf of their employers.
While some major financial institutions have endeavored to challenge these accusations by separating their investment banking and research units, an even more radical proposal has been suggested: a purely independent research entity, funded by the settlement payment from several firms under investigation. This entity would act as a liaison between investors and the firms in which they hold interests. By eliminating the financial obligation, the industry hoped to eliminate the potential for biased analysis and coverage.
This goal is laudable and honorable, but the reality is that many worthy and important companies will be overlooked in the keen competition for analyst attention. In some cases the only viable option for companies will be to pay an independent research firm to provide the needed coverage and exposure. Paid-for analysis may represent a clear example of highly subjective recommendations based upon direct financial incentives.
From this example, it may appear that there is no feasible way to avoid the numerous pitfalls of tainted research. The answer, therefore, is not in the affiliation, but in the content of the reports.
Independent research attracts and entices the investment community by providing them with the necessary tools and information with which to make sound investment decisions. These reports distill and present only the essential facts of the covered company: no projections, no buy/sell ratings, no overwhelming financial jargon or technical information, and no siren call of stock price prognosticators. This type of research allows investment professionals to make fully informed and educated investment decisions based on the most important recommendation: their own.
The National Investor Relations Institute (NIRI)
The National Investor Relations Institute (NIRI) concurs with this model of independent research.
"...Such reports should contain factual research conducted by a qualified analyst and should avoid the expression of opinions about the company's prospects and must not contain a recommendation that one should acquire the stock."
Those on the buy-side are already working to accommodate the need for this type of independent coverage. Several investor-sponsored entities have been established to report analyst-free coverage aimed at providing investors with unbiased research. While still performing on a relatively small scale, the demand for this type of research is growing.
The next phase of this reform process will occur on the sell-side. Small-cap companies must seek out independent research firms that can undertake the same type of fact-based analysis or face the consequences in the intense competition for outside investor funding.
By implementing a new and innovative style of independent research, it will be possible to put these conflicts of interest in the background and bring about reform in a way never thought possible. The unyielding call of investors for truly independent research in its purest, most untainted form would then be answered.