A few good women and men. "Many stockbrokers haven’t plied their trade well; having instead focused on the easy money of the mafia to drive prices up and then convince gullible retailers, or better still, pension funds to take over the junk. Investment banks also haven’t been held to account for the tosh they pass around labelled research," says an insightful article appearing in a new financial magazine ‘Echelon’ titled ‘A Crisis of Trust’.
The article quotes several leading and respected professionals in the country’s capital market sector and shows how broker firms contributed to the status-quo, where many now seem to think all is well with the stock exchange now that it is back among the top performing bourses in the world.
Following are excepts from the article:
"Over the past year, crimes affecting Colombo’s small stock market have seriously eroded confidence in its integrity. Scandal after scandal has dogged the market and the apparent erosion of the, regulator’s ability to act independently in the face of blatant market manipulation, insider trading and challenges to its authority have all contributed to the crisis. The crisis has been exacerbated by economic hardship, rising interest rates and confidence sapping general deterioration in law and order.
"This crisis had been unfolding for some time due to a number of reasons. Under siege, the regulator has been unable to crack down on insider trading. Excessive credit to unwary investors, governance issues at state controlled investment funds with exposure to the stock market and a complex web of self interest and nepotism have all contributed to eroding trust in the market. However in the analysis the role some investment advisors or stock brokers have played in exacerbating the crisis perhaps deserves greater scrutiny than it has received.
"Violating rules here has no expense. If you violate something there has to be consequences. When there are none and you get away with it easily, people take that route, because human greed is always there- everybody wants to make money and that’s where things go wrong.
"When it becomes apparent that leaders have a wonky moral compass and are flip flopping on values - those publicly preached and privately practiced - the message of those behaviours are transmitted to the rest of society and quickly become part of the culture.
"The past few years have not been kind to many equity research analysts. For a start most investors didn’t care to check what analysts thought because the market saw an unprecedented boom. Secondly and more embarrassingly their false and rosy predictions about the sustain-ability of a bubble have left them red faced. However not everybody got carried away. A few brokering houses, investment banks and independent equity research units did advice clients to run for the door but only a few, mostly mutual funds, were willing to listen to sane voices.
"Tackling the crisis of trust be-devilling equity analysts and the market is complex due to several reasons. Firstly during the bubble the primacy of investment banking and brokerage sales to profit was so great that integrity of research departments were compromised by traders and financiers keen not to offend clients.
Market wide credibility has been eroded after analysts fell over each other to recommend the IPO’s of Soft logic Holdings and Expo Lanka. Forecast EPS for Softlogic Holdings for 2012 by Asia Wealth, CT Smith, John Keells Stockbrokers, BMS and Lanka Securities ranged from Rs2.98 to Rs1.7 for the year, but the actual was Rs. 0.66 a variance of up to 450%. Its oversubscribed IPO was priced at Rs29 a share which now trades at Rs9.40. Similarly some analysts offered a rosy outlook for Expo Lanka IPO of Rs14 a share. Forecast by John Keells Stock, Asia Securities, Heraymila, CT Smith and BMS were 190% to 148% above the actual. Expo Lanka shares are now trading at less than half the TO price at Rs. 5.90. Market needs a bit of credibility, which it lost especially after some of the recent IPOs.
"To be fair, analysts are often young graduates looking for a kick start to a capital markets career and are usually an underequipped lot. Because of the subjugation by overbearing investment bank chief executives, the whole industry of equity research has lost its aura, its credibility and ability to influence markets.
"Of course there have been whimpers of protest about the perils of pump and dump and advice to ‘only invest in fundamentally strong counters’ but that falls far short of good advice. Any confident analyst would have encouraged clients to significantly reduce equity exposure or be heavily underweight on stocks. But the young bucks had not seen a market cycle in their careers and certainly lacked the experience to make a bold call. They also seem to have been hired for just those reasons; to profit from their incompetence.
"Some analysts have also been cosying up to investment banking clients but the practice hasn’t raised howls of protest. In fact it isn’t unusual for analysts here to moonlight as investment bankers deftly switch back to their official role and offer a rosy recommendation on their client’s stock with a wink or a nod.
"Investment banks running the book for IPOs have to be up to scratch with their due diligence. Any IPO almost, is approved by the SEC, but it is the investment bank that does the due diligence, does the valuation and has to make sure there is fair play. Investors also need to get something out of an IPO but if it’s overpriced, the company may benefit in the short term but investors won’t. In a mad frenzy retail investors snapped up any and all IPOs without examining the credential or thoroughness with which investment bankers had dealt with these. Some of those IPOs were overpriced drastically. That’s the issue; the lack of regard for reputational damage.
"This serious breakdown of ethics and the pooh-poohing of that impact by chief executives and managers at investment banks and brokerages is perhaps the second crisis of trust bedevilling equity analysts and investment banks.
"If you look at the EPF portfolio there are lots of speculative or so called junk stocks now. A long term investor should not have that kind of a portfolio, so clearly we see a deterioration of the quality of management. Long term pension funds should have an investment policy statement and strategy in keeping with their mandate. Even if share prices as a whole decline, fundamentally strong companies will continue to be profitable, which isn’t likely to be the case with speculative storks.
"A group of highly leveraged stock traders- referred to by the former SEC Chairman Thilak Karunarathne as a ‘mafia’ - has replaced the regulated institutional investor segment in the market. Traders are leveraged and they look for arbitrage; they are a different segment to retail investors. Traders want to push prices up and dump on the retailers. Retail investors will be much better off investing through mutual funds - which by and large due to their superior fund management skills - bought stocks at their lowest prices and sold most of those shares before the market crashed. In the mutual fund industry, holdings of listed shares have declined to 42% of assets by end 2011 from as high as 60% in 2009.
"There were stocks that were certainly manipulated and some investors were misled, who is to blame for that? More than anyone else it is the guys advising them.
"When companies realise they are about to have a disappointing earnings season, they start avoiding analysts and nosy reporters. When that isn’t working chief executives turn on the charm to mislead analysts, perhaps one reason why none have been known to forecast a profit decline."
The article goes on to suggest that the stock broker community and their research units undergo self evaluation.
The complete article can be read in the ‘Echelon’ available at Keells Supermarkets and bookshops.