Goldman Sachs has taken welcome steps towards setting a standard of professionalism and honesty
Many predictions were made for the internet - it would revolutionise productivity, overthrow the old industrial order, allow everyone to work from home, and so on. Nobody predicted that it would bring ethics to the investment banking industry, an arena of endeavour so far largely untouched by philosophical considerations. Right now that looks to be one of its main consequences ' which just goes to show what unpredictable stuff new technology is.
After the new economy's boom and bust, and more particularly in the face of lawsuits and investigations, the big global investment banks are trying to clean up their acts.
Merrill Lynch and Credit Suisse First Boston, two giants of the industry, have both decided that from now on their analysts will not be allowed to own shares in the companies they cover. Then Goldman Sachs decided its analysts would be allowed to own shares in the companies they study, but will have to disclose those holdings.
Those decisions prompt two reflections. The first regards the cavalier attitude the banking industry takes toward any ordinary standard of professionalism and honesty. The second is that, faced with a decision that may change their industry, Goldman has almost certainly got it right, and Merrills and CSFB have just as certainly got it wrong.
Of the decision to tackle the issue of analysts' holdings, the first question is: What took them so long? If a telecoms analyst tells people to buy shares in Marconi, or an auto analyst says sell Ford shares, what could have persuaded the bank that employs them that it's irrelevant what personal holdings in those companies the analyst has? Surely investors who might foolishly be swayed by the opinions were entitled to that information?
In truth, there can be no answer to that question. The decision to conceal for years what holdings analysts have in the companies they cover reveals the casual insolence with which most banks deal with issues of honesty or fairness. For years the only question they have troubled themselves with when presented with any issue of commercial ethics has been, 'Can we get away with it?' If the answer was yes, they went ahead.
That is now in the past. The consequence of the tech collapse may be the imposition of ethical, professional standards on the banking industry. And the banks that deal with that in the smartest way may score a significant advantage over their rivals.
It is rare that business offers such a clear-cut choice as that offered between Goldman, Merrills and CSFB. The management of all three organisations have reached a fork in the road. Goldman turned in one direction, Merrills and CSFB in another. We will find out soon who is right.
The smart money should be on Goldman. Banning analysts from owning shares was an easy fix. It makes a good soundbite, and it does resolve the conflict of interest issue. But it creates an odd situation. It is not as if tipping shares were in some way incidental to what these people do. It is what they do. Would you want to buy pizza from a chef who isn't allowed to eat Italian food? Or a cocktail from a barman who's not permitted to drink? Telling analysts they can only own shares in companies that they don't know much about may make them more sympathetic to the ordinary investor, but it will hardly increase confidence in their work.
The risk Merrills and CSFB now run is that their analysts will become ever more disconnected from reality. Goldman has chosen a more sophisticated position. Yet does the bank understand what kind of genie it has released, or how difficult it might be to get it back in its bottle?
Here are two questions Goldman and any bank tempted to follow its lead need to think about. One: Why should disclosure stop with analysts? Wouldn't it be interesting to know what shares corporate financiers own? If they are fixing a merger between two companies, do they own shares in them? Likewise, on an IPO, what shares do the bankers own? Disclosure is contagious. Goldman may find itself requiring all staff to disclose all their shareholdings that are relevant to their work, as indeed they should.
Two: Won't it change the nature of the business? Analysts will be forced to buy the stocks they are recommending, and sell the ones they ditching. If you are recommending shares in BP but own a pile of shares in Royal Dutch Petroleum, how much weight will your voice have? In truth, once you start disclosing shareholdings, you'll have to start walking it like you talk it. In time, analysts might run private portfolios which are disclosed, and which switch every time that analyst changes a recommendation.
That sounds suspiciously like a fund manager, except one who does much more original research on companies. And that would be no bad thing. The main problem with analysts in the past decade is they have had the wrong bosses. They have been attached to investment banks, which have mainly used them as PR men for deals. They should be attached to asset management firms, which would need them to tell them which companies were good, and which were rubbish.
Disclosure may be the trigger to kick-start that migration. Here's a prediction. Merrills and CSFB analysts will become even more of joke than they already are. As non-share-owning share tippers they'll have trouble even getting mid-afternoon slots on CNBC.
Goldman's analysts, and those following their lead, will become more influential, but will gradually change their jobs. And the current analyst, that strange creature who masquerades as an objective commentator while actually a promoter of M&A deals, will make a welcome exit from the financial universe. They are now what they might refer to as a 'weak hold' (or in normal language, completely doomed).
Tough, independent analysis of companies is an important element of an efficient capital market. Without it, you get what economists refer to as capital mis-allocation ' or what the rest of us call giving truckloads of venture capital to idiots who blow it on parties and websites. The corruption of analysis was one reason why so much capital ended up going to the wrong places during the tech bubble. Restoring honesty is an important task but there's a long way to go before the story is complete.
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