Ethical Issues Facing Stock Analysts

Abstract

Much has been written about the bull market environment in the late 1990s that created numerous conflicts between the analysts' duty to the investor community and their firm's investment banking. But relatively little has been written about what those specific responsibilities were and why inevitable conflicts are so central to the position. This article argues that the role of a sell-side analyst (sell-side analysts are securities research analysts that work for brokerage firms as opposed to those that work for money management firms) is inherently one of attempting to balance the interests of its various constituencies. Although the further regulatory separation of investment banking and sell-side analysis created by the passage of the Sarbanes-Oxley Act of 2002 and new regulations from the Securities and Exchange Commission (SEC) and National Association of Securities Dealers (NASD) helped to reduce such conflicts, this article argues that conflicts continue to exist and in some cases are likely never to be solved. The author argues that, ultimately, the only constraint that will allow an analyst to do the right thing for all its constituents is a focus on the analyst's reputation. In the short-run it is possible for an analyst to sacrifice his reputation for gain, but in the long-run it is the favourable reputation of the analyst that ultimately entices clients to work with his stock brokerage company. In this article, the author discusses what the author believes are the three primary responsibilities of the sell-side analyst, how those responsibilities conflict, and how these conflicts are likely never to be fully resolved. The article concludes that the sell-side analysts' role, by its very nature, is one of weighing conflicting responsibilities to a variety of constituents and that there is no simple rule of behaviour that will satisfy all concerned.