Canadian Regulator Must Tighten the Playbook on Analysts

There are so many sad examples of analysts behaving badly. For example, after Bre-X made its outrageous claim about Busang being “the world’s largest gold deposit,” not a single analyst went to Indonesia to check it out. Then, there is Mary Meeker, the so- called “Queen of Internet,” whose bold recommendations cost people their life savings after the tech bubble burst. Not to mention analysts who publicly touted, while they privately laughed at, so many Enron(s) and WorldCom(s) of this world.

This is why analysts in the U.S. have been put under a microscope, tough new rules have been imposed, and things like straddling fences have become a distant memory. In Canada, however, there is still some road left to travel.

Canadian regulatory body governing investment dealers is the Investment Dealers Association (IDA). And, (surprise, surprise!), this regulatory powerhouse is turning a blind eye when it comes to oil patches in the Canadian West.

Here is a story for you. There is a research analyst who owns a piece of property rich in “black gold,” and who also works for an investment dealer that publishes his opinion on an investment trust owning that same property. Oddly enough, the IDA is perfectly fine with the arrangement, as long as everything is fully disclosed.

Well, disclosure is all fine and well. But issuing an opinion about a property in one’s ownership is the equivalent of being a real estate agent selling a home and arranging for its financing. The conflict of interest is clear–a positive recommendation for the income trust issued by an analyst not at arm’s length makes that analyst a promoter.

Of course, this person can be an analyst and he can be a promoter, but he should not be both. Having such a dual role makes it very hard to distinguish whose interests come first–that of an analyst or his clients.

Aside from turning the blind eye, the IDA is known for one more thing, which is passing the buck. Instead being the enforcer, which is its mandate, the IDA transferred the responsibility of monitoring analysts on its members–investment dealers.

This whole thing is based on two very feeble assumptions. First assumption is that investors are capable of drawing their own conclusions whether recommendations they read are reliable or not. And, the second assumption is that investment dealers are the ones responsible for ensuring their analysts’ objectivity.

But, that is a pure nonsense. Having an analyst issuing opinions and doing business with the same company cannot happen in this day and age. It is as simple as that. And, here is why!

I spend most of my day in the office researching companies I recommend or have already recommended. But, I am not paid by an investment dealer to peddle those stocks, nor am I paid by the companies that I recommend. I am actually paid by you–the subscribers. So, I better do my job right to justify your confidence.

By the same token, I am not allowed to invest in any of the stocks I recommend, nor can I own physical property in such companies as a private investor. Basically, all that I am allowed to do is to issue an opinion.

Now, I have to say that current rules prohibit analysts from issuing recommendations on stocks that their firms are doing deals with. But, analysts in Canada have found a loophole, whereby they can, in effect, cover companies that they, as individuals, are doing business with. Well, the IDA can say whatever it wants, but this regulator is making a distinction without a difference. Or, in plain English, the IDA is wrong!

Bear in mind that actually buying a property in, for example, an energy income trust, is not the same as buying stocks in an oil and gas company. When an analyst buys shares in an open market transaction, those shares must be publicly disclosed, they have to sit in a personal account, and they cannot be sold without the analyst’s “sell” recommendation. Some firms go as far as outright prohibiting share ownership in companies analysts cover.

In contrast, property deals are private transactions. They are done far away from the public eye. And, information about them is not publicly available, which is why the IDA should have them prohibited.

Considering the bad karma that analysts have gained after all the scandals of the new millennium, the rules must be tightened and investors must be provided a level playing field. After what they went through, this is the very least the industry owes them!