STOCKBROKERS are protesting against the arrest of the chief executive officer and two directors of the AKD Securities by the Federal Investigation Agency for a research report about a textile company, Amtex Limited, that allegedly caused a loss of Rs370 million to the Employees Old-Age Benefit Institution (EOBI).

The EOBI bought shares of Amtex Limited in August 2010 in contravention of the Employee’s Old-Age benefits (Investment) Rules, 1979. The stocks bought at the average cost of Rs19.46 took a steep dip to Rs2.73 causing diminution in the value of shares by Rs17 and a total loss to EOBI amounting to Rs370m. As many as 22 persons have been named whose involvement in the transactions would be determined during the course of investigation.

While the FIA documents clearly state that the “alleged officials of EOBI were in a position to avoid the loss to EOBI but they wilfully and intentionally cause huge wrongful monetary loss to EOBI in violation of investment rule”, the brunt of the blow has been taken by the AKD Securities. That may be due to a suspected conflict of interest as the brokerage had conducted the Initial Public Offer (IPO) and listing of Amtex Limited on the Karachi Stock Exchange.

The question that boggles many minds is where the onus of blame falls: on the writer of a research report or those who wilfully made wrong decision to invest? And secondly, should analysts be arrested if a research conducted on a company goes wrong?

It would perhaps depend on the intention of the analyst: whether that was fair or as suspected by the FIA in this case, a “criminal offence”.

Lesson could perhaps be drawn from the Enron scandal in 2001. In addition to being the largest bankruptcy in American history at that time, Enron was cited as the biggest audit failure. The company’s stock price, which achieved a high of $90.75 per share in mid-2000, plummeted to less than $1 by the end of November 2001. However, analysts following the company continued to be optimistic. Even after Enron announced $1.2 billion reduction in shareholders’ equity, all 15 of the analysts employed by the largest investment banking firms rated Enron as a “strong buy” or “buy”.

When Enron filed for bankruptcy protection, only two analysts recommended sale of its shares. Seven rated it as a “hold” and one still listed it as a “buy”. Richard Gross of Lehman Brothers wrote: “We think investors should rustle up some courage and aggressively buy the stock.” Neither Richard Gross nor any other analyst is known to have been incarcerated, though the company auditors Arthur Anderson took the flak.

All analysts’ research notes put at the foot of the report a ‘disclaimer’, which in a way gives them the liberty to escape the blame where their assertions go wrong or even where the reports were written to mislead the investors. The courts would establish if the AKD Securities’ report on Amtex was a wilful default or fair and impartial assessment that went wrong.

The SECP has now questioned the role of the research analysts and tried to streamline the reporting rules.

On July 27, 2015, the chief regulator released the ‘Research Analysts Regulations, 2015’. It provides for minimum professional qualification for a research analyst and requires a person to obtain mandatory certification for research analyst as specified by the commission. The law also asks for addressing actual or potential conflict of interest arising from dealings or trading in securities of the company on which research is conducted, by the analyst, the company and its officials.

Other requirements have been specified as: The analyst should have adequate documentary basis, supported by research for preparing a research report. The analysts shall base report on reliable information and source of such information would have to be disclosed; analysts would have to disclose in the report the valuation methods used to determine the target price, if any, that has a reasonable basis and shall be accompanied by disclosure concerning the risk that may impede achievement of the price target. The law prescribes punishment for the brokerage and research analysts who contravene any provisions of the regulations.

Most brokerage houses have greeted the rules with a cool response as they believe the regulations to be too stringent. Research reports churned out in dozens by brokerage houses have trickled to a minimum. But regulations were surely required to keep analysts and the brokers they serve in check. It is a common observation that most research reports for ever signal a ‘buy’ and almost never a ‘sell’, possibly as the brokers’ livelihood depends on selling optimism. But in doing so, the investor could rightly be misguided in the absence of the regulations that have now come into force.

Published in Dawn, January 9th, 2016

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