When clients of CSL Stockbrokers received a research report on the Access Bank secondary offering in their email in August 2007, many were shocked at its contents. In the report, Jude Fejokwu, head of research at the firm, raised blazing red flags over the bank's treatment of goodwill, audit committee membership of both the CEO, Aigboje Aig-Imoukhuede and his deputy, Herbert Wigwe, share price manipulation in the run up to the offering and sharp practices in its financial reporting. Almost immediately, his employers, which had strong investment banking relationships with Access Bank, sent emails to recipients of the research report, announcing that it had dismissed its head of research for the preparation and unauthorized distribution of the document. CSL, which disclosed its business relationship with the issuer in the email, made clear that the analyst's claims using the imprimatur of the firm were unacceptable. In this post, we question whether the firm's reaction and the dismissal of the head of research was a conflict-of-interest case or not, and we suggest an alternative for how CSL and Access Bank should have handled the case.
Analyst independence and analyst-issuer relations have been live issues even before Eliot Spitzer, the former attorney-general and later governor of the state of New York, revealed that most US tech stocks which were presented to the investing public as safe, sound and solid by Wall Street investment banks during the internet bubble (1995 – 2001) had very weak fundamentals. Analysts at the bulge bracket banks which brought these companies to the market knew of these weaknesses, but chose not to disclose them for fear of losing the lucrative fees that their investment banking colleagues depended on. In a nutshell, the boom had been fueled by fraud.
By the end of Spitzer’s investigations, almost every major Wall Street bank was found guilty of explicit and/or tacit pressures on analysts to hype stocks in support of the firms’ investment banking businesses. In the end, the indicted firms agreed to pay a global settlement, and to establish Chinese walls between the research and investment banking.
Although the value of independent analyst research has never been in doubt, its exposure to the risk of abuse has caused grave concern to regulators and consumers of research. Many were shocked by the raw cynicism contained in emails from analysts, who were publicly hyping stocks of companies but deriding them in private. According to Arthur Levitt, the former chairman of the US Securities and Exchange Commission (SEC) in a 1999 speech, Quality Information: The Lifeblood of Our Markets:
I can only point to what I see as a web of dysfunctional relationships – where analysts develop models to gauge a company’s earnings but rely heavily on a company’s guidance; where companies’ reported results are tailored more for the benefit of consensus estimates than to the reality of the ups and downs of business; where companies work to lower expectations when they fully expect they’ll beat the estimates; and where the analyst attempts to walk the tightrope of fairly assessing a company’s performance without upsetting his firm’s investment banking relationships.
Our review of the relationship between companies and the analysts who follow them indicates that analysts, all too often, are falling off that tightrope on the side of protecting the business relationship at the cost of fair analysis. Analysts are a fixture on business pitches and investor road shows – doing their bit to market their own firm’s underwriting talents and to sell a company’s prospects. What’s more, analysts’ compensation is increasingly based on the profitability of their firm’s corporate finance division, and their contribution to the deals to which they are assigned.
Needless to say, you can see how an analyst who recommends selling a client’s stock because it’s overvalued would not be terribly popular. In many respects, analysts’ employers expect them to act more like promoters and marketers than unbiased and dispassionate analysts. An all too candid memo from a leading Wall Street firm’s corporate finance department couldn’t have framed the conflict more plainly: ‘We do not make negative or controversial comments about our clients as a matter of sound, business practice. The philosophy and practical result needs to be “no negative comments about our clients”.’
Just as these abuses were being exposed in the US and measures put in place to ensure they did not recur, the stock markets in frontier markets, with less developed investor protection systems, were taking off. With no clear rules to protect analysts working in global banks from their fee-dependent colleagues in investment banking, it was only a matter of time before a publicly contested clash between the role of the analyst as fiduciary with a duty to produce objective research for investors and the role of the analyst as member of a wider firm where research was typically a cost center.
Before we go further, let us provide a bit of historical context to the analyst independence and conflict-of-interest debate.
Most stockbroking (securities) firms in Nigeria distribute their research free of charge to their clients. In fact, the websites of many stockbroking firms have email subscription boxes where visitors can sign up to receive investment research free-of-charge. While a few firms like Agusto & Co, which by the way is not a stock broking firm, sell their research, they are in the minority. It is important to point this out.
In the United States, the whole conflict-of-interest issue arose from the historical analyst research production business model at sell-side firms. The analysts produced research for sale to institutional investors. In turn, these investors usually directed trading business, based on the contents of the research, to the trading desks of the firms that issued it. This generated comfortable trading commissions for the firms. Over the years, trading commissions dropped to the point where neither it nor the revenues from the sales of research reports could sustain the costs of research. Consequently, analysts began to succumb to pressures from their investment banking colleagues to effectively ‘blow’ stocks of companies they represented or sought to represent in their research reports, irrespective of their own independent or critical views. In a Machiavellian sense, the investment bankers could argue that if their fees were going to subsidize research analysts, then the least they could do was to support their clients with positive recommendations.
Does a fiduciary responsibility to investors exist when the research is not paid for by them?
Does the analyst not owe any responsibility to the trading, asset management and investment banking parts of his firm when they alone produce all the revenues of the firm?
Is it correct to speak of a conflict of interest where the conflict, as defined by US standards and practices, does not even exist?
Does analyst reputation matter if no independent and objectively verifiable analyst ranking system similar to the Institutional Investor magazine league tables exists?
What should be the primary purpose of research in an evolving market? Should it be to help investors understand the business and support management in the articulation of the company’s narrative or to provide a critical commentary and serve a watchdog role?
How do we define ‘objective’ research? In what lies the objectivity? Methodology, analyst independence within the firm, tone of reporting, analyst compensation determination within the firm?
Is the role of the analyst identical to that of the auditors and securities market regulators?
Regarding certain matters like the claims contained in the report, should the analyst not seek meetings with the company covered before publishing report; and disclose the results of such meeting requests and/or meetings with readers of the report?
In cases where the analyst has concerns about certain issues relating to what are, properly speaking, under the purview of auditors and securities market regulators, is it not sufficient to raise the question and invite the company to address them, rather than leveling allegations that may attract legal consequences for the analyst and his employers?
We have raised these questions because we feel that they are central to the issues at hand. Markets across the world differ, and it would be hasty, in the least, to transplant rules devised for a different historical evolution to other circumstances.
The question then is: was Fejokwu’s dismissed for refusal to hype the Access Bank offering, in which case his analyst independence would have been compromised, or was his dismissal the outcome of irresponsibly reported accusations?
This we feel is the case here. While there have been a lot of comments on the matter, notably on internet forums, they were generally focused on a red herring, that is, the allegations he raised, rather than on the qualification of the analyst to make them, in what capacity he made them, and if indeed, the claims should be described as objective rather than subjective.
In our view, the matter ought not to have been the specific allegations of impropriety leveled against Access Bank by Jude Fejokwu, important as those are, but rather, his qualification en tant queanalyst, to report on the allegations he raised and distribute such as analyst research using the firm’s reputation as a stamp of authority. Perhaps, if Fejokwu was a journalist, then he would be recognized as operating under that cover, and the leave and license given that profession extended to him. But as an analyst, he should be held up to higher standards of substantiation and evidence.
On pages 2 and 4, the analyst refers variously to ‘financial shenanigans’, ‘contravention of the Banks and other Financial Institutions Act (BOFIA)’, ‘market price manipulations’ and ‘reckless business decisions’. Leaving aside the gravity of the claims, excluding the last, that is, reckless business decisions, all the rest are punishable offenses that require the attention of the regulatory and law enforcement agents.
These are all matters that exceed the ambit of investor notification. Beyond the sensationalism generated by the claims, one would expect responsibility on the part of the analyst in drawing the attention of his management to the risks of issuing a report on an issuer whose actions are in violation of the law.
At the time of Fejokwu’s report, the bank had published and distributed its Securities and Exchange Commission (SEC) and Nigerian Stock Exchange-approved prospectus. Therefore, his claims also raise questions about the diligence and/or integrity of the listing review committees of the regulatory bodies. So an indictment of the bank, was by extension, an indictment of the regulators.
Under Hedge Clause on page six of the report one reads:
This research note has been prepared by the Investment Research Department of CSL Stockbrokers.The author of this research note is Jude Fejokwu, Head, Investment Research & Strategy and a team of analysts.
CSL Stockbrokers has established procedures to prevent conflicts of interest and to ensure the provision of high quality research based on research objectivity and independence. These procedures are documented in the CSL Stockbrokers Standards of Professional Conduct.
CSL Stockbrokers Investment Research department is organized independently from and does not report to other business areas of the First City Group.CSL Stockbrokers has made no agreement with Access Bank to write this research note.CSL Stockbrokers research reports and notes are prepared in accordance with the CFA Institute’s Ethical rules on Research Reports writing.
After careful consideration we feel that analyst independence was never under attack in this particular case. Rather, the firm acted to defend the integrity of a business client, when its records had not raised any impeding red flags sufficient to derail its qualification for selling securities to the investing public. The main issues raised by Fejokwu pointed at the integrity of the firm’s client, which is the responsibility of its auditors and regulators, and not its business strategy, operations, trading multiples or prospects, which are within the ambit of the analyst’s competence.
So how should CSL Stockbrokers and Access Bank have reacted instead after the report was sent?
Here are a few suggestions.
First, CSL Stockbrokers should have issued a press release, with contacts, on its website and national dailies. The key points of the CSL Stockbrokers press release should have been:
The immediate withdrawal of the report.
The suspension, not dismissal, of the analyst pending the outcome of an internal investigation.
The name and brief bio of the new head of research.
A list of the specific allegations.
The gravity of the unsubstantiated accusations, which imply criminal offense, and the possibility of court redress for the libel, malice and defamation against the analyst.
The submission of the analyst’s claims to the Institute of Chartered Accountants, Chartered Institute of Stockbrokers, Nigerian Stock Exchange and Securities and Exchange Commission for their own independent investigation into the matter.
CSL Stockbrokers approval of the internal controls, corporate governance, financial reporting and business strategy of Access Bank.
The basis of analyst coverage at CSL Stockbrokers.
CSL Stockbrokers voluntary withdrawal of analyst coverage of Access Bank till December 31, 2007. CSL Stockbrokers will continue to cover other companies on the Nigerian Stock Exchange.
CSL Stockbrokers continuing commitment to analyst independence and balanced reporting and responsible research with a link to the CSL Stockbroker webpage where the CSL Stockbrokers’ Standards of Professional Conduct in the Preparation of Analyst Research.
A clear statement that CSL Stockbrokers has never allowed the firm’s investment banking relationships to interfere with the integrity and independence of its analysts.
CSL Stockbrokers relationship with FCMB Capital Markets, and their joint relationship to the offering.
A short list of prominent investment banking clients of CSL Stockbrokers and FCMB Capital Markets, with a personal statements by Gboyega Balogun, CEO of CSL Stockbrokers, and Francis Wood, CEO of FCMB Capital Markets, that such relationships have never impaired its judgment or balance.
The duration of coverage for this list of investment banking clients.
Web links should be provided to such research.
Appreciation to all of CSL Stockbrokers’ clients who have called and sent emails to question the tone and quality of the claims in the report.
Invitation to sign up on the CSL Stockbrokers site (full address provided) for its research.
Second, CSL Stockbrokers should have sent an email to all its clients and stock broking firms in Nigeria with a commented response to each of the allegations.
Third, on resolution of the internal investigation, CSL Stockbrokers should have announced the specific disciplinary action taken against the analyst.
Fourth, as part of its redress sought in court, CSL Stockbrokers should demand full page apologies in retracting the allegations contained in the report in two national dailies. The same apology and retraction should be sent from the personal email address of Jude Fejokwu to all the firm’s clients and stock broking firms in Nigeria. One full page apology will be addressed to CSL Stockbrokers Limited and the other will be addressed to Access Bank. The apologies will appear on the same day and appear side-by-side.
Fifth, CSL Stockbrokers should also have entered some of the discussions going on the forums, to state its own position. Its spokesperson would clearly identify himself as such, and state clearly that he would like to take part in the discussion on the event because of the importance of their fora to forming investor opinions and intelligence of ideas exchanged on it. Even if a few members turn out to be rude, most would welcome the recognition accorded the group and be open to hear the firm’s side. Furthermore, when visitors are led to the forum page by search engines, they would also have the chance to read a balanced discussion with the firm’s position fully presented. Needless to say, the representative would use his real name and provide his email address, office and mobile phone numbers.
Now, we mention a few things that CSL Stockbrokers should not have done.
Failure to specify the exact reasons for disciplinary action against Jude Fejokwu.
Immediate dismissal of the analyst.
And how should Access Bank have reacted. The 2007 case of Bethany McLean, the US financial journalist, and Macquarie Infrastructure Group (MIG), the Australian company, provides a good example of how companies have reacted to allegations that question their business model. McLean, is generally credited as the first reporter to expose the incoherence between Enron’s business model and its financial results at the company’s zenith in a 2001 article, ‘Is Enron Overpriced?‘. In 2007, McLean, wrote an article, ’Would you buy a bridge from this man?‘ in which she questioned the aggressive debt piling at the foundation of all the group’s deals. In response, the group issued a rebuttal of each point she had raised.
Although McLean is a journalist, not an analyst, and Fortune is a publisher, not a stockbroking firm, the example points out how firms can respond to the misinformed allegations. Yet, neither in the case of Enron nor Macquarie did the journalist make criminal charges against the institutions.
Rather than keeping silent as it did, the bank should have issued a press release with a title similar to ‘Access Bank restates commitment to strict governance and reporting standards.’ The press release would make no direct reference to Jude Fejokwu, the allegations or CSL Stockbrokers. It would be released on the same day as the CSL Stockbrokers press release.
The main points of the release would have been:
A brief description of the lofty founding principles of the bank.
A brief history of the bank’s achievements under its current management with link to page on web site.
A brief description of the bank’s corporate governance rules with link to the relevant page describing this policy on the bank’s web site.
A brief description of Access Bank’s financial reporting principles with link to relevant page describing these principles on bank’s web site.
Personal statements by the CEO of the bank and a partner at its auditors attesting to the soundness of its books.
A brief description of the value motivation of the bank’s M&A strategy, and its validation by the facts.
The bank’s record of shareholder wealth creation since 2002, with supportive statements from one foreign institutional shareholder and one local institutional shareholder.
The bank’s commitment to giving analysts access to senior management and non-interference in analyst research. Here the bank should provide a link to a page on its web site with a comprehensive description of this policy.
A list of analysts at top firms covering the firm and their contacts.
Contacts for investor relations and press at the bank.
Then the bank should have issued a second release referring to the analyst report, and offering counters to each erroneous claim contained in them similar to MIG’s response to Bethany McLean. It would also state that its lawyers have commenced the legal process to seek redress against the analyst for the libellous statements in the peport.
In a related case, in 2006 Goldman Sachs JBWere, the Australian financial services firm, issued an equity portfolio strategy report, that raised a number of questions about the group’s business and fees charged investors in its funds. The bank issued a prompt rebuttal.
It is important that none of these reports cast any aspersions of criminal behaviour on the management of the Macquarie Infrastructure Group.
From a investor point of view, if Access Bank had taken such steps it would have gone a long way in addressing the allegations in the report.
As we have said, the core issues in this case were:
The qualification of the analyst to make categorical and irresponsible statements on the company without providing substantive evidence to support his claims, and not the independence of the analyst or integrity of analyst research in general.
The inappropriate method of notification of those claims or concerns.
Failure to follow internal approval processes for sign-off before distributing reports.
In the heat of the moment, without a patient study of the merits of his status to make those claims, the analyst quickly rose to the status of martyr, when that should never have been the case.
Companies coming to raise capital and their advisors owe it to investors to respond as comprehensively as possible to any insinuations or misleading statements. They owe it to investors and shareholders to clear the air on any misleading claims put out to the public. While most companies have a policy of not commenting on rumours, in a case like this, where there is solid documentary evidence the issuer has an obligation to issue a statement. It cannot dismiss such accusations with a simple wave of the hand. This is the responsible, reasonable and right thing to do.
One cannot help noticing how Niyi Meka Olowola, Oando's Head of Corp Comms, is nodding in approval. Maybe Goldman Sachs can learn lessons.04:47:49 PM January 25, 2012from HootSuite
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