'Pre-deal research is extremely useful because analysts can provide a host of information which is important for performing fundamental analysis of a stock.' Hong Kong Investment Funds Association MY ALL-TIME favourite piece of pre-deal research was a weighty report from HSBC on the listing of MTR Corp five years ago, weighty in that it went 'thump' if you dropped it on the floor. It was otherwise rather light in terms of content. Rah-rah-rah, MTR, it said. Here is a must holding for your portfolio, a new star of the Hong Kong market. Buy now while stocks last. I do not blame the analyst who wrote it. HSBC was a sponsor of the issue and the lawyers were vetting all research reports put out by the sponsors to ensure that they were ... ahem ... correct. The report could hardly be an independent arm's length assessment of the MTR's investment prospects in these circumstances. But while lawyers understand law, you may yourself have noticed that most of them are, to put it mildly, somewhat at sea in investment matters. It is my guess that the HSBC analyst recognised as much and knew of a way around them. Buried in the middle of the report was a one-page table on key investment ratios and well down the page was the notation, ROIC-WACC, followed by a string of forecast negative numbers all the way to 2015. What lawyer would know that this stood for Return on Invested Capital over Weighted Average Cost of Capital? What lawyer would recognise how the analyst had just told investment professionals that he thought the MTR was in the business of destroying its own capital and had no hope of turning things around for the foreseeable future? But this report at least made some forecasts. It is not the usual practice in pre-deal research these days and for the good reason that the investment banks writing this 'research' are for the most part also writing the prospectuses on the deals and these prospectuses do not make forecasts. Put a forecast in the analyst's research and potential subscribers to the issue may well ask why it could not also go into the prospectus. The reason, of course, is that the sponsors are somewhat more at risk for what goes into the prospectus and risk is something that makes these supposed risk-takers shudder. They shudder at it so much that they are now up in arms at the proposal, put forth in a consultation paper from the Securities and Futures Commission, that investors be allowed to sue them for inaccuracies in prospectuses. But even a pre-deal research report does little to tell investors whether they really have as good a prospect on their hands as the report claims. This is because the report does not include a price for the issue. At best, it suggests only a range of prices. Odd, you may think, and it is, but you cannot publish a price in a research report until the sponsors have settled on one and they are reluctant to do this until they have tested the waters, worked out a price at which they can get the issue away and received firm commitments at that price. The pre-deal reports are published only to help them work out that price. The problem for them is that they cannot publish a prospectus without a price and without underwriting that price. This constitutes risk and they thus hold back on publishing the prospectus until they have already sold the issue. Only then is the public given the official and legally binding document that describes the issue. But too late. The issue has already been sold by then and the sponsors can collect big underwriting fees for no underwriting risk. All that was available earlier were reports heavily compromised by a conflict of interest and even these were distributed to only a few big investors. It is all very clever and it has the added advantage for the sponsors that it stymies other brokers from doing any independent research before the issue is sold. They are cut off from the information flow until it is too late. So here are my two suggestions to the SFC in the matter. First, make it a requirement that a prospectus for a new issue be published at least a week before the issue is open for subscriptions. This will give the investing public the time it needs to evaluate the issue. The investment banks will howl at this idea, I know. It would put them on the underwriting hook. Purported risk-takers would have to take risk. The world would be turned upside down. Second suggestion: Make some inquiries about the membership of this Hong Kong Investment Funds Association that so favours the rigged game of pre-deal research. I find it odd that real investment fund managers should take a stand so contrary to their own interests. It is my guess that what we have here is investment bank wolves dressing themselves up in sheep's clothing.