HK investors need to know what a 'buy' may be selling

Why should Hong Kong suffer regulatory overkill just because of rampant corporate and investment banking abuses unfolding in the United States?

That is a question some asked last week when the Securities and Futures Commission (SFC) said it wanted to follow the winds of change in the US by introducing tougher guidelines on the conduct of financial analysts.

Yet it is clearly an issue Hong Kong needs to examine as well. As shown by a recent case.

On May 23, DBS Vickers Securities issued a report on Star Cruises which recommended a 'strong buy'. Since then the share has dropped - to yesterday's HK$3.30 close from about $4.

Of course, no one is surprised when the predictions of analysts do not match the actual movement of stocks. What is intriguing is that one week later, on May 30, DBS Vickers said it would be the co-manager, as well as a lead placing agent and a book-runner, for the cruise operator's HK$624 million placement.

There is no reason to believe there was not the proper segregation - the so-called Chinese wall - between the group's analysts and corporate finance operations. In fact, such a segregation may be the reason why the research report did not mention anything about the possibility of such a fund-raising, although about that time some other firms, such as Kim Eng Securities, had put a 'sell' recommendation on the stock and warned of an expected US$100 million cash call.

The case nevertheless brings up some interesting issues.

In Hong Kong, such issues are mainly governed by the SFC's guidelines and code of conduct, which require a broker to disclose interests when potential conflict of interest rises, and to segregate research and corporate finance operations.

But the rules are vague. They do not specify under what circumstances they should disclose, or in what manner should they declare their interests.

In this case the broker declared its interest with a few lines in small print at the end of the report: '[The group] may from time to time have interests in the securities mentioned in this document . . . [and] may also perform broking, investment banking and other banking services for these companies.'

Is that enough?

Or should investment banks be prohibited from issuing research on a company if their corporate finance team is doing a placement or carrying out some other key financial transaction?

Corporate governance advocate David Webb, editor of Webb-site.com, takes the stricter view.

'They should have to disclose transactions when they are working on it - [or] they shouldn't be putting out research during the transaction,' Mr Webb said.

He suggested requiring brokerages to provide their clients with a weighting of their own calls - the ratio of their 'buy', 'sell' and 'hold' recommendations.

Brokers usually issue far more 'buy' than 'sell' recommendations, which some critics attribute to the desire to win corporate finance business.

According to Thomson Financial First Call, 'sell' recommendations account for just 4.03 per cent of the consensus recommendations on Hong Kong and China stocks, while 'strong buy' and 'buy' account for 58.06 per cent.

While the international houses with US business are already having to comply with stricter Wall Street regulations, local brokers are proving resistant.

The chairman of the Hong Kong Institute of Financial Analysts and Professional Commentators, Simon Lam Ka-hang, said Mr Webb's suggestion on disclosure of interest was going a bit too far.

'Now we are talking about analysts' integrity. Could you claim an analyst is less honest just because he always issues 'buy' recommendations?' he asked.

He also expressed reservations about the idea of banning links between an analyst's pay and bonuses to corporate finance revenues.

In the brokerage industry, research departments are often subsidised by other parts of the business such as investment banking.

Mr Lam did say his organisation supported the idea of introducing requirements for analysts to declare their personal as well as corporate interests in the stocks they are analysing.

KBC executive director George Ngan suggested the regulator should establish a system to evaluate whether particular analysts were qualified to make comments. He had noticed some analysts made comments on everything, despite lacking specific expertise.