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Author: 
KHALID I. NATTO
Publication Date: 
Thu, 2011-06-09 02:36

This week we would like to discuss the degradation of the quality of research reports over the last 16 years. It seems the markets have changed to the degree that investors and financial market commentators scoff with disgust at analysts and their estimates.
Furthermore, the presence of High Frequency Traders (HFT) makes the market react in an even more irrational manner, which dilutes the credibility of the markets even further.
We have devised a solution that we believe addresses the concerns of investors, and allows for the analysts to do a more comprehensive job. 
Simply do away with the buy, sell or hold recommendation and allow investors to make their own decision.
The new standard of research reports should include both the positive and negative scenarios of any given company.
The details would describe both the near term and long term milestones of the company, and the statistical probability of successfully completing each milestone.
In essence, the reports will include all the different risks from the macro-economic, micro-economic, industry, and company specific perspectives.
All the usual details will be discussed on each company including cashflow, research and development, cost of goods sold, administration expenses, etc.
The idea is to curb the propaganda and agenda oriented research with statistical analysis of different scenarios of risk, and then let the readers and investors decide whether to invest.
In the past, there were two kinds of research reports, and they were commonly referred to as buy side and sell side research. This meant one set of reports was for the bank and the other was for the public.
In essence, the bank or brokerage firms held assets until they believed they were no longer going to ascend in value, then they would build a secondary market for the assets by continuing to sell their old euphoric research to the public.
The pipeline of timely research started with venture capitalists (VC), investment bankers (IB), and brokerage analysts.
The timely information was always in the hands of the first investors, which were usually the original risk takers.
The birth of the Internet information age changed the dynamics of the flow of information.
At first they promised the democratization of the markets with the Freedom of Information Act.
On one side the media and retail investors devoured the new data on platforms like Edgars Online and Yahoo finance.
The hope was that the availability of these portals of data would lead to a more educated type of investor, who could somehow determine their own level of risk.
The model does not work, which is evidenced by the low volume or trades on the various exchanges.
Both the investors and the analysts seem to have settled for a flood of data points.
Entirely too much information is available on the web in the form of blogs, articles, research reports, and social networking sites.
We have gone from Chartered Financial Analysts, MBA Graduates, & Series 7 licenses all the way over to anybody with an opinion can publish their view on the web.
The truly scary part is that HFT traders have programmed their computers to scan the web for tweets on Twitter, and searches on Google.
It’s no longer an issue of quality or accuracy of information because now it’s simply down to quantifying the sheer volume of the new data points.
Another sobering fact is that analysts might not be able to publish detailed reports, because of the fear of losing investment banking commissions from the companies in their universe of coverage.
So the pressure to produce euphoric research reports can come from internal management at the expense of the overall credibility of the analyst.
The investment banking commissions were the priority in the late 1990s leading to the repeal of the Glass Steagall Act. However, even these fees were not safe from the trend of open access on the Internet.
From the perspective of the various companies they found that they could suddenly find pools of investors with a great deal more ease.
In fact the process of listing on the exchanges became commonly available on the web.
Keep in mind that most of the exchanges that were stout pseudo-regulators in the past became publicly traded companies in their own right, which means they are driven by the same maddening hunger for earnings as every other company.
They are literally competing with each other for the listings of IPOs, and it seems that they are not scrutinizing the accounting.
The ensuing problem was the deterioration of the credibility of the information.
The truly sad issue is that the current standard of “buyer beware” has been adopted as an industry standard around the world. The research reports are truly lacking the credibility of the past.
The caveats at the end of the research report literally disavow the brokerage house of any responsibilities.
The Senate in the US has literally designed new laws called the Volcker Rule that forbids the banks from proprietary trading. This was done in an attempt at trying to surgically remove the profit incentive for publishing bad research reports.
Time will tell if this latest legislated solution will derive greater transparency and credibility from the various analysts and investment bankers.
Meanwhile, we would like to reiterate our proposal of removing all recommendations from research reports.
Merely state the facts, possible risks, and the forecasted milestones along with a statistical estimate of probability of the success of each milestone.