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RECENT RULE CHANGES TO ANALYST RATINGS

Analyst Rating

Analysts play a significant role in evaluating the stocks of publicly traded companies. With mass media and the advent of the Internet revolution many analyst evaluations have the potential to gain widespread exposure within a short timeframe. However, investors that look to such ratings must also research the background of each analyst as they often have a vested interest in the stock or company. Many conflicts of interest exist and the SEC, FINRA and NYSE have taken note by instituting various limitations and disclosure requirements for analysts.

Although FINRA and the NYSE have implemented disclosure rules for analysts governing conflicts of interest, the SEC further implemented amendments to these rules on May 10, 2002. The new guidelines aim to comprehensively address conflicts of interest while increasing analyst independence. Some of the key amendments are listed below:

  1. There are “quiet periods” following a public offering that prohibit a firm that is underwriting a securities offering from issuing rating reports until 40 days have passed. If research coverage by an analyst cannot be released at the time of an initial public offering (IPO), the company will not seem as attractive.
  2. To maintain objectivity and independence, research analysts cannot be supervised by investment banking divisions. What’s more, investment banking professionals cannot discuss ratings reports with analysts prior to publication. Analysts are also prohibited from sharing draft research reports with the companies they cover unless it is to verify facts following confirmation from the firm’s legal department.
  3. Analyst compensation cannot be linked with investment banking transactions. If it is, it must be disclosed in the firm’s research reports. This works to maintain analyst objectivity as their views will not be skewed in an effort to increase their revenue stream.
  4. A firm that managed or co-managed a public offering for a company must disclose such details and any earnings it received for investment banking services in the last 12 months or plans to receive in the upcoming 3 months. This works to inform potential investors of any bias in analyst ratings.
  5. Analysts and members from their household cannot invest in a company’s securities prior to its IPO if the company is in the industry that the analyst covers. There are also “blackout periods” that bar analysts from trading securities of the companies they cover for 30 days before and 5 days after they post a research report about the company. What’s more, analysts cannot trade against their most recent recommendations.
  6. Analysts are required to disclose ownership of shares in companies they cover. Brokerage firms are also required to disclose 1% or more ownership of a company’s securities as of the previous month’s end.
  7. In rating reports, firms must explain the meaning of all ratings terms and terminology they use in plain language. Moreover, they must supply the percentage of all ratings they have provided for the company, whether buy, hold or sell valuations. They are also required to provide a chart that displays the historical price movements of the security and periods in time in which they initiated or amended ratings and/or price targets.
  8. During public appearances, such as radio and television features, market analysts are required to disclose any affiliation with the stock, whether the company is an investment banking client or the analyst and direct family members are officers, directors or advisory board members of the recommended company.

Not all market analysts are created equal. It’s worth your while to fully vet any analyst you plan to reference for your investment undertakings. It’s best to rule out any bias, subjectivity and conflict of interest by reviewing the SEC-issued guidelines listed above.