Months before investment analysts were accused of maintaining favorable recommendations as Enron Corp. collapsed, their trade group, the Association for Investment Management and Research (AIMR), began to examine the analyst independence question. Members were asked last summer to comment on a proposed issues paper, "Preserving the Integrity of Research," that discussed conflicts of interests experienced by analysts at investment-banking and brokerage firms. The paper is the first of a three-part AIMR initiative to support independent and objective research reports and investment recommendations. The group also plans to formulate research objectivity standards to provide specific, measurable ways for firms to manage internal conflicts, reduce pressure from other sources and effect appropriate and adequate disclosures to investors. It also intends to develop a topical study of existing practices to achieve independent and objective research reporting for its next practicing-standards handbook. The initiative is a response to criticism of analysts' reports and recommendations following the decline of dot-com and high-tech telecommunication stocks. One AIMR member suggests pressure to produce favorable research was a logical consequence of the unprecedented economic growth during the 1990s. The association's paper identifies three sources that are more specific. • Sell-side firms may exert pressure on their analysts to issue favorable research on current or prospective investment-banking clients. AIMR noted that companies often select an investment bank based on its analysts' reputations, quality of work and profile in the industry. • The companies analysts cover also may exert pressure for favorable reports and recommendations. Management may believe a company's common stock is undervalued and find it difficult to accept negative research reports or Sell recommendations. Management compensation also may depend on stock performance. But an unfavorable report or recommendation may be the result of business cycles, market fluctuations or other influences, according to AIMR. "For instance, a 'good company' does not always translate into a good stock rating if the current stock price is fully valued," it explains. • Institutional investors and portfolio managers also may create pressure if they own significant numbers of common shares in a company under review. A downgrade also might affect a fund manager's compensation, which usually is tied to portfolio performance. "Moreover, portfolio performance is increasingly subject to media and public scrutiny, which may affect the manager's professional reputation," the paper says. "Consequently, some portfolio managers may, implicitly or explicitly, support sell-side ratings inflation." They also might raise the threat of their own kind of retaliation, such as reporting sell-side analysts to the covered company so exclusionary measures might be instigated and access to management denied. AIMR emphasizes that most portfolio managers don't engage in such practices, but warns that the perception by a research analyst that a reprisal is possible still may make it difficult to remain objective. The report identifies personal investments by analysts and their families in covered companies, the inherently greater appeal of a Buy than a Sell recommendation and analysts' tendencies to grow attached to companies they follow for long periods as other factors that might threaten investment-analyst objectivity. It also suggests the financial press should recognize its increasingly important role in conveying business information and do its own due diligence in determining the relevance and reliability of such information. "Research analysts must always place the interests of their investor clients first," AIMR emphasizes. "...Yet research analysts should not be expected to uphold these high principles alone. Their employers, their colleagues, their investor clients, the companies they evaluate and the financial media all must strive to give them support and encouragement if they are to maintain their commitment to these standards." -Nick Snow

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