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Chair
Dirk Koerber's address to the Shareholders Research
Alliance on the September 20, 2005, webcast at the site
of the annual SEC Forum in San Francisco:
"Good Morning.
"My name is Dirk Koerber. I am a private investor and a retired VP of Investor Relations. During more than 20 years in IR I have worked in the U.S. and in Europe for large, mid- and small-cap companies with activities in aerospace/defense, computers & software, oilfield services, industrial and retail automation and medical electronics. During this period I also helped to establish two corporations on the NYSE and with the financial community.
"A few days ago more than 100 private investors followed the ‘call-to-action’ to become Overseers for the Shareholders Research Alliance to oversee independent, paid-for or company-sponsored research and the ethical behavior of all parties involved. I represent this group of private investors today as the Chairman of the Oversight Advisory Group. The Oversight Advisory Group has five board members which were elected by the Overseers and then, between the five, elected its Chairman and Vice Chairman.
"Elections are being held annually and we will not serve more than two year terms.
"Right at the beginning it is important to note that we are not being paid for our time and efforts within the Shareholders Research Alliance and act on a voluntary basis. It also tells you that we can not be held liable for the results of our independent reviews.
"So, why did we come together and what do we see as our self-described task?
"Reg FD, SOX, SEC Section 501 and NYSE and NASD guidelines about conflicts of interest within the investment and especially investment banking community have greatly impacted one group of professionals: research analysts.
"The WSJ reported that the largest sell-side firms follow approximately 25% less stocks than in 2000. 1300 companies lost coverage after the so-called
'Spitzer effect.' A survey last year disclosed that almost 40% of NASD and 20% of NYSE listed companies have no analyst coverage at all. Against this background you have the 90 million Americans who are in the market, looking for companies as an investment.
"It is therefore not surprising that everybody wants public companies covered by independent research. The companies want it, because it supports their interest in accessing capital and reducing the cost of it. Portfolio managers of large and small institutions or pension funds want it because it provides them with one of the most important decision-making tools for investing our moneys. We, the private investor want it for the same reasons. And the analysts want it to keep their jobs.
"I am sure, the Stock Exchanges, the SEC and Mr. Spitzer want it too, because ethically performed research provides what we all want: transparency. Or, as Bill
Hambrecht, founder of the San Francisco investment house, said at the recent SEC Forum on small business capital formation:
'Transparency solves problems.'
"Research coverage without doubt creates transparency.
"The problem is: there is no such thing as free research. But the cost of research can no longer be covered by an analyst’s work in investment banking.
"It is either paid for by the buy-side or through the trading commission structure in so-called soft dollars. And even that could be further curtailed in the future.
"Large institutions responded to the reduction in research by concentrating on fewer sell-side firms to have more clout and access. Or they commission single analysts or boutique houses to get exclusive research on a company and its industry. Or they use more database tools and complement them with their own, in-house buy-side research.
"So, all is well?
"No. Because we have not talked about us, the private investor and the intriguing investment group of small to mid-cap companies.
"Small- and mid-cap corporations have the potential to grow earnings and cash flow faster than many large cap counterparts, especially during early recovery periods of the economic cycle or in the establishment of new technologies or services.
"Even large institutions, while limited by the trading volumes of these companies, subscribe to this notion. At the SEC meeting for small company capital formation Chris
Ailman, Chief Investment Officer of the California State Teachers Retirement System, said that ‘they are expecting better growth out of smaller
companies.'
"Smaller companies are an appealing investment target especially for private investors. But there is little help from the reputable sell-side investment houses. Even if they cover small or mid cap companies it will be primarily those with sizeable floats that can create trade volumes and thus commission revenues.
"No doubt – small and mid-cap companies struggle to attract sell-side coverage. And coverage reflects validation. Even, if at times the rating result is not too favorable. No coverage creates, as one presenter at the SEC conference said, no coverage creates second class citizens and results in an illiquid market. And we know; liquidity has value.
"There is another irony in this story. While we have seen major reductions in the research staff of the sell-side industry, all of us – companies, money managers, private investors, and all shareholders – have an interest that this professional talent is not lost and kept intact and up-to-date.
"This is why we, the private investors, have such an interest in this subject. This is why more than 100 private investors immediately responded to the call of the Independent Research Alliance and offered active, voluntary support to establish and support an ethical, transparent process of ‘paid-for research’. Given the market conditions, it currently represents probably the most important solution to this issue. So, let’s make it right and reliable.
"How will we do this?
"While we are just starting our discussion and see ourselves a ‘work in progress’ certain issues and ways of involvement are visible today. In fact, when you read the First Research
Consortium/Investrend policies and add to that the CFA/NIRI Guidelines on paid-for research you know basically what our task is: constant and real world review of the procedures of all involved.
"On the Company side: that payment is made to the provider upfront and before a project starts; that the company does not try to influence the direction and outcome of the report; that the covered company remains neutral in the selection of the analyst by the Provider; that non-cash payments, like stock, are deposited in an independent escrow account for transformation into cash, preferably before the analyst starts her/his work.
"On the Provider level: the ethical selection of a professional, institutional-like analyst with CFA or CFA-like credentials; no influence on the independent analyst to perform her/his task; a payment (cash-like) structure that prevents conflict of interest; the disclosure of fees/compensation from corporate clients or agents; no investor relations or promotional work for companies that contract for research; a timely and immediate distribution of research products; no interference with this Oversight Advisory Group and the Overseers to guarantee an honest process; full disclosure of information for the Overseers’ reviews.
"On the Analyst level: the proof of
credentials (CFA or equivalent) and professional experience; independence from companies, agents and providers; balance in
reporting (positives/opportunities & negatives/risks); no stake in and trading of researched company stock; full disclosure of compensation in report and any research note; acceptance of Standards of Ethics of the CFA Institute; adherence to the rating/price target/recommendation rules set up by the Independent Research Alliance; disclosure of their identity in any published report.
"These are the most important points, but I am sure we will develop more as we go forward.
"The Overseer involvement can be in the form of an in-depth review, spot-checks or both. It includes reviews of documents, emails, contracts as well as conversations & interviews. One or more Overseers might be assigned to a project.
"The group of Overseers comprises investors with interest in only one single company and others who are open for reviews of any company under the Shareholder Research Alliance coverage.
"Requests for reviews can come from anyone interested in the process. Shareholders, companies, providers, analysts or outside parties. The Oversight Advisory Group will coordinate this process and identify those Overseers that might be ready to perform the review. Especially at the beginning most reports will probably flow through the Oversight Advisory Group and will be disseminated to the parties involved with possible recommendations for how to improve or correct the process. While we still have to work out these details in our procedures, the report flow through the Oversight Advisory Council should make sure that an assigned Overseer does not follow a private agenda in her/his review and report.
"As all Overseers provide their services on a voluntary basis it can not be excluded that a few members might have a special agenda. This is where the Oversight Advisory Group will come in to secure and keep the process transparent, ethical and trustworthy. You also should keep in mind that each Overseer can only offer a limited time to any of these reviews as they are done during our participants’ spare time. We do not provide any legal or audit services and can not be held liable for the contents and findings of the reviews. But we will strive to provide a professional review process to company-sponsored research.
"Review reports will become a matter of public record and we will probably provide access to them via our website. This, again, will demonstrate that this is a serious and honest process that improves transparency.
"Our interest as private investors is that more companies get professional research coverage, because it reduces volatility and thus risk, and over time creates a price premium and thus shareholder value. No doubt, institutional investors can also subscribe to this objective.
"Smaller-cap corporations are often left with only one solution to achieve this: issuer-paid research. Our processes should help to validate this solution as credible and trustworthy.
"We know that paid-for research still carries a stigma with many investors. A snap-shot survey by NIRI last year between companies that had used paid-for research said that 36% did not even disclose who paid for the research.
"There was probably a reason why these companies didn’t make that disclosure and one can assume that there was a somewhat arguable relationship between company and research party. Either in the form of payment or the mingling with PR-type or promotional services or a direct contract or even equity link between analyst and company.
"No wonder that this type of paid-for research is then rated as ‘company-hype’. What these companies and their contract partners don’t seem to see is that this not only hurts the credibility of that particular corporation, it also hurts the credibility of all paid-for research. Not surprisingly the most important result of that NIRI survey was actually not who was paying for it, but
'How credible is it?'
"This is why we as private investors support transparent models as outlined in the Shareholders Research Alliance.
"For us, paid-for research is here to stay. But it needs transparency and ethics and professionalism to get over the hurdle of its image.
"Maybe, the SEC should introduce a trademark that only those research reports are allowed to carry that stringently subscribe to the rules and regulations for paid-for research and allow open reviews of the process.
"As we actively help in this process we hope the stigma will disappear and conflict-free paid-for research will become widely accepted. And who knows? Maybe, soon we all will compare it to audits. Here it is accepted that they are ‘paid for’ by the companies for whom they are performed."
The SEC has not offered, nor has it been asked to endorse this independent event or
program.
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