Smith affair throws spotlight on analysts: The impartiality of stock market research is being questioned, writes Richard Thomson

Richard Thomson
Saturday 15 August 1992 23:02 BST
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TERRY Smith, one of the City's leading research analysts, spent most of Thursday night closeted with his lawyers. His legal position was complex. Thanks to his book Accounting for Growth, which is due to be published in the next few weeks, he has been suspended by his employer, UBS Phillips & Drew, which has taken out an injunction to stop publication of his book. Even before being published, it has turned out to be far more controversial than anyone suspected.

At first sight, his suspension appears to be the result of a bizarre and almost incomprehensible squabble with his employers over an article of company policy. By suspending its head of UK equity research, P&D has triggered an avalanche of apparently unnecessary bad publicity. If Mr Smith and his publishers are right, however, the issue is the far wider question of the freedom of City analysts to publish independent and unbiased research. P&D, the publishers claim, is trying to censor him.

The story of how Mr Smith fell out with his employers is opaque. The book is based on some award-winning research published by P&D in January 1991 about the creative accounting techniques used by leading companies. It detailed ways in which legal accounting methods allowed companies to manipulate their accounts to show higher earnings and lower debt gearing.

Earlier this year, Mr Smith obtained permission from his firm to turn this into a book carrying P&D's name on the front. Some new research was added and the book was due to be published in September. Earlier this month, the Mail on Sunday published some of its findings, naming Grand Metropolitan as one of the accounting offenders.

Disturbed that he had had no warning, GrandMet's chief, Sir Allen Sheppard, duly complained to Rudi Mueller, the head of UBS P&D. Mr Mueller demanded the book's publication be delayed while the companies mentioned were shown the work. Mr Smith refused and last week he was suspended.

P&D does not seem unduly worried about anything the book actually says. But it insists that Mr Smith was suspended because he broke the house policy of showing research documents to the companies concerned before they are published. Most broking houses follow a similar rule. The aim of the policy is to give companies an opportunity to correct possible factual errors.

P&D analysts say, however, that the procedure is only required when the firm is broker to a company. With other companies, it is up to the individual analyst whether he goes through the checking procedure. This makes P&D's action against Mr Smith look even more peculiar because GrandMet is not a P&D client.

The book is certainly critical of many companies. On its so- called 'blob table' showing which companies use the largest number of creative accounting techniques, it lists GrandMet as among the worst offenders. The company uses nine out of a possible 12 techniques. Yet the original piece of P&D research contained a similar table, which also showed GrandMet to be one of the biggest users of creative accounting methods. In short, the book was old news.

Undoubtedly a clash of personalities is involved. Mr Smith has a history of annoying employers by his outspokenness. In 1987, he angered Barclays Bank by publishing a 'sell' note on it when he was working at BZW, its broking arm. Two years ago, he left James Capel after falling out with its new management. On one occasion he head-butted a client from the insurance company, Allied Dunbar, at a black-tie dinner. He is a man of strong opinions. Some believe P&D's apparently inexplicable anger over the book is just an excuse to oust Mr Smith.

Mr Smith and Random Century claim the real matter at stake with P&D, however, is nothing less than the independence of stockbroking research. Pressure from companies such as GrandMet, they say, has embarrassed P&D into blocking the publication of the research. GrandMet, meanwhile, denies it has applied any pressure or that it has even seen the book.

Whether or not censorship has been applied, however, the accusation hits a raw nerve in the City. The independence of research is one of the trickiest of all issues in the Square Mile. If research is not independent, it is worthless. In which case, several thousand brokers are doing a pointless job and their firms lose one of their chief methods of salesmanship.

Ideally, research is impartial - a service to help investors understand companies and make up their minds about them. In reality, everyone in the stock market recognises certain ground rules. As one former P&D employee says: 'It is regarded as a sales tool to persuade people to buy or sell shares.'

While research of this kind, therefore, may have valuable things to say, it is not altruistic. It is designed to stimulate turnover. Often this means brokers may exaggerate their opinions. 'Because of pressure to get business, there is always a pressure to be extreme in either a buy or a sell recommendation.'

This pressure is frequently unspoken, but it can be overt. Mr Smith himself, as head of UK research at P&D, forbade analysts to issue 'hold' recommendations on shares because, says one former colleague, it did not stimulate business. Analysts had to come out strongly in favour of either buying or selling a particular share even if they thought this opinion was too strong. The policy was only suspended when clients complained.

The stock market also implicitly recognises the self-censorship firms apply to their own research on companies to which they are brokers. They are generally assumed by investors to be better informed about the company but less honest in their opinion of it. 'When you are a company's broker, you never put a sell recommendation on its shares in your research,' says one analyst.

More problematical still is the situation where a single firm combines a corporate finance and stockbroking operation. There are Chinese Walls to stop them influencing each other, but analysts around the City frequently admit privately to having felt pressure from within their firms to mute any criticism of, for example, a company whose rights issue the corporate finance team is arranging. The pressure is usually subtle and oblique. It is designed to head- off direct complaints from the companies they analyse.

Sometimes it fails and a company's reaction can be vicious. Robert Maxwell took it to an extreme, threatening and intimidating several firms into withdrawing critical comments. Investors do not always know, however, when such pressure has been exerted.

(Photograph omitted)

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