ESN - European Securities Network LLP

Securities analysts can improve the efficiency of financial markets by diffusing and processing information. However they could potentially face conflicts of interest that would alter their independent, unbiased opinions.

In order to help “financial institutions” either eliminating or managing these conflicts, the International Organisation of Securities Commissions (IOSCO) issued on September 25, 2003 a statement of principles for addressing “sell-side” securities analyst potential conflicts of interest.

- the identification and elimination, avoidance, management, or disclosure of conflicts of interest faced by analysts;

- the education of investors concerning the actual and potential conflicts of interest analysts face.

The word “research” does encompass any written or electronic document that is sold or distributed to the clients of “brokerage firms” or “investment banks” or, more generally, “financial institutions” or to the general public, which presents information about securities and expresses an opinion or makes a recommendation about the investment potential of the issuer’s equity security, fixed income securities, or derivatives of such securities”.

The Members of ESN share the objectives of the IOSCO Statement of Principles. The Members’ Meeting of ESN, held in London on 15 October 2004, adopted the following set of rules, inspired by the IOSCO principles. Over a nine months period following the official adoption, each Member will have taken significant measures in order to comply with the ESN “Analyst Code of Conduct”.

ESN intends to review these rules on an ongoing basis and revise them if need be.

As a common cross-country code of conduct cannot be all-inclusive, the ESN code is a minimal standard. Each Member of ESN has to obey rules imposed by national law and/or by the domestic regulatory authorities and may adopt complementary rules on a voluntary basis.

Principle 1: Mechanisms should exist so that analysts’ trading activities or financial interests do not prejudice their research and recommendations.

Analysts provide investors with research and recommendations regarding the securities of public issuers. Analysts can face a conflict of interest insofar as these recommendations influence the decisions investors make. An analyst whose research and opinions are widely respected can affect the price of a security through his or her recommendations. If an analyst has a financial interest in an issuer that he or she reviews, there may exist a conflict between this interest and the analyst providing clear and unbiased research accurately reflecting what the analyst believes is the issuer’s true financial prospects.

Being aware of this conflict of interest and in order to prevent analysts’ research and recommendations from being prejudiced by their financial interests or trading activities, ESN members have decided to require from analysts that they certify they do not breach the following rules :

– (1.1) not to trade in securities or related derivatives of an issuer they review in a manner contrary to their outstanding recommendations, except in special circumstances subject to pre-approval by compliance or legal personnel;

– (1.2) not to cover an issuer, where the analyst serves as an officer, director or member of the issuer’s supervisory board and requiring disclosure of any such relationship involving individuals closely related to or associated with the analyst; in the alternative, requiring analysts covering an issuer to disclose if they, or individuals closely related to, serve as officers, directors or members of the issuer’s supervisory board;

– (1.3) not to trade securities or related derivatives one week ahead of publishing anticipated research on the issuer of those securities and 24 hours after publishing such a research, except in special circumstances subject to pre-approval by compliance or legal personnel; and,

– (1.4) to disclose, either publicly or to internal compliance or legal personnel, if the analysts have investment positions or otherwise have financial interests in issuers that the analysts review.

Principle 2.a: Mechanisms should exist so that analysts’ research and recommendations are not prejudiced by the trading activities or financial interests of the firms that employ them.

The firms that employ analysts may have financial interests or business relationships that present conflicts of interest insofar as these firms influence the research or recommendations that the analysts make. Firms that employ analysts may be involved in a variety of businesses, investments or practices that may benefit from favourable research or recommendations issued by the analysts they employ. They also frequently trade securities of the issuers their analysts cover. Depending on the circumstances, these analysts may feel pressure or have an incentive to issue research or recommendations biased in favour of their employers’ interests.

Being aware of this possibility and in order to protect analysts’ research and recommendations from being prejudiced by the financial interests or trading activities of the firms that employ the analysts, ESN members have adopted the following rules :

– (2.1) to require analysts, or firms employing analysts, to publicly disclose if an analyst’s firm makes a market for securities of an issuer that the analyst reviews or if the firm has a financial interest in the issuer in excess of the domestic transparency threshold;

– (2.2) to require analysts or the firms employing analysts to publicly disclose if individuals employed by or associated with the firm serve as officers, directors, or members of the supervisory board of an issuer that the analysts review, the disclosure could be based on the official list of mandates, if any;

– (2.3) to prohibit firms that employ analysts from improperly trading securities or related derivatives ahead of the analyst publishing research on the issuer of those securities, where improperly means using analyst unpublished information; and,

– (2.4) to require analysts or the firms that employ analysts to broadly and/or simultaneously disseminate their research reports according to standard internal procedures.

Principle 2.b: Mechanisms should exist so that analysts’ research and recommendations are not prejudiced by the business relationships of the firms that employ them.

In many cases, the firms that employ analysts also provide investment banking or other services to the issuers that the analysts cover. As such, the promise of favourable reviews may encourage an issuer to engage the services of a particular firm — creating a conflict of interest for the analyst. The nature of such conflicts, however, can vary considerably, depending on the type of business relationship.

Being aware of these risks and in order to prevent analysts’ research and recommendations from being prejudiced by the business relationships of the firms that employ them, ESN members have adopted the following rules :

– (2.5) to establish robust information barriers between analysts and a firm’s other divisions in order to limit the potential for conflicts of interest and prevent other individuals in the firm from attempting to influence analysts’ research;

– (2.6) to prohibit firms that employ analysts from promising issuers favourable research coverage, specific ratings, or specific target prices in return for a future or continued business relationship, service or investment;

– (2.7) to allow analysts to participate in investment banking activities, but prohibiting them from making use of insider information and preserving their independence;

– (2.8) to require analysts or the firms that employ analysts to publicly disclose if an analyst’s firm has or recently has had an investment banking relationship with an issuer that the employer reviews;

– (2.9) to mandate a “quiet period” – during which time the analyst may not publish research reports about the issuer or, at least, does not publish any investment recommendation – from the day a securities Public Offering underwritten or managed by an investment firm employing a analyst is announced until 40 days after the end of the offering, and;

– (2.10) to require analysts to certify that the opinions they express and recommendations they make in research reports and/or public appearances are, in fact, the opinions they themselves hold.

Principle 3: Reporting lines for analysts and their compensation arrangements should be structured to eliminate or severely limit actual and potential conflicts of interest.

In many jurisdictions, actual and potential conflicts of interest arise for analysts because of the manner of compensation and reporting structure within their firms. The investing public has a right to expect objectivity in analysts’ recommendations. Where an analyst’s likelihood for promotion or financial bonus depends on his or her ability to promote the firm’s investment banking business or promote shares that the analyst’s employer has underwritten, objectivity may be compromised because the analyst’s interests and those of the investing public diverge. The degree to which reporting and compensation structures present conflicts of interest for analysts varies considerably; in some jurisdictions, analysts are largely salaried employees and do not report to anyone outside the firm’s research department.

Being aware of the direct conflict of interest reporting lines and compensation arrangements may pose and in order to structure analyst compensation and reporting arrangements in such a way as to severely limit actual and potential conflicts of interest, ESN members have adopted the following rules :

– (3.1) to prohibit analysts from reporting to the corporate finance function;

– (3.2) to prohibit analyst compensation from being directly linked to specific corporate finance transactions; and,

– (3.3) to prohibit the corporate finance function from pre-approving analyst reports or recommendations, except in circumstances subject to oversight by compliance or legal personnel where corporate finance personnel review a research report for factual accuracy prior to publication.

Principle 4: Firms that employ analysts should establish written internal procedures or controls to identify and eliminate, manage or disclose actual and potential analyst conflicts of interest.

Requirements imposed by regulators, SROs and industry associations do not discharge firms from their own responsibilities to actively identify and address through their own internal mechanisms the conflicts of interest that may influence the research and recommendations made by the analysts they employ. As with all procedures and controls within a firm, senior management bears ultimate responsibility for the adequacy and enforcement of written internal procedures and controls designed to identify and eliminate, manage or disclose analyst conflicts of interest.

Being aware of the importance of such internal procedures and in order to avoid a “one-size-fits-all” approach, ESN members have adopted the following rule :

– (4.1) to require firms that employ analysts to have written internal procedures for addressing actual and potential analyst conflicts of interest.

Principle 5: The undue influence of issuers, institutional investors and other outside parties upon analysts should be eliminated or managed.

Issuers and large shareholders often have a deep interest in the reviews provided by securities analysts because these reviews can encourage or dissuade investors from purchasing or selling shares of a company. These outside parties may try to pressure an analyst into making a favourable recommendation through a variety of means, ranging from monetary bribes to refusing to provide the analyst with key information provided to the analyst’s competitors. In some cases, such pressure may be viewed as a form of fraud and/or market manipulation.

Being aware of these risks and in order to eliminate or manage the undue influence of outside parties, ESN members have adopted the following rules :

– (5.1) to require that analysts, or the firms that employ analysts, publicly disclose whether the issuer or other third party provided any compensation or other benefit in connection with a research report; and,

– (5.2) to prohibit analysts from accepting, or requiring analysts to publicly disclose, any separate compensation they receive from issuers they review or from institutional investors or other outside parties.

Principle 6: Disclosures of actual and potential conflicts of interest should be complete, timely, clear, concise, specific and prominent.

Insofar as analysts face conflicts of interest, the complete nature of these conflicts should be disclosed, in a timely fashion, to investors who might rely on the recommendations or research these analysts provide. What, how and in what form these disclosures are made will vary according to the nature of the market and the laws and regulations of a particular jurisdiction, as well as the media by which the analyst makes a recommendation (e.g., research report provided to clients, the Internet, public appearances, etc.). In some cases, however, even disclosures of actual and potential conflicts of interest may be inadequate if the disclosures are difficult to understand or provided in areas of a report or document likely to be overlooked by readers. Similarly, disclosures may use generic language that merely lists a variety of possible conflicts that may or may not apply to the particular analyst, report or circumstance.

Being aware of the possible lack of clarity of disclaimers and in order to allow investors’ informed judgement about the potential conflicts of interest, ESN members have adopted the following rule :

– (6.1) to formulate disclosures in a complete, timely, clear, concise, and prominent manner so that investors obtain the full benefit of the information provided.

Investors expect analysts to be both competent and honest. Requirements for honesty lessen the potential that analysts will be swayed by the conflicts of interest they may face. Fundamental to the analyst function is that analysts should have a reasonable basis for the analyses and recommendations they give investors.

Being aware of the importance of credibility and in order to hold analysts to high standards of integrity, ESN members have adopted the following rules :

– (7.1) to impose to analysts and/or the firms that employ analysts to act honestly and fairly with issuers and clients;

– (7.2) to prohibit analysts and/or the firms that employ analysts from acting in ways that are deliberately misleading or deceptive;

– (7.3) to require analysts to disclose their real names and license status when making comments on issuers or recommending securities via the media;

– (7.4) to require analysts to define the terms they use when making recommendations; and;

– (7.5) to require analysts to include in their reports the key assumptions underlying their recommendations.

Code of Conduct

for sell-side securities analysts