Regulatory Issues in Investment Research Brian McDonnell Associate

850 Attorneys, 18 offices, Since 1901 Investment Research – Areas of Regulatory Concern Issue of regulatory focus  Conflicts with investment banking  Producing favourable research to maintain/win business  Involvement in sales pitches/roadshows  Management structure and analyst remuneration  Editorial control and timing of publication  Conflicts with trading desks  Dealing ahead  Personal account dealing by/financial interests of analysts

850 Attorneys, 18 offices, Since 1901 COI and Investment Research The regulatory response  Many sources of regulation - rule development  Senior management responsibility – CEO letter – 17/9/4

850 Attorneys, 18 offices, Since 1901 Regulation of Investment Research PrinciplesRules Principle 1 (integrity)COB 5.10 (conflicts in the context of corporate finance business) (1 May 2004) Principle 2 (due skill, care and diligence) COB 7.1 (fair treatment) Principle 3 (management and control)COB 7.3 (dealing ahead of investment research) (changed 1 May 2004) Principle 5 (market conduct)COB 7.13 (personal account dealing) (changed 1 May 2004) Principle 6 (customers’ interests)COB 7.16 (investment research) (1 July 2004) Principle 7 (communications with clients) COB 7.17 (required disclosures) (1 July 2005) Principle 8 (conflicts of interest)COB 7.18 (bundling) (1 Jan 2006)

850 Attorneys, 18 offices, Since 1901 Regulation of Investment Research  “Investment research” is defined as: “a document … or material the substance of which is common to a number of documents although worded as though they are personal recommendations, which contains one or more of the following:  the results of research into a designated investment or its issuer  analysis of factors likely to influence the future performance of a designated investment or its issuer”  Held out as “impartial”  What does this cover?

850 Attorneys, 18 offices, Since 1901 COI and Investment Research: COB 7.16 Identification of conflicts  Use of investment research to maintain and win business  Firms duty to investment trading clients as against that to corporate clients (eg. book building)  Firms role as proprietary investor and underwriter  Dealing ahead of investment research

850 Attorneys, 18 offices, Since 1901 COI and Investment Research: COB 7.16 COB  Establish and implement a management policy in relation to conflicts which may affect the impartiality of investment research  Record the policy and retain for at least three years  Take reasonable steps to ensure compliance  Make written copy available on request  Take reasonable steps to ensure the policy remains appropriate and effective  Disclosure – necessary but not sufficient

850 Attorneys, 18 offices, Since 1901 COI and Investment Research: COB 7.16 The policy must:  Identify types of investment research to which it applies  Provide for systems, controls and procedures which identify COI affecting the impartiality of investment research and manage those COI effectively in relation to at least:  supervision and management of investment analysis  remuneration of investment analysis  extent to which investment analysts may become involved in other activities  extent to which inducements may be accepted by investment analysts/senior employees  timing and manner of publication and distribution  appropriate information/disclosures to be included

850 Attorneys, 18 offices, Since 1901 COI and Investment Research: COB 7.16 Policy contents: supervision and remuneration of analysts  Those with responsibilities that might conflict with interests of those to whom the research is published/distributed should not be responsible for:  day to day supervision/control of analysts  decisions on content or timing of publication  determining remuneration of analysts  Remuneration structure should not create an incentive inconsistent with the provision of an impartial assessment  Remuneration not to be linked to a specific transaction or recommendations in research

850 Attorneys, 18 offices, Since 1901 COI and Investment Research: COB 7.16 Policy content: involvement of analysts in other activities  No involvement in activities likely to appear to be inconsistent with the provision of an impartial assessment e.g.:  soliciting corporate finance business  attending roadshows relating to issues/allocations  Can be used to:  research corporate finance business opportunities  provide ideas to sales/trading staff  provide information and advice to investment clients

850 Attorneys, 18 offices, Since 1901 COI and Investment Research: COB 7.16  Accepting inducements to provide favourable research  Giving editorial control to someone whose role/commercial interests might conflict with interests of those to whom research is published/distributed Policy content: avoiding inappropriate influences e.g. prohibition on:

850 Attorneys, 18 offices, Since 1901 COI and Investment Research: COB 7.16 Policy content: means and timing of publication  Investment research to be published/distributed in an appropriate manner, e.g.:  through usual channels  prohibition on communication of the substance of the research except as set out in the policy  Consider whether other business activities create a perception that research may not be impartial e.g. restrict publication of relevant research around the time of an investment offering

850 Attorneys, 18 offices, Since 1901 Required Disclosures: COB 7.17 “Research recommendation” is defined as:  “Research or other information concerning one or several financial instruments admitted to trading on regulated markets … accessible by a large number of persons (not including informal short-term personal recommendation or advice given in the context of a takeover bid (rule 3) …) … which recommends … an investment or... expresses an opinion as to the present or future value … of such instruments”

850 Attorneys, 18 offices, Since 1901 Required Disclosures: COB 7.17  Fair presentation  Disclosure  Identity of producers of research  All relationships and circumstances that may reasonably be expected to impair the objectivity of the research recommendation  All substantially material sources  Whether research recommendation disclosed to issuer and amended following disclosure  The methodology for any valuations  Mutual shareholdings – 5%>  Other financial interests  That firm is market maker

850 Attorneys, 18 offices, Since 1901 Required Disclosures: COB 7.17  Disclosure (… cont)  That firm was lead (co-lead) manager in previous 12 months (or other agreement for the provision of investment banking services)  Any agreement relating to the production of the research  The organisational arrangements to manage conflicts of interest  Details of the receipt/purchase of issuer’s shares by the firm/analyst prior to offering  Quarterly disclosure of buy/sell/hold recommendations

850 Attorneys, 18 offices, Since 1901 Current and Future Developments UK  Recent analysis of the impact of the FSA’s rules on conflicts of interest and dealing ahead EU  Markets in Financial Instruments Directive (“MiFID”) – Nov 2007 US  Gone further in many respects than UK  analyst training and self-certification requirements  funding of independent research  quiet periods  detailed disclosure requirements

850 Attorneys, 18 offices, Since 1901 Issues in Analyst Research  Relationship with corporate finance  Future role of analysts  Usefulness of non “impartial” research  Pre IPO research - timings  Investor/issuer education