“RESEARCH OBJECTIVITY A PATH TO INDEPENDENCE by linxiaoqin

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									                “RESEARCH OBJECTIVITY: A PATH TO INDEPENDENCE”
                               September 26, 2002
                                  Boston, MA

Panelists:
Thomas A. Bowman, CFA                 AIMR, president and CEO
Chuck Hill, CFA                       Thomson First Call, director of research
Shawn Johnson, CFA                    State Street Global Advisors, director of research
Matthew Patsky, CFA                   Adams, Harkness & Hill, director of research
Tom Newberry                          GTC BioTherapeutics, vice president of corporate
                                      communications
Geoff Smith                           Business Week, correspondant

Moderator:
Shahriar Khaksari, CFA                Suffolk University, professor of finance

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DR. SHAHRIAR KHAKSARI, CFA: Good afternoon, everyone. Thank you for coming. In
the interest of time, we are going to get us started with our panel discussion as you are finishing
your lunch.

I will start by introducing myself. My name is Shahriar Khaksari. I’m a Finance Professor at
Suffolk University Sawyer School of Management. I will serve as moderator for our panel
discussion today.

Today we will focus on research objectivity and obviously this is a very timely issue. As a
student of economics, we all recognize that a necessary condition for a well-functioning financial
market is trust and confidence. We also know that economic prosperity and growth is not
possible without an efficient and well-functioning financial market.
As you are aware, the events of the past few months have damaged the trust and the confidence
that market participants have had in the markets. The resulting costs are enormous. The impact
is far-reaching. Every citizen, whether they own equity investments or not, has been affected by
these events. In fact, in today’s global economy, a well integrated global economy, people
around the world have been influenced by this climate of distrust.

In the midst of these circumstances, we look to AIMR and the Boston Security Analysts Society
who have had a past history of educating public and investment professionals on ethical and
technical issues that are central to rebuilding the trust and confidence in the financial markets.
Today’s panel discussion deals with one of the key strategies in preventing that which is now
taxing our profession, the investment community and the economy as a whole.
I would also like to mention that today’s session is one of a series of panel discussions that are
being held in New York, London and in other major cities around the globe. The purpose of
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these discussions is to bring constructive attention to the critical issue of financial security
objectivity and in particular to the proposal that AIMR has made to foster an environment
promoting the objective securities research and analyst independence.
I want to start by thanking AIMR for helping to set up this exciting event and Boston Security
Analyst folks for hosting it, and I want to recognize Tom Bowman of AIMR, and I would also
like to recognize Harry Markopolos, the President of BSAS, and one of my colleagues, Chris
Argoryple who could not be here today, a principal at Delta Partners and a political professor at
Suffolk University Sawyer School of Management.

I would also like to recognize BSAS staff and officers, Kitty Kennedy, Executive Director;
Stephanie Field, Associate Director; Gayle Buff, Vice-President of Education; Warren Johnson,
Johnson Portfolio Group; and Samuel Jones, from Trillium Asset Management Group; and
Jonathan Snyder, from North American Management Corporation. Thank you all for making this
event to happen.

Also, I would like to point out that the audio of today’s discussion is being broadcast live on the
web and will be archived later on at the AIMR website, www.aimrdirect.org. So all AIMR
members around the country can listen to it. And I would also like to welcome the members of
the press for participating in this discussion.

Now, we’ll turn to our distinguished panel. We’re really fortunate to have with us a panel that is
made up of representatives from all the market participants that are included in AIMR’s
standards and guidelines. This panel includes representatives from the sell side, buy side,
corporate issuers and media.

I’m not going to introduce Tom again, because he has already been introduced once, so I would
start with Chuck Hill. Chuck is very well known to many of you because he’s rather famous and
he’s Vice-President of Programs at BSAS. Charles Hill, as he is formally known, is the Director
of Research for First Call Corporation, the Thomson Financial Company. Mr. Hill serves as the
chief financial analyst for First Call earning data. Chuck is featured regularly on ABC’s World
News Tonight, CBS Evening News, CNN, CNBC and the Nightly Business Report and serves as
a resource for top media outlets including the Associated Press, the Boston Globe, Business
Week and many others.

He has more than 25 years of experience in the field of financial analysis. He holds a M.B.A.
from Harvard and a B.S. in chemical engineering and a B.A. in history from the University of
Delaware, as well as the CFA charter.

Representing the sell side from a somewhat more particular point of view today will be Matt
Patsky. Mr. Patsky is a Director of Equity Research at Adams, Harkness & Hill, here on Boston.
He supervises a team of 21 research analysts focused on emerging growth companies in the area
of technology, healthcare and specialty consumers. Mr. Patsky joined Adams, Harkness & Hill
seven years ago as an analyst, focusing on the consumer healthy living sector. His interest in
cultural trends related to health conscious and aging consumers led him to spearhead the
development of the healthy living investment team.
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He has authored a number of industry reports, including the first report ever published by an
investment bank on socially responsible investment. Mr. Patsky has a B.S. degree from
Rensselaer Polytechnic Institute in Troy, New York, and is a CFA charterholder.

Representing the buy side is Shawn Johnson, Director of Fundamental Research at the State
Street Global Advisers, where he’s also a principal. Mr. Johnson is responsible for managing
global fundamental investment research and analysis for equity, fixed income and high yield as
well as for overseeing the expansion of SSGA’s fundamental coverage of securities and markets
worldwide. He’s also a board member of SSGA’s fiduciary committee and SSGA’s Tuckerman
Real Estate Committee.

Mr. Johnson joined the firm in 1997 and brings to it more than 15 years of experience in
management, management consulting and engineering experience. He’s often seen on such
programs as CNBC’s Power Lunch and Market Wrap and CNN’s Moneyline News Hour and
Street Sweep.

Mr. Johnson earned a B.S. in aerospace and ocean engineering, a M.S. in electrical engineering
from Virginia Polytech Institute and State University, as well as a M.B.A. from Amos Tuck
School of Dartmouth College.

The fifth member of our panel today representing corporate issuers is Tom Newberry. Mr. Tom
Newberry joined GTC BioTherapeutics Inc. in Framingham, May 2000 as Director, Investor
Relations. He is currently Vice-President of Corporate Communications and is responsible for
all of GTC’s corporate communication programs.

Before joining GTC, he was Director of Investor Relations for North American Vaccine in
Maryland and before that, director of Investor Relations at Rochester Gas and Electric
Corporation. There, he developed that company’s first dedicated investor relations program. So
Mr. Newberry has a long experience with many corporate issuers. Altogether, he has over 20
years of business experience, some of it very different than from what he does now. He has a
bachelor of science from Rochester Institute of Technology.

Last but not least, we are grateful to have with us Geoff Smith, from Business Week. Mr. Smith
has been with Business Week for 12 years, all of them in the Boston bureau. Before that, he was
with the Boston Herald. He is co-recipient of the prestigious Gerald Loeb Award for Business
Reporting and has won many other awards for his writing on personal finance and related topics.
Mr. Smith has written extensively about investing in high-tech stocks and writes a column about
online financial services for Business Week online. He has a degree in journalism from
Northwestern University.

Let me thank you again for joining us today. I’m going to ask each of you to give a brief
opening statement on the topic of research objectivity and the standards and guidelines AIMR
has proposed and then I’m going to open the floor to questions.
We are going with Mr. Hill first.
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CHUCK HILL, CFA: As was mentioned, I am a CFA and I’m proud of it. Like Tom, I’ve
testified in front of Congress numerous times on this analyst conflict issue and I do have a
passion that I bring to the table about it and in the interest of full disclosure, I must say that I
have a selfish interest in this in that I want my kids to be able to say that not only was their father
good at his job but that he worked in an honorable profession.

So I certainly want to do anything I can to fix the problems we have.

A couple of things that I would point out though in reference to the subject today, the big
problem on the conflict issue I think is not so much the objectivity of the sell-side analyst,
although there certainly have been some instances where that was violated. But the bigger issue
I think is the allocation of their time. We have too many sell-side analysts who are out chasing
deals rather than spending their time doing good fundamental research on industry. So I think
when we look at these rules or standards, we should keep that in mind.

It’s the old story that when we look behind what the real problems are, you’ve got to follow the
money. Obviously until we do something about the compensation issue at the investment
banking houses in terms of paying their analysts, we’re not going to really solve the conflict
problem. And I think the buy side needs to look in the mirror on this. It’s the old story, you get
what you pay for. You drove commissions down to almost nothing and research can’t stand on
its own feet economically anymore, and I think we need to try to address that issue if we really
want to solve the problems. But in the meantime, we have to try to live with doing what we can,
and these standards are a good start.

The one suggestion that I made in the talk I gave on this down at Charlottesville last weekend for
when they had a conference of the Society leaders was that in terms of the buy side and pressure
from the buy side and the sell side analyst and from the companies, you can’t really expect the
sell side analyst to say hey, this company’s putting pressure on me and go to try to fight his own
battle with a company, and the same with the investment management firms that are putting
pressure on and saying don’t say sell as long as I own your stock.

So my suggestion was that AIMR have an ombudsman that an analyst can go to and quietly
describe the problem and have AIMR put the pressure on the company or the investment
management house.

I think on the disclosure issue for sell side analysts, we need to go further. I think if a sell-side
analyst wants to invest in companies, in an industry they cover, then he should provide full
disclosure in the sense of what over the last year or so whatever time’s determined, what his or
her transactions have been, how much, etc. I mean, it doesn’t mean much to say I own the stock
or I don’t own it. Have you owned it in the last three months or do you only own some tiny
amount where it doesn’t influence? I mean, we need more information if that disclosure is going
to be useful.

I’m sure the analyst would say that’s going into my personal life. Well, hey, there are 15,000
other companies out there that you can invest in, and all you have to do is walk down the hall to
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get some good research on them. So if you want to invest in your own companies, then you’ll
have to pay the price of full disclosure.

I had a question about the road show participation. I think analysts bring a lot of value to that,
but we would have to first totally remove the conflict issue. If we could get that done, then I
think it makes sense for the analyst to be involved with the road show because they are the
experts, presumably, on that company. But as long as the conflict issue persists, then their
presence is likely to be tainted.

On recommendations, unless a sell side analyst is at a firm that does significant retail business,
their recommendations really don’t mean a whole lot. I mean, certainly the institutions are not
paying for recommendations. That’s what they get paid for. They’re interested in the
recommendations of only what direction is this analyst coming from? Are they bulls or bears?
But the institutions are really paying for access to the analyst, to pick their brain about what
makes this company tick.
So with those comments, I’ll pass it on.

KHAKSARI: Thank you very much. Mr. Patsky?

MATT PATSKY, CFA: Good afternoon. First, I’d like to add my thanks to AIMR and the
Boston Security Analyst Society for sponsoring this event and Chris Argoryple, who is here, for
inviting me to speak today.

Adams, Harkness & Hill – and I’m assuming many of you are not aware of Adams, Harkness &
Hill in this room – is a small firm. John Adams I think is probably known to more of you than
the firm. The firm was historically and remains at its core a research boutique focused on the
emerging growth market and serving only institutional investors. In the early 1990s, Adams
began to build an investment banking effort that mirrored its areas of focus in research. John
Adams, the Chairman of the firm, was by profession a research analyst and deeply committed to
maintaining objectivity in the research process.

Following an academic study that questioned the ability of investment banks to provide objective
research, John began tracking our performance in stock recommendations through a measure that
he coins the AH&H integrity index. It’s an internal measure by which we measure all of our
analysts. The premise was a simple one. If the research product is truly objective, the
performance of your strong buys that are banking clients should mirror the performance of your
strong buys that are not banking clients.

Indeed, over a decade of data later, we have continued to succeed in providing objective research
with no meaningful difference in the performance of our strong buy rated stocks. While we
watched many competitors seemingly soar meteorically in the late 1990s, we now watch I think
with equal amazement as many of them start to close their doors. In the end, I have to say I have
renewed faith that a free market economy seems to be self-correcting.
We at Adams are experiencing steady growth in revenues year-to-date. We’re gaining significant
market share among our peer groups. It’s an indication to me that something that we were all
taught by our parents I think is undeniably true. Over time, honesty really does pay.
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I think one of the things we’re missing from this debate is that there are of the 40,000 AIMR
professionals a lot of honest people and we at AH&H welcome this increased focus on the
integrity of the research process. The job of our research department is to provide our buy-side
clients the best advice we can and to assist them in improving the returns of their funds. That is
the way I start the interview process when I interview new candidates and there is nobody in our
department who doesn’t understand that. It’s the way we compensate people at year-end.
With that I will say thank you and turn it over to the next speaker.

KHAKSARI: Thank you, Mr. Patsky. Mr. Johnson.

SHAWN JOHNSON: I guess I’ll be the bad guy. First of all, thank you again for inviting me.
Since I only have about three to five minutes, I’m going to limit my comments to the standards
for the sell-side analysts from a buy-side perspective and to the standards for the buy-side firms.
Further, I will limit my comments only to negative points of view and I’m going to avoid
commenting on the obvious positive aspects of the proposed standards. These views are my own
and not necessarily those of State Street Corporation or SSGA. There’s my out.

If you want, you can follow along because all of the bullets that I’m going to comment on are in
your packages. The first one being align analyst compensation to the quality of research and do
not link your compensation to investment banking. If you implement this, then sell-side research
as we know it today will cease to exist. Trading profitability as simply insufficient to generate
enough revenue or earnings to pay for quality research. As a result, you will force the buy side
to dramatically increase its research efforts, particularly for maintenance research. While this
effort seems to appeal to politicians and regulators, it will have a major, long-term negative
effect on our industry.

The next bullet is to segregate research and investment banking to ensure it does not influence it.
My answer to that is why? Everyone in the industry knows that sell-side research is potentially
biased. That does not mean it is not extremely useful and informative.

I used to sit on the board of directors at First Call. I had the CEO of First Call run a report on the
First Call database. There were 18,000 recommendations in the database and 97 percent of them
were strong buy, buy, or hold. Do you really think anyone is using this information to build a 50-
stock portfolio?

The only exception is the retail brokerage networks of the sell-side firms. The retail brokers, say
at Salomon Smith Barney, only have access to Salomon Smith Barney’s research. Perhaps the
only way out of that box is to set the retail brokers up as an independent asset management
company and let them trade with any of the sell-side firms so that they have research just like the
rest of us institutional managers.

I liken this to if you’re going to regulate these guys, then you need to regulate used car salesmen
and you need to regulate doctors that prescribe drugs manufactured by pharmaceutical
companies in which they own stock. Everybody is biased and we live in a buyer beware society.
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We’re going to change that? Nobody held a gun to my head and told me to buy askjeeves.com at
100 times revenue.

Prohibiting research analysts who participate in marketing activities including road shows,
candidly, I think that’s just silly. As an investor, I sometimes need the sell-side analysts at the
road show to ask them questions, perhaps about the company and the industry. To not have him
or her there simply creates more work for me and I have to call him later.

Adopt a three-dimensional rating system, an interesting idea but not particularly practical.
Merrill has a four-dimensional rating system and I still can’t figure it out. Research is focused
on the industry, on the company and the stock and should clearly explain why analysts believe it
is a good investment. Period.

I’ll skip the next bullet. Establish a rating system that helps investors assess suitability. Research
is not portfolio management. They are two different disciplines. You shouldn’t try to confuse
them.

Suitability of security is a portfolio manager’s decision, not a research analyst’s decision.
Research job is alpha. Portfolio manager’s job is risk adjusted alpha. There are simply too
many types of investors to have a tailored approach for the sell-side, in my opinion.
Do not allow analysts to buy or receive pre-IPO shares. Why? If the analyst thinks it’s a good
investment, why shouldn’t he be able to buy some, or receive pre-IPO shares in the form of
compensation for services? This standard presumes that pre-IPO shares will be worth more post-
IPO. It’s not always the case. It just happens to have been true in the late 1990s. IPOs have
opened poorly, if history can be used as a guide.

Firms may permit analysts to own shares but they can’t sell it if they don’t have a buy or hold
rating. Again, I ask why? From CEOs to analysts, there are many reasons for selling a stock.
Perhaps it is a material amount of his overall wealth, whether they be an analyst or a CEO. The
analyst may want to sell some of his or her own shares simply to diversify his portfolio. You
want them to be forced to downgrade a stock because they’re making a portfolio decision on
their personal behalf? I don’t think that’s reasonable. Perhaps the appropriate standard should
be that they disclose this in a similar way that CEOs are forced to disclose trading in any security
of companies that they are a chairman of.

Preventing employees from front running, as far as I know, everybody already does this. When
discontinuing coverage issue, a final research report is not very practical if you’re a sell-side
firm firing 300 analysts at a time. I think that’s again not practical.

From the buy-side, and then I’ll be quite, prohibit retailing analyst research retaliating. The
retaliating thing I think is interesting. I know of no buy-side firm that has a practice to allow this
behaviour, although some portfolio managers may participate in it. Most of the time buy-side
firms retaliate when an investment decision doesn’t work out over time, not when a rating is
changed. And by retaliation, I mean they usually just direct commissions to the investments that
are working out, not in some sort of weighing change.
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Pressuring sell-side analysts relative to the other firms, as I indicated earlier, I don’t know of any
firms that really do this as a practice. And most buy-side firms don’t focus on ratings. As Chuck
said, they’re not particularly informative.

Whether or not corporate relationships with the sell-side have anything to do with the buy side, I
don’t understand that. Most of the time, most buy-side folks don’t have the time, the patience or
interest in leaning on corporate management teams. They vote with their feet and just sell.
Provide full and fair disclosure, the next couple of bullets, and require employees to discuss their
research to make them public. Usually, I'm a fan of full disclosure. I think all of us would be.
But my uncle works at G.E. Do I have to disclose that every time I talk about G.E.? We have
lines of credit and loans to many companies. I don’t even know who they are. Do I have to
create a process of disclosing something I don’t know? We run 401K plans and pension assets
for many companies. I don’t know all of them. Do I have to disclose that?

While I understand the intent of the standards, it seems pretty impractical. I might have to go
through five minutes of disclosure on CNBC before I could say buy G.E. at 25 bucks. I would
expect they’d never invite me back if I actually had to do that.

The last one, the ability to front-run, again I think that’s a standard operating procedure at every
firm and receiving pre-IPO securities again is a standard nobody allows. I think the only
exception is if your spouse is employed at the company going public, there is some sort of papal
dispensation to allow her to have shares.

Those are my comments. You can hit me now.

KHAKSARI: Thanks. Mr. Newberry.

TOM NEWBERRY: Well, I think both Chuck and Shawn have expressed something that I’m
feeling here. It’s sort of a current among ourselves as well as in the public that somehow
everybody is out to gain the system. And it’s easy to see how people reach their conclusions
with high profile cases that are in the news, both in the financial community and among
corporate issuers themselves. But in the end, I think the majority of us are trying to do a job
honorably and well and we have to recognize that our capital markets aren’t some sort of lottery
system that’s designed to get certain people rich and other people not.

Our capital markets, they allocate money to business growth and they’ve done that very well
throughout history. The companies compete with each other in both the stock and the debt
markets to win capital, to grow. Investors reasonably expect a decent return for risking the funds
on this growth. Analysts need to compete with each other to be recognized by investors for
providing advice that helps them get to the right risk reward ratio for them.

I think these basic functions tend to get lost in the discussion that is occurring in the public
today. I think what we need to do is accept our joint responsibility to ensure that our
participation in the capital markets are fair and equitable, at least as far as it can reasonably be
achievable.
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When the public sees us striving to achieve this responsibility every day, there will be higher
levels of trust regardless of how many organizations have issued standards, or how many laws
have been passed in Congress.

In a relationship between analysts and companies, the companies want to feel that they’re being
handled in an equitable way as they compete for capital and the whole idea of buy, hold, sell
ratings can get very problematic. Both Chuck and Shawn and even Matt have talked about the
great limitations of a buy, sell, hold.

AIMR is trying to add some depth with the additional rating. Let’s face it. When you’re in
competition for capital and somebody comes out with a sell rating, that’s a real tough handicap
for a company and most companies, at least the ones that are trying to operate fairly and
honorably, have some advantages to some investors somewhere so there is some source of
capital available and that 15-second sound bytes that says sell is saying it doesn’t deserve
anybody’s merit. That is a very tough thing for a company to deal with.

Having said that, no, it isn’t right for a CFO or a CEO to get on the phone to an analyst,
screaming about the sell rating. Quite frankly, if the analyst community can come up with
reasonably objective standards for these ratings and are implementing them fairly and there’s a
lot more sells out there, I think the stigma around it would be a little less onerous.

I also think that there’s a little bit of naivety in this idea that we can simply require a sort of
loyalty oath from companies yearly that they will treat everybody fairly. I know there’s a certain
intellectual attraction to that type of thing, but I really think the selling of research is somewhat
similar to the situation in the media company where a reporter is doing a story. He gets his
sources from companies, let’s say, and those same companies may also be advertising with their
publisher or their producer or whatever type of media company you want to talk about here.
And in the end, it’s that media company that sets the policy. They don’t ask their advertisers to
sign an open loyalty or fidelity each time they place an ad or ask the company to sign some sort
of good guy statement before an interview is done. No, and the company may have a
disagreement over something that is written or something that is done, and they may voice that
disagreement to the company. There’s nothing wrong with that process. And the media
company takes a very appropriate position if they deny the influence of that discussion. If it
doesn’t have merit, if it’s simply pressure, I don’t know of any media company that wouldn’t
stand up and say no, I’m not going to respond to your complaint.

On the other hand, if it does have merit, they oftentimes do respond. That’s the give and take
that’s part of our society.

So one piece of advice I’d like to give analysts, and it sort of amplifies on Chuck’s comment, is
find a way to be of value to investors. What investors are you trying to serve? Don’t just try to
be a rapid transmission mechanism of company information. Don’t just try to be the first to
come out with the latest piece of news.
Right now, I'm working in the biotech industry. I think it’s quite ironic when a piece of news
comes out in the media that says a certain company’s drug candidate might not get approved by
the FDA. The following morning, there’s six analysts that are downgrading that stock. Or, there
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is a positive outcome of the FDA and the morning after this, the same six analysts are increasing
the rating of the stock. Who have you helped?

So find a way to have a lasting value. Work with those people who are willing to look at your
value over the long term, and not just in your immediate recommendation of the moment. And
continue to build relationships with people you can trust. And maybe by doing that, we can
squeeze some of the less than trustworthy people out of our industry. Thank you.

KHAKSARI: Thank you. Mr. Smith.

MR. SMITH: I don’t have any prepared remarks, so I’ll keep my comments short but hopefully
provocative and give you guys something to think about.

I think a lot of the ideas in here are interesting but they’re probably soon going to be moot,
particularly with the proposals on the sell-side. And I’ll tell you why. I’ve spent the last week
and quite a bit of time reporting on this issue and I think there are a lot of real problems in this
industry and there are a lot of very angry investors out there and angry politicians. I think
there’s a regulatory steamroller that’s moving on this issue and I think it’s just going to come
down pretty hard.

I was amazed to learn recently that prosecutors are considering bribery charges in connection
with the IPO spinning case that CSFB is accused of; these are the kinds of things that the
regulators are thinking about, and it’s pretty serious stuff. This morning, I think Harvey Pitt
came out with a proposal to completely separate research and investment banking and I have a
feeling that this is where it is all headed. I don’t know how he’s going to do it, but I don’t think
that the compensation system as outlined in here is going to do it. I think it’s going to have to be
tougher than that.

So those are my thoughts, for what it’s worth. There’s a proposal in here for the media that I
probably should comment on, the idea is that publications should have a policy on dealing with
analysts’ comments. It’s probably not a bad idea, but I don’t think it’s probably going to happen.
Officially, I don’t think there’s going to be anything written, but the press, particularly at the
bigger publications have known for a long time about these conflicts. We talk to analysts all the
time and they tell us they have a buy rating on a stock and we’re just incredulous because it’s
just not credible. So it’s up to reporters. A lot of reporters already try to vet the quality of
analysts’ research just through their reporting, so we don’t need any kind of formal policy to tell
us that.

But it’s an interesting and thoughtful idea and it’s probably one that some publications are going
to consider doing. So for what that’s worth, that’s where I’m coming from on this.

KHAKSARI: Thank you very much. I would now like to open up discussions to questions and
first, I would like to exercise my right as moderator to ask the first question. I would like to ask
Mr. Bowman given that AIMR does not have enforcing powers, to what extent do you think
these guidelines and standards would be adopted?
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BOWMAN: I also agree that the regulatory and legislative process is on the trail here and I do
believe that we’re going to see a lot more activity, a lot more of what I believe is unnecessary
legislation coming down the pipe so that it may be a moot point.

But in any event, even without corporate membership or regulatory authority over entities,
AIMR knows that it would be the entities who would be asked to adopt these voluntary
standards, and we have some precedent here. Back in the late 80s, we saw a lot of abuses in the
way investment performance was reported and AIMR and its predecessor organizations at that
time took it upon themselves to develop performance presentation standards.

And at the time, there was a real hue and cry from investment management firms and consultants
about these performance standards and very few people were enthusiastic about them at the time.
But after a while, market forces took over and when competitors started staying that they were in
compliance with AIMR-PPS, other competitors listened and got on board to the point where now
the vast majority of people claim that they’re in compliance with the AIMR-PPS and now it’s
developed into global investment performance standards.

So what we’re hoping here is that these standards will be much like the performance presentation
standards, and that over time market forces will be such that they would be voluntarily adopted.

KHAKSARI: Thank you. I would like to give our panelists a few minutes to ask each other
questions if they have any because it seems like we have some interesting discussion here and
some of them not necessarily consistent with each other.

HILL: There were some remarks made, I don’t remember by whom, inferring that Wall Street
research has always been biased. I don’t agree with that. There was a time when I think there
was a reasonable wall between investment banking and research that worked pretty well. I’m
not sure of the answers now with negotiated commission rates or how we rebuild it. That might
be a big issue. But there was a time when I think research was reasonably independent because
our compensation was tied to the votes, as we call them, that the buy side gave to the firm. And
the commissions were big enough that a reasonable bonus pool could be generated that way for
the research department. If I did something for investment banking, it was the frosting on the
cake. The problem today is that’s the cake.

But in my day of being an analyst, which was prior to 1990, I put sells on investment banking
clients and didn’t hear anything from the company or from the investment banking department. I
mean, stocks get overvalued at times. It’s not saying anything negative about the company. If
your analysis supports that this stock is overvalued, the company shouldn’t have a problem with
it. But we’re in different times.

KHAKSARI: Very good, thank you.

BOWMAN: I just wanted to make one point of maybe clarification. I really appreciated
Shawn’s remarks, but maybe when I was going over the proposals, when I got to the
compensation issue, I just want to make sure that I am clear about this. This was probably the
most confrontational and controversial aspect of the task force’s deliberations over the last 18
                                                   12


months. And as you can imagine, it went all the way from the gamut from splitting them, as we
saw Pitt wanting to do this morning, to basically letting well enough alone.

And where we came down was that we did not advocate actually divorcing the two. Where we
came down was that there should be a) no supervisory role by the investment banking people and
b) that the research analyst be paid based on the quality of their research and not having anything
to do with the success of the investment banking side.

However, that still enables the sell side research analysts to receive compensation or bonuses
from the overall corporate pool including investment banking profits. It doesn’t mean that they
can’t be paid or that they can’t have any of those investment banking dollars. It simply means
that if they’re going to get any of it, it should be based upon the quality of their research rather
than participation in getting any investment banking deal.

Now, whether you agree with that or not, that’s the way the standards are worded and I just
wanted to make sure that I clarified that we weren’t saying you had to split them in two totally.

KHAKSARI: Thank you. Now, we can take questions from the floor and if I may ask the
panelists to repeat their questions because we are broadcasting these on the Web and we would
like to make sure to get a clear voice.

ATTENDEE: The focus of today’s discussion has been investment research. But the issue of
integrity extends to other areas as well, and is a societal problem. Do you see a need to apply
your proposals and recommendations to areas outside of investment research and do you see the
opportunity for cooperation with other professional organizations towards this objective?

BOWMAN: A very good question. Let me see if I can repeat it for the Webcast. In essence,
what is being asked is that while the research objectivity standards are meant to apply to research
analysts, because of societal problems outside the profession, do we see the research objectivity
standards, or the spirit embodied in those standards, applying to other areas of society and would
spur cooperation with other organizations.

I don’t know. The whole thing is one like was mentioned earlier today--that this is all about
ethics and it’s all about professionalism, and that’s really all it is and you can’t legislate ethics.
You can’t make people be ethical and professional if their nature is such that they’re just not
going to be that way. So I mean I think that probably our society in general already embodies
the values of high ethical standards and honesty. So, I’m not sure whether or not other parts of
society adopting the principles of our ROS is really going to add anything. But that’s the best
answer I can give you because it’s a tough question.

ATTENDEE: (question not recorded)

BOWMAN: Well, first of all, since it’s directed at entities rather than individual members, to
the second part of your question, there would be no teeth. I mean, this would be voluntary and
there’s nothing AIMR can do to enforce it at this point unless we were to become an SRO which
has all kinds of complications that are beyond the scope of this discussion.
                                                13



But the standards really are aimed at entities – media, buy-side, and sell-side firms. Instead of
calling them standards, I like to think of them as maybe recommended best practices that
corporations and entities could adopt or modify in some way.

But getting back to something that Shawn said, is that almost everybody sitting in this room are
investment professionals and we know how to take and how not to take Wall Street research and
we know how this business works and we understand it. But with the huge increase in individual
investors who are not as sophisticated as the people sitting in this room, I guess the purpose of
these standards was not so much to remind you all how this should work but to remind the
investing public or to somehow or other instill confidence in the investing public that we are
aware of these standards, that entities are aware of these standards and they adopt them. And I
think these have been written more from the perspective of the average investor than from our
perspective. Because perception is just as bad as reality in many cases, and if there are perceived
conflicts out there, they’re just as serious as real conflicts. And so what these ROS standards
intend to do is to somehow or other help instill confidence. But they’re really aimed not so
much at our individual membership as they are aimed at corporate entities.

ATTENDEE: (question not recorded)

NEWBERRY: I understand at one point you said that you wouldn’t want to issue reports
without a company review, and from the company’s side, I appreciate that. And you’re right.
The reports, if they come our way, don’t have a rating on them. And if it did, it would be
inappropriate for me to say you have the wrong answer because those are your conclusions.
But oftentimes, especially the first time through, you might have the wrong assumption and
erroneous information of some type. And I think it’s fair and valid for analysts to have the
proper information. If the company’s the best source, they should ask the company, but there are
boundaries around that.

And as you pointed out, Chuck and I also belong to the National Investor Relations Institute. We
also have policies, standards, criteria on which we operate, and I like to think that we’re all
mature enough to deal appropriately in that environment.

ATTENDEE: (question not recorded)

PATSKY: The question is if somebody in a different group gets pre-IPO shares in a different
sector than what they cover. I haven’t dealt with that personally in our firm and I can understand
how it could be perceived as a swap. But we haven’t dealt with that and I suppose if it would
depend on how it was happening that I would want on an individual circumstance basis, if I
knew somebody wanted to participate in a private placement in a sector that was not their own,
and that we were going to have a reasonable chance at being the firm that took them public, I
don’t see a conflict. If a specialty retail analyst wants to buy pre-IPO shares in a private
placement in a biotech company and then we take the biotech company public, I’m not sure I see
that as a conflict particularly, depending on the biotech analysts to make the judgement on
whether or not we think the company is of quality that we would want to be involved with.
                                                 14


ATTENDEE: Well, presumably as long as you’re making all the disclosures.

PATSKY: Right.

JOHNSON: Would you extend that comment to law firms that occasionally receive pre-IPO
shares as far as compensation?

DIFFERENT SPEAKER: Again, if the guy’s willing to do the work and pay for it, God bless
him. But I can understand if you’re relying on the filing with that legal opinion that you might
perceive that as a conflict of interest. I can certainly understand that perspective as well. But it
is a practice that became a little bit more popular in the heyday of the late 90s. But I’m not a
lawyer.

DIFFERENT SPEAKER: I think that something would happen when it’s calculated in as part
of compensation for the underwriter if the shares were issued within a certain time frame. But I
don’t know how it’s all calculated. It’s probably got to be meaningful in order to have any real
impact.

KHAKSARI: I have a question for Mr. Smith. To what extent do you think that the media is
culpable for the messes of the 90s?

SMITH: It’s all our fault. There’s enough blame to go around for everyone, I suppose. But I
would also point out that it’s the media that really exposed this. I mean, there were stories about
IPO spinning back in 1995. We did a cover story on who can you trust? Despite the
grammatical error in the headline, it was a long exposé of conflicts of interest that analysts face.
So we’ve done our share of reporting of analyst recommendations without fully exploring the
conflicts of interest. At the same time, we have dug deep into this issue to try to figure out
where the problems are and what the solutions are. We’ve written about this extensively over
the last few years.

So I would say I think that we’re more part of the solution than part of the problem.

HILL: I think the financial media behaved pretty well during the 90s. I think given the low
quality of a lot of the sell-side research, although again I want to emphasize there was some
extremely good research coming out of investment banking houses in the 90s, there were just too
many analysts not doing what they should be. And of course, we had a lot of rookies that came
in, but I think in many cases, the analysis that was being done by the financial media was better
than a lot of the Wall Street research. It’s just they weren’t getting paid as much.

ATTENDEE: (question and response not recorded)

KHAKSARI: I have a question for Chuck. What do you think is the feeling amongst sell-side
analysts regarding these proposed guidelines and standards? Do you think that the majority of
them are going to support these or not?
HILL: I’m probably the wrong one to answer that because I don’t have a good feel of this.
                                                 15


I think they should be able to live with these regulations, or standards. I don’t see anything as a
former sell-side in here that would trouble me at all.

ATTENDEE: (question not recorded)

BOWMAN: The question has to do with the proposed ROS standards not totally divorcing
investment banking fees from analyst compensation, but rather allowing analysts to participate in
the overall corporate pool, based on the quality of their research. Isn’t there a murkiness there
that may continue the uncertainty among investors that don’t understand how analysts are
compensated and thus, won’t the conflict continue?

It gets back to the previous question, and that is, will the sell-side embrace this? There were
people on that task force and others who felt that the research objectivity standards ought to
come down and say they ought to be totally split. For example, no dollars in any way from
investment banking.

On the other hand, there were many people who feel, as Shawn does, and that is that to do that
would create bigger problems than those we’re trying to solve. And also, they felt that if there
was any chance of getting the sell-side to embrace these standards, they had to be at a level that
the sell-side could live with, and they felt that if they went that next step and divorced the
compensation, then we could forget it on the sell-side. The proposals would be a joke and there
would be no chance that the sell-side was going to adopt them.

And again, I’m giving you AIMR’s view. I have my personal views as well, but the task force’s
feeling was that they wanted to get something in the middle that might have some teeth but not
drive the sell side away in terms of the support they might want from them.

HILL: In relation to your question about how do you measure research, whether it’s good or not,
there is an effective way, and it’s being used today. Unfortunately, it doesn’t carry as much
weight, and that is that the institutions, at least the bigger ones, send in a letter every quarter
saying we did X amount of commission business with your firm in return for services provided
by the following analysts.

When I was an analyst, if my name appeared on more of those letters than anybody else’s, I got
the biggest share of the research department bonus pool. It was based on the kind of research
that I did, as the clients were feeding back. And so I was highly incentivised monetarily to spend
my time doing good research. If I did something for investment banking, as I said before, it was
the frosting on the cake. But I had far better fish to fry by going out and doing my industry
research than I did by chasing deals. And that’s what we have to get back to.

KHAKSARI: Very good. Thank you very much. I would like to thank our distinguished
panelists and I would also like to thank our audience. They asked wonderful questions, and I
would like again to thank Tom Bowman and Harry Markopolos and Chris Argoryple. Thank you
very much.
*****

								
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