Good morning, I am Thomas A. Bowman, President and Chief Executive Officer of the Association for Investment Management and ResearchÒ (AIMRÒ ) and a holder of the Chartered Financial AnalystÒ (CFAÒ ) designation. I would like to thank Senator Sarbanes, Chairman, and other members of the committee for the opportunity to speak on behalf of the more than 150,000 investment professionals worldwide who are members of AIMR or are candidates for the CFA designation.
AIMR is a non-profit professional membership organization with a mission of advancing the interests of the global investment community by establishing and maintaining the highest standards of professional excellence and integrity. AIMR is most widely recognized as the organization that conducts qualifying examinations and awards the CFA designation. In 2002, over 100,000 candidates from 143 countries have registered to take the CFA exam, which is administered annually in more than 70 countries worldwide.
Although not a license to practice financial analysis or investment management, the CFA charter is the only globally recognized standard for measuring the competence and integrity of financial analysts. The CFA Program consists of three levels of rigorous examinations, which measure a candidate's ability to apply the fundamental knowledge of investment principles at a professional level.
To be awarded the CFA charter, a candidate must pass sequentially all three levels of the examinations, totaling 18 hours of testing. They must have at least three years of relevant professional experience working in the investment decision-making process and fulfill other requirements for AIMR membership. All AIMR members, CFA charterholders, and candidates must sign and submit an annual Professional Conduct Statement that attests to their adherence to The Code of Ethics and Standards of Professional Conduct (AIMR Code and Standards). A violation of the AIMR Codes and Standards, including failure to file the Professional Conduct Statement, can result in disciplinary sanctions, including suspension or revocation of the right to use the CFA designation.
The AIMR Code of Ethics requires AIMR members to always:
The issues the committee is addressing─ corporate governance; integrity and adequacy of the U.S. financial reporting and disclosure system; the effectiveness of certified financial audits and regulatory oversight; insider trading and conflicts of interest among securities underwriters and financial analysts─ are all extremely important to AIMR constituents. Although most AIMR members are not subject to the conflicts of interest that financial analysts working for Wall Street and similar "sell-side" firms face, all investment professionals are disadvantaged in their ability to conduct research, make investment recommendations to, or take investment action for, their investing clients by some companies’ exploitation or disregard of financial accounting standards and the important principle of disclosure, and by any failure of regulatory oversight to enforce those standards.
Enron’s alleged exploitation of financial reporting rules is remarkable only for its egregiousness and its scale. We believe Enron is not an isolated case of accounting abuse. The current environment allows any company to play games with their financial reports to a greater or lesser degree. Research commissioned by the Financial Executives Institute (FEI), a private, non-profit organization of company executives, supports our belief. This research shows that, from 1998 to 2000, 460 companies restated various financial statement items, including many that were material. However, with the amount of flexibility that financial reporting standards allow, we are surprised that any company would resort to fraud to mislead even the most sophisticated investors.
Adequacy of Financial Accounting Standards and the Regulatory Oversight System
We believe that the Financial Accounting Standards Board (FASB) has the will to provide appropriate accounting and disclosure for the benefit of investors, but external pressures have prevented it from doing so. The existing standard on accounting for share-based compensation is a perfect case in point. However, there are several key areas with deficient rules that must be addressed immediately if investor needs are to be met. Such rules are an engraved invitation to the kind of abuses alleged at Enron. We offer the following examples:
For the past 20 years, AIMR has advocated that all off-balance sheet activities be reported in the parent company’s financial statements. This includes activities such as leasing transactions as well as consolidation of subsidiaries, special purpose entities, joint ventures, and partnerships. Current accounting rules are inadequate because they have "bright lines" that allow companies to tailor their transactions to be on- or off-balance sheet. For example, subsidiaries are not consolidated unless the company owns more than 50%. Consolidation on an SPE requires more than 97% ownership. Partnerships and joint ventures can escape consolidation altogether. Rules for recognition of liabilities under leasing arrangements allow companies to keep significant assets and liabilities off the balance sheet and can distort the reporting of operating cash flows and earnings.
As the market in derivatives and other complex financial instruments has grown, we have argued for reporting of financial assets and liabilities at fair value, rather than historic cost. Given the volatility of these instruments, we believe that reporting these assets or liabilities at their fair value is the only way to understand their risks and rewards. Corporate objection to this change has been fierce. The resulting standards require some instruments to be recorded at fair value but others not; some changes in value are recorded in earnings but others not. Even when fair value changes are recorded in earnings, companies need not disclose in what income statement item they appear. This situation turns financial analysis into an impossible game of hide-and-seek.
Investors also need more informative disclosures regarding financial assets and liabilities. In response to rule proposals by the Securities and Exchange Commission (SEC), AIMR argued for disclosure of sensitivity analysis to allow investors to understand fully the potential risks of these instruments to changing market conditions. Companies lobbied heavily against improved disclosures. The Senate Committee on Banking, Housing, and Urban Affairs held hearings at which the FASB, SEC and AIMR testified in support of the SEC rule proposal, but corporate issuers opposed the improved disclosures. The regulations that were implemented give companies too much flexibility in the type of disclosure. They are generally so simplistic as to be all but useless to investors.
Stock options and other equity-based compensation have become an important part of executive compensation in the U.S., particularly in new and growing industries. Such compensation should be a way to align management and shareowner interest, but unfortunately has led to earnings manipulation to improve share price. Contrary to what managements would have investors believe, stock options are not "free" or of "little or no value." If so, why would management accept them in lieu of cash? In fact, exercise of executive stock options reduces external shareholder interest and increases management’s interest, generally on unfavorable terms to shareholders. Nor do these options better align management and shareholder interests, since research shows that managers are more apt to sell the shares they receive when options are exercised.
In 1994, to its credit, the FASB was prepared to issue a new rule to require recognition of compensation expense for stock options. Heavy corporate lobbying and legislative intervention, however, led FASB to allow footnote disclosure rather than recognition. Disclosure is no substitute for recognition and measurement. A recent AIMR survey shows that 83% of responding fund managers and analysts support recognition and believe that current disclosures are inadequate and difficult to use.
Another creative way in which managements mislead investors and manipulate investor expectations is by communication of "pro forma earnings," company-specific variations of earnings, or "earnings before the bad stuff." With all its deficiencies, we believe that earnings data based on Generally Accepted Accounting Principles (GAAP) are still the most useful starting point for analysis of a company’s performance. Analysts and other investors at least know how GAAP earnings are computed and, hence, there is some comparability across companies. We believe that GAAP earnings should always be displayed more prominently than non-GAAP earnings data.
Unfortunately, just the opposite seems to be the norm, particularly in press releases where pro forma earnings get the most emphasis and GAAP earnings may not be mentioned at all. GAAP earnings and associated balance sheet may only become available to investors in SEC filings one to two weeks after pro forma earnings are announced. While pro forma earnings can be helpful supplemental information for analysts, the practice of providing pro forma earnings is widely abused. Companies selectively exclude all sorts of financial reporting items, including depreciation, amortization, payroll taxes on exercises of options, investment gains and losses, stock compensation expenses, acquisition-related and restructuring costs. John Bogle, the respected investment professional, recently noted in a speech to the New York Society of Securities Analysts, "In 2001, 1,500 companies reported pro forma earnings─ what their earnings would have been if bad things hadn’t happened." We recommend that either the FASB or SEC curtail this practice or ensure that pro forma earnings data never have more prominence than GAAP earnings in company communications.
Inappropriate legislative intervention in the standard-setting and regulatory processes has resulted in less transparency for investors in preference to corporate interests. We hope that such intervention will cease. The FASB must be allowed to be independent in its decision-making and be supported with adequate funding to proceed quickly and expeditiously to address both long-standing and emerging issues. The FASB cannot only be reactive to financial reporting failures; it must be proactive and continuously review and update its standards. We are concerned that its current rush to "fix" the existing standard for Special Purpose Entities (SPE) will be only a "band-aid" for SPEs rather than a solution to the larger, underlying problem of off-balance sheet liabilities.
We do not believe that SEC regulatory oversight and enforcement of FASB standards and its own regulatory rules are consistent or adequate. We also observe that its attitude toward corporate/issuer versus investor/user interests changes when the SEC leadership and membership changes. Even when the SEC has been concerned with investor needs, it has severely lacked the economic and human resources to address all the issues, including those for which here there are no accounting or disclosure standards.
For example, in 1996, SEC staff approached AIMR about a project on disclosure requirements for asset-backed securities. Considerably less disclosure is mandated for these securities than for equity securities, either in securities offering documents or in subsequent continuous disclosure filings. To respond to the SEC’s request, we convened a task force of interested and knowledgeable AIMR members who expressed concerns about their ability to fulfill their fiduciary responsibilities in the current environment and were excited that better disclosure might be forthcoming. They were anxious to communicate investor needs to the SEC. The task force drafted a formal response to the request, outlining the information that investors need to make good initial and on-going decisions about these securities; why the information was needed; and how it would be used. That is the last that we have heard from the SEC about this project. In answer to our subsequent inquiries about the project’s status, we were told that the staff members assigned to the project had left the SEC and the project would be resumed when new staff was assigned. We have heard nothing since. We still consider this to be an important project and an important area where critical investor needs for information are not being met.
Audits and Auditors
Financial statements should be the single best source of information about a company, its financial health and its prospects for the future. Investors use the information they contain as an analytical tool, as a "report card" of management’s performance and accountability and as an early indicator of the company’s future success or potential failure. Financial statements are an indispensable source of information for shareholders and investors, employees, lenders and suppliers, customers, governments, and regulatory agencies. But these users of financial statements must have assurance that the information is reliable and credible.
Such assurance begins with management, which must establish a strong internal control system to facilitate reliable financial reporting and assist the company in complying with applicable laws and regulations. But high quality internal controls will not guarantee a company’s success, reliable financial reporting, or compliance with laws and regulations. Decision-making can still be faulty and simple errors and mistakes can creep in. Controls can be circumvented by collusion of two or more people and management generally has the ability to override the system. The chief executive officer, therefore, must accept "ownership" of the system and set a tone that strengthens the integrity and ethics of the control environment. Of particular importance to the process are the financial officers and their staffs.
Although financial statements are the product and responsibility of management and a high quality internal control system is critical, no external party plays as important a role in the achievement of reliable financial reporting than the independent certified public accountants. They must bring an independent and objective view to management and the board of directors. Auditors bring assurance about the reliability and credibility of financial statements to a higher level, and attest to their fairness in conformity with generally accepted accounting principles.
Unfortunately, although internal controls are the first line of defense against fraudulent or misleading financial statements, the auditor does not generally focus on their adequacy. Therefore, one of our recommendations is that auditors be required to test and report on the effectiveness of internal controls as part of their audit responsibilities. An assurance about internal controls should be reported publicly as part of the audit opinion. We also believe that required audit procedures must be improved to ensure the auditor has a greater ability to detect fraud.
Independence is an essential element in an auditor’s ability to perform effective audits, disclose improper accounting choices, whether in accordance with GAAP or not, and enhance the credibility of financial statements. Arthur Andersen, Enron’s auditor, has come under such intense pressure that it may not survive. But at some time, all of the major international, "Big Five", accounting firms have been charged with a lack of independence, similar in kind if not severity. Investment professionals have understood these conflicts for some time and have viewed auditors as advocates for their corporate clients rather than for shareholders and investors. One only has to read audit firm advertisements or a description of their business to understand that auditors support their clients’ interests. The following descriptions have been copied from the websites of two of the Big Five audit firms, but are indicative of all:
AIMR members are concerned about the effectiveness of audits and the independence of auditors. A subcommittee of the AIMR United States Advocacy Committee has dedicated itself to responding to initiatives of the Independence Standards Board and others on audit issues. In September 2000, we testified before the SEC on this important issue. We believe that independent auditors, by helping to maintain the credibility of financial information, also help to maintain the overall stability and strength of financial markets. Reliable and credible information ensures that capital is allocated to those investments that create the highest returns commensurate with the risks and uncertainties of the investment.
To facilitate our responses to proposed changes to auditor independence requirements, AIMR conducted three separate surveys of AIMR members and CFA candidates who work as either financial analysts or portfolio managers. Each survey addressed one of the following issues: financial ownership and interests in audit clients held by audit firms, partners or other audit professional staff; non-audit services provided to audit clients; and employment relationships involving personnel with the audit firms and clients. A total of 2,273 individual responded to the three surveys sent to AIMR members working in the United States.
There were 875 respondents to the survey on financial ownership and interests. Over 85% of the respondents indicated that audit firms and audit partners should be prohibited from owning shares in their audit clients, and over 77% indicated that holdings in the audit client should also be prohibited for professional staff on the audit. There was less concern about other partners or professional staff.
Over 50% of respondents to the survey on non-audit services indicated that providing the following services impairs independence:
We believe that prohibiting all non-audit services would be too severe and that some, such as tax planning and compliance or information systems design, may provide beneficial synergies to the audit.
Our primary concern is actually with the basic concept of audit firms marketing non-audit services, even to non-audit clients. The evolution of the audit firm into a multi-service business advisory firm, providing consulting and management advisory services in addition to tax and audit services, has shifted the emphasis of the firm’s practice from the original purpose of the audit and formation of a professional opinion on the financial statements. This is entirely understandable; audit services are extremely price sensitive and non-audit services are far more profitable. The audit is viewed within the firm as a commodity or "loss leader" and non-audit partners and activities have more value and prestige.
We recommend the following enhancements to existing rules regarding auditor independence:
Corporate governance and the influence of investors in the governing process are issues of growing importance in the global capital markets. Good corporate governance protects the interests of shareholders and investors. It is critical not only to the development and integrity of financial markets, but also to investor confidence in these markets, giving investors an incentive to risk their capital. Given the magnitude of investment in the United States, the potential power and influence that institutional investors, representing millions of individuals, can wield over the companies in which they hold interests is staggering.
Corporate governance should foster transparency: full disclosure of the conditions─ risks and opportunities─ to which investors in a particular market, or a particular company, are subject. At the macro level, these conditions encompass a market’s various legal, financial reporting and disclosure, regulatory and supervisory standards and regimes. At the micro level, these conditions include an individual company’s financial performance and outlook, as well as full disclosure of how a company is governed, and the qualifications, responsibilities and compensation of its board of directors. Even more importantly, a good corporate governance framework provides evidence to shareholders and potential investors of the independence of the board of directors. Only when companies exhibit good corporate governance will investors have the confidence to provide them with the capital they seek.
A framework for corporate governance must encompass the duties, responsibilities and powers of the board of directors, the procedures for selecting members of the board, and the process for making those decisions that materially impact a company’s value. Such decisions include whether to merge with a competitor, to divest certain assets, or to repurchase equity. Essentially, frameworks or codes for corporate governance are designed to help boards fulfill their fiduciary duty─ doing the right thing, even when no one is looking─ thereby earning the trust, confidence and capital of investors, especially outside investors.
Best practice frameworks exist and can be applied. Even markets that already recognize the need for good corporate governance can benefit from improvement to their frameworks.
To that end, we recommend the following best practices in corporate governance:
Standard-setting bodies increasingly recognize that, to govern effectively, board members need to have a relatively high level of knowledge of the corporation’s business activities, as well as its financial condition. For example, the National Association of Corporate Directors has issued a set of new guidelines for enhancing the professionalism of board members. We support the following qualifications and responsibilities for directors and recommend their adoption:
We also recommend that institutional investors play a greater role in corporate governance. The fiduciary duty of pension fund sponsors and trustees and mutual fund managers entails duties of care and loyalty to their investors and clients. It entails an obligation to add value to clients’ investments and protect their interests in the long-term health of the companies in which they invest. This is particularly important for passive or index fund managers who may have significant positions in a company’s securities but do not have the flexibility to influence corporate management by simply selling shares. As the founder of Deutsche Bank, George Siemens once said, "If one can’t sell, one must care."
We recommend that institutional investors assume a role that ensures that corporate policies serve the best interest of a corporation’s investor-owners. Although we would not expect that institutional investors would seek involvement in the day-to-day operations of the companies in which they invest, we believe that institutional investors should recognize the need for conscientious oversight of and input into management decisions that may affect a company’s value. Although institutional investors should follow clear and transparent general voting guidelines, available to all investor-clients, in voting their proxies, they must also recognize the need to review all votes individually and not permit minority shareholders to be treated unfairly.
Ideally, we would like to see a private-public partnership of investors, financial industry participants, and government regulators that would unite to help eliminate market barriers by establishing, implementing and maintaining corporate governance standards that mandate transparency, timeliness and accuracy of corporate financial reporting. For these standards to work and offer real investor protection, there must also be enforcement of fiduciary laws and standards through effective market monitoring and surveillance by regulators as well as self-regulatory organizations. The standards and their enforcement work together to create a level playing field for all market participants─ foreign and domestic─ and to encourage competition in the market. The end result is better protection for investors, instilling them with confidence, and giving them more and better investment choices and increased access to opportunities.
To reiterate, the AIMR mission is to advance the interests of the global investment community by establishing and maintaining the highest standards of professional excellence and integrity. Clearly, the erosion of investor confidence in the independence and objectivity of "Wall Street" research reports and recommendations does not enhance those interests and could seriously harm the reputation of the entire investment profession. We believe that all market participants have a mutual responsibility to create and maintain an environment that enables "Wall Street" research analysts to fulfill their responsibilities with independence and objectivity. Only if the investing public believes that the information available to them is fair, accurate, and transparent can they have confidence in the integrity of the financial markets and the investment professionals who serve them.
Investment professionals expect the companies they research, recommend or whose securities they hold to provide full and fair disclosure. They should expect no less of themselves. But just as investment professionals would not make an investment recommendation or take investment action based on earnings information alone, so too investors should not make investment decisions based on a simple, one-dimensional rating.
AIMR is committed to the principle that the best interests of the investing client must always take precedence over the needs of the research analyst, investment manager, and his or her employer. With respect to relationships with clients and prospective clients, The Code of Ethics and The Standards of Professional Conduct of our organization specifically require AIMR members to:
AIMR members are individual investment professionals, not firms. They work in various capacities in the global investment industry. Approximately 9,000 (18%) of our members work for "Wall Street" or similar firms worldwide, known as the "sell-side" (i.e., broker-dealers and investment banks). Those who work as research analysts for these firms, whose independence and objectivity have been questioned, are an even smaller percentage of AIMR members. In contrast, more than 65% of AIMR members work as investment advisors or fund managers for the "buy-side," the traditional, and still the primary, purchasers of "sell-side" or "Wall Street" research. They are not subject to most of the conflicts of interest faced by sell-side analysts.
Based on our experience in setting ethical standards for AIMR members, I can tell you that ethical standards are most effective when developed by the profession and voluntarily embraced rather than externally and unilaterally imposed. In making your determination about whether to trust the private sector to manage analyst conflicts of interest effectively, I ask that you consider AIMR’s commitment to developing and recommending practical, long-term solutions for the conflicts of interest and ethical dilemmas that Wall Street analysts face.
It is important to recognize that the conflicts that Wall Street analysts face are not new. They have, however, been magnified in an environment that emphasizes short-term performance and where profits from research and brokerage are minuscule compared to profits from investment banking and other corporate finance activities. In this environment, penny changes in earnings-per-share forecasts have dramatic effects on share prices. And in this environment, individual investors rely on analyst ratings or recommendations without even reading their research reports─ in contrast to institutional investors, who learn what they can from the report, judge the validity of the methodology and analysis, and ignore the ratings. It is more than unfortunate─ it is untenable─ that the serious business of investing one’s assets for retirement has become a "sport", like horseracing where investors are always looking for "hot tips." Unfortunately, investments are not "sure things." Many, in fact, are "long shots." Investors must be cautioned about making investment decisions based on ratings alone.
The analysts’ responsibility is to conduct thorough and comprehensive research and then to form an opinion about the future prospects for a security. This opinion is communicated by a recommendation or rating based on their firm’s rating system. The resulting report is then "sold" to investing clients, primarily institutional investors, who direct brokerage to the firm. Unfortunately, this responsibility must be carried out despite sometimes opaque and misleading financial information, designed to hide the "bad news" while promoting the "good news". Unless analysts’ clearly see through companies’ bending of accounting rules, the positive bias in financial statements can influence analysis.
Besides this bias, are Wall Street analysts sometimes pressured to be positive about the prospects of the companies they follow? Yes. But these pressures come from many sources, and not all from their employers. Effective solutions to these pressures can only be developed when all the pressures and those who contribute to them are identified and addressed.
In the wake of Enron, the particular conflict posed by Wall Street analysts’ involvement in their firms’ investment-banking activities continues to be the focus of media attention. However, even if Wall Street investment banks were prohibited from selling research to investing clients or if in-house research analysts were prohibited from collaborating with investment banking, the problem of analyst objectivity would not be solved. As long as securing corporate clients for investment banking is in part dependent upon keeping management "happy" with analyst "buy" recommendations, investment banking will inevitably seek out those research analysts, independent or not, who are favorable toward the client company.
Collaboration between research and investment banking is by no means the only conflict that must be addressed if we are to provide an environment that neither coerces nor entices analysts to bias their reports and recommendations. For example, strong pressure to prepare "positive" reports and make "buy" recommendations comes directly from corporate issuers, who retaliate in both subtle, and not so subtle, ways against analysts they perceive as "negative" or not "understanding" their company. Issuers complain to Wall Street firms’ management about "negative" or uncooperative analysts. They bring lawsuits against firms― and analysts personally ―for negative coverage. But more insidiously, they "blackball" analysts by not taking their questions on conference calls or not returning their individual calls to investor relations or other company management. This puts the "negative" analyst at a distinct competitive disadvantage, increases the amount of uncertainty an analyst must deal with in doing valuation and making a recommendation, and disadvantages the firm’s clients, who pay for that research. Such actions create a climate of fear and intimidation that fosters neither independence nor objectivity. Analysts walk a tightrope when dealing with company managements. A false step may cost them an important source of information and ultimately their jobs.
Institutional clients, the "buy-side," have their own vested interests in maintaining or inflating stock prices and, thus indirectly, recommendations and ratings. Fund managers do not want to be "blind-sided" by a change in recommendation that might adversely affect their portfolio performance, and hence their compensation. When they find out about a negative analyst, the "buy-side" has been known to "turn in" that analyst to the subject company.
An investment professional’s personal investments and trading pose another conflict, one that AIMR addressed extensively in a 1995 topical study that now forms an important component of the AIMR Code and Standards. We do not believe that it is in clients’ best interests to prohibit Wall Street analysts, or other investment professionals for that matter, from owning the securities of the companies they follow or in which they invest their clients’ money. Rather, permitting personal investments better aligns analyst and investor interests as long as strict, and enforced, safeguards are in place that prevent analysts from front running their clients’ or their firms’ investment actions, and that prohibit analysts from trading against their recommendations.
The content and quality of research reports and investment recommendation is also affected by this simple fact: analysts are human. No matter how experienced, expert, or independent, Wall Street analysts do not have crystal balls; they are not infallible. Even in the absence of fraud, the more opaque a company’s disclosures and the more reticent company management, the more difficult it is for the analyst to predict changes in the company’s fortunes. Much has been made about some Wall Street analysts’ failures to change their recommendations as the price of Enron began and continued to fall. But I wish to remind the committee that many "buy-side" investment managers with major positions in Enron, who do not suffer from the alleged investment-banking conflicts of Wall Street analysts, have admitted that they too could not predict soon enough the downturn in Enron’s fortunes or the speed with which it would spiral into bankruptcy. These failures were not due to a lack of independence, skill, or due diligence, but to the lies allegedly told them by a company that apparently betrayed their trust.
I have recommended improvements to accounting standards, regulatory enforcements, auditor independence and corporate governance. I can do no less for analyst independence. In recommending specific measures to increase the likelihood that investors will receive unbiased recommendations from Wall Street, I am seeking to inform as well as protect those investors who may not be aware of the pressures on Wall Street analysts from the sources I cited and the limitations in analysts’ ability to make foolproof recommendations. This is especially true for those investors who receive shorthand information through various media outlets rather than by purchasing and reading the full research report directly from the Wall Street firm. Surely, no one would recommend that individuals make important decisions, such as taking medication or buying a home, solely on what they read in the press or hear on television. How much more critical then are the investment decisions that can adversely affect their own and their families’ financial welfare?
We do not dispute that some Wall Street firms may pressure their analysts to issue favorable research on current or prospective investment-banking clients, or that this practice must stop. These and the other forces I mentioned create an environment replete with conflicts of interest, one that undermines the ethical principles upon which AIMR and the CFA Program are based. We condemn all who foster or sustain it.
However, the relationship between research and investment banking is symbiotic and an important part of the firm’s due diligence when evaluating whether or not to accept a company as an investment banking client. Although we do not believe that this collaborative relationship is inherently unethical, it poses conflicts that can lead to serious ethical problems for analysts, especially when a large portion of the firm’s profitability comes from investment banking. If such collaborations are allowed, investment-banking firms must take particular care to have policies and procedures that minimize and manage all real and potential conflicts, and that fully and fairly disclose them to investors.
To effectively manage these conflicts, AIMR is currently developing proposed standards to improve research objectivity. These standards include the following recommendations:
Enhanced disclosures are a key part of the AIMR proposal. At a minimum, we believe that Wall Street analysts must disclose― and their firms must require them to disclose― the following information prominently on the front of the research report and, even more importantly, in all media interviews and appearances:
We caution, however, that effective disclosure in media interviews and appearances will only be accomplished with the full cooperation and active support of the media itself. Neither Wall Street analysts nor their firms should be held accountable for what the media won’t publish or broadcast. We call upon the media to ensure that these disclosures reach their intended audience.
We also think that rating systems need to be overhauled so that investors can better understand how ratings are determined and compare ratings across firms. Ratings must be concise, clear and easily understood by the average investor. We would also suggest that, in addition to the recommendation itself ("buy-hold-sell" or market "outperform-neutral-underperform"), the rating should also include a risk element, to provide a measure of expected price volatility or other risks, and a time horizon, to provide an estimated time period for the stock price to reach the price target or which the analyst expects the current rating to hold. We believe that adding a risk measure and time horizon to the rating, and always communicating all three elements, will provide investors who do not read or have access to the full research report with better information by which to judge the suitability of the investment to their own unique circumstances and constraints.
Finally, under normal circumstances, Wall Street analysts and their firms should also be required to update or re-confirm their recommendations on a timely and regular basis, and more frequently in periods of high market volatility. They should be required to issue a "final" report when coverage is being discontinued and provide a reason for discontinuance. Quietly and unobtrusively discontinuing coverage or moving to a "not rated" category, i.e., a "closet" sell, does not serve investors’ interests.
In closing, I would like to impress upon the committee that AIMR and its members appreciate the seriousness of the problems facing our financial markets at this time. We believe that only with the cooperation and involvement of all market participants will effective long-term solutions be developed and implemented. Specifically, we are convinced that:
Finally, I believe that if we put even a fraction of the creativity and energy into strengthening the integrity of our financial markets that has gone into undermining it─ and I mean strengthening each and every one of its disparate elements that I have discussed today─ we will be rewarded with renewed investor confidence in those markets, greater reliance on financial reporting information and the research and recommendations that flow from analysis of that information, and with the kind of transparency that will be a long-term benefit for investors in those markets and the envy of investors in every other financial market in the world.
Thank you. I will be happy to answer any questions that you might have.
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