Shooting the messenger?

Unflattering research reports by brokerages draw the ire of companies even as Sebi moves in to solve the mess

Indian companies have found a new villain: the army of analysts working for various brokerage houses and financial companies. So long as they write research reports which cause the stock price to rise, they are lapped up by the companies. The moment they put out reports that can wipe out crores from shareholders' wealth, the same companies go after them with unbridled malevolence. And it is not just the promoter who can see millions wiped out of his wealth with one adverse report and hence vocal in his criticism of the analysts - it is also the employees who own stock options. This comes at a time when the Securities & Exchange Board of India, or Sebi, wants research analysts to adhere to the highest standards of integrity in order to avoid any conflict of interest with other divisions of their company: they shouldn't be found writing reports that can affect the value of a stock their company holds.

The latest war of words broke out when homegrown Ambit Capital released a report titled The Underbelly of Indian IT - the ugly, the bad and not so good to its clients. The report stirred a hornet's nest as it said many Indian information technology bigwigs, including Infosys and Tech Mahindra, have failed to maintain the highest standards of corporate governance. Of course, Ambit is not the first to criticise the practices of an Indian company and face the ire. Last year in February, when CLSA came out with a negative report on Tata Steel saying the company needs to sell its plants in Europe to save itself from a cash crunch, the report was panned by the company.

Some companies say such reports are motivated. In fact, Canada-headquartered independent research firm Veritas - which correctly predicted the collapse of Kingfisher Airlines even when banks were pouring money into it - is facing a police probe for extortion when it came out with a negative report on Indiabulls (see Indiabulls versus Veritas).

In another case, the research head of a reputed domestic brokerage firm was not allowed into an analyst conference by a large energy company after he came out with a negative report on the company. "Some of the companies do take it personally, especially when the media picks up the report," says an analyst asking not to be quoted. "They (companies) retaliate by not giving access to their top management and price-sensitive information and we have to simply stop covering those companies."

The case of Infosys

On Infosys, the Ambit report focuses on the under-representation of independent directors on the board, guidance which leads to volatility in its shares and, of course, the comeback of Infosys founder NR Narayana Murthy as chairman with his son Rohan in tow. Infosys has not officially reacted to the charges but KV Kamath, an independent director on the Infosys board, has rubbished the charges. Investor advisory firms too have raised the red flag in the past. "Corporate governance at Infosys came down a few notches when Murthy returned to Infosys to drive growth. That said, Infosys still ranks high in terms of disclosures and transparency, given the high investor scrutiny," says Shriram Subramanian, founder and managing director of Ingovern Research.

Ambit officials admit they have lost business in the past when they wrote negative reports on Indian companies or against multinational corporations. "We have received calls from top businessmen to complain about our recommendations, but we have kept the research section independent of our other businesses so as to build credibility," says Ambit Chairman Ashok Wadhwa. Earlier, Ambit had come out with reports on the shenanigans of multinationals on related-party transactions and high royalty charged by them from their Indian subsidiaries. Very few multinationals reacted officially to these charges.

Ambit's scathing March 24 report on the information technology sector says while some companies such as Financial Technologies, Educomp and Geodesic are already understood by the market for what they are, others such as Rolta, MCX, Infosys, Tech Mahindra and KPIT are yet to be discounted by investors. Most of these companies barring Rolta and Educomp chose to keep quiet. On Delhi-based Educomp, Ambit had said the creation of a special purpose vehicle to transfer its receivables and then securitise those was an attempt to improve its cash conversion and make its balance sheet look lighter.

"We completely reject the opinion being put out in this report that too on an accounting practice that the company has discontinued over two years ago. We will go through this report and take necessary action against what seems to be an ill-researched and motivated piece to mislead the investors," a senior Educomp official said in an email response to this paper.

Sebi takes note

Such charges and counter-charges have obviously reached Sebi, the market regulator. In November 2012, it decided to regulate research analysts following several complaints. In a consultation paper released in December last year, Sebi said many a time conflicts may hamper the neutrality of a research report, which affects the investment decision of investors. It said if some entity produces a biased research report to inflate the price artificially, the market at large gets affected. Hence, Sebi said proper guidelines should be followed so that analysts' trading activities or financial interests do not impact their reports. "The mechanisms should exist so that analysts' research and recommendations are not prejudiced by the trading activities or financial interests or business relationships of the firms that employ them," Sebi said.

The regulator said the reporting lines for analysts and their compensation arrangements should be structured in such a way that it should eliminate potential conflicts of interest. Firms that employ analysts should establish written internal procedures or controls to identify and eliminate, manage or disclose actual and potential conflicts of interest on the part of analysts. The undue influence of issuers, institutional investors and other outside parties upon analysts should be eliminated or contained, Sebi said. It added that regulations for research analysts and research in the United States ensure that retail investors understand the various conflicts that may affect the objectivity of research analysts' views through enhanced disclosure requirements.

Besides, US laws also seek to reduce the opportunities for conflicts through prescriptive measures by strengthening existing "Chinese walls" between research and business units in integrated financial services firms, regulating analysts' ability to own and trade equities of the firms that they cover and modifying the incentive structure in integrated financial services firms that may encourage the issuance of biased research.

One of the important recommendations of Sebi was that when a company organises an analyst meet, the analysts and the company should make a press release or post relevant information on its website. This is important as many a times companies share price-sensitive information with analysts but deny the same information on a media query. Hence, Sebi said the companies may even consider live webcast of analyst meets. Sebi said all research analysts should be registered in India, including those from foreign firms researching Indian companies. The final guidelines on this issue are still awaited.

INDIABULLS VERSUS VERITAS

In August 2012, Veritas Research came out with a scathing report on Indiabulls, saying most of the group companies had failed to adhere to the highest standards of corporate governance and were milking investors to favour a few insiders. Indiabulls reacted angrily and filed an extortion case with Gurgaon police against the company and its analysts, alleging the company was trying to extort money from it before the report came out. Veritas had earlier published a report on Kingfisher Airlines saying that Vijay Mallya was "teetering on the verge of bankruptcy" and another one that said DLF was a "crumbling edifice". After Indiabulls' police complaint, Veritas no longer covers Indian companies.