Allen Morgan Jr. is CEO of Morgan Keegan and 2002 chairman of the Securities Industries Association (SIA). As chairman of the trade association, one of his jobs is promoting public trust and confidence in the industry. In the wake of Enron's collapse, he agreed to a question-and-answer session with The Memphis Flyer.
Flyer: There's a perception that Enron and other companies treat accounting rules the way they treat tax laws: If it isn't expressly forbidden, it's okay. What do you say?
Morgan: I am not an expert in accounting, so I think it is difficult for me to comment. I do think that by and large U.S. companies are managed with honesty and a commitment to ethical principles. If they deceive investors, investors will sell their holdings, resulting in the company's demise.
What is your personal reaction to the Enron officers now appearing before Congress?
I think the collapse of Enron, based on news reports, resulted from errors in accounting. I think it is too early to tell who was at fault, and I would not want to speculate on who was responsible and who wasn't. I think Enron is causing Capitol Hill and the regulators, particularly Security and Exchange Commission chairman [Harvey L.] Pitt, to ask a lot of tough questions about accounting practices, disclosure obligations, and the oversight system that is supposed to protect investors against fraud.
What is the industry doing to shore up public trust and confidence?
Over the last six years the industry, through the SIA, has been monitoring the concerns of investors, and it has found that the public's trust and confidence in our industry and our capital markets remain strong. An SIA survey last November found that 91 percent of investors remained satisfied with their brokers' services, down from 94 percent in 2000.
That said, the industry's highest priority remains public trust and confidence. In response to Enron, the industry supports the efforts of Pitt to improve the integrity of the financial-disclosure and accounting system. Disclosure is a critical part of the success of our financial markets. The financial information about companies must be reliable. Those responsible for ensuring the accuracy and clarity of the financial information a company provides must be held accountable for their work.
Do research analysts work hand in hand with their firm's investment bankers, and is that not an inherent conflict of interest?
The best practice of the industry is to have in place policies and procedures that ensure the integrity of research. This means research should not report to investment banking or any other business unit that may compromise its integrity. It also means that an analyst's pay should not be directly linked to specific investment-banking transactions, sales and trading revenues, or asset-management fees but should reflect all aspects of job performance. Recommendations should be transparent and consistent.
Here at Morgan Keegan, we've always maintained independence between our analysts and bankers. The analysts don't check with investment banking prior to making ratings changes, and they don't recommend stocks based on banking involvement. Our analysts are not directly compensated for referring potential clients to investment banking. Their compensation is based on the performance of their stocks and their contributions to the overall success of the equity division.
Should analysts be allowed to invest in companies they cover?
That has been a decision that each firm has made. On the one hand, allowing analysts to own stock in the companies they know and believe in makes sense. On the other hand, it may create the appearance of a conflict of interest. That's why I think disclosure will work. If a firm and its analysts disclose in research reports their financial interest, the investor reading the report will understand clearly that the firm and its analysts are committing their own capital behind that company.
Morgan Keegan's research analysts are permitted to invest in the stocks they follow subject to certain stipulations. Our long-standing policy requires that analysts must wait a full business day after publishing a report or ratings change before taking any personal action on a stock. Also, our analysts are restricted from selling any stock with an "outperform" rating until they lower the rating and wait 24 hours. These policies ensure that our clients have the first opportunity to purchase or divest stocks we follow.
Should analysts and brokerage-firm executives be allowed to buy private stock in companies that they later plan to take public and recommend, as Morgan Keegan did with Crossroads Systems and other companies? (Note: In 1999, Morgan Keegan insiders bought private stock in Crossroads Systems at $10, took it public at $18, and watched it soar to $98 the first day of trading. It traded recently at $4.50. So-called lock-up rules may restrict the ability of insiders to sell stock for certain lengths of time.)
I'm of the view that if an analyst or a firm wants to commit their own capital to help a company build to the point where they can be taken public, that is a good thing. You're providing the capital that finances entrepreneurism, that enables an innovator to take an idea and make it into a viable business that improves the speed of a computer, the development of new drugs that treat cancer, and the safety of automobiles. That is what has made our country the unique and astonishing success that it has been.
Is it realistic for ordinary investors to plow through hundreds of pages of disclosure documents? Is there a better way?
Disclosure is a remedy. I think you are seeing a change in the industry to make that disclosure easier to understand and more readily accessible. As one Supreme Court justice put it, "Sunlight is the best disinfectant."
As to investors, they have a responsibility too, and that means they should be doing their homework, educating themselves, asking questions, and understanding for themselves their financial goals, willingness to take risk, and savings strategies.
How can your industry do a better job of assuring small investors that they're getting a fair shake when they buy stocks?
Each firm knows their success or failure is based upon the quality and success of the advice they provide to their clients. If a client is unhappy, that client is going to close out their account and walk down the street to a competitor.