The biggest investment bank in the US, Merrill Lynch, recently reached a settlement to the tune of US$100 million with the New York State Attorney General over a conflict-of-interest case. Merrill Lynch agreed to reform its securities research division, while at the same time reviewing the payroll system for research analysts.
That Merrill Lynch would actively seek an out-of-court settlement isn't surprising because its reputation has hit bottom since the investigation was initiated and its market capitalization has shrunk by over US$10 billion. Had legal proceedings been initiated, the loss would have been even higher.
This incident not only high-lights the conflicts of interest between financial institutions and investors, but also shows that financial institutions must take responsibility for intentionally misleading investors.
The investigation of Merrill Lynch was linked to the crash of information technology (IT) shares. Toward the end of the 1990s, bullish Wall Street analysts created a wave of investment in IT shares. When the dotcom bubble burst in 2000, investors suffered severe losses. IT shares took a serious fall, but analysts still continued to go long for fear of affecting the underwriting inter-ests their institutions. As a result, many investors who had trusted the experts became victims of the crash. Many of them sued financial institutions, in particular Merrill Lynch and Goldman Sachs. The US government also initiated investigations against other financial institutions that had used the same methods.
Here in Taiwan, we see financial institutions making use of the same techniques and causing even more harm to investors. But very few investors have woken up to this and politicians and government agencies are completely indifferent to it. Foreign financial institutions frequently release so-called "research reports" in Taiwan's media to help them to recruit clients and attract funds.
Even more frequently, domestic financial institutions encourage speculation or promote funds under the guise of giving expert advice. Their efforts are aimed at earning enormous consignment underwriting benefits, sales commissions and fund management fees. Investors who suffer losses because they fail to investigate matters for themselves can only resign themselves to their misfortune. No government organ is willing to help members of the public seek justice.
Conflicts of interest between the research and sales roles of financial institutions exist in financial markets around the world. But in Taiwan, not only does no one seem concerned about introducing laws to control this kind of behavior, but existing laws are not enforced.
The most obvious example lies in the management of securities and investment advisory companies. Article 39 of the Regulations on the Management of Investment Advisory Businesses 2000 (投顧事業管理規則) states, "Securities investment advisory businesses providing services of promoting and recommending foreign securities may not raise money for, distribute, or trade [those securities] domestically."
Some foreign fund companies, however, have established investment advisory services in Taiwan. They provide research reports about the funds sold by the companies and publicize these reports in the media. They also sign contracts with the banks commissioned to sell the funds and take a share of the handling fees collected. Investment advisory companies are effectively acting as marketing organizations, but I have never seen the Securities and Futures Commission take action against this illegal practice.
Whatever happened to the rights of investors?
The heart of the conflict of interest in the Merrill Lynch case lies in the fact that the marketing of financial products should be carried out entirely independently of related research and analysis services.
Taiwan should learn from this and completely de-link research and analysis services from the marketing work done by financial institutions. These institutions should be restricted from providing research and analysis services to the public while the revenues of investment advisory companies must be strictly controlled so that their is no relationship whatsoever between such revenues and the marketing efforts. It is particularly important, at a time when financial holding companies are springing up, to prevent them from providing conflicting investment and advisory services.
The results of the Merrill Lynch case may seem exotic and foreign to us in Taiwan because similar conflicts of interest are so widespread here that it barely raises eyebrows. This also high-lights the low priority given in Taiwan to the protection of the rights of investors. Moreover, given the lack of clarity regarding investor's rights, it is impossible to raise people's interest in investment. This will have a negative effect on Taiwan's economy, one which will not be quickly dissipated.
Brian Yu is general manager of MagniFinance LLC.
Translated by Perry Svensson and Ethan Harkness
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