In a passionate talk at the 65th CFA Institute Annual Conference in Chicago, veteran banking analyst Mike Mayo, CFA, delivered some advice for young analysts thinking of issuing a negative rating on a stock: do your homework, make sure you’re right, and develop a thick skin.
As chronicled in Mayo’s book, Exile on Wall Street: One Analyst’s Fight to Save the Big Banks from Themselves, companies that are the subject of less-than-glowing coverage may come after you, and, says Mayo, the managing director of the banks group at CLSA, “they have a lot of ways to humiliate you and make you look stupid.”
This is one reason why — even after the 2008 financial crisis — only 3% of U.S. stocks are rated by analysts as a “sell.”
When first contemplating whether to issue a sell rating on a bank he covered, Mayo said he wrestled with the feeling that he was violating loyalties — to company management, to his employer, and even to his family, who could suffer if he lost his job as a result of the downgrade. “But that’s not what I was taught in the CFA Program,” he said.
“The CFA Institute Standards of Professional Conduct are very clear on this point: client interests must come first, and investment actions must be carried out for the sole benefit of the client,” he said. Failure to adhere to this simple guideline might explain why “sell” ratings are so rare on Wall Street, and, by extension, why only 23% of the public trusts the financial system, according to the Chicago Booth/Kellogg School Financial Trust Index.
To be effective, Mayo said, analysts must assert three essential rights: the right to ask for information; the right to get information; and the right to act on information, always with client interests in mind. This is just as important today as in the years leading up to the financial crisis. According to Mayo, the crisis was a result of poor incentives, and a failure of the checks and balances that investors rely upon to maintain the integrity of financial markets. “The problem was that no one — not the regulators, the rating agencies, the banks, or the analysts who covered them — was doing what they were supposed to be doing,” Mayo said.
In his view, the key cause of the crisis has yet to be rectified. “Fix the incentives, fix the problem,” he said, noting that the recent “Say on Pay” vote at the Citigroup Annual Meeting was “phenomenal” and that he hopes it marks the beginning of a trend of more investor influence over management behavior. “If shareholders had more say, the big banks would have been broken up by now,” he added, thereby posing less of a systemic risk to the financial system.
Asked if he favors the Volcker Rule, which would place limits on banks’ ability to engage in proprietary trading, Mayo said: “Paul Volcker is my hero, and I don’t say that lightly. I love the idea that banks not take prop trading risks, but it’s so tough to implement” since distinguishing between prop trading and legitimate hedging activities is difficult. “We [analysts] need to do our own policing,” even if that means suffering backlash and intimidation from banks unhappy with their coverage.
Asked what he wished he’d known as a younger analyst, Mayo replied: “I didn’t expect the severity of the backlash my reports generated when I made my analytical case. I now understand that a disproportionate defensive reaction to an analyst report can be an indication that the analysis is correct.”