A warning from the regulator for companies not to selectively disclose financial information to analysts appears to have been on the money, with new research showing evidence of ‘tipping’ to privileged clients by some brokers.
A study conducted by Capital Markets Cooperative Research Centre (CMCRC) has revealed abnormal trading volumes prior to public release of analyst recommendations on associated stocks.
This follows a warning last week from the Australian Securities and Investments Commission (ASIC) that it will be closely monitoring instances of investment analysts receiving more information than the market.
The study examined broker trading volumes before and after analyst recommendations are made public and found spikes in the trading volume by recommending brokers before the public release of the analyst reports, suggesting analyst recommendations are possibly provided to broker clients via private release prior to the public release.
However, while the practice advantages those in privileged positions, it is not technically illegal, according to CMCRC chief executive Michael Aitken.
“Our results document that after the private release of the information, trading activity increases most significantly for small and medium cap stocks,” he said.
“Since smaller stocks have less analyst coverage, it is likely that analyst recommendations in these stocks provide new information to the market, which provides greater profit potential from ‘tipping’ activities.
“We also noted that a direct relationship exists between recommendation changes (from buy to sell or vice versa) and volume, as significant changes in trading volume eventuated from recommendation changes.”
The paper also identified an incentive for brokers to ‘tip’ clients - recommending brokers experience similar market impact costs as their peers, providing an incentive to tip clients to stay competitive for trading commissions, the paper stated.
The paper noted the introduction of broker anonymity in 2005 reduced market impact costs experienced by all brokers. It also noted some brokers had implemented policies and procedures to avoid ‘tipping’, with analysts being dismissed for inappropriate behavior.
The study was conducted by Professor Andrew Lepone, Dr Jin Boon Wong and PhD candidate Ming Ying Lim, and examined broker trading volumes before and after analyst recommendations are made public. It was based on publicly available data that contains brokers' ID for approximately 3,800 analyst recommendations on 338 ASX listed stocks, CMCRC stated.