Financial Security Analysis

This article examines the process of financial securities analysis as well as the work conducted my financial securities analysts. Various specialties with which financial securities analysts are concerned are illuminated. In addition, the regulation of the financial services industry is reviewed along with how the regulations impact financial securities analysts and their clients. The organizations that lead or participate in these government and self-regulatory efforts are reviewed. The impact of globalization on the complexity of financial markets and thus the work of the financial securities analysts are also examined. Finally, the studies called for by the Emergency Economic Stabilization Act of 2008 (EES Act) are reviewed.

Keywords: Economic Crisis; Emergency Economic Stabilization Act of 2008 (EES Act); Financial Advisers; Financial Securities; Fiduciary Responsibility; Global Economy; Market Regulation; New York Stock Exchange (NYSE); Regulatory Modernization

Financial Security Analysis

Overview

Financial securities are economic investment instruments that provide a means for individuals, investment banks, mutual funds, or retirement funds to invest money in a company, an industry sector, or even a region of the country or the world. These securities have several purposes.

• First, they facilitate the process of attracting investors by providing an investment mechanism that is openly and publicly scrutinized by securities analyst and other investors.
• Second, they provide a means for investors or securities buyers to invest their funds and track their wealth and eventually receive dividends. There is a wide range of financial securities including stocks, bonds, and notes.

These securities are brought to the market in a variety of ways. Companies can issue and sell stock publicly or to private investment groups. Mutual funds can sell shares to individuals or retirement funds. Government entities such as municipalities, school districts, or libraries, can issue bonds for building projects. Governments can also establish programs like the United States Savings Bond which allows investors to gain a low yield in a highly secure investment instrument.

Financial Securities Analysts

The financial securities market is complex and detailed. The role of the financial securities analyst is to understand and research a specific aspect of the marketplace and provide analysis to investors or others interested in the market. Financial securities analysts are versed in the many forms of written material about their area of expertise. This could include corporate financial statements, annual reports, industry news, or government indices that may show trends that impact companies or sectors reviewed by the analyst. Market activity is monitored by the securities analyst which includes stock prices, product or service pricing offered by companies in their area of expertise, and global trends and events that could impact either stock prices or corporate revenues.

Use & Importance

Financial securities analysts are employed by a variety of organizations. Investment management firms, or those companies that help individuals or institutional investors mange their portfolio, employ financial securities analysts to help determine if a company or even an industry sector will provide a good return. Brokerage firms, those companies that sell financial securities to investors on behalf of the organizations seeking investors, employ financial securities analysts to help advise or attract potential buyers of the securities. Mutual funds, as another example, may employ their own financial securities analysts to help guide the investment strategy of the fund ("Financial analysts," 2009).

Large financial services firms that sell stock or invest large sums in a company are most likely to employ securities analysts to focus on the specific company. The analyst responsible for that research watches the activities of the company on a daily basis. This includes monitoring stock prices, reading reports issued by the company, as well as reports from other analysts about the company. The securities analyst may also attend meetings or conferences sponsored by the company or events where the company or industry may be a topic. The 2008 economic downturn resulted in many financial securities analysts being laid off from large brokerage and investment firms (Pressman, 2009).

Industry-Specific Analysts

Securities analysts that focus on an industry, such as the automotive, telecommunications, or computer industries, watch the activities of the large or otherwise significant companies in that industry sector. The analyst also reviews reports issued by or about the companies that have an impact in or on the industry. Most of the analyst's attention is focused on the larger companies as they draw the largest amount of outside investment. However, newcomers or start-up companies to the industry are also of interest if they have a new or innovative product offering that may impact the industry or make them an acquisition target. Industry analysts must also monitor business trends or government actions that could significantly change business practices in an industry (Ennis, 2009).

Region-Specific Analysis

When financial securities analysts focus on a specific region of the United States or of the world, their research is far broader but generally has less depth. These analysts are often fluent in one or more of the languages of the region in which they specialize. The regional analyst is also likely to spend considerable time in the region in which they specialize and will attend major business or trade events that examine or showcase the companies in the region. The activities of the larger companies in the region are monitored by the analyst along with the policies of local governments toward business, globalization, and world trade.

Key Concepts

Regardless of their specialization, a financial securities analyst needs an in-depth understanding of business financial practices; especially those that impact stock prices or draw investors. Analysts must constantly research their areas; most observers agree that research is the most important aspect of analysis (Birkner, 2009). Financial securities analysts also need to understand how political, economic, and social conditions impact business. An understanding of investors focusing on what investors desire to know about individual businesses and trends is also necessary (O'Dowd, 2009).

Globalization has made the work of financial securities analysts far more complicated. There are now numerous well-established financial markets in the world. The interconnectedness of these national economies means that when there is a downturn in one country, most markets will feel some sort of shock wave ("A three-year global recession," 2009). The globalized economy also means that government policies around the world, especially monetary policies can have far more than a local impact. This potential impact is often complicated to understand and sometimes impossible to predict (Mishkin, 2009).

The globalization of the economy and the accompanying widespread global trading of commodities, technology, and consumer products has also increased the speed of change. The benefit of this proliferation to national societies is that people have faster access to a wider variety of products and services. The downside of this interconnectedness is that when things go wrong, the damage is more widely spread. Polluting products or technologies, for example, are being sent all over the world with little if any effort to minimize their negative impact. Ecosystems, cultures, and communities can change and grow but they can also collapse. This adds more pieces to the puzzle that the financial securities analyst is trying to piece together (Halal, 2009).

Applications

Investment Portfolio Management

Personal & Professional Portfolio Management

Financial securities analysis is an essential and ongoing activity for individuals who manage their own investment portfolio and for the managers of mutual funds or retirement pension funds. There is considerable public concern for the management of pension funds. This is especially true for multi-employer pension plans that typically cover workers in trucking, building and construction, and retail food sales. Many of these plans were established by labor unions and the companies that employ the union workers. These plans allow a union worker to maintain their pension fund even though they may work for several different employers over a period of years (Private Pensions: Multiemployer Plans Face Short- and Long-Term Challenges, 2004). The decline in value for pension funds can be very troublesome because the funds can end up being under funded, or in practical terms: Lacking enough assets to pay the promised pensions to members when they retire.

Individuals who manage their own funds have numerous sources of information that they can access and take into consideration. Opinions are mixed as to whether or not individuals should go it alone in managing their own investment portfolio. However, the dynamics of the 2008 economic crisis clearly show that many managers of large organized funds did not fair very well in protecting the wealth of their investors.

Fund managers also have access to many sources of information and expertise but they also have a fiduciary responsibility for the decisions that they make which impact the value of the fund that they manage on behalf of fund investors. This responsibility requires that the board properly directs fund activities and establishes a process by which investment decisions are appropriate and adequately documented (Moynihan, 2009).

Many mutual funds or pension funds have a board of directors that oversee the policies and investment decision making process utilized by the fund. The board is also responsible for regulatory compliance. Under the direction of the board, there is often one or more managers responsible for the investment process and operational activity of the fund. The fund manager may have considerable financial securities experience that can help guide the investment decisions. Most funds also rely on outside financial securities analysts to advise in investment strategies and decisions.

Investment advisers

Financial securities analysts provide support to individual investors, managers of mutual funds, and managers of pension funds. Investors turn to analysts for knowledge and advice about the potential promise of an investment opportunity. Fund managers as well as individuals use the information from financial securities analysts to help them decide what risks are inherent in a specific security and thus in their investment strategy. When investors are uncertain of their own risk analysis, they often turn to investment advisers.

Benefits

The use of investment advisers, especially for pension fund managers, has several benefits.

• First, the adviser supposedly provides a level of expertise or insight that the fund managers or in-house financial securities analysts do not have.
• Secondly, when an adviser charges a retirement fund for advice, the adviser then has fiduciary responsibility for the impact that such advice has on solvency of the fund.

The 2008 Downturn

The economic downturn of 2008 was considered to be a very severe situation by most analysts. Blame for the downturn abounds with many pointing the accusing finger at Wall Street, while still others criticize government regulation or lack there of as major reason why financial services firms turned to ashes (Reinganum, 2009). The boards of directors and the managers of many pensions and mutual funds also came under public scrutiny because so many funds lost value; combined, over $100 billion was lost in value in 2008 (Morgado, 2009).

The 2008 economic downturn has also led to many lawsuits against investment advisers (Morgado, 2009). The outcome of those lawsuits is yet to be determined. The legitimacy of many of the lawsuits will eventually come into question and the judicial system will have a difficult time sorting things out. Many of the tried and true investment strategies that advisers relied on including diversification of risk seemed to all fail at one time. The value of a wide range of assets including real estate, stocks, bonds, and commodities all fell dramatically in a short period of time (Steverman, 2009).

Issue

Maintaining Integrity with Financial Securities Analysis

The financial securities analysis field is complicated and imperfect (Duan, Hu & McLean, 2009). As economic conditions tumbled into chaos in 2008, many people wondered why the financial analysts on Wall Street got paid so much money to be so wrong. Newspapers and weekly magazines were full of articles depicting various scandals, lies, or deceptions. By the end of 2008, it looked like the rapid economic downturn consisted of a series of events in which most securities analysts had trouble keeping their bearings or drawing rational conclusions (Morse, 2009).

Two questions plague the contemporary financial securities analyst profession.

• First, are financial securities analysts honest? Honesty in this case requires a lack of bias in pursuing their work as well as real due diligence and fiduciary responsibility.
• Second, are financial securities analysts competent and using proven research and forecasting methods as opposed to fabricated formulas aimed at guessing what the future will bring?

Governmental Regulation Efforts

Numerous laws govern the behavior of people working in the financial securities industry including the Securities Act of 1933, Securities Exchange Act of 1934, Investment Company Act of 1940, and Investment Advisers Act of 1940. The industry and the workers in the industry also operate under the administrative rules that were developed by the major enforcing agency, the Securities and Exchange Commission (SEC). There is also The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (Remedies Act) which imposes penalties for a range of securities trading violations. The SEC has indeed enforced these and other laws and fined investment firms and individual advisers in those firms hundred of millions of dollars ("Mutual fund trading abuses," 2005).

The New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ) are also active in regulatory efforts. Both exchanges have established a division to enforce marketplace rules and federal securities laws. They have also developed Rulebooks that contain principles of trade and business practices that the members of the exchange are required to follow. The rules were developed to prevent fraudulent or manipulative acts and practices and support appropriate disciplinary actions against members when violations occur. The SEC is the government agency that oversees the exchange activities and all rules and rule amendments must be submitted to the SEC for approval.

The Financial Industry Regulatory Authority (FINRA), performs market regulation under contract for the NASDAQ, the American Stock Exchange, the International Securities Exchange, the Chicago Climate Exchange. In its regulatory efforts, FINRA oversees nearly 5,000 brokerage firms, about 173,000 branch offices and approximately 659,000 registered securities representatives.

Non-Governmental Regulation Efforts

In addition to the stock exchanges which many brokerages are members, there are also several other non-government organizations that set standards and codes of conduct for investment and financial advising firms. Many of these organizations were established as the securities laws were going into effect in the 1930s and 1940s.

The Investment Adviser Association

One of the oldest organizations is the Investment Adviser Association (IAA) which has established principles of conduct for investment advisers. The IAA contends that its principles continue to be used by Congress and the Securities and Exchange Commission in the development of legislation and regulations concerning the practices and conduct of investment advisers. The IAA principles also influenced the definition of fiduciary conduct, established by the United States Supreme Court, which applies to all investment advisers.

IAA contends that investment advisers have a special relationship of trust with their clients. To live up to this trust, an investment adviser must always place the interests of clients first and utilize a reasonable basis for its investment advice. In addition, to meet standards of conduct, advisers are required to fully disclose to clients all material facts about the advisery relationship and especially those that relate to potential conflicts of interest.

The Securities Industry and Financial Markets Association

The Securities Industry and Financial Markets Association (SIFMA), as another example, has members that include international securities firms, U.S.-registered broker-dealers, and asset managers. The association supports the securities industry in regulatory and legislative issues, and assists in outreach, training, education and community involvement.

The Emergency Economic Stabilization Act

Even though these regulatory efforts are in place and there a rules and codes of conduct, 2008 seemed to be a year ripped with scandals and disappointment. The downturn basically turned many earnings forecasts into worthless speculation (Clark & Karr, 2009). Many investment funds and millions of people lost value in their investments during the year.

Commonly called the bailout bill, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (EES Act) was signed into law. The bill provided for several types of emergency funding for financial institutions but also required steps be taken to remedy some of the problems in the financial sector. The EES Act, in addition to establishing an oversight process also called for several studies to be conducted that will examine problems in the financial sector. One of the studies focuses on regulatory modernization and examines the financial regulatory system and its effectiveness. Other studies focus on trading practices and investment instruments.

The EES Act established an oversight board composed of the Chairman of the Federal Reserve Board, the Treasury Secretary, the Chairman of the SEC, and the Secretary of the U.S. Department of Housing and Urban Development. One of the many tasks that the board is charged with is reporting suspected fraud, misrepresentation, or malfeasance regarding any actions relating to the economic crisis or use of emergency recovery funds to appropriate authorities.

To the satisfaction of many people who lost money in the 2008 meltdown, the EES Act also called for limitations on the salaries of top executives of firms that are receiving assistance under the bailout program. The yearly limit was set at $500,000 and also addresses incentive payments that may require unnecessary and excessive investment risks. The compensation limits applied to both publicly traded and privately held companies (Foley & Lardner, 2008).

At the heart of the global financial crisis that began in 2008 were mortgage backed securities (MBS). Reckless lending practices allowed uncreditworthy persons to make real estate purchases, which drove rising real estate values, which in turn drove a thriving market in lucrative securities backed by loans that closer scrutiny would have concluded were doomed to default. Billions of dollars in MBSs were bundled and sold into secondary markets where individual mortgages became thoroughly entangled in instruments too complex to effectively sort out when the avalanche of defaults began. The Dodd–Frank Wall Street Reform and Consumer Protection Act was signed into law in 2010. This law required securitizers to bear 5% of losses suffered by MBS investors, thus incentivizing more prudent behavior by lenders. A limited exception was made for loans meeting very high standards. In 2013, Bair & Frank warned that capitulating to industry efforts to amend the 5% rule to apply only to loans that do not meet the basic lending standards set by the Consumer Financial Protection Bureau (CFPB) would reintroduce large numbers of questionable loans back into the MBS market. CFPB standards are aimed at eliminating the worst pre-crisis lending practices without eliminating all but buyers with stellar credit and a large downpayment from the home buying mix. Mortgages continue to carry a higher risk for banks than in the more conservative past, and analysts must be wary as well as savvy in weighing the value of MBSs.

Conclusion

Modern economies depend largely on the ability to manage financial investments and the financial securities markets which enable the investment process. These markets allow large as well as small investors to participate in the economic process by providing funds for companies, governments, and entire nations to utilize capital that they would otherwise not have available.

The role of the financial securities analyst is to research investment opportunities and advise their clients or potential investors as to the benefits and risks associated with an investment. It is critical that the work of the financial securities analyst proceed and is diligently executed without bias or self-interest on the part of the adviser.

Terms & Concepts

Fiduciary Responsibility: The responsibility that a board of directors or fund managers has in assuring that investment activities and decisions are appropriate and adequately documented.

Financial Securities: are economic investment instruments that provide a means for individuals, investment banks, mutual funds, or retirement funds to invest money in a company, an industry sector, or even a region of the country or the world.

Monetary Policies: Government policies that control, shape, or impact how a nation's money supply and exchange with other currencies is managed.

Regulatory Compliance: The management of a fund in accordance to all laws and regulations that govern the funds investment and distribution activities.

Bibliography

A three-year global recession. (2009). Asia Monitor: South East Asia Monitor Volume 1, 20, 8. Retrieved March 11, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36170540&site=ehost-live

Bair, S., & Frank, B. (2013). Watch out. the mortgage securities market is at it again. Fortune, 167, 69. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=87863611&site=ehost-live

Bartolini, L., Hilton, S., Sundaresan, S., & Tonetti, C. (2011). Collateral values by asset class: Evidence from primary securities dealers. Review of Financial Studies, 24, 248-278. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=56517010&site=ehost-live

Birkner, C. (2009). Getting started in trading. Futures: News, Analysis & Strategies for Futures, Options & Derivatives Traders, 38, 46-48. Retrieved March 4, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36665067&site=ehost-live

Clark, E., & Karr, A. (2009). Warnings weigh on retail stocks. WWD: Women's Wear Daily, 197, 20-1NULL. Retrieved March 5, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36281437&site=ehost-live

Duan, Y., Hu, G., & McLean, R. (2009). When is stock picking likely to be successful? Evidence from mutual funds. Financial Analysts Journal, 65, 1-12. Retrieved March 5, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36797901&site=ehost-live

Ennis, R. (2009). End of an era. Financial Analysts Journal, 65, 6-8. Retrieved March 5, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36179348&site=ehost-live

Financial analysts and personal financial advisers, nature of the work. (2009). United States Department of Labor, Bureau of Labor Statistics. Retrieved March 4, 2009, from United States Department of Labor, Bureau of Labor Statistics. http://www.bls.gov/oco/ocos259.htm

Foley, F., & Lardner, L. (2008). A comprehensive summary and analysis of the Emergency Economic Stabilization Act of 2008. Blue Chip Financial Forecasts, 27, 1-8. Retrieved March 4, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=35647894&site=ehost-live

Freund, S., Prasad, D., & Andrews, F. (2013). Security selection factors: novice versus experienced investors. International Journal of Business & Finance Research (IJBFR), 7, 115-126. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=86260859&site=ehost-live

Halal, W. (2009). Emerging technologies and the global crisis of maturity. Futurist, 43, 39-46. Retrieved March 11, 2009, from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=36400461&site=ehost-live

Mishkin, F. (2009). Globalization, macroeconomic performance, and monetary policy. Journal of Money, Credit & Banking (Blackwell), 41, 187-196. Retrieved March 11, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36190638&site=ehost-live

Morgado, D. (2009). Economic consequences to companies, states, and municipalities sponsoring pension plans from recent market losses and potential ERISA fiduciary liability to investment advisers. Employee Benefit Plan Review, 63, 7-8. Retrieved March 12, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36674585&site=ehost-live

Morse, N. (2009). Who's to blame? Many answers, few certainties. Mortgage Banking, 69, 98-101. Retrieved March 4, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36112289&site=ehost-live

Moynihan, M. (2009). Key issues for mutual fund boards in the midst of the financial crisis. Investment Lawyer, 16, 1-11. Retrieved March 12, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36674567&site=ehost-live

Muller, F.L. (1994). Equity securities analysis in the U.S. Financial Analysts Journal, 50, 6-9. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9405244150&site=ehost-live

Mutual fund trading abuses: SEC consistently applied procedures in setting penalties, but could strengthen certain internal controls. (2005). United States Government Accountability Office. Retrieved March 12, 2009, from the Government Accountability Office. http://www.gao.gov/new.items/d05385.pdf

O'Dowd, S. (2009). Ten predictions for financial services in 2009. Securities Industry News, 21, 6-6. Retrieved March 6, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36334826&site=ehost-live

Pressman, A. (2009, January 19). In search of stock research. BusinessWeek, (4116), 56-57. Retrieved March 5, 2009, from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=36087720&site=ehost-live

Private pensions: Multiemployer plans face short- and long-term challenges. (2004). United States General Accounting Office. Retrieved March 12, 2009, from the Government Accountability Office. http://www.gao.gov/new.items/d04423.pdf

Reinganum, M. (2009). Setting national priorities: Financial challenges facing the Obama Administration. Financial Analysts Journal, 65, 1-4. Retrieved March 6, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36798026&site=ehost-live

Steverman, B. (2009, February 12). A changed world for financial advisers. Business Week Online, 29. Retrieved March 12, 2009, from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=36540813&site=ehost-live

Suggested Reading

Bogoslaw, D. (2009, February 11). Should you manage your own portfolio? Business Week Online, 14. Retrieved March 5, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36564490&site=ehost-live

Carlson, G. (2009). The focused 10 funds hold their own in a trying year. Morningstar FundInvestor, 17, 16-17. Retrieved March 4, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36065881&site=ehost-live

Foley, F., & Lardner, L. (2008). A comprehensive summary and analysis of the Emergency Economic Stabilization Act of 2008. Blue Chip Financial Forecasts, 27, 1-8. Retrieved March 4, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=35647894&site=ehost-live

Garmhausen, S. (2009). In turmoil, bankers see a chance to woo advisers. American Banker, 174, 8-9. Retrieved March 12, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36586711&site=ehost-live

Hanna, S., & Lindamood, S. (2008). The decrease in stock ownership by minority households. Financial Counseling & Planning, 19, 46-58. Retrieved March 4, 2009, from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=36318531&site=ehost-live

How the crash will reshape America. (2009, March). Atlantic Monthly (10727825), 303, 44-56. Retrieved March 11, 2009, from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=36539332&site=ehost-live

Larson, M. (2009). Fiduciary prudence in uncertain economic times. Employee Benefit Plan Review, 63, 13-14. Retrieved March 12, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36674587&site=ehost-live