Brokerages’ integrity questioned

The price of shares in Hanmi Pharmaceutical, the country’s top drug maker, fell more than 50 percent over the last five months for a very good reason.

Three of the company’s employees have been charged with leaking inside information about the termination of a contract with German drug maker Boehringer Ingelheim to enable some investors to sell shares prior to the official notice.

The contract was terminated because of severe skin-related side effects of a Hanmi lung cancer drug.

And yet the vast majority of analysts at local brokerages told investors to buy Hanmi stock even as the investigation unfolded. The most conservative rating was put out by NH Investment & Securities, which recommended investors hold the stock.

The Hanmi case illustrates a chronic problem in Korea’s securities industry: analysts like to give favorable ratings to companies even when they shouldn’t - and even when it’s ludicrous to do so.

According to data released by the Financial Supervisory Service last week, 18 Korean brokerages failed to publish a single sell recommendation for a period of three years. They included small brokerages such as Shinyoung Securities and Leading Investment & Securities, but also big ones like Mirae Asset Daewoo, Shinhan Investment and Samsung Securities.

Local brokerages’ reluctance to recommend selling shares becomes even more obvious when compared to the assessments of foreign financial companies.

The Financial Supervisory Service said that sell recommendations accounted for a mere 0.1 percent of local brokerages’ stock reports over the past five years. When looking at foreign companies reports on Korean stocks, that figure was 11.1 percent.

The dirty little secret behind this tsunami of positive evaluations is a tidy relationship between securities companies and listed corporations. Brokerages refrain from offending listed companies with unfavorable ratings because the companies are or can be clients of their investment banking and financial advisory services.

“The listed companies are often major clients of the securities companies,” said Jang Joon-kyung, head of the capital market supervision division at the Financial Supervisory Service. “And since the investment banking sector often handles big deals, analysts may feel forced to curry favor with the listed companies.”

Even if the brokerages and companies are not in a direct corporate client relationship, the listed players sometimes impose retaliatory action against analysts who lower price target or ratings.

Jeong Yoo-seok, a Kyobo Securities analyst in charge of its tourism sector rating, received a notice from the nation’s largest tour company, Hana Tour, last March saying he was banned from visiting the company or joining any of its future investor relations sessions.

The company didn’t say why, but the circumstance suggests that the analyst’s opinions were behind the bans.

Jeong lowered Hana Tour’s suggested per-share price from 200,000 won ($170) to 110,000 won in a report, saying that the company’s plan to bring luxury fashion brands to its new SM Duty Free store in Insa-dong, central Seoul, was being postponed and that the delay was likely to affect the company’s revenue.

Acknowledging that such cozy relationships are deeply ingrained in finance circles, financial authorities have taken steps to safeguard the independence and integrity of the ratings process.

The Financial Supervisory Service announced earlier this month that it will order major brokerages to form an internal deliberation committee so that analysts’ reporting can be reviewed in a more transparent manner.

The financial watchdog will also ask securities companies to adopt a new salary system that weighs the quality of research over an analyst’s contribution to the company’s business.

Still, the measures are not legally binding. “The intention is good. But I am not sure whether they can drastically change the current practice,” said a source at a local brokerage company who declined to be named. “When it comes to the salary system, it rarely changes without any legal enforcement. And since the internal committee also consists of employees, it is hard to ensure objectiveness.”

BY PARK EUN-JEE [park.eunjee@joongang.co.kr]