In the first issue of the Financial Analysts Journal of January 1945 the question “Should Security Analysts have a Professional Rating” was debated.

Benjamin Graham (of Graham & Dodd fame) wrote in the affirmative.

Lucien O. Hooper (a founder of the Security Analysts Federation, and a vice president, director of research, and analyst of W.E. Hutton & Company) took the contrary point of view.

In time, Benjamin Graham’s point of view was adopted and the first CFA exams were held in June 1963.

However, some of Mr. Hooper’s initial objections are worth remembering.

Lucien Hooper’s objections

Although written 64 years ago, some of Mr. Hooper’s objections to the issuance of CFA credentials are relevant in light of the Crash of 2008.

He wrote:

Unless our employers, the investing public, or some government regulatory body force regimentation upon us, we earnestly desire to remain free from this unnecessary formalism.

It is not a matter of record that the Securities & Exchange Commission, the New York Stock Exchange, the Association of Stock Exchange Firms, or financial institutions have shown even an academic interest. It is not charged that the practices of the profession are honeycombed with abuses which need immediate and radical correction. Nor can it be contended that the mere establishment of the rating of Qualified Security Analyst (analogous to Certified Public Accountant) would make security analysts any more moral, more intellectually honest, less lazy, or more competent. Most analysts of experience will agree that laziness is our professions most virulent enemy.

So far as incompetence is concerned, every one of us knows that it more frequently is due to unwillingness to put in the required number of hours of work than to the lack of any formal education.

… the rating itself would be meaningless unless the rating authorities are able to enforce penalties. Lawyers are disbarred, doctors may have their licenses taken away, and a man who loses his C.P.A. rating often sacrifices an important part of his earning power.

No penalties for the lazy or incompetent

It is often recognized that failure of securities analysis and investment research was an aspect of the Crash of 2008. The analytical ability of the major credit rating agencies has been severely criticized by Congress. Failure of analysts to warn investors of problems with auction rate securities or insured municipal bonds have been noted.

As the Crash evolved, leading investment banks confessed that they were unable to value billions of dollars of securities held in their own portfolios.

This clearly indicates a problems in the profession of “security analyst”.

However, not a single credentialed analyst lost his or her certification. The SEC imposed no penalties on S&P or Moody’s for sloppy work. As Lucien Hooper indicated three generations ago, the CFA credential is largely meaningless, measuring neither competence nor commitment to professional responsibilities.

In fact, the credential is useful mainly in getting a job and as a marketing gimmick to dress up a firm’s portfolio of analysts.

It is also the source of substantial income for the CFA Institute that runs the certification program for fat fees.

Will there be changes in the profession of security analyst?

It is unlikely that there will be any significant reform of the credentialed profession of “security analyst”. As Mr. Hooper pointed out, the value of credentials for this profession is questionable. This weakness is compounded when there is no ongoing discipline associated with continued certification.

Furthermore, even if the CFA Institute were to raise standards of the profession, say by regular re-examinations or disciplinary actions for sloppy analysis (if that were even possible), there are many credential mills willing and able to churn out some combination of letters to attach to a person’s name to dress up a job resume.

Mr. Hooper seemed to suggest that anyone with above-average intelligence and a willingness to work hard at digging out information and thinking about the value of securities could do a better job than a credentialed analyst that succumbs to laziness, or whose time is devoted to trading securities or marketing chores, rather than research and analysis.

Security analysis requires not so much the possession of certain knowledge for which one might be tested, but rather the skill and determination to work hard at researching new areas, without predetermined conclusions or knowledge.

Between 1963, when the first CFAs were certified and the Crash of 2008, capital markets became increasingly complex, covering many more types of securities, institutions, jurisdictions, and instruments. Consequently, the work required to get the research job done properly today has increased considerably over the decades.

Furthermore, the traditional focus of a security analyst — financial statements and market prices — needs to expand to cover legal and operational aspects of complex instruments in exotic jurisdictions and circumstances, many, or even the majority, invented after certification may have been granted.

As indicated in the article, “British CFAs reject the Efficient Market Hypothesis“, elements in the curricula of analyst certification often fall behind the reality of today’s market.

Moving away from certification of knowledge

The lesson of the Crash of 2008 might be that future security analysts should be trained on-the-job, in actual research, with less emphasis on fixed curricula and studying for certification exams.

After all, if the structure and details of the market are constantly changing, with ever-increasing complexity, and if an analyst must be able, above all, to learn new things as one goes along, everyday, throughout his or her career, why not get right down to it, rather than waste time studying for exams on sterile topics?

This entry was posted on Sunday, July 26th, 2009 at 4:45 pm and is filed under Bankers, Brokers, Fund Managers. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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