Friday, April 01, 2011

Volume 3 Issue 13: Intelligent Investing

Integrity in Research

Here are 2 completely unrelated issues about investment research and why it is important to maintain integrity at all times. The first story is about the recent resignation of David Sokol of Berkshire Hathaway, touted to be one of the possible successors of Warren Buffett at the company.

Apparently, minus all the details of the deal that transpired, David Sokol had purchased 90,000 shares of Lubrizol several weeks before Berkshire acquired the company. It was made known that Sokol was the one who proposed the deal to Buffett. Although Buffett rejected the deal initially, he finally decided to listen to Sokol for whatever reasons. Now, post-acquisition, Sokol's investments saw a gain of 29% or USD3 million.

With the legality of his actions still in debate, there is really no point speculating on what is right and what is wrong. The point that I am trying to make is that Berkshire's squeaky clean image that was built up over the past 50 years or so is now tarnished, or at best, clouded.

As Warren Buffett wisely pointed out:
"We can afford to lose money - even a lot of money. But we can't afford to lose reputation - even a shred of reputation."
Imagine if David Sokol was proven to be guilty of acting on material non-public information. From then onwards, every deal that Berkshire makes, many would ask, "Does this deal serve the interests of one of Berkshire's executives?" This kind of publicity could spell the end of some businesses.

For further reading, click here. For a more detailed write-up from the Wall Street Journal, click here.

The second story is much closer to home.

This is about RHB Research Institute's report on Perisai Petroleum Teknologi Bhd. On 30 March 2011, RHB Research released a report which questioned the integrity of one of its acquisitions. This caused a major sell-down on Perisai and pretty much forced the Securities Commission to launch an inquiry on Perisai.

One of the quotes in the article was:
"Moreover, we believe there is a corporate governance issue relating to the effective purchase of the asset at 14x premium to the original disposal price of the same asset"
Raising a flag over a corporate governance issue points towards a sketchy deal but a day later, RHB Research realized that they did not find out the appropriate facts. After Perisai clarified the matter, RHB Research realized that they had made a mistake and published a counter report on the next day, 31 March 2011, and withdrew their previous report.

This clearly shows very careless and irresponsible research on RHB Research's end. They caused a sell-down on Perisai and many people lost money on it. This brings us back to the issue of integrity. So from now on, every time one reads a research report from RHB Research, one would start questioning the quality of its research. "Could it be as bad as the Perisai case?"

Here is another of Buffett's infamous quotes:
"It takes 20 years to build a reputation and five minutes to ruin it"
To conclude, I would just like to point out that writing research reports is not easy. A lot of care and thought has to be put into it to ensure that lies and irresponsible research is not thrown around as it could have adverse effects on people's lives. This is the level of care, responsibility and integrity that we hope to aspire to at the Mainstreeter.

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