2003 Investor Trust
HOW U.S. MARKET PROFESSIONALS VIEW THE REBUILDING PROCESS
Prepared by Broadgate Consultants, Investor Relations Specialists with offices in New York, Washington, Dc and London, England

Corporate scandals, a declining economy, poor consumer confidence, the aftermath of September 11th and looming war with Iraq. By any measure, 2002 was a turbulent period for the world and its financial markets. Demonstrating their resilience, professionals in the world’s financial markets are generally optimistic about the prospects for 2003.

As the scandals that devastated investor confidence unfolded, a number of extreme reforms were implemented. Broadgate Consultants, Inc., a Partner firm of Public Relations Organisation International, Inc. in New York, sought the opinions of more than 15,000 U.S. institutional market participants on certain key issues.

While most welcomed 2002’s sweeping corporate governance and disclosure reforms and continued to convey their disappointment in the lack of corporate board leadership, many expressed concerns about the future as the "law of unintended consequences" took hold. The potential casualties include small U.S. and many non-U.S. companies.

Market Outlook Somewhat Brighter
Despite 2002’s dismal market performance, investors reflect a degree of optimism about the prospects for 2003. In fact, many consider those companies that were touched by scandal in the past year to be potentially attractive investments now that they are under new board and management leadership.

A majority also believe that M&A activity will increase in 2003 from the $469 billion in U.S. M&A transactions in 2002.

Given the depressed market environment, a majority of investors also agree companies that pay regular dividends are more attractive investments - particularly those with consistent dividend payment records - as investors increasingly demand a cash return on investment, irrespective of the proposed tax changes.

Corporate Disclosure and Governance in the Spotlight
Notwithstanding the increased attention that has been drawn to corporate governance, there is little concern among investors that qualified professionals will be discouraged from filling roles on corporate boards or as senior management.

With regard to the heightened focus on corporate governance, some companies have been proactive in unveiling changes that include expensing stock options, creating a board-level committee to focus on governance issues, and making additional disclosures to investors.

Measures such as these, along with NYSE rule changes, have helped to rebuild investor confidence and strengthen corporate governance practices. However, many companies have not taken a proactive stance on corporate governance. A major reason is a lack of board leadership, according to investors. When asked if the roles of chairman of the board and chief executive officer should be split, the majority of investors agreed that they should be separated.

Recent moves by public companies to cut back on disclosure, however, have not been well received. Toward year-end 2002, for example, Coca-Cola Company announced that the company would no longer provide quarterly and annual earnings guidance.

Other companies, such as McDonald’s, Gillette, Intel and Berkshire Hathaway have also moved away from quarterly earnings guidance.

A large majority of investors greeted the move with skepticism. In the event such guidance is eliminated, most investors say that companies should still give projections of other metrics affecting earnings, such as revenue, tax rate, gross margin and performance of key business units.

Among fund managers’ other top concerns are stock option grants and their potentially dilutive effect. Still, many in the investment community believe that corporate disclosure is better today than it was before financial reporting troubles made the headlines.

Research and Investor Confidence
To help restore confidence and integrity to analysts’ research, respondents said they favor the newly accepted practice of brokerage firm analysts plotting their past ratings against a stock’s price chart in their research reports. Although most investors will rely to the same degree on sell-side research to make investment decisions, a majority have indicated that increased regulatory scrutiny of analysts has led to a greater focus on research quality and independence.

Along with the increase in regulatory scrutiny, many firms have significantly reduced headcount in their research departments resulting in a decrease in the number of companies covered. Investors agree that this decrease in coverage will have the greatest impact on small and mid-size companies, which could find themselves without any coverage whatsoever and could have profound consequences for capital formation.

SEC Effectiveness Questioned
While investors welcomed reforms, many had doubts about the Securities and Exchange Commission’s effectiveness, saying that the agency had not been aggressive enough.

Furthermore, investors were not particularly enchanted with the selection of William H. Donaldson as Chairman of the SEC.

Many expressed fears that Donaldson’s investment banking background could prove to be an issue in light of the increased scrutiny of Wall Street firms, in much the same way that Harvey Pitt’s representation of accounting firms created conflicts of interest. The majority of investors polled were uncertain whether Donaldson was the right person for the top SEC job.

In contrast to this generally negative view of the SEC was investors’ positive response toward the high profile investigations into the activities of investment banks led by New York Attorney General Elliot Spitzer and other state attorneys general.

Regulatory Initiatives Welcomed by Investors
As 2002 unfolded with almost daily news of corporate scandal, there was intense government and regulatory scrutiny of corporate practices which led to the most sweeping changes to U.S. securities laws since the Great Depression. Even as the news of scandals abated, a large majority of investors favored additional corporate governance and disclosure reforms.

The SEC has been plagued by many problems over the months and is in need of leadership. Despite questions regarding the suitability of his background, the president’s choice to fill the role of chairman of the SEC, William Donaldson, has the support of former chairman Arthur Levitt.

Investors agreed that the creation of a watchdog for the accounting profession would prove to be a positive step. While the SEC has stumbled along the way filling this position, the designation of Charles D. Niemeier as the Acting Chairman of the Public Company Accounting Oversight Board in January 2003 indicates that accounting reform is finally in progress.

Mixed Views of Non-U.S. Companies and Sarbanes-Oxley Compliance
President Bush’s signing of the Sarbanes-Oxley Act in July brought about the reality of a "crackdown" on corporate practices. While aimed at U.S. companies, the legislation could also have significant consequences for foreign companies.

Investors expressed concern that the regulatory and legislative changes would dampen the enthusiasm of non-U.S. companies for listing their shares on U.S.-based markets. Despite these concerns, a majority of investors and analysts believe that non-U.S. companies should not be exempt from certain provisions of the Sarbanes-Oxley Act, such as the requirement to set up an in-house audit committee comprised of outside directors.

These views stand in contrast to those expressed by SEC chairman nominee Donaldson, who has argued that foreign companies should not always be held to U.S. accounting rules and governance standards if they conflict with home country regulations. Many believe that Donaldson will be sympathetic to foreign issuers’ complaints about certain elements of the Sarbanes-Oxley Act.

Still, U.S. institutional investors perceive more disclosure risk in non-U.S. companies relative to their U.S. counterparts, although the Financial Accounting Standards Board and the International Accounting Standards Board recently agreed to work towards convergence of global standards. Many within the financial community also believe that sell-side coverage of non-U.S. companies is likely to decline in the face of layoffs among brokerage firm research staff.

Conclusion
Needless to say, investors believe that there is much to be done as we head into 2003.

First, companies need to be more forthcoming and accurate in their disclosure practices. Investors and analysts alike rely on the information provided through corporate disclosure to rate company performance and to make investment decisions.

Second, investor confidence on Wall Street needs to be restored. Obviously, if analysts receive the proper information, they can make more accurate predictions, recommendations and ratings. Research reports will then be something on which investors will feel they can rely.

Third, progress needs to be made with regard to non-U.S. companies and their compliance with the Sarbanes-Oxley Act. In some countries, complying with certain aspects of the Act will require these companies to disobey their own country’s laws. A prompt resolution is needed.