Taking stock in IT

In the analytical and consulting businesses, the phrase "vendor impartiality" is used quite often by service organizations wishing to promote themselves as pure and untainted when pursuing end-user consulting/analytical work. By this phrase, the analyst or consultant is indicating that he has no vested interest in the vendors that he is about to discuss, evaluate or analyze. Users, in turn, look for organizations that have no conflict of interest when it comes to vendor recommendations. That is to say that users want to avoid getting advice from a consultant/analyst that stands to benefit monetarily or otherwise from recommending a particular vendor's solution.

Unfortunately, there are lots of those in this industry that do have conflicts of interest. For example, some systems integrators that offer consulting services often have a financial relationship with the vendors they "integrate" or service. And it is not uncommon to find consultancies that derive significant portions of their consulting revenue from Vendor X recommending that particular vendor more than they probably should. Nor is it uncommon to find industry "experts" who have some sizable stock holdings in some of the companies they often recommend.

Is this surprising? It shouldn't be. After all, who better to evaluate the stock potential of a company than a leading industry consultant/analyst that spends their waking days analyzing and dissecting IT vendors and market segments? But it doesn't mean that it is right. Now I am not necessarily talking about the person that owns a few shares of the major industry players - doesn't every IT investor own at least a few shares of Cisco or Dell? Instead, I mean the person that owns quite a few shares of a company where his actions could result in his investment returning some serious profit.

To counter this image, and the perceived conflict of interest that goes with it, many consulting and analytical firms (mine included) have set guidelines for their employees regarding what they can and cannot do regarding their own personal investments. These typically involve rules targeted around firms that they consult on or analyze such as: you cannot own more than 1% of a publicly traded firm; you cannot have more than 10% of your total stock portfolio in any one company; you cannot buy or sell stock in any firm with which you have a nondisclosure agreement that gives you access to confidential or proprietary information the typical investor would not be aware of; and you may not provide commentary or advice on any firm in which you just bought stock.

Many individuals and firms have moved to blind trust as a way for their staff to continue to own stock in the IT market but not be influenced on a daily basis by market events. Others promote an industry perspective to investing. This means that an employee cannot invest in individual companies in a particular industry without investing in all the major firms in that industry sector. For instance, if an employee buys Cisco stock, he also must buy stock from 3Com, Cabletron and Bay. This method allows the consultant/analyst to benefit from overall trends within a market sector without having a vested interest in any one company.

Many firms have also created policies that prevent the firm itself from accepting stock from companies. Many small start-ups readily offer stock in place of cash compensation during their early years. Would you, as an end user, take a consultant's advice to purchase products from Start-up A if you knew that the consultant owned 50,000 shares in that firm? Do 50,000 shares seem like a lot? How about $50,000 worth? Unfortunately, we all too often hear of experts that own hundreds of thousands of dollars worth of stock in companies they directly cover on a day-to-day basis.

I am not talking about offering casual advice here such as "yeah, I think that company is OK." Instead I mean targeted advice that a client purchase what may be a significant amount of product from a particular vendor in which the consultant/analyst owns a significant amount of stock.

Interestingly, this has not stopped the financial firms from being looked at as a source of "accurate and insightful" information. These firms often publish vendor updates that talk about why a particular stock should be bought or held onto. They almost never advise anybody to sell a stock until after the stock has crashed and burned. And at the bottom of each of these reports is the phrase: We make a market in this security. Translated: The firm owns the stock and is actively promoting it to clients in this report.

If this is a problem that you too have seen in the past, drop me an e-mail and let me know. I'd like to get a sense as to the scope of this problem. I'd also be interested in what your firm has done policy-wise to discourage this type of activity. I'll be following up shortly with the results of your replies.

Until then, don't be afraid to ask firms or individuals offering advice if they own stock in the particular company you are discussing. And don't be surprised if they do. Rather, look for steps they have taken to blunt any potential conflict of interest (i.e., industry investing, mutual funds, etc.).

Fred McClimans is CEO of Current Analysis, Inc., a competitive intelligence and analysis firm. You can link to the Current Analysis Web site or reach Fred at fred@ currentanalysis. com