Brokerage firm India Infoline has flashed the ‘Chinese wall’ concept to explain its contrasting calls on the same scrip on the same day. But is it credible?

Moneylife had earlier reported on how India Infoline had come out with two different reports on Punj Lloyd Ltd exactly on the same day but with opposite recommendations (Read here: http://www.moneylife.in/article/8/5870.html). After Moneylife wrote about it and also brought it to the attention of the Securities and Exchange Board of India (SEBI), the brokerage firm has come out with a press release clarifying the research calls made by different teams of the IIFL group.

 However, the company's stand does nothing to comfort the investors; in fact it should raise eyebrows higher.

India Infoline had published two reports on 31 May 2010. In one report, the firm wanted institutional investors to 'sell' shares of Punj Lloyd, with a 12-month target price of Rs97 or 29% lower than the then trading price of Rs137 as on 28th May.

On the other hand, the second report issued on the same date recommended its private client group to 'buy' Punj Lloyd shares with a target price of Rs158. No time horizon was mentioned for the private client group report.

The company, in its response, has very conveniently stated that the IIFL group has two separate and distinct retail and institutional research teams that are separated by 'Chinese walls'. In today's world of finance, it isn't too difficult to see the irony in this idea. The Chinese wall concept is most commonly utilised in financial institutions with interests in both investment banking and brokerage operations. Its purpose is to provide a separation between the two, while allowing the company to engage in both activities without creating a conflict of interest. This wall is not a physical boundary, but rather an ethical one that financial institutions are expected to observe.

While this was widely practised until a few years ago, wide cracks have become increasingly evident in the Chinese wall model over the years. The porous nature of this so-called wall was in full display during the recent debacle in Wall Street, when investment banks tumbled one after the other. These institutions are supposed to have internal policies that necessitate impartiality on the part of analysts. But very often, these policies are based on flimsy structures, open to being twisted and violated in the process. These institutions compensate the very same 'impartial' analysts based on some investment banking deals they might have participated in. The end result is there for all to see.

The case is no different in India where insider trading and market manipulation are rampant. Fancy portfolio management services (PMS) products offered by various brokerages show that there are, in effect, no Chinese walls. Moneylife has written about cases where PMS money has dramatically shrunk because the broking arm took the money heavily traded in and out of stocks that not only meant huge costs but also huge losses. These products are designed in such a way as to entice high net-worth individuals (HNIs), but are usually based on shoddy strategies that end up creating havoc on the client's portfolio. Very often, the advice to HNIs is diametrically opposite to that given to retail investors.

India Infoline's press release also states, "The respective research teams conduct independent research and reports are made by separate research analysts considering the various factors including client group to which they are providing the services, risk profile, investment goals, horizon of investment etc. Since the different sets of investors, institutional and non-institutional customers, have different time horizons and different investment philosophy, they need to be serviced differently." This looks good only on paper. Besides, we are not even sure if this is what the reality is. Indeed, SEBI is now thinking of actually removing Chinese walls inside asset management companies because they actually serve no purpose.