New legislation and the market risk (page 1 of 4)

US STOCKS

The "Big W" signed into law legislation granting the government new powers to police the accounting profession and increasing prison terms for rogue executives. The President and Congress once again demonstrated that they could be quite effective when push came to shove, as Americans vote with their pockets. Notwithstanding whether the latest legislation can completely fill the loopholes, nonetheless, it is a start. We have no illusion that President Bush will try to lead the reform, but rather taking a more passive role.

What's new:

• The accounting oversight board under the SEC will set standards for accountants and review their audits

• It will cover oversea firms performing work for US corporations

• Prohibits accounting firm from providing 9 types of consulting services to audit clients (they may seek a waiver)

• Firms that seek non-audit services needs approval from independent directors on the company's board

• Securities fraud will be made a crime that carries a maximum of 25 years in prison

• Increases penalties

• Chief executives will have to vouch for their companies' financial statements and may be subject to jail terms and fines if they knowingly deceive in disclosures

• Company has to notify SEC within 1 day on information that has an impact on their financial statements

• The SEC will set rules on what information is covered

• Makes easier for investors to recover losses in case of securities fraud

• SEC has to draft rules with regards to conflict of interest for stock analyst who research companies that also are investment-banking clients of their firms

• Bars retaliation against researchers who issue "sell" recommendations on clients' stocks

CEOs will have to sign the affidavits when their companies file their next financial statement or report a significant event after August 14, 2002. Corporations will have to wait until spring for their next audited annual reports to straighten out their books. Therefore the risk of further accounting surprises will be with us for a while. Meanwhile, the under-funded pensions will be a drain on earnings.

Given the current market risk, the risk and reward is definitely not favourable though there are values in the market.

JP Morgan Chase & Co. (JPM, $23.85, CSFB recommendation: Buy): At the time of the merger between the old Chase and the old JP Morgan, the company announced its intent to be a top five equity player in three years and a top three player within five years. The management is focusing initially on improving the operating structure and related personnel, which sounds right.

For the long-term growth, JPM's greatest challenge in the equity business could be its ability to create a highly profitable secondary equity business. At the moment, according to Autex/BlockData, the company does not rank in the top 10 in domestic listed/OTC trading market share nor does it appear in the top 10 European Ordinary/ADR market share league tables. For the short-term, although the stock could appear cheap, headline risk remains significant. However, if the company would be able to increase its market share in the secondary equity business, this should offer to JPM sustainable growth. Hold


We are more positive on Citigroup Inc. (C, $30.88, CSFB recommendation: Strong buy) than on JP Morgan Chase $ Co due to stronger fundamentals.