From the Archives: Benjamin Graham and the Founding of the CFA
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As students begin to prepare for this round of CFA exams it's interesting to look back at the history of the charter. In the mid-1940s a debate raged in the finance community over whether or not there should be a professional rating for security analysts. In this excerpt from the Analysts Journal (January 1945), Benjamin Graham, the man widely considered to be the father of security analysis, argued for the creation of a professional rating, and Lucien O. Hopper argued against the need for certification. Graham's side eventually prevailed, leading to the formation of the CFA in 1959.
Should Security Analysts Have a Professional Rating?
In 1942, the Committee on Standards of the New York Society of Security Analysts proposed to the membership that a rating or professional title be established for security analysts. This rating was designated tentatively as "Qualified Security Analyst" or "QSA." The proposed machinery included the following: A Board of Qualifiers was to be set up by the Society and cooperating agencies—e.g., the Association of Stock Exchange Firms, insurance companies, investment counsel, etc. The Board would confer the rating upon applicants who met designated standards, including those relating to:
(b) Education and experience
(c) Passing of an examination.
The latter test might be waived for suitable reasons. Application for the rating would be on a voluntary basis and would be motivated by the desire for prestige and practical advantage. Eventually, however, it might be expected that the QSA rating would become necessary for those doing the work of a senior security analyst having direct or indirect contact with the public. No final action has been taken on the Committee's findings. The following articles analyze the arguments for and against this proposal. The Editors will welcome expressions of opinion from the members.
by Benjamin Graham
The issues involved in this rating proposal are comparative ly simple and may be argued largely by analogy. Some fifty years ago, trained accountants were wrestling with a similar idea, and at that time the difficulties and drawbacks of the proposed CPA designation no doubt appeared quite serious to many of them. Today the need for a professional rating in that field and in many others is taken for granted. It takes no prophet to predict that once we surmount the initial hurdles involved in a rating for security analysts, the procedure will establish itself firmly and will come to be considered as indispensable to the public interest.
For purposes of this discussion, a security analyst is defined as one whose function it is to advise others respecting the purchase and sale of specific securities. This definition would exclude the following:
(1) Junior statisticians or analysts who merely assemble data.
(2) Business or financial analysts and economists who do not deal with specific security values.
(3) Teachers and students of theory as such.
Strictly considered, this definition would also exclude stock market analysts since they ordinarily do not advise about specific securities. The writer believes, however, that ultimately, if not now, market analysis will be regarded as a special department of security analysis and that every competent market analyst will be grounded in security analysis.
In any event, by security analysts in this context are meant those giving advice or suggestions on security transactions to customers (and partners) of brokerage houses, investment bankers, banks and trust companies; those engaged in investment counsel; and those having similar functions on the staff of investment companies, insurance companies, other corporations, philanthropic organizations, and the like. The field is wide and undoubtedly includes several thousand practitioners in this country.
Advantages of a Rating System
The advantages of a rating system may be summarized thus: Those dealing with a QSA will know he has met certain mini mum requirements in regard to knowledge of his field and has professional competence. They will know also that to retain his designation of QSA, the analyst will have to observe rules of ethical conduct which no doubt will become increasingly definite and stringent as time unfolds. These benefits Will apply both to the direct employers of security analysts and to the clients of such employers.
The analyst who qualifies for the rating will have the obvious advantages of prestige, improved ability to get a job, and the chance for higher pay. In addition, he is likely to develop a more professional attitude towards his work and a keener interest in maintaining and advancing the standards of his calling.
Answers to Some Possible Objections
It would seem advisable to list the various objections advanced against the proposed rating and to comment briefly on them. These objections apply both to the underlying soundness of the idea and to its practical application.
Objection 1: It is basically impossible to distinguish between qualified and non-qualified analysts, since skill in this field rests largely on judgment rather than on specific knowledge or technique. Good judgment can not be tested by ordinary examinations.
Answer: While judgment plays an important role in security analysis, it requires the aid of well-established methods and of specialized knowledge and experience. More and more emphasis is being laid on sound techniques in analysis—by employers, by teachers, by those entering the field, and by the work of this Society.
Technical ability and adequate information may, of course, be determined by suitable tests, and this applies also to some of the more obvious judgment factors entering into security analysis.
Objection 2: The QSA rating may mislead the public, because it indicates but can not guarantee that its holder is a capable analyst.
Answer: This objection has a certain validity, but no more than the observation that an M.D. may be a poor doctor. As in similar fields, the QSA rating will purport to guarantee only that the holder has met certain minimum tests—not that he possesses maximum abilities. The chance of misconception is smaller here than in other fields because the typical analyst is employed by an executive with considerable practical knowledge of his own, and not by unsophisticated members of the general public.
Objection 3: The QSA rating is a step in the direction of privilege for some and limited opportunity for others. It is a closed shop or cartel development.
Answer: There is no reason why the QSA rating should be denied to anyone who deserves it and wants it. It might result in the exclusion of unqualified practitioners from the field, but this would not be unfair or unsound. The right of every individual to practice his chosen trade is subject to the higher right of society to impose standards of fitness where these are advisable.
Objection 4: The plan has administrative difficulties. Who would judge the competence of others and by what right? Who would give the necessary time to the task?
Answer: This rating proposal involves no more difficulties than are found in similar requirements imposed in other fields. Suitable people will be found to act as Qualifiers, as they are found for the Character Committees of the Bar Associations, for the Board of Psychiatric Examiners, etc. Public-spirited analysts of reputation will devote time to this task as to other non-profit work.
The initiation of the program presents certain special problems. It might appear presumptuous for some analysts to pass on the qualifications of others of similar experience and standing. This hurdle might be overcome, if advisable, by waiving the examination at the outset for those with practical experience of not less than ten or fifteen years. With the passage of time, a constantly larger percentage of analysts will have been subject to the test.
The level of competence necessary to qualify for the rating will have to be determined by the Board of Qualifiers. If precedent in other fields is followed, it will probably be set rather on the low side at first and gradually raised thereafter. It is the writer's personal view that the test may be equivalent to that given for students completing a full year's college or graduate school course in Security Analysis. Character and experience requirements would be set up separately, but some interchange of credit for academic work as against business experience would be advisable.
There is in this discussion no desire to minimize the practical difficulties faced by the rating proposal. However, it does not seem that these problems are essentially different from those met in the fields of accounting, law, medicine, and other professions. If these analogies appear too elevated, we can point to the licenses or Certificates of Fitness required, in various areas, for real estate brokers, insurance salesmen, and customers' brokers employed by Stock Exchange houses. It is hard to see why it is sound procedure to examine and register customers' brokers but not sound to apply corresponding standards to security analysts. The crux of the question is whether security analysis as a calling has enough of the professional attribute to justify the requirement that its practitioners present to the public evidence of fitness for their work. The publication of this Journal is in itself an assertion of professional status for security analysts. It would seem to follow, almost as an axiom, that security analysts would welcome a rating of quasi-professional character, and will work hard to develop this rating into a universally accepted warranty of good character and sound competence.
by Lucien O. Hooper
Mr. Graham's admirably prepared statement concisely out lines the details of the proposal. His answers to those objections, which he attempts to rebut, are presented fairly. However, there always are two sides to every question.
From the beginning, a number of members of our Society have opposed the suggestion to establish a professional rating for security analysts. The opposition has not been merely against this plan, but against any plan. Our objections are fundamental and basic.
Who Wants It, and How Much?
Unless our employers, the investing public, or some govern mental regulative body force regimentation upon us, we earnestly desire to remain free from this unnecessary formalism. The life of an analyst is complicated enough without the addition of any unnecessary appurtenances.
Those who employ security analysts, and the investors the profession serves, have evinced practically no interest in this proposal. The idea has been advanced in a more or less perfunctory manner, rather than with unremitting enthusiasm, by a comparatively small number of more serious-minded members of the New York Society of Security Analysts, Inc. The mass of the membership has been indifferent. It has been casually rather than keenly interested. There has been no spontaneous response to the rating proposal either from within or from without the profession. This, in itself, is important because the success of the plan depends on its general acceptance and on the profession's enthusiastic determination to make it work.
It is not a matter of record that the Securities & Exchange Commission, the New York Stock Exchange, the Association of Stock Exchange Firms, or financial institutions have shown even an academic interest. It is not charged that the practices of the profession are honeycombed with abuses which need immediate and radical correction. Nor can it be contended that the mere establishment of the rating of Qualified Security Analyst (analogous to Certified Public Accountant) would make security analysts any more moral, more intellectually honest, less lazy, or more competent. Most analysts of experience will agree that laziness is our exacting profession's most virulent enemy.
Unlike members of labor unions, our relationships with employers and clients are highly personal. The position of a factory worker can be improved by group pressure. Both the analyst and the employer, however, would resent group interference in their relationships.
So far as incompetence is concerned, every one of us knows that it more frequently is due to unwillingness to put in the required number of hours of work than to the lack of formal education. Sometimes, of course, it is due to inherent inability to make decisions, a human quality which it would be difficult for any board of examiners to detect.
Does the Profession Need It?
Our profession, during the past twenty-five years, has developed more rapidly than almost any other. The causes for this rapid evolution are many. Among them may be numbered the ever-widening circle of investors, caused by the amazing spread of corporate organization in our national economy, the public's new disposition to invest in stocks rather than merely to gamble in them, the evolution of much more adequate sources of in formation, and the salutary influence exerted by the general effect (if not all the details) of the legislation surrounding the SEC. The net influences of all of these things have been: (1) to provide a spontaneous demand for the services of analysts, (2) to give analysts better tools to work with, and (3) to enable analysts to do a better job.
If there is any doubt about the progress which the profession has made, it is suggested that the financial and economic literature of today be compared with that of 1918 and 1919, the last transition period; or that some of the better quality, publicly circulated corporation analyses of the 1920's be compared only with some of the run-of-mine analyses now being produced. All the progress which has been made has been accomplished with out a degree of Qualified Security Analyst, and without any regimentation in our profession.
There is not a single field of security analysis where out standing progress has been lacking. The various corporation services are doing a better job. The financial press is published on a higher plane. Prospectuses for new issues contain more adequate, more accurate and more complete information. Annual reports of corporations have ceased to be perfunctory and are now sources of most important basic information. The great investment advisory services have evolved into institutions from mere personal ventures. In many large financial houses, the analytical department has become the mainspring of the whole organization.
This profession of ours is robust and healthy. The abuses which have crept into it are of a minor rather than of a major nature. They are no more of a problem than they are in the professions of medicine, law, engineering, or accounting. The fact that these other professions have ratings, it should be noted, has not enabled then to eradicate all the incompetents, crooks, and charlatans.
Some Basic Difficulties
Thus far this discussion has been based around the demand, or lack of demand, for a professional rating for analysts and what such a rating, if adopted, might or might not accomplish. Because Mr. Graham has called attention to the plan's administrative difficulties, there seems little object in dwelling on them in detail. It should be said, however, that the administration of such a plan, if successful, naturally would demand much of the time of many of our most competent and busiest members; that it cannot be successful unless both the administration and those administrated are enthusiastic and cooperative; and that the administration itself would involve a considerable financial expense.
The task of judging an analyst is much more difficult than that of judging a potential lawyer, doctor, accountant, or engineer. Furthermore, the rating itself would be meaningless unless the rating authorities are able to enforce penalties. Lawyers are disbarred, doctors may have their licenses taken away, and a man who loses his CPA rating often sacrifices an important part of his earning power. As Mr. Graham points out, the difficulties of administration are not insoluble—they do, however, present a problem which should not be overlooked.
Is This the Right Time?
If the objections cited are to be waived or dismissed as inconsequential, there still is another point to consider. Is the time propitious? Some of the members who have been most violently opposed to this proposal are now in the Armed Services and unable to voice their objections. It should be recognized that the average age and experience of our present membership is very different from what it will be two years after the end of the war. The younger members and the juniors should be consulted before we take this far-reaching step. After all, this rating idea is more important to them than to established senior analysts.
Moreover, a code of ethics for the profession should be adopted before, rather than after, the rating is established. When the members of most other professions are initiated into full standing they take an oath to support and observe a definite set of principles and rules. We have no stated set of principles to which we may ask new analysts to conform. To establish a professional rating before we legislate (in our Society, not in government) a code of professional principles is placing the cart before the horse.
To sum up, (1) there is no emphatic demand for a professional rating, either from analysts themselves or from their employers and clients, (2) there are no outstanding professional abuses to be corrected, (3) it is hard to prove that the proposal would hasten the development of a profession, which has made such amazing progress without any regimentation, (4) the cost in time and money would be considerable, (5) the idea should not be adopted in the absence of juniors now in the Armed Forces, and (6) to adopt a professional rating before a code of ethics is established is ill-advised sequence.