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| CBS
News | 60
Minutes II |
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"I couldn't get up in the
morning and look in the mirror and know that I just caused
somebody to lose 50 percent of their retirement money because
I exaggerated and lied."
Tom Brown,
former banking analyst for Donaldson, Lufkin & Jenrette
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Wall Street Prophets
Public Unaware Of Conflict Of Interest For Stock Analysts
Their Wall Street Firms Often Take Companies Public
And Have Stake In Very Firms They Report On
Jan. 30, 2001
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| AP |
| (CBS) If
you're like many people you lost a lot of money in the stock
market lately whether you traded yourself or just watched your
401(k) dwindle.
A lot of that money was lost following
the advice of Wall Street stock analysts, the experts who work
for big brokerage houses. Think of them as the prophets of
Wall Street. They analyze a company, look into the future and
recommend whether to buy the stock.
So how did so many
get it wrong? Many investors don't realize that some
high-profile analysts and their firms stood to make a fortune
on stocks they recommended. A lot of their advice was tailored
to make them rich, not you, as Correspondent Scott
Pelley reports.
"I don't know frankly how some
of these analysts live with themselves," says former
analyst Tom Brown. "I couldn't get up in the morning and
look in the mirror and know that I just caused somebody to
lose 50 percent of their retirement money because I
exaggerated and lied. And that's exactly what I saw at
DLJ."
Forty-two-year-old Brown worked at the Wall
Street firm Donaldson, Lufkin & Jenrette for seven years.
He was a top banking analyst with a reputation for blunt
honesty. Brown says he recalls a DLJ meeting where an analyst
explained their job was to make the stocks they represented
look good.
"The line was, 'You have to understand;
forgive me, Father, for I have sinned,'" Brown says.
"You were going to have to go back to the sales force after
having lied to them and tell them that you were wrong."
If there is pressure to lie, it stems from a very
simple conflict of interest. Wall Street's brokerage houses
make 70 percent of their profits from what's called investment
banking: raising money for companies that need cash.
For example, when Amazon needs money, it goes to its
broker, Merrill Lynch. And Merrill Lynch offers Amazon stock
for sale.
The higher the price, the more the brokerage
makes. Now imagine what the analyst is going to tell the
public about stock his or her firm wants to sell.
"They really are cheerleaders," Brown says,
noting even if analysts cover a company that's not a client of
the firm, it could be a potential client. "So the
investment banking group wants you to be wildly bullish about
everybody."
So if there's bad news about a stock,
you're not likely to hear it from the analysts. A 1999 study
from Dartmouth College and Cornell University says analysts
showed "significant evidence of bias" when they
recommend stocks handled by their firm. The study points to an
internal company memo from brokerage house Morgan Stanley that
tells analysts, "We do not make negative or controversial
comments about our clients." Morgan has disavowed that
memo.
Recently, though, Morgan Stanley made millions
in fees raising money for Priceline. Morgan's analyst, Mary
Meeker, recommended buying Priceline's stock at $134 a share.
When it fell to $78, she repeated her buy
recommendation. And she kept recommending Priceline as it fell
to less than $3.
Are
analysts free to be critical of clients of their firms?
"I don't think analysts are so free since I was
fired for being critical of, not only clients, but potential
clients," Brown says.
Brown was very critical
"in the 1995 to 1998 time frame of the mergers and
acquisitions activity that was taking place among the largest
banks," he says.
"I frankly thought they were
paying too much and that they were using unrealistic
assumptions and that shareholders were going to be hurt,"
he declares.
Brown says he was fired because those
banks he criticized stopped doing business with DLJ. The
company told 60 Minutes II that Brown was fired
because of "his persistent inability to operate effectively
within a team infrastructure." DLJ insisted there is a
separation between investment banking and analysts, and said
its analysts are encouraged to be candid.
Brokerage
firms say analysts disclose their conflicts of interest in
every research report they write. (It's those paragraphs of
small print, at the bottom of the page.) Disclosures like
these are not good enough for Arthur Levitt, chairman of the
Securities and Exchange Commission, in charge of enforcing the
law on Wall Street.
"I think the analyst has a
responsibility to reveal a conflict of interest. And that's
something that the commission is urging upon the stock
exchange...to see to it that their rules are changed in a way
which will force the analysts to reveal conflicts," Levitt
says.
"There's got to be much greater disclosure of
the kinds of conflicts that are part of today's market."
Adds Levitt: "I'd say it's less than moral."
|
| Discuss Disclosure |
Should the federal government require
more disclosure by stock analysts of conflicts
of interest? Express your view on 60
Minutes II's message
boards.
| | |
One
result of these conflicts was the inflation of so-called
target prices, analysts' predictions of how high a stock would
go. In the wildly speculative Internet market, analysts set
inflated targets with no connection to a company's real worth.
The setting of target prices has "been a practice
as long as we've had analysts," Levitt says. "If
investors are prepared to take that at face value, they have
to be prepared for the consequences," Levitt says.
For example Amazon was selling for about $275 a share
when a little-known analyst, Henry Blodgett, predicted it
would go to $400 - even though Amazon had never made a profit.
Amazon did go to $400 and beyond.
Amazon's backer,
Merrill Lynch, responded by replacing its pessimistic Amazon
analyst. His replacement? Henry Blodgett. While this was great
for Blodgett, it proved not so good for investors, many of
whom got soaked when Amazon's value fell 75 percent.
Blodgett has said his prediction was based on sound
analysis using new ways to measure a company's performance.
Wall Street coined a new verb: to "blodgett" a stock.
Former Internet analyst Lise Buyer says experienced
hands on Wall Street couldn't make sense of soaring target
prices.
"Those of us who've been in the business
for a while looked at the wild targets that people were
putting out there, and our jaws dropped," says Buyer.
"And then we watched the stocks follow suit."
"The
market that we had over the past couple of years: Amazon went
to 400 because Henry said it would," Buyer says. "It
was analysts proclaiming what the stock would do, not
analyzing what the businesses said they would do."
One of the differences during the latest stock market
frenzy was the success of cable business channels. The shows
needed guests; so the analysts became TV stars.
Many
appear on CNBC's Squawk Box, hosted by Mark Haines.
After a stock was recommended by a guest, he says, "I'd
look down at the quote machine, and all of a sudden it had
jumped five bucks or 10 bucks."
Thousands, new to
investing, were watching the analysts with no idea that a
conflict of interest might exist on the stocks they were
recommending. CNBC now requires its guests reveal conflicts of
interest before they appear.
"When CNBC started 10
years ago, it had a relatively small audience that was almost
entirely professional," Haines says. "There was no need
to point out these relationships because our viewers knew
about them."
"As the audience broadened, more
and more and more people were coming to this not knowing the
rules," he says.
One of the rules that many
analysts live by is never say "sell," because that would drive
down the price of the stock. Currently there are about 8,000
analyst stock recommendations, according to Zacks Investment
Research, and only 29 sells. That's less than one half of 1
percent.
"You
rarely see sell," Buyer says. "It angers management; it
doesn't help institutional investing clients....So what you
say is, 'We're downgrading this to a 'hold' and believe it
promising for those with a three- to five-year investment
horizon,' which, for those in the know, means, 'See ya.'"
Not even a company's imminent collapse could force
analysts to say sell. Much of Pets.com's financing was raised
by Merrill Lynch. Merrill made millions. Merrill's analyst
Henry Blodgett made a buy recommendation at $16. When it fell
to $7, Blodgett said "buy" again. Again a "buy" at $2 and
again at $1.69. When it hit $1.43 a share, Blodgett told
investors to "accumulate." Pets.com was recently kicked off
the stock exchange.
Investors may have lost a fortune,
but last year Blodgett and Meeker were paid about $15 million
each. Both analysts declined requests for interviews.
Merrill Lynch, Blodgett's firm, did send 60
Minutes II an email saying its analysts "make
independent recommendations based upon their best
judgments."
Mary Meeker at Morgan Stanley sent a
statement saying, in part, "We maintain a strict separation
of the (investment) banking and research functions within the
firm. Our research is objective and has a long-term
focus."
Buyer, the former Internet analyst,
defends most of her former colleagues. She says some analysts
work for firms without investment banking clients, and others
can take the heat.
Haines notes, however, that
investors ignored warnings before the Nasdaq's dramatic drop,
even when there were clear indications a company was
vulnerable.
"We would invite on the CEOs, and we
would interview them, and we would say, 'Do you have any
patents?' And they would say 'No.' 'Well, would it be hard for
me to go into business to compete with you?' And they'd say
'no,'" Haines says.
"'Do you have any cash?'
'No.' And I'd look down, and the stock would be up $40,"
observes Haines.
"You would point out the risks;
you would point out how crazy it was. There was a mania going
on out there where people were just throwing money,"
Haines adds.
And Haines says investors didn't seem to
listen when he pointed out analysts' conflicts of interest on
the air. "It was put in their face, and they pulled the
lever on the slot machine anyway."
Last year Tom
Brown started his own investment company. He decided to leave
the analyst game because there's too much pressure to be
dishonest, he says. DLJ offered him the usual severance deal,
but he rejected it because it required him to keep quiet.
"DLJ offered me $400,000 to not say anything,"
Brown says. "And I decided in August of '98 that it was
worth more for my pride to be able to shout it from the
mountaintop that something was wrong, and tell them to keep
the $400,000."
Copyright MMI Viacom Internet Services Inc. All Rights
Reserved.
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