E-Mails Open Window on Wall St.
Blunt Notes on Stock Ratings at Heart of Analyst Probe
Stock analyst Henry Blodget in Merrill Lynch's N.Y. offices. Prosecutors say analysts offered glowing reports about firms they privately dismissed. (File Photo by Helayne Seidman - For The Washington Post)
By Robert O'Harrow Jr.
Washington Post Staff Writer
Friday, April 12, 2002; Page A01
NEW YORK, April 11 -- In January last year, an American Express Co. executive asked star Merrill Lynch & Co. analyst Henry Blodget why the investment bank had suddenly started rating the stock of an obscure Internet company called GoTo.com.
"What's so interesting about GOTO except banking fees????" the investor wrote in an e-mail.
Blodget's response: "nothin."
That blunt exchange goes to the heart of an escalating state investigation into allegations that Wall Street stock analysts promote companies they don't believe in while their banks earn fees selling the firms' stock and offering advice.
Investors and securities watchdogs have long complained about inappropriate ties between analysts and investment bankers. But they've rarely had access to the e-mail and other gritty, behind-the-scenes details about dealmaking cited in this case.
"It has never been as specific, as real-time as this," Dana Hermanson, director of research at the Corporate Governance Center at Kennesaw State University in Georgia, said about the details in the case. "It definitely shakes the system."
State Attorney General Eliot Spitzer has subpoenaed thousands of documents and e-mails from Merrill Lynch that, he says in court documents, demonstrate that Blodget and other analysts routinely offered glowing reports about companies they privately dismissed as "junk" or "crap."
Spitzer's office has subpoenaed at least four other investment banks. And he has said he intends to have Merrill Lynch analysts and officials publicly testify about their practices.
Merrill Lynch officials today said Blodget's e-mail reflects banter between sophisticated investors, not a disavowal of GoTo. While defending the integrity of the bank's research reports, spokesman James Wiggins acknowledged "there was inappropriate communications in some cases going back and forth between bankers and analysts that violated our policies."
Wiggins added: "There is language that is ill chosen, inappropriate and frankly embarrassing. But that does not add up to bias in the research reports."
Spitzer contends that there is no mystery to why Blodget and his colleagues began researching GoTo, an Internet search engine: They wanted to woo the firm, now known as Overture Services Inc., for the fees it would pay for help on stock offerings.
Wall Street firms say they have erected a "Chinese Wall" to separate analysts, who are supposed to be independent, from investment bankers, who market stocks and provide advice for fees.
"GoTo was a paradigm of what was wrong at Merrill Lynch," Spitzer spokesman Darren Dopp said. "Not only did they use ratings to solicit investment banking business, they used negative ratings to punish those who took their business elsewhere."
Kasey Byrne, a spokeswoman for Overture, said company officials have been cooperating with Spitzer's probe. She said they were "surprised and disappointed" to see how Merrill Lynch handled them.
An affidavit that Spitzer's office filed with a judge Monday devotes nine pages to what it called the "troubling" example of the Wall Street firm's relationship with the newly rated company:
GoTo's chief financial officer told investigators that Merrill Lynch investment banker Thomas Mazzucco promised him that Blodget would initiate research coverage if GoTo agreed to give Merrill Lynch fees on a private stock placement planned for a European subsidiary. That deal was never completed.
A Merrill Lynch analyst, Kirsten Campbell, was given the assignment to write a research report on GoTo in September 2000.
Within weeks, Campbell was e-mailing the company details and a draft report containing Merrill Lynch's proposed rating, which investors look to as bottom-line advice on the stock's merits. Sharing a company's rating with that company beforehand is a violation of Merrill Lynch's rules, according to the affidavit. Wiggins declined to comment on specifics of Campbell's actions.
With urging from her colleagues on the investment banking side, Campbell sent another draft of her report to GoTo in November, allowing company officials to type in changes or supply full text. Though her research indicated GoTo wouldn't be profitable for years, Campbell moved the date up after the company complained.
That same month, she complained to Blodget in an e-mail that she didn't "want to be a whore for [expletive] management" by starting at a higher rating. "We are losing people money and I don't like it. John and Mary smith are losing their retirement because we don't want todd [GoTo's chief financial officer] to be mad at us."
In that note Campbell also described her conversation with Mazzucco. "I said to him the whole idea that we are independent from banking is a big lie . . . and he said, 'you guys are independent you can do what you want -- i'm fine with that . . . ' "
Attorney Steven Fuller, speaking for Campbell, who left Merrill Lynch last April, said "she disagrees with the readings of the communications. . . . She did nothing to compromise the independence of her coverage."
When Blodget gave sworn testimony to the state, he conceded, the affidavit said, that investment bankers had veto power over his starting coverage of GoTo with a 3, or neutral, rating.
The initial Merrill Lynch research report on GoTo was issued Jan. 11, the same day a GoTo competitor was downgraded to the same rating.
Merrill Lynch upgraded GoTo in April, and in May Blodget and Merrill investment bankers sponsored a "road show" for GoTo executives to meet big-money investors. After that, the affidavit said, its stock rose 20 percent.
The tone of Merrill Lynch's relationship with GoTo changed overtly when the Internet company said it wanted to sell more stock but planned to work with Merrill Lynch competitor Credit Suisse First Boston -- and give them the fees.
Merrill Lynch banker Mazzucco drafted an e-mail to GoTo directors expressing his dismay, "particularly given the tremendous effort we have put forth on the company's behalf." He cited Blodget's upgrade and meetings he had set up with potential investors, "which dramatically moved the stock price. . . . "
Almost simultaneously, the affidavit said, an analyst e-mailed Blodget a draft downgrade of GoTo. Blodget's response this time: "beautiful fuk em."
Within an hour of GoTo's June 6 announcement that it had decided to use Credit Suisse, Merrill Lynch announced that it was downgrading the stock, citing its sharp increase in price.
In a statement, Merrill Lynch said the GoTo downgrade "not only was the right call, it was exactly the opposite of what the investment bankers would have preferred." It added that every witness has testified that the analyst "had no advance knowledge of any pending investment banking mandate, and investors who heeded the downgrade would have benefited." |
