DJ: Heard on the Street: Analysts' Contracts Link Pay to Deal Work ---- By
(Wall St. Journal Full Text 05/06 02:03:16)
Charles Gasparino
The wording in the Wall Street analysts' contracts is clear and to the
point:
In one, the analyst is offered 1% to 3% of "the firm's net profit per
transaction . . . with a cap of $250,000" for investment-banking deals he
helps bring in. In another, the contract provides "banking-related
compensation" to an analyst thinking about jumping ship. And an
"inter-office memo" calls for a bonus of 8.5% of revenues for an investment
deal that "the analyst is clearly instrumental in obtaining."
For years, Wall Street firms have denied directly linking analysts' pay and
the stock-and-bond deals they generate. While investment-banking work was
always tracked in some way, such considerations were never hard and fast
when determining analysts' compensation, executives said. There were no
formulas to calculate year-end bonuses, and never would an analyst receive
compensation for helping the investment-banking team win a specific deal,
they said.
But The Wall Street Journal has reviewed documents -- including proposed
contracts given along with job offers to unidentified analysts --
demonstrating that such links were more direct than anyone was letting on.
Not only did these contracts and documents contain specific provisions for
analysts to be paid based on banking business, they often laid out in
specific terms what type of deals would benefit analysts the most and
exactly how much analysts could earn on a deal-by-deal basis.
Now, employment contracts like these are likely to become a focus of
regulators as they sift through the evidence for conflicts of interest
involving Wall Street researchers, many of whom earned well over $1 million
a year during the bull market of the late 1990s, thanks in part to their
role in securing investment-banking assignments. The New York State Attorney
General, the Securities and Exchange Commission and other regulators are
conducting an industrywide probe of whether analysts' recommendations were
improperly influenced by investment-banking fees.
At issue for regulators: Can Wall Street's research analysts be expected to
provide investors with unbiased research on corporate clients when they are
compensated by helping their firms win lucrative underwriting assignments
from the same companies. New York Attorney General Eliot Spitzer says they
can't, and vows to push firms, such as Merrill Lynch & Co., the focus of his
probe, to completely sever the links between its investment bank and
research units as part of any settlement.
In fact, talks between Mr. Spitzer and Merrill have sputtered as Mr. Spitzer
has demanded the firm completely sever its investment banking and research
functions. One central demand: That Merrill no longer pay analysts out of a
pool of money related to investment-banking deals. A spokesman for Merrill
had no comment on the negotiations, and said that only a "portion of
analysts' total compensation comes from investment banking."
"We're just beginning to see massive evidence that analysts' research for
years have been tainted by employment contracts that directly compensate
them" for investment-banking work, Mr. Spitzer said in an interview.
"Analysts cannot be compensated on transactional work . . . This is a
central issue of the reforms we are seeking."
The two contracts reviewed by the Journal were offered to analysts by Credit
Suisse First Boston, a unit of Credit Suisse Group, and Donaldson, Lufkin &
Jenrette Securities Corp., while an in-house memo laid out the compensation
arrangements for analysts at Prudential Securities. The contract offer from
DLJ occurred before that firm was acquired by CSFB in 2000. And the offer
from the securities unit of Prudential Financial Inc. came before Prudential
jettisoned most of its securities underwriting business that could have
benefited from analyst-generated deals.
The proposed contract from CSFB senior management was written in 2000, just
as the bull market in stocks began to fade. The contract said the analyst
would received a "total minimum guaranteed compensation" for 2000, 2001 and
2002, which includes a "cash incentive performance bonus" as well as a
salary. But that isn't all. The contract also said the analyst could make
more money through "incentive programs" that involved helping the firm win
stock deals and high-yield or junk-bond transactions.
As the contract points out, this extra pay is based on the analysts' "level
of . . . contribution" in helping the firm win these types of deals. This
banking-related compensation could range from 1% to 3% of "the firm's net
profit per transaction . . . with a cap of $250,000," the contract said.
That means on an average stock deal of $200 million to $300 million, which
might generate $3 million to $5 million in profit for the firm, the analyst
could earn an extra $30,000 to $150,000 by that formula. Wall Street
executives say firms would regularly complete a half-dozen such transactions
during the course of a year.
The DLJ contract, written in 1999, offers the job candidate a similar deal.
Under the heading "Banking-Related Compensation," the contract says that the
analyst "will be paid" for investment-banking work "during the two calendar
years covered by this agreement, beginning with the payment to be made in
January 2000."
That compensation, according to one person with knowledge of the matter,
could exceed $1 million over the two years in question. Such payments "are
made at the end of each calendar quarter for business which was closed in
the preceding quarter," the contract noted. It also said: "We know you can
make a substantial contribution to DLJ's business and we are very excited
about the prospects of your joining us."
A spokeswoman for CSFB confirmed the authenticity of both contracts. She
added, however, that the firm had linked analyst pay with investment banking
work in only a "handful of cases." She said CSFB abolished this practice
last year, in line with changing industry standards, and has since revised
these contracts to sever links.
"CSFB is strongly committed to maintaining the integrity of our research and
has worked aggressively" with Wall Street's trade group, the Securities
Industry Association, and regulators "on developing standards for analyst
independence," she said.
The spokeswoman said in the spring of last year the firm adopted a set of
"best practices" adopted by the association that "prohibit any direct link
between analysts' compensation and specific banking transactions."
She said the firm "fully supports" proposals by stock regulators that "would
adopt this standard into federal securities regulations."
A similarly direct link between analyst pay and investment-banking work can
be found in an October 1997 memo from Prudential Securities, which alerted
all senior-equity analysts the firm had "formulated fixed percentages for
the purpose of determining bonuses to be paid to analysts as a function of
revenues associated with investment banking transactions that are retained"
in its capital-market group.
The memo detailed how much money an analyst could make on a particular
transaction. For example, on a stock deal in which the firm served as a
"lead manager for a first-time client" and "the analyst is clearly
instrumental in obtaining the mandate," the researcher would receive 8.5% of
revenues coming into the capital-markets group. For a junk-bond transaction
under the same circumstances, the analyst would receive 5% of the revenues,
the memo said.
A spokesman for Prudential said: "the memo doesn't suggest that Prudential
Securities ever did anything that was improper." The spokesman said for the
past year or so, the firm has dropped the bulk of its investment-banking
activities, and thus provides "unfettered" research to investors.
Other firms give similar explanations. A spokesman for Lehman Brothers said
that only "four or five" of the firm's 230 or so analysts have as part of
their contracts provisions that track their contributions to
investment-banking revenues. "There really isn't a connection between the
two," the spokesman said. Meanwhile, a recent subpoena from Mr. Spitzer's
office sent to Salomon Smith Barney covers the compensation contract of its
star telecommunications analyst Jack Grubman, who in addition to his work as
a researcher also helped the Citigroup Inc. unit win scores of
telecommunications deals.
Investigators want to know whether Mr. Grubman's compensation was possibly
related to his initially optimistic calls on telecom stocks that have since
fallen on hard times and cost investors big bucks, according to people close
to the matter.
A spokeswoman for Salomon Smith Barney said Mr. Grubman's contract, however,
included "no guarantee of fees or revenues and no compensation based on transactions."
05/06/2002 02:00 |
