Trust Shattered, Wall Street Can't Afford Coincidences
NY Times 7.28.02
By GRETCHEN MORGENSON
Wall Street analysts are definitely under the microscope these days.
Which makes a sequence of events of last Thursday and Friday involving
Goldman Sachs' semiconductor stock analyst very intriguing.
Semiconductor stocks were crushed on Thursday when the Taiwan
Semiconductor Manufacturing Company announced that it was sharply
cutting its capital expenditures because of nonexistent demand for
chips. Investors in chip stocks ran for the exits, correctly assuming
that if such a big maker in Taiwan saw no demand, neither would the
rest of the producers.
Shares of big-name United States producers like Intel and Applied
Materials sank on the news. The Philadelphia Stock Exchange
Semiconductor Index - known affectionately as the Sox - tumbled. And
the action took down the Nasdaq as well.
Although the Sox closed down 10 percent on Thursday, the index had
been far lower earlier in the day; it recovered on significant buying.
One especially large trade in the afternoon came from Goldman Sachs:
the purchase of 10,000 call options on an exchanged-traded fund -
called Semiconductor HOLDRs Trust - that is a basket of large
semiconductor stocks.
The options are traded on the Chicago Board Options Exchange, and an
order to buy 10,000 is unusually large. The open interest on these
options - similar to the freely trading shares, or float, on a common
stock - was around 1,400 before the order came in.
Any investor buying call options is betting that the stock underlying
them is going to rise significantly. Given the excessive volatility in
the market as a whole and the wide swings characteristic of
semiconductor stocks in particular, it would take a person of great
confidence to make such a trade.
Now for the intriguing part. On Friday morning, two hours before the
market opened, James Covello, the semiconductor analyst at Goldman,
upgraded the semiconductor equipment sector to overweight from market
weight. Mr. Covello's reasoning? The big selloff in the sector was
overdone.
"While fundamentals are not likely to improve in the near term, we
believe that funds flow and seasonality may drive a meaningful move in
the stock," he wrote. Mr. Covello added that his call on the group
would be appropriate for shorter-term investors "who can be nimble
enough to take advantage of a funds flow-driven rally and/or
seasonality in the electronics supply chain." In other words, his
recommendation was a trading buy.
When asked about these events, Katherine Baum, a spokeswoman at
Goldman Sachs, said: "There is absolutely no connection between any of
Goldman Sachs' trading activities and its investment research. And
given the current environment it's outrageous to suggest that there
is." She added that Goldman has strict guidelines on how much an
analyst can communicate around an upgrade or downgrade. She declined
to comment on whether the purchase was made by the firm for one of its
customers or for the firm's own trading book.
Maybe it was just a giant coincidence that a Goldman Sachs trader put
in an order to buy almost seven times the open interest in call
options on the Semiconductor HOLDRs half a day before the firm advised
its clients to buy into the sector. Although the shares in the
exchange-traded fund closed on Friday roughly where they had wound up
the previous day, they rose 3 percent early in the day as news of
Goldman's upgrade spread. It is unclear whether the call options were
sold.
In life, things happen by accident and they happen by design. It is
not always possible to know which force is at work in each situation.
But this much is known: Wall Street firms thrived during the late
1990's in part because investors were willing to suspend their
disbelief. Those days are over. And Wall Street firms had better get
used to the scrutiny.
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