Great article. Doesn't IMO really apply to Cisco, but it is interesting nonetheless. Also, the article does mention Cisco.
Wall Street Firms Try to Keep
Internet Mania From Ending Badly
By REBECCA BUCKMAN and AARON LUCCHETTI
Staff Reporters of THE WALL STREET JOURNAL
Adorning the office of Susanne Lyons, a senior Charles Schwab Corp. executive in San Francisco, is a gift recently sent by some Florida employees: a gale-warning flag. It refers to a huge effort Schwab has been making, in staffing and technology, to cope with the crush of trading in Internet stocks, a campaign Schwab calls "Market Storm."
That term resonates with Wall Street executives these days, with a different meaning. A growing number of them are concerned that the financial world's equivalent of a hurricane -- with a menacing "dot.com" at the eye -- could be hurtling the market's way. The signs are all there: wild price swings, valuations that seem from another world, rapid-fire trading by people completely new to the game.
Join the Discussion: Do you think Internet companies will grow into their high valuations, and that Net stocks will avoid a bust?
So now, brokerage firms and industry regulators are battening down the hatches, to protect both themselves and their customers in case it happens. So fretful are firms that, in a few cases, they are even turning away business, the Wall Street equivalent of a bartender shooing away a patron who has had enough. "In the case of Internet stocks," marvels L. Keith Mullins, a managing director and head of growth-stock research at Salomon Smith Barney, "there's enough concern to overcome Wall Street greed."
Tuesday, Federal Reserve Chairman Alan Greenspan, in his usual circumspect way, expressed concern about the level of stock prices, noting that stock-market bubbles are sometimes not identified until after they're popped.
One hopeful sign, though, is that some of the froth in individual Internet stocks has drained off gradually in recent weeks, suggesting that even if highfliers are overvalued, they can avoid a blowup. But here is the Street's worst fear: that the volatile mixture of high-priced Internet stocks, novice investors and buying on margin is so combustible that a shock could spread quickly through the rest of the market, ruining some investors and jeopardizing the health of some smaller firms.
It also could shake the confidence of a generation of fledgling investors. In that way, a sharp tumble could be "no different than 1987," asserts Blake Darcy, chief executive of DLJdirect, the online-trading unit of Donaldson, Lufkin & Jenrette Inc. "There were a lot of people in the market at that point who got burned and sold their portfolios ... and didn't get back into the market for a long, long time."
So the barricades go up, even as Wall Street executives concede there's only so much they can do to head off trouble:
The Nasdaq Stock Market, which boasts in its marketing that it rarely stops investors from buying and selling, is considering authorizing trading halts under certain circumstances.
DLJdirect, Schwab, Salomon Smith Barney, Waterhouse Securities Inc. and other firms are making it harder for customers to buy Internet stocks with borrowed funds. In some cases, they are barring clients from ordering shares of hot initial public offerings without setting a maximum price.
Several online brokerage firms, including Schwab and E*Trade Group Inc., are scrambling to upgrade computer systems, which have sometimes faltered under the weight of heavy trading. Schwab, realizing that such breakdowns amid a plunging market could be catastrophic, has rigged its computer systems to run on two mainframes instead of one, buying time until it can make more permanent upgrades.
Why the sudden fuss? After all, for much of last year, Internet stocks rose robustly and online-stock trading was heralded as the next revolutionizing force on Wall Street. But unsettling swings in several little-known issues around Thanksgiving jolted regulators and securities firms into action.
Around that time, tiny IPOs like theglobe.com Inc. and Ticketmaster Online-CitySearch Inc. skyrocketed in their opening minutes of trading, then plummeted, touching off investor complaints. Obscure companies like Books-A-Million Inc. tripled after announcing Web upgrades. Many investors got hurt in these swings, after placing orders when stocks were at one price but getting them filled when prices were very different.
Amid this turbulence, Frank Zarb, chairman of the National Association of Securities Dealers, which runs Nasdaq, hastily called a teleconference with NASD executives. "This is not business as usual," he told his lieutenants, calling the volatility in Internet stocks "serious." Mr. Zarb, a former brokerage executive, told his regulatory staff to look at such drastic moves as expanding authority for the NASD to halt trading in some stocks. The NASD board is scheduled to consider the idea next month.
Mary Schapiro, president of NASD Regulation Inc., and her staff started calling online brokerage firms to grill them about their clients' exposure to the stocks of companies doing business on the Internet. How many customers held the stocks? How much were they borrowing to hold them? Later, regulators sent a memo to 5,500 brokerage firms listing steps they could take, including explaining the risks to investors and limiting their ability to buy with borrowed money.
These ideas weren't easy to swallow. Patrick Campbell, Nasdaq's enthusiastic chief operating officer, long opposed any notion of trading halts except in the rarest of circumstances. But he adjusted his view after noticing that some stocks were soaring simply because investors were mistaking their symbols for those of Internet companies.
This was a sure sign of trigger-happy investing. "We have an orderly market to run," says Mr. Campbell, choosing his words carefully. Glancing at a monitor on his desk, he sees that a hot computer stock has just dropped 7% in heavy trading. "These are extraordinary times," he concludes.
So extraordinary that Mr. Zarb phoned his chief competitor, New York Stock Exchange Chairman Richard Grasso, about a month ago to discuss whether Internet stocks should carry a higher margin-maintenance requirement, the amount of overall cash and equity customers need if they have bought stocks on borrowed funds. Mr. Grasso told him this would be "overkill," and Mr. Zarb ultimately dropped the idea.
Some firms haven't waited for industry regulators to move. At Salomon Smith Barney, Horace Derrick, a senior vice president who handles margin accounts, called in two risk analysts and asked what would happen if highfliers like Amazon.com Inc. and Yahoo! Inc. dropped 30% or more.
One of the risk analysts ran a test. The results discouraged him: Hundreds of customers, having put up money for only part the price of a stock and borrowed the rest from Salomon Smith Barney, could see their accounts wiped out by a big fall. And the firm's customers had a huge $13 billion in margin loans. It was "a very risky situation," the analyst, Colin Carney, told his boss. Mr. Derrick agreed, and persuaded the firm to raise margin requirements on 18 Internet stocks, and later on 85 in all.
"It's a big change," but customers were coming close to going into debt, he says.
At DLJdirect, Mr. Darcy grew concerned about the Internet frenzy as he prepared to board a flight to Japan the Monday after Thanksgiving. From a club lounge at Newark airport, he called the firm's head of compliance, Tony Festa, on a cell phone. "How are we doing?" Mr. Darcy asked, most worried about customers with heavy margin debt. Fine so far, Mr. Festa replied. But he was worried, too, and had a plan of action, a series of steps that mostly involved monitoring potentially troublesome stocks more closely and better scrutinizing each morning's queue of trade orders. The two also hastily identified about 15 stocks to add to their list of issues with tighter margin requirements.
Mr. Festa's parting words were, "Don't worry about it, Blake. We got it." But Mr. Darcy didn't stop worrying. Later in December, DLJdirect deepened its already-intense monitoring of "concentrated" accounts to look at short positions, in which clients sell borrowed shares in hopes of profiting from a decline. Because the client is obligated to replace those shares even if the stock soars, "with a short position, there's no limit to the amount of money you could lose," Mr. Darcy says.
DLJdirect is no stranger to risk. It and a few other firms have long sent form letters to customers who do rapid-fire or high-risk trading, warning them of the dangers and asking them to acknowledge receipt of the warning. But the stiffened margin rules "are a really clear signal" that the industry is concerned about the volatility, says James J. Angel, an associate finance professor at Georgetown University. That's because the rules limit trading, and "brokerage firms have a natural tendency not to want to slay the goose that's laying the golden eggs."
One concern is how many unseasoned traders the Internet stocks and online trading have attracted. At Schwab, the largest online broker, 50% of new customers are considered inexperienced.
At Ameritrade Holding Corp., a graduate student from Indianapolis named Lael Desmond opened a margin account in late 1997 even though he didn't know what a margin account was. Mr. Desmond, 27, had simply heard from his sister that "you can make a lot more money quickly" that way. He concedes he didn't read the fine print on the margin agreement.
He took notice in August, though, when his fully leveraged, $100,000 account took a dive after stocks such as Amazon, Excite Inc., Dell and Yahoo! stumbled. His margin calls, the added money Ameritrade required him to put up, exceeded the equity left in his account. Mr. Desmond wound up borrowing about $12,000 on four credit cards, though he also filed an arbitration complaint challenging the way Ameritrade handled the situation. Ameritrade says it hasn't yet received a copy of the complaint and thus can't comment.
"I will never trade on margin again," declares Mr. Desmond, who says he thought margin loans were like bank loans, requiring regular payments. He has since taken out a loan against his house to pay off the credit-card balances.
The same volatility and heavy trading by individuals convinced a market veteran, Bernard L. Madoff, that his trading firm should stop making a market in four wild Web stocks. "You're literally seeing hundreds of thousands of orders in these stocks," Mr. Madoff says. "That puts a strain on everybody's systems. And on the way down, it's always more extreme."
Throughout the fall, Mr. Madoff, at his trading desk in Manhattan, watched tiny orders scroll across his monitor for stocks like Amazon, Yahoo, Infoseek Inc. and Egghead.com Inc. Then, he saw IPOs skyrocketing. But what did it for him was the action in Amazon in mid-December. An analyst from CIBC Oppenheimer Corp., Henry Blodget, issued what seemed an outlandish price "target" of $400, which equals $133 today after a 3-for-1 split. The stock leapt 19% in one day. Then Merrill Lynch & Co.'s better-known Jonathan Cohen struck back with a price target of only $50, or $17 after the split. The stock whipsawed back down.
To Mr. Madoff, "it was insanity. This thing was getting out of control." In January, his New York firm, which bears his name, dropped Amazon, Yahoo, Infoseek and Egghead, even though trading them had been very profitable. Interestingly, shares of Amazon now trade at a bit over $115 a share -- or, presplit, very close to Mr. Blodget's forecast. Mr. Cohen has since left Merrill. Mr. Blodget is now expected to take his job.
But Mr. Madoff lived through the 1987 crash -- as Nasdaq's chairman. "I had to field all the unhappy phone calls when people felt the Nasdaq market had pretty much shut down," he says. "My attitude was, I do not want to relive that event." And now, even more of the trading is done by individuals.
Further complicating matters is the rapid rise of online trading, to an estimated 13% of stock transactions. On heavy days, they have jammed computer systems. E*Trade, Waterhouse and Ameritrade have all suffered embarrassing technology glitches that locked investors out of their systems and away from their money. So a question concerning some Wall Street executives is what would happen in a panicky market. To be ready for any rush of trades, Schwab persuaded a vendor in December to deliver a new server computer via chartered jet, a month ahead of schedule.
At a recent "town hall" meeting at a hotel near Disney World, Schwab staffers nevertheless were restless, peppering Ms. Lyons with questions about technological readiness. In an interview, she says that "virtually every project that's long term has been tabled so we can devote every resource to build up capacity."
But brokers remain on guard. On a recent day, investors who use the phone rather than a computer were pelting Schwab broker Amy Hommas in Orlando with requests: How much can I get for my shares of Global DataTel Inc.? How can I unload CyberGuard Corp. now that it has been delisted from Nasdaq? What's the market for options in Cisco Systems? Ms. Hommas handled the requests smoothly, telling the man who was trying to dump the thinly traded CyberGuard that "I can't guarantee you execution while we're on the phone."
Nearly all the calls came from investors in Internet stocks. During a one-hour stretch, Ms. Hommas handled exactly one call from a customer trading a traditional blue chip, and even it was far from staid -- Lucent Technologies Inc. Ms. Hommas, concerned about clients being overexposed to Web stocks, says she tries her best to guide them, gently asking if they are diversified beyond Internet shares.
In all this, brokers are limited in the precautions they can take. They don't know how likely they are to face a market hurricane, and even if they do, they can't fully prepare. Says DLJdirect's Mr. Darcy: "You can never predict perfectly the scenario that's going to occur and how quickly it's going to occur. ... All the planning we have will probably not have prepared us for a 40% correction."
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