Tom Paine.Common sense
Hot Air On Wall Street
Inflating The Internet Bubble
Gregg Wirth is a freelance writer who has covered Wall Street for most of the past decade. He lives in Bloomsburg, Pennsylvania.
Last summer, the Security and Exchange Commission revealed that some Wall Street stock analysts actually bought and sold shares in companies they were hyping to the investing public. That was the tip of the iceberg, and now the SEC is launching a deeper look at these and other apparent conflicts of interest.
"This is the next step -- and a critical one -- in the Commission's year-long review of analyst practices," SEC Commissioner Harvey Pitt said in a statement on April 25, adding that because of recent disclosures, "further inquiry was warranted."
"Warranted" because, if the allegations prove out, it would make much of the Internet stock boom look like a fiction. "Warranted" because it looks like that fiction was written to script by Wall Street fixers who stood to collect, and did collect, buckets money by duping the investing public. The scope of this scam could make Al Capone look like a two-bit stick-up man.
The SEC's investigation follows up on one started in mid-2001 by New York Attorney General Eliot Spitzer. That probe recently forced the nation's largest brokerage, Merrill Lynch, to issue an apology for its analysts' past actions. Boiled down, what Spitzer uncovered was a bipolar world in which superstar stock analysts would tirelessly cheerlead "hot" Internet stocks to the public, while in private voicing deep reservations -- even derision -- about the stocks they were pushing.
In e-mail communications unearthed by Spitzer's investigation, Merrill Lynch analysts were brutally frank. One analyst described one company as "such a piece of crap," while at the same time, the analyst had a "buy" recommendation on the stock. Other internal messages also hinted at the real reasons for such positive ratings. Nothing interesting about this company, another e-mail read, "except the banking fees."
The driving force behind all this double-dealing was profit pressure. Many analysts were paid, in part, based on how much investment banking business they could attract; and of course, positive coverage by a highly visible stock analyst was a great reason for a company to chose one investment bank over another.
Toward the end of what's been called the "Internet bubble," some analysts were so closely aligned with the companies they were covering that any objective analysis was impossible, according to some of Spitzer's findings. Indeed, investigators found numerous instances of analysts pole-vaulting over ethical hurdles: acting as consultants to companies they covered; pre-arranging positive coverage as favors to client companies (those using the analyst's firm for investment banking business); and even agreeing to downgrade a competitor's stock so its rating would be in line with a client company's rating.
The media -- especially CNBC, MSNBC, and CNN -- became a megaphone for the hucksters.
It's important to remember the image Wall Street was portraying to Main Street investors at the time. Americans were deluged with media sound bites and commercials portraying stock market trading as a virtual free ride on the gravy train. High priests in the Church of Adam Smith were offering their free-market mantra as a solution to every social and economic ill (works great on rheumatism, too). The ever-rising market indices seemed to prove their contention. The media -- and especially the cable networks like CNBC, MSNBC, and CNN -- were so enamored of Wall Street that they closed any critical eye. They became a mere megaphone for the hucksters.
There was a burgeoning celebrity for new entrepreneurial heroes -- Internet CEOs, day-traders and, of course, stock analysts. The stock markets, we were told, were going to be great wealth-creating equalizers where the average rube could easily make as much money as a professional stock picker. When analysts from Merrill Lynch or Morgan Stanley or Goldman Sachs (or even Joe's Garage) talked, everybody listened. The result was predictable: Americans loaded their retirement accounts with risky high-tech stock funds or rabidly grabbed any Internet IPOs they could through their online broker, all the while keeping one eye on CNBC or MSNBC for the latest stock tip.
More often than not, the tip amounted to "buy, buy, buy" -- what a surprise. When Global Crossing hit $60 a share, we felt rich. Now that it's in bankruptcy and hovering around six cents a share, we feel like fools. What a surprise.
"Wall Street banks put these analysts on TV and made superstars out of them, so they should be held responsible for what they said," says Jacob Zamansky, a New York attorney.
Last year, Zamansky settled a lawsuit brought against Merrill and its Internet analyst Henry Blodget on behalf of a client who lost $400,000 by following Blodget's advice. That settlement sparked New York AG Spitzer's probe. (Merrill recently hired former New York mayor Rudy Giuliani to advise it in dealing with Spitzer's inquiry. The last time Wall Street ran afoul of regulators -- during the junk-bond scandals a decade ago -- it was then-U.S. Attorney Giuliani, ironically, who was leading handcuffed bankers through the perp walk.)
The crux of the problem, Zamansky explains, is that Wall Street simply didn't tell investors that the companies they were rating so highly were also investment banking clients, paying the bank -- and by extension, the analyst -- millions of dollars in banking fees.
"Investment banks were saying 'trust us,' but they weren't saying they were conflicted," Zamansky adds.
Wall Street must have hoped all these scandals would evaporate once the stock market began its upward crawl following the terrorist attacks. That hope was dashed in April by the uncovered smoking-gun e-mails, more lawsuits, and a new round of subpoenas issued to almost every investment bank on the Street. Some members of Congress voiced carefully worded outrage. More sure-to-embarrass hearings and additional investigations are likely. The Justice Department said it's keeping an eye on the situation, too.
But the just-a-bit-tardy concern from Washington is neither surprising nor offers much comfort. Investors have lost their money. And Wall Street always has friends in Congress and in the White House, no matter what party is running things. In the 2000 election cycle, the securities and investment industry gave over $92 million to federal candidates -- 45 percent to Democrats, 55 percent to Republicans -- according to the non-partisan Center for Responsive Politics.
On May 12, a New York Times headline asked, "Will Wall Street Become a Regular at the Courthouse?"
"What the investigating agencies want is a major hanging of all the superstar bankers and analysts to please the mob," says one adviser to large investors, requesting anonymity. What that means is that smaller investors, quick to hop on the free-market express when times were good, want a little of that old-fashioned, government-imposed accountability now that the party's over.
And that may be the final irony. Now that millions of investors have had their retirement accounts picked clean by what appears to be a well-coordinated system of market rigging, they are clamoring for regulators to once again set things right and provide them with their pound of flesh if not financial retribution. The number of arbitration cases investors filed with the National Association of Securities Dealers, the industry body that oversees brokers and investment banks, jumped 24 percent in 2001, hitting a new record. Also last year, investors filed a record number of securities fraud lawsuits against Wall Street investment banks and the companies they brought public -- more than double the total of any previous year in the last decade. On May 12, a New York Times headline asked, "Will Wall Street Become a Regular at the Courthouse?"
Will anything change? On May 8, the SEC passed several new rules addressing the behavior of investment-bank research analysts. Immediately, consumer groups and Wall Street critics complained that the rules don't go far enough -- they were written not by the SEC but by the securities industry's self-regulating organizations. Key members of Congress, including Sen. Paul Sarbanes, chairman of the Senate Banking Committee, were also unimpressed with the new rules and threatened to pass legislation to more drastically curtail analyst conflicts. SEC Commissioner Isaac Hunt, anticipating criticism, said, "These rules may not go as far as some commentators, the Commission, Congress or investors may expect."
SEC Chairman Pitt also attempted to turn down the heat, describing the new rules and the commission's renewed investigation as a critical first step, stating emphatically: "our efforts are not concluded."
Several investment banks, such as Merrill Lynch and Morgan Stanley, have announced plans to rework the way they issue ratings on stocks, possibly eliminating "buy" and "sell" recommendations. But these corrections smack of PR-consultant "crisis management" -- just enough mea culpa and "voluntary action" to sooth public opinion and cool the ire of regulators.
It's all too late to save investors, large and small. The big institutional investors have time and lots of lawyers on their side. But small investors are not so lucky. Anyone betting on the short memory of the American people would be wise to remember it took more than 30 years for people to trust the markets again after they lost out in the Great Crash of 1929. Back then, far fewer Americans owned stock than during the Internet bubble, when almost half the adult population played the markets.
Does anyone smell a populist political issue in the upcoming November elections? It could be -- but then again, recall all those industry campaign contributions to both political parties. Watch how well it insulates Wall Street from meaningful reform. Washington's regulators and their political overseers might bark, but nothing softens their bite as well as wads of cash.
Published: May 14 2002
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