April 29, 2003

In a Wall St. Hierarchy, Short Shrift to Little Guy

ocuments disclosed as part of yesterday's settlement show how Wall Street firms, in pursuit of investment banking fees, put the interests of their individual clients dead last.

As an analyst at Lehman Brothers told an institutional investor in an e-mail message, "well, ratings and price targets are fairly meaningless anyway," later adding, "but, yes, the `little guy' who isn't smart about the nuances may get misled, such is the nature of my business."

In a newly disclosed tactic, Morgan Stanley and four other brokerage firms paid rivals that agreed to publish positive reports on companies whose shares Morgan and others issued to the public. This practice made it appear that a throng of believers were recommending these companies' shares.

From 1999 through 2001, for example, Morgan Stanley paid about $2.7 million to approximately 25 other investment banks for these so-called research guarantees, regulators said. Nevertheless, the firm boasted in its annual report to shareholders that it had come through investigations of analyst conflicts of interest with its "reputation for integrity" maintained.

Among the firms receiving payments for their bullish research on companies whose offerings they did not manage were UBS Warburg and U.S. Bancorp Piper Jaffray. UBS received $213,000 and Piper Jaffray, more than $1.8 million.

What jumps off the page in these documents is the Wall Street firms' disregard for the individual investor in pursuit of personal benefit.

One comment made by a Bear, Stearns analyst is telling. While participating in a conference call by SonicWall, an Internet company whose shares Bear, Stearns had sold to the public, the analyst told a colleague that he was trying to make the company look good with his questions. A few moments later, he said, "we got paid for this," adding, "and I am going to Cancun tomorrow b/c of them."

But because greed is a part of human nature and human nature seldom seems to change, Alan Bromberg, professor of securities law at Southern Methodist University, remains skeptical that the terms of the settlement will bring substantive change to Wall Street.

"I don't see this as a great reformation," Mr. Bromberg said. "I don't see this as a new world we are moving into. The pressures are still going to be there. Brokerage firms don't make money other than by selling securities, so they're going to inevitably be encouraging people to buy and will always have pressures to hype what they think is good or what they're otherwise involved in."

The heaviest penalties in the settlement went to Salomon Smith Barney, Credit Suisse First Boston and Merrill Lynch. Regulators contended that analysts at these firms committed securities fraud by recommending stocks to the public they had expressed misgivings about privately.

But securities regulators also found that all the firms failed to supervise adequately the research analysts and investment banking professionals they employed. They failed, therefore, to protect clients who were basing investment decisions on research that had been written to attract or maintain investment banking clients.

While the symbiotic relationship between Wall Street research analysts and investment bankers harmed investors, it was beneficial to the firms. Lehman Brothers and Goldman, Sachs, according to regulators, encouraged analysts to work closely with investment bankers to generate deals.

Goldman, Sachs aligned its research, equities and investment banking divisions to work collaboratively and fully leverage its limited research resources. In 2000, Goldman noted happily that "research analysts, on 429 different occasions, solicited 328 transactions in the first 5 months" and that "research was involved in 82 percent of all won business solicitations."

Crucial to the firms' failure to supervise themselves was the tendency by their analysts to publish research that was not based on sound analysis or principles of fair dealing or good faith, the regulators said. Eight of the 10 firms that settled — Bear, Stearns; Credit Suisse First Boston; Goldman, Sachs; Lehman Brothers; Merrill Lynch; Piper Jaffray; Salomon Smith Barney; and UBS Warburg — issued such reports. The firms' research also contained exaggerated or unwarranted assertions about companies, or opinions that had no reasonable bases.

For example, at Credit Suisse, regulators contend that its analyst covering Winstar, a small telecommunications concern that never turned a profit and that filed for bankruptcy two years ago, failed to disclose the risks inherent in the company. The firm began equity research coverage of Winstar in May 2000, with a "strong buy" rating and a 12-month target price of $79. Credit Suisse retained the $79 target from Jan. 5 to April 3, 2001, even as the stock plummeted to 31 cents a share from approximately $17 and the company's market capitalization fell to $30 million from $1.6 billion.

Some of the most entertaining reading in the masses of evidence that regulators have made public for use by aggrieved investors in their own lawsuits is the commentary by Salomon Smith Barney brokers about Jack B. Grubman's performance as the firm's top telecommunications analyst.

As far back as 2000, brokers were expressing outrage and betrayal over Mr. Grubman's woeful stock picking, which many noted was related to his dual roles as investment banker and analyst. Yet even as the brokers howled about Mr. Grubman's tendency to keep recommending stocks as they collapsed in price, the analyst retained his job at Salomon until last August.

Here are some outtakes from Salomon brokers late in 2000. Mr. Grubman "should be publicly flogged," one said. "Under the category, Bonus for Creating Tax Loss Carry Forwards for Retail Clients, Grubman should be recognized accordingly as our best analyst."

Many said the analyst should be fired, while another broker said, "If Jack Grubman is a top `research analyst' then I have a bridge to sell."

Another remarked: "Boo Hiss. Banking showed its ugly head."

During the year these comments were made, Mr. Grubman was paid $14.2 million in salary and bonus.

As a result, Salomon's brokers emerge as yet another group victimized by Mr. Grubman's conflicted status. As one broker, or financial consultant, put it: "Grubman has zero credibility with me or my clients. He is collecting from two masters" at financial consultant expense.

Then referring to investment banking functions, he continued: "He brings IB business to the firm and loses his objectivity. I am sure that nothing will come of my comments. The spin-masters will say that everyone else does it. Is there an honest person left?"