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Sunday Times - 23rd April
INVESTORS were stunned last month when they discovered that Nina Brink,
chairman of World Online, a newly floated Dutch internet group, had sold
most of her 9.5% stake before the offer.
What shocked them most was not that Brink had pocketed the money but that
Goldman Sachs, one of America's top investment banks, which co-managed the
float, had not made more of her actions and her apparent lack of confidence
in the company in promoting the shares to investors.
The Japanese government, horrified by the scandal, has now announced it may
ban Goldman Sachs from participating in a series of privatisations that
could have brought the firm hundreds of millions of dollars in fees.
In the fiercely competitive battle for big underwriting deals, banks are
resorting to practices that are alarming regulators. They are hyping stocks,
encouraging companies to use creative accounting and, if they are
venture-capital investors, dumping stocks as soon as the companies float.
Individual investors often pay for these practices. They act (often with
disastrous results) on the "hot tips" of analysts appearing on 24-hour
financial television channels. They are persuaded to believe commercials
that tell them they can become overnight millionaires by trading stocks. And
they are completely misled by the creative accounting condoned (but not
revealed) in some analysts' reports.
One 30-year Wall Street veteran says: "It is the most corrupt thing I have
ever seen. After the market crashes later this year or next, you are going
to see congressional hearings into all the terrible things that have been
going on."
Arthur Levitt, the Securities and Exchange Commission (SEC) chairman, has
repeatedly complained about the glowing reports that analysts issue on
companies with which their firms hope to do business.
The "Chinese walls" that once separated researchers and bankers have all but
disappeared in today's banking world and researchers have often become
blatant pitchmen for bank deals. Levitt says they "act more like promoters
and marketers than unbiased and dispassionate analysts . . . a 'sell'
recommendation from an analyst is as common as a Barbra Streisand concert".
In recent years it has not always been easy for analysts to keep pace with
the roaring stock market. They have had to introduce bizarre reasons to
justify increasingly high share prices and to argue that the price will go
much higher in the future and the stock is still worth buying.
Ron Chernow, author of Titan: The Life of John D Rockefeller, wrote in The
New York Times last week: "Our most prestigious investment houses have
invented bogus mathematical formulas to justify stratospherical stock prices
and have fed the inexhaustible appetite of small investors for internet
businesses that are little more than concepts dressed up as companies."
In their desire not to offend corporate clients, banks hardly ever put a
negative rating on a stock. Ten years ago buy recommendations outnumbered
sells 10 to 1. Today less than 1% of the 28,000 individual recommendations
tracked by First Call/Thomson Financial are sell ratings, despite the fact
that the stock market has recently shown signs of cooling down and the
technology-heavy Nasdaq index is 28% below last month's peak.
Sell orders are so rare they are considered media events. Two such events
occurred last week when Credit Suisse First Boston (CSFB) put a sell rating
on Campbell's Soup company and Needham told investors to "avoid" Intel.
Bankers are not the only ones keen to keep stocks soaring. When Goldman
Sachs' Abby Joseph Cohen, who is America's most celebrated bull, warned two
weeks ago that stocks were no longer undervalued, some angry investors
blamed her for the market's subsequent plunge.
"She received threats and Goldman Sachs has had to hire her a bodyguard,"
says a banker. Goldman Sachs would neither confirm nor deny this.
Among those who have been pitching hardest for deals is Mary Meeker, Morgan
Stanley Dean Witter's celebrated internet analyst. She played a pivotal role
in winning a deal for Morgan Stanley to be the lead manager of
Lastminute.com's float last month. Her exuberant report on the company was
supposed to encourage investors. But the shares are now trading at less than
half their flotation price.
One of her former bosses at Morgan Stanley says: "She has become a
combination analyst and banker. It is a model that doesn't really work.
"Lastminute plunged and so did ArtistDirect.com, another IPO [initial public
offering] she did a couple of weeks later in America. Because of their poor
performance it has brought to light the whole problem of Mary's model."
America's "net queen" is objective enough to point out that 70% of the net
companies that have gone public will never make money and more than 90% are
overvalued. Nevertheless she has had a buy rating on every one of the 15
stocks she covers.
Salomon's Jack Grubman, one of America's top telecommunications analysts, is
another researcher-cum-banker who has raised eyebrows.
Rival bankers were surprised last year when he suddenly changed his negative
views about AT&T, the leading long-distance carrier, and put a buy
recommendation on the stock. Within a month his firm was selected to
joint-underwrite the flotation of AT&T's wireless-tracking stock.
"That was a very odd set of circumstances - it was so blatant," says one
banker.
The reason for the change in the role of researchers is that, since broker
fees were deregulated in 1975 and have shrunk to a fraction of what they
used to be, analysts' huge salaries are increasingly being paid by the
banking side of the business. Meeker's salary is about $15m a year.
Presumably the bankers want to get more than just research for that sort of
money.
Chuck Hill, research director at First Call, a firm that collates analysts'
estimates, condemns another increasingly common and deceptive practice of
deliberately understating a company's expected earnings.
He says: "Nowadays it is imperative not to miss your estimates [because the
market will punish the stock]. More and more firms are giving [confidential]
low-ball guidance figures to analysts, knowing they can beat them. It is
naive and it is going to end badly."
Another development that alarms old-timers is the way that public-relations
men and political "spin doctors" are being recruited to head investment bank
press offices.
A former Salomon press officer says the whole morality has changed. He says:
"I once gave a journalist a little guidance on the company's earnings to
stop him writing a negative story on our firm. But Mr [Warren] Buffett [then
chairman] sure put the fear of God into me when he found out about it.
"He said what I had done was unfair as it was giving information to one
section of shareholders and not to another. He was very strict. His ethical
standards were very high."
American financial journalists are belatedly waking up to Wall Street's
shenanigans. Last month Fortune magazine carried a cover story on the seedy
practices of Silicon Valley start-ups (aided and abetted by their bankers).
BusinessWeek followed with a cover story on "Wall Street's Hype Machine".
Last week The Wall Street Journal devoted a front-page story to founding
investors and insiders who unloaded technology shares before the market's
recent plunge.
The huge "overhang" of restricted stock sold into the market at the end of
lock-up periods in February and March was one of the big factors in causing
the Nasdaq market to go into a tailspin.
Bob Gabele, First Call's insider research director, says: "Sales of
restricted stock hit $22 billion in February. Everyone was getting excited
about the record $35 billion that investors put into mutual funds that
month. But if you included the restricted stock sales with new IPOs there
was actually a negative flow of money."
Although most insiders and bankers insist they sold only a small percentage
of their stakes in these companies it is clear from SEC filings that many
tried to grab profits while they could. CNET, Commerce One and Ariba are
among the companies that have lost more than half their value since insiders
began dumping shares.
For the investment banks it does not really matter if a new company lives or
dies. They make their fees upfront on the flotation and, hopefully, on
secondary issues. Underwriters earn fees of about 7%.
Goldman Sachs probably earned about $60m from World Online's float. It
earned more than $100m as joint global coordinator for two offerings of the
Japanese government's stake in NTT, the telephone company, and is still
hoping to underwrite the next $13 billion NTT issue (which will pay $216m in
bankers' fees).
Goldman Sachs is currently leading in the flotation league tables. By the
middle of this month it had done 27 deals in America, worth $8 billion.
Morgan Stanley had done 20 deals, worth $4.9 billion, and CSFB had done 23,
worth $3.6 billion, according to Securities Data.
Despite all the recent bad publicity, Americans continue to be infatuated
with the stock market and with its so-called experts.
Television presenters, who often seem to have the flimsiest understanding of
finance, are accorded the status of Wall Street gurus. By merely mentioning
a stock they can double its price in 10 minutes. Real experts, such as Henry
Blodget, Merrill Lynch's net analyst, and Ralph Acampora, Prudential
Securities' equity strategist, are credited with virtually divine wisdom.
Investors are equally excited by the exotic adverts that intersperse their
financial shows. One Morgan Stanley ad, criticised by the SEC and no longer
running, showed a truck driver congratulating himself on his stock-market
winnings and the island he had bought with them.
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