Wall Street Analysts Cry ‘Sell’ at Their Own Peril
Shortly after the Internet stock craze began in mid-1998, Wall Street stock analyst Lise Buyer got a phone call she’ll never forget.
The caller was a professional investor who accused Buyer of fueling an Internet stock sell-off by publishing a report that showed a temporary drop in traffic at several prominent Web sites.
The investor “just went ballistic at me, saying how could I have been so stupid,” recalls Buyer. Last year, she quit the analyst ranks to join a venture capital firm.
Wall Street brokerage analysts have been cast as villains this year for doling out relentlessly bullish--and, critics say, intentionally misleading--advice to investors. But as Buyer’s experience demonstrates, it isn’t easy to be forthright and unbiased in the high-pressure and high-stakes confines of Wall Street.
The fury over analysts has glossed over a major reason why they are so upbeat: because multiple constituencies--including small investors--often love it when they’re bullish and hate it when they’re bearish.
Brokerage firms, large investors and others all stand to gain when analysts recommend the stocks of companies they cover. But they can suffer greatly when analysts turn bearish.
That deeper, systemic force may be the biggest hurdle that regulators will face this year as they confront widespread concerns that analysts give tainted advice to investors.
Analysts always have been pressured to praise the stocks they cover, even if they didn’t truly believe what they were saying. But broad trends in the investment industry during the 1990s intensified that pressure.
Once faceless number-crunchers toiling in Wall Street’s back offices, some analysts became stars of the late-1990s market boom. Now they are the primary targets of investors’ wrath as the 17-month slide in stock prices has wiped out trillions of dollars in paper wealth.
Critics say a drive for fame and riches--and a desire to keep brokerage investment bankers and corporate clients happy--prompted many analysts in recent years to aggressively tout the stocks of questionable and overvalued companies, especially in the technology sector.
A little-known PaineWebber analyst, for example, sent shares of wireless technology firm Qualcomm soaring $156 in a single day in 1999 after he prophesied the stock would hit $1,000. Qualcomm briefly neared that level but has since lost nearly two-thirds of its value.
Despite the plunge in share prices in general since March 2000, today just 1.5% of all analyst recommendations in written reports exhort investors to sell individual stocks, a percentage that has remained relatively constant throughout the market slide, according to data tracker Thomson Financial/First Call in Boston. The vast majority of analyst recommendations advise buying stocks; the rest counsel holding.
More troubling to some are allegations of inside dealing.
The Securities and Exchange Commission, the nation’s top market regulator, recently revealed that more than one-quarter of 57 analysts it surveyed bought shares of companies at low prices before recommending the stocks to investors. The agency is considering bringing enforcement charges against three unnamed analysts who sold their holdings even while recommending them publicly.
Congress is holding hearings on analyst credibility, and individual investors have filed a spate of lawsuits accusing analysts of giving misleading advice that caused them to lose money.
But on Wall Street, the long-recognized truth is that an analyst who talks down a stock faces attacks on multiple flanks.
Investors who own the stock may pull their business from the analyst’s brokerage firm. The company whose shares are attacked may retaliate by limiting the analyst’s access to executives and information. And the analyst’s firm may lose lucrative investment-banking business with the company.
“At the end of the day, the only thing an analyst really has is his or her own integrity, and you have to be as true to that as you can be,” said Buyer, now with Technology Partners in Palo Alto. “But we need to be realistic about why analysts don’t issue sell recommendations--because nobody is happy to see them and you end up only hurting yourself.”
Analysts say it’s simply safer professionally to be bullish and wrong than to be bearish and wrong.
“Think about all the Internet analysts who made really terrible [bullish] calls,” said Dan Niles, a well-known technology analyst at brokerage Lehman Bros. in San Francisco. “How many of them have gotten fired? [But] if you make a bearish call and you’re wrong, that can get you fired.”
Even individual investors, who are bringing legal actions against Wall Street in record number for perceived bull-market excesses, often hate it when their stocks are downgraded by analysts.
“I’ve never gotten a threatening phone call because I was too bullish, ever,” Niles said. “It’s kind of funny, huh? You give analysts all this grief because they’re too positive. And when you make some negative calls trying to save people money, you get all these phone calls.”
Moreover, some analysts say their bullish bent is due to their inherently optimistic view of the companies and industries they cover.
“We obviously love the industry [we follow], and it’s a congenital defect of analysts that they fall in love with their companies and with their managements,” said Jonathan Joseph, a technology analyst at Salomon Smith Barney in San Francisco. “It didn’t just start last year.”
Brokerage firms, including Merrill Lynch & Co. and Morgan Stanley, declined comment on the analyst issue.
Market historians say the current vilification of analysts is part of a long-standing tradition that has followed severe drops in stock prices: Those who have lost money engage in a search for the guilty, trying to affix blame for their financial pain.
After the late 1960s market plunge, the chief targets of ire were the so-called go-go mutual fund managers who gambled on shares of space-race companies and conglomerates.
After the 1987 crash, Michael Milken, Ivan Boesky and other financiers accused of insider trading were held up as symbols of Wall Street’s sins.
And perennially, complaints against stockbrokers surge after market downturns.
“Main Street has always had a love-hate relationship with Wall Street,” said John Coffee, a securities law specialist at Columbia University. “At the top of the market they love it, and [after] the fall there is disdain and contempt for Wall Street.”
Some analysts reject the idea that they misled individual investors. Many small investors, they say, insisted they were do-it-yourselfers in the late-1990s--until, that is, their portfolios shriveled.
Said one veteran analyst who requested anonymity: “You can’t, on one hand, have five years in which people are talking about being empowered, making their own decisions and refusing to pay for research and brokers, and then when the market collapses turn around and say, ‘Hey, it wasn’t my decision. It was the analyst. It was the brokerage firm. It wasn’t me.’ ”
Still, industry experts say there is no denying that the role of analysts--and the pressures on them--underwent seminal changes in the 1990s as the number of U.S. brokerage analysts rose to the current estimate of more than 6,000.
In the 1970s, brokerage research was considered a valuable commodity for which large investors such as mutual funds were willing to pay. A mutual fund seeking an analyst’s work paid for it by steering stock-trading business to the analyst’s firm, on which the firm earned commissions.
From their inception, brokerage research departments always have been pushed by their firms, and by the companies they covered, to churn out upbeat reports.
But starting in 1975, competition began to shave trading commissions razor-thin. Over time, trading commissions no longer could adequately subsidize research departments.
At the same time, mutual funds and other investment firms began to beef up in-house research teams and no longer relied exclusively on brokerage analysts.
With their units no longer generating enough revenue, analysts in the 1990s were under pressure to generate profits.
In the 1990s, power on Wall Street came to rest more than ever with investment bankers, the pinstriped legions who churn out initial public stock offerings and advise companies on mergers, all for hefty fees.
Analysts came to play a central role in the initial public stock offering, or IPO, craze managed by investment bankers: Stamping their imprimatur on a deal through an appropriately timed “strong buy” recommendation was viewed as a seal of approval that investment bankers could point to as justification for bringing public a fledgling company.
At some brokerages, analysts could block an IPO that was especially speculative. But they had to wield veto power judiciously because it meant their firms forfeited juicy fees, said Buyer and others.
More often, there was an unspoken pact in which analysts understood that they were expected to comment favorably on companies for which their firms did investment banking work, industry insiders say.
Some analysts say they disliked kowtowing to investment bankers, but others were happy to play along because of the financial rewards, according to veteran analyst Paul Nisbet, who worked as a Wall Street analyst for 12 years before starting his own research firm in 1993.
As is common on Wall Street, the bulk of analyst pay comes from annual bonuses that can be highly subjective and can be torpedoed for lack of cooperation with investment banking objectives.
Average analyst compensation, including bonuses, soared from about $400,000 in the mid-1980s to $2 million to $3 million by the late 1990s, said Gary Goldstein, chief executive of the Whitney Group, a Wall Street search firm. Star analysts pulled down $10 million or more a year, he said.
Of nine brokerages surveyed by the SEC earlier this year, seven acknowledged that their investment banking departments have had input on analysts’ compensation.
“Do I say, ‘OK, I’m not going to [be misleadingly bullish] because my family doesn’t need to have the things it used to have?’ Or do I say, ‘These guys are willing to pay [me] for it. I’ll give them what they want’?” one analyst asked rhetorically.
The increasing potential for analyst conflicts of interest was well known across Wall Street by the late 1990s. Indeed, professional investors often said they placed less credence in the opinion of an analyst whose brokerage handled a particular company’s stock IPO.
Some money managers have sworn off brokerage stock research altogether. “We don’t use them [analysts]. We don’t think it would do us any good to use them,” said Ben Inker of Grantham, Mayo, Van Otterloo & Co. in Boston. “It’s not because they’re stupid. It’s not because they’re evil. It’s because [objective research] is not what they’re paid to do.”
But critics say the hordes of individual investors who flooded the market in the late 1990s didn’t know how things worked on Wall Street.
Suddenly, small investors had more access to analysts than ever before, thanks to the direct link provided by financial channels such as CNBC, the Internet and new investment publications.
Analysts historically had been anything but telegenic, but such Internet analysts as Mary Meeker of Morgan Stanley and Henry Blodget of Merrill Lynch became TV stars.
Historically, analysts’ pay was far below that of investment bankers. But as they came to personify the record-setting bull market, analysts’ stature--and paychecks--soared.
But that cachet lured a new breed of analysts who were less interested in objectively sizing up a company’s balance sheet than in earning brand-name recognition, Buyer contends.
“We had a bunch of analysts who came in wanting to play the game as opposed to doing the analysis,” she said. “There was a lot of nonsense last year. There was a lot of cheerleading. There were a lot of analysts who were trying to make the news instead of analyze the news.”
Buyer started on Wall Street in 1985 and split her time over the following 15 years between being a Wall Street analyst and working for money management firms.
Buyer considers herself part of an old guard who supplemented the study of financial statements with street-level reporting. While covering retailer Toys R Us Inc. in 1988, she said she spent Thanksgiving weekend driving to more than a dozen malls asking Santa Clauses which toys were in hot demand.
Some analysts still do such nitty-gritty work, Buyer said. But she frets that there is less time for it in today’s hectic market and that fewer analysts see the benefit of such basic research.
The changed role of analysts contributed to Buyer’s decision last August to jump to a venture capital firm.
“You get tired of fighting,” she said. “Much of why I left the business in part was because the job of analyst had changed from analyst to cheerleader, almost from sleuth to cheerleader.”
Whether Wall Street analysts’ research can become more objective to suit critics remains an open question.
The brokerage industry’s chief trade group, the Securities Industry Assn., recommended guidelines in June to bolster analysts’ credibility, including a suggestion that analyst pay be decoupled from brokerage investment banking.
Major brokerages insisted they already complied with the guidelines, raising doubt among critics that genuine reform would occur.
Others note that, despite criticism of analysts--and professional investors’ insistence that they don’t listen to what brokerage research says--the power of analysts to move stocks still is evident on Wall Street nearly every day.
Just this week, shares of video game retailer Electronics Boutique Holdings Corp. jumped 17% after analysts at Merrill Lynch and Credit Suisse First Boston launched coverage of the stock with buy ratings.
A week earlier, those two brokerages led the underwriting team that sold 4 million new shares of the company to investors, generating fee income for the firms.
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Relentlessly Bullish
Wall Street stock analysts strongly recommended Yahoo stock last year even as the shares plummeted 86% amid the Internet-stock collapse. Analysts have turned less bullish this year as the stock has tumbled an additional 53%. Here are the numbers of analysts who recommended that investors buy, hold or sell Yahoo stock in the last two years as the price of the shares declined.
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Jan. 1, 2000: Buy: 27; Hold: 2; Sell: 0
July 1, 2000: Buy: 27; Hold: 2; Sell: 0
Jan. 1: Buy: 17; Hold: 11; Sell: 0
July 1: Buy: 9; Hold: 16; Sell: 1
Source: Thomson Financial/First Call
