The case against Wall Street's analysts seems so easy to make. We have e-mails from analysts to corporate-finance bankers joking about having to recommend pure crap in order to get big bonuses. We have e-mails from analysts pleading with banks to be able to downgrade horrid stocks simultaneous with the release of positive recommendations of those same stocks. We have damning correspondence that shows that buy recommendations were for sale at Merrill Lynch and First Boston for the price of follow-on business, a secondary here, a bond deal there. Heck, these e-mails are a prosecutor's dream; a first-year law student could find these clowns guilty of fraud.
But before we convict the whole analyst industry and send it to Sing Sing, someone in the prosecution's got some explaining to do. How is it that while there are many documented instances of analysts' being pressured to stay positive long after the stock bubble turned into a fiery zeppelin, there were far more totally independent analysts still willing to hop onto the balloon as it disintegrated into the proverbial Lakehurst grave? While we all know that Jack Grubman, the now-disgraced telco analyst late of Smith Barney, loved WorldCom literally to death, what was the excuse of the dozen analysts who got no investment-banking business but loved this giant scam anyway? These WorldCom acolytes had nothing to gain for their recommendations, because WorldCom did most of its banking with Smith Barney. Yet they banged the drum, in some cases even more ferociously than Grubman.
And WorldCom isn't anomalous. Wall Street analysts routinely recommended stocks that eighteen months later would fizzle or go bankrupt, and received absolutely no extra recompense for doing so. They simply blew it. As Eliot Spitzer pointed out last week in his deconstruction of Institutional Investor's All-America Research Team Awards, even the so-called stars usually got it wrong.
Of course, Smith Barney's Jack Grubman loved WorldCom literally to death, but what was the excuse of the dozen analysts who got no investment-banking business but loved this giant scam anyway?
While there was corruption behind some of these buy recommendations, I think stupidity played a much bigger role. Either they thought that stocks would keep rising and they didn't want to rock the boat or they genuinely believed in the promise of the New Economy.
As someone who has spent his career trying to discern which stocks are going to go up and which ones are slated to go down, I can tell you that the process is harder than it seems (despite what everyone presumed during the bubble). At Cramer Berkowitz, the hedge fund I've since retired from, I interviewed dozens of people a year who insisted that they could pick winning stocks. As a ritual, I would ask them to pick some for me. But in a dozen years of trying to find talented stock pickers from the sell side, I found only two who could demonstrate the ability to pick stocks right. I passed on hundreds who simply couldn't pick stocks to save their lives. And that was in a bull market! It's just simply a very difficult process that most can't get right, even when they have the potential to make far more money working on the buy side, at a hedge fund, than they could kowtowing to their investment-banking masters in order to get lucrative bonuses -- the essence of the prosecutors' case against the research analysts.
To be sure, that doesn't mean the current scheme is corruption-free. In the late nineties, when you brought your company public, you pretty much were buying a positive research report to be issued, like clockwork, 30 days after your company came out of the chute. These "initiate buys" fooled no one except the hapless public, which didn't know how the game worked. Why get in the way of a freight train in the name of principle?
Now let's make things even more complicated. Wall Street's no monolith. Some firms apparently had very weak controls and coerced analysts into upgrading stocks that belonged in the dog pound. Those who balked were fired, and more compliant people were brought in. But other firms, notably Morgan Stanley, pressured no one and even took the incredibly unusual posture of downgrading some of the most lucrative clients out there. The decision by Morgan Stanley telco analyst Simon Flannery to take Qwest to a sell at a time when Qwest would have loved to do business with Morgan Stanley distinguished that firm as honest in my eyes. To make matters even more black and white, Morgan Stanley had no Enron analyst at a time when Enron was doling out millions in investment-banking fees to any firm that touted its securities. Even Morgan Stanley's Mary Meeker, the analyst who is claimed to be among the more ethically challenged for her buy recommendations of dubious dot-coms, did the most rigorous work and was far less enthusiastic than her dot-com-analyst compadres in the end.
Still other firms, such as Goldman Sachs, Lehman Brothers, and Bear Stearns, plied their allegedly corrupt research only to wealthy people, who the government has long held do not need the special protections others in the marketplace are afforded. Why should these firms be held to the enforcement standard meant for those who sold stock to the great unwashed masses of investors? If the rich lose money, to paraphrase Lenin, isn't it their own darned fault?
Of course, the current investigations don't even begin to take into account so many of the other pressures on analysts: They are always loath to downgrade the stocks owned by the big mutual funds that pay the commission bills. They are also desperate not to alienate those who have bought the stocks on their recommendations, even if the companies behind the stocks start disappointing. Better to let the companies disappoint the clients than disappoint them yourself.
No matter. We are now in the massive-recrimination stage, and these niceties -- patient consideration of extenuating circumstances -- have no place in the process. Given that no firm had totally clean hands or heads during the boom, we can expect that the government's piper has to be paid. I just hope there's someone at the table for the brokers arguing, "Call us stupid, call us dumb, but don't call all of us corrupt."
That's the position, in this murky moment for Wall Street, that has the most truth on its side.