Stock trader Marty Fiascone says he's not normally a sore sport. Yet one trade continues to irk him.
In March, he lost $70,000 of his own money when the shares of MicroStrategy Inc., an Internet software company, tanked. Fiascone, a managing director at Stafford Trading in Chicago, insists securities analysts knew MicroStrategy would restate its books to conform with standard accounting practices and that its earnings and stock price would suffer.
Rather than alert him, the analysts kept urging him to buy shares, he says. On March 20, MicroStrategy did announce the accounting change. The stock plummeted 62 percent to 86 3/4 that day. Yesterday, it closed at 32 5/8.
``They have no credibility,'' Fiascone says, getting angrier at the analyst corps with each breath. ``They should be exposed for what they are. They're used-car salesmen.''
Fiascone isn't alone. Many investors these days complain that stocks they own fall precipitously without a warning from the analysts who persuaded them to buy the shares in the first place.
Palley-Needelman Asset Management, a San Diego money manager, says it lost almost $10 million on its UnumProvident Corp. shares last year because it believed analysts who kept recommending the company in the face of evidence that its disability insurance business was deteriorating. Palley-Needelman sold the stock in December.
P&G Falls
Molly Guenther, who oversees $220 million in investments at SunTrust Banks in Atlanta, had about 4 percent of her customers' money in Procter & Gamble Co. stock on March 7. That day, the consumer-products giant said its earnings would fall short of analysts' estimates. The shares tumbled 30 percent.
Guenther says she had no idea something was awry. Many of her clients were unaware of P&G's problems until they got their quarterly reports -- and then started calling her. ``It's one thing to lose money in an aggressive, speculative investment, but for a company like P&G to have a drop like that is very upsetting to them,'' she says.
Why didn't Wall Street pros issue warnings before the routs? Well, why would they? Analysts are more rainmakers than researchers these days. They're paid to be positive: Their fawning research reports help their firms win and keep investment-banking clients -- and keep the brokerage machine oiled.
The Skinny
``An analyst is just a banker who writes reports,'' says Stephen Balog, former research director at Lehman Brothers and Furman Selz, who left the latter firm after ING Groep bought it in
1997. ``No one makes a pretense that it's independent.''
Analysts would sooner stop covering a company than recommend selling its stock. Of 28,000 analyst recommendations on 6,700 companies in the U.S. and Canada, less than 1 percent are ``sells'' or ``strong sells,'' according to First Call/Thomson Financial, which tracks ratings. By contrast, one-third of the ratings are ``strong buys,'' another third are ``buys'' and almost all the rest are ``holds.''
The ratio hasn't changed since First Call started to keep count five years ago. It's not likely to change as long as analysts' pay -- $2 million to $3 million annually for the top-ranked names and as much as $15 million for the superstars -- is linked to how much business they bring to their firms.
At Donaldson, Lufkin & Jenrette Inc., for instance, analysts get quarterly bonuses from the investment-banking budget. Tom Brown, chief executive of Second Curve Capital, a hedge fund, says that when he was a banking analyst at DLJ, an analyst who brought in, say, a midsize bank with assets of about $10 billion as a potential merger candidate could earn a $250,000 bonus if the merger came about. A DLJ spokesperson says the bank doesn't comment on compensation.
Small Print
Analysts must disclose their firm's relationship with companies covered, and they usually do it at the end of a report, in tiny type that's easily overlooked.
The pressure from the top of the firm for buy recommendations can put analysts through the wringer. Sean Ryan, a former banking analyst at Bear Stearns Cos., says he recommended Net.Bank Inc., an Internet bank based in Alpharetta, Ga., even though he thought it was a crummy company. ``I put a `buy' on it because they paid for it,'' says Ryan.
Bear Stearns underwrote two stock offerings and one subordinated debt sale for the company in the first half of 1999, helping it raise $307 million. Morgan Keegan, an investment bank in Memphis, Tennessee, that managed the bank's initial public offering in 1997, had downgraded the stock a year earlier.
Ryan then called a few customers -- some who paid Bear Stearns a lot in trading commissions -- and told them what he really thought. ``I said, We just launched coverage on Net.Bank because they bought it fair and square with two offerings,''' he says. ``Unless money is burning a hole in your pocket, there isn't any reason to own it.''' Net.Bank traded at 12 3/16 yesterday, down from a high of 83 in April 1999.
Censored?
The analyst says he left Bear Stearns in January to form Byrne Ryan & Co., a brokerage that promised unbiased research. (It closed in May, and Ryan joined Banc of America Securities in June.) Ryan alleges that Bear Stearns censored his tough reports on First Union Corp., then refused to let him write about the bank.
ear Stearns disputes Ryan's version of events. ``Bear Stearns stands by the quality and integrity of our research,'' the firm said in a written statement. ``Our analysts are encouraged and expected to maintain their independence and provide the best possible research product to our clients. Since his departure from Bear Stearns, Sean Ryan has made disparaging comments about the Bear Stearns research department in an effort to generate publicity for his latest business venture. The comments are the same ones he has made before and, as in the past, are totally inaccurate.''
Comment, Please
Many analysts routinely send drafts of their research reports to the companies being covered for comment and tweaking. ``The way the game is played is that we want to make money for our clients,'' Richard Leggett, head of research at Friedman, Billings, Ramsey & Co., a small investment bank in Arlington, Va., said at a conference in late March. ``So if a company guides us lower in our earnings estimates and then the company blows out the estimate, I look good, the company looks good,'' he said. ``We all win.'' Except, of course, for the investors who took the analysts' advice at face value.
Headhunters know the game. The first question they ask about an analyst they might hire is whether the analyst is investment-banker friendly, says Balog. That is, does the researcher bring in deals, or if a bank does a mediocre deal, will the researcher look the other way?
Today's star analysts are Jack Grubman, 46, of Salomon Smith Barney and Mary Meeker, 40, of Morgan Stanley Dean Witter & Co. These people are much more than stock pickers.
In February 1998 executives at SBC Communications Inc., pondering an acquisition, invited Grubman to a strategy session in Arizona and asked for his overview of the industry and his opinion of where it was heading.
``He confirmed the strategy we were working on,'' says James Kahan, SBC's senior executive vice president of corporate development, who adds that the company didn't specifically discuss possible acquisition targets. ``We valued his judgment because of his experience and knowledge.''
