Salomon on Board
In April 1998 San Antonio-based SBC hired Salomon to advise it on its plans to acquire Ameritech Corp., another former Baby Bell, based in Chicago. Kahan says SBC's decision to retain Salomon for the Ameritech acquisition, which it announced that May, was not connected to Grubman's comments. Salomon earned $33 million on the SBC/Ameritech deal, which closed in October 1999.
Grubman, who did not return phone calls seeking comment for this story, covers 34 companies. He has ``buy'' recommendations on all but three. Last November, Grubman raised his rating on AT&T Corp. to ``buy'' from ``neutral.'' Rival analysts suggested that Grubman had to be nice to AT&T so that Salomon could win a role in the largest U.S. IPO ever: the $10.6-billion sale in April of a so-called tracking stock in AT&T's wireless unit. AT&T did, in fact, name Salomon, Goldman, Sachs & Co. and Merrill Lynch & Co. to manage the underwriting.
In May, Grubman praised WorldCom Inc. for first-quarter results that put the company far and away at the top of the industry. The glowing report came just at the time Salomon was comanaging a $5 billion sale of bonds for the telecommunications company. Asked to comment on these developments, a Salomon spokesperson said, ``We as a firm do objective research.''
Analyst Marketers
It can't be easy for analysts with such extensive access to keep their dual duties separate. ``They're trying to be analysts, but at the same time they're marketers for the company,'' says Kent Womack, a finance professor at Dartmouth College. Because of that, opinions generally are more biased than they used to be, Womack says.
Meeker made her name with a 300-page report in 1995 that hailed the dawn of the Internet age. She has since turned corporate finance on its head by valuing companies on their potential rather than their past. The upshot: start-ups now routinely seek her backing. Morgan Stanley has underwritten such IPOs as Priceline.com Inc., HomeGrocer.com Inc., Martha Stewart Living Omnimedia Inc., Ask Jeeves Inc. and Drugstore.com. Inc.
Forever Bullish
Dubbed Queen of the Internet, Meeker has been consistently bullish about her subjects. She has recommendations of ``outperform'' (read ``buy'') on all but two of 20 companies she covers; she's ``neutral'' on VeriSign Inc., a maker of Internet security software, and Electronic Arts Inc., a designer of interactive entertainment software.
Morgan Stanley managed underwritings on 14 of the IPOs for these companies and comanaged another. Says a Morgan Stanley spokesperson, ``Long before the IPO boom, we erected a strict system of Chinese wall separations between the research and banking functions, and it still serves us well today.''
The schmoozing and selling an analyst must do these days takes time away from doing research. That, in turn, reinforces a researcher's dependence on spoon-fed information from the companies. Junior analysts right out of college or business school often crunch the numbers. ``It's private-label research,'' says Ryan, the former Bear Stearns analyst. ``You just slap your name on it. Even I did that.''
Ryan says Bear Stearns expects analysts to make 150 calls per month to clients, mostly institutional investors, to update them on companies they follow and to pitch stocks. A survey of 2,181 analysts at 102 securities firms by Tempest Consultants found analysts spent 40 percent of their time doing fundamental research in 1999. The analysts expect to spend less time this year -- 36 percent -- on research and more time on selling stocks.
SEC Concern
Analysts' conflicts of interest have worried Securities and Exchange Commission chairman Arthur Levitt Jr. for some time. In speeches in April and October of 1999, the stock market's top regulator complained that analysts all seem to have graduated from the Lake Woebegone School of Securities Analysis: the one that boasts that all stocks are above average.
Levitt warned that analysts were protecting business relationships at the cost of fair analysis. ``I worry that investors hear from too many analysts who may be just a bit too eager to report that what looks like a frog is really a prince,'' he said in April. ``Sometimes a frog is just a frog.''
Analyst conflicts aren't new. Wall Street is for bulls, and nobody in a firm likes to hear an analyst say sell. Investors have learned that a ``hold'' recommendation is really a warning to sell the stock. Still, researchers used to be thought of as people who visited companies, kicked some tires and drew independent conclusions.
That started to change after 1975, when brokerage firms could no longer fix commissions and Wall Street started to make more money from new stock and bond sales and mergers. The stakes have soared since: The top 25 investment banks handled $68.9 billion in U.S. initial public offerings during 1999, up from $4.5 billion a decade earlier. The value of mergers and acquisitions stood at $1.6 trillion, 11 times the amount for 1990.
Campaigning
Big-name analysts always have been a magnet for new business. That's why securities firms campaign each year to get money managers to vote for their analysts when Institutional Investor magazine picks the top research talent. Now the stars are even more important as the returns from investment banking and mergers businesses increase.
Consider the case of Regeneron Pharmaceuticals Inc., based in Tarrytown, New York. The company shifted its business to Merrill Lynch, largely because biotechnology analyst Eric Hecht had moved there three years ago from Morgan Stanley Dean Witter. Morgan Stanley handled the company's last stock sale in 1995. Regeneron's chief financial officer, Murray Goldberg, says: ``A bank is basically selling a company's stock to its customers. It can only do that if the analyst supports it. You need an analyst who understands your industry and your company and who has enthusiasm for the company.''
Biotech Booster
Hecht, 40, filled the bill. A medical doctor who ranked third in his category in Institutional Investor's latest poll published in October, he had long been a biotech booster. Better yet, he liked Regeneron even though it hasn't made a cent in the 12 years it's been developing drugs to treat obesity, arthritis, cancer and other diseases.
On Feb. 23, when he recommended Regeneron shares as a ``long-term buy,'' Hecht was the only analyst covering the company. One was enough: Regeneron's stock price, which had crawled along the floor at less than 10 for most of 1999, jumped 75 percent the day Hecht's report came out and reached an all-time high of 57 3/8 six days later.
No Precondition
Regeneron moved quickly to take advantage. Goldberg says that a week after the report came out, Regeneron met with underwriters and hired Merrill to lead the deal. On March 6, it registered the sale with the SEC. The company sold 2.6 million shares on March 29 to raise $77.4 million. Goldberg says the bullish coverage was not a precondition for Merrill to win the business.
The preponderance of glowing research reports coming from Wall Street has made it increasingly difficult for investors to discern the truth. Stock trader Fiascone, for one, relied on favorable reports on MicroStrategy from firms like Friedman, Billings, Ramsey. That firm had helped take MicroStrategy public in June 1998 and comanaged a $54 million secondary issue in February 1999. FBR was also in on another sale of 4 million shares being planned for March.
Michael Saylor, who started MicroStrategy in 1989, was never shy about his company's mission. He boasted that his firm would purge ignorance from the planet with data-mining software that could tell companies who was buying what where. Managerial and personal quirks like a mandatory annual Caribbean cruise for the staff (no spouses allowed) and lavish parties at places like Washington's Corcoran Gallery lifted the company's profile.
After MicroStrategy went public at 12, its prospects looked good. The company's client roster included big names like General Electric Co. and Est,e Lauder Cos. Analysts loved the stock, which rose to 150 in late November 1999. If anyone saw trouble, they didn't admit it.
