Near the Corner of Church and State (Update)

Efforts to insulate sell-side analysts from investment bankers will hurt some capital-raisers, but help others.

Remarkably, finance-watchers say some CFOs have actually barred bearish analysts from conference calls, or kept them out of lavish corporate gatherings. Executives at America Online, for instance, are said to have once excluded Jeff Goverman of S.G. Cowen from a party after Goverman published a negative report about AOL.

Some companies have gone so far as filing lawsuits against investment firms that issued negative reports. In 1999, for example, Sunrise Technologies International slapped defamation suits on two Wall Street firms because of less-than-enthusiastic coverage.

Nevertheless, a number of finance chiefs defend much of the behavior. They argue that it’s only natural for CFOs to develop strong ties to banks that have faith in their companies’ business models.

It’s also understandable, they assert, if corporate executives gravitate to banks that will help them raise capital on the most favorable terms. “Why would a CFO hire an investment banker whose analysts find something wrong with the company, when others don’t,” asks Raghanvan Rajaji, CFO of software vendor Manugistics.

Albert Meyer, a short seller at David Tice & Associates, agrees. “If you’re a CFO trying to raise capital, and you need the highest P/E you can get,” he states, “you’re going to go to the investment bank whose analysts will write a compelling story about your business.”

In part, this may explain why, at the peak of the Nineties stock market boom, a mere 1 per cent of stock recommendations from Wall Street analysts were a “sell.”

Another Brick in the Wall

Once the stock markets started to plunge last year, competition among investment banks turned noticeably fierce — particularly for lucrative equity underwritings. Given the white-hot competition, it’s possible that some Wall Street firms began applying even more pressure to analysts to help scare up business.

Certainly, it appears that some bankers at Merrill Lynch were applying the screws to analysts. Communications retrieved by Spitzer’s office were nothing short of disturbing. A senior analyst, for example, wrote: “The whole idea that we are independent (of the banking division) is a big lie.”

Still, Manugistics CFO Rajaji thinks the Merrill case was the exception rather than the rule. “Most investment bankers respect the Chinese Wall and are very cautious about even insinuating that they will produce positive coverage,” says Rajaji. He adds: “My feeling is this is a case of a few bad apples. I don’t think it is as widespread as people are making it seem.”

Possibly. But Spitzer uncovered evidence that the problems at Merrill may have gone beyond a single analyst or research unit.

For example, the head of the equity division wrote to analysts: “We are once again surveying your contribution to investment banking … please provide complete details on your involvement…paying particular attention to the degree your research played a role in originating ….banking business.”

Although Merrill Lynch never admitted any wrongdoing in the $100 million settlement with New York state, the bank’s management agreed to make substantial reforms to insulate research analysts from the firm’s investment banking divisions.


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