The Hard Sell

Can regulators put an end to improper collaboration between analysts and investment bankers?

The bubble burst, and the recriminations came next.

In the 18 months leading up to September 11, some $6 trillion in U.S. equity investments evaporated. Shares in technology and Internet companies that once traded for hundreds of dollars dipped to a few bucks, or worse. As the Dow sank, bankruptcies, layoffs, and restructurings rose.

At the uncertain beginning of the new war on terrorism, it’s easy to forget that until two months ago, angry investors sought to blame others for their stock market losses. Chief among their targets was the Wall Street research community. “Analysts are the sacrificial lamb,” said A. Gary Shilling, an economic consultant and money manager, in an interview last August. Little wonder, given their track record of irrationally optimistic reports and their bias for touting companies that deliver handsome investment-banking fees.

While concern over the credibility of analysts has understandably receded, it hasn’t gone away. Shareholders are still suing Wall Street firms for too- bullish calls. Congress has held two hearings this year on the deterioration of the so-called Chinese walls that are supposed to eliminate conflicts of interest among analysts and bankers, and plans to hold more. Regulators have made troubling discoveries, such as analysts executing trades in their own accounts that ran contrary to the advice they gave the public.

One party, though, remains to be heard from: chief financial officers. They have not been asked to testify in Washington, nor have they been quoted much, if at all, in the press. Yet perhaps no one knows better about Wall Street’s questionable conduct than CFOs. Although not privy to details about a brokerage firm’s internal reporting relationships and compensation schemes, they have a unique vantage point–that of an outsider who nevertheless sees what goes on behind the scenes through regular dealings with analysts and investment bankers.

“The illusion that there is some kind of Chinese wall between those two [research and banking] organizations is laughable at best, illegal at worst,” says one CFO, who, like most of the 20 or so we contacted for this story, agreed to be interviewed only on condition of anonymity. Another, the former CFO of a now-defunct Internet company, indicated that saying anything was “a no-win situation,” then hung up.

But others were willing to reveal stories of a dysfunctional relationship. Like the CFO who took a call last summer from an analyst who griped that because his firm wasn’t chosen for the company’s latest underwriting assignment, his bosses thought he wasn’t doing a good job. Or the CFO who says that last year, within weeks of an analyst initiating coverage, the bankers came calling to peddle their services. Or the one who in recent years has been told by “two dozen” brokerage firms that their analysts won’t follow the company–until there are better prospects for corporate finance or M&A advisory fees.

These are examples of the pressures that many CFOs face when dealing with analysts. They are evidence of a credibility gap, one that raises worries over biased coverage (or no coverage at all). The problem isn’t nearly as glaring as that of superstar analysts flogging sky-high price targets for unprofitable dot-coms, but it’s corrosive of confidence all the same, and perhaps harder to solve.


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