Chairman of the Securities and Exchange Commission from 1993 to 2001.
In one of your speeches you talked about cozy relations between analysts and
company management. You called it "a web of dysfunctional relationships" in an
era of "gamesmanship." What did you mean?
What I meant by that is that the economics of Wall Street has changed
dramatically. When fixed commissions were eliminated [in 1975], more and more
of Wall Street's profits had to come from investment banking. But what is the
very best way to get investment banking business? The language of Wall Street
is, "We'll get you coverage." And what kind of coverage does that mean? An
overwhelming number of research reports written about investment banking
clients are favorable.
And all too often, corporate executives on the other side of the table who are
anxious to get favorable coverage, to get hype for stock ... will try and
embrace a favored analyst, intellectually at least, and say to that analyst, "I
will share with you information that will not be made available to anybody
else, certainly none of your competitors. You'll have it first." It's not said
in those words. But it's a very easy relationship to establish.
The analyst very often is compensated by bringing in investment banking
business as much as he is by the quality of his or her analysis. So those
relationships between companies, bankers and analysts can become much too
incestuous, much too cozy and work against the best interest of the individual
investor, who is very often the last person in the cycle for that information.
And what is most dangerous about this is the confidence of the individual
investor is vastly more important at this time in the market cycle -- they are
really the most important factor in our markets. For them to lose confidence in
the independence of the research that they've been basing their investment
decisions on could have serious implications for our market as a whole. ...
You sent SEC staff to talk to the financial media about disclosure. Can you
recount that for us?
I asked members of our staff to meet with the financial media and urge upon
them the discipline of getting their guests to identify the conflicts of
interest that existed. ...
The networks, in general, felt that they had no responsibility in terms of
monitoring the guests that appeared on their programs. And my feeling was that
the analysts [who] came on those shows and promoted certain stocks that
represented companies involving investment banking clients for their employers,
had a responsibility to clearly reveal that on camera. I still feel that way.
I still feel that the kind of exposure we're getting from analysts in both
print and electronic media is incomplete and inadequate. ...
If it's in [Wall Street's] interest to maintain an investing public, why do
these things continue to happen?
In a kind of bubble environment, the excesses on all levels of the chain of
raising capital are most manifest. It brings out the basest qualities of all
the players; the kinds of guidelines that monitor corporate behavior tend to be
more flexible at a time when there's excess, and it feeds upon itself.
The public is part of this process as well. They're not guiltless. The public
simply lacks the kind of skeptical monitors that should always be part of the
And the people that feed into that, in terms of the brokerage firms and the
analysts and the mutual funds and others in the chain of distribution tend to
be giving the customers what they believe the customers want. And they also
tend to believe their own rhetoric. ...
Were there particular instances of analysts going on television, that you
can remember, where your blood boiled a little bit and you thought, "Man, we're
really out of control here"?
I can't recall the specifics, but I've always felt that investing is a
professional discipline. You are dealing with people's lives. And some of these
practices representing advertising, representing analysts who treat this like a
horse race, rather than a serious discipline, do a disservice to what should be
a profession. I think that the hype, the feeding frenzy of recent years, played
to investors' basest instincts, and that was unfair to the process and, I
think, denigrating to the image of analysis, which should be very different
than what we've seen.
Former analyst with Bear Stearns who covered Internet stocks.
To some extent, what you're doing is serving the market what the market wants.
My job as an analyst is really just to lay out the case for why the company
might succeed and why the company might fail, and to monitor everything they
do, and fall on one [side], either positive or negative at any given point in
time, based on what's happened most recently at the company. ...
But if the company was going to hit the milestones and be on a path towards
success, I wasn't going to turn negative on the company. But over time, as the
company stopped meeting the interim goals which we had set for them, it became
clear that there was much less hope that they would become a successful
company. So we downgraded one notch, and ultimately downgraded to a neutral,
which was essentially one of the lower ratings that we had at the firm. And
thought, "This is not a company that we believe in any more." But at the time
of the IPO, we thought they had a lot of potential.
You downgraded it to a neutral, and that's the lowest --
There's actually a lower rating at Bear Stearns. It's infrequently used. I
think it's a sell.
You think it's a sell?
I never used it.
You never used a sell?
That's one thing the public doesn't understand. Neutral sounds like "OK,
maybe I should have it." But, in fact, it meant sell.
Well, my ratings were really for our institutional clients. Bear Stearns was an
institutional bank, and everybody knew what that meant. I don't actually agree
with [your statement]. Because if you look at the price action of a stock that
gets downgraded to a neutral, even at a very retail-oriented firm like Merrill
Lynch, the stock goes down dramatically.
But that could be argued to be the result of institutional and large
investors who are savvy.
That's true. But you have a tough time making a case for the unsophisticated
retail investor duped by those clever institutional guys on Wall Street. ... I
would get in a taxicab, and a taxicab driver would recognize who I was from
being on CNN before, and say, "Oh, I disagree with what you think about Yahoo."
I mean, they had a pretty good familiarity with analysts, and what analysts
did, and what the game was. Our research was widely consumed -- by analysts
generally on Wall Street, [and] was pretty widely consumed by the mass
audience. So I don't really agree with that.
You don't agree with the public's naiveté?
So why didn't you issue a sell?
I didn't put too much thought into it. I didn't put a lot of oomph behind
ratings. Ratings didn't matter to me that much. It was much more important to
read my report, or to listen to what I had to say. ...
One of the other criticisms that has come up now that everybody is playing
the blame game ... is the issue of disclosure of the interests of the bank. For
instance, when you took a company public, you would issue buy recommendations.
... But you went on television and didn't necessarily disclose the relationship
that the bank had with the company that you were covering.
I would say toward the end of my work at Bear Stearns, a lot of times the
interviewer on TV, from whatever network was interviewing me, would actually
disclose that we had a banking relationship with [the company].
Why wasn't it done more regularly in the beginning, and why did it change?
I don't know. It wasn't something that we were required to do. It wasn't
something that we were hiding at all. If asked, I'd be happy to admit that.
Frankly, if I was positive about a company, if I was recommending that you buy
it and thought it was a good company, I'd be proud to also be associated as an
underwriter, because it's a company that I liked. In the same way that if I
liked a company, I would want to do the underwriting business for them, because
I was already recommending purchase of the stock. They fit together nicely.
But I think there are some people in the public who think that, when you go
on television and talk about a stock, you're coming from a pure place -- that
you're an analyst on that stock; that there's no other interest that your
employer has in that company; and that, therefore, disclosure is important.
Why do they think that? I work for -- it says, Scott Ehrens, Bear Stearns.
But they figure that Bear Stearns is offering an analyst up there to give
research to investors.
That's right, and that's what we are doing.
Executive editor of Fortune magazine and the author of A Piece of the
Action: How the Middle Class Joined the Money Class (1994).
Let me begin with a question that you put on your cover, [when
Fortune ran the article about Morgan Stanley's Internet analyst, Mary
Meeker]: "Can we ever trust Wall Street again?" ... What did analysts do to
breach public trust?
The problem for the public is that they don't understand how analysts get paid.
They think that the analyst is on their side, working for them; or at least
that's what they used to think when things were good and stocks were going up.
But in fact, analysts get paid on the basis of how many deals [i.e., IPOs] they
can bring to their firm, and how tightly integrated they are with the
underwriting process -- which has nothing to do with helping small investors.
The public is not naïve, however. It used to be different.
That's right. It did used to be different. ... I can tell you the exact day it
changed. The world changed on May 1, 1975 -- May Day -- because that was the
day commissions were deregulated. ...
The downside of deregulated commissions is that the research function in a
brokerage house had always been supported by, basically, regulated commissions.
That's how they got paid. They did a good job for somebody, a Fidelity or a
Janus or one of the big mutual funds, and the mutual fund would repay the house
by basically buying stocks that the analysts recommended through that house.
And the commissions were high enough that everybody felt like this was a good
arrangement. As commissions went down -- and for the big boys, we're talking
pennies, we're talking four and five cents a share -- suddenly research
couldn't justify itself as a stand-alone business. So it had to find some other
way to make money for the house. The way it wound up making money for the
brokerage houses was by becoming part of the investment banking team. And
really what you've seen over the last 20 years is a steady but gradual
corruption of securities analysis in America. ...
What's wrong with the Mary Meekers of the world calling the shots and making
the deals [that bring IPOs to their firm]? And why shouldn't they recommend
these things to both their banker, their company, and to the small investor?
In theory, why do you bring an analyst into the deal in the first place? What
is the reason an analyst has to sign onto a deal? That's an interesting
question. Well, the reason is they're supposed to be the person with the
integrity to turn the deal down if it doesn't smell right.
From the point of view of the banker?
No, sir, from the point of view of an investor. If the research analyst puts
their stamp of approval on an IPO, on a deal, what the research is not only
implicitly but explicitly saying is, "I, the voice of the investor, the voice
of the investment community, the person who is trying to watch out for the
investor, am saying this is a good deal. This passes my muster. This company is
worth investing in." ...
The kind of moral degradation that took place had to do with analysts still
signing onto deals, in fact going out and finding deals, being part of the team
sniffing them out. So the person who internally was supposed to be watching out
for the investor completely opted out of that role. ...
The problem is that in 1998 and 1997, and through the Internet mania era,
standards were degraded. And people were putting their stamp of approval on
stuff that not only was bad, but that they knew was bad. And they were holding
their noses as they were taking [it] public. No one will say that on the
record. But behind the scenes, a lot of people will admit it. They were under a
lot of pressure to do deals -- for internal reasons, for financial reasons --
and people lowered their standards. As a result, investors got hurt. ...
The analysts from these formerly white-shoe firms, such as Morgan Stanley
and Goldman Sachs, were saying, "Yes, they have no profits, but that's OK.
We're into new metrics here." And these were big firms. Goldman Sachs and
Morgan Stanley, those are big reputations.
That's true. But people wanted to believe in new metrics. If you walked around
in your neighborhood, people were talking about the glories of Priceline, and
how Amazon was going to take over Wal-Mart. We were all caught up in it. And
the analysts were the cheerleaders for it. But we were in the stands, on our
feet, saying, "Yeah, yeah, yeah, go Mary, go Mary!"
And television and print media gave them a platform.
No question. CNBC is involved in this. Fortune magazine is involved in
this. The Wall Street Journal. It was everywhere. The market became a
game. Everybody forgot that stocks were risky. People just assumed that, as
their portfolio had doubled in 1999, it was going to double again in 2000, it
was going to double again in 2001. People just completely forgot that there's
risk and danger in the market. Investors forgot. Analysts forgot. Investment
bankers forgot. CEOs at dotcoms forgot.
Did the bankers forget? Or did they just change their priorities?
No. Nobody thought the party was going to end. They just tuned out the idea
that it could end.
Former director of Internet/new media research at Credit Suisse First Boston
If you've been in the business a while, you know that one of the maxims is
"Don't fight the tape." The tape is smarter than I am. ... So you do your
homework. You look and say, "What is the intrinsic value of the stock, what do
I think they can earn, what do I think is their profitability and how rapidly
will it grow year over year?" Because at the end of the day, a stock price is
meant to reflect the discounted stream of future earnings -- that's it. So you
try to figure out what that might be. And you get a number that is way
different from what the stock is doing. Then you need to ask yourself, "So has
this stock gone mad, or am I missing something?" In the beginning you clearly
assume that the stock has gone mad, because periodically stocks do funky
things. But when it goes on and on and on, as it did through 1997 and into
1998, you're left to conclude that the market, quote, "knows more than I do,"
so I just need to work harder to figure out what it is that I don't get that
everyone else sees. ...
So market momentum had a way of weeding out anybody who was not a
Yes, yes, that is exactly correct. And momentum superceded analytical work. ...
This was one of the things that troubled me over time, some of the bigger stars
were cheerleaders, not analysts. It was no longer about who was doing the best
analysis, because the best analysis got you nowhere. It was who was being the
best cheerleader for those companies. And that's problematic; that's
[But] let's not underestimate where the retail investors were at this point.
You put out a note that was even moderately cautious about a stock, and you got
a flood of hate mail. It's fine to stand up now and say, "Oh, those poor retail
investors who got hurt here." But the retail investors were going ballistic
that you weren't cheerleading their stocks every which way. Every once in a
while you'd go look in the chat rooms -- a bad thing to do, but it was kind of
amusing -- to see what are people saying. And you'd just see thousands of posts
about what an idiot you were because you didn't love their favorite stock. ...
There was a perception that the cable TV programs [CNNfn, CNBC, etc.] became
competitive and that you as analysts became part of that. ...
One of the difficult things is that analysts were very used to conveying their
information in these written notes ... you had a couple of paragraphs: Here's
what they said, here's my interpretation, and here's a bunch of caveats ... hey
look, it's a stock, it's risky.
But of course on television you've got a minute and a half. And you have a
question. And so you answer the question directly. But there's no place for the
caveat. You don't get the risk factors. So, unfortunately, it became
Headline News versus The New York Times. Those were very
different ways to convey information. Something gets lost in the translation,
and that is a really unfortunate aspect of what happened over the last couple
of years, although hopefully we all learned from it.
And the involvement of your bank in the particular stock you were talking
about was not always evident?
... You know, you put a camera in front of an analyst and ask him about a stock
that they were instrumental in helping take public, odds are good they're not
going to say, "Oh, by the way, we did the banking here." They're just going to
answer questions directly and honestly. But it would have been in the research
notes that we write -- there are caveats all over the bottom that say we took
this company public. Disclosures that are right there, can't miss them.
Sometimes they're right at the very top. ... And the audience that we were used
to dealing with -- the institutional investors -- they knew that if you said,
"Yes, this is a long-term buy for very risk-tolerant investors," if you use a
sentence like that in writing about a company you took public, they knew how to
read that, which was, "Pretty darn speculative, take your chances, but be
careful." ... Unfortunately, when you take the Headline News approach,
you just see CS First Boston says "Buy," and you miss all of the underlying
background information. ...
The critics will say you as professionals had our trust and abused it.
When things go wrong, it's important to have someone to blame. I would not
disagree at all that there were some analysts saying crazy things. And
absolutely everybody made some mistakes, because none of us had been through an
environment like this before. ...
It's not the media's fault, it's not the analysts' fault, it's not the
investor's fault. We were in this period where stocks stopped making sense.
But can something really go wrong this big and be nobody's fault?
... Shoot, where do we really point the finger? Human nature and greed.
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