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Dot Con
Program #2010
Original airdate: January 24, 2002

Written and Produced by
Martin Smith

Saran Silver

NARRATOR: Buried in the debris of September 11th are the case files of a wide-ranging investigation by the Securities and Exchange Commission involving some of the biggest banks on Wall Street. Now those cases are being reassembled and pursued. Tonight on FRONTLINE, the story of a scandal, an investigation delayed but not destroyed.

There's hope on Wall Street that the worst is over, that last year's market collapse and the September 11th attacks are history, that in the new year, investors will forget the past, regain their faith and come back strong.

But a shadow still hangs over Wall Street. For the last year and a half, both government regulators and private attorneys have been investigating whether the go-go markets of recent years were steeped not just in excessive speculation but fraud, whether investment bankers and brokerage houses concealed conflicts of interest and deliberately manipulated stock prices. Did the biggest names on Wall Street violate the public trust?

MEL WEISS, Attorney: CS First Boston, Goldman Sachs, Morgan Stanley, Merrill Lynch- I mean, these are the biggest players. And that's what makes this so shocking, that it could infect even institutions of that size. These are revered institutions in Wall Street.

ARTHUR LEVITT, Former Chairman, SEC: A bubble environment 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 of excess, and it feeds upon itself.

    NEWSCASTER: This was generally a good day for investors-

NARRATOR: Just a couple of years ago, Americans sat mesmerized as the investment bank's stock analysts went on television and touted stock after stock after stock.

    HENRY BLODGET, CIBC Oppenheimer: AOL, Yahoo,

    ANTHONY NOTO, Goldman Sachs: EToys has really created a very strong brand awareness-

NARRATOR: It was Wall Street's version of a telethon.

    SASHA SALAMA, CNNfn: shot up today-

    BILL TUCKER, CNNfn: Looks like we're on track to hit a billion shares today.

    PETER JENNINGS, ABC News: Internet stocks drove a powerful surge on Wall Street today. The Dow-

NARRATOR: At the heart of it was the mad scramble by bankers and venture capitalists to take hundreds of unprofitable young Internet companies public.

    JAY HOAG, Technology Crossover Ventures: But I think the long opportunity really is to bring the customer interface to your doorstep.

    BETSY STARK, ABC News: Some say the Internet is so revolutionary that the usual roles for valuing a stock, such as revenues and earnings, no longer apply.

NARRATOR: Over and over again, scenes like this one would play out at the dot-coms. On the day their company's stock went public, employees would watch the value of their stock options soar, making paper millionaires out of many of them. Between 1990 and mid-2000, more than 4,700 new companies debuted on America's stock exchanges.

MIKE LEE, Venture Capitalist: The conclusion we came to, rightly or wrongly so, was that the Internet was going to fundamentally change the way business was run across the board, in every sector of business.

LISE BUYER, Former Stock Analyst: Everybody thought they could get rich quick, everybody across, from retail investor to investment bank. We had this period where money was growing on trees, which is totally cool while it's going on.

    ELOAN EXECUTIVE: We are now up to 34! The daily volume 3.7 million shares. We are almost a $2 billion company!

NARRATOR: This company, ELoan, opened at $14 a share and closed at $37, a first-day gain of 164 percent. As investors clamored for more, bankers - who make a hefty 7 percent fee on all the new public offerings they underwrite - eagerly trolled for new Internet companies.

MICHAEL BARACH, Former CEO, The day that we moved into our offices, we started getting calls from investment bankers inquiring as to what our thoughts were on raising additional capital or going public. This is before we had furniture. Literally, we had boxes for our desks, and we were sitting on the floor.

NARRATOR: Michael Barach was CEO of

MICHAEL BARACH: There was that level of buzz in the overall public markets at the time. And you laugh about it. You're sitting there with your box going, "Should I buy furniture, or should I talk to the investment banker about going public?"

BRIAN NESMITH, CEO, CacheFlow: Going public at that time, in my mind, is probably almost exactly the same as if I was raising a first or a second round of venture capital. There's a lot of unproven elements.

NARRATOR: Brian NeSmith was head of an Internet technology company called CacheFlow.

BRIAN NESMITH: I haven't proven that we can be profitable. I haven't proven that I can really grow the revenue. I don't have all the members of the management team. The product may even still have some technology issues that we have to validate. And effectively, the way I started to think of it is, we had millions of investors that started acting like venture capitalists, and they're not necessarily very smart ones. They don't do the due diligence. They don't do the fundamental work.

LISE BUYER, Former Stock Analyst: There were so many deals that went through during, you know, '99 and 2000. And the hardest part - for both sides, for bankers and analysts - the hardest part was that a lot of companies that looked like there was no there there, were getting out into the marketplace and going to the moon.

NARRATOR: It could be as simple as adding a ".com" to your name while making a few Internet-sized promises.

    SETH WERNER, As we like to say, one day we will touch every mortgage in America.

NARRATOR: When Seth Werner changed the name of his First Mortgage Network to and went on the Net, the estimated market value jumped from $100 to $800 million.

SETH WERNER, Former CEO, We went around to all of the underwriters, the largest underwriters in the country, the most prestigious by anybody's count. Every one of them was suggesting that this was a wonderful time to take a company like ours public.

NARRATOR: Helping taking companies public is one of the most profitable businesses investment banks have. And naturally, we wanted to talk to the investment bankers about the process. We called and we wrote lettersd, but Goldman Sachs, Credit Suisse First Boston, Bear Stearns, Merrill Lynch and Morgan Stanley all said that they didn't want to talk.

    [Morgan Stanley television commercial]

    ANNOUNCER: Trust. We are not born with-

NARRATOR: These institutions have been asking us to trust them for a long time.

    ANNOUNCER: Trust must be earned. Trust must be proven.

NARRATOR: But what has been obscured behind the veil of advertising rhetoric and images is how the nature of their business has changed.

    ANNOUNCER: And that is why we measure success one investor at a time.

JOE NOCERA, "Fortune" Magazine: When did things change? I can tell you the exact day it changed. The world changed on May 1, 1975, May Day, because that was that the day commissions were deregulated.

NARRATOR: Joe Nocera is an editor and writer at Fortune magazine.

JOE NOCERA: As commissions went down, suddenly, you had to find some other way to make money for the house.

NARRATOR: These institutions, once primarily thought of as brokerage houses, used to make their big profits by offering advice to clients on what stocks to buy or sell and then charging commissions on those transactions. But when deregulation forced commission rates to drop, they began to rely more on the money they made from investment banking. In the '80s, it was mergers and acquisitions.

Then in 1995, along came the Netscape initial public offering, or IPO. The company was less than 18 months old, had little revenue and no profits. Its debut would change everything.

JOE NOCERA: In 1995, Netscape goes public. It's the first big- it- nobody expects what happens at Netscape. It's the first big pop stock. It was just, "Whoa!" You know, "What was that all about?" And suddenly, if you're an investment bank, you realize that this is something that can be taken advantage of.

BILL HAMBRECHT, CEO, WR Hambrecht & Co., Investment Banker: It was very hard to justify the price of it on any rational economic benchmarks that you usually use.

NARRATOR: Bill Hambrecht was the one investment banker who did talk to FRONTLINE. He's an industry veteran who specializes in technology companies and was one of the bankers who took Netscape public.

BILL HAMBRECHT: There was this perception that, "Oh, boy. I've got to get into these early-stage Internet companies" because the first wave of early-stage Internet companies, starting with Netscape, did very well for customers.

NARRATOR: After Netscape, hundreds of new startups suddenly sprouted up in California's Silicon Valley, companies like Yahoo, Ebay and Excite. New companies are usually never profitable. But they usually aren't offered to the public until they are.

KARA SWISHER, "Wall Street Journal": Most companies in Silicon Valley used to take, you know, six or seven years of losses to finally go - to get to profitability, and then a little bit longer to go public. So there was- you know, there was a more measured quality of moving these companies into the public space.

NARRATOR: Kara Swisher writes a column for The Wall Street Journal and served as a consultant to FRONTLINE on this project.

KARA SWISHER: Presumably, the people that are in the public markets, they're buying fully-baked companies. And these weren't even- these weren't even in the oven for 10 minutes, these kind of things. They were not even close to being baked, and they were offering them up as cooked.

NARRATOR: In Silicon Valley, the investment banks have long relied on a group of venture capitalists, or VCs, to find and nurture the companies the banks would then bring public. After Netscape, a new class of more aggressive venture firms appeared. Jay Hoag founded Technology Crossover Ventures in 1995.

JAY HOAG, Technology Crossover Ventures: I think what Netscape triggered was a sense that you didn't have to be profitable to go public. But if you were growing fast enough, at some point in the future, you would- you know, you would grow into profitability. And you know, it unleashed a lot of different things, including huge numbers of IPOs, a really big up cycle in venture funding, and to some extent, some bad ideas.

NARRATOR: During the tech bubble, Hoag's firm, TCV, put up impressive returns, posting over 100 percent gains in their portfolios for several years running, one of the best investing records in Silicon Valley. In mid 2000, TCV was able to attract 1.6 billion investor dollars to form the largest technology venture capital fund in U.S. history. But unlike traditional venture firms that invest early in companies and bring them up slowly, TCV invested in many companies just months before their IPOs.

We asked Jay Hoag and his partner, Rick Kimball, if they now think it was appropriate to rush such young companies to market.

JAY HOAG: All these businesses that are losing money have to be financed. You have to go get money somewhere. At that point in time, what the market was saying was you should go get basically almost free capital, and in the process, go public. So as a board member, the decision would be very tough to not push a company toward an IPO.

NARRATOR: The problem was that many of the people who bought TCV-backed companies in the public markets - or as the insiders call it, the "aftermarket" - lost big.

KARA SWISHER: There was a banker taking a company public, a pretty prominent banker. And he sent me the prospectus for the company. And the company had no revenues. There was no money coming in. Like, they had no customers. And they were taking it public. And he said, "What do you think?" And I said, "I'm looking out my window, and there is a grandmother on the street with a- with a purse. And I bet if I go mugged her, we could go do it together right now, because that's what you're doing. You're mugging the public."

MARTIN SMITH, FRONTLINE: Do you believe there was inappropriate transference of risk to the public?

RICK KIMBALL, Technology Crossover Ventures: You know, I- we can't- words like "inappropriate," I- you know, I don't feel in a position to make a value judgment about what is, quote, "appropriate," versus what is- is inappropriate.

    [Credit Suisse First Boston television commercial]

    CABBIE: Where to, sir?

    PASSENGER: Airport.

NARRATOR: New companies kept going public, whether it was appropriate or not.

    PASSENGER: An IPO would really put us on the map.

NARRATOR: The process began with calling the bankers.

    PASSENGER: There are no trade-offs. Are we going to make it?

    CABBIE: Don't worry. We'll get you there.

MICHAEL BARACH, Former CEO, What you do is, you invite the bankers who've expressed interested in to talk to you at a board meeting. And they- they pitch their services. It's called a "bake-off." And so in- I believe it was June, we had a board meeting where we had a number of investments bankers who came in and pitched our board.

BRIAN NESMITH, CEO, CacheFlow: You're looking at past reputation. What position do they have in the investment community? What- how much are they willing to stand behind what they're doing in this environment? And a lot of it, too, is it's a name for you.

LISE BUYER, Former Stock Analyst: If it's a good, solid company with solid backers, you know, CSFB and Morgan Stanley and Goldman Sachs, they'll all want to take them public.

SETH WERNER, Former CEO, The top companies in the running for our consideration were Lehman Brothers, Merrill Lynch, Morgan Stanley, Goldman Sachs and CS First Boston.

NARRATOR: Once a bank is selected, the bankers take the company on a two-week whirlwind tour, visiting the big mutual funds and other big-money investors, making their pitches, lining up buyers for the IPO. It's called a "road show."

BRIAN NESMITH: The road show is just a repetitious repeat of the message that you're trying to help investors understand about the product. The bankers then take you out. And it's done as a very condensed event. It's anywhere from a two to a three-week process. We started in New York, then, you know, Boston, Philadelphia, Washington, Chicago, Minneapolis, Houston, Dallas, San Francisco, Los Angeles.

DAVID SIMINOFF, The Capital Group: And the poor company for two weeks is in meetings from 6:00 in the morning until 7:00 at night, back to back, you know, doing meetings with all these various institutional investors, pitching their story.

NARRATOR: David Siminoff is a money manager for The Capital Group, which oversees the American Funds, one of the largest mutual fund families in the world.

DAVID SIMINOFF: So what happens is a sales trader will call and say, you know, "I have an IPO that you ought to look at. And they're coming around," you know, April 7th. And they're going to be in San Francisco. Can you sit down and meet with them an hour and hear their story?"

MICHAEL BARACH: You could put me in front of a human being or a mannequin or a gorilla, [laughs] I was going to go through the same pitch. Of course, I had to be responsive to their questions, but I'm just there to sell. You know, pull the string and I'm selling.

BRIAN NESMITH: In the end, what CacheFlow wanted to get out of the IPO was a half dozen institutional investors that believe - believe in what you're doing, believe in the company, believe in the management team - and are not only going to be purchasing the IPO but are going to be long-term accumulators of the stock.

    WILLOW BAY, CNN "Moneyline": In tonight's "Moneyline Movers," CacheFlow up 102 and three eighths in its stock market debut. The networking equipment maker enjoyed one of the best opening days ever, the stock trading at five times its offering price.

NARRATOR: CacheFlow was a huge hit. And theirs remains one of the top 10 biggest first-day pops of all time.

    BRUCE FRANCIS, "Digital Jam": Akamai is Hawaiian for "cool," but investors-

NARRATOR: Hot IPOs became a staple of the technology telethon.

    BRUCE FRANCIS: Shares of the web technology company soared more than 450 percent-

    CNN REPORTER: -the stock that stole the show today. It is called Freemarket.

NARRATOR: The pops gave the companies publicity but not much more.

    CNN REPORTER: -came public today, selling shares to the public. And take a look at what this stock did, up 482 percent or so!

JOE NOCERA, "Fortune" Magazine: If the investment banks had been doing their job the way they were supposed to be doing, if they really had the best interests of their companies at heart, you would have never seen the situation where stocks- where IPOs go up 200, 300, 400 percent on the first day. I mean, that is a crime.

    STEVE YOUNG, "Digital Jam,": is the latest beneficiary of the Internet stock craze. Shares of the Internet commerce company debuted at $16. They closed at $69, a rise of over 330 percent.

JOE NOCERA: The famous case is, which I believe went up over 500 percent on the first day. And it was, like, "Oh, my God. Look at that! Look at that!"

    CNN REPORTER: Earthweb was up 379 percent and, which only traded one day, gained 606 percent on the week!

JOE NOCERA: What is the reason you have an IPO? It's to put money in the coffers of the company. That's the reason you do it. When you have a situation where it's going up 300 percent on the first day, that's 300 percent that the company is not getting.

    WILLOW BAY, CNN "Moneyline": The of drugstores went public today in the latest smashing Net debut. nearly tripled in price.

NARRATOR: Individual investors did not benefit much from these big pops, either. That's because almost all of the IPO shares had already been allocated to big mutual and hedge fund investors during the road show.

    CNN REPORTER: Shares of the online pharmacy exploded on their debut trading day-

NARRATOR: Then, when the stocks skyrocketed, the institutional managers sold immediately. It was called "flipping."

DAVID SIMINOFF: In a four-year period, I saw over 500 IPOs. We probably owned 200 or 250 of them for 10 minutes, many of them for 10 minutes, you know, where they would- at $8 or $10 a share, you thought, "O.K., I can understand how this can compound at 20 percent a year if they hit their target." But when the first print of the IPO was $95, it was very easy to sell.

KARA SWISHER, "Wall Street Journal": You get them for $15 dollars, and they go up to a $126, and you sell them. And of course, everybody wanted them because it was a sure thing. There was no way you could lose money because every time one of these companies went public, they- they shot up by, you know, 500, 600, 700 percent. So really there was no way to lose money.

[ Take a closer look at the IPO game]

BRIAN NESMITH, CEO, CacheFlow: The great majority of the people that we saw on the road show bought the stock at the IPO and flipped it that same day or flipped it within a couple weeks.

NARRATOR: Silicon Valley's undisputed king of IPOs was banker Frank Quattrone. His star rose while at Morgan Stanley, where in 1995 he made IPO history when he took Netscape public. He was one of the first Wall Street bankers to set up an office in Silicon Valley, and he made big impression.

KARA SWISHER: He was sort of this larger-than-life figure in the Valley who had some huge successes and was considered sort outrageous and opinionated and aggressive and sort of swashbuckling. He has that swashbuckling reputation.

SUSAN PULLIAM, "Wall Street Journal":: I think he really identified much more with the Silicon Valley entrepreneur than his investment banking cohorts back in New York.

NARRATOR: Quattrone declined to speak with FRONTLINE, but Wall Street Journal reporters Susan Pulliam and Randall Smith have followed Quattrone's career from the early days at Morgan Stanley to Credit Suisse First Boston.

RANDALL SMITH, "Wall Street Journal": The thing that distinguished First Boston here is that they- they did have the foresight to hire the best technology banker in the business just before this enormous boom in technology stock issues. And it- it literally took the firm from being an also-ran in stock underwriting to the very top in the rankings. But the thing that people come back to most often when they talk about Frank Quattrone is control, that he's a control freak and wants to be involved in every step of the process.

KARA SWISHER: The people at Morgan and Goldman had more of a conservative air, and Frank had more of- like a venture capitalist himself. He has kind of a big personality. I mean, you don't- it's not about CSFB, it's about Frank Quattrone.

NARRATOR: By 1998, Quattrone had taken more companies public than any other investment banker in the Valley. He relied on a select group of venture capitalists to feed him young companies, and he treated them to a piece of the action in order to encourage them to keep the deals coming. In the Valley, they were called "friends of Frank."

RANDALL SMITH:: Being a friend of Frank involved being either a venture capital executive or an executive of a company that was about to go public or was public or just- just the technology executives. But one of the perks of being a friend of Frank was you got to invest in some of his deals or, you know, in some cases, all of his deals.

MARTIN SMITH: What does that mean, "You got to invest in his deals"? Anybody can invest in his deals. Or not?

RANDALL SMITH:: Well, no. I mean, I think, in order to get- you and I, if we went to our broker and tried to get an IPO allocation, would be told, "Gee," you know, "maybe or probably not." But the- and a- but a hedge fund that would generate a lot of commissions might have a chance to get an IPO allocation. And similarly, part of the process of being a client of Credit Suisse First Boston was that would have a better shot at getting shares of some of these IPOs that were skyrocketing in price.

MARTIN SMITH: Can you give an example of that?

RANDALL SMITH:: Well, I- I- you know, VA Linux clearly is a case where some- one of Frank's best clients, Jay Hoag of TCV - Technology Crossover Ventures - got 50,000 shares, which is a pretty large allocation.

NARRATOR: Jay Hoag's venture firm, Technology Crossover Ventures, received its share allocation on December 9th, 1999. Although TCV had not funded VA Linux, Hoag was the kind of regular supplier of hot companies Quattrone wanted to favor. VA Linux's IPO was a rocket.

    SASHA SALAMA, CNNfn: VA Linux, LNUX, is up again this morning in pre-market trading.

NARRATOR: The allocation gave TCV's franchise hedge fund the right to buy 50,000 shares of VA Linux at the offering price.

    SASHA SALAMA: This stock came public yesterday at $30 a share. And now it's at $262, according to Instinet.

NARRATOR: As it turned out, VA Linux posted the biggest first-day gain in Wall Street history. TCV invested $1.5 million. At the end of the first day of trading, the value of TCV's allocation was just short of $12 million.

BILL HAMBRECHT, Investment Banker: Suddenly, you get this huge surge, where the stock leaps seven times, creates $1 billion or $1.2 billion of market value. That's profit to the person who got the IPO allocation. And if you trace it out, I think you'll find anything that goes that high, almost all of it is flipped because it just doesn't make sense almost not to.

So effectively, the underwriter parceled out $1.2 billion of guaranteed profit to his clients. That's- that's quite a- you know, as you can imagine, that's a very nice thing to happen.

MICHAEL BARACH, Former CEO, It's like legalized bribery. It's favor-building. It's like taking someone out to lunch and paying for their meal. And that's OK, but if you gave me a yacht, that would probably not be OK.

NARRATOR: Hoag has refused to talk specifically about the VA Linux deal, but he defends the IPO allocation process.

JAY HOAG, Technology Crossover Ventures: The specific allocation of how IPOs happens is the investment bank's business. Why we, you know, have been allocated shares- again, we have an ongoing- you know, we're generating trading commissions because of the- because of the franchise fund with a whole variety of investment banks. So in some cases, we don't get IPO allocations because they say, "Now," you know, "based on the criteria we're making for allocations, you're not big enough to warrant it." In other cases, where we're an important- perhaps, you know, generating trading commissions or other things, we do.

RICK KIMBALL, Technology Crossover Ventures: People tend to focus on the period where it seemed, right, like every IPO was going up 100 or 200 percent. We can tell you, many times, including the very first IPO that TCV was involved with - a little company called Saville [sp?] Systems, where, we placed- we placed our order for the IPO and got our IPO shares and watched the stock drop- watched the stock drop 20 percent in, you know, about an hour and a half.

NARRATOR: But at TCV, that rarely happened. According to Fortune magazine, TCV lost money on only 2 of 76 companies it invested in between 1995 and '99. In some cases, privileged investors, like TCV, were given the option to buy into an IPO allocation even after the stock had started trading up.

MICHAEL BARACH: In one case in particular, I can remember getting a call toward the end of the first day of trading for a company. They had priced the IPO at $13. It was trading- you could look at your Quotron screen and say it was trading at $40. And you get a call from the investment banker, saying, "Would you look 5,000 shares of this company?" Hello? It's-

MARTIN SMITH: At what price?

MICHAEL BARACH: Well, at $13. You can buy it because they still haven't-there's still this allocation, this stock, this IPO stock that isn't fully allocated yet, so you can buy it at $13, when it's selling right there on your Quotron at $42.

MARTIN SMITH: So the investment banker has offered you free money.

MICHAEL BARACH: You get a call. Absolutely. And you can sell it and flip it right then and there.

BILL HAMBRECHT: I think underwriters' economic agendas started to determine who would get the stock. Instead of a situation where you're hired as an underwriter to place the stock with people who are going to be the long-term shareholder, when you get into volatile hot markets where you get this unusual first-day trading profit, there's a tremendous propensity to give that stock to your best clients. And they, in turn, sell it and take a quick profit. And then the long-term buyer, the guy who you want in the first place, ends up buying it at the volatile aftermarket price.

And it happens only when you get into these really hot markets. But it also creates an atmosphere where an underwriter's sales force is, in effect, giving away guaranteed profit. And if you're giving away guaranteed profit, you probably, at some point in the food chain, are going to have some deal made that returns something to the underwriters.

NARRATOR: By mid-1999 it was common knowledge among insiders on Wall Street that some banks had begun taking what could be called kickbacks from some mutual and hedge fund investors in return for hot IPO stock allocations. But in the midst of the frenzy, there was no one yet willing to blow a whistle. Too many people were getting rich.

We asked former SEC chairman, Arthur Levitt, to comment on a hypothetical case.

MARTIN SMITH: If a large mutual fund is receiving an allocation in an IPO on the understanding that they will make certain purchases or pay higher commissions in the aftermarket, is that a serious violation?

ARTHUR LEVITT, Former Chairman, SEC: I think if the- hypothetically, if that investor - that recipient of an IPO - was required to pay extraordinary commissions on a non-related transaction or required to make specific aftermarket purchases, I believe that, hypothetically, you could consider that a manipulative action.

MARTIN SMITH: That manipulates the price of a stock.


MARTIN SMITH: It could manipulate the price of a stock. The intention is to manipulate the price of a stock.


MARTIN SMITH: I would assume that that's the intention, is to manipulate the price of a stock upwards, and finally dump it to the public, and all the insiders get out.

ARTHUR LEVITT: I wouldn't comment on that.

MARTIN SMITH: But I wouldn't be too far off base to guess that that's- would be the result?

ARTHUR LEVITT: It's a possibility, on a hypothetical instance.

    CNBC ANNOUNCER: Only one network truly covers the financial markets around the globe.

NARRATOR: Once an IPO is issued, the stock starts trading on the so-called aftermarket. To ordinary public investors, it's their first chance to buy in.

    CNBC ANNOUNCER: -every day with analysts and reporters stationed around the globe.

NARRATOR: This is where the bank's stock analysts and the media play a vital role.

    CNBC ANNOUNCER: The world leader in business news. It's CNBC. Profit from it.

LISE BUYER, Former Stock Analyst: If you are the investment banker for a company, I think it's 30 days- or 25 days after the company goes public, your obligation is to put out a research report saying, "Here's what this company does. Here's how I valued it. Here's what I think of it."

NARRATOR: Analysts would often appear on TV, and Lise Buyer admits they were under pressure to issue positive news to keep their clients happy. Here she is, touting, a company that her bank, CSFB, had taken public.

    LISE BUYER: [CNNfn] Little, a much smaller company, is working very hard on downloading products to consumers. That will be a big deal. Small today, but watch it going forward.

If your firm has done banking work for a client, it's understood that the analyst is not going to come out and say, "Bad idea. Stay away from this."

    HENRY BLODGET, CIBC Oppenheimer:: Over the last several years and quarters, they've trended upwards. So if you can stand the volatility, they're good stocks to own.

NARRATOR: The more sway an analyst had, the bigger the pressure.

LISE BUYER: Some of the bigger stars were cheerleaders, not analysts. And it didn't- 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 troublesome.

    CNNfn REPORTER: And in today's "Stock Picks" segment, Internet analyst Scott Ehrens from Bear Stearns-

NARRATOR: Positive recommendations could have a dramatic effect. When Bear Stearns took software company Digital River public, the bank's Internet analyst, Scott Ehrens, issued a "buy," and the stock rose 500 percent over the next three months. Later he reiterated his buy on CNN.

    SCOTT EHRENS, Former Stock Analyst, Bear Stearns: And I like Digital River because I think its an undiscovered e-commerce name that's-

NARRATOR: Many who lost money in the markets now believe that analysts like Ehrens should have revealed that his bank, Bear Stearns, had taken Digital River public and had an interest in keeping the stock pumped up.

    SCOTT EHRENS: I think it's relatively undiscovered and has a great management team, and I expect it to be a big success.

NARRATOR: Analysts rarely ever issued "sells." Ehrens's bank, Bear Stearns, has issued sells in less than 1 percent of its recommendations.

MARTIN SMITH: Why do you never use a sell recommendation?

SCOTT EHRENS: I wouldn't say- I mean, I don't think it's true to say that people never used a sell recommendation.

MARTIN SMITH: Well, why did they rarely ever use a sell recommendation?

SCOTT EHRENS: Because I guess they rarely thought that you should be selling the stock. They thought that maybe it was a longer-term hold.

MARTIN SMITH: Did it have to do with a feeling that a sell recommendation would possibly do too much damage to the company? Was that a factor?

SCOTT EHRENS: Can you be more specific?

MARTIN SMITH: You couldn't issue a sell. I mean, Bear Stearns just wouldn't allow you-

SCOTT EHRENS: Oh, sure they would. People issued sells. I mean, have you- have you looked at-

MARTIN SMITH: But you said the neutral was the lowest that you gave, so I-

SCOTT EHRENS: That I gave. That was the lowest that I gave.

MARTIN SMITH: So why wouldn't you issue a sell?

SCOTT EHRENS: I didn't put too much thought into it.

[ More on analysis, IPOs and the media]

JOE NOCERA, "Fortune" Magazine: The problem for the public is that they don't understand how analysts get paid. And so they- they think that the analyst is sort of on their side, kind of 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, you know, analysts get paid on the basis of how many deals 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 and everything to do with bringing IPOs public, which makes a huge amount for the firm and which makes a huge amount for the sort of investing professional insiders who get these deals.

    ARTHUR LEVITT, Former Chairman, SEC: [Speech at Boston College] In many respects, a culture of gamesmanship has taken root in the financial community, making it difficult to tell salesmanship from honest advice.

NARRATOR: Chairman of the Securities and Exchange Commission Arthur Levitt made stock analysts and television a major focus of his public statements.

    ARTHUR LEVITT: A lot of analysts that we see on television recommending stocks work for firms that have business relationships with the same companies that the analysts cover. And some of these analysts paychecks' are typically tied to the performance of their employers. One can only imagine how unpopular an analyst would be who downgrades his firm's best client.

NARRATOR: At one point, Levitt sent an SEC staffer to talk to the producers of the major money shows about the issue of analysts' recommendations.

ARTHUR LEVITT: 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 disclosure we're getting from analysts in both print and electronic media is incomplete and inadequate.

NARRATOR: In spite of hand-wringing and concern from regulators, the markets continued on their way to record heights.

    WILLOW BAY, CNN "Moneyline": First, more on our top story. NASDAQ 5000. America's favorite stock index closed above five K for the first time today after-

BRIAN NESMITH: The euphoria- where it started and who started exactly what is a debatable point. But once the circle started spinning, everybody fed it. You know, the public market investors did. The venture capitalists did. The bankers did. The companies that are involved in it did. Everybody got caught up into the feeding frenzy. I was a part of it, and I'm sure if you were a purchaser of stock in that market, you were caught up into it.

    CNBC REPORTER: Who's making money? Brian NeSmith, CEO of CacheFlow. Shares of the network equipment maker shot up nearly $14 after Credit Suisse First Boston raised its price target and repeated a buy rating on the stock. That put its one-day gain on paper at more than $29 million.

BILL HAMBRECHT, Investment Banker: The kind of valuations that were going on and the kind of trading that was happening in the public markets- it really is- it's really fueled by what you would call the "greater fool" theory. In other words, there has to be a greater fool than you that buys it, or the whole thing collapses. Well, ultimately, you run out of greater fools,

    BRIAN WILLIAMS, NBC News: After what they are already calling "black Friday," they are counting up the damage on Wall street tonight-

NARRATOR: In the spring of 2000, the stampede reversed.

    BRIAN WILLIAMS: -and sent the Dow and the NASDAQ plummeting. It was the worst single day point loss ever for both exchanges.

BRIAN NESMITH, CEO, CacheFlow: Some person or some groups of people - and I think it was mainly the large institutional investors - stood up and said, "No. I'm not putting another $100 million in this company because you've not made any progress to getting profitable." And once that happened, that spilled back into those companies, who stopped purchasing equipment from suppliers like us or from other companies, who then- our revenue started to go down, and it all happened very quickly.

    [ television commercial]

    ANNOUNCER: At, we're constantly checking our products, like gingko biloba, a natural herb from China used to enhance memory.

NARRATOR: MotherNature fell along with everyone else. Their stock had dropped to under $2 by April of 2000.

MICHAEL BARACH, Former CEO, We started to believe- management started to believe that we were not going to easily recover, and we should operate the business differently. We should stop spending so much money. We were on TV at that time. We were burning money at $8 million a month.

    ANNOUNCER: Over here, they're checking out Maca, a Peruvian herb that's said to enhance mail virility.

    MEN: Good morning, Mother Nature!

MICHAEL BARACH: We were a wonderful cash-burning machine. So the first thing we did- we just decided to cut our marketing spending. And so we just stopped the cash burn.

    RON INSANA, CNBC: The dot-com failures continue to mount, especially-

NARRATOR: Throughout the remainder of the year, by fits and starts, the market continued to decline.

    RON INSANA: The company announced today it's laying off 518 people or 84 percent-

NARRATOR: New business orders dried up.

    RON INSANA: Technology stocks got trounced on a day of uncertainty-

BRIAN NESMITH: As soon as one person called "Stop," you know, it's- there was so much momentum built up, it just- just came apart.

    CNBC REPORTER: Who's losing money? Brian NeSmith. He's the CEO of CacheFlow. Shares of the Internet appliance provider got hammered today, losing over 10 points after Bear Stearns issued some cautious comments on the stock, citing slowing shipments. His one-day loss on paper was nearly 23 million bucks.

NARRATOR: At MotherNature, they were quickly learning that all their assumptions about the Internet were wrong.

MICHAEL BARACH: Now, in the direct marketing business - which is what a B-to-C company is - the only metric that works here is what's called "lifetime customer value." For the average customer you get, what do they spend the first time? What percent come back and buy? What do they spend the second time? What does it cost to service each of those transactions? And to do this analysis, you need a lot of data.

NARRATOR: The team spent days crunching numbers.

MICHAEL BARACH: We concluded that our lifetime customer value, given the data so far, was only about $10. In other words, we could not be a profitable company unless we could acquire a customer for less than $10. And at the time, it was costing us $60 to $80 to get a customer. And that was a very sobering conclusion.

And the whole theory of e-commerce, the whole theory was that on-line customers would be valuable. You'd get these customers, and they would be worth a lot, so you could afford to spend- you could afford to spend a lot of money to get them. And what we realized - and I think we were one of the first to realize it - was that, gee, they're not that valuable.

NARRATOR: Less than a year after opening, MotherNature closed its doors, in November of 2000.

In the aftermath of the collapse, everyone is second-guessing. At one point in 1999, had been offered a buy-out offer from Internet financial company Intuit, an offer Credit Suisse advised CEO Seth Werner to turn down. Werner says he is now sorry he listened to his bankers.

SETH WERNER, Former CEO, The fact is that they make more money doing an IPO and your becoming a company in their stable of companies that they've taken public than if they just do a one-time fairness opinion, and then you're now a subsidiary of another public company.

NARRATOR: Just before the IPO, Warner wrote a two-page email to his board of directors.

"'s management is unanimous in wanting to pursue the Intuit deal. The VCs," he noted, "are undoubtedly anxious to maximize the returns on their investment by going public."

SETH WERNER: At one point in time, TCV - and I don't remember who it was, whether it was Jay or Tom - said to me, "We have done this on numerous occasions. We have made a lot of money for ourselves and our shareholders. We know what we're doing. The public- as opposed to taking this price, we should do the IPO." And that's basically the message I got from all three of the venture capital companies. I should have been more forceful in the process of getting them to accept those five million shares and move on.

MIKE LEE, Venture Capitalist: In hindsight, we should have sold the company rather than go public.

MARTIN SMITH: Is this a story of greed?

MIKE LEE: Absolutely. Yeah, but that is the definition of venture capital.

MARTIN SMITH: You'd better elaborate on that.

MIKE LEE: [laughs] Isn't it? Well, I mean, the- I mean, that's- we- we- our goal is to get the biggest return possible from every company we invest in.

NARRATOR: This is what is left of today: hundreds of boxes of paper stored in a warehouse just north of Miami. One of the attorneys suing on behalf of creditors and investors says wasn't just about greed. He says the VCs and the bank, Credit Suisse First Boston, pursued an IPO while intentionally misrepresenting the company's history and its financial situation.

SAM BURSTYN, Attorney: The fact is that their conduct as fiduciaries must be judged based on what choices they made and what they did after there was no Intuit deal. And what they did was, instead of scaling this thing properly, trying to run a business, they concealed information, manipulated financial information and, against the advice of their internal financial people, pawned this off on to the public. Well, what's the justification for that, "The devil made me do it"?

NARRATOR: Two months after's IPO, Jay Hoag of Technology Crossover Ventures was a guest on Louis Rukeyser's Wall Street Week on PBS. Hoag stated that was among TCV's favorites.

    JAY HOAG, Technology Crossover Ventures: In the business-to-consumer area, we're very high on both Autoweb and These are literally companies serving trillion-dollar markets, enormous opportunity.

NARRATOR: According to Sam Burstyn, Hoag should have known better, and Burstyn has filed suit against TCV, as well as CS First Boston. He says the insiders were simply looking for a way to keep the stock value up until they could get their money out. Hoag and CS First Boston do not want to discuss today.

SAM BURSTYN: One of the lessons that the public has to learn is that the fact that an investment banker is underwriting a public offering does not mean that it's a sound investment, and indeed, often means that it's not a sound investment, but that the IPO is merely an exit strategy for the insiders.

TOM TEW, Attorney: Underwriters traditionally looked very carefully at building a business that would last. You would get it up to a sustainable level, and it would be built. That philosophy was gone in the tech revolution.

NARRATOR: In the 1980s, attorney Tom Tew successfully sued Michael Milken and his firm Drexel Burnham Lambert for using spurious junk bonds to raise capital for Wall Street. Now he is among those attorneys suing Credit Suisse First Boston for how it handled the IPO. He sees distinct similarities between the IPO market of the '90s and the junk bond market of the '80s.

TOM TEW: And what you saw in that phenomenon is early on, there were probably a lot of good companies. Then there was a rush to replicate that. Drexel needed more and more product because once you set up that engine, the salesmen, the people out on the street, they're all starting to rely on that distribution, and which is all generated by fees. At some point, you get to a point when the good deals are not separated from the bad deals. And I think you might find, in this dot-comedy that we went through, once the mechanism for those IPOs were set up, it was, like, stamping them out to keep everybody eating and making a lot of money.

Now, that's not to say that a lot of them weren't good deals. A lot of the junk bond deals turned out to be good deals. But as the thing progressed and more momentum is there, there was a lot of money chasing bad deals, and there weren't that many good deals.

NARRATOR: In June of 2001, under pressure from private and government investigations, CS First Boston fired three of its bankers and its CEO. All denied wrongdoing. Then in December, 2001, the Justice Department dropped its criminal investigation of CS First Boston. But the bank has agreed - without admitting they did anything wrong - to pay a $100 million fine to the SEC, the fifth largest in SEC history. Meanwhile, the SEC continues to investigate other banks.

[ Experts' views on the investigations]

SAM BURSTYN, Attorney: The public needs to realize really two things. One, that these people are not promoting the public's interest in any of these transactions. But two, if they rely on them, and the information is false or was recklessly provided, they have recourse. They sue the bastards.

NARRATOR: Mel Weiss is a Manhattan attorney who has filed 110 lawsuits against scores of companies and seven leading investment banks.

MEL WEISS, Attorney: We're dealing with a market manipulation by the investment banking community. And that's the scary thing, that the investment banking community that has a fiduciary responsibility and a statutory responsibility to protect the customer is actually in creating the artificiality in the market.

BILL HAMBRECHT, Investment Banker: The only way you can ever take the possible excesses out of the system is to have a non-preferential way of allocating the stock. It's got to be fair. It's got to be open. And in that way, you get rid of the kind of things that sneak into a system where you have preferential allocation. That's why we came up with the auction.

NARRATOR: Hambrecht calls it a "Dutch auction." Put the IPO on the Internet and let any adn all buyers post their bids.

BILL HAMBRECHT: We go out to the world and say, "Here's company X. How many shares do you want, and what are you willing to pay?" If we want to sell a million shares, we start at the highest-priced bid and count down to the millionth share. And that millionth share becomes the clearing price for the transaction. In other words, everybody who bid the clearing price or higher gets the stock they bid for at the clearing price.

NARRATOR: But at the height of the bubble, Hambrecht's idea got a cool reception.

JAY HOAG, Technology Crossover Ventures: Is there an opportunity for a new way of doing IPOs, you know, intellectually? Sure. It doesn't appear that the Dutch auction has gotten a huge amount of traction yet.

LISE BUYER, Former Stock Analyst: Dutch auctions make a great deal of sense theoretically, right? Everybody pays what they're willing to pay, and that's how you parse out the stocks. But it didn't play well in an environment where people wanted that marketing news, right? You don't get- there is no headline that says, you know, "XYZ Corp trades up 90 percent on its first day" if there's a Dutch auction.

MICHAEL BARACH, Former CEO, When we were looking to go public, we considered that. We thought it was conceptually a beautiful solution. But we were led to believe that the institutions would not support our stock. So if we did that, if we went the Hambrecht method, we would not get any institutional support.

BILL HAMBRECHT: There wasn't anybody, truly, that really wanted to listen to us. I kind of felt like the designated driver at a New Year's Eve party. You'd come in and say, "Hey, guys," you know, "this isn't going to turn out well." And their reaction was, "What could be better than this? I sell my stock at 10 and it goes to 100, and everybody's rich. And who's lost? And isn't this a wonderful thing?"

[ Read the interview]

    DOUG ATKIN, Instinet: All right. All right! Good morning, good afternoon and good evening, depending where you are.

NARRATOR: For now, most companies are reluctant to break ranks with Wall Street.

    DOUG ATKIN: The Dutch auction was incorporated into the Instinet offering. As you all know, 17.5 percent of the shares were-

NARRATOR: As a kind of experiment in underwriting, Instinet, the electronic brokerage company, decided to split its IPO between Hambrecht and a traditional underwriter, Credit Suisse First Boston.

    DOUG ATKIN: -bringing continued innovations into the marketplace, which is something this company stands for. And I know Bill Hambrecht has really lead the charge in that vision. And we'd like to thank Bill, as a partner-

NARRATOR: Instinet opened at 14 a share and closed at 17.65.

    DOUG ATKIN: -both very well together. This is the first time that retail investors who bid 14.50 or higher are guaranteed an allocation in shares.

NARRATOR: In the post-bubble environment, this IPO was considered a success and proof that the Dutch auction process could work. But without the IPO allocation favor bank, the process strikes fear in the hearts of traditional bankers.

BILL HAMBRECHT: The ultimate leverage is being able to include somebody or exclude them from an offering that he thinks is attractive. That's the leverage that people fight to keep. That's the- at the very base of a lot of these firms is that leverage of allocation.

The whole implication of the Internet is bringing transparency and a level playing field to marketplaces. This is- this is what it's all about. And I think the big firms understand that, I mean, they- and ultimately know, that no matter how they want to fight to keep a cozy kind of relationship and to keep transparency out of the marketplace, it just isn't going to happen. Somebody is going to bring transparency to this marketplace.

NARRATOR: But Hambrecht may be overly optimistic about Wall Street's willingness to change. The IPO explosion of recent years generated a feeding frenzy worth billions to Wall Street's banks. Very few people who work here believe the system needs fixing.

JOSEPH NOCERA, "Fortune" Magazine: You know, democratization has been going on in this country, financially, since the '70s. And people do have a lot more information than they used to and they can make better decisions, and they can trade stocks more easily. Now, all that is true. But if this thing- if this- if this- if the events of Internet mania prove anything, they prove that Wall Street is still a club and that insiders still have an enormous advantage over the rest of us. And all the technology and all the democratization has simply not been able to trump that one fact.


Martin Smith

Sarah Silver

Ben Gold

Will Lyman

Kara Swisher

Ben McCoy
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Ray Day
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Michael H. Amundson

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A FRONTLINE coproduction with Rain Media, Inc.

© 2002

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