In "Dot Con," award-winning FRONTLINE producer Martin Smith takes an inside look at the precipitous rise and fall of the Internet economy -- and examines the allegations that brokers at some of Wall Street's most prestigious firms manipulated the hot IPO market of the late 1990s. Wall Street, of course, would prefer to forget the past. But investors and investigators want to know: During the headiest days of the Internet bubble, did investment banks and venture capitalists betray the public's trust? Did "irrational exuberance" give way to fraud?
"CS First Boston, Goldman Sachs, Morgan Stanley, Merrill Lynch -- I mean, these are the biggest players," Manhattan attorney Mel Weiss tells FRONTLINE. "We're dealing with a market manipulation by the investment banking community."
The Securities and Exchange Commission (SEC) has already announced that the investment banking firm Credit Suisse First Boston (CSFB) -- far and away the leader in hot technology IPOs during the late 1990s thanks to its flamboyant chief technology banker, Frank Quattrone -- has agreed to pay $100 million (without admitting or denying any wrongdoing) to settle the SEC's investigation into its IPO allocation practices. It's the fifth largest settlement in SEC history -- and the regulators aren't finished. The SEC is still looking into IPO practices at other investment banks, and CSFB and other Wall Street firms face an onslaught of class-action suits brought by investors who claim they were harmed by the way IPOs were handled.
How did Wall Street get to this point? What drove the dotcom IPO mania of the late 1990s? These are the questions this FRONTLINE report explores, through interviews with leading Silicon Valley venture capitalists, dotcom entrepreneurs, Wall Street analysts, the former chairman of the SEC, class-action litigators, journalists at The Wall Street Journal and Fortune magazine, and a veteran investment banker who offers an intriguing alternative to Wall Street's traditional way of handling IPOs.
The documentary traces the rise of the bubble from the day in August 1995 when a young company called Netscape Communications went public. As everyone knows by now, Netscape had developed an exciting new type of software product known as a Web browser, which allowed users to easily navigate the still-nascent World Wide Web. Within a few hours of the market's opening on Aug. 9, 1995, Netscape's stock shot from $28 to $75 per share, closing at $58.25 at the end of its first day of trading. It was an historic -- and prophetic -- moment on Wall Street.
"Nobody expects what happens at Netscape," says Joe Nocera, executive editor at Fortune magazine. "It's the first great Internet stock. It was just, 'Whoa! 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."
"I think what Netscape triggered was a sense that you didn't have to be profitable to go public," says Jay Hoag of Technology Crossover Ventures, one of Silicon Valley's most successful -- and aggressive -- venture capital firms. "But if you were growing fast enough, at some point in the future you would grow into profitability. And it unleashed a lot of different things, including a huge number of IPOs, a really big up-cycle in venture funding, and to some extent, some bad ideas."
FRONTLINE asked Hoag and his partner Rick Kimball if they now think it was appropriate to rush such young companies to market. Was there an inappropriate transfer of risk -- risk that the venture capitalist usually assumes -- to the investing public? "You know," says Kimball, "words like 'inappropriate,' I don't feel in a position to make a value judgment about what is, quote, 'appropriate,' versus what is 'inappropriate.'"
New companies kept going public whether it was appropriate or not.
FRONTLINE goes on to tell the story of how the investment banks -- and the Silicon Valley venture capital firms that fed Wall Street a seemingly endless stream of dotcom startups -- took advantage of investors' willingness to gamble on these young, unproven companies. It's a story that raises fundamental questions about American capitalism, about how our financial markets operate, and about what the Internet and the "new economy" are supposed to promise.
"A bubble environment," former SEC Chairman Arthur Levitt tells FRONTLINE, "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."
At least one Wall Street insider sees a need to address the excesses, and abuses, of the status quo. Bill Hambrecht -- the only investment banker who would speak to FRONTLINE during the making of "Dot Con" -- has developed an innovative online IPO using a "Dutch auction" model. He argues that by doing away with Wall Street's traditional method of allocating IPO shares only to its best and biggest customers, the Dutch auction offers both more transparency and a more equitable outcome for investors and the companies going public. But the response to Hambrecht's method during the bubble, even though it had been proven to work, was lukewarm. Wall Street's big players don't want to give up the leverage of IPO allocations, and a company going public tends to prefer a prestigious name-brand Wall Street underwriter on the cover of its prospectus.
"[During the bubble] there wasn't anybody who truly wanted to listen to us," says Hambrecht. "I kind of felt like the designated driver at a New Year's Eve party, to come in and say, 'Hey, guys, 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 is rich, and who's lost?'"
But Hambrecht maintains that the system has to change. "The whole implication of the Internet is bringing transparency and a level playing field to marketplaces. And I think the big firms understand that. ... Somebody is going to bring transparency to this marketplace."
Not everyone is so optimistic, however, about Wall Street's willingness to change. "If the events of Internet mania proved anything," says Joe Nocera, "they proved that Wall Street is still a club, and that insiders still have 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."
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