Congress getting into analyst blame game

"Are there some problems? Yeah, but analysts didn't cause the economy to tank," said Chuck Hill, Boston-based director of research for First Call. "They contributed to the Internet bubble...but I wouldn't say that they're responsible for people losing all this money."

The hearings before the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises will focus on "across-the-board grade inflation," according to a spokesman for U.S. Rep. Richard H. Baker, R-La., chairman of the subcommittee. The hearing will also cover the potential conflicts of interest between ostensibly objective research analysts and the underwriting divisions of the investment banks that employ them.

The hearing and resulting research or legislation--if any--could have a significant effect on the technology sector. The industry fueled a historic stock market bubble in the late 1990s, and bullish technology analysts--particularly Merrill Lynch's Henry Blodget and Morgan Stanley's Mary Meeker--became media icons.

Even in the downturn, most researchers continued to publish upbeat notes urging investors to buy stocks. A correction in April 2000, which caused some stocks to lose one-third or more of their value in a few weeks, persuaded few analysts to reverse their positive calls.

Despite the steep decline in tech stocks and the Nasdaq, fewer than 2 percent of stocks tracked by First Call have the equivalent of a "sell" rating, said First Call research associate Steve Rigo.

Feeling duped, angry investors have been busy penning complaints to their congressmen. Now Congress is investigating how to rein in the analysts. The New York attorney general's office has also been investigating possible conflicts of interest among analysts.

The potential conflict stems from the close ties between the analysts, who are supposed to take an unbiased view of stocks and provide neutral recommendations to investors, and the underwriting division, which is supposed to find promising companies and promote their stocks on Wall Street. Although the groups are technically separate, most firms have analysts who cover the very companies the bankers are promoting, and the analysts' compensation is tied closely to how those stocks fare.

Although companies are required to disclose potential conflicts, current disclosures "may be so incomprehensible that (they are) tantamount to no disclosure at all," Baker said.

At least one brokerage house has taken steps to alleviate the appearance of impropriety; Prudential Securities recently announced that it would no longer lead initial public offerings and streamlined its rating system for stocks.

Analysts who became multimillionaires and television stars during the boom are only the latest party to sit in the hot seat of the stock meltdown. Other groups--from venture capitalists to investment bankers to greedy investors themselves--have also come under attack as historians search for reasons for the stock market implosion.

A Merrill Lynch spokesman said the company did not want to comment on the congressional hearings, and calls to Morgan Stanley were not immediately returned.

There were early naysayers among the analysts, notably U.S. Bancorp Piper Jaffray's Ashok Kumar and Ravi Suria, formerly a convertible-bond analyst for Lehman Brothers and now an officer at Duquesne Capital Management, who issued early warnings that stocks such as Intel and Amazon.com were overvalued.

Some traders say they stopped listening to analysts long ago, the first time they were burned by a "buy" rating on a stock that tanked.

"We discredited them even back then, in the bubble," said Tim McAdams, president of San Jose, Calif.-based Pacific Day Trading. "A lot of traders got their hands slapped, and then they didn't pay attention to those guys after that. The analysts went from the penthouse to the outhouse in 20 minutes...Unfortunately, the very amateur players got burned because they never stopped listening to them."

But it's unclear whether the congressional investigation is too little, too late. In the year after the initial crash, investors--including first-time stock market players who digested analyst reports as gospel--lost billions of dollars. Lawrence Haverty Jr., senior vice president of State Street Research, said the stock market losses for AOL, Yahoo and Amazon alone erased $300 billion in market capitalization between March 2000 and February 2001.

Better late than never, politicians say.

"A big part of the reason why it's come into focus (now) is that the market's falling. With the fall, people look around and try to figure out why this happened, and who's to blame," said James Spellman, spokesman for the Securities Industry Association. "When the tide lowers, it exposes all the debris on the ocean floor."

The SIA is working on a set of guidelines that would allow analysts to regulate themselves and will release a set of "best practices," he said. The group plans to release the plan Tuesday, but it will not be enforceable by fines, incentives or government mandates.

The hearing Thursday promises to be a bitter pill for Wall Street. Scheduled presenters include Thomas A. Bowman, who leads the Association of Investment Management and Research; Benjamin Mark Cole, author of "The Pied Pipers of Wall Street: How Analysts Sell You Down the River"; and Mark E. Lackritz, president of the Securities Industry Association.

Prominent analysts did not receive invitations to the hearing, but they are likely to monitor the event closely. A source close to Baker said that the congressman's office had considered inviting some of the more high-profile analysts, but they were unable to attend because of legal considerations. Baker's subcommittee does have subpoena power, but he "wasn't interested in starting off that forcefully."

"The subcommittee will inquire into the relative degree of erosion in the 'Chinese wall' that has traditionally shielded analysts from the influence of investment banking interests," Baker said in a statement. "Of special concern will be whether individual investors receive fair and ethical treatment by the new market arrangement, and whether steps should be taken to rebuild both the barriers that shield analysts from conflicts and the trust of individual investors."