The Star Analyst Years

This is the first in an occasional series about the decades of the 1990s and 2000s, when so much about the investment business changed.

In the early 1980s, inflation and interest rates were sky high and stocks were in the doldrums.  In the years that followed, the forces of disinflation, globalization, the internet, and the democratization of finance led to a boom on Wall Street.

During that time, sell-side analysts became household names.  Before then, to the extent that anyone outside of the investment world even knew about those analysts, they were mostly thought to be numbers nerds, poring over financial statements to analyze companies for investment.

That image would change as the bull market grew stronger.  While most analysts would still be anonymous to the public, some of them would become famous, wield great influence, and have paydays that were extraordinary.  Not just because of those forces providing the tailwinds for higher prices, but because of new ways of doing business on the Street.

Three analysts — Mary Meeker, Jack Grubman, and Henry Blodget — came to typify the era.

Changes in the game

In his book, Blood on the Street, Charles Gasparino tells the story of that time through the careers of those analysts.  They were the biggest names and most prominent examples of how investment banking came to dominate research.  At the height of their powers, Meeker was at Morgan Stanley, Blodget at Merrill Lynch, and Grubman at Salomon Smith Barney, but all of the major firms tried to cash in on the bonanza, cutting corners in the process.

It’s not that there wasn’t pressure on research from banking before that, but the balance of power was such that conflicts were more limited.  Sometimes an analyst would be brought “over the wall” — the so-called “Chinese wall” that kept investment banking and research apart — but over time that wall started to crumble.  Firms saw that research could drive investment banking business (where the really big money was, leading initial public offerings or advising on mergers).  The way to win that business was to have a star analyst who would promote the stocks of companies who would be generating those big fees — those already public and those who were going to be doing an IPO.  They all wanted the blessing of the hottest analysts around.

The analysts got involved in more and more aspects of the banking business.  During the hectic years of the dot-com bubble, Blodget told Merrill Lynch that he was having a hard time producing research on the rapidly expanding stable of companies, despite working very long hours.  He estimated that banking-related activities were taking up 85% of his time.  Meeker’s self-evaluation from 1999 illustrates the emphasis on dealmaking in her job.

As the roles of the analysts kept expanding, it seemed like they were everywhere, selling the promise of a changing world to companies and investors alike.

Here’s Gasparino on Meeker’s involvement in the famous (and famously disastrous) AOL Time Warner merger:

She was one of the key players in pitching the deal to TimeWarner’s board of directors, giving a rousing speech that heralded the vision of AOL’s CEO, Steve Case, a man she compared to legendary Time Inc. founder Henry Luce.

Analysts became sounding boards for CEOs — for the companies that they were supposed to be objectively analyzing.  They would travel together on “road shows” to see institutional investors (some of whom got preferential treatment and better information).  Research reports often would be sent to companies in advance, supposedly for fact checking, but with banking business on the line, it amounted to approval.  Plus, the investment banks engaged in “spinning” — awarding shares in other hot IPOs to CEOs to line their pockets and curry favor with them.  (Gasparino wrote that Goldman Sachs “perfected the practice.”)

The conferences put on by the analysts were described as rock concerts, where they were the stars along with the CEOs that they lauded.  Their every recommendation seemed to move the prices of stocks — with the research reports often accompanied by catchy titles (such as Meeker’s “Yahoo, Yippee, Cowabunga . . .”), new-fangled metrics, and bold predictions, like Blodget’s fabled $400 price target on Amazon.com.

The press

The attention received by the analysts drove the banking business (and stock trading), so the firms tried to get them all the press they could.  Grubman, Blodget, Meeker, and others received fawning coverage from CNBC, an ever-expanding number of market-related magazines trying to cash in on the bull market, and the major newspapers.

Grubman got the front-page treatment from the Wall Street Journal, in a piece titled “The Jack of All Trades; For Salomon, Grubman Is a Big Telecom Rainmaker.”  Meeker was on the cover of Barron’s as the “Queen of the Net” (and was profiled in the New Yorker).  Blodget was all over financial television — some eighty times in 1999 alone.

But then came the year 2000, when the air went out of the bubble and the coverage started to change.

The May 15 issue of BusinessWeek had a cover story on Grubman: “The Power Broker: From his Wall Street perch, Jack Grubman is reshaping telecom and stirring up controversy.”  Gasparino wrote that the magazine “scored a major scoop by exposing Grubman as a fabulist, a man who would make up almost any story, concoct almost any lie to get ahead.”  In many respects, his backstory wasn’t as had been advertised.

The article was also one of the first public reveals of the real workings of Wall Street.  When asked about whether he was objective enough in his research, Grubman said, “What used to be a conflict is now a synergy,” disparaging those who clung to the old ways as “uninformed,” lacking his inside knowledge.

As time went on and the stocks kept going down, the press got worse.  At the end of the year, the headline on a Gretchen Morgenson column in the New York Times asked, “How Did So Many Get It So Wrong?”  She wrote that “investing veterans say that the quality of Wall Street research has sunk to new lows . . . the result of shifting economics in the brokerage business that have pushed many researchers to put their firms’ relationships with the companies they follow ahead of investors.”

That was a view that was getting increased attention from the regulatory authorities (who had been asleep on the job) and the investing public.  The brokers who did whatever the star analysts of their firm had told them to do tired of dealing with clients that had large losses.  They turned on the analysts, just like the media turned on them, in a replay of the age-old cycle of adulation and revulsion of prophets — from GOAT to goat.

In May 2001, Fortune did a spread on the conflicts in investment research.  Meeker was on the cover, which read, “Can We Ever Trust Wall Street Again?”

In November, the iconic stipple drawings of the three faces of the boom and bust appeared in the the Wall Street Journal together.  The article, “Rock Stars of Wall Street Lose Luster Amid Slump,” read like a eulogy:

They were the rock stars of Wall Street — but now they’re out of tune, and in some cases, out of gigs.

Big-name stock-research analysts have always been well-known among the legions of professional Wall Street investors, but in the past few years, they have also become celebrities.  They were paid princely sums.  They were regulars on TV and on magazine covers.  Followers hung on their every word.

No more.

Grubman

Of the three analysts, Grubman comes off the worst in Gasparino’s book and in the other accounts of the times.  His relationships with many of the firms he covered went beyond even the loosened norms of the day, especially in regards to WorldCom.  The stock was a huge success at first, but ultimately a colossal failure, ending up in bankruptcy, with CEO Bernie Ebbers going to jail.  Grubman was a master promoter of it, but not a master analyst of it.

He made so much money for his firm that he could get by with things that others couldn’t.  His wife was able to open an investment account at another firm, which was otherwise prohibited.  He finagled Wall Street legend Sandy Weill into making a million-dollar donation to the 92nd Street Y so that Grubman’s twins could go to preschool there.  In exchange, Grubman upgraded AT&T stock (which he hadn’t liked) in advance of a deal; Weill sat on its board.

Investigations by the regulators included discovery of thousands of emails from Wall Street firms.  They illustrated the conflicts in the business model, and included examples of contrasting opinions from analysts about firms that they followed:  glowing public statements and private disparagements.  An embarrassment of a different kind was revealed when Grubman’s emails included salacious entreaties from an institutional investor who had a romantic interest in him, who fed his ego and his animus toward other analysts (one in particular).

The settlement

The last third of Gasparino’s book deals with the regulatory back-and-forth that culminated in the Global Settlement.  It was an agreement between five regulatory bodies and ten investment banks over conflicts of interest in investment research.  (Two additional firms were added at a later date.)  In addition, it included settlements with two analysts, Grubman and Blodget.  They paid fines and disgorged some previous earnings — and were permanently barred from associating with a broker, dealer, or investment advisor.  (Meeker was not charged and stayed at Morgan Stanley until 2010.)

Every frothy era on Wall Street seems to be marked by excesses that are then addressed by new rules, with the violators promising that it will never happen again.  And it might not, at least not in the same way, but the cycle is bound to repeat.  It always does.

In the wake of the reinforced standards brought on by the settlement, many top analysts decamped to hedge funds and other organizations.  There are influential analysts with sway on the Street today, but it’s nothing like it had been.

Conflicts continue to exist.  While the pressure isn’t as overt as it once was, investment bankers and company CEOs are still interested in seeing positive ratings on stocks.  After the settlement, firms modestly increased the number of sell recommendations (from almost zero during the boom years), but they have declined again after that bump.

Despite everything that happened, the research business is still biased toward promoting stocks.  That’s what makes the world go ’round.