by John M. Curtis
(310) 204-8700

Copyright June 14, 2001
All Rights Reserved.

onflicts of interest, biased reports, and a lack of oversight, cast alarming doubt over the legitimacy of Wall St.’s practices. When the tech-bubble burst in Spring 2000 many investors held onto coveted tech-stocks, believing analysts’ “buy” or “strong buy” recommendations. Even as late as June 2001, with the Nasdaq down nearly 70% from its peak in February 2000, 67% of analysts maintained “buy” or “strong buy” on companies worth ten cents on the dollar. With more than half of America investing in the stock market, analysts’ reports are essential for sound financial planning. But with so many brokerages performing their own investment banking—sponsoring publicly traded companies—growing doubts over stock investing leave many investors on the sidelines. Now holding congressional hearings, Rep. Richard H. Baker (R-LA), chairman of the House Financial Services subcommittee on capital markets, promised to get to the bottom of “grade inflation,” leading analysts to rate “hold” when, in fact, investors should “get out now.”

       Amid growing criticism, brokerage firms have voluntarily set guidelines allowing analysts greater objectivity in rating companies. While it’s a good start, it’s too late for countless investors watching their portfolios go down the tubes. Brokerage houses frequently point to disclaimers, cautioning investors that “the stock market is risky” or “past performance is no guarantee of future results.” But what does that have to do with analysts’ ratings? When the FDA approves certain drugs—including the deadly diabetic drug Rezulin, pulled from the market in March 2000—it posts warnings to physicians. Before banning Rezulin, the head of the FDA’s prestigious drug approval unit Janet Woodcock told doctors: “If physicians felt the drug was dangerous, they shouldn’t have prescribed it.” How cavalier is that? What’s the purpose of watchdog agencies like the FDA, other than protecting consumers? When it comes to financial health, federal agencies like the Securities and Exchange Commission also have obligations to investors. Allowing analysts to hype stocks when companies are at death’s door is scandalous.

       Celebrated analysts like Merrill Lynch’s Henry Blodget and Morgan Stanley’s Marry Meeker hyped tech-stocks as “strong buys” before, during and after the meltdown in March 2000. According to First Call/Thomson Capital, tracking over 25,000 analyst recommendations by the disastrous end to 2000, only 1.5% specified “sell” ratings. Surely, disciplined analysts are ahead of the curve reviewing companies vitals—at least enough to warn investors of potential insolvency. Now under investigation, the SEC is finally looking into the shoddy practices leading investors to lose billions during the latest market downturn. Even the New York attorney general’s office announced that it’s looking into analysts’ conflicts of interest—including taking stock options for delivering favorable ratings. With the Sony Pictures’ fraudulent movie review scandal still in the headlines, investors are more suspicious than ever about deceptive advertising. While wasting $8 dollars for a lousy movie is small potatoes, investing retirements and lifesavings into toothless companies is no laughing matter.

       Brokerage houses have consistently sold investors on the idea of “long-term” investing. They argue, over time, that it’s impossible to time the market, namely, buying on dips and selling on spikes. But fund managers frequently move in and out of shares daily, making their profits by selling high and buying low. Average investors, though, don’t have the luxury of day trading. When bull markets evaporate, long-term investors typically recoup losses by holding on, unless, of course, companies go broke. When the latest tech-bubble burst, the hardest hit were the dot.coms—those Internet companies hopelessly dependent on market capitalization for cash flow. Thanks to Alan Greenspan, the rug was pulled out from underneath the fledgling dot.com industry, eventually taking down the entire tech-rich Nasdaq. As the Fed chokes credit by hiking interest rates, it’s just a matter of time before equity markets collapse. Regardless of overly zealous analysts, unprofitable companies usually go under when bear markets occur. Brokerage houses and analysts certainly can’t be blamed for that. But they must be held accountable for recommending shaky companies as “strong buys.”

       When the good times roll, oversight agencies—like the SEC—usually relax standards because no one’s complaining. With billions going up in smoke, it’s easy for angry investors to point fingers at analysts and brokers. Yes, there’s no doubt that analysts must be independent enough to give dispassionate ratings. Yes, conflicts of interest prevent analysts from issuing unequivocal “sell” ratings on companies with whom they have financial ties. But, in all fairness, bull markets have a funny way of papering over cracks when frenetic buying produces abundant cash-flow. Despite the ratings, analysts contend that insolvent companies would have survived had the bull market kept going. It’s well known that most businesses fail from under-capitalization. Pointing fingers only at analysts totally ignores investment bankers who took companies public. Companies with dubious business models, little chance of profitability, and only capable of generating revenue though selling stock, shouldn’t have gone public in the first place. In the euphoria of a bull market, it’s easy for the SEC to turn a blind eye to otherwise unsound businesses.

       Wall St.’s dirty little secret involves the SEC’s lack of oversight, untrustworthy analyst reports, and, of course, the cavalcade of players lining their pockets at the expense of clueless investors. When everyone’s making money, few people scrutinize the “due diligence” needed to safeguard eventual investors. Like the FDA, the SEC also has a critical role in protecting the financial health of consumers investing in publicly traded companies. Relaxing standards, glaring conflicts of interest and pushing unworthy companies public invites unnecessary financial risk. If companies aren’t profitable from the get-go, the SEC shouldn’t approve Initial Public Offerings. Approving companies on speculative earnings invites the kind of bankruptcies harming investors and giving the stock market a black eye. Instead of blaming analysts, the SEC should turn the spotlight on itself and admit its lax standards for approving IPOs. No matter what direction the market turns, the SEC shouldn’t allow flimsy companies to go public.

About the Author

John M. Curtis is editor of OnlineColumnist.com and columnist for the Los Angeles Daily Journal. He’s director of a Los Angeles think tank specializing in political consulting and strategic public relations. He’s the author of Dodging The Bullet and Operation Charisma.

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