06/28/2001
60 Minutes II Interviews Tom Brown- former DLJ Analyst
SCOTT PELLEY, co-anchor:
Since we first broadcast this story, both Congress and the New York state attorney general have launched investigations into stock market analysts and the bad advice that cost investors a fortune when the market tumbled. The Nasdaq lost nearly 40 percent of its value last year. In all, about $1.5 trillion in investments were wiped out. A lot of that money was lost following the advice of stock analysts, the experts who work for big brokerage houses. Think of them as the prophets of Wall Street. They analyze a company, look into the future, and recommend whether to buy the stock. Investors hung on their every word during the technology boom, but there was something about the analysts most investors didn't know. Some of the high-profile analysts worked for firms that stood to make a fortune on the stocks they recommended. A lot of their advice made their firms rich, not you. Listen to what a former analyst told us in January about Wall Street's prophets and your losses.
Mr. TOM BROWN (Former Analyst): I don't know, frankly, how some of these analysts live with themselves. I couldn't get up in the morning and look in the mirror and s--and know that I just caused somebody to lose 50 percent of their retirement money because I exaggerated and I lied. And that's exactly what I saw at DLJ.
(Footage of Tom Brown in an office; DLJ building)
PELLEY: (Voiceover) Tom Brown worked at the Wall Street firm DLJ, Donaldson, Lufkin & Jenrette, for seven years. He was a top banking analyst, with a reputation for blunt honesty. Brown says he recalls a DLJ meeting where an analyst explained to the group that their job was to make the stocks they represented look good.
They actually said that in a meeting of analysts at Donaldson, Lufkin & Jenrette?
Mr. BROWN: The line was, `You have to understand, "Forgive me, Father, for I have sinned,"' because the--the point of that was that you were going to have to go back to the sales force after having lied to them and tell them that you were wrong.
PELLEY: If there is pressure to lie, it stems from a very simple conflict of interest.
Wall Street's major brokerage houses make about 70 percent of their profits from what's called investment banking--simply put, that's raising money for companies that need cash. Here's an example. When Pets.com needed money, it went to one of its bankers, Merrill Lynch. Merrill Lynch offered Pets.com stock for sale to the public, and the higher the price of the stock, the more money the brokerage would make. Now imagine what that analyst is going to tell the public about a stock his firm is trying to sell.
Mr. BROWN: They literally are cheerleaders because even if you're--this company that you're working on is not a client of the firm, every company's a potential client, so the investment banking group wants you to be wildly bullish about everybody.
(Footage of board showing companies and their stock prices; study document; Morgan Stanley internal memo; Priceline.com Web page; Mary Meeker; chart indicating Priceline's stock performance)
PELLEY: (Voiceover) Meaning that if there's bad news about a stock, you're not likely to hear it from the analyst. This 1999 study from Dartmouth College and Cornell University says analysts show `significant evidence of bias' when they recommend stocks that are handled by their firm. The study points to this internal memo from brokerage house Morgan Stanley. It tells analysts, quote, "...we do not make negative or controversial comments about our clients..." Morgan has since disavowed that memo, but just look at a recent example of one of the firm's clients, Priceline.com. Morgan made millions in fees raising money for Priceline. Morgan's analyst, Mary Meeker, seen here on CNBC, recommended buying Priceline's stock at $134 a share. When it fell to $78, she repeated her buy recommendation and she kept recommending Priceline as it fell to less than $3.
Are analysts free to be critical of clients of the firm?
Mr. BROWN: I don't think analysts are so free since I was fired for being critical of not only clients but potential clients of the firm.
PELLEY: How did you come to be fired?
Mr. BROWN: Well, in my case I was very critical, in the 1995 to 1998 time frame, of the merger and acquisition activity that was taking place among the largest banks. I frankly thought they were paying too much and that they were using unrealistic assumptions and that shareholders were going to be hurt.
(Footage of Brown in an office; a letter)
PELLEY: (Voiceover) Brown says he was fired because the banks he criticized stopped doing business with DLJ. The company told us that Brown was fired because of, quote, "...his persistent inability to operate effectively within a team infrastructure..." The company insisted that there is a separation between investment banking and analysts, and it says that its analysts are encouraged to be candid.
Do you think the average investor has been hoodwinked in all of this?
Mr. BROWN: I do.
(Footage of building in New York City; Wall Street sign; company document; Arthur Levitt)
PELLEY: (Voiceover) The brokerage firms disagree. They say that analysts do disclose their conflicts of interest in every research report. So we checked. Here's an example. It's that paragraph of small print, right there at the bottom of the page. Obscure disclosures like these concern Arthur Levitt. He was chairman of the Securities and Exchange Commission when we interviewed him. He enforced the law on Wall Street.
Mr. ARTHUR LEVITT (Chairman, Securities and Exchange Commission): I think the analyst has a responsibility to reveal a conflict of interest. And that's something that the commission is urging upon the stock exchange: To see to it that their rules are changed in a way which will force analysts to reveal conflicts.
PELLEY: You think Wall Street, in this instance, can police itself?
Mr. LEVITT: Yes, I do. There's got to be much greater disclosure of the kinds of conflicts that are part of today's market.
PELLEY: Is it dishonest?
Mr. LEVITT: I'd say that it's less than moral.
(Footage of stock exchange activity)
PELLEY: (Voiceover) One result of these conflicts was the inflation of so-called target prices, an analyst's prediction of how high a stock would go. In the wildly speculative Internet market, analysts set high-flying targets with little connection to a company's real worth.
Is it appropriate for an analyst to set a target price for a stock, to say, `I believe the stock's going to go here'?
Mr. LEVITT: That's been a practice for as long as we've had analysts, and I think if investors are prepared to take that at face value, they have to be prepared for the consequences.
(Footage of Amazon.com Web page; chart showing Amazon's stock price; from CNBC's "Squawk Box"; Merrill Lynch building; Amazon's Web page; Wall Street; Liz Buyer)
PELLEY: (Voiceover) Like the consequences for investors in Amazon.com. Amazon was selling for about $243 a share when a little known analyst named Henry Blodget, who had no conflict of interest, predicted that it would go to $400, even though Amazon had never made a profit. Incredibly, it did go to $400 and beyond. Great for Blodget, but not so good for investors, many of whom got soaked when Amazon's value fell 75 percent. Blodget has said that his prediction was based on sound analysis using new ways to measure a company's performance. Wall Street created a new verb for it: `to blodget a stock.' Liz Buyer is a former Internet analyst who says experienced hands on Wall Street couldn't make sense of these soaring target prices.
Ms. LIZ BUYER (Former Analyst): Those of us who'd been in the business awhile looked at some of these wild targets that people were putting out there, and our jaws dropped. And then we watched the stocks follow suit.
PELLEY: Did Amazon go to 400 because Henry Blodget said it would, or did it go to 400 because that's what the market demanded?
Ms. BUYER: Isn't that the--the key question? I think in the market that we had over the past couple of years, Amazon went to 400 because Henry said it would. It was analysts proclaiming what stocks would do, not analyzing what the businesses said they should do.
(Footage of taping of program; "Squawk Box")
PELLEY: (Voiceover) Especially if they said it on television. One of the big differences in this stock market frenzy was the success of cable business channels. The shows needed guests, so the analysts became TV stars.
Mr. MARK HAINES (Host, "Squawk Box"): Welcome back to CNBC "Squawk Box." I'm Mark Haines.
PELLEY: (Voiceover) Many appear on CNBC's "Squawk Box," hosted by Mark Haines.
Mr. HAINES: A stock would be recommended by the guest sitting next to me, and I'd look down at the--at the quote machine, and all of a sudden it had jump 5 bucks or 10 bucks or whatever.
(Footage of New York Stock Exchange building; CNBC taping set)
PELLEY: (Voiceover) Because thousands of people new to investing were watching the analysts with no idea that a conflict of interest might exist on the stocks they were recommending. CNBC now requires that guests reveal conflicts before they appear.
Mr. HAINES: (Voiceover) One of the problems is when CNBC started 10 years ago, had a relatively small audience that was almost entirely professional.
There was no need to point out these relationships because the--our viewers knew about them. OK?
PELLEY: The pros on Wall Street knew.
Mr. HAINES: The pros knew. As time went by, the so-called democratization of the market occurred, and as--and the--as the audience broadened, more and more people were coming to this not knowing the rules.
PELLEY: And one of the rules that many analysts live by is never say sell, because that would drive down the price of the stock. When we first reported this story, there were about 8,000 analyst stock recommendations before the public. How many of those were recommendations to sell? Twenty-nine out of 8,000. That's less than 1/2 of 1 percent.
Ms. BUYER: You rarely see sell. It angers management, it doesn't help institu--institutional investing clients, and it makes a lot of people very hostile at you. So what you say instead is, `We're downgrading this to a hold and believe it promising for those with a three- to five-year investment horizon,' which for those in the know means, `See ya.'
PELLEY: But that's just the point. The guy at home, the guy trading on his PC in his kitchen, isn't a guy in the know.
Ms. BUYER: Yes.
(Footage of trading floor)
PELLEY: (Voiceover) And not even a company's imminent collapse could force analysts to say sell.
(Excerpt from Pet.com commercial; Merrill Lynch corporate headquarters; Pets.com's stock chart; "Squawk Box"; Pets.com's stock price at 1/8)
PELLEY: (Voiceover) Take Pets.com. Almost a third of Pets' financing was raised by Merrill Lynch. Merrill made millions. Henry Blodget, by then Merrill's analyst, made a buy recommendation at $16. When it fell to $7, Blodget said buy; again, a buy at $2 and again at $1.69. When it hit $1.43, Blodget told investors to accumulate, whatever that means. Pets is now a dog, literally kicked off the stock exchange.
Mr. HAINES: We had an analyst downgrade a stock the other day that's at 50 cents. Well, if it's already down to 50 cents, what's the point of selling it? You've already lost all your money. You might as well hang on. Maybe it'll come back a little.
(Footage of a trading floor; Blodget; Meeker; Merrill Lynch document; letter with excerpt, "We maintain a strict separation of the (investment) banking and research functions within the firm. Our research is objective, and has a long term focus...")
PELLEY: (Voiceover) Investors may have lost a fortune, but last year Blodget and Meeker were reportedly paid about $15 million each. Both analysts declined requests for interviews. Merrill Lynch, Blodget's firm, did send us an e-mail saying its `analysts make independent recommendations based upon their best judgments.' Mary Meeker at Morgan Stanley sent us a statement, saying in part, `We maintain a strict separation of the investment banking and research functions within the firm. Our research is objective, and has long-term focus.'
There were subtleties to this game...
Ms. BUYER: Yes.
PELLEY: ...that people didn't understand.
Ms. BUYER: Yes, there were. Yes, there were. Should the individual feel badly about some of that? Yes. On the other hand, no one ever said anywhere that stocks were a risk-free game.
(Footage of Buyer)
PELLEY: (Voiceover) Liz Buyer, the former Internet analyst, defends most of her colleagues.
Ms. BUYER: I do not think that 99 percent of the analysts out there have ever intentionally misled anyone.
(Footage from "Squawk Box"; NASDAQ information tower)
PELLEY: (Voiceover) And Mark Haines says that investors ignored warnings, even when there were clear indications that a company was vulnerable.
Mr. HAINES: We would invite on the CEOs and we would interview them, and we would say, `Do you have any patents?' And they'd say no. Well--and, `Would it be hard for me to go into business to compete with you?' And they'd say no.
PELLEY: Do you have any cash flow?
Mr. HAINES: `Do you have any cash?' `No.' And I'd look down and the stock would be up $40. It didn't make any difference to--to people. You would point out the risks, you would point out how crazy it was. There was a mania going on out there where people were just throwing money. And they--you c--if you had grabbed them by the lapels and shaken them and pointed out the risks, it didn't make any difference.
(Footage of Haines on "Squawk Box")
PELLEY: (Voiceover) And, Haines says, investors didn't listen when he pointed out an analyst's conflict of interest on the air.
Mr. HAINES: It was put right in their face and they pulled the lever on the slot machine anyway.
PELLEY: Didn't want to hear it.
Mr. HAINES: Yeah, because greed overcomes the fear.
(Footage of Brown in an office; aerial view of New York)
PELLEY: (Voiceover) Last year, Tom Brown started his own investment company. Brown decided to leave the analyst game altogether because he says there's too much pressure to be dishonest. DLJ offered Brown the usual severance deal when it fired him, but he refused because it required him to keep quiet.
Any regrets?
Mr. BROWN: No, I have no regrets, though DLJ offered me $400,000 to not say anything.
PELLEY: To shut up.
Mr. BROWN: To shut up.
PELLEY: To not do this interview?
Mr. BROWN: Yeah.
PELLEY: To not tell people what you knew?
Mr. BROWN: Right. And I decided in August of '98 that it was worth more for my pride to be able to--to shout it from the mountaintop that something was wrong and tell them to keep the $400,000.
PELLEY: Since we broadcast our report, the securities industry said it would regulate itself with voluntary guidelines, including better disclosure of potential conflicts. But Congress is not sure that's enough. A House subcommittee on financial services started hearings two weeks ago to consider whether the law should be changed to protect investors.
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