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Analysts in the hot seat
Enron analysts were grilled during a Senate hearing. But can Congress really change Wall Street?
February 27, 2002: 6:37 p.m. ET
By Staff Writer Paul R. La Monica

graphic NEW YORK (CNN/Money) - Wall Street analysts seem to be almost as good at spin doctoring as politicians are.

During a Senate hearing on Wednesday, four analysts had to explain how they could remain bullish on Enron throughout its fall from grace -- even after all the allegations of accounting improprieties came to light.

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And the analysts stuck to their guns, trying to push off the blame on Enron whenever possible. Antatol Feygin, the analyst who followed Enron for J.P. Morgan Chase, said the accuracy of public information is important for any analyst to do his job effectively. Ray Niles of Salomon Smith Barney said that a company's public financial information is the "bedrock" of sound analysis. In other words, "Don't blame us. We're not the ones cooking the books."

But the senators weren't about to let it go at that (just consider the title of the hearing -- "The Watchdogs Didn't Bark: Enron and the Wall Street Analysts"). And they were quick to point out a string of gaffes made by the analysts after it became painfully obvious that Enron was in a lot of trouble:

  • Feygin did downgrade Enron on Oct. 24, but it was simply from a "buy" to a "long-term buy." And that was eight days after the company announced that it would write down more than $1 billion in investments and two days after Enron disclosed that it was the subject of an SEC probe.

  • Niles actually reiterated a "buy" rating the day the SEC probe was announced and finally downgraded Enron from buy to neutral on October 26, two days after then CFO Andrew Fastow was fired and a day after Standard & Poor's downgraded Enron's credit outlook to negative.

  • Following a conference call on Oct. 24, Richard Gross from Lehman Brothers wrote in a research report that Enron gave an "inadequate defense of its balance sheet" during the call. Despite that indictment, he still maintained a "strong buy" rating on the stock.

    To a man, the analysts (Credit Suisse First Boston's Curt Launer was the other one to appear before the panel) stressed that their integrity and independence was crucial and that they were never pressured by investment bankers to keep saying positive things.

    The senators on the panel, which included the former CEO of Franklin Covey, Sen. Robert Bennett (R-Utah), and a former stockbroker, Sen. Jim Bunning (R-Ky.), weren't buying it. Sen. Bunning was particularly skeptical of some the analysts' claims about not knowing whether or not their employers owned stock in Enron or other companies they covered.

    Can Congress rebuild the Chinese Wall?

    The only problem, however, is that harsh words from senators or even legislation might not really fix anything. Two other witnesses -- Howard Schilit, president of the independent research firm Center for Financial Research & Analysis, and Chuck Hill, director of financial research for Thomson Financial/First Call -- testified that nothing would change with Wall Street analysis unless the so-called "Chinese Wall" separating research and investment bankers is rebuilt.

    The National Association of Securities Dealers recently proposed new regulations for analysts, including more disclosure of what stocks an analyst owns, as well as a ban on compensation tied to investment banking deals.

    But even if analysts don't get explicitly rewarded for helping to land an investment banking client, it's hard to imagine a wave of more skeptical research from these analysts as long as their employers are still doing investment banking work. The investment banks would not want to anger their customers.

    And should politicians really be the ones telling analysts how to do their jobs? Sen. Bennett, pointing to a CSFB report that showed a stock chart picturing Enron in free-fall, instructed analysts to not "buck the trend." He seemed incredulous that analysts could possibly continue to recommend a stock as a "buy" even when the stock is falling.

    In the case of Enron, the fact that Wall Street analysts refused to change their ratings even as the company was clearly on a collision course with bankruptcy is inexcusable.

    But in defense of analysts, simply recommending stocks with positive momentum and telling people not to buy stocks that are falling is not exactly legitimate fundamental analysis.

    It isn't illegal to be wrong

    Sen. George Voinovich (R-Ohio) said in his opening remarks that he didn't think there was anyone in the room who hadn't made an investment decision based on an analyst's recommendation. Perhaps that's the biggest problem.

    Instead of complaining about the conflicts of interest on Wall Street as if this were a new phenomenon, the best way for investors to not get burned by bad recommendations from Wall Street analysts is probably to simply not take them all that seriously in the first place.

    It's no secret that Wall Street analysts are more willing to recommend stocks than tell people to sell them. But even when you get past that fact, there's one other issue that Congress cannot do anything about. Stock picking isn't easy and even analysts with no conflicts of interest can make a bad call. Even Bennett admitted as much.

    "There is no way that Congress or anyone can prevent people from being wrong," he said. graphic

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