The real culprit in the analyst scandal
Eliot Spitzer nailed the investment banks -- but what about the companies that bullied them?
By Bethany McLean, FORTUNE senior writer

NEW YORK (FORTUNE) - It was over three years ago that the analyst scandal of the late, great bull market of the 1990s reached its denouement, when Wall Street firms agreed to pay $1.4 billion to settle charges from Eliot Spitzer that their research misled investors.

The hero was Spitzer, and the villains were the craven analysts and the investment bankers who bullied them into issuing sunny reports. If that's the story line, you might well believe that Spitzer's settlement, by pretty much forbidding one side to have anything to do with the other, fixed research.

But actually, the real culprit in all of this has gone unpunished. The real culprit, of course, is corporate America. After all, it is corporations who told investment bankers that they wouldn't get any business unless their firm's analyst told investors to buy the stock -- the investment bankers only cared because the companies cared.

Spitzer's reforms have made it difficult for companies to exert that particular form of leverage. But never fear: They have others.

Indeed, over the last few years, the worry about the ways in which companies punish non-sycophants has been growing. According to a memo written by Richard Colby, the deputy director of the SEC's division of market regulation, the agency did an informal survey of brokers, and concluded that retaliation by companies -- as well as by others including large investors and venture capitalists -- "continues to be a problem."

In fact, six of the firms the SEC talked to said it was an issue. (Three did not.) The memo cited a laundry list of well-known tactics including limits on participation in company events and conference calls, access to management, intimidation and humiliation, and threats of litigation.

Some incidents have made the press. Gretchen Morgenson wrote a story for the New York Times about how Digital River, which provides ecommerce solutions, sent a bullying message to an analyst who had expressed negative views. "I expect we'll be seeing you in the papers under the heading 'white collar criminal,'" wrote the CEO, Joel Ronning.

Then, there's, which filed a lawsuit against a shortseller, Rocker Partners, and an independent research firm, Gradient Analytics, alleging that the two conspired to drive down Overstock's share price -- despite the fact that Overstock's financial results have repeatedly failed to meet targets.

In a press release, Gradient writes that this case "is about the rights of investors to obtain information enabling them to make better investment decisions. Gradient will not be intimidated by those who don't like our opinions and who want to strangle any and all negative comments with contentious litigation..." ( argues that the case is not about free speech, but rather "unlawful conduct.")

A court will eventually rule who's right, but some said that the suit has already had a chilling effect on small research firms -- most of whom don't have the financial resources to risk a lawsuit.

In a letter raising the issue of retaliation last spring to the SEC, George Kramer, the acting general counsel of the Securities Industry Association, wrote that tactics have "run the gamut from the subtle (refusing to take an analyst's questions during a conference call, or denying an analyst the same access to senior management that is accorded the analyst's peers) to the blunt (threatening to withdraw management of an employee 401(k) account or other business from the analyst's employer unless the analyst's coverage becomes more positive. In some cases, we understand that analysts and their firms have been threatened with defamation litigation.)"

There are other, more subtle ways in which companies try to silence critics. Some companies -- MBIA among them -- won't take questions on their conference calls from skeptical analysts. Others won't allow those who might short their stock -- ie, hedge funds -- to meet with management.

The head of research at a major firm says that this it's not uncommon for hedge fund analysts to be blackballed from company meetings at conferences. And companies are often supported in this by "long-only investors" -- such as most mutual funds, which cannot take short positions -- who will also refuse to participate in a meeting in which a hedge fund is present.

You'd think that there if there were a bearish thesis, they'd want to hear it so they could sell. But often, their positions are so large that they can't sell, so instead, they try to play ostrich and prevent any tough questions from getting asked.

There's some evidence that regulators may try to act. Last fall, Christopher Cox, the new head of the SEC, wrote to a member of Congress that "I share your concerns regarding the potential impact that issuer retaliation may have on the ability of investors to obtain objective research." In the letter, Cox said the SEC was considering "several possible solutions for recommendation."

But as the research head says, "the real challenge, is, how do you do anything about it?" After all, the overt acts are one thing, but the subtler intimidation is very difficult to police. And no matter how tough analysts are, it's hard to always be immune to this.

In other words, there are still plenty of reasons to have a little caution about the "research reports" you read. Top of page

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