Wall Street gets an F

Take Hemant K. Shah, an independent high-profile pharmaceutical analyst who used his pulpit to sell, then slam, Biovail, a Toronto company that manufactured time-release versions of popular drugs. Shah's gripe had little to do with fundamentals; he praised the company when it got a new CEO in 1989, and even helped the small company raise money. He touted the company's shares to his money manager clients even as he tried to manage a deal for Biovail -- an obvious conflict of interest that he didn't disclose at the time.

Then the company did a deal of its own, cutting Shah out. He turned nasty. According to court documents that Cole collected, Shah planted false negative news about the company in the press, told his clients not to buy and even claimed (falsely) that George Soros was following his advice. Biovail stock rose in value anyway, but the company sued. Executives now estimate that Shah's 1996 and 1997 campaign forced Biovail's stock to trade at a third below the proper level.

Shah's case is hardly unique. Cole has collected quotes from several analysts and former analysts who readily admit that their research was biased toward their firm's investment banking interests. Sean Ryan, a Bear Stearns analyst, told Bloomberg Markets Magazine that in 1999 he recommended the online bank NetBank even though he thought it was a crummy company. "I put a buy on it because they paid for it," he said. Though he told institutional investors what he really thought of the company, Ryan maintained his stance of public praise.

Another analyst, who regularly put "buys" on stocks she covered, said she couldn't remember the last time she read a 10-Q quarterly report -- a key set of documents that a public company must file with the SEC. Still another, eyeing the close relationship between investment banking and analysts, told Cole that "research is supposed to be independent, but it is hard to see how it can be." Corporate pressure and the incentive to earn cash by brining in new clients, he said, damned the system.

Even Benjamin Edwards III, scion of the A.G. Edwards investment banking empire, admits that "an analyst has a hard time being objective if the client is important. They [the investment bankers] always want us to be optimistic and bullish."

A few of the analysts that Cole quotes counter his claim that Wall Street research has become a form of "customer service" rather than a tool for accuracy. They admit that during the boom their ratings didn't tie in to fundamentals but they argue that fundamentals weren't driving the market. "Stocks don't go up and down because they have a specific 'value,'" says superstar analyst Henry Blodget, in a quote that Cole pulls from a May 1999 Fortune magazine article. "They go up and down because investors decide to buy or sell."

Or, as Meeker put it: "A stock can go up and down based on money flows at a much more rapid clip than it can on the fundamentals." In other words, "buy" ratings were justified because people kept buying.

Cole points out, however, that analysts maintained buy ratings even after people started selling. In the spring of 2000, with Amazon.com down 70 percent from its high, Blodget still called the stock a "buy." The other Internet stocks he covered -- eToys, Pets.com and others -- also suffered a bloodbath but until July, Blodget maintained his recommendations. And even then, he only downgraded the companies to "holds."

The numbers confirm that Blodget's upside bias was hardly unique. Cole cites three independent studies, which show that analyst picks have become increasingly less accurate since the 1970s, underperforming the market and tending to be overly optimistic by a 3-to-1 margin. Of 33,169 buy, sell and hold recommendations in 1999, for example, only 125 -- or 0.3 percent -- were pure sells, according to Zacks Investment Research.

But is there an actual danger to such overwhelming optimism? Cole concludes that unsophisticated investors lost out. But the greatest weakness of "The Pied Pipers of Wall Street" is that Cole never quantifies the damage. He never even bothers to quote from investors who supposedly lost money by relying on analysts. Indeed, because of this oversight -- along with its scattered, collagelike structure and insider focus -- "Pied Pipers" will probably not become the definitive work on the shifting role of Wall Street analysts.

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