I. Introduction

As the NASDAQ Composite soared into the stratosphere in the 1990’s, a previously anonymous Wall Street group emerged at the forefront of what was thought to be the beginning of a technology and telecommunications revolution. These initially reluctant bandleaders in some cases became overnight sensations with each song sung harmonizing the virtues of the latest Internet, technology or telecommunications sector initial or secondary public offering.

It would appear that many in the media as well as the general investing public, clung to the words of crooners like Henry Blodget, Mary Meeker, Jack Grubman and others as though their words were divine melodies from the heavens. Looking back on it all today as the bubble has burst and the stock prices of many of these companies have come crashing back to earth, it seems that much of work of these analysts while initially thought to be the work of virtuosos, may have been nothing more than sirens’ songs. Many of the companies these analysts touted have, in an unprecedented fashion, lost hundreds of billions of dollars of market capitalization and have or may be forced to seek protection under the U.S. Bankruptcy Code. Investors have been left with staggering losses in their portfolios, and brokerage firms are feeling the heat. A Wall Street analyst has estimated that one Wall Street firm discussed in this article faces potential liability from investors and regulators estimated at between 3.8 and 5.2 billion dollars.⁴ 

Are the analysts really to blame? What happened and why did these analysts, in certain circles, become more popular and listened to than Mick Jaggar and Jon Bon Jovi? Why are these analysts and their employing firms being castigated with the same fervor that brought them their fame? To understand the rise and fall of these Wall Street “rock stars,” we must first journey back to the purple haze of the 1970s.

The roots of this hard rock phenomenon can be traced back to 1975 when the Securities and Exchange Commission (“SEC”) approved rules aimed at ending fixed commission trading. Previously, investment banks had profited lucratively from sometimes hefty trading commissions from their institutional and retail trading customers. Reduced commissions meant that these firms were forced to generate additional sources of revenues from other related businesses like investment banking. 

The tension between research analysts and investment banking can be traced to the early 1980’s and reached a boiling point in the frenzied 1990’s. Many Wall Street firms discovered that, from an economic viewpoint, pitching research to institutional investors who would pay the firm $0.05 per share in commissions, would be far less lucrative than if analysts devoted their time with the investment bankers seeking to land public offerings where the firm could earn multiples of 15 to 30 times that amount. In addition, related merger and advisory fees could be equally lucrative. ⁵ In this new environment, negative research reports would obviously hurt efforts to capture and maintain investment banking and corporate finance clients. 

Beginning in 1999, Internet analysts moved from the Industry Standard “price to earnings” valuation methodology to price to “revenue multiples” to justify their valuations. During that time, many analysts moved “off the charts” to value stocks based on “visits to websites,” “mouse clicks” and other “statistics” which had no basis in traditional reality and were inconsistent with prior industry standards. Several commentators have stated that this valuation criteria, as used by analysts in certain cases, may not have comported with the Standards of the Association of Investment Management and Research. ⁶

¹    Raymond L Moss is a founding partner in the Atlanta office of Sims Moss Kline & Davis LLP where he concentrates his practice on corporate finance, broker-dealer regulation, securities arbitration and litigation. Mr. Moss can be reached at his email address: rlmoss@mossgilmorelaw.com.

²    Michael P. Gilmore is a partner in the New York office of Sims Moss Kline & Davis LLP, where he concentrates his practice on broker-dealer regulation, securities arbitration and litigation. Mr. Gilmore can be reached at his email address: mpgilmore@mossgilmorelaw.com.

³    Gerald B. Kline is also a founding partner in the Atlanta office of Sims Moss Kline & Davis LLP where he concentrates his practice on broker-dealer regulation, securities arbitration and litigation. Mr. Kline can be reached at his email address: gbkline@smkdlaw.com.

⁴    See Gretchen Morgenson, Will Wall Street Become a Regular at the Court House?, N.Y. Times, May 12, 2002, p. 1.

⁵   Jeffery M. Laderman, Wall Street’s Spin Game, Business Week, October 5, 1998.

⁶   See Jacob H. Zamansky, Assessing Analysts’ Liability for Securities Fraud, 227 (No. 2) N.Y.L.J., at 1 (2002). Also see Association for Investment Management and Research, Standards of Professional Conduct for Chartered Financial Analysts.