Wall Street analysts told a Senate panel Wednesday that the judgments made by a majority of those covering Enron Corp. to continue recommending the stock as a “buy” through mid-November 2001 were based on publicly available information that ultimately proved to be wrong. And despite supposed conflicts of interests within the analysts’ companies — many of which were lending money to Enron at the same time their analysts were recommending buys — the analysts testified that the “Chinese Wall” maintained by research and investment units prevented their judgment from being swayed.
Anatol Feygin, the senior analyst for J.P. Morgan Securities covering the domestic natural gas industry, said he had “complete freedom” with respect to his recommendations, and added that he had never received any compensation “from any company in any form, including Enron.” Noting that he relied on information that was publicly available, Feygin began following Enron in June 1999, and initiated a “buy” on the stock after conducting extensive research.
“I met with senior management, and I believed Enron’s business model could be applied elsewhere. I saw very positive developments which justified the ‘buy’ rating until August 2001,” Feygin said. That month, CEO Jeffrey Skilling resigned, citing personal reasons, but Feygin said he did not think Enron’s outlook had “become less certain” with Skilling’s departure because of its “deep and valuable management team.”
Feygin said that last fall he still did not believe Enron’s stock, which was quickly plummeting, had become less valuable, but he noted there had been a “developing crisis of confidence…negative press coverage” that led him to downgrade the stock Oct. 23 to a long-term buy. By Nov. 29, however, his company suspended coverage of Enron.
Richard Gross, a Lehman Brothers analyst in the equity research division, also covered Enron for his company. Like Feygin, Gross said he had analyzed Enron’s public information, Securities and Exchange Commission filings, company press releases and information about competitors to make his “buy” recommendations. “We believed Enron’s core business model was strong and growing rapidly…this was the strength of Enron.”
As the company’s stock fell, Gross said research indicated that the broadband business was not succeeding as rapidly, but the company was still reporting record quarters. He said there was confirmation in the business models of other companies he covered, and Enron’s core business appeared “very very strong” after Skilling’s departure and until late October 2001, when the SEC began an investigation into accounting practices.
Curt Launer, managing director of Credit Suisse First Boston, said he had followed Enron and its predecessor companies for 18 years. “The inaccuracies in Enron’s reporting affected my reporting on Enron,” he said. He said much of the information he learned about Enron’s accounting practices and opaque business dealings came from the media. And while he noted that Enron was “unique” in its use of off-balance sheet accounting, he did not think that it was “problematic in and of itself.”
Launer, recalling an Aug. 15, 2001 analyst call following Skilling’s departure, said he specifically asked if there would be further disclosures, and that company executives indicated there was nothing to disclose and that the company was in great shape. “Had I known any of these items, I would have revised my ratings. Hindsight allows a view I otherwise did not have.”
Raymond C. Niles, senior analyst in integrated power and natural gas for Salomon Smith Barney (SSB), was the fourth analyst who covered Enron testifying before the Senate Governmental Affairs Committee. He first issued coverage on Enron in January 1998 while working at another firm, and said it was his professional opinion then that the company was “well positioned to take advantage” of the coming deregulation. “It was my professional opinion that the core merchant energy model was sound…and I believed the core platform could be applied to others.”
Niles testified that in an April 2000 report for SSB, he rated Enron as “1-H,” a buy with high risk attached to it. He continued to recommend the stock, even after Skilling resigned, he said, because of his belief in Enron’s business model. “Barring any further disclosure, I still felt positive about the company.” On Oct. 19, 2001, following further disclosures, Niles downgraded the stock to 1-S, or buy speculative, followed by a neutral 3-S rating the following day. Noting that corporate financial statements were the “bedrock” for his analysis, Niles said Enron’s “did not represent the company’s true financial condition.”
Quizzed by senators about the inherent conflicts of interest at the investment firms where they work, which were loaning money to Enron at the same time analysts were rating the stock a “buy,” those testifying said there was never any pressure on them to keep their “buy” ratings.
“The concern obviously is whether you were influenced on favorable recommendations that now seem so wrong,” said Joseph Lieberman (D-CT), who chaired the panel. “Your business was doing business with Enron…maybe becoming too close to Enron.” He said that together with the “growing media concern last fall…the four of you…continued to recommend a buy.” (More than two-thirds of those analysts covering Enron continued to recommend a buy until late fall, he noted.) “The obvious question is, why?”
But the analysts questioned maintained that integrity was key to their recommendations. “It is absolutely essential in this line of work,” said Feygin. “My outlook pointed to a solid core business,” and he said announcements by Enron last fall to sell off assets that were losing money and to focus on its core business were positive steps. “There were no pressures on me to maintain the rating.”
Like his peers, Launer said that to “protect the integrity of our research, we follow ‘Chinese wall’ procedures,” where the research group is physically separated from the investment banking group. While there are instances where the research analysts meet with the investment bankers on specific deals, Launer and the others said “going over the wall” is rare.
Still, Sen. Jim Bunning (R-KY) was unconvinced. “It blows my mind you didn’t know” Enron was having problems, he said, referring to the investment bankers making hefty loans to Enron to keep it afloat last year. “What I hear from you is very difficult for me to believe.” As a former account executive himself, Bunning said, “I knew about the walls, but the walls are not impenetrable. People in your company know just what you are recommending and why you are recommending it because you are helping the other side of the wall.”
Sen. Robert Bennett (R-UT) agreed. “I do remember what I was taught in my 20s when I was first getting into the market. It was very, very fundamental. Don’t buck the trend.”
When asked why the ratings remained high while Enron’s stock fell from more than $90 to less than $40 in less than a year, Gross attributed it to a “broadband bubble.” Fagin added that the rise in Enron’s stock came when the country was “extremely bullish on energy and the energy business,” and its fall was a normal business cycle. “A stock doesn’t go down because it gets tired,” added Launer. “There is some change in business dynamics. Very often, other than a bubble we experienced if a stock is in a down draft, it doesn’t stop going down because it gets tired.”
The final panel member to testify, Dr. Howard Schilit, made it clear that there is definitely a “herd” mentality among analysts. As an independent financial analyst with the Center For Financial Research and Analysis in Rockville, MD, Schilit authored “Financial Shenanigans: How to Detect Accounting Gimmicks and Fraud in Financial Reports.”
“Every time I see an analyst go out on a limb, I see him go against the grain,” aid Schilit. “He then becomes a very controversial analyst…which could prevent him from moving up the hierarchy in Wall Street’s establishment. You don’t rock the boat. That’s why firms won’t say there’s a problem at a company.”
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