Evidence uncovered in the investigation of stock analysts is shocking even some of Wall Street's most experienced players, including Felix G. Rohatyn, former head of the New York City arm of international banking house Lazard Fr?res. Rohatyn became widely known nearly three decades ago for successfully restructuring New York's debt and resolving the city's fiscal crisis. He went on to negotiate for major corporations in the takeover wars of the 1980s and capped his career by serving as U.S. Ambassador to France at the end of the 1990s.
He's alarmed that analysts were apparently recommending stocks they knew would hurt their investing clients. Surely, analysts and investment bankers have always been inclined to believe in deals that will make them money. But going so far as to knowingly promote bad investments does real damage to the American financial system, says Rohatyn. Now a corporate consultant, he spoke with BusinessWeek Associate Editor David Henry on Apr. 30. Edited excerpts of their conversation follow:
Q: Has the evidence on analysts gathered by New York State Attorney General Eliot Spitzer surprised you?
A: Yes. The tenor of these e-mails -- where [there] was deliberate falsification -- was quite stunning.
Another thing that I found stunning is the view I've seen in editorials that buyers should've known to beware of being lied to.... Our entire modern capitalistic system is based on disclosure and veracity...on the notion that you protect the public by making sure that people disclose what has to be disclosed, that it's fairly presented, and that people are telling the truth.
Q: What is the consequence?
A: Look, we have to import $500 billion a year to deal with our deficits. Most of that money comes in investments in our markets by foreigners. The moment foreigners begin to think "buyer beware," this may change. It could have dramatic repercussions on the dollar, on domestic inflation, on the economy.
One of the precious things we have is the integrity of the financial market. That integrity should be partly protected by the way security analysts behave and recommend securities to their clients. After all, it is their clients who are supposed to be serviced, not the investment-banking department.
If Wall Street knows what is good for it and what is good for this country, it will very definitely clean up its act.
Q: Some stock analysts have apparently given in to the temptation of investment-banking fees and promoted bad investments. Have investment bankers likewise been pushing companies to do bad deals?
A: There has always been the temptation to urge a deal on a client, because if he doesn't do the deal, you don't get a fee. That was as true in the 1980s, when we had a big merger boom, as it was in the 1990s. It's not an issue of a conflict of interest. It's an issue of judgement and ethical behavior.
Q: Are ethical lapses making for bad takeovers?
A: Frankly, I've never seen it happen. I've seen a lot of bad deals. I've seen a lot of deals where people got overenthusiastic, paid too much, or bought the wrong company. What can happen is an overenthusiastic banker can team up with an overenthusiastic client and make the wrong deal.
But the notion that you would just push somebody into the wrong deal is unlikely. It goes to the board of directors of the client company, their lawyers, and their experts. You have a lot of people around who can ring the alarm bell if something looks wrong.
What you have in these analyst situations -- where people knowingly write something false to induce people to buy in order to generate more investment-banking business -- is fundamentally different than succumbing to overenthusiasm to push a deal.
Q: There are many hungry investment bankers around, people hired during the boom. Aren't they under pressure to promote bad deals just to survive?
A: You may get bad deals promoted, but managers are much more leery today of making deals. That's why the deal flow is very much dried up. They're suspicious of overeager investment bankers in very lean times. They're leery about their auditors. They are leery about the market...about analysts.
And, with Enron, Tyco, and Global Crossing...you have a very careful climate. Think of the trillions of dollars of market value that have vaporized. When you see a company like WorldCom seem to melt down, that just reinforces the view that people have to be supercareful.