From the Sunday Times
April 20, 2003

Investors sunk by never say sell gurus

STEPHEN DEEN is angry and disappointed. Five years ago he and three friends invested more than 100,000 in Energis shares at 300p each. Now they are worthless, with the former telecoms giant in administration.
But Deen, a former clothing industry executive from Mill Hill, north London, is not just furious at the demise of the company. He feels betrayed by the research analysts and investment banks that promoted and rated Energis, even when the stock entered freefall.

Ever since the technology bubble burst, the world of investment analysts has been in turmoil as the big banks have been forced onto the defensive. They are reluctant to say why so many investors were misled into backing so many companies that proved to be worthless.

Until now the focus has been on Wall Street, where the New York attorney-general, Eliot Spitzer, led accusations that banks made biased recommendations. The bias arose, he says, because they earned hundreds of millions of dollars in fees from the same companies.

Any day now Spitzer and other American regulators will publish a report after a 900m settlement with the investment banks. Featuring internal e-mails and memos, it will make uncomfortable reading for many bank executives.

Meanwhile a new front is opening up in Britain, where accusations of bias have so far failed to stick. Stephen Alexander, a partner at Class Law, the London solicitors, said Deen is one of at least 20 investors, including some large charities, seeking legal redress.

They say banks were ready to promote companies with buy recommendations as stocks rose to peaks in 1999 and 2000, but were reluctant to say sell, especially on clients shares.

While many institutional investors knew the analysts code and pulled out earlier, private investors continued to believe in buy and hold recommendations, even as shares bombed.

An investigation by The Sunday Times, involving interviews with analysts and executives throughout Londons investment banking community, supports this conclusion.

One former insider is Louise Barton, an analyst with Investec Henderson Crosthwaite for 12 years. She soon realised if you didnt deliver the goods, you didnt survive.

She admits part of delivering the goods meant a favourable interpretation of research into a banks clients. It was not advisable to issue a sell note on a clients shares.

In theory, the City expects banks to maintain a Chinese wall between analysts and their investment banking division to preserve the integrity of investment advice. But analysts like Barton say this wall was often paper thin.

There has always been an unspoken code. If you say hold about a house stock, it means sell, she says. The institutions know, but it is unfair to private clients, who may believe what they are told.

Many executives across the industry privately agree with Bartons analysis. One former JP Morgan analyst says: You could not go below a hold at most City banks.

When asked if it was difficult for a sell to be issued on a client company, a spokesman for WestLB Bank acknowledged: This has been the case.

Barton, who is pursuing a claim for sex discrimination, could be seen as having an axe to grind, but her allegations are supported by other City figures.

One analyst said that under the unwritten code the word sell would almost never be used, even for stock in freefall. If you use sell, it means run for your life, he said.

Investec, like some other investment banks in London, did not distribute research reports to private investors: it dealt only with institutional clients and so, it says, never misled private investors.

But, in practice, recommendations were in wide public circulation through word of mouth, the media, the internet, or private brokers advice. It was the word of star analysts that drove many stocks to dizzy heights.

An official at the Financial Services Authority (FSA), the UK market regulator, said: The private investor may be unaware that the headline recommendation may be biased.

At the height of the bull market some banks did distribute reports directly to private investors, but this was never as widespread in London as in America. As the banks acquired broking firms, investors were offered not just the chance to deal online, but also access to brokers latest research and analysis. They were offered real-time analysis and quotes, and could even trade from their lap-tops. This only increased the prospect of being misled.

For example, in April 2000 Merrill Lynch launched its first global online banking and investment partnership. It was a 6.4 billion joint venture with HSBC, based in the UK, that gave clients outside America direct access to research.

After the stock market crash there was a more sober assessment of advice. Investors wanted to know who said what, when and why.

Spitzer found that US analysts at Merrill Lynch issued positive research notes on firms they privately dismissed as crap. The motive, he decided, was to attract new business or to flatter existing clients.

In London, the FSA does not relish Spitzers bare-knuckle tactics. There have been no big raids or sifting of old e-mails. But senior City figures confirm that some American abuses were common in London.

Per Lindberg, telecoms analyst at Dresdner Kleinwort Wasserstein, said: At some banks analysts are in a difficult position if they want to issue a reduce or sell notice on a house stock . . . The most unscrupulous will put analysts under enormous pressure to produce reports that will help them win business. They are incentivised which is another word for bribed by being told they will be rewarded if they produce the most bullish report.

Lindberg emphasised that research issued by his bank had not been biased, but there had been a problem with big technology flotations in the 1990s.

Analysis of recommendations of some leading banks clients, using data from Multex and banks own declarations, indicates that some analysts had an almost pathological reluctance to use the word sell.

For example, from the beginning of 2000 to February this year Merrill Lynch analysts produced research on 19 quoted corporate advisory clients of the bank, but apparently issued only one sell note. And out of 26 quoted UK clients of Goldman Sachs it seems no sell notes were issued by analysts until September last year.

A study of five London clients of UBS Warburg whose stock market value has fallen by more than 90% suggests it failed to issue a single sell note on any of them. One client was Trafficmaster, which handles live traffic information. Its shares peaked in March 2000 at more than 11. In the next 20 months they plummeted, but UBS Warburg analysts maintained advice to buy.

Investors who took that advice lost 99% of their money. For those with any nerve or confidence left, UBS Warburg says in a recent report: hold. Trafficmasters shares closed last week at 8.

UBS Warburg says research reports go only to institutional clients. A spokesman added: No analyst may permit himself to be biased by the interests of the issuer, by UBS Warburgs trading or investment banking operations, by any client or by personal interests.

Merrill Lynch refused to comment because of legal negotiations, but said it was taking measures to strengthen the objectivity of research.

Goldman Sachs declined to comment.

HSBC said it no longer publishes headline recommendations on client companies. There is evidence that recommendations on corporate stocks tend to be skewed and there are legitimate reasons why this may be, a spokesman said.

Meanwhile investors may be forgiven for a more careful interpretation of analysts findings. As Peter Bradshaw, a UK analyst, said about the dotcom collapse: In the Merrill universe there are almost no sells and neutral means dont touch this with a bargepole.

Insight: Stephen Grey, Jon Ungoed-Thomas, Mark Hollingsworth, Michael Gillard, Edin Hamzic, Dave Connett