Ed picked me up at my house in a taxi. My home, at the time, was nothing super fancy, but Paula and I had put a lot of sweat into it and were quite proud of it.
Ed took one look at the house and almost started laughing. “You ought to come to Wall Street and hit the big time,” he said.
JULY 14, 1989
“This Is the Street Where They Fool People.”
THAT’S WHAT I WAS THINKING as I stepped off the early morning express train from Scarsdale and stood on Madison Avenue, blinking nervously in the bright sunlight. As I gazed up at the rows of tall buildings and tried to avoid colliding with the natives, I felt the tiniest sense of relief.
At least my job was on Wall Street. Madison Avenue, by contrast, was the center of the advertising world, the place where smart and manipulative companies burned loads of cash and creative energy to convince us that we needed to wash our hands with Dial, brush our teeth with Colgate, and wipe our derrières with Charmin. At least I was going to be an analyst whose job it was to evaluate companies on their merits, not someone whose raison d’être was to seduce America’s soap-opera watchers with meaningless slogans and exaggerated promises.
My new job in equity research, I believed, had nothing to do with manipulation and everything to do with balanced, rational thinking. I had made the leap to Wall Street in part because of the money, but also because being an analyst seemed like the perfect job for a serious guy like me who liked to reason his way through life. Sure, emotion and hype sneaked into my line of work occasionally, but in the end, the stock market was rational, analytical, cool. Fooling people wasn’t part of this equation.
Or so I thought. In retrospect my naïveté sounds charming or—let’s not be charitable—silly. Of course Wall Street was as much about fooling people as Madison Avenue was, at least if you were one of the corporate executives trying to convince investors—and analysts—that your company’s shares would shoot to the moon. But my job, I hastened to tell myself, was all about shooting straight. I had been in a sales role before, and I’d never liked it. Now I’d have a chance to focus entirely on the facts.
I grabbed on to that belief as if it were a life preserver and clutched it as I walked up Madison, then west on Forty-eighth Street and north on Sixth Avenue until I reached the headquarters of Morgan Stanley at Fiftieth and Sixth. I was 36 years old, it was my first day on Wall Street, and I was scared out of my mind.
Not that I had fallen off the turnip truck or anything. I had moved here from Washington, D.C., where I had been director of business analysis at MCI, the brash upstart that was shaking up the telecommunications business. I had interacted with Wall Street and its analysts and bankers for the past two years, trying to make them see my company as positively as I did. What I loved the most was the intellectual sparring as we debated the future of MCI and the telecom industry. It had been a great gig.
But this was the big time. I had been recruited by one of the premier investment banks, a place better suited to Brooks Brothers–clad Greenwich bluebloods than a middle-class public school guy from Buffalo, New York. I was going to be one of a select group of some 35 analysts at Morgan Stanley whose job it was to recommend stocks—and, I had been told, move the financial markets. The prestige and power of my new job filled me with pride. But the responsibility terrified and humbled me. All of a sudden I was in the major leagues, and I’d never even played Class A ball. What was I doing in the middle of this?
Already, I’d ventured pretty far from my beginnings as the son of a scrap-metal dealer with a high school education. I’d been a political science major and math minor at the State University of New York at Albany, where I’d met my wife-to-be, Paula Zimmer, during a Wiffle ball game on the first day of our second year. She studied art history and then went back to school to become a pediatric-intensive-care nurse. And I’d gone on to become a starry-eyed graduate student of Middle East politics at the University of Chicago and Princeton University, certain I wanted to devote my life to bringing peace to that powder keg of a region.
I ended up at the LBJ School of Public Affairs at the University of Texas, earning a master’s degree in 1979. I was hoping for an assignment that involved foreign policy but instead accepted a $24,000 offer from Coopers & Lybrand, one of the world’s largest accounting and consulting firms, as an economic consultant in its Washington, D.C., office. For a few years, I was really happy at Coopers. The job appealed to my inner wonk, and I worked my way up the food chain. But once I was promoted to manager, my job became more and more about selling new consulting services to clients. The whole selling thing turned me off. I didn’t want my life to be defined by the spin and hype of selling. Working inside a growing company began to sound a lot more interesting.
From Consulting to Communications: MCI
It just so happened that the Coopers’s D.C. office building backed up against the new offices of MCI, an upstart telecommunications company that had been in business since 1968. MCI had emerged as a young, exciting David to AT&T, the ultimate corporate Goliath, with a more responsive, entrepreneurial culture. Its founder, Bill McGowan, had found a way to compete against AT&T in the long distance market even before the November 1982 court order that would break up the monopoly Bell system into AT&T and seven companies that became known as the Baby Bells. MCI had grown wildly in the early 1980s, quadrupling its sales to $400 million between 1979 and 1983.
I knew a few former colleagues from Coopers who had gone over to MCI, and decided it sounded like a great opportunity. MCI made me an offer to work in its finance department, though it would mean a 10 percent pay cut from my current salary of $38,000 to $34,000 and the end of my rise up the Coopers & Lybrand partnership ladder. I talked it over with Paula, and although it was going to be tough for a while, she agreed that the potential to work at a fast-growing, dynamic company was worth giving up some salary in the short-term.
Most of all, I wanted out of anything to do with sales and marketing. I was a cerebral type who liked reasoning through complex issues rather than trying to turn everything into a slogan or sales pitch. It would become a familiar refrain in my career, and an ironic one too. Every time I tried to escape the sales aspect of a job, I made a move that brought me closer to that world.
But I didn’t know any of that then. I was 30, with a wife, a two-year-old daughter, and another baby on the way—no longer an idealist seeking world peace, but no cynical sellout either. So I started at MCI in 1983 as a capital-budget analyst, which essentially meant that I reviewed all the requests for money from around the company and recommended approval or rejection. It was a classic middle management job, but it was exciting work in a company like MCI. Within four years, I had become the senior manager of budgeting and planning, doing nuts-and-bolts financial stuff that was right up my alley. And then, in 1987, I got a call from Bill Conway, MCI’s wunderkind 36-year-old chief financial officer. He wondered whether I’d be interested in a job in the investor relations department as the liaison between MCI and the Wall Street analysts who now covered us.
Every time a new industry came along, Wall Street staffed up with analysts, traders, and bankers to cover it. And while telecommunications wasn’t new, the number of publicly traded telecom stocks was about to triple. In 1984, what was just one company—AT&T, or “Ma Bell”—became eight when the Bell system was broken up in an antitrust settlement with the U.S. Department of Justice. It was a decision that would usher in a new world of competition, major technological advancements, and billions and billions of dollars in new investment.
There were now eleven major telecom companies—AT&T, the seven Baby Bells, GTE, Sprint, and MCI. Former AT&T shareholders were given shares in each of the Baby Bells and, of course, in the new AT&T, which now provided long distance service and manufactured telecom equipment. These companies, now publicly traded, were suddenly vulnerable to the vicissitudes of the stock market, and Wall Street desperately needed people who could help investors figure it all out. So in the early 1980s the Street went on a hiring binge, recruiting practically everyone it could find with experience in both financial analysis and the telecom sector.
These analysts were a small but elite group of people who researched companies’ publicly traded stocks and made recommendations to investors on whether or not to buy them. They studied companies in their area of expertise by doing everything from analyzing the financial trends in an industry to interviewing the top executives to gauging the impact of upcoming regulatory changes.
There were two kinds of analysts, each with different responsibilities. The first group, some 500 strong in total by the late 1980s, worked for investment banks like Morgan Stanley or Goldman Sachs. They published their research in reports that were then “sold” to outside investors from large pension funds, mutual funds, and other large institutions, which is why they were known as “sell-side” analysts. In practice, these reports were not really sold; they were given to the institutional investors in exchange for the fund managers buying or selling stocks through the firms with the most helpful research. At some banks, brokers in the “retail” arm of the business would also provide this research to individual investors. The sell-sider had to walk an odd sort of tightrope, providing research that was supposed to be completely independent of any banking business his employer might do with the companies the analysts covered.
The second group of analysts, a much larger but not as well-compensated group, worked directly for the large institutional investors that bought the sell-siders’ research. Their job was to recommend which stocks their employers should own in their portfolios. They were known as “buy-side” analysts because their firm would “buy” the “sell-siders’” research. Although these analysts made their own investment decisions, buy-siders certainly read sell-side research, and sell-siders catered to them as their clients. Buy-siders didn’t publish their own research, however, and had no responsibility to investors outside their own firms. The only master they served was the large pension-, mutual-, or hedge-fund manager that employed them.
My new investor-relations job at MCI, if I took it, would be to pitch MCI to both of these newly minted groups of research analysts. That meant explaining MCI’s strategy, providing financial information, interpreting regulatory decisions, and doing whatever was necessary to help these influential people make their investment decisions. Hopefully, of course, their opinions would be favorable toward MCI and their firms would buy MCI’s stock, which would make my bosses happy and anyone who owned MCI shares richer.
My first reaction was that it was basically a public relations job, and PR was definitely not my forte. But MCI’s CFO, Bill Conway, whom I liked a lot, kept after me, and I finally decided that it would be good for me to try it. After all, the job did have some advantages, one of which was its location on the company’s executive floor. I figured I’d have a lot more interaction with the top brass and in the process learn a lot about how a rapidly growing company is managed.
In early 1987, it was also a tougher job than it had been. In December 1986, MCI had taken a huge write-off and the stock had crashed from over $20 to under $5 per share after a disastrous acquisition of a satellite company. Investors had lost enormous amounts of money; they felt betrayed and angry. The previous two-person investor relations team had been shunted aside, virtually run out of town by rabid institutional investors seeking vengeance. Though they clearly were not responsible for the company’s misfortunes, many professional investors felt that the previous team had spun a misleadingly bullish story just as that acquisition was going south. So, at this point, the investor relations job was more about damage control and reestablishing the company’s credibility than anything else.
I was assigned to work with Jim Hayter, a tall, lanky regulatory troubleshooter who started in 1972 as MCI’s 85th employee. Jim was a true extrovert; he loved to interact with people and had an innate ability to find out what makes someone tick. He used self-deprecating humor, a beguiling yet devious smile, and a deep-throated, sometimes-forced laugh to disarm people. He had a way with the ladies too.
We made a great tag team: I taught Jim the ins and outs of financial analysis and forecasting, and he taught me about regulation and market psychology. Coming from within the bowels of the company’s financial organization, I had good knowledge of what internal factors drove the company’s future, and I also had solid sources inside MCI’s financial, marketing, and engineering organizations. They gave me credibility with Jim and, more important, with Wall Streeters as well.
We divided up the analysts we’d each handle, more by personality type than anything else. As the stoic member of this dynamic duo, I dealt with the more analytic and empirical analysts, like Ed Greenberg at Morgan Stanley and Robert Morris at Goldman Sachs. Jim got the ones who were more intuitive and, shall we say, emotional. I marshaled facts to explain the merits of MCI’s strategies and earnings prospects, while Jim used psychology to entice investors into buying MCI shares.
My First Run-in with Jack Grubman
Jack Grubman was one of those emotional sorts. Jack was a PaineWebber analyst who had left AT&T for the Street in 1984. He was loud, opinionated, and seemed to exaggerate everything in order to make it sound more dramatic. He had a somewhat high-pitched, nasal voice, two large front teeth, and a receding hairline with jet black hair. Most Wall Street analysts were, well, analytic; their reports were as dry as a day-old turkey sandwich. But Jack punctuated his dispatches with the written equivalent of a scream.
I had met Jack recently when MCI CFO Bill Conway, Jim, and I had done the rounds on Wall Street, visiting with each of the major investment banks’ telecom analysts. Like me, Jack was a bit of a wonk, having studied math as an undergraduate at Boston University (though he claimed his degree was from MIT) and then earning a master’s degree in probability theory from Columbia University. AT&T recruited him into its management training program. After the breakup of AT&T into eight separately traded stocks in 1984, PaineWebber recruited him to be its analyst for the new telecom services sector.
Jack came to Wall Street with a deep understanding of the regulatory changes underway in the industry, as well as a great background in telecom engineering. He went out of his way to flaunt that engineering knowledge in the reports he wrote. A middle-class guy from Philly, Jack made much of his supposed rough beginnings and loved to remind people that his father had been a boxer and that he, too, liked to box for fun. Although his nose hadn’t been flattened yet, there was an in-your-face quality about Grubman that made you pay attention.
My first noteworthy interaction with Jack came in March of 1988. We in investor relations got word that he had written a negative report on MCI. I had to scramble to get a faxed copy from a buy-sider who owned lots of MCI shares and was panicked about the report’s allegations. Using a heap of technical jargon that no one in the investment world could make head or tail of, Jack argued that Sprint’s network was far superior to MCI’s and that MCI had chosen the wrong technical path, with potentially disastrous implications. “We think Sprint will do to MCI what DEC did to Data General, surpass a supposedly better competitor by having superior technology,” he wrote.1 Dense with detail and layered with so much techno-speak as to make it unintelligible yet impressive-sounding, the report had the effect of dissing MCI without anyone understanding exactly why. It was a technique Jack would use again and again on the Street: overwhelm everyone with technical stuff and therefore make everyone else’s research appear shallow—and uninformed—by comparison.
The president of MCI, Bert Roberts, read the report and went ballistic. “This jerk is not just saying he doesn’t recommend our stock,” he fumed, “he’s basically telling the world that we don’t know what the hell we’re doing!” Bert, an engineer by training, said there were tons of errors in the report. He told Jim and me to counter Jack’s “crap” with the facts and to make sure the buy-side and other sell-side analysts did not believe his conclusions. Longer term, we obviously needed to turn this guy around to our line of thinking. So while we would certainly try to discredit what was inaccurate, we’d also play a little bit of good cop–bad cop, wining and dining him and trying to change his attitude. That was the plan, anyway.
Jim assigned me the task of dissecting the report and countering it point by point. My first move was to meet with MCI’s own engineers and come up with a list of inaccuracies. I found lots of them. Armed with my talking points, I called Jack.
“Look,” I said, trying to keep my voice cordial, “I’ve talked with our engineers, and I’d like to run through a bunch of things with you.” I went through about six or seven points, explaining how his report stated that we were doing the opposite of Sprint when in fact we were actually using the identical technical approach. Jack listened carefully, or at least that was my impression. To my surprise, he didn’t even really try to debate me. “I’m really sorry,” he said, although he didn’t sound very apologetic.
“How did you get this information in the first place?” I asked. “Why didn’t you at least run it by us to see whether it was true before publishing the report?”
“I ran it by an engineer friend at AT&T,” he said, without a trace of shame. “He said it was a great report.”
Now, I’m a pretty calm guy, but I almost lost it when I heard that. He had relied on someone who worked for AT&T, a competitor that would do almost anything to discredit our long distance service. Was this how Wall Street research was done, by relying on biased sources and unchecked assumptions?
I was angry, but for a different reason than one might think. Of course, Grubman’s report would hurt MCI and make our jobs tougher. Even if he wrote a clarification, it would be difficult to erase the impression that he had created in the minds of the brokers at PaineWebber, who had already been fed summaries of Jack’s conclusions, as they were with all research reports. They had already taken those summaries, chewed them up into even tinier bits, and, like a herd of cows with their cuds, redigested them for PaineWebber’s masses of investor clients, down to one basic message: MCI is in deep trouble; dump its shares.
As irritating as that was, what offended me the most was the notion that Jack Grubman was more interested in making a splash than in really understanding what he was writing about. I couldn’t believe that he was willing to sign his name to research so shoddy. I would have been mortified if someone corrected me like that, mortified that people would think that my analysis and research were shallow and misleading. But maybe this was my own insecurity coming to the fore. I had always been the one who outresearched or outstudied everyone else rather than wowing people with quick answers or brainpower. I’d never been the genius—not in high school, college, or at work. Rather, out of necessity I suppose, I simply tried to work harder and dig deeper than anyone else.
So I couldn’t really help myself as I listened to Jack’s grating voice and heard that feigned apology. “This is embarrassing for me,” I said, turning red. “I’m a Chartered Financial Analyst (CFA) and I’m embarrassed to be part of a profession that has people like you doing research that is so misleading and irresponsible.” Jack responded with a series of condescending mumbles to the effect that I didn’t have a clue about how Wall Street worked, that he was simply doing what he was paid to do and, given the huge amount PaineWebber was paying him, he must be damn good at it. We hung up. He didn’t change his report, though, fortunately, it had less impact than we’d feared. I had had my first clash with Jack Grubman.
Despite my troubling experience with Jack, I came to really enjoy the investor relations job and my interactions with the wild, fast-paced world of Wall Street. I quickly learned that investor relations was more of an art than a science—especially when it came to managing the analysts’ earnings expectations. Knowing how companies did this was a skill that would serve me very well later, when I moved to the Street.
Bert Roberts, MCI’s president, believed that it was critical that MCI’s shares trade higher on the day of quarterly-earnings releases. This was because the next day’s press coverage would be enthusiastic if we met or beat expectations, and full of fawning quotes from the analysts that followed us. But if we missed the Street’s earnings expectations and our stock price fell that day, the articles would be negative and critical. This, Bert believed with good reason, would influence customers’ perceptions of MCI as a stable supplier of telecom services. The more positive the press coverage, the easier it would be for a corporate telecom manager to buy more services from upstart MCI rather than old, reliable AT&T. So that meant that those of us in investor relations had to try to make sure that the stock reacted positively on earnings day.
In practice, that meant two things. If it had been a bad quarter, we needed to leak that information slowly and quietly, so that the stock would drop during the week or two before the earnings announcement, but without generating any media attention. That was a lot better than the stock plummeting on earnings day, when the world was focused on it. Positive news would also be leaked but downplayed a bit, so that the stock would still see a decent bounce when the better-than-expected news hit. It was a common practice, so common that I didn’t even take note of it at the time. (The SEC’s Regulation FD, for Fair Disclosure—which required that all financial information be released to everyone at the same time—wasn’t passed until 13 years later.) Yet it meant that some people benefited, while others, primarily small investors, never knew what was going on. It was simply, I learned, part of the game.
Sometimes getting that news out meant making just a few calls to the analyst community. If we felt the Street’s earnings projections and thus MCI’s stock price were too low relative to what we were likely to deliver, we often would call two or three top sell-side Wall Street analysts. The conversation would go something like this: “Hey, Robert [Morris, Goldman Sachs’s top-rated telecom analyst]. What’s going on? We haven’t talked in a while.” Knowing exactly what was up, Morris would say, “You know, I’ve got my model here in front of me and I wondered if my revenue growth projection of 25.3 percent this year was within range.” We would then launch into a little game of “warmer,” “colder,” until Morris “divined” that his quarterly projection for MCI’s earnings per share was a penny or two too low. He’d thank us, hang up, and call his sales force to announce that he had just spoken to management (i.e., me) and that he felt good about how the quarter was shaping up, so he had decided to increase his MCI forecast. Brilliant.
We’d usually call two or three analysts at about the same time, but Morris was consistently the first to call back and the first to get his updated forecast out. Like magic, when the NASDAQ opened at 9:30 AM, MCI shares traded up. By the time the other analysts called back, Goldman’s sales force had informed virtually every buy-side analyst and portfolio manager in the Western world of the new forecast. And then the other sell-side analysts—the ones we hadn’t called—would start getting calls from buy-side clients asking what they thought of Goldman’s earnings increase and what, if anything, they had heard from MCI.
They’d flood our phone lines, and we’d simply say that Morris had been going over his model and increased it. “That seemed okay to us,” we’d say. They then revised their estimates, and the boost to our stock price caused by Morris’s earlier update held firm. If you were among the largest institutional money managers, you had it made. If you were an individual investor, you were inevitably too late to the party; the stock had already risen and you’d missed its move.
On the other hand, if the news was bad, we might also call a few of the most influential analysts, but, more often, we would pack up and, with minimal notice, fly to Boston for a day of meetings. Boston was where the largest and most powerful mutual funds were located, companies such as Fidelity, Putnam, and many others. We always booked Fidelity first, at 8:00 AM, and then usually Putnam at 9:30 AM, followed by Wellington, MFS, State Street Research, and other large institutional investors.
The meetings were almost always the same: with a group of 15 or so Fidelity portfolio managers, including the famous Peter Lynch, watching, Fidelity’s telecom analyst would run us through a grueling series of questions regarding every line on MCI’s income statement. Fidelity’s portfolio managers paid attention to every word we spoke, every number that left our lips, even our tones of voice and facial expressions. Eventually, it would dawn on someone that we were guiding down our earnings estimates, at which point the Fidelity portfolio managers would suddenly bolt out of the room, hustle down to Fidelity’s trading floor, and tell their in-house traders to sell MCI shares when the market opened at 9:30 AM. Brilliant again.
These various Fidelity portfolio managers, armed with an inside edge that no one else had, would now be racing to unload their MCI shares ahead of their competitors at other money management firms. FIDO, as the Street called it, wouldn’t exactly make money on a morning like this. Rather, it wouldn’t lose money when the stock fell on our bad news. Many others did lose money, however. They were the ones buying the shares that Fidelity was unloading at 9:31 AM.
It was a fate that other institutional investors couldn’t avoid. And the little guy, the individual investor, the retiree? If they owned a Fidelity mutual fund, it worked to their advantage—this time. No wonder Fidelity was the country’s investment darling. But if they didn’t, they were out of luck. It was my first lesson that life on the Street, with its uneven information flows, often rewarded the powerful and connected over the merely smart. It distorted the entire market in the process.
By mid-1988, my new career was working out well. I didn’t feel like I was changing the world, exactly, or bringing peace to it, but I was working for a company that was doing some good by making phone calls cheaper and improving the quality of phone service. Plus, I was now making $70,000 a year. By my standard of seeking work that I found intellectually interesting, it was working out well. And by my more practical standard of earning a decent living for my family, I was content too.
Over time, I had developed a good working relationship with some of the other analysts, particularly Ed Greenberg, the telecom analyst from Morgan Stanley. Physically, there was nothing impressive about him—he was a shortish and baldish guy—but his brain was something worth celebrating. He was one of the smartest people I’d ever met, with an incredible analytical ability but also a variety of other intellectual interests ranging from theater to music to baseball. Even in his forties, he still joked that his dream was to play center field for the Yankees.
According to Institutional Investor, a magazine that ran what I thought at the time was an obscure survey of buy-siders, Ed was the number-two-rated Wall Street telecom analyst, behind Goldman’s Robert Morris. I was vaguely aware that the ranking meant a lot for analysts in terms of their compensation, and that we in MCI’s investor relations department needed to provide special care and feeding for the top vote-getters, since they were, as that famous line from George Orwell’s Animal Farm goes, more equal than others. But I liked Ed, not because of his ranking, but because of the way he thought. He figured out trends in telecom two or three years ahead of anyone, often even ahead of the chief executives and chief strategists at the companies he covered. In fact, he was so prescient that he often recommended investments far too early.
Unlike that Grubman guy, this was someone whose approach to Wall Street research I appreciated. Ed was a deep thinker and extraordinarily thorough in his analytic work. He also was a no-bullshit kind of person who told you what he thought and why. And he was really good at the other side of the Wall Street job—interacting with buy-side investor clients and executives of companies like mine.
At the time, I only vaguely understood that being an analyst required a bit of socializing too. Not only were you wined and dined constantly by the companies you covered, all of whom hoped desperately to convince you to say positive things about their company and its stock, but you in turn had to market yourself—and your research—to as many professional analysts and money managers as time would allow. Your reputation didn’t come only from the quality of your thinking, I later learned, but instead that was just one piece of a jigsaw puzzle that included how responsive you were to a client’s questions, how well clients liked you, and what kind of special tidbits you could dole out to them to make them feel special and appreciated. Basically, you had to be smart, you had to work your tail off, and you had to be popular. It reminded me of high school.
In November 1988, Ed proposed that Morgan Stanley sponsor a European investor-relations “road show” for MCI. A road show for a company was a marketing trip in which its executives traveled around the country or the world, meeting with investors and, hopefully, convincing them to buy its stock. Acting as a friendly adviser, Morgan Stanley had offered to arrange meetings with the largest mutual and pension funds in each of Europe’s major cities. Morgan’s salespeople, along with Ed, would chaperone us around from meeting to meeting, telling our story.
Jim convinced MCI’s new CFO that the trip made sense, since MCI needed more visibility in Europe and it would be good to be sponsored by an analyst and firm as well-respected and bullish on our shares as Ed Greenberg and Morgan Stanley. We offered Ed a ride on MCI’s corporate jet, a Falcon 50, and he accepted, naturally; six hours in the air with MCI’s CFO was an analyst’s fantasy, not only an opportunity to learn lots of new things about MCI and its strategy, but an experience he could layer into every conversation he had with his large investor clients, thus enhancing his reputation as a “well-connected” analyst.
So that Monday morning, Ed picked me up at my house in a taxi. My home, at the time, was nothing super fancy, but my wife, Paula, and I had put a lot of sweat into it and were quite proud of it.
Ed took one look at the house and almost started laughing. “You ought to come to Wall Street and hit the big time,” he said. “I’m serious. You’d be good at it, you’d make plenty of money, and you’d get to do analysis all day long instead of just parroting management bullshit.”
Parroting management bullshit? I was offended—until I realized that he was absolutely right. That was exactly what I’d spent much of the last year and a half doing in investor relations. My job was not to express my own opinions but rather to pass on the company’s party line.
Our trip to Europe was a blast, made even more fun one day by the fact that the Morgan Stanley salespeople had arranged for us to be chauffeured in a sleek black Bentley, complete with a wonderfully obsequious driver. Even by Wall Street’s standards, this was over the top. I started to wonder exactly how much money Wall Street analysts made, anyhow. What they did didn’t seem any more difficult than my job, and it did sound more appealing to be the one whose opinions moved markets rather than the one who had to react to those opinions. I figured if I could be about 30 percent as smart as Ed and 20 percent more practical, I had a chance to do all right on the Street.
I knew the basics of how an investment bank worked, but not much more than that. My understanding was that they advised companies on strategic and financial issues and raised money for companies by selling stocks and bonds, taking a piece of the proceeds. And they worked with investors, helping them select investments, matching up buyers and sellers of securities, and charging a commission on every trade.
But I had no desire to move up to that snake pit called New York. I was fine in D.C.; Paula had a good job, and we now had two young daughters. By early 1989, I was promoted to director and put in charge of MCI’s business analysis group, running a group of MBAs analyzing everything from how to price a new MCI service to how much to spend on new technologies. But then Ed came back to me, telling me that he was rethinking his own career. Because Ed was so smart, he was also easily bored, and he was bored with being an analyst after so many years. He wanted to do something different. He decided to become a banker.
“Come work at Morgan Stanley,” he cajoled, “and take my job. I’ll train you and make you as good as me.” I told him I wasn’t moving. The cost of living in New York was way too high. Ed just laughed. “Just come up here and meet the people,” he said.
So I did. In fact, I took two trips to meet various research managers and institutional salespeople at Morgan Stanley. I’d been told that Morgan Stanley was a white-shoe investment bank that advised many of the largest and best companies in the world. It had a reputation of being genteel, refined, and snooty, with an old-money sensibility about it. Morgan Stanley didn’t trample all over people trying to bring in business like some banks did. It didn’t have to.
I enjoyed myself during these visits to Morgan Stanley. The meetings convinced me that the job would be fascinating and fun and that, with Ed’s tutelage, I could probably do it. I didn’t meet anyone from the banking side: apparently they didn’t care who replaced Ed as telecom analyst. I really had no idea what bankers did or why they might matter. My vague notion was that bankers made the lion’s share of the dough on the Street and that their job was the most prestigious. They served as advisers to the top executives at top companies, helping them to find other companies to acquire or merge with and raising money for them. It never occurred to me that they had anything to do with analysts, or that there was any significant interaction between the two groups. In any case, if Ed was interested in being a banker, they couldn’t be all that bad.
At the end of my second visit, Peter Dale, Morgan Stanley’s director of U.S. equity research, told me he would call me in the next few days with an offer. I still wasn’t sure if Paula would be willing to move, or of how disruptive such a move and career change might be to our family and marriage. I’d read an article in The Wall Street Journal that said top-ranked analysts were making $250,000 and up. That seriously impressed me, but of course there was no guarantee I’d ever be a top-ranked analyst. Plus 1988 had been a bad year on Wall Street. The stock market had been flat and investment banks had been in the tank. So when Peter called with my offer, I held my breath. “We’ll start you at $150,000,” he said. That meant $75,000, plus a $75,000 guaranteed bonus. My heart raced; he was doubling my salary.
Paula and I had calculated that it would take $175,000 to replicate our D.C. lifestyle by buying a similar-sized house in a comparable school district. This magic number also meant Paula could stay home with the kids, a luxury we hadn’t had until now and one we might need given the grueling travel schedule of a Wall Street analyst. For days, Paula and I stewed over how to handle the negotiations. Would I blow the deal by asking for another 25 grand? What if they wouldn’t give it to me? Could I still accept the job or would I have lost face? It seemed so, well, forward to ask for more. But that was the way it worked up there, wasn’t it?
I called Peter and nervously laid out my proposition. “This is the right job for me,” I said, trying to sound cool. “But,” I said, speaking like the true quant guy I was, “it’s tough to make the numbers work.” I needed another $25,000, I croaked.
“Okay,” Peter said, as if he’d just been asked to pass the salt. “Fine.” He didn’t have to ask anyone for permission; there was even the hint of a smile in his voice. Geez, was I clueless about the scale and scope of life on Wall Street. Apparently, $25,000 was the equivalent of a sneeze up there. “Dammit!” I said to Paula. “I didn’t ask for enough!”
Although I was excited about the money, that wasn’t why I was uprooting my family. To some it may sound disingenuous—everything on Wall Street, I was soon to discover, was all about the money—but for me that was never truly the point. Sure Ed loved to tease me, saying, “Dan, I drive a Beemer. What do you drive?” (I drove a four-year-old Chevy Nova and Paula drove a Pontiac 6000 station wagon.)
The money was certainly appealing. But it was more about the intellectual challenge and avoiding that malaise, that blah, that woulda-coulda-shoulda of making the safe choice. I could stay on at MCI, but my next job was probably going to be managing the accounts payable department, made up of 300 clerks. The Morgan Stanley job, by contrast, was a chance to test myself against some of the smartest people in the world. I wanted the brass ring. I wanted to become a top-ranked analyst in that poll, whatever it was called. I wanted to take the challenge and I wanted to win.
If I needed any more assurance that I was making the right move, I got it when we had dinner with Steve and Gloria, neighbors of ours in Potomac. Steve was an economist at the Federal Home Loan Bank Board. He was smart, well connected, and, in my view, way too comfortable. Five years older than me, he was already thinking about the day when he could retire from his job as a government employee.
“Dan,” he said, “you’ve got a great career going at MCI, you know all the top execs, and you have an extensive network of relationships throughout the company. Why would you give that up and start all over? You’re not young anymore, you know. You’re 36.”
Suddenly, I had a flashback to my grad school days in public policy, when I had planned on a career in government or academia, or even at a think tank. Like a lot of people who came of age in the early 1970s, I thought anything that smacked overtly of capitalism or the private sector was crass, tacky, bloodsucking. But in the summer between my first and second years at grad school, an internship at the Department of Education made me feel differently. Something had happened to all those idealists once they got into a slow-moving bureaucracy with job security. They had come in thinking they were going to change the world. Now they were 40 years old and hated their jobs. These guys had become bureaucrats through and through; as their idealism faded, their cynicism expanded. They no longer yearned to change the world, at the Department of Education or anywhere else. They were simply marking time until retirement.
On the ride home from dinner with Steve and Gloria, I said to Paula, “What Steve was saying was in a couple more years I’m going to be afraid of change and afraid of risk. I’ll end up like him. I will never forgive myself if I don’t at least give it a shot.” We made the decision to move that night.
Breaking the news to my colleagues at MCI wasn’t easy. One day, I ran into Orville Wright (yes, that is really his name), MCI’s vice chairman, in the hall. He was a big, tall, bald, conservative, former IBM man who always wore a white shirt. When I told him my news, I expected the standard pat on the back, but instead, looking down at me (he was a lot taller than me), he said, “Dan, I sure hope you know what you’re doing,” as if he knew something that I didn’t about the ways of Wall Street. Orville walked on without even congratulating me on what was the most important decision of my career.
A few days before my last day at MCI, Jim, my colleague in investor relations, came in and gave me a teasing look, that same look he used when he was looking for an impromptu audience for his latest tales of female conquest.
“Danny, I know how well you rise to challenges,” he said. “I was just talking to your best buddy on the Street.”
I rolled my eyes. “Which one might that be?” I parried, knowing full well who it was.
“I wasn’t going to tell you this, because it might make it difficult for you to sit next to him in meetings,” he said, “but Jack Grubman says you’re not going to make it on Wall Street.”
“Oh, really, why?” I queried. “Because I’m not a good liar or what?”
“Not exactly, Dan,” Jim responded. “He said you’ll never be able to handle the marketing and selling part of the job.”
I laughed it off when Jim said that, but this was, of course, exactly the thing I was most nervous about. I didn’t want to have to sell myself as much as my ideas. I was not an exaggerator or a cheerleader type. I’d never really been a backslapping, beer-chugging, frat guy. I didn’t want to overplay everything in order to get attention, the way I thought Jack did. I simply hoped I could write reports from the quiet of an office overlooking midtown Manhattan as competently as any telecom analyst out there. Maybe Jack was right. But it was too late. I had already given notice at MCI and it was time to make the move. It was July 1989.
It turned out that $175,000 in Scarsdale translated into a house that was pretty darn similar to the Potomac house that my friend Ed had maligned. We bought a four-bedroom colonial that was maybe 300 square feet bigger but cost us $65,000 more than we sold the previous house for. It was one of the smaller houses in town, but it did have an attic—which I set up as an office. I had no idea how much time I’d be spending in it over the next several years.
My first few months at Morgan Stanley were remarkably free of the types of pressures that would later be splashed across the front page of The Wall Street Journal. My job was to cover telecommunications services—primarily the Baby Bells, which along with GTE provided local phone service, as well as AT&T, MCI, Sprint, and a few others that sold long distance service.
Ed was still the main telecom analyst at Morgan Stanley, so he just showed me to an office next door to his and told me to get cracking on my first report. I was to sit in that room, research the bejesus out of this industry, and come up with a groundbreaking report that would put my name on the map and bring the firm some attention. I didn’t have to test my marketing mettle yet; I was just supposed to think, reason, puzzle. No one told me what to say, how to react, which companies were our banking clients, or anything else for that matter. Not even Ed, who had been positive on the Baby Bells, tried to sway me to his point of view.
I did, however, get my first taste of the good life in August 1989, when Ed took me on my first business trip to meet the top brass at the companies I was going to cover. Over the course of 10 days, we hit most of the Baby Bells, flying to Atlanta to meet BellSouth’s top executives, to Denver for US West, to Washington and Philadelphia for Bell Atlantic, to Chicago for Ameritech, and to St. Louis for Southwestern Bell. This was a new, heady experience. I sat in the office of each CEO and asked the toughest questions I could come up with. They actually answered them too. It was a blast.
Even more of a blast was the way Morgan Stanley, unlike the utilitarian MCI, loved to spend its money. We traveled first class, stayed in the finest hotels, and ate at some of the most happening spots in the country. It would be unseemly not to; it was the Street, after all, and not spending the money implied you didn’t have it to spend. Money begat money. My trip to San Francisco to meet with Pacific Telesis ended with a quick flight to Los Angeles to meet Tim Armour, the telecom analyst at Capital Group—next to Fidelity the largest and most important institutional investment firm on the Street—and his wife, Nina, for dinner. I knew Tim from my days in MCI’s investor relations department, and Ed was quite close to him. We went to Chinois on Main, Wolfgang Puck’s “It” restaurant of the 1980s, and found ourselves sitting next to Madonna. Tom Cruise was standing outside, chatting with someone. I tried not to gape and failed. Working on Wall Street didn’t make you a Hollywood stud—yet.
The next morning, we flew back to JFK on MGM Grand Air, at the time an all first-class airline. Ed and I had a “stateroom”—four seats, facing each other, with partially drawn curtains—and the plane had a bar section with lounge chairs, each of which had its own airphone. I looked across the aisle and realized that in her own stateroom, with her own personal assistant, was none other than Elizabeth Taylor. She was, we later learned, en route to Morocco, where she would attend Malcolm Forbes’s over-the-top 70th birthday party—to this day, one of the most lavish parties ever held.
Our analyst jobs didn’t get us invited to that shindig, so we had to content ourselves with spying on Miss Liz, which was tons of fun in itself. She slept for several hours, her personal assistant helping her turn until she was perfectly comfortable and carefully arranging her blanket around her. It would be a lie to say she looked glamorous; without her makeup, she looked like just another middle-aged lady. Eventually, she woke up and headed for the bathroom. Ed, ever the in-your-face New Yorker, decided he wanted to get up close and personal, so he followed her. She eventually came back, and I watched through the curtains as her assistant applied layer after layer of makeup to get her ready for the press at JFK. Let’s just say that I was glad to be a man.
Suddenly, Ed entered our “suite” with an enormous grin on his face. “So what happened?” I asked. “Did you talk to her? Did she realize what a big swinging dick you are, that your opinion moves stocks, like, daily?”
“No, I didn’t talk to her,” Ed said, cracking up, “but I did sit on the same toilet seat!” I think he was sincerely thrilled. After all, how many people can say they sat on a can heated by Elizabeth Taylor’s tush? Ahhh, Wall Street. I was beginning to like it here.
I LIKED IT A LITTLE LESS, however, when I actually had to sit down and write my first report. Believe it or not, my first report as a Wall Street equity research analyst took nine months to write. And the funny thing was that no one thought that there was anything outrageous about that. At the time, analysts were expected to spend a lot of time thinking and reasoning, and the firm was totally supportive. No one saw analysts as a potential source of income, so if it took nine months to write a report, well, so be it.
The harder I worked, the more my nerves got the better of me. My insecurities kicked in once again. “This is the Ivy League, not SUNY Albany, where I went to college, and Morgan Stanley is paying me all this money,” I fretted every time I found myself at my computer at 3:00 AM. “I’d better blow them away or else. I’d better know every single detail of every line in that report cold,” I warned myself.
My response to insecurity was to work harder. So I worked my tail off at the office, came home to Scarsdale, locked myself up in my attic office, and worked some more. Sometimes, Paula would bring me dinner upstairs, which I really appreciated, because I wouldn’t have had a chance to see her—or to eat—otherwise. I tried to learn every facet of the telecom industry, every twist, every angle. The pressure, however, was coming from me and only me. Ed was calm, Morgan Stanley was calm, and everyone else seemed to have faith that I could actually do this job.
Finally, in early April, exactly nine months after I had started at Morgan Stanley, I screwed up my courage and handed a 90-page draft to Ed and Peter Dale, the head of research. I braced myself for the worst: “You’ve worked on this for nine whole months and this is all you’ve got to show for it? What the hell have we been paying you for?” I imagined them exclaiming. Much to my surprise, both Ed and Peter liked the report, but each suggested many specific changes. An editor colleague, Fred Miller, helped me with a lot of rewriting and came up with a catchy title that I could never have imagined myself: “Max Headroom,” which was taken from a TV science fiction series that was big at the time.
In “Max Headroom,” I argued that serious competition was coming to the Baby Bells from new local phone companies. Even worse, their earnings would be held down by regulatory rules that provided limited “headroom.” The Bells, in my view, were going to have a tough time growing earnings as fast as others thought. I rated four of the seven Baby Bells as Holds, which meant that I thought these stocks were not going up much; they were stuck where they were.
Every brokerage firm and investment bank had a different rating system for its stocks, but overall they were quite similar: Either a three-, four-, or five-point system, with the top rating called Buy or Strong Buy, the middle rating called Hold or Neutral, and the worst rating of all usually called Sell. In the five-point systems, there were two other categories: Outperform or Accumulate, which usually meant the analyst thought the stock would rise at a moderate level, by say, 10–20 percent, over the next year; and Underperform or Reduce, which meant the analyst expected the stock price to fall by around the same amount.
At Morgan Stanley at this time, there were only three ratings: Buy, Sell, and Hold. Buys were stocks we thought would rise more than 20 percent over the next year, Sells should fall more than 20 percent, and Holds stood in between, expected to rise or fall somewhere between 0 percent and 20 percent during the same time period. I didn’t see much upside for the majority of the Bells, so Hold was the appropriate rating. In the eyes of investors, I learned, this was considered a negative call, a group of stocks not worth investing in. That’s because the objective of a professional money manager is to do better than, or outperform, the broad stock-market indices such as the S&P 500 Index or the NASDAQ. So a stock that wouldn’t make that happen was not a stock most professionals wanted to own.
Though I didn’t realize it for a while, my opinion was pretty much the opposite of the one presented by Jack Grubman, who, five months earlier, in December 1989, had written a bullish report strongly recommending the Baby Bells. He argued that they would benefit from a string of high-tech new features and services, particularly video services. It was the beginning of an intense rivalry that would last more than a decade.
NOW THE REAL FUN was about to begin. The report went to Morgan Stanley’s legal compliance team for review, to make sure that I wasn’t disclosing—knowingly or not—any nonpublic information that our bankers, or anyone at the firm, might have become privy to. For example, if I had unwittingly discussed a potential merger that was already in process, all references to it would be omitted from the report. Even worse, the entire report might be scrapped if the lawyers did not want anyone, me included, to get the slightest hint of the pending, confidential deal. Fortunately, “Max Headroom” cleared those hurdles, and now it was time for my debut. I would present my report at Morgan Stanley’s institutional sales meeting on the afternoon of May 9, 1990, and officially take over coverage of what was called the “wireline” telecom sector from Ed.
All of Morgan Stanley’s top salespeople would attend the meeting, some by phone, most in person. Since Morgan Stanley didn’t yet have a retail brokerage arm that sold stocks directly to regular folks, these salespeople called primarily on big institutional investors and extremely wealthy individuals. They would listen to my presentation, and then, assuming they bought my argument, take it out to the Street. If the Street paid attention, we’d see these stocks fall, since I was presenting a pretty unenthusiastic opinion. Was I actually going to move the stock market?
Two days before the report was published, I was told to give the banker who covered the Baby Bells a copy of the report as a courtesy. I didn’t know what to expect, especially considering the fact that my opinions were not going to endear me to the Baby Bells—or to Bob Murray, the banker. But Bob couldn’t have been more professional. He read the report, and put it back on my chair the next day. His only comment? “BellSouth is one word, not two.” No interference, no “helpful” suggestions, no nothing. That was the way I first experienced life as a research analyst at an investment bank.
Since my report was now 70 pages long, and I doubted the salespeople would read the whole thing (or any of it), I wrote and distributed a two-page crib sheet outlining my argument. That afternoon, I waited nervously as other, more experienced analysts made their presentations, describing softness in demand for deodorant and an uptick in orders for personal computers. Finally, they turned the microphone over to me, and for 10 or 12 minutes, I did my best to convince Morgan Stanley’s salespeople that my analysis of the Baby Bells was worth passing on to their buy-side clients.
I knew this material inside and out. But, as I started to speak to Morgan Stanley’s institutional sales force that afternoon, I feared that I was going to slip up somehow, or that I’d made the wrong call on the stocks. In this job, I’d get my report card quickly, when the next day’s stock market would make clear whether people thought I was a bozo or a brainiac. I made it through my presentation, but during the Q&A that followed, Bill McElroy, an astute salesman, stopped me cold with the most innocent of questions.
“Are you saying that investors should be underweighted or overweighted in the sector?”
Whaaaa? I froze. I was not prepared for such a basic but reasonable question, focused as I was on all the obscure details. What he was asking was whether one should put a higher percentage of one’s assets in telecom stocks than they represented as a percentage of the overall market. Basically, he wanted to know if I thought the Baby Bell stocks would perform better than the market. I glanced over at Ed, sitting in the fifth row center, who was calmly mouthing “under, under.”
“Underweight,” I blurted, trying to sound confident.
Once finished, I raced back to the office for the next phase of releasing a report. I called as many buy-side clients as I could to further explain my position to them and to make that “personal contact” I was learning was so very important.
After ten months of sweating bullets, the whole thing was something of an anticlimax. The salespeople were moderately but not overly impressed. I was just another analyst making just another report. And the stocks themselves? They didn’t budge. It was a humbling experience.
I eventually realized three things: first, I was covering slow-moving stocks that didn’t fluctuate a lot; second, I was brand-new and no one was going to invest money on my recommendations yet; and third, I had presented an entirely well-reasoned but entirely unsexy report. It didn’t have any juice, any pop, any emotion, any insider-type info. Other than “Max Headroom,” its title, it didn’t even have any catchy phrases. Those were the calls they loved, the calls that moved markets.
Ed consoled me. “Your job is not to move stocks the first day,” he said. “It is to get yourself recognized as someone who knows the industry. Your job is to get Fidelity and Capital Research and Alliance Capital Management to call you before they decide to buy or sell telecom stocks.” These were the huge mutual funds that were Morgan Stanley’s biggest trading clients, as well as the biggest owners of stocks and bonds in the world.
I knew Ed was right, but for years, I couldn’t help but stare hopefully at the screen the morning after I announced a change in ratings or put out a new report. Sometimes, particularly after I became known on the Street, my reports moved stocks immediately. But if I had interpreted an event or news report as bearish and Bell Atlantic or PacTel closed up 50 or 25 cents, I took it personally. Why was someone at Putnam or Fidelity buying when I’d laid out such a well-reasoned argument against doing so? Eventually, I calmed down, but it always struck me that, unlike many people in the corporate world, investors and their advisers got graded every day. If I missed some news or made a bad call, I’d hear about it immediately, first from the trading prices of the stocks and then from an unhappy money manager who’d followed my advice or a Morgan Stanley salesman who’d pitched it hard.
The month after my piece came out, Jack Grubman wrote a quarterly update report, mentioning that those who were looking at regulatory “headroom” were looking at the wrong issue. He meant me. It was a personal shot, yet I got some satisfaction from the fact that I had at least gotten some attention and free advertising from a competitor who had confidently predicted my failure.
“We Do Not Make Negative or Controversial Comments About Our Clients.”
Over time, I acclimated myself to this whole new world. Yes, I had to sell myself, and surprisingly, I didn’t dislike it as much as I’d anticipated. But for the most part, I was free to pursue research, to write my honest opinion without the interference of bankers or anyone else, and to do the job the way I’d envisioned it.
It was a rare period in Wall Street history. People were on their best behavior, in part because of the spate of insider-trading cases that had rocked the world just a few years earlier. Ivan Boesky had recently been convicted of insider trading, using inside information to profit on deals that hadn’t yet been announced. That inside information had been leaked to Boesky by some investment bankers. In this context, few people wanted to push the envelope. And the market was puttering along as well. The operative word of the day was steady. And steady was a concept I felt very comfortable with.
Although the mere mention of insider trading was enough to strike fear into any Wall Streeter’s heart at the time, no one got too up in arms over the interaction between research analysts employed by investment banks and the banking business itself. In part, that was because analysts exist thanks to the banking business; they don’t generate enough profit to support themselves. In effect, analysts are loss leaders for banks. Their work is funded by the fees brought in by bankers and the commissions brought in by salespeople and brokers.
That’s why there were and are strict rules governing the interaction between the two. At Morgan Stanley, a written policy given to me upon my arrival at the firm officially and emphatically declared the independence of the research division from pressures by the investment bankers.
“Morgan Stanley’s research is totally separate from the investment banking of [sic] and merger and acquisition activities of the Firm,” it read. “Rigid rules ensure the separation of association and information. A basic tenet of our philosophy is that research must have integrity and therefore requires absolute and impartial freedom of judgment.”2
In practice, however, it was slowly becoming a different story. Although I had not experienced any overt pressures, some sordid stuff was beginning to swirl around the firm.
One of these was the Clay Rohrbach memo. Clayton J. Rohrbach, III, was the head of stock capital markets, in other words, a big-shot banker. The way I remember the story of Clay’s memo, a young guy named Sandy Cohen was Morgan Stanley’s utility analyst at the time. Like me, Sandy had been mentored by Ed Greenberg and had developed a habit of speaking his mind, even if it angered the companies he covered. He had developed a special methodology for rating his companies, a very technical one that spit a lot of components into a formula and came out with an opinion.
One of the criteria he plugged into his model was the quality of management. Some of the people who ran companies were true dolts, while others were real strategic thinkers. Anyway, Sandy ranked one of his utilities low in the management department, and Clay, as the keeper of the flame, or that “special relationship” with the company, apparently got an earful about it. From Clay’s perspective, research must have seemed like something of a waste of time. It didn’t make any money—and was, in part, paid for by the fees generated by bankers like him. So wasn’t it logical that an analyst, whose salary and bonus inevitably came from the money earned on deals, shouldn’t do anything that could jeopardize that deal flow? Ticked off by Sandy’s conclusions, Clay wrote a memo in September 1990 that shocked all of us on the 20th floor, which was where Morgan Stanley’s research analysts worked.
“As we are all too aware,” it said, “there have been too many instances where our Research Analysts have been the source of negative comments about clients of the Firm…. Our objective is to have a zero failure rate on this subject and to adopt a policy, fully understood by the entire Firm, including the Research Department, that we do not make negative or controversial comments about our clients as a matter of sound business practice.”3
This, of course, was absurd. Did Clay think we should rave about every stock in the entire stock market, even if it was a dog? Although Clay’s memo was later portrayed as a one-off outburst, he clearly felt strongly about the issue. Earlier that year, Clay had written a draft memo proposing that research-analyst pay be determined partly by how much they had helped bankers win deals, with analysts getting an A, B, or C grade depending on how “instrumental” they were in the firm’s winning of a transaction.4
What Clay was trying to do, in effect, was make the analysts earn their keep. He, and some others, were trying to change the analyst’s job from giving good advice to investors to helping bankers do deals. For me, it was the first example of the crossing of that supposedly sacred line between banking and research.
What Clay was experiencing was the end of the genteel old world of banking, in which belonging to the same country club and living in the same town was as much of a draw for a corporate executive choosing a banker as the actual services the bank was offering. As banking became more competitive, these relationships weren’t enough anymore. Banks needed to offer something extra, some special sauce. As time went on, that special sauce would often involve bullish research.
I guess I was lucky, both because I had an old-school banker in Bob Murray, who didn’t interfere with my opinions, and because the telecom sector did virtually no deals at that point, so there was no reason to meddle and no way to assess my level of “cooperation.” At the same time that my colleagues were murmuring that they were starting to get heat for their opinions, I had a Sell rating on one stock, Ameritech, and Holds on most of the Baby Bells, and never heard a peep about it from anyone.
In any event, someone eventually leaked Clay’s memo to The Wall Street Journal, which ran a front-page story on the shenanigans in July of 1992. It was a huge embarrassment for Morgan Stanley—the most highbrow firm now essentially being caught red-handed trying to influence research. As far as I know, Clay was never disciplined. He went on to have a long career as a senior banker at several major houses. The whole episode is a reminder that the scandals of the late 1990s, as shocking as they were, had plenty of precedent and plenty of warning.
I heard these things but reacted to them a little bit like an ostrich. No one was bothering me, so it didn’t seem like something to get worked up about. In my world, Morgan Stanley seemed pure. I didn’t see anyone daring to put the squeeze on Ed, my mentor. He managed to have strong opinions—positive and negative—without being pressured by anyone, not bankers, not management. As his protégé, I felt insulated and protected.
By now, Ed had initiated coverage of the cellular, or mobile, phone industry with negative views. He predicted much lower prices resulting from increased competition, as the federal government was awarding many new licenses. He assigned Sell ratings to five of the seven cellular companies he covered and Hold to the remaining two. Several of the companies were even Morgan Stanley investment-banking clients. Yet no one seemed to raise an eyebrow. Ed’s Sell ratings made sense in the context both of his detailed analysis and of the overall stock market. Indeed, the major stock market indices had been trading sluggishly for quite a while and there was nothing to suggest that was going to change anytime soon.
Ed’s report was outstanding, perhaps the best I had ever seen. It was deep in its analysis, thorough in its consideration of the numerous variables that would drive the future of the cellular industry, and prescient in its prediction that the federal government would allow many more competitors.
Yet contrary to Ed’s predictions, several of the cellular stocks took off, driven by a massive consolidation wave throughout the industry. Several large companies, including AT&T and the Baby Bells, went on acquisition binges, paying hefty prices for the stocks Ed disparaged in order to fill in geographic holes in their cellular coverage. And technological improvements and lower prices meant customers began to use cell phones more than anyone could have imagined.
More significant than all of these factors, however, was the suddenly turbocharged bull market. In the 12 months after Ed’s bearish report, the Dow Industrials rose 17 percent and the NASDAQ index, where most of the cell phone stocks traded, rose over 20 percent. Once that bull began to rage, bearish calls like Ed’s were ruthlessly stampeded: within four years of his call, for example, the Dow had risen almost 50 percent and the NASDAQ by 67 percent. Ed was lucky. He was a top-rated analyst, had a stellar reputation, and was about to move to banking anyway. Many other bears, however, found themselves overrun by the roaring bull market of the 1990s, and were never heard from again.
There were two very simple lessons to be learned from Ed’s experience with the cellular stocks. The first was to never get on the wrong side of a major bull or, for that matter, a major bear market. Either one can flatten you, no matter how astute your insights and sophisticated your analysis.
The second lesson was that Sell ratings offer little payoff to a Wall Street analyst. This is because, for the most part, institutional investors are paid to pick stocks that go up. They need to outperform the overall stock market by enough to compensate for the risks, fees, and trading costs they incur. As a result, stocks that perform in line with the market are of no interest to these money managers.
If a stock falls or performs in line with the market, the Wall Street analyst who rated that stock Hold or Neutral looks almost as good to his clients as the one who rated it Sell. As a result, analysts didn’t have much incentive to go out on a limb with a much riskier Sell rating, even before the banking pressures emerged.
At that time, I didn’t fully understand any of this. And I soon learned that Ed had been protecting me from other matters as well. One morning in October of 1991, I was toiling away on a very long report on a local phone company called Centel. I had spent about two months working feverishly on it, and was just about finished, when I looked up at my computer screen to see a news flash: “Centel Board to Put Company up for Sale.” Even more surprising to me was the fact that the board had hired none other than Morgan Stanley to be the banker in charge of this auction. How could I not have known?
Ed walked in that morning and said, “I have to apologize to you, Dan. But I couldn’t tell you.” It turned out that Ed had known all about the pending announcement for weeks and had been asked to give his opinion to the bankers on whether Centel should sell itself to a larger company or go it alone. Ed’s expertise and knowledge of the industry was eagerly sought by Morgan Stanley bankers and telecom executives. Because he had been brought “over the Wall” to the banking side, he said, using a cryptic—and compelling—term I had never heard before, he couldn’t tell anyone, not even me, without possibly running afoul of insider-trading rules. If he told his wife, his colleague, or his plumber, he’d be improperly sharing proprietary inside information with other people.
The wall that Ed was referring to going “over” was something commonly known on the Street as the Chinese Wall. Meant to be as big and impenetrable as the Great Wall of China, the Wall was a metaphor for keeping information about pending deals or transactions in the hands of the bankers who helped put those deals together. If that information leaked out to the rest of an investment bank—anyone from traders to research analysts to even the cafeteria workers—someone could use that information to buy or sell the stocks involved, making an unfair and illegal profit. This was what Ivan Boesky and bankers from Drexel Burnham Lambert and Kidder Peabody had been convicted of just a few years before. I knew all about the Chinese Wall, of course, but I had had no idea until that moment that there were exceptions to this rule for analysts. Apparently bankers didn’t have all the answers when it came to deals. In some cases, analysts could provide some added perspective that might never have occurred to the bankers and company executives.
My first reaction was frustration. I had just spent two months learning everything there was to know about Centel, and my own bank couldn’t even tell me it was being sold. This deal also meant that I’d now be “restricted” from publishing my report while Morgan Stanley’s bankers handled the auction, which could take several months. And if the bankers did manage to sell the company, the report would become irrelevant anyhow, so I’d essentially wasted two months of my life.
But Ed had done the right thing by keeping quiet, I soon realized. This was the way the game was played, and if I lost a few weeks but managed to avoid the temptation of insider information, well, that was just fine by me. At the same time, the more I thought about this over-the-Wall stuff, the more intrigued I became. I was fascinated—and wondered if my views would ever be respected enough to be asked to come over the Wall one day.