LIKE ANY MODERN bank, JPMorgan Chase had to juggle its interests. All the parts of its sprawling operations, from retiree savings accounts to complex derivatives, were covered by regulations designed to prevent conflicts of interest or self-dealing at the cost of clients.
Steve Tusa was a sell-side analyst in the bank’s New York headquarters, and he was a good one. As a sell-side guy, his job was to rake through the financial records and public utterances of the public companies he covered and find unappreciated problems before they hammered the stock price so that every investor who paid for his research would have a chance to escape to safety.
Now Tusa had found some problems in the financial disclosures of one of the bank’s biggest and most historic clients: General Electric.
GE wasn’t just a hugely important company, with a combative investor relations department that didn’t take kindly to negative research notes from Wall Street analysts. It was also an enormously important customer of JPMorgan Chase, which had become a go-to banker for GE over the years.
The inherent conflicts of interest embedded in the Wall Street research models employed by massive banks had supposedly been corrected by a $1.4 billon settlement with regulators in 2003. Regulators had come down on the banks in an effort to erase the pressure on their analysts to publish overly positive research on companies that would help their firm’s bankers land lucrative investment banking deals. It was deals and trading commissions, not research, that made money. But even years later, the stock recommendations still skewed strongly to the positive as companies found other ways to incentivize analyst behavior.
Sophisticated investors with their own internal analyst teams had eventually found the watered-down research from banks to be of little use. Instead, the real use for analysts was access. Investors depended on their analysts to arrange private meetings with top-level executives at companies. Private meetings, however, also created pressure to come up with positive ratings. Even openly negative analysts admitted how difficult it was to assign a sell rating on a company that could suddenly stop providing valuable one-on-one time with executives. They couldn’t afford to get cut off.
Regardless of the relationships within JPMorgan, Tusa’s doubts were real. He had been on the team covering GE for years, and a couple of years earlier he had fired what amounted to a warning shot across GE’s bow. In the spring of 2006, in a research note, Tusa had noted that GE Capital’s tax rate had come in unexpectedly and conveniently low—14 percent compared to the 17 to 19 percent that the company had previously projected. A sharply lower effective tax rate had the effect it would have on any household: for that quarter, GE recorded that it had taken home more earnings. That was the sort of thing that investors loved. It was also what analysts like Tusa called “low-quality earnings”—a slightly more polite way of saying “awfully convenient.”
This was not an instance of profit from additional goods sold or loans closed. And as with any tax rate–generated gain, there was no guarantee that the same benefit would be there just three months later, in the next quarter. Calling out low-quality earnings, as Tusa did, was coded Wall Street jargon that signaled to sophisticated investors, and to the well-heeled, that GE’s public declarations about how well the business was doing weren’t quite what they seemed.
JPMorgan’s relationship with GE went all the way to the top. As Immelt was buying and selling business units at a relentless pace, he often turned to JPMorgan for advice. The dance partners had a relationship that went way back: for GE, the titular financier J. P. Morgan was arguably a much more important historic figure than Thomas Edison. More important, the most eager chatterbox in Midtown, the irrepressible JPMorgan banker James Bainbridge Lee Jr., was working his way ever deeper into the inner councils of GE.
Jimmy Lee had a rapport, to hear him tell it, with virtually everyone in American business, but he especially loved GE. He had bonded deeply with Welch, known Immelt for years, and helped bring numerous deals from the big industrial at 30 Rock a few blocks over to JPMorgan Chase’s glass-fronted tower near Grand Central.
“This doesn’t sound good when I say it this way,” he once told us, “but I’m like the only guy on Wall Street that knows them this well.”
Lee’s comments privately demonstrated the stakes for Tusa as he highlighted the rising questions around GE. A tough note from a Morgan analyst could lead to pressure in Lee’s crucial banking relationship with a client like GE. But the fact that JPMorgan had a strong banking connection to the company also lent strong credibility to Tusa’s more negative observations. To those who knew the research game, Tusa was the last guy who should rock a boat as big as GE. When he did, the thinking went, he must have had a good reason.
Tusa was a son of Greenwich, Connecticut, the Napa Valley of hedge funds and the bedroom community of Manhattan finance’s elite. His father was a successful lawyer, and as a child he rode bikes with friends named Ian and Shep Murray, who would go on to found the uber-preppy clothier Vineyard Vines.
Tusa had earned a political science degree but skipped the standard path to finance of getting an MBA. Instead, he had headed straight into banking, and what he learned there on the job helped him, he believed, to understand GE.
He was also tough. He had a contrarian impulse and was more likely to cheer for a team to lose than to pick a winner. The analyst liked to say that his first career choice would have been playing center for the New York Rangers. Tusa played hockey competitively into adulthood and carried himself with an athlete’s wiry intensity. When he first met one of us, Tusa was sporting a mullet, which he had grown out of superstition because his beloved Rangers had made it into the NHL playoffs.
As he sat in his Midtown office in 2008, reading yet another round of GE financials also gave Tusa a bad feeling of déjà vu from those early days at Morgan. He had arrived on the industrials beat just in time to see up close the enormous collapse of Tyco International, a seemingly impregnable industrial company, known for its smooth and consistent earnings that fell to pieces overnight. Tyco had been a massive accounting fraud, but analysts missed the story. The smoothness of the earnings had rocked them to sleep long enough for the investors they served to lose everything.
The scandal had left a deep impression on Tusa, who emerged from it determined to be skeptical of everything. Though he maintained the peculiar faux-civility of the earnings calls, Tusa, like many of his colleagues, tried to ask tough questions without rocking the boat hard enough to get pushback from a company’s investor relations department.
Now, as the head of the JPMorgan team that covered GE, he was resolved to dig deeper. Tusa had placed an “overweight” rating on the stock, which meant that investors should hold more of it than the average investment. An overweight rating was a tacit endorsement to buy the shares at their current price. Regardless of his published rating, however, Tusa’s skeptical nature led him to keep a close eye on Immelt as he struggled to find growth and adjust to the new world of running GE without the supports that Welch had enjoyed.
When GE missed its earnings target, Tusa decided that the time had come. Dropping a bomb that shocked investors, the analyst downgraded GE from “overweight” to “neutral.” This financial jargon might have held little meaning for an outsider, but insiders knew that it represented the withdrawal of an endorsement worth tens of millions at least.
Tusa explained himself. Speaking of GE in a note he distributed to his clients, he wrote: “It would appear as though accountability for hitting targets is the top priority, and some managers might be chasing earnings.” He added: “We also think the high bar for success in such a competitive environment could create a scenario in which bad news is not tolerated, making necessary communication with senior level managers a challenge until it’s too late to fix.”
In other words, the bosses demanded results at any cost and problems could be hidden for the sake of preserving performance, thus allowing small problems to become big problems before they were detected.