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July 24, 2000

Are Analysts Compromised When They Say 'Buy' While the Bankers Sell?
By Mark Maremont, excerpted from The Wall Street Journal

And Individual Investors End Up The Losers ... Weiss comments

NEW YORK - In December 1999, the investment bank Chase H&Q; published an analyst's report praising Infospace Inc. as a "must-own holding." A few weeks later, H&Q; reiterated the "buy" recommendation.

But while the bank's analysts were telling customers to load up, H&Q; itself was bailing out. In late January, with the buy rating still in place, the Chase Manhattan Corp. unit sold all of the Infospace stock owned by its venture-capital arm, plus a stake owned by an H&Q; employee fund, for about $72 a share, or a total of roughly $42 million.

H&Q; and some fortunate employees pocketed a 7,000% gain in 18 months in a company H&Q; had taken public in late 1998. Investors who bought Infospace stock early this year based on H&Q;'s repeated recommendations aren't doing as well. Some may even have lost money. The stock is currently trading at about $48.

Lured by huge returns in technology stocks, Wall Street banks have dramatically stepped up their venture-style investments in the past year or so. But as investing in privately held companies on the verge of going public becomes a new profit center on Wall Street, it also is creating potential conflicts of interest for the banks.

An investment bank's analyst, for example, may be tempted to boost the stock of a company in which his employer -- and possibly the analyst himself -- owns a stake. This possibility, while almost impossible to prove in particular cases, nevertheless can erode the credibility of analysts' recommendations, on which many investors rely.

Wall Street houses deny that their venture investing creates any conflicts. A Chase Manhattan spokesman says that H&Q;'s sale of Infospace stock in January was "completely separate" from the H&Q; analyst recommendations.

Not every investment firm is selling while its analysts tell the public to buy, of course. But selling a stock while simultaneously recommending it is just the final stage of what some bankers and venture capitalists say is an increasingly common cycle on Wall Street: First, an investment bank secures a stake in a promising start-up, sometimes by suggesting a willingness to take it public. After a successful IPO, the bank's research department issues positive opinions on the stock. When securities regulations allow it to sell its venture stake, the bank does so, frequently reaping a big profit.

In some cases, analysts and bank executives have a personal interest in the outcome, either by means of individual pre-IPO investments, or, more commonly, through employee venture pools that many banks recently have set up.

Ted R. Dintersmith, a principal at Charles River Ventures, a Waltham, Mass., firm that has backed many successful start-ups, believes the pattern represents a "new investment-banking model," in which Wall Street firms "push like crazy to get a large amount of [their own] money" into a promising young technology firm, then "turn around and take the company public."

"Where it crosses the line," Mr. Dintersmith adds, is when "you see analysts at investment-banking firms issuing aggressive buys at high prices and see the same investment banks aggressively selling. Something about that seems highly inappropriate." (The question of whether securities-fraud laws were violated would arise only if there were manipulation -- for instance, if a bank's venture-investment executives asked an analyst to effectively deceive investors by postponing downgrading a stock to allow the bank to sell its stake at a higher price.)

Controversy has percolated for years over the widely held perception that some Wall Street analysts issue glowing reports on companies to help attract and keep those companies as investment-banking clients. Now the phenomenon appears to have escalated. Banks are seeking opportunities to make pre-IPO investments with potential payoffs dwarfing ordinary Wall Street fees. And the banks' chances of landing those pre-IPO stakes are enhanced because technology start-ups are eager to associate with Wall Street institutions that can take them public and then publish positive analysts' reports about them.

This isn't news to us. In fact, we've reported on this before. These deceptive investment practices occur so often, it's regarded as standard industry practice. From this article, it's clear that many major investment bankers dump stocks highly touted by their analysts. And, you can see that individual investors are the ones who get ripped off, while investment banks and their analysts get a tidy profit.

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