Lock up the analysts and throw away the key

An investor who followed expert advice lost $100,000. He wants vengeance, but history suggests he's not likely to get it.

By Damien Cave

May 20, 2002 | A couple moves to Hawaii and after a lifetime of work saves $400,000 for retirement. It's 1999, so they put their money in stocks and ask their son to take charge of the portfolio. He's only 22, having just graduated from Carnegie Mellon University, but he's a tech-savvy math wizard who's considering a career in finance. They figure he's got what it takes to make millions.

But things don't go according to plan. Using an account at Charles Schwab, the son -- let's call him Sunil -- follows analysts' recommendations. He buys 1,000 shares of the wireless high-flyer Qualcomm when it's at $150, trusting the advice of supposed experts like Merrill Lynch analyst Mike Ching, who declared in early 2000 that the stock's price-to-earnings ratio of 100 -- five times the historical market average -- "fairly values" Qualcomm's prospects.

Then the market deflates. But Sunil holds on to the stock even as he begins to notice news stories about how analyst "buy" orders seem to uncannily favor precisely those companies whom their employers wish to attract as investment banking customers. He can hardly believe what he's reading. By the time the SEC gets actively involved in early 2002, his Qualcomm stock is trading at about $30 a share. Sunil has lost $100,000. Now, two years after his first investment, he's convinced that Wall Street analysts deserve some of the blame for his losses. And he's calling out for their punishment.

"Is there anyone else out there as irate as me?" he asks, in a message posted in mid-May on Craig's List, a San Francisco community Web site. "Wall Street & venture capitalists can go to hell. A slap on the wrist ain't going to fix the problem."

Banning bad analysts from the industry -- the most common form of white-collar punishment -- isn't enough, he says in a phone interview, while asking to remain anonymous because he now works in the finance sector and fears for his job. Instead, analysts need to be held personally responsible. "The first thing they should do is return the money they earned to the people, the mom-and-pop investors," he says. "Then they should go to jail."

Sunil isn't the only investor boiling over with rage. Other victims of plunging stock prices are also calling for analysts to trade in their pinstripes for prison stripes. News reports generated by New York Attorney General Eliot Spitzer's release of damning e-mails from Merrill Lynch, which revealed how analysts boosted stocks in public while slamming them in private, have fanned the flames.

But will individual analysts take a fall? History suggests they won't. White-collar criminals almost never pay out of pocket or go to jail. The reasons go deeper than just the ability of analysts to hire the best lawyers. According to experts, American capitalism at the turn of the 20th century does a great job of encouraging entrepreneurship and risk taking but lacks an effective mechanism for punishing those who go too far. The two predominant legal responses -- the criminal prosecution and civil class-action suit -- continually fail to do the job.

Federal prosecutors, for example, rarely pursue finance-related cases, preferring to focus their resources on easier targets. Meanwhile, the civil system is dominated by class-action lawyers who fixate on obtaining the largest possible settlement, and not on pushing for the kind of personal accountability that might actually keep future criminals from committing similar crimes. As a result, bad behavior is rewarded: Executives, analysts and other Wall Street players who take part in fraudulent financial schemes usually get to keep their winnings. Not even Spitzer's surprisingly effective campaign against Merrill Lynch, critics argue, will be enough to buck historical trends.

"The long and the short of it is that no one will do time for this," says Ben Cole, the author of "The Pied Pipers of Wall Street: How Analysts Sell You Down the River." "Merrill will pay fines. The SEC will ban the direct payment to analysts of investment banking fees, while the indirect payment will stay in effect. Nothing will change."

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