Confessions of a Wall Street Analyst (26 page)

It worked like this: prior to the ruling, the SEC prohibited research analysts from issuing opinions on companies that had hired their firm’s investment bankers for M&A work. This had two results, one good and one bad. First, it kept the research analyst’s opinions from being influenced by the interests of the bankers or their corporate clients. Otherwise the analyst might be pressured to put out a positive opinion on the companies involved, helping convince the companies’ shareholders to approve a proposed merger—and guaranteeing a fat fee to his firm. The second, unintended, effect was that individual investor clients of, say, Merrill Lynch, no longer had access to the analyst’s recommendations and explanation of the transaction, leaving them in the dark if they had an account with only one brokerage firm.

On October 21, 1997, Merrill’s law firm wrote a letter to the Securities and Exchange Commission. Merrill said it would like to be able to publish analyst recommendations on the shares of an investment banking client
even while a merger or acquisition was pending.
⁷
The SEC responded with its “No-Action Letter,” which is not a formal approval but rather an assurance that should Merrill do what it proposed, the SEC would not take any punitive action.
⁸
The SEC wasn’t saying that doing this was right or wrong, but rather that the commission would not interfere if Merrill or, indeed, any investment bank did issue some recommendations.

The letter therefore essentially sanctioned behaviors like Jack’s bullish report on Frontier and Global Crossing, even though the merger was awaiting approval and his firm’s fee was contingent on the deal going through. Before the No-Action Letter, a firm with an influential, well-respected, and bullish analyst often lost out on deals because the corporations involved knew the analyst would be muzzled in order to avoid the possibility of conflicted research. They did not want to lose that analyst’s bullish influence while the deal was underway.

The letter turned that upside down. Now that analysts were no longer restricted from commenting on pending deals, it made sense for corporations, in search of supportive commentary and higher stock prices, to hire firms with pliable or bullish analysts. Arthur Levitt, who was chairman of the SEC in 1997, gave speeches castigating analyst conflicts of interest. But he also presided over the creation of one of the most pernicious and costly conflicts in the history of Wall Street.

I didn’t understand any of this at the time. So, when Ray phoned another Merrill lawyer, I sat and listened in to the call, taking copious notes. After a while, yet another Merrill lawyer was brought onto the call as well. As the call dragged on, it became clear to me that each of the lawyers had different interpretations of the SEC’s regulations, and that there was no clear answer. I had to leave for a client meeting, so we agreed to meet again the next day.

When we reconvened, I don’t remember who said what, but the group of lawyers spent a lot of time trying to justify my publishing research on this deal. One suggestion was for me to write a detailed report on Frontier but not on Global Crossing, explaining the merger terms, forecasting revenue and earnings for Frontier, and setting a target price for Frontier shares. This was what Salomon had allowed Jack to do and would be okay, the argument went, because Merrill’s bankers, like Salomon’s, were advising Global, not Frontier. However, in contrast to Jack’s report on Frontier, I wouldn’t be allowed to give Frontier shares an investment rating.

Nevertheless, if I set a target price for Frontier based on the number of shares of Global stock it was being offered, any reasonably intelligent pro
fessional investor would be able to deduce my target price for Global Crossing. I would leave blank what Jack had spelled out explicitly: the pros would know what I was thinking about both stocks, but the amateurs—the individual investors who lacked the time or expertise to read through these tea leaves—would know far less.

It was all very convoluted and inconsistent. My mind was spinning. I was in a jam, and no one was offering me a clear way out. If I wrote anything positive, it would be perceived as urging shareholders to vote in favor of the merger. And then one of the Merrill lawyers topped it all off by telling me that there was some risk the SEC would sue us if we followed this plan. Someone else chimed in that it could be an important test case of the rules.

“Whoa,” I yelped to Ray, who was sitting across from me. “So I’m the guinea pig for these legal guys to test the SEC’s rules? No way, José!” (Ray thought I said, “No way Ray.”)

Ray interjected, “Neither Dan nor I are comfortable with the scenario you guys have painted. Do you have any other ideas for us to consider?”

Two more ideas were offered. I could simply write nothing—and mark the stocks as “restricted” in the Merrill computer systems. Or I could continue to write factual reports as I already had, again with the rating column marked “Rstr” for restricted. I nodded positively to Ray, and it was resolved. I would stick to “just the facts, ma’am,” like Sergeant Friday in the 1950s television series classic
Dragnet,
and issue no ratings, forecasts, or target prices on either stock.

But I came away with two very disturbing conclusions: one, that the lack of clarity in the No-Action Letter was actually doing more to promote analyst conflicts than to resolve them, and two, that people in all different parts of my firm were interested in pushing the envelope any way they could in order to promote banking and trading. The lawyers were not so much pressuring me as facilitating me. If it wasn’t explicitly barred, it must therefore be okay. It was a scary and sobering realization.

“How Can Your Best Friends Become Your Worst Enemies?”

Just one month after the Global-Frontier merger announcement and just two days after
Forbes
had published a big cover story on Gary Winnick, Global Crossing’s chairman, entitled “Getting Rich at the Speed of Light,” I flew to
Los Angeles for my annual West Coast marketing tour and asked Gary to lunch. I brought a copy of the
Forbes
story for him to autograph, and he was flattered, just as I had intended. The article pointed out that Gary had reached $1 billion in net worth faster than anyone in history—even Bill Gates.

Gary was dressed in a suit, and the first thing he did was to introduce me to his personal trainer, some TV workout celebrity. Gary promptly began his workout on the treadmill—with his suit still on. Perhaps this was meant to show what a fabulous multitasker he was. Perhaps he had simply scheduled us both at the same time by accident. But someone probably should have told him that suits don’t breathe too well. I felt sorry for whomever he was meeting after his workout—until I remembered that we were going to have lunch together. Sheesh.

While Gary ran on the treadmill, I visited with some of the other Global executives. Then Gary and I went to lunch together at Hillcrest, a country club in Beverly Hills. Gary introduced me to a woman whose son wanted to go to Cornell Law School. I guess she was a good friend, because he told me he had donated $100,000 to Cornell to get him in. As we ate, person after person stopped by to congratulate him on the
Forbes
cover. Gary, who puffed up with pride, was thrilled to be perceived as one of the kings of the new economy. When we were able to speak uninterrupted, I repeated that I thought a Baby Bell would be his best buy going forward.

Exactly six weeks later, on May 17, 1999, Global announced another deal: it was acquiring Baby Bell US West, even before its Frontier acquisition had closed. I had heard nothing about it until the evening before, when the Merrill bankers asked me to go over the Wall and show up at the Rainbow Room at 6:00 the next morning, armed with a list of tough questions that the two CEOs, Sol Trujillo of US West and Bob Annunziata of Global, should be ready for before their presentation to analysts later that morning. Salomon was advising Global, and Merrill’s telecom banking team—switching sides this time—was advising Global’s prey, US West.

Sol Trujillo, a friendly but intense career US West employee who had worked his way up to the top, clearly saw this deal as a way to transform his conservative, slow-growing, dividend-paying telecom company into a high-growth new-economy outfit. He had been enamored with the buzz—and stock prices—these new-economy companies were fetching ever since he had attended the Vortex Conference at Laguna Niguel a year earlier.

But neither Global Crossing’s nor US West’s shareholders were enthusiastic about the deal. The conservative US West holders saw it as radical and
risky, while Global Crossing’s holders, new-economy-Kool-Aid drinkers, saw it as a waste of money on old, tired assets. Global’s shares, which had hit an all-time record of $64 a share by May 13, fell 30 percent in three weeks, closing at $45.75 on June 2. US West shares fell, too, by 15 percent, in part because many of its shareholders lacked confidence in Global.

The pressures on Sol to find a better deal were mounting. And it didn’t help matters any that the analyst at their investment bank—me—was not publishing anything but factual research on his company, US West. The US West executives were livid, especially because they saw Jack Grubman at Salomon publishing aggressive buy recommendations on Frontier and, by extension, Global Crossing. In effect, Jack had written a glowing prognosis for a merger even though Salomon’s fees, like Merrill’s, were contingent on the deal going through.

US West couldn’t understand what was going on. After all, I’d had an Accumulate, or “2,” rating on US West before the Global Crossing–US West deal was announced. What had happened to it? Al Spies, US West’s CFO, feared that investors were perceiving my silence as opposition to the deal. “How can your best friends become your worst enemies?” Al asked one of our bankers. I wasn’t an enemy, I tried to explain. I was simply trying to avoid any allegations of conflicts of interest. But that didn’t do them much good.

While the US West–Global Crossing marriage foundered, over at Qwest Communications, many of the largest and most important buy-siders were pressuring its CEO, Joe Nacchio, to do something equally grandiose with his equally high-flying stock. Eventually, he called the telecom bankers at DLJ, one of the few unattached firms in this banking feeding frenzy. US West had hired Lehman Brothers in addition to Merrill, Morgan Stanley was advising Frontier, and Salomon was on the Global Crossing side.

Joe told the DLJ bankers to prepare a bid for both Frontier and US West. On the evening of Sunday, June 13, 1999, while Qwest’s PR team called reporters, Qwest’s chairman, Phil Anschutz, called Sol Trujillo, and Joe Nacchio called Frontier’s CEO, Joe Clayton, to explain their proposal. Qwest was offering a total value of $32 billion, or $61.37 a share in Qwest stock—only a dollar more than what Global’s offer was now worth—for US West; and $11.4 billion, or $61.70 a share for Frontier, roughly equivalent to Global’s $62 offer. Joe and Phil were assuming, apparently, that Qwest was a more appealing partner and thus didn’t need to outbid Global by much.

They were wrong. When the markets opened on Monday, Qwest shares sank faster than a mobster in cement shoes. They fell 24 percent that day,
from $44.88 to $34.13, and proceeded to fall another few dollars to $32.50 over the next two weeks. Apparently, investors were worried that the bidding war would escalate into an out-of-control war of egos, and that Gary Winnick and Joe Nacchio were violating their new-economy creed by selling their souls to the old world.

Believers asked themselves, Why would any company that was all about the infinite growth in demand for Internet communications waste its valuable stock on an old-school company whose copper wires were already obsolete? Or, more chilling still, did these companies know something their investors didn’t—that their stock prices were overinflated, and that their true business prospects weren’t good enough to go it alone? Both choices spooked investors, and the result was a market that gave both possible combinations the Bronx cheer.

Nonetheless, Qwest’s CEO and its chairman, Joe and Phil, never good losers, decided to up their offers by $4 billion. On Wednesday, June 23, Qwest issued a press release announcing it was now offering $69 for US West shares and $68 for Frontier shares. Several weeks passed with no apparent movement. Yet behind the scenes, I subsequently learned, both companies were beginning to realize that this bidding war was hurting everyone. Eventually, both Joe and Gary sent out feelers via their bankers to look for a compromise, or at least a cease-fire. A harried, complex series of four-way negotiations ensued. Bankers and lawyers scrambled.

By Friday, July 16, the egos appeared to have been wrestled back to Earth. Global and Qwest agreed to a truce: Qwest would get US West for $69 per share, and Global would get Frontier at $63 per share. All four boards voted approval, and the PR teams began to prepare press releases.

But that, of course, would have been too easy. A major snag occurred as the lawyers and the bankers were meeting at DLJ’s offices to put the finishing touches on the documents and get ready for a celebratory dinner. Early in the negotiations, Phil Anschutz, Qwest’s chairman, had told Sol that he and Joe would be co-CEOs of the newly merged companies, or at least that is what Sol understood. When the US West board voted in favor of the merger, the deal they approved had them as co-CEOs.

But Joe had no intention of sharing power with anyone, particularly not with some Bellhead. He had dealt with too many of those guys during his 26 years at AT&T. So when someone from his public relations office asked him to approve some language describing the setup, he blew a gasket. He ran
down the halls of DLJ in search of Tom Middleton, the Merrill banker, and yanked him out of a meeting and into an adjoining conference room. As Tom told me years later, Joe closed the door, poked Tom in the chest, and said, “If you think I’m going to be co-CEO with that bozo, you are wrong! I don’t know where that idea came from and if it stays, the deal is off.”

Tom, trying to stay cool, told Joe that that was the deal that had been approved by US West’s board, and for that to change, there would have to be another board vote. “US West will have half the board seats,” Tom told me that Joe yelled, incensed, “and that will give them veto power over all major decisions. They don’t need to have a co-CEO and, besides, what a stupid idea. You better go back and tell them we have a serious problem here.”