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Enron collapse may spur analyst reforms

Less than two months before Enron Corp's spectacular collapse, Goldman Sachs Group stock analysts informed investors that they considered the energy trading company to be "still the best of the best."

They weren't alone. Most of Wall Street was bullish on the company. Enron, for its part, was a good friend in return, paying millions of dollars for corporate financing fees, investment banking and merger advice for its diverse and frequent dealings.

Now, following the Enron collapse, Wall Street analysts' cosy relationship with companies is coming under fire, just as it did after the tech-stock bubble burst. This time, regulators and industry groups are under even greater pressure to require fuller disclosure from the firms about who pays them and who is looking out for investors interests.

"This Enron thing is going to be the poster boy for serious, widespread reform," said Henry T C Hu, a law professor at the University of Texas.

"Here you have a company that is being pitched as a blue chip, owned by the worthies of the world (and) it turns out that at its core are some very, very serious reliability issues."

In the Enron case, the Wall Street analysts --whose job it is to recommend stocks for investors to buy and sell --- were holding their bullish view all the while the stock fell from its peak at about $90 a share to its present level of less than 50 cents.

Even when the company appeared to be in trouble, Wall Street held its rosy outlook. In late October, after Enron management held a conference call to discuss investor concerns over murky off-balance sheet deals that would later trigger the company's downfall, Goldman still saw only 'limited risk in (Enron) shares', which it had given its top 'Recommended List' rating.

Goldman wasn't alone in giving sinking Enron the thumbs up. Other brokers were also bullish. At the start of November, UBS Warburg declared that Enron shares, then trading at $14, had "the potential for a doubling or greater over the intermediate to long-term."

Even in the final few days before Enron's December 1 bankruptcy filing, eight of 16 Wall Street analysts still rated its shares 'strong buy' or 'buy', while six held the more tame 'hold' rating. Just two listed it as a 'sell'.

Enron is just the latest chapter in an ongoing controversy that's brought previous calls for reform. The investment profession came under attack last spring and summer following the demise of much-touted Internet and telecom shares. The September 11 terror attacks for a time overshadowed the Wall Street controversy but Enron's fall is once again fanning the fires.

Congress has already held hearings in which longtime Enron employees have testified to losing most of their life savings as the company's shares fell. The fiasco has refreshed bad memories of the dot-com days, when Wall Street analysts, eager to generate corporate finance fees, reaped millions by boosting shares in risky, ill-fated start-ups.

THE ENRON "DEAL MACHINE

Concern over analyst cheerleading for Enron may even rival the fanfare over the bursting of the tech and telecom stock market bubble.

Last year, Enron was the seventh-largest company in the US by sales -- and it has had a high profile as "a deal machine" constantly involved in Wall Street transactions involving limited partnerships, loans, and derivatives, Professor Hu said. Those transactions generated huge fees for Wall Street firms -- some of the same ones who encouraged investors to buy the stock.

The failure of analysts, or even debt rating agencies such as Moody's or Standard & Poor's, to provide adequate warning of Enron's problems will attract regulatory interest because "neither of the explanations (for the failure) is comforting -- either you were inept, or there were conflicts of interest," Hu said.

In one of the most trenchant comments on the issue, the chairman of the Securities and Exchange Commission, Harvey Pitt, said analysts need to stick to the numbers and cut the bluster. Enron's demise, he wrote in a December opinion piece, makes clear the need for "analyst recommendations predicated on financial data they have deciphered and interpreted."

"Analysts and their employers should eschew expressing views without an adequate data foundation, or when confused by company presentations," he wrote.

Pitt's swipe at analysts is significant because he has a reputation for being less confrontational toward Wall Street than his predecessor, Arthur Levitt. Also, Pitt, who took office in August, has expressed reluctance to propose rules for analysts before Wall Street has had sufficient chance to devise its own approach.

Last summer, Wall Street firms endorsed -- with fanfare -- a series of 'Best Practices' formulated by the Securities Industry Association, an industry trade group, that were intended to demonstrate the firms' embrace of independent analyst research.

If Wall Street "doesn't take this thing seriously enough, Pitt will have to do something at the governmental level," Hu said. "I've got to believe that it's in Wall Street's interest to do much more to clean up its act."

INDUSTRY LOOKS AT ITSELF

Efforts at reform for now remain in the hands of self-regulatory and nonprofit organisations such as the National Association of Securities Dealers, which oversees the Nasdaq Stock Market, and the Association for Investment Management Research, which awards the Certified Financial Analyst designation.

Both groups have proposed rules to require analysts to disclose conflicts of interest regarding stocks they cover. That means letting investors know if analysts' opinions are colored by their firm's business dealings or their own personal stock holdings.

"The traditional method of dealing with conflicts is disclosure," said Alan Bromberg, a law professor at Southern Methodist University. "It's primarily a question of how much disclosure and whether at the firm level or at the analyst level."

The conflict of interest issue goes to the heart of the issue: Is Wall Street providing high quality and independent investment advice?

"The independence of Street research has declined over the past decade," said Christopher Ailman, chief investment officer for the California State Teachers Retirement System, which, with about $101 billion in assets, is the world's fourth-largest public pension fund.

"The quality of research was an issue in July and it's still an issue here in December," Ailman said.

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