Originally created 05/11/02

Wall Street jolted by a pair of critical analysts' reports



NEW YORK -- Eyebrows shot up in the financial world this week when two stock analysts issued critical reports about JetBlue Airways and Edison Schools, sending their shares tumbling.

Wall Street analysts are under huge pressure amid accusations that they issue rosy stock recommendations on companies they cover so their firms can win generous investment banking fees - for arranging mergers or new stock offerings for the same companies.

Observers were left wondering whether the pair of reports signaled a new era of analyst independence, or at least some soul searching among the stock researchers' ranks. They weren't swayed by statements from the firms that their analysts were simply following tradition by calling their stock ratings as they see them.

"I think it's natural to assume, in a time when the focus is so intense on analyst integrity, that many analysts will go out of their way to display their integrity," said David Beim, a finance professor at Columbia University's business school. "It's having some effect on actual analyst behavior."

In JetBlue's case, the low-fare airline's shares fell as much as 9 percent Tuesday after UBS Warburg analyst Samuel Buttrick initiated coverage of the company's stock at "reduce," warning that the shares were overpriced.

The report drew intense attention because UBS Warburg was one of the underwriters of JetBlue's initial public stock offering less than a month earlier, which was followed by a trading debut that saw JetBlue stock double.

UBS Warburg spokeswoman Amy Rosenberg said Buttrick's report is "consistent with the way our research department has always operated - and that is independent from the investment banking division."

Others weren't so sure. John Bogle, founder and former chairman of The Vanguard Group of mutual funds, suspects analysts are feeling the heat of investigations by New York's attorney general and the Securities and Exchange Commission into the way they rate stocks.

But he also said it's too early to say whether a sea change of analyst objectivity is in sight.

"These are certainly things that would not have happened a year ago or two years ago, but I'm not convinced it's a conversion," Bogle said.

A day after Buttrick's report shook Wall Street, US Bancorp Piper Jaffray analyst Mark Marostica downgraded Edison Schools to "market perform," the firm's second-lowest rating and reduced his price target for the stock from $32 per share to $3.

Shares of Edison Schools, the largest private operator of public schools in the United States, plunged 41 percent because of Marostica's doubts about the company's prospects of landing more schools to manage.

Piper Jaffray spokeswoman Erin Freeman said the firm is a longtime advocate of analyst independence and that the report "was based on fundamental research which we strongly support."

Still, investors should be skeptical about most analyst reports, said Robert Aliber, an economics and finance professor at the University of Chicago Graduate School of Business.

That's because brokerages that provide analyst services make much of their money off investment banking, and provide their research as a side benefit to clients. Clients want their stock recommended in return.

So the firms analysts work for "would take a big hit if they called it like they see it," he said.

New rules approved this week by the Securities and Exchange Commission prohibit securities firms from tying their analysts' compensation to some investment-banking business the firms do for companies.

Proposed by Wall Street's self-policing bodies, the rules have been criticized by consumer advocates and some lawmakers as not going far enough.

Beim said analysts should be not be paid at all from the pool of money brokerages get from investment banking.

"It needs to be a separate business with a separate income stream and a separate stream of payments," he said. "They have to make a dramatic change in the culture and say analyst are responsible only for the quality of their recommendations."