The Bloody Mess After the Internet Bubble

When the Internet bubble collapsed, many investors knew where to place the blame on those brokers who had gulled them into believing in all those New Economy stocks. They sued. They took their business elsewhere. The public figured brokers were getting what they deserved. Charles Gasparino, a Newsweek senior writer and a longtime Wall Street Journal reporter, takes a more nuanced approach in his new book, Blood On The Street: The Sensational Inside Story of How Wall Street Analysts Duped a Generation of Investors

When the Internet bubble collapsed, many investors knew where to place the blame — on those brokers who had gulled them into believing in all those New Economy stocks. They sued. They took their business elsewhere. The public figured brokers were getting what they deserved. Charles Gasparino, a Newsweek senior writer and a longtime Wall Street Journal reporter, takes a more nuanced approach in his new book, Blood On The Street: The Sensational Inside Story of How Wall Street Analysts Duped a Generation of Investors ($26, The Free Press). Reps come in for their share of criticism — like the Merrill broker who put the life savings of a retired truck driver into Internet funds — but Gasparino is generally sympathetic. He makes clear that reps were also victims of the corrupt research regimes. Blood goes into great detail on how the top Internet boosters at the three biggest wirehouses — Henry Blodgett at Merrill, Mary Meeker at Morgan Stanley and Jack Grubman at Salomon Smith Barney — betrayed the brokers who were pressured to use their recommendations to push dubious stocks like InfoSpace and Global Crossing.

In this excerpt, Gasparino offers two versions of the broker story. The first deals with a novice who got into the business just in time to ride the Internet wave. The second shows how even the most seasoned wirehouse brokers were hijacked by Grubman's hype machine.

The Newbie

At 32, John Cunha, was looking to reinvent himself. PaineWebber had fired him for failing his Series 7. But at Morgan Stanley, the former ski-resort employee found a winning pitch — using Mary Meeker's reports to sell Internet stocks.

Cunha was one of about two dozen brokers in the Iselin, New Jersey, branch who were inexperienced but hungry to make a quick buck. The office was run by a crew of managers and experienced brokers, such as branch manager Brian Rogers and his assistant branch manager, Kevin Johnson, a gray-haired Tom Selleck look-alike, whose job it was to look after some of the new recruits like Cunha, but who spent much of his day working on client accounts. The compliance officer, who was supposed to make sure all trading out of the branch met NASD standards, was a dour man by the name of Ed Tierney, who rarely spoke to brokers like Cunha. Despite his position as office watchdog, Tierney also kept a sizable book of business. During the trading day, as brokers were handling tens of millions of dollars in trades affecting the life savings of scores of small investors, he could be found in his office with his door shut, helping his own clients. (Morgan says Tierney's brokerage activities were consistent with its policies.)

At Morgan Stanley, brokers were required to complete a three-week training session in New York, at the firm's retail brokerage headquarters in the World Trade Center. Even for a novice like Cunha, the training seemed overly simplistic.

For Cunha, the pressurized environment of a Morgan Stanley branch office was jarring. He spent his initial weeks working twelve-hour days seated in the office's “bull pen,” scouring the local community for potential clients and most of all, pushing Morgan's technology stocks by reading directly from Meeker's research. His standard line was, “She's the best and she loves the stock,” For many investors, it was all they needed to hear.

Cunha and many other newbies were moderately successful through the end of 1999 and into 2000. But as the markets began to crash in early 2000, investors began demanding real answers. Cunha recalls investors flooding the office with so many calls that brokers couldn't handle the volume. They simply let the messages roll into voicemail. But ignoring the problem could only go so far as the stocks continued their decline. What made the market decline so terrifying was that brokers had spent the past five years selling risky New Economy stocks. These companies weren't just experiencing temporary setbacks; many were being exposed as near frauds with little other than a dot-com next to their names.

As far as many brokers were concerned, Meeker didn't help matters. She often rated Internet stocks not just on traditional balance-sheet measurements, but also on something called “usage metrics,” like website page views and estimates on how many “eyeballs” viewed a particular website. Meeker believed such measurements were the best way to assess money-losing but promising Internet companies because they measured possible future performance, although most small investors had no clue what they meant.

During cigarette breaks, Cunha and other brokers angrily complained that Meeker rarely updated her research on several stocks during 2000, when investors needed her guidance most. One such stock was AOL, which had merged with TimeWarner in early 2000. Morgan executives blamed it on the firm's strict “quiet period” rule that lasted, they say, a full year after the deal on which Morgan advised TimeWarner. Meeker's role turned out to be particularly important. She was one of the key players in pitching the deal to TimeWarner's board, giving a rousing speech that heralded the vision of AOL's CEO Steve Case, a man she compared to legendary Time Inc. founder Henry Luce.

While Meeker's reports may have been dated and conflicted, Cunha says he and other brokers treated them as if they were gold. In pitching shares of the postmerger AOL, he says they read straight from her old reports. “No one told us not to,” Cunha says, “And management knew what we were doing.” For a time it worked, but by the end of 2000 many of Cunha's clients were no longer trusting either him or Meeker. “You motherf**ker, I just lost half my money on this stock!” an angry investor screamed one afternoon in late 2000. Cunha knew he had run out of excuses, “I'm sorry,” he said, “I was relying on Mary Meeker's research.”

Jack Grubman was the “ax” on telecom. A one-time AT&T employee, he had spent years telling brokers to forget Ma Bell and put clients into up-and-comers like Global Crossing, Winstar and, above all, WorldCom. However, in 1999, he surprised Smith Barney brokers by suddenly recommending AT&T, citing its new cable-TV strategy. Only later did they learn that Grubman's change of heart had nothing to do with AT&T's prospects, but everything to do with a massive investment-banking opportunity for parent Citigroup — which Grubman was happy to help along because he sought Citi Chairman Sandy Weill's help in getting his kids into the 92nd Street Y preschool.

It's Not All Right, Jack

One morning in late November 1999, Phil Spartis tuned into the company's internal “squawk box” to hear Jack Grubman announcing a major about-face on AT&T, placing his coveted “buy” rating on the stock.

Grubman's edict created tremendous buzz inside Salomon Smith Barney's massive retail sales force, which employed nearly twelve thousand brokers. Like its competitors, Salomon encouraged brokers to actively push those stocks that were being “recommended” by the research department. After listening to Grubman, Spartis hit the phones. One of his first calls was to Michael Grimley, a WorldCom executive. “Jack went to a buy on AT&T this morning,” Spartis said, adding that it was “the first time in five years” Grubman had upgraded the stock. “There's an analyst meeting on December 6,” Spartis added, “and he [Grubman] thinks they'll have to rent out Madison Square Garden,” given all the excitement the new strategy will generate. Grubman, Spartis said, believes that if AT&T follows through on its plan, it could be a “$2,000 stock.” The sales pitch worked. Grimley bought around three thousand shares, but as he would soon find out, Grubman's call didn't measure up. About a month later, he ordered Spartis to begin unloading his AT&T position as shares began to nosedive. In the end, Grimley racked up a $30,000 loss.

Spartis said he isn't to blame; he was only following orders to sell stocks recommended by Grubman. “Jack was the leading telecom analyst in the country,” Spartis said in an interview, “and we were trained to push his calls.”

Spartis was later fired by Smith Barney and accused of putting his WorldCom clients into inappropriate investments by advising them to hold onto WorldCom shares on the strength of Grubman's recommendations (see Betrayed?, Registered Rep., March 2002).

Grubman could have used his connections to give investors some insight about WorldCom's trouble into late 2001, but all he offered was spin and hype. Only now, his hype seemed to fall flat as shares of the company continued to drop no matter what he said. Around this time, Grubman's wife, LuAnn, sold her stake in WorldCom, which had been getting killed in the crash. (Grubman says through a spokesman that she sold the stock following a companywide edict.)

It's one thing for multimillionaires like the Grubmans to take a beating, but when average people take losses the stakes are higher. Robert Goss, a WorldCom employee, was near suicidal when much of his savings, tied up in WorldCom stock, began to disappear before his eyes. “Oh God, somebody just needs to take me out in the parking lot and shoot me,” he told his broker, Amy Elias [a partner of Phil Spartis]. Goss didn't do anything foolish, but a short time later, he said he was relying on a higher authority for help. “The wife and I are both praying,” he told Elias. Elias said she was praying as well.

Nothing, it seemed, could save WorldCom from the fate that struck Winstar, Metromedia, Global Crossing, and a host of other Grubman touts. In early February 2002, Grubman personally coached Ebbers on how to answer analysts' questions about his company's deteriorating finances. When Ebbers was finished, WorldCom fell to $8 a share. In March, Grubman reiterated his “buy,” just as the SEC launched an investigation into possible accounting irregularities. In an email, Grubman assured a colleague that WorldCom, “is executing better than any time over the past 10 years,” and the SEC inquiry “is mostly general in nature… very straightforward — almost boilerplate.”

Ebbers, Grubman said, had provided ample evidence that the company was on the rebound in a speech the same day the SEC commenced its inquiry. The speech “reinforced that industry landscape is getting better.” WorldCom, he reminded investors, “has the highest quality balance sheet in the telecom industry…” and the company believes its “growth will manifest from new products and expansion of its international business.”

Shares of WorldCom barely budged, while his critics inside his firm continued their assault. In the past, brokers couldn't wait to get their hands on Grubman's words of wisdom, now they couldn't wait to get their hands around his neck. One afternoon, brokerage chief Jay Mandelbaum received an angry email from one of his top brokers, Cheryl Schwarzwaelder, complaining about Grubman's research and looking for some help. “As far as Global Crossing, Jack had the stock at a buy rating from $60 all the way down to $1!!!” she wrote. “Now he is falling into the same footsteps with WorldCom…I can not have 2 bankruptcies with an analyst who keeps stocks at BUY ratings all the way to bankruptcy!!!"

On April 22, 2002, Grubman announced that he had cut his long-held “buy” rating to a “neutral,” citing growing concerns over the company's operations and the looming possibility of bankruptcy. “It would obviously be easier to not downgrade the stock, and therefore not suffer the inevitable and justified slings from various parties,” he wrote sheepishly, adding, “clearly, we have been wrong on the stock.”

In late June, Grubman cut his rating from “neutral” to “underperform.” Shares of WorldCom were already trading at just $1.22. Two days later, WorldCom put itself out of its misery and filed for bankruptcy protection.

Brokers at Salomon were outraged. One wrote in an email that Grubman should be “publicly flogged,” while others just wanted him fired. Brokers realized a key fact that the company's management failed to recognize: Grubman represented short-term gain but long-term pain as investors turned away from the firm in droves. One Salomon broker was so upset by the impact of all the attention given to Grubman that he wrote an email to a Wall Street Journal reporter to complain. The paper, he wrote, was “biting the hand that feeds you,” given the heavy amounts of advertising the paper gets from Wall Street.

When contacted by the reporter, the broker quickly apologized. He had been getting an earful from angry clients about Grubman's conflicted stock picks. “If Jack Grubman was sitting here,” he added. “I'd hit him with a baseball bat and piss on him.”

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