Senator Joe Lieberman
Opening
Statement:
“The Watchdogs Didn’t
Bark:
Enron
and the Wall Street Analysts”
Governmental Affairs
Committee Hearing
Wednesday, February 27, 2002
Thank you all for being
here for this hearing, “The Watchdogs Didn’t Bark: Enron and
the Wall Street Analysts.” This is the third in our series of
hearings on the largest bankruptcy in American history and is
part of an ongoing attempt to assess the damage, learn the
lessons, and help craft the solutions to the problems that led
to the fall of Enron and its many connected catastrophes.
Future hearings of the
full committee and its investigative subcommittees will look at
the role of other watchdogs including federal agencies,
auditors, and the Board of Directors. Today we focus on the
private analysts whose warnings could have, and many say should
have, alerted investors to the fiscal fissures in Enron’s
foundation before everything crumbled, but who instead continued
to urge investors to buy Enron’s stock even after it began to
crumble. Why were the analysts blinded to the company’s deceit
and disintegration, and how can we prevent similar failures in
the future?
These are crucial
questions, because the Enron earthquake has left millions of
Americans worrying that their stocks are standing on shaky
ground. According to a recent BusinessWeek/Ipsos-Reid
poll, 68 percent of investors said they have little or no faith
that the stock market treats average investors fairly. And 54
percent of investors said they are concerned about the honesty
and reliability of the investment information they receive.
According to BusinessWeek, “the worry is that thousands
of companies have consistently, and legally, overstated earnings
for the past few years.” In other words, even when the Enron
smoke clears, people are worried that there may be more
accounting smoke and mirrors lurking. This is consequential.
It’s serious not only for our investors but for our economy.
The average investor today
is like a swimmer who’s seen a shark. She or he doesn’t know
how many more sharks are in the water or whether there are any
good lifeguards on duty.
Making sure those
lifeguards are on the lookout is part of our purpose here, and
it is a very important purpose, because this is more than a
crisis for a small slice of America’s economy. It really hits
at the very heart of our prosperity. Spreading 401(k) accounts
and rising markets have spurred a seismic shift in stock
participation over the last two decades. From 1930 to 1980, the
number of Americans investing in the market hovered between 5
and 15 percent. By 1998, that had jumped to more than 50
percent.
It’s these middle-class
Americans, the new investor class, who are most shaken today.
When equipped with trustworthy, up-to-date, and independent
information on a company and its competitors, investors—whether
professional or amateur—can choose stocks wisely. But without
sound information—or even worse, with misleading
information—they may as well go gambling.
We don’t expect Wall
Street analysts to be fortune tellers, but average investors
expect them to filter out the vast and potentially confusing
flow of information about companies and markets—to dissect and
decipher the financials of companies, especially those with
hard-to-understand business models, in a way that’s meaningful
not only to Wall Street insiders but to investors on Main
Street. Information, after all, is one of the most precious
cargos in America’s economy, and Wall Street analysts are
expected to transport it with maximum care.
This is the unwritten
agreement that has drawn middle class investors into the market
and it’s what they rely on in entering the markets. They know
there is risk, that not every stock will always rise, but they
rely on the watchdogs – public and private – to keep the stock
market fair and to give them accurate information to help them
decide where to put their money and, with it, their hopes for
economic advancement and retirement security.
The question we ask today
is have the Wall Street analysts kept their side of the
agreement? I regret to say, based on the investigation this
Committee has done, that my answer is no, they have not. Ten
out of 15 analysts who follow Enron were still rating the stock
as a “buy” or a “strong buy” as late as November 8 [CHART ON
ENRON ANALYSTS’ RATINGS], which was three weeks after the
initial report of the company’s hidden losses appeared in The
Wall Street Journal and about two weeks after the SEC
announced an investigation of Enron.
Enron’s ad campaign, as
you may remember, was “Ask why?” It now seems clear that too
many analysts failed to ask “why” before they said “buy.” And
often when they did ask “why” but didn’t get a straight answer
from Enron’s executives they went right on touting the stock.
At least one analyst did
know better. On May 6, 2001, the Off Wall Street Consulting
Group issued a report calling Enron stock overvalued and
pointing out many of the problems that would later be revealed
in full when the company collapsed. That was on May 6, 2001.
Among other things, the report questioned the fact that the
company appeared to be using accounting tricks to pump up its
revenue.
Regrettably, the analyst’s
performance with Enron is indicative of a broader problem.
David Becker, General Counsel of the SEC, said last August, and
I quote, “Let’s be plain: broker-dealers employ analysts because
they help sell securities. There’s nothing nefarious or
dishonorable in that; but no one should be under any illusion
that brokers employ analysts simply as a public service.”
This is jarring news to
many investors, who have considered “strong buy,” “buy,” “hold”
and “sell” recommendations to be honest investment advice.
One of the most stunning
facts I have learned is that committee’s investigation is no
matter what the market does, analysts seem to just keep saying
“buy.” According to Thomson Financial, two-thirds of all
analyst recommendations are “buy.” And only one percent are
“sell.” Take a look at this chart. It shows that [CHART ON
RECOMMENDATIONS AND S&P 500.] In fact, over the last two
years, no matter what the S&P 500 did, the recommendation of the
major analysts was virtually unchanged.
How can that be?
I fear – and I am not
alone in this fear – that one of the reasons is that the vast
majority of analysts work for Wall Street firms and banks,
particularly in the investment banking business. In fact,
analysts’ compensation is often tied directly to the success of
their firms’ investment banking business. And analysts usually
develop cozy relationships with the companies they
cover—relationships that are valuable to their firms and could
be endangered by their release of a critical report or opinion.
All of these influences
compromise analysts’ objectivity and mean that the average
investor should take their bottom-line recommendations with at
least a grain of salt, if not with a whole bucket.
A new set of proposed
rules designed to improve analyst independence, crafted by the
National Association of Securities Dealers before the Enron
debacle, were submitted to the SEC on February 7, and I believe
they are a valuable step forward. The rules would limit
compensation that analysts can receive from investment banking
activity, restrict analysts’ trading of stocks they cover, ban
them from reporting to their firms’ investment banking
divisions, and prohibit them from promising favorable ratings to
companies they cover.
But because of how deeply
analysts are entwined with the fate of the companies they cover,
I believe more must ultimately be done to guarantee that their
analyses are truly independent.
As President Franklin
Roosevelt said in 1937, “We have always known that heedless
self-interest was bad morals; we know now that it is bad
economics.” Over the last few months, because of Enron, too
many people and our economy as a whole, have painfully
rediscovered the meaning of those words over the last few months
thanks to Enron. Our job is to make sure that from this point
forward, this wisdom spreads not through painful experience but
through proactive and progressive policies.
I look forward to hearing
from our witnesses today, who I hope can help us do just that.
Press
Statement
Enron
Chart |