Jack Grubman Is Not Alone

Jack B. Grubman, Wall Street’s lionized telecom analyst during the 1990s, is under government scrutiny for his bullish ratings of communications giants that subsequently went belly up.

Many industry observers, including senior analysts at market research firms, say Grubman is not the only Wall Street analyst who championed now-questionable companies in an industry that has lost an estimated $2 trillion in equity value over the last two years.

Market research firms wary of Wall Street

Allan Tumolillo, chief operating officer of Probe Research, says his organization was never as bullish as the securities analysts. While Probe noted the sky-high stock prices influenced by Wall Street analysts, the research firm was warier of some telecom providers than was Grubman, including the nascent long-haul carriers such as Level 3 Communications Inc., he says.

“Those companies had a very big struggle ahead of them,” he says. “We didn’t predict bankruptcy [for companies such as WorldCom Inc.] back then but I don’t think many people did.”

Tumolillo says Grubman’s influence on market researchers was “minimal.” Grubman, who resigned from Salomon Smith Barney last week, vehemently denies he promoted companies with flawed business models in order to score investment business for his parent company, Citigroup Inc. Technology analysts explain Wall Street analysts were operating under a different set of circumstances.

“We recognized long ago that the securities analysts have their own agendas, and if I worked as a securities analyst I imagine that my priorities would be very different from what they are as an independent industry analyst,” says Michael Smith, co-founder and managing director of Stratecast Partners, a division of Frost & Sullivan. “You have to take what they say with a grain of salt.”

During the Q&A period of quarterly conference calls, many Wall Street analysts have complimented companies on their earnings — a move some people perceive as cheerleading.

“It’s not opining. It’s advertising,” Smith says. “It’s, hey, for everybody on this call whether you are a mutual fund manager or even . an individual investor just in case you are looking for an opinion on these results let me give it to you, `Hey, great quarter guys, great quarter.’

“I can’t tell you how many times I have heard that statement uttered when you know full well, if you look at the results, the quarter was not great,” Smith added. “It was anything but great but, again, if you are working as a securities analyst and you are in some way connected to investment banking relationships obviously you have got a whole different set of priorities.”

Grubman and his Wall Street brethren are not alone.

How bullish were tech analysts in telecom’s heyday?

After Congress deregulated the telecommunications industry in 1996, technology analysts asserted that hundreds of competitive local exchange carriers, web hosting providers, long-haul carriers and other startups had innovative business models that would allow them to succeed in the new economy. Before the Internet boom went bust, many researchers seemed to figure broadband would mean endless wealth for a seemingly endless number of companies.

A senior telecom analyst at market research firm The Yankee Group says founder and former president Howard Anderson “pretty much kept the company reined in when it came to the Internet boom.” The analyst says the firm was more bullish on competitive local exchange carriers than long-haul providers.

The analyst also insists The Yankee Group was less optimistic than Wall Street. “I would say 50 percent of the time we are in disagreement with what is going on with the Wall Street firms,” the analyst says. “More often than not it is the bullish nature of their forecasts.”

Market researchers face conflicts of interest

However, Wall Street is not the only place where analysts face conflicts of interest. Market research firms that earn their keep selling research to clients, such as Verizon Communications Inc. and Nortel Networks Corp., don’t always find it easy to criticize client companies in independent analysis or in interviews with reporters, even if the criticism is justified. The line between consulting and independent analysis occasionally is blurred.

Asked whether market research firms face conflicts of interest, a person at one of the world’s largest telecom equipment manufacturers says, “All the time.”

“There are individuals within . firms that perhaps cross the line,” says Norma LaRosa, president and co-founder of the Kensington Group, a company providing consulting and research to help IT vendors, financial analysts, venture capitalists and others forge relationships with technology analyst and researchers. “It’s a minority. It’s not a majority.”

“That gap is narrowing because more and more people are becoming aware of the issue and research firms are trying to develop practices where those conflicts of interest do not occur and may have strict guidelines about that," she says.

Analysts stress virtues of objectivity, independence

Mary Petrosky, an independent telecom analyst who used to work for the Burton Group, says, “I think there is a pretty good Chinese wall between the sales side and the analyst side of these places.”

The Yankee Group analysts are not under pressure to sacrifice objectivity for a client’s sake, The Yankee Group telecom analyst says. “It is not a pressure we have to cave to,” he says. “Management has already told us, `Call the shots as you see them.’ For major clients it is not uncommon to get a phone call from them questioning your research, questioning your opinion.”

Gartner analyst Alex Winogradoff says independence is a priority at his firm.

“As for independent firms like Gartner we pride ourselves in our independence to the point that we often upset our clients because we tell it like it is and have opinions that might run counter to theirs,” Winogradoff says.

Still, analysts know if they are going to knock a client they better be right, the Yankee Group analyst says. “You don’t go looking to kick the hornet’s nest,” he says.

Paul Robinson, vice president of The Eastern Management Group, says, “I would personally not want to get into saying things that particularly anger a client right now. That’s not to say I want to put a client in the most glowing light — that isn’t reasonable.”

Robinson says he would prefer to discuss general problems symptomatic of the industry, rather than taking to task a particular company.

Chris Mines, Group Director of Research at Forrester Research, says objectivity and independence are the cornerstones of the company’s philosophy. “The basic message to our analysts at the time we hire them, as we train them and to refresh even the old war horses like me is that our business fundamentally depends on objectivity and independence,” Mines says. “That is a fundamental pillar of value proposition we take to the marketplace.”

“I sometimes end up with the opposite problem,” he added. “I end up with people that take that to an extreme. That it is a license for vendor bashing. We are not out to trash these guys. We are not out to simply expose their weaknesses. We are out to provide objective, balanced, fair and therefore . useful [analysis]. That is what makes it valuable to our client base.”

Practices questioned

Still, observers cite a number of questionable practices that could jeopardize the ability of an analyst to conduct neutral research.

* With the budgets of telecom providers and vendors chopped in half, technology analysts must work twice as hard to sell their market research. The Strategis Group, a Washington D.C.-based telecom research firm, closed shop earlier this summer. A source at one of the country’s largest software vendors says she probably gets solicited eight to 10 times a year from smaller firms inferring that they would cover the company if the vendor bought their research. “Smaller firms you will get the pay for play but not the big ones,” she says.

* Some analysts earn money based on being quoted in the press, and research reports that have highlighted sky-high forecasts of say, the now defunct bandwidth trading market, frequently grab headlines. Atlantic-ACM, a market research firm, one year issued a forecast on the prepaid industry that exceeded the projections of other analysts.

“Suddenly we were quoted everywhere,” says Judy Reed Smith, CEO of Atlantic-ACM. “They just quoted us and quoted us. It’s because ours was the highest that year. We started watching which analyst is quoted the most and in every industry it is the highest quote that is chosen.”

* Some market research firms have accepted stock from companies they are covering in a report, a practice that some critics argue is wrong because the analysts now have a vested interest in those organizations. Atlantic-ACM has accepted a mix of stock and cash from some companies. “It is so little money it is not enough money to drive any of our opinions,” Smith says. “We are more careful once we own something to not only advertise that company.”

* Other technology firms write white papers about vendors, their clients. There is nothing wrong with this practice unless the IT firm is representing the information to the press or other organizations as independent analysis, says Carter Lusher, co-founder and senior master strategist at SageCircle, a company that helps IT vendors establish better relationships with analysts. However observers say white-paper-for-hire firms disguise the research as independent analysis.

* Some market research firms allow a company to use their quote in vendor and carrier press releases. “There is a very fine line analyst companies need to walk if they become cheerleaders for a company to the point of having their name associated with company marketing or sales pieces,” says Gartner analyst Winogradoff, who notes his company doesn’t allow analysts to endorse any products or services in a press release. “I don’t think these analyst firms can truly consider themselves independent.”

Despite any firm’s commitment to objectivity, there are business realities that prevent any analyst from being completely independent, say observers.

Clients: How are analysts influenced?

Swamped with research deadlines, media requests, national conferences and client briefings, analysts don’t have nearly enough time to respond to every company requesting their time. However, the salespeople of a market research firm can persuade an analyst to schedule a briefing with a client, say observers. A startup has a better chance of getting an analyst’s attention if the company buys the firm’s research, says independent analyst Petrosky. “You kind of have to be in the money game a little bit,” she says.

There are other factors that can contribute to what some observers might perceive as slanted analysis. For instance, if a firm does not separate independent analysis from consulting, an analyst that is working with a client on a large project is likely to have a much better understanding of that particular vendor than its competitors, according to Petroskey. “Clearly that is going to influence your thinking,” she says.

Most researchers "try to do the right thing"

Experts following the market research firms say most analysts do their best to be credible experts. “I think generally speaking research firms are trying to do the right thing,” says LaRosa, of Kensington Group.

In fact, some firms get an unfair rap, contends Lusher, a former research fellow at Gartner. Advisory companies such as Gartner Inc. and META Group Inc. have no good reason to compromise their objectivity in exchange for a vendor’s business, he says. Technology buyers pay the advisory firms which also have research arms such as Gartner’s Dataquest for objective analysis.

The advising firms generate most of their revenue by selling research to American companies implementing technology, Lusher says. They also sell to vendors. However, analysts would only be harming themselves if they unfairly promoted one vendor over another. Lusher says such a practice could threaten to alienate their bread-and-butter clients: financial institutions, insurance companies, service providers and other American companies implementing technology.