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Lifting the Lid:
Analysts Won't Say "Sell" even as Stock Tanks
REUTERS NEWS
By Lilla Zuill and Dan Wilchins
March 10, 2006

HAMILTON, Bermuda/NEW YORK - It's a story straight out of the pre-Enron playbook: An investment bank takes an insurance company public, keeps some of the company's shares for itself, and then issues a report telling investors not to sell even as the shares plummet.

In fact it's a story from March 2006, nearly three years after New York Attorney General Eliot Spitzer settled with Wall Street firms in a scandal over tainted research, and it signals that broker research is still far from free of potential conflicts.

The bank is Friedman Billings Ramsey Group , and the insurer is Quanta Capital Holdings Ltd., which last week reported unexpectedly high losses in its preliminary fourth quarter results.

Quanta's shares fell more than 50 percent over two days, but FBR analysts kept a "market perform" rating on the company, signaling that investors should not sell their shares, and possibly buy more as the price fell.

The bank did not mention that FBR and the bank's founding director are among the biggest shareholders in the company, nor that the founding director is on the board of both companies, although FBR did mention that it holds more than one percent of the company's shares.

FBR did not break any rules, and a spokeswoman for the company declined to comment after being called several times, but its conduct leaves a bad taste in the mouths of some securities lawyers and compliance experts.

"In this case, if all they are doing is the boilerplate disclosures, they are asking for trouble," Jacob Zamansky, a securities lawyer whose lawsuit against Merrill Lynch five years ago helped to prompt Spitzer to investigate conflicts in Wall Street research.

In general, potential conflicts seem to influence analyst recommendations, an academic research report by Anup Agrawal and Mark Chen said in 2004. But that does not mean that FBR analysts' behavior was in any way influenced by the bank's stake in Quanta, experts said.

A 2003 settlement between Spitzer and 10 Wall Street firms was meant to reduce apparent conflicts between analysts, who are supposed to generate research reports that help investors evaluate stocks, and investment banking groups, whose main goal is to win underwriting business.

Enron Cheerleaders
In the 1990's and early part of this decade, research analysts often turned into cheerleaders for their sales departments, relentlessly touting stocks even as companies slouched toward bankruptcy.

As late as Nov. 8, 2001, 11 of the 15 analysts covering Enron recommended buying the stock, even after serious questions about the company's finances had surfaced, and the company's shares had sunk about 90 percent from their all-time high.

The problem with questionable analyst ratings was hardly isolated to Enron, surveys showed.

Even in the post Spitzer settlement world, analysts are somewhat reluctant to issue sell ratings. According to Reuters Estimates, just 7.7 percent of analyst ratings are "underperform" or "sell," compared with about 1.7 percent in June 2001.

FBR noted ample risks with respect to Quanta, including ratings downgrades, further charges, and the potential for its best clients to leave.

But the bank still rates Quanta a "market perform," signaling that investors should remain in their current positions and add as the valuations become more attractive.

Friedman Billings owns nearly 2.9 million Quanta shares, or more than four percent, and W. Russell Ramsey, a founding director of FBR, owns about the same number of shares through Ramsey Asset Management, a company that he controls. Ramsey is also a Quanta board member.

FBR has had an investment banking relationship with Quanta since before the insurer went public.

FBR led a 2003 private offering for Quanta, and took it public in May 2004. In December 2005, FBR raised about $130 million of common and preferred shares for the insurer, to provide it with additional capital after storm losses.

"It sounds like they are complying with minimum requirements but not complying with legislative intent or ethical, or certainly the good governance (guidelines) to disclose conflicts of interest," said David Finegold, a professor who has done research in corporate governance.

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