Confessions of a Wall Street Analyst Part 8

My Multibillion-Dollar Mistake: AT&T PERHAPS IT WAS simply the pressure of dealing with so many companies and deals at the same time. Perhaps I was beginning to feel out of step with a stock market that knew no bounds. Perhaps I was swayed by the charisma of a new, uberconfident chief executive. Whatever the reason, I kicked off 1999 with a multibillion-dollar mistake-one of the worst decisions of my professional life. simply the pressure of dealing with so many companies and deals at the same time. Perhaps I was beginning to feel out of step with a stock market that knew no bounds. Perhaps I was swayed by the charisma of a new, uberconfident chief executive. Whatever the reason, I kicked off 1999 with a multibillion-dollar mistake-one of the worst decisions of my professional life.

Way back in October 1997, AT&T's board had finally made a bold move after a humiliating series of events. First, CEO Bob Allen had bullied the board into choosing the corporate empty suit John Walter as AT&T's CEO-in-waiting. Then, when it became clear Walter was a disaster, the press had excoriated the board for paying him $26 million in severance for nine months of work. On October 20, it brought in a new CEO, C. Michael Armstrong, a dynamic turnaround specialist from Hughes Electronics Corporation. The market loved this choice, and AT&T stock leaped more than 16 percent, from $43 to nearly $50, in the two weeks between the time the rumors began and the decision became official.

Armstrong, a balding, impressive smooth talker with a disarming smile who seemed to understand technology, quickly charmed the press and the Street, in part because he had miraculously transformed Hughes Electronics from a defense contractor to a satellite TV business, DirecTV. In many ways, AT&T was like the Hughes Corporation Armstrong inherited in 1991-a dying giant with a need to spend enormous sums to gain a foothold in a new business. The changeover at Hughes had been painful, involving huge employee and cost cuts, significant startup costs to get the satellite TV business underway, and enormous risk. Armstrong openly acknowledged that it was a bet-the-company strategy, and it had paid off.

After his predecessors, dull powercrat Bob Allen and the woefully underqualified John Walter, Mike Armstrong had the aura of a savior. He tackled AT&T's problems head-on and laid out a clear action plan. He did nothing to discourage the increasingly popular belief that if anyone could fix this broken company, he could. I listened to everything he said and liked what I heard. Still, I remained skeptical: I thought that AT&T had simply delayed the inevitable for far too long and that Armstrong's challenge might be simply too great and too costly. So I left my rating at Neutral for quite some time, even as my inst.i.tutional investor clients became enamored of Mike and AT&T shares rocketed to $75.75 at the end of December 1998. Anyone who followed my advice missed a huge run-up.

From the beginning, Armstrong promised to address AT&T's main problems: getting local access to add to its established long-distance prowess and expanding its international reach. His first big move came in January 1998 when he bought Teleport, the startup local phone company that Mark and I liked so much, for $11.3 billion, thus gaining an instant presence in the market for local phone service for business customers. To address the local phone market for consumers, he bought cable company Tele-Communications International. And finally, in December 1998, just before Bell Atlantic's run at AirTouch, Armstrong announced he was buying IBM Global Network, an IBM business unit that provided communications services for large multinational corporations around the world. He had filled AT&T's major strategic holes in less than a year. I started to wonder if this guy really was the knight in shining armor for this antiquated old bureaucracy, and whether I should think about upgrading the stock.

So I did what I always did in these circ.u.mstances: I began a debate with myself and with all of the people whose opinions I respected, such as Bill Newbury, TIAA-CREF's (Teachers Insurance and Annuity a.s.sociation-College Retirement Equities Fund) telecom and cable a.n.a.lyst and a major client of mine. Newbury was a major bull on AT&T and taunted me, saying that I was missing the biggest stock in telecom. I absorbed the digs. It was always fun to argue an unpopular position, and since I had actually been quite right for a long time (AT&T did eventually go as low as $30.75 after I downgraded it three and a half years earlier, when it was trading at $55), I wasn't too concerned. But the conversation did add to my growing sense that some important things were going on at AT&T.

The other point that got my wheels turning was that it had been widely reported that AT&T was considering using a tracking stock tracking stock to separate its cable and wireless divisions from its long distance business. The use of tracking stocks allows a company to create separate stocks for different units. It would separate the big startup losses of AT&T's fast-growing cable and wireless businesses from the slowing but still-profitable long distance business. This came at a time when the stock market was paying incredible premiums for fast-growing businesses, even those with no earnings, while devaluing old "traditional" a.s.sets-in this case, AT&T's voice long distance business. to separate its cable and wireless divisions from its long distance business. The use of tracking stocks allows a company to create separate stocks for different units. It would separate the big startup losses of AT&T's fast-growing cable and wireless businesses from the slowing but still-profitable long distance business. This came at a time when the stock market was paying incredible premiums for fast-growing businesses, even those with no earnings, while devaluing old "traditional" a.s.sets-in this case, AT&T's voice long distance business.

With Armstrong's recent acquisitions, the company now had a chance to radically transform itself. I thought the tracking stock, if it did what it had done for Sprint and others, would give AT&T more financial flexibility and a higher stock valuation. I set up a meeting with Dan Somers, AT&T's CFO, to discuss AT&T's future. I asked him whether the tracker was still going to be announced at next month's annual a.n.a.lyst meeting, and he smiled rea.s.suringly.

So with the tracker as the news hook, in late December of 1998 I decided to upgrade AT&T, outlining my thoughts during that family vacation in Florida before I was interrupted by the Bell AtlanticAirTouch negotiations. I knew there was an AT&T a.n.a.lyst meeting scheduled for Friday, January 8, 1999, and I thought the upgrade should come out just before then. By the time I got off Bell Atlantic's jet, I had started typing up the AT&T draft report on the way to Ivan Seidenberg's office. That Sat.u.r.day, of course, was taken up by the over-the-Wall meetings at Bell Atlantic, but as soon as I got home I shifted gears, spending two close-to-sleepless nights editing the draft. We went out with the AT&T upgrade on Merrill's morning call on Tuesday, January 5, raising the stock one notch, from Neutral to Acc.u.mulate. AT&T shares traded up about 2 percent that day, a sign, I figured, that my argument resonated with investors.

The next morning, I got a call from the Merrill banker responsible for the AT&T relationship, telling me that I would be brought over the Wall on Thursday for an AT&T rehearsal in order to help it prepare for its Friday a.n.a.lyst meeting, which would have several hundred a.n.a.lysts, money managers, and journalists in attendance. It was a hectic week for me, with my AT&T upgrade, a trip to Arkansas, and two over-the-Wall sessions for two different companies within four days.

I showed up at AT&T's bucolic Basking Ridge, New Jersey, headquarters and strolled into the boardroom, expecting a boring day listening to predictable slide presentations. The sell-side a.n.a.lysts had the best seats, and I was seated directly across from Mike Armstrong, with Jessica Reif-Cohen, Merrill's cable a.n.a.lyst, to my left and Jack Grubman next to her. Frank Governali of Goldman sat to my right, with Denny Leibowitz, the legendary DLJ cable, media, and wireless a.n.a.lyst who had been rated number one in his category on the I.I. I.I. list for over 15 years, to the right of him. Along with a few other a.n.a.lysts, there were several bankers. I was just about to settle into my seat when the Merrill banker pulled me into a corner. list for over 15 years, to the right of him. Along with a few other a.n.a.lysts, there were several bankers. I was just about to settle into my seat when the Merrill banker pulled me into a corner.

"Dan," he whispered, not messing around with pleasantries, "the tracker is canceled."

It was one of those moments that seemed to last for hours. I could feel the blood draining from my face and my legs beginning to wobble. How could that be possible? I had just upgraded AT&T in large part because of the likelihood of a tracking stock for AT&T's wireless and cable units. I would look like a complete and total fool without the tracking stock plan. Geez, Connie Weaver, who several years earlier had left MCI and become AT&T's head of investor relations, had even named her dog Tracker!

Just then, Mike Armstrong walked in, br.i.m.m.i.n.g with confidence as usual, and sat directly across from the other a.n.a.lysts and me, flanked by AT&T's key executives. The bankers in the room were relegated to seats along the periphery. Mike asked everyone to take their seats and took a small piece of paper out of his shirt pocket on which he'd handwritten his own notes. No cue cards or teleprompters for this guy; it was impressive. After thanking everyone for coming on such short notice, Mike began reading from his crumpled piece of paper. He explained that he'd decided not to do the tracker because AT&T shares had done very well lately, and since the point of the tracker was to attract investors, perhaps it wasn't necessary.

Armstrong emphasized that he could always return to the tracker if he thought the company or its stock price needed it. I tried to look impa.s.sive, but I was burning up inside, thinking about how everyone in the room knew how bad I looked, and that many of them were enjoying my misery. Wrapping up, he said he'd like some feedback from the a.n.a.lysts in the room before he gave us a preview of the next day's presentation. "How do you react to what I just said?" Armstrong asked. "How will the market react?"

I could barely think straight. All I could think about was what a fool I was going to look like the next day, and if he really wanted to hear what I thought, it wasn't going to be pretty. I watched as the a.n.a.lysts, one after another, each told Armstrong he was making the right decision. I waited for the others to finish speaking, partly because I wanted to hear as many perspectives as possible, but also because I desperately needed time to figure out what to say and how to say it without looking as if I was chewing on a bunch of sour grapes. Finally, it was my turn.

"I disagree," I said, trying my best to sound professional and change Armstrong's mind. "In this market, if you don't unlock the value in the high-growth but money-losing cable and wireless units, you are robbing AT&T of future growth opportunities." I added that I thought that most around the table would agree that Sprint's two trackers together had achieved a higher stock market value than otherwise would have been achieved, and that this gave Sprint PCS, the wireless portion, the ability to spend more money and to build out its network more rapidly. Everyone was silent for a moment, until Armstrong, sounding a bit perturbed, thanked me. It was clear that his decision was final and he was just practicing his speech.

Finally, at the end of the day, Connie Weaver, AT&T's investor relations head, told me Armstrong wanted to meet with me in his office. She took me in and closed the door as she left. It was unprecedented for Connie to leave me alone with an AT&T executive-she was infamous for never letting that happen-but I guess Armstrong wanted this to be totally private. I walked in and took a seat on his couch. He sat down in the lounge chair to my right.

I didn't know what to expect. If it were Joe Nacchio, I would have received a verbal spanking: "Who are you to question a decision that my board, my management committee, and 29 well-trained bankers and a.n.a.lysts in that room today agree with?" But that would have been Joe. Mike Armstrong was a gentleman and a professional. I imagined he'd say something like, "You know, Dan, you have the respect of many people in this industry, but in the future if you don't agree with an aspect of what I'm doing, please tell me privately."

But he was a lot subtler than that. In fact, he hardly acknowledged my earlier comments and reiterated his excitement about AT&T's future. "Dan, you know you can call me anytime you want," he stated. Was he insinuating that if I had called him and asked about the tracker, he would have given me nonpublic inside information about the tracking stock being sc.r.a.pped? I doubted that, but I didn't know what he really meant. I told him I appreciated that, but it was not my style to run my draft reports by management before I published.

It turned out that AT&T investors didn't see the decision as a problem. Much to my surprise and relief, AT&T shares did not fall following the a.n.a.lyst meeting the next day. They held steady, a sign that investors still liked AT&T, tracking stocks or not. Ehud Gelblum, the most recent addition to my research team, and I wrote a report summarizing the meeting, t.i.tled "AT&T: The Magical Mystery Tour Continues: More Notes from Bullish a.n.a.lyst Meeting," reflecting my amazement that investors continued to believe in Armstrong even when he flip-flopped. Indeed, the stock continued to soar, moving up 22 percent to an all-time high of $95 over the next thirty days and bailing me out-for the moment. Thank G.o.d for this crazy market, I said to myself.

"You're Missing the f.u.c.king Boat on Level 3"

The Internet boom was now in full swing, and rather than being a phenomenon that would include telecom, it began to define telecom. No longer were the companies I covered relevant because of the traditional phone calls or voice communication they transmitted. Now it was all about data transmission, which was growing at what appeared to be an exponential rate. Data transmission meant sending e-mails, pictures, huge data files-you name it-over the Internet. Just as the railroads had unleashed the power of America's manufacturing muscle a century earlier, the telephone, cable, and wireless companies were laying the tracks (fiber-optic, in this case) to connect the virtual economy. Or so went the hype.

I had been fully aware of the Netscape IPO, Al Gore's information superhighway, and, of course, the stock market hype that was exploding all around me. But the light hadn't really begun to click on inside my head until that August 1996 meeting with Jim Crowe, who was then the CEO of MFS. I first heard at that meeting about Internet protocol, or IP, the technology that would be built into the telecommunications networks of the future and could truly transform every company I followed.

I had believed for a long time that the voice long distance business was in big trouble because of compet.i.tive pressures. But it began to occur to me that the growth in data traffic from the Internet could possibly make up for the pressures on the voice side. If the demand for this stuff was as dramatic as Jim Crowe and others were saying, perhaps it wasn't just the Baby Bells that would be the winners; perhaps everyone would win. Still, I was skeptical that anything could grow at the rate that some were predicting.

And the predictions were shocking. In 1997, Michael O'Dell, the chief scientist at UUNET, the Internet services provider that WorldCom had bought a year earlier, was the first of many to proclaim that overall Internet traffic was doubling every 100 days. Later that same year, at an a.n.a.lyst meeting for WorldCom, John Sidgmore, WorldCom's vice-chairman, announced that demand for bandwidth was doubling every 3.5 months. By early 1998, even the U.S. Department of Commerce was echoing O'Dell's 100-day statement and delivering bullish reports to Congress on the Internet's potential.1 And these numbers were still being presented a year and a half later. In May 1999, Sidgmore told And these numbers were still being presented a year and a half later. In May 1999, Sidgmore told Red Herring Red Herring magazine that "the Internet continues to grow at 1,000 percent a year in terms of bandwidth demand." magazine that "the Internet continues to grow at 1,000 percent a year in terms of bandwidth demand."2 These numbers were hard to believe. But, then again, I thought to myself, WorldCom does run the largest Internet transmission service in the world, so it was not unreasonable to view its traffic growth as a rough approximation of the overall market's growth, even if it wasn't sustainable forever. Reinforcing the bullish point of view was the fact that even the slow-growing Baby Bells were reporting 30 percent growth in their data services divisions, far beyond the 46 percent growth rates of more traditional Bell product lines. O'Dell's and Sidgmore's numbers would go on to become those "statistics" that everyone cited as gospel without knowing where they came from or whether they were actually true.

In May of 1998, I attended the grandly named Vortex Conference, a dot-com and technology get-together organized by Bob Metcalfe, the scientist from Xerox's famous Palo Alto Research Center who invented Ethernet, today's standard for rapid computer networking, and later founded 3Com. It took place at the Ritz-Carlton in Laguna Niguel, California, a gorgeous resort south of Los Angeles overlooking the ocean. But no one there cared much about the surf. The conference was chock-a-block with new companies trying to get funded, existing companies touting their technology, and, of course, bankers, a.n.a.lysts, and investors.

The speakers included John Chambers, CEO of Cisco Systems, Internet guru George Gilder, and others. Frank Quattrone, tech banker extraordinaire, was there, mobbed by startups looking for funding or merger partners. Sol Trujillo, CEO of US West, was there, trying desperately to gain some credibility as he tried to transform his company, and himself, from a boring old Baby Bell into a "new-economy" superstar. And Jim Crowe, my flat-topped buddy from MFS, was there, spreading the Internet word again, but this time on behalf of his new company, Level 3 Communications.

One afternoon as we sipped c.o.c.ktails by the Ritz's pool overlooking the Pacific Ocean, Jim explained to me that Level 3 was going to provide the tubes through which the information economy would flow. It would run a national long distance network that would carry only data, not voice. By this time, Jim Crowe was viewed as an Internet deity, having been early to the game with MFS and then selling it at a huge premium for WorldCom stock, which then soared. The response to his new company was as frenzied as a Michael Jackson concert in the Thriller Thriller days. days.

As we sat by the pool, Jim sketched out on a piece of paper his vision of the Level 3 network in the hope of convincing me to begin covering his company. I looked at the paper, which had a lot of swirls and chicken scratches, and saw nothing. To me, the whole thing seemed like just gibberish. I didn't get it. And although it made me nervous that just about everyone else said they did get it, I wasn't going to start coverage of a stock if I couldn't fathom what the company actually did.

Some clients tried to convince me of Level 3's merits. One was Bill Newbury of TIAA-CREF, who had helped talk me into the AT&T upgrade. Ja.n.u.s Funds, a big new-economy mutual fund group, loved the stock so much that its portfolio managers wouldn't even meet with me when I came to Denver, because, I supposed, they figured I would dis the company and they didn't want to hear it. I was beginning to feel like a Luddite, stubbornly sticking to the stuff that could be measured as the rest of the world rushed onward. Were they right, or was I?

Level 3 was a virtual fee machine for Wall Street firms because it was constantly raising money by selling bonds and stock. Making matters worse was the fact that Crowe, who obsessively quantified everything, also quantified the performance of the banks he hired. He developed a bizarre measurement system that graded the banks on everything from the number of calls a banker made to Level 3's CFO or treasurer each month to try to drum up business to the number of calls an a.n.a.lyst made to buy-side clients to talk about Level 3's stock. How he got that data, I have no idea.

A Level 3 doc.u.ment I received in 1999 listed the criteria he used to measure the banks' performance. Number two on the seven-point list was "Equity Research Commitment," measured in the following ways: "a.n.a.lyst calls made to inst.i.tutions/investors. a.n.a.lyst one-on-ones with investors. Perceived strength of a.n.a.lyst and a.n.a.lyst's understanding of, and confidence in, Level 3's Plan. Ongoing research coverage of Level 3."3 All of these factors were compiled into one total score that would presumably determine the portion of Level 3's business each bank would be awarded. Clearly, Crowe saw the a.n.a.lyst and the banker as inextricably entwined. It was troubling. I never heard of another company that had such an explicit method for monitoring its investment banks. But this was Jim Crowe to a tee. Needless to say, he wasn't a big fan of mine, and the three firms I worked for never got much business from him.

By March 1999, my refusal to cover Level 3 was becoming a major problem for Merrill, made even worse by two rah-rah reports issued by Jack Grubman the month before. The first one, a two-pager on February 18 that raised Jack's target price to $70 from $54, came out the same day that Level 3 announced plans for a huge secondary stock offering-underwritten, of course, by SSB.

Four days later, he put out a ma.s.sive, 39-page report t.i.tled, "Level 3 Communications: Optimizing a Layer of the Telecom Value Chain: The Intel Inside of Telecom."4 In it, he outdid himself. Discussing how bandwidth was the "enabler of the Internet," he exclaimed that bandwidth-centric companies such as Level 3, WorldCom, Global Crossing, Qwest, and a startup local carrier called Metromedia Fiber Network were In it, he outdid himself. Discussing how bandwidth was the "enabler of the Internet," he exclaimed that bandwidth-centric companies such as Level 3, WorldCom, Global Crossing, Qwest, and a startup local carrier called Metromedia Fiber Network were "good values at any price." "good values at any price." Jack's reasoning? Internet-based applications were growing exponentially, he said. "This is why we believe Jack's reasoning? Internet-based applications were growing exponentially, he said. "This is why we believe the value of these stocks will perpetually rise the value of these stocks will perpetually rise as long as management executes." as long as management executes."

The National a.s.sociation of Securities Dealers (NASD), the securities industry's self-regulatory organization, requires that all Wall Street research reports have a "reasonable basis" for their conclusions. How could a view that stocks will rise "perpetually" and that some stocks are "good values at any price" be reasonable? This wasn't a.n.a.lysis by any stretch of the imagination. It was hyperbole and should have been stopped by SSB's compliance department, its research directors, or the NASD. If he had stood outside on a street corner yelling these inanities at the top of his lungs, people would have thought he was completely bonkers. But, when this stuff showed up in a Wall Street report by a big-name a.n.a.lyst, even professional money managers with Harvard MBAs lapped it up.

Jack's target price increase looked to me like an overt attempt to "condition" or hype the market for Level 3's offering by building demand for the new shares. And condition it did! Despite the fact that announcements of secondary offerings almost always temporarily depress a company's stock price, according to The Wall Street Journal, The Wall Street Journal, his target price increase caused the stock to jump from $51.75 to $54 a share. his target price increase caused the stock to jump from $51.75 to $54 a share.5 With such strong demand, Jim Crowe decided to up the number of shares offered by 25 percent, to 25 million. By my calculations, without Jack's report, Level 3 shares normally would have traded down to roughly $50 per share. So, in effect, Jack netted Level 3 a cool $100 million because Level 3 was able to sell its 25 million shares at a price of $54 each, approximately four dollars higher than it would have otherwise. Advantage: Level 3 and its bankers. Disadvantage: small investors, who had no clue what was going on and paid $4 per share more than they would have just days before. The amazing thing was that this was happening in plain sight of everyone, from investors to regulators to the readers and writers of The Wall Street Journal The Wall Street Journal-and no one seemed to mind. No wonder every CEO wanted Jack on his side!

Jack's lock on Level 3 didn't stop my Merrill buddies on the banking side from trying to get a seat on its gravy train. Although Level 3 did most of its business with Salomon, Crowe also liked to spread the business around a bit, with the expectation that the research side would play ball. On one deal, with no help from me, Merrill managed to get included as a low-level co-manager, and Frank Maturo, a pushy banker who had just moved to Merrill from Salomon, decided to pay me a little visit. He sat down in my office and told me that Level 3 was simply the greatest "f.u.c.king company" he had ever seen.

"f.u.c.k, you guys, you're missing the f.u.c.king boat," he said, mentioning his "great f.u.c.king relationship with Crowe." Lots and lots of business would come Merrill's way, he said-as soon as I started recommending its stock. He even said that Jack was not responsible for all the business Salomon did with Level 3; instead, Frank claimed, "I f.u.c.king was." Frank had quite a broad vocabulary.

I decided to do what had always served me best-play it straight. "Frank, let me tell you three things," I said, beginning with a nice one. "One, it's very nice to meet you. You are truly different from anyone I have ever met at Merrill and I suppose your high energy level and aggressiveness might be needed in this somewhat sleepy firm. Two, I doubt Level 3 is the greatest company in the world. And three, we're pretty busy here and Level 3 seems to be getting hyped up all over the Street. Its stock is very high, so it may be too late to recommend the shares anyway. If we can find some time, we'll take a look, but no promises."

Frank didn't hear a word I'd said. He just kept repeating what an incredible stock Level 3 was going to continue to be, how well connected he was, and how much money he could make for Merrill Lynch if only the telecom research a.n.a.lyst would get on board. He wasn't there to listen to an a.n.a.lyst. He looked on a.n.a.lysts as the first wave of privates on Omaha Beach, the heroes to be sacrificed for the higher good. But this was one war I wanted to sit out.

"You Know He Can't Keep His Mouth Shut"

March 1999 was a tense time: our Global Telecom CEO Conference was fast approaching and we were in the final stages of panic, praying, as we did every year, that our key speakers wouldn't cancel. This year, I had invited everyone from WorldCom's Bernie Ebbers to AT&T's Mike Armstrong to Ed Whitacre, SBC's chairman and CEO, as speakers. On Thursday, March 11, just four days before the conference was to begin, I was on the way back from visiting clients all over the southeastern U.S. when I got a call from Michael Costa, Merrill's telecom M&A banker: "Dan, we need to bring you over the Wall on something tomorrow afternoon. Will you be back in time for a 2:00 PM PM meeting at the midtown offices of [top law firm] Skadden Arps?" meeting at the midtown offices of [top law firm] Skadden Arps?"

A day later, I was sitting in a conference room with Jack Grubman as a bunch of bankers briefed us on Global Crossing's pending confidential offer to acquire Frontier, the former Rochester Telephone Company, which had recently added long distance, data services, and Web-hosting to its repertoire of phone services. These a.s.sets made Frontier a very attractive acquisition. Both Salomon and Merrill were representing Global. My old colleagues at Morgan Stanley were the bankers representing Frontier. Talk about incestuous!

Global Crossing was the new international long distance company that had gone public with a bang in August 1998. It had laid cables under the Atlantic Ocean and intended to run fiber-optic cable all the way around the world to meet the exploding demand for Internet and telecommunications access. Global Crossing had sold just 25 percent of its cable capacity under the Atlantic Ocean-the "Atlantic Crossing"-and had already recouped 90 percent of its costs.

In March 1999, Global looked like a home run. From its IPO price of $19, it was now at $48, having doubled in the first three months of this year alone. Before Global's IPO, former president George H. W. Bush gave a speech to the company's most important customers and opted to be paid in pre-IPO stock instead of taking his usual $80,000 honorarium. That decision netted him $14 million.

Global Crossing's founder was Gary Winnick, a former junk-bond salesman at Drexel Burnham Lambert, Michael Milken's hotshot firm, whose fortunes had evaporated when Milken pleaded guilty to securities law violations in 1990.6 Winnick was a heavyset, wide-shouldered Long Islander who would have looked right at home in a used car lot. I initiated coverage of Global Crossing shares with a "2," or Acc.u.mulate, rating, meaning I predicted a rise of 1020 percent over the next 12 months-fairly unimpressive numbers in the context of what was happening to most stocks in the tech and Internet categories. Yet I was intrigued by what appeared to be very strong demand for the company's undersea fiber. Winnick was a heavyset, wide-shouldered Long Islander who would have looked right at home in a used car lot. I initiated coverage of Global Crossing shares with a "2," or Acc.u.mulate, rating, meaning I predicted a rise of 1020 percent over the next 12 months-fairly unimpressive numbers in the context of what was happening to most stocks in the tech and Internet categories. Yet I was intrigued by what appeared to be very strong demand for the company's undersea fiber.

Because Global was perhaps the premier "new-economy" company in the telecom sector and had been seen as purely an international play, its decision to acquire Frontier was a shocker. Frontier was an old-economy real telecom company, not a virtual one. This meant a major strategy change for Global Crossing. The deal, which preceded the AOLTime Warner merger by almost a year, was the first case in which an upstart new-age company with few customers but major growth expectations used its high stock valuation to buy a traditional company. Global Crossing was offering a very rich price for Frontier of $62 per share, 41.3 percent above Frontier's current price of $43.88. I was very happy with the transaction. It validated my Buy rating and target price of $60 on Frontier, and my view that Frontier was a takeover candidate. Moreover, the Luddite in me thought it was terrific for Global, since it now would own a traditional company with real a.s.sets, real customers, real revenues, and real earnings.

The bankers told us that the deal would likely be announced the following Wednesday, after both companies' boards met and approved the deal on Tuesday. d.a.m.n, I thought. This meant the press conference and a.n.a.lyst meeting would interfere with my own conference, siphoning off my attendees. The Morgan and Salomon folks were probably thrilled, as an unsuccessful conference might mean fewer votes for me and a lower stature for Merrill's telecom franchise.

So we swung into action, quickly offering to let the two companies announce their merger at our shindig. We would shuffle some speakers around and create a one-hour slot early in the morning so Global Crossing's and Frontier's CEOs could present the deal and the new company's plans. We convinced the executives that they would get far greater attention with all the major large investors in one place. We even offered to let my compet.i.tors from other Wall Street firms into the Grand Hyatt's ballroom for the meeting, which normally we wouldn't have done.

We couldn't flag the schedule change, since it was confidential information and astute buy-siders would quickly suspect something was up. Last-minute events such as CEO or CFO cancellations were watched closely by professional investors because they often signaled important news in the offing. I did not tell my team about the upcoming merger, nor did they have any reason to suspect anything.

But apparently, other people did. Monday morning, as I was exiting the hotel elevator and approaching the coffee and m.u.f.fins, stopping to greet every client I could, one of my most important clients pulled me aside. With a big s.h.i.t-eating grin spreading across his face, he said: "So, Dan, who's going to buy Frontier on Wednesday for $62 a share?"

I blanched. He was blatantly flaunting the secret information he had. I looked down to try to hide my shock. How could he know? And what made him think I knew something about it? If I implied I knew, he'd take it as a confirmation and I might be illegally disclosing inside information. Fortunately, I was already harried, since in about five minutes I had to go to the podium and make my opening remarks.

"Wow, I didn't know that," I said, concentrating on holding my poker face. "Where did you get that from?"

"Oh, I went to a boxing match with Jack on Sat.u.r.day night. You know he can't keep his mouth shut."

"I'll try to check into it," I said. "Let me know if you hear anything more, but I've got to get into the ballroom. I think I'm late already." I didn't have time to think too much about the leak; it was time to get the conference started. But it had happened again-with a deal I knew about this time. I wish I could have said I couldn't believe my ears, but by this time, sadly, I could.

Later that day, Megan told me that same client also approached her and posed the same question, saying he had heard it from Jack at the Lewis-Holyfield heavyweight boxing match at Madison Square Garden on March 13. She, of course, had no idea what was going on at the Skadden law offices across the street and thus simply exclaimed, "Really?" and probed him for more.

Later that afternoon, Michael Costa, the Merrill banker, found me in the Grand Hyatt hallway and asked me if I could meet with Global's board at around 2:00 PM PM the next day at Skadden's office. They were asking both Jack and me, separately, to give our sense of how the markets would react to the deal. It was going to be very tough for me to sneak out of my own conference without anyone noticing, but I managed to get to Skadden at about 2:05 the next day at Skadden's office. They were asking both Jack and me, separately, to give our sense of how the markets would react to the deal. It was going to be very tough for me to sneak out of my own conference without anyone noticing, but I managed to get to Skadden at about 2:05 PM PM on Tuesday. I was shunted off to a small conference room and informed that the board would call me when it was ready. on Tuesday. I was shunted off to a small conference room and informed that the board would call me when it was ready.

After about a half hour, I was getting antsy. I wanted to get back to my conference before anyone noticed I was absent. I certainly didn't want to miss the 4:30 meeting I had arranged with our dinner speaker, Steve Case, AOL's chairman and CEO. Although about 700 clients attended the conference, I had invited a select group of my top 25 clients to this meeting, which had to be kept very quiet. These kinds of meetings were highly sought after by buy-siders, because lots of important information came out. This was just another example of the fact that even the inst.i.tutional investors didn't play on an even playing field. Some would have a chance to chat in near-private sessions with Steve Case, while others had to try to trap him on his way to the men's room before his speech.

Finally, bored and anxious, I took a walk down the hallway. I spotted Global chairman Gary Winnick milling about by some snacks. We chatted about the deal, and I suggested to him that if the market reacted well to this one, he ought to keep going, leveraging his supercharged stock as currency for the acquisitions of other companies. Chuckling, but somewhat serious at the same time, I said "Gary, I don't see why you don't buy US West and then BellSouth."

Gary's eyes lit up. He clearly liked the idea. But it soon became clear he had something else on his mind.

"You know, Dan, our stock is down $4 today," he said, with the kind of bellowing laugh that can emanate only from a wealthy man, "and I've lost almost a billion dollars in just a few hours! Can you believe that? My net worth is actually down a billion dollars today!"

I laughed, as apparently was required. I guess it was somehow truly amusing that the coming or going of $1 billion did not really seem to matter. What a 1999 moment.

Much less amusing was the fact that Global Crossing shares had fallen so much today, while Frontier shares were up $2.50, just a day ahead of the merger announcement. It looked as if the news of the merger had leaked out to more people than just Jack's boxing buddy.

As I stood there with Gary, being introduced to a few of the board members and to Tom King, a Salomon banker, someone came running out of the conference room looking for Gary. "Gary, I've got Joe [Clayton, Frontier's CEO] on the phone. You need to talk to him." He and Bob Annunziata, Global's CEO, went into the conference room, returning about 15 minutes later with worried looks on their faces. Gary told me there was a last-minute snag with "those b.a.s.t.a.r.ds in Rochester," but that it would work out. By 3:00 PM PM, another phone call came through, and everyone was relieved: they had a done deal.

We all went into the conference room, and the board members asked for my reactions to the deal from Global Crossing's perspective. I told them it was a smart move, but that they should be prepared for some skepticism from those Global shareholders who were true believers in the power of the Internet.

"The market has given Global a currency with which to build itself, via acquisition, into a major company in this industry," I said. "And you should use that currency while the bull market supports it." Everyone listened politely. I finished and dashed back to my conference, slipping in just in time to introduce Steve Case to the 25 lucky buy-siders who were awaiting the private session.

Steve Case was up there with Level 3's Jim Crowe as one of the most pa.s.sionate advocates of the Internet, only he was a little more approachable. He was as ebullient as you'd have expected from an AOL CEO in 1999. Case was also our dinner keynote speaker. Over 700 buy-siders crammed into the Grand Hyatt's ballroom and an overflow room. Sitting at Steve's table was the new Merrill Internet a.n.a.lyst, Henry Blodget, a group of five buy-siders I'd handpicked, and me.

Before Case sat down, I leaned over and whispered to Henry, "Henry, you want to introduce Case as our dinner speaker, right?"

"Yeah, I should do that. You know I've never met Case. It will be interesting to introduce someone who I've never met."

Hmmm, I thought to myself. This guy covers AOL and, on behalf of Merrill Lynch, recommends its stock to thousands of individuals and inst.i.tutions around the world. How can he publish research reports on a company without having ever met the driving force behind it? Geez, I bet sixth graders feel they know Steve Case better than Henry Blodget does. After all, Steve regularly writes e-mails to AOL subscribers.

Henry did a fine job introducing Case and moderating the Q&A session. No one could tell these two men were meeting each other for the first time. It was so un-Grubmanesque. Henry had a vision. He didn't seem to need insider relationships. In fact, it didn't seem to have even dawned on him that those relationships were necessary at all. How different the paths to Wall Street stardom and notoriety can be.

The next morning, Wednesday, March 17, the Global CrossingFrontier merger was announced at about 7:00 AM AM. Megan said, "You knew this all along, didn't you? And Jack told [the client], didn't he?" I shrugged my shoulders. "I just can't believe he can get away with this much longer," I said. It was just another day in M&A-except, of course, for those who knew about the deal before it happened. For them, it was a great day.

The SEC's Deadly Mistake As I stood in the back of the Grand Hyatt's ballroom at my conference listening to Global Crossing's Bob Annunziata and Frontier's Joe Clayton outline the deal's terms and their joint future, Megan came over and asked, "Are we going to write this up or are we restricted?"

"Restricted, I'm sure," I whispered in reply. "But check with compliance." Since Merrill's bankers were advising Global Crossing, I a.s.sumed I would not be able to say or write a word about the deal or either company until the merger was completed, which could take months. I had learned many years earlier that federal securities regulations didn't allow a Wall Street firm to issue research on a company when the firm was acting as a financial adviser to that company. This was intended to avoid the accidental leakage of inside information and to keep research a.n.a.lysts from conditioning the market conditioning the market-hyping a stock's price or biasing shareholders in some way.

There was another factor, too: although Merrill was going to be paid $20 million for its advice to Global Crossing, most of the fee was contingent on the deal being approved by shareholders and regulators. My opinion, if positive, could easily be interpreted as trying to influence shareholders to vote yes on a deal that my firm had millions riding on. I certainly didn't want my clients to view my research as tainted, and I figured Merrill's watchdogs would have the same view. So, when clients approached me at the conference, asking what I thought of the deal, I could only explain, "Oh, sorry, looks like we're gonna be restricted for a while, since we're advising on the deal."

An hour or so later, Megan slipped me a note while I sat on the dais listening to our next speaker. It said, "Restricted yes, but we can write the facts. Should I write it up?" I nodded yes, and thanked her.

Although it was a relief to be free of the pressure to opine on the deal, being restricted hurt me in other ways. It gave me fewer topics to talk to my clients about, which might push them into the arms of my compet.i.tors. The timing was particularly bad in this case because I.I. I.I. voting season was fast approaching. Factual summaries didn't help, because they couldn't include forecasts, stock recommendations, or target prices for the two companies involved in the merger-and therefore, added no value for my inst.i.tutional clients, who had access to the same facts. The factual summaries were really written for Merrill's retail brokers and, indirectly, their individual clients whose only other information source would be newspapers and CNBC. voting season was fast approaching. Factual summaries didn't help, because they couldn't include forecasts, stock recommendations, or target prices for the two companies involved in the merger-and therefore, added no value for my inst.i.tutional clients, who had access to the same facts. The factual summaries were really written for Merrill's retail brokers and, indirectly, their individual clients whose only other information source would be newspapers and CNBC.

Now, I'm no securities lawyer. But I figured the other firms involved in the deal, Salomon Smith Barney and Morgan Stanley, would also restrict their a.n.a.lysts. Salomon, along with Merrill, was Global Crossing's banker, while Morgan Stanley advised Frontier. But I was wrong: the next morning, Jack issued a seven-page report upgrading his rating on Frontier shares two notches, to Buy ("1") from Neutral ("3") and dramatically raising his Frontier target price to $80, from $38 per share. He argued, correctly, that Frontier shares should be viewed as a derivative of Global Crossing's. As such, his new Frontier rating and target price were derived from his new target price on Global Crossing, which he pegged at $72 per share.

Although Jack hadn't explicitly issued an opinion on Global Crossing, since Salomon had represented Global and he was restricted from issuing an opinion about it, he had managed to get his point across indirectly through his Frontier report: the deal was a great one for both companies and shares of both companies offered tremendous upside to investors. Global Crossing shares were worth $72 at a minimum, 53 percent above their current price. And Frontier was worth at least $80.

I realized instantly that I (and Merrill) would be at a major disadvantage if I wasn't publishing opinions on these two companies and Salomon was. Our traders would do less trading and thus make less in commissions. The same would hold for our 12,000 retail brokers, who would have no recommendations to pa.s.s on to their customers. And Gary Winnick, Bob Annunziata, and Joe Clayton, I figured cynically, weren't going to be very happy if one of the two banks they were paying millions to for merger advice went mute for the next three or four months. So although I felt that publishing anything like what Jack had done would be the wrong thing to do, I figured I'd better get some professional help to be sure.

The next morning, with my conference over, I walked down the hall to Merrill's research compliance department. "How come Grubman can write this stuff?" I asked Ray Abbott, the compliance department's resident lawyer, waving Grubman's Frontier upgrade in front of his eyes. "I'm restricted, right? Why isn't he?"

Ray took a glance through the report and said he saw my point. He then said there had been some changes in SEC regulations in late 1997. Ironically, he said, Merrill had actually been the firm that convinced the SEC to loosen up its research regulations a bit on M&A deals. But now Merrill's compet.i.tors were using it to their advantage.

"It's called a No-Action Letter," Ray said. He tried to explain the SEC's logic, but when he saw my eyes glazing over, he called another Merrill lawyer and asked him what I could and could not write about.

It turns out that this "No-Action Letter" was an extremely significant doc.u.ment, one that inadvertently further intertwined banking and research, put a.n.a.lysts in even more conflicted positions, and made investor interests subservient to those of investment banking clients.

It worked like this: prior to the ruling, the SEC prohibited research a.n.a.lysts from issuing opinions on companies that had hired their firm's investment bankers for M&A work. This had two results, one good and one bad. First, it kept the research a.n.a.lyst's opinions from being influenced by the interests of the bankers or their corporate clients. Otherwise the a.n.a.lyst might be pressured to put out a positive opinion on the companies involved, helping convince the companies' shareholders to approve a proposed merger-and guaranteeing a fat fee to his firm. The second, unintended, effect was that individual investor clients of, say, Merrill Lynch, no longer had access to the a.n.a.lyst's recommendations and explanation of the transaction, leaving them in the dark if they had an account with only one brokerage firm.

On October 21, 1997, Merrill's law firm wrote a letter to the Securities and Exchange Commission. Merrill said it would like to be able to publish a.n.a.lyst recommendations on the shares of an investment banking client even while a merger or acquisition was pending.7 The SEC responded with its "No-Action Letter," which is not a formal approval but rather an a.s.surance that should Merrill do what it proposed, the SEC would not take any punitive action. The SEC responded with its "No-Action Letter," which is not a formal approval but rather an a.s.surance that should Merrill do what it proposed, the SEC would not take any punitive action.8 The SEC wasn't saying that doing this was right or wrong, but rather that the commission would not interfere if Merrill or, indeed, any investment bank did issue some recommendations. The SEC wasn't saying that doing this was right or wrong, but rather that the commission would not interfere if Merrill or, indeed, any investment bank did issue some recommendations.

The letter therefore essentially sanctioned behaviors like Jack's bullish report on Frontier and Global Crossing, even though the merger was awaiting approval and his firm's fee was contingent on the deal going through. Before the No-Action Letter, a firm with an influential, well-respected, and bullish a.n.a.lyst often lost out on deals because the corporations involved knew the a.n.a.lyst would be muzzled in order to avoid the possibility of conflicted research. They did not want to lose that a.n.a.lyst's bullish influence while the deal was underway.

The letter turned that upside down. Now that a.n.a.lysts were no longer restricted from commenting on pending deals, it made sense for corporations, in search of supportive commentary and higher stock prices, to hire firms with pliable or bullish a.n.a.lysts. Arthur Levitt, who was chairman of the SEC in 1997, gave speeches castigating a.n.a.lyst conflicts of interest. But he also presided over the creation of one of the most pernicious and costly conflicts in the history of Wall Street.

I didn't understand any of this at the time. So, when Ray phoned another Merrill lawyer, I sat and listened in to the call, taking copious notes. After a while, yet another Merrill lawyer was brought onto the call as well. As the call dragged on, it became clear to me that each of the lawyers had different interpretations of the SEC's regulations, and that there was no clear answer. I had to leave for a client meeting, so we agreed to meet again the next day.

When we reconvened, I don't remember who said what, but the group of lawyers spent a lot of time trying to justify my publishing research on this deal. One suggestion was for me to write a detailed report on Frontier but not on Global Crossing, explaining the merger terms, forecasting revenue and earnings for Frontier, and setting a target price for Frontier shares. This was what Salomon had allowed Jack to do and would be okay, the argument went, because Merrill's bankers, like Salomon's, were advising Global, not Frontier. However, in contrast to Jack's report on Frontier, I wouldn't be allowed to give Frontier shares an investment rating.

Nevertheless, if I set a target price for Frontier based on the number of shares of Global stock it was being offered, any reasonably intelligent professional investor would be able to deduce my target price for Global Crossing. I would leave blank what Jack had spelled out explicitly: the pros would know what I was thinking about both stocks, but the amateurs-the individual investors who lacked the time or expertise to read through these tea leaves-would know far less.

It was all very convoluted and inconsistent. My mind was spinning. I was in a jam, and no one was offering me a clear way out. If I wrote anything positive, it would be perceived as urging shareholders to vote in favor of the merger. And then one of the Merrill lawyers topped it all off by telling me that there was some risk the SEC would sue us if we followed this plan. Someone else chimed in that it could be an important test case of the rules.

"Whoa," I yelped to Ray, who was sitting across from me. "So I'm the guinea pig for these legal guys to test the SEC's rules? No way, Jose!" (Ray thought I said, "No way Ray.") Ray interjected, "Neither Dan nor I are comfortable with the scenario you guys have painted. Do you have any other ideas for us to consider?"

Two more ideas were offered. I could simply write nothing-and mark the stocks as "restricted" in the Merrill computer systems. Or I could continue to write factual reports as I already had, again with the rating column marked "Rstr" for restricted. I nodded positively to Ray, and it was resolved. I would stick to "just the facts, ma'am," like Sergeant Friday in the 1950s television series cla.s.sic Dragnet, Dragnet, and issue no ratings, forecasts, or target prices on either stock. and issue no ratings, forecasts, or target prices on either stock.

But I came away with two very disturbing conclusions: one, that the lack of clarity in the No-Action Letter was actually doing more to promote a.n.a.lyst conflicts than to resolve them, and two, that people in all different parts of my firm were interested in pushing the envelope any way they could in order to promote banking and trading. The lawyers were not so much pressuring me as facilitating me. If it wasn't explicitly barred, it must therefore be okay. It was a scary and sobering realization.

"How Can Your Best Friends Become Your Worst Enemies?"

Just one month after the Global-Frontier merger announcement and just two days after Forbes Forbes had published a big cover story on Gary Winnick, Global Crossing's chairman, ent.i.tled "Getting Rich at the Speed of Light," I flew to Los Angeles for my annual West Coast marketing tour and asked Gary to lunch. I brought a copy of the had published a big cover story on Gary Winnick, Global Crossing's chairman, ent.i.tled "Getting Rich at the Speed of Light," I flew to Los Angeles for my annual West Coast marketing tour and asked Gary to lunch. I brought a copy of the Forbes Forbes story for him to autograph, and he was flattered, just as I had intended. The article pointed out that Gary had reached $1 billion in net worth faster than anyone in history-even Bill Gates. story for him to autograph, and he was flattered, just as I had intended. The article pointed out that Gary had reached $1 billion in net worth faster than anyone in history-even Bill Gates.

Gary was dressed in a suit, and the first thing he did was to introduce me to his personal trainer, some TV workout celebrity. Gary promptly began his workout on the treadmill-with his suit still on. Perhaps this was meant to show what a fabulous mult.i.tasker he was. Perhaps he had simply scheduled us both at the same time by accident. But someone probably should have told him that suits don't breathe too well. I felt sorry for whomever he was meeting after his workout-until I remembered that we were going to have lunch together. Sheesh.

While Gary ran on the treadmill, I visited with some of the other Global executives. Then Gary and I went to lunch together at Hillcrest, a country club in Beverly Hills. Gary introduced me to a woman whose son wanted to go to Cornell Law School. I guess she was a good friend, because he told me he had donated $100,000 to Cornell to get him in. As we ate, person after person stopped by to congratulate him on the Forbes Forbes cover. Gary, who puffed up with pride, was thrilled to be perceived as one of the kings of the new economy. When we were able to speak uninterrupted, I repeated that I thought a Baby Bell would be his best buy going forward. cover. Gary, who puffed up with pride, was thrilled to be perceived as one of the kings of the new economy. When we were able to speak uninterrupted, I repeated that I thought a Baby Bell would be his best buy going forward.