[Senate Hearing 107-385]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 107-385


                               before the

                              COMMITTEE ON
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION


                           FEBRUARY 27, 2002

      Printed for the use of the Committee on Governmental Affairs

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               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 FRED THOMPSON, Tennessee
DANIEL K. AKAKA, Hawaii              TED STEVENS, Alaska
RICHARD J. DURBIN, Illinois          SUSAN M. COLLINS, Maine
MAX CLELAND, Georgia                 PETE V. DOMENICI, New Mexico
THOMAS R. CARPER, Delaware           THAD COCHRAN, Mississippi
JEAN CARNAHAN, Missouri              ROBERT F. BENNETT, Utah
MARK DAYTON, Minnesota               JIM BUNNING, Kentucky
           Joyce A. Rechtschaffen, Staff Director and Counsel
                     Cynthia Lesser Gooen, Counsel
                  John N. Wanat, Congressional Fellow
         Hannah S. Sistare, Minority Staff Director and Counsel
           William M. Outhier, Minority Investigative Counsel
                   Jana C. Sinclair, Minority Counsel
                     Darla D. Cassell, Chief Clerk

                            C O N T E N T S

Opening statements:
    Senator Lieberman............................................     1
    Senator Thompson.............................................     4
    Senator Levin................................................     6
    Senator Collins..............................................     7
    Senator Torricelli...........................................     9
    Senator Voinovich............................................    11
    Senator Bunning..............................................    13
    Senator Bennett..............................................    13

                      Wednesday, February 27, 2002

Anatol Feygin, Senior Analyst and Vice President, J.P. Morgan 
  Securities, Inc................................................    15
Richard Gross, Analyst, Equity Research Division, Lehman 
  Brothers, Inc..................................................    17
Curt N. Launer, Managing Director, Global Utilities Research 
  Group, Credit Suisse First Boston..............................    18
Raymond C. Niles, Senior Analyst, Citigroup Salomon Smith Barney.    20
Howard M. Schilit, Ph.D., CPA, President and Founder, Center for 
  Financial Resarch & Analysis, Inc..............................    23
Hon. Robert R. Glauber, Chairman and Chief Executive Officer, 
  National Association of Securities Dealers, Inc................    50
Thomas A. Bowman, CFA, President and Chief Executive Officer, 
  Association for Investment Management and Research.............    52
Charles L. Hill, CFA, Director of Research, Thomson Financial/
  First Call.....................................................    54
Frank Torres, Legislative Counsel, Consumers Union...............    56

                     Alphabetical List of Witnesses

Bowman, Thomas A., CFA:
    Testimony....................................................    52
    Prepared statement...........................................   100
Feygin, Anatol:
    Testimony....................................................    15
    Prepared statement...........................................    67
Glauber, Hon. Robert R.:
    Testimony....................................................    50
    Prepared statement with an attachment........................    90
Gross, Richard:
    Testimony....................................................    17
    Prepared statement...........................................    72
Hill, Charles L., CFA:
    Testimony....................................................    54
    Prepared statement...........................................   109
Launer, Curt N.:
    Testimony....................................................    18
    Prepared statement...........................................    73
Niles, Raymond C.:
    Testimony....................................................    20
    Prepared statement...........................................    82
Schilit, Howard M., Ph.D., CPA:
    Testimony....................................................    23
    Prepared statement with attachments..........................    86
Torres, Frank:
    Testimony....................................................    56
    Prepared statement with an attachment........................   111


Chart entitled ``Enron Stock Recommendations by Broker'' 
  (submitted for the record by Chairman Lieberman)...............   127
Chart entitled ``S&P 500 Price Index Versus S&P 500 Consensus 
  Recommendation'' (submitted for the record by Chairman 
  Lieberman).....................................................   128
Chart entitled ``Enron Consensus Recommendation Versus Stock 
  Price'' (submitted for the record by Chairman Lieberman).......   129
Chart entitled ``Banking Firm'' (submitted for the record by 
  Senator Levin).................................................   130
``AIMR Standards of Professional Conduct pertaining to Gifts,'' 
  response to a question by Senator Levin submitted by Mr. Bowman   131
``Association for Investment Management and Research (AIMR) 
  Survey on Accounting for Stock Options,'' response to a 
  question by Senator Levin submitted by Mr. Bowman..............   132
Damon A. Silvers, Associate General Counsel, on behalf of the 
  American Federation of Labor and Congress of Industrial 
  Organizations, AFL-CIO, prepared statement with attachments....   135



                      WEDNESDAY, FEBRUARY 27, 2002

                                       U.S. Senate,
                         Committee on Governmental Affairs,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 9:33 a.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Joseph I. 
Lieberman, Chairman of the Committee, presiding.
    Present: Senators Lieberman, Levin, Torricelli, Thompson, 
Voinovich, Collins, Bunning, and Bennett.


    Chairman Lieberman. This hearing will come to order. I 
thank you all for being here.
    This hearing, which is called ``The Watchdogs Didn't Bark: 
Enron and the Wall Street Analysts,'' is the third in a series 
of hearings that our Committee is holding on the largest 
bankruptcy in American history. It is part of our 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 our Permanent 
Subcommittee on Investigations 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 stock even after the company began to crumble.
    Why were the analysts blinded to the company's deceit and 
disintegration? And how can we prevent similar failures in the 
    Those are the crucial questions we are going to ask today, 
and they are crucial because the Enron earthquake has left 
millions of Americans worrying that their stocks are standing 
on shaky ground. According to a recent Business Week/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 Business Week, ``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. And this is consequential. It is 
serious not only for those investors but for our economy.
    The average investor today I am afraid feels like a swimmer 
who has seen a shark. He or she doesn't know how many more 
sharks are in the water and whether there are any lifeguards on 
duty who are doing their job.
    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 heart of our recent prosperity.
    Spreading 401(k) accounts and a rising market--or rising 
markets, really, have spurred a seismic shift in stock 
participation over the last 2 decades. From 1930 to 1980, the 
number of Americans investing in the markets hovered between 5 
and 15 percent. By 1998, that had jumped to more than 50 
    It is 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 
    Average investors I think don't expect Wall Street analysts 
to guarantee that they are going to get rich. But they do 
expect them and others 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 is 
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, I think, is the unwritten agreement that has drawn 
middle-class investors into the market, and it is what they 
rely on as they enter the markets. They know that there is risk 
there, that not every stock they invest in will always make 
money. But they rely on the watchdogs, both private and public, 
to keep the stock markets 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 
    The question we ask today is: Have the Wall Street analysts 
kept their part of the bargain? And I regret to say that, based 
on the investigation our Committee has done, 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. This chart \1\--the dark green being ``strong 
buy,'' light green ``buy,'' yellow ``hold,'' and red ``strong 
sell,'' pink ``sell''--shows you that as of November 8, 10 of 
the 15 companies and analysts listed there were still 
recommending that Enron was a good buy. And that was 3 weeks 
after the initial report of the company's hidden losses 
appeared in the Wall Street Journal and about 2 weeks after the 
SEC announced an investigation of Enron, and literally months 
after the challenging and provocative article by Bethany McLean 
that we have all learned so much about, and months after at 
least one independent analyst, who I will refer to in a moment, 
began to ring alarms about Enron.
    \1\ Chart entitled ``Enron Stock Recommendations by Broker,'' 
referred to by Senator Lieberman appears in the Appendix on page 127.
    Enron's ad campaign, or one of them, as some 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 no better. On May 6, 2001, the Off 
Wall Street Consulting Group issued a report calling Enron 
stock ``extremely overvalued'' and pointing out many of the 
problems that would later be revealed in full when the company 
collapsed. That was May 6 of last year. Among other things, the 
report questioned the fact that the company appeared to be 
using accounting tricks to pump up its revenue.
    Regrettably, the analysts' performance with Enron that I 
have referred to is indicative of a broader problem. Let me 
quote David Becker, general counsel of the SEC, who said last 
August, ``Let's be plain. Broker-dealers employ analysts 
because they help sell securities. There is nothing nefarious 
or dishonorable in that, but no one should be under any 
illusion that brokers employ analysts simply as a public 
    Well, I am afraid that a lot of average investors in the 
country are under that illusion, and Mr. Becker's statement is 
jarring news to them who have considered ``strong buy'' or 
``buy'' or ``hold'' and ``sell'' recommendations to be honest 
investment advice.
    I must say, in our Committee's investigation, one of the 
most stunning facts that has come to my attention is that, no 
matter what the market does, analysts seem to just keep saying 
``buy.'' According to Thomson Financial, two-thirds of all 
analysts' recommendations are ``buy'' and only 1 percent are 
    If you take a look at this chart,\1\ this is over the last 
2 years, and the dotted line is the S&P 500, which, we can see 
beginning at January 3, 2000, was up and down, down on February 
3, 2002. This straight line is giving a numerical value to 
``strong sell,'' ``sell,'' ``hold,'' ``buy,'' and ``strong 
buy'' of analysts' recommendations, coming out with an average, 
and it is really quite remarkable that the line remains almost 
exactly straight at a ``buy'' recommendation no matter what 
happens to the market, even as it went down.
    \1\ Chart entitled ``S&P 500 Price Index Versus S&P 500 Consensus 
Recommendation,'' referred to by Senator Lieberman appears in the 
Appendix on page 128.
    Today we want to ask the analysts: How could that be? Of 
course, I fear--and I am not alone in this fear--that one of 
the reasons is that the majority of analysts work at Wall 
Street firms and banks that are doing business, particularly 
investment banking business, with the companies the analysts 
are analyzing. In fact, in a general sense, analysts' 
compensation is tied directly to their firm's success in 
attracting and holding investment banking business. And 
analysts usually develop close relationships with the companies 
they cover, relationships that are valuable to their firms and 
could be endangered by the release of a critical report or 
    All of these influences I am afraid compromise analysts' 
objectivity and mean that average investors really ought to use 
analysts' recommendations with a great degree of caution.
    There is a new set of proposed rules designed to improve 
analysts' independence crafted by the National Association of 
Securities Dealers, which were submitted to the SEC on February 
7. I think these are a very 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 their firm's 
investment banking decisions, and prohibit them from promising 
favorable ratings to companies they cover.
    In today's hearing, we are going to ask whether more should 
be done, and we are going to receive some recommendations, I 
believe, about more that could be done, even as we try to 
describe today the current system of investment analysis as a 
way to provide full disclosure and warning to investors, and 
hopefully to push Wall Street, on whose integrity and vitality 
so much of our economic strength relies, to clean up this part 
of its act.
    In 1937, a long time ago, President Franklin Roosevelt 
said, ``We have always known that heedless self-interest was 
bad morals. We now know that it is bad economics.'' Over the 
last few months, because of Enron, too many people individually 
and our economy as a whole have painfully discovered the wisdom 
of those words. Our job today is to make sure that from this 
point forward that wisdom spreads, not through more painful 
experiences but through enactment of new ethical and 
progressive policies.
    I look forward to hearing from our witnesses today, who I 
hope and believe can help us do that job.
    Senator Thompson.


    Senator Thompson. Mr. Chairman, thank you very much. You 
have very completely addressed the issues that we are dealing 
with here today. I would ask that my statement be made part of 
the record and merely reiterate the fact that we are seeing a 
loss of investor confidence at a time when there is a 
remarkable surge in the number of Americans who invest in our 
stock markets. We have seen a growing lack of competence with 
regard to financial statements, accounting, and now we are 
having to deal with the reliability and objectivity of sell-
side analysts' recommendations, which have also been called 
into question.
    We have questions with regard to whether or not some of the 
things we have seen have been brought about by the obvious 
conflicts of interest that are in the system, whether or not 
those problems can be solved simply by disclosure. We have 
questions as to whether or not analysts really understand some 
of the data and the information that they are given, whether or 
not they were, in fact, misled.
    On the other hand, as you point out, one study, at least, 
shows that ``sell'' recommendations account for just 1.4 
percent of all analysts' recommendations. That raises the 
question as to whether or not there is something more 
systematic at issue here beyond Enron's confusing financials.
    Of course, the question of analysts' independence is not a 
new one. It has had a renewed interest since Enron's collapse. 
I am looking forward to hearing the witnesses on our second 
panel about rule changes to address at least the perception of 
conflicts of so many of these analysts as well as to provide 
better ways of public disclosure.
    I am also interested in hearing the explanations and 
opinions of the analysts testifying on our first panel. 
However, I would like for a moment to point out something 
concerning the first panel. The companies represented here 
today are not the only ones that covered Enron while also 
making other business relationships with the company. Merrill 
Lynch, Goldman Sachs, UBS Warburg also had investment banking 
relationships with Enron or invested in Enron partnerships, 
including LJM Partnerships, controlled by Andrew Fastow. So in 
a larger sense, there are other banks that may not have covered 
Enron that also engaged in this dual role with regard to other 
companies. So I sincerely hope that the investing public will 
not single out the particular banks represented here today 
simply because it is not feasible to call every bank that may 
have been similarly situated.
    So, Mr. Chairman, I thank you for holding this hearing, and 
I believe it is a legitimate concern. At our first hearing we 
asked former SEC Chairman Arthur Levitt whether an American 
investor today can depend on Wall Street analysts, and his 
disturbing answer that Wall Street sell-side analysts have 
virtually lost all their credibility. And I hope today we can 
learn from our witnesses about the system so the Committee can 
contribute toward helping restore the faith of investors in our 
capital markets.
    Thank you very much.
    [The prepared statement of Senator Thompson follows:]

    Thank you Mr. Chairman. As we all know, one of the major fallouts 
of the Enron collapse has been the loss of investor confidence in our 
capital markets. Investment of capital is the lifeblood of our economy 
and we have seen a remarkable surge in the percentage of Americans that 
invest in our equities market over the last several years.
    However, the collapse of Enron has shaken the confidence of 
investors in the transparency of the capital markets. It has also 
brought to the forefront the number of conflicts of interest that 
permeate different aspects of our system. Anyone seeking empirical 
evidence for the effect of these revelations need look no further than 
the recent volatility in the stock market and the constant references 
in the press to ``Enronitis.''
    Unfortunately, reported problems with financial statements and 
accounting are not the only issues that have shaken investor 
confidence. The reliability and objectivity of sell-side analyst 
recommendations have also been called into question. Reports indicate 
that as of early October 2001, there were 16 analysts who covered 
Enron, and of them, 15 had a ``buy'' or ``strong buy'' rating, one had 
a ``hold,'' and none had a ``sell'' or a ``strong sell.'' Most of these 
analysts continued with ``buy'' or ``strong buy'' ratings even after 
the resignations of Enron CEO Jeff Skilling and CFO Andrew Fastow and 
after the restatement of earnings and reduction of shareholder equity.
    I am sure that one of the reasons for these recommendations was the 
fact that analysts, like everyone else, were misled by Enron's 
financial statements and disclosure. On the other hand, I understand 
there is one study that found that sell recommendations account for 
just 1.4 percent of analysts' recommendations. That raises the question 
whether there is something more systemic at issue here beyond Enron's 
confusing financials.
    The question of analyst independence is not a new one, but it has 
received renewed interest since Enron's collapse. I look forward to 
hearing from the witnesses on our second panel about rules changes to 
address at least the perception of a conflict for many of these 
analysts as well as to provide disclosures for the public.
    I am also interested in hearing the explanations and opinions of 
the analysts testifying on our first panel. However, I would like to 
take a moment to make a point about that first panel. The companies 
represented today are not the only ones that covered Enron while also 
maintaining other business relationships with the company. Merrill 
Lynch, Goldman Sachs, and UBS Warburg also had investment banking 
relationships with Enron or invested in Enron's partnerships, including 
the LJM partnerships controlled by Andrew Fastow. And in a larger 
sense, there are other banks that may not have covered Enron that also 
engage in this dual role with regard to other companies. I sincerely 
hope that the investing public will not single out the particular banks 
represented here today simply because it is not feasible to call every 
bank that may be similarly situated.
    Mr. Chairman, I thank you for holding this hearing. I believe it is 
a legitimate concern. At our first hearing, I asked former SEC Chairman 
Arthur Levitt whether an American investor today can depend on Wall 
Street analysts. His disturbing answer was that Wall Street sell-side 
analysis has lost virtually all credibility. I hope that today we can 
learn from our witnesses about the system so that the Committee may 
contribute toward restoring the faith of investors in our capital 

    Chairman Lieberman. Thank you, Senator Thompson. Thanks for 
an excellent statement. And you make a good point. The analysts 
that have been asked to come forward here were asked as a 
result of our staff's investigation because the staff judged 
them to be among the most prominent analysts who were covering 
and dealing with Enron. But you are quite right; there were a 
number of other firms, as the chart I held up showed, that also 
had analysts dealing with Enron and whose recommendations were 
really quite similar.
    Senator Levin.


    Senator Levin. Mr. Chairman, first, thank you for convening 
this hearing. I think that most Americans who participate in 
the stock market--and that is most Americans--don't really 
think about or understand the role of the financial analyst in 
the investment banking world. We see the faces of analysts on 
TV. We read their comments in magazines and online and in 
newspapers. And I think most of us just see them as experts. 
But we don't think about their place in an investment banking 
enterprise and their dual role in facilitating investment 
banking deals as well as providing advice to investors. This 
hearing will help us hopefully explore that dual role and to 
address some of the inherent conflicts later on when we start 
    Most financial analysts wear two hats. One is the allegedly 
independent analyst of publicly traded companies providing us 
their educated and experienced insight on a company's future 
based on publicly available information. The other hat is that 
of the sophisticated insider investment banker analyst who 
helps his or her company attract and carry out investment 
banking business. Moreover, the analyst's compensation is often 
tied to the success of the investment banking business, as is 
the analyst's standing within the company. That is a problem, 
because as long as a company is a client of the analyst's 
investment banking firm, the analysts have incentives to 
promote the stock of that company.
    Mr. Chairman, you have identified some of the suggestions 
of the National Association of Securities Dealers to address 
these inherent conflicts, and I think we should take a close 
look at those. Senator Fitzgerald and I have sponsored 
legislation to address the conflicts of interest problem with 
respect to analysts. It is in some respects similar to the NASD 
proposal. Our bill would require analysts, the investment banks 
for which they work, and persons or entities associated with 
the analysts to disclose any time the analysts' comments 
publicly, either in writing or orally, on a company that the 
analyst is covering on the following items: The fees the 
analyst or his employer received from the covered company in 
the last 3 years; the merger or acquisitions worked on by the 
analyst or his employer in the last 3 years relating to the 
covered company; and the amount and type of debt or stock owned 
by the analyst and his employer in the covered company. We 
would also have civil penalties and fines, depending on the 
gravity of the violation of those rules.
    One out of every two Americans today have a stake in the 
stock market so addressing the problems uncovered under the 
Enron rock is not a choice but a necessity. And if we are going 
to maintain public confidence in our markets, as both you and 
Senator Thompson have indicated is such a necessity for us, we 
must act in these areas to address these inherent conflicts.
    The role of the financial analyst is an important piece of 
the Enron puzzle. We know how dependent Enron was on its stock 
price, and that it provided significant business to the 
investment banking firms on Wall Street, initiating dozens of 
investment banking deals every year. So it is not hard perhaps 
to understand why the financial analysts waited so long to 
issue a ``sell'' recommendation when so much hung in the 
balance--indeed why most, perhaps the majority of analysts, 
never did issue a ``sell'' recommendation.
    Thank you again, Mr. Chairman for convening this important 
hearing today.
    Chairman Lieberman. Thank you, Senator Levin. Senator 


    Senator Collins. Thank you, Mr. Chairman. I want to thank 
you for continuing this important investigation.
    I ask unanimous consent that my complete statement be 
included in the record, and I will just make a few comments.
    Chairman Lieberman. Without objection.
    [The prepared statement of Senator Collins follows:]

    Mr. Chairman, thank you for calling these hearings to focus on the 
role played, or, more accurately, not played by Wall Street analysts in 
the events leading up to Enron's bankruptcy.
    Individual investors at times know little about the stocks they 
purchase. They tend to know what business the company is in and they 
might have some familiarity with its product. They may also know 
whether their broker's analysts rates the stock a ``buy,'' a ``strong 
buy'' or something else. It's unlikely, however, that they will dig 
into a company's financial statements. As a consequence, there is a 
large reliance by individual investors on professionals whose job it is 
to look at one industry, or perhaps even one company, closely and make 
a recommendation on the purchase or sale of that company's stock.
    Some financial analysts have pointed out that some of the 
information Enron gave them was inaccurate or incomplete. Analysts 
would ask questions but be brushed off or even lied to. But, why didn't 
they press for answers or see the lack of information as warning signs?
    After all, top Enron executives were selling substantial positions 
in the company. Bad investment after bad investment was being made by 
Enron. One analyst says that ``Enron was a `black box' company, where 
no one, not the analysts nor any of the institutional or individual 
investors, was really sure how the company made money.'' Another called 
a lack of transparency and disclosure an ``Enron hallmark.'' Yet, he 
continued to keep it on his firm's recommended list, which connotes its 
highest ranking. A third noted that Enron's explanations were ``an 
inadequate defense of the balance sheet.'' Yet he recommended its stock 
be ``bought aggressively.''
    Analysts generally work for the same investment houses that seek to 
do business with the companies their analysts rate. As a consequence, 
do these ``sell side'' analysts, as they are known on Wall Street, come 
under pressure to base their conclusions on more than just the numbers? 
Many analysts believe that it is better to know the true picture of the 
company even if they can't reflect it in their recommendations because 
to do so would be lose their contact. As a result, a code develops. 
Analysts use terms like ``hold.'' To many of us, Mr. Chairman, ``hold'' 
would mean that an investor should neither buy nor sell. Wall Street 
insiders understand that stocks rated ``hold'' should be gotten rid of 
    We need to determine whether it was such conflicts that led so many 
analysts to perform so poorly in their evaluations of Enron. Just weeks 
prior to Enron's declaration of bankruptcy, analysts from some of the 
best known firms on Wall Street were telling investors that concerns 
over Enron's finances were ``very much exaggerated.''
    These analysts saw warning signs but ignored them. Common sense 
tells us that we should not recommend investments that we cannot 
understand. The analysts understood that there was something missing, 
something wrong with Enron. But the thing that was missing of most 
importance, Mr. Chairman, wasn't information. As one observer noted, 
what was missing most was skepticism and a willingness to delve for 

    Senator Collins. Mr. Chairman, there is a large reliance by 
most individual investors on professionals whose job it is to 
examine closely an industry or perhaps even one company and 
make a recommendation on the purchase or sale of that company's 
    Some financial analysts have pointed out to the Committee 
that information provided by Enron was incomplete or 
inaccurate. Analysts would ask questions but be brushed off or 
even lied to, and that raises the issue of why didn't these 
analysts press for answers or see the lack of cooperation and 
the lack of information as warning signs. After all, top Enron 
executives were selling substantial positions in the company. 
Bad investment after bad investment was being made by Enron. 
One analyst said that Enron was a black box company where no 
one--not the analysts nor any of the institutional and 
certainly not the individual investors--were really sure how 
the company made its money. Another called the lack of 
transparency in disclosure ``an Enron hallmark,'' yet this 
analyst continued to keep it on its firm's recommended list, 
which connotes its highest ranking. A third analyst noted that 
Enron's explanations were ``an inadequate defense of the 
balance sheet.'' Yet he, too, kept recommending the stock be 
bought aggressively.
    Analysts generally work for the same investment houses that 
seek to do business with the companies their analysts rate. As 
a consequence, the question arises whether or not these sell-
side analysts, as they are known on Wall Street, come under 
pressure, either direct or indirect, to base their conclusions 
on more than just numbers. Many analysts believe that it is 
better to know the true picture of the company, even if they 
can't reflect it in their recommendations, because to do so 
would jeopardize their contact. As a result, Mr. Chairman, a 
code develops. Analysts used terms like ``hold.'' Now, to many 
of us, perhaps to the average investors ``hold'' would mean 
that an investor should neither buy nor sell. But Wall Street 
insiders understand that stocks rated ``hold'' should be dumped 
    We need to determine whether it was such conflicts of 
interest that led so many analysts to perform poorly in their 
evaluations of Enron. Just weeks prior to Enron's declaration 
of bankruptcy, analysts from some of the best-known firms on 
Wall Street were telling investors that concerns over the 
company's finances were very much exaggerated. These analysts 
saw the warning signs but ignored them. Common sense tells us 
that we should not recommend investments that we do not 
understand. These analysts understood that there was something 
missing, something wrong with Enron. But the thing that was 
missing of most importance wasn't information. As one observer 
noted, what was missing most was skepticism and the willingness 
to delve for answers.
    I look forward to hearing our witnesses today as we seek to 
ensure that there are improvements made in the system.
    Thank you, Mr. Chairman.
    Chairman Lieberman. Thank you very much, Senator Collins.
    Senator Torricelli.


    Senator Torricelli. Thank you, Mr. Chairman, very much.
    First, thank you very much for holding these hearings. I 
think it is an important contribution, and somewhere on Capitol 
Hill there should be some thoughtful analysis going on of this 
situation. There has been a great deal of commentary. There has 
been a good deal of cross-examination. But there is a need to 
have some venue that indeed is looking at some of the 
regulatory issues and the roles of the different institutions 
in depth, and I am proud that our Committee is doing so.
    This is, of course, not entirely a new problem. The 
American people may be hearing about some of these issues for 
the first time, but it is not a new concern. There is very 
little happening here in the concern about the analysis being 
offered and the credibility of the profession that some were 
not asking during the dot-com fiasco. Companies with enormous 
multiples, involving tremendous risk, with conflicting 
information coming forward about their prospects, and, as my 
colleague noted, 1 percent were receiving ``sell'' 
    There is a belief by most American investors, who may be 
unsophisticated but remain a critical part of the Nation's 
capital markets, that analysts are somehow on their side. That 
an analyst is your advocate. They are impartial. They are 
bringing you information as your advocate.
    It may not be to the level of a lawyer or a doctor, but 
most clients do believe they are in a relationship with the 
person that is selling them stock and the analyst that person 
is relying upon has some degree of impartiality.
    That, of course, was never the case, and perhaps there is 
some fault in people ever having been led to rely upon it. But 
it has been a reality in the marketplace.
    An analyst for a firm who receives a bonus may be involved 
in IPOs, may own shares themselves, obviously has inherent 
conflicts of all types. The question before the Congress, as we 
deal now with these twin fiascos--the dot-com meltdown and now 
the Enron problem, different in some respects but having some 
of the same core issues--is what we do about it.
    As you are answering these questions today and making your 
presentations, remember that before this Committee is the issue 
of whether this is best dealt with in the marketplace. The best 
answer may just be that, based on the experiences of the 
technology sector and now Enron, some firms will have 
credibility and some will not. Some firms will find the means 
of restoring the confidence of their customers, and their 
customers will rely upon their analysis. You will provide to 
them descriptions of how you are avoiding conflicts, how you 
are restoring credibility, and you will succeed, and others 
firms that don't will fail. The marketplace may be the best 
answer. Or it may be that as a profession or within the 
industry, it is to be dealt with yourselves: Set standards as 
to what stakes analysts can own themselves, what conflicts will 
be tolerated, and what must be disclosed.
    Or failing all that, is there a role for the government? 
Should we indeed place walls between analysts and brokers?
    It is always the belief of most of us here that that is a 
role that is reserved for the most extraordinary of 
circumstances. But these are extraordinary circumstances. It 
may be that many of these people who lost their life savings 
were not sophisticated investors. Maybe some believe that is 
how the marketplace works.
    But this country can't operate that way and maintain the 
success of the capital markets. In a society of a quarter of a 
billion people and a $10 trillion economy, our reliance upon 
average investors with their retirement savings, the little bit 
of money they can set aside is not a luxury in this economy. If 
it wasn't for our concern for their retirements or their 
security, it would still be important because it fuels our 
economic growth.
    I hope you will remember all those questions. But I do want 
to place it in perspective. While I am as critical as any of my 
colleagues of how we got in the situation, I also remind my 
colleagues that for all the similarities to previous problems, 
Enron is distinguished in this: This is also outright fraud. It 
may be that all of your analysts should have been more 
inquisitive, should have pressed harder. But before you begin 
your own testimony, if you will indulge me, Mr. Chairman, I 
will quote just two sections from a transcript of Mr. Skilling 
and Mr. Lay on August 14 speaking to analysts, which may help 
us understand why they perhaps were not more inquisitive but, 
nevertheless, were misled:

          Mr. Lay: ``In the second quarter, net income was up 
        40 percent, earnings per share about 32 percent, 
        operation and physical volume of deliveries are up 60 
        percent. Again, if anything, in the last 5 years, we 
        have had a 20 percent per year compound annual growth 
        in earnings per share.'' Pretty good, pretty 
        impressive--if true. Yes, analysts are to be faulted, 
        but they do have to rely upon the information coming 
        from executives as being truthful.

          Finally, Mr. Skilling: ``One of the questions the 
        analysts''--analysts, parenthetically, I am asking--
        ``were asking was on the new products. I think we have 
        gotten really good traction from the new products. The 
        numbers are looking good. I think in the last quarter, 
        the second quarter, every one of those products, 
        whether it was crude and crude products, metal, pulp, 
        paper, coal, volumes had more than doubled. Every 
        single one of them in the second quarter of 2001 or the 
        second quarter of 2000 have all profited, which is a 
        really good thing. So I am feeling very good, and I 
        assume that we will continue on into next year. It 
        looks like we are going to be succeeding very, very 
        well in the wholesale businesses.''

    There is a lot of fault to go around all the way. I am not 
going to say that I am not faulting the analysts or the firms, 
but I will say if I had been in that conversation and I had 
listened to those numbers, frankly I wouldn't have been telling 
people to sell either. It was a fraud.
    Thank you, Mr. Chairman.
    Chairman Lieberman. Thank you, Senator Torricelli. Senator 


    Senator Voinovich. Thank you, Mr. Chairman. I would like to 
express my appreciation to you for holding this hearing. As the 
Committee gathers information, I hope that it will allow us to 
develop real and productive changes, changes that can ideally 
prevent another Enron debacle from happening.
    One of the things that is a little frustrating to me, Mr. 
Chairman, is some of the things that need to be done are not 
within the jurisdiction of this Committee.
    Today's hearing focuses on the role of Wall Street's 
analysts in the financial markets through their ``buy,'' 
``sell'' and ``hold'' recommendations. We have already heard 
the important role that stock analysts play in terms of people 
relying on their advice. I suspect that there isn't anybody in 
this room that hasn't based a decision to buy or sell stock on 
what a group of analysts has said about a particular stock.
    Unfortunately, in the Enron situation, in my State 
thousands of private investors lost as a result of the bad 
information they received. My State's pensions funds lost over 
$127 million as a result of the Enron debacle.
    Overall, I have been pleased with the steps being taken by 
the industry to address some of the issues raised by the 
bankruptcy. Two weeks ago, the Securities and Exchange 
Commission proposed changes to the corporate disclosure rules 
that would require companies to expedite the release of annual 
and quarterly reports and require companies to immediately 
disclose trading by company executives. In addition, as was 
pointed out by one of the other Senators, the National 
Association of Securities Dealers announced new rules earlier 
this month that would increase the independence of Wall Street 
stock analysts, such as prohibiting stock analysts from owning 
stock in a company they review.
    Investment banking firm Goldman Sachs recently announced 
that it is removing its research department from its investment 
banking operation and making it a separate independent division 
of the firm. I expect that other firms are going to take 
similar actions in that regard.
    Nevertheless, 40 different legislative proposals have been 
introduced to date in Congress in the wake of Enron's collapse. 
Each would in some way or another change our Nation's laws 
regarding pension plans, financial disclosure or auditor 
independence. Close to 30 Enron-related hearings have been held 
in the House and Senate since the company's bankruptcy less 
than 3 months ago. I think that before Congress acts to 
overhaul financial disclosure and accounting rules, we should 
proceed cautiously, take into account the non-legislative steps 
that have been taken, and make sure we all know all the facts 
before we act to overhaul laws governing the strongest 
financial markets in the world.
    I think we also understand that the private checks and 
balances in this country are working as more and more 
individuals and entities are being sued for their fraud, 
dishonesty, negligence, and lack of due diligence. The Enron 
nightmare is going to be around for a long time, and many of 
the individuals involved will be taking that nightmare to their 
    One final area of concern to me--and you won't be 
surprised, Mr. Chairman--regards the human capital resources of 
the Securities and Exchange Commission. The fact of the matter 
is that we have seen an increase of 660 percent in the amount 
of activity in the market over the past 10 years. During that 
same period of time, the Securities and Exchange Commission has 
not increased the people that are capable of dealing with it at 
all to put up with that increase in activity.
    In addition, I recently found out that one-third of the 
people at the Securities and Exchange Commission have left the 
Commission because the salary schedule there is not competitive 
with other regulatory agencies or with the private sector. And 
it seems to me that as we go through these hearings and receive 
testimony from witnesses in regard to various aspects of Enron, 
it is incumbent on this Committee to make sure that the Federal 
agencies that have the responsibility for oversight have the 
personnel and the competent people to get the job done. And as 
I have observed over the years, too often we have hearings and 
lots of TV and newspaper publicity and the rest of it, but 
after it is all over with, what have we done to make the 
situation better? I think our responsibility in this Committee 
is to make darn sure, as part of our oversight, that those 
agencies that have responsibility for these markets have the 
adequate personnel and the expertise to get the job done to 
protect the American people.
    Thank you.
    Chairman Lieberman. Thank you, Senator Voinovich. Someday 
somebody is going to give you the award you deserve for 
reminding us constantly about the importance of investing in 
the human capital, the people who operate and run our 
    There is a vote that is going off on the floor. What I 
would like to propose is that we go to Senator Bunning and 
Senator Bennett. I am going to leave, go and vote, try to get 
back real quickly so we don't interrupt the flow of the 
hearing. If I am not back, I would ask that the last Senator 
standing--or sitting, as it were--just recess the hearing for a 
few moments.
    Senator Bunning.


    Senator Bunning. Thank you, Mr. Chairman.
    The Enron collapse and that of Global Crossing is 
troubling, to say the least, and has shown many weaknesses that 
need to be fixed. I was in your business for 25 years prior to 
coming to the Congress, so I know how inherent some conflicts 
can be, particularly those firms that have an investing, an 
equity, an underwriting, and also an advising position.
    If you take a position in a stock, an equity position in an 
underwriting, and then you become an analyst and are not 
independent of that firm, you have a direct conflict of 
    I hope at the end of the day all these hearings are not in 
vain and that Congress can make some necessary changes, 
especially to our pension laws. Today's hearing will focus on 
why some analysts continued to recommend stocks to investors 
even as the companies were restating its financial earnings and 
those stocks were in free fall. Investors' confidence in our 
markets without a doubt has been shaken, and many may be more 
hesitant--and I see that presently in the market--to trust the 
information they receive about a company before investing in 
it. I hope that is the case.
    As a couple of our witnesses will testify today, there can 
be some very direct conflicts of interest and pressures that 
analysts face as they rate and recommend stocks. These 
conflicts need to be looked at and dealt with as they come up.
    However, it is important to remember analysts are only as 
good as the information they receive. Any changes that are made 
will not make a bit of difference if the companies they are 
dealing with are not honest about their financial situations.
    The representatives from the National Association of 
Securities Dealers and the Association for Investment 
Management and Research have some suggestions for us about how 
the system can be improved. If you all remember, there used to 
be a column in the Wall Street Journal called ``Heard on the 
Hill.'' And you know what happened there. The person who was 
writing ``Heard on the Hill'' was investing and taking a 
position on the stock and then writing columns about how good 
this stock was going to be. And on the swing up, they would 
unload the stock and make a profit.
    Now, you know about that as well as I do if you have been 
around the investing business very long. That kind of conflict 
of interest is in direct contradiction in what we want to see.
    I am looking forward to the hearing today, and the other 
witnesses that are going to appear, and I thank you, Mr. 
Chairman, for allowing me the time.
    Now, Senator Bennett, you are up.


    Senator Bennett. OK. I get to be the Chairman.
    Simply for the record and for the information of the 
witnesses that are waiting to testify when we get back from 
voting, I want to note that I think the hearings are useful. I 
think an airing of this issue in a forum as public as this one 
is a salutary thing. But I recognize that human beings being 
human beings, we are not going to come to a clear solution that 
will pass into law and bring us into the promised land.
    I have been involved in IPOs. I have been involved in 
presentations to security analysts. I have been the CEO of 
publicly traded corporations and have gone through the 
experiences. I know about road shows. I know about ``buy'' and 
``sell'' recommendations and all the rest of it. I wish my 
colleagues were here that I could share with them, but we will 
share with the witnesses the experience of seeing analysts make 
``buy'' recommendations for the funds that they represent and 
seeing the funds purchase stocks that then dropped off the 
cliff in the face of which experience the analysts kept saying, 
This is a great buy opportunity at the lower price, keep 
buying. And they were playing with their own money, that is, 
their own firm's money. They were absolutely convinced that 
their analysis was correct, and they ended up losing the firm 
that they worked for huge sums because they were wrong.
    There is no way that the Congress or any other legislative 
body in the world can prevent people from being wrong. You 
don't have to be dishonest. You don't have to be engaged in 
fraud. You can make a mistake. And all of us, all of us have, 
and all of us will continue to do that in the future.
    I wonder if at some point in your testimony you gentlemen 
could address what I would call the Stockholm effect. Those of 
you who don't know that term, the Stockholm effect refers to 
someone who is taken hostage--I don't know why it happened in 
Stockholm or why the term is applied to it, but someone who is 
taken hostage and then at the end of his or her incarceration 
has fallen in love with or embraced his captors and is more on 
the side of the captors than the liberators.
    Maybe Patty Hearst is an example of that when she was 
kidnapped and ended up, at least for a brief period of time, 
joining her kidnappers.
    I have seen analysts who have come in very glinty-eyed, 
very skeptical, as analytical and as objective as they can 
possibly be, examined the company's books, examined the 
company's business, fallen in love with what they found, and 
then blindly continued to support that first decision and urge 
people to buy stock in that company even as the business has 
turned. They have become so enamored of the management, which 
they thought they were viewing very objectively, so enamored of 
the market, which they thought they were looking at in very 
glinty-eyed terms, that they really did believe that everything 
was going to turn out all right after all. And they continued 
to recommend the stock out of complete conviction, no conflict 
of interest pushing them, complete conviction that this was the 
right thing to do, and they simply made a mistake. They were 
simply wrong.
    So while it is good for us to air all of these things, I 
think these hearings are a wonderful thing to be doing. I think 
it is a very good exercise for everybody to go through 
periodically. I would just underscore the fact that when it is 
all over, we should not kid ourselves into believing that a set 
of congressional hearings are going to render every analyst 
completely objective and completely wise. And the ability to 
make a mistake is programmed into the DNA, and it is still 
going to be there for human beings when we are over.
    With that, I now have to go save the Republic, so I will 
declare this hearing temporarily postponed until the return of 
the Chairman.
    Chairman Lieberman. I thank the witnesses and all in 
attendance for your understanding. We are just completing a 
vote on the Senate floor.
    I now go to our first panel. As is the custom of the 
Committee, I would like to ask the members of the panel to 
stand and please raise your right hands. Thank you. Do you 
solemnly swear that the testimony you are about to give this 
Committee today is the truth, the whole truth, and nothing but 
the truth, so help you, God?
    Mr. Feygin. I do.
    Mr. Gross. I do.
    Mr. Launer. I do.
    Mr. Niles. I do.
    Mr. Schilit. I do.
    Chairman Lieberman. Thank you. Please be seated and let the 
record show that all of the witnesses answered in the 
    I thank you for being here. I want to say for the record--
although perhaps this doesn't have to be said, but it hasn't 
been the case in other committees--that all of the witnesses 
are here at their own decision and judgment and did not require 
a subpoena to ensure their presence. I appreciate that very 
    We will begin. Obviously you have heard our concerns, which 
are deep, and we want to hear you now and then have the 
opportunity to question you. We are going to hear first from 
Anatol Feygin, senior analyst and vice president at J.P. Morgan 
Securities, Incorporated. Mr. Feygin.


    Mr. Feygin. Good morning, and thank you, Mr. Chairman.
    \1\ The prepared statement of Mr. Feygin appears in the Appendix on 
page 67.
    Mr. Chairman, Members of the Committee, my name is Anatol 
Feygin. I am a senior analyst and vice president of the U.S. 
Equity Research Department of J.P. Morgan Securities. My area 
of coverage is the domestic natural gas industry, and I am 
pleased to have the opportunity before you today to discuss my 
work as an analyst on Enron Corporation.
    At the outset, Mr. Chairman, I would like to make four 
important points. As you mentioned in your opening remarks, 
absolute integrity is essential in our line of work. Second, I 
do not own any stock of the companies I cover and never owned 
stock in Enron Corporation; neither has my family at any point 
in my tenure at J.P. Morgan. Third, I have complete freedom 
with respect to the recommendations that I issue on the 
companies that I cover, and my compensation is not tied in any 
way to those recommendations. Finally, I have never received 
any compensation in any form from any company that I analyze, 
including Enron.
    Consistent with J.P. Morgan's policies of analyst 
independence, in analyzing the companies I follow, I rely on 
publicly available information. My sources of information 
include the audited financial statements of the companies, 
their filings with the Securities and Exchange Commission and 
other regulatory bodies, annual reports, and presentations to 
analysts. The accuracy of this publicly available information, 
as Senators Torricelli and Bunning pointed out, is absolutely 
essential to the accuracy of the resulting recommendation.
    Let me now turn, as the Committee has requested, to my work 
with respect to Enron. I began following Enron in June 1999, 
and prior to issuing my report and my initial ``buy'' 
recommendation on the stock, I conducted extensive research for 
nearly a year, tapping all publicly available sources of 
information. I also met with senior management at Enron and 
other personnel, and I believed that Enron's innovative 
business model could be successfully applied in other 
industries to generate stable and growing earnings while 
assuming minimal risk.
    In 2000 and in the 7 months leading up to August 2001, we 
saw for the most part very positive developments as they 
related to Enron that justified our ``buy'' rating. Enron's 
revenue grew from $40 billion to $101 billion in 2000, and its 
business model accounted for dramatic successes in various 
industries. Enron's outlook did become a little less certain 
with the sudden resignation in August of the past year of Mr. 
Skilling. We did view that as a negative event. But this did 
not lead to a downgrade because one of the things that Enron 
brought to the table, in our opinion, was a very deep and very 
talented management team and a successful business model.
    By mid-October, the picture had deteriorated somewhat, but 
still not to the point where we believed that a downgrade was 
justified. On October 16, Enron did report a third quarter loss 
of $618 million and took a $1.2 billion charge to shareholder 
equity I should say. However, at the same time they reported a 
35 percent increase in its core business, and even though this 
release was made in the morning, the stock closed the day up 2 
    Nevertheless, during the next week, we saw a developing 
crisis of confidence. It was fueled by negative press coverage, 
Enron's disclosure that the SEC had launched an informal 
inquiry, and Enron's failure to address the resulting investor 
concerns head-on.
    On October 24, I downgraded Enron's rating from a ``buy'' 
to a ``long-term buy'' and removed it from our company's focus 
list. Let me just clarify this point. A ``long-term buy'' does 
not mean that the stock would be a good investment in the near 
term. Instead, the rating tells my institutional clients that 
the company is facing near-term challenges that, once resolved, 
should allow the stock to outperform its peers.
    On November 8, Enron filed documents with the SEC revising 
its financial statements for the past 5 years to account for 
$586 million previously unrecognized losses. I did not believe 
that a second downgrade was justified because Enron's results 
for the first three quarters of 2001 were not materially 
impacted by this restatement.
    On November 9, a proposed merger was publicly announced 
between Enron and Dynegy. As the Committee may be aware, J.P. 
Morgan was one of the advisers to Enron with respect to this 
merger. I, however, was not involved in the transaction and was 
only informed of it a few hours before it was publicly 
announced. Otherwise, I was not privy to any non-public 
information with respect to Enron, Dynegy, or the proposed 
transaction. I viewed the proposed merger as a positive event 
and believed that if the merger was consummated, the combined 
entity would go on to outperform its peers.
    The merger was abandoned on November 28 following Enron's 
downgrade to below investment grade. And immediately following, 
on November 29, we suspended coverage of Enron. As everybody 
knows, Enron filed for bankruptcy protection on December 2.
    Thank you, Mr. Chairman, and I would be pleased to respond 
to any questions that you or other members of the Committee may 
    Chairman Lieberman. Thank you, Mr. Feygin.
    Now we go to Richard Gross, who is an analyst at the Equity 
Research Division of Lehman Brothers, Incorporated.


    Mr. Gross. Good morning, Mr. Chairman and Members of the 
Committee. My name is Rick Gross. As indicated, I am an analyst 
in the Equity Research Division at Lehman Brothers. Lehman 
Brothers is a global investment bank and securities firm that 
provides research, investment banking, brokerage and other 
services to corporations, institutions, governments, and high-
net-worth investors.
    \1\ The prepared statement of Mr. Gross appears in the Appendix on 
page 72.
    I have been an equity analyst covering the energy industry 
for 27 years. I have been an analyst at Lehman since 1991. 
Prior to Lehman, I worked as an analyst at other firms for 16 
years. I have a B.S. and M.S. in finance from the University of 
    At Lehman Brothers, I cover a sector called ``United States 
Energy/Power, Natural Gas.'' One of the companies in my 
universe of coverage is Enron. As an analyst, I analyze the 
publicly available information about a company and its 
industry. This information can include: Information made 
available to me through SEC filings that the company makes; 
press releases and company presentations; materials from the 
rating agencies; information about competitors that I can glean 
in the marketplace, trade journals, seminars; general 
information about the industry as well as whatever public 
information is available that I can reasonably obtain. I 
compile all of this in a framework for my analysis.
    My analysis includes relative valuations arrived at by 
reviewing historical and current industry trends, reviewing 
market valuations, comparing the company being analyzed to its 
peers. Based on this analysis, I develop opinions and make 
recommendations, and the factors on which they are based are 
reflected in my reports. These reports are available to clients 
of Lehman Brothers, which in general are primarily 
institutional in nature, although we also serve a high-net-
worth individual group.
    I appreciate the opportunity to answer questions before the 
    Chairman Lieberman. Thank you, Mr. Gross. Maybe one of 
those shorter opening statements we have had in the history of 
the Committee. We will be back to you for questions.
    Next, Curt Launer, Managing Director, Equity Research 
Group, Credit Suisse First Boston.


    Mr. Launer. Good morning, Mr. Chairman. My name is Curt 
Launer, and I am a Managing Director at Credit Suisse First 
Boston. I head the Global Utilities Research Group of CSFB that 
comprises 28 professionals. My specific research coverage is 
the natural gas and power sector, and as a research analyst for 
the past 18 years, I have followed Enron and its predecessor 
companies. I would like to make four main points today.
    \1\ The prepared statement of Mr. Launer appears in the Appendix on 
page 73.
    First, the role of an analyst is to make informed judgment 
about companies based on publicly available information. We 
depend on senior corporate officials and independent 
accountants to ensure the accuracy of public disclosures. 
Without accurate and complete financial reporting from a 
company, I simply do not have the proper tools to do my job.
    CSFB's client base is largely comprised of sophisticated, 
institutional investors, not individual retail customers. My 
clients have their own research staffs. They look to me for 
quality information and projections and challenge the 
information and analysis that I provide to form their 
investment decisions.
    My second point is that inaccuracies and lack of 
information in Enron's financial reporting affected my 
conclusions and ratings on Enron. Each day there are new 
allegations in the media concerning Enron about which I was 
previously unaware.
    Third, I performed my analysis independently and 
objectively, and I never felt pressure from Enron or any 
investment banker or other employee of my firm to reach any 
conclusions other than my own. Not only have I done my work 
independently, but, in addition, my firm has strict rules that 
prevent me from even having access to the kind of confidential, 
non-public information that investment bankers often have. CSFB 
has also adopted rules banning stock ownership by analysts in 
the companies we cover.
    In this regard, I would like to note that before that ban, 
my sons each owned 100 shares of Enron that were sold in 
December 2001 to comply with new CSFB rules. My family's only 
current investments related to Enron are $18,000 I invested in 
the NewPower Company and an Enron bond held by my mother, which 
is now in default.
    Finally, I applaud any effort to craft thoughtful responses 
to improve the overall quality of public company disclosures 
and restore confidence in our markets. To protect the integrity 
of our research, CSFB consistently and without exception 
follows Chinese wall procedures. To maintain our independence 
and ensure that our research is not influenced improperly, the 
Research Group is physically separated from the Investment 
Banking Department. We have no access to the confidential files 
or data of any other unit of the firm.
    In addition, CSFB not only complies with the Securities 
Industry Association's best practices for security analysts, 
but also has worked with the SEC, the NYSE, and the NASD to 
create new rules for analysts and investment banks which, after 
months of work, were recently announced.
    Enron was unique in its use of off-balance-sheet 
financings, off-balance-sheet partnerships, fair value 
accounting, and other techniques and vehicles. Any one of these 
would not be problematic in and of itself. Many fine companies 
use these techniques. However, Enron used all of them in ways 
that apparently were not fully disclosed and that we are just 
beginning to understand.
    It now appears that some critical information on which I 
relied for my analysis of Enron was inaccurate or incomplete. 
For example, in January 1998, I attended an analyst meeting at 
Enron with over 100 analysts. During this meeting we toured a 
trading floor of Enron Energy Services. In viewing the activity 
in the trading room, I was impressed at the progress Enron had 
made in developing this new business. It has now been alleged 
in press reports that Enron staged the activity on that trading 
floor, and if this allegation is true, the progress of the 
business unit was illusory.
    In addition, during the August 15, 2001, analyst conference 
call following Jeff Skilling's resignation, I specifically 
asked him whether his departure suggested that there were 
likely to be further disclosures with respect to Enron's 
finances. Mr. Skilling responded that there was nothing to 
disclose and that the company was in great shape. Furthermore, 
Enron never publicly disclosed the alleged use of the Raptor 
investment vehicles. It now appears that these entities may 
have engaged in trades with Enron simply to establish 
artificially higher asset values. Had I known any or all of 
these items, the information would have significantly affected 
my analyses and recommendations.
    I believed as of late November of last year that Enron 
could have survived if it had taken the appropriate steps. 
These steps would have been a substantial capital infusion 
combined at complete disclosure of off-balance-sheet 
liabilities and debt levels, plus a decision to slow growth, 
all of which could have, in my opinion, resulted in Enron's 
survival. Essentially, these are the elements that could have 
been provided by the Dynegy merger. Indeed, it appears that 
Chevron-Texaco and Dynegy had much the same view of Enron as I 
did. Chevron-Texaco was willing to commit $2.5 billion in cash 
to its view of Enron, and Dynegy was willing to issue $8.5 
billion of additional shares to acquire Enron.
    In sum, hindsight allows a view that I as an analyst never 
had. I based my views and ratings on the information that was 
available every step of the way.
    In 2000, the SEC adopted regulation FD in order to promote 
equal access by preventing the selective disclosure of 
information to some individuals, but not the public at large. 
As laudable as that goal is, the regulation can be used as an 
excuse by company officials, as it was by Enron, to duck tough 
questions from analysts and, thus, thwart full disclosure. The 
point, of course, is that these tough questions should be 
answered and the answers made available not just to the 
questioners but to the public.
    The focus of any policy changes should be more complete, 
more timely, and more understandable disclosure. We should 
consider full disclosure of off-balance-sheet financings and 
related-party transactions, more accelerated disclosure of 
insider transactions and corporate reports, and enhanced 
disclosure of stock option programs. Greater scrutiny of 
accountants and other professionals and additional resources 
for regulatory agencies like the SEC may be necessary as well.
    Thank you again for the opportunity to appear today, and I 
look forward to answering any of your questions.
    Chairman Lieberman. Thank you, Mr. Launer.
    Now we go to Raymond C. Niles, senior analyst, Citigroup 
Salomon Smith Barney.

                      SALOMON SMITH BARNEY

    Mr. Niles. Thank you, Mr. Chairman and Members of the 
    \1\ The prepared statement of Mr. Niles appears in the Appendix on 
page 82.
    Since March 2000, I have been the senior analyst at Salomon 
Smith Barney for the integrated power and natural gas sector. 
Before that, and since 1997, I was the senior analyst for the 
integrated power and natural gas sector at Schroder. I covered 
Enron at both Schroder and at Salomon Smith Barney.
    As an analyst, my job is to report to investors about 
business and market developments in my industry sector. I also 
develop and communicate timely and detailed recommendations 
about particular companies in that sector.
    In order to do this job, I work with publicly available 
information to develop financial models, earnings estimates, 
and price targets for the stocks of the companies that I 
follow. I also follow and analyze industry trends, such as 
power prices, spark spreads, generating capacities, the trend 
toward deregulation, and similar items. Part of my job also is 
to forecast the impact on individual stock prices of the supply 
and demand for electricity and natural gas, the overall health 
of the national economy, and even such variables as the 
weather. In performing these analyses, I make use of computer 
modelings techniques, economic theory, and other tools.
    At the heart of my work are the financial statements of the 
companies that I follow. I review and analyze a company's 
financial statements, press releases, and public filings before 
I make a recommendation. I also go beyond the paper record and 
participate in regular conference calls held for analysts by 
senior and financial management of the companies that I cover. 
I visit the companies and call on company personnel in order to 
obtain clarification and context regarding the company's 
finances and business prospects.
    Although I collect and analyze a great deal of information, 
I must stress that all of the information I use is and must be 
public information. Under Securities and Exchange Commission 
rules, a company cannot make selective disclosure of 
confidential information only to certain analysts.
    Also, investment banks that trade securities establish 
information barriers--you have heard those referred to as the 
Chinese wall--so that confidential information that may be 
known to a company's bankers does not reach the analysts and 
salespeople who may be recommending or trading that company's 
stock. Therefore, when I issue a report on a company on behalf 
of Salomon Smith Barney, I am prevented by rules and 
regulations, as well as by the firm's policy, from asking my 
banking colleagues about their non-public dealings with the 
company that is the subject of my report.
    If an analyst is ever brought ``over the Chinese wall'' to 
receive non-public information, he is not permitted to make 
recommendations with respect to the particular company until 
the information learned by the analyst becomes stale or has 
been disclosed publicly.
    With this background, I would like to summarize for the 
Committee my reports concerning Enron.
    I initiated coverage of Enron in January 1998, when I 
worked at Schroder. I developed my own methodology for 
forecasting the company's earnings, and based on my analysis of 
the company's reported financial results and business 
prospects, I placed Enron on the firm's ``recommended list.''
    It was my professional opinion that Enron was well 
positioned to take advantage of the deregulation of the 
electricity industry. By that time, Enron had already built an 
impressive reputation and had achieved dominance in the 
competitive natural gas industry, which deregulated about a 
decade before.
    It was also my professional opinion that Enron's core 
merchant energy business model was sound. Under that model, 
economies of scale, innovative marketing, and risk management 
could allow Enron to offer cheaper and more customized energy-
related services than those provided by its competitors. I 
believed that Enron's objective--using risk management products 
and long-term contracts to address the needs of wholesale 
energy customers in the volatile commodity markets--was a 
successful paradigm. The strength of Enron's reported results 
appeared to confirm the correctness of this objective and 
Enron's success in achieving it.
    While I was at Schroder's, Enron's performance in the gas 
and electricity commodity markets was impressive. I believed 
that Enron's core platform could be applied to other 
inefficient markets for commodities that were delivered over a 
network, such as bandwidth.
    In March 2000, just before our firms merged, I joined 
Salomon Smith Barney as a senior analyst. I issued my first 
report on Enron at Salomon Smith Barney in April 2000. At that 
time I rated Enron as a 1H, which means a ``buy'' 
recommendation, with high risk attached to it. The high-risk 
notation refers to the business risk given that Enron was a 
first mover in new markets.
    I continued to recommend Enron during the rest of 2000 and 
into 2001.
    In a report dated August 14, 2001, shortly following an 
announcement that Jeff Skilling had resigned, I noted that 
although he was an architect of the company's energy merchant 
strategy, I believed in the soundness of their business model, 
and even though it was a negative factor, barring any further 
disclosures from the company, we still felt positive about the 
    Beginning in October, Enron began to make public disclosure 
of the transactions and financial restatements and writeoffs 
that eventually led to its bankruptcy. I made timely reports as 
the significant facts were announced.
    On October 16, I noted Enron's decision to take $2.2 
billion in charges, but reported that the charges, as described 
by Enron, did not relate to its core merchant energy business. 
Accordingly, I continued to rate the company a ``buy'' with a 
``high risk'' rating.
    On October 19, when the stock was still trading at over $32 
per share, I issued a report which noted that the company's 
``complex off-balance-sheet vehicles have raised concern,'' and 
that there could be further writeoffs, and I was also concerned 
that Moody's had put the debt on review for a possible 
downgrade, but that we were still evaluating these issues at 
that time. Later that day I issued another report, again 
raising concern about their off-balance-sheet financing, and 
again about the uncertainty and magnitude of potential 
writeoffs of the company.
    I downgraded my rating to 1S, or ``buy, speculative,'' on 
October 25, and lowered it again to ``neutral, speculative,'' a 
3S rating, the next day. In my report that day, I noted that 
management had to address issues related to credit and 
liquidity, particularly the use of off-balance-sheet vehicles.
    Given everything that has happened since late October, I 
think it is appropriate to ask why the analyst community, at 
least the vast majority of its members, missed the mark on 
    The short answer, Mr. Chairman, is that we now know that we 
were not provided with accurate and complete information.
    A company's public certified financial statements are the 
bedrock of any analysis of the value or the prospects of a 
company's stock.
    It is now common knowledge that Enron's financial 
statements, which had been certified by its independent 
auditor, did not represent the company's true financial 
condition. The analyst community relied on these financial 
statements, which were restated. The company restated 3 years' 
worth of its earnings in November.
    When analysts look at certified financial statements, we 
assume that they are accurate and that they fairly and 
completely represent the company's financial condition. In 
Enron's case, that assumption turned out to be invalid.
    As analysts, our reputation and ultimately our livelihood 
depends on our making timely and correct calls. I did not want 
to get this wrong in terms of Enron. I recommended Enron's 
stock because I believed in the company's core business model, 
and I trusted the integrity of the company's certified 
financial statements and the representations of the company's 
management. At all times, I exercised and communicated to 
investors my best professional judgments based on the 
information that was available to me.
    Thank you, Mr. Chairman and members of the Committee.
    Chairman Lieberman. Thank you, Mr. Niles.
    The last witness on this panel, Dr. Howard Schilit, 
president and founder of the Center for Financial Research and 


    Mr. Schilit. Thank you very much, Senator. I do have a 
prepared statement, but I just wanted to interject before I got 
into that, at the conclusion of that if you would like me to 
comment on what I just heard and also my analysis on Enron that 
came out of the public records, I have some interesting 
findings in front of me.
    \1\ The prepared statement of Mr. Schilit with attachments appears 
in the Appendix on page 86.
    Chairman Lieberman. Fine. Let me ask that you go ahead and 
do the opening statement, and during the question and answer 
then we will give you an opportunity to offer your reactions.
    Mr. Schilit. Senator Lieberman and esteemed colleagues, I 
am pleased to appear before this Committee to describe my role 
as an independent financial analyst and some of the important 
differences between Wall Street research and our independent 
    Before proceeding, I want to emphasize that my comments are 
based solely upon personal observations over the last decade 
rather than on a comprehensive study of Wall Street or other 
independent research boutiques.
    My name is Howard Schilit. I am founder and president of 
the Center for Financial Research and Analysis, or CFRA, based 
in Rockville, Maryland. Prior to that, I was employed for 17 
years as an accounting professor at American University. I also 
authored a book called ``Financial Shenanigans: How to Detect 
Accounting Gimmicks and Fraud in Financial Reports.''
    My organization has been writing research reports since 
1994, warning institutional investors about companies 
experiencing operational deterioration or using unusual 
accounting practices. Our reports are published daily and 
distributed over our website.
    We use a variety of quantitative and qualitative screens to 
initially select companies for review. Then an analyst reviews 
the financial reports and other public documents to search for 
any problems. If any are found, we interview company management 
to discuss these issues. If concerns remain, we publish a 
report on our website. We make no buy or sell recommendations; 
rather, we simply discuss the issues of concern.
    Our clients are mainly institutional investors who purchase 
the research on a subscription basis. We are paid a fixed fee 
based on the number of actual users at the firm, similar to a 
license fee on software. Subscribers receive an E-mail each 
morning with a notification of the companies profiled, and the 
reports are posted on our website at 9 a.m.
    All CFRA subscribers receive the information in the same 
way and at the same time. In addition, all subscribers have 
equal access to discuss issues with our analysts.
    CFRA has a variety of strict editorial policies and ethical 
guidelines that protect clients' interests and ensure CFRA 
employees receive no remuneration based on stock price 
performance of companies they profile. I have attached those 
policies with my formal statement.
    In short, we have no brokerage, investment banking, or 
money management operation. We have no conflicts of interest. 
We have one client class: Those who make economic decisions 
based on financial disclosures. And we have one overarching 
goal: To help them make the best decisions.
    In contrast, Wall Street research is fraught with real and 
potential conflicts of interest.
    Wall Street brokerage firms have at least two major client 
groups: Those that purchase investment banking services and 
institutional investors. Typically, a company needing funding 
will hire a brokerage firm to underwrite securities in a public 
offering. The brokerage firm receives a fee, generally 6 
percent or higher, for this investment banking service. Shortly 
thereafter, the successful analyst at the brokerage firm will 
begin coverage on this new client with a positive research 
report. Generally, future research reports on this investment 
banking client will remain positive. Future investment banking 
fees on stock or bond offerings depend on a close relationship 
with the corporate client.
    If CFRA or another critic raises concerns to investors, the 
brokerage firm often publishes a rebuttal to show support for 
the investment banking client, and in some cases with 
disastrous results.
    This shows the inherent conflict of interest; the brokerage 
firm serves both the underwriting client--the subject of the 
report--and the investor, who must be informed when problems 
    The method of paying for research also differs 
substantially at Wall Street firms. Whereas we receive a cash 
payment for selling subscriptions, brokerage firms are paid by 
investors in commission dollars. The trading volume affects the 
amount, the timeliness of the information, and access to speak 
to research professionals. That is, the bigger clients 
typically get the first call from institutional brokers and 
salesmen, while smaller clients have lesser access.
    Moreover, non-institutional investors who generate no 
commissions often have no or very limited access to such 
research. CFRA, for example, was not permitted to purchase 
brokerage research through First Call--the distributor of 
brokerage research--because we generate no commission. They 
refused our offer to purchase the research for cash.
    I have outlined in a chart ten important differences 
between the work of our independent boutique and Wall Street 
firms, and I will leave that for you to go over, perhaps during 
the question and answer period.
    In conclusion, as a result of the conflicts of interest and 
internal policies, Wall Street research has regularly failed to 
warn investors, so not just Enron but regularly failed to warn 
investors about problems at companies. I would be happy to 
answer any questions at this time.
    Chairman Lieberman. Thanks very much, Dr. Schilit.
    To the four analysts here, obviously, Dr. Schilit has laid 
down a challenge and raised concerns and issued charges that 
are very much on the minds of all of us, and I want to ask you 
a series of questions, as other Members of the Committee will, 
to respond to those.
    To one extent or the other, the four analysts who are here 
from the firms this morning have defended the fact that jumps 
out at us, that you were continuing to recommend Enron long 
after it appears that there were warning signs. Some did it 
quite specifically, others of you quite generally.
    The concern obviously is whether you were influenced in 
those favorable recommendations that now seem so wrong by the 
fact that your firms were doing business with Enron or perhaps 
just because you had become too close to Enron. We have a 
syndrome that they sometimes talk about in diplomacy where the 
Ambassador we send to a foreign country becomes the advocate 
for the foreign country as opposed to the advocate for the 
United States. And I wonder about that as I listen to you.
    But let me cite the Bethany McLean article in Fortune 
Magazine in March 2001, very direct, strong questions about 
Enron's viability. At least one analyst, Mark Roberts, of Off 
Wall Street Consulting Group, May 2001, which is an independent 
research firm, diagnosed the problems with Enron in a research 
report that was printed on the Web and talked about shrinking 
profit margins, raised questions about Enron's related party 
transactions, even identified one dark fiber transaction as 
being used to exceed earnings expectations for two quarters in 
2000. In additional reports in July and August of last year, he 
raised concerns that Enron was relying even more heavily on 
related-party transactions and that Enron's cash flow from 
recurring operations and return on capital was poor as compared 
to its competitors. Finally, he noted that insiders at Enron 
were selling like crazy, then put together the growing media 
concern during last fall about Enron with some specific 
allegations being made in articles and places like the Wall 
Street, and the beginning of the SEC investigation. And yet the 
four of you--and, in fact, by our calculation, about two-thirds 
of the analysts on Wall Street who were really focused on Enron 
continued to recommend a ``buy,'' to say the other obvious fact 
which I haven't mentioned, the stock price was dropping 
significantly over the period of time.
    So the obvious question is: Why? And why shouldn't we or 
average investors feel that you were not really doing 
independent analysis but that you were affected by the fact 
that--by either of the factors I mentioned: One, that you got 
too close to Enron; or, two, that your firms were benefiting 
from ongoing business relationships with Enron? Mr. Feygin.
    Mr. Feygin. Thank you, Mr. Chairman. Again, I would like to 
go back to something you said in that integrity is absolutely 
essential in this line of work, and we focus on the core 
operations, the business model, and the publicly available 
    In the releases from Enron and the conference calls they 
had and the financials that were published, the core operations 
were doing exceptionally well; as I mentioned, even in the 
third quarter with the charge, they were up 35 percent. And as 
you mentioned, the stock kept sliding while I believed that the 
core operations were continuing to do well. I thought that the 
deterioration and all of the issues that were raised were more 
than factored into the stock price, and, again, my outlook, 
which is what my recommendation is based on, pointed to a solid 
core business, the rapid move by Enron to rid itself of some of 
these distractions that you mentioned, and I firmly believed 
that the stock would go on to outperform until fundamental 
issues arose and we downgraded it on October 24 pending the 
resolution of those issues.
    Chairman Lieberman. Let me ask you more specifically, isn't 
there a natural way in which the public's growing skepticism 
about the independence of analysts working for firms, as you 
do, is justified? In other words, I understand one of you--
perhaps it was you, Mr. Feygin--said you didn't receive any 
compensation from Enron. I understand that is true. But I 
gather that the income that you make, including bonuses at the 
end of the year, is affected by your firm's overall performance 
during the year, including its investment banking and other 
businesses, which Enron was significantly contributing to.
    So weren't there implicit or explicit pressures on you to 
continue to recommend a buy for Enron as it slowly collapsed?
    Mr. Feygin. The answer to the last part of your question is 
no, there were no pressures on me to maintain the rating.
    Chairman Lieberman. Mr. Gross, why don't you answer that 
question? I understand the defense, notwithstanding the 
evidence I have presented, that you are all saying you made a 
judgment call. But why should average investors feel that you 
and the other analysts working for the firms that were doing 
business with Enron were not affected by that, since your 
advice seemed to be so counterintuitive? As the stock price 
slid, the insiders were selling like crazy, and there were all 
sorts of growing--not just speculation but accusations that 
something was very rotten at Enron.
    Mr. Gross. Well, I think we have all reiterated in one way 
or another that the core business, the basic business model, we 
believed was very strong, was growing rapidly, was portable 
into other commodities, and that this was the strength of 
Enron. It materialized when the stock went from $45 to $90, and 
we believed that that franchise was portable into broadband in 
a context where there was a lot of enthusiasm in general about 
    As the stock fell, it became evident that the broadband 
business was not going to pan out as rapidly as most observers 
had viewed it. We were back to an energy company. The energy 
company still, as we were reporting, they were reporting record 
quarters. They were reporting very strong volumes. We could see 
the confirmation of the business model in the other companies 
that we followed that were also doing very, very well. And so 
the core business all along, I think each and every one of us 
believed was very, very strong.
    As we got toward the end and we got incremental pieces of 
information--we would get a piece of information saying that 
management was selling stock. The early sales of stocks were 
from individuals that in my belief were on their way out of 
Enron or retiring. The stock sales of many of the other senior 
managers we believed were normal sales. They were programmed 
sales. They were very regular.
    When it came down to Jeff Skilling quitting, once again, 
all of us in our own way interpreted that. My own reports 
indicated that this is an issue, but at the end of the day, the 
bench is very deep. We had two instances in the 1990's where 
senior executives at Jeff's level had quit abruptly, early in 
1992-93, an individual named Mick Seidel and an individual 
named Rich Kinder. The bench took over and the stock continued 
to do well.
    It was only toward the very end that it became evident that 
the core business, because of lack of management credibility, 
because of some rating issues, was going to deteriorate, 
possibly to the point where we had significant problems with 
that core business. And I think that was the essence of how we 
were able to recommend the stock as it----
    Chairman Lieberman. We try to keep each of the Senators, 
including the Chairman, on a time allotment. I have gone over 
mine. I just want to ask, not for a defense of what you did 
because you gave it in your opening statement, Mr. Launer and 
Mr. Niles, but how do you explain why you missed the signs that 
Mr. Roberts of Off Wall Street Consulting Group saw?
    Mr. Launer. As an analyst, I worked very hard on Enron, on 
all of the publicly available information. I have made it a 
practice throughout my career not to use other research reports 
written by anybody. I was aware of the Roberts report because 
some of the claims in it were brought to my attention by the 
institutional investors that I serve.
    The questions that came up at that time were relatively 
easy to answer analytically through our own work. One of the 
main comments in that report dealt with Enron being overvalued 
because it was simply a trading business. The analysis that we 
have done of the merchant energy business that Enron and other 
companies take part in is that the business has substantial 
barriers to entry, needs a lot of capital, and has a utility 
function to serve and, therefore, justifies a higher multiple 
than a trading business.
    From the standpoint of the other concerns about dark fiber 
sales that you mentioned, we had seen that from Enron and other 
companies, and those issues were disclosed and part of our 
analysis in terms of the company having included dark fiber 
sales in their earnings reports in the year 2000.
    In terms of related-party transactions, there simply was 
incomplete disclosure, as we now know, of the related-party 
transactions. And in terms of the return on capital employed 
having come down, that was consistent with Enron's business and 
strategy of investing heavily in new start-up businesses that 
weren't counted on to provide earnings or returns for the first 
couple or 3 years of their existence.
    So, overall, from the standpoint of hindsight allowing a 
view that we simply did not have, we relied on the information 
that was available at the time.
    Chairman Lieberman. Mr. Niles, I am going to let my 
colleagues question you because time is up. I want to leave you 
with a quote, and maybe some of you will respond to it. James 
Chanos, a short seller who gained recognition for doubting 
Enron's value fairly early on, testified before the House 
Energy and Commerce Committee on February 6 that he met 
sometime early in 2001 with the analysts covering Enron from CS 
First Boston and Salomon Smith Barney. I trust that was the two 
of you? Do you remember meeting with Mr. Chanos?
    Mr. Launer. Yes, I do.
    Mr. Niles. Yes.
    Chairman Lieberman. Anyway, he testified that, ``They saw 
some troubling signs. They saw some of the same troubling signs 
we saw. A year ago, management had very glib answers for why 
certain things looked troubling and why one shouldn't be 
bothered by them. Basically, that is what we heard from the 
sell-side analysts. They sort of shrugged their shoulders. One 
analyst said, `Look, this is a trust-me story.' ''
    I would like to hear as this morning goes on your response 
to that recollection of his to those conversation.
    Senator Thompson.
    Senator Thompson. Thank you, Mr. Chairman.
    Mr. Gross, what did you consider to be Enron's core 
business, as you referred to it? You thought the core business 
remained strong?
    Mr. Gross. Yes, its wholesale energy markets and trading 
    Senator Thompson. All right. But they were doing quite a 
few other things in addition to that, weren't they? They were 
trading other things besides----
    Mr. Gross. Yes, as they began to migrate the business model 
to other commodities, we thought that it would be successful in 
the context of the success they had already had and experienced 
in natural gas, the experience and success they had in energy, 
and the numbers that they were reporting in the way of volumes.
    Senator Thompson. Is it fair to say that they made quite a 
bit of money with their energy trading but they lost a lot of 
money with regard to other trading areas, broadband and a lot 
of other things, in addition to losing money on most of their 
foreign investments, their base business, their bricks-and-
mortar business or pipeline business and all that? They were 
making money in a very speculative area and losing money in 
other areas. That is a great generalization, but is that not a 
fair generalization?
    Mr. Gross. I would say it is a partial characterization. In 
general, Enron had invested in international infrastructure, 
and a good portion of that historical portfolio, beginning with 
some of the investments in the early 1990's, did not generate 
high returns.
    Senator Thompson. Well, none of it generated a profit, did 
    Mr. Gross. The way it was reported to us in the audited 
statements, it showed that it was making money.
    Senator Thompson. Well, we know now that some of the 
profits they were showing, if not most of the profits they were 
showing, was because they were utilizing these 3,000 or so 
partnerships, the Raptors and so forth, and disguising or not 
reporting some of the losses and taking credit for some of the 
gains generated from self-dealing and all that. We know that 
now. The question, I guess, is what did we know back in the 
    I don't think we will ever be able to really second-guess 
your analysis about what you were thinking at the time. To me, 
just because a stock is going down, that doesn't necessarily 
mean that you ought to sell it, for sure. Some of the richest 
people in the world, most successful people in the world, don't 
do that. So we have got to look at it from an objective 
standpoint, and the question is: What are the American people 
going to think, what is the average investor that our economy 
is so dependent upon now going to think?
    On the one hand, you have the objective factors that 
everybody looks at that have been described here. Mr. Skilling 
leaves under questionable circumstances. By September the stock 
had lost 60 percent of its value from its high. All these other 
things were going on. And then analysts had a conference call 
on October 22, in which you were basically told, ``Don't bother 
me, I'm busy.'' And then the next day Lehman Brothers came out 
and said Enron's conference call began as a methodical review 
of current liquidity and deteriorated into an inadequate 
defense of the balance sheet; despite this, we affirm our 
strong buy recommendation.
    So when the public looks at all these objective factors and 
then they look at what we now know is a system that is complete 
with conflicts of interest where your interests and your firm's 
interest is in the stock going up, they have to balance that 
over against what you say was basically a reliance on corporate 
executives. As I see it, they were telling you everything was 
going to be all right.
    Let me ask you, in a general sense, I would assume that 
that would be a situation you would run into a lot, that a lot 
of corporate executives would try to be optimistic with regard 
to their own firm. Accounting principles is another issue. But 
do you normally rely on just what the public record has got out 
there that anybody could look at, plus what the corporate 
executives are telling you? Even in light of all these 
objective factors and the inherent conflicts of interest with 
regard to your job, does the former outweigh the latter?
    Mr. Gross. Each of us in our own way go about determining 
management credibility in their statements, in that context 
where we would be able to confirm or not confirm how Enron was 
doing if they are in a market with other competitors. It has 
been mentioned earlier that Enron in aggregate generated a 
rather poor return on capital. You could see competitors 
trading in the marketplace with financials that basically 
represented that core business that were earning very high 
returns. You could check out the statements of management with 
their competitors. Is the market good? Is it bad? Is it 
deteriorating? Is it improving?
    So there are all kinds of cross-checks at the end of the 
day that we have to perform, instead of just taking statements 
at face value from the individual companies.
    Senator Thompson. Well, I understand that. But let me give 
you a cross-check on the other side of the ledger. Mr. Feygin, 
I was looking here at a clip from the London Times, March 21, 
2001, where it says J.P. Morgan reins in analysts. It says that 
the independence of J.P. Morgan's stock research is being 
questioned after analysts at the U.S. investment bank were 
instructed to seek approval from corporate clients before 
publishing recommendations on those stocks. In a memorandum 
circulated to J.P. Morgan analysts last week, Peter Houghton, 
head of Equity Research, said that he must personally sign off 
on all changes in stock recommendations. In addition, the memo 
further sets out rules described as mandatory, requiring 
analysts to seek out comments from both the companies concerned 
and the relevant investment banker, J.P. Morgan, prior to 
publishing the research.
    He says, ``If the company requests changes to the research 
note, the analyst has a responsibility to incorporate the 
changes requested or communicate clearly why the changes cannot 
be made.''
    So it looks to me like J.P. Morgan is telling their 
analysts that they have got to get a sign-off from the company 
they are analyzing and the mortgage banking side of the 
operation before they can make any changes.
    As I say, nobody can get in anybody's head and dispute the 
fact that there are some factors out there that might lead one 
to go in another direction. But over here, you have not only 
all of the objective things that were going on out there in the 
marketplace that anybody could see, plus the mortgage banking 
houses basically letting the companies they are analyzing, it 
looks like, call the shots.
    What kind of investor confidence comes out of a situation 
like that?
    Mr. Feygin. Thank you for the question, Senator Thompson. I 
have to say that I learned of this memo from the press. Peter 
Houghton is the head of our research franchise in London, and 
those rules did not apply to my actions. Until the rules were 
changed recently, senior analysts were not required to seek 
approval for ratings changes, period.
    In the initiation process for the companies that we are 
about to pick up coverage on, we do send part of the report to 
the company, what we call the back of the report, which 
factually describes the businesses for fact checking. But after 
that point, the recommendations, the evaluation, and our 
opinions are not second-guessed by outside or inside people.
    Senator Thompson. So this only applies to new businesses as 
opposed to companies that you are already doing business with? 
Is that----
    Mr. Feygin. To my best understanding--and, frankly, since 
it didn't apply to me, I didn't study it in great detail, but 
that applied to the London research--the department in London, 
and it did apply to rating changes broadly, not just to new 
    Senator Thompson. And is it still applicable?
    Mr. Feygin. I don't know the answer to that for the London 
    Senator Thompson. My time is up, Mr. Chairman. Thank you.
    Chairman Lieberman. Thanks, Senator Thompson. Senator 
    Senator Levin. Thank you, Mr. Chairman.
    The Powers Report says, ``There is some evidence that Enron 
employees agreed in undocumented side deals to ensure the LJM 
partnerships against loss in three transactions.'' Now, one of 
the documents that we have identified in the materials that we 
have been reviewing at the Permanent Subcommittee on 
Investigations confirms this with respect to several deals that 
were called the ENA CLO Trust. Enron North America agreed to 
buy back accounts receivables that it sold to LJM if these 
receivables could not be collected.
    Now, three of you, representing Credit Suisse, J.P. Morgan, 
and Salomon Smith Barney, were limited partners in LJM. So it 
is logical to conclude, I would ask you, that they knew about 
these guarantees. And those guarantees were apparently not 
reported on Enron's financial statements because that would 
have defeated the purpose of the transaction in the first 
place. So any of the three of you representing the companies 
that I have mentioned, did any of you work on any of the deals 
related to LJM or any decisions relating to the LJM 
partnership? Let me start with you, Mr. Feygin.
    Mr. Feygin. Absolutely not.
    Senator Levin. OK. Mr. Launer.
    Mr. Launer. I was not over the wall for any of the LJM 
activity of our firms.
    Senator Levin. Thank you. Mr. Niles.
    Mr. Niles. No.
    Senator Levin. OK. Now, if you had known about the 
guarantees, I assume that you would have considered those 
guarantees a liability to Enron, lessening to some degree, at 
least, Enron's financial standing. Is that correct?
    Mr. Feygin. That is absolutely right.
    Senator Levin. Mr. Launer.
    Mr. Launer. The same answer would apply here.
    Senator Levin. Mr. Niles.
    Mr. Niles. I believe so. I might just add, though, if this 
was material non-public information, I would have to go to my 
attorney, and I wouldn't be able to comment on Enron because of 
the Chinese wall restriction.
    Senator Levin. But I am asking if that information were 
known to you, if it had pierced the wall, it would have 
affected Enron's value.
    Mr. Niles. Yes.
    Senator Levin. OK. Now, the value of the partnership 
depends to some extent on the Enron guarantee. The 
partnership's value, which is being assessed, touted, sold by 
the other part of your firm, depends to some extent on that 
guarantee. So should the fact of the guarantee be known to the 
analyst since guarantees are significant liabilities? In other 
words, you said that it would have affected your judgment had 
you known. Part of your firm knew. You didn't because of the 
    Should you have that information available to you before 
you begin telling the public that this is good stock to buy 
since someone else in your firm knows, hey, there is something 
that is not appearing on that balance sheet which would affect 
that analyst's judgment? Mr. Feygin.
    Mr. Feygin. Again, if the question is if this information 
is material, it is absolutely incumbent upon the company to 
issue and disclose that in its financial statements, at which 
point it becomes public information for me----
    Senator Levin. It was not in its financial statements, 
according to the document.
    Mr. Feygin. Correct.
    Senator Levin. Now, someone in your company knows something 
that is not in the financial statement, because there is 
evidence that those guarantees were issued without being 
publicly disclosed. Now, does that not create an inherent 
problem for your company and for you? Because someone in your 
company knows something which affects the value of a stock that 
you are analyzing and that you do not know that would affect 
that analysis.
    Mr. Feygin. The issue of the Chinese wall has been brought 
up often in these hearings, and I am sure there is a lot of 
information that is on the other side of the wall, the non-
public information that resides within our institution that I 
am not privy to. That is not my role, and, regrettably, that is 
not something I can incorporate into my analysis.
    Senator Levin. So the information that I have just 
described, you don't think should be available to the analyst?
    Mr. Feygin. If it is material, it should be made available 
to me by the company itself.
    Senator Levin. All right. And if it is not disclosed by the 
company but kept private on the other side of the wall, but it 
affects your recommendation, then what?
    Mr. Feygin. As the laws are structured today, obviously 
that information cannot flow to me from the other side of the 
    If inadvertently it did, I would have to report that to our 
Compliance Department and action would be taken after that.
    Senator Levin. Therefore, on the other side of the wall, 
they know that you are giving an analysis which is based on 
incomplete information which affects what they are doing 
because the more that Enron stock is held to be valuable 
because it is not known that that guarantee exists which would 
reduce its value, the greater is the partnership interest that 
it is selling, the more valuable it is. There is an inherent 
conflict right there. How do we solve it?
    Mr. Feygin. If it is a material issue, again, the forces at 
play should make the company disclose that information openly 
and publicly.
    Senator Levin. Or your company should itself insist that 
that information, that guarantee, be made available on the 
financial statement, should it not?
    Mr. Feygin. In this case, the company being Enron? 
    Senator Levin. No. The company being your company.
    Mr. Feygin. Should insist that Enron disclose that 
    Senator Levin. Yes, that it be on the financial statements.
    Mr. Feygin. I can't speak to that call being made on the 
other side of the bank.
    Senator Levin. Anyone else, just with the three companies, 
have a comment on this?
    Mr. Launer. The only comment I would make is it is not our 
job to disclose material non-public information. It is the 
responsibility of the company, meaning Enron, their accountants 
and their lawyers.
    Senator Levin. Why is it not the responsibility of your 
company, on the investment side of your company, to make sure 
that something which should be disclosed in that financial 
statement which would have an effect on the stock be disclosed?
    Mr. Launer. Material non-public information. We are not 
over the Chinese wall and do not have possession of that 
    Senator Levin. By not insisting that it be disclosed, it is 
leading the other side of the company to be giving an appraisal 
of stock, a valuation of stock which is based on information 
which the other side of the company knows to be incomplete. And 
it seems to me that creates an inherent conflict that we have 
to address and the investment community has to address.
    My time is up, and I will pick up later. Thank you.
    Chairman Lieberman. Thanks, Senator Levin. That was a very 
interesting line of questioning.
    Let me just for the purpose of clarity, because there was 
something assumed in the line of questioning. There is this so-
called Chinese wall between the research departments, or the 
analysts always say, and the rest of the business of the firms 
you work for, correct? That is what we are talking about. But, 
Mr. Launer, I think you used the term--and we have all heard it 
here in these discussions--being ``brought over the wall.'' I 
take it--am I correct that there are occasions when you as 
analysts are brought over the wall into other parts of your 
firm's business? Is that correct?
    Mr. Feygin. That is correct.
    Mr. Launer. Yes.
    Chairman Lieberman. But you were all saying in the specific 
instance that Senator Levin was interested in, you were not 
brought over the wall.
    Mr. Launer. That is correct.
    Chairman Lieberman. Were there any occasions, since each of 
your firms, the four of you were doing--each of the firms was 
doing business with Enron, when you as analysts were brought 
over the wall with regard to any deals or business arrangements 
with Enron? Mr. Feygin.
    Mr. Feygin. Certainly. In the case of Enron, on November 9, 
prior to the merger with Enron and Dynegy being announced, a 
couple hours prior to that I did receive--I believe I received 
the press release of the merger, at which point I was brought 
over the wall and was frozen and could not comment on the 
    Chairman Lieberman. And you were brought over the wall for 
what purpose?
    Mr. Feygin. For the purpose of having the information and 
being able to respond to investor questions once the deal with 
    Chairman Lieberman. So you were no longer giving public 
analysis? Is that what I understand you to say?
    Mr. Feygin. From the point that I was given that material 
non-public information that this merger was about to be 
announced and saw the details of that merger, I could not 
comment, I could not publish research until it was publicly 
announced and disseminated.
    Chairman Lieberman. Mr. Gross, were you brought over the 
wall in any business transactions related to Enron?
    Mr. Gross. Specifically here, we were the adviser to 
Dynegy, and I was brought over the wall in late October.
    Chairman Lieberman. So to advise your company about Enron--
    Mr. Gross. My primary role here was to gauge how investors 
would react to the merger, to gauge their concerns, and in that 
light help formulate but not actually execute due diligence 
that Dynegy would do on Enron.
    Chairman Lieberman. Did you continue to provide analysis 
that was----
    Mr. Gross. No. At that point, my ratings, according to 
company policy, are frozen.
    Chairman Lieberman. Mr. Launer.
    Mr. Launer. I was over the wall relative to Enron for 6 
weeks in the September-October period of the year 2000 for an 
IPO of the NewPower Company.
    Chairman Lieberman. Mr. Niles.
    Mr. Niles. There was one occasion. In January 2001, I was 
brought over the wall for a 24-hour period, I believe, for a 
convertible security offering by Salomon Smith Barney for Enron 
    Chairman Lieberman. All right. I appreciate your 
responsiveness, and I see each of you in one sense or another 
presenting evidence that your companies had rules. But you can 
see how at least I, as one just sitting here, have doubts 
raised in my mind. You have got this expertise, and your 
companies have business interests in other dealings, including 
with Enron. The public is relying through the media, through 
websites, etc., on your analysis of Enron. And yet there is a 
feel of a conflict which, no matter how hard you tried with the 
freezing of your public analysis and all, still leaves me 
feeling that the rules were not adequate, particularly in light 
of your continuing recommendation to buy Enron after most 
everybody was selling it.
    I am going to stop there. Senator Voinovich.
    Senator Voinovich. It looks to me like there are a couple 
of things we have to be concerned about. Do you guys have a 
conflict of interest by owning stock, your family owning stock, 
and whether you ought to disclose ownership, or be prevented by 
law from owning any stock that you report on. That one is 
    External is the Chinese wall. Should we have any Chinese 
walls at all? Should you all go into the business that Mr. 
Schilit is in, and that is that you are an analyst and you have 
got nothing to do with the other side of the business. And, 
this gets back to what Senator Lieberman was saying--if you are 
in the same outfit, there ought not to be a wall. If you have 
got information, inside information, and you are an analyst, 
that information should be made available when you do your 
reports. So there is no problem of whether you have got a wall 
or you don't have a wall. Also, Mr. Launer, you are complaining 
about the fact that you didn't have the information that you 
needed. What information more do you need to do a better job of 
being analysts if you stay in the same kind of outfit that you 
are in today? Is there something that we can do in terms of the 
law, requiring more information so you can make better 
    Have any of you changed the way you are doing business 
because of Enron? Are you doing things the same way as you did 
them before? Are you a little bit more cautious? Are there 
other things that have changed in terms of your operation?
    I would like to hear from all of you. Do you think we ought 
to have legislation that says that you can't do any kind of 
analyst work on stock that you own? And, do you think that you 
should be required to disclose if you are an analyst of the 
stock that you own? Yes or no. We will start with you, Mr. 
    Mr. Feygin. I agree that we should be required to disclose, 
which is J.P. Morgan policy, the stocks that we own, as well as 
some other disclosures that are standard in our research.
    Senator Voinovich. And do you think it should be required 
by law that that be the case?
    Mr. Feygin. I would like to fall back on something Senator 
Torricelli said, and that is the markets do take care of this 
issue. And to the extent that firms will be more trusted and 
their analysis will be deemed more valuable, the market itself 
will impose those disclosures.
    Senator Voinovich. So you don't think you need legislation 
that requires that?
    Mr. Feygin. I can't really comment on that. I know that at 
our firm we do disclose that, and hopefully that helps our 
product. And I would welcome any changes that would enhance our 
product offering. If that is one of them, by all means.
    Senator Voinovich. Mr. Gross.
    Mr. Gross. No, disclosure I think is a good thing. And, in 
general, Lehman Brothers in the past has had outright bans for 
analysts owning stocks that they follow.
    Senator Voinovich. Legislation or no legislation.
    Mr. Gross. That is a difficult call for me to make 
    Senator Voinovich. Mr. Launer.
    Mr. Launer. No legislation, to answer your direct question. 
Our firm has adopted the SIA best practices. They effectively 
contain provisions which require----
    Senator Voinovich. Yes, but before your firm did that, your 
family did own--had bought a bond, had stock. Your sons had 
stock in Enron. And then the firm changed the rules, and then 
you had to transfer stock, except you had to hold a bond that 
is not worth anything anymore. But did that color your judgment 
when you owned--I mean, you were working on Enron, you or your 
family members were buying stock in Enron. Did that color your 
judgment in terms of your analysis of Enron stock?
    Mr. Launer. No, it did not, and it was fully disclosed each 
step of the way.
    Senator Voinovich. But right now you don't have to--you 
can't deal with any stock that you are an analyst for, right?
    Mr. Launer. That is right.
    Senator Voinovich. And your family can't, according to the 
rules of the firm.
    Mr. Launer. That is correct.
    Senator Voinovich. And you don't think we need legislation 
to require that?
    Mr. Launer. No, I don't.
    Senator Voinovich. Mr. Niles.
    Mr. Niles. Our firm prohibits buying stocks in companies 
that we cover, and as far as the policy matter, I haven't 
really given it a lot of thought. But I do know our firm 
prohibits buying stocks in companies----
    Senator Voinovich. OK. How about the Chinese wall? Do you 
think that you ought to split off to avoid what Senator 
Lieberman and some others have talked about, the issue of 
having the same firm being analysts and at the same time being 
investment bankers and having all kinds of information on one 
side that the people who are doing the analysis can't have 
because it is not public? I know what Mr. Schilit is going to 
    What do you say, Mr. Feygin?
    Mr. Feygin. Senator, I believe in your question and in a 
lot of the statements there is the presumption that there is a 
conflict of interest, and on some levels perhaps it exists. But 
the value that I bring to the firm, again, is in my 
independence and the credibility I have with my investors. And 
that is absolutely key. To the extent that that helps our firm 
gain business, that is great and the firm will prosper.
    To the extent that it is a ``buy'' recommendation that 
helps me build credibility, we have commented--this panel has 
commented on numerous occasions that there were multiple buys 
on the stock.
    Senator Voinovich. I understand the whole thing is trust 
and trustworthiness. Enron has destroyed that for a lot of 
people in this country. And those of you in the business are 
going to have to respond to it because it is really going to 
hurt the business, it is already hurting the business.
    Let's say, for example, that your firm has a Chinese wall. 
Do you disclose to the people that you are analyzing stock for 
that there is a Chinese wall and that your firm is doing other 
work for the companies that you are analyzing the stock for?
    Mr. Feygin. It is company policy to disclose if J.P. Morgan 
had a role as an underwriter or was involved in an offering for 
the company when we publish any reports.
    Senator Voinovich. So that is something that you are 
already doing.
    Mr. Feygin. Yes. Now, we do not disclose on every report 
that there is a Chinese wall because, again, our role focuses 
exclusively on publicly available information.
    Senator Voinovich. Mr. Gross, how do you feel about it? Do 
you think you ought to break it up so you don't have a problem?
    Mr. Gross. No, I think that in general that the methods 
that we follow to handle potential conflicts are adequate. 
Going back to Senator Levin's comment, the investment bankers 
periodically have material non-public information. The vast 
majority of it is not applicable to what I do. It may be in the 
context of Company A wants to buy Company B, never does execute 
that transactions. That is material non-public information.
    The type of disclosure that Senator Levin was talking about 
I think is more appropriately handled in that the rating 
agencies see consolidated balance sheets. We have some new 
disclosure rules which will allow us on the outside to do so. 
The auditors deem what is material or not. We have talked about 
in different forms tightening some of those screens.
    So there are mechanisms that are out there that would 
provide that flow of information to the investment community 
without curtailing my role, which is a materially different 
role in how I would help the firm with--as I said, my role in 
the Dynegy deal was basically to tell the companies the 
investor reaction to doing this. So from a standpoint of the 
nature of serving multiple clients, I don't think the conflicts 
are all that prominent, nor are they that insurmountable when 
    Senator Voinovich. Well, I will finish because I am out of 
time, but you now have a problem of appearances. Before this 
you didn't. It is the issue of appearances of conflict of 
interest. And what we are trying to do as quickly as possible 
is to restore people's faith in the financial markets in this 
country so we can get back to business. And I would say to all 
of you that are here, the faster you can move internally within 
your own organizations to get out and change some of these 
things--and I would love to have your recommendations, this 
Committee would, on some of the things in terms of legislation 
that we need to do so you have better information so that you 
can do your job better.
    Thank you, Mr. Chairman.
    Chairman Lieberman. Thank you, Senator Voinovich. Senator 
    Senator Torricelli. Thank you, Mr. Chairman, very much.
    What is extraordinary about the Enron matter is the 
confluence of failures: Unethical business practices by 
executives which could constitute fraud or gross mismanagement; 
the failure of a proper accounting to basic standards that 
would be acceptable; and now the issue of whether the analysis 
was never properly at arm's length or simply failed because of 
inadequacy of information.
    If any one of these three institutions had actually had the 
proper information and acted according to highest expectations, 
a great deal of pain would have been saved for a great number 
of people.
    Our role here is to focus on the third of these functions, 
each of your roles in the marketplace. I can only supplement my 
colleagues' questions by asking your thoughts on several things 
to help me better understand some of these relationships.
    First, let me go to this issue of information you were 
receiving from Enron. On this conversation of August 14 in 
which you received this analysis by Mr. Skilling and Mr. Lay, 
characterize for me whether in your judgments this constituted 
simply exaggerating information properly available, was just 
routinely misleading, or you consider yourself to have been 
defrauded by some of this information that was provided by Mr. 
Skilling? I go back to the quotes I provided to you earlier, 
which I assume you to be familiar with, the numbers, the 
projections, and particularly the references to the new 
businesses of the crude, the crude products, metal, pulp, 
paper, and coal. Some have doubled. Every one of them in the 
second quarter or the quarter before, all are profitable.
    The characterization then put on the company in August, now 
that we know what, in fact, those executives knew about the 
company, about the partnerships, about the deteriorating 
situation, the warnings they had received from people 
internally, as professionals. Looking back on the conversation, 
the judgments you made based on it, how do you characterize 
this as a business?
    Mr. Feygin. Thank you for that question. I will break it up 
into two parts. One, the characterization of the businesses' 
performance provided by Mr. Skilling. To date, there is no 
evidence yet that those new businesses were not performing in 
line with what Mr. Skilling said. I think one of the most 
impressive aspects was, as the company got into new products 
such as pulp and paper when it was about to collapse, the 
Scandinavian pulp and paper markets were panicked because of 
the size of Enron's presence in that marketplace, or perceived 
size of Enron's presence. So it appears today--and we have no 
evidence to the contrary--that those businesses were, in fact, 
gaining traction and growing.
    In hindsight, it certainly seems that, as it relates to the 
partnerships and the exposures of Enron, we were misled.
    Senator Torricelli. Mr. Gross.
    Mr. Gross. I would say obviously, in retrospect, that the 
nature of the disclosure was leading with your best foot and 
letting the other drag behind. And in the context of the 
subsequent information that has come out, there is no question 
that we weren't receiving the full story about the health of 
the company.
    Senator Torricelli. In your mind, as someone who has done 
these calls before, is this in keeping with the culture of the 
business and the way these disclosures are made? Or do you feel 
that you personally and your clients were victims of a fraud?
    Mr. Gross. Well, without materially more information, I 
can't draw a line between the communications that we received 
and outside--outright fraud. I think that will be subject to 
further investigations.
    Senator Torricelli. Anybody else want to comment on this?
    [No response.]
    Senator Torricelli. Explain to me further the operation of 
the separation of the firms. Apparently each of you are 
prohibited from owning positions in the stocks you analyze or 
are required to disclose those positions for yourself or family 
members. Is that accurate?
    Mr. Gross. In our case, I mentioned earlier that at times 
we have had that ban. We currently are able to own stocks, and 
we have severe restrictions about the nature of how we can own 
them and when we can buy or sell those securities.
    Senator Torricelli. Now, in the way the separation works, 
are you then also not operating with knowledge about the 
positions that the firm may be holding on its own account? Or, 
for example, if you had done underwriting, the firm had done 
underwriting for a company, whether you have future positions 
with this firm, or separately whether you are holding large 
numbers of bonds for the firm. How knowledgeable are you about 
the exposure of the firm itself and its own position in any 
particular company, not necessarily this one? Mr. Feygin.
    Mr. Feygin. No knowledge whatsoever of actions that are, 
again, on the other side of the wall.
    Senator Torricelli. You wouldn't indeed know other than 
what might be publicly disclosed? I assume if you searched for 
it, you could find some public disclosures whether or not the 
firm had any of these positions?
    Mr. Feygin. Sure. You know, in the case of Enron and our 
firm's involvement in particular, all I learned about our 
exposure I learned from the press.
    Senator Torricelli. Well, we all did. Mr. Niles.
    Mr. Niles. I am sorry, Senator. The question was am I aware 
of the firm's positions on----
    Senator Torricelli. I want to get a feel for how these 
walls operate within these firms, whether, in fact, you have 
knowledge of the firm's exposure in what position it may have 
from doing underwriting for these firms and its future 
potential or the bonds that they are holding at the time.
    Mr. Niles. I don't have access to that kind of information.
    Senator Torricelli. So, in practice, not simply Enron but 
any of these firms, you find these absolute?
    Mr. Niles. I don't have that information.
    Senator Torricelli. Let me ask you finally, in seeking 
resolution to this and where this Committee ultimately will be 
left is whether to recommend statutory changes or, indeed, as I 
suggested earlier, this is worked out in the marketplace or 
professionally, is there an argument that, in fact, the 
analysis function should be professionalized and separated and 
be a product which is individually purchased by the brokerage 
firms rather than the investment bankers, the brokerage parts 
of this, having it in-house and connected in any case? These 
could indeed be separated, much as the accounting industry, we 
thought previously, had been separated and made independent. Is 
there an argument for taking these out of the same roof at all 
to restore public confidence?
    Mr. Feygin. Well, Senator, again, these are obviously very 
large public policy decisions that we as a firm would be 
pleased to work with this Committee on. I firmly believe that 
there are plenty of rules and guidelines in place that ensure 
our independence and, from a legal framework, ensure our 
integrity, as well as the fact that it is, as you pointed out, 
paramount in the marketplace, that the marketplace perceive our 
product as one of integrity.
    Senator Torricelli. Things are not going to be in the 
future as they were in the past. The status quo is not an 
option. We are either going to take a bright yellow sticker and 
put it on the windshield of all of your firms, revealing your 
gas mileage and your resale values, much as this Congress did 
30 years ago with a different industry, to know what your track 
record is, what your rules are about disclosure, and the 
holding of equities and your conflicts of interest so the 
public can make its judgment in the marketplace, which is my 
own preferred solution; or indeed this Congress is going to 
write a regulatory framework to impose some of that.
    One of the options is to simply separate the functions, 
that if Smith Barney wants analysis, buy it from an independent 
firm so the customers know that, in fact, they are--what is 
happening here is genuinely at arm's length and can have more 
than a Chinese wall, we can have a brick wall separating you by 
physical location and management.
    I want to conclude this by asking your advice. Do you all 
favor simply letting this work out in the market: The public 
will have confidence in some firms, they won't have confidence 
in others? I suspect anybody with a portfolio right now is 
scurrying around town trying to figure out who was right, who 
was wrong. They are all looking at these sheets. Who came up 
with the right answer first to get out? That is one answer, how 
our system operates. Or we can go further. Is there anybody 
else who wants to add on this in a recommendation? That is, 
after all, why you are here. We are trying to figure out how to 
make recommendations to our colleagues to proceed with this.
    Mr. Schilit. Yes, I have been sitting quietly for a long 
time because I am not part of the Wall Street community. There 
is a lot wrong, and to answer your specific question, it 
absolutely should be expected that the research should be an 
independent function, should be set up separately. Customers 
should pay a fee for that, and the marketplace decides the 
value of that research.
    In answer to Senator Voinovich in terms of what steps any 
of us have taken in the wake of Enron, sadly we are a tiny 
firm. We only had six analysts up until very recently, so one 
of the industries we did not cover was the energy group. But we 
have hired an additional six analysts, and we are looking at 
100 percent of the S&P 500 companies just for these type of 
corporate governance problems, a weak control environment.
    Also, I did want to--because I have the floor for a few 
moments, I did want to comment on were there any signs in any 
of the public filings that there were problems at Enron? A very 
logical question. Everybody is saying they hid from us, they 
lied to us, they committed a fraud. Did you read the public 
filings that were published at the SEC? I spent an hour of my 
time last night going through every quarterly filing proxy, no 
more than an hour, and I have three pages of warnings, words 
like ``non-cash sales,'' words like ``$1 billion of related-
party revenue.''
    Chairman Lieberman. These were all from last year?
    Mr. Schilit. This was beginning in March 2000. Every single 
quarter there was a little blurb looking at the reported 
profits, for one quarter $338 million, and $264 million of 
that, a pretty material amount, represent earnings from 
unconsolidated affiliates, more than two-thirds of the 
earnings, and it goes on and on.
    Senator Torricelli. These corporations we have heard about, 
the 3,000 or so Raptors or whatever, they were referred to in 
one of those footnotes.
    Mr. Schilit. Well, they gave little snippets of 
information, but the point is this: I am heartbroken that I was 
not covering this company when I could have done some good. But 
for any analyst to say there were no warning signs in the 
public filings, they could not have read the same public 
filings that I did.
    Senator Torricelli. Your disappointment is nothing compared 
to that of a lot of other people who wish that you were 
following it. When you see these footnotes, though, and it is 
clear a lot of this is happening off the balance sheets, in 
reference to Senator Thompson's question, are there references 
only to the gross amounts of these that are happening off the 
books? Or is there some indication, some window in the numbers 
of these partnerships?
    Mr. Schilit. They don't give any clue. I was astounded when 
I heard it was 3,500. But just looking at the most basic things 
that any investor could understand, if a company reports a 
profit of a billion dollars and that same period the company 
says we had negative $1.1 billion of cash received from that 
operation, there has got to be some warning out there. And 
those numbers came right from the June 2001 quarterly report.
    Senator Torricelli. Thank you, Mr. Chairman.
    Chairman Lieberman. Thank you. Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    In regard to some of Senator Torricelli's questioning, I 
want to refer to the J.P. Morgan, Lehman Brothers, First 
Boston, Citigroup Salomon Smith Barney. Tell me how much your 
companies were involved in the selling group or the 
underwriting groups or what equity position your company had in 
Enron. You can start with the first and go on down, because 
from 1961 to 1986, I was in your business. And the same thing 
was going on in 1961 that is going on the year 2002. Our 
company would take a position in an underwriting group. Then 
they would come to the sales force and say: We have an equity 
position in this stock. We are recommending it to you to sell.
    Now, help me out.
    Mr. Feygin. Easy question for us. We are not involved in 
any equity underwriting for Enron----
    Senator Bunning. Or selling group?
    Mr. Feygin. We were not a part of any syndicate on Enron 
equity offering.
    Senator Bunning. And you own none for your own personal----
    Mr. Feygin. Own none for my own personal----
    Senator Bunning. Not your personal. The corporation's 
    Mr. Feygin. I do not know whether the asset management side 
of J.P. Morgan holds or has ever held a position in Enron.
    Senator Bunning. That is impossible, sir. I am sorry. That 
is impossible for you to tell me that.
    Mr. Feygin. Why is that?
    Senator Bunning. Because if you know that they weren't in 
the selling groups of any type and you know that they weren't 
in any underwriting group, you ought to know, if you are in the 
business of recommending, whether they are in the equity end of 
the--in other words, whose stock are you recommending, the 
stock that your company owns or the stock that is owned in the 
public market?
    Mr. Feygin. The stock that is owned in the public market.
    Senator Bunning. Next?
    Mr. Gross. We have participated in several offerings that 
Enron--most of them were on the fixed-income side. The equity 
    Senator Bunning. Debt instruments?
    Mr. Gross. Debt instruments.
    Senator Bunning. OK.
    Mr. Gross. We were a co-manager in an affiliate called 
Northern Border Pipeline in the last year.
    Senator Bunning. You were an adviser to them on your----
    Mr. Gross. We were a co-manager, which means we did not run 
the books.
    Senator Bunning. OK.
    Mr. Gross. We participate in the sales.
    In general, once again, the vast majority of these sales 
will take place with companies that are already trading in the 
public domain. They will be distributed to institutional 
    From a standpoint of our position, yes, the way a syndicate 
is formed is they own stock for a brief amount of time. We have 
a money management wing where we have a high-net-worth group of 
    Senator Bunning. For which a portion----
    Mr. Gross. They may own Enron in that system. It is very 
difficult for me to know. But, in general, because it is 
investors' money, it is not ours. It is investors' money. The 
same thing with J.P. Morgan investment and management company. 
It is investors' money, not J.P. Morgan's, that they are 
managing. It is an independent wing.
    Basically what we will have is in and around, like I say, 
an offering, it will be for a brief and limited amount of time. 
It is generally in a security that is already publicly traded--
    Senator Bunning. But you have taken the position so that 
you can sell the securities?
    Mr. Gross. Yes.
    Senator Bunning. OK.
    Mr. Launer. Senator, the disclosure on the bottom of our 
research report says that our firm may from time to time hold 
positions in the securities of the company that is the subject 
of the report.
    Senator Bunning. Thank you.
    Mr. Launer. It does not say anything specifically. For me, 
over the wall, the period of time was only the 6-week period in 
    Senator Bunning. Over the wall. It is in the Wall Street 
Journal who is in the underwriting groups. I mean, that is 
public knowledge, who is in the selling group, who is in the 
underwriting group. The position that your company might have 
in that equity, if you are selling as an owner of or as a 
broker for or----
    Mr. Launer. The disclosure that needs to be made has been 
made relative to those things. Yes, we have been in selling 
groups. But it really comes down to the level of our specific 
involvement in those when we are over the wall. In 1998, I was 
at Donaldson, Lufkin & Jenrette before the acquisition of our 
firm by CSFB. I was involved in an equity offering where we 
were the lead manager for Enron securities. So for that period 
of time that I was over the wall, I was aware of the firm's 
position and how we were handling the entire equity offering. 
That ends at the time that the prospectus delivery requirement 
relative to that offering----
    Senator Bunning. You don't feel that inside, supposedly 
non-public information, that you got while you were over the 
wall would shade your judgment at all in your analysis now of 
that same corporation?
    Mr. Launer. No.
    Senator Bunning. Mr. Niles.
    Mr. Niles. Yes, Senator, our firm, it is a large 
institution. We have an investment bank, a corporate bank, and 
we have been involved in a number of offerings with regard to 
Enron. And, I would just say we definitely--that is part of our 
practice as a firm. I am not aware of the specific ownership 
interest in the securities or how that works or quantities.
    Senator Bunning. That blows my mind, because just as an 
account executive, I was aware of it. I was aware of whether we 
took a position and we were selling stock out of our own 
portfolio or if we were just going to the market and buying and 
then delivering the stock to a customer. So some of the things 
you are telling us are very difficult to believe.
    Now, if we are going to solve this problem and we have come 
to you for assistance and you are going to testify as you have 
testified today, you are asking us to intercede, not by your 
suggestions but by our own initiative from what we hear. And 
what I hear from you is very difficult for me to believe. And I 
know about the walls. But the walls are not impenetrable. 
People within your company know just what you are recommending 
and are for what you are recommending because they know it is 
going to help the other side of the wall. And I think that is 
something that we have to look at very closely, Mr. Chairman, 
and I am willing to go if you are.
    Thank you.
    Chairman Lieberman. It is always good to be on the side of 
a member of the Hall of Fame. [Laughter.]
    He threw some high hard ones in his day.
    Senator Levin. Whichever side of the wall he is on, by the 
    Chairman Lieberman. Well, your questions are right on 
target, and, you express the concerns that I certainly have. 
And I guess the question is: Each of the four of you have said 
at one point or another you went over the wall. You went over 
the wall according to the rules of the firms. But, the question 
that I have and I think Senator Bunning's and other questions 
raised is: If you can go over the wall, was it high enough? In 
other words, does it not raise questions in all of our minds 
about your ultimate independence or the intermixing of the 
different functions of your firm?
    Thanks, Senator Bunning. Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman. I won't re-rake 
the leaves. I think they have been gone over sufficiently. But 
I can't pass the opportunity while you are here to raise 
another question that occurs to me. I have not been an account 
executive like Senator Bunning, but I have been in the market a 
good bit in my career. I have made some fairly substantial 
money in the market, and I have lost some fairly substantial 
money in the market. And without the education that would be 
necessary to be an analyst for pay, I do remember something 
that I was taught when I was in my 20's, first getting into the 
market, very, very fundamental. Don't buck the trend. And when 
I inquired as to my counselor, well, how do you know when the 
trend is going on? He said, well, it is very simple. A trend, 
once established, continues until it is over.
    I turn to your testimony. Here is the Credit Suisse sheet 
that says up at the top: ``Recommendation, strong buy.'' And it 
is within inches of a chart that makes the trend pretty 
obvious. The stock has been going down on a very steady basis 
for a year.
    My gut reaction is I don't want to buy that unless in the 
copy that says ``strong buy'' there is an indication as to why 
the trend is over. A trend, once established, continues until 
it is over. I want something here that says this is what has 
happened different in the firm that shows that there is going 
to be a bounce. And I read the copy, and there is nothing here 
that shows there is going to be a bounce. Everyone here--and 
the copy of the rest of it. I am not just picking this one out. 
I picked this one out because it happened to have a chart, and 
I like visual aids. But there is nothing in any of the copy of 
any of the recommendations that says there is a shift in the 
    And so my question to you, which has nothing to do with 
what we are talking about, is just interest, the fact that you 
are here, and I hope you can educate me. What in your opinion 
caused the stock to go down? While analysts were recommending a 
buy all the way through, the market was saying this is a dog, 
we want out of it.
    The uncoordinated decisions of hundreds of thousands of 
investors were sending a strong signal, we want out of this 
stock. The chart shows that the market says this is a dog.
    What did the market see that the analysts didn't? What 
caused the stock to go down? Was it people like Mr. Schilit 
sitting up at night reading the footnotes? What in your opinion 
caused Enron, prior to the disaster--let's say the disaster 
didn't occur and we are back on October 24. You have got a 
stock that has gone down, according to this chart, index price 
has gone down from $100 to $30 in less than a year. It has lost 
70 percent of its market value. Why in your opinion did the 
market decide this stock was worth only 30 percent of what it 
has been worth a year before? Anybody?
    Mr. Gross. Principally, the backdrop prior to that is that 
the stock had more than doubled to get to $90. And if you look 
at the backdrop for emerging market securities, new businesses, 
the NASDAQ had gone from 2800 to 5100 and in that same period 
had fallen to 1700. So a good portion of what you were seeing 
in Enron stock was the entry into emerging businesses which 
subsequently didn't work out for the entire industry, not just 
of Enron.
    Increasingly what you saw was incremental pieces of 
information, whether it was the resignation of a chief 
executive officer, etc., that took little increments down. But 
the stock moving from $40 to $90 back to $40 was principally 
broadband bubble.
    Senator Bennett. Is there consensus on that?
    Mr. Feygin. I think there is also, in addition to what Mr. 
Gross has said, which I absolutely agree with, there is also a 
period in this country and in investor sentiment of being 
extremely bullish on energy and the fact that we had a 
shortage, which would be a boon for companies, especially in 
the deregulated part of the energy business, and that also came 
and went in roughly the same period.
    Senator Bennett. Was the consensus in the analyst community 
to say ``buy'' during the slide from $100 to $30? Or do we 
    Mr. Feygin. I think your charts have shown pretty clearly, 
with some corrections, but there was a consensus to be 
recommending Enron stock throughout most of that period.
    Senator Bennett. So there was a ``buy'' when it was at an 
index price of $100, and there was a ``buy'' when it was at 
$70, and there was a ``buy'' when it was at $50, and there was 
a ``buy'' when it was at $40, and then we know there was a 
``strong buy'' when it hit $30. Well, OK. I take your point 
about NASDAQ. I didn't participate in any of that because I 
decided in my own mind this is tulip time. And I don't know at 
what point the Dutch are going to wake up and discover that 
they can't get much nourishment out of eating the bulbs, and, 
therefore, they are not worth the total farm, which is what 
they went through. And we went through that with the dot-coms. 
And my kids would say, Should I be buying this? As I say, I 
said this is tulip time. And I would feel better just staying 
out of the market until the tulip bulbs have come back down to 
    But as I say, I don't want to re-rake any of the other 
leaves. I am just interested in what might be the herd 
mentality of some analysts saying, well, everybody else is 
recommending it. That is a legitimate question. Is there that? 
Do you fear that, gee, all of my fellows who work for big fancy 
companies are saying buy this, and if I say sell, I am going to 
be embarrassed? Believe me, the herd mentality rules this town. 
So it is not an unusual human reaction.
    Does anybody have a comment on that? Or should we just go 
    Mr. Feygin. If I may, I think one of the premises, again, 
is that there is a bias to these ``buy'' recommendations. And 
to answer your question, as we now know, had somebody been 
clairvoyant, had we seen through some of these charades and 
some of these financials, nothing would have been more 
impactful or valuable for the analysts to have called that 
ahead of everyone else. I think I to some extent speak for the 
panel that we have very different views and arrive at our 
conclusions based on our own independent analysis, obviously. 
It happened to be that in this case we didn't have the right 
    Senator Bennett. Well, I can understand a sense that as 
long as the core business is OK, you have shaken it down to 
$30, and $30 is the logical place for the core business to be. 
So at $30 you can buy it. I had a little problem with the 
``buy'' recommendations before that. That is hindsight, and it 
is easy for me sitting up here to exercise hindsight. I 
appreciate your----
    Mr. Schilit. While I am more of an expert on accounting 
tricks than on predicting stock prices, where they are going to 
stop dropping, very often after we have found problems at a 
company and the stock gets cut in half and gets cut in half 
again, and people would ask me, well, has this played out? What 
I typically tell them, a stock doesn't stop going down because 
it gets tired. There usually has to be some type of 
interventions as you were showing with your chart. Is there 
some change in the business dynamic? Perhaps a new chief 
executive comes in. Perhaps they are selling off a money-losing 
business. But very often, other than the bubble that we 
experienced, when a stock is on a long-term down draft, it 
usually doesn't stop going down because it gets tired. There is 
usually more problems that will be coming out.
    Senator Bennett. A trend, once established, continues until 
it is over.
    Mr. Schilit. Absolutely.
    Senator Bennett. OK. Thank you.
    Chairman Lieberman. Thanks, Senator Bennett, for an 
interesting line of questions. We are going to have one more 
question each, and then we have got to go on to the second 
    My question does relate to what Senator Bennett has just 
described as the herd mentality, and I am particularly thinking 
about what Dr. Schilit said earlier on about the hour he spent 
last night looking at reports at the SEC that Enron had filed. 
I want to show you two charts and then ask you one question 
about the second one.
    The first is the Enron consensus recommendation versus the 
stock price, and the red line here is the consensus 
recommendation, mostly above the ``buy'' until real late; and, 
of course, the stock price is here.\1\
    \1\ The chart entitled ``Enron Consensus Recommdenation Versus 
Stock Price,'' referred to by Senator Lieberman appears in the Appendix 
on page 129.
    Chairman Lieberman. But the other chart that I really want 
to ask you the question about is the one that I referred to 
earlier on, and this is to speak more generally, not just of 
Enron but of Wall Street analysts. And here, this is the S&P 
500 from January 2000 to February 2002, and you can see it is 
up, it is down, it is down, it is down. But the consensus 
recommendation on the S&P 500 is almost a straight line at 
    What you said, I think, Mr. Feygin, earlier, just a few 
moments ago about you would think that naturally an analyst 
would want to be the first to say that, no, this company is 
going down or this market is going down. Something is not 
working right here. To state this with the clearest edge that I 
can, I will quote David Becker from the SEC again, last year 
when he said, August 7, 2001, in a speech to the American Bar 
Association: ``Let's be plain. Broker-dealers employ analysts 
because they help sell securities.''
    So the question is: Have analysts become more salespeople 
than analysts? And if not, how can we explain that only 1 
percent, slightly more than 1 percent of the recommendations 
that analysts made over the period of time studied--that is the 
other, the Thomson study--were to sell and two-thirds were buy 
and the rest were to hold?
    Mr. Feygin. Thank you, Mr. Chairman, for that question. 
First, again, I have to go back to the salespeople versus 
analysts issue, and especially in the context of this herd. How 
much impact can I have--and I believe on this panel I joined 
the ranks most recently. But how much of an impact can I have 
as an analyst coming into a herd and agreeing with the herd? I 
don't believe that that will give my firm any leverage in any 
business and will in any way promote my franchise. So I have to 
bring something different and something new and something that 
will establish my credibility and value to the investment 
community, the institutional investment community, my clients.
    So at this point, just as a point of reference, in my space 
I only have two ``buy'' recommendations on the stocks that I 
    Now, I do believe that the natural gas industry overall--
and my ratings are relative to a benchmark. I do believe that 
the natural gas industry overall is in a very good position. It 
is a limited resource. It is domestic. It does have significant 
incremental drivers going forward from gas-fire generation and 
so on. So in my industry, I believe that there is a reasonable 
bias to be bullish on the performance of those companies, and 
yet only two are rated ``buys.''
    Chairman Lieberman. OK. Anyone else have different--
obviously you understand that in the public mind, in our mind 
now, we are concerned that the pressure may be from the 
companies that you are analyzing and who are doing business 
with the other divisions of your firm, and that is an even 
greater pressure on you to recommend ``buy'' than the kind of 
pressure that you describe, which would be to give the most 
independent analysis you could.
    Mr. Niles, I didn't get to ask you anything on the last 
round, so I wonder if you want to respond to that.
    Mr. Niles. Well, I would just say this: I do my best to 
give the appropriate ratings. In fact, last year I downgraded 
an entire group of subsector of stocks I cover. I was actually 
the first one on Wall Street to do it. It was controversial. 
And, I endeavor to get the call right as often as I can. Right 
now not a lot of stocks are rated positively. There are few 
that are.
    Chairman Lieberman. So let me ask the broader question. 
Apart from what each of you may have done in this area, do you 
have any explanation for the average investor out there who 
goes on to the Internet, checks stocks, watches television when 
some of you come on, as to why only 1 percent of the 
recommendations during that period studied were to sell and the 
rest to buy? Dr. Schilit, maybe you get the last word.
    Mr. Schilit. Again, I am not part of the Wall Street 
establishment, but every time I have seen an analyst go out on 
a limb and go against the conventional wisdom, which is you 
have to be very positive on the companies that you are writing 
about, that becomes a very controversial analyst. It could be a 
very good career step if they want to leave the sell side and 
go to work for a hedge fund. In fact, there is a fellow from 
Lehman Brothers who wound up with a wonderful job at a hedge 
fund. But if you want to move up the hierarchy in the Wall 
Street establishment, you don't rock the boat. And that is the 
reason why nobody at those firms will say there is a problem at 
a company.
    Chairman Lieberman. Time is really running. Senator 
    Senator Thompson. Yes, Mr. Chairman, I was just wondering 
whether or not with regard to any of you or anyone on your 
research or brokerage sides of your companies, whether or not 
your compensation is in any way tied to the profitability of 
the investment banking side of your business, salaries, bonus, 
anything. Just yes or no, unless you care to elaborate.
    Mr. Feygin. No.
    Senator Thompson. It is not dependent upon the 
profitability of the mortgage banking side of the business in 
any way?
    Mr. Niles. Yes, I think investment banking profitability, 
the profitability of the overall firm factors into my bonus, 
but it is a general matter.
    Senator Thompson. Anyone else? Is that the case?
    Mr. Gross. It is the same issue.
    Senator Thompson. Beg your pardon?
    Mr. Gross. It is the overall profitability of the firm 
where the ultimate pool is drawn from, but there is no direct 
    Senator Thompson. That the bonus is dependent upon?
    Mr. Gross. Overall profitability of the firm, yes, and the 
investment bank is part of our firm.
    Senator Thompson. Is that the same thing, Mr. Feygin?
    Mr. Feygin. That is correct.
    Senator Thompson. All right. Thank you very much.
    Chairman Lieberman. Thanks, Senator Thompson. Senator 
    Senator Levin. Thank you, Mr. Chairman.
    First, a comment, then my question. Mr. Launer, you said 
that, relative to Enron, you were on both sides of the wall 
relative to one deal, but that the information that you got 
when you were here on the investment side of the wall you did 
not use when you came back onto the analysis or the brokerage 
side of the wall.
    I find that just difficult to accept, frankly--that you can 
put a wall in your mind between information that you get on one 
side and not use it when you go on the other side of the wall. 
I don't think the wall can possibly mean that the same person 
can be on both sides of the wall. I think it has got to mean 
you are either on one side of the wall or the other.
    It still has problems because the wall is penetratable, but 
in the example you give, it seems to me it defeats the purpose 
of the wall for one person to be on both sides of the wall 
structuring a deal relative to Enron and then going on the 
other side of the wall brokering the stock of Enron, because I 
think it is impossible to ignore what you have learned on the 
investment side of the wall.
    Now, that is a comment, not a question, because I want to 
stick to the one-question rule. [Laughter.]
    Mr. Launer. May I respond?
    Senator Levin. I think in fairness, if you don't mind a 
response to----
    Chairman Lieberman. Go ahead.
    Senator Levin. We get one response, and then I will reserve 
my question.
    Chairman Lieberman. We have walls here in the Senate that 
one is able to go over as well.
    Senator Levin. We penetrate walls here.
    Chairman Lieberman. Do you want to respond?
    Mr. Launer. I thought we set up a wall.
    Chairman Lieberman. No.
    Mr. Launer. Senator, the circumstances I referred to and 
generally circumstances relative to being over the wall are 
quite similar. It is when you become in possession of material 
non-public information, and that is a decision made by many 
others surrounding me at the firm.
    Relative to a public offering of securities, as I mentioned 
in response to the other question, I was over the wall for a 
period of time with my knowledge that that offering of 
securities was coming. Enron was doing an $850 million equity 
offering. For a period of approximately 3 weeks, that offering 
was pending. That offering needed to be filed for at the SEC. 
Then that offering needed to be announced.
    During the period of the marketing of the offering, I was 
also over the wall because I had had the opportunity to have 
that material non-public information first. When the offering 
was completed and the stock began to trade the next morning and 
the syndicate relative to that offering was completed and, as 
it said to the SEC, the syndicate is broken, I then am not in 
possession of material non-public information anymore and go 
back to being an analyst as I had been before I was over the 
wall. So it is not a situation that continues beyond.
    Senator Levin. My question does relate to IPOs, and let me 
ask all of you this question. In July of last year, Laura 
Unger, who was then the Acting Chairman of the SEC, reported on 
an SEC study of financial analysts that found that 16 of 57 
analysts reviewed had made pre-IPO investments in a company 
that they later covered. Subsequently, the analysts' firms took 
the company public, and the analysts initiated research 
coverage with a buy recommendation. That is the SEC study, 16 
of 57 analysts reviewed had made these pre-IPO investments in a 
company that they later covered.
    My question is this: Have any of you personally 
participated in an IPO issue or bought stock in the IPO company 
before it went public and then recommended the stock? Putting 
aside your current company rules because that may have changed 
what you are allowed to do now, but at any time during your 
career as an analyst, did you recommend a stock where you had 
personally participated in the IPO issue or had bought stock in 
the IPO company before it went public? Mr. Feygin.
    Mr. Feygin. Yes, I participated in an IPO issue, but I 
never bought stock in the companies that were brought public. 
One of the IPOs that I was involved with never came to 
fruition. In another I did end up recommending a buy rating.
    Senator Levin. And are you allowed to do that under current 
    Mr. Feygin. I am not allowed to own stock.
    Senator Levin. Anymore.
    Mr. Feygin. Anymore.
    Senator Levin. You can still participate in the IPO?
    Mr. Feygin. Sorry, participate in the IPO as a firm and 
    Senator Levin. No. You personally, can you----
    Mr. Feygin. No, absolutely not.
    Senator Levin. You are not allowed to do that, nor have you 
ever done that?
    Mr. Gross. No and no.
    Senator Levin. Mr. Launer.
    Mr. Launer. In one instance, in the NewPower Company IPO, I 
was with Donaldson, Lufkin & Jenrette at the time. I referred 
to it in my opening statement. I invested $18,000 in NewPower 
prior to that IPO.
    Senator Levin. And then recommended the stock?
    Mr. Launer. Yes, I did.
    Senator Levin. And can you do that now?
    Mr. Launer. No, I cannot.
    Senator Levin. Mr. Niles.
    Mr. Niles. No.
    Senator Levin. I don't think I have to ask you at all, Mr. 
    Thank you.
    Chairman Lieberman. Thanks, Senator Levin. Thanks to all of 
you. The testimony you have given has been very important to us 
and I believe--and I hope--very important to the investing 
public. Thanks very much.
    Could I ask the members of the second panel to please come 
and stand by your seats and raise your right hand, if you 
would. Thanks. Do you swear that the testimony that you are 
about to give to this Committee today is the truth, the whole 
truth, and nothing but the truth, so help you, God?
    Mr. Glauber. I do.
    Mr. Bowman. I do.
    Mr. Hill. I do.
    Mr. Torres. I do.
    Chairman Lieberman. Thanks very much. Please be seated, and 
the record will show that each of the witnesses answered the 
question in the affirmative.
    Let's begin with the Hon. Robert Glauber, chairman and 
chief executive officer of the National Association of 
Securities Dealers. Thanks to all of you for being here today.


    Mr. Glauber. Thank you very much, Mr. Chairman. If I might 
just read a brief oral statement and have my entire comments--
    \1\ The prepared statement of Mr. Glauber with an atachment appears 
in the Appendix on page 90.
    Chairman Lieberman. Please, let me say that the testimony 
that you have given, the complete testimony, will be printed in 
full in the record.
    Mr. Glauber. Thank you very much. Thank you, Mr. Chairman 
and Members of the Committee, for the opportunity to testify.
    First, let me briefly describe the NASD because who we are 
bears directly on both the substance of what I will be saying 
and on the usefulness of what we have been doing to strengthen 
analyst independence.
    The National Association of Securities Dealers is the 
world's largest self-regulatory organization, or SRO. Under 
Federal law, every one of the roughly 5,500 brokerage firms and 
more than 700,000 registered representatives in the U.S. 
securities industry comes under our jurisdiction, which also 
includes every securities analyst employed by a member firm. 
Our mission and our mandate from Congress is clear: To bring 
integrity to the markets and confidence to investors.
    Employing industry expertise and resources, we license and 
register industry participants, write rules to govern the 
conduct of brokerage firms, educate our members on legal and 
ethical standards, examine them for compliance with NASD and 
Federal rules, investigate infractions, and discipline those 
who fail to comply. We are staffed by 1,600 professional 
regulators and governed by a Board of governors, at least half 
of which are unaffiliated with the securities industry.
    All of this has given NASD a special responsibility to do 
something about the lack of transparency and increasing 
conflicts of interest that have eroded public confidence in 
securities analysts' recommendations. And, Mr. Chairman it has 
given us the means to do something about it as well, for the 
NASD is equipped to provide a layer of real private sector 
regulation between the industry and the SEC.
    In July of last year, well before Enron collapsed, NASD 
issued a proposed new rule: To significantly expand analyst 
disclosure obligations. And 3 weeks ago, culminating a process 
several months in the making, I joined several of your 
congressional colleagues and SEC Chairman Pitt in announcing 
far-ranging proposed new rules to govern the overall 
responsibilities of securities analysts when they recommend 
    These tough, comprehensive rules represent a big step 
forward, I think, in investor protection. They will provide 
disclosure of much more information about analysts' potential 
conflicts of interest as when analysts or their brokerage firms 
own stock in the company being recommended or their brokerage 
firm receives investment banking revenue from the company. And 
they will prohibit certain kinds of behavior as simply being 
too riddle with such conflicts, such as analysts' receiving 
pre-IPO stock--the issue just raised a moment ago--or trading 
against their recommendations or promising favorable research 
to get underwriting business. The bottom line is not only 
enhanced investor protection, but enhanced analyst 
    Now, will our analyst rules themselves prevent another 
future Enron? I am not going to sit before you and make that 
claim, for Enron was a multifaceted disaster, involving 
corporate governance that didn't govern and accounting that was 
unaccountable, as well as analysts who were far from analytical 
in ferreting out the truth. I think there is no doubt that 
analysts dropped the ball with Enron.
    But I will say this: Under our new rules, the perverse 
incentives that may have causes analysts not to want to know or 
acknowledge the truth about Enron, because, say, their 
investment banks had lucrative client relationships with the 
company, those kinds of incentives will be reduced in part 
because sunlight is the most effective disinfectant. And if 
there is any remaining reason to wonder whether an analyst has 
a conflict, he will have to 'fess up to it and disclose why he 
has that conflict to the investing public.
    Let me make one final point which I believe is critical. 
These new rules are a matter of private sector self-regulation, 
not self-regulation in name but self-regulation in fact. The 
proposed rules were hammered out by the industry's foremost 
SROs, acting under the strong oversight of Congress and the 
clear vision of SEC Chairman Pitt. They will strengthen the 
industry's own business practices and ethical standards, but as 
enforceable regulatory rules, not trade association best 
    The new rules' impact is already being felt as some firms 
hasten to adopt tougher standards. They will be enforced by the 
NASD with a full range of disciplinary actions, which this year 
alone have included multi-million-dollar fines and expulsions 
from the industry. And as detailed in my written testimony, 
NASD has not hesitated in the past to use its existing 
enforcement authority against analysts whose conduct has 
undermined market integrity.
    Simply put, Mr. Chairman, these proposed rules will have 
teeth because self-regulation in the securities industry does 
have teeth. It is what Congress wisely intended more than 60 
years ago, and it is what we continue to deliver with these 
rules today. Thank you.
    Chairman Lieberman. Thank you, Mr. Glauber. I look forward 
to questioning you on some of those recommendations, which I 
    Next we have Thomas Bowman, president and chief executive 
officer of the Association for Investment Management and 
Research. Thank you for being here.


    Mr. Bowman. Good afternoon. My name is Thomas A. Bowman. I 
am the president and CEO of the Association for Investment 
Management and Research and a holder of the Chartered Financial 
Analyst designation.
    \1\ The prepared statement of Mr. Bowman appears in the Appendix on 
page 100.
    Thank you, Chairman Lieberman and other Members of the 
Committee, for the opportunity to speak on behalf of the 
150,000 investment professionals worldwide who are AIMR members 
or candidates for the CFA designation.
    Allegations that analysts lack independence are 
particularly important to us because they cut to the heart of 
our core ethical principles and taint a proud profession and 
its practitioners.
    Most AIMR members are not subject to the majority of 
conflicts of interest under discussion today, but all of them 
are disadvantaged by companies' exploitation of financial 
accounting standards and the important principles of 
transparency and disclosure.
    Enron's disgrace must primarily be attributed to Enron's 
management, who are alleged to have played the most egregious 
games with financial reporting rules and misled many of even 
the most sophisticated investors.
    We are convinced that most companies play such games to a 
greater or lesser degree. And until financial reporting 
standards are developed and enforced for the benefit of 
investors rather than the benefit of issuers, investors will be 
disadvantaged. Until auditors renounce their advocacy of 
corporate interests, regain independence, and become vigilant 
watchdogs for fair disclosure, investors will be disadvantaged. 
Until corporate managements put shareholder interests first and 
stop retaliating against analysts for unpopular opinions, 
investors will be disadvantaged. Until Wall Street firms 
recognize that it is in their best interest to reward high-
quality, independent research, investors will be disadvantaged. 
And, finally, until all Wall Street analysts adhere tenaciously 
to a code of ethics and standards of professional conduct that 
place their investing client's interest before their own and 
their firm's and require research objectivity and reasonable 
basis for recommendations, investors will be disadvantaged.
    When Wall Street analysts are assigned companies whose 
public disclosures are opaque and for whom transparency is a 
dirty word, research reports and recommendations are made with 
great uncertainty. There is no obvious point where lack of 
transparency and uncertainty about a particular company's 
prospects should result in a no recommendation or a sell. 
Warren Buffett, one of the most respected investors in the 
world, advises that if you don't understand the company, don't 
buy it.
    What is obvious is that even with the full disclosure 
financial analysis is more art than science. No analyst has a 
magic formula that accurately and consistently predicts stock 
prices. But their firms must reward them for high-quality 
research and success of their recommendations. That said, are 
Wall Street analysts sometimes pressured to be positive? Yes, 
but by many forces and not all internal to their firms. These 
forces create an environment replete with conflicts of 
interest, one that undermines the ethical principles upon which 
AIMR and the CFA program are based, and we condemn all who 
foster and sustain it.
    These pressures to be positive are intensified in a market 
that emphasizes short-term performance, one where investment 
recommendations are now prime-time news, often in 30-second 
sound bites, and where the serious business of investing 
becomes a sport like horseracing where investors are always 
looking for the hot tip.
    But we don't dispute that the collaboration between 
research and investment banking is fraught with ethical 
conflicts. But it is critical to a firm's due diligence in 
evaluating investment banking clients under the current system.
    To effectively manage these conflicts, we believe that 
firms must first foster a corporate culture that protects 
analysts from undue pressure from issuers or others and 
constantly communicate publicly the measures in place to ensure 
that this happens;
    Second, have reporting structures that prevent investment 
banking from approving, modifying, or rejecting reports or 
    Third, have clear policies for analysts' personal 
investment and trading to ensure that investors' interests come 
    Fourth, not link analyst independence directly to the 
success of the investment banking activities; and
    Fifth, disclose conflicts in reports and media appearances 
that are prominent, specific, plain English, and not marginal 
or boilerplate.
    At a minimum, analysts should disclose their personal 
investments, the compensation to their firm from the subject 
company, and material gifts received from the subject company.
    Finally, security ratings systems must be concise, clear, 
and easily understood by the average investor. In addition to 
the recommendation itself, ratings should include a risk 
measure and a time horizon to provide investors better 
information to judge the suitability of the investment to their 
own unique circumstances and constraints.
    In closing, I would like to impress upon the Committee that 
we appreciate the seriousness of the problems facing Wall 
Street analysts but also their complexity. A precipitous 
solution that addresses only one aspect of the problem is not 
the answer.
    I will be happy to answer any questions later. Thank you 
very much.
    Chairman Lieberman. Thank you, Mr. Bowman, for a very 
strong statement. You are absolutely right, and just to make 
clear what I said at the outset, the analysts weren't the only 
watchdogs that didn't bark here. There were a lot of others who 
let the investing public down. Also, I think you have made some 
excellent recommendations, which I look forward to talking to 
you about in the question and answer period.
    The next witness is Charles Hill, who is the director of 
financial research at Thomson Financial/First Call, which is 
one of the groups that we have cited with appreciation here 
today. Thanks, Mr. Hill.


    Mr. Hill. Thank you. Chairman Lieberman, Ranking Member 
Thompson, and Members of the Governmental Affairs Committee, I 
am Charles L. Hill, director of research at Thomson/First Call. 
I appreciate the opportunity to testify in front of this 
Committee today. I believe the issue of analyst conflicts is an 
important issue that needs to be addressed. It is one of 
several investment issues that needed to be addressed before 
the Enron debacle, and now even more so. It is important not 
only to the future health of the investment community, but it 
is of greater importance to the public's perception of and 
confidence in the overall capitalist system.
    \1\ The prepared statement of Mr. Hill appears in the Appendix on 
page 109.
    Given the importance of these hearings, I appreciate the 
attendance at this hearing by the two Committee members that 
are still here today. Thank you.
    The most obvious symptom of the analyst conflict problem is 
the positive bias of analyst recommendations in general, as 
well as the extreme positive bias of their recommendations on 
Enron in particular.
    For at least the last several years, roughly one-third of 
all broker analyst recommendations were strong buys--or 
whatever their equivalent terminology was for the top category; 
similarly, one-third were buys and one-third were holds. The 
total of both sells and strong sells was always less than 2 
percent. This is still true today despite the severe criticism 
analyst recommendations have been increasingly subject to in 
recent months. It is interesting that the analyst 
recommendations were at their most positive levels at the peak 
of the market in the spring of 2000.
    That means that if an individual investor--oops, I have 
left something out.
    The above normal positive bias persisted until early 2001, 
even though the stock market indices were in decline from the 
spring 2000 highs. The shift that did occur was fairly minimal, 
roughly 6 percentage points shifted from strong buy to buy, and 
above 5 percent from buy to hold, and about 1 percent from hold 
to sell.
    In the specific case of Enron, the analysts were in a 
different position. Enron had morphed into what was essentially 
a hedge fund. As a result there was very little transparency in 
recent years as to where earnings were coming from. Analysts 
were virtually limited to Enron's historical earnings record 
and to the company's guidance for future earnings.
    Therefore, it was not surprising that on the eve of Enron's 
third quarter 2001 earnings report, 13 broker analysts had a 
strong buy--or their equivalent terminology--three had a buy, 
and none had a hold, sell, or strong sell.
    However, despite a number of red flags from October 16, 
2001 on, the analysts dallied in lowering or discontinuing 
their recommendations in the face of increasing risk. By 
November 12, almost a month after Enron had announced a $1.2 
billion write-off that Ken Lay could not explain on a 
conference call, almost a month after the Wall Street Journal 
reported Enron executives stood to make millions from Enron 
partnerships, 3 weeks after the CFO was fired, 2 weeks after 
Enron announced it was being investigated by the SEC, and 4 
days after Enron announced that it had overstated 4 years of 
earnings by $600 million--after all these red flags, there were 
still eight analysts with a strong buy, three with a buy, one 
with a hold, and one with a strong sell. At that point, none 
had dropped their recommendations.
    The new proposals from NASD go a long way toward addressing 
some aspects of the bias problems. They provide for better 
disclosure of the firm's investment banking relationships with 
the company, and of the firm's and the analyst's holdings. They 
provide for some standardization of recommendations across the 
brokerage industry. The requirement for analyst reports to show 
the recommendation distribution of all the firm's 
recommendations hopefully will lead to less of a positive bias 
in analyst recommendations.
    Unfortunately, the new NASD rules do not sufficiently 
address the key issue of analyst compensation. It is the old 
story: Follow the money. Until the so-called Chinese wall 
between research and investment banking is restored at the 
brokerage houses, there will continue to be a problem with 
analyst objectivity.
    In the interest of full disclosure, before coming to 
Thomson/First Call, I spent 4 years as a buy-side analyst and 
16 years--or 18 years as a sell-side analyst. As a sell-side 
analyst, I did put sells--and not holds that meant sell--on 
investment clients, investment banking clients. But my monetary 
incentives in those days were heavily tied to doing objective, 
incisive research rather than what I did for investment 
banking. We need to try to return to those days of yesteryear.
    Also, in the interest of full disclosure and in view of Mr. 
Skilling's being pilloried in yesterday's Senate hearing for 
being a Harvard Business School MBA, I also have to admit to 
being a Harvard MBA.
    Chairman Lieberman. Now you are in trouble. [Laughter.]
    Mr. Hill. Harvard's motto is ``Veritas''--truth. Hopefully 
I can do a better job of upholding that motto than Mr. Skilling 
    On the assumption that all of you have heard my earlier 
testimony in front of the House subcommittees, I have purposely 
kept my testimony short, although I guess I did run over 
slightly, so we can focus on the questions. I look forward to 
responding to those questions.
    Chairman Lieberman. Thanks, Mr. Hill. Thanks for all you 
have done. I don't know whether you will take this as a 
compliment from me as a Yale graduate, but I think you have not 
only upheld the ``veritas,'' you have upheld the ``lux'' in the 
Yale motto. Light and truth. So I thank you.
    Next, and last, is Frank Torres, legislative counsel of the 
Consumers Union. Thanks, Mr. Torres, for being here. Thanks for 
your patience.


    Mr. Torres. Mr. Chairman, Senator Levin, thank you for the 
invitation to be here today. We are here because the 
marketplace has failed. Market forces failed to discipline 
market participants. The watchdogs didn't just fail to bark; 
they let in the crooks and led them to the cash. And there is 
enough blame to go around. We are here today talking about the 
analysts, but we could be talking about the auditors or even 
the regulators and their failure to fully oversee the industry.
    \1\ The prepared statement of Mr. Torres with an attachment appears 
in the Appendix on page 111.
    No one seems to be able to answer confidently, I don't 
think, given the testimony here today, that there are not more 
Enrons out there. In the end, that uncertainty is a problem not 
just for investors, institutional and individual, but also for 
the marketplace and the economy as a whole.
    Today over half of American families invest, and I think we 
as a society encourage that. Companies benefit, the economy 
benefits. And it is a good thing. And they rely on the 
expertise of the analysts to digest raw data, to talk to 
insiders, to put together the recommendations. Analysts' 
research is likely to be the most detailed information some 
investors have. Unfortunately, too many securities analysts 
have become cheerleaders for the companies their firms are 
doing business with. Investors don't need more cheerleaders. 
They need critical evaluations and analysis.
    It is apparent that the analysts aren't asking the tough 
questions. They believed the Enron sales pitch and got duped 
just like the Enron employees who were told by Ken Lay and 
others to buy and to hold on to their stock. But aren't 
analysts supposed to be the experts? We expect them to be more 
skeptical of sell jobs by company executives.
    We are not saying that Congress needs to protect against 
bad advice. But how can investors have confidence in such an 
environment? And what value, then, are analysts 
recommendations? And how is this any different from the SEC 
going after the New Jersey teenager who was offering stock tips 
over the Internet? In fact, he might have been better off 
because he wasn't privy to all the inside information that 
apparently was leading all the analysts astray.
    Now, no one has denied the pressures created by the 
conflicts in this industry. In fact, firms and analysts 
sometimes get punished for negative reports about companies, 
and there is enough evidence of that. Expert analysts are 
expected or should be expected to overcome those pressures.
    This situation is amazing. No one seems to know anything 
about what these companies do or how things operate. Analysts 
point to the auditors. The auditors say Enron wasn't 
forthcoming. I am waiting for Enron to blame the investors for 
investing in their own company's stock. Where is this going to 
end? Who is going to be accountable and who is going to be the 
watchdog for investors?
    We are pleased with the NASD proposed rule and will work on 
submitting comments to that. But the rule has some shortcomings 
and has some very good things.
    The rule seems to be focused on disclosure. However, no 
disclosure will create a Chinese wall big enough to prevent 
some of these conflicts from occurring in the first place.
    Analyst ownership of stock and the restrictions on that are 
a good step, but as was pointed out by others here on this 
panel, the analysts know where their paycheck is coming from. 
Just because you are prohibiting the sale of stock and 
restricting some things around the IPO issuance isn't going to 
prevent the conflicts. And we heard from the earlier panel that 
profitability of the company plays a role in that.
    When you have got companies--and somewhere on the earlier 
panel that I won't mention--having multi-hundreds of millions 
of dollars of investments in companies like Enron, how can the 
analyst not recognize that and not work to protect that in some 
way, if not directly then indirectly? If not intentionally, how 
can you not picture that in the back of their minds as 
influencing their decisions?
    We have some recommendations on the NASD proposal that I 
would like to go over now very briefly. One is: Why don't we 
give a boost to the independent analyst? Why not create some 
sort of certification system for them so that investors reading 
a report from an independent analyst or listening to one on TV 
would know right away that that analyst is conflict-free? 
Investors could choose to disregard advice by analysts without 
this independent designation.
    Second, why don't we require analysts and firms to publish 
their research quality ratings, a step that would likely 
encourage them to produce more reliable recommendations? Better 
yet, develop standardized measurements of the success of 
analyst recommendations, publish the good ones, let people know 
who are the bad ones are, too. I think the NASD rules get us 
halfway there. We need to take the next step.
    Disclosing conflicts is important, but it won't get rid of 
the underlying bias. They are important, though. They are 
important, but we think that they should not just simply say 
that there are conflicts that exist, but extend that to include 
both the nature and extent of the conflicts. How much money 
does a firm have invested in a particular company that they are 
developing a report on?
    Finally, uniform language should be developed that all 
firms should be required to use about their recommendations. It 
is kind of weird English that ``hold'' really means ``sell.'' 
What is up with that? A lot of investors I think are confused 
about this. It is great for the insiders who know what is going 
on, but the analysts knew full well that people will make--
investors were making decisions based upon those types of 
    One firm has proposed using the terms ``overweight'' and 
``underweight'' to describe those recommendations. While this 
sounds like more appropriate for junk food labels, I think that 
is a promising start.
    And, finally, I would like to commend this Committee for 
taking a look beyond some of the villains in the company 
themselves, and I think it is important to take a look at some 
of those players, but in looking beyond that and in trying to 
get to some ideas that will help the investors and the 
consumers in this country.
    Thank you very much.
    Chairman Lieberman. Thanks, Mr. Torres, for very 
constructive testimony.
    It is true that this Committee is trying to more broadly 
focus on the lessons we learned from Enron, not just from 
within Enron, and in this case we were drawn to the analysts 
and the fact, as you have all indicated, that they continued to 
recommend buying Enron stock long after, it seems to the casual 
observer, there should have been reason to do so, and then that 
led to the larger concern about the independence of analysts, 
which I want to get to in a moment.
    Senator Levin has to leave in a few moments, and I am going 
to yield to him to ask the first questions, and then I will 
wrap up.
    Senator Levin. Thank you so much, Mr. Chairman. I 
appreciate your yielding. As always, you are courteous, and it 
is most appreciated. Three questions of Mr. Bowman and that is 
    One, you indicate in your prepared testimony--and you also 
said something about this in your oral testimony--that firms 
should implement compensation arrangements that do not link 
analyst compensation directly to their work on investment 
banking assignments or the success of the investment banking 
activities. Then under that formulation, they could continue to 
receive compensation based on the overall firm--the overall 
well-being of the firm or how well the firm did in a particular 
year. Would you leave that open?
    Mr. Bowman. Yes, that is being left open as it currently 
exists, Senator. We have had a research objectivity standards 
task force in place now for about 18 months, and as you can 
imagine, this has been the subject of great debate within that 
    Certainly, I think Senator Lieberman is the one that 
referred to it, the implicit risk that is inherent in any 
situation where, directly or indirectly, analyst compensation 
is tied to success of the overall firm, which means primarily 
in many cases the investment banking side. And certainly, the 
implicit risk would, in effect, go away with regard to that 
aspect of it if analyst compensation had nothing to do with the 
success of the investment banking side. I don't think anybody 
could argue with that point.
    The issue, however, is that once--what seems like a very 
reasonable and simplistic change could have implications that 
really need to be discussed and debated.
    For example--you could argue both sides of this, but, for 
example, Wall Street firms will make the claim that they need 
to be able to attract the top-quality analysts to their firms, 
and in order to do that, they have got to pay for it. And in 
order for them to pay for it, they have got to go to the place 
where most of the money is made, and that is investment 
banking. And their bonuses are heavily dependent upon the 
investment banking success.
    Wall Street firms will then tell you that if they can't do 
that, they are not going to be able to afford these high-
quality analysts because they will be attracted to other 
    Senator Levin. Well, the other firms are bound by the same 
    Mr. Bowman. Well, no, other non-sell-side firms who don't 
have this conflict.
    Senator Levin. Which may not be all bad.
    Mr. Bowman. And their argument is--I am the messenger here, 
but their argument is that in the end, therefore, investors who 
are relying on Wall Street research will be hurt.
    I think, frankly, Senator, speaking as an individual 
investment person and one who grew up on the buy side, it would 
certainly be more appropriate if they could find--if the sell-
side group could find some way to compensate their analysts in 
a way that would attract and keep them and keep them out of 
this conflict that we are all concerned about, it would be all 
to the good.
    Mr. Hill. Senator, could I respond to that as well?
    Senator Levin. Sure.
    Mr. Hill. As I mentioned, I was on the sell side for 18 
years. In those days, we got paid for doing research. The way 
the system worked was that every quarter the institutions sent 
a letter in to the firms saying we did X amount of commission 
business with your firm in return for services provided by the 
following analysts. If my name was on those lists more than 
anybody else, I got the biggest piece of the Research 
Department bonus pool. In those days, there was a meaningful 
Research Department bonus pool because the commissions were 
more meaningful. Since then, they have brought them down to 
almost nothing. The institutions need to look in the mirror. 
They are complaining that their research isn't as good a 
quality or as objective as it used to be. It is the old story: 
You get what you pay for. It is the same with the individual 
investors that are paying almost nothing today in commissions.
    We have to do something about changing the way the 
brokerage firms can get compensated for research. We probably 
can't put the fixed commission rate genie back in the bottle. 
Whether the institutions would be willing to pay hard dollars 
for research instead of just commissions remains to be seen. We 
know that that is anathema to institutions. They try to soft-
dollar everything. If they could soft-dollar the janitor 
service, they would.
    Senator Levin. Thank you. The second question I am just 
going to put in for the record, if, Mr. Glauber, both you and 
Mr. Bowman would answer this for the record.Tell us what the 
current rules are relative to gifts from companies that are 
being analyzed to those analysts--just for the record, what 
current rules exist? Mr. Bowman, you made reference to the need 
for disclosure of material gifts received by the analysts from 
either the subject company or the Wall Street firms' investment 
banking department. If you would for our record give us the 
detail of what you are recommending on that, I would appreciate 
    \1\ The information requested entitled ``AIMR Standards of 
Professional Conduct pertaining to Gifts,'' from Mr. Bowman appears in 
the Appendix on page 131.
    Senator Levin. This would be the last question, and it 
would be for Mr. Bowman. Your association has surveyed your 
members relative to stock options and whether they ought to be 
reported or not. And here is what a release of yours says back 
in November 2001: ``More than 80 percent of the financial 
analysts and portfolio managers around the world who responded 
to a survey believe that any stock options granted to employees 
are compensation and should be recognized as an expense in the 
income statements of the companies that grant them.'' As you 
know, that is a position that I have espoused personally, but 
can you give us----
    Chairman Lieberman. Your time is up, Senator Levin.
    Senator Levin. Right. [Laughter.]
    Taking advantage of your good nature----
    Chairman Lieberman. Go right ahead.
    Senator Levin. Can you tell us, if you would, why you 
believe that such a large percentage of your members take that 
    Mr. Bowman. With regard to gifts, Senator----
    Senator Levin. No, not gifts. Skip the gifts. Give us that 
for the record. Just respond to the press release saying that 
80 percent of financial analysts and portfolio managers believe 
stock options should be expensed.
    Mr. Bowman. Well, for many, many years, AIMR has taken the 
position that stock options should indeed be reflected on the 
income statement, the balance sheet. And I think the reason why 
80 percent of our members have indicated that they believe that 
should be the case is that they tell us they believe that it is 
a form of compensation and, therefore, an expense to the firm 
and, therefore, should, like any other expense, be included on 
the income statement. That is the reason that they give us, 
and, frankly, we have made a very strong position that that 
should be the case.
    Senator Levin. Would you submit for the record the way the 
question was asked that was responded to by the 80 percent? 
Could you give us the questionnaire's question? For the record, 
just submit it later.\2\
    \2\ The information requested entitled ``Association for Investment 
Management and Research (AIMR) Survey on Accounting for Stock 
Options,'' from Mr. Bowman appears in the Appendix on page 132.
    Mr. Bowman. Let's see----
    Senator Levin. If you could give it to us after the hearing 
is over, that would be good.
    Chairman Lieberman. You don't have to do that now, Mr. 
    Senator Levin. I am trying to save time.
    Chairman Lieberman. Thanks, Senator Levin. I have a feeling 
this topic will come up on other occasions, in other places, I 
am sure. [Laughter.]
    Senator Levin. Thank you.
    Chairman Lieberman. Not at all.
    Let me ask a final series of questions. First, Mr. Hill, 
the research that Mr. Hill's firm did on the recommendations of 
analysts over a period of time was, as I mentioned in my 
opening statement, one of the more stunning facts that I 
learned in preparing for this hearing, this business that less 
than 2 percent of the recommendations were to sell, when the 
market was going up and down, and even as the S&P 500, as our 
chart showed, was going down.
    I just want to ask--and so that raises in me and others 
this concern, suspicion, conclusion in some that there can't be 
any rational basis for that, it has to be that for one reason 
or another, either at one extreme that the analysts have become 
salespeople, or in another sense that they have just gotten so 
swept off their feet by the companies they are analyzing that 
they are on longer independent. Each of you has thought about 
this and worked in this area to one degree or another. Is there 
any other explanation for why, as the S&P 500 went up, and 
particularly went down, the consensus recommendation continued 
to be buy, buy, buy? Mr. Glauber.?
    Mr. Glauber. Sure. I think the points you have made are 
clearly part of the answer to the puzzle. I think investors 
also are looking to invest, and so they are looking for 
companies to buy. Most investors want to buy stocks rather than 
sell them short. So I suppose there is going to be some kind of 
    I think one good way to deal with this--and, clearly, it is 
a form of grade inflation or bias--is to give investors 
information. One of our rules that we have proposed is that 
each firm publish the distribution of buy, hold, sell 
    Chairman Lieberman. Yes, that was, I thought, a very 
important recommendation because that information itself may 
have an effect on the analysts. Certainly it will have an 
effect on the consumers of their analysis.
    Mr. Glauber. I think so. And, of course, related to that is 
a rule that is in our proposal to require a price chart to 
accompany each research report in which the price of the stock 
is shown together with the analyst's ``buy'' and ``sell'' 
recommendations during that historical period. Again, I think 
it is going to alert investors to just how good--Mr. Torres 
said he would like some more information on just how good the 
analyst's record is.
    Chairman Lieberman. Right.
    Mr. Glauber. That is going to be that kind of information.
    Chairman Lieberman. Mr. Bowman.
    Mr. Bowman. Yes, Senator, I spent 17 years as an analyst 
and a portfolio manager before joining AIMR, and I can give you 
a little personal perspective about some other forces that 
might be in place here besides the conflict issue that we have 
talked about earlier. That is, when an analyst, especially in a 
smaller firm, is assigned two or three different industries to 
follow, that individual, if he were to follow or she were to 
follow every publicly trade company in each of those 
industries, would literally be responsible for following and 
giving due diligence to hundreds of companies, which is just--
there is not enough hours in the day or the week or the month 
in order to do that.
    So when I was practicing, in my firm what we did was we had 
certain screens, basic criteria and characteristics that we 
wanted to look for in a company before we even look at it and 
do research on it. And a lot of the companies fell out of those 
screens because they didn't meet the minimum criteria that we 
had in place to look at the company.
    So right away the analysts are looking at a biased group of 
stocks before they begin research, so what would traditionally 
have been sells, had they been covering them all, are filtered 
    So I think that is one of the things that is going, that 
since analysts can't follow every company there is to follow, 
some screens, screen out some of the inferior companies, and so 
they end up following an upwardly biased select group of 
    So I am not really surprised that there are significantly 
more buys than sells out there, just because an analyst can't 
cover every stock in the universe. I think that is one thing.
    And I think the other thing--and you called it the 
ambassador effect earlier, of who is the ambassador advocating, 
and I believe Senator Bennett mentioned something about the 
Stockholm effect, which has to do with not seeing--you get so 
close to something that you can't see the forest for the trees. 
I think there is some of that that goes on, too. I think that 
analysts can get very close to their companies, fall in love 
with the companies, but a very important point is you can be in 
love with a company but not necessarily be in love with the 
stock because the stock fluctuates in price. So what might be a 
wonderful company, if it is too rich and the PE is too high or 
whatever else you are looking at, you shouldn't be in love with 
the stock as well.
    So I think those are a couple of things----
    Chairman Lieberman. I hear you. We talked about this as we 
were preparing for the hearing, about the first point you made 
and the filtering-out effect in terms of how many stocks are 
evaluated. But I do think that the chart with the straight red 
line at ``buy'' was a consensus of the S&P 500. So I think we 
were measuring apples and apples there.
    Mr. Hill. That is the average of the consensus 
recommendation for each of the 500 companies.
    Chairman Lieberman. Right. I don't know whether either of 
you want to add anything, because you----
    Mr. Hill. I do.
    Chairman Lieberman. Go ahead.
    Mr. Hill. I agree on this filtering-out process, but let's 
put it into perspective. If you go back to the peak of the 
market in the spring of 2001--or spring of 2000, I guess it 
was, the ratio of buys and strong buys to sells and strong 
sells was over 100 to 1. Now, filtering out doesn't get you to 
    Chairman Lieberman. I agree.
    Mr. Hill. The other thing, too, is that the analysts are 
only recommending buy, where is the money coming from to buy 
those stocks? You have got to sell something. So, if they want 
to generate business, they ought to be putting some sells out 
there, too. But I think it is part of the Lake Wobegon problem. 
All the children are above average.
    Mr. Torres. Senator, we would attribute the problem 
directly to some of the conflicts of interest that I think will 
only grow worse in the future as the Gramm-Leach-Bliley act 
comes into play, where you have bigger consolidation in the 
financial services industry. The thing that I am surprised at, 
if the analyst doesn't have enough resources to cover all that 
they are supposed to cover, why are the buy recommendations 
left hanging out there? Why isn't there another designation, 
need to be updated, need more information, instead of having a 
recommendation out there that you might not be solid on?
    Chairman Lieberman. Mr. Bowman, I was going to ask you, you 
made a very interesting point, which I guess others may have 
made along the way, though not today, that part of what we are 
dealing with at Enron is a good system gone to extreme, gone 
bad, and the pressure of companies to continue to generate more 
quarterly earnings, leading people to make--leading what I 
might say are good people to make bad decisions, leading people 
to lose sight of their ethical bearing. And you make a proposal 
about attaching ethical standards, if I understand, to either 
CFA certification or maybe to the conduct of analysts 
generally. And, you do wonder whether if they were under some 
explicit series of standards personally--I know the analysts 
now, some of them I guess are certified, but a lot of them are 
accountable through their companies that come under the NASD.
    If they had a clearly articulated standard that their 
responsibility, like a fiduciary, was to serve their clientele, 
the public, that they were to be purely independent, and you 
wonder at some point whether if any of them were under 
pressure. There has been testimony here on the Hill that Mr. 
Lay and Mr. Skilling were pressuring analysts, or perhaps even 
under pressure from the investment banking side of the 
business, they could say at those points, hey, wait a second, 
pal, I would like to help you but I am about to lose my 
certificate if I do this.
    Is this kind of ethical standard that Mr. Bowman proposes 
capable of being administered and enforced?
    Mr. Glauber. Well, it is an interesting idea. We think of 
our rules as embodying a set of principles of proper behavior, 
if you want to call it ethical standards. And we think the 
articulation of these specific rules is the enforcement of 
those standards. So I agree with you that in the end, so much 
of what we are discussing here is not an issue of fraud. It is 
not an issue of violation of the 1933 or 1934 act. It is an 
issue of proper behavior for professionals.
    Chairman Lieberman. Right.
    Mr. Glauber. We think that can be embodied in private 
sector regulatory rules, like our rules, which in essence set 
what you would call an ethical standard. Your idea of going to 
an explicit ethical standard is an interesting one, I think.
    Chairman Lieberman. Mr. Bowman, did you want to add 
    Mr. Bowman. Yes, I do, Senator. We as chartered financial 
analysts and members of AIMR, some 55,000 of us, as a condition 
for retaining the right to use that designation, have got to 
annually sign a statement that says we comply with our code and 
our standards. And AIMR regulates its members. And if there are 
violation, AIMR has the processes to investigate them, and if 
those violations are deemed to be egregious enough, we have 
every right to basically prevent that person from continuing to 
use the CFA designation.
    And all of these individual codes of ethics and standards 
of professional conduct embody everything we have talked about 
here today: Reasonableness of recommendation, objectivity, 
    Chairman Lieberman. Am I right--excuse me a second--that a 
lot of the Wall Street analysts are not chartered?
    Mr. Bowman. They are not. A very small percentage of Wall 
Street analysts are chartered financial analysts.
    Chairman Lieberman. Is one possibility that we require or 
that NASD require that they be chartered?
    Mr. Bowman. I think that is a definite possibility, and we 
would be more than happy to work with you on that.
    Mr. Glauber. The point I would make is that the standards 
embodied in our rules are imposed upon all security analysts. 
You cannot be a member of a broker-dealer if you don't meet our 
rules, because violations of them, we toss you out.
    Chairman Lieberman. Mr. Hill.
    Mr. Hill. I agree that I think at least one of the analysts 
covering a company should be a CFA. I am a CFA even though my 
sign doesn't say it, like Mr. Bowman's.
    Chairman Lieberman. It is implicit.
    Mr. Hill. But in my career as a sell-side analyst, I was a 
CFA during that time.
    It is interesting, if we bring that down to Enron, the 
analysts that moved soonest and most aggressively in lowering 
their recommendations and actually going to strong sells, I 
mean, first to a hold and then to a strong sell, one was a CFA, 
the other was a CFA candidate. And out of the 16 analysts that 
covered Enron, only four were CFAs, plus the one that was a 
candidate in the midst of taking the exams.
    Chairman Lieberman. Very interesting.
    Let me ask a final question. You have been very generous 
with your time. Senator Torricelli raised a good point earlier, 
and it is the point that all of us are considering, which is: 
How can we act on the lessons we have learned from the Enron 
scandal and collapse? And how can we be constructive and 
restore confidence in the capital markets and, particularly, to 
give some greater confidence to these millions of middle-class 
families that have come into the market in the last two 
decades? I would like to think that the hearings that are being 
held on Capitol Hill and, I must say, the investigative work 
being done by journalists, people in the media, has given some 
warning and information, if you will to the investing public 
about where to put their confidence and where not to put their 
confidence. But now we also have to try to restore confidence. 
Some of it will come by natural forces of the market. There is 
a way in which I think Enron's experience--perhaps even the 
analysts who were here today and others analysts may not want 
to be called before a congressional committee. Certainly Enron 
and executives of other companies presumably don't want to be 
the targets of investigative journalists, etc.
    So there is a way in which the process going on now will 
have some effect, at least for a period of time, but then the 
question is what follows that beyond the natural forces of the 
marketplace. And the question is some things can be done within 
industry and professional groups to raise standards, as we have 
talked about. The question for us ultimately is: Is there any 
area--I know there are some areas where we should legislate in 
response to Enron. But in the specific case of the analysts, is 
there a proper place that any of you see for legislation?
    Mr. Glauber. Mr. Chairman, I think that the question of 
getting the balance right between legislation and SEC 
rulemaking and self-regulatory rulemaking is a very difficult 
one. The one place that you have discussed frequently during 
these hearings today is the question of structural separation 
between investment banking and security research.
    I would prefer to see if we can't make that work through 
private sector and SEC rulemaking rather than going to that 
kind of structural separation because I think it runs a risk of 
seriously reducing the amount of information available to 
    Chairman Lieberman. But you would keep the option open?
    Mr. Glauber. I surely would keep the option open. I think 
it is one you should discuss. It is a completely debatable 
issue. In my view, I think we can do it--that is, we, the SEC, 
the SROs can do it--through rulemaking, but I think the issue 
has to be kept on the table.
    Chairman Lieberman. Mr. Bowman, any place for lawmaking 
    Mr. Bowman. Well, as I said during my comments, Senator--
and I would agree with Mr. Glauber--we would very much prefer 
to see the industry itself resolve these problems. It has been 
our experience, anyway, through establishing the CFA program 
and others, setting other standards, that if it comes from the 
business, it is probably more apt to be embraced and obeyed 
than if it comes from outside sources.
    But certainly I would agree that in the absence of the 
industry being able to handle this on their own, it should be 
kept on the table.
    I think that one--there are two things, I think, that 
legislation cannot do, but I think we all really need to be 
aware of it in terms of protecting the public. The first one is 
that the FASB and the SEC have got to be allowed to act 
independently and set rules on behalf of investors rather than 
on behalf of issuers of financial statements. There has been 
way too much money being spent by the issuers of financial 
statements to lobby against accounting rules and accounting 
proposals that will actually favor investors but will cause 
companies, or whatever, to not be able to manage their earnings 
as effectively. And I think that the SEC and the FASB have got 
to be given the independence to do that, and the money, 
    The other thing is that individual investors--we are in a 
very early stage of individual investors becoming involved in 
the stock market. Before 1990--I can't remember what the 
percentages are, but the percentage of individual investors who 
had investment in the stock market was infinitely smaller than 
it is today. And I think individual investors are still going 
through an educational process here. What is investment? And 
what am I listening to on the TV?
    And I think that we need to be able to educate investors to 
understand that this is serious business. They are not going to 
treat their own medical problems without going to a doctor, and 
they are not going to represent themselves in a court of law 
without hiring an attorney. And I would like to see some of the 
same mentality be there on the part of individual investors 
that this is something that they can't do alone and they should 
rely on professional help to save their precious retirement 
accounts and their assets.
    Chairman Lieberman. And, of course, that is the problem. 
Right now there is a lack of confidence in the professional 
help, and that is what we have got to restore. Mr. Hill.
    Mr. Hill. I strongly echo Mr. Bowman's comments about the 
FASB and the SEC. As a matter of fact I spent all day yesterday 
at FASB as part of a financial performance reporting task force 
where hopefully we will make some changes that will alleviate 
some of these problems.
    But it is the money, again. FASB needs more money and needs 
to be treated independently, as was mentioned. The SEC, I think 
Arthur Levitt as chairman, set a new standard there. Hopefully 
that tradition can be carried on. But, again, they are 
understaffed because of not getting enough money.
    Chairman Lieberman. But right now you wouldn't propose any 
legislating regarding analysts?
    Mr. Hill. I think we have to move carefully there. Like the 
others, I wouldn't rule it out. As I said before, you have got 
to follow the money, and until we do something about changing 
analyst compensation, the problem is going to continue because, 
either consciously or subconsciously, it is likely to creep 
into the analyst's thinking. So if there was a way that you 
could solve the problem of the firms getting paid again for 
research so we could get it back to where it was, that would be 
    I don't have a good answer myself, but that is the issue.
    Chairman Lieberman. It is a pretty good one. Mr. Torres.
    Mr. Torres. Mr. Chairman, I think there is a very 
appropriate role for Congress to make sure that there is 
accountability in this industry and that there is an 
appropriate watchdog group set up to oversee it.
    I would go back to the lessons that we learned when Arthur 
Levitt was chairman of the SEC. He tried to push for strong 
rules on the accounting industry, and those got pushed back. 
When Chairman Pitt took over, there was talk that he was going 
to dismantle the fair disclosure rules that were passed. And, 
of course, in light of Enron, all that has changed.
    Congress needs to--should step in to ensure that the right 
rules are put into place and give some direction to both the 
industry and the regulators on how to handle this. The best way 
to restore the confidence in the marketplace for consumers and 
investors is for Congress to take a leading role here.
    Chairman Lieberman. I thank all of you for your time. You 
have made a substantial contribution to this Committee's effort 
to constructively respond to the Enron collapse and scandal.
    I am going to leave the record of the hearing open for an 
additional 2 weeks, if any of you or the other witnesses have 
any additional testimony you would like to submit, and to allow 
my colleagues on the Committee to submit questions to you in 
writing. But for now I thank you, and the hearing is adjourned.
    [Whereupon, at 1:22 p.m., the Committee was adjourned.]
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