Independent Financial Reseach Attacked

TALKING BUSINESS; Making Sure The Negative Can Be Heard

By JOE NOCERA
May 12, 2007

''If my attorneys knew I was here, they would be here with a hook,'' joked David A. Rocker a few weeks ago, looking out at a sea of people some 1,600 strong.

Mr. Rocker, 64, is a short seller -- or rather, a retired short seller; he hung up his spurs at the beginning of 2007 after a career that spanned almost four decades. His audience was made up largely of securities analysts from all over the country. This was the opening day of their annual convention, which was being held in the Hilton hotel in Midtown Manhattan.

Mr. Rocker and his firm, you may recall, were sued in the summer of 2005 by Patrick M. Byrne and his company Overstock.com. The suit asserts that he, along with the independent research firm Gradient Analytics and others, illegally conspired to drive down the company's stock. Gradient, the suit says, took its marching orders from Mr. Rocker, who paid it to publish damning reports that parroted what he wanted, so that he could make money as the stock went down.

The facts are not on Mr. Byrne's side -- Mr. Rocker wasn't even a client of Gradient when it began writing its tough-minded reports on Overstock, and indeed, the Securities and Exchange Commission recently sent Gradient a ''no action'' letter, which essentially cleared the firm of Mr. Byrne's charges.

But you know how lawsuits are: a year and a half later, the thing has barely gotten started. And you know how lawyers are: although Mr. Rocker believes passionately that Mr. Byrne's suit is nothing more than an attempt to silence criticism of his troubled company, he has held his tongue because that's what his lawyers have told him to do.

Not anymore. ''Free speech in America is very important,'' he told me recently. ''For securities analysis to be valid it needs to be objective.'' As Mr. Rocker pointed out in his speech, although 50 percent of all trades consist of people selling stocks, the vast majority of analyst recommendations remain bullish. Despite the settlement that the former New York Attorney General Eliot Spitzer (now governor, of course) extracted from Wall Street in April 2003 -- a settlement aimed specifically at making research more tough-minded and independent -- ''there are very strong pressures to be only positive about companies,'' Mr. Rocker said.

One pressure point is investors themselves; individuals and institutions alike want to see stocks go up, so they prefer bullish analysts over bearish ones. But another, greater source of pressure are the companies the analysts cover. Managements that are showered in stock options have their personal wealth directly tied to a rising stock price, so they are often infuriated when an analyst puts out a critical report or downgrades a rating to a sell. And they retaliate.

They refuse to allow the negative analyst to ask questions on conference calls. They somehow ''forget'' to include him in e-mail messages that are sent to other analysts. They decline to attend that analyst's conferences. They complain to his boss, who then inquires as to why the analyst has to be so darn negative all the time. Many companies still use investment banking business as a way to reward the firms that employ analysts they like and punish the ones with analysts they don't like -- even though that is a practice Mr. Spitzer sought to eradicate.

And sometimes companies sue, just as Overstock did. True, it's not an everyday occurrence -- and when it does happen, companies never admit that their suits are intended to silence critics, or put them out of business. Mr. Byrne, for instance, has always denied that his intent was to shut down criticism of Overstock. But it is hard to believe that silencing critics isn't the intent.

''It is a pernicious practice,'' said Owen Lamont, a professor at the Yale School of Management and a defender of short sellers.

''The rising threat of litigation is a huge disincentive for expressing negative views,'' Mr. Rocker said in his speech. ''It is costly and immensely time consuming. You have to face personal disparagement in the media, because they always have to include the allegation that you supposedly manipulated stocks. And it creates internal discord within the firm.''

Plus, it works.

You don't believe me? Exhibit A: David Maris, an analyst who used to cover Biovail, a Canadian biotech company, for Banc of America Securities. After writing a series of blistering reports about Biovail, Mr. Maris and his wife discovered they were being followed by private investigators. For a time, Banc of America stood by its analyst, providing security and giving him free rein to cover the company as he saw fit. But in February 2006, Biovail filed a lawsuit against Gradient, a handful of hedge funds and Mr. Maris, making the same kind of stock manipulation accusations that Overstock made six months earlier. Not long after, a suit was filed on behalf of Biovail's shareholders that included Banc of America Securities itself as a defendant.

Once Banc of America Securities was involved in the litigation, it dropped coverage of Biovail. ''Regrettably,'' wrote Joan Solotar, the firm's head of equity research, ''our coverage decision removes an informed and independent voice on Biovail.'' Well, that's one way of putting it. Here's another: Biovail won.

Officials at Banc of America Securities insist that the situation is an aberration. But is it, really? What will it do the next time an angry company sues? If the tactic worked for Biovail, which by the way insists that the evidence will support our allegations, why won't it work for any other company annoyed at BofA's analysts? As for Mr. Maris, he is no longer with Banc of America Securities. He left last December for a hedge fund, which means his research no longer helps anybody except his fund. So his independent voice has been silenced permanently.

Exhibit B: Timothy Mulligan, former author of the newsletter ''The Eyeshade Report.'' Mr. Mulligan, a forensic accountant and lawyer, started a small business writing reports on ''quality of earnings'' -- that is, how shaky (or solid) a company's reported earnings were. A few years ago, a company called Matrixx Initiatives, which makes Zicam, a nasal spray, sued a group of anonymous message board critics -- presumably to shut them up. In 2004, Matrixx subpoenaed Mr. Mulligan, demanding that he turn over his sources and subscriber list, on the theory that that would help Matrixx identify the message board critics.

Mr. Mulligan resisted, but the case dragged on for years. In the meantime, Mr. Mulligan, who was representing himself, was spending more time on his legal case than on his business. ''It was overwhelming,'' he said. ''If I had had a lawyer, I would have had a legal bill in excess of $300,000. Our legal system is such that you can easily keep a frivolous lawsuit alive for years.'' Indeed, although Matrixx abandoned the case in January, it was too late for Mr. Mulligan. By November 2005, he had closed the business. (A Matrixx official did not return my phone call.) Another independent voice silenced.

Exhibit C: John Gwynn, an analyst with the small firm of Morgan Keegan, who covered a Canadian insurance company called Fairfax Financial Holdings, which also has a history of lashing back at critics. (What is it about these small Canadian companies?) Last July, Fairfax filed a big lawsuit against 20 defendants, asserting -- what else? -- stock manipulation. One defendant was Mr. Gwynn, who had been one of the few bearish analysts covering the company.

In the immediate aftermath, Mr. Gwynn, who declined to return my phone calls, continued covering Fairfax. But in January, he dropped coverage. ''The discontinuation of Fairfax coverage is not a reflection of any change in our relatively negative perspective of the company's fundamental business prospects,'' he wrote in a note to his clients. ''Rather it is the result of a litigation strategy designed by Fairfax to silence negative research coverage.'' Another firm that has been openly skeptical of Fairfax, Institutional Credit Partners, has had its staff followed and investigated, just like Mr. Maris.

In an e-mail message, Mike Sitrick, who represents Biovail and Fairfax, said: ''The only analysts Fairfax named in its lawsuit are those which it alleges used improper means to attack the company and impact the price of the company's stock. Mr. Rocker's assertions that the suit was filed to stifle criticism are not only untrue in the case of Fairfax, but a thinly veiled attempt to divert attention from the wrongdoing alleged in the complaint.'' Mr. Sitrick denied that Mr. Maris was ever ''tailed'' but says that Fairfax has investigated International Credit Partners.

And then there's Gradient, a skeptical independent voice if ever there was one. As it happens, Gradient's co-founder and editor in chief, Donn Vickery, has also decided the time has come to speak out. I talked to him a few days after I heard Mr. Rocker's speech.

''If we hadn't been around for 10 years, the lawsuits might have put us out of business,'' he said. ''As it was, our growth was slowed, and our customer retention was more difficult. Certainly our legal costs are way up. We've had employees accosted in parking lots by private investigators. Calls to home numbers and cellphones. We've had more turnover during this time, and you have to figure this has had an impact.'' And of course, he's still embroiled in two lawsuits, both of which deserve to be thrown out of court, but will probably last for years.

These are bullish times in the stock market, so it is easy to forget how important it is to have skeptical -- and even negative --voices to counterbalance all the happy talk surrounding stocks. Even when the skeptics are wrong, they make the market healthier because they offer a point of view that people need to hear. And quite often, of course, they're right. Mr. Rocker, for instance, sniffed out problems at Boston Chicken and Krispy Kreme long before the market did. Wouldn't you have wanted to know what he was saying about those companies?

''I hope all of you will recognize this threat and act courageously to protect free expression in the investment business,'' Mr. Rocker said to the assembled analysts at the end of his speech. ''We need to show those who would silence us that they are wrong.''

Are you listening, Banc of America Securities?

Copyright 2007 The New York Times Company