June 19, 2005
Analyst Behavior After Regulation AC
Posted by Christine Hurt

One of the first Wall Street practices to come under scrutiny after the bursting of the stock market bubble, and one of the first practices to be immediately surrendered, was the customary trumpeting of issuer shares by analysts employed by the underwriters of those shares.  As stories of analysts' pronouncing shares as "buy" or "strong buy" even while disparaging the same shares in emails came to light, the SEC quickly passed Regulation AC and approved NASD rule 2711, which purported to separate analyst work from investment banking work to ensure that research reports would be independent and not paid for by the issuer.

Today, a NYT article details the story of the Warner Music IPO and Merrill Lynch, a member of the underwriting syndicate.  Warner Music had chosen ML because of an analyst who worked there, Jessica Reif Cohen, who was known as the expert on music industry stocks.  However, it was Ms. Reif Cohen who interrupted the road show euphoria to say that the emperor had no clothes, or in this case, the shares were not worth the $25-30 that the lead underwriters were predicting.  Ms. Reif Cohen said that the shares were worth $16 and could not be persuaded otherwise.  Merrill Lynch eventually dropped out of the syndicate.  News of the break-up hit the street, the share price range had to be dropped to $17, and on Friday, the shares closed at $16.82.

In 1999, would Warner Music and its shareholders been able to put enough pressure on ML to change Ms. Reif Cohen's tune?  (small pun intended).  We definitely have enough stories that comport with that scenario to think it's a possibility.  But this time, the analyst and the firm did not budge, either out of a sense of a new culture or fear of legal consequences. 

On a side note, I wonder if the street value is $16 and change now because that is the true fundamental value and Ms. Reif Cohen knew it or is the street value $16 because Ms. Reif Cohen said it was?

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