Were underwriters really undertakers?
As an Internet analyst at investment bank PaineWebber, James Preissler witnessed the birth of traffic as the currency that would fuel the Internet's early commercial history.
He was part of the land rush of entrepreneurs, venture capitalists and investment bankers who latched onto traffic--the number of people visiting Web sites--as the measurement to gauge success in the absence of any established business precedents. Their thinking was simple, if not simplistic: Why bother with difficult matters such as revenue and earnings when big traffic was all that was needed for a successful initial public offering?
"There was no experience--we were all shooting in the dark," Preissler, now an executive at HelloAsia, an Internet direct-marketing firm, said in an unusually frank interview. "Everyone was making a very tenuous connection between basic metrics they didn't fully understand and some nebulous projections that it would become revenue."
Such was the dubious foundation for the house of cards that was to become the digital economy.
Start-ups manufactured from business plans drawn on the backs of envelopes were rushed through the IPO process by banks and other institutions in the complicated procedure known as "underwriting." In shepherding a company's stock to the open market, underwriters buy the new securities in preparation for selling them to institutional and retail investors.
In the past, underwriting a company meant taking on some risk. But as the Internet bubble grew, the process became akin to minting money at a time when companies routinely expected their stock prices to at least double or triple on their first day out. For the underwriters, the payoff comes from selling the stock at a higher price to the public than what they paid to the company--a practice that led Wall Street firms to reap record revenues from the IPO boom of the late '90s.
"Undoubtedly there was hype, and lots of money was made," said one investment banker who requested anonymity. "It is really hard to tell people to make less money: 'Come into work every day and make less money.'"
A lesson in objectivity
That hype is what others find troubling. Most, if not all, of these underwriters were part of larger financial institutions charged with providing impartial advice on stocks to individual investors. The ability of these institutions to remain objective while benefiting from underwriting certain stocks has long raised questions involving potential conflict of interest.
Some investment bankers say they served as the voice of reason, telling prospective companies to cut their projections in half and to create realistic goals. But others say such warnings were the rare exception at the height of the merger frenzy that gripped the industry.
"I don't understand what (underwriters) mean by 'being the voice of reason,'" said Fred Taylor Isquith, an attorney at Wolf Haldenstein Adler Freeman & Herz, a law firm that specialises in securities class-action suits. "Underwriters are salesmen; they are committed to selling the stock."
Although the issue is not new, the practice of underwriting has fallen under unprecedented scrutiny in no small part because so many investors lost such large amounts of money in the free fall of Internet stock prices.
Take the case of TheGlobe.com, an online community site, which soared about 606 percent the first day it traded back in November 1998, pumped up by its exuberant traffic numbers--the steroid of choice. The stock has plunged more than 96 percent from its offer price as traffic figures have failed to produce promised revenue.
Wall Street's role in this kind of debacle has drawn the attention of Congress. Richard Baker, a member of the House Committee on Financial Services, on May 16 announced a hearing tentatively scheduled for mid-June to examine the possible conflict of interest between the investment banks' underwriting branches and their analysts, who purportedly provide unbiased opinions on stocks often held by their own banks.
"While the agenda for the hearing has not been set, when you examine possible conflict-of-interest issues in the investment banking business, the IPO question is likely to come up," said Michael DiResto, Baker's press secretary.
