Old 07-25-2008, 09:20 AM Offline   #1 (permalink)

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Default A Dot-Com Banker Who's Stuck in the Past

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Frank Quattrone thinks the dearth of startup IPOs in today's market is due in large part to the Wall Street research reforms made after the tech bubble burst.
He's wrong.
At a technology conference at Stanford University yesterday, Quattrone said the industry should petition to remove the regulations that prevent sell-side research analysts from being compensated for their efforts in getting startups through the IPO process. "It hurts the competitiveness of our country to deny companies access to research analysts," he said.
The reforms were made after then New York Attorney General Eliot Spitzer went after research analysts including Henry Blodget and Jack Grubman for publicly recommending stocks they privately disparaged.
Quattrone, who was arguably Silicon Valley's top investment banker during the dotcom boom, spent years fighting federal charges relating to an investigation into his allocation of IPO shares. He eventually prevailed, and he now runs a technology boutique bank called Qatalyst Group.
To understand why Quattrone is wrong, it's helpful to remember how Wall Street research worked before the reforms. I witnessed it firsthand as a research associate at Hambrecht & Quist in the mid-1990s, when startup software companies were practically lining up at the door for their chance at the public markets.
Research analysts back then were more like startup consultants, doing everything from working with bankers to pitch new business to IPO candidates to hosting roadshow presentations with institutional clients ahead of the offering.
There was no "Chinese Wall" between banking and research. I once had a banker ask me for the models for two companies we covered, because they were weighing a merger. In fact, bankers and research analysts worked so closely that it was difficult to determine where one department stopped and the other started.
Both groups received bonuses based on the business they won and the performance of the stocks after their debut. That's all well and fine for the bankers, who moved on to other deals after celebrating at the closing dinner. But 25 days after the IPO, the research analyst was supposed to initiate coverage using his objective analysis.
Invariably, this recommendation would be a "buy" or a "strong buy."
At H&Q, only once did I see an analyst initiate coverage of a hot IPO the bank had underwritten with a "hold" recommendation. The stock, i2 Technologies, had simply climbed too high in the first few weeks of trading to justify an investment recommendation.
The morning his report was issued, the analyst faced a stream of irate institutional sales staff and perturbed bankers. They flooded his office, screaming at him behind closed doors, reminding him how much i2 had just paid the bank.
Under the new rules, this scenario would seem preposterous. Bankers and research analysts are physically separated, and they must clear legal hurdles even to speak. Research analysts rightfully play no role in pitching the startups or in selling the stock to institutional investors. And they also don't receive additional compensation for business the bank gets from companies they cover.
Quattrone argues that this is all wrong, and that startups can't attract investor interest without the expertise of the research analysts. He thinks that's partly to blame for the fact that we're not seeing many IPOs in Silicon Valley these days.
He argues that small companies can't get coverage because the few research analysts left on Wall Street only focus on large cap stocks.
The fact is, startups shouldn't have to rely on their bank's analysts to sell their story for them. If their business model is sound and their valuation reasonable, their stocks will get noticed by institutions.
And why should any bank's institutional clients be subjected to a sales pitch from an analyst who is fundamentally incapable of providing an objective opinion? Individual investors aside, it's the banks biggest clients who should be thankful they no longer have to hear a used-car sales pitch from their brokers every morning.
The IPO market isn't thriving for many reasons. But bringing back the old sell-side research scheme to revive it isn't the answer.


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