It's easy to look back on the tech bubble at the turn of the 20th century with a sense of nostalgia. Unlike the greedy financiers of late, the decade preceding Y2K was marked by naive 20-somethings intent on changing the world with a newfangled form of communication called the Internet.
It was a time when dated and musty ideas like revenue, profit, and margins were shunted aside in favor of "stickiness" and "eyeballs." An era when a company like Pets.com could go public to wide market acclaim even though it lost money on virtually every sale it made and went bankrupt less than a year after its IPO.
Indeed, the late 1990s were truly the heyday of initial public offerings. In the decade prior to 1999, the market averaged 547 IPOs a year. It's averaged 192 since.
Yet underneath the innocence and ingenuity of Silicon Valley, there lay a more sinister force responsible for the artificial inflation of IPOs and the resulting $5 trillion in wealth that evaporated virtually overnight when the tech bubble burst on March 20, 2000.
The Global Analyst Research Settlement
In what came to be known as the Global Analyst Research Settlement of 2003, 10 of the county's biggest financial firms -- including Goldman Sachs (NYSE: GS ) , JPMorgan Chase (NYSE: JPM ) , and Citigroup (NYSE: C ) , among others -- coughed up nearly $900 million for producing misleading and sometimes fraudulent research reports to their retail clients in order to pump up shares and attract IPO underwriting fees from investment banking clients.
"The banks did this," said Eliot Spitzer, the New York Attorney General at the time, "because of the conflicts of interest woven into their business model. They were underwriting the very stocks they were also touting, making the investing public dupes helping the banks generate enormous fees."
The behavior of Piper Jaffray (NYSE: PJC ) in August of 2000 provides a typical example. That month, the firm's investment bankers made a pitch to underwrite the IPO of a highly speculative medical technology company. Included was a mock research report recommending the stock as a "Strong Buy." After being awarded the desired role, due in part to the pitch, and recording the nearly $4 million in associated fees, research analysts at the investment bank initiated coverage of the company with the promised, and ostensibly independent, "Strong Buy" recommendation. Piper Jaffray even compensated research analysts based on how much revenue the investment bank was earning from the company.
As a result of the settlement, in addition to paying nearly $900 million in fees and disgorgement, at the time a historic amount, the financial firms agreed to physically and operationally separate their research and investment banking departments. Known in the industry as Chinese walls, the purpose was to help ensure that the latter didn't continue to improperly influence the independent judgment of the former.
More recently, it's been reported that Facebook's (Nasdaq: FB ) underwriters (including Morgan Stanley, JPMorgan, and Goldman Sachs) privately warned some of their favored clients about the company's slowing revenue prospects as they continued to hype its public offering.
IPOs at any cost
The JOBS Act removes many of the investor protections that Wall Street agreed to in the Global Settlement. While it does so under the auspices of job creation, one must wonder whether boosting IPOs at the likely expense of fraud is really the most effective means to achieve this end. We don't think it is.
Let the SEC know how you feel about the JOBS Act by following this link. Simply tell them you're an individual investor and feel free to share your concerns or suggestions.
Click here to read the final piece in our series: "Our Letter to the SEC."
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