Piper's Pickers

How the Street Changed

To understand what is happening with Piper and the brokerage industry generally, let’s step back for a moment to get our bearings. Wall Street and that amorphous thing known as “the stock market” essentially cleave into three distinct pieces.

One is the “retail side” (they like to call themselves “sides”). These are the people who manage brokerage accounts for individual investors. The research analysts at places like Piper, Merrill Lynch, UBS, and Wachovia Securities don’t interact much with retail stockbrokers, and most brokerage houses want it that way. In fact, most brokerage houses discourage retail stockbrokers from picking individual stocks for their clients: too many potential compliance problems. Instead, retail brokers are encouraged to “gather assets” (i.e., get your money), then put those assets into mutual funds and other professionally managed investments.

A second piece is Wall Street’s “sell side”—brokerage-house research departments. They “sell” investment ideas to the third piece of the market, the “buy side,” which comprises the army of professional money managers known as institutional investors. These are the people who manage mega-million-dollar portfolios of stocks for mutual funds, endowments, foundations, pension funds, and (more recently) hedge funds. Institutional investors account for the vast majority of the trading on Wall Street.

Looming in the background are the regulators—the SEC, the National Association of Securities Dealers (NASD), public legal eagles like New York Attorney General Eliot Spitzer, and state securities overseers across the United States.

Two immensely important things have happened in the past five years to transform the professional lives of Munster and the thousands of other sell-side analysts serving Wall Street’s institutional marketplace.

The first was an SEC ruling called Regulation Fair Disclosure. Before Reg FD was put into effect in October 2000, analysts on both the sell side and the buy side (mutual funds and other institutional investors have analysts, too) could ingratiate themselves with the managements of public companies, gleaning tidbits of insight into their businesses. The sell-side analysts perceived to know the most about a company would get the first call from the buy side, and would be rewarded with trades and the commissions they generated.

FD stopped all that. Now companies are required to disseminate information equally and simultaneously to all investors, putting an end to all sorts of under-the-table “guidance” that the sell-side guys were using to add value to their research.

The second major event was the implosion of the dot-com/telecom bubble. We’re all too familiar with the corporate scandals precipitated by the crash: Enron, WorldCom, Tyco, and the hundreds of Internet companies that came and went with the puff of a ginned-up pro-forma income statement.  In the late ’90s and into 2000, stock analysts crisscrossed the country teamed up with investment bankers, hawking deals, promising glowing research reports to prospective corporate clients looking to go public, and reaping millions in banking fees for themselves and their firms.

Indeed, investment banking ruled the ’90s.  According to SEC documents, Piper’s investment banking profits from 1998 through 2001 totaled $660.7 million, a staggering sum for a firm its size. This kind of money was the methamphetamine of the day, fueling the frenzy for investment banking business and the excesses that too often accompanied it.

What’s more, since the mid-1980s, Piper Jaffray has endeavored to run with the likes of Merrill Lynch, Goldman Sachs, and other top-tier investment banks. Not satisfied with financing companies in its own backyard, Piper reoriented its banking and research department nationally, focusing on the rich vein of banking opportunities in biotechnology, medical devices, software, computer networking, and other sectors. And to elbow its way into this highly competitive environment, Piper had to offer more “loyal” analysts, more favorable coverage, more unbending support.

In 2002, after the bubble exploded, regulators went after 10 sell-side brokerage houses, including Piper Jaffray. That December, the firms and the regulators agreed to a $1.4 billion “global settlement” stemming from excesses perpetrated during the bubble. Piper’s portion of the bill: $32.5 million. In particular, regulators cited its analysts’ touting of shaky dot-com stocks to attract investment-banking business and earn big bonuses.

The result of Reg FD and the global settlement: A long-time compensation model for analysts went up in flames, leaving sell-side brokerage houses facing the possibility that their research departments might actually be cost centers rather than profit centers. Says Bob Kleiber, a former Piper analyst (now vice president of investor relations for Eden Prairie–based technology company Digital River), “There are some on the buy side who continue to tell me that they are struggling to find a purpose for the sell side [since Reg FD].” And since the global settlement, the cozy relationship between investment banking and equity research is severed.

All of this brings us to Robert W. Peterson.