Last of six articles

John E. Olson, a senior natural gas analyst at Merrill Lynch & Co., wasn't surprised to see his boss walk into his 27th-floor office first thing in the morning. He'd mentioned that he'd be flying in from New York to interview a job candidate.

What shocked Olson that morning in May 1998 was that his boss closed the door and sat down, "and the first word out of his mouth was 'Enron.' "

"How could you do this?" his boss said.

"Do what?" Olson wondered.

"You've blown this deal," he remembers his boss, the firm's research director, saying. "We're missing this thing." He meant that Olson's stubborn resistance to giving Enron Corp.'s stock a "strong buy" rating -- which Olson knew had infuriated the energy giant's top management for years -- was having unacceptable repercussions for Merrill Lynch.

His boss, Andrew J. Melnick, then threatened to strip Olson of his stock options and other benefits critical to his eventual retirement, Olson says. Alternatively, Melnick, who declined to comment on the encounter, said he would consider allowing Olson to take early retirement at age 56. Either way, after six years with Merrill Lynch, he was out.

There didn't seem to be much room for negotiation. Olson went home and told his wife he'd been forced out of his job. "If your choice is to walk the plank and get eaten by alligators or to take early retirement, what are you going to do?" Olson says now.

In retrospect, perhaps he shouldn't have been so shocked.

Hadn't he tangled at analysts' meetings, sometimes even at social occasions, with top Enron executives who asked when he was going to raise his recommendation? Instead, he'd downgraded its rating from "accumulate" to "neutral" the summer before. Hadn't he heard "rumbles, backdoor things" about how ticked off Merrill Lynch's investment bankers were at his intransigence?

But Olson, who'd been an equities analyst for more than 30 years, hadn't quite grasped the extent to which his profession, and the financial industry itself, had changed around him. He was still relying on "Chinese wall" policies that traditionally protected analysts' independence, insulating their research from their firms' banking and trading interests -- and the wall was crumbling as the '90s brought more deals, more money, more pressure.

Not until this spring, when Senate investigators obtained internal memos and e-mails indicating that Enron and Olson's own colleagues were gunning for him, did he realize just how out of step he'd become.

Now resettled at a smaller Houston securities firm, reading press revelations about what some analysts have done and what's been done to them, about multimillion-dollar fines and "spinning" and lawsuits, he almost mourns. "The business," he says, "has been so hopelessly compromised."

'Analyst' Redefined

Once, in the years before federal, state and industry regulators began scrutinizing them for conflicts of interest, analysts were Wall Street's scholar-geeks, poring over balance sheets and running financial models.

"Good securities analysts," Olson says, "are crossword-puzzle people and chess players." They didn't expect to get paid nearly as much as investment bankers or traders; in 1966, when Olson received his Wharton School MBA, the thought of an analyst ever earning seven figures in a year was laughable. They were not public figures. They liked quietly figuring things out.

Olson still does. An exemplar of the breed, he is unassuming, thoughtful. Everything about him is long and thin -- face, limbs, torso -- and a pair of schoolmasterly tortoise-shell reading glasses heightens the resemblance to Ichabod Crane. Neat stacks of prospectuses, trade journals and regulatory filings cover much of his office floor at Sanders Morris Harris Inc., where he is the director of research.

He learned the trade during nearly five years at Smith Barney in New York, then spent several years at investment firms in Atlanta, doing what analysts did: talking to company managers and customers, examining quarterly reports and other documents, doing legwork, issuing data and forecasts. Always concentrating on the energy industry, he was excited to be recruited by a regional firm in Houston, which in the late '70s was "the energy capital of the planet." He visited oil fields in Guatemalan jungles and on Alaska's North Slope.

Like most on Wall Street, he didn't foresee that federal legislation in 1975 would have a seismic effect, eventually transforming the analyst's job description. Amendments to the Securities Exchange Act of 1934 deregulated the fixed commissions that brokers charged for stock trades, and the commissions promptly "fell off a cliff," said John C. Coffee Jr., a Columbia University securities-law expert. Since firms' trading departments had paid analysts' salaries, and the profit margins from trading were shrinking, someone had to pick up the tab. The upshot was that investment-banking divisions began paying an increasing proportion of "sell side" research costs and expected certain services in return.

(Sell-side analysts like Olson work for brokers and dealers who sell securities; those who manage mutual funds and pension funds hire analysts, too, but that "buy side" research stays in-house and rarely reaches the public.)

The changes began affecting Olson's career, but in small, almost imperceptible ways. Throughout the '80s he felt few ripples, though he did catch a glimpse of the way corporate chieftains had begun expecting analysts to sound perennially upbeat. Working for Drexel Burnham Lambert Inc. in Houston, he crossed paths with one of its more colorful clients, oilman T. Boone Pickens. Olson didn't think Pickens's attempt at a hostile takeover of Gulf Oil L.P. would succeed, and he said so; he says Pickens subsequently collected his skeptical published comments and sent copies to Drexel Burnham's board members -- and to Olson. Olson's packet included a note from Pickens complaining that his remarks were "singularly inappropriate." (Pickens says he remembers Olson but not the incident.)

Whatever its later problems -- the firm imploded in the midst of the junk-bond scandal -- Drexel Burnham supported its analyst and, according to Olson, "never once told me that I needed to recommend anything."

But the growing influence of investment banking was becoming more evident. In 1990, by then working for First Boston Corp. in Houston, Olson gave an interview to Forbes magazine, recommending eight natural gas stocks he considered likely to prosper after the Iraqi invasion of Kuwait. Enron was not among them.

He'd covered the energy company and its predecessor firms for years, "since before Enron was Enron," knew many of its people, and had even attended chief executive Kenneth L. Lay's wedding reception. And he'd already begun to hear from Lay about the lukewarm recommendations. Lay, he'd found, was "very affable and amiable" with analysts but would call their bosses or investment bankers when he had complaints. But concluding that Enron "was still having trouble earning its dividend," that "it still had a lot of leverage" -- meaning debt -- "and it was very expensive," Olson left the stock off his list.

First Boston's head of energy investment banking was in his office shouting almost as soon as the magazine hit the stands. "He'd just been visiting with Ken Lay," as Olson remembers the conversation, "and Ken was saying he paid First Boston millions of dollars a year in investment banking, and its blankety-blank analyst couldn't have Enron featured in Forbes magazine?"

If Olson didn't give Enron a "strong buy" recommendation by the end of the year, he'd be fired, the banker warned. He called Olson's boss -- First Boston's research director in New York, who confirms Olson's account -- and made the same threat.

His boss, however, "was right there, telling these bankers to get out of his business, that they were way beyond the pale," Olson said. Ignore the blustering, Olson's boss told him. The Chinese wall held.

But for how long? As Olson worried that his small team didn't have a future at First Boston, Goldman Sachs & Co. called with a job offer, and Olson and his group moved over. "Many sell-side analysts spent their careers on roller skates," Olson explains, "because the opportunities kept getting better and better."

At Goldman he experienced no pressure to upgrade stocks, but the structural changes affecting analysts were becoming more apparent. Olson felt "an implicit sense" that his primary role was no longer to produce research but to help secure new business -- underwriting initial public offerings and advising on mergers and acquisitions -- for the investment bank. That's how Goldman made the bulk of its money, and that's how its better-paid analysts, whose compensation was determined largely by how helpful they'd been to the banking division, made theirs. Olson spent much of his time on "bake-offs" -- new-business presentations.

So when Merrill Lynch called in 1992 with "a very, very generous offer," he and his team roller-skated over. He thought the switch would mean a return to a more traditional research role. He was wrong.

Stars Are Born

By the mid-1990s, the pressures on securities analysts were Wall Street's open secret. Investment bankers seeking to underwrite a deal not only wanted analysts' advice beforehand, they wanted their analysts to be high-profile stars who could help fend off competing underwriters and land deals. Afterward, they wanted the analysts' reports to stay bullish enough to keep the stock moving and the new banking clients happy.

One who saw this firsthand was Thomas K. Brown, an analyst at Donaldson, Lufkin & Jenrette Securities Corp. during the '90s who specialized in regional banking stocks and repeatedly won the coveted top slot in Institutional Investor magazine's annual All-America Research Team rankings. "I'd go on calls with investment bankers," Brown recalls, "and they'd say, 'Here's the number one regional bank analyst in the country. He can do wonders for the valuation of your stock if he follows your company. But Tom only has so much time, so if he's going to follow your company, we would want to do your investment-banking business.'

"And everybody knew -- myself, the bankers and the company -- that [I] was going to 'follow the company' with a favorable investment opinion," Brown says.

At many firms, analysts' rewards for their cooperation with bankers were reflected in their annual bonuses. At DLJ (as at some other firms), however, analysts say they were promised a percentage of the banking fees.

Their boss made the rounds of analysts' offices each quarter, reviewing just how much an analyst would receive -- usually six figures -- for each deal completed. Brown's biggest payout was more than $100,000 (on top of his $1 million-plus annual salary and bonus) for helping to take the now-faltering Affinity Technology Group Inc. public in 1996. He was fired in 1998 for being, he said, "a big wet blanket" on mergers and acquisitions. Credit Suisse First Boston Corp., which acquired DLJ in 2000, declined to comment.

The '90s certainly fattened analysts' wallets. Salaries ballooned for those highly ranked by Institutional Investor, the "axes" who could move markets. And it was easier to be a star, as new financial media outlets such as CNBC, CNNfn and Fox News needed talking heads. Many senior analysts were making $1 million to $2 million a year by the late '90s, and in hot sectors like telecommunications and technology, the Street was gossiping about "three-by-five" deals (a three-year guarantee at $5 million a year) and "three-by-sevens."

An old hand like Olson watched in astonishment as Mary Meeker, Morgan Stanley's Internet analyst, graced the cover of Barron's ("Queen of the Net," it proclaimed) and was profiled by the New Yorker. Henry Blodget made his rep by predicting in December 1998 that Inc. (then at $242) would trade at $400 within a year; when it got there within three weeks, Merrill Lynch promptly hired him for $3 million. As Blodget made waves and media appearances -- about 125 on CNBC and CNN -- over the following two years, his compensation rose to $12 million, according to an affidavit filed in New York state's lawsuit against Merrill Lynch.

At Salomon Smith Barney Inc., telecom analyst Jack Grubman was quite open about being a dealmaker -- "banking-intensive" was the way he described himself to BusinessWeek -- and later told a House committee that he made more than $15 million a year. The underwriting deals such stars could attract were so enormous that firms found them worth the investment.

But while analysts prospered financially during the '90s, many also felt the heat.

They were expected to pitch in with marketing efforts. The sales force wanted them to make scores of phone calls to banking clients and to alert investors to market developments that could help sell stocks. Marketing calls and client visits ("roadshows") were important for snagging top Institutional Investor rankings, since the buy-siders they schmoozed with were those the magazine polled.

Nobody in this environment liked "sell" ratings. Not the bankers, who needed rising stock prices to please their clients. Not the clients, who wanted their companies to be worth more. Not the sales and trading staff, who could unload more shares when profits seemed inevitable. Not even the investor customers -- either institutional or "retail" (translation: small individual investors) -- who didn't want to hear that they'd bought losers. Any of these parties might call spoilsport analysts to complain. Investors trashed analysts on Web sites. A few analysts even reported death threats when they downgraded stocks.

Feeling bullied from all sides, most analysts simply stopped using "sell" ratings at all. The proportion of those recommendations fell below 1 percent in 2000, according to Thomson First Call. Meanwhile, analysts complained that all their new responsibilities meant they no longer had time to do quality research.

Exacerbating this, of course, was the long bull market, which rewarded -- for a while -- relentless optimism. The tech field, in which more infant companies went public each week, was uncharted territory: Nobody could really be an expert, so anyone could plausibly claim to be. An analyst skeptical about an Internet company's prospects -- as veteran Lise Buyer, most recently at Credit Suisse First Boston, sometimes was -- was simply a party pooper. "People around you could point to 10 other companies with the same math and they'd gone public and were doing well," she says. "It was very hard to say no."

Buyer's moment of truth -- she left CSFB two years ago -- was Blodget's call on Amazon. "That was the ringing of the bell: It was the cheerleaders, not the analysts, that were the stars in that market," she says. "The fundamentals of analysis went by the board."

"Cheerleader" was the comparatively nice way to put it. On the buy side, money managers like Robert Gensler, who runs T. Rowe Price Inc.'s Media and Telecommunications Fund and its Global Technology Fund, were growing increasingly mistrustful. Office doors at Price were sprouting cutout photos of tulips, reminders of an earlier case of market mania. "Certain shops, it was just known that their analysts were banking whores," Gensler says. "That was the term we all used."

Because analysts often did have valuable insights, even if they didn't feel free to express them, Gensler and other clients learned to "drill down" during lengthy phone calls. Eventually, "you could find out what they really knew," he says. "But the public, how would they know?"

For the most part, the public didn't. "The individual investor had to send in a box top to get his secret decoder ring," says Charles L. Hill, director of research at Thomson First Call.

Savvy investors understood that an analyst's "buy" rating probably meant "hold," that "hold" was a cue to sell, that "sell" might never appear. They could decipher red flags included in a research report, even when the rating was positive. Certain academics were on the case, too: A 1999 study co-authored by Dartmouth College and Cornell University professors in the Review of Financial Studies concluded that analysts' recommendations on other banks' IPOs were reasonably reliable, but on deals their own firms were underwriting, they showed "significant evidence of bias." But ordinary investors watching CNBC or trolling the Net for tips might well remain in the dark, unable to interpret what they were seeing.

Still, most analysts thought they could "manage the conflicts" -- a common phrase -- and if they were senior enough or powerful enough, some did resist the pressures. Olson thought he could, even when the same investment bankers he'd jousted with at First Boston moved over to Merrill Lynch shortly after he did.

Olson wasn't a star. He ranked third or runner-up in Institutional Investor's All-America poll most years; he wasn't on TV. He never had a million-dollar year, or even an $800,000 year, and suspected that his skepticism about Enron -- a minority opinion among energy analysts -- cost him hundreds of thousands of dollars annually in reduced bonuses. Certainly Olson had heard from Lay and his successor, Jeffrey K. Skilling, when he sought explanations about Enron's baffling financial statements at analysts' meetings, that he "just didn't get it."

Olson, says a fellow energy analyst, "can be very pointed in his questions."

"Pointed is not necessarily a bad thing, but in that environment it was not acceptable," the analyst says.

Yet Olson was willing to play ball to some extent, dutifully making scores of marketing calls in April 1998, when Enron was issuing a common-stock offering. It was a pointless exercise, given that everyone knew his doubts, and one that made him uncomfortable; he didn't think it a proper role for an analyst. "Do I endorse it? Not really," he says of the practice. "Was it part of the job description? Yes."

So while he knew he wasn't popular with his bankers or with Enron, Olson didn't expect to be ousted. "People trashing you, making allegations, that's part of Wall Street," he says. "But you thought your boss would protect you, that you'd have a fair hearing. None of that happened."

In his last months at Merrill Lynch in the summer of 1998, and thereafter, his health took a beating along with his self-esteem. He slept poorly; his doctor issued warnings. Never hefty, he dropped from his normal 175 to 185 pounds to 138. "I'm the only person in Houston," he says, "on a cheeseburger-and-chocolate-milkshake diet."

Conflicts Exposed

By 2001, Olson had regained much of his weight and his equilibrium, but he was still getting the occasional jibe from Enron. A framed note to his current boss from Lay, disputing a comment Olson made in the June 18 issue of U.S. News & World Report, hangs on his office wall. "John Olson has been wrong about Enron for over 10 years and is still wrong," Lay wrote in black pen. "But at least he's consistant [sic]." Four months later, Enron's enormous losses, hidden deals and accounting abuses came to light; the company filed for bankruptcy in that December.

Olson had finally given Enron the "strong buy" it had long sought that fall, when the company's stock fell so low that it briefly looked alluring. But if anything, he'd been too kind to Enron for years. "You couldn't see how bad some of the failures were," he says, "because they'd buried the bodies."

When a House energy subcommittee held Enron hearings this February, Olson agreed to testify. He put on his reading glasses, introduced himself and proceeded to condemn the changed culture of sell-side research. "Enron paid out lots of investment-banking fees," he told the legislators. "The bankers loved Enron. Enron loved analysts' 'strong buy' recommendations. Guess what happened: It got them. Lots of them. This is an abuse."

How much Merrill's bankers loved Enron emerged a few months later, when investigators for the Senate Permanent Subcommittee on Investigations called Olson with word of internal Merrill Lynch communications. The month before his May 1998 showdown with Melnick, investigators found, two Merrill investment bankers sent a memo to President Herbert M. Allison Jr. The firm was being excluded from a $750 million common-stock offering by Enron, the memo said, because "our research relationship with Enron has been strained for a long period of time."

Olson, it continued, "has not been a real supporter of the Company" and made "snide and potentially embarrassing remarks about the Company." The two bankers asked Allison to call Lay to intervene; after he did, Merrill Lynch became a co-manager on the offering.

With Olson gone, Merrill's new analyst upgraded Enron's stock. A few months later, in January 1999, one of the bankers e-mailed Allison to say that "any animosity in that regard seems to have dissipated in the ensuing months." He noted that Merrill Lynch had since been awarded Enron business worth $45 million to $50 million in banking fees. For Olson, who knew nothing of those communications until this summer, "a great beacon went on."

Merrill Lynch insisted to the Senate subcommittee this July, and still insists, that its research was not compromised, that Olson's departure was due to a "consolidation" and that his replacement's upgrade on Enron was entirely unrelated. But even before the Senate hearings, it agreed to pay a $100 million penalty -- while not admitting guilt -- and to enact reforms aimed at eliminating investment bankers' influence over analysts' pay. New York Attorney General Eliot L. Spitzer had charged that Merrill's Internet analysts had done exactly what Olson wouldn't: issued biased and misleading stock ratings to secure investment-banking business.

As Spitzer's investigation broadened -- along with parallel efforts by congressional committees, the Securities and Exchange Commission and NASD, an industry self-regulatory body -- Olson was reading the news like everyone else and learning that the conflicts ran deeper than he knew.

Spitzer more recently has focused on "spinning," in which analysts at certain firms, allegedly including Salomon Smith Barney and Credit Suisse First Boston, distributed shares of companies about to go public -- and to instantly soar in value -- to executives who also steered millions in banking fees to the firms. Some analysts took shares in about-to-go-public companies for themselves as well, other analysts say; they bought in during venture capital funding or took seats on the companies' advisory boards.

Shareholders have filed lawsuits, as have analysts who claim they were fired for lack of banker cooperation. The Manhattan district attorney, in an indictment of two top executives from Tyco International Ltd., has charged that the company's CEO prevailed on Merrill Lynch to replace an agnostic analyst with a Tyco supporter; the new analyst and the CEO then exchanged gifts of wine.

"What were these people thinking?" Olson wonders. "Do they think they can get away with this? That investors won't get wise to what's going on?"

Now, the Fallout

Things are quieter on Wall Street. Since the Bubble burst, IPOs have grown scarce. It's easier, these days, for an analyst to be negative. The number of "sell" recommendations has crept past 10 percent and will probably level off in the mid-teens, said Thomson First Call's Hill.

Henry Blodget left Merrill Lynch and is writing a book; his group's e-mails privately disparaging companies the firm was publicly recommending formed a key part of Spitzer's case against Merrill. Jack Grubman was forced out of Salomon this summer with a $30 million severance package; he faces multiple investor lawsuits and possible criminal prosecution. Mary Meeker is keeping a low profile at Morgan Stanley.

Announcements of reforms have become purification rituals. Most brokerage firms quickly adopted the changes Merrill Lynch agreed to, now sometimes called the Spitzer Principles, though questions remain about how effective they can be. The SEC also approved analyst reforms.

Meanwhile, regulators and a dozen major Wall Street firms are negotiating an unprecedented "global settlement," under which banks would each contribute $10 million to $20 million annually to purchase research from independent companies to distribute to their brokerage customers. In an attempt to deter the conflicts that have caused post-Bubble scandals, the settlement would further limit interactions between bankers and analysts. Harvey L. Pitt's resignation as SEC chairman may delay the process, but basic questions -- how analysts will function in the future, who will pay them, how many there will be -- are on the table.

Olson, who likes his work too much to retire yet, is still at it, and he's arguing for strict separation of church and state. At his new firm, he rarely even has to speak to an investment banker, and that's the way he wants it. "Otherwise," he said, "we're subject to all the four winds."

Researcher Richard Drezen contributed to this report.

Analyst John E. Olson was censured for being skeptical about Enron. "The business has been so hopelessly compromised," he says.John E. Olson framed this note from Enron chief executive Kenneth L. Lay disputing a comment Olson made in U.S. News & World Report.