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Boom and Bust: High-Octane Banks Pumped Raging Bull

Nov 28, 2002 | The Washington Post

On Oct. 8, 1999, a small software startup in Silicon Valley called Interwoven took its turn at the bellows of the stock market bubble.

In a story repeated hundreds of times during the technology boom, Interwoven started trading at $43 a share and ended the day up 141 percent from its IPO price of $17. And as usual with initial public offerings, huge amounts of money were made, both by those who were able to buy shares ahead of time and by the investment bank that handled the offering. In this case, it was Credit Suisse First Boston (CSFB), which earned $2.7 million in fees.

Frank Quattrone, the star technology banker who helped make CSFB Silicon Valley's leading bank for initial public offerings, had a special interest in the deal's success. Quattrone, who at the time reportedly made $100 million a year, was able to buy Interwoven shares with several other CSFB bankers at an even lower, pre-IPO price: $8.49 a share, according to regulatory filings.

A year later, when the stock had risen to $90 a share after splitting twice, the bankers sold their shares for $3.4 million, the filings show. An internal fund operated by the bank cashed in shares worth an additional $19 million.

That year, a research analyst at the bank touted Interwoven's stock, calling the market for Web-site-building software an "explosive, multibillion-dollar opportunity." CSFB maintained a positive rating on the stock into the spring of 2001.

Today Interwoven trades for less than $3, but its performance has been remarkably consistent: It has never made money.

Celebrated in an earlier boom, the 1980s as "Masters of the Universe" for their skill in leveraged buyouts and corporate mergers, Wall Street's investment bankers found lucrative new opportunities in the 1990s, an era whose hallmark was the extraordinary availability of capital.

Some sold new forms of derivatives, complex and high-risk investments that offer tantalizing returns if the buyer is willing to make a bet on, say, whether the value of the currency of Thailand will go up or down.

Others advised corporations on "structured" financings that allowed companies such as Enron to raise billions in cash but also to avoid taxes and hide debt through complicated partnerships, off-the-books transactions and related exotic investments.

Still others pounced when the tech boom hit.

Ticket to the big time

Although venture-capital funds gave tech startups the money to begin operations as fledgling private companies, the investment banks took them to the big time the public stock markets enabling many unprofitable firms to raise billions of dollars. This helped spawn a stock market boom that enriched many in the know but ended in losses for hundreds of thousands of less-informed Americans.

Today, several major investment banks Morgan Stanley, Goldman Sachs and Merrill Lynch are under investigation by regulators and face multimillion-dollar fines and lawsuits for banking practices over the past five years. One of the besieged, but less well known, is Credit Suisse First Boston.

It has paid $100 million to settle claims it demanded kickbacks from investment managers in exchange for hot IPO shares. It is being sued by Massachusetts regulators for providing misleading or deceptive research to boost demand for stocks. Overseas, its bankers have run afoul of regulators in Britain, Sweden and Japan.

Quattrone, once a Silicon Valley celebrity, now stands vilified as an icon of excess.

In many ways, CSFB mirrored the times. Just as many tech startups sought to displace established industry giants through aggressive innovation, CSFB sought to topple its bigger Wall Street brethren. CSFB "was as aggressive as it gets," said Michael Holland, a New York money manager who worked at the firm. "Wall Street is a very small place. In terms of competitiveness, these were the cowboys. It was no holds barred, take no prisoners."

Officials at CSFB refused to make Quattrone and other top bankers, including Chief Executive John Mack, available to comment. They said the bank's practices were the industry standard at the time and that it should not be unfairly singled out.

But they point to several changes Mack has instituted since joining CSFB last year. These include bringing in Gary Lynch, a former Securities and Exchange Commission enforcement chief, as general counsel; changing how the bank allocates IPOs; and giving research analysts more independence from bankers.

"Wall Street, like all of corporate America, is facing a crisis of investor confidence exacerbated by a protracted bear market and some shocking examples of corporate abuses," Lynch said in a statement. "In hindsight, it is easy to see that many investment banks with most institutional investors, government and independent economists, the media and other market participants were overly optimistic about the anticipated performance of some high-growth sectors in the economy."

Modern-day investment banks trace their roots to post-Depression reforms in the financial system. That's when regulators prohibited traditional commercial banks whose primary role was making loans and taking deposits from being involved in the securities business. But those lines were formally wiped away with the repeal of the Glass-Steagall Act in October 1999.

By then, Morgan Stanley, Goldman Sachs and Merrill Lynch were entrenched as the heavyweights of Wall Street. For years, CSFB had tried to break into the rarefied top tier.

It was First Boston during the 1980s, a firm that was the prototype of the aggressive suspenders-and-slicked-back-hair culture popularized in the movie "Wall Street." In 1988, First Boston was bought out by the Zurich-based financial conglomerate Credit Suisse Group.

First Boston got a deep-pocketed partner from the deal, and Credit Suisse gained a strong foothold in the United States.

The combined CSFB went on an acquisition spree, adding smaller trading and banking firms around the world to fill holes in its areas of expertise or market share. In 1996 it had roughly 5,000 employees. By the end of 1999, that number had nearly tripled.

Leading the charge was Chief Executive Allen Wheat, a blunt-spoken expert in trading derivatives. Wheat was famous for raiding whole teams of professionals from competitors. Just as the technology sector began to hit overdrive in 1998, he hired Quattrone to run CSFB's technology-banking group.

Philadelphia-born, Quattrone was educated at the Wharton School and Stanford University. He started work on Wall Street at Morgan Stanley. He was not a typical Wall Streeter, heading west to Silicon Valley in the early 1980s. When Quattrone arrived on the West Coast, the personal computer was making its debut, and a handful of successful companies such as Apple Computer and chipmaker Intel were riding the first wave of the tech boom.

Quattrone cultivated relationships with venture capitalists and tech executives, dressing casually and grasping technology's growth potential before his colleagues back in New York. Eventually, he persuaded Morgan Stanley to underwrite tech-company IPO deals that were so small they would normally be ignored by the Wall Street giant.

In 1995, Quattrone took Netscape Communications public. The stock soared 107 percent on the first day and helped change the calculus.

Unlike the computer-hardware companies that provided appliances that would make work and life more efficient, the Internet threatened to scramble the foundations of commerce itself, not to mention those of its major players. The technology of the Internet and a networked world was in its infancy, but its potential seemed certain and limitless. Investors were eager.

A new kind of alchemy was born. The requirement for near-term profit Netscape, for example, was giving away much of its software and losing money was replaced by almost any measure of growth that hinted at the promise of domination later.

Enabling a large portion of the public to invest in these stocks minimized the risk for the financial institutions and early investors who helped launch the companies. Regardless of how a business fared, its stock usually soared high enough, and for just long enough, for many on the inside to cash out.

In 1996, Quattrone began to get antsy, according to those who worked with him. By then a Silicon Valley fixture, he believed his bosses in New York still didn't understand tech's potential, didn't give him enough control and didn't pay him enough.

"As part of the bubble, investment bankers got a lot of leverage with their employers," said one person who knew him. "In 1996, Frank put the screws to them pretty good."

Quattrone wanted control over the entire tech-banking universe at Morgan Stanley, including analysts who followed tech companies, according to several people familiar with his operation.

Combining authority over banking functions and research was a novel idea. Conventional wisdom held that analysts served as important checks against bankers whose compensation came from doing deals with companies regardless of their prospects.

But Quattrone, say those who worked with him, believed the relationships needed to be integrated so that a potential client with an IPO would have some assurance the bank would support it with research if it took it public.

Other banks did the same, and, as several regulators have charged, stock research was compromised or deceptive. Decisions to take companies public were reinforced by the bankers' research units.

Quattrone's demands were turned down by Mack, then president of Morgan Stanley. Quattrone jumped to a firm that gave him a better deal and some of the control he wanted: Deutsche Morgan Grenfell, a German-owned bank with aspirations to grow in the United States.

In 1997, Quattrone scored another major tech IPO: The following year, Wheat persuaded him to join CSFB.

Quattrone took so many members of his team with him in July 1998 that CSFB took over the offices they were in and changed the name on the doors. Bankers said he got control over tech banking, tech trading and tech-stock research, as well as the commitment of at least $25 million from the bank to invest in internal funds that traded stocks for the bankers and other special clients.

Such was Quattrone's independence that a CSFB insider described it as having "a company within the company."

Jump to first place

The results were remarkable. In 1998, CSFB handled six domestic tech IPO deals, valued at $269 million, putting it sixth among the banks, according to financial data from research firm Dealogic. By the end of 1999, at the height of the bubble, it jumped to first, handling 51 deals — twice the number of Goldman Sachs or Morgan Stanley.

In 2000, CSFB again handled nearly twice the number of issues as its top competitors, although in overall dollar terms it was never able to topple its big rivals.

For two years, demand from companies seeking to go public was "insatiable," said one banker, and Quattrone "was feeding the market what it wanted to eat."

"Frank didn't care about anything else. ... It was buyer beware. He got paid for the IPO," the banker said.

Quattrone was willing to let some people in on the action, through what became known in the valley as "Friends of Frank" accounts. Quattrone promised shares of IPOs the bank was handling to wealthy potential clients, such as chief executives and venture capitalists, if they would open private bank accounts at CSFB, people familiar with the firm said.

According to the bank, the client could not cherry-pick among the offerings and had to decide whether to accept all IPO shares or none.

In a 1998 interview with Fortune magazine, while still at Deutsche Morgan Grenfell, Quattrone said standards for bringing companies public had loosened, partly because of investor demand. Nonetheless, he maintained the bank turned down a majority of the companies seeking to go public.

The first rupture of the bubble came in March 2000. And although many companies continued to go public that year, the markets began their relentless slide. By mid-2001, the banks were hurting.

That June, CSFB announced it was firing three of Quattrone's tech brokers amid a Securities and Exchange Commission investigation into the bank's IPO-allocation practices. The bankers were accused of demanding kickbacks from money managers for allocations of hot IPO shares. Two of those fired subsequently sued the bank for allegedly sacrificing them as scapegoats.

Under the scheme, the SEC said, money managers were required to pay inflated commissions to buy shares of other stocks through the bank's trading operation. The inquiry would prove to be an early insight into an array of industry IPO-trading practices that regulators say helped power the raging bull market and reinforce its momentum.

The most serious of these was a practice known as "laddering." Clients were told that in exchange for IPO allocations, they had to agree to purchase shares of the stock after it opened for trading, thus heightening demand and driving the price higher.

CSFB denies it engaged in the practice, although it is accused in shareholder lawsuits of having done so. To date, the SEC laddering inquiry has focused primarily on Goldman Sachs and Morgan Stanley.

Probe of IPO rewards

The banks are also being investigated for allegedly using IPO allocations as a reward for getting other business from companies.

A month after CSFB fired the three bankers, it fired Wheat. The SEC investigation was but the latest in a string of international embarrassments that resulted in regulatory action against the bank in Sweden, Britain and Japan.

In place of Wheat, CSFB hired Mack, whose stated intention was to restore the bank's integrity and improve its bottom line, hurt because . tech banking had essentially dried up.

This January, CSFB formally settled the SEC investigation by agreeing to pay $100 million in penalties. The settlement does not single out Quattrone, although former employees say he controlled virtually every activity of the tech banking group.

About nine months later, the SEC fined and suspended two CSFB bankers in connection with the case. CSFB said it did not find sufficient cause to fire Quattrone or the other two bankers, although the firm reportedly increased the fines and length of the suspension of the two already disciplined by the SEC.

Quattrone remains head of global tech banking and was elevated to the bank's executive board late last year.

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