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The Blodget Witch-Hunt

Jan 6, 2003 | The Globe and Mail

Just as investors elevated certain people both analysts and executives to almost god-like status while the dot-com boom was booming, so too they have looked for easy scapegoats once the bubble went bust. In many cases, the person they have latched onto is the same: former Merrill Lynch analyst Henry Blodget. After playing a starring role in the Internet bubble follies, he is now a star player in the market's blame game.

Last week, the National Association of Securities Dealers (NASD) the self-regulating body that oversees the brokerage business in the United States, and until recently ran the Nasdaq exchange sent Mr. Blodget a letter informing him that he could face fraud charges on the basis of his past stock recommendations. The letter was what is known as a "Wells notice," giving him time to refute the allegations before action is taken.

USA Today has reported that Mr. Blodget is negotiating a settlement that would see him barred from the securities industry and fined $10-million (U.S.) a deal similar to that arranged by former Salomon Smith Barney analyst Jack Grubman, who was fined $15-million and barred from the industry. Mr. Grubman was widely criticized for his ties to the companies he followed, including now-bankrupt telecom equipment player WorldCom.

Mr. Blodget has also been named in several class-action civil lawsuits by aggrieved investors, who allege that his recommendations played a key role in their losses. He appears as a defendant along with Merrill Lynch in suits launched by investors in dot-com holding company CMGI, consumer products company LifeMinders, telecom startup Exodus Communications, Internet real estate firm, bankrupt fibre-optic player Global Crossing and Internet search engine LookSmart.

But is it fair for investors to blame Mr. Blodget for single-handedly inflating that bubble? No. Obviously the NASD is entitled to levy whatever penalties it sees fit against members such as Mr. Blodget and Mr. Grubman. At the same time, however, the two cases are quite different: Mr. Grubman, for example, was clearly involved in a serious conflict of interest with WorldCom, which he helped as a consultant while also recommending the stock. Mr. Blodget's case is more complicated.

By now, everyone is probably familiar with the e-mails that were made public last year during the investigation of Merrill Lynch by New York's crusading Attorney-General Eliot Spitzer, in which Mr. Blodget privately described some of the brokerage firm's top picks as "garbage" and "a pile of crap." There's no question he issued reports that didn't accurately represent his opinions about either the company or the stock.

It's also fairly clear, however, that Mr. Blodget was fighting the combined might of Merrill Lynch's entire corporate finance department, which relied on his bullish research reports to drive demand for the stock and to encourage new business for the underwriting division. Many of the e-mails are excerpts from letters in which he threatens to tell the truth about certain stocks if the underwriting side doesn't lay off. Have any of those executives at Merrill been the target of personal lawsuits?

A couple of other things also become clear from a perusal of Mr. Blodget's record: One is that he appears to have actually believed much of what he was writing about the Internet stocks he covered that they would remake the entire U.S. economy, and so on. Those beliefs may seem absurd now, and the share prices they were based on equally ridiculous, but there were a whole pile of knowledgeable people who believed the same thing at the time, and made investments based on that belief.

There are also signs that Mr. Blodget tried to rein in some of the wild speculation about Internet stocks at several points. According to Wall Street Journal columnist Dave Kansas, in January of 1999 after he made his famous call that would go to $400 the analyst said in a research report that "the current Internet stock phenomenon clearly looks like a bubble, assuming 'bubble' means enormous manic increases in price without corresponding changes in the fundamental outlook."

This is Henry Blodget, the supposed Internet hype king, recommending that "investors continue to limit exposure and actively manage risk." Later that year, he told the Los Angeles Times that 75 per cent of Internet companies would likely fail, and recommended that only aggressive investors should have holdings in the sector and even then that they should make those investments a small part of their portfolio.

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