Analysts, Ratings Agencies Image Hurt By Enron

AFX News
Leslie Wines

NEW YORK (AFX) - Public trust in brokerage analysts and debt rating agencies will remain seriously eroded for months by their failure to issue timely warnings prior to Enron Corp's Dec 2, 2001 bankruptcy filing, but they face few legal and financial consequences, analysts said.

About 16 brokerage analysts maintained 'Buy" orders on Enron right up until Dec 2, according to Steven Toll, a partner with Washington, DC securities law firm Cohen, Milstein, Hausfield & Toll, which has filed a shareholders' class action case against Enron.

Standard & Poor's Corp downgraded the debt of Enron Corp in late November, triggering the collapse of merger plans with Dynegy Inc and the bankruptcy filing. The downgrade came a full three months after the company first revealed its own problems.

Toll said that the extremely late response of analysts was highly disturbing to countless investors who depend on them in large part for investment decision advice.

But he said he has no plans to launch a class action suit against brokerages and ratings agencies on behalf of investors because such a case would have scant chances for success as these institutions do not have a legal fiduciary duty to warn stock buyers.

"The problem is they (analysts and ratings agencies) are not paid by shareholders," Toll said. "They are paid by their employers and owe a duty to them. It would be very hard to show that they have a duty to everyone in the marketplace."

In addition, a recent US Supreme Court ruling largely restricts fraud litigation to those suspected of committing it directly, such as, in this case, certain Enron executives and their auditors at Arthur Andersen LLP.

Brokerage analysts, ratings agencies and other additional parties who may have "aided and abetted fraud" in the Enron case would not be easy to sue under the current US Supreme Court's legal interpretations, Toll said.

However, an individual investor who sues his personal broker or analyst might have a better chance of success, he said.

George Perry, a fellow with the Brookings Institute in Washington, DC, said: "This thing is going to upset a lot of people before it's over, but in general I don't think that the analysts will be in legal trouble."

Margaret Blair, another Brookings Institute fellow and a Georgetown University School of Law professor, said the delayed response of brokerage analysts to the Enron developments intensified a public confidence crisis that began in 2000 when they failed to warn investors of the technology sector's impending sharp deterioration.

"The analysts' reputation was already shot after they contrived to put out glowing reports on the internet sector well after the party was over," Blair said.

In addition, she said some shrewd investors began to express reservations about the trustworthiness of analyst research even before the Nasdaq market began its decline.

"Any time someone appears to be minting money, it's fishy. And it's the duty of analysts to ask tough questions. If they don't, people will lose respect," she said.

"I think analysts will have to work harder than ever to show that they understand the companies they cover," Blair said. "It may be a long time before the public falls for what they have to say."

By contrast, she said criticism of debt ratings agencies may be less severe because their function is chiefly to analyze the financial information provided to the general public by corporations, and in the Enron case this information itself was flawed and possibly fraudulent.

"I'm not sure you can blame the ratings agencies for not having access to what went on at Enron," she said.

However, J. Edward Ketz, an associate professor of accounting at Penn State's Smeal College of Business, said ratings agencies' delayed response to the Enron crisis is "a serious problem."

"The problem of ratings agencies moving too late has been there for years," he said.
"Ratings agencies generally make changes only after a problem is known by everyone."

"I don't know how many investors know this, but some ratings agencies look at companies in depth only once every two to three years. The rest of the time they just take cursory looks at the listed companies once in a while."

Ketz said that in some cases investors with a knowledge of statistical models would be better off taking quarterly corporate financial statements and making their own assessments of profits performances.

He also said that brokerage analysts' usefulness to investors has been gradually weakened in recent years by a shift in analysts' approach to their own roles.

"In the past analysts looked at financial statements and other information and tried to come up with an independent objective view," he said. "But now they seem closer to marketing firms for the companies they cover," Ketz said.

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REPORTERS & EDITORS: For more information, please contact Wyatt DuBois in the Smeal College of Business Media Relations Office at 814-863-3798 or wed112@psu.edu .

Penn State's Smeal College of Business offers highly ranked undergraduate, MBA, executive MBA, Ph.D., and executive education opportunities to more than 5,500 students at all levels. Featuring academic departments of accounting, finance, marketing, insurance and real estate, management, and supply chain and information systems, the college is also home to major research centers such as the Center for Supply Chain Research, the Institute for the Study of Business Markets, the eBusiness Research Center, the Farrell Center for Corporate Innovation and Entrepreneurship, the Center for Global Business Studies, and the Center for the Management of Technological and Organizational Change.

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