Republican Presidential Candidate Donald Trump has been called many things based on his public and private behavior against fellow Republicans, Syrian refugees, John McCain, the disabled and some women, but we have to thank him for an almost forgotten episode in financial history which has inadvertently shed some light on how the 2000 tech crash (aka the Dot Com Bubble) happened.
The first episode in this story began in April 1990 when a securities analyst, Marvin Roffman, who worked at the Philadelphia securities firm Janney Montgomery Scott, said in a Wall Street Journal interview that bondholders should sell junk bonds issued on Trump’s newly-opened Taj Mahal Casino in Atlantic City, New Jersey.
As reported by Jonathan Laing in this complete Barron’s article, Roffman said the $675 million in junk bonds, issued at 14%, were not sufficiently secured by casino revenues to pay the interest. At the time, the Trump organization said the casino would be “The Eighth Wonder of the World.”
Trump’s inflated name and reputation pushed the bond price to 101 cents on the dollar, Barron’s said, but soon reality set in and the bond price fell to about 80 by 1990-1991 and soon to 20 cents on the dollar as casino revenues failed to materialize.
I covered this story as editor for Zacks Investment Research in Chicago and the story developed at about the same time that more investment firms were starting to question the quality and motives of equity analysts who wrote research reports on some companies.
While there has been research produced by brokerage firms who sell stocks (called “sell-side” research) and other research produced by buyers of brokerage and banking services (called “buy-side”), an increasing number of buy-side institutions began setting up separate, independent research divisions to produce their own company research for in-house use only.
A study issued in 1990 by McKinsey & Co. found that more buy-side firms, such as mutual funds and some money managers, were producing a larger percentage of their research in-house, and presumably, were buying more of their research from outside independent sources. The push towards producing almost all research in-house was very popular at Merrill Lynch Asset Management, Barclays Global Investors, State Street Global Advisors and Putnam Investments.
There were two main reasons for this change in analyst coverage. One was due to a re-allocation of internal resources based on covering stocks in more specific market capitalizations. The other was political and this will soon take us back to equity analyst Marvin Roffman and Trump’s Taj Mahal Casino.
Questioning Analysts’ Motives
But back in 1990, people on Wall Street were starting to raise questions about the motives behind some analyst’s stock recommendations. Specifically, some analysts were saying that the very profitable venture capital, underwriting and brokerage revenues were being used to influence their recommendations.
In one case at the time, Sean Ryan, who was an analyst at Bear Sterns, gained notoriety when he issued the first “attractive” rating” signal in May for First Union Bank. A month later, he rated the bank a takeover candidate.
While his recommendations were straightforward enough, Ryan said he soon encountered problems which arose from “internal political issues.” The source of this pressure came from the fixed income sales desk after Ryan began making increasingly bearish predictions about First Union’s earnings prospects and management issues.
In late-June 1990, Ryan said he had a meeting with the firm’s then-director of research, who was “livid and really tore my head off” asking why Ryan had made negative comments about the bank. She also accused him of making ad hominin attacks against top bank managers. When he explained his rationale, she said “It just doesn’t matter because you can’t say these things,” according to Ryan. At issue was the $10 million in commissions generated from bond trading with the bank, plus other revenue relationships, he said.
The meeting took Ryan by surprise since he had never received negative feedback from any departments at Bear Sterns. “The institutional sales department liked the candid assessments,” he said at the time.
But as the fiscal year was winding down, Ryan soon found himself increasingly ostracized from department events. Eventually, he was passed over for promotion to managing director, then he lost his assistant, his subscriptions to other research were eliminated and he essentially became a persona non-grata.
To smooth the situation over with First Union, Bear’s CEO Alan “Ace” Greenberg called First Union president Ed Crutchfield to secure the business. But two weeks later when Ryan got his bonus numbers, it was one-third of the average for his seniority level.
Bear, like other major investment banking firms at the time, was making large profits from trading and investment banking. Speaking in 1990, one analyst at Bear said “fundamentally, what we have in the Street is a pretty corrupt system and it is starting to collapse under its own weight. They get paid 5 cents a share on the brokerage and they also make millions in underwriting fees, so we can sell this tendentious research to their institutional customers, and they make it up to the institutions by selling them underpriced IPOs.”
In the early-1990s, Bear Sterns gave editorial control over its own analyst reports to the investment banking division. This allowed them to change recommendations to favor investment banking clients.
Slanting supposed objective equity analyst reports to make them more saccharine to banking clients was a precursor to what would be happening in the tech sector in the coming years as it was being fueled by securities underwriting and investment banking.
As he presciently looked ahead in 1990, Ryan said “I would suspect that statistically there is an even more extreme situation in the tech sector where almost everything is being rated a “buy” and almost no “sells.” High-tech has been the best sector of the past several years and that has been a huge source of deal flow. With so many investment banking firms out there competing for business, the last thing you want is to have a skeptical analyst writing reports is more likely to get you into trouble.”
While granting editorial control over analyst reports can certainly censor conclusions that are critical, some bad new may get into print. And when it does, it provides a rare glimpse into how far the brokerage firms will go to save their investment banking or underwriting relationships.
Back to the Taj
This takes us back to Marvin Roffman and his negative opinion about the junk bonds issued by the Taj Mahal Casino.
As cited by Laing and Alan Abelson, who both wrote about this Trump-Roffman episode for Barron’s, Trump went ballistic when Roffman warned investors about the danger of the Taj junk bonds. To punish Roffman, Trump called the CEO of Janney Montgomery, made some false and disparaging personal remarks about Roffman (sound familiar?) and threatened to sue the firm unless Roffman wrote a public apology. Under pressure, Roffman agreed, however Trump then wanted him to change a sentence in the letter saying the bonds were a viable investment, but after consulting with his lawyer, Roffman said he could never positively endorse the junk bonds to investors, so he retracted the apology letter as described in Laing’s Barron’s article. Janney then proceeded to fire Roffman.
The conclusion is that Trump never sued Janney, the Taj defaulted on its first interest payment in October 1990, forcing Taj junk bonds prices into the 20s. And as predicted, the Taj filed Chapter 11 bankruptcy in the spring of 1991.
As for the people involved, Roffman exited his 30-year career as an equity analyst and became a successful money manager. He also won a $750,000 arbitration case against Janney and he settled with Trump for an undisclosed amount that remains secret due to a confidentiality agreement.
As for Trump, he is still up to his old tricks at the national level. Maybe he can “Make American Great Again” just like he made the Taj Mahal Casino in Atlantic City into “the Eighth Wonder of the World.”