A Thorny Question for Donaldson


The brokerage firm that William H. Donaldson co-founded, Donaldson, Lufkin & Jenrette, was proud to call itself "The House That Research Built." But research may prove to be a thorny issue for Donaldson, who faces Senate confirmation hearings on whether he will succeed Harvey L. Pitt as chairman of the Securities & Exchange Commission. BusinessWeek has learned that an Internet company in which Donaldson was a director, EasyLink Services Corp. (EASY), paid $25,000 to a California firm to produce ostensibly independent research that briefly boosted the high-tech company's share price.

And that poses a troubling question: Did Donaldson endorse the controversial practice, common among microcap companies, of paying for research? Donaldson's close ties to Wall Street and his controversial tenure as chairman of Aetna Inc. (AET) have made him a subject of widespread criticism by investor advocates. Any connection between Donaldson and the decision by Edison (N.J.)-based EasyLink to commission the research -- which mimics Street research so closely that it appears to violate industry guidelines -- could fuel criticism that he is not sympathetic to investor concerns.

PROMOTION GIMMICK. Donaldson, who left the EasyLink board on Nov. 12, declined comment on whether he or the board had approved the hiring of J.M. Dutton & Associates to produce the reports. Through a staffer, he referred questions to Gerald Gorman, EasyLink's chairman and a former DLJ investment banker, who said he didn't recall discussing Dutton with Donaldson, or asking for board approval. He declined to say if the board ever discussed the general issue, saying, "Those are not matters we discuss publicly."

Paid research, though legal, is generally viewed by regulators and market pros as a stock promotion gimmick rather than genuine research. Says Joseph P. Borg, the Alabama Securities Commissioner and an authority on microcap issues: "When we look at these things, more than half are usually, you know, crap."

Louis M. Thompson Jr., president of the National Investor Relations Institute, says the group banned paid research entirely until January, 2002, because of the potential for abuse. NIRI then enacted stringent, though voluntary, guidelines requiring that reports not resemble ordinary analyst reports and mandating explicit payment disclosure.

"UNDERVALUED"? Market reaction to the first Internet-distributed Dutton report, on Sept. 3, was ecstatic. Share prices jumped 37%. Contrary to NIRI guidelines, the report gave EasyLink a "speculative buy rating." It noted Donaldson's presence on the "strong board of directors" and said the company "appears to be undervalued."

The report says "the cost of enrollment in the Dutton & Associates one-year continuing research program is US $25,000" -- but does not explicitly say that EasyLink paid Dutton. The firm's president, John M. Dutton, confirmed the payment and said there was no understanding that Dutton would provide favorable reports.

The SEC has set no rules specifically governing paid research and has announced no plans to look at the issue. But that could change if more distressed companies decide to resort to this controversial form of stock promotion. Gorman is right. What happened at EasyLink board meetings is a private issue. But the Senate may not take "no comment" for an answer. By Gary Weiss in New York


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