For Keefe, Bruyette&Woods, rebuilding the firm means rebuilding its vaunted research department.
By Justin Schack
December 2001
Institutional Investor Magazine
John Duffy nearly gave up.
Sixty-seven of his colleagues at Keefe, Bruyette & Woods, including his 23-year-old son, Christopher, perished in the World Trade Center collapse on September 11. The private firm lost one third of its capital along with the ranks of deceased partners. For weeks after the disaster, every day brought more funerals, more families to console.
The attack was only the latest, though certainly the most painful, blow to the ill-starred KBW. Duffy’s predecessor, James McDermott, had gone to prison for insider trading after tipping off his mistress - a porn star - about pending mergers involving KBW clients. The scandal scuttled the firm’s planned April 1999 initial public offering, which it had decided to pursue after failed merger negotiations with fellow investment-banking boutique Fox-Pitt, Kelton. Duffy, 52, had just begun to put the mess behind him when his firm suffered a blow of immeasurably greater magnitude.
United Airlines Flight 175 struck Two World Trade Center just below KBW’s headquarters on the 88th and 89th floors. Among the senior personnel lost: Joseph Berry, who became co-CEO with Duffy after McDermott resigned in disgrace; chief financial officer Jeffrey Fox; David Berry, head of research and a board member; Joseph Lenihan, head of fixed income and a board member; and Frank Doyle, head of equity trading.
“The first week or two when I was home, I was having trouble concentrating on business, obviously,” says Duffy, the Bronx-born son of a subway train operator and a waitress, who had made his name as a KBW investment banker. “The thought definitely crossed my mind: Is this just too big a job? Should we even try to rebuild the firm? But that only lasted a minute or two. I didn’t know how the hell we would do it, but I instinctively knew that I wanted to rebuild.”
Other top KBW executives agreed. They also settled on priority No. 1: Reconstruct the research department. Says Duffy: “Those first days back, the senior guys all agreed the first thing we needed to do was rebuild research because that’s what the firm’s been known for. That’s our foundation.”
That was a wise choice. KBW has maintained a long-standing and well-deserved reputation for excellent research. Founded in 1962 by Harry Keefe, Gene Bruyette and Norbert Woods as a research boutique, it attracted trading business from money managers impressed with its incisive reports on financial services companies. Corporate clients hired KBW as adviser and underwriter for the same reason.
“I started out following the regional banks because the analysts then on the sell side just focused on the money center banks,” says Keefe, who was an analyst and partner with brokerage Tucker Anthony before co-founding KBW. “I introduced several of these stocks to the big East Coast institutions, and that’s how the firm became identified with regional banks and with research.”
This year, when Institutional Investor asked money managers to rank the best research produced by boutique brokerage firms, KBW dominated the financial services sectors. It also finished first in more sectors (five) in the “Best of the Boutiques and Regionals” poll than any other firm. (SoundView Technology Group and Howard Weil prevailed in three sectors, while five other firms each won two. See rankings below.)
Indeed, the kind of research KBW has championed for nearly 40 years is becoming more important to investors. Burned by analysts at the big Wall Street houses who clung to positive ratings for overvalued stocks even after the market bubble burst, money managers are turning increasingly to smaller, more focused firms, as well as to so-called independent research shops. Analysts at these firms are thought to be less likely to compromise their objectivity to please investment bankers or corporate clients (see story below).
The results of the poll are at once extraordinary and sobering for KBW, whose 30-person research department was decimated by the Trade Center attacks. In addition to Berry, who covered multinational banks while running the department, 21 other research employees lost their lives, including brokerage industry analysts Dean Eberling and L. Russell Keene III and regional bank analysts Marni Pont O’Doherty and Thomas Theurkauf Jr.
One silver lining: Amid declining profits and layoffs on Wall Street, KBW has little competition in the labor market. Duffy and his management team began by looking for a new research director and banking sector team. Starting with a list of about 40 potential candidates, they vetted names with clients and colleagues, narrowed it down to about 20 and hit the phones.
About a dozen responded, and by mid-October KBW had made some hires. Michael Corsaniti, a highly ranked portfolio manager who specialized in financial stocks for Neuberger Berman, succeeded Berry as head of research and multinational bank analyst. Thomas McCandless joined from CIBC Oppenheimer to cover regional banks. Corsaniti had recently left Neuberger and planned to form his own firm with some other analysts, including Vincent Daniel and Jeffrey Spetalnick, also formerly of CIBC. The pair followed him to KBW. Daniel now covers consumer finance and credit card companies, while Spetalnick is doing quantitative work.
With that core in place, Duffy left research recruitment largely to Corsaniti and moved on to the equity trading desk. Two KBW alumni, Phil Cuthbertson and Lawrence Vitale, returned to work under John Ragan, whom the firm promoted to succeed Doyle. Cuthbertson had served 13 years as head trader before taking early retirement last year. Vitale researched regional banks for KBW during the 1980s and most recently worked for hedge fund Lone Pine Capital.
Duffy hopes to be fully staffed within a few months: “Next year may be a tough one for the market again, so I don’t know if we’re going to hire the exact number we lost. But out of the 67 we lost, I’d be surprised if we don’t hire 50 people.”
Along the way KBW has needed, and received, lots of help. Its longtime law firm, Wachtell, Lipton, Rosen & Katz, offered spare office space in midtown Manhattan until Duffy and his team could find a new permanent headquarters. (Last month it finally settled on 55,000 square feet on the fourth floor of the Equitable Building, at 787 Seventh Avenue in Midtown.) Competitors such as Greenwich Capital Markets, Merrill Lynch & Co. and Citigroup’s Salomon Smith Barney unit made KBW co-managers on a handful of securities offerings that came to market in the weeks after September 11, providing the firm a boost in the form of underwriting fees and sales commissions. Numerous institutional investors have designated portions of large trades to KBW on a “give-up” basis, even though they were executed by the big Wall Street houses.
Looking back - and ahead - Duffy is glad he didn’t throw in the towel.
“The challenge of rebuilding is somewhat cathartic,” he says. “It can be very tiring, but I think it makes us feel better that we’re doing something. I would hate to still be at home just mourning the death of my son. I do that every day. I don’t need to do it every day, all day. To the extent that we can rebuild this place and make some decent money at it, we can do some things for these families, whose economic future is less certain than our own.”
Independents day
“When I go to work in the morning, I know that no matter what I say, I’ll annoy at least half of my clients,” says William Whyman, president of independent research shop Precursor Group. Not long after he opened for business in June, Whyman alienated more than a few of his buy-side customers when he published a terse one-page report predicting doom for content delivery vehicles and Internet hosting and service providers such as Akamai Technologies, Exodus Communications and EarthLink. “These companies are not enduring,” he wrote. Clients who owned the stocks could only cringe. Exodus filed for bankruptcy in October; Akamai Technologies hit a low of 2 midyear before recovering to 5 in November.
Founded by a group of former Legg Mason analysts, Precursor joins the growing ranks of firms producing independent research that is both analytically rigorous and intellectually honest. It’s an increasingly valuable commodity to institutional investors who have been seared by sell-side research compromised by investment banking conflicts. Even when the Nasdaq composite index was riding high, a small cadre of independent analysts, at Sanford C. Bernstein & Co. and a few other places, boldly predicted the sorry end of the tech-telecommunications craze. “People thought we were obsolete,” says Lewis Sanders, the calm, direct, no-nonsense CIO of Alliance Capital Management and the former chairman and CEO of Sanford C. Bernstein. “But we were vocal [in our belief] that 1999-2000 was a financial fantasy that would destroy a substantial amount of wealth.”
When the tech bubble popped, so did the credibility of much Wall Street research. Factor in wobbly markets and pervasive investor unease, and there has rarely been a better time for research boutiques and independents to try to take on their bigger Wall Street competitors. Certainly, not all boutiques produce independent research, and a bear market is tough for everyone. But the boutiques are quick to point out that most of the majors are deeply conflicted, twisted like pretzels as they try to win major investment banking mandates while simultaneously producing unbiased research.
The chief exception among mainstream Wall Street firms has been Bernstein. Established in 1967, the boutique-size research team does no investment banking, is widely esteemed for its independent thinking (even though it was sold to Alliance last year) and has regularly appeared among the leading investment houses on the Institutional Investor All-America Research Team. This year more than 60 percent of investors polled in the 2001 All-America Research Team (II, October 2001) said they did not trust sell-side research, but when asked whose research they trusted most, they overwhelmingly identified Bernstein - by a margin of almost four to one over the second-place finisher.
The Bernstein business model - focus on brokerage and money management, swap research for institutional trading commissions and shun investment banking - has been copied by many upstarts. Bernstein prides itself on its contrarian sensibility and its in-depth reports (analysts publish “black books” - usually the result of one year’s work ). “If you’re not arguing with the consensus, you’re not adding anything,” says Sanders.
Says Brooks Taylor, a portfolio manager at MFS Investment Management, “Bernstein analysts take a strong view and often a controversial view, and I don’t care if they are right or wrong.”
Bernstein is now part of the Axa conglomerate, but other independent research firms, like Fulcrum Global Partners, founded in May, are classic boutiques. Many of the top-rated boutiques from this year’s All-America Research Team rankings offer investment banking services, including Leerink Swann & Co., which focuses on biotechnology and specialty pharmaceuticals; SoundView Technology Group, which covers technology and software; and four financial services boutiques, Keefe, Bruyette & Woods; Fox-Pitt, Kelton; Putnam Lovell Securities; and Dowling & Partners Securities (story).
Says Jeff Leerink, CEO of Leerink Swann, “During rough periods the people who do the extra digging will pick up market share.”
Buy-siders agree. “Independent research reports tend to be more thorough,” says Anna Dopkin, a portfolio manager at T. Rowe Price Associates who still believes that quality research is done by sell-side firms. “There appears to be less pressure to launch coverage immediately after joining these firms.”
Boutiques can offer deeper, more specialized knowledge of their subjects. But autonomy remains their greatest asset. Even many of the firms that offer investment banking derive less of their revenues from it than do their big competitors - institutional brokerage or money management kicks in the bulk of their profits - so the firms are simply less beholden to the companies they cover than are their Wall Street counterparts.
“At boutiques like ours, analysts have more time to dig into their industries and companies,” says Mark Loehr, CEO of SoundView.
Whether independent research shops will be able to withstand the agonies of a bear market remains to be seen. But they remain convinced that they have found a better way. “The Street’s system was broken,” says Precursor’s Whyman. “We believe that independent research provides better results. At the end of the day, it’s our job to say it like it is.” - Jenny Anderson
