I drafted an outline of the report I proposed and sent it to the Prophet. At the end of September, I got this memo back:
INTER-OFFICE MEMO
Date: 9/28/72
To: M. SCHWARTZ
From: THE PROPHET
I like the start of your Hospital Management report and I urge you to devote all efforts to this. It has the potential of being a very, very fine piece of work. Feel free to take the Sphinx’s time to help you. I think Sphinx is quite willing and very able to aid you.
TP:mc
cc: T. Sphinx
So I teamed up with the Sphinx and together we started working full-time on the report. On weekends, I’d drive up to his beautiful house in Westchester County and we’d go down to his basement, lay out all the reports, and dig into the numbers. Once we had the numbers digested, we did what analysts do. We started drawing charts and looking for trend lines on everything that might have an adverse effect on the hospital management industry.
We had a chart on hospital expenditure as a percent of GNP (thanks to Medicare and Medicaid, it was soaring). We had a chart on occupancy rates (they had not been increasing at “mature hospitals,” those open for three or more years). We had a chart on inpatient days (they had been decreasing nationally due to greater use of outpatient facilities and lower birthrates). We had a chart on hospital prices (during the past year, price increases had been limited to 6 percent annually). We had a chart on new hospital construction, a chart on payroll as a percent of total expenses, a chart on total expenses as a percent of GNP, a chart on reimbursable costs, a chart on nonreimbursable costs, and a chart on total costs. We made assumptions about revenues, contractuals, net revenues, total expenses, and pretax income per patient day and all the while Sphinx kept reciting, “Marty, Marty, these companies shouldn’t be selling at high multiples. This is a utility rate of return business.”
In our original draft, we discussed trends that might cause the future earnings growth of hospital management companies to decline from the 15 to 20 percent rate recorded by the industry during the past five years. We said that a cost squeeze was developing and that the first effects of this squeeze were manifest in the recent quarterly reports of the two leading companies in the industry, Hospital Corporation of America and American Medical International. These two stocks were selling at the highest multiples, and they stood the best chance of getting hammered if our projections came true. We concluded with a warning, “Although investors have generally accorded hospital management companies premium price/earnings multiples, we caution that any disappointment in future profit expectations could adversely affect their price/earnings multiples.”
By the end of October, Sphinx and I were ready to present our preliminary draft to my subgroup. Each subgroup had a weekly meeting where all the analysts would get together and present their ideas. This was basically a waste of time because analysts didn’t care about anybody else’s companies. They were too worried about their own. The only people who cared what the analysts were doing were the brokers, because research reports, especially from a high-powered firm like the Pyramid, would have a direct and immediate effect on the price of a stock. The brokers weren’t allowed at the analysts’ meetings. There was a Chinese wall between the brokers and the analysts, which was supposed to ensure the equitable dissemination of research efforts to the clients, the investment community, and the public. Still, the brokers were always hanging around the analysts, sucking them up, trying to squeeze out a tidbit or two that would give them an edge.
I was all fired up about our report. I remembered being at Amherst, watching the weirdos from the Students for a Democratic Society protest the war in Vietnam. I thought they were egghead assholes. Then I remembered being in the marines and realizing that sometimes it took as much guts to protest a war as it did to fight it. I reminded myself that it always took more courage to go against the establishment than it did to go with it, and now, with Sphinx’s help, I was going to expose the establishment. Like the Vietnam protesters, I was convinced that I was right.
Predictably, nobody gave a shit. Nobody cared about hospital management; their only concern was whether another stock recommendation would crash. The Great Pyramid wasn’t Kuhn Loeb. There was no communal farming. Everybody was working their own fields, and unlike Favia and Bronchtein, the High Priest and the Prophet didn’t even show up for most of the meetings.
Every analyst at the meeting got a copy of the draft. Everyone knew that preliminary reports were highly confidential and that the copies were to be destroyed after the discussion. Paul Standish was the only analyst at the meeting who seemed at all interested in our predictions for the hospital management industry. Standish was a drug analyst, and Medicare and Medicaid paid for a lot of drugs. If our assumptions were right, the drug companies could also get squeezed.
I didn’t know it, but as it turned out, when Standish left the meeting he didn’t destroy his copy. He took it with him and a few days later discussed it on a flight back from California with another drug analyst from Scudder, Stevens & Clark, an old-line Boston-based investment counseling firm.
Telling an analyst from Scudder what was in our report was clearly on the brink, but then on November 7, 1972, Standish went over the edge. He mailed a copy of our draft to the scumball from Scudder. To this day I have no idea what Standish thought he was going to get out of it, but giving a copy of our report to someone from another firm was beyond stupid; it was unethical.
During the week of November 13, word began to spread. The scumball at Scudder passed our draft around to other people at Scudder. Scudder’s clients began selling their hospital management company stocks. On November 21, news of the leak appeared in the papers and the price of American Medical International tumbled 57/8. In a week, Hospital Corporation of America plummeted 22 percent. Rumors of market manipulation were swirling around the Street. The phones began ringing off the hook at the Pyramid. Thanks to our Chinese wall, our clients had been left out in Mongolia, and they weren’t very happy. Our retail brokers were even more upset. How could Scudder’s clients get a copy of our research report before they did? What the hell had happened? Where were the High Priest and the Prophet? The blocks of the Pyramid began to tremble.
For a kid who’d always wanted to be a detective, I didn’t have a clue. When the Prophet called me in and asked me how the report had been leaked, I said I didn’t know. That was not the answer he wanted to hear. Besides our brokers and our clients, Uranus J. Appel, the chairman of the board of American Medical International, was going orbital. Uranus was sure that the Pyramid was manipulating his stock and suspected that the leak was part of an orchestrated plan to push the price down. He was demanding that the New York Stock Exchange start an investigation.
On Wednesday, November 22, the General Counsel came into my office. “Marty,” he said, “you’ve been called to testify at the New York Stock Exchange.”
Testify? Why should I have to testify? I’d already told the Prophet everything I knew. Why not send the Sphinx? The Sphinx was older and more respected than I and it was his idea to write the report in the first place. I felt the weight of The Great Pyramid coming down on my shoulders. I fought to regain my composure. I hadn’t done anything wrong. I was just a small block on one of the lowest levels. Surely the Pharaohs, Khufu and Khafre, would make sure that the High Priest and the Prophet kept me from being crushed.
The General Counsel briefed me on what to expect and assured me that I was a valued member of the team. “Just tell the truth, Marty,” he said, “and everything will be fine.” Then, as he was getting up to leave, he added, “Oh, and Marty, by the way, if at any time your interests and our interests diverge, we’ll advise you that we’re not on the same team anymore and that you’ll need to get your own counsel.”
As soon as the General Counsel left, I grabbed the phone and called my brother Gerry. Gerry was an advertising lawyer for Davis and Gilbert, but he was the only lawyer I could trust. “Gerry, these
bastards just handed me a live grenade. What do I do? Do I get my own lawyer or what?”
“No. You didn’t do anything wrong and this is just a hearing. It’ll look bad if you come in with your own attorney. Just go in there and tell them the truth.”
So that’s what I did. On Friday, November 24, I marched down to the New York Stock Exchange and for six hours I testified under oath. I’d been through a Marine Corps interrogation training course, but nothing could have prepared me for this ordeal. They had a court stenographer recording everything, and they just kept pushing me, asking me the same questions over and over.
Why did I decide to write a negative report on the industry when before I’d always been positive? Where did I get my information? With whom did I discuss it? Who had access to the report? Did I give copies to anyone outside of my group? Did I, or anybody I knew, sell shares of American Medical International, Hospital Corporation of America, or any other company in the hospital management industry within the last three months? Six months? A year?
I have a great memory and I just kept telling them everything I knew. After six hours, it must have been obvious that I didn’t know who leaked the report, and if the leak had been part of an orchestrated effort by the Pyramid or anybody else to manipulate stock prices, I didn’t have anything to do with it. I left the Exchange confident that I’d be exonerated, but there was still one problem that had to be resolved. The Great Pyramid had yet to publish the report.
In all likelihood, the report never would have gotten released if the Prophet, or the High Priest, or certainly the Pharaohs, had seen it before it was leaked. Our report was, in effect, a “SELL” recommendation for the hospital management industry, and nobody on Wall Street ever made a “SELL” recommendation. “HOLD” was as low as you went and a “HOLD” recommendation meant run, don’t walk, to your broker and dump. If the Prophet had been doing his job, he would have been on top of what Sphinx and I were doing and he would have been at the meeting when we presented the draft. If he had been there, he would’ve killed the report on the spot. But the Prophet hadn’t been at his post, he’d been watching the quote machine, and now it was too late to bury the report.
Under the now watchful eyes of the High Priest and the Prophet, Sphinx and I did a complete rewrite. We omitted all references to American Medical International, we softened our assumptions, we changed a whole mess of “wills” to “mights,” “probablys” to “possiblys,” and “therefores” to “maybes.” Most important, we stressed that we expected the industry to maintain its 15 to 20 percent growth rate in earnings through the rest of 1972 and all of 1973. We made it very clear that this report was not a “SELL” recommendation, but rather an “alert” to clients of potential longer-term problems that might be facing the hospital management industry.
The official report was released on Friday, December 1, 1972, but by that time nobody was buying it. On Monday, November 27, Dan Dorfman’s “Heard on the Street” column in the Wall Street Journal talked about the leak, and how the original report was much more negative than the one that the Pyramid was publishing. “It was a ‘nightmare’ for The Great Pyramid, or so, at least, one inside source describes it,” Dorfman began. The report got out without authorization, it caused hefty losses for stockholders of the hospital management companies, and due to some short selling, there was suspicion that The Great Pyramid was manipulating the market. Dorfman ended with a quote from one savvy Big Board trader who said, “‘I think these are down stocks. What the Pyramid has done is to seriously question the future earnings power of the industry. Who knows if they’re right or wrong, but if they’re right, the game’s over for these stocks.’”
No wonder Uranus J. Appel and other executives in the industry kept pushing the New York Stock Exchange to investigate. On December 1, 1972, Uranus, who had seen a copy of the original draft, was quoted as saying that it was “amateurish” and “shows very little understanding of what the health care field is all about.” He added angrily that the stock’s sharp decline had caused a major acquisition to be canceled.
The Exchange, through its Stock Watch program, began looking at the trading in the stocks of hospital management companies during the week of November 13. The leak was traced back to the scumball at Scudder and, ultimately, to Standish. Standish, after first denying that he’d leaked the report, admitted on December 12, 1972, that he’d taken our preliminary draft and given it to the scumball. On December 14, George Johnson, CEO of Scudder, acknowledged that one of his analysts had obtained a copy of the draft and that some Scudder clients might have sold stock holdings before the steep price declines that followed wide circulation of the leaked report. At last I was vindicated, or so I thought.
On January 26, 1973, a group of stockholders from California who’d owned American Medical International stock sued The Great Pyramid and me personally, contending that
[O]ne of its general partners and its security analyst devised a “short-sale” scheme whereby they disseminated false information under the guise of its being “insider information” which reflected unfavorably on the financial condition of American Medical International, Inc., a company in which the plaintiffs held stock. As a result, the market became depressed, causing plaintiffs to sell at a depressed price, allowing the defendants to purchase to cover their short position. This was a concerted plan, a conspiracy to create a short market in AMI stock.
They asked for damages of $74,200 and punitive damages of $742,000 for a total of $816,200. The General Counsel said not to worry, that the suit had no merit, but still, it wouldn’t go away. Uranus wouldn’t let it go away. By the end of January, AMI’s stock had fallen to 24½, a 50 percent drop.
At a meeting of the New York Society of Security Analysts on February 2, 1973, Uranus blasted the Pyramid, the report, and me. He extolled American Medical’s 20 percent increase in earnings for the most recent quarter and told the analysts that his company had “never been in a stronger position on which to build for future growth.” He assailed the unauthorized release of the report, saying it was an “underground publication” that contained at least seven basic misstatements of fact in addition to “half truths, misconceptions and sins of omission.” He stressed that “this inaccurate presentation was served up by two young men after only a two-hour interview in my office.”
Executives of the hospital management companies, my former buddies, wanted nothing to do with me. I was an analyst with nothing to analyze. Even worse, by that time, the whole market had gone to hell. The small stocks had started falling in the second half of 1972. In the fall of ’72, the only stocks still going up were the “nifty fifty,” institutional favorites like Polaroid, Kodak, and Avon. Fifty stocks were carrying the whole show, all selling at fifty to sixty times earnings. In January of 1973, the Dow topped out at 1,017 and we went into one of the worst bear markets this country has ever seen. On March 15, the suits were dismissed for lack of venue, but hardly anybody noticed. Since the whole market had gone into the crapper, the hospital management industry was just another sad face in the crowd.
In July 1973, the Prophet called me in. He told me that due to the downturn in the market, the Pyramid was cutting back on its overhead. “Marty, I’m sorry, but we’re gonna hafta letcha go.”
I was stunned. I thought that we were a team, and for six months I’d been carrying the ball for these guys. Now they’d dumped me. But I should have seen it coming; once again, the big boys were looking out for Number One. After Standish got caught and admitted that he was the one who’d leaked my report, people on the Street like Dan Dorfman started wondering publicly who was watching the shop at Pyramid. The High Priest and the Prophet weren’t about to take the hit. I was the guy who’d written the report, so I was the block that would be crushed. They couldn’t crush me as long as the suit was hanging over their heads, because they knew that I knew things that could really rock The Great Pyramid. It was much safer for them just to keep on paying me for a few months until the suit was
dismissed and then can my ass.
I was only twenty-eight and still naive in the ways of Wall Street. I’d been to business school, but nobody had ever taught me about business. My father was a small-time merchant. My mother was a high school guidance counselor. My degree in economics from polite, gentlemanly Amherst was irrelevant, and the marines were Semper Fidelis, Always Faithful. At Kuhn Loeb, I was part of a team, and Favia and Bronchtein watched out for me. I just wasn’t prepared for the Pyramid. At the Pyramid, you didn’t wear a bulletproof vest in the front, you wore it in the back.
I had forty-odd thousand saved up, so I wasn’t in a rush to find another job. I decided to take the summer off and stay out at my group house in the Hamptons. I ran into some guys on the beach who were playing commodities. They convinced me to take a trip to Chicago to the Mercantile Exchange, where they were trading cattle and pork bellies. The next thing I knew, I was $5,000 into a computer geek named Paul Goldstein who was running a time-sharing computer commodity trading system. Goldstein didn’t have his own computer and couldn’t afford to buy computer time except at three in the morning. I was also $20,000 into a Russian wheat futures deal I got from my old gambling buddy Ricky G., who had a commodities broker, Billy H., who had a brother-in-law who supposedly had a direct line to a guy in Washington who knew a guy at the Department of Agriculture who’d been to Moscow. Talk about long shots.
By October, I was down $25,000 and things were getting tight. I figured I’d have to go back to being a securities analyst, so I started calling all of my contacts on the Street. “Oh, yeah, Schwartz. Yeah, your résumé is great and everything, but weren’t you in the middle of that Pyramid thing? Geez, I’m sorry, with the market down like it is, you know, I don’t think we’re hiring.”
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