Buy, Lie, and Sell High: How Investors Lost Out on Enron and the Internet Bubble

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Why did the Internet and Enron stock collapses really happen? Was it arrogance? Greed? The "madness of crowds"? Just plain bad luck? Or something else entirely?

In Buy, Lie, and Sell High, Harvard Business School Professor D. Quinn Mills offers the first systematic analysis of both the Internet stock bubble and the Enron scandal. Drawing upon new research-including an extensive review of the latest lawsuits and securities documents-Mills uncovers both systemic causes and ...

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Overview

Why did the Internet and Enron stock collapses really happen? Was it arrogance? Greed? The "madness of crowds"? Just plain bad luck? Or something else entirely?

In Buy, Lie, and Sell High, Harvard Business School Professor D. Quinn Mills offers the first systematic analysis of both the Internet stock bubble and the Enron scandal. Drawing upon new research-including an extensive review of the latest lawsuits and securities documents-Mills uncovers both systemic causes and outrageous misbehavior. He demonstrates how each link in the "financial value chain," from venture funds to auditors and regulators, not only failed to protect small investors, but also actively contributed to their losses.

Mills demonstrates why it didn't have to be that way, comparing the U.S. experience with that of Germany, which experienced its own Internet stock bubble with far milder consequences to ordinary investors. He then offers practical and detailed recommendations for investors, citizens, and policymakers seeking to keep it from happening again.

Includes exclusive interviews with and contributions by:

  • Ted Dintersmith, Charles River Ventures
  • Julian Kurz, The Boston Consulting Group
  • Robert Glauber, CEO/President, National Association of Security Dealers
  • Barbara Boehnlein, Ph.D., ABN AMRO Rothschild
  • Patrick Boos, entrepreneur, Webmiles
  • Wilfried Beeck, entrepreneur, Intershop
  • Christoph Peck, Management Angels
  • Christiane Sommer, entrepreneur, BRAND EINS
  • Juergen Kohr, entrepreneur, DATACOM.net

The Internet bubble: What really happened—and why.

  • Includes the first detailed analysis of the Enron collapse
  • Why the Internet stock collapse was no accident
  • Who lost—and who benefited
  • How the disaster could have been averted
  • Avoiding the next speculative bubble: techniques for investors, recommendations for policymakers

Investors lost millions of dollars in the Internet collapse—and, according to conventional wisdom, they only have themselves to blame for being greedy, shortsighted, and ignorant of business fundamentals. But is that the real story? In this riveting and insightful book, Harvard Business School Professor D. Quinn Mills argues that the Internet bubble and subsequent collapse was no accident: Blame can be placed squarely at the feet of venture firms, investment banks, accountants, mutual funds, brokerages, federal regulators, and the Federal Reserve—not "dumb small investors." Through extensive original research and the contributions of many active participants, Buy, Lie, and Sell High offers authoritative answers to the questions every investor is asking: "What actually happened during the Internet bubble?" "Who got the money I lost?" "Why did it happen?" "Who's to blame?" "What can I do about it?" "Will it happen again, and how can I keep it from happening to me?"

Mills compares the U.S. Internet bubble with events in Germany, where an Internet bubble also arose—but with radically different and far less serious consequences. Drawing on the same ideas, he also offers the first detailed analysis of the Enron collapse. Then Mills presents a specific, rigorous analytical structure for helping investors avoid future bubbles—as well as the first detailed proposals for effective reform.

Through extensive original research and the contributions of many active participants, Buy, Lie, and Sell High offers authoritative answers to the questions every investor is asking: "What actually happened?" "Who got the money I lost?" "Why did it happen?" "Who's to blame?" "What can I do about it?" And most important of all, "Will it happen again, and how can I keep it from happening to me?"

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Product Details

  • ISBN-13: 9780130091130
  • Publisher: Pearson Education
  • Publication date: 6/19/2002
  • Pages: 288
  • Product dimensions: 6.22 (w) x 9.26 (h) x 1.02 (d)

Read an Excerpt

Preface

Why This Book Has Been Written

I've written this book because of what happened to a friend of mine. She was in her 50s, and had painfully accumulated over her working life a nest egg. When she lost her job, she received the money in a lump sum. It was to help support her old age. She visited the Web site of one of the largest mutual fund companies and studied the performance record of the 15 or so funds they offered for annuity contracts. She identified those with the best returns. She then called a representative at the company to ask about an investment. He told her that she had picked the two best funds, just what she should do, and he arranged for her to make the investment. She now had an annuity contract with the mutual fund company with her capital invested in a single fund.

Three months later the fund began a rapid collapse. She called the company and was told that the decline was temporary, and that the proper long-term strategy was to remain invested. She did, and the fund fell to about 30 percent of its level at which she had bought it. It turned out that the fund had been heavily invested in Internet stocks.

"Why did I lose my money?" she asked me. "Why was my pension money invested in such speculative stocks? Who got the money I lost?"

How This Book Was Written

So a small team and I went to work studying the great Internet bubble. We looked at the various players who were involved in the process by which venture funds and entrepreneurs built companies, and then with the investment banks, took them public. We made a list of how the venture funds changed their investment criteria as the bubble developed, and how investment bankschanged their criteria for taking firms public. We looked at how the mutual funds shifted their investment criteria so that many funds became loaded with dot-com and telecom stocks. We looked at Alan Greenspan's warnings, and at the inflation and then bursting of the bubble. We looked at who made money in the outcome, and who lost.

We have read the literature on financial manias and explored the explanations being given for the recent bubble. The key explanations are that (1) it was an accident: A group of forces came together like the perfect storm—new technology, an affluent investing public, and a booming economy—and then blew themselves out; (2) it was engineered: The incentive structures in financial service firms made their blowing up into a bubble a certainty; (3) it was a result of inexperience: Investment professionals (including the business press) were young and inexperienced, and believed that the New Economy was qualitatively different from the Old Economy so that valuations weren't recognized as inflated; and (4) it was another example of the madness of crowds—individual investors were prone to mass hysteria and didn't do their homework and so drove stock prices to unreasonable levels, and when the bubble burst, got what they deserved.

We also asked whether or not the entrepreneurs, venture firms, investment banks, brokerages, and mutual funds really thought that the companies they sold the retail investor were legitimate firms; and we looked at the litigation now underway about how IPO sales were conducted.

We asked whether or not a bubble was a necessary consequence of the operation of our free markets—the way western economies raise capital to fund technological innovation? Or, alternatively, whether the bubble was a dangerous aberration that should be avoided if possible?

Our research convinces us it is the latter, so we asked what might prevent another bubble, or at least help protect retail investors from the worst ravages of one if it occurs.

We also looked at Germany, which had a somewhat similar bubble in Internet stocks, but with a very different outcome for small investors, and asked why. In this book, several times we provide German examples of what happened in the Internet bubble; they provide important supplementary material showing how the bubble leapt international boundaries, and how its elements were often the same but sometimes different. But in this book, to avoid confusion we usually are talking about the American experience, except where Germany is explicitly cited.

We were fortunate to find many knowledgeable people willing to talk with us about the bubble. Some were willing to do so for attribution; others were unwilling to let themselves be identified, in part because litigation about events during the bubble is gathering force today, and many people are either involved in or hoping to stay out of the legal fray.

Regardless of whether or not people were willing to be identified in print, they provided us with an ongoing dialogue from which this book emerged. It's the hope of our research team that readers will engage their own friends and acquaintances in a discussion of the important issues which arise in this book. To encourage such a dialogue, we have provided a small group of talking points at the end of each chapter—not a summary of the chapter, but rather the key points that a person might want to take from it to a discussion with others.

An Unusual Feature of This Book: Contributions from Others

An unusual feature of this book is that it includes short contributions from people other than the author and his team. Several American and German participants in the bubble have consented to give their experiences and their views about the issues with which this book is concerned, so that this book provides a forum within which some of the players in the Financial Value Chain can discuss what occurred during the bubble. Sometimes contributors to this book don't agree with the author, but differences in opinion will help the reader make up his or her own mind about what happened in the Internet financial mania and what it means for each of us.

The Message of This Book: How to Avoid Another Bubble and How to Protect Yourself If It Occurs

From our inquiry, we've developed a set of suggestions as noted in Chapter 16, "Reforms to Protect Small Investors," about how entrepreneurs and investors can help avoid another bubble or protect themselves from it if it occurs, including proposed regulatory reforms that would provide much more protection for investors in the event of another bubble.

Talking Points

Many investors took heavy losses during the Internet bubble. How did that happen and what, if anything, should be done about it?

Read More Show Less

Table of Contents

Acknowledgments
Pt. I The Bubble and Capital Markets 1
Ch. 1 How to Use This Book 3
Ch. 2 Destroyed by the Bubble 7
Pt. II How the Bubble Happened 17
Ch. 3 Causing the Bubble 19
Ch. 4 Inflating the Bubble: The Financial Value Chain 33
Ch. 5 What it Meant to "Do the Right Thing" at Enron 47
Pt. III Inexperienced Leaders 57
Ch. 6 Dumb Kids? 59
Ch. 7 How Some VCs and Bankers Led Entrepreneurs in the Wrong Direction 75
Pt. IV How Venture Firms Changed Their Criteria 91
Ch. 8 Building to Flip 93
Ch. 9 Choosing the Wrong People 107
Pt. V Taking Start-ups to the Public 117
Ch. 10 How Investment Banks Inflated the Bubble 119
Ch. 11 The Retail Investor: Victim or Fool? 135
Ch. 12 Influencing Factors: Where Does Responsibility Lie? 145
Pt. VI The Road Kill of Capitalism 157
Ch. 13 Sell, Sell, Sell 159
Ch. 14 Dire Consequences 173
Pt. VII A Troubled System 193
Ch. 15 Can America Lead? 195
Ch. 16 Reforms to Protect Small Investors 207
Pt. VIII Less Damage Next Time 223
Ch. 17 What Does the Future Hold? 225
App. A NEMAX (The German New Market) and NASDAQ 235
App. B Financial Value Chain Influencers 237
Contributors 249
Endnotes 251
Index 257
Read More Show Less

Preface

Why This Book Has Been Written

I've written this book because of what happened to a friend of mine. She was in her 50s, and had painfully accumulated over her working life a nest egg. When she lost her job, she received the money in a lump sum. It was to help support her old age. She visited the Web site of one of the largest mutual fund companies and studied the performance record of the 15 or so funds they offered for annuity contracts. She identified those with the best returns. She then called a representative at the company to ask about an investment. He told her that she had picked the two best funds, just what she should do, and he arranged for her to make the investment. She now had an annuity contract with the mutual fund company with her capital invested in a single fund.

Three months later the fund began a rapid collapse. She called the company and was told that the decline was temporary, and that the proper long-term strategy was to remain invested. She did, and the fund fell to about 30 percent of its level at which she had bought it. It turned out that the fund had been heavily invested in Internet stocks.

"Why did I lose my money?" she asked me. "Why was my pension money invested in such speculative stocks? Who got the money I lost?"

How This Book Was Written

So a small team and I went to work studying the great Internet bubble. We looked at the various players who were involved in the process by which venture funds and entrepreneurs built companies, and then with the investment banks, took them public. We made a list of how the venture funds changed their investment criteria as the bubble developed, and how investment bankschanged their criteria for taking firms public. We looked at how the mutual funds shifted their investment criteria so that many funds became loaded with dot-com and telecom stocks. We looked at Alan Greenspan's warnings, and at the inflation and then bursting of the bubble. We looked at who made money in the outcome, and who lost.

We have read the literature on financial manias and explored the explanations being given for the recent bubble. The key explanations are that (1) it was an accident: A group of forces came together like the perfect storm—new technology, an affluent investing public, and a booming economy—and then blew themselves out; (2) it was engineered: The incentive structures in financial service firms made their blowing up into a bubble a certainty; (3) it was a result of inexperience: Investment professionals (including the business press) were young and inexperienced, and believed that the New Economy was qualitatively different from the Old Economy so that valuations weren't recognized as inflated; and (4) it was another example of the madness of crowds—individual investors were prone to mass hysteria and didn't do their homework and so drove stock prices to unreasonable levels, and when the bubble burst, got what they deserved.

We also asked whether or not the entrepreneurs, venture firms, investment banks, brokerages, and mutual funds really thought that the companies they sold the retail investor were legitimate firms; and we looked at the litigation now underway about how IPO sales were conducted.

We asked whether or not a bubble was a necessary consequence of the operation of our free markets—the way western economies raise capital to fund technological innovation? Or, alternatively, whether the bubble was a dangerous aberration that should be avoided if possible?

Our research convinces us it is the latter, so we asked what might prevent another bubble, or at least help protect retail investors from the worst ravages of one if it occurs.

We also looked at Germany, which had a somewhat similar bubble in Internet stocks, but with a very different outcome for small investors, and asked why. In this book, several times we provide German examples of what happened in the Internet bubble; they provide important supplementary material showing how the bubble leapt international boundaries, and how its elements were often the same but sometimes different. But in this book, to avoid confusion we usually are talking about the American experience, except where Germany is explicitly cited.

We were fortunate to find many knowledgeable people willing to talk with us about the bubble. Some were willing to do so for attribution; others were unwilling to let themselves be identified, in part because litigation about events during the bubble is gathering force today, and many people are either involved in or hoping to stay out of the legal fray.

Regardless of whether or not people were willing to be identified in print, they provided us with an ongoing dialogue from which this book emerged. It's the hope of our research team that readers will engage their own friends and acquaintances in a discussion of the important issues which arise in this book. To encourage such a dialogue, we have provided a small group of talking points at the end of each chapter—not a summary of the chapter, but rather the key points that a person might want to take from it to a discussion with others.

An Unusual Feature of This Book: Contributions from Others

An unusual feature of this book is that it includes short contributions from people other than the author and his team. Several American and German participants in the bubble have consented to give their experiences and their views about the issues with which this book is concerned, so that this book provides a forum within which some of the players in the Financial Value Chain can discuss what occurred during the bubble. Sometimes contributors to this book don't agree with the author, but differences in opinion will help the reader make up his or her own mind about what happened in the Internet financial mania and what it means for each of us.

The Message of This Book: How to Avoid Another Bubble and How to Protect Yourself If It Occurs

From our inquiry, we've developed a set of suggestions as noted in Chapter 16, "Reforms to Protect Small Investors," about how entrepreneurs and investors can help avoid another bubble or protect themselves from it if it occurs, including proposed regulatory reforms that would provide much more protection for investors in the event of another bubble.

Talking Points

Many investors took heavy losses during the Internet bubble. How did that happen and what, if anything, should be done about it?

Read More Show Less

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