Overture’s ‘Victim’ Role in Merrill Controversy Open to Interpretation

By ANTHONY PALAZZO

Staff Reporter

Overture Services Inc. claims to be the victim of allegedly tainted investment advice given out by Wall Street brokerage house Merrill Lynch last year, and it’s easy to see why.

Stock of the Pasadena-based Internet company fell 10.7 percent on the day Merrill’s star analyst, Henry Blodget, downgraded the company, allegedly in retaliation for Overture’s decision to hand some investment banking business to a rival.

But details of earlier interaction between Overture officials and Merrill, revealed by New York Attorney General Eliot Spitzer last week, raise questions about just how well the “victim” label fits.

“It could be claimed (Overture) benefited from this kind of non-traditional discussion with Merrill to begin with,” said Henry Hu, a corporate and securities law professor at the University of Texas at Austin. “The hands are not perfectly clean.”

Merrill’s coverage of Overture formerly GoTo.com was cited by Spitzer as he accused Merrill of biased analyst coverage. Spitzer’s affidavit, containing e-mail samplings from Overture and Merrill officials, was posted on the Attorney General’s Web site.

“We kind of believe we were a victim of Merrill’s practices,” said Kasey Byrne, chief communications officer of Pasadena-based Overture. “When we saw those e-mails we were surprised and very disappointed in them.” Overture has been cooperating with Spitzer’s investigation, and is a witness in the matter, Byrne said.

The e-mails cited in the Spitzer affidavit show an astonishing amount of collaboration between Overture officials, Merrill’s bankers, and its research analysts, who are supposed to form independent opinions.

“It’s too early to say whether the company itself was the victim,” said Marc Violette, a spokesman for Attorney General Spitzer. He added that the investigation was ongoing, but declined to characterize Overture’s place in it.

“It appears quite obvious that there’s a fundamental, very serious betrayal of trust by analysts at Merrill Lynch to investors who were relying on those analysts for sound, unbiased assessments,” Violette said.

(Merrill Lynch has issued a statement blasting Spitzer for drawing inaccurate conclusions, and called the June 6, 2001 downgrade by Blodget “the right call.” Spitzer, meanwhile, has widened his probe into securities industry research to include other firms.)

Controversial report

From the e-mails, it appears that the now-departed Blodget and members of his team thought less of Overture than their published research indicated.

“Nothin” was Blodget’s response when an institutional investor asked, via e-mail, “What’s so interesting about GOTO except banking fees????”

The query came in January 2001, just after Blodget initiated coverage of Overture with a report that gave the company a higher rating than members of Blodget’s own team had recommended.

Overture officials, along with Merrill’s investment bankers, pressured members of Blodget’s team for the optimistic assessment, the attorney general alleged.

For example, Overture’s then-head of corporate development, Russell Benaroya, pushed for higher revenue and profitability projections than the ones Merrill’s analysts proposed. Benaroya allegedly sent the following e-mail to Overture Chief Financial Officer Todd Tappin and another colleague:

“Based on these numbers, why would they even want to initiate on us. Todd should call back and pose that question. This is ridiculous and totally frustrating. Merrill will never take my company public.”

According to the affidavit, Overture “got its way: the final published initiation research report had profitability occurring sometime in 2002 rather than in the first quarter of 2003.”

Overture even had input into Merrill’s downgrade of a rival company, LookSmart Ltd., according to the affidavit.

Later, Blodget praised Overture as Merrill bankers attempted to win its investment banking business. But when Merrill lost out on a deal to rival Credit Suisse First Boston, Blodget quickly issued a downgrade. On that day, June 6, 2001, Overture’s stock fell $2.86 to $23.78.

“It may be difficult for GoTo to complain that somehow the decision to pick CSFB harmed them because Merrill took retribution,” Hu said. “There’s the issue of unclean hands.”

‘Expressing frustration’

Overture’s Byrne said she took Benaroya’s e-mail to mean that “if he were to have a company some day and that company were to go public he wouldn’t work with Merrill. He was just expressing some frustration.”

Byrne also said that Overture was reviewing and commenting on the factual accuracy of Merrill’s pre-published reports.

Indeed, Overture’s interactions with Merrill don’t appear to violate SEC rules, said William Klein, a professor emeritus and corporate law specialist at UCLA School of Law.

Merrill, in its statement, said the e-mails “show that there was a normal give and take as well as vigorous debate among analysts as they assessed different companies.”

Spitzer plans to propose broad measures to restore investor confidence in Wall Street research, Violette said. It’s too early to tell whether those will include new rules governing company input into research. “The announcement (Spitzer) made about Merrill Lynch he characterized as the tip of the iceberg,” he said.

Meanwhile, the Street’s view of Overture one of the few profitable firms to emerge from the Internet train wreck show little evidence of research that resembles anything more than cheerleading.

Just last week, Goldman Sachs analyst Anthony Noto issued a report calling Overture, along with Ebay Inc., Amazon.com, Yahoo Inc. and other Internet names, “relative safe havens.” “Yahoo will be the first Internet company to report earnings and could serve as a catalyst attracting investors to look for other Internet names that can deliver strong quarterly results,” Noto said.

On April 11, after Yahoo posted first quarter revenues that disappointed investors, its stock fell 16.2 percent in a broad market downturn. Overture, which Noto called “our favorite New Media name,” fell $3.89, or 14.1 percent, to $23.75. Ebay and Amazon also fell.

Overture may yet turn out to be a successful choice for stock pickers who are following Noto’s recommendation. But the company’s stock price is highly dependent on its ability to maintain a few large relationships with Web sites that host its paid search results.

Two of its largest three contracts, with America Online and Yahoo, are being evaluated for renewal right now, at a time when Overture faces new competition from privately held Google and others. The AOL deal was recently extended through April 24, while the deal with Yahoo lasts through June.