2001 Review: Wall Street Winces

Call it a year of reckoning.

In 2001, Wall Street was forced to answer for the flagrant excesses of the 1990s in so many ways. Steep declines in trading and the once-lucrative IPO market eroded business and profit margins. Investors who lost their shirts in the downturn raised a chorus of boos against brokerages and analysts, accusing them of actionable grandiosity in legal challenges.

The industry has been scrambling to get its house in order. Global operations and lower-end services, many of which were added during the '90s, have been scaled back. After huge staffing drives, thousands of industry employees have lost their jobs, while many others have seen pay and bonuses scuppered. Spendthrift executives and high-profile analysts who burned investors with bad stock picks have been ousted.

Boom to Bust

After trillions of dollars in capital disappeared from the nation's stock markets, investing ceased to be a hot topic in bars and living rooms across America, and retail investing fell flat in 2001. If institutions like pension funds, hedge funds and mutual funds continued to trade vigorously this year, individuals did not, and average daily trading volumes on the Nasdaq through October were half what they were last year, according to the Securities Industry Association.

The IPO market, another cash cow in the boom years, stopped producing. Only 80 deals have been done this year, compared with 429 in 2000. Mergers and acquisitions slowed to a crawl. With trading revenue and underwriting fees drying up, industry profits are expected to total around $10 billion, less than half of last year's $21 billion, according to the SIA.

Blue Issues Not surprisingly, IPO volume was way down in 2001

*January to November. Source: Securities Industry Association.

As a result, securities firms are cutting fat wherever they can. Bank of America (BAC Quote - Cramer on BAC - Stock Picks), for example, is rethinking its move into investment banking, with a particularly critical eye toward its European operations. Knight Trading (NITE Quote - Cramer on NITE - Stock Picks), the largest market maker for Nasdaq stocks, is also reducing its overseas presence. Retail brokerage Charles Schwab (SCH Quote - Cramer on SCH - Stock Picks) is trying to attract high-end customers by offering access to hedge fund products.

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Slipping in the Oil Patch

The industry has cut workers, with many companies scaling back to the staffing levels they had before the dot-com bubble. After almost doubling their workforces in the 1990s, securities firms have handed out pink slips to 26,000 people since February of this year, when industry employment peaked at more than 700,000 workers, according to the SIA. Companies are also expected to trim 30% from year-end bonuses, which averaged $74,000 last year.

Trading Places

Stan O'Neal, the new president and chief operating officer of Merrill Lynch (MER Quote - Cramer on MER - Stock Picks), and John Mack, the new chief executive of Credit Suisse First Boston, part of Credit Suisse Group (CSR Quote - Cramer on CSR - Stock Picks), might best represent the change of tone.

O'Neal, who assumed his position in July after serving as president of Merrill's U.S. private client group, has begun reversing a trend established by Chairman and CEO David Komansky. During the '90s, Komansky bulked up the firm with pricey acquisitions -- 19 in all -- in a rapid expansion that was squeezing profits even before the stock market turned down. Among other assets, the firm bought Japan's fourth-largest brokerage, Yamaichi Securities, after the Japanese firm went bankrupt in 1998.

O'Neal has gained a reputation for merciless cost-cutting. Since his tenure began, he has announced drastic reductions in global operations and is insisting brokers shift their focus to investors with more than $1 million to spend. He has also announced plans to lay off 15% of the company's workforce, offered buyouts to 2,600, and put a cap on salary increases until at least the middle of next year.

Syndication Blights After two huge years, equity underwriting crashed

*January to November. Source: Securities Industry Association.

Mack, meanwhile, took the helm at Credit Suisse First Boston in July, shortly after the company encountered allegations it received kickbacks from clients on hot IPOs. Also hired to bring costs under control, he was known as "Mack the Knife" for his management approach as an investment banker at Morgan Stanley. Mack replaced Allen Wheat, who was credited with transforming the business into an equities and M&A powerhouse, but who faced criticism for its fast and loose reputation with regulators.

Hot Topic

Among other measures, CSFB's new chief has cut many of the special deals and guarantees the firm was offering its bankers after an expensive merger with Donaldson Lufkin & Jenrette last year. Mack has also worked to settle with regulators over the IPO scandal, and the company recently agreed to pay $100 million to resolve a federal investigation. The payout won't break CSFB's bank, but it is the fifth-largest regulatory settlement ever in the securities business.

Wall Street firms including CSFB still face up to 1,000 lawsuits seeking class action status. Separately, the Securities and Exchange Commission is investigating Goldman Sachs (GS Quote - Cramer on GS - Stock Picks), the Robertson Stephens unit of FleetBoston (FBF Quote - Cramer on FBF - Stock Picks), the securities unit of J.P. Morgan (JPM Quote - Cramer on JPM - Stock Picks), and Morgan Stanley to see if they artificially pumped up IPOs in the aftermarket by making clients promise to buy additional shares after trading started.

CSFB made more money on the IPO boom than any other securities firm, pulling in $700 million in fees during 1999 and 2000. Frank Quattrone, who headed up the West Coast technology group that managed many of CSFB's underwriting of IPOs, has emerged from the scandal with his job intact, though three people who worked under him were fired. He was recently asked to renegotiate a juicy salary, but the powerful banker was given a seat on the firm's executive committee in exchange.

Departures

Other high-profile analysts and strategists have had to pack their bags. Star Internet analyst Henry Blodget probably grabbed the most headlines among analyst departures. Once a hotshot Internet guru, many of his favorite stocks bombed as the Nasdaq slipped from its peak. The analyst accepted an estimated $2 million buyout package in mid-November and plans to write a book.

Blodget is one of many analysts accused of maintaining high ratings on stocks to encourage future underwriting business for their firms. The difference is that Merrill agreed in July to pay an investor $400,000 to settle a claim over one of his recommendations. Mary Meeker, famed champion of Internet stocks at Morgan Stanley, was also sued by investors in August, but the judge dropped the case, calling it "abusive."

Other high-profile employees have left Merrill recently. In early December, former tech analyst hotshot Thomas Kraemer left the firm. Tech fund manager Paul Meeks departed less than two weeks later. Merrill also replaced uber-bull investment strategist Christine Callies with the more bearish Richard Bernstein in early December.

Whether Wall Street's new frugality will last the winter remains to be seen. The industry's immediate challenge is to make the massive restructuring and layoffs of the last 12 months show up on balance sheets and profit statements. Beyond that, it'll have to contend with an SEC that shows no signs of loosening its grip on practices it spent most of the last decade trying to rein in.