Wall Street: The Cleanup Is Overdue

Merrill Lynch & Co. (MER ) announced that it's prohibiting its equity analysts from buying shares in the companies they cover. It's about time. The investment firm deserves kudos for being the first on Wall Street to actually do something about the potential conflict of interest surrounding its analysts. But let's face it, the move is long overdue. Congress is already holding hearings on the connection between stock recommendations and analyst compensation, the Securities & Exchange Commission is issuing "investor alerts" warning stockholders not to take research reports at face value, and a burst bubble has shareholders looking for someone to blame.

The truth be told, stock analysts are good candidates. As BusinessWeek's "Who Can You Trust" (Oct. 5, 1998) showed, the interests of investors and securities analysts have been growing further and further apart. Despite their claims to objectivity, analysts have repeatedly crossed the line to become rainmakers for their investment-banking colleagues, grandly enriching themselves along the way. Not only have most of them collected bonuses for the business they channel to underwriting bankers via their optimistic valuations, they have been allowed to trade in the stocks they promoted. The National Association of Securities Dealers and the New York Stock Exchange have argued that conflicts of interest were best prevented by self-regulation. This argument has clearly proved to be a joke. When Wall Street's trade group, the Securities Industry Assn. (SIA), belatedly issued its own "Best Practices for Research" voluntary guidelines recently, its rules were so pathetically weak that 13 of the 14 firms that signed already met the new, "higher" standards.

Of course, we now know that the most flagrant transgressors were the analysts covering the Internet economy. When the bull was running they acted as TV cheerleaders, chief rationalizers of ludicrous valuations, and major deal-makers for initial public offering underwriters. When the Net bubble burst, they continued to issue "buy" ratings in the face of horrendous losses. Some continue to do so to this day.

Merrill Lynch says its analysts can choose to sell their existing stock portfolios, put them in accounts over which they have no discretion, or keep them but disclose the positions on future research reports. Given the low level of credibility most analysts now have, it would serve Wall Street well to insist that analysts invest in mutual funds, not specific stocks, and disclose all holdings to investors. And it would serve the SEC, the SIA, the NYSE, and Nasdaq to ask why it took a bear market to force Wall Street to begin to clean up its act.

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