Commentary: Can This Man Make Wall Street Behave?

By Marcia Vickers

Remember the Chinese Wall? Well, if anyone doubted that Wall Street analysts are in cahoots with their firms' investment bankers, read this: Excite@home is "such a piece of crap." As for "Nothing interesting about this company except investment-banking fees." These are just two of the e-mails Merrill Lynch & Co. (MER ) analysts sent to each other concerning stocks on which they maintained enthusiastic ratings.

So much for Wall Street research. These e-mails, which lay bare the extent of deceit rampant among Street analysts, were presented at a briefing by New York State Attorney General Eliot Spitzer on Apr. 8. They are part of the evidence his office has gathered during a 10-month investigation focused on Merrill in which he concludes Street research often results in "a fundamental deception of the public."

Merrill denied there was any basis for the attorney general's allegations. In an Apr. 8 statement, it dismissed his findings as "just plain wrong."

No doubt, these are tough times for analysts, who seem to be joining the ranks of trial lawyers and used-car salesmen in the public's mind. Perhaps for good reason. As another e-mail from a Merrill analyst to an investment banker stated: "The whole idea that we are independent from banking is a big lie."

Analysts, of course, have been on the hot seat for awhile. Congress has held hearings on analysts' conflicts, and the National Association of Securities Dealers and the New York Stock Exchange have both proposed ways to limit those conflicts. But the sheer arrogance of these e-mails could do more to spur reform than a dozen high-profile hearings.

Spitzer has already won a court order forcing Merrill, the country's largest brokerage, to provide greater disclosure of its investment-banking ties in its research reports. Much now depends on what other evidence Spitzer finds. Sources close to the investigation say he's probing other major Wall Street firms, including Goldman Sachs (GS ), Credit Suisse First Boston, Lehman Brothers (LEH ), UBS PaineWebber, and Salomon Smith Barney (C ), and he may subpoena records there, too. He may also file criminal charges against the firms.

The types of reforms he is pushing for are key. Although he has called for "significant structural changes" on Wall Street, many of Spitzer's reform ideas aren't practical. He recommended to Merrill during negotiations, for instance, that it spin off its research arm as a separate business. Merrill refused. Some experts say spinning off research is a naive proposition. Investment research is typically given away, and its cost is shared between the investment-banking and brokerage divisions, since both use it to help drum up business from clients.

Spitzer may be wiser to target compensation, since analysts are typically paid according to the amount of investment-banking business they generate. Spitzer's affidavit features a fall 2000 memo from Henry Blodget, then Merrill's Star Internet analyst, to his bosses stating that he had been involved in over 52 investment banking transactions and had earned $115 million for the firm during the year. Shortly after, Merrill renegotiated Blodget's pay package, which shot up to $12 million in 2001 from his $3 million contract in 1999, according to the attorney general.

But Spitzer's best weapon may be his power to slap analysts with criminal charges for hyping stocks--a power other regulators don't have. The threat of action alone may improve analysts' reports. Certainly, Merrill, which continues to negotiate with the AG, is scrambling to bolster procedures. On Apr. 9, a Merrill executive said it would start evaluating analysts on stock picks and earnings estimates. And it has already begun barring analysts from buying stock in companies they cover.

That's better, but still not enough. "Investors are waking up and realizing that Wall Street research is merely a marketing tool used for selling stocks," says Kent Womack, a professor at Dartmouth College's Amos Tuck School of Business. Given the money it brings in, only the threat of criminal action may change that reality.

Associate Editor Vickers covers Finance

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