Eliot Spitzer's Bad Idea

Pssst. Want a hot stock pick from the government? We didn't think so, which is why the proposal by New York Attorney General Eliot Spitzer to set up a government-appointed board that would buy independent stock market research for small investors fell flat on its face. The alternative idea being floated by Spitzer, that Wall Street firms directly buy independent analysis and distribute it alongside their own, isn't much better. It won't end the appearance, if not the reality, of conflict of interest. To his credit, Spitzer is the one regulator who has steadfastly championed the small investor over the past scandal-ridden year. His negotiations with Merrill Lynch & Co. (MER ) and Credit Suisse First Boston (CSR ) have forced them to pay hefty fines that went to settle claims by investors. But Spitzer's two attempts to end the conflict of interest between investment banking and research are not workable. There is a better way.

Citigroup (C ) may have it. Citi is under investigation for possible conflicts of interest regarding telecom analyst Jack Grubman and its allocation of initial public offering shares to CEOs in exchange for corporate business. To clean up its act, Citi has decided to split off global research and retail brokerage operations into a new division. To run it, Citi (C ) has hired Sallie L. Krawcheck, the former chairman and chief executive of Sanford C. Bernstein & Co. (AC ), a leading boutique stock research company on Wall Street. Citi's solution isn't perfect. Krawcheck still reports directly to Citi CEO Sanford I. Weill, who admits he asked Grubman to review his rating of AT&T (T ) when he was on its board of directors. But Citi's solution is still cleaner than Spitzer's. It puts plenty of air between analysts and investment bankers while making its most valuable stock research available to all Citi clients, big and small. It's a better model for all of Wall Street.

Spitzer and the big Wall Street firms want a single "global settlement" that allows them to keep their most valuable analysts tied to investment banking while putting the scandal behind them. But it might be better for Spitzer to continue his investigations into wrongdoing on Wall Street, punish those who have broken the law, and urge Wall Street to follow the Citigroup example of hiving off research--the retail brokerage paying for it--into an independent unit.

Spitzer should also go further and end the long-standing and corrupting Wall Street practice of secretly allocating IPO stock to special friends, be they big investors or CEOs willing to throw back corporate business in return. IPOs should be allocated through an open-auction system that gives all investors a chance to make money--or lose it.

It would be far better for the Securities & Exchange Commission to take charge of reforming Wall Street, but under ex-Chairman Harvey L. Pitt, it didn't step up. That left it to Spitzer, who should finish the job.

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