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N.Y. Attorney General Requires More Disclosure From Merrill Lynch

Apr 8, 2002 |

The New York state attorney general obtained a court order on Monday requiring Merrill Lynch (MER:NYSE) to disclose conflicts of interest between its research and investment banking businesses after an investigation by the office concluded that the firm's advice was tainted.

"This was a shocking betrayal of trust by one of Wall Street's most trusted names," state Attorney General Eliot Spitzer said in a statement. "The case must be a catalyst for reform throughout the entire industry."

The latest attempt to clean up Wall Street research in the post-Internet bubble era follows a 10-month long investigation into Merrill, in which Spitzer alleged that research analysts at the firm gave high recommendations for stocks in order to win investment banking business.

The attorney general's office didn't name a specific stock or a particular analyst, but said Merrill's stock ratings were "biased and distorted."

A spokeswoman for the attorney general said Spitzer is looking into practices at other firms. "We've issued subpoenas to other brokers," she said. "We believe the problem extends beyond one firm."

A 'Piece of Junk'

The alleged conflicts of interest at Merrill were revealed by internal email messages, the attorney general's office said, which showed analysts privately disparaging companies while publicly recommending their stocks.

In one example, the attorney general's office said, an analyst made very negative comments about the management of an Internet company, calling it "a piece of junk, yet gave the company which was a major investment banking client the firm's highest stock rating."

The attorney general went on to describe an email message, in which a senior manager allegedly wrote, "We are off bases in how we rate stocks and how much we bend over backwards to accommodate banking."

Merrill Lynch vehemently denied Spitzer's allegations in a statement. "His conclusions are just plain wrong," the firm said in a statement. "We are outraged that we were not given the opportunity to contest these allegations in court."

Merrill said the allegations show a lack of understanding of how securities research works. "They cite a limited number of employee emails, taken out of context, as 'proof' that investment banking had undue influence in determining research ratings," the firm said. "In fact, these emails prove nothing of the sort."

Though New York authorities didn't single out any stocks, Merrill named, now Overture Services (OVER:Nasdaq) and defended its research on the company.

"In the specific case of GoTo, the Merrill Lynch analyst's downgrade on June 6, 2001, not only was the right call, it was exactly the opposite of what the investment bankers would have preferred," the company said. "Every witness, including the analyst, has testified under oath that the analyst had no advance knowledge of any pending investment banking mandate, and investors who heeded the downgrade would have benefited."

Merrill said a fair review would show it has conducted its research with independence and integrity.

Getting on Board

The New York attorney general's complaint against Merrill is one of a growing number of actions taken against Wall Street firms since the markets began their slide following their highs in 2000.

Last summer, Merrill awarded a $400,000 settlement to a client who alleged that Internet analyst Henry Blodget's optimistic stock recommendation caused him to lose money. Blodget left the firm late last year. Morgan Stanley Dean Witter Internet analyst Mary Meeker has been sued by investors who allege that her research regarding some companies was flawed or biased.

Investment banks and their research departments have been under increasing criticism in the past several months from some investors, who blame the optimistic recommendations for their personal losses. Some investment banks have taken steps in an effort to shore up investor confidence, such as limiting analysts' ownership of stocks they follow. Various business media outlets now make it a practice to disclose the relationship between a firm whose analyst they quote for material and that firm's banking relationship with the company being discussed.

Still, the anger that investment banks face shows no signs of dissipating. For example, a shareholder lawsuit has been filed alleging that nine investment banks financed schemes that helped energy trader Enron maintain its glorified status, even as the company appeared headed for a collapse amid questions about its accounting practices.

A 485-page amended complaint was filed Monday alleging that the banks had knowledge of Enron's complex partnerships and business arrangements, and that they still pushed securities on investors, even though the company's financial situation should have been questioned.

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