Disinformation on Wall Street
Editorial
The New York Times
April 11, 2002
It just got a lot harder for Wall
Street analysts to claim that
they were merely ignorant when
they touted all those dubious
dot-com stocks up until the day
they went bust. An affidavit
submitted this week in a legal
proceeding by New York State's
attorney general, Eliot Spitzer,
provides strong evidence for a
more troubling explanation: that
the research departments of the
big investment and brokerage
firms were simply too blinded by
conflicts of interest to deliver objective analysis.
Mr. Spitzer's 10-month investigation into Wall Street's
generally mediocre performance focused on Merrill
Lynch's vaunted team of Internet analysts. What he
learned from 30,000 internal e-mails obtained from
Merrill is that at the height of the dot-com mania only the
clients were deluded, not the analysts. In these e-mails,
Merrill analysts routinely dismissed stocks recommended
by the firm as "a powder keg," "a piece of junk," or worse.
The attorney general's 37-page affidavit is compelling
reading, and offers longtime critics of Wall Street's
research what would seem to be a smoking gun. Merrill
Lynch denies that its research was tainted, arguing that
the excerpts are taken out of context, and that it has not
been given a chance to answer the attorney general's
claims in court. Merrill also says its Internet stock
recommendations always made clear that these were
high-risk investments. But that is having it both ways.
Despite this general disclaimer, not once did Merrill's
Internet research team, under the leadership of Henry
Blodget, a market-bubble celebrity who is no longer with
the firm, issue a "sell" or "reduce" call on a stock, the
lowest two of five possible ratings.
Investors who trusted Merrill's integrity relied on Mr.
Blodget's bullish assessments. What they could not know,
however, was that Mr. Blodget and the other brainy
analysts who held forth on CNBC and other media outlets
were often used as marketing tools to sell investment
banking services to the same companies they were
appraising. The e-mails further suggest that the supposed
"Chinese Wall" separating Merrill's researchers from its
bankers was more like Swiss cheese. Indeed, according to
some e-mails, the promise of a favorable report by Mr.
Blodget's team appears to have been one of the
inducements Merrill used to attract banking business
from Internet companies. Other e-mails refer to
negotiations between the firm's bankers and their
corporate clients over what a stock's rating issued by the
supposedly independent analysts should be.
In one e-mail, reacting to dishonest guidance, Kirsten
Campbell, a Blodget subordinate, complained: "We are
losing people money and I don't think that's the right
thing to do." In another, Mr. Blodget, whose compensation
was linked to his rainmaking power, threatened to start
doing what the outside world assumed he already was
doing - calling stocks "like we see them, no matter what
the ancillary business consequences are."
Mr. Spitzer has obtained a state court order designed to
force Merrill to be more forthcoming about these
"ancillary" relationships by requiring the firm to disclose
whether it has, or intends to have, a banking relationship
with any company on which it issues a research report.
That improves upon the array of modest reforms the
industry has embraced in a belated effort to restore
investor confidence. Merrill itself has barred analysts from
trading in stocks they cover to address another potential
area of conflict, and has pledged to tie analysts'
compensation to the accuracy of their reports.
There is nothing to suggest that Merrill's practices were
singularly egregious; Mr. Spitzer is also looking into the
practices of other Wall Street firms. He may decide to
pursue criminal prosecutions or seek civil fines.
Regardless, his findings should convince federal
regulators of the need to do more to protect investors and
the integrity of the nation's financial markets.
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