Taking Sides: Merrill eats its own in lieu of real reform

Just when you think the current brouhaha over Wall Street analysts can’t get any worse, Merrill Lynch & Co. Inc. steps in to remind us just how the Street got into this mess in the first place – with arrogance and greed.

In the wake of the dot-com crash, of course, analysts have come under unyielding attack, from the chat rooms of Yahoo! to the halls of Congress. As InvestmentNews reporter Sarah O’Brien noted last week, Rep. John LaFalce, a New York Democrat, is vowing to push ahead with legislation to rein in those analysts.

gathering storm

You know blood is in the water when a top securities lawyer such as Jacob Zamansky announces he’s seeking clients to sue some of the Internet pied pipers who led tens of thousands of investors to the very top of the tech stock bubble (InvestmentNews, June 18).

The Securities Industry Association, the trade group that represents the brokerage industry, tried to soften the blow of legislative hearings last month by offering its own set of proposals to encourage the industry to police itself.

But that did little to quell the gathering storm. Rep. Richard H. Baker, R-La., who held the first round of hearings, intends to go at it again this fall with a new panel examining the SIA’s proposals.

With those hearings looming – and even more public scrutiny on the way – you have to wonder where Merrill Lynch was coming from with its own offering to appease the regulatory gods. Two weeks ago, the nation’s leading brokerage company announced that it would no longer allow securities analysts to buy stock in the companies they rate.

“We don’t believe that analyst ownership creates a conflict, as long as existing compliance procedures are followed. Nevertheless, we wanted to remove any doubt or perception that a conflict might exist,” said Susan McCabe, a Merrill Lynch spokeswoman.

Puhleeze.

The move actually drew praise from Mr. Baker, who called it a “meaningful component in an overall reform equation.”

Maybe so, but the industry veterans we talked to belted out hearty guffaws – not so much because the idea is ridiculous on its face (it isn’t; more on that in a bit) but that Merrill would have the gall to pose only that change as a solution to the problem.

It’s basically the equivalent of tossing a virgin into a seething volcano to keep it from erupting. OK, analysts are hardly virgins in this mess, so the analogy is limited.

But the point is, preventing some hapless analysts from making a few bucks – or a few million, depending on the deal – by limiting their ability to buy stocks in the companies that they cover hardly begins to address the problem.

The real issue – and the real conflict – arises out of the investment banking relationship between the company being covered and the company for which the analyst works.

Now, we’re talking about hundreds of millions of dollars in fees. What kind of conflict is that?

Yet you don’t see Merrill Lynch or any other securities firm rushing to restructure that relationship or to address that conflict. And you won’t. The stakes are far too high.

Instead, they feed their analysts to the lions. Not that they don’t deserve it.

integral roles

During the tech stock run-up, analysts such as Morgan Stanley’s Mary Meeker and Merrill Lynch’s Henry Blodget became virtual adjuncts of their firm’s investment banking arms.

They played integral roles in the efforts of their companies to drum up IPOs. Their unrelenting “buy” recommendations, even as tech stocks plummeted, were just part of the deal to pump up the stocks.

According to Fortune magazine, some companies even made coverage by Mr. Blodget or Ms. Meeker a condition before agreeing to let Merrill Lynch or Morgan Stanley take them public.

Getting back to Mr. Baker, he is correct. Prohibiting analysts from owning stocks in the companies they cover is a “meaningful component” in an overall solution – but nothing more than a component, and a small one at that. Real reform will come only when analysts are removed from the shadows of their company’s investment banking operations, and the Chinese wall that once existed between the two is erected again.