Conference Call – Merrill exec sticks to company line: We’re fair

In one of Merrill Lynch & Co. Inc.’s first public defenses of its stock research, a top executive insisted that the New York company’s analysts operate with “independence and integrity.”

Rosemary Berkery, executive vice president and general counsel, made the assertion last week only days after a court ordered the company to overhaul its research operations because its stock ratings were “biased.”

Her comments, voiced at a panel discussion on analyst independence at the Public Policy Day meeting of the North American Securities Administrators Association Inc. in Washington, were quickly disputed.

Television producer Martin Smith, who spent nine months working on “Dot Con,” a documentary about the dot-com crash, said the securities industry’s response to criticism of analysts was surprising.

“The blame was being laid time and time again on the public,” said Mr. Smith, whose program aired on the Public Broadcasting System show “Frontline.”

While much of the public was well aware that high-flying high-tech stocks were risky investments, “what they didn’t understand is … the conflicts of interest that existed by those who were delivering … information to them,” he explained.

Industry rocked

Since the rapid decline of tech stocks two years ago, various government agencies have begun investigations into how analysts made stock recommendations.

But two weeks ago, New York state Attorney General Eliot Spitzer’s 10-month investigation of the relationship between Merrill’s analysts and its investment banking arm rocked the industry.

Mr. Spitzer concluded that Merrill’s research was used to win investment banking business instead of serving small investors, and he convinced a judge to order Merrill to change its practices.

Ms. Berkery said Merrill Lynch disagrees with Mr. Spitzer and is “working to resolve the issues” with his office. The company reportedly is in settlement negotiations.

A major issue in the controversy is the overwhelming number of analysts who issued a steady stream of “buy” recommendations – in most cases on stocks of companies that were investment banking clients – even as stock values were crashing.

Ms. Berkery said that the ratio of “buy” to “sell” recommendations was entirely appropriate.

Brokerage firms, she said, look for good investments for their clients, rather than poor ones.

Few investors want their advisers to call them to say, “`Let me tell you about a stock I don’t like and I think you shouldn’t buy,”‘ Ms. Berkery said.

Merrill Lynch has long had standards in place to separate analysts from investment banking deals in terms of compensation and influence, she said.

“For every deal that actually came to the table and that we underwrote as a firm, there is at least one, if not two, where the analyst said, `[Merrill Lynch] should not be associated with that transaction,”‘ she said.

Ms. Berkery said she believes the demand for more “sell” recommendations will force brokerage firm research departments to start following unpromising companies in which investors have little interest.

George Kramer, vice president and associate general counsel of the Securities Industry Association in Washington, said that “research is not improved by an equal number of `buys’ and `sells.”‘

Mr. Kramer said there is a need for more investor education on analyst ratings.

“The conflicts have been there for a long time,” he said regarding the relationship between brokerage firm research departments and investment banking arms.

“What’s changed to a large degree is the audience,” he said. In the past, the audience for research reports primarily comprised professional institutional investors, he noted.

In the 1990s, the audience for such research changed to retail investors.

Ms. Berkery said the current controversy highlights the importance of financial advisers. “It’s the financial adviser who should put front and center what’s the risk tolerance of the investor” and other factors, she said.

positive steps

Mr. Kramer said recent proposals by the National Association of Securities Dealers and the New York Stock Exchange to reduce conflicts of interest between analysts and brokerage firms, and to require more disclosure to the public, are good steps.

Mr. Smith also blamed the media – in particular, cable television shows that featured analysts pushing hot stocks – for “hyping this whole process.”

“The repeated mantra of caveat emptor, caveat emptor, caveat emptor, [was] stated by all involved along the food chain in the whole phenomenon that we’ve come through,” he said.