Merrill Fined $100 Million Over Bullish Stock Advice

Brokerage giant Merrill Lynch & Co. agreed Tuesday to pay $100 million in fines to settle charges of tainted advice by its stock analysts and said it would adopt reforms aimed at restoring the credibility of Wall Street’s investment guidance.

The deal with New York Atty. Gen. Eliot Spitzer, reached after weeks of negotiations that lasted until 2 a.m. Tuesday, should be a template for industrywide change, Spitzer said.

But the agreement doesn’t require Merrill to admit wrongdoing and provides no restitution for investors who believe they lost money when they followed allegedly misleading stock advice. Investors will have to sue Merrill on their own, Spitzer said.

Nonetheless, some experts said the Merrill case is a landmark in exposing for average investors the inherent conflicts of interest at major brokerages. Critics have long contended that research analysts face pressure to skew opinions of stocks simply to better the chances that the subject companies would grant fee-rich investment banking work to their brokerages.

Those conflicts were amplified in the stock market’s boom years of the late 1990s, but few questions were raised until the boom went bust starting in 2000.

Controversy over the credibility of analysts’ advice prompted Congress to hold hearings on the issue a year ago. But it was Spitzer’s probe that triggered a firestorm in early April when he released e-mails he obtained by subpoena, showing how Merrill analysts in 2000 and 2001 privately denigrated many Internet stocks even as they urged the public to buy them.

Some stocks with “buy” ratings were referred to as “a piece of crap” or worse in the e-mails. Many of the Internet shares have since collapsed to penny prices, or zero, wiping out billions of dollars in investors’ wealth.

Merrill issued an apology Tuesday for the e-mails, some of which, it said, “violated internal policies, failed to meet the high standards that are our tradition and will not be tolerated.”

In its settlement with Spitzer, the brokerage agreed to completely separate analyst pay from investment banking, forbidding bankers from having any input on analyst compensation; create a panel to review and approve all stock ratings; increase disclosure about ratings; and appoint a “compliance monitor” for one year.

“The actions we are taking will ensure that analysts are compensated only for activities intended to benefit investors,” Merrill Chief Executive David Komansky said.

Spitzer said his office is continuing to investigate potential conflicts of interest at other major Wall Street firms, and he called on them--without naming names--to fall into line behind Merrill.

Brokerages reportedly still under investigation include Goldman Sachs & Co., Salomon Smith Barney and Morgan Stanley & Co.

The federal Securities and Exchange Commission is conducting its own probe in the matter.

“To other investment houses that have received subpoenas,” Spitzer said at a news conference Tuesday, “I would suggest that you review your e-mails, review your documents, and once you have conducted that review ... come in and have a forthright conversation with us as we continue to march forward and reform this industry.”

Goldman Sachs, perhaps hoping to forestall reforms imposed from the outside, on Tuesday named E. Gerald Corrigan, former president of the Federal Reserve Bank of New York, as an in-house ombudsman to protect analyst independence.

Spitzer, asked about allowing Merrill to settle without admitting wrongdoing, said, “It would in essence have been a death warrant for the company to admit liability.”

Still, he added, investors who lost money following what they believe were tainted stock tips have “a much stronger case today than they did eight weeks ago,” before he released the private e-mails.

Spitzer said that he supported investors’ efforts to obtain restitution but that it must be done through the courts.

Industry experts said there was no assurance that any reforms could guarantee that brokerage advice will be entirely objective. As long as investment banking remains a major profit center for securities firms, it is impossible to eliminate all potential conflicts of interest, critics said.

They noted that brokerages have perpetually insisted that their analysts operated independent of investment banking.

But some critics said the reforms would help to shine a bright light on Wall Street practices and highlight the need for investors to be more careful in taking advice.

“I’m not convinced that bolstering investor confidence in Wall Street research really ought to be our goal,” said Barbara Roper, director of investor protection at the Consumer Federation of America.

“Perhaps bolstering a healthy skepticism about Wall Street research is a better goal, and Mr. Spitzer has certainly accomplished that,” Roper said.

The $100-million penalty--$48million to New York, the rest to the 49 other states, the District of Columbia and Puerto Rico, if all parties agree--rivals the largest fines assessed against brokerages by the Securities and Exchange Commission. It equals January’s $100-million settlement by Credit Suisse First Boston of SEC charges that it mishandled initial public stock offerings. That was the fifth-largest brokerage settlement in SEC history.

The fine is less than one-fifth of Merrill’s total net profit last year of $573 million.

The settlement quickly drew criticism from Washington, where Spitzer was accused of trying to usurp the SEC’s authority.

The deal “raises an important issue as to whether the capital markets will continue to be regulated by the SEC, or whether state attorneys general and the trial lawyers will become the de facto regulators of the securities market,” said Rep. Michael G. Oxley (R-Ohio), chairman of the House Financial Services Committee.

“Grandstanding by ambitious and publicity-hungry officials will not lead to healthy and responsible securities markets,” Oxley said.

Spitzer, 42, is a Democrat who is seeking reelection and, according to friends, is considering a future run for governor of New York.

Spitzer said his office and the SEC are partners in their investigations and that he had talked by telephone Tuesday morning with SEC Chairman Harvey L. Pitt.

However, Spitzer said he considered his settlement with Merrill to be “better, a little more complete” than recent reforms proposed by the National Assn. of Securities Dealers and adopted by the SEC.

He called those rules “too porous and a bit meager” in addressing the key issue of separating analyst compensation from a firm’s investment banking business.

Stephen M. Cutler, the SEC’s enforcement director, said that “while this settlement is an important milestone for investor protection, it is not the finish line and will not preclude our own efforts on behalf of the investing public.”

Northwestern University law professor David S. Ruder, a former SEC chairman, said one of the most important reforms for investors will be increased disclosure about analysts’ ratings.

Merrill, under Tuesday’s deal, will announce when it discontinues research coverage of a firm, state the reasons and disclose that its previous rating is no longer valid.

The change is meant to rectify situations in which a “buy” recommendation might have lingered long after a company’s stock had crumbled and the brokerage had terminated research coverage.

Merrill also will disclose the percentage of its ratings that are “buy,” “hold” or “reduce” so investors can better gauge what analysts mean when they say “buy.”

“The public was sort of left out of the code that sophisticated investors knew, that there was seldom a ‘sell’ recommendation,” Ruder said.