USA Today
Published On: May 22, 2002

USA TODAY (Thor Valdmanis)

NEW YORK — Rebuilding the so-called Chinese Wall that is supposed to separate investment bankers and research analysts will take more than the $ 100 million Merrill Lynch agreed to hand over Tuesday.

Most observers believe billions of dollars will need to be paid out to angry investors and major structural reforms adopted before Wall Street recovers from what promises to be its greatest challenge since the Depression.

“I don’t think this settlement resolves all the issues with all the parties for all time, by any stretch of the imagination,” says Connecticut Attorney General Richard Blumenthal, one of several state attorneys general to join the Wall Street conflict-of-interest probe. “There is still a good deal of work to be done.”

That is what frightens top executives at the USA’s leading investment banks. While many are adopting reforms aimed at safeguarding the integrity of their research, the widespread worry is that the scandal sweeping Wall Street could end up devastating an industry that is already in its worst slump in 25 years. Failure to restore investor confidence could see Wall Street firms saddled with the very “sell” ratings their analysts have been so loathe to apply to corporate clients in recent years.

“Investors are really unhappy right now,” says attorney Jill Abrams, who is bringing a class-action lawsuit against Merrill on behalf of shareholders. “The message is: ‘You can’t cook the books. You can’t jump over the Chinese Wall. You can’t sweep bad news under the carpet.’ “

New York Attorney General Eliot Spitzer says that was the point of his Merrill probe, which has since expanded to include Salomon Smith Barney, Morgan Stanley, Credit Suisse First Boston and at least three other leading firms.

In many respects, the dark cloud hanging over Wall Street is another symptom of the larger crisis of confidence in professions, such as investment banking and accounting, that are crucial to maintaining the integrity of the USA’s capital markets.

But there is no denying that investment banks today are in a bind that could make earlier scandals involving Michael Milken’s junk bonds or Nasdaq’s price-fixing look like child’s play.

Wall Street has already come under scrutiny for its shady practices with initial public offerings and its role in setting up and selling the partnerships that helped trigger Enron’s collapse.

With its reputation in doubt, Wall Street must now defend itself against charges that analysts were encouraged and paid to tailor research to please investment-banking clients, not investors.

To prove his case, Spitzer released e-mails showing Merrill analysts, including former star Internet analyst Henry Blodget, privately derided stocks they publicly touted.

Merrill executives say they are relieved their settlement avoided drastic penalties, such as spinning off its research department. Merrill also sidestepped making an explicit admission of wrongdoing that would have made it more vulnerable to costly investor lawsuits.

But Merrill and its rivals still risk the prospect of billions of dollars in potential liability from shareholder lawsuits. Research directors and other high-ranking executives could also face jail time should prosecutors decide to charge firms with systemic fraud. And when the dust finally settles, few believe analysts will be allowed to carry on as rainmakers celebrated on CNBC. Whatever the outcome, their role is certain to be diminished.

In an effort to fend off critics, investment banks are accelerating their own reviews into the independence of analysts and the way in which they are compensated.

Goldman Sachs announced a series of initiatives Tuesday, including creating a board of outside directors to review its analyst compensation process. It also appointed Gerald Corrigan, the former head of the Federal Reserve Bank of New York, to counsel analysts on potential conflicts of interest.

Other investment banks, including CSFB, Morgan Stanley and Salomon, said they have made changes and are open to making more.

Investors recognized the risks, driving down most banking and brokerage stocks Tuesday. Merrill actually rose 47 cents to $ 43.85. But that gain was minor considering it has lost $ 8.2 billion, or 19%, of its market value since Spitzer announced his probe April 8.

While some Wall Street executives see the campaign against them as an ill-timed and ill-advised witch hunt, there is no disputing the fury of investors who have witnessed more than $ 5 trillion in market value disappear since the high-tech bubble burst two years ago.

Despite the settlement, individual investors remained skeptical that brokerage reports would get better. “After all that adverse publicity, you’d think they would get better, but those reports are still nothing but sales tools,” says Sharon Adams, a retired teacher in Spartanburg, S.C.

Much of that skepticism stems from bitter experience in the bear market. Harvey Baxter, a retired food industry executive in Mustang, Okla., estimates that his stock investments declined $ 300,000 the past few years, in part because of brokerage advice. “They have all hyped stocks that haven’t been worth a darn,” he says. He doubts any changes will last. “It will make Christians out of them for three to five years, but if the market gets back to boom times, it will be the same,” he says.

Andrew Stoltmann, an attorney who represents investors in securities-fraud lawsuits, says he hopes the settlement will mean “an end to doublespeak by brokerage firm analysts.” But he says the prospects for unbiased research remains unclear. “Merrill Lynch will trumpet this as a cure-all, but it’s still very early to say whether it’s going to help small investors.”

But Stoltmann says many Wall Street firms have already taken steps to separate their research and investment-banking divisions. He says the magnitude of the fine compelled them to act.

“Anytime a firm agrees to a $ 100 million fine, that’s a big number,” Stoltmann says. “I’m used to seeing the Securities and Exchange Commission fining a firm $ 1 million, maybe $ 5 million.” At $ 100 million, the Merrill settlement “is going to get the attention of all these other firms.”

Investors in arbitration cases involving Merrill may be the biggest beneficiaries, Stoltmann says, because they will be able to point to the changes Merrill has made as evidence of problems before.


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