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Post date: April 8 2002

Merrill Lynch Stock Rating System Found Biased By Undisclosed Conflicts Of Interest

State Attorney General Spitzer today announced a court order requiring immediate reforms in investment counseling by one of the nation's oldest and largest securities firms.

The court action against Merrill Lynch was the result of an investigation by Spitzer that concluded that the firm's supposedly independent and objective investment advice was tainted and biased by the desire to aid Merrill Lynch’s investment banking business.

Spitzer cites dramatic evidence that the firm’s stock ratings were biased and distorted in an attempt to secure and maintain lucrative contracts for investment banking services. As a result, the firm often disseminated misleading information that helped its corporate clients but harmed individual investors.

"This was a shocking betrayal of trust by one of Wall Street’s most trusted names," Spitzer said. "The case must be a catalyst for reform throughout the entire industry."

Spitzer’s office uncovered a major breakdown in the supposed separation between the banking and research divisions at Merrill Lynch. In fact, analysts at Merrill Lynch helped recruit new investment banking clients and were paid to do so. The public, however, was led to believe that research analysts were independent, and that the firm’s rating system would assist them in making critical investment decisions.

As part of a quid pro quo between the firm and its investment banking clients, Merrill Lynch analysts skewed stock ratings, giving favorable coverage to preferred clients, even when those stocks were dubious investments.

This problem and other conflicts of interest are revealed by internal e-mail communications obtained during the investigation by the Attorney General’s office.

These communications show analysts privately disparaging companies while publicly recommending their stocks. For example, one analyst made highly disparaging remarks about the management of an internet company and called the company's stock "a piece of junk," yet gave the company, which was a major investment banking client, the firm's highest stock rating.

The communications show analysts complaining about pressure from Merrill Lynch’s investment banking division. For example, a senior analyst writes: "the whole idea that we are independent of (the) banking (division) is a big lie."

A senior manager stated: "We are off bases in how we rate stocks and how much we bend over backwards to accommodate banking." But nothing was done to remedy this fundamental problem.

The communications show that the problems at Merrill Lynch went far beyond a single analyst or research unit. For example, the head of the equity division wrote to analysts: "We are once again surveying your contribution to investment banking ... please provide complete details on your involvement .. paying particular attention to the degree your research played a role in originating ....<banking business.>"

And most importantly, the communications show how individual investors were harmed. A research analyst complained about giving a buy rating to a poor investment: "I don’t think it is the right thing to do. John and Mary Smith are losing their retirement because we don’t want a client’s CEO to be mad at us."

The court order obtained by Spitzer requires Merrill Lynch to now make disclosures to investors about its relationship with investment banking clients and provide more context for its stock ratings.

Spitzer described the court order as a preliminary step designed to protect investors while the investigation continues. He said his office has issued subpoenas to other securities firms. The nearly year long investigation is being handled by the Attorney General’s Investment Protection Bureau, under the direction of Assistant Attorney General Eric Dinallo.


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