Merrill Lynch Scratches the Surface

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So Merrill Lynch, talking like it has forever banished conflict of interest from within its walls, will now bar its army of 850 stock analysts from owning the stocks they analyze. No more can a member of the Lynch mob be accused of touting a company to line his own pockets.

"This move underscores Merrill Lynch's commitment to setting the standard for objectivity, independence and quality of research," said Andrew Melnick, director of Merrill Lynch Global Securities Research. "As a firm, we've always focused on the investor client and if the investor client had concerns in this area it was important to rebuild the trust between research, the firm and our investor clients."

In the words of the immortal Chris Farley: Whoop-de-freakin'-do. Because as far as conflicts of interest go, those analyst portfolios are just the tip of the iceberg.

The Street tries self-regulation

In the wake of the dot-com bubble-burst, in which it became apparent that most of those instant-celebrity analysts — and the Internet stocks they blessed with hundred-dollar price targets — had been full of hot air, Wall Street found itself staring down the barrel of congressional scrutiny and decided to polish its own image.

Richard Baker, the Louisiana Republican who held Congressional hearings about analyst conflicts last month, commended Merrill for taking the initiative. "Without question, this is a positive development," he said.

It's like when the airlines promised to always find your luggage. Of course, what the airlines didn't promised to do was actually make your flight arrive on time, and similarly Merrill — and the rest of Wall Street, which seems only mildly interested in going even as far as Merrill did — has left the real problem utterly untouched.

The fall of the Chinese wall

Ever hear of the Chinese wall? It used to be a serious matter, the invisible boundary within a brokerage house that separated analysts who tracked companies from the investment bankers who pumped those companies full of outside money and brought them public (or helped them merge, or get bought out) and took a lucrative slice for themselves. The analysts were supposed to provide the information, not only for the dealmakers (who frequently became big investors in their projects along the way) but for the ordinary investor. But they weren't supposed to write glowing research reports because the dealmakers needed a sales pitch to attract more investors.

Another metaphor: The supposed church-state wall between the editorial and business sides of a newspaper. Same motivation: keep the information pure and unbiased, so everybody could trust that, say, the science wasn't touting a new Merck wonder drug because Merck had paid good money for all that ad space on the facing page.

Somewhere in the middle of the boom, though, Wall Street figured out that analysts weren't journalists. Wall Street was in the business of making money, purely and simply, and this was a herd-driven, Ponzi-scheme kind of time, in which all prophesies were self-fulfilling.

Besides, who was paying the bills and keeping a firm like Merrill's own stock price up? Not the analysts — what they produced didn't even pay their salaries. The investment bankers were the ones who brought in the big IPOs, the big deals and the big money, and with the right sort of research reports and CNBC soundbites from analysts, that money could get even bigger. In the time of the bubble, hot air was king.

The bubble's bitter end

Then the bubble burst, and the stocks went south, and the commission-taking investment bankers seemed like the only ones who'd gotten permanently rich. Wall Street watchers felt betrayed. Congress started sniffing around. FORTUNE (corporate cousin to this publication) ran a cover with a decidedly unflattering picture of Morgan Stanley interent analyst Mary Meeker, the most spectacularly fallen of the analyst stars, above the caption "Can We Ever Trust Wall Street Again?"

Suffice it to say that Merrill Lynch's move — which will either spur a wave of similar image-primping among other financial-services houses or merely provide a really good reason for Merrill analysts to go work somewhere else — doesn't change the answer to yes. Heck, a lot of investors, professional and otherwise, aren't even so crazy about what Merrill did. Many like the idea of their tipsters, if not exactly free of company bias, at least having their money where their mouth is. (Even Merrill's Melnick was agnostic on the question just weeks ago, telling USA Today "You can come down on both sides, and that's the problem. I really don't have a definitive point of view.")

Caveat CNBC viewer

Most of what comes out of analysts' mouths — especially the digestible version that most of us deal with — is drivel anyway. Like the ratings system — "Sell" ratings make up less than 2% of all ratings, with ratings like "hold," "neutral," or "market perform" standing in for the s-word. And the dot-com bust routinely saw stocks fall as much as 90% from their high before analysts removed their "buy" ratings.

But this unabashed puffery is more likely due to the vested interests of analysts' colleagues on the dealmaking side than anything in the analysts' own portfolios. (After all, if they knew so much about how to fatten their own wallets, wouldn't they just buy winners instead of wasting credibility propping up dogs?) The real conflicts of interest are institutional, and keeping individual analysts from actively investing in their own sectors doesn't address the fundamental problem.

If it even is a problem. Whose idea was it to start trusting Wall Street in the first place? Transparency of a company's books are essential to a fair and efficient market, but the credibility of soundbite-dishing analysts is not. During the dot-com gold rush, a lot of investors bet a lot of money on analysts whose opinions turned out to be rubbish. Now we're in the head-shaking phase, where everyone's gotten wise and the hidden-agenda company analysts of the late '90s are down in financial history with snake-oil salesmen. Should anyone have been too surprised?

What the marketeers will bear

If Merrill Lynch and Goldman Sachs and Morgan Stanley decide that it's better for business to make their analysts credible again, they'll do it — more "sell" ratings, more disclosure, a rebuilding of the Chinese wall. Dealmakers and stock-pickers will stop talking to each other, and analysis will no longer be considered part of the investment bankers' sales pitch to investors.

But stock analysts aren't journalists, or judges, or even politicians — they're in the profit business, and there's nothing inherently sacrilegious about company employees spinning the truth so the company makes money. So if they think they can continue to fool enough of us enough of the time with institutional cross-pollination, well, then they'll keep it up.

For the rest of us investors still looking for some free get-rich-quick advice, caveat emptor will have to do.