This past week Merrill Lynch, the world's biggest financial services firm, agreed to pay a fine of $100 million to the state of New York to settle allegations of conflict of interest between its investment banking and brokerage operations.
Merrill Lynch has not admitted to wrongdoing. But by settling a lawsuit from the state of New York, Merrill is implicitly saying there are built-in conflicts between its stock selling and investment banking operations. For example, if Merrill's bankers advised company A on how it could boost its profits, isn't there a temptation for Merrill's stock analysts to advise clients to buy shares in company A?
Bernie Markstein is an economic consultant outside Philadelphia, Pennsylvania. "The problem is that the people on the research side were aware of where the company stood in terms of investment banking," he explained. "And either consciously or unconsciously, they shaded their opinions, knowing that they were doing business with these people."
The solution, adds Mr. Markstein, is to have clear internal corporate boundaries between stock research and investment banking.
Rich Wyler of the Association for Investment Management and Research, a non-profit organization of financial analysts in Charlottesville, Virginia, says the Merrill Lynch agreement is encouraging but that the industry needs to do more to foster analyst objectivity.
"The compensation for an analyst should be based on the quality of his or her research and the performance of his stock recommendations over a period of time," he said. "So if, in fact, he is a research analyst he is paid to do research and not investment banking."
The U.S. securities industry is reeling from a series of scandals beginning last year with Enron, the Texas energy company that pushed the rules of accounting so that losses were presented as profits. Enron's auditor, Arthur Andersen, has been widely accused of complicity in the affair and has been indicted for destroying documents by the U.S. government.
During the boom in technology stocks three years ago, Merrill Lynch technology analyst Henry Blodgett was among the most ardent backers of technology shares. Merrill Lynch did investment banking for many technology companies.