Half a crusade

The state of New York and the investment firm Merrill Lynch have jointly announced the terms of a settlement in the state’s investigation into conflicts of interest in Merrill’s rating of stocks. The settlement is already being painted as a victory for New York State Attorney-General Eliot Spitzer, and as a real reform in investment house research practices, which had long been tarred with the suspicion that they were slanted to favour companies that were also corporate-finance clients.

On the one hand, this is true. Merrill has agreed to separate analysts’ compensation from the amount of corporate finance business the firm gets. Corporate-finance people will have no input into analysts’ bonus assessments. And Merrill is paying US$100 million to state governments (US$48 million to New York and US$52 million among the other 49 states) as a penalty.

But it is not a genuine victory for the regulators or for clean stock markets. The state agreed to a settlement without getting an admission of wrongdoing from Merrill; and while the Attorney-General’s office said it required “a statement of contrition on the part of Merrill Lynch for failing to address conflicts of interest,” it got nothing of the sort.

Consider what Merrill Lynch apologized for: “the inappropriate communications brought to light by the New York State Attorney General’s investigation.” Not the conflict of interest; not the rosy ratings that masked the reality; not for telling its clients to buy junk.

“We sincerely regret that there were instances in which certain of our Internet sector research analysts expressed views that at certain points may have appeared inconsistent with Merrill Lynch’s published recommendations.” On a careful reading, the apology says that Merrill is sorry for the internal e-mails in which stocks were described as “junk” or worse. Such descriptions “may have appeared inconsistent” with Merrill’s buy recommendations. (Certainly the words junk and buy “appear” inconsistent to most people conversant with the language.) And Merrill is sorry you had to find out about it.

But Merrill is not sorry for the lousy recommendations. “We view this situation as a very serious matter and have informed our research department personnel that such communications, some of which violated internal policies, failed to meet the high standards that are our tradition and will not be tolerated.” So what are we left to conclude? That the firm’s internal policies outlawed frankness about bad investments? That the ratings were fine but the internal comments were not?

The reality is precisely the reverse: these were high ratings on bad stocks, and the internal e-mails said so — contrary, Merrill says, to the firm’s policies. The revelations in the company’s internal communications, on their face, show Merrill holding to a “high standard” of duplicity; not a tradition to be proud of.

It does not need to be a surprise, with Merrill facing a number of class-action lawsuits, that the firm is evading its real misdeed. Any apology for the ratings themselves would be tantamount to an admission of the central fact of the class-action cases. And certainly it is no surprise that Merrill is not admitting wrongdoing, for admitting the ratings were tainted by a conflict of interest would prove the plaintiffs’ cases for them.

Indeed, Attorney-General Spitzer said as much, conceding that to have insisted on an admission of wrongdoing in the settlement could have destroyed Merrill. But is the company bigger than the law? Perhaps Merrill really ought to lose these lawsuits.

In all this, it is worth bearing in mind that Merrill was not the only company playing this game, or the worst among them; and Spitzer has commended Merrill’s co-operation in the state’s investigation. At least five other firms are under investigation, and admissions of wrongdoing would hurt them just as badly. Still, the case was being watched closely as a model for other possible settlements, and with Merrill managing to avoid an admission, it is reasonable to expect the others will point to that concession in their own negotiations with the state — and have the protection of not having admitted wrongdoing in suits against them.

(One other aside, particularly relevant to this industry: this newspaper has always found Merrill analysts covering the mining business to be among the most critical and independent on the street; the firm’s larger failures should not reflect on individuals and departments that do good work.)

David Komansky, Merrill’s chairman, wants to “reassert our traditional position as a valued source of information for investors.” To hear Komansky tell the story, this is all about restoring the respect Merrill deserved, not about earning back the trust it squandered through conflicts of interest. In Komansky’s world, nobody at the top ever has to pay his dues again.

The stocks Merrill’s analysts recommended went into the abyss. On the strength of the firm’s non-apology, it will be meet and right if Merrill’s reputation follows them there.