The virtual paper trail

With the news that regulators in the United States — not the mighty Securities and Exchange Commission, but lowly state authorities — have opened the issue of analysts’ recommendations, we see a faint hope that some of the more unsavory practices of the last market bubble might be curtailed. But it’s only very faint.

The office of the New York State Attorney General has obtained an order that Merrill Lynch produce vast documentation covering the firm’s recommendations on stocks during the runup in Internet stocks from 1999 to 2001. Other large houses are reported to be under investigation, and one, Morgan Stanley, has acknowledged it is co-operating with the state authorities.

The Attorney General said Merrill analysts, while publicly rating stocks as “buy” or “accumulate,” were privately describing them as “junk” or worse, and talking about retail clients “losing their retirement money.”

Corporate finance executives at Merrill were found to have advised and pressured analysts to put high ratings on paper Merrill would be moving, reminding them that bonuses depended on the success of Merrill-led financings.

Merrill Lynch has objected that the e-mails were taken out of context, though it is difficult to see just how “context” of any sort could soften concepts like “junk” or “losing retirement money.” To the contrary: it is not unreasonable to think that in these e-mail exchanges, people might just have been saying what they meant.

Rosemary Berkery, general counsel for Merrill, even suggested it was not surprising there were so few “sell” ratings, because Merrill brokers and clients were not interested in hearing negative recommendations. Merrill’s famed bull trademark takes on a meaning one presumes was never intended.

On the face of it, the evidence the state has presented makes a strong case for what many people believed about the Internet stock bubble: that the great investment houses looked only to the lucrative corporate finance market, and when the interests of their financing clients and their retail ones diverged, the people in charge knew just which set of interests could be sacrificed.

But while nobody is particularly surprised to find that these things went on, the whiff of gunpowder these e-mails provide ought to concentrate the minds of the people who run large investment houses. They have to see, at least, that pretending to serve two masters while in fact serving only one is dishonest dealing. Leaving aside Merrill’s dismissal of the New York evidence as obligatory public denial — immediate action number one for a company facing charges that might expose it to later civil liability — there is no general assertion from the houses that their act needs cleaning up. It is true that many houses have announced restrictions on analysts’ trading in stocks they cover, but that was not the central problem with the bubble. Any analyst describing a stock as “junk” has reason enough not to be long, even if he supposes the market will provide a thousand greater fools tomorrow. He knows better than anyone that he just might be wrong.

The central problem — borne out by the incautious comments some of Merrill’s corporate finance people made to the research side — was that performance bonuses were tied to the firms’ success in attracting financings. That, not the opportunity to grab some of the mad money that followed every initial public offering in the boom days, was the most direct incentive for analysts to sweeten their recommendations, and, in the extreme, play false with the firm’s clients.

Cash talks, and in those halcyon days it talked a whole lot louder than ethics.

We would love to hear a statement from the National Association of Securities Dealers, or from one of the major firms, or better still from one of the houses that was a front-row cheerleader for the late-’90s bubble, expressing a recognition of the duty a brokerage house owes all its clients, large and small, and a willingness to enforce some exceedingly elementary moral standards.

Less than nothing, and dreams: for in a litigious society, none could afford to be seen correcting a wrong, because that means there was a wrong in the first place. So we wait, and are instead offered the diversions of bluster, spin and doubletalk, which only reinforces an impression in the public mind that these people are all crooks. Nobody whose livelihood depends on raising capital can afford to have that impression making the rounds; especially if, after these matters are settled, that impression turns out to be true.