Be Wary of Brokerage Firm Stock Analysts

ews of the New York State Attorney General's legal action against Merrill Lynch has undermined the trust that so many investors placed in Merrill Lynch and its highly touted independent and objective research and investment advice.

So far, the systematic deception has involved only Merrill Lynch, particularly its Internet stock recommendations. But the New York Attorney General, now joined by the Securities and Exchange Commission (SEC), in coordination with the New York Stock Exchange (NYSE) and the National Association of Securities Dealers (NASD), has expanded the fraud probe to about ten other brokerage firms. Reportedly, some of these firms are Morgan Stanley Dean Witter, Salomon Smith Barney, Lehman Brothers, Goldman Sachs, PaineWebber, Credit Suisse First Boston and Bear Stearns.

According to the press release issued by New York State Attorney General Eliot Spitzer, Merrill Lynch misled investors in what he described to be "a shocking betrayal of trust":

[T]he 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.

Spitzer, the SEC, the NYSE and the NASD may find similar "dramatic evidence" of this wrongdoing at the other brokerage firms that they are investigating. Currently, a considerable amount of Spitzer's evidence is available to the public upon request. In his press release dated April 8, 2002, Spitzer highlighted some of his evidence, including internal email communications. According to Spitzer, these communications show "analysts privately disparaging companies while publicly recommending their stocks". Merrill Lynch denied the charges.

In the affidavit provided to the court, Spitzer submits a chart of examples "demonstrating discrepancies between the numerical investment ratings assigned by the internet group and the group's contemporaneous internal analysis or opinions". Until June, 2001, Merrill Lynch had a five category stock rating system, from "1" to "5". Rating "1" is a Buy (20% of more price growth expected); "2" is Accumulate (10% to 20% price growth expected; "3" is Neutral (10% price growth to 10% price drop expected); "4" is Reduce (10% to 20% price drop expected); and "5" (20% or more price drop expected. Additionally, Merrill Lynch ratings used two categories, the first based upon the intermediate term (present through the next twelve months), the second based upon the long term (beyond twelve months). Spitzer's chart certainly shows the misleading disparity:

Company	Date	Contemporaneous Analyst Comments	Published Rating
Aether System	3/15/01	"might have announcement next week…which could pop stock…but fundamentals horrible"	3-1
Excite@home	12/27/99 12/29/99	"we are neutral on the stock.... Six month outlook is 'flat', without any 'real catalysts' for improvement seen"	2-1
Excite@home	6/3/00	"such a piece of crap"	2-1
GoTo.Com	1/11/01	Nothing interesting about company "except banking fees"	3-1
InfoSpace	7/13/00	"this stock is a powder keg, given how aggressive we were on it earlier this year and given the 'bad smell' comments that so many institutions are bringing up"	1-1
InfoSpace	10/20/00	"piece of junk"	1-1
Internet Capital Group Inc.	10/5/00	"Going to 5" (closed at $12.38)	2-1
Internet Capital Group, Inc.	10/6/00	"No hopeful news to relate.... We see nothing that will turn this around near-term. The company needs to restructure its operations and raise additional cash, and until it does that, there is nothing positive to say."	2-1
Lifeminders	12/4/00	"POS"	2-1
24/7 Media	10/10/00	"piece of s___)	2-2

Although Merrill Lynch (and other firms) surely will be the subject of regulatory disciplinary actions, as well as scores of customer arbitration claims seeking to recover losses, it appears now that most stockbrokers at the firm(s) were unaware of the deception perpetrated upon the investing public. A list of the companies with which Merrill Lynch has an investment banking relationship can be found at www.ml.com/research/disclosure.asp.

The message is clear: investors must be wary of brokerage firm "research" and recommendations. Whatever the Madison Avenue advertising campaigns say about "trust", "integrity" and "independence", investors simply play second fiddle to the lucrative investment banking deals that financially benefit brokerage firms.

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James J. Eccleston is a securities attorney, representing investors as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He is a past co-chair of the Chicago Bar Association's Securities Law Committee, a past chair of its Financial and Investment Services Committee, a registered investment advisor and a licensed securities principal of the National Association of Securities Dealers (NASD). He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat & Filipowski and can be reached at 312-621-4400.