SEC Called Into NY State Flap Over Analyst Reforms

According to the Wall Street Journal, officials from the Securities and Exchange Commission (SEC) joined in talks this week to discuss analyst reforms. The central issue regards alleged conflicts-of-interest that can affect the judgment of securities analysts employed by giant financial firms such as Merrill Lynch. If the SEC decides to take an active role in the resolution of this issue, it could lead to an industry-wide framework to reform how Wall Street research departments rate stock for investors.

Threat of Criminal Charges

At the center of the controversy is a public statement released last week by New York State Attorney General Eliot Spitzer. The statement reveals the results of a 10-month study and concludes Merrill Lynch's investment advice has been tainted and biased by a desire to aid the firm's investment banking business. Mr. Spitzer said he had obtained a court order requiring immediate reforms by Merrill Lynch, and he maintains, "the case must be a catalyst for reform throughout the entire industry."

Merrill Lynch said there is no basis for the allegations made by Mr. Spitzer, and the firm is outraged that it was not given the opportunity to contest the allegations in court. In recent months, Merrill Lynch has initiated voluntary reforms, such as developing for internal use a set of generally accepted analytical standards that focus on earnings prepared according to generally accepted accounting principles. The voluntary reforms notwithstanding, Mr. Spitzer has threatened the firm with criminal charges for misleading investors with overly optimistic research.

Settlement Talks

Talks to settle the charges have focused on such matters as appointment of an independent board to oversee the firm's research activities, additional disclosures about investment banking relationships, and establishment of a restitution fund to help investors, including those who lost money when the dot-com bubble burst.

Merrill Lynch announced on April 18, 2002 that an agreement has been reached with respect to the added disclosures, and it said productive discussions are continuing with the Attorney General's office with the objective of resolving all remaining issues. However, the media reported that negotiations have stalled due to difficult-to-resolve issues, including the firm's refusal to admit wrongdoing and its opposition to the establishment of a restitution fund. Additionally, Merrill has said that any reforms applied to it should apply to others in the same industry.

A decision by the SEC to take part in the investigation would elevate the probe to a much more significant level. Mr. Spitzer has said he welcomes the SEC's involvement.

-Rosemary Schlank


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