Wall Street Credibility Hit Again

Wall Street’s image suffered a fresh blow Monday as a pair of court filings raised new questions about the credibility of major investment banks and the advice they give investors.

In a surprise legal action, the New York state attorney general, alleging severe conflicts of interest at Merrill Lynch & Co.’s Internet-research operation in recent years, asked a judge to order the company to begin disclosing new information about the interaction between the firm’s investment-banking and stock-research units.

The attorney general described the request as an initial salvo in a wider investigation of Wall Street practices.

Separately, Enron Corp. shareholders who lost billions of dollars charged that the company’s investment banks played a central role in the firm’s downfall by creating many of the off-the-books partnerships that fed its collapse. The allegations, which were reported Monday in The Times, were included in an expanded class-action suit filed in Houston.

In the Merrill case, New York Atty. Gen. Eliot Spitzer said a 10-month investigation of the brokerage’s Internet-research group discovered that Merrill analysts routinely questioned the validity of their own stock recommendations and, in some cases, bemoaned the pressure they felt to talk up the prospects of companies that were investment banking clients.

In one example, an analyst labeled tech firm InfoSpace Inc. “a piece of junk” in an e-mail, but nevertheless gave the stock Merrill’s highest rating, according to the filing.

“Merrill Lynch failed to disclose to the public that Merrill Lynch’s [stock] ratings were tarnished by an undisclosed conflict of interest,” Eric Dinallo, New York’s assistant attorney general, wrote in the court filing. “The research analysts were acting as quasi-investment bankers for the companies at issue, often initiating, continuing and/or manipulating research coverage for the purpose of keeping and attracting investment banking clients.”

The attorney general did not file suit against Merrill, but rather asked a state Supreme Court judge to order the firm to increase disclosure about its relationships with clients “and provide more context for its stock ratings” while the state’s investigation proceeds.

The judge agreed, but gave Merrill 72 hours to comply.

In the statement, Merrill said the charges are “just plain wrong.”

“The allegations reveal a fundamental lack of understanding of how securities research works,” the firm said, and pointed out that its top Internet analyst “repeatedly and publicly warned that a substantial majority” of Internet companies would fail.

One of those named in the New York case is Henry Blodget, who was one of Merrill’s highest-profile Internet analysts during the tech sector’s boom years.

In the Enron suit Monday, plaintiffs named nine investment banks, including Merrill, and two law firms to a previously filed class-action complaint that had named Enron executives and accounting firm Andersen.

The suit alleges that investment banks deliberately structured a series of sham transactions that let Enron mask its deteriorating financial condition from investors. In some cases, Wall Street executives profited personally even as public investors and employees suffered debilitating losses, the suit says.

Even as the brokerages knew Enron’s health was failing, the suit says, they continued to tout the company’s stock to investors.

The investment banks deny the charges. Salomon Smith Barney, a unit of Citigroup Inc., said the company incurred severe losses in loans made to Enron.

“It defies all logic to say we profited from our relationship with Enron when we already announced Enron-related exposure of $2.6 billion and actual losses of $453 million,” said Kristin Lemkau, a spokeswoman for J.P. Morgan Chase. “We were damaged as well.”

Experts said the Merrill case and the Enron suit will reignite the debate about Wall Street’s credibility--an issue that flared after stocks crashed in 2000. Congress last year launched a series of hearings on brokerages’ potential conflicts of interest.

“One theme common to both is what [the firms] privately think and what is told to the public,” said Henry Hu, a securities-law expert at the University of Texas.

Experts said the Enron suit is an attempt to target well-heeled Wall Street firms now that Andersen’s ability to pay sizable reparations is in doubt because of its precarious financial state.

In the Merrill matter, the New York attorney general said his office has reviewed more than 30,000 documents, including thousands of e-mails. He said some e-mails indicated that the company’s Internet analysts often recommended shares to investors only to lure lucrative investment banking work that would boost their pay.

In one case, an analyst wrote an e-mail saying there was nothing interesting about the stock “except banking fees.”

In another instance, an analyst bemoaned giving a “buy” rating to a stock, stating, “I don’t think it is the right thing to do. John and Mary Smith are losing their retirement because we don’t want the client’s CEO to be mad at us.”

In some cases analysts allowed companies to “redraft” research reports and “indicate which ratings would be acceptable to them,” the filing says.