SAN FRANCISCO (CNN/Money) -
Everyone has long known about the open-sore conflict of interest that is Wall Street research housed within investment brokerages.
But it used to be that only preening pundits would put forward the one workable solution: That is, cleaving the two in half, separating research from banking, removing the temptation of scaling the Chinese wall.
This is the only way to keep Wall Street honest. And now, the attorney general of New York is giving the idea legs.
In his ongoing and rather public negotiation with Merrill Lynch, the politician Eliot Spitzer has suggested Merrill simply spin off its research department. That way its analysts would no longer hype stocks to please Merrill bankers in the myriad embarrassing ways Spitzer has documented. (Read more on the talks between Merrill and Spitzer.)
The country's biggest brokerage has responded the way the securities industry always does. It argues that research alone doesn't sell. In fact, the way the system works now, research is a loss leader. It's given for free to brokerage clients on the presumption they'll trade with the brokerage and that the clients will have access to offerings underwritten by the firm's bankers.
And so research does sell. Companies pay handsomely in the form of underwriting fees for the research that hypes their stocks.
That, of course, is the problem. Professional investors long ago learned to discount the information they get from brokerage analysts. The unsuspecting public -- often non-clients, it should be noted -- are the ones who got duped. Free-speech concerns prohibit one sensible solution, which would be to prevent analysts from speaking on TV. So since Wall Street won't muzzle itself, we're back to Spitzer's suggestion of separating the functions.
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RECENTLY BY ADAM LASHINSKY
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The irony is that investors are absolutely willing to pay for quality research. They're doing it now. Every mutual fund company from Fidelity to Putnam to Soros Fund Management employees scores of analysts whose job it is to research stocks and make recommendations to portfolio managers. Those analysts cost big money and the investors are willing to pay for the research they generate.
Thus Merrill's (and the rest of the Street's) logic for not wanting to split off its research division rests on a kind of false version of game theory: Merrill can't charge for research while competitors are offering a comparable product for free. That's where the visible hand of government intervention comes in to right an obvious wrong.
Force Merrill (or its spun-off successor) to charge for independent research and serve notice that the types of shenanigans discovered at Merrill won't be tolerated elsewhere. Before you know it investors might be paying for objective, high-quality research up and down Wall Street.
Adam Lashinsky is a senior writer for Fortune magazine. Send e-mail to Adam at adam_lashinsky@timeinc.com.
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