(MONEY Magazine) – It's been a year since I returned to CNN and financial journalism full time--a milestone that's prompted me to pause and look back over the past 12 months. It's been an incredible period in terms of current events, the economy and the markets--a period that has demonstrated both the best and worst of Wall Street. The best, of course, is represented by the reopening of the financial markets just six days after Sept. 11--a heroic task that required round-the-clock efforts from both the private and public sectors. A day that made not just Wall Street professionals, but all working Americans, proud. The worst? Well, a few months back you might have said Enron. But the sad truth is, the worst may be yet to come. The crisis in corporate accounting has been compounded in recent weeks by the crisis in Wall Street's research and investment practices, brought to light by New York Attorney General Eliot Spitzer. The result? A breakdown in the financial oversight system, many say, that is further battering investors whose confidence has already been shaken by two years of painful market losses.

Spitzer's probe, which is still in progress, examines what appear to be blatant conflicts of interest at several leading Wall Street brokerages. The investigation uncovered incendiary e-mail messages at Wall Street's biggest brokerage, Merrill Lynch, showing analysts slamming stocks while recommending them to investors. As Spitzer told me soon after the messages were made public, "The problem here is that they were touting stocks not because they believed the stocks were good, but because those companies were investment banking clients." Spitzer added that this conflict of interest has been common knowledge for years, but "nobody has ever obtained the proof that this sort of distorted advice was being given to the public." Until now.

In late May, Merrill Lynch agreed to a settlement. Among the terms: Merrill will pay a $100 million fine and not compensate analysts for helping to win investment banking business. However, Merrill stopped far short of promising to rebuild the fire walls that are supposed to separate investment banking from research. In fact, Merrill CEO David Komansky told me in an interview before the settlement was reached that research plays "a critical role in the capital-raising process." Komansky acknowledged that having analysts play both the banking and research sides of the business "can give way to certain conflicts," but he believes that Wall Street is still capable of policing itself.

As a confirmed opponent of almost all new--and inevitably burdensome--regulation, I wish I could agree. But this time the abuses appear to be so egregious, the arrogance so intolerable, that I believe the government may need to step in. (For more on this topic, see "Why Analysts Still Matter" on page 98.)

How did we get here? Some point to shifting business models at accounting firms and brokerages that made auditing and research practices subordinate to the more lucrative consulting and investment banking practices. But the overarching force was the stock market mania of the late '90s. As John Coffee of Columbia Law School recently said in the New York Times, "Securities analysts lost their skepticism." He adds that in 1990 analysts issued six buy recommendations for every sell. By 2000, the ratio was nearly 100 to 1. Joel Seligman, the dean and Ethan A.H. Shepley professor at Washington University School of Law, tells me, "The euphoria of the '80s and '90s just carried people away in terms of taking the federal securities laws and the SEC less seriously." Seligman likens it to the euphoria that led to terrific abuses in the late 1920s. He adds, however, that "the contempt that some of the e-mail shows for investors--the notion that they're just fools to be manipulated--is absolutely extraordinary."

So what's to be done? In late April, the House passed the Corporate and Auditing Accountability, Responsibility and Transparency Act (CARTA) with the support of the accounting industry. Among other measures, CARTA would create a new accounting oversight board. As of this writing, the Senate is working on a much tougher reform bill. On the subject of brokerages' investment banking and research practices, the Senate proposal would more clearly separate analyst and banking operations. However, the Senate bill faces tough opposition, and it may be difficult to get anything signed into law this year.

The SEC recently backed a new set of brokerage guidelines proposed by the New York Stock Exchange and Nasdaq, although critics were quick to say it's too little, too late. Spitzer, in fact, called the new rules "at best a stopgap, but frankly very inadequate." Further complicating matters, SEC chairman Harvey Pitt has come under fire for meeting with the head of an accounting firm that is currently the target of an SEC probe. (Pitt denies that anything relevant to the investigation was discussed.) Some companies have also come forward with suggested reforms. Leading credit agency Standard & Poor's recently enacted tougher standards for the way it calculates corporate earnings. And the Spitzer probe is far from over. The Attorney General will continue his investigation into other prominent Wall Street brokerages. In addition, Merrill still faces numerous lawsuits from individual investors.

In my view, the Merrill settlement did not produce the kind of meaningful change needed to eliminate conflicts of interest and restore investor confidence. It simply does not go far enough in separating the firm's research and investment banking operations. Spitzer should be recognized for bringing the issue to light, but he should also be held to account for not pushing harder for the dramatic changes needed. As investors who saw their portfolios wiped out know all too well, it's no longer an acceptable argument to say that conflict-of-interest issues have always and will always exist on Wall Street. Clearly, we need solid fire walls between auditing and consulting, and investment banking and research. Clearly, those responsible for safeguarding the public interest should not--simultaneously--profit from the companies that they are expected to report on objectively. Clearly, we need a more transparent system of financial disclosure.

Why is this time so markedly different from past Wall Street imbroglios? Because Wall Street is so markedly different. According to the Securities Industry Association's most recent data, more than 80 million Americans own stocks or mutual funds--that's nearly three times the number two decades ago--as do nearly half of all U.S. households. And that increased role has inevitably led to increased public scrutiny as the market turned south. Investors are outraged by Wall Street's abuses. They want answers and they'll keep demanding them until they get them--unless lightning strikes twice and the markets make a miraculous rebound that wipes out the huge losses of the late '90s.

That brings us to the other lesson of this debacle: no matter what reforms are put in place, no matter how "independent" brokerage research may become, individual investors ultimately must protect themselves. That means viewing research and financial reports with the appropriate level of skepticism. Seligman suggests that if you're going to rely on an investment analyst, there's now a stronger case for dealing with an independent. Investors must also return to a more balanced approach to investing: the time-tested strategy of diversification, which, of course, dilutes the impact of a single stock as it skyrockets, but also softens the blow as it--inevitably--crashes back to earth.

Lou Dobbs is the anchor and managing editor of CNN's Lou Dobbs Moneyline.