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Mopping up after Merrill Lynch
A storm of wrongdoings, illegal maneuverings, and shady deals has shaken investors' confidence.
April 15, 2002: 3:27 PM EDT
By Eric Hellweg, CNN/Money Contributing Columnist

NEW YORK (CNN/Money) - These are not good times for investors. I'm not talking about the schizophrenic Dow or the depressed Nasdaq, but the crisis of faith currently enveloping the business world at large.

According to a Wall Street Journal/NBC poll released on April 11, 57 percent of the 1,005 people surveyed said the "standards and values of corporate leaders and executives" have dropped in the last 20 years. Four years ago in the same poll, the findings were nearly reversed, with 53 percent reporting the values were "the same or higher."

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What happened? Many things. Most recently, of course, the Enron (ENE: Research, Estimates)/Andersen accounting debacle has thrown investor trust down a sinkhole, the depths of which haven't been seen since the junk bond fallout of the late 1980s. But a potentially more pernicious situation has just been uncovered through the diligent efforts of New York state attorney general Eliot Spitzer.

Spitzer is investigating Merrill Lynch's (MER: up $1.10 to $47.99, Research, Estimates) Internet research department, specifically its undisclosed ties to the company's investment banking arm -- ties that the attorney general alleges led to widespread investor deception. On April 8, the judge in the case issued a preliminary court order that Merrill Lynch must begin to disclose, on every research report it issues, any relationships it has or is seeking to have with another company.

Anyone interested in the case -- which should include every investor out there -- should read through the attorney general's 38-page affidavit. It offers a fascinating look behind previously closed doors. And it doesn't paint a pretty picture. "It's smoking gun after smoking gun," says a spokesman for the attorney general.

Merrill Lynch issued a press release after the preliminary court order was issued, saying that it was "outraged" by not being able to contest the allegations, and that the attorney's evidence -- primarily e-mail records -- was "taken out of context" and "just plain wrong."

It's pretty hard to imagine any context in which Merrill's e-mail exchanges would be considered acceptable. In one instance, the head of the company's equity division e-mailed the research department, saying, "We are once again surveying your contribution to investment banking...please provide complete details on your involvement...paying particular attention to the degree your research played a role in originating...[banking business]." Henry Blodget, then the head of the Internet research group, responded with his group's many contributions. Shortly thereafter, his salary jumped from $3 million to $12 million.

Blodget, a former star of the Internet boom, plays a starring role in the attorney general's affidavit. The affidavit profiles the Internet research group's coverage of two companies -- (now and (INSP: down $0.07 to $1.39, Research, Estimates) -- in its statement.

According to the affidavit, Merrill courted and obtained a banking arrangement with, after promising the company that the research group would initiate coverage of it. This promise was a tacit guarantee that would receive favorable coverage, since Merrill's research department never issued a "reduce" or "sell" order, according to the affidavit.

One institutional investor e-mailed Blodget after hearing of Merrill's research coverage, asking him, "What's so interesting about GOTO except banking fees????" to which Blodget replied, "nuthin." The filing also alleges that Merrill's research department even sent drafts of research reports to GoTo for approval before they were published.

In the case of InfoSpace, the affidavit points out that even though the company's stock price plummeted from $261 to $13.50, Merrill never issued a sell order. This, despite the fact that internal e-mails exchanged by members of the research group called the company a "piece of junk." Why wasn't the stock marked a sell? According to the attorney general, it's because the investment banking group was actively doing business with InfoSpace.

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These are just a few of the dozens of conflicts of interest uncovered by New York's attorney general. The investigation isn't stopping with Merrill Lynch either. Though the spokesman for the office wouldn't name names, he confirmed that subpoenas had been issued "to other prominent Wall Street firms" and that "they're all major players." What's more, he said, the SEC is very interested in the case. "We've had a number of discussions with them."

A spokesperson for Merrill Lynch claimed that the company could not comment on the case, citing a confidentiality agreement.

The Spitzer report, the Enron/Andersen episode, and ongoing accounting investigations have shattered faith in the integrity of the markets -- at a time when the U.S. economy desperately needs investors to feel confident. Unfortunately, as investigators continue to uncover the ethical lapses perpetrated during the long bull market, it's becoming clear that it will take a lot of hard work and rigorous reform to clean out the filth on Wall Street.

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