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Wall Street's Discovery of Ethics Is Too Little, Too Late

The amusing element of Merrill Lynch's decision Tuesday to prohibit its research analysts from owning shares in the companies they follow is the suggestion that this move will inject integrity into the research process. If that's not an admission that integrity doesn't exist now, what is? Merrill Lynch's move is little more than press-release chest thumping. It won't improve the quality of its research. It won't eliminate the conflicts of interest between investment banking and retail brokerage activities. And it won't make the unsuspecting individual investor trust analysts any more than they do now.

Worse for Merrill Lynch (MER) and any brokerage that decides to follow its lead is that now Merrill analysts will have to put up with the gripe against high-minded journalists who write about the investment world: If you don't have any skin in the game, if you aren't willing to put your money where your mouth is, why should I listen to you?

The answer is that there's only one reason to listen to anyone giving you investment advice: if they make money for you by telling you what to do or give you good ideas that help you make money. That Merrill is taking a step to require its analysts to behave more ethically than they were before is nice, but it won't really change what matters.

In essence, this is all background noise to the end-of-an-era drama of a system breaking down. The last 10 years were all about the democratization of the capital markets. Everyone got caught up in the fun, from the housewives in Carmela Soprano's upscale neighborhood and the Beardstown Ladies to my fishing guide in Alaska last month (he wasn't any luckier helping me catch a king salmon than he was in investing in the IPO of Internet advertising agency Avenue A (AVEA)) and brothers proud of being Foolish investors. Merrill Lynch, the big-name brokerage with the most significant collection of individual investors for clients, got caught up in the fun. It even jettisoned a research analyst who was a sourpuss on (AMZN) in favor of one who was sufficiently bullish.

But the fun is over. And the evidence is that the institutions that were supposed to care about individual investors suddenly are covering their rear ends. The Securities and Exchange Commission publishes an otherwise fine primer on how to recognize analysts' conflicts of interest. "We advise all investors to do their homework before investing. If you purchase a security solely because an analyst said the company was one of his or her 'top picks,' you may be doing yourself a disservice." If only the SEC had published this guide when it might have helped, like three years ago. Oh well, it's unlikely anyone would have listened. long has felt it's important that readers know if its writers have conflicts of interests, which is why most editorial employees here don't own stock in individual companies and everyone discloses what they do hold. Should analysts own stock in their coverage areas? No, of course not.

"When I started in this business, that was always the rule," says Lise Buyer, who originally worked at the former Prudential Bache before moving on to T. Rowe Price and Credit Suisse First Boston and now is a venture capitalist. "It appears to be a conflict of interest, and who wants that? This is a return to the way it used to be. And should be."

Expect to see more firms embrace Merrill's move, and expect analysts to kick up little fuss. Now is not the time to complain about the terms and conditions of a good job.

For now, Goldman Sachs still allows its analysts to own shares in companies they cover, says a spokesman. However, purchases require the approval of management and a compliance committee and a minimum 30-day holding period. Importantly, Goldman analysts only can purchase stocks rated a trading buy or that already are on the firm's recommended list and can't sell them unless they are rated below a trading buy. No analyst can take any action until 24 hours after the firm changes its rating. So Goldman's policies ensure that an analyst won't benefit from recommendation changes, but that's about as far as it goes.

Robertson Stephens has a stricter policy, implemented in September 2000, according to a spokeswoman. Analysts aren't allowed to own stocks in companies they cover. If they already owned shares in a company they want to include in their coverage, they must sell the shares or place them in a blind trust. The trustee presumably could sell the shares or do nothing with them.

But forcing analysts to embrace ethics now only highlights how out of touch Wall Street was with good business practices before. Then again, the outrage on Main Street over Wall Street's shenanigans exposes how little individual investors understand the games that are played.
In keeping with TSC's editorial policy, Adam Lashinsky doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. Lashinsky writes a column for Fortune called the Wired Investor, frequently guest hosts the TechTV cable television news show Silicon Spin, and is a regular commentator on public radio's Marketplace program. He welcomes your feedback and invites you to send it to Adam Lashinsky.

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