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Examining Merrill's Motives

Is the BlackRock deal a fancy way of sidestepping conflict?

Some skeptics are raising questions about

Merrill Lynch's


motive in merging its asset management division with




The issue centers on the deal's unique structure. Under the merger, Merrill is surrendering its mutual fund unit to BlackRock in exchange for a 49.8% stake in the crosstown bond fund specialist. Merrill billed the transaction as a way to keep significant skin in the lucrative asset management game while freeing up capital to invest elsewhere.

Others wonder if Merrill's goal was less noble. Could the deal have been a way to get around regulators' distaste for brokerages that push in-house mutual funds, while still harvesting the benefits?

"To me, this is very perplexing," said Richard Bove research analyst from Punk Ziegel & Company. "Why would you give up control of a business that is growing like Merrill Lynch's investment management group?"

The way Bove sees it, Merrill -- since it's now a major participant in BlackRock's earnings -- has a big incentive to push BlackRock products to its clients. That the funds now bear the BlackRock name also gives Merrill Lynch brokers a way to hide that interest.

Merrill was quick in its efforts to squelch such criticism last week. Bob Doll, the chief investment officer of the Merrill Lynch investment management group, said in an interview with

that conflict issues had "zero" to do with the transaction. The deal, he said, provides brokers with more freedom in product sales, not less, and extends Merrill rebranding that would help grow business outside of the firm.

Many analysts defend that position, noting that Merrill Lynch has been at the fore of efforts to encourage "open architecture," or the separation of asset management from the financial advisers who sell their products. They say the combination of BlackRock's fixed-income products and Merrill Lynch's stock funds offer brokers an independent name with a variety of investments.

To the critics, it isn't that simple. Although a name change does give brokers at other firms the ability to sell Merrill funds under BlackRock's name, it also affords brokers at Merrill Lynch the same luxury.

In the past,

Morgan Stanley


has been fined for promoting sales of its own funds by rewarding brokers with prizes when they pushed in-house funds. Morgan Stanley has said it stopped this practice, but skeptics still warn clients to ask brokers at their financial management firms about who manages a fund before buying it.

Bove is critical of this deal, and offers two explanations for Merrill Lynch's decision to surrender both majority control and management presence with the new firm. Either Merrill Lynch believes that the regulatory climate won't allow asset management businesses to grow in the future, or the company plans to leverage its large private client base to tout and sell BlackRock's fixed-income products.

The fact that Merrill Lynch retained a 49% ownership in the company makes the latter explanation more likely.

If Merrill Lynch uses the transaction to beef up sales of BlackRock's fixed-income products to those in its private client base, it "flies in the face of what regulators wanted to do."

"All of a sudden, Merrill Lynch brokers sell more BlackRock products because of Merrill's ownership. Isn't that what the regulators don't want?" said Bove.

To be sure, Merrill Lynch's private client business was just as capable of selling BlackRock's funds in the past as it is now. But analysts agree that the new relationship is an advantage for both, and can help different businesses within the private client group. One particular Merrill Lynch business, separately managed accounts, may get a boost.

Separately managed accounts are a unique asset management tool that provides rich clients with specialized fund management. Instead of clients' portfolios being grouped with thousands of others and traded based on a general portfolio goal, these particular high net-worth individuals get fund advice for their individual needs.

BlackRock's fixed-income expertise will be especially attractive to Merrill Lynch's separately managed accounts because the firm can package tailored fixed-income products for these clients. As the client base ages, fixed-income products make up an even greater percentage of its clients' portfolios.

"Demographically, we are going into a society that will be aging," said Denise Valentine, a senior analyst at Boston-based financial research and consulting firm Celent. "The most common investment is fixed-income securities. This large entity with huge distribution capability will help give private clients what they want."

Individuals with separately managed accounts are more likely to stay with a firm, and are also more willing to pay for the service. The partnership could create a unique advantage for this area of the business, analysts say.

But that is not what the regulators wanted, according to Bove.

If Merrill Lynch "loved BlackRock's products, what prevented

the company from selling them before?" said Bove. "Why are they so excited about it now? Because Merrill owns 49% of BlackRock."

Meanwhile, a Merrill Lynch spokesperson continues to argue its party line: Merrill Lynch is hoping to grow its business outside of its in-house private client group by rebranding with the BlackRock name. Financial analysts at other firms who had been reluctant to sell products managed by Merrill Lynch won't have that issue.

Still, with Merrill retaining a 49% interest in BlackRock, a little confusion about who is benefiting from the sale of a particular fund can't hurt.