Merrill Lynch


says it's yet to schedule a meeting with New York Attorney General Eliot Spitzer, but the brokerage has reason to want to put the conflict-of-interest scandal quickly behind it.

Since news of the investigation was announced on April 8, Merrill has been pounded with negative publicity that has sent its stock down 21%.

"When you lose credibility, you've got a real issue," said Robert Lamm, a securities lawyer at Gunster, Yoakley & Stewart.

After initially claiming that Spitzer's allegations were "just plain wrong," Merrill Chief Executive David Komansky recently apologized for emails that showed analysts privately disparaging companies while publicly recommending them. Merrill has also agreed to disclose potential conflicts of interest on its research reports.

But neither concession on its own is likely to satisfy Spitzer. Indeed, he has already talked about creating "structural reform" to alter the way in which analysts and investment bankers interact.

Good Fences

"I'd be surprised to see a total divorce

between investment banking and research business, because it's just too integral to the business, but we'll probably see much better Chinese walls," noted Alan Bromberg, a securities law professor at Southern Methodist University.

Securities experts say splitting apart the two units would require a major restructuring and would be inconsistent with current regulatory philosophy. Just three years ago, the White House repealed the Glass-Steagall Act that for six decades kept the banking, securities and insurance businesses separate from each other.

Instead, Spitzer may attempt to change the way in which analysts at Merrill are compensated.

"You cannot have analysts being paid to a great extent as a result of their contribution to the investment banking side of the house," he said in a recent interview with



Some experts suggest that analysts' bonuses should be tied more to their stock picks and less to how many banking clients they win for the firm. The number of buy ratings on Wall Street has far exceeded the number of sell recommendations for the past two years, and investors have lost billions of dollars as a result.

Basing analysts' compensation on the stocks they have chosen seems unfair to some observers, though. After all, few analysts could have predicted the collapse of a company like


, which had consistently lied to Wall Street. Still, most agree Enron was a rare case, and the idea is gaining traction.

Pay Stubs

Another idea being floated is that Merrill should disclose how much of its analysts' compensation is based on the investment banking revenue they have generated for the firm.

"I think it's safe to say that Merrill would prefer less burdensome restrictions and more disclosure," said J. Boyd Page, a securities lawyer at Page, Gard, Smiley & Bishop. "In other words, don't make us totally separate the analysts' compensation from investment bank relationships, but do require us to make new disclosures about it."

Spitzer, on the other hand, is more inclined to want total prohibition on certain types of conduct, Page said, although the ultimate arbiter may be the

Securities and Exchange Commission.

The SEC will meet May 8 to weigh new analyst rules put forth by the

New York Stock Exchange



. Still, changes made at Merrill could be seen as a blueprint for the rest of the industry. Spitzer has subpoenaed records from a number of brokerages as part of a wider investigation of misconduct, and the SEC has been seeking research materials from 10 brokers, according to

The Wall Street Journal


One potential outcome of the settlement between Merrill and the New York state attorney general is that changes will be made to the way Merrill rates companies.

Merrill altered the way it rates stocks just last year by dropping the accumulate rating. The company now rates stocks strong buy, buy, neutral and reduce/sell. But experts say it is necessary to have clearer definitions of those ratings and to standardize the system across the brokerage industry.

Bottom Line

Of course, no settlement would be complete without some sort of financial penalty. Merrill has reportedly refused to discuss a $100 million settlement and balked at the creation of a restitution fund for investors who lost money because of poor research.

But a hefty fine is seen as inevitable by many securities lawyers. Prudential Securities has estimated that Merrill could ultimately pay as much as $2 billion in a worst-case scenario, although the firm's chief executive has disagreed with this view.

"Many of these Internet stocks were very hot and just tanked, so billions may be the better estimate," said Thomas Hazen, a securities law professor at the University of North Carolina.

In the end, efforts to distance corporate banking and research are likely to remain superficial, experts say. But many believe that this experience has already created a change to the way brokerages do business. Komansky has vowed to "redouble" the firm's enforcement of existing policies "and take strong actions against anyone who violates them."

"Anything is a significant improvement," said Page, the securities lawyer. "Clearly if investors are told about the conflicts of interest, that's a big step towards saying, 'Well, they're making an informed decision.'"