There are some things that even Eliot Spitzer can't change about the way Wall Street does business.

To settle charges by the New York State Attorney General that Merrill Lynch's analysts misled investors with bullish stock ratings on shaky companies, the firm agreed on Tuesday to pay $100 million and change the way it pays its stock analysts.

Now, Spitzer, in his campaign to weed out conflicts of interest in Wall Street research, is going after other firms, including

Morgan Stanley




(C) - Get Report

Salomon Smith Barney.

Hopefully, the attorney general's crusade will force the industry to correct these conflicts and restore some investor confidence in the country's financial system. At the very least, individual investors will be more aware of the conflicts that exist in this industry.

But research and investment banking divisions at full service financial firms might be too intertwined to extricate. Here are some things that Merrill Lynch's settlement doesn't change.

Analysts will still have some role in drumming up banking business.


Merrill Lynch


didn't admit any wrongdoing, the firm has agreed to several measures to detach research from investment banking activities. Merrill will separate how it pays analysts from its banking business, create a committee to review new research coverage and changes in stock recommendations, and appoint someone to monitor compliance with these reforms.

But even with this settlement, Merrill analysts will still be allowed to identify investment banking opportunities for the firm and even attend pitch meetings with bankers. (Any recent pitches, however, must be disclosed in analyst reports.)

Analysts have long been key to a firm winning banking business from a company that's about to raise money in the market. "When five bankers show up at a company, they all look the same," says one former Wall Street research director. "But if an analyst walks in and says, 'I am the top-ranked analyst and everyone listens to me,' then that's a more compelling reason to give the firm that banking business."

A company wants and needs a high-profile analyst with a following among big institutional investors to support its stock through favorable research coverage. That isn't going to change.

Investment banking will still have some effect on what an analyst gets paid.

A firm's research department isn't a profit center. Investors don't directly pay for research, report by report. Instead, a firm has to devise a way to compensate the analysts that takes into account the amount of trading and banking business the analyst generates and even how well the analyst's stock picks have performed.

Analyst compensation hasn't always been


linked to the generation of investment banking business. It was the greed and frenzy of the '90s tech-stock boom that augmented pay.

With so many tech companies going public, there were enormous profits to be made in investment banking. And because analysts were a key part of winning this valuable banking business, firms started giving the analysts an actual percentage of the business they helped generate. Until the mid-'90s, analysts made about $500,000 to $700,000 a year, and only a handful of analysts made $1 million or more a year, estimates one long-time Wall Street observer. But by the late '90s, many top-tier analysts were making $2 million to $4 million a year, with some taking home annual pay packages in excess of $10 million.

The Spitzer settlement with Merrill separates analyst compensation from investment banking business. However, underwriting business can still be an indirect factor in calculating analyst pay. According to Merrill Lynch's press release on the settlement, "research analysts will be compensated for only those activities and services intended to benefit Merrill Lynch's investor clients." But such language still leaves the chance that some kinds of investment banking business might be interpreted as helping investor clients.

Recommendations are always going to be skewed.

Spitzer's deal with Merrill and rules that the

Securities and Exchange Commission

introduced several weeks ago will certainly improve the disclosure of conflicts of interest in research. The new SEC rules, for example, require analysts to disclose whether they or their firms own stock in a covered company and what percentage of recommendations fall into buy, sell and hold categories.

But analyst ratings are probably always going to be heavy on the buys and thin on the sells. Indeed, all the recent attention directed at analyst research hasn't forced these professionals to be more negative. Of the 25,000 stock recommendations in this country, only 2.5% were sells or strong sells at the beginning of this month, according to Thomson Financial/First Call. That's up from about 1.5% in the late '90s, but it still says that few analysts are willing to say "Sell!"

Analysts usually cover companies that they like, simply because they don't want to produce negative research. Think about it: Pessimism doesn't help sell stocks. And a company's executives can still get mean and nasty if an analyst puts a sell on that stock.

A company can always pull its banking business from a Wall Street firm that gives its stock an unfavorable rating. But when there's no banking relationship to sever, company executives have been known to stonewall analysts who are negative on those stocks -- not taking their questions on conference calls, for example, or paying more attention to other analysts. That favoritism can put an analyst -- and ultimately investors --- at a distinct disadvantage. And no rule has been passed that addresses this weighty issue.

But with the Merrill settlement and other initiatives exposing analyst conflicts, investors at least will be more aware of all the back-scratching that happens on Wall Street.

You can still use research from Street analysts; just don't take what they have to say at face value.

In keeping with TSC's editorial policy, Dagen McDowell doesn't own or short individual stocks, nor does she invest in hedge funds or other private investment partnerships. Dagen welcomes your questions and comments, and invites you to send them to

Dagen McDowell.