Eliot Spitzer, New York's Attorney General, uncovered a number of e-mails written by Merrill Lynch investment analysts describing as "junk," "crap," and "a disaster," stock that they were publicly rating at "buy." In his initial accusation (April 8, 2002), Spitzer argued that this biased investment advice was rooted in an undisclosed conflict of interest. The analysts had continued to give favorable coverage to Internet companies through 2000, even though their stocks had been in continual decline. The investment advice, Spitzer charged, was biased by the analyst's desire to support Merrill Lynch's investment banking interests.
Investment Banking Influence on Analysts
Brokerage firms generate large revenue from their investment banking operations. Corporations and municipalities, which do their investment banking through brokerage firms, have a natural interest in banking with firms whose analysts give their stock favorable coverage. Because of this potential conflict of interest for analysts, firms have a responsibility to keep them free from the influence of the investment banking side of company operations. The bullish ratings given by Merrill Lynch analysts to floundering Internet companies hint that such conflicts of interest existed within Merrill Lynch.
Conflict of Interest?
Henry Blodget, once Merrill Lynch's top Internet securities analyst, advised investors to buy Internet stock through most of 2000. During this time the securities were in heavy value decline overall. On November 8, 2000 Blodget admitted that Internet businesses were in trouble. Unfortunately, many investors had continued to buy Internet stocks on Blodget's advice in the months leading up to this announcement. Many investors who had trusted his research and credible opinion had stayed in and continued to buy.
A securities fraud lawsuit alleging poor investment advice was brought against Merrill Lynch by investor Debases Kanjilal in 2001. Kanjilal lost about $500,000 on his investment in InfoSpace, a company Blodget had touted. When his stock was at $60 a share (May, 2000), Kanjilal had wanted to sell, but his Merrill Lynch advisor told him to stay in, maintaining that Blodget was bullish on the stock. To settle the lawsuit, Merrill Lynch paid $400,000 to Kanjilal on July 20, 2001.
The 2002 investigation into Merrill Lynch headed by Attorney General Spitzer exposed evidence of analyst bias. Spitzer found e-mail correspondence between analysts berating the companies they were giving high ratings to. Among these companies was InfoSpace. Blodget described InfoSpace stock as "junk," at the same time he gave it the highest buy rating (1-1). InfoSpace did not use Merrill Lynch as its investment banker, but Go2Net, a company it was in the process of purchasing that summer (2000), did. The $2.7 billion purchase closed on July 26, 2000. Spitzer charged Merrill Lynch with advising under a conflict of interest.
Further E-mail Records
Merrill Lynch wanted to keep recommendations high for the following companies, among others, because of its own vested interest in their success. These records show the disparity between information being circulated among the analysts and advice being given to investors.
Internet Capital Group (ICGE)
E-mail: October 5, 2000 - "Going to 5?" (strong sell); October 6, 2000 - "No helpful news to relate, I'm afraid. This has been a disaster- there really is no floor to the stock."
Investor advice: October 5, 2000 - 2-1 rating (buy to strong buy)
E-mail: June 3, 2000 - "ATHM is such a piece of crap!"
Investor advice: June 3, 2000 - 2-1 rating (buy to strong buy)
E-mail: December 4, 2000 - "I can't believe what a POS that thing is."
Investor advice: December 4, 2000 - 2-1 rating (buy to strong buy)
Merrill Lynch Settlements
Merrill Lynch settled with New York on May 21, 2002 for $100 million. $48 million went to New York's treasury and $52 million went to the treasuries of other states that had been affected. In April of 2003 the SEC and other regulators added an additional $100 million to the penalty. In response to the reform movement in the industry Merrill Lynch set up a compensation system through which analysts would be rewarded for how close their predictions came to actual stock performance.
Henry Blodget was barred from the securities industry and fined $4 million in April of 2003.
Merrill Lynch Investment Banking Clients
Investigations are being made into the ratings published by Merrill Lynch of these companies:
- Aether Systems
- GoTo.com, Inc.
- Internet Capital Group