RESEARCH ENDORSEMENTS

Arthur Levitt Endorses S&P/Wall Street Advisor Independent Research Model

New York -- May 13, 2002. Former SEC Chairman Arthur Levitt gave his endorsement of the independent research model in an interview with the Bloomberg news service, published May 8.

Discussing the need to reduce analyst conflicts of interest in the wake of news surrounding Merrill Lynch, Levitt said, "I think what we're looking for in this new world, in this new environment, which is very different from what it was six months or a year ago, is a research function that is totally pure, in terms of both conflicts of interest and perceived conflicts of interest."

Asked if firms will simply have to stop doing research altogether due to the economics of bias-free research, Levitt replied, "I think that's part of the risk. And part of the answer to that could be the development of independent research boutiques that sell their research to the very firms that they're researching in the same way that the rating agencies, such as Standard & Poor's, sell their ratings. That's a possible development."

He added, "I think that Wall Street has suffered a grievous credibility gap here. And something has got to be done. The leadership of firms such as Merrill Lynch, great firms, have got to rethink the way they're doing business and re-orient it."

Listen To Levitt Interview

Cleaning Up Stock Market Research

New York -- (New York Times Editorial) Investment banks, whose analysts were touting stocks with overwhelming zeal even as the stock market started crashing, are now trying to rehabilitate their images. Last week Merrill Lynch, by some measures the world's biggest investment bank, declared that except under strictly monitored circumstances, its analysts would be prohibited from holding shares in the companies they research. The goal is to remove any incentive for them to boost a stock to ensure their own enrichment. But this novel policy will not entirely prevent conflicts of interest from arising. It should be regarded as a springboard to a more complete revamping of the relationship between publicly available research and investment banking.

Analysts have strong institutional reasons to overrate shares of companies with which their investment banks do business. Whether the banks are helping the companies in share offerings, mergers or debt issues, a stock price boosted by enhanced demand from investors always helps. Owning shares in these same companies gives analysts an additional, personal reason for over enthusiasm.

Merrill Lynch has curtailed this practice among the roughly 20 percent of its analysts who had engaged in it. Credit Suisse First Boston, led by its new chief executive, John Mack, could soon follow suit. Yet this kind of policy does not solve the problem. The investment banks themselves could still easily reward their analysts for puffing up clients' shares through bonuses, perks or promotions. Investors should not suddenly begin to accept analysts' reports from these banks as gospel.

Serious questions about the reliability of in-house research have dogged investment banks for some time. Less than 1 percent of American stocks are currently rated as "sells" or "strong sells" - the same as during the recent boom. A Wall Street adage holds that the "true" rating for a stock is usually a notch or two below what an analyst says it is. But new investors do not enter the market with this understanding.

Worse yet, exaggerated optimism about specific stocks underwritten by banks is even more difficult for the average investor to detect and take into account. The banks could gain greater credibility for their research by paying their analysts based on the accuracy of their predictions, as well as by disclosing and actively avoiding institutional conflicts. But the banks themselves will never be able to free themselves of all bias when their own interests are at stake. That is not to say they should not try. Merrill Lynch, which announced sagging profits on Tuesday, certainly could use any new business drummed by adopting better practices.

A profitable opportunity also exists for independent research firms. If investors truly value accurate research, analysts not associated with any investment banks " and barred from holding shares in companies they analyze " should be able to charge a premium for their reports. Even the companies that contract with investment banks will be grateful for a more accurate assessment of their competitors, if not of themselves.