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Attorney-general takes bulls by the horns

The decision by New York&#39s attorney-general to investigate the practices of Merrill Lynch has raised the question of trust between investors and the investment bank analysts who advise them.

Eliot Spitzer&#39s accusation – that Merrill analysts recommended moribund dotcom companies to boost investment banking work – has left some investors wondering if they were given sound advice or merely used to bump up the analysts&#39 bonuses. If reports from across the Atlantic are accurate, a far greater number of people may soon be asking the same question, as Spitzer is believed to be widening his investigation to include banks such as Credit Suisse, First Boston and Goldman Sachs.

It could lead to litigation running to hundreds – if not thousands – of millions of dollars. Yet the reaction to the news in the UK has been muted, considering that many of the companies mentioned are hardly without presence here.

Plan Invest joint managing director Michael Owen says: “I cannot assume it does not happen in the UK. We just do not know. No matter how tight the rules are – and I do not know if we are better or not than the US at stamping this kind of practice out – there will always be people who slip through the net.”

The FSA appears to be unconcerned, pointing out that the US authorities have been deluged with complaints from disgruntled investors, whereas it has not. However, it is at least prepared to acknowledge that there is a potential problem.

Spokesman Robin Gordon-Walker says: “We have done some research in this area – how analysts are managed and so on – and did not find any significant shortcomings. But we are looking at the rules on business conduct to see if they need tightening from the previous regime.”

If the FSA were to discover evidence of the type uncovered in the US, Gordon-Walker says it would take steps to stamp out poor practices. But even if the regulator is not groaning under the weight of thousands of complaints, does that mean that analysts in this country are beyond reproach?

Hargreaves Lansdown head of research Mark Dampier says: “You have to take their forecasts with a pinch of salt. The trouble is that most analysts will not stick their head above the parapet because they are liable to get it blown off. Their job is on the line so they are scared to say anything against the consensus.”

With this kind of pressure being exerted on analysts, Dampier says it is questionable whether anyone could regard them as being truly independent. If this were not worrying enough for investors, there also seems to be considerable concern over the way investment banks structure their bonus systems.

According to some US commentators who reported on the Merrill case, six-figure bonuses were routinely paid to analysts who helped promote client companies – regardless of their prospects – to investors. Even without the kind of pressure Dampier believes analysts are often under, these bonuses must offer considerable incentives for them to push stock they perhaps would not otherwise have done.

Owen says: “It is just sheer greed on the part of the analysts. The culture they work in means they have a certain lifestyle to support in a time when their regular bonuses are being cut back. There is no doubt that there needs to be more internal controls imposed.”

Even so, according to Owen, investment banks can only go so far to stamp out bad practices, even if they cut the bon-uses they pay to analysts.

For their part, investment banks are prepared to admit that a fair number of investors must have fallen prey to some sharp practices in the past although they do not believe there is a serious problem in the UK.

Schroders director Robin Stoakley says: “I am sure that some people in this country were punted some pretty bad stock during the tech boom. But the take-up of individual stock by individual investors is much lower here than in the States.

“The principle for this kind of problem certainly exists in the UK but the magnitude – if were to be proven – would be much smaller.”

Another mitigating factor, as far as Stoakley is concerned, is that there are far fewer firms selling stocks aggress-ively here than in the US, with only UK tipsters and private client stockbrokers comprising some kind of equivalent.

Some IFAs believe the Merrill case – and the fallout which threatens to engulf a number of other banks – may serve as a warning shot to those analysts who fail to balance their obligation to investors and their firms.

BestInvest deputy managing director Jason Hollands says: “The very fact that this is happening in the States may well mean analysts here are keener than ever to be seen as whiter than white. They know they will be watched closely and are unlikely to want to give poor advice.”

Yet many others remain uncomfortable with the notion that analysts are often caught between investors seeking a profit and the corporate finance arms of their paymasters. But unless a barrage of complaints flood into the FSA&#39s in-tray, their fears may go unheeded.


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