MOYERS: Welcome to NOW. Wall Street's collaborators in Washington attacked New York Attorney General Eliot Spitzer this week, saying his multimillion-dollar settlement with Merrill Lynch was grandstanding and coercion.
But the fact remains that Merrill Lynch was caught red- handed, its analysts publicly praising stocks they privately trashed.
Furthermore, some Wall Street insiders say the deceptive practices don't stop with one brokerage firm.
They are the rule instead of the exception.
Tonight, we learn more about how Wall Street plays the game and how you are affected.
NOW's Brenda Breslauer produced our report.
It was big news across the country. The largest brokerage firm on Wall Street in a $100 million dollar settlement for misleading its investors
NEW YORK STATE ATTORNEY GENERAL ELLIOT SPITZER: It was the Mr. and Mrs. Smith, whether in Utica, New York, or in Topeka Kansas, or in Jupiter, Florida who were the victims of this scam.
MOYERS: Merrill Lynch's commercials had conveyed a warm fuzzy feeling, Wall Street firms as purveyors of family values, a safe place for customers.
TV COMMERCIAL: Because they trust a team of financial advisors at Merrill Lynch.
MOYERS: Actually, the small investor was being treated like a hick from the sticks as New York Attorney General Elliot Spitzer discovered in his investigation.
SPITZER: My office developed evidence indicating that analysts gave misleading advice.
MOYERS: The evidence? Spitzer discovered a trail of damaging e-mails, e-mails that showed Merrill Lynch was recommending stocks to the public that its research analysts were privately trashing.
SPITZER: At the very moment they were telling us buy this stock, invest more of your money in it, they were saying internally, there's absolutely no reason to own this stock..It's a dog. It's worse. They were making us lose money so they could get rich.
MOYERS: Example: Lifeminders, an internet company. Publicly, Merrill recommended the stock as an "attractive investment" and advised investors to "Accumulate" it. Privately, Merrill's analyst was saying another thing about the very same stock: "I can't believe what a POS [piece of sh-t] that thing is."
For Excite@Home, a stock known as ATHM, Merrill publicly said: "We do not see much more downside to the shares" and recommended investors "Accumulate." But privately the analyst was saying this "ATHM is such a piece of crap!"
SPITZER: The small investor was the victim. The big institutional investor, the sophisticated investors, probably knew the analysts reports should not be relied upon.
MOYERS: The heart of the scam was a conflict of interest built into the system. A lot of the analysts you see on television picking stocks work for the research division of a Wall Street firm like Merrill Lynch. The Research Department is supposed to be completely separate from the banking division, a "Chinese Wall" between them, to avoid conflicts of interest.
But in reality analysts feel unspoken pressure from the investment bankers to come out with recommendations to buy stock.
The reports can then be used by the investment bankers to attract big corporate clients.
Spitzer's investigation revealed that the more business an analyst generated for the investment banking side, the more money the analyst made.
SPITZER: So even when they knew the stock was bad, they would say buy it, because the company whose stock they were promoting was a client. It was somewhat like the restaurant reviewer being a partner in the restaurant. He issued a good report and said, come to this restaurant. But if you read the review and didn't know he was an owner in the restaurant, you were snookered.
MOYERS: That's what happened to these women in Jupiter, Florida who formed their own investment club in 1996.
FRAEDA KOPMAN, INVESTOR: : I think that we put a lot of emphasis on the work that the analysts were doing for the various brokerage firms. Especially the big ones. Because we believed in them. I guess we were very naive. And we thought that that information was correct. They were the ones that were visiting the companies. So obviously, they would know a lot more than I would know by just reading about a company.
HELEN EHLERS, INVESTOR: Historically, you believed in the stock market because everybody knows, knew the stock market went up, the stock market went down, you assumed the analysts or whoever was following the stocks back in the older days knew what they were talking about.
MOYERS: One of the stocks they bought was Infospace, a wireless and computer software company.
KOPMAN: It was being touted as this phenomenal growth company with this fantastic chairman. Everything we read about it was good. And it looked like a good, solid company.
The main analyst that we were following was Henry Blodget from Merrill Lynch.
MOYERS: Henry Blodget, a telegenic whiz kid in his mid thirties, was Merrill's star analyst for internet stock.
Blodget wrote this research report for Merrill which says "Infospace continues to be one of the best ways to play the wireless internet" and recommends a "Buy". But his private e-mail says, "this stock is a powder keg." An e-mail from a colleague in Blodget's department reveals: Infospace is "very important to us from the banking perspective."
Now, translate that for the ladies down in Jupiter.
SPITZER: What that means is, we're going to tell you to buy the stock not because it's a good stock but because it's a big client for us and it's generating fees for us. And that is a classic example of the conflict of interest, the taint we'll give you bad advice because we're getting a lot of revenue, and that's your problem, tough. Nobody will find out. Well, we found out.
MOYERS: But the Florida investment club didn't find out. They were following Blodget's advice closely.
KOPMAN: Henry Blodget's rating of Infospace was a buy. When the stock started sliding, we were bewildered because suddenly here is this stock that's going down. However, the analyst at Merrill Lynch still felt it was a strong buy. He didn't just think it was a buy; it was a strong buy. Well, he must know something that we didn't know.
MOYERS: What he knew was that it was a "piece of junk." The Women's Investment Club lost nearly $6000 on Infospace which once sold at a high of $261 but today trades at less than $1 per share.
MOYERS TO SPITZER: What is the responsibility for a man like Blodget in this? I mean, he was making, what $15 million a year?
SPITZER $12, $15 million a year. His obligation is to tell the truth. His obligation is to the investors who are relying upon his advice.
MOYERS: Did you find evidence that the analysts were receiving bonuses and higher salaries, if they, in fact, tainted the evidence for the investment bankers?
SPITZER: Absolutely. The analysts were compensated not based on the quality of their research for the public but based on the degree to which they had helped investment bankers generate deals and satisfy the companies.
MOYERS: And apparently, this is no secret inside the Wall Street club. Take a look at this e-mail from Blodget: "If there is no new e-mail forthcoming from Andy·[Blodget's boss] we are going to just start calling the stocks·like we see them, no matter what the ancillary business consequences are."
SPITZER: He said, if you don't tell me what to do I'm going to start telling the truth regardless of the impact on investment banking. He was threatening to tell the truth. It just shows you how twisted the mindset had become.
MOYERS: And, says Spitzer, it's not just these extreme examples. Because of the way Wall Street is structured, the small investor never gets the same information as the big boys on the block.
MOYERS: Is there a two-tiered system at work here? Is there a double standard so that the ladies in Jupiter who just read the report that Merrill issues get one piece of information but the big institutional investors, the big pension funds, the ones that bring in the big money to a company like Merrill, they sort of get a wink and a nod?
SPITZER: The big institutional investors knew not to rely on the analyst reports. They were more sophisticated. They understood·
MOYERS: How did they know?
SPITZER: Because they're from Wall Street. They're part of the culture where they understood these analysts are hyping and they understood that the analysts were responsive to the investment banking side of the house.
MOYERS: So no one blew the whistle.
SPITZER: Nobody blew the whistle because·
SPITZER: Too many people were doing too well.
CNNFN ANCHOR, FROM TAPE: Sean, nice to have you back on CNNFN.
MOYERS: Sean Ryan knows first hand. He worked as an analyst on Wall Street for nine years.
MOYERS: Do firms say one thing to small investors and another thing to large institutional customers?
RYAN: Not officially but in practice. A little old lady in Peoria will get the same report as Fidelity. What's different is Fidelity will also get a call from the analyst explaining the nuances of the report. And shading his opinion. So perhaps saying yes, I really like this company, but here are some of the things that, here are some of the flaws in the story that I didn't go into in great detail in the report but you may want to bear in mind.
MOYERS: And the small investor never hears about the other way the firm uses the research report, never knows the banking department uses that same report to seduce big corporate clients.
RYAN: The first thing he does is calls up the CEO of XYZ corporation and says, "I'm sending you over a copy of this report that I think you'll really enjoy because it's very positive about your company. And it shows how well we understand you company. And I think given how well we understand your company and are advocating it in the marketplace, you may want to think about, you know, perhaps offering us some business in the future.
MOYERS: Here's what Sean Ryan told us happened to him when he wrote a negative report about a big corporate client while working for the brokerage firm Bear Stearns.
RYAN: I got a very irate visit from the head of research who asked me what the hell I was doing. After a fairly lengthy tirade I was informed I'd imperiled something on the order of 10 million dollars in annual business for the firm. And if I wanted to stay at Bear Stearns and have a bright future there, I should straighten up and fly right.
MOYERS: And giving your honest opinion was not what you were expected to do.
RYAN: I called the Associate Director of Research and at one point said, how can I express these honest opinions in a way that isn't going to to cause these sorts of problems. And her response was it's like your mother told you. If you can't say anything nice, don't say anything at all.
Which I think as a matter of etiquette is well advised. But I can't really reconcile that with the job of analyst, as I understand it.
MOYERS: Bear Sterns disputes Ryan's account saying "our analysts are encouraged and expected to maintain their independence and provide the best possible research products to our clients."
But tired of the pressure to compromise his work, says Ryan, he quit.
RYAN: There are things I'm not willing to do to have a career on Wall Street.
MOYERS: Help me to understand, is this more likely to be a few bad apples in the, in the barrel or is this sort of thing this sort of pressure, this sort of ingrained conflict of interest, pervasive?
RYAN: Well, I think it is a few bad apples in the sense that most analysts are smart, honest people who want to do the right thing. But they're all operating in a corrupt system.
MOYERS: So if everybody on the team is using steroids, nobody questions the use of steroids.
MOYERS: It's the way you win the game.
RYAN: Right. And if you don't want to use it, then maybe you just don't belong on this team.
MOYERS: Merrill Lynch's team includes some powerful players, including former-Mayor Rudolph Giuliani as a consultant. The firm hoped Guiliani could sway Spitzer an ironic assignment for a man who originally made headlines himself for prosecuting Wall Street insiders.
MOYERS (ADDRESSING SPITZER): It's reported that he didn't want you to go public with this.
SPITZER: Well, I think that he was arguing on behalf of his client, Merrill Lynch, saying, you will harm Merrill Lynch. And my response to him and to others was, we will not change this system unless we make those e-mails public. I insisted that they be made public, because only the e-mails would persuade people that something fundamentally amiss was occurring on Wall Street.
MOYERS: The smoking gun.
SPITZER: The smoking gun.
MOYERS: We showed the Florida investment club those smoking guns, the e-mails uncovered by Spitzer's investigation.
Like one from an analyst who privately protested that the company was deliberately hurting it's small customers for the sake of its big corporate clients.
"I don't want to be a whore for f-ing mgmt . . . we are losing people money and I don't like it. John and Mary Smith are losing their retirement because we don't want Todd [company CFO] to be mad at us."
"The whole idea that we are independent from banking is a big lie."
KOPMAN: This is sick. Very very sad. No wonder they settled.
JUPITER INVESTORS: To me this is no different than going to, you know, John and Mary Public who have a small grocery store and sticking them up with a gun and taking the money out of their cash register. They just did it differently.
KOPMAN: This is awful.
GERRY CARRERA, INVESTOR: Other people lie on a statement for a bank and that's called bank fraud. If you fill out an application for a bank and you lie on it, you're liable for that. And you can go to jail and serve time. If we did that. Now, how can they do things like this?
SPITZER: If they've lied about the value of that stock and whether it's a good investment, they've violated the law.
MOYERS: But as part of the hundred million dollar settlement with Merrill, the New York State Attorney General has agreed not to prosecute them criminally. It will be left to individual investors and their lawyers to seek restitution.
KOPMAN: And hopefully, we'll be able to recoup some of the money that we lost back. Somebody has it. I mean obviously.
RYAN: The money that has been lost in internet shares can't be brought back. It's in money heaven.
MOYERS:Ryan advises those women not to hold their breath. And as for future investors, he says buyer beware. Merrill Lynch may have settled with the New York Attorney General and pledged to separate its research department from investment banking, but federal regulators have not been watching out for the public.
RYAN: You know you have this open secret on Wall Street and the SEC has been dragging its feet to such an extent that it falls to a state attorney general to finally take some action and achieve some concrete results.
MOYERS: In the wake of Spitzer's headlines, the SEC announced new rules this month to address analyst conflicts of interest. But Ryan claims they are far too weak to make a difference in the entrenched club culture.
RYAN: I'm sure it took an army of government lawyers several weeks working day and night to come up with such exquisitely useless reforms...it's like dealing with organized crime. Much of the worst behavior goes unspoken. It's a wink and a nod. And it's very tough to prosecute that.
MOYERS: And those in the club know the wink and the nod.
MOYERS: And since the SEC hasn't taken strong action with all the evidence released thus far, this former insider is less than optimistic.
RYAN: When you have what's to me essentially fraud being carried out on this scale, you know it makes me wonder if the SEC isn't prepared to act on this, I don't know why it exists.
SPITZER: I think we need more substantial reform because if we are going to restore the public's confidence in Wall Street, which is critical, we must be able to say to investors, you can trust the advice that is given to you.
KOPMAN: It never dawned on me that they were giving me fraudulent information to stuff their pockets with money.
I'm hurt. And that sounds ridiculous to say, hurt, to be hurt emotionally.
HELEN EHLERS: I'm more betrayed.
EHLERS: I mean you feel betrayed by people you trusted.
MOYERS: Wall Street has no problem getting powerful people on its side. It hires them or influences them one way or another. Who is looking out for the little guy in this kind of market?
SPITZER: Look, there are many more small investors than there are big sophisticated investors. And I think if we can explain to the public, your interests are being subverted, hopefully those folks will stand up and say, wait a minute, somebody's got to do something. And then maybe we will see real reform out of Washington, at the SEC, and there will be a change.