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Spurred by Merrill Lynch & Co.’s settlement with the New York state attorney general, investment banks are racing to establish the independence of their equity research analysts. But will making it to the finish line ensure they won’t face criminal penalties? Not necessarily. “If you run somebody over and kill them, you can’t undo the damage by backing the car back over the body,” said Bill Singer, a regulatory partner with Duane Morris in New York. “It’s a healthy thing that they’ve made the changes, but it’s not going to stop the regulatory matter or any lawsuits.” Professor John Coffee of Columbia University Law School agreed. “I don’t know that prospective reforms can immunize that past conduct,” Coffee said. On Wednesday, 17 more states said they would take responsibility for probing investment banking and analyst conflicts at most of the firms under investigation. That makes 30 states total investigating the investment banks. With his probe into Merrill settled, New York state Attorney General Eliot Spitzer is reportedly concentrating on just two firms: Salomon Smith Barney Inc. and Morgan Stanley. But Brad Maione, a spokesman for Spitzer, said instituting reforms will not get other firms off the hook. “It’s not like these other firms decided to do this and we’re going to end the investigations,” he said, noting that the changes are still welcome. “They’re all in the same position Merrill was in before the settlement. We’re looking forward to sitting down with them to talk about these issues.” Banking sources say several firms have already handed over thousands of e-mails, analyst compensation records and other internal documents to Spitzer’s office. Indeed, the states have decided to share the burden of investigating other firms partly due to the sheer volume of the documents involved, one source said. In addition, Coffee said, the investigations will take plenty of time as the firms look at their liability: “Everyone is going to be slower and more selective in giving out their e-mails because they’ve seen how it can explode,” Coffee said. Meanwhile, many firms are taking steps to avoid the fate of Merrill Lynch, which agreed on May 21 to pay a $100 million fine to settle Spitzer’s investigation into its analyst practices. On May 22, Salomon Smith Barney voluntarily chose to adopt all the reforms that Merrill adopted in its agreement with Spitzer on the 21st. And Goldman, Sachs & Co. said on the 21st it would initiate some reforms in its equity research department, including adopting a statement of its research principles, appointing an ombudsman to oversee analyst conflicts and reviewing its analysts’ compensation. Credit Suisse First Boston, which has also instituted some own reforms over time, said May 21 that it, too, is examining the Merrill Lynch settlement. “We are carefully reviewing the changes adopted by Merrill Lynch and will take whatever steps are necessary to maintain our commitment to the highest level of analyst objectivity and integrity,” chief executive John Mack said in a statement. For the major investment banks, there is not much further to go to reach an industry standard for analyst practices. Almost every firm has adopted or will adopt recent analyst-oversight rules approved by the Securities and Exchange Commission, the New York Stock Exchange and the National Association of Securities Dealers. In addition, many banks, including UBS Warburg, Morgan Stanley, Salomon, Credit Suisse First Boston and Goldman Sachs already make sure their analysts don’t formally report to their investment bankers. In fact, according to a former high-profile analyst, all the banks can do to avoid a penalty now is “make sure to rack up all the brownie points” with regulators. Or, in Singer’s words, “If a firm shows it spotted a problem on its own and expressed the appropriate levels of remorse, then the regulators will give that weight in determining their administrative sanctions.” But remorse will go so far, he said. “If a regulator or prosecutor looks at these changes today, [the firms] are not going to get a lot of credit, because they didn’t do it of their own volition,” Singer said. “They did it in anticipation of criminal charges.” Coffee agreed that the banks’ motives in instituting reform, though smart, are not pure. “The banks are doing this not because the most important pressure on them is legal, but that competitive pressure dictates they respond to the steps taken by the largest brokerage firm in the country,” Coffee said. The competition doesn’t end there, Coffee noted.: “I think the SEC is very embarrassed by taking a back seat in a major regulatory initiative,” he said. “Now the SEC feels the pressure of regulatory competition.” Meanwhile, the arrangement dividing up the investment banks among different state regulators created several odd couples. Massachusetts, for instance, will be investigating CSFB; Texas and Alabama will have a crack at J.P. Morgan Chase & Co. and Lehman Brothers; and Utah will look at all Goldman, Sachs & Co. documents. The states are all part of the North American Securities Administrators Association, or NASAA, but Singer noted that the fray over research-analyst conflicts now resembles less a regulatory initiative than a pile up as state regulators rush to join the charge led by Spitzer. “This is politics,” Singer said. “A number of these guys got together, and they each got a little piece of the pie.” “The assignment of these firms … borders on the unseemly,” he added. “Utah may be many things in this world, but it’s certainly not a hotbed of securities matters.” Copyright (c)2002 TDD, LLC. All rights reserved.

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