WHAT should individual investors do with stock analysts who have a potential conflict of interest in recommending investments?
The easy answer: Check them out first.
Most Wall Street analysts, whose firms also earn profits from launching new stocks and advising companies on investments, have an inherent conflict, no matter how many ethics codes are in place. The pressures to be positive about client companies is a fact of life for them.
Still, many investors tend to trust a single source with a reputable name, perhaps naively. They must beware analysts who are compensated for knowingly suppling investors with an upbeat spin on stocks when they know otherwise.
That's the thinking behind the probe of New York State Attorney General Eliot Spitzer, who believes the largest US stock broker, Merrill Lynch, misled investors during the dotcom, high-tech boom of the 1990s.
Merrill Lynch's motive, allegedly, was to promote the stock of certain companies that were lucrative clients of the firm's investment banking arm. Profits generated by underwriting securities or consulting on mergers helped pay the analysts' salaries. Investors who heeded their advice and held questionable stock when the market bubble burst, lost a bundle.
Bolstering Mr. Spitzer's claim that investors were misled is a trove of Merrill Lynch e-mails he subpoenaed that seem to expose a wide gap, in some cases, between an analyst's positive public statements on stocks and his negative private opinions. Merrill Lynch claims the e-mails were taken out of context.
Last week, the federal Securities and Exchange Commission joined the hunt. SEC Chairman Harvey Pitt said he wanted to assure investors that whatever new rules or reforms come from the probe will apply across the country, protecting all investors.
The securities industry is on the case, too. Merrill Lynch itself, prodded by the investigation, has agreed to broader disclosure of which companies are paying it investment-banking fees.
With that information, at least investors can add a grain of salt to analysts' reports pumping the stock of such companies.