The legacy of Henry Blodget may haunt Merrill Lynch & Co Inc MER.N as it negotiates a settlement with regulators for the way it sold auction rate securities to investors.
Blodget, you’ll recall, was a Merrill analyst who earlier became the poster boy for the excesses of the Internet era when he was caught publicly recommending stocks he privately dismissed in e-mails.
While five other banks have settled with state regulators over their sales practices for the notes, legal experts say a deal with Merrill Lynch may take longer because of the firm’s history of tainted research and evidence research may have been influenced in this case.
Documents seem to show Merrill Lynch analysts were pressured to write positive reports about auction rate notes, which were sold to investors as safe cash equivalents, but have proven increasingly difficult for investors to sell at face value over the last year.
That pressure on analysts follows Merrill’s 2002 settlement with regulators over conflicts in research and could make settlement talks with New York Attorney General Andrew Cuomo much more drawn out and acrimonious.
“I think the attorney general is going to come down pretty hard on Merrill,” said Jacob Zamansky, a securities attorney representing investors and auction-rate securities holders. “The research element looms large in the stalemate.”
A spokesman for Cuomo’s office declined immediate comment, while Mark Herr, a spokesman for Merrill, also declined comment.
Wall Street firms have broadly been accused of understating the risks of owning auction-rate securities.
Last month, Massachusetts Secretary of State William Galvin charged Merrill Lynch with separate counts of fraud and dishonest and unethical conduct in relation to selling auction- rate securities after he amassed e-mails and research documents as evidence. A spokesman for Galvin declined comment on Tuesday beyond noting the office is in talks with Merrill.
Cuomo’s office said on Friday it is also preparing legal action against the bank after rejecting Merrill’s settlement offer earlier this month. The New York attorney general said at the time that Merrill had five days to agree on a settlement plan before his office sues.
Merrill agreed in 2002 to cut links between research and banking to avoid conflicts of interest and Blodget was eventually barred from the securities industry and ordered to pay $4 million.
“Merrill does have a tawdry history with this,” said Steve Thel, professor of securities law at Fordham University, referring to Merrill’s settlement in 2002 with then attorney general Eliot Spitzer.
E-mails show a senior banker directed Merrill’s research department in 2007 to revise a report seen as undermining the auction-rate securities market. In another e-mail in January, a senior research analyst passed a report to bankers for review, writing: “I want to make sure research cannot be accused of causing a run on the auction desk, like was the case in August.”
Lance Pan, director of investment research at Capital Advisors Group, said Merrill was “a bit more aggressive in using the research arm in obtaining a positive light before the market collapsed.”
But for regulators, this apparent use of research is likely to be key.
“This company was aggressively selling (auction rate securities) to investors and its auction desk was censoring the research analysts to make sure they downplayed ARS market risks in research reports up to the day Merrill pulled the plug on its auctions,” Galvin said in a statement in July.
(Editing by Andre Grenon)
By Elinor Comlay