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Investment Scandal

"We are losing people money and I don't like it."

That message, in an internal e-mail from America's largest consumer stockbroker, Merrill Lynch, captures the growing unease inside an organisation at the centre of a scandal that's being compared to the Enron debacle.

The Attorney General of New York, Eliot Spitzer, claims to have uncovered evidence that the firm's analysts were recommending that investors bought shares in companies which the analysts were privately describing as junk. And that was one of their politer terms.

Now the investigation is spreading to other banks on Wall Street.

Our Business Correspondent, Paul Mason reported.

Watch the item

It was 1999, the year of the dotcom boom. Share prices soared. Wall Street went internet crazy and the backing track was the constant bubble of share price analysts telling people to buy, buy, buy.

(Former Investor)
I'm almost 99% sure that they knew this bubble was going to burst and all the big guys had cashed out.

The internet boom made Wall Street's analysts into stars. Millions of people poured money into brand-new companies in an ever-rising market. Only the analysts understood the economic secret, the new paradigm that was supposed to be driving it. Now, of course, the party's over. The bubble burst two years ago. But as share prices collapsed, the remarkable thing was, that the analysts weren't telling people, "Sell, sell, sell." In fact, for a while it looked like they were collectively in denial, and now we know why. At one of New York's most prestigious banks, they were saying one thing to investors and another thing behind closed doors.

I brought a ground-breaking case on behalf of a public investor who claimed that he was deceived by the research of Merrill Lynch's superstar internet analyst Henry Blodget on a stock called InfoSpace. Based on Mr Blodget's research report and his broker's hyping of the report, my client invested half a million dollars in a stock called InfoSpace, and he lost it all. After we filed the claim and it was reported publicly, Merrill Lynch settled the case and paid $400,000.

That case threw up evidence that's given investors a stunning view of life on the inside. It kicks off wide-ranging probe by the New York Attorney General. He's now released a pile of e-mails from Henry Blodget's team that show a big gap between hype and reality. Merrill Lynch had a 5-point scale for rating shares. The bottom two rungs meant the price would fall, but they were never used. They should have been. The e-mails show the analysts despised some of the stocks they were recommending. InfoSpace, an internet services company, was rated top of the range. Privately, the analysts said it was a powder keg and a piece of junk. Though its share price fell from $261 to just $14, Merrill's analysts never once recommended selling it. The high-speed internet company, Excite@Home, was rated accumulate or buy. Privately, Blodget's team called it "a piece of crap". In April 2000, the internet marketing company Lifeminders, was rated accumulate or buy. Privately this is what they thought of it. At an investment bank, there's supposed to be what they call a Chinese wall between two sets of people. The share analysts are there to advise the investors, the people buying the shares. On the other side of the wall, the bankers make most of their money advising the companies who issue the shares and the wall's there to stop the obvious conflict of interest. Only now it seems that's not how it works in practice.

I believe that Merrill Lynch and the other major banks pumped up the tech bubble to reap huge investment banking fees and have left the public holding the bag. There's supposed to be a wall separating research from investment banking. That wall did not exist. There was a tremendous conflict of interest. Merrill Lynch's research analysts had a financial interest in the stocks that they were recommending. That was not disclosed to the public, the public have been deceived.

In response to the publication of e-mails from Mr Blodgets and his team, Merrill Lynch said,

" Fragments of e-mails can be taken out of context. At the same time, some of the e-mails cited fall below our professional standards, and we regret that. Our research department has operated with integrity for many decades and we intend to lead the industry in establishing new standards for the integrity and independence of research."

Merrill Lynch is doing a deal with the New York prosecutor that will change the way its analysts work. Meanwhile, the scandal seems to be gathering a momentum of its own. The lawyers seem to have virtually the whole of Wall Street in their sight. The money they're talking about in compensation will be eye-watering. Now Mr Zamansky has a new target in his sights, the investment bank Saloman Smith Barney.

The case is coming along. I think it's going fabulous. I couldn't be more pleased.

George Zicarelli is an investor who lost $450,000 in a company called Global Crossing. Zicarelli blames Solman's star analyst, Jack Grubman, for repeatedly recommending the shares when they were collapsing.

Originally, I bought 1,000 shares costing around $50 a share, and with this glowing report from Jack Grubman. I trusted him and it sounded all glowing, aggressive buyers. Eventually, I finally sold my list. 10,000 shares at 57 cents. Because of the money I borrowed to buy more, I had to declare bankruptcy.

This case is not about e-mails. Mr Zicarelli alleges there was an undisclosed conflict of interest because some of the analysts' income came from generating business for the banking side. Saloman Smith Barney told Newsnight:
"Mr. Zicarelli's claims rely heavily on the benefit of clear market hindsight. We consider his claim to be baseless and without merit."
Some believe it goes way beyond the analysts. The banks have been accused of manipulating share prices at the point dotcom companies first issued their shares, a process called IPO. Mel Weiss, a top New York business lawyer, has launched a class action against the biggest names on Wall Street based on that claim.

(Millberg Weiss Bershad Hynes & Lerach)
The IPOs were rigged and they were rigged in the following ways. There were certain customers to whom IPO allocations were made, where the investment banks forced those people in order to get the allocations to give kickbacks. In addition, and this is part of the rigging mechanism, if I was one of those customers and I was allocated 10,000 shares of the IPO, I would have to promise that on the first or second day of trading in that stock, I would buy 30,000 shares in the open market or at least put in an order to buy 30,000 shares. That was intended to create artificial momentum.

The Securities and Exchange Commission, the financial regulator, has been attacked for doing too little, too late. It's drawn up new rules for analysts, but can the SEC say today that Wall Street is not rigged in favour of insiders?

(Director, Market Regulations, SEC)
I think that to some extent this crisis of confidence is obviously very unfortunate. It's always the case that you'll have a few bad actors in these things and that the regulators need to act. I don't mean to suggest that Wall Street is happy with this rule set, but there is a recognition that our markets are based on investor confidence. This is a market and this is a industry that recognises that fact and realises that something must be done.

While the lawyers, the bankers and the regulators wrangle with each other, the pressure is on for Wall Street to clean up its act. Ever since Enron, people have been asking where's the next bad apple? Now they're taking a close look at the whole barrel.

This transcript was produced from the teletext subtitles that are generated live for Newsnight. It has been checked against the programme as broadcast, however Newsnight can accept no responsibility for any factual inaccuracies. We will be happy to correct serious errors.

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