US analysts fight the credibility gap

WALL Street's major players have instituted major reforms but are struggling to regain credibility after a year-long barrage of charges of tainted research advice similar to those levelled at the City's leading investment banks in the stinging report from the Financial Services Authority.

The most noticeable impact in America over a year-long investigation of Wall Street analysts has been a surge in unfavourable ratings on firms that previously received analysts' hardy support. A year ago, the proportion of 'sell' or 'underperform' ratings on Wall Street was less than 1%. Today, 3% of recommendations are negative, according to Boston-based research company First Call.

Still, given the summer-long bear market and the poor outlook for corporate profits, the ratio of companies with the weakest ratings remains far too low, experts believe.

This week the Securities and Exchange Commission said analysts should personally certify their reviews to reduce the tendency towards overly enthusiastic ratings.

US brokers have already taken steps better to insulate research divisions from investment banking units and many have revamped the way they dissect corporate performance, focusing on more conservative analysis.

Some have switched to a simple three-tier ranking system. The change has been noticeable at Morgan Stanley Dean Witter, which simplified its rating system to give investors a clearer picture of a company's investment potential. Out of 864 companies Morgan Stanley covers, 179 now have 'underperform' or 'underweight' ratings.

The changes come amid continuing investigations of misleading advice. New York Attorney General Eliot Spitzer has turned his sights on Salomon Smith Barney and especially its telecommunications guru Jack Grubman, who was personally close to industry executives and for a long time maintained high ratings on firms beset by scandal, including Qwest, Global Crossing and WorldCom. Morgan Stanley admitted in a recent regulatory filing that it, too, is the subject of Spitzer's ongoing probe.

Analysts' reluctance to issue sell ratings is not without cause. In a Reuters survey last summer, 25% of companies admitted to shutting out analysts who give them a bad review.

This week, a Congressional committee accused Merrill Lynch of replacing a research analyst who was critical of Enron, after the energy company complained and cut Merrill out of an underwriting opportunity.

Merrill's prior settlement of charges of misleading advice included a $100 million fund for investors burned by bad advice during the dotcom boom.

Like Grubman, Merrill's 'star' analyst Henry Blodget stayed bullish on internet shares even as they began to implode.