The last dot-com victim: Truth

If you ever find a need to work up a lather of righteous indignation about egregious violations of the truth, then go download a copy of the New York state attorney general's investigation of Merrill Lynch's investment counseling during the heyday of the dot-com era.

Simply put, we all got conned into believing that some of the "best" minds on Wall Street were giving their honest appraisals of the Internet phenomenon as represented by the sundry companies they covered.

Turns out, it was anything but.

With the benefit of 20-20 hindsight, it's become fashionable to dis the breathless reports once issued by Merrill Lynch and the rest of that crowd about Internet start-ups as hopelessly naive. But that's letting the authors off too easily. The report issued by N.Y. Attorney General Eliot Spitzer makes it clear that this was scoundrel time.

The state of New York has a law on the books, which, among other things, essentially labels fraud a violation of the law. This is the sort of stuff your mother warned against when you were little--but updated to apply to big boys. Just in case those freshly minted M.B.A.s didn't get the word when they took their first jobs out of business school, New York's Martin Act makes it illegal to engage in fraudulent and deceptive practices in connection with the sale and purchase of securities.

But when the Internet frenzy got going, that admonition took a backseat to the chief objective of drumming up business for the firm. Like its brethren elsewhere on the Street, Merrill Lynch did not separate its banking and research arms, an obvious structural weakness that invited inevitable abuse.

And abuse followed in torrents.

Because Merrill Lynch's research analysts were essentially acting as "quasi-investment bankers" for Internet companies they covered, they had a clear self-interest in hyping their prospects for growth. So it was that the incestuous relationship between the investment-banking and stock-rating sides of the company led to some major shucking and jiving.

So it was that the incestuous relationship between the investment-banking and stock-rating sides of the company led to some major shucking and jiving.

"Part of the reason we didn't highlight (a risk) is because we wanted to protect Internet Capital Group's banking business," the report quotes one Merrill Lynch analyst as saying.

That's a rare admission. Confronted by investigators with documents spelling out their words in black and white, the targets of the probe came down with inexplicable cases of amnesia when asked about key conversations and physical evidence. Offering the mother of all understatements, Spitzer's office concluded that the credibility of the witnesses "is consequently suspect."

If these folks do one day decide to talk, it should make for fascinating bedtime reading. We learn that some of their clients--and prospective clients--received the opportunity to rewrite reports about their companies and ghost quotations, which would later be attributed to the analysts. Even worse, in some cases they also decided what ratings would be acceptable.

From the spring of 1999 to the fall of 2001, Merrill Lynch's Internet analysts never issued a reduce or sell rating on any of the cyberstocks they covered. But at the same time that these cheerleaders were telling the public one thing, they were telling each other--and certain fat cat clients--a very different story.

Among the highlights of the e-mail communications between Merrill analysts, InfoSpace was referred to as a "piece of junk," Excite@Home was called "such a piece of crap," while 24/7 Real Media was cleverly concluded to be a "piece of s***."

When analysts were being compensated for how much investment banking business they could drum up, any promises about objectivity and independence became impossible to satisfy.

After shares of Internet Capital Group closed on Oct. 4, 2000 at $12.38--down from its December 1999 high of $212--Merrill Lynch's hotshot analyst Henry Blodget privately told associates that ICG "was going to 5" and "this has been a disaster...There really is no floor to the stock." Yet Merrill didn't downgrade the stock for another month. All the while, the share-buying public was left to believe that Merrill Lynch's rosy public recommendations still applied.

And so on and so on. It makes grim reading as you realize that Merrill Lynch basically viewed research as a sales tool for investment banking. When analysts were being compensated for how much investment banking business they could drum up, any promises about objectivity and independence became impossible to satisfy.

Earlier this week, Merrill Lynch belatedly agreed to include more details in its research reports about its investment banking ties with companies it covers. That won't help any of Merrill Lynch's clients who got suckered into buying Internet flameouts, but at least it's a start.

For the record, Merrill Lynch says the allegations of tainted research have no merit. I'll let you decide that one. In the end, though, the truth will emerge--badly bruised, perhaps, but always the truth.