DJ New Study Casts Doubt On Conflicts On Wall St.

By Judith Burns Of DOW JONES NEWSWIRES

WASHINGTON (Dow Jones)--Did get it wrong?

A new research paper suggests he might have, finding Wall Street research analysts who touted technology stocks in the late 1990s were influenced more by peer pressure than investment-banking business.

The finding raises questions about the landmark $1.4 billion settlement reached by the New York Attorney General and securities regulators with 10 Wall Street firms over alleged research conflicts.

Wall Street firms settled the case in 2003 without admitting or denying claims their analysts touted stocks they privately trashed to gain investment-banking business.

Merrill Lynch & Co. (MER) technology analyst Henry Blodget and Salomon Smith Barney telecommunications analyst , two of Wall Street's biggest cheerleaders during the market's go-go years, also settled with regulators.

Claims of conflicts on Wall Street were widely reported and public confidence was damaged by the perception that analysts recommended stocks they privately disparaged.

Yet a study of technology stocks in the late 1990s found "little impact of the investment banking relationship on recommendations" issued by Wall Street analysts.

Analysts were swayed less by the prospect of investment banking business and more by market performance and other analysts, the study found. It said individual analysts raised their recommendations to bring them in line with others, becoming more bullish as the market rose and as other analysts issued "strong buys" on stocks.

Authors Patrick Bajari, an economics professor at Duke University, and John Krainer, an economist at the Federal Reserve Bank of , said the peer pressure is understandable.

Since analysts are evaluated based on how they perform compared with their peers, they have an incentive to follow the crowd, because even if their picks turn out to be bad, their relative performance won't suffer, the authors reason.

Another problem identified by researchers: The tendency for Wall Street analysts to grade stocks as generously as professors grade students, rarely awarding a "C" for average performance.

"There was something funny going on with the grading," Bajari said in a telephone interview Thursday. In the first quarter of 2000, none of the analysts in the study issued a recommendation to sell or hold a stock, evidencing strong agreement on the market's rosy prospects.

The study examined more than 12,000 stock recommendations by analysts at 185 brokerage firms between January 1998 and June 2003. The authors found analysts were more conservative in recommending stocks after Spitzer began complaining about industry practices in mid-2001, but said the steep market drop also may have been a factor.

The authors acknowledge investment banking had some impact on research, but said it appears to have been small, particularly when compared with peer effects.

Bajari admits he was surprised by the findings.

"The industry was not perhaps as blatantly corrupt as it was portrayed as being," he commented.

While some analysts may have been corrupt, Bajari figures most did their best, given the scant information they had about firms without a proven track record.

"They didn't do such a great job, but these were very difficult stocks to price," he said.

The study's findings cast doubt on the massive settlement between Spitzer, federal, state and industry regulators, and some of the biggest names on Wall Street - Bear Stearns & Co. (BSC), Credit Suisse First Boston, Goldman Sachs & Co. (GS), Lehman Brothers Inc. (LEH), J.P. Morgan Securities Inc. (JPM), Lynch & Co. (MER), Morgan Stanley & Co. (MS), the Salomon Smith Barney Inc. unit of Citigroup Inc. (C), UBS Warburg Inc. and U.S. Bancorp Piper Jaffray Inc.

The settlement required firms to pay fines, return some profits, provide customers with independent research for five years, and shield analysts from undue influence. Critics called for more sweeping changes that would mandate more separation, or force brokerage firms to spin off research altogether.

"Taken at face value, our findings suggest that none of these proposals would have much effect on reducing conflicts of interest," the study concludes.

Spitzer's office didn't return a phone call seeking comment.

Bajari doesn't fault Spitzer, figuring he cracked down on the worst behavior on Wall Street and reduced some of the bullish bias without eliminating the benefits provided by analysts.

"A little bit of law enforcement does clean up markets," Bajari said.

The study is available online at http://www.nber.org.

-By Judith Burns, Dow Jones Newswires; 202-862-6692; [email protected]

(END) Dow Jones Newswires

08-19-04 1747ET

Judith Burns Dow Jones Newswires (202) 862-6692 fax (202) 862-6644