[A-List] Merrill Lynch next?

["Keaney Michael" <Michael.Keaney@xxxxxx>]

On 13 December, 2001 I wrote:

Merrill Lynch next?

Readers of the Financial Times have been regaled during the last few
months with stories which, if linked together, pose some interesting
questions about the activities of Merrill Lynch.

See
http://lists.econ.utah.edu/pipermail/a-list/2001-December/003815.html
for full details.

=====

Merrill's reputation is in tatters. Is Stan the man to save the
thundering herd?
The excesses of the last boom have left Wall Street's biggest brokerage
reeling
By Chris Hughes and David Usborne
The Independent, 21 May 2002

Everyone has heard of Merrill Lynch, but in a matter of months Wall
Street's pre-eminent stockbroking and investment banking firm has had
its fame mutate into an unenviable notoriety.

Merrill's raging bull logo and its nickname, The Thundering Herd,
proudly promote the headlong pursuit of wealth. They have helped
establish the firm as a proxy for the fortunes of the wider investment
banking industry. But now Merrill has become a microcosm of Wall
Street's travails.

Its status as America's largest retail stockbroker has made Merrill the
prime suspect in the investigation by the New York Attorney General into
Wall Street analysts who touted companies in the hope of generating
investment banking business for their firms while privately deriding
their tips as turkeys.

Last month, Eliot Spitzer's inquiry uncovered private e-mails
distributed by its star internet analysts, who described as "shit"
stocks that their formal investment research advised clients to buy.

David Komansky, Merrill's chairman and chief executive, and his chief
operating officer Stanley O'Neal need Mr Spitzer like a hole in the
head. Merrill's day-to-day management is the responsibility of Mr
O'Neal, who was appointed only last year and needs to deliver if he is
to succeed Mr Komansky.

In common with every other investment bank and stockbroker, Merrill is
feeling the pain as the continued weakness in the equity markets dents
trading volumes, and mergers and flotations which provide hugely
lucrative investment banking fees. Last week it failed to pull off the
flotation of Punch Taverns, and was yesterday preparing to revive the
issue at a knock-down price.

The firm is having a tough time elsewhere. Its asset management arm,
Merrill Lynch Investment Managers, is facing lawsuits over disappointing
investment performance after settling an action with Unilever last year
midway through court proceedings. Last week it lost Co-op as a client.

Meanwhile, any hope of a takeover bid from HSBC has evaporated after
Merrill walked away from their $1bn wealth management joint venture.
Small wonder that Merrill's share price has underperformed its peers.

While the stock market collapse is at the centre of Merrill's problems,
many observers of the firm argue that it has suffered worse because of
the strategy pursued by Mr Komansky since he took the driving seat in
April 1997. He is not one to take prisoners, and the firm's aggressive
expansion has, according to some, reflected his aggressive personality.

"He is Wall Street's answer to Jabba the Hutt," said one City observer
likening Mr Komansky to the Star Wars character who eats his underlings
for breakfast.

During the Nineties bull market, bankers would have revelled in such
comparisons. Indeed, it would be equally appropriate to refer to any of
Mr Komansky's fellow investment banking chiefs in the same way. This is
not a industry for teddy bears.

That said, Mr Komansky was more keen than his peers to focus his bank's
strategy on the booming equity market. He oversaw a massive increase in
headcount - and costs - as he sought to establish Merrill as the leading
purveyor of investment banking and brokerage services to New Economy
companies and their potential investors.

That has left the business particularly vulnerable in the present
downturn. Its overexposure to the equities market has largely excluded
the firm from the recent boom in fixed-income trading, an area that
softened the impact of the downturn on better-balanced rivals such as
Goldman Sachs and Morgan Stanley. As one analyst puts it: "Merrill Lynch
is a bull market machine."

According to some analysts, there was another problem - an element of
arrogance creeping into Merrill's go-getting culture.

"I don't think there are many firms where analysts would have sent
e-mails like that," one said. "Even if they weren't being ironic, it was
phenomenally careless and stupid."

The suggestion was hotly rejected by a Merrill executive yesterday. "I
take great exception to the notion that we are more belligerently
aggressive than others on the Street. In fact, we are known for being
quite circumspect and reserved in our policies and practices. Having a
large retail side to the firm encourages such conservatism, because we
are constantly in the public eye."

Many followers of the company - including its rivals - are inclined to
agree.

One executive at a rival investment bank said: "Merrill is the victim
more of bad luck than of bad judgement. It happens to have a large
technology business, it also happens to have a huge retail investor
client base. That has turned out to be an unfortunate combination now
that retail investors are angry following the collapse of technology
shares."

Another friendly rival said: "There wasn't much demand for bearish
internet analysts two years ago. Sure, some analysts were positive about
internet stocks, but there were plenty of equity strategists in
investment banks who were negative. David Komansky could hardly stop
people sending e-mails."

Nevertheless, many are now speculating that Mr Komansky, who is due to
step down in April 2004, may leave Merrill earlier in the wake of recent
events. Meanwhile, it is Mr O'Neal's task to get the Thundering Herd
back on its feet. The function of the company president and COO is to
run the show. Their reward is usually the chief executive's job.

Mr O'Neal's first task is to resolve the Spitzer problem. Since the New
York Attorney General's 10-month investigation was revealed on 10 April,
Merrill's stock has fallen 21 per cent.

Merrill is looking to resolve the case before Thursday when court
proceedings are set to begin. The hearing could involve testimony by
some of the firm's top executives in New York and thus further damage
its standing.

Both sides now appear close to a deal, even though there remains the
chance that Mr Spitzer, who has been accused of grandstanding for
political gain, could then proceed to file criminal charges. Most
observers expect Merrill to accept a fine of about $100m, with half
going to New York State and the remaining half divided between the 49
other US states. The firm is also expected to give an assurance that it
will sever any link between what it pays its analysts and the
performance of the investment banking division.

Mr Spitzer is said to have backed away from insisting on a statement of
liability as part of the settlement, which could open Merrill to an
avalanche of lawsuits from customers who believe they were given bum
steers in the past on buying stocks. Some lawsuits have already been
filed and analysts estimate that under a worst-case scenario the affair
could cost the firm $4bn. An agreement to apologise without admitting
liability could substantially limit the scope of possible lawsuits,
however.

Beyond that, Mr O'Neal has three challenges: raising market share,
restoring morale, and cutting costs. "Merrill is caught in a vicious
circle. Market share slips, so it cuts costs, which hits morale leading
to loss of business. So it cuts more jobs, and so on," one analyst said.

Mr O'Neal's success in breaking that cycle will determine whether he
steps into Mr Komansky's shoes.

In the meantime, Merrill can at least look forward to the spotlight
falling on its rivals. Mr Spitzer and the US Securities and Exchange
Commission have subpoenaed e-mails from seven of its Wall Street rivals.
Given the excesses of the internet boom, there is every chance that
their revelations may overshadow Merrill's present woes.

=====

Blow to Merrill as more pension fund mandates are withdrawn
By Katherine Griffiths
The Independent, 21 May 2002

More question marks hung over Merrill Lynch Investment Managers
yesterday after a number of pension fund trustees said they were
considering sacking the company as manager of their members' money.

The Church of England and the aerospace manufacturer GKN said they were
reviewing the management of their funds, which may lead to them
terminating their contracts with Merrill.

The move comes after the Co-operative group said on Friday that it had
decided to stop using Merrill as the manager of £500m of assets
because it was "disappointed" with the company's performance.

The Co-op said it was considering using Merrill for its "historic
record", which relates to when Mercury Asset Management handled its
funds in the 1990s. Merrill bought Mercury, at the time run by Carol
Galley, in 1997.

The Church of England said it was considering where to place £160m of
pension assets. "We have been reviewing the situation since November and
no decision has yet been made," a spokesperson said.

GKN, which was using Merrill among other managers, said it was now
conducting a "beauty parade" over its £350m fund. The review has been
triggered by the fact that GKN merged three pension funds into one in
2001, but the company is expected to take the recent barrage of
criticism of Merrill into account when making its choice.

Another client of Merrill, the London Borough of Hounslow, is also
reviewing its pension fund and may switch to a different fund manager.
Its review will be completed by the time its pension fund trustees meet
at the end of next month.

Merrill's record as a pension fund manager came into the spotlight at
the end of last year when Unilever sued it for failing to fulfil a
contract in 1996 and 1997 to perform in a similar way to a benchmark.
Merrill said it would not undershoot the benchmark by more than 2 per
cent but in fact underperformed by 10 per cent.

A number of other pension funds are also considering whether to sue
Merrill for underperformance. They include Surrey Country Council,
AstraZeneca and J Sainsbury.

The vast majority of the troubled pension funds were managed by
Merrill's Select Team, which included a young fund manager Alistair
Lennard and his boss John Richards.

Merrill's fund management has suffered from low morale since the court
case, which involved the US investment bank handing more than £70m in
compensation out of court.

Since then Anne Richards, head of Merrill's UK equities Alpha team has
left along with four members of her team, and Andreas Utermann, global
head of equities.