Merrill to Simplify Stock Ratings, Revamp Analysts’ Pay

NEW YORK —  Merrill Lynch & Co., scrambling to repair its image with investors, said Friday that it will simplify its stock ratings and overhaul the way it pays analysts.

The big securities firm will introduce a three-tiered rating system--labeling stocks either “buy,” “neutral” or “sell”--to make the recommendations more understandable to small investors.

The firm also said it will base analysts’ pay on stock-picking ability rather than investment-banking work. That change was required as part of a recent $100-million legal settlement with the New York attorney general, who had accused Merrill analysts of giving tainted advice to investors.

Merrill’s announcement is the latest attempt at reform by securities firms, which are frantically trying to regain investor confidence amid a furor over Wall Street’s alleged ethical lapses.

Securities firms have been hit hard by allegations that analysts mislead investors with rosy recommendations aimed at winning lucrative investment-banking business for their firms.

Securities firms clearly are worried about the bottom line. The Wall Street Journal reported Friday that two big public pension funds are considering pulling business from companies that do not implement analyst reforms.

Wall Street sought to reassure investors this week.

The New York Stock Exchange proposed sweeping changes Thursday to boost the integrity of corporate boards. The Nasdaq Stock Market advanced its own plan and promised a tougher one next month. On Wednesday, the chief executive of Goldman Sachs Group Inc. called for significant changes in the way firms are run.

In March, Morgan Stanley Dean Witter & Co. introduced a simplified stock-rating system, and other Wall Street firms may announce similar reforms. Goldman Sachs said it is developing a new stock-rating system. Salomon Smith Barney, a unit of Citigroup Inc., is “looking at everything regarding our policies and practices,” a spokeswoman said.

Experts say Wall Street firms are rushing to portray themselves as reformed, said John Coffee, a securities law expert at Columbia University.

“A big change by Merrill Lynch requires big changes by all its competitors or they will lose market share,” he said.

As for the changes announced by Merrill, “I don’t think they’re revolutionary, but they’re helpful,” Coffee said.

In its settlement with New York’s attorney general, Eliot Spitzer, Merrill agreed last month to make major changes in its compensation and oversight of analysts, primarily by taking steps to separate its stock-research and investment-banking units.

The deal calls for analysts to no longer be evaluated and paid based on their role in securing investment-banking work. To that end, Merrill said Friday that analysts will be judged on such factors as the accuracy of their stock ratings and earnings estimates.

The simplified stock ratings will be unveiled in September. The three ratings will replace a four-tier system, which took the place of a five-tier system in December.

Merrill’s ratings previously have relied heavily on numbers and letters. For example, a “D-3-1-7” rating meant a stock was highly volatile, rated neutral for its 12-month prospects and a strong buy over three to five years, and had a secure dividend.

Historically, Wall Street analysts have slapped “sell” ratings on fewer than 1% of all stocks they cover. That number hit a new high recently, but at the current 2.7% still is a fraction of the 61.9% of stocks rated as “buys,” according to Thomson Financial/First Call.

Robert McCann, Merrill’s head of global securities research, said his firm would issue “sell” ratings when warranted.

“Analysts everywhere are casting a more discerning eye on the companies they cover, and it wouldn’t surprise me at all that we will see more ‘sell’ recommendations,” he said.

Morgan Stanley introduced a three-tiered system in March--labeling stocks “overweight,” “equal weight” or “underweight.” About 22% of all stocks rated by Morgan Stanley are in the lowest group.

Though companies historically have retaliated against analysts who give low ratings--such as by cutting off access to top executives--that has not happened, said Dennis Shea, Morgan’s head of global equity research.

“Truthfully, we were a bit surprised,” he said.