The ghost of Eliot Spitzer the Reformer kicked Bear Stearns on its way down yesterday, adding insult to the firm’s injuries and a grim footnote to the former governor’s professional obituary.

Bear Stearns had asked the New York State Court of Appeals to rule that its insurers must pay its part of a landmark 2003 accord imposed by Mr. Spitzer on Wall Street’s 12 largest firms. The court denied the petition, adding some $45 million in extra costs to the cash-strapped investment bank. The settlement with the 12 firms is perhaps the most enduring legacy of Mr. Spitzer’s career. Of all the campaigns he waged as state attorney general, few were as intrusive as his reordering of “sell-side” research. Did the required new regulations help or hurt investors?

From conversations with multiple participants in the research community, it appears that the 2003 settlement didn’t do much to curb industry abuses or to promote more balanced stock recommendations. One highly respected director of research, who views this topic as too politically sensitive to let me use his name, says: “The settlement changed nothing. It only introduced an enormous amount of bureaucracy.”

Though I abhor Mr. Spitzer’s arrogant attacks on the likes of John Whitehead and the management of AIG, I had some sympathy with his efforts to combat the flagrant conflicts of interest that often swayed Wall Street analysts. As an analyst, I found the cynical recommendations of Merrill Lynch’s Henry Blodget of companies that he privately considered “pieces of s—” totally reprehensible.

For years many Wall Street analysts enjoyed the inflated remuneration that came from teaming up with their firm’s investment bankers to secure business from the companies they followed. It was understood that part of the deal was writing positive reports about these companies; criticism generally didn’t win business.

Analysts involved in the corporate finance effort benefited from a constant stream of privileged information that was the by-product of sitting in on planning meetings with company managements and bankers. These analysts were in a much stronger position than their competitors to judge a company’s prospects.

Sophisticated institutional investors knew how the game worked. They were not deceived by the steady stream of “buy” recommendations that certain aggressive banking firms published. Retail investors, however, may have been influenced by such reports.

Mr. Spitzer tried to eliminate these conflicts of interest through the “Global Research Analyst Settlement.” The purpose was: 1) to limit the communication between the firms’ analysts and investment bankers; 2) to alert investors to potential conflicts of interest, and 3) to push the firms to make more balanced recommendations. For example, he argued that they should occasionally rate stocks a “sell” — not a common practice then.

The 12 firms that signed the agreement, including most of the big players, such as Merrill Lynch, Citigroup, and Lehman, were required to provide a second source of information on every stock they covered. The firms had to hire “independent consultants” to oversee this effort and to mete out the tens of millions of dollars that were to be spent on that research. This access to research provided by firms such as Morningstar or Standard & Poor’s has received little attention from the brokers or clients of the firms, two of the ICs, who would not speak for attribution, said. Each year the ICs have to file a report on the subject. The reports filed from Credit Suisse indicate that in the first year of the settlement, retail clients accessed the independent research source only 110 times; in the second year, that dropped to 54. Meanwhile, Credit Suisse was spending more than $10 million a year for this extra research.

This arrangement coincided with industry developments that rendered the change pointless, some argue. One of the ICs, Patricia Chadwick, points out, “It is ironic that just as this agreement was implemented, the role of the retail brokers was shifting — away from that of stock picker and increasingly as one of gathering assets from their clients and turning those assets over to portfolio managers who selected the stocks.”

Ms. Chadwick says she relayed that to the Securities and Exchange Commission after the first year of the agreement to explain why retail investors weren’t using the research. Another IC said: “The people who might want a second source have their accounts at Schwab, not at Merrill Lynch.” What about the wall erected between research and investment banking? This effort is viewed with extreme skepticism. “This has just resulted in investment banking no longer having access to the brainpower of the analysts,” one IC said. A research director on the Street says: “The issue is completely unchanged. When the banker goes in to make a pitch, the issuer wants to know who the analyst is and what his view of the stock is.”

The underlying problem is that Wall Street research is not a profitable business on its own, and therefore has to be underwritten by investment banking fees. Proving the point are companies like Fulcrum Partners, which became one of the largest independent research firms on the Street, with some 35 analysts, but ultimately went bust.

“It’s like price controls,” one participant says. “It’s trying to suspend the laws of economics.” Have firms become more balanced in their recommendations? Anecdotally, it appears that there are more “sell” notices than ever before. One of the ICs scoffs at this observation: “All the firms changed their ratings approach, so now the analysts are rating their stocks compared to others in their universe, or their industry. So there are more ‘sells’ and ‘holds,’ but it doesn’t mean anything; it’s just in comparison to an industry group.”

In the end, it appears that investors are no more shielded from “investment banking bias” than they were before. As most participants point out, ethical behavior comes from leadership; some firms have higher standards than others. As long as company managers are able to choose their investment bank, there will be a tie-in with positive research.

Also, one IC points out that the downdraft in analyst compensation that accompanied the detachment from banking has caused many of the top researchers to flee to hedge funds or other buy-side firms, where they can earn more. He sees this as a real negative for the investor community. On a more positive note, one observer says the settlement and attendant publicity brought back into some balance the pressure on analysts from investment bankers. That shift, though, came at quite a cost. The lack of communication between research and banking is reportedly unhelpful to issuers, to bankers, and ultimately to investors.

One of the ICs said flatly, “Nothing good came out of it.” In other words, not much of a legacy after all.

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