The NewsHour with Jim Lehrer

[Lehrer]: I'm Jim Lehrer, today's news staying alert, Merrill Lynch settles, and the words of Steven Jay Gould tonight on the NewsHour. [silence]

[silence] [silence] [silence] Good evening, I'm Jim Lehrer. On the NewsHour tonight, a summary of today's news, some perspective on staying alert to terrorism, pre and post 9-11, a look at the Merrill Lynch settlement over what its analysts

told investors, and the reprise of a conversation with science writer and thinker, Steven Jay Gould, who died yesterday. [Announcer]: Major funding for the NewsHour with Jim Lehrer has been provided by... Imagine a world where we're not diminishing resources, we're growing, ethanol, a cleaner burning fuel, made from corn, ADM, the nature of what's to come. And by SBC Communications, from high-speed internet access and voice services to data transport, networking, and e-business solutions, when it comes to providing what it takes to help the world communicate, we're on it, SBC Communications. And by the Corporation for Public Broadcasting, this program was also made possible by contributions to your PBS station from viewers like you. Thank you.

[Lehrer]: The FBI warned today terrorists might attack the Statue of Liberty and other landmarks in New York City. Police Commissioner Raymond Kelly confirmed a warning about general threats, but he gave no details. Major news organizations reported the information came from Afghan war captives and had not been independently verified. Defense Secretary Rumsfeld had a warning of his own today. He predicted terrorists will obtain weapons of mass destruction someday and use them. At a Senate hearing, he said at least five countries with ties to terror groups have been developing chemical and biological arms. They're also aggressively trying to get nuclear weapons. Also today, the State Department reported one of those countries, Iran, remained the most active sponsor of terrorism last year. We'll have more on terror threats in a moment. Airline pilots will not be allowed to have guns in the cockpit, the head of the new Transportation Security Administration announced that today at a Senate hearing. John McGaw said highly trained marshals should be the only on-board officers with firearms.

He said giving guns to pilots could create too many complications. [McGaw]: 14,000 more pilots in airports carrying weapons. How many of them will want to do that and how many will be able to pass the qualification and they can't pass the qualification that they now not fly? I mean, there's huge issues here. When I weighed all of them, I made a decision and stick by that decision because I've taken me along enough to make it that I will not permit firearms in the cockpit. [Lehrer]: McGaw said pilots could use special in-flight maneuvers to knock hijackers off guard. He said he was still considering whether to let them carry stun guns or other non-lethal devices. Indian and Pakistani forces traded fire today in Kashmir amid fears of a broader conflict. At least five people were killed in fighting along the disputed border. Americans ambassador to Britain told the BBC the two countries were very close to war.

Both have nuclear weapons. India blames Pakistan for attacks by Muslim militants in Kashmir, including one last week that killed 34 people. Merrill Lynch will pay $100 million because of allegations its analysts misled investors. The money will go to New York and possibly other states and a settlement announced today. The nation's largest investment firm was accused of overrating various stocks to land the company's as investment banking clients. Merrill Lynch did not admit to any wrongdoing, we'll have more on this story later in the program. Also coming, alert to terrorism and Stephen Jay Gould. Being alert before and after September 11, Kwame Homan begins. [Homan]: From the White House to the Pentagon to the Capitol, official Washington reacted today to the controversy over terror warnings.

This morning, the New York Times reported Attorney General John Ashcroft and FBI Director Robert Mueller were told of an FBI agent's concern over suspicious pilot training within days after the September terror attacks, but did not tell President Bush. The Phoenix-based agent alerted FBI headquarters that Islamic militants were trying to gain access to U.S. flight schools. The agent briefed senators in a closed session at the Capitol this afternoon. At the White House, spokesman Ari Fleischer was asked if the president should have been informed about the memo sooner. [Reporter]: Does the President not see a problem that this memo was out there that the FBI and Attorney General at least were briefed broadly without these suspicions, and they were not communicated to the White House or to the President until a week or two ago? [Fleischer]: I don't think anybody needed a memo after September 11th to know that there were general suspicions that people were in flight schools. Everybody knew it as a result of September 11th. [Homan]: The flap about the memo comes as high-level officials continue to warn of possible future attacks.

Homeland Security Director Tom Ridge told a group of business executives today that it would be naïve to think the United States now is immune from suicide bombings or other attacks. [Ridge]: While we prepare for another possible terrorist attack, we need to understand that it's really not a question of if, but a question of when. The Office of Homeland Security operates on the assumption that this sophisticated, persistent terrorist organization that has cells around the world that has struck us on September 11th in the most horrific kind of way, we'll do it again at some point in time. We operate on that assumption. [Homan]: Ridge said the nation's terrorist status remains at yellow, an elevated state of alert. Leaders of the House and Senate Intelligence Committees were briefed late today by Attorney General John Ashcroft. Afterward, Florida Democrat Bob Graham was asked about a report the Islamic group Hezbollah

might target the United States. [Graham]: What we have in terms of targeting is a general increase in the threat. Somewhat similar, unfortunately, to what we were hearing in July and August of last year. We know that Hezbollah, while it has not attacked the United States within our homeland, has attacked U.S. interest abroad and has operatives in the United States who have been trained and recruited for the purpose of carrying out terrorist activity. [Homan]: Defense Secretary Donald Rumsfeld made his comments about possible terrorist use of nuclear weapons before Senate subcommittee this morning. [Rumsfeld]: With respect to the nature of the weapons, there's no question but that we will continue to be surprised in the sense that if you think about taking in one of our airliners filled with our people and using it as a missile to fly it into the World Trade Center or the

Pentagon, that is a new technique of terrorism. We can expect other new techniques of terrorism. The problem I see, and it's a very serious one, is that there has been a proliferation of weapons of mass destruction. And the terrorist networks have close linkages with terrorist states, the states that are on the worldwide known terrorist list, Iraq, Iran, Libya, Syria, North Korea, one or two others. Now, those countries have been developing weapons of mass destruction for some time. They are testing and weaponized chemical and biological weapons. They are aggressively trying to get nuclear weapons. We know that. [Homan]: Two more administration officials appeared before another Senate panel. They, too, were quizzed about the pre-9-11 memos and intelligence.

But first, Commerce Committee Chairman Fritz Hollings criticized the idea of arming airline pilots. [Hollings]: First, the pilots wanted guns, no, will give them stun guns, then the flight attendants wanted metal bars, 18 inches long, crowbars. And I guess if we're going to give the passengers machetes and all, and let them all just fight it out in the cabin. If I was a terrorist, I'd say, whoopie, we don't have to worry about all this security in your EDS system and whatever else. They got all the weapons on board for me, all I got to do is grab a bunch of them and take the plane over. [Homan]: Democratic senators then pressed transportation secretary Norm Mineta for answers about the FBI memos and warnings gathered before September 11th. [Mineta]: In reviewing all of those reports, they really are generalized information, gleaned from the intelligence reports, and very little in terms of specificity about the method or

kind of things that might take place. And I remember asking one time, after, soon after the 11th of September, is there a way of taking all of the pieces of information that we've heard since I've been here on the 20th of January and putting those dots together to have anything point to anything. It's very, very difficult to do that. [Reporter]: Yesterday's Wall Street Journal, Mr. Secretary, reported that the FBI informed the FAA a week before September 11th the arrest of Mr. Moussaoui, a terrorist who wanted to learn obviously to fly large planes. The FAA chose not to pass along this information to the airlines, I gather, because the individual was arrested.

[Mineta]: The FBI sent the FAA the following information in the cable, June 5th. It was a classified cable, meaning its contents were not to be widely shared. It said that Moussaoui's arrest was part of an ongoing FBI investigation. It stated that the only suspect was in custody, indicating any threat that he might have created had been removed. Nothing in the cable indicated that an event was imminent. The cable they sent to the FAA simply said that Mr. Moussaoui wanted to learn how to, quote, take off and land a 747, unquote. It did not, and I repeat, it did not, say that he only wanted to learn how to take off and was not interested in learning how to land.

The cable to the FAA said rightly or wrongly, the only pilot training he wanted was how to take off and land. So take off and landing are the only two things a suicide bomber is not interested in. So based on the nature of all this information, the FAA decided the threat was general and not specific enough that it would wait for further information from the FBI before it should notify stakeholders in the aviation community. [Homan]: Mineta said the various agencies monitoring threats to airline security now participate in twice a day secure phone calls. [Lehrer]: Margaret Warner has more. [Warner]: How do those on the front lines of protecting the public respond to terror warnings like the ones issued in recent days? For that, we turn to Thomas Menino, the mayor of Boston and currently president of the U.S. Conference of Mayors.

Robert Olson, the police chief in Minneapolis and currently president of the police executive research forum and organization of big city police chiefs. Charles Barkley, president of the American Association of Airport Executives, the organization of managers of airports nationwide, he also served on the airport security rapid response team created by Transportation Secretary Mineta after September 11th to come up with recommendations on airport security and retired Colonel Randy Larson, director of the answer institute for Homeland Security, a nonprofit research firm. He helped develop dark winter, a two week exercise in the summer of 2001 that simulated a major terrorist attack on the U.S. He spent 32 years in the Army and Air Force. Welcome to both of you, Randy Larson, beginning with you. How useful are terror warnings of the sorts we've seen in the last few days? [Larson]: These warnings, Margaret, need to go into two categories. First of all, general awareness for the public.

I was a little bit disturbed this morning to find out, but a recent poll that only one-third of the American public believe they're going to be future attacks. Now I can't tell you it's going to be tomorrow or next week or even a year from now, but I can guarantee you, there are going to be future attacks on this country from international terrorism. But that's the general awareness category that we all need. On the other hand, we need some specific information for governors, mayors and county executives that they can make decisions. One of the problems is we're spending a lot of money on overtime for first responders and police officers. Of all the money we sent Washington, New York City, shortly after the attacks, 70 percent of that went to overtime. So one of these days, we're going to have to cut down on the overtime and save it for when we need it. We're also draining the energy of those first responders out there. So what we really need is some specific information for state and county officials, and we need general awareness for the American public. [Warner]: So Mayor Menino, what use do mayors like yourself put on or from these warnings, especially when they're generalized warnings, like the one the vice president issued?

[Menino]: Well, we rely on the intelligence we have. Our police department works for the federal officials and the information that we get back from them. We appropriate deploy our police in the city of Boston. Like it was just said, we have over the last eight months spent a lot of money on overtime and it's draining our city officers. They're talking about the federal assistance, they're talking about the money for first responders. None of them has come into cities and cities are really draining their resources at this time. And also the public, I wasn't surprised by that poll because of all the warnings over the last eight months. And how many times can you go up there and say something's going to happen, nothing happens. People lose confidence in the warnings, but I think the police and the FBI are working hard on these issues. [Warner]: How often do mayors get specific warnings, but maybe unpublicized of the kind we saw this afternoon, where they actually, the FBI warns the New York Police Department and the New York Police Department goes about protecting, say, landmarks in New York. How often do you get those specific ones?

[Menino]: Well, I've only gotten one call from the Attorney General saying that we were going to see Boston was going to be attacked by terrorism. And we checked with everyone else, nobody had information. And that was on a Friday, on the Sunday, the FBI said, we cannot collaborate this, the warnings and what happened, it froze our city for a whole weekend because they told the state and the city. While we weren't talking to anyone and it got out to the press and the press was asking me all weekend, what's going to happen to our city? Well, we had no information, our intelligence, we had a good task force working, Boston Police and the FBI for the last several years. So we had all the information that was so-called, good information, turned bad. And so it's those warnings that people get frightened about and I don't know how to deal with those. [Warner]: Chief Olson, do you find these warnings useful and how good is the specificity of the intelligence that police chiefs like yourself and in other major cities are getting from the FBI and from intelligence?

[Olson]:Well, I have to say that since September, these alerts have gotten a lot better. As that Mayor mentioned, there's a lot of chaos in those early months on just what kind of information was coming out. And so now it was refreshing to hear today, again, pointing out the fact that we are going to be targeted at some juncture. And so the issue of specificity is not so much important as it relates to the entire country, but to the specificity of the region and or city of where they have definitive intelligence information that something might happen. This has to get to us so that we can make appropriate moves within our organizations to deal with it. [Warner]: So is it getting to you? Are there a lot of specific warnings that you all are getting that we in the public just don't know about? [Olson]: We are getting some. But I think even more so, we're getting some of the information that they really don't have, which I think is very refreshing again. We've got a great relationship with the FBI. Bob Mueller has done really a great job in reaching out to local law enforcement. And at least in our city for sure and several of our members, they are now getting direct

calls from the SAC saying something's up and here's the information we have. So we think this is all very, going in the right direction. [Warner]: Mr. Barkley, what about the airports? There's a lot of discussion we ran a little bit of the hearing today about the fact that there were warnings back in 2001, just from the FBI to the FAA, some cases the FAA moved them on to the airlines and the airports. But airlines and airports said there wasn't enough specific. Are these warnings being responded to in any different way now? [Barkley]: So, in the aviation system, we've had for some time a series of levels of security alertness similar to those that have been introduced for the nation. And we have been ratcheting up those levels based on security warnings. But we need to improve the aviation system, much as you're hearing the other panelists talk about the need for local governments and airports or creatures of local government

to get better information, to get more information, and to get more specific information. And I don't think it's surprising that this is an evolving process of getting these warnings better because the problem's fairly new. [Warner]: But are you saying that in the absence of specific warnings, they aren't very useful? Or are you saying you have to be at a heightened state of alertness all the time anyway? And so the warnings are sort of immaterial? [Barkley]: Well, if we're at the highest level of warning now. And so if we could get specific information about a localized threat and a specific kind of threat, we certainly make changes there. But for aviation, the important issue is that we're now facing what is virtually a military kind of threat, a special ops team of suicide pilots on 9-11 that would have trained to get around whatever security measures we had in.

So what we now believe we've got to do is put in a series of security measures, both public and very importantly non-public, and then vary those procedures so that the enemy doesn't know exactly what they're going to get in terms of security. And that's the effort we're going at. If we can get better intelligence on specific threats, we'll do even better at those targeted ideas. [Warner]: Colonel Larson, if though the reality is that most of these warnings are going to continue to be generalized because there isn't a lot of specific information. And authorities still want to be trying to prevent them. What are the greatest areas of vulnerability do you think in a generic sense in this country now, post 9-11? [Larson]: Okay. I think one thing the American people need to understand is that in the transportation community, most of the people in the transportation community talk about the airline system as Fort Knox. It is the best protected system we have. Can we make improvements? Yeah.

But I'd say this weekend my wife's going to fly to Texas to see the grandkids and I'm going to go give a speech in Illinois and people should feel secure to fly on the airplanes. However, other elements of the transportation system, those six million containers that come into our seaports every year, less than 2% are inspected. So if you're a terrorist, you've got a 98% chance of sending a nuclear weapon in a shipping container into the United States. We need to do something about that and we cannot defend our ports by working in our ports. We have to defend an international transportation system, which means we have to work with our trading partners very closely to do that. 103 nuclear power plants, 68 of them are next to the navigable waterways. There's a threat for you. But I'm a retired Air Force pilot. We would refer to the United States as a target rich environment. Okay. We're not going to make it 100% secure. What we do have to do is educate the American people and I think we can look at the model they use in Israel, one of the five elements of their counterterrorism program is preparing the general public psychologically for more attacks. We need to do that in this country. [Warner]: But then you're not talking about preparing the public to help prevent attacks, but just

essentially to be ready for whatever comes? [Larson]: We need to have a realistic understanding. Look, between Friday night and Tuesday morning this weekend, 250 Americans will die on highways. We know that's a fact that will happen. Now you're not going to drive a car, I'm going to drive a car, let my daughter drive a car. But what I will do is say, where you're seatbelt, don't drink while you drive, be a defensive driver, there are certain things we can do and it's the same thing for the anti-terrorism or protect ourselves. We need to remain vigilant. [Warner]: Mayor Menino, how helpful, how much guidance are mayors getting from the feds, from federal officials in terms of identifying their areas of greatest vulnerability, whether it's their port, whether it's their power stations, whatever, or does this mean you all have to do on your own? [Menino]: Well, most of us, like I said earlier, we have this task force between the FBI and the Boston Police, that identifies certain locations. The criminal was right on the waterways. We have LNG tankers, like I'm right into Boston harbour, to residential area, natural gas.

And that's a real explosive issue, and I've been dealing with that with the Coast Guard for the last eight months. Yeah, for years this came in, but the world has changed forever, and how do we deal with that? Some of those ships are coming from Algeria, and what do we know who's getting onto those ships? This issue also, that we have to deal with, and we're trying to deal with the Coast Guard and those issues. But I'm going to tell you, one of the things I think is hopeful in all these is, it's Tom Ridge. Tom Ridge, you've been very helpful to cities of America over the last several months. He's responsive. You know, people say he needs more power, he sure does need more power because he's the most responsible federal official we have. [Warner]: But what specifically do you get from him and his office? [Menino]: Well, we get Tom Ridge's advice, help, and information. And that's what we need. And we sure would like to have resources, and that's another battle we'll go through. But at least we have a contact, somebody who will talk to us, and give us the information that we need to deal with the situation. Like when the LNGs were coming into Boston harbour, he gave us information.

He worked with us on those issues. That's what we need. [Warner]: Chief Olson, same general question to you, how much assistance and guidance are police chiefs getting from federal intelligence and law enforcement officials in terms of protecting potential targets, in terms of prevention? [Olson]: Well, like Boston, we're involved in a joint terrorism task force. We have regular meetings with the FBI, and all of the other federal agencies meet with the locals. And we've done all of those kinds of groundwork things with them. I have to say that the collaboration and cooperation, since September, has quadrupled in its level. And it's been really a great start. The FBI, specifically, who local law enforcement does most of their interaction with the federal government with, has just really been great in reaching out to local law enforcement. [Warner]: But can you give me an example, for instance, without naming a city, of the kinds of information or tips you're getting from the federal level, about a particular installation that you only need to step up protection on, or a particular kind of facility?

[Olson]: Well, I don't know that we, most of these things are pretty well obvious. And in fact, when you really look at it, it's the local officials and the state officials that have a far better perspective on the importance of some of these installations than the, I mean, the nuclear power plants and all those things are obvious. But there's a lot of other things that the local communities probably know more than they do. And it's us advising them as we discuss the issues that need protection. [Warner]: And Chip Barkley, in terms of the airports, again, how specific, how useful are the federal law enforcement intelligence officials? I mean, is this, is this now something they're running, or are the airlines running it, or are you, airport managers running it, or is everybody involved in it at once? [Barkley]: Well, no, the information is all coming from the same federal agencies that are feeding the information to other branches of the local government. And that comes into FAA, they parse it out, or now TSA, and they're sending some of it to the airlines if it has to do with passengers and baggage.

And of course, they're now doing the screening in airports. The airports are responsible for perimeter security and the police protection and parking and some of the other things at airports. So it depends on the kind of threat as to what you're getting. But we do need to, we need to vastly improve the intelligence we're picking up and the method of distributing it. And the more we can do with specific targeted information, it's going to be much more useful in aviation. [Warner]: I guess what I'm really asking you is apparently last summer what the airlines said was, well, they gave us warnings, but they didn't suggest any specific security steps. Now, that they didn't say start barring your cockpit doors. You know, are you getting specific suggestions or are you getting the warnings? And then you all are supposed to figure out what to do. [Barkley]: No, we're getting, we're not getting specific warnings, but we are getting specific direction to increase security, but that's a general increase in security things like increasing

the number of patrols and doing sweeps of terminals. [Warner]: All right. Well, gentlemen, we have to leave it there. Thank you all. Thank you. Thank you. [Lehrer]: Still to come on The NewsHour tonight, Wall Street Analysts and Remembering Stephen Jay Gould. The Merrill Lynch settlement and the Gwen Ifill. [Ifill]: The stock market roller coaster has exacted an especially high toll on internet and telecommunications companies, but the financial services industry where analysts and investment bakers fueled each boom and bust has come under tough scrutiny, too, with government investigators now making a case against Wall Street itself, specifically that many Wall Street analysts hyped companies their own firms were doing business with. Such behavior would be a violation of what is often called a Chinese wall, an understood

separation between a firm's analysts who are supposed to give independent advice and the work of its investment bankers. At this recent hearing, senators told Wall Street analysts that the collapse of that wall is part of what drove the Enron debacle. [Joseph Lieberman]: The Wall Street analysts kept their part of the bargain and I regret to say that based on the investigation, our committee has done, my answer is no. They have not. Ten out of fifteen analysts who follow Enron were still rating the stock as a buy or a strong buy as late as November 8th. [George Voinovich]: You now have a problem of appearances. Before this, you didn't. The issue of appearances of conflict of interest. What we're trying to do as quickly as possible is to restore people's faith in the financial markets in this country so we can get back to business. [Ifill]: New York Attorney General Elliot Spitzer has been investigating such conflicts of interest involving Merrill Lynch, the nation's largest brokerage firm.

As part of his case, Spitzer released a set of private emails from Henry Blodget once the star internet analyst for Merrill Lynch. And one of the messages Blodget dismissed the prospects of the internet firm Excite@ Home, but he touted the stock publicly. He also publicly recommended the internet's stock goto.com, but wrote in a private email, nothing interesting about this company. Today, Merrill Lynch settled the case brought by the attorney general. [Spitzer]: This agreement provides real reform. It changes the way Wall Street operates, severing the direct links between the research and banking divisions that tainted investment advice. Merrill Lynch agreed to pay a $100 million fine to New York and 11 other states. Separate completely its analysts and investment bankers and to ban analysts from being paid based on investment banking profits. The firm also issued a public statement of contrition, apologizing to clients and shareholders. Merrill Lynch CEO David Komansky spoke today on CNBC.

[Komansky]: We clearly will be above and beyond reproach, have a much stronger system of checks and balances. [Ifill]: The Merrill Lynch settlement does not end the investigation. Several other analysts working at firms like Morgan Stanley, CitiGroup and Goldman Sachs have also been subpoenaed. And late last month, the Federal Securities and Exchange Commission launched its own inquiry. For more, we're joined by John McConnell, professor of finance at Purdue University's Cranert School of Management, Paul Kedrosky, professor of business at the University of British Columbia, he was an equity analyst at HSBC Securities and Investment Bank in the mid-1990s, and Gretchen Morgenson, a financial writer and columnist for the New York Times. Gretchen, what was the significance of today's settlement? [Morgenson]: Well, $100 million is a sizeable amount, although to affirm the size of Merrill Lynch it really is not as large as it is to you and me.

And their public apology, I think, is meaningful, however, I do think that we do have to keep an eye on things at these firms because even though they said there were policies and procedures in place to prevent this kind of thing from happening, they obviously weren't minding their p's and q's as Mr. Spitzer found out. [Ifill]: Professor McConnell, do you think that this was a significant settlement today? [McConnell]: I see good news and bad news in the settlement, the good news is that the sanctions or the agreement was quite mild, it's not going to have much impact on the way business is done. The bad news as I perceive it is that Mr. Spitzer was able to get away with it, basically legislating by the threat of criminal indictment. I think that's a very unfortunate precedent to set for the Attorney General. [Ifill]: How about that professor Kedrosky? Is there an unfortunate precedent set by the Attorney General's prosecution of this? [Kedrosky]: Well, obviously, you'd much rather see the firms deal with these problems themselves.

I mean, whenever you have analysts saying one thing and probably then doing something else in private or in any way misrepresenting or even saying anything that suggests something different from what their public position is, I'd like to see the firms manage that problem inside the firm and not have to resort to having an Attorney General show up and introduce discipline because that's just, you know, it is a bad precedent in the sense. I'd rather not see litigators show up telling companies how to run their own businesses certainly. But in this case, I mean, there was just no sign that the major brokerage firms were doing very much concrete to change the way they've done business for many, many years now. [Ifill]: Well, Gretchen, let's talk about the way they've done business. Is this a widespread practice? What was happening at Merrill Lynch and what, apparently, he is investigating other companies for as well? [Morgenson]: Well, it's hard to know we do not have, of course, all the documents from the other firms, but I can tell you that during the mania, the tech stock boom that we had in the late 90s and in 2000, anything goes was the mantra. And that meant, as long as the investment banking fees were coming in, rolling in, and as

long as investors were eager to have the next offering, really, there was nobody minding the store, nobody policing, nobody making sure that these recommendations had some basis in fact. There were crazy valuations given on these stocks by these analysts that were held out as independent observers. [Iffil]: So Professor McConnell, if you believe that the Attorney General should not have been involved in this, and who should have been minding the store? [McConnell]: Well, first I've looked at the email messages in detail, including the one that Mrs. Morgenson had in her New York Times article, and in that particular email, she excised, deliberately excised, the last sentence, which completely exonerated Henry Blodget. So, having looked at the evidence, I don't know that I've seen evidence that there is anything wrong, and so I'm bewildered by the rush to somehow correct the problem that I don't perceive existing. [Iffil]: Share with us, how do you believe that that last detail in the email exonerated Henry Blodget?

[McConnell]: Sure. I mean, let me read it to you. I'll be happy to do so here. I have it. If I can find it in my notes, the last sentence was as follows. "It is hugely ironic to me that we are being investigated for potential conflicts of interest over a stock that we put a neutral on, and after that, we upgraded it, doubled it, and downgraded it, dropped 40%. If there was ever a better example of independent high-quality research, I don't know what it was." [Iffil]: Gretchen, is that exoneration? [Morgenson]: Not, in my view, at all. I mean, his idea of what a neutral was on that stock was eight pages of breathless recommendation to buy it. It really was not neutral at all. [Iffil]: Professor McConnell, is there a possibility, is it even possible for complete separation between these two parts of the same hole, which is to say the analyst, the research firm of a company and the investment banking, is that even doable? [McConnell]: I think in terms of letting the markets separate and regulate our enterprises and an institution such as Merrill Lynch, or any other financial institution, is not providing

its customers with the services they demand and expect. There are many, many, many alternatives available. Discount brokerage firms, full service brokerage firms, incredible opportunities for individuals within the U.S. to trade through any number of mechanisms. And if Merrill Lynch or any firm is somehow deceiving their customers and clients, they will go elsewhere. That's the beauty of the American capital market. We are not forced to participate. And if we do choose to participate, we can participate by any mechanism or any vehicle or any avenue that we desire. So I'm... [Iffil]: Professor Kedrosky. [Kedrosky]: I think that's true. But I mean, having been on both sides of the fence on this one, I mean, there's sort of a deeper context here, which is that insiders in the business that sophisticated investors, people like Fidelity, the big institutions buying stocks, they know that analyst estimates, you know, aren't worth the paper they're written on.

It's slightly sort of obfuscation and cheerleading and general confusion and noise. But people at retail investors, the waves and waves of people like you and I who showed up in the markets over the last decade, they didn't know that. No one gave them a crib sheet telling them this is the way the game works. And so now, you know, we're all standing back saying, well, you should have known better. And I think to some extent, caveat, I'm talking about where it does apply. But by the same token, you know, there's an awful lot of, you know, sub-message here that these folks didn't get. They didn't know that analysts estimates were, you know, largely come back from the company. They don't know that the recommendations that analysts make, it's very difficult for it not to be influenced by investment banking relationships. I've been there, I saw it. [Iffil]: Well, question, tell us, who was hurt by this, were they, when we talk about individual investors, are we talking about large investors and small people, small time, what are you talking about? [Morgenson]: We're pretty much talking about probably newcomers to the market, which were coming in in droves, as you know, in 95, 96 and through 2000. They were lured, of course, in by low cost trading, which was, you know, much different from what the way it had been in the early 90s or 80s.

I guess my fear about the whole thing, Gwen, is that this really goes to the heart of the trust in the capital markets. The idea that a firm's research is somehow related to its investment banking deals is going to give investors pause about whether or not they should buy stocks at all. So the fact that there were no internal police mechanisms at these firms to prevent this thing from happening is troubling to me because I know America has the best capital markets in the world and they ought to stay that way. [Iffil]: But Professor McConnell, what about that, has trust been undermined by individual investors in the market and in these companies? [McConnell]: Well, let me go back to the point that there was no internal monitoring. I, again, I've looked at the evidence and I have not seen the massive breakdown in the internal mechanisms that have been so widely declared. That's the first point, as regards trust, we have money invested in our capital markets from every country in the world.

I have basically my entire retirement fund invested in equity markets and have had for 30 years. So I personally have complete faith in the integrity of our capital markets. Does that mean I haven't lost money? No, of course not. But that's to be expected, it's a risky undertaking and sometimes we're going to lose and sometimes we're going to win. [Iffil]: Well, let me ask you about the things that Merrill Lynch agreed to today in this settlement with the Attorney General. They agreed to change compensation for analysts to put that in a different stream and they agreed to this complete separation we're talking about. Is that an admission by Merrill Lynch so they were doing things the wrong way before? [McConnell]: First, I don't know what their compensation strategy was before the fact. So I don't know to what extent this is a change in their practice. My understanding has been I defer to Professor Kedrosky on this point because he's worked on the street. My understanding is that the analysts are by and large paid on the basis of their evaluation by customers.

That is the retail and wholesale brokerage customers. So I really don't know to what extent that's a change in Merrill Lynch's compensation strategy or techniques. [Iffil]: Let me direct that question then to Professor Kedrosky as well? [Kedrosky]: You know, it's all money to the same pot. So I guess in the sense, it's hard to get away from the research salaries coming from investment banking. So the question, from my point of view, is just how explicit that connection is made. And Elliot Spitzer gave some document showing how there had been explicit connections in the cases of a number of analysts, a couple, between the business they brought in from an investment banking standpoint and how they were paid. As analysts, that's not a widespread phenomenon to make an explicit connection like that. But by the same token, I mean, money's money, whether it comes in from investment banking or it comes in from other ways, at the end of the day, if it shows up in my paycheck, I'm not dumb. I can recognize that. And I know how my bread gets buttered. [Iffil]: Okay, Gretchen, now that the SCC is talking about getting involved in this investigation, what do you expect them to do and what should their role, what can their role be in this

case that the Attorney General hasn't taken on himself? [Morgenson]: Well, of course, they are the nation's securities regulators. So they are, you know, on a federal level, obviously the top dog in this department and they are already formulating new rules and regulations that they want the firms to adhere to with the other regulators like the National Association of Securities Dealers. So, and they have said today an statement that they will continue to investigate this, like this is by no means the last word on this matter. So I think that they will continue to do so. [Iffil]: And does the settlement today protect these companies from civil lawsuits? [Morgenson]: Not at all. They are obviously open to any case that can be made by a lawyer. Of course, it has a lower threshold than a criminal case, the proof of it. But I think that these firms are still very vulnerable to that kind of civil litigation, whether it's in an arbitration or a class action lawsuit.

[Iffil]: So Professor McConnell, in your opinion, will today's settlement changed the way businesses done on Wall Street? [McConnell]: Well, I want to go back to this point that Ms. Morgenson noted that the firms are particularly in Merrill Lynch are very vulnerable, but that presumes that the evidence is, in fact, as it has been portrayed. I'm personally not yet convinced of that case. So I think it's yet to be determined to the extent to which they are vulnerable. Now, the second point you just asked me, will it change the behavior? My own sense of reading the Wires Service reports on these settlements is that it's a relatively mild set of recommendations to which the Merrill Lynch has agreed. And I defer to Mr. Kedrosky, Dr. Kedrosky, but my impression is that it's a little bit to do with compensation, and there's going to be a committee and oversight committee. I think that's my experience, and again, I defer to the professor again.

[Iffil]: Well, let me direct that question to Professor Kedrosky again. [McConnell]: Absolutely. [Kedrosky]: Is it going to make a change, yes and no, but it's going to make a change, but not for the reason that I think it's been presented as. The thing that's going to change in the industry is there's now kind of a sea change in people's awareness of what independence really means. I don't think the specific sort of rulemaking that you see going on is going to materially change the way analysts work, but I think forcing people to be more aware that there are people out there who actually didn't understand the role of analysts and what objectivity means. Maybe that's in a small way a change is rippling through the industry. Will it change things in a whole cell? I don't think so, unfortunately, I'm still kind of pessimistic about it. [Iffil]: All right. Well, thank you very much for joining us. [Lehrer]: Finally tonight, remembering Stephen J. Gould, the Harvard professor in zoology and geology professor of zoology and geology, died yesterday at age 60.

He was a prolific writer, a long time columnist for Natural History Magazine and author of numerous bestselling books. In 1996, he talked here on The NewsHour with David Gergen, editor at large of US News and World Report. Their subject was his then newest book, Full House: The spread of excellence from Plato to Darwin. Here's a reprise of that conversation. [Gergen]: Steve, you've written this very challenging book about evolution, challenging the notions that are in our heads. Maybe we ought to start with what the conventional notion is about evolution. [Gould]: The conventional view is more a result of what Western culture makes us want to think than what actually happened in the history of life. Darwin's theory of natural selection doesn't make any reference to any notion of progress or development or increasing complexity. It's only a theory about adaptation to a changing environment. There is many ways to adapt to local environments by becoming less complex, by getting more complex. But for reasons of our history and our biases and our preferences, we very much want to

spin back to that theory and make it appear as though the history of life is a predictable rise to increasing complexity and progress. I think so that we can validate ourselves as the crown of creation after all humans have only been here for a geological eye blink in the three and a half billion year history of life. And that leads to the frightening thought that we might be an insignificant little twig that was never meant to be and is here only by accident, which I think is right. But if we spin back to the process and make evolution appear like a predictably progressive sequence, then our late evolution makes sense. I think that's why we do it. [Gergen]: That's right. It's one of those are human arrogance, a notion that there's a ladder that sells right at the bottom of the ladder and worth the top of the ladder. [Gould]: That's how we always draw the history of evolution from amoeba to human or from crouch chimpanzees to upright white male in a business suit thereby encoding other biases of that culture into the process. But evolution isn't that. Evolution is a process of constant branching and expansion. Life began three and a half billion years ago, necessarily, about as simple as it could

be, because life arose spontaneously from the organic compounds and the primeval oceans. You couldn't begin by precipitating a giraffe out of this primordial soup. So you began the history of life with the simplest possible form of cellular life, namely bacteria, and since there's no way of getting any simpler, as life expanded every once in a while, you get something more complex, because that's the only direction open. But if you look at the full range, rather than falsely and myopically concentrating on the history of the most complex things through time, what you see is that the most outstanding feature of life's history is the constant domination by bacteria. In fact, this is not the age of man as the old textbooks used to say, or the age of mammals or usually the age of insects, which is more correct if you want to honor multicellular animals. This is the age of bacteria. Bacteria have always been dominant. The bacterial mode, the mode being the most common form of life, is never altered in three and a half billion years.

We don't see it that way, because bacteria tie in and they live beneath us, but bacteria live in a wider range of environments. There are more just E. coli cells. That's only one species in the gut of every human being than there have ever been people on Earth. And if this report on Martian life is true than the bacterial mode is universal, it's not only planetary, and there's no universality for little green men. So this is a bacterial planet. You can't nuke them into oblivion. They've always dominated life on this planet. As far as they're concerned, we're just little islands of mobile resources, which they can exploit for a while. They're happy to let us strut and fret this little hour on the stage, because they'll still be here when we're gone. You see, you don't see that unless you're willing to look at the history of life as the full range of its variation through time. I mean, it is true. The most complex thing has gotten more complex once they were only bacteria. Now there are humans, but that's not the result of an intrinsic defining central drive. It's just a kind of random movement away from a necessary beginning at maximal bacterial simplicity.

That's all it is. [Gergen]: You used an analogy, which I found quite helpful to me in thinking about the randomness of it all. You talked about the drunk coming out of a bar and staggering. Could you just answer that? [Gould]: Yeah, it's a whole statistical paradigm called the drunkard's walk, which is a wonderful way of illustrating how you can get directional and predictable motion within a totally random system. Right? Here's the story. Drunk staggers out of a bar. Here's the bar. And he's leaning right against the wall of the bar. Now, he's staggering completely at random, back and forth. There's a gutter 30 feet away. He staggers five feet. Every time he staggers completely at random. Goes towards the bar as often as he goes away, except if he hits the bar wall, he can't go through it. So he just stands there until he staggers away. Now, where does he end up every time? Well, of course he ends up in the gutter. He falls down the gutter with the things over. We understand that very easily. He's going to end up in the gutter every time. It's like flipping six heads in a row because he staggers five feet. But his movement is entirely random. The only reason he ends up in the gutter is that he's beginning next to this wall that he can't go through. History of life did the same thing. History of life began with a bacterium next to the left wall of maximal simplicity.

So, in its random motion back and forth occasionally, a species staggers over towards greater complexity. But it arises within an effectively random system. [Gergen]: But the complexity is over here toward the gutter. [Gould]: Yeah, the complexity towards the gutter in that analogy. And the bar wall is home. [Gergen]: Now, what's interesting about that is that the bar in effect is the left wall. It's the simplicity. You can't get any simpler than that left wall. [Gould]: You can't get simpler than a bacterium. So as life expands, there is a real trend. The real trend is the success and expansion of life. If you begin at maximal simplicity, there's no room to get any simpler. So what happens is this position of maximal simplicity. The bacterial mode just gets higher and higher through the history of life. It's never moved. We just ignore it. We tend to look only at the most complex thing as it moves away from the wall. [Gergen]: And the other part of your argument was though that culturally or in some fields such or baseball or musical composition, there's not a left wall.

But there's a right wall in effect, how fine you can become, how terrific you can become. That was interesting. We haven't had a 400 hitter in baseball. [Gould]: It's 55 years. [Gergen]: 55 years. [Gould]: Totally. [Gergen]: And what ever happened to the foreigner? [Gould]: Yeah, it used to happen between 1900 and 1937. Different players did it nine out of those. And no one's done it in 55 years. To understand that, you have to use the same perspective of considering the full range of variation rather than our usual false way of just looking at a single thing moving through time. That's why I call my book Full House. It's not only the poker hand and life's randomness. It's a plea for looking at the full range of variation. Everybody assumes that 400 hitting disappeared because hitting's gotten worse. After all, it was good. It used to exist in abundance. Nobody's done it for 55 years. What you have to do is reconceptualize the whole problem in terms of variation. That is the full house, the full range of variation. When you do that, you realize the following, the average batting average is never changed. It's always been around 260. That's what fluctuates back and forth, but it stays around 260.

And that's not an absolute measure like running a mile or throwing a javelin, 260 is a balance between hitting and pitching. The fact that it stayed 260 only shows you that the balance has been maintained. I say it's been maintained as everyone who's gotten better. Hitting's gotten better, pitching's gotten better, everything's gotten better, the balance remains the same. Now, as everything gets better, the variation shrinks. That's all that happens. There's a right wall of human limits based on how tall we are. And our musculature. Nobody's ever going to hit a ball a mile or pitch it 200 miles an hour. Ty Cobb was standing right next to that right wall in 1910. But the average level of play was so much worse. He was so much better than the average that his hitting could be measured as 420. Today everybody's gotten enormously better. Wade Boggs a few years ago, Tony Gwynn today. I'm standing the same place Ty Cobb was an inch from the wall. The best players are always there. But everyone's so much better now that the average has moved right next to them. So their performance, which is equal to Cobb's, is now measured as 340 or 350. So in other words, the disappearance of 400 hitting paradoxically is measuring the general

improvement of play. And not as we always thought the exact opposite of the disappearance of batting skills. But you've got to have that full house perspective. [Gergen]: I understand that. Let me ask you this. You also write about German composers. We've had this period from the late 1600s until the early 1800s, a very short period. When we have Bach and Beethoven and Mozart and Hyde and all these wonderful German composers. [Gould]: Their full life spends between 1685 and 1820s. Where are they today? And I speculated in there that this concept of right wall has any validity. It's conceivable. I'm not sure this is so. That you can run out of accessible styles since the arts demand innovation as a criterion of genius, it's possible in certain fields that you can run out of accessible styles. The arts loves to say, well, the avant-garde isn't understood, the next generation will. And maybe that's often true, but it need not always be true. Maybe you can really run out of styles that intelligent people can comprehend. And perhaps that's happened with the classical music tradition.

I'm not sure that's the exact same paradox. [Gergen]: You think the same paradox holds that you may not have the box in the Beethoven's, but it's a general level of musical compositions improved, do you think that? [Gould]: I think there have to be box in Beethoven's. There are so many more people, musical trainings available, there's so many more. But it may be that we've hit a right wall in terms of accessible styles. And since we demand innovation, that's a criterion of genius that may not be more innovative styles to be found. [Gergen]: Final question. When Darwin completed his book on evolution in 1859, in the final paragraph was, there is a grandeur in this view of life. Is there a grandeur in your view of life? [Gould]: Oh yes, and I shared Darwin's position, because Darwin's very explicit. The grandeur is in the spreading of the diversification, the constant surprise, the constant novelty. And he compares it to the planet, which just cycles around the sun, year after year and after. He says, and whilst this planet is going on endlessly cycling, from so simple beginning, endless forms, most beautiful and most wonderful, have been and are being evolved, that's his closing line.

[Gergen]: And that's your closing line as well. Thank you very much. [Gould]: Thank you. [Lehrer]: Again, the major developments of this day. The FBI warned terrorists might attack the Statue of Liberty and other landmarks in New York City. Defense Secretary Rumsfeld predicted terrorists will obtain weapons of mass destruction someday and use them. And Merrill Lynch agreed to pay $100 million because of allegations its analysts misled investors. We'll see you online and again here tomorrow evening. I'm Jim Lehrer. Thank you and good night. [Anouncer]: Major funding for The NewsHour with Jim Lehrer has been provided by Imagine a world where no child begs for food. While some will look on that as a dream, others will look long and hard and get to work. ADM, the nature of what's to come. And by SBC Communications.

From high-speed internet access and voice services to data transport, networking and e-business solutions, when it comes to providing what it takes to help the world communicate, we're on it. SBC Communications. And by the Corporation for Public Broadcasting. This program was also made possible by contributions to your PBS station from viewers like you. Thank you. Video cassettes of The NewsHour with Jim Lehrer are available from PBS Video. Call 1-800-328-PBS-1. This is PBS. Video cassettes of The NewsHour with Jim Lehrer are available from PBS Video.

Good evening, I'm Jim Lehrer. On The NewsHour tonight, a summary of today's news. Some perspective on staying alert to terrorism, pre and post 9-11. A look at the Merril Lynch settlement over what its analysts told investors. And the reprise of a conversation with science writer and thinker, Stephen J. Gould, who died yesterday. Major funding for The NewsHour with Jim Lehrer has been provided by

Imagine a world where we're not diminishing resources we're growing. Ethnal, a cleaner burning fuel, made from corn, ADM, the nature of what's to come. And by SBC Communications. A high-speed internet access and voice services to data transport, networking and e-business solutions. When it comes to providing what it takes to help the world communicate, we're on it. SBC Communications. And by the Corporation for Public Broadcasting. This program was also made possible by contributions to your PBS station from viewers like you. Thank you. The FBI warned today terrorists might attack the Statue of Liberty and other landmarks in New York City. Police Commissioner Raymond Kelly confirmed a warning about general threats, but he gave no details. Major news organizations reported the information came from Afghan war captives and had not been independently verified.

Thank you.