UPDATE 1-U.S. judge weighs in on 2003 analyst deal

* Judge allows some SEC-approved changes

* Changes proposed after 5-year period

* Spitzer says SEC move "staggering"

(Recasts, new throughout)

By Caroline Humer

NEW YORK, March 18 (Reuters) - More than six years after Wall Street banks split their research and investment banking operations in a landmark settlement with the Securities and Exchange Commission, that firewall is being scaled down.

While a federal judge this week rejected a request by major Wall Street banks to modify one part of the 2003 legal agreement, he approved other changes the two sides had agreed upon such as having separate legal and compliance staffs.

The firewall, which was created as part of a pact between the SEC and the companies, essentially requires separate research and investment banking departments and prohibits communication between them without a compliance officer.

The 2003 settlement with companies such as Morgan Stanley and Citigroup came after the technology stock bubble burst and regulators released emails showing that some research analysts had privately disparaged the stocks of companies they publicly lauded.

Many of those companies were also investment banking clients, and the SEC and other regulators filed complaints against the banks, worried that the research had been tainted by their desire for investment banking business.

That settlement has governed those Wall Street firms since they were agreed to in court. But it came with a timeline and included wording that in 5 years the SEC was expected to agree to modifications provided they did not go against the "public interest," according to documents released on Wednesday.

An SEC spokesman said that the key investor protections remain in place.

"Under the court-approved amendments, the settling firms remain under more rigorous restrictions than other firms. The firewalls between research and investment banking remain in place," SEC spokesman John Nester wrote in an emailed statement.

But New York's former governor and attorney general, Eliot Spitzer, who rose to national prominence in 2002 when he stepped over the SEC to challenge Wall Street banks, said that the SEC's acceptance of the changes was "staggering."

"For the SEC to join with the banks to diminish consumer protections with respect to the quality of advice and research is absolutely and fundamentally violative of their duty to the public," Spitzer told Reuters.

JUDGE RULES ON BANKS' REQUEST

After being asked in a letter last summer to rule on the amendments, Judge William Pauley III of the Southern District of New York in a Monday order approved many changes.

In some cases the requested changes were replaced by rules that have been put in place since 2003 by other regulators, while in other cases, some specific requirements were removed.

For instance, one rule requiring a compliance officer to be present when research personnel are speaking to a group of 10 or more of the firm's sales force was removed. Other changes suggested by the banks were not approved by the SEC and were not included in the amendment, the documents show.

Pauley did not ease the rules governing communication about market or industry trends between the two departments, saying that it would undermine the separation of research and investment banking.

Modifications are typical in consent decrees, according to one securities expert.

"The judge has to be persuaded that, on balance, the benefit to be gained by altering a decree is greater than the risk of harm. Quite often, when the government sides with the private party, the court will go along. What is unusual is to have the court not go along," said Gregory Mark, professor of law at Rutgers University in Newark, New Jersey.

"This restriction strikes me as eminently sensible because it helps sever the potential for, and perception of, bias in analysts' work," Mark said.

Morgan Stanley, Citigroup, Bank of America for Merrill Lynch, Goldman Sachs, UBS Securities, Barclays Capital (which bought part of Lehman Brothers), and Credit Suisse declined to comment.

JP Morgan, U.S. Bancorp Piper Jaffray, Deutsche Bank Securities, and Thomas Weisel Partners were not available for comment.

The case is SEC v. Bear Stearns & Co, U.S. District Court, Southern District of New York, No. 03-2937.

(Reporting by Caroline Humer, additional reporting by Joseph Giannone; Editing by Phil Berlowitz)