Probe of Analysts May Face Hurdles

The resignation of a prominent stock analyst this week shows how deeply the furor over analysts’ credibility has shaken Wall Street, and signals that the controversy may grow in coming months as regulators press on with a series of investigations.

With his departure from Salomon Smith Barney late Thursday, Jack Grubman became the highest-profile casualty in the 15-month-long scrutiny of stock analysts. Grubman left the firm in what Salomon called a “mutual agreement.”

Several regulatory agencies are studying Grubman’s relentlessly bullish stance on telecommunications stocks since 2000, even as many of the companies collapsed, costing investors billions of dollars in lost market value.

The attention to Grubman is part of a broader inquiry by regulators into whether many analysts’ boosterism for certain stocks was driven by undisclosed financial conflicts--specifically, the desire to lure investment banking business from the subject firms.

In a related probe, investigators are focusing on how brokerages granted shares in hot new stock offerings to favored clients during the tech-stock boom. Such grants may have violated securities laws if there was understood to be a direct link to future banking business.

As for the role brokerage analysts played in Wall Street’s alleged abuses of the late 1990s, experts say it may be tough for authorities to prove serious wrongdoing by those individuals.

Fifteen months after the first congressional hearings on the credibility of brokerage stock touts, authorities have yet to charge any analysts with civil or criminal wrongdoing.

In the most celebrated case so far, Merrill Lynch & Co. in June agreed to pay a $100-million penalty and to change its analyst practices, as part of a settlement with New York State Atty. Gen. Eliot Spitzer to avoid a full-scale legal assault.

Spitzer’s case against Merrill was boosted by his discovery of dozens of incriminating e-mail messages in which the brokerage’s Internet industry analysts privately derided the stocks they were pitching to investors.

But none of Merrill’s analysts faced charges individually in the case. And suits filed by private plaintiffs’ attorneys alleging that Merrill analysts misled investors primarily are seeking damages from the firm rather than from the analysts.

State and federal regulators have been hunting for other “smoking gun” evidence in their probes of brokerages’ research operations. But their investigations have been hampered because some Wall Street firms appear to have destroyed internal e-mails that they are required to hand over in such probes, according to published reports.

Without such concrete evidence to verify wrongdoing, regulators must build cases by less direct methods, such as by studying analysts’ compensation contracts for indications that pay was based on investment banking leads, said Nina McKenna, a former enforcement attorney at the National Assn. of Securities Dealers.

“It’s going to be very challenging because you don’t have a smoking gun like the e-mails,” said McKenna, who now is a brokerage industry attorney at Sonnenschein Nath & Rosenthal in Kansas City. “You’re stuck with evidence that is a lot more amorphous.”

Still, a number of high-profile probes of analysts are continuing. Spitzer and the NASD are investigating Grubman and Salomon. The Securities and Exchange Commission and the U.S. attorney in Manhattan are conducting their own industry-wide analyst probes.

The NASD may be close to bringing action against Grubman. It has notified him that it may charge him with violating securities rules for his bullish recommendations of Winstar Communications Inc. even as the company crumbled.

Grubman has denied wrongdoing.

Experts say the challenge in prosecuting analysts is in showing that they had an intent to deceive, and that stock touts that went awry simply weren’t cases of bad judgment. Grubman, for example, said he “always wrote what he believed.”

But brokerage reports must be based on reasonable assumptions of companies’ prospects, said James Cox, securities law professor at Duke University. If a report can be shown to be lacking in that regard, then the case against the analyst may be strong, he said.