Wall Street Will Pay $1.4 Billion
One of the biggest scandals in Wall Street history reached an important watershed Monday when securities regulators announced a sweeping legal settlement that will change the way brokerage firms do business and require their stock analysts to tell the truth.
The accord, reached with 10 major firms after months of painstaking negotiations, calls for the industry to pay $1.4 billion and implement various reforms to restore investors’ shaken trust in Wall Street.
The long-awaited deal, which largely tracks a preliminary settlement reached in December, ends several investigations into whether analysts intentionally skewed the advice they gave to ordinary investors.
The probes peeled back the curtain on a host of unsavory practices that, unbeknownst to most investors, became commonplace on Wall Street during the late-1990s. Chiefly, they revealed that analysts, despite personal misgivings, touted stocks in order to entice companies to hire their firms for fee-rich services such as underwriting securities or giving merger advice.
“These cases reflect a sad chapter in the history of American business -- a chapter in which those who reaped enormous benefits based on the trust of investors profoundly betrayed that trust,” said Securities and Exchange Commission Chairman William Donaldson.
The centerpiece of the probes was a raft of e-mail messages uncovered by investigators in which analysts privately derided the same stocks they talked up publicly. For example, a Bear Stearns & Co. analyst who had a “buy” rating on Micromuse Inc. revealed his true feelings in an e-mail, calling the stock “dead money.”
Outside experts generally praised the settlement, though they said it’s not a panacea for the deep conflicts of interest crisscrossing Wall Street.
“This is a substantial improvement and it means that many analysts will be able to do a more independent and objective job,” said John Coffee, a law professor at Columbia University. “But I think the public will not quickly come to trust research” from Wall Street.
Indeed, experts questioned whether the settlement, even if it alters the behavior of stock analysts, will have a lasting effect on Wall Street conduct and prevent scandals in an industry that has become pockmarked by them.
What stood out about the analyst saga was not that it occurred, but that it hit Main Street so hard, largely because of the way small investors streamed into the market in the 1990s.
The brokerage firms seem “inclined to make the same mistakes again, when it benefits their bottom line,” said Mark Maddox, a plaintiffs attorney in Indianapolis. “You can bank on Wall Street’s dishonesty.”
In key ways, the analyst issue will reverberate for years.
Aggrieved investors who almost deified analysts during the late-1990s bull market have since lodged scores of arbitration cases and lawsuits, most of which are in the early stages.
And regulators still are considering bringing cases against individual analysts and their supervisors. Indeed, one of the last unknowns is the degree to which regulators will pursue high-level executives on charges they failed to rein in analysts and their bloated predictions.
Regulators announced Monday that they have fined and permanently barred from the securities industry two of the bull market’s most prominent analysts -- Henry Blodget and Jack Grubman -- and indicated that other cases will follow.
“This isn’t the end,” said Eliot Spitzer, the New York attorney general. “This is very much the beginning for those who acted improperly.”
As is common in such settlements, the firms neither admitted nor denied guilt. However, regulators said their primary goal was to bolster investors’ legal cases against the firms.
To that end, regulators released reams of e-mails and other documents -- equivalent to the size of several phone books.
The two sides had sketched out a tentative deal in December, but spent the last four months haggling over wording of the final terms. The firms sought to soften the language to limit their legal liability.
Under the final settlement, the firms will pay $487.5 million in penalties; $432.5 million toward the distribution of research from independent brokerage firms; and $80 million for investor-education efforts. The firms also will disgorge $387.5 million in ill-gotten gains.
Of the total, $387.5 million will be earmarked for a federal restitution fund that will reimburse aggrieved investors. The qualifications for reimbursement are not set yet, though investors would recover only a fraction of what they lost.
One point in the settlement talks centered on whether the firms would be allowed to write off the payments on their taxes or seek reimbursement from their insurance carriers, thus effectively reducing their financial punishment.
The deal bars the firms from deducting or being reimbursed for the $487.5 million in fines. It adds that the ban is not intended to imply that other payments should be written off or reimbursed.
Spitzer stressed that federal law prevented the barring of deductions or insurance relief for other payments.
But some lawmakers criticized that aspect of the deal.
“This looks like half a loaf,” said Charles E. Grassley (R-Iowa), chairman of the Senate Finance Committee, who introduced legislation Monday to limit the deductibility of the pact.
Regulators accused three firms -- Citigroup Inc., Credit Suisse First Boston and Merrill Lynch & Co. -- of securities fraud, the most serious of the alleged infractions.
Some firms on Monday acknowledged making mistakes.
Citigroup Chairman Sanford I. Weill apologized in a statement and outlined new steps the world’s largest financial services firm was taking to enhance analyst independence.
“Certain of our activities did not reflect the way we believe business should be done. That should never have been the case, and I am sorry for that,” Weill said. “We never again want to have questions raised about the objectivity of our research.”
“Clearly, we are not perfect, and we haven’t always lived up to our ideals,” said Stanley O’Neal, Merrill Lynch’s chief executive. “The process of rebuilding investor confidence is well underway.”
Said John J. Mack, chief executive of CSFB: “This settlement represents significant progress for our industry and is an important step as we continue to work to restore investor confidence in the markets.”
The settlement will form the basis for industrywide rules that the SEC is expected to apply to the rest of the brokerage industry in the near future. The deal itself applies only to the 10 firms, though they are the industry’s largest.
The pact requires a number of structural reforms intended to insulate analysts from investment-banking pressures.
Investment bankers cannot evaluate analysts or have input on their compensation, and they are not allowed to choose which companies analysts cover. Analysts also would be barred from soliciting banking business from companies.
A key component of the reforms requires the firms to pay for, and distribute to their customers, research reports written by independent firms without investment-banking operations. Regulators hope that providing a potentially divergent opinion will further coax analysts to speak candidly.
Some experts praised it as a novel idea that could benefit investors. However, others said the boutique shops would feel compelled to parrot the opinions of the larger firms that would be hiring them. They also worry about the quality of the independent research.
“You get what you pay for,” said Scott Cleland, chief executive of Precursor Group, an independent firm whose clients include pension funds and insurers.
The firms also agreed to cease a widely criticized practice known as spinning in which they sought to curry favor with corporate executives by giving them shares of coveted IPOs. The IPO allocations were “virtual commercial bribes,” said Robert Glauber, chief executive of the National Assn. of Securities Dealers.
Some experts said regulators didn’t do enough to help investors, who still must contend with the courtroom tactics of well-heeled brokerage firms.
The SEC should have streamlined the arbitration format to speed the process by which investors can be compensated, said Manhattan securities lawyer David Kaufmann. As things stand, the firms will use delaying tactics to stretch out arbitration cases for years, he said.
“They have good lawyers, too,” Kaufmann said.
In the end, the government’s evidence rested on the analyst e-mails, many of which pointed the finger at investment bankers. One UBS Warburg drug-industry analyst apologized to traders at the firm for maintaining a “buy” rating on Triangle Pharmaceuticals even though he knew the company probably would fail to get FDA approval for a key drug. The stock plunged 23% on the news.
“Triangle is a very important client of [the firm],” the analyst wrote. “We could not go out with a big research call trashing their lead product.”
In another example, a Lehman Bros. telecom analyst sent an anguished e-mail to his supervisor, complaining about investment banking’s heavy hand on his research.
“Enough is enough,” he wrote. “It’s hard to be right about stocks, it’s even harder to build customer relationships when all your companies blow up, you knew they were going to, and you couldn’t say anything.”
The analyst was particularly worried about RSL Communications Ltd., which was struggling then and is now insolvent.
“For the record, I have attempted to downgrade RSLC three times over the last year, but have been held off for banking reasons each time.”
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Wall Street settlement
Ten investment banks agreed to changes in the way they do business as part of a $1.4-billion settlement finalized with securities regulators Monday. Here are the major provisions of the settlement:
* Stock research must be separated from investment banking at Wall Street firms.
Analysts are barred from soliciting business or accompanying investment bankers on pitches and roadshows, or identifying investment banking prospects. Investment bankers will be barred from input into employee evaluations and compensation of analysts.
* Investment banks will hire monitors to make sure the firms comply with separation of stock research from investment banking.
* The first page of stock research reports will warn customers of possible conflicts of interest if the brokerage firm does, or is seeking to do, business with the company covered in the reports.
* For the next five years, the 10 firms covered by the settlement must contract with at least three independent research firms and provide this research to customers.
* Firms voluntarily agreed to cease allocating shares of “hot” initial public stock offerings to executives of potential investment banking clients, a practice known as “spinning.”
Source: Reuters
Los Angeles Times
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Hamilton reported from Washington, and Mulligan from New York. Times staff writer Josh Friedman contributed to this report.
