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Deal On Broker Scandal Expected

Sources Say A Pact With Regulators Includes More Than $1 Billion In Fines Over Questionable Recommendations By Stock Analysts

Dec 20, 2002 | Los Angeles Times

Government regulators are expected to announce today that they have reached a long-awaited settlement with major Wall Street brokerages that would require the firms to pay more than $1 billion to resolve investigations of biased research by stock analysts, sources familiar with the matter said Thursday.

The pact, which seemed remote less than a week ago, came together in the last few days as regulators pressured about half a dozen holdout firms to sign on to the accord before Christmas. Among its noteworthy provisions, the deal calls for some money to be paid to aggrieved investors but would not subject Wall Street executives to individual civil charges, sources said.

The announcement follows a year of grueling investigations and media leaks that shone an unflattering light on the practices of securities firms in the late-1990s bull market.

The probes uncovered incriminating e-mail messages written by analysts, who admitted to harboring serious doubts about stocks they were recommending to individual investors but churned out bullish research reports anyway in hopes of winning lucrative corporate financing business for their firms.

The analyst controversy is the latest in a long list of Wall Street scandals. What differentiated it from others, such as the insider trading scams of the late 1980s, was its direct effect on small investors. Individuals streamed into the market in the 1990s, in part because of the upbeat pronouncements of analysts.

As of Thursday night, 10 firms had given their assent to the expected deal, one source said. Two smaller firms U.S. Bancorp Piper Jaffray and Thomas Weisel Partners had not signed on, but negotiations were continuing, sources said. A Piper spokeswoman declined to comment. A Weisel spokeswoman could not be reached.

Federal and state regulators are expected to say they have reached an agreement in principle with the brokerages and that they will draw up formal documents early next month. Barring any last-minute snags, the deal will be announced at a news conference at 1 p.m. at the New York Stock Exchange, one source said.

Sources said the pact calls for Citigroup Inc., parent of Salomon Smith Barney, to pay the largest fine, $300 million, and for Credit Suisse First Boston to pay the second-biggest, at$150 million.

The talks hit what appeared to be a serious snag last week when a contingent of mid-tier firms including Lehman Bros. Holdings, Deutsche Bank, UBS Warburg and Bear Stearns Cos. protested the penalties asked of them. But the recalcitrant firms each agreed to fines of $50 million under heavy prodding from officials at the Securities and Exchange Commission, the NYSE and the New York attorney general's office in the last two days, sources said.

Goldman Sachs Group Inc., Morgan Stanley and J.P. Morgan Chase & Co. also would pay penalties of $50 million.

The pact calls for some of the money to be earmarked for investor restitution. For example, at least half of Citigroup's $300 million fine would go to an investor recovery fund. The details are not yet worked out, but it is likely that several restitution funds would be created, a source said.

In addition to the fines, the firms also would make additional payments to fund the distribution of independent research to investors. The firms would have to buy research done by independent research boutiques and give it to their clients along with the firms' in-house stock reports. The payments for research would be spread over five years.

Some firms also would make payments to fund investor education efforts, one source said.

For example, Citigroup and Merrill Lynch & Co. each would pay $75 million for independent research and $25 million for investor education. Goldman Sachs would contribute $50 million for independent research and $10 million for investor education.

Morgan Stanley would pay $75 million and CSFB $50 million for independent research but nothing for investor educa-tion. Deutsche, Lehman, Bear Stearns, UBS and J.P. Morgan each would contribute $25 million for independent research and $5 million for investor education.

The deal also calls for stronger separation of the firms' research and investment banking units.

It would prohibit "spinning," the practice of awarding shares of initial public stock offerings to corporate executives in return for investment banking assignments, sources said.

The accord also calls for the creation of a public database that would detail analysts' past stock picks for investors to study before taking their advice, one source said.

However, the deal would not include charges against Wall Street executives, sources said. Eliot Spitzer, the New York attorney general, said in a TV interview that executives would not be charged individually.

The announcement would not include the release of detailed findings of fact specifying wrongdoing at each firm, sources said. That probably would come later, after a final deal is signed.

Private e-mails and other communications among analysts, investment bankers and brokerage executives could be crucial to private lawsuits seeking damages for individual investors.

"You should arm the victims with the facts" of what was uncovered, said Thomas Hargett, a plaintiffs' attorney with law firm Maddox, Koeller, Hargett & Caruso in Indianapolis.

The investigations were spearheaded by Spitzer, who was once little-known even in his home state but gained national renown when he reached a $100 million settlement with Merrill Lynch in May over analyst conflicts of interest. (Merrill would not pay any additional fines under the new agreement.)

NYSE Chairman Richard Grasso and Stephen Cutler, SEC enforcement chief, also played key roles in the probes.

In many ways, stock analysts personified the stock market's stratospheric rise and later collapse.

Analysts such as Jack Grubman at Salomon Smith Barney and Mary Meeker at Morgan Stanley became celebrities on CNBC and financial shows on other TV networks.

Analysts' rising fame was accompanied by increasing doubts about their integrity and allegiance to investors. For years, academic studies and anecdotal evidence indicated that analysts favored the stocks of companies that hired their firms for investment banking work such as merger advice or securities issuance.

Those concerns were largely ignored by the investing public and by securities regulators until the stock bubble burst starting in early 2000.

The harshest scrutiny came this year when Spitzer alleged that Merrill analysts had privately disparaged stocks in e-mails labeling one stock "crap" and another "junk" despite touting them publicly.

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