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Penalizing Wall Street: Pick a Fine, Any Fine

Punishments For Research Abuses Could Be All Over The Map


Banks and regulators are haggling hard over fines to settle charges that Wall Street analysts brazenly touted companies they considered poor investments to win their investment banking business. Regulators and prosecutors want banks to pay between $75 million and $500 million each, depending on how egregious their behavior was and the firm's size. Some banks hope they can get off paying just $25 million.

Where do these numbers come from? How does the punishment fit the crime? Unfair as it may seem to investors who lost big, whatever the banks pay will be arbitrary. "There's no art or science to how you fine someone," says Deborah Bortner, Washington State director of securities. "You put a number out for negotiation. We never want to cripple a firm. But we want to send a very strong message that this was unacceptable behavior."

The closest thing to logic in the bank case seems to be what New York State Attorney General Eliot Spitzer calls "The Merrill Plus" method. That means using as the benchmark Merrill Lynch & Co.'s (MER ) $100 million fine in a similar case settled in April. It's probably no coincidence that Merrill's fine matched what Credit Suisse First Boston (CSR ) paid to settle Securities & Exchange Commission allegations of improprieties in hot initial public offerings though Spitzer has never publicly called it his benchmark. Spitzer has said he aimed to hit Merrill hard enough that the public noticed without damaging the firm.

In any case, based on the Merrill methodology, Citigroup (C ) could pay as much as $500 million, say sources close to the negotiations, because it's so huge and because telecom analyst Jack Grubman was the cheerleader for so many companies that went bankrupt. His positive ratings on telecoms helped Salomon Smith Barney earn about $2.9 billion in fees in the sector between 1997 and 2001, Thomson Financial says. At the other end of the scale, Banc of America Securities and U.S. Bancorp Piper Jaffray might pay $75 million or less, the sources say.

Spitzer and the SEC are eager to wrap up a settlement by yearend. But not all their fellow enforcers are happy about that. Their complaint: Some states started investigations only this summer, so there's a risk some banks could get off lightly because their cases aren't nailed down. Spitzer had 10 months to make his case against Merrill, says Andre Pineda, deputy commissioner for California's Corporations Dept., who is investigating Deutsche Bank (DB ). "He had all the facts, and he pushed for a number that would send as strong a message as possible to the public," he says. Pineda and others believe that with time to investigate thoroughly, the states would find solid evidence of misdeeds that merit big fines. But without the evidence, banks are making convincing cases for lower fines, he says.

The harsh reality is that the fines, even at the high end, are gnat bites for the banks. For Citigroup, even $500 million is equivalent to a loss of just $1,600 for an investor with a $640,000 portfolio, notes Pineda. Investors who followed Grubman's advice should have been so lucky.

Clearly, setting arbitrary fines doesn't serve justice. And imposing an arbitrary time limit on the investigations into the banks makes matters worse.

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