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Penalties Just The Start For Errant Banks

Apr 28, 2003 | FT.COM

Ten investment banks reached a final agreement on Monday to settle conflict of interest claims with US state, federal and industry regulators.

The $1.4bn agreement is the most expensive bill in history to settle violations of securities laws, and in an effort to minimise problems in the future It includes strict rules governing the relationship between investment bankers, who raise capital and merge corporations, and research staff, who offer insight into the stocks of those clients for individual investors.

Some critics have said the penalties are not high enough. For instance, Citigroup's penalties of $400m are the largest, but are a pittance compared with the $15.3bn in net income the world's largest financial services group reported last year. Still, the biggest cost to banks is not the penalties it is the blight on their reputations.

Evidence of alleged misconduct during the investigations was released along with the settlements and will continue to exact a toll both on the reputation of Wall Street and on investor confidence.

One Lehman analyst had written in an email released on Monday that "the 'little guy' who isn't smart about the nuances may get misled, such is the nature of my business". Not any more, say regulators. Now divisions between investment bankers and analysts will be maintained and disclosure will be strengthened.

The settlements were reached between regulators including the Securities and Exchange Commission, National Association of Securities Dealers, the New York Stock Exchange, the New York State attorney-general, and other state agencies and investment banks Bear Stearns, Citigroup, Credit Suisse First Boston, Goldman Sachs, Lehman Brothers, JP Morgan Chase, Merrill Lynch, Morgan Stanley, UBS, and US Bancorp Piper Jaffray. Several of the banks have said they would implement the new rules worldwide.

Two individuals, former Citigroup analyst Jack Grubman and former Merrill analyst Henry Blodget, also settled. Both are barred from the securities industry. Mr Grubman will pay $15m in penalties and Mr Blodget will pay $4m. The individuals and banks have neither admitted nor denied the charges against them.

Regulators say all 10 groups failed to maintain appropriate supervision over their research and investment banking operations in violation of NASD and NYSE rules.

CSFB, Merrill Lynch and Citigroup are charged with issuing fraudulent research reports in violation of the Securities Exchange Act of 1934 as well as various state statutes. Bear Stearns, CSFB, Goldman, Lehman, Merrill, Piper Jaffray, Citigroup and UBS are accused of issuing research reports that were not based on principles of fair dealing, did not provide a sound basis for evaluating facts and contained exaggerated claims. These are considered violations of NYSE and NASD rules, as well as state ethics statutes.

UBS and Piper Jaffray are accused of being paid for research and not disclosing the payments, a violation of the Securities Act of 1933 as well as NYSE rules. Those two, as well as Bear Stearns, JP Morgan and Morgan Stanley are also alleged to have made undisclosed payments to others for research.

CSFB and Citigroup are alleged to have engaged in inappropriate "spinning" of hot IPO allocations and to have broken record-keeping rules. As part of the settlement, all of the banks agreed to stop giving clients shares of IPOs with the aim of winning investment-banking business.

The investment banks will pay penalties totalling $875m, including a previous payment of $100m by Merrill Lynch when it settled with states last year. They will not be allowed to treat the civil penalties as tax deductible or eligible for reimbursement under insurance policies.

In addition, the banks involved will be required to pay $432.5m to provide investors with research from groups with no banking ties for five years. Seven will make payments totalling $80m for investor education.


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