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Wall St. Investment Firms to Pay $1.4 Billion In Fines

Apr 29, 2003 | AP Securities regulators Monday detailed a settlement that will cost 10 big Wall Street firms at least $1.4 billion and require them to adopt reforms to resolve allegations they issued biased stock ratings to lure investment banking business.

One of the largest penalties ever levied by securities regulators, it follows a lengthy investigation by the Securities and Exchange Commission, New York Attorney General Eliot Spitzer, other state regulators and market regulators. The settlement, based on a tentative agreement reached in December, will change the way major investment firms including Citigroup, Merrill Lynch and J.P. Morgan Chase--do business.

''These cases are an important milestone in our ongoing effort both to address serious abuses that have taken place in our markets and to restore investor confidence and public trust by making sure these abuses don't happen again,'' SEC Chairman William Donaldson said at a news conference at the agency's Washington headquarters.

What firms will pay

A breakdown of how Monday's $1.4 billion settlement between securities regulators and 10 Wall Street firms will be paid by the individual firms. The amount listed for each firm is its total outlay.

Donaldson, a former chairman of the New York Stock Exchange and co-founder of a major Wall Street investment firm, said he was ''profoundly saddened and angry'' about the conduct detailed in the regulators' complaints. Allegations against Merrill Lynch, Credit Suisse First Boston and Salomon Smith Barney reached the level of securities fraud.

Barbara Roper, director of investor protection for the Consumer Federation of America, cautioned investors not to ''rush to bestow renewed trust on Wall Street firms.''

''There are too many questions that only time will answer about the effectiveness of the new requirements,'' Roper said.

A fund of more than $387 million will be set up for customers of the 10 firms; the remainder of the fines will go to the states. The airing of the regulators' allegations could open the way for a flurry of private lawsuits against the firms by investors who believe they were defrauded.

Said Spitzer: ''It will take time, but because we put all this information in the public record, investors will be able in due course to recover the funds that they lost on false research.''

Under the settlement, two former star analysts: Internet expert Henry Blodget of Merrill Lynch and telecommunications analyst Jack Grubman of Citigroup's brokerage business, Salomon Smith Barney have agreed to pay $19 million in fines and penalties and be banned permanently from the securities industry to settle fraud charges. Blodget and Grubman are neither admitting nor denying any wrongdoing.

Grubman will pay $15 million for undisclosed conflicts. He faces a lifetime ban from working for an investment firm or acting as an investment adviser, dealer or broker.

Blodget will pay $4 million.

The SEC filed formal complaints Monday in federal court in Manhattan against the firms, Blodget and Grubman, and outlined the terms of the settlement to the court.

The five SEC commissioners had discussed the settlement in closed-door meetings last week before approving it. In the final deal, the Wall Street firms will not be able to deduct any of the payments against their taxes a change from the tentative accord.

The settlement with the brokerage firms will require that certain analysis from an investment house would have to be made public within 90 days after each quarter concludes to allow investors to compare the performance of analysts from different firms and promote objective rankings.

Brokerages will also be banned from allocating to executives and board directors preferential access to initial public offering shares of firms they have courted as investment banking clients.

An independent monitor will be assigned to each firm to make sure the terms of settlement are met. An $85 million investor education program is also being created at the expense of the brokerages. Brokerages would pay $450 million over five years into the independent research fund.

The firms neither admitted nor denied that they had misled investors, although Citigroup agreed to a statement of contrition. The investigation was based on internal e-mails in that the firms' financial analysts privately derided stocks they were touting to the public.

Salomon Smith Barney, a unit of Citigroup, will pay the heaviest fine: $300 million. Citigroup will also provide $75 million toward an independent research fund and $25 million toward an investor education program. But Citigroup CEO Sanford Weill won a guarantee that he would not be prosecuted.

At Morgan Stanley Co., regulators found the firm failed to manage conflicts of interest between its investment banking and research divisions and failed to properly supervise senior researchers. Morgan Stanley will pay a $50 million penalty as well as $75 million toward the independent research fund.

Last May, Merrill Lynch, the nation's largest brokerage, agreed to a separate settlement that included a $100 million fine and the separation of its analysts from investment banking. Under the settlement detailed Monday, Merrill will pay an additional $100 million toward the independent research fund and an investor education program.

Other firms included in the settlement were: Bear Stearns, Goldman Sachs, Lehman Brothers, US Bancorp Piper Jaffray, UBS Warburg (now UBS Paine Webber).

The trail of e-mail excerpts in hundreds of documents filed in federal court in Manhattan Monday gave form and color to the allegations made by Wall Street regulators for months.

Regulators say the internal messages show the conflicts of interest by analysts and their firms using inflated stock ratings to land investment banking clients:

* An e-mail within Morgan Stanley explained that analyst Chuck Philips ''was instrumental in our winning'' investment banking business.

''The call we received Monday of this week is an example of how powerful Chuck's coverage has become a $2 billion merger of a company we do not cover at all was awarded to us on the explicit condition that they could attract Chuck's coverage.''

Morgan Stanley won two equity transactions from Veritas ''just for promising that Chuck would pick up coverage after the deals.''

Merrill Lynch Internet stock analyst Henry Blodget was less exuberant when corresponding with clients about the companies he regularly promoted in research:

In January 2001 when Blodget started covering Internet portal GoTo.com, a client asked him in an e-mail, ''What's so interesting about Goto except banking fees????'' Blodget replied, ''nothin.''

In a May 6, 2001 e-mail to an institutional client, Blodget said GoTo and another stock ''have had very strong runs and are overdone, in my opinion.'' But less than three weeks later, Merrill Lynch reiterated its positive rating for GoTo, without disclosing Blodget's negative views.

Hundreds of employees in Citibank's retail sales force were critical of star analyst Jack Grubman in internal evaluations in 2000-01:

*Grubman was called a ''poster child for conspicuous conflicts of interest.''

*''I hope Smith Barney enjoyed the investment banking fees he generated, because they come at the expense of the retail clients.''

*''His opinions are completely tainted by 'investment banking' relationships.''

*''Investment banker, or research analyst? He should be fired.''

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