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Wall Street Firms Facing Wave Of Investor Lawsuits

Jan 15, 2003 | Wall Street Journal

Wall Street firms are emerging from a $1.4 billion settlement with securities regulators over alleged conflicts between their stock research and investment banking departments. Now, the private litigation barrage has begun.

Monday, a law firm filed roughly 100 arbitration claims on behalf of investors against Citigroup Inc.'s Salomon Smith Barney and its former star telecom stock analyst, Jack Grubman, alleging that they misled investors with overly rosy research on WorldCom Inc., the former telecommunications high-flier that filed for bankruptcy last year.

Another group of plaintiffs' attorneys is preparing to soon file as many as 2,000 arbitration cases against both Salomon Smith Barney and Merrill Lynch & Co., making similar claims.

The actions won't necessarily argue that investors were hurt by bad stock-picking calls.

Instead, they will make a novel claim: that the Wall Street firms did not disclose to investors that their analysts issued the research reports to help win investment banking business such as mergers and stock underwriting work for their firms.

Both sets of claims aim to piggyback on findings that regulators already have released alleging that analysts at both Wall Street firms issued overly optimistic research reports to win banking business.

In the next few weeks, regulators will file additional findings against the firms as part of the $1.4 billion settlement, which was announced in December.

The unusual filings underscore that Wall Street still has problems with alleged conflicts between the two halves of securities firms' operations: investment banking and stock research.

Investor complaints are likely to continue after regulators release additional details of the civil allegations against several major securities firms.

So far, regulators have released only specific information, such as e-mails, detailing their case against Merrill Lynch and Salomon Smith Barney.

"The amount of money these firms have forked out to date is indicative of past structural problems, and it is expected more e-mails and the like will soon be released by" regulators, says Henry Hu, a corporate and securities law professor at the University of Texas.

"In some ways, what has been paid so far out may only just be the beginning," Hu says. "This type of evidence might well be helpful to plaintiff attorneys in proving their case, and potentially financially troubling to Wall Street."

A Salomon spokeswoman said that, based on its review of similar claims, the firm believes these actions will be without merit. A Merrill spokesman said the firm will defend itself against this "baseless litigation."

It is unclear whether the claims will be successful. Regulators have aired damaging e-mails that show some Wall Street analysts felt pressured by investment bankers to publish glowing research reports, and in some cases didn't believe in the stocks they were recommending that investors buy.

And although Wall Street firms long have maintained that they keep what the securities industry calls a "Chinese Wall" separating their research and investment banking operations, until recently many analysts were paid partly for the amount of banking business they brought in.

But lawyers filing these cases are arguing that these firms failed to disclose material information that, if conveyed to their clients, would have influenced the clients against investing in the stock.

No major arbitration cases relating to Wall Street research have made this claim, according to arbitration specialists.

Until now, investors who have successfully taken on Wall Street over analyst research have demonstrated that they relied on the research in making investment decisions.

For instance, in July 2001, Merrill paid $400,000 to settle a case brought against it by Debases Kanjilal, a 46-year-old pediatrician, who bought shares of InfoSpace Inc. in March 2000.

He says he maintained the position despite the stock's decline based on bullish reports issued Henry Blodget, the former Merrill tech-stock analyst.

Kanjilal later had a loss of more than $500,000 as the stock crumbled, the claim says.

Among the lawyers preparing to handle the 2,000 claims is Boyd Page, who has experience in going up against Wall Street.

Page, an Atlanta lawyer, filed dozens of claims against Prudential Securities in the early 1990s after its limited-partnership scandal; he says the vast majority of the research claims are on behalf of investors who lost less than $25,000.

An investor with a complaint against a brokerage firm is almost guaranteed to end up in arbitration, as brokerage contracts generally require customers to go that route, rather than to court.

Most securities-arbitration panels consist of three people, one selected by the industry and two from the public.

For claims seeking less than $25,000, the NASD requires just one arbitrator.

These claims typically are less complicated and often take less time to rule on because they don't require a panel.

Often, many lawyers don't bother pursuing such small cases, but in bulk they can be lucrative: Lawyers typically receive one-third of any arbitration awards, or settlements.

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