Enter the judges. Until recently the class-action suits against investment banks for the excesses of the late boom have consisted of volleys from each side: briefs and accusations from the plaintiffs, motions and denials from the defense.
But in the past few months judges have finally weighed in, and as a rapper might put it, it’s all good for the shareholders. And very, very bad for Wall Street.
Last month New York federal judge Shira Scheindlin refused to let 55 investment banks out of a suit in which they are accused of manipulating the IPOs of 309 stocks. That came on the heels of a similar decision in December by Houston federal judge Melinda Harmon, who declined to excuse eight investment banks from a class action in which they’re charged with enabling and encouraging fraud at Enron.
The decisions weren’t a shock, since it doesn’t take much to keep a lawsuit going in the early stages. The surprise was that both judges took pains to suggest that they see merit in the plaintiffs’ cases. “They are harsh,” says Georgetown law professor Donald Langevoort of the two opinions. That’s especially true of the IPO ruling. “The rhetoric [Judge Scheindlin] used sends a pretty powerful message that maybe you guys ought to be talking a little more settlement with the plaintiffs,” says Duke law professor James Cox.
Scheindlin devoted 20 pages of her opinion to the history of underwriting misconduct in past booms, such as “laddering” agreements that require clients to purchase stock at higher prices in the aftermarket to gain access to a hot IPO. This is exactly what the current plaintiffs charge. If it happened before, the judge seemed to suggest, there’s a good chance it happened this time. Scheindlin even praised the plaintiffs lawyers, noting that their filings were “well drafted by competent counsel,” and she repeatedly criticized lawyers for the underwriters, in one instance accusing them of an “Alice in Wonderland-like reading of the regulations.” It’s hard to argue with the man whose name adorns the door at the feared class-action firm Milberg Weiss: “This was virtually a clean sweep for the plaintiffs,” says Melvyn Weiss, co-chief lawyer in the IPO case. (Asked if he was popping champagne, Weiss growled, “That’s your term, not mine.”)
Weiss and his cohorts can now begin discovery. That means stratospheric legal fees for the banks and, yes, a whole new battery of lawyers delving into Wall Street’s e-mail. The sides will posture and squabble, with the defendants trying to delay and limit, while the plaintiffs grab for as many documents as possible and threaten that executives could spend weeks in depositions. It all adds up to a powerful incentive for banks to seek a treaty. Cox and others think an IPO settlement could cross the billion-dollar threshold. Others say it could exceed the record-setting $3.2 billion deal in 1999 occasioned by Cendant’s book cooking.
Given the huge number of potential plaintiffs, shareholders shouldn’t expect a windfall. By the time the lawyers take their fees and the proceeds are divided among tens of thousands of investors a few years down the road, well, let’s just say all this will hurt Wall Street more than it helps you.
The investment banks, meanwhile, have begun preparing rainy-day funds to cover IPOs, Enron, the Spitzer settlement, and myriad other legal entanglements. Citigroup has set aside $1.3 billion; J.P. Morgan Chase, $900 million; CSFB, $450 million. But Georgetown’s Langevoort says they have low-balled the reserves to discourage plaintiffs lawyers from asking for even more. He expects the banks to take new charges down the line and predicts that the total bill to resolve all civil and government actions could top $20 billion, a historic number but not one that would break any bank. Unfortunately, that’s what passes for good news on Wall Street these days.