April 29, 2003

10 Wall St. Firms Settle With U.S. in Analyst Inquiry

ASHINGTON, April 28 — Prosecutors announced a settlement today with the nation's biggest investment firms that bars the head of the largest bank from talking to his analysts, details a far greater range of conflicts of interest than previously disclosed, and leaves the industry exposed both to further regulation and costly litigation.

The $1.4 billion settlement by 10 firms and 2 well-known stock analysts reached tentatively last December but completed in the last few days, resolved accusations that the firms lured millions of investors to buy billions of dollars worth of shares in companies they knew were troubled and which ultimately either collapsed or sharply declined.

The Securities and Exchange Commission, state prosecutors and market regulators accused three firms in particular — Citigroup's Salomon Smith Barney, Merrill Lynch, and Credit Suisse First Boston — of fraud. But the thousands of pages of internal e-mail messages and other evidence that regulators made public today painted a picture up and down Wall Street of an industry rife with conflicts of interest during the height of the Internet and telecommunications bubble that burst three years ago.

At firm after firm, according to prosecutors, analysts wittingly duped investors to curry favor with corporate clients. Investment houses received secret payments from companies they gave strong recommendations to buy. And for top executives whose companies were clients, stock underwriters offered special access to hot initial public offerings.

"These cases reflect a sad chapter in the history of American business — a chapter in which those who reaped enormous benefits based on the trust of investors profoundly betrayed that trust," said William H. Donaldson, the new chairman of the Securities and Exchange Commission. "The cases also represent an important new chapter in our ongoing efforts to restore investors' faith and confidence in the fairness and integrity of our markets."

In a reflection of regulators' concerns about the prospect for conflicts of interest at Citigroup, Wall Street's biggest bank, the settlement bars its chairman and chief executive, Sanford I. Weill, from communicating with his firm's stock analysts about the companies they cover, unless a lawyer is present.

But the regulators found fault with every major bank on Wall Street.

In addition to the three firms accused of fraud, five others — Bear Stearns, Goldman, Sachs, Lehman Brothers, Piper Jaffray and UBS Warburg — were accused of making unwarranted or exaggerated claims about the companies they analyzed. UBS Warburg and Piper Jaffray, were accused of receiving payments for research without disclosing such payments.

And Salomon Smith Barney and First Boston were accused of currying favor with their corporate clients by selling hot stock offerings to senior executives, who then could turn around and sell the shares for virtually guaranteed profits.

The two banks agreed to end that practice, known as spinning.

In settling the cases, the firms neither admitted nor denied the allegations, following the standard practice in resolving such disputes with the commission.

In monetary terms, the $1.4 billion in fines, restitution and other payments equals nearly 7 percent of the industry's profits last year, which was Wall Street's worst year since 1995. Of that sum, $387.5 million will go to repaying investors who file claims with the government. But armed with the regulators' findings, lawyers are sure to seek many times that total in private litigation.

The firms also agreed to abide by what officials said were significant new ethics rules and to build barriers between investment bankers and stock analysts in hopes of relieving analysts from the business pressures that many succumbed to during the 1990's. For example, the compensation of analysts is to be based on the quality of their research, not their contribution to the firm's investment banking business.

As part of the agreement, two analysts whose fortunes rose with the markets, Jack B. Grubman of Salomon Smith Barney and Henry Blodget of Merrill Lynch, agreed to lifetime bans from the industry, along with significant fines.

The singling out of Mr. Weill stemmed in part from his efforts to try to influence Mr. Grubman to change his view of AT&T — a Citigroup client that had Mr. Weill on its board — to positive from negative. He and Citigroup's other senior officers — whose contacts with the banks' research analysts are also restricted under the settlement — were the only Wall Street executives to agree specifically to such a prohibition. Any top Wall Street executive directly involved in investment banking, however, would be barred from discussions with his company's analysts under the terms of the agreements.

For all the anticipation of today's announcement, the voluminous record of complaints and damaging evidence left many unresolved questions for both investors and the securities industry.

Foremost among those was what long-term impact the settlement will have on the culture of Wall Street, the integrity of stock analysis and the confidence of investors. Concerned that the settlement might not be far reaching enough — and might also have unintended consequences — officials at the S.E.C. are considering the adoption of a new set of regulations governing stock analysts.

"It's critically important that we now step back and thoroughly examine the issues," said Harvey Goldschmid, one of the commissioners. Wondering whether the settlement might discourage research for smaller markets, he added, "No research is certainly better than skewed research, but honest research would be even better."

Critics who fear that the settlement falls short of protecting investors said that they welcomed further efforts by regulators.

"What they have imposed is a solution where they will try to regulate behavior, ethics and business practices," said Scott Cleland, the chief executive of Precursor Group and a member of a coalition of small research firms without ties to investment banks that have been seeking broader changes. "What they didn't do is address the conflict at its source — the commingling of trading, research and banking commissions.

"The analogy is that if this were an operating room, they disinfected everything but the scalpel," Mr. Cleland said. "The scalpel is left dirty."

While providing $375.5 million in restitution that can be sought by investors, the cases leave unresolved how much investors might ultimately recoup after relying on the analysts to make what turned out to have been calamitous investments. Federal and state officials said today that one aim of the settlement was to shake out enough strong evidence to assist shareholders in private lawsuits and arbitration efforts.

"This is very much the beginning," said the New York attorney general, Eliot Spitzer, whose early inquiry into conflicts on Wall Street prompted federal and market regulators to begin focusing on the issue — and who supporters say might try to ride his success in the case to the governor's office in Albany. "One of our objectives was to put information into the marketplace to permit investors on their own to seek relief."

Wall Street executives acknowledged that the findings of the regulators would probably draw more lawsuits against their firms.

"It's sort of like throwing a party and inviting a lot of people in, isn't it?" E. Stanley O'Neal, Merrill's chief executive, said at the firm's annual shareholders meeting in Plainsboro, N.J.

Government officials also emphasized today that the settlements did not preclude them from further investigation — pointedly noting, for example, that they were examining whether any top executives at the investment firms had failed to supervise the analysts adequately.

"Just wait," said Stephen M. Cutler, the head of enforcement at the commission and a leading architect of the agreement.

In addition to the restitution, the firms also agreed to pay $487.5 million in penalties, $432.5 million to pay for independent research, and $80 million for investor education. Mr. Blodget agreed to pay $4 million and Mr. Grubman $15 million to settle the charges against them.

The fines, restitution and other penalties were divided as follows: $400 million will be paid by Citigroup; $200 million each by Credit Suisse and Merrill Lynch (which includes an earlier Merrill settlement of $100 million); $125 million by Morgan Stanley; $110 million by Goldman Sachs; $80 million each by Bear Stearns, J. P. Morgan, Lehman, and UBS Warburg; and $32.5 million by Piper Jaffray.

One of the final issues negotiated involved which companies would bear the brunt of the penalties and how much might be covered by insurance polices and deductible from the firms' taxes.

Under tax law, none of the $487.5 million in penalities is deductible, and the firms agreed not to seek reimbursement under their insurance policies.

Prosecutors also inserted a clause in the settlement that might make it harder for the firms to try to deduct any of the $512.5 million in independent research and investor education.