With the burst of the “Internet Bubble” starting in April 2000, and running through the end of that year, investors lost an untold amount of money in the stock market. While one can debate the size of the losses, and whether the profits made investing in Internet stocks can really be counted as a loss, the fact remains that sections of the nation are examining the reason for the decline, and for some, someone to blame.
In June 2001 the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises held hearings on “across-the-board grade inflation” in stock recommendations, and the potential conflicts of interest between ostensibly objective research analysts and the underwriting divisions of the investment banks that employ them.
At the same time, the Securities Industry Association, in an effort to restore confidence in the brokerage industry, issued a press release, endorsing compilation of best practices followed by brokerage firms to ensure the ongoing integrity of securities research and analysis. The best practices — which cover, among other things, analyst compensation and stock ownership, relations with investment banking units, and disclosures — were compiled by an ad hoc committee of senior level research professionals from the SIA’s member firms.
At the same time, the SEC issued an Investor Alert on the issue. SEC Investor Alerts are typically issued to address important fraud issues in the financial community which affect investors. Past Alerts have been titled “Stock Market Fraud ‘Survivor’ Checklist”, “The Fleecing of Foreign Investors: Avoid Getting Burned by ‘Hot’ U.S. Stocks”, “Prime Bank Fraud Information Center”, “Broken Promises: Promissory Note Fraud”, “Identity Theft: Learn How To Protect Yourself”, “Affinity Fraud: How To Avoid Investment Scams That Target Groups”; well, you get the idea. The SEC’s analyst related alert, titled “Analyzing Analyst Recommendations” did an excellent job of identifying the problem with analysts and their potential conflicts, but took an incredible posture – that investors should do their own research.
The issue, in a nutshell, is that analysts have potential conflicts of interest when making recommendations. There are disclosure rules which cover most of the conflicts and no one has accused the analysts of violating those rules. The SEC is critical of the nature of the disclosure, and questions whether investors actually understand the disclosures. Additionally, there are other conflicts which are created when a brokerage firm’s investment banking arm (which handles offerings of stock) gets involved with the analysts.
These issues continued to boil during the summer. In July 2001, the press was full of reports of a settlement entered into by Merrill Lynch with an investor who claimed that he was damaged by the conduct of Henry Blodget, the well known Internet analyst at Merrill. According to the reports, Merrill paid the investor $400,000 to settle his allegations of undisclosed conflicts regarding Infoseek and JDSU.
The Blodget settlement caused a significant stir, with many commentators fearing, or cheering, a flood of lawsuits against analysts and their firms. In August, 2001, as Congressional Hearings were concluding, those suits were filed, mostly as class actions, for their bullish opinions on technology and Internet stocks.
As of August 25, four of the suits have been dismissed by a federal judge in New York.
A chronology of selected news stories follows:
Judge throws out more Meeker suits – Reuters, August 24
RPT-Analysts can breathe easier after Meeker ruling – Reuters, August 24
Judge, 94, Witnesses Span of Century – AP Financial. August 22 – The closing bell rang early on lawsuits against high-profile Internet stock analyst Mary Meeker when they landed on the desk of a 94-year-old federal judge whose first job as a lawyer came on the cusp of the Great Depression.
Judge Rejects Meeker Suit as “Gross” – Industry Standard, August 21
Investors Win Small In Analyst Dispute – LA Times, August 10 – a group of investors seeking 1.75 million dollars from Goldman Sachs and one of its analysts recovers less than $300,000.
Amazon, eBay shareholders sue analyst – Reuters, August 1 – Mary Meeker, the Morgan Stanley analyst once dubbed “Queen of the Internet” for her bullish reports on the industry, was named as a defendant in a pair of lawsuits Wednesday alleging she provided biased research on eBay and Amazon.com.
Analyst hearing could change Wall Street – CNET News, June 15
Congress getting into analyst blame game – CNET News, June 11- An upcoming congressional hearing aimed at “analyzing the analysts” of Wall Street is already drawing fire as a Republican-led partisan attempt to find a scapegoat for the deteriorating economy.
Nothing herein is intended as legal or financial advice. The law is different in different jurisdictions, and the facts of a particular matter can change the application of the law. Please consult an attorney or your financial advisor before acting upon the information contained in this article.
Return to The Securities Law Home Page
Visit Beam & Astarita, LLC