In a related column, I addressed the impact that the May 21, 2002 settlement by Merrill Lynch with the New York State Attorney General might have on customer arbitrations, and readers should review that column for details about the settlement and its effects. The full text of the press release is online, as is the settlement agreement.
The Merrill analyst issue, and the Spitzer settlement have an obvious impact on Merrill Lynch brokers themselves. When customers sue, they may very well sue their brokers as well.
For customers who sue over the analyst recommendations themselves, without other causes of action, some brokers may have a defense to a claim that the recommendations were false or fraudulent. Naturally, such defenses are extremely fact specific, and will not apply in all cases, but brokers will undoubtedly argue that in recommending particular securities to their customers, that they were in fact relying on the recommendations of the firm, that they were entitled to rely on those recommendations, and that they had no knowledge of the false nature of the recommendations. If the facts fit, that defense should be successful for the individual broker with respect to a false recommendation claim.
Of course, that defense provides no defense to a customer’s claim of unsuitability, overconcentration, failure to diversify or churning, which will be contained in many of these lawsuits, but the fact remains that individual brokers, in the “usual” case, should not be liable for the false or misleading recommendations of Merrill analysts, assuming of course that they were not aware of the false or misleading nature of same.
However, according to certain press reports, it appears that Merrill Lynch is preparing to blame its own brokers for the investor losses arising from these recommendations. Clearly Merrill has a series of problems in its research department, and many of the stocks that it was recommending to its customers were “pieces of crap” where Merill was simply attempting to obtain investment banking business.
The New York Times reported on May 25, 2002, that Merrill was creating a new defense with respect to one particular security. In one lawsuit, according to the Times, an internal Merrill memorandum has been used, which said that a particular Internet fund “was never marketed directly to clients, but to Merrill Lynch financial advisers sophisticated investment professionals who manage client accounts and make their own decisions about the suitability of products for their clients based on a myriad of factors.”
While the Times did not disclose the date of the memorandum, if that allegation is true, Merill is looking to insert its retail brokers in-between the firm and its analysts, and will attempt to blame the brokers for making the recommendations of the touted securities to investors. For those of you still having doubts, the Times has additional comments from Merrill executives and spokesmen. According to the Times, “James Gorman, who runs Merrill’s brokerage operation, declined to explain that position” and “James Wiggins, a Merrill spokesman, said that the firm’s analysts ‘do not make specific recommendations to specific clients.’ ‘That’s the job of a financial adviser,’ he said. ‘It’s ultimately between the financial adviser and the client.'”
According to the Times, Merrill is setting its brokers up to take all or part of the fall. When an individual investor sues over the rogue recommendations, Merrill is going to claim that it did not recommend the securities to the customer, that its research department recommended the securities, but that the broker is the one to blame since he recommended the security to the customer.
I’m assuming that the Times quotes are accurate. If they are, Merrill is planning to sacrifice its retail brokers to save its own corporate skin.
We all know that Merrill, at best, screwed up and let its analysts get too involved with the investment banking side of the business. We all know that Merrill set up a compensation scheme for its analysts where the conflict was inherent, since they paid research analysts based on investment banking business generated by them. To be generous, Merrill screwed up. To some, that was not accidental, but rather was intentional fraudulent conduct by the firm, designed to dupe investors.
But the point is not whether the conduct was negligent or intentional, the point is that the Times is reporting that Merrill is setting itself up to blame the brokers for the misconduct of Merrill and its analysts. Why? The total potential liability for Merrill in this fiasco is 5 billion dollars. While the 100 million dollars is significantly less than what Merrill spends on postage and office supplies in a year, 5 billion dollars is not chump change.
This allegation provides an interesting insight into Merrill Lynch. On one level it is attempting to put the brokers in the middle, telling the brokers to tell their customers “if you sue, you will be suing me.” Merrill is clearly attempting to save its own corporate skin by playing off of the relationship between its brokers and their customers. The fact is, that many customers have close relationships with their brokers, and will not want to sue the broker. The second level of the strategy is more insidious. Most of Merrill’s brokers have written contracts with the firm, and many of those contracts have what lawyers call an indemnification provision. It provides, in essence, that if the broker has caused any losses to the firm, that the broker will pay Merrill for the losses. Even without the contract, Merrill has a legal argument that if the broker is the wrongdoer, the Merrill is entitled to have the broker pay any of the losses to investors. Merrill apparently intends to have its brokers pay part of that 5 billion dollars in losses.
Using the brokers as a shield might be a clever corporate ploy, but it also demonstrates what is important to Merrill Lynch; and that is certainly not its brokers. The defense is not of significant concern to investors, as Merrill, like every other employer, is responsible for the actions of its employees. If an arbitration panel decides that the broker was wrong, Merrill and the broker are both responsible to pay the investor, and the investor will recover his losses. If it turns out that the brokers were providing information to customers that Merrill provided to them, and that information was false or misleading, without the broker’s knowledge, then Merrill will be held responsible.
However, the claim that it was the broker’s fault will give Merrill the opportunity to collect money from the brokers, and to offset its own liability by obtaining all or part of the award from the broker.
I am not saying that this is a valid defense, and if a broker relied on the recommendations and representations of Merrill in making recommendations to his customers, Merrill, not the broker, should be the responsible party. Of course, every case is different, and these determinations are all fact specific. I have provided a more detailed analysis of this liability in a related column.
But the point is not just liability, it is loyalty. Brokers themselves will be the defendants in customer arbitrations, and none of this affects a broker’s liability for suitability, churning, overconcentration or other causes of action, and perhaps even for the recommendations themselves. However, if the Times’ story is correct, Merrill is attempting to manipulate its own brokers, in the first instance to use them as a shield, and attempting to have the brokers use their personal relationships with their customers to stop the filing of arbitrations. At the same time, Merrill is setting up a defense for itself to argue that liability should ultimately rest with the broker, not Merrill. The claim will be, as stated by the Merrill spokesman quoted above, that the firm’s analysts “do not make specific recommendations to specific clients…That’s the job of a financial adviser…It’s ultimately between the financial adviser and the client.”
Who said loyalty and honor was a hallmark of the securities industry?
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.
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