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Customers Gearing Up to Sue Merrill

Success in Arbitration May Not Be Easy. Considerations for Investors Seeking to Sue Merrill for Analyst Recommendations.

By Mark J. Astarita, Esq.  

On May 21, 2002 New York State Attorney General announced a settlement of his office's lawsuit against Merrill Lynch, whereby Merrill Lynch would pay $100 million and agree to modifications in its procedures regarding analyst compensation and their interaction with the investment banking side of the business. The full text of the press release is online, as is the settlement agreement itself.

As most readers are well aware, the settlement arises from allegations by the Attorney General that Merrill's research analysts were too close to the investment side of the business, and that the research department had become a marketing arm of the investment banking division, nearly trading "buy" recommendations for investment banking business, and recommending some securities as a "buy" while calling them "pieces of crap" in private. The Attorney General's allegations, as contained in an affidavit filed in the New York State Supreme Court was an eye-opener for even the most seasoned securities professional, as the affidavit makes the claim that while the Merrill research analysts were putting buy recommendations on securities, they were calling those same securities "pieces of crap" in private emails. The full text of the affidavit is available at the Attorney General's web site.

While the $100 million settlement is a significant sum of money, it is important to keep in mind that Merrill's gross profits are in excess of 20 billion dollars a year, and it spends more than $200 million every year in postage and office supplies. Additionally, none of the funds will go to investors, the funds will go to the State of New York and the 49 other states, as well as the securities regulators of those states. Investors will have to commence their own actions in order to recover their losses.

According to press reports, investors are scrambling to bring lawsuits against Merrill Lynch for fraud in connection with the stock recommendations. Merrill's estimated liability is in excess of 5 billion dollars, according to the New York Times. Large ads have sprung up in major newspapers and on the Internet by securities arbitration attorneys, non-securities attorneys, and "arbitration specialists", individuals who are not lawyers, who profess to have some expertise in representing customers in arbitration.

The ads make it sound very easy - some simply say "Have you purchased the technology or Internet related securities recommended by Merrill Lynch between 1999 and 2001? Call us" Of course, securities arbitration is not that simple, and the mere fact that a customer purchased technology or Internet stocks from Merrill is not enough to win an arbitration. I have written extensively on the process of securities arbitration, and for those readers who are interested, I would recommend reading my columns Introduction to Securities Arbitration, Typical Customer Claims in Arbitration and Introduction to the Federal Securities Laws.

The securities laws are not simple, and a securities arbitration is unlike most other dispute resolution mechanisms. While securities arbitrations can, in theory, be handled by most attorneys, the process itself is unique, and the myriad of rules and regulations creates an extensive hurdle for the non-securities attorney to overcome in the successful representation of a customer against a major brokerage firm. Clearly, in the face of a potential 5 billion dollar liability, Merrill Lynch is going to be represented by experienced securities litigators. Customers who rely upon anything less will start the litigation with one hand tied behind their backs.

It will not be enough for investors to merely prove that they purchased the securities mentioned in the Spitzer lawsuit. First, the Spitzer affidavit only addresses the securities of 7 issuers - Excite@Home, Infospace,, Aether System, Internet Capital Group, Lifeminders and 24/7 Media. Merrill had recommendations out on numerous securities, not only these. Second, the affidavit covers only particular time periods when recommendations were made while analysts were denigrating the stocks in private. Third, there is a legal obstacle to overcome. Legally, the settlement is not an admission by Merrill Lynch of any wrongdoing. Of course, arbitrators are not bound by the rules of evidence, and investors may be able to introduce the settlement in their arbitrations, but this is by no means a foregone conclusion.

While the Attorney General's investigation and settlement is to be commended, one is left wondering what the actual benefit is to investors. Not only do customers not get portion of the fines, the settlement was made without an admission by Merrill Lynch, and, in theory, cannot be used by investors in their own lawsuits. Certainly their cases are bolstered by the settlement, but investors may have to prove the allegations of the Spitzer affidavit at their individual arbitrations, and discovery may need to be conducted to obtain the emails and documents referenced in the Spitzer affidavit. Additional discovery will be required to determine if similar allegations can be made regarding the other securities recommended by Merrill Lynch.

One cannot help but wonder why the Attorney General did not push Merrill for an admission, or for a stipulation that Merrill would not contest the allegations in individual arbitrations, as was done during the Prudential limited partnership investigations and settlements. The situation is, that he did not do so, and investors must deal with this issue.

While it is entirely possible, and plausible, that arbitration panels will accept the Merrill settlement as evidence of wrongful conduct, investors may be required to prove those allegations in their own arbitration. Given the settlement, the task is not difficult, but given the complexity of the issues, with limited discovery opportunities, such a process is not for the inexperienced. The process will be further complicated if investments were made in securities which are not the subject of the Attorney General's action, or if investments were made outside of the time frames set forth in the affidavit.

In addition, investors will have to prove at their hearings not only that the recommendations were false or misleading, but that the investor himself relied upon those recommendations. An essential element of a fraud claim is not only that there was a false or misleading statement, but that the investor relied upon that misrepresentation. There are a number of ways to prove reliance, other than the obvious, and this article is not intended to be a treatise on proving a fraud claim in arbitration. The point is, that contrary to the advertisements and some commentary, it is simply not enough to prove that the investor purchased the security in question, he must prove that he purchased the security, or held the security, in reliance upon the recommendation of the firm.

The investor must also prove that his losses were occasioned by the foregoing, and he must establish the amount of those losses. Again, it is not sufficient to merely present a damage calculation; the damages must be caused by the wrongful conduct.

Another important point that is overlooked is that many investors may have claims against Merrill that are not directly related to the analyst issue. For example, if a customer's portfolio was overconcentrated in Internet or technology stocks, that in and of itself may be wrongful conduct on the part of Merrill, and may have little to do with the analyst issues. An investor, or attorney, who brings a case relying solely on the analyst issue may be missing additional causes of action, and additional damages.

The Attorney General's investigation resulted in serious allegations regarding the Merrill analyst and investment banking departments. However, that revelation does not mean that every investor is entitled to recover his losses, and investors should carefully consider whether their losses are recoverable, before undertaking the time, and expense, of pursuing claims against Merrill, or any other brokerage firm.

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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Copyright 2010. VGIS Communications LLC. All Rights Reserved. VGIS Communications, LLC - 41 Watchung Plaza, Suite 249, Montclair, New Jersey 07042 - 973-559-5566. 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 adviser before acting upon the information contained in this article. For additional information, contact Mark J. Astarita, Esq., a partner in the law firm of Beam & Astarita, LLC, who represents clients in a wide variety of finance related matters. Mr. Astarita can be contacted by email at

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