Wall Street Firms Settle Charges Over Research in $1.4 Billion Pact

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Cuthbert Richard Payne
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1 Search Quotes & Research Advanced Search Symbol(s) Name As of 11:08 a.m. EDT Tuesday, April 29, 2003 In Today's Paper Columnists Portfolio Setup Center Setup Site Map Discussions Help Contact Us Log Out Today Your Service Lind Simulated Trading-30 Days FREE! Order Free Annual Reports Order Free Fund Prospectuses FREE report >> Forbes columnist's stock market analysis Give the perfect gift: The Online Journal More Insights. Better Decisions. Visit The Business Insight Center. Visit the WSJ.com insurance archive sponsored by Liberty Mutual Get there with IBM e-business on demand. PAGE ONE Wall Street Firms Settle Charges Over Research in $1.4 Billion Pact Record Deal With Regulators Ends Probes Related to Analysts' Conflicts for 10 Firms By RANDALL SMITH, SUSANNE CRAIG and DEBORAH SOLOMON Staff Reporters of THE WALL STREET JOURNAL In a pact that could change the face of Wall Street, 10 of the nation's largest securities firms agreed to pay a record $1.4 billion to settle government charges involving abuse of investors during the stock-market bubble of the late 1990s. The long-awaited settlement, which followed an intense investigation that brought together three national regulatory bodies and a dozen state securities authorities, centers on civil charges that the Wall Street firms routinely issued overly optimistic stock research to investors in order to curry favor with corporate clients and win their lucrative investmentbanking business. The pact also settles charges that at least two big firms, Citigroup Inc.'s Citigroup Global Markets unit, formerly Salomon Smith Barney, and Credit Suisse Group's Credit Suisse First Boston, improperly doled out coveted shares in initial public offerings to corporate executives in a bid to win banking business from their companies. Regulators unveiled dozens of previously undisclosed examples of financial analysts tailoring their research reports and stock ratings to win investment-banking business. They added up to a scathing critique that scorched all the firms involved. The boss of one star analyst, Internet expert Mary Meeker of Morgan Stanley, praised her for being "highly involved" in the firm's investment-banking business. An analyst at the UBS Warburg unit of UBS AG explained she soft-pedaled concerns about a drug because its developer was "a very important client." THE STOCK-RESEARCH PACT Settlement Creates Restitution Fund Spitzer Views Salomon Notes as Key IPO 'Spinning' Comes Under Fire More Lawsuits Could Follow Deal How You Come Out in Settlement Will the Wall Street settlement eliminate conflicts of interest? Participate in the Question of the Day. See excerpts of firms' internal s released by regulators. See who's paying what and where it's going. See a gallery of key players. "I am profoundly saddened -- and angry -- about the conduct that's alleged in our complaints," said William Donaldson, chairman of the Securities and Exchange Commission. "There is absolutely no place for it in our marketplace and it cannot be ANALYZING THE ANALYSTS See complete coverage of Wall Street's settlement over allegedly conflicted research at wsj.com/analysts THE REFORMS advertisement The main points of the settlement: A clear separation of stock research from investment banking "Independent" research for investors at no cost Better disclosure of stock rankings

2 Listen to the SEC's press conference. See other resources available online. tolerated." The penalties included lifetime bans from the securities business for two former star analysts, Jack Grubman of Salomon and Henry Blodget of Merrill Lynch & Co., who were charged with issuing fraudulent research reports and agreed to pay penalties of $15 million and $4 million, respectively. Both the firms and the individuals consented to the charges without admitting or denying wrongdoing. But the regulators vowed to pursue cases against analysts and their supervisors as far up the chain of command as possible. Bowing to political pressure from Congress, the regulators, which also included the National Association of Securities Dealers, the New York Stock Exchange and state regulators led by New York's Eliot Spitzer, also won a promise by the firms not to seek insurance repayment or tax deductions for $487.5 million of the settlement payments. The agreement sets new rules that will force brokerage companies to make structural changes in the way they handle research. Analysts, for instance, will no longer be allowed to accompany investment bankers during sales pitches to clients. The pact also requires securities firms to have separate reporting and supervisory structures for their research and banking operations, and to tie analysts' compensation to the quality and accuracy of their research, rather than how much investmentbanking fees they help generate. Moreover, stock research will be required to carry the equivalent of a "buyer beware" notice. Securities firms, regulators said, must include on the first page of research reports a note making clear that the reports are produced by firms that do investment-banking business with the companies they cover. This, the firms must acknowledge, may affect the objectivity of the firms' research. In documents released Monday, the SEC singled out former star technology-industry banker Frank Quattrone of CSFB for criticism for his role in directing analysts' coverage to win investment-banking business, and for a practice known as spinning, which involves allocating hot IPO shares to executives who could steer investment-banking business to CSFB. Mr. Quattrone was charged with obstruction of justice last week by federal prosecutors for forwarding an urging colleagues to "clean up" their files shortly after he learned that a federal grand jury had issued a subpoena to the firm seeking information about CSFB's IPO allocations. Mr. Quattrone has denied wrongdoing. The SEC charged that CSFB issued Ban of IPO "spinning" $1.4 billion payout, including a $387.5 million investor fund Penalties aren't tax deductible for the firms WHO ALLEGEDLY DID WHAT Issued fraudulent research reports CSFB Merrill Lynch Salomon Smith Barney Issued unfair research, or research not in good faith Bear Stearns CSFB Goldman Sachs Lehman Brothers Merrill Lynch Piper Jaffray Salomon Smith Barney UBS Received or made undisclosed payments for research UBS Piper Jaffray Bear Stearns Morgan Stanley J.P. Morgan Engaged in spinning of IPOs CSFB Salomon Smith Barney Source: Securities and Exchange Commission FROM THE ARCHIVES Wall Street Braces for Revelations 04/25/03 SEC Ousts Thomas Weisel From Pact 04/03/03 After Settlement Comes Spin Cycle 03/31/03 COMPANIES Citigroup Inc. (C) PRICE Dow Jones, Reuters :39 a.m. Credit Suisse Group ADS (CSR) PRICE :35 a.m. Morgan Stanley (MWD) PRICE :39 a.m. UBS AG ADS (UBS) PRICE :36 a.m. Merrill Lynch & Co. Inc. (MER) PRICE

fraudulent research on two stocks, Digital Impact Inc. and Synopsis Inc.; produced misleading research on Numerical Technologies Inc., Agilent Technologies Inc.

3 fraudulent research on two stocks, Digital Impact Inc. and Synopsis Inc.; produced misleading research on Numerical Technologies Inc., Agilent Technologies Inc. and Winstar Communications; and failed to disclose ownership stakes by the firm and two analysts in NewPower Holdings Inc. 11:39 a.m. Goldman Sachs Group Inc. (GS) PRICE :39 a.m. At Digital, a CSFB analyst twice attempted to drop coverage of the stock based on concerns about the company's competitive position, but was talked out of it by two investment bankers and left his "buy" rating on for nearly another month, the SEC said. At Synopsis, a CSFB analyst explained in an that he rated the company a "strong buy" in order "not to annoy the company, or [investment] banking personnel." On one occasion, the SEC alleged, Mr. Quattrone urged certain bankers and analysts to threaten to drop coverage of a company, Aether Systems Inc., in an effort to obtain a lead manager's role in a securities offering. In an on Jan. 29, 2000, Mr. Quattrone reminded colleagues: "[W]e have agreed on the script, which is books" -- meaning the lead manager's role -- "or walk and drop coverage." CSFB and Mr. Quattrone declined to comment. U.S. Bancorp (USB) PRICE Merrill Lynch, which settled a probe by Mr. Spitzer a year ago, was charged with fraud for its research on GoTo.Com and InfoSpace Inc. and for making exaggerated statements about certain stocks, including Excite@Home Corp., Internet Capital Group Inc. and Homestore.Com. An released Monday showed a Merrill analyst shared his unpublished research reports with top management at Tyco International Ltd. In a February to the Tyco finance chief, the analyst attached his unpublished report and asked the executive to "Please review ASAP. I will not send it out until I hear from you first! Loyal Tyco employee!" Although Morgan Stanley officials have crowed that their firm's settlement payments were smaller than those of some major rivals, the SEC said the firm paid its analysts based in part on the amount of investment-banking business they brought in. Morgan was also accused, along with other firms, of failing to ensure that investors were informed that it had paid other firms to provide research coverage of companies that were Morgan's investment-banking clients. The alleged conflicts between Morgan's research and investment-banking divisions are demonstrated in performance reviews of analysts including Ms. Meeker, once known as Queen of the Net. In Ms. Meeker's 2000 review, her boss, Dennis Shea, described the analyst as being "highly involved" in investment banking. "You continue to drive our Internet business on the primary side, and are very involved in the M&A [mergers and acquisitions] assignments as they come up and as you can be brought over the wall on them...," he wrote. (See .) In her 1999 self-evaluation, Ms. Meeker said: "Bottom line, my highest and best use is to help MSDW [Morgan Stanley Dean Witter] win the best Internet IPO mandates (and to ensure that we have the appropriate analysts and bankers to serve the companies well) and then to let them work their way through our powerful research and distribution system." (See .) Morgan Stanley said it was "pleased that there were no allegations of fraud or violations of federal securities law" against the firm or its people, and no findings that its analysts "reported :38 a.m. RELATED INDUSTRIES Banking * At Market Close Financial Services & Insurance Personalized Home Page Setup Put headlines on your homepage about the companies, industries and topics that interest you most.

4 anything other than their honestly-held beliefs." At another blue-chip firm, Goldman Sachs Group Inc., regulators found analysts were also paid in part based on their participation in banking-related activities. Analysts were allegedly required to prepare business plans that discussed, in part, what steps the analysts planned to take to aid banking efforts. In one , former Goldman analyst Craig Kloner, when asked by the firm what his three most important goals were for 2000, wrote: "1. Get more investment banking revenue. 2. Get more investment banking revenue. 3. Get more investment banking revenue." (See .) Mr. Kloner died last year. A Goldman spokesman said the firm is committed to upholding the principles of the settlement, saying: "With the benefit of hindsight it is clear we all could have done better." At UBS Warburg, regulators charged that six research analysts were promised "investmentbanking bonuses" based on the investment-banking fees they helped win. And two analysts from the firm's PaineWebber unit were promised compensation equal to 15% of underwriting fees that the firm earned in their sectors. When a decision by the Food and Drug Administration in December 1999 delayed the release of a drug by Triangle Pharmaceuticals Inc., a UBS investment-banking client, sending the stock down 23%, the UBS analyst who covered Triangle said she wasn't completely surprised despite her "buy" rating on the stock. Questioned by a UBS executive, the analyst explained Triangle was "a very important client. We could not go out with a big research call trashing their lead product, although we had a feeling the FDA might balk." UBS says it "fully supports efforts to restore investor confidence." At the Piper Jaffray unit of U.S. Bancorp, the SEC charged, analysts helped pitch for deals at meetings with potential underwriting clients. In an August 2000 pitch to be lead manager of an offering by TheraSense Inc., a Piper analyst prepared a mock research report labeled "Strong Buy," claiming that initial sales of a product were "nothing short of breathtaking." After Piper won the underwriting assignment, which carried fees of $3.8 million, the analyst began coverage with a "strong buy." Piper Jaffray said it strongly supports the proposed reforms. At Lehman Brothers Holdings Inc., regulators found analysts' pay was tied to their success in pulling in banking business. For example, six of Lehman's roughly 100 senior research analysts had employment contracts linking their bonuses directly to investment-banking revenue from companies they covered. A Lehman analyst who covered Razorfish Inc. wrote to an institutional investor: "Ratings and price targets are fairly meaningless anyway... but, yes, the 'little guy' who isn't smart about the nuances may get misled, such is the nature of my business." Lehman declined to comment, saying it is happy to have the matter behind it. At Bear Stearns Cos., regulators charged, analysts were "encouraged" to work closely with bankers. At one meeting, the head of research told analysts, "being a partner to banking is part of your job." Several s showed a disparity between what Bear analysts were saying publicly and privately. One analyst who kept a "Buy" rating on CAIS Internet Inc. from the time Bear Stearns managed its IPO in 1999, wrote to colleagues in January 2001 asking if there was "any other scoop on this piece of [expletive]?" The securities unit of J.P. Morgan Chase & Co. was also charged with allegedly exerting

5 "inappropriate influence" by investment bankers over analysts. Regulators also charged J.P. Morgan with promising companies an "extended warranty" of positive research in exchange for banking business. The firm declined to comment. Write to Randall Smith at Susanne Craig at and Deborah Solomon at Updated April 29, :08 a.m. Sponsored by Return To Top Corrections Contact Us Help About Dow Jones Mobile Devices Setup Account Information Privacy Policy Subscriber Agreement Copyright 2003 Dow Jones & Company, Inc. All Rights Reserved Copyright and reprint information.

Lawyers sued over advice to board

Lawyers sued over advice to board Misrepresentation, negligence Publicly held company Number of employees Over 1,000 Approximately $2 billion A large public company misstated its revenue during three quarters