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One of the basic truths of Wall Street is that when the government announces a probe, it will not be long before the lawsuits begin to flow. So when New York state Attorney General Eliot Spitzer reported last week that he was investigating the research practices at Merrill Lynch and other Wall Street firms, speculation immediately arose as to how quickly the private bar would take up the cause. Spitzer is alleging the firm mislead investors by issuing overly positive stock ratings of companies that also were investment banking clients. As it turns out, though, investors have been pursuing similar claims against Wall Street companies for over a year. But since the claims are typically in arbitration and not the courts, they tend to proceed unnoticed by the press or anyone else, for that matter. “The cases are already out there,” said Ross Tulman, an investment advisor in Columbus, Ohio, who frequently serves as an expert witness in securities arbitrations. “I think the legal community was onto the issue long before the attorney general’s announcement.” But others said Spitzer’s efforts will give rise to even more cases. “We’ll see more and more of these claims,” said David E. Robbins, a partner at Kaufman Feiner Yamin Gildin & Robbins and former director of arbitration at the AMEX. “Whether they’ll win is another question.” Certainly, details of the 10-month-old probe, which the attorney general made public last week, and which are available on-line at www.oag.state.ny.us, read like a plaintiff lawyer’s dream. E-mails disclosed by Spitzer show that Merrill Lynch analysts privately harbored opinions of companies that often differed dramatically from what they publicly stated in their research reports. The Internet company InfoSpace, for instance, during the time it was publicly rated “buy-buy” by the firm, was internally described as a “powder keg” and a “piece of junk” by the head of its Internet research group, Henry Blodget. Other former dot-com favorites such as [email protected] and 24/7 Media were described as “crap” and “shit” by analysts, while publicly rated “accumulate-buy.” Other e-mails show that analysts felt pressured by the banking division to tailor their coverage to its needs. “I think we are off base on how we rate stocks and how much we bend backwards to accommodate banking, etc.” read one typical e-mail. At one point, Blodget himself, apparently tired of kowtowing to the banking division, threatened “to just start calling the stocks … like we see them, no matter what the ancillary business consequences are.” Merrill Lynch has denied that it acted inappropriately and asserts that the e-mails were taken out of context. Spitzer says the e-mails provide evidence that the firm’s stock ratings were biased and distorted in an attempt to secure business for its investment banking division. Last Monday, he won a court order forcing Merrill Lynch to disclose to investors whether the firm had or intended to pursue an investment-banking relationship with the companies covered in its research reports. The order, which was issued by New York Supreme Court Justice Martin Schoenfeld, was made pursuant to the Martin Act, New York’s securities fraud statute. The firm won a stay of the order until April 19, and is reportedly in settlement discussions with the attorney general. Merrill Lynch appears to be only the first among many under scrutiny. Spitzer has said that the investigation has expanded to other companies and there are reports that practically every major Wall Street firm has received or shortly will receive subpoenas from his office. CLAIMS IN ARBITRATION Wall Street’s attention is understandably riveted on the attorney general, who has stated that he is contemplating criminal charges against firms that he believes misled investors by hyping stocks of investment banking clients. But for at least a year, private investors have been quietly pursuing such allegations themselves. Although some claims have been brought in court, most are in arbitration, where because of the private nature of the proceedings, they generate almost no publicity. Only awards are made public and their value as a resource tends to be limited since more often than not only a dollar amount is disclosed. Yet anecdotal evidence shows that claims are being made. Last July, Merrill Lynch agreed to pay an investor $400,000 for losses he alleged were incurred because of a misleading buy recommendation on Infospace stock. And last August, an arbitration panel awarded three Texas investors more than $260,000 on a claim that the investment bank Goldman Sachs & Co. misled them on a research report. The public disclosure program of NASD Regulation, which handles 90 percent of securities arbitrations, revealed at least eight complaints accusing Salomon Smith Barney’s telecom analyst, Jack Grubman, of issuing misleading stock recommendations and one against Merrill Lynch’s Henry Blodget. Experts say this is only the tip of the iceberg. Not only are NASDR records often incomplete, they said, most of the cases name only the brokerage firm and not the analysts themselves. Securities arbitration lawyers who were interviewed for this article all said they personally were involved in arbitrations claiming analyst conflicts and knew of others. Jake Zamansky, a New York lawyer who has brought two such cases, said he recently asked the audience at a meeting of the Public Investors Arbitration Bar Association if anyone had a case alleging an analyst conflict of interest. “Thirty or forty hands went up,” he said. And Tulman, the securities expert, said “it’s still early in the game.” The average arbitration takes about a year and a half to get to a hearing, he said, so cases that were filed in late 2000 are just coming up. For example, a claim against Morgan Stanley and its once-high-flying Internet analyst Mary Meeker that was filed in arbitration last May is just now being set for a hearing, according to Greenbaum & Ferentz, the Newport Beach, Calif., law firm pursuing the case. CLASS ACTIONS DISMISSED The plaintiffs’ bar has also brought a number of class action lawsuits accusing analysts and their firms of conflicts of interest. So far, most have not met with success. In one highly publicized instance last August, a federal court in Manhattan dismissed eight shareholder lawsuits against Morgan Stanley and Meeker just three weeks after filing. U.S. District Judge Milton Pollack, a widely regarded expert in securities law, said the suits, which accused Meeker of issuing overly bullish reports during the high-tech stock boom, were an example of “abusive litigation.” He described the plaintiffs’ allegations as an “entangled mass of verbiage,” filled with “a collection of market gossip,” and “in grossly bad taste.” At least six or seven conflict-of-interest cases brought in state court have also been dismissed, including one against Merrill Lynch accusing it of breaching its fiduciary duty by maintaining a positive rating on Internet Capital Group despite knowing that the company faced serious financial problems. In e-mails disclosed by Spitzer, Merrill Lynch analysts commented that the company’s stock was “going to 5″ (it closed at $12.38) at the time it was publicly rated “accumulate-buy.” The lawyer who is handling the state claims, Daniel A. Osborn of New York’s Beatie and Osborn, said in each instance, the dismissals were on technical grounds. He said he is working on revising the complaints and plans to refile sometime in the next few weeks. A class action filed in March in federal court in Houston accuses Paine Webber of misleadingly maintaining a “buy” rating on Enron Corp. stock. Another class action pending in district court in Washington against InfoSpace was amended earlier this week to add Merrill Lynch as a defendant. PROBE MAY HELP CLAIMS Lawyers said whether Spitzer’s investigation would help investor claims would depend largely on the facts of the individual case. “As an arbitrator, I recognize that everyone and his brother lost money in the past two years,” said Kaufman Feiner’s Robbins. “I ask myself, why is this case different?” He said the possible existence of an undisclosed conflict of interest is insufficient. “You need more than the appearance of impropriety,” he said. “You need substantive proof of a material omission or misrepresentation.” Robbins said arbitrators tended to shy away from the deeper level of discovery required to prove such claims. But, he added, perhaps the attorney general’s action will convince arbitrators that documents exist that should be disclosed, “like e-mails.” Class actions could still have a tough time as well, experts said. Proving a firm’s wrongdoing is not enough, said Tulman, the securities expert. “You still have to create a nexus between the stock recommendation and its purchase by the investor,” he said. In general, though, lawyers said the attorney general’s probe would help investor claims in at least two ways. First, it adds credibility to the allegation that such conflicts exist, said Fred Isquith, a partner at Wolf Haldenstein Adler Freeman & Herz, one of the firms that brought the case against Meeker. The investigation also provides plaintiffs with the kind of heavy factual backup they normally do not have access to, said Jenice L. Malecki, a New York securities lawyer. “Document discovery in arbitration is the Wild Wild West,” said Malecki, who represents both claimants and respondents. “Claimants can’t get anything they need.” She said if Spitzer were able to marshall the same level and kind of evidence he got in an earlier investigation of the on-line brokerage industry, “every Wall Street firm should be scared.”

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