NEW YORK - The nation's biggest brokerage firms have agreed to pay almost $1 billion in fines to end investigations into whether they issued misleading stock recommendations and handed out hot new shares to curry favor with corporate clients, people involved in the negotiations said yesterday.
The firms, about a dozen in all, have also agreed to sweeping changes from the way research was done on Wall Street and new stocks were distributed during the boom of the 1990s.
As part of the settlement, which is expected to be announced today, the firms will pay an additional $500 million over five years to buy stock research from independent analysts and distribute it to investors. The agreement is not final, but regulators were rushing yesterday to prepare an announcement to put an encouraging cap on a year fraught with corporate scandal.
The agreement is a result of roughly five months of fractious negotiations between the firms and securities regulators. It is intended to force Wall Street to produce honest stock research and to protect analysts from pressure within the firm to issue upbeat forecasts to attract investment banking fees. Under the terms of the deal, brokerage firms will also be barred from dispensing hot stocks to top executives or directors of public companies.
The broad agreement does not include the punishment of any Wall Street analysts or executives who supervised them, though state and national regulators may still pursue investigations of some analysts. That means Sanford I. Weill, chairman of Citigroup, would not be charged with any violations of securities laws under the agreement. Weill has said that he asked Jack B. Grubman, who was a star analyst at Citigroup, to take a fresh look at his negative rating on AT&T; stock in 1999. Grubman, who has been criticized for being too cozy with corporate clients, may still be singled out and punished. Regulators plan to fine him more than $10 million and bar him from the securities industry for life in a separate settlement, people involved in the investigations said.
"The objective throughout this investigation has been to protect small investors by ensuring integrity in the marketplace," said Eliot Spitzer, attorney general of New York, who was a lead negotiator of the settlement. "Hopefully, the rules that are embodied in this potential settlement will restore investor confidence by restoring integrity to the marketplace."
Regulators may not provide much more evidence of wrongdoing until the settlement is officially drawn up next year.
In agreeing to the fines, the firms would neither admit nor deny charges that they had misled investors. It is not clear how much of the fines will go to a restitution fund for investors.
The money will be split about evenly between the national regulators and the states. Half the proceeds will go to the national regulators, the Securities and Exchange Commission, the NASD and the New York Stock Exchange. The states will divide their share of the proceeds using a formula based largely on population.
Christine A. Bruenn, president of the North American Securities Administrators Association, said last night: "We're very, very close to a resolution of these matters. A settlement will help restore faith in our markets if it changes the corporate culture, metes out meaningful penalties, gives investors independent research and the facts that they need."
Under the corporate governance law passed this year, fines collected by the SEC must go to a restitution fund. But state regulators argue that it is too difficult to determine exactly who is owed restitution relating to research offenses. They say some of the money may go toward investor education, but much of it may go into states' treasuries.
"It would be nice if some of the more egregious violators were punished," said Alan R. Bromberg, professor of corporate and securities law at Southern Methodist University. Bromberg said he was disappointed that investors would not recoup more from the firms.
"To an extent, it's always individuals who are responsible for wrongdoing," Bromberg said. "This sort of settlement smoothes that over so there's only corporate or institutional responsibility, not individual responsibility."
The expected settlement came roughly a year and a half after Spitzer began to uncover deep conflicts of interest in Wall Street research. Some analysts recommended stocks to investors not because of their prospects but because the analysts could share in the investment banking fees that rosy research helped generate. Investigators from other regulatory organizations, including the SEC, NASD and the New York Stock Exchange, later joined Spitzer in putting Wall Street practices under the microscope and showed that allocations of hot new stocks had been heaped on executives of companies that could bring additional banking business.
Individual investors, meanwhile, were relying heavily on the research coming out of Wall Street firms, not knowing that much of it was biased. Individuals were typically shut out of new stock offerings and could buy such shares only after they had risen significantly in price.
As a result, dubious research and preferential treatment in the allocation of hot new shares contributed to vast losses by individual investors in the sharp stock market fall of the past 2 1/2 years. Revelations about the nature and extent of the unfair practices have led to a significant decline in investor confidence in the nation's financial markets.
Under the settlement, the type of selling activities that had become a large part of an analyst's job during the stock market mania will be curtailed. Analysts will no longer be allowed to help sell stocks their firms are underwriting by accompanying investment bankers to meetings with investors. Neither will analysts' services be included in pitches made by their firms to companies hoping to sell shares or bonds to the public.
In addition, a firm's investment bankers will be barred from putting pressure on analysts to change their views on a company. Bankers will not be involved in analysts' performance reviews or in discussions relating to their compensation. The firms will have to designate people in their legal and compliance departments to monitor the interaction between analysts and their colleagues in other departments.
To ensure that the principals abide by the terms of the settlement, regulators will conduct examinations of each firm beginning 18 months from now.
Each firm covered by the agreement will pay $5 million to $15 million annually for five years to obtain stock research from at least three sources that have no ties to an investment bank, people involved in the negotiations said. The firms would have to make those alternative views available to their customers by highlighting them in their regular communications, these people said.
The selection and purchase of the outside research would be overseen at each firm by an independent monitor appointed by regulators, they said. To improve transparency of their investment recommendations, the big Wall Street firms would have to make their research publicly available on their Web sites within 90 days of original publication, they said.
Some brokerage firms have agreed to pay larger fines than others and to pay different amounts for independent research and investor education. The final numbers were being negotiated as late as last night and could change, people involved in the talks said. Citigroup's Salomon Smith Barney unit will pay the largest fine: $325 million. Grubman, the firm's former telecommunications analyst, has been sued by NASD over his recommendations on the stock of a corporate client, Winstar Communications. He is also the subject of intense scrutiny for his unceasing support for companies whose stocks and bonds Salomon had underwritten but that in most cases lost almost all of their value. A spokesman for Grubman declined to comment last night on any settlement talks.
Credit Suisse First Boston, a powerhouse in technology investment banking and research during the late 1990s, will pay $150 million. Merrill Lynch has paid a $100 million fine to the states.
Seven other firms have agreed to pay about $50 million each. They are Bear Stearns, Deutsche Bank, Goldman Sachs, J.P. Morgan Chase, Lehman Brothers, Morgan Stanley and UBS Warburg. Two smaller firms, US Bancorp Piper Jaffray and Thomas Weisel Partners, have tentatively agreed to pay a combined $50 million, people familiar with the negotiations said.
Including the money paid by Merrill, the total fines paid by the firms covered in the settlement rises to $975 million.
The settlement is the second time in less than a decade that Wall Street firms have agreed to pay about $1 billion to settle regulatory charges of anti-investor practices. In 1997, about 30 brokerage firms and Nasdaq agreed to pay about $1 billion to settle an investor lawsuit that they had colluded to keep costs unnaturally high in the trading of Nasdaq stocks.
But that case was overseen by federal investigators at the SEC and the Justice Department, while the investigation into Wall Street research was launched by Spitzer, a state official. Federal regulators seemed late to recognize the severity of the conflicts among Wall Street analysts and joined in the investigation only this year, after Spitzer released e-mail messages written by Merrill Lynch analysts that showed them privately deriding some of the same companies whose shares they were recommending to the public.