When New York Attorney General Eliot Spitzer finalizes his $1.4 billion conflict-of-interest suit, the settlement might be the end of one chapter in the legal saga, but it's almost certainly the beginning of another, equally perilous one.
Spitzer plans to release reams of evidence he collected during his investigations of Wall Street firms — evidence that is likely to touch off a tsunami of civil litigation. “There's no restitution for public investors as part of Spitzer's proposed settlement, but the quid pro quo is his release of the evidence so that individual investors can seek private remedies,” says Charles Parker, partner in the Houston law firm Hill Parker & Roberson. How important is Spitzer's evidence going to be to retail investors' lawyers? Parker puts it this way, “As a practical matter, without the evidence disclosed by Attorney General Spitzer, I couldn't afford to prosecute these brokerage firms because of the expense involved for the discovery.” The importance of the attorney general's findings, for litigators is hard to overestimate. Says Parker: “This is the first time that you've had potentially tens of thousands of primarily small investor arbitrations dealing with the same set of facts. All of these claims are based on either material misrepresentations in research, omission of material facts, or a failure to disclose the relationships of the investment banking side with the stock analysts.” Parker says that he and many other lawyers, are simply waiting until the AG's reports are made public to start filing.
Brokers are understandably concerned about this development. Will disgruntled clients name them personally, or just their firms?
Already, the conflict-of-interest scandals have damaged their image. And, as a result, some wirehouse reps are trying to find jobs at firms that have not been sullied by the analyst-investment banking conflict complaints.
James Bashaw, president of James E. Bashaw & Co., a Houston RIA (affiliated with LPL), says he has seen a dramatic uptick in recent months in the number of brokers — and clients — looking to leave the wirehouses. “This is just the beginning,” Bashaw predicts.
Brokers to Dodge Lawsuit Bullet?
For brokers, the good news, if you call it that, is that they are not the primary targets for civil lawsuits. James Hooper, a personal injury lawyer based in Orlando, filed 71 requests for paper arbitrations (those requesting damages under $25,000) with the NASD Arbitration Dispute Resolution. And he expects to file “thousands” more arbitration requests on behalf of small investors in the coming months. However, he does not have brokers in his crosshairs, and he has gone so far as to say as much in his television ads.
“I do not believe it's right to name brokers in analyst conflict cases,” says Hooper. “Brokers were fooled just as much as the clients. If anything, I think they've got a claim against their firms, as well.”
Parker, the Houston securities attorney, said his team of five prominent securities litigators declines to name brokers for the same reasons.
However, that begs the question: Should reps working for the tainted firms sue their own firms a là Spartis, Elias v. Jack Grubman and Salomon Smith Barney [see Registered Rep., March 2002]? Parker has not yet taken a broker-initiated case based on the allegedly tainted research. “I'm not saying that I wouldn't take one, but right now I haven't seen the right one,” he says. “The right one might be when the broker loses a substantial book of business due to the firm's research conflicts.”
Some counsel against such suits. “Why would you turn on your own employer?” asks Jeffrey Markham, a securities professor at the University of North Carolina and co-author of Broker-Dealer Operations Under Securities and Commodities Law. “If I were representing the broker, there's no way that I'd have him get involved in this.”
Still, brokers need to think about their defenses. They could be sued over whether they have helped clients choose unsuitable investments, Parker said. And, adds Hooper, there's always the possibility that the wirehouses could decide to file cross-claims. Hooper says that in cases where damages are above $25,000, the analyst conflict issue might be a component of a larger loss “due to suitability or over-concentration.”
However, by far the greatest fear among brokers is receiving a black mark for being involved tangentially in a suit.
“As a producing manager, my biggest fear for brokers is that they're going to be U-4'd or U-5'd over this,” says Bashaw. He says that if a firm drags its brokers and managers into suits, the result will be a double whammy of research allegations for the home office and failure to supervise at the branch. He predicts a “perfect storm” in terms of customer service: With branch managers and advisors preoccupied with saving their careers from such suits, Bashaw fears clients will be ignored.
Linda Fienberg, president of NASD Dispute Resolution, which handles 90 percent of securities arbitrations worldwide, says the unit is prepared for the sizeable increase. “This will be the first time that we've handled something of this nature — hundreds of cases filed by the same attorneys involving the same allegations,” Fienberg says. “But, I'm confident that we'll be able to handle them.” Fienberg notes that in the last two years, claims have increased by 40 percent. She says, “We've handled that without a hitch.”
Should NASD need new rules to handle the influx of cases, Fienberg won't hesitate to file with the SEC for help. With about 7,000 arbitrators, “Our current pool should be sufficient to handle increased demand.”
Some experts disagree. “Will the system slow down? That's a definite,” says Constantine Katsoris, a Fordham University securities professor and one of the three original public members of the Securities Industry Conference on Arbitration (SICA). Adds Hooper: “Fienberg may be overly optimistic. I don't think the system can bear the weight of the thousands of claims we're planning to file.”
Katsoris says regulators should look at ways to streamline the arbitration process. Markham, the UNC professor, agrees. “I'd be interested in whether or not there's a mechanism that could be used so that more than one case can be assigned to a panel at the same time, similar to U.S Federal District Court multi-state litigation.”
The arbitration system is already overloaded, lawyers say. And filing hundreds of complaints will be easy, says J. Boyd Page of the legal firm of Page, Gard, Smiley & Bishop. “Once the Spitzer evidence is made available, all you've got to do is get hard copies of the memos and documents,” he says. “It'll be fairly easy to prepare the expert reports with the supporting evidence. The timelines are pretty clear.”
Still, the release of the Spitzer evidence doesn't ensure plaintiff recovery in these cases, warns Markham. Given the volume of cases expected, courts could choose to scrutinize arbitration awards more closely, and they might be more willing than in the past to overturn awards, experts say.
“This is going to be complicated,” Markham says. “It's going to be interesting to see how it plays out when you have these kinds of widespread claims and there isn't a class format.”
Bashaw, the Houston advisor, is gearing up for some interesting times as well. “I've had calls from brokers with as much as 21 years of experience,” he says. “They're tired of reading their firms' names in the Wall Street Journal in a sentence about a $1.4 billion settlement.” But more importantly, “they're worried about how they're going to defend against a suitability claim by a 72-year-old grandma, who had 10 percent of her stock allocated to Internet offerings,” Bashaw says. “It may have been reasonable in an asset allocation program, but with the conflict issues, it will come under scrutiny.” He adds, “Brokers' self-esteem is shattered. The cow's out of the barn.”