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Suing the Street over Bum Advice


Former AT&T manager Jim Luzzi considers himself a Wall Street casualty. Last April, he invested his life savings of $295,000 in the $10.6 billion initial public offering of AT&T's wireless unit. From the prospectus, he understood that along with AT&T itself, it was racking up revenues. But on May 2, five days after the IPO, AT&T's disappointing first-quarter results deep-sixed the tracking stock below its $29.50 offering price. Luzzi lost roughly a third of his savings.

Now, Luzzi and other investors want to make Wall Street and AT&T pay. In a pending class action filed in December, they allege that lead underwriters--Goldman Sachs, Merrill Lynch, and Salomon Smith Barney--were negligent because they failed to disclose problems such as the loss of major long-distance service contracts. The banks and AT&T declined to comment.

Investors have lost $3 trillion in the stock market since last March and are striking back. They are suing investment banks for everything from allegedly botching trades to suckering them into overhyped IPOs. Corporations, too, are going after their bankers for doling out bad advice. "A rising market raises all ships and hides a multitude of sins," says John Halebian, a partner at New York law firm Wechsler, Harwood, Halebian & Feffer LLP, which specializes in class actions. "When the market is not rising, then a lot of things get exposed."

HIGHER AWARDS? Investment banks, law firms, and regulatory agencies are all bracing for an upsurge in lawsuits. Already, in January, there was a 19% jump in the number of new arbitration cases filed with the National Association of Securities Dealers. "In a marketplace with a lot of volume and volatility, there will naturally be more suits against underwriters," says a senior lawyer at one investment bank.

To be sure, market corrections have spurred flurries of lawsuits before. Many were resolved without a trial, since "underwriters are not liable if they have conducted a reasonable investigation [of an issuer]," says Robert F. Wise Jr., partner at Davis, Polk & Wardwell, which represents investment banks.

But this time around, damage awards may be higher. "The amount investors have lost in larger IPOs is greater than ever," says Jim Newman, publisher of the newsletter Securities Class Action Alert. Worse, investment banks can't rely on hard-pressed issuers to foot settlement bills as much as before. "The concern is that investors will look at the deep pockets," says Wise.

With as much as $26 billion in annual revenues, investment banks are a prime target. So far, the banks haven't needed to disclose legal expenses in their financial reports because they were so small. Also, they have felt protected by the Private Securities Litigation Reform Act passed by Congress in 1995 to curb class actions. But the act is encouraging investors and their lawyers to laser in on more troublesome cases with higher stakes, such as alleging violations of accounting or due-diligence principles. "Investors no longer sue simply because of a stock-price drop," says Mark Holland, a partner at law firm Clifford, Chance, Rogers & Wells LLC. The result: Settlements are typically 17% higher when underwriters are co-defendants, says research outfit National Economic Research Associates.

Some legal precedents have already gone against the Street. The Portland (Ore.) U.S. District Court recently confirmed a NASD award to six investors of $1.8 million in damages from a subsidiary of Fiserv Inc., which cleared trades for now-defunct broker Duke & Co. Fiserv is mulling an appeal. "We still think the decision is wrong," says Fiserv General Counsel Charles W. Sprague. For now, though, the ruling sets a potentially expensive standard for those securities firms such as Bear Stearns Cos. that argue they are not responsible for their clients' actions.

WHAT PLAN? Investors are especially keen to seek revenge against the Wall Street wizards who stoked an IPO frenzy through early 2000. Litigants are alleging that startups such as Internet-based application service provider pcOrder.com and its underwriters, Goldman Sachs, Credit Suisse First Boston, and SG Cowen Securities Corp., failed to warn them in the prospectus that the company did not even have a formal business plan. In a statement, pcOrder.com's parent company, Trilogy Software Inc., said it considers itself one of many high-tech companies targeted by plaintiffs because of the tech downturn. Other investors allege that companies such as Turkish mobile-phone operator Turkcell Iletisim Hizmetleri and its advisers, including Goldman Sachs and others, misled them by seriously misrepresenting the rate at which the company was losing customers, according to a suit filed in December. Turkcell could not be reached for comment. Its legal counsel and bankers declined to comment.

The way banks handled IPOs is under attack, too. For instance, a class action filed in January against computer systems provider VA Linux Systems Inc. and its lead underwriter, CSFB, alleges that CSFB failed to disclose commissions and manipulated the market by allocating shares to customers who agreed to buy Linux shares in the aftermarket at set prices. CSFB and VA Linux declined to comment on the case, which may be the first of many. "We're doing a lot of investigation into other similar situations," says Melvyn I. Weiss, senior partner at New York law firm Milberg Weiss Bershad Hynes & Lerach LLP.

Meanwhile, a May, 1997, ruling by the Ninth Circuit Federal Court in Pasedena, Calif., has opened the floodgates to suits by companies against their investment bankers and other advisers. These advisers have a fiduciary duty to act in the best interests of corporate clients in transactions such as mergers--an obligation they weren't explicitly saddled with before. Subsequently, clothing chain Merry Go Round sued Ernst & Young for its handling of the retailer's restructuring. The case was settled out of court in April, 1999, with E&Y coughing up $185 million. E&Y said it could not comment.

Similar cases are starting to pop up. On Jan. 12, phone and Internet company Log On America Inc. filed a suit alleging that CSFB advised it not only to accept financing that diluted Log On's stock price but also to buy $47 million in services from Nortel Networks Corp., another CSFB client. Log On's stock has since cratered, in part because of CSFB's advice, says CEO David R. Paolo. Greenville Casino Partners is suing CSFB's commercial-mortgage unit for $550 million for allegedly failing to arrange a promised $36.2 million loan in a timely fashion. The delays, and higher fees, left Greenville without enough working capital to run its business, the suit states. Two of the company's three casinos are being foreclosed. "We believe these cases have no merit, and we will continue to defend ourselves vigorously," says a CSFB spokesman.

Of course, Wall Street has never forced advice on anyone. And companies' financial staffs are paid to sift through sales pitches, good and bad. "You have to be skeptical," says attorney M.Breen Haire at Cravath, Swaine & Moore. But even if chief financial officers and individual investors put too much faith in the Street's sages, they're still out for their pound of flesh. By Emily Thornton, with Heather Timmons, in New York


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