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How Settlement Is Worded Could Be Costly To Merrill

New York Times

How much will the investigation into the behavior of Merrill Lynch’s stock analysts cost the firm?

With estimates running into the billions of dollars, Merrill’s shares have been bouncing all over the map. Merrill executives hope to reach a settlement soon with Eliot L. Spitzer, the attorney general of New York, that would require Merrill to pay a fine of as much as $100 million.

But that may be just the beginning: the real cost of that agreement, if it can be reached, would hinge on what Merrill says in response to Mr. Spitzer’s accusations.

Mr. Spitzer has demanded that Merrill admit to wrongdoing, while the firm’s executives are holding out hope that apologies will suffice, people close to the negotiations said. Big Wall Street firms rarely say they are sorry CC as Merrill’s chief executive, David H. Komansky, did two weeks ago. Out of fear of making themselves more vulnerable to private lawsuits, however, they almost never admit to doing anything wrong.

In a notable recent case, Credit Suisse First Boston agreed to pay $100 million in fines and penalties to end investigations into how the firm sold new stocks. Although regulators had detailed evidence that First Boston sales representatives illegally siphoned millions of dollars in trading profits from customers, the firm did not admit or deny guilt.

One reason securities firms settle so many cases with the Securities and Exchange Commission, rather than fighting them in court, is that those agreements are not admissible in subsequent lawsuits by investors. The firms do not want to provide ammunition for class-action suits that could cost them millions or even billions of dollars in damages.

“Mr. Spitzer is trying to show that in several respects, he is getting more than the typical S.E.C. enforcement proceeding,” said John C. Coffee Jr., a law professor at Columbia. “At a minimum, he is getting something that will benefit investors looking to sue for much more than the typical S.E.C. settlement.”

Mr. Spitzer is also likely to extract promises from Merrill that it will prevent its investment banking department from having any say about how analysts are paid, people close to the negotiations said. They also expect the firm to agree to limit the involvement of analysts in pitching prospective banking clients. But Merrill is insistent that it cannot afford to acknowledge that it misled investors.

Speaking to Merrill’s employees on Wednesday, Mr. Komansky said, “Our reputation has been tarnished, and we have to repair the damage.” Still, E. Stanley O’Neal, the firm’s president, said any settlement “must not impair our ability to defend ourselves in other litigation.”

Early on in his negotiations with Merrill, Mr. Spitzer was asking Merrill to pay more than a fine. He wanted the firm to set up a fund to compensate investors who claim they lost money buying stocks that Merrill’s analysts recommended for the wrong reasons. Mr. Spitzer has accused Merrill of using its analysts to promote companies whose investment banking business Merrill wanted to get or keep.

Mr. Spitzer has softened his position, telling The Associated Press in Albany this week that “restitution is best accomplished through private actions that individual investors will bring based on the particular facts of his or her or their investments.” He now is likely to settle for a fine that rivals the amount that First Boston paid, people on both sides of the negotiations said.

Merrill has already settled a complaint by a single investor for $400,000. That complaint was filed against the firm and Henry Blodget, Merrill’s former lead Internet analyst. If Merrill had to pay to resolve complaints from the many customers who bought stocks that crashed while Mr. Blodget was recommending them, the judgments against Merrill could run into the billions of dollars, Professor Coffee estimated.

In the month since Mr. Spitzer announced his accusations, Merrill’s stock has fallen more than 20 percent, slicing more than $9 billion off the firm’s stock market value. It rallied almost 8 percent on Wednesday on reports of an imminent settlement, then fell back 2.4 percent yesterday, to $42.91.

David Trone, an analyst at Prudential Securities, figured the potential cost of investor suits to be much lower, no more than $420 million. He said there was “virtually no chance” of Merrill’s losing in court because it would be difficult for investors to prove they relied on Merrill’s advice in making bad investments.

Prudential’s lawyers relied on that clause to prevent investors from using any public statements the firm’s executives made in the settlement as evidence in their individual complaints against the firm.