S.E.C. v. Bear, Stearns & Co. Inc.

• Decision Date: 10 June 2009
• Docket Number: No. 03 Civ. 2937 (WHP).,03 Civ. 2937 (WHP).
• Citation: 626 F.Supp.2d 402
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. BEAR, STEARNS & CO. INC., Defendant.
• Court: U.S. District Court — Southern District of New York

626 F.Supp.2d 402

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. BEAR, STEARNS & CO. INC., Defendant.

No. 03 Civ. 2937 (WHP).

United States District Court, S.D. New York.

June 10, 2009.

S.E.C., Asst. Chief Litigation Counsel, Antonia Choin, Luis R. Mejia, Securities and Exchange Commission, James Andrew Meyers, Orrick, Herrington & Sutcliffe, LLP, Washington, DC, for Plaintiff.

Dennis J. Block, Cadwalader, Wickersham & Taft LLP, New York, NY, for Defendant Bear, Stearns & Co. Inc.

Sarah Loomis Cave, Hughes Hubbard & Reed LLP, New York, NY, for Defendant Lehman Brothers, Inc,

Dixie L. Johnson, Fried, Frank, Harris, Shriver & Jacobson, New York, NY, for Defendant Merrill, Lynch, Pierce, Fenner & Smith, Inc.

Mitchell A. Lowethal, Cleary Gottlieb Steen & Hamilton LLP, New York, NY, for Defendant UBS Securities LLC.

MEMORANDUM AND ORDER

WILLIAM H. PAULEY III, District Judge:

Six years after the Securities and Exchange Commission's ("SEC") much-heralded announcement of the "Global Research Analyst Settlement," more than $79 million intended for aggrieved investors cannot be distributed and continues to accrue interest. This predicament should have been anticipated by the parties prior to bringing these cases and the proposed consent judgments to Court. The quandary of what to do with undisbursable funds presents cautionary lessons for regulators, courts, and all other participants in securities fraud litigation. When such cases settle and the adversarial process melts away—the engagement and commitment of the parties to bring the matter to conclusion weakens. Further, the application of inherently incompatible remedial principles—disgorgement, penalties, and restitution—should be analyzed carefully before a Court is burdened with tortured restructuring and embarrassing consequences.

BACKGROUND

I. The Proposed Consent Judgments

On April 28, 2003, the SEC filed civil actions to redress alleged violations of the Securities Act of 1933 and rules of the National Association of Securities Dealers, Inc. ("NASD") and the New York Stock Exchange, Inc. ("NYSE") against ten separate investment banks: Bear Stearns & Co. Inc. ("Bear Stearns"); Citigroup Global Markets Inc., f/k/a Salomon Smith Barney Inc. ("Citigroup"); Credit Suisse First Boston LLC f/k/a Credit Suisse First Boston Corporation ("Credit Suisse"); Goldman, Sachs & Co. ("Goldman Sachs"); J.P. Morgan Securities Inc. ("J.P. Morgan"); Lehman Brothers Inc. ("Lehman Brothers"); Merrill Lynch Pierce Fenner & Smith, Incorporated ("Merrill Lynch"); Morgan Stanley & Co. Incorporated ("Morgan Stanley"); UBS Warburg LLC ("UBS Warburg"); and U.S. Bancorp Piper Jaffray, Inc. ("U.S. Bancorp"). The SEC alleged that the investment banking groups at these institutions exerted inappropriate influence over captive research analysts, compromising their objectivity and spawning conflicts of interest. The SEC also filed civil actions against two former research analysts: Jack Benjamin Grubman, formerly employed by Citigroup; and Henry McElvey Blodget, formerly employed by Merrill Lynch. In February 2004, two additional investment banks—Deutsche Bank Securities Inc. ("Deutsche Bank") and Thomas Weisel Partners LLC ("Thomas Weisel")—were added to the roster. These lawsuits grew out of a lengthy investigation by federal and state securities regulators.

Concurrent with filing the complaints, the parties submitted proposed consent judgments, inter alia, to disgorge ill-gotten gains, assess civil penalties, untangle investment banking and research, and compensate aggrieved investors. The proposed judgments included: (1) structural reforms in the relationship between investment banking and research; (2) $460 million for independent investment research; (3) $528.5 million in disgorgement and penalties to the states¹; (4) $432.75 million in disgorgement and penalties as a federal payment; (5) $85 million for investor education programs²; and (6) the preservation of investors' rights to pursue any other remedy or recourse against the Defendants.³

The SEC offered no specificity regarding the federal payment of disgorgement and penalties to be used for restitution. The proposed consent judgments failed to offer a clear framework for formulating and implementing a distribution plan and left those matters to the Court, an unnamed administrator and independent consultants. The consent judgments simply stated that eligibility to participate in the proposed distribution funds was limited to investors who (i) purchased (ii) equity securities (iii) of a company referenced in the complaint (iv) through the investment bank defendant named in the complaint (v) during the relevant time period described in the complaint. Likely anticipating the specter of private securities litigation, the investment banks were also silent on the subject. This absence of particulars—such as identifying specific securities, specific violations, or cabining time periods for investor losses—belied the parties' public pronouncements about the extensive investigations and lengthy negotiations culminating in the proposed settlements. It also suggested that the litigants sought to quiet the public furor quickly and shift the formulation of a rationale for a critical element of the settlements—distribution—to the Court. The parties were equally vague about the contours of the $85 million investor education program. In short, the parties proposed to end the adversarial process the very day the lawsuits were filed and pass to the Court responsibility for freighting this substantial consignment.⁴

This Court declined the parties' invitation to embark on such an odyssey without any navigational aids. It should be reasonable to assume that sophisticated parties, like the SEC and Defendants investment banks, understand why they agree to make payments or accept them in satisfaction of a claim. A proposed judgment should include the essential terms of the settlement and provide sufficient detail to allow the Court to assure compliance. Hopefully, when funds from a settling defendant are to be distributed under Court supervision, the parties fully understand the relationship between the fund's corpus and the intended beneficiaries. However, this straightforward concept appeared to elude the parties in these settlements.

By Orders dated June 2 and July 3, 2003, this Court sought clarification of the proposed judgments' generalized and inchoate requirements. See SEC v. Bear, Stearns & Co., 03 Civ. 2937(WHP), 2003 WL 21517973 (S.D.N.Y. June 2, 2003); SEC v. Bear, Stearns & Co., 03 Civ. 2937(WHP), 2003 WL 21513187 (S.D.N.Y. July 3, 2003). Specifically, this Court prodded the parties to identify the relevant securities and time periods that would provide the essential parameters for disbursement of funds as to each investment bank. Such information would also help satisfy the requirement of Fed. R. Civ. P. 58 that a judgment be "a self-contained document." Massey Ferguson Division of Varity Corp. v. Gurley, 51 F.3d 102, 104 (7th Cir.1995).

Even the seemingly pedestrian task of identifying relevant securities turned into a kabuki dance between the SEC and each of the investment banks. And some Defendants continue the dance marathon to the present. The SEC complaints alleged three claims: (1) violation of NASD and NYSE conduct rules due to conflicts of interest resulting from interactions between investment bankers and research analysts; (2) violation of NASD and NYSE rules by paying underwriting fees to other broker-dealers for research; and (3) violation of NASD and NYSE rules by failing to supervise. (See, e.g., Complaint against Morgan Stanley & Co., Inc.) The SEC provided a list of all the companies referenced in each complaint, but added that a number of companies may not have been mentioned by name. (See SEC Mem. in Response to the July 3, 2003 Order at 4-5.) The SEC also suggested, inter alia, that allegations in the complaints about the publication of misleading research should be part of the fund administrator's calculus.

Not surprisingly, the Defendant investment banks responded with different understandings about the reach of the consent judgments. Because the investment banks settled without admitting or denying the allegations, they argued there were no false or misleading statements in any research reports. J.P. Morgan's response was emblematic. After agreeing to pay $25 million in disgorgement and a $25 million penalty, it asserted that the SEC had not brought fraud or advertising charges against it and that no securities identified in the SEC's complaint were subject to charges that the bank published fraudulent research. (See Mem. of J.P. Morgan in Response to Question 1 of the Court's July 3, 2003 Order at 1-2.) In fact, now seeking to disclaim any responsibility, J.P. Morgan asserts that the equity securities and relevant time periods "were selected solely by the SEC." (See Comments and Proposal of J.P. Morgan Regarding the Distribution Fund Administrator's May 2009 Report at 2.)

The cacophony of diverse views suggested the SEC and the Defendants did not share an understanding regarding the basis for either the amounts of disgorgement and penalties or the distribution of funds. For example, the SEC and U.S. Bancorp agreed to a $12.5 million disgorgement and penalty to be used to compensate aggrieved investors. Yet when pressed to identify the securities at issue, U.S. Bancorp named only two: one security in which there were no transactions through U.S. Bancorp and another security involving only a $6,589 loss during the relevant time period. Morgan Stanley took a different tact asserting that "the stocks . . . do not readily lend themselves to ground rules for identifying which customers . . . should qualify for distributions from the settlement fund." (Morgan Stanley's Supplemental Response to the Court's July 3, 2003 Order at 1.) In sum, the destiny of the disgorgement and penalties seems to have been...