“Where is the compensation for the victim as the shareholder? He has lost his money through believing that the markets would police themselves.”

InvestmentNews (April 14, 2003 11:01 pm) — As the dust settles, tensions are mounting over how the $1.5 billion in global settlement money stemming from analyst conflict-of-interest arbitration will be doled out.

Equitable-distribution and arbitration reform issues took center stage at the North American Securities Administrators Association Inc.’s annual public-policy conference in Washington last week.

Some state securities officials and Securities and Exchange Commission staff members concede that it will be difficult to find equitable ways to distribute the massive fines expected to be collected from investment banks.

Others suggest that restitution can be made to investors who can clearly show they were injured by investment advice stemming from tainted analyst research reports. However, establishing and assessing damages is easier said than done.

The Sarbanes-Oxley Act, which went into effect last year, includes a provision giving the SEC discretion to use penalties collected in securities fraud cases for investor restitution.

The SEC has long required companies to “disgorge” funds from ill-gotten gains, and much of that money has been used to repay wronged investors.

But Sarbanes-Oxley will enlarge restitution funds for investors, which is causing concern among some securities officials.

“We as enforcers can’t just continue to increase and ratchet up punishment by imposing higher and higher civil penalties,” says Douglas Ommen, securities commissioner of Missouri.

“It’s not helping the market to just continue to take monies and put [them] into government coffers,” he says.

“We should make [fines] hurt” companies found guilty of securities fraud, “but we should give it back to people who were hurt, so they can give it back to the capital markets.”

IDENTIFYING VICTIMS

Mr. Ommen says Missouri officials want to set up a restitution fund from the analyst settlement, and mirror whatever is done nationwide to get money back to investors.

But NASAA president Christine Bruenn says it would be difficult for securities regulators to assess damages to make restitution awards.Damages could spread far and wide, she says.

“You could even make the argument that anybody who bought any stock at all in that time period bought an overinflated security,” adds Ms. Bruenn, who is Maine’s securities administrator.

“In this particular case, we cannot find a way to identify all of the victims,” she says. “I’d rather take the money in penalties than fail to make meaningful restitution … only find[ing] a small subset of the victims and compensat[ing] them to the detriment of the many thousands that I can’t identify. I think that will lead to more anger.”

Both Mr. Ommen and Ms. Bruenn say state regulators have discussed their views on restitution cordially.

But there’s a difference in priority, Mr. Ommen says. “We see [identifying victims] as difficult, but we don’t think that just because it’s difficult, we need to avoid it. It can be done … I hate to see us throw out the baby with the bath water.”

A key issue revolves around which investors would stand the best chance of showing they were directly harmed by tainted analyst advice.

“There is a small set of retail customers who may have good claims against a variety of the investment banks,” says Donald Langevoort, a professor at Georgetown University Law Center in Washington.

But narrowing down the list to investors who were the most directly harmed would leave only those with well-established full-service-brokerage relationships, and probably sizable portfolios, he says.

“They’re the ones who can use arbitration most effectively anyway,” Mr. Langevoort says.

“They don’t need the restitution fund. If we somehow limit the restitution fund claims to people like that, it’s going to create the impression that only the well-to-do are going to be able to participate in this, which is politically unpalatable.”

arbitration reform

Mr. Langevoort also questions whether firms paying the fines will attempt to set limits on their liability.

At last week’s conference, Joan McKown, chief counsel of the SEC’s enforcement division, said it will be “extremely difficult” to identify investors who have clearly been harmed in the conflicts cases.

“People talk about the perfect being the enemy of the good,” Ms. McKown said, “but there are some situations where [identifying harmed investors] is difficult.”

Arbitration reform itself is also being discussed among securities regulators.

An NASD official and the president of a plaintiff’s attorney organization participating on a panel at the NASAA conference agreed that arbitration disclosure rules adopted in California last year are unworkable.

The rules, which are being challenged in federal court by NASD and the New York Stock Exchange, state that failure to disclose potential conflicts of interest can result in disqualifying an arbitrator from an arbitration panel. It can also result in awards being vacated.

Even inadvertent oversights of possible conflicts could be grounds for disrupting cases.

NASD and the Big Board initially stopped holding arbitration hearings in California. Later, they required claimants to sign waivers of their rights under the California ruling, which has led to more litigation between claimants and the two organizations.

Pat Sadler, president of the Public Investors Arbitration Bar Association in Norman, Okla., says the problem with arbitration is that conflicts that are disclosed “need to be acted on.”

Mr. Sadler, an attorney with Sadler & Hovdesven PC in Atlanta, says that in several cases where arbitrators didn’t disclose possible conflicts of interest, NASD refused to grant requests from plaintiffs to remove the arbitrators from the cases.

Joseph Meyer, an NASD arbitrator and president of Meyer and Associates, a money management firm in Ormond Beach, Fla., says a fund should be set up to allow victims to reclaim losses in the analyst case.

“The state has fined these broker-dealers hundreds of millions,” says Mr. Meyer.