The nation's leading investment banks and brokerage houses will pay $1 billion to settle allegations of conflicts of interest in a deal to be announced Friday that will usher in some of the broadest securities industry reforms since the Great Depression, sources close to the situation said tonight.
The deal will bring to a close a handful of state, federal and industry probes into alleged conflicts of interest that have driven Wall Street's reputation to its lowest level in decades and produced a steady flow of scandal headlines that have helped erode investor confidence.
Some of the $1 billion in fines will go to a restitution fund for shareholders who lost money because they were misled by analysts. The rest of the fines will go to the federal government and the states involved in the probe, including New York, Massachusetts, Connecticut, Texas, Alabama, New Jersey and California.
The deal also will require that firms pay at least an additional $500 million to $1 billion over five years to buy research conducted by firms that do no investment banking and distribute it to individual investors. Interaction between investment bankers and analysts will be more strictly limited. Current industry rules forbidding firms from handing out shares in initial public offerings to favored executives at investment-banking clients will be more aggressively enforced.
"This settlement will be as significant as any major reform we've seen since 1933-'34," said Samuel L. Hayes, a professor of finance at the Harvard Business School. "If it does what it says it's going to do, it will be a fundamental change in the way securities firms do business. It will mean more reliable research for individual investors and higher costs for the firms."
The agreement, which could ultimately cost the industry as much as $2 billion, comes after a frenetic two-day round of final negotiations led by New York Attorney General Eliot L. Spitzer.
Citigroup Inc., parent of investment bank and brokerage Salomon Smith Barney Inc., will pay the biggest fine, sources say, at $300 million, because regulators have discovered the most damaging information in the firm's research reports and IPO allocations, sources said.
Credit Suisse First Boston Corp. will pay the second-largest fine, $150 million. Regulators have uncovered e-mails and other documents showing, they say, that analysts at both firms placed inflated "buy" ratings on otherwise questionable companies to generate lucrative investment-banking business from those companies. Regulators also say both firms improperly awarded hard-to-get IPO shares to favored corporate executives, something the firms deny.
Citigroup and Credit Suisse are both expected to release statements of apology, though details of those statements were still being worked out tonight.
Spitzer, who has handled the Citigroup investigation, is also expected to release a detailed account of his findings. This account will include e-mails embarrassing to Citigroup chief executive Sanford I. Weill, a source familiar with the document said, but will not include a "smoking gun" that could put Weill in legal jeopardy.
Spitzer plans to end his probe into Citigroup and Weill but will continue to weigh possible charges against other individuals, notably former Salomon telecommunications analyst Jack Grubman, sources said. A spokesman for Grubman, who was forced out of the company this summer, did not return a call tonight.
A handful of other firms, including Morgan Stanley, Goldman Sachs & Co., Bear Stearns Cos., Lehman Brothers, UBS Warburg and Deutsche Bank AG are expected to pay $50 million each. These firms are likely to be charged with violating industry rules as part of the settlement. The exact wording and nature of formal charges against all the firms was still being worked out tonight.
Two smaller regional firms, U.S. Bancorp Piper Jaffray Inc. and Thomas Weisel Partners LLC, are expected to pay significantly less than $50 million but no final amount was set tonight, sources said.
Sources say the settlement will also ultimately include a significant restitution fund for individuals who say they lost money by following the stock picks of high-profile Wall Street analysts such as Salomon's Grubman and Merrill Lynch's Henry Blodget.
One source familiar with the talks said that half of all the fines paid by the dozen firms would go to such a restitution fund. But some regulators said there was no agreement on the percentage of fines that will go back to investors. Details of who would qualify for restitution and how the money would be distributed to individual investors remained murky tonight.
Several outside commentators said the task of distributing the funds would be monumental. Regulators also acknowledged that the restitution fund would not come close to matching the amount of money lost in the stock market collapse.
Regulators said money could be distributed in several ways. Under one scenario, each firm would appoint a special consultant who would review investor claims and determine who should receive money and how much. The firms would be bound to follow the consultants' recommendations. Under another scenario, money would be collected and put in the care of a federal judge who would determine how the funds should be distributed. Industry arbitration panels could also hear claims and distribute money.
Spitzer and other regulators declined to comment. Spokesmen for the Wall Street firms involved in the talks also declined to comment.
In addition to fines, the settlement will require that firms contribute between $500 million and $1 billion over five years to create a fund to purchase and distribute stock research from firms that do no investment banking. These firms are theoretically free from the conflicts of interest that regulators say color Wall Street stock picks.
The amount each firm will contribute will depend on the number of individual investors they serve. Firms with large numbers of individual clients, such as Morgan Stanley, will be asked to pay $75 million over five years, while firms with fewer individual clients will be asked to pay closer to $25 million. The firms will be required to hire independent monitors to ensure they are buying the research from at least three sources and distributing the reports to brokerage clients.
The deal will also include significant structural changes, including barring analysts from joining bankers at "pitch meetings," typically where Wall Street firms try to win investment-banking business. Critics say Wall Street often uses the promise of positive research coverage to win banking deals. Analysts will also be banned from "road shows" where bankers visit institutional investors and try to convince them to buy shares in initial public offerings.
Securities and Exchange Commission officials say much of the settlement could ultimately be enacted as agency rules. The deal will also include new requirements that banks disclose their analysts' track record in picking stocks.
Spitzer sparked the raft of probes when he used New York's tough anti-fraud business law, the Martin Act, to subpoena documents from Merrill Lynch. In May, he released a thick stack of internal Merrill e-mails in which the firm's analysts derided stocks they were publicly recommending. Merrill eventually agreed to pay $100 million to avoid criminal charges. Other regulators then began probing similar allegations.
Wall Street firms quickly began to complain that they could not respond to the fusillade of probes. Those complaints led to an agreement between regulators to work together toward a global settlement.
The securities industry's main trade group praised the settlement tonight, saying it would help Wall Street close an ugly chapter. "This historic settlement shows the deep commitment of our industry to implement the tough solutions needed to help restore public trust and confidence in our capital markets," said Marc E. Lackritz, president of the Securities Industry Association.
Purveyors of independent research also praised the settlement, which is likely to drive up revenue for their firms. "If handled right this settlement could spark a revolution in the way the individual investors get information," said Thomas S. White, president of Best Independent Research LLC, a consortium of independent research firms. "Enron would not have happen had this structure been in place, because individual investors would have had access to analysts who were screaming bloody murder."