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12 October 1996
"Anyone who goes to Las Vegas and loses can't sue the croupier." So said Judge Milton Pollack, snappily summing up the gist of a judgment that this month became the toast of Wall Street.
The 96-year-old district judge had, in typically flamboyant style, kicked out three class action suits against Merrill Lynch and its discredited analyst Henry Blodget brought by investors who were drowned when the dotcom bubble burst.
The hope of the US investment banking community is that his scathing ruling will bring a quick end to a potentially nasty outbreak of investor litigation.
Judge Pollack's legal career started in the year of the 1929 stock market crash, but age has clearly not withered this judicial brain.
His judgment ran as follows: "Seeking to lay the blame for the enormous internet bubble solely at the feet of a single actor, Merrill Lynch, plaintiffs would have this court conclude that the federal securities laws were meant to underwrite, subsidise and encourage their rash speculation in joining a freewheeling casino that lured thousands obsessed with the fantasy of Olympian riches, but which delivered such riches to only a scant handful of lucky winners."
Commentators in the financial press have been only too happy to laud the judge's "Solomonic wisdom", as one paper had it, and seize upon his judgment as the definitive word on the madness of those bygone dotcom days.
The judge's line was that it was the collapse of the internet bubble that caused investors' losses and not research analysts such as Blodget, who became infamous when he was discovered to have rubbished the same stocks that his company Merrill Lynch was promoting.
This revelation prompted numerous legal actions and an increase in industry arbitrations. Judge Pollack is overseeing another 25 class action suits against investment banks but, as he put it, he refuses to allow New York's legal system to be used as some kind of "scheme of cost-free speculators' insurance".
Eliot Spitzer, the New York Attorney-General who conducted an investigation into conflicts of interest on Wall Street which exposed the behaviour of Blodget, called upon investors to make claims.
The US investment banks settled with Spitzer for £1.4bn earlier this year, after he accused their analysts of promoting internet stocks to private investors in a bid to win lucrative investment banking business.
Although many of the claims in the
recently dismissed suits have been characterised as unbelievably frivolous even by US standards and, critically, not concerning Merrill Lynch clients, as ever there is another side to the story.
"What Merrill Lynch and some of these other firms did was the worst kind of fraud ever perpetrated on the US public," claims Steven Toll, lawyer for the plaintiffs and a partner at Cohen Milstein Hausfeld & Toll. "You believe that brokers recommend stock because they have a real and true belief that this stock is good, but the reality was that they were hyping these stocks solely to get investment banking business to make money. It's one of the worst scandals you can ever imagine and this is an astounding, horrible and disturbing result."
Daniel Woska, a securities lawyer at Oklahoma City firm Woska & Hasbrook who specialises in investor actions, reckons that by the end of the year he will have brought close to 1,000 complaints for investors alleging bias in reports by Merrill Lynch and others. "The spread of people who use their money to invest in brokerage houses runs from poor, blue collar people to the speculators who Judge Pollack was taking about," he says.
But he adds: "Unfortunately for Judge Pollack, when he delivered his decision it didn't address the people I represent, who are typically the uninformed, blue collar, elderly people who were taken advantage of."
Woska cites a Spanish-speaking client from Mexico who worked for Southwest Airlines as a machinist for 35 years, saving up all his own and his wife's money. "He put a million dollars with Merrill Lynch when he retired, thinking they'd take care of him," Woska says. "Well, they took care of it alright, and his saving was down to a little less than £300,000 in 15 months." This is the kind of person that Spitzer wants to see compensated, he adds.
So what kind of precedent does the ruling represent? In an interview following his judgment, Judge Pollack said the Merrill Lynch case is the first of a group of 160 cases involving 27 different stocks. "This was something of a test case for [lawsuits] involving similar facts," he said. "The question is, are the facts similar?"
Columbia University law professor John Coffee says the ruling was "a huge victory for Merrill Lynch" and represents "the death knell" for the 23 pending cases before Judge Pollack. "As for the other securities firms, this is one of the first real precedents of how the law of securities fraud applies to an analyst recommendation, as opposed to a statement by the company about its finances," he says.
Coffee reckons that Judge Pollack's most important line of reasoning is that the plaintiff has to prove "loss causation".
"They can't simply prove that the plaintiff was fraudulently induced to buy the stock by the false inflated and insincere recommendation, but rather he has to prove first, and then later, that the recommendation was causally related to the stock's ultimate fall." That is a very difficult burden for litigators to have to meet, he adds.
"Judge Pollack has dismissed cases brought by non-Merrill customers who were speculating on internet stocks and couldn't show that they relied upon fraudulent research," explains Jacob Zamansky, an arbitration lawyer in New York who won a $400,000 (£250,600) claim against Merrill Lynch in 2001. "By contrast, Merrill customers who bring arbitration claims against the firm and can show they actually relied upon fraudulent research in deciding to buy or hold the stock should be able to win."
According to Zamansky, the "key evidence" in such cases is Merrill Lynch customers "showing that they received research reports contemporaneous with their decision to buy or hold the stock", plus emails or notes of conversation with their brokers showing that "they actually discussed and relied upon the research in making their investment decisions".
"If you didn't even know who Henry Blodget is, and you didn't read the research reports, then you shouldn't be allowed to sue him, but that doesn't apply to a Merrill customer who has a contractual relationship with the firm who pays higher commissions and expects honest, unbiased research," Zamansky continues. "There's a hell of a difference."
Toll is considering an appeal on behalf of his clients. "Some of his views about the plaintiffs were just totally wrong and ignored the people before him," he said of Pollock.
In particular, he takes issue with the depiction of his clients as "rash speculators" and gamblers. "The evidence was to the contrary, these were people who had sold their businesses and as a result acquired their stock," he says.
If there is a criticism of Judge Pollack's judgments, Coffee believes it is that the nonagenarian judge characteristically "tends to paint in black and white" rather then "nuanced distinctions in shades of grey".
According to Michael Chepiga, a partner at New York firm Simpson Thacher & Bartlett who clerked for the judge in the late 1970s, the Merrill Lynch ruling is "classic Milton Pollack".
"He wants to be clear, to the point, and deal with the problem," says Chepiga. "He doesn't have the time to waste and he goes straight to the heart of things. It's not a concern of his if it gets reversed."
Woska remains unimpressed with the spate of eulogies following Judge Pollack's judgment. "He's 96 years old, hates class actions, always has, and makes no bones about it," he says. "If you're one of the lucky few his decision is a good thing, but for the rest of us - that is, 90 per cent of us - it's not."