Brokerage stocks are now some of higher-risk investments

Monday, May 5, 2003

NEW YORK -- When Wall Street's biggest brokerage firms settled charges this past week that they issued biased research, their own stocks suddenly became higher-risk bets.

Analysts say investors are concerned that the brokerages, which include Merrill Lynch and Goldman Sachs, will face a possible deluge of investor lawsuits at the same time they're being forced to change the way they do business -- both of which could hurt their profits.

"If investors take massive action, that is going to have a severe negative impact on stock prices" of the brokerage firms, said Martin D. Weiss, chairman of Weiss Ratings, Inc., a Palm Beach Gardens, Fla., firm that evaluates the creditworthiness of companies.

Weiss Ratings has already lowered the credit ratings of some of the brokerages to take into account their potential legal liabilities.

The $1.4 billion industrywide settlement called for one of the largest penalties ever levied by securities regulators. It also made public evidence of how securities firms misled or took advantage of investors during the 1990s bull market.

Lawyers are already sifting through evidence showing that some analysts hyped stocks or issued overly upbeat reports on companies so their firms' investment banking arms could score lucrative deals from those companies.

The settlement and the evidence released by regulators also shows that some of the firms promised shares of hot initial public offerings to companies that agreed to give them more business in return.

Analysts believe the consequences of the settlement could take the firms years to resolve and cost them millions of dollars in addition to the $1.4 billion they must pay to set up a restitution fund for investors and to establish other investor-related funds.

The 10 firms are: US Bancorp Piper Jaffray, Morgan Stanley, Lehman Brothers, Merrill Lynch, J.P. Morgan, Goldman Sachs, UBS Warburg, Citigroup, Credit Suisse First Boston and Bear Stearns.

The other unknown is how the reforms the firms agreed to will affect profits for several quarter and possibly years into the future.

"They are higher risk from the standpoint of litigation but also from the underwriting side. That is more a question about the future earnings outlook," said Bert Ely, an independent banking consultant in Alexandria, Va. "Are the investment-banking (divisions of the) companies going to be able to make a lot of money off IPOs if in fact they don't have analysts out there pumping for them?"

With brokerages' stock prices currently at the high end of their 52-week ranges, there's room for declines if a wave of lawsuits along with the reforms bring down profits.

But for now, the securities firms' shares have taken the settlement news in stride. All 10 of the brokerage stocks managed to trade higher Monday when the settlement was announced and ended the week higher.

That resilience is probably due to the fact that settlement wasn't a surprise, having followed a lengthy investigation by the Securities and Exchange Commission, New York attorney General Eliot Spitzer and other regulators. The settlement is also based on a tentative agreement reached in December.

Gary Kaltbaum, market technician for Investors' Edge Partners in Orlando, Fla. said, "I think it's already in there."

It's the longer-term health of the companies and their stocks that analysts say could suffer.

The market's major indexes all ended the week higher.

The Dow Jones industrial average rose 276.33, or 3.3 percent. It closed Friday at 8,582.68, the highest level since Jan. 17.

The Nasdaq composite index had a weekly gain of 68.34, or 4.8 percent, closing at 1,502.88 on Friday, the highest level since June 18, 2002.

For the week, the Standard & Poor's 500 index rose 31.27, or 3.5 percent, to finish at 930.08, the highest level since Jan. 14.

The Russell 2000 index, the barometer of smaller company stocks, had a weekly advance of 19.17, or 4.9 percent, closing Friday at 407.67.

The Wilshire 5000 Total Market Index, which tracks more than 5,700 U.S.-based companies, ended the week at 8,834.06, up 308.17 from the previous week. A year ago, the index was at 10,202.04.

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