In a case that could unleash a legal tidal wave against Wall Street, Merrill Lynch & Co. said Friday that it has settled a high-profile arbitration case in which an investor claimed he was duped by the firm's Internet-stock analyst.
The New York-based brokerage agreed to pay $400,000 to settle the case brought by a pediatrician who lost money by following the allegedly tainted recommendations of Merrill analyst Henry Blodget.
Debasis Kanjilal said he chose not to sell his shares of InfoSpace Inc. last year because of Blodget's repeatedly bullish pronouncements about the money-losing Internet company. Kanjilal alleged that Blodget touted the stock because of a financial conflict of interest, and that he would have dumped his holdings had he known about it.
The settlement surprised many legal observers, in part because it is likely to trigger scores of similar cases from aggrieved investors who have lost millions of dollars on failed Internet stocks in the market plunge of the last 16 months.
It's also likely to intensify the furor over the integrity of Wall Street stock analysts. Critics say analysts' recommendations are sometimes compromised by hidden financial conflicts that prevent them from giving unbiased advice to investors.
"On a scale of 1 to 10, [the settlement] is about a 10," said Mark Maddox, a securities attorney in Indianapolis. "It's one of the most watershed things to happen in a securities arbitration case in a long time."
Merrill settled the case to "avoid the further distraction and expense of protracted litigation," the firm said in a statement.
"We stand behind the integrity of our research. Henry Blodget is the top-rated analyst in his sector," said Joseph Cohen, a Merrill spokesman, who declined to comment further.
The central issue is how analysts are paid. In recent years, analyst compensation increasingly has been tied to the amount of investment-banking business they generate for their firms.
Congress held a hearing on the subject and the National Assn. of Securities Dealers has proposed rules that would force analysts to divulge financial conflicts of interest.
Kanjilal's attorney, Jacob Zamansky, alleged that Blodget issued glowing reports on InfoSpace because Merrill was the financial advisor for Go2Net Inc., an Internet firm that InfoSpace bought last July for $4 billion. Negative reports from Blodget could have hurt InfoSpace's stock, potentially derailing the merger and costing Merrill money, Zamansky alleged.
The case garnered considerable attention because it was one of the first to target a stock analyst. Most arbitration cases are directed at brokerage firms and individual stock brokers.
However, the settlement doesn't set a formal legal precedent that could affect the outcome of similar cases that are heard by arbitration panels. Investors generally are required by their brokerage agreements to take disputes to arbitration rather than to court.
Zamansky said he is considering filing cases soon against Mary Meeker, a well-known Internet analyst at Morgan Stanley, and Jack Grubman, a Salomon Smith Barney telecom analyst.
Brokerages have taken steps to assuage critics, with some firms announcing new rules governing analyst conduct.
Merrill Lynch last week became the first major brokerage to bar its analysts from buying shares of companies they cover. The move addresses concerns that analysts have an incentive to push stocks they own.
Blodget became one of the most visible Internet analysts during the late 1990s, earning the moniker "King Henry."
The arbitration claim, however, alleged that Blodget used questionable methodology to back up his bullishness on InfoSpace.
Analysts expressed surprise at the size and timing of the settlement.
"Merrill Lynch knew this was the flagship case. They knew that by settling this case they would invite copycat cases," said Henry Hu, a securities law professor at the University of Texas at Austin.
Several factors indicate that Merrill was anxious to dispose of the case, analysts said.
For instance, Kanjilal received 80% of the $500,000 he sought, compared with the 30% to 60% range for settlements in cases of that size, Maddox said.
Also, instead of occurring during an arbitration hearing, as many settlements do, it appears to have come during the "discovery" portion of the case, Maddox said. He speculated that Merrill was reluctant to turn over Blodget's files for fear they could contain information that could leave Merrill vulnerable in other cases.