Finally, small investors get best shake
Did you buy XO Communications stock sometime between April 26, 2001, and Nov. 1, 2001?
How about drugstore.com Inc. between April 25 and July 24, 2000? Or Real Networks Inc. between July 11 and Oct. 17, 2000?
Those were golden days for those Northwest high technology stocks, and many others besides. Reports from highly paid stock analysts made each company’s prospects seem practically to glow. Only the timid ignored the opportunity right in front of their faces.
And then the brave had their financial heads handed to them.
Turns out those analysts were working for the house, raving about a stock in public while privately calling some dogs, or worse. Investment banking fees were more important than the commissions earned from broker clients. As a result, investors lost an estimated $2 trillion.
Regulators struck back, in 2003 negotiating settlements worth $1.4 billion with a dozen brokerages. Unless there is a snag, in April $432.75 million of that will start flowing back into the pockets of aggrieved investors. And, for once, it looks like the small investor will get the best shake.
The allocation formula developed by Duke University law professor Francis McGovern bases distribution of the money on four factors. Of those, the most pertinent is the “information principle,” according to which the largest investors are more apt to base their decision to buy a stock on more diverse information than just the recommendation of a single analyst. When calculating how much an investor might recover, then, the smaller the investor, the lesser the information available when he or she made the decision to buy a stock.
The second major guiding principle is that of “proximity.” In other words, the closer to the release of an upbeat analyst opinion, the more likely it is an investor acted on that information.
The brokerages have most of the information a U.S. District Court in New York will need to determine who gets what according to those first two principles. Principle No. 3 is getting checks out to investors as fast as possible, probably a period of nine months.
But oh, those details.
Remember those XO shares? Not only did you have to purchase them within the designated time period, you had to purchase them from Citigroup affiliate Salomon Smith Barney. Salomon’s Jack Grubman was among Wall Street’s more notorious shills.
Drugstore.com was a Morgan Stanley project. Real Networks was chaperoned by Lehman Brothers. All told, the brokerages copped to deceiving investors on more than 50 stocks. You had to buy your “dog” from the appropriate doghouse in order participate in the settlement.
Also, the amount of money available from each brokerage varies from $4 million to $157.5 million. Some investors may come out of this process whole. Most will not be fully compensated for their losses, but McGovern told the Wall Street Journal no one would receive mere pennies on the dollar.
“They obviously said ‘How do we get the money to the small investor?’ ” Deb Bortner says.
Bortner was head of the Securities Division of the Washington Department of Financial Institutions when she helped investigate and negotiate the settlements.
From the start, she adds, regulators knew the task of sorting out and weighing every claim would be impossible. They pursued only the strongest cases, knowing that setting aside others would likely deprive many investors any hope of recovering their losses.
“It’s a matter of luck if a particular security came up,” says Bortner, who now holds another position in the department. “You’re lucky if you bought one of those and you’re unlucky if you didn’t.”
Awkward and arbitrary as the process may have been, an alternative such as a class-action lawsuit ultimately returns less to investors, she says. “Anything that gets money back is a good thing.”
Bortner says no one ever came up with an estimate of how many of the investors affected by the settlement live in Washington. Even McGovern’s estimate for all of the U.S. runs from 50,000 to 100,000 – all in all, relatively few of the many small investors who had a share of that $2 trillion meltdown.
None of the individuals or brokerages involved admitted any wrongdoing.