December 29, 1999
Heard on the
Wall Street Analysts Run Risk
Of Suits for Negative Reports
By ELIZABETH MACDONALD
Staff Reporter of THE
Wall Street analysts who dare to take the unusual step of criticizing
companies in their research reports routinely risk being pilloried by their
institutional-investor clients, frozen out of company conference calls or
Now they have another problem to contend with: libel suits.
That's what Sturza's Institutional Research, a medical-technology stock
research firm in New York, and Avalon Research Group of Boca Raton, Fla.,
are dealing with.
When analysts at the two research firms issued separate reports this
summer questioning the profit potential of Sunrise Technologies
International, the company, which manufactures lasers to correct vision
problems, slapped each of them with a defamation suit.
The two research firms aren't alone in their fears of libel suits. Some
officials of the New York Society of Security Analysts have been so
concerned that National Presto Industries -- which was the subject of
an unflattering joint report by a group of society members -- may file a
defamation suit that they convened a meeting in November to review analysts'
constitutional rights of free speech.
Even the threat of a libel suit is relatively rare for Wall Street
analysts. "But then again, we've never seen a market like this," says lawyer
James Goodale, a First Amendment expert who spoke at the analysts' meeting.
The threat of analysts' being dragged through the courts comes at a time
when companies prize good relations with analysts, and when fawning research
reports have become commonplace.
To be sure, there's a long and memorable history of angry companies that
retaliate against analysts who go negative on them. Paul Schlesinger, a top
investment analyst at Donaldson, Lufkin & Jenrette Securities, says he has
his own chapter to offer involving FDX, the parent of Federal
Express, which he says tried to freeze him out of a company meeting with
analysts last spring following his critical reports.
Fuming, he sent a terse letter to Arthur Levitt, chairman of the
Securities and Exchange Commission, noting his predicament. And Mr. Levitt
in a subsequent speech described a similar situation without mentioning
names. Since then, Mr. Schlesinger says, the company has put him back on its
communications list. "It was an unpleasant experience," he says, adding the
market doesn't like it when analysts "foul the punch bowl; it's considered
antisocial to do so."
William Margaritis, corporate vice president of FDX, says: "Our
longstanding philosophy is to be proactive with analysts and to provide
complete and timely information to them through a variety of channels."
Getting put in the penalty box is one thing. Libel suits are another.
"Even the frivolous ones" threaten to devastate analysts' wallets and chew
up precious time, says Gary Lutin, a New York investment banker who was a
co-sponsor and adviser on a critical analysts' report on National Presto.
While it may be that legal threats aren't all spilling over into the courts,
the mere specter of legal action has shaken up the analyst industry.
In the case of Sunrise, the two critical reports came at a particularly
sensitive time, when the Fremont, Calif., company was asking an advisory
panel at the U.S. Food and Drug Administration to recommend to the agency
that it approve its request to market its laser. Specifically, Avalon and
Sturza's both issued reports recommending the sale of Sunrise stock. The
reports argued Sunrise's treatment had limited chances of commercial
Sunrise says it filed the defamation suits in U.S. District Court in San
Francisco after both firms ignored requests to retract their reports. The
suits against the firms allege both reports were fraught with "false and
misleading statements." For one, Sunrise says the Sturza's report seriously
overstated the company's quarterly "cash-burn" rate, the amount of cash it
is spending to bring the product to market. Analysts "may be protected by
the First Amendment, but the potential to deceive potential shareholders is
vast and it's wrong," says Russ Trenary, Sunrise's president and chief
Steven Hibbard, an attorney defending Avalon, says the suits will "have a
chilling effect on the free-speech rights of securities analysts." In a
motion to dismiss, Avalon called the lawsuit "baseless." Sturza's didn't
return calls seeking comment. The case is still pending. After the FDA
advisory panel voted against recommending approval, Sunrise refiled its
request with the panel.
Presto Report Criticizes Executives (July 28)
At issue in the National Presto dispute is a critical report prepared by
a group of members from the New York Society of Security Analysts after a
six-month inquiry. The report -- which was the subject of a Wall Street
Journal "Heard on the Street" column in July -- maintained the tepid
stock-price performance of the kitchen-appliance company in Eau Claire,
Wis., stemmed from poor corporate-governance practices.
The unusual, joint report came from a group of eight stock analysts and
portfolio managers, among others, who chose National Presto as a test case
in an effort to show how corporate-governance practices could affect
shareholder value and influence investors' decisions to buy, hold or sell
stocks. Group members say National Presto won the distinction for reasons
including a large stake held by one family, and because the company has
criticized past attempts by shareholders to instigate change.
Specifically, the report said the company, which has a stock market value
of about $250 million, is sitting on a $241 million cash hoard, and that the
board lacks independence from management. National Presto's president,
Maryjo Cohen and her father, Melvin, who is chairman, control about 30% of
the stock. In the past five years, the stock has remained nearly flat while
some market indexes have tripled.
For its part, National Presto maintains the report was "replete with
factual errors." It said the group unfairly compared it with companies that
were generally much bigger; just three were direct competitors in small
appliances. And the company says the report failed to adequately acknowledge
that its profit margins and dividends are strong.
The complaints didn't end there. Vahan Janjigian, a member of the New
York Society of Security Analysts, who reviewed the study, said after
National Presto saw the report it was "threatening legal action." Minutes of
a Nov. 9 meeting of the society's corporate-governance committee describing
an "update on the National Presto forum" cited "implied threats of lawsuits"
from the company as having forced the group to proceed with "caution."
Although James Bartl, National Presto's executive vice president and
counsel, says the company is "not threatening anyone with lawsuits," the
company did force the group to pull the report from the society's Web site (www.nyssa.org2)
earlier in December by arguing that it didn't get a chance to review the
study. A revised version is now back on the site.
Whatever the outcome of these fights, Mr. Goodale, the First Amendment
expert, says analysts can take heart. He says a defamation claim can be
difficult to prove because to win a libel claim, a company would first have
to establish that the information the analyst reported was factually false.
The company would also have to prove the analyst knowingly put material
falsehoods in the report, and that the analyst acted in reckless disregard
of the truth. Beyond that, Mr. Goodale notes that much of what analysts
publish is opinion, which is protected as free speech by the Constitution.
Mr. Goodale, though, has another concern about such suits. "If the market
starts to fall, investors are going to look for people to blame, including
analysts," he says. So analysts shouldn't let legal threats stop them from
putting out bad news, "so long as it's the truth," he says. "If analysts
aren't going to do it, who will?"
Write to Elizabeth MacDonald at
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