Legal Beagles Bite JPMorgan

The bank boots a big settlement for the second time in two years.
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JPMorgan Chase

(JPM) - Get Report

needs to hire some new lawyers.

For the second time in two years, the nation's third-largest bank has bungled its handling of a major lawsuit.

A federal appeals court ruled late Tuesday that a suit claiming that Wall Street banks manipulated the prices of hundreds of dot-com IPOs should never have been certified as a class action.

The news should be a victory for the big investment banks, which have fought the suit every step of the way. But JPMorgan, at least, has egg on its face once again -- because it moved in April to reach an early $425 million settlement in the case.

At the time, many were saying the decision to settle was a shrewd move, since JPMorgan had long ago set aside money for a possible payout. But now, legal experts say JPMorgan could be out the money in a case that otherwise may not yield big paydays for plaintiff lawyers. Lawyers say a settlement is like a contract and the parties are bound to it, unless there is an out clause.

It's not clear how JPMorgan intends to proceed in the wake of the ruling by the Court of Appeals for the Second Circuit. A bank spokesman declined to comment.

The reversal comes just a year after JPMorgan's last settlement snafu. The bank passed up an early $1.4 billion offer to settle with shareholders in the WorldCom litigation. But after some adverse rulings in the case, JPMorgan ended up paying $2 billion instead.

Tuesday's 51-page ruling from the three-judge appellate panel is a big victory for the other 54 Wall Street firms that are still defendants in the lawsuit. The ruling means that the allegedly aggrieved investors must now pursue their cases on the own, if they hope to collect any damages.

Given the high cost of litigation and the difficulty proving the manipulation allegations, it's likely that many investors will opt not to go it alone against the likes of

Goldman Sachs

(GS) - Get Report

,

Merrill Lynch

(MER)

,

Citigroup

(C) - Get Report

and

Credit Suisse

(CS) - Get Report

and

Morgan Stanley

(MS) - Get Report

.

The IPO suit contends that 55 investment banks defrauded investors by artificially inflating the value of dot-com IPOs for companies such as Ask Jeeves, iVillage, Razorfish and TheGlobe.com. The suit claims they published bullish reports to prop up those stocks and struck deals with institutional investors to encourage them to buy shares of those companies in the aftermarket.

JPMorgan does have a few things in its favor. First, it has yet to actually pay the money to Milberg Weiss, the law firm that's serving as lead counsel in the IPO litigation. Second, the settlement, although agreed to in a memorandum of understanding between the parties, hasn't been put into a final document.

Some are suggesting that JPMorgan is in a no-lose situation since it already has set aside a legal reserve for the $425 million payout. If the bank can somehow void the settlement, it will get an unexpected half-billion windfall in some future quarter.

Still, that may be wishful thinking on the part of the bank, and it doesn't negate the questions about the bank's legal strategy in handling litigation.

It's worth noting that JPMorgan opted to settle the case at a time the other Wall Street defendants already had filed an appeal in the case. Legal experts say Judge Shira Scheindlin went a bit out on a limb when she certified the lawsuit as a class action.

Donald Langevoort, a professor at Georgetown University's law school, says the judge, at the time, conceded Scheindlin was "stretching" the law a bit. But she argued that doing so was within her discretion in order to allow the investors to proceed with their claims.

The appellate court, however, disagreed. In the ruling, the court says the judge moved prematurely in certifying the lawsuit as a class action and had not dealt fully with some factual disputes and differences between the various claims first.

In the WorldCom litigation, JPMorgan similarly misread the legal crosswinds. In that case, JPMorgan was the last large bank to reach a settlement with WorldCom shareholders. The bank could have gotten out of the lawsuit for just $1.4 billion if it had accepted an earlier settlement overture.

But the bank opted to roll the dice and wait to see how the judge ruled on a series of motions. The bank's wait-and-see strategy proved costly, when the judge ruled that the bank could potentially be on the hook for up to $10 billion in damages if the case went to trial. JPMorgan quickly settled a few days after the ruling.

Meanwhile, the JPMorgan settlement isn't the only one cast into a bit of jeopardy by the appellate ruling.

Two years ago, the plaintiffs in the IPO case reached a tentative $1 billion settlement with the insurers for 309 mostly dot-com companies. One of the companies included in that preliminary deal was

TheStreet.com

(TSCM)

, publisher of this Web site.