Judge Says Merrill Clients Should've Known Better

In tossing out a class-action suit over tainted stock research, U.S. District Judge Milton Pollack notes the plaintiffs' failure to recognize a bubble.
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Updated from 3:53 p.m. EDT

Investors trying to sue

Merrill Lynch

(MER)

over tainted research got a slap in the face Tuesday when a federal judge tossed their suit and lambasted the investors for their own naivete.

The judge referred to the investors as "high-risk" speculators who seek to hold Merrill Lynch accountable for their own folly and "rash speculation." The suit was the first of two dozen class-action suits filed against the brokerage.

The ruling by U.S. District Court Judge Milton Pollack in New York applies only to claims raised by investors in two stocks,

24/7 Media

(TFSM)

and

Interliant

.

But it could be critical because Pollack oversees all the research class actions against Merrill Lynch. In a footnote to his 43-page decision, the judge indicated that he has yet to determine whether his ruling in dismissing the case will be applicable to all those remaining lawsuits.

One Up

The dismissal is the first victory for a Wall Street firm in the aftermath of this year's $1.4 billion tainted-research settlement. It sparked buying in Merrill's shares: They closed at $48.20, a rise of $1.52, or 3.26%, in

NYSE

trading, while the Philadelphia Bank Index rose 1.28% on Tuesday.

A Merrill Lynch spokesman said "we are pleased with the judge's decision." A lawyer for the investors could not be reached for comment.

The dismissed lawsuit alleged that investors lost money on the stocks because Merrill Lynch analysts, led by disgraced Internet guru Henry Blodget, misled them by publishing overly bullish reports. Lawyers bringing the lawsuit on behalf of thousands of investors introduced evidence gathered during New York Attorney General Eliot Spitzer's investigation last year of Merrill Lynch's research division.

Pollack was unmoved by the emails Spitzer's office unearthed, in which Blodget and other Merrill analysts referred to some of the stocks they followed as "piece of crap" or "piece of junk." In fact, he blamed investors for ignoring an obvious stock market bubble in the making, and simply holding onto the stocks until it was too late to sell.

"The alleged omissions are not the 'legal cause' of the plaintiff's losses," said Pollack. "The plaintiffs controlled their ultimate exit from the stocks after waiting no doubt for a market reversal."

The judge also took umbrage with the complaint filed by the plaintiffs' lawyers, noting that the allegations were "not linked with the tightest of logical rigor." At other points, he referred derisively to some of the emails gathered by Spitzer's office as "snippets."

Another One Falls

In another case, a federal judge dismissed a similar analyst research case brought by investors in

Covad

(COVD)

against

Goldman Sachs

(GS) - Get Report

,

Credit Suisse First Boston

and

Morgan Stanley

(MWD)

.

The spate of favorable rulings for Wall Street may be an indication that despite this year's $1.4 billion settlement, it will not be easy for investors to prevail in cases brought against Wall Street firms. That's partly because investors must show that they relied on an analysts' misleading research in deciding to buy a stock and hold onto it.

The Wall Street victories also come just days after more than 300 companies, whose shares were allegedly manipulated during the initial public offering craze, settled with investors for $1 billion. The litigation against 55 Wall Street firms that underwrote those IPOs continues.

Precedent

One thing is for sure: Pollack, a 96-year-old semiretired judge, has shown a dislike for lawsuits alleging that investors lost money on stocks because of misleading or fraudulent research. Two years ago, he dismissed a tainted research class action brought against Morgan Stanley and its star Internet analyst Mary Meeker. That class action was one of the first tainted-research lawsuits ever filed.

The Meeker lawsuit was thrown out before Spitzer produced email evidence showing that Merrill analysts privately doubted the health of the companies they were touting.

Several securities lawyers said Pollack, who began practicing law just days before the 1929 stock market crash, has a history of siding with Wall Street firms in disputes with investors. He may be best known for overseeing the civil litigation stemming from the collapse of the junk bond firm Drexel Burnham Lambert.

The ruling by Pollack does not necessarily have any impact on similar research class actions brought against other Wall Street firms. But the judges hearing those cases could look to Pollack's ruling for guidance. It also will not have an impact on the hundreds of arbitration proceedings Merrill customers have initiated in the wake of the analyst scandal.

Already, some on Wall Street are applauding the decision. Prudential Securities brokerage analyst David Trone, in a brief research note, hailed the ruling, saying a "wise old man brings sanity to the research world."

"Pollack's ruling, in our opinion, provides zero opportunity for plaintiffs' attorneys to bring these suits back in a different form," Trone wrote. "While they may posture in the media the next few days, we fully expect the other stock claims against Merrill to be withdrawn, since the argument and Pollack's ruling were cookie-cutter."