Heard on the Street

Wall Street Analysts Run Risk
Of Suits for Negative Reports

By ELIZABETH MACDONALD
Staff Reporter of THE WALL STREET JOURNAL
 

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 even fired.

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 success.

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 executive officer.

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.

1National 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 elizabeth.macdonald@wsj.com³

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