Investment Banks: Who Will Foot Their Bill?

Insurers may have to pay up for the Street's research misdeeds

What's a word worth? If it's "settlement" instead of "fine" or "judgment," potentially billions of dollars to investment banks that have been investigated for allegedly conflicted research practices. That's because their insurers may have to cough up for a settlement, but not for a fine or a court ruling favorable to thousands of aggrieved investors suing the banks in the civil courts.

The Securities & Exchange Commission and New York State Attorney General Eliot Spitzer's office are hammering out the final details of a global settlement with 10 banks that is expected to be announced soon. The banks will be required to pay $1.4 billion in penalties and to fund independent research for investors. But the precise wording of the document will be crucial. Worried insurance executives approached regulators in January and asked them to specify that any payments should come out of banks' pockets. But regulators rebuffed them, say people close to the negotiations, because they worried that banks would challenge such a ruling's legality and slow down the process.

Now, even though investors got burned by following bad Wall Street advice, there's a risk that insurers could end up paying a big chunk of the settlement agreed to by the banks. Furthermore, the banks may be able to deduct the portion of the payout devoted to independent research and education from their taxes as a cost of doing business. In short, the bulk of the punishment for the banks' bad behavior could land in the laps of others.

The insurers are at odds about what to do. Many are raising the banks' premiums. Some are mulling taking the banks to court. "If you commit a crime, you don't have a proxy go to jail for you, do you?" says American International Group Inc. Chief Executive Maurice "Hank" Greenberg. Banks "may think it's a gray area but it's not, in my mind," he says of payouts for the Spitzer deal.

In reality, the $1.4 billion deal is small potatoes to both the banks and insurers. What's at stake is who will foot the bill for the lawsuits from retail investors, which could cost tens of billions, estimates Prudential Securities Inc. Most suits are expected to be settled out of court, without banks admitting guilt. If so, the insurers could be on the hook again because the plaintiffs wouldn't have proved intentional fraud.

Unfortunately for the insurers, the banks might be under intense pressure to settle. Regulators have vowed to make public all the documents, e-mail, and information they have collected from banks that may show their actions were misleading. "We're going to err on the side of inclusiveness," says one. "We want to put some evidence out there that the private plaintiffs might need." Buoyed by such evidence, plaintiffs may have a much better chance of winning in court, which could make banks eager to settle.

So some insurers want to go after the plaintiffs' lawyers. On Feb. 5, Chubb Inc. Vice-Chairman John J. Degnan told Professional Liability Underwriting Society members that the insurance industry should band together and form the Institute for Securities Class Action Defense. The new group would "confront and reverse a very troubling pattern of abusive, outrageously aggressive, and, in some cases, downright dishonest conduct on the part of the plaintiffs' bar in class-action securities litigation," Degnan said. His logic in teaming up with the banks may seem perverse, but banks are some of insurers' biggest customers.

Even if Greenberg and AIG stiffen the resolve of other insurers and organize a fight against the banks, the insurers may still end up paying for Wall Street's mistakes. Case in point: A congressional investigation claimed that many banks' transactions with Enron Corp. were no more than "accounting scams." Still, in a suit that was settled in early January, insurers paid 60% of banks' losses on the deals.

Banks say they're simply protecting their investors. Credit Suisse First Boston has an "obligation to shareholders" to make a claim if it's appropriate, says a CSFB spokesperson. But when it comes to Wall Street's accountability, the lesson seems to be clear: It's not what you do, or how you do it. It's what you're insured for.

By Heather Timmons, with Emily Thornton, in New York and Mike McNamee in Washington

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