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Federal Judge Questions Wall Street Global Settlement

William H. Pauley III, U.S. District Judge for the Southern District of New York, has raised a number of issues in connection with the approval of the recent Wall Street global settlement under which 10 of the nation's top investment firms settled enforcement actions involving conflicts of interest between their research and investment banking divisions. The court wants the SEC and other participants to the settlement to provide explication on a number of issues by June 16, 2003.

The total of all payments in the settlement would be roughly $1.4 billion, with amounts divided among a federal fund distribution, investor education efforts, independent research, and the states. The distribution funds will be administered by an SEC-recommended, court-appointed distribution fund administrator, who will formulate a plan to distribute the funds in an equitable manner to customers who purchased the equity securities of companies referenced in the complaint against the firm through which the customer bought the securities. The fund administrator's plan of distribution will be subject to court approval.

Initially, the federal court noted that settlement provisions indemnifying fund administrators from all civil or criminal claims or liability are too broad. While appreciating the need to indemnify administrators, the court declined to approve any decree holding harmless administrators, agents or attorneys acting on their behalf from criminal liability.

Turning to the substance of the consent judgments, the court then asked the participants to the settlement, including the SEC, to respond to four specific sets of issues. First, while the consent judgments are called final, the court noted that the plans to return money to investors, to educate them and to fund independent research are "seemingly inchoate." The judgments spoke in "abstractions," said the court, and deferred the specifics to unnamed administrators and independent consultants.

Secondly, in Judge Pauley's view, the judgments contemplate future, but not assured, acceptance by the states. The court queried what will happen if one or more states reject the settlement offer. In addition, the court asked if there is a time frame for state acceptance.

Third, the court wanted to know the identity of the beneficiaries of the distribution fund. For example, the court must be told if any categories of injured investors are excluded from claims against the distribution fund, such as mutual fund investors and investors in derivatives.

Fourth, the consent judgments require the federal payments to be designated as a penalty and disgorgement in equal proportions. The court asked if that allocation will be affected by the state's acceptance of the settlement offer. Finally, the court wanted an explanation of the tax ramifications of this arrangement.

¨ SEC v. Bear, Stearns & Co. will be published in a forthcoming REPORT .