Highly paid City analysts were left contemplating big cuts in their salaries and the possibility that many of their most valuable pearls of wisdom will have to be passed on by word of mouth after Morgan Stanley was yesterday found to have given biased advice by a French court.
The bank was ordered to pay €30m (£21m) in damages to the French luxury goods group LVMH by Gilbert Costes, a French commercial court judge. In a landmark judgment, he found that Morgan Stanley, in research on LVMH written by the top-rated analyst Claire Kent, had "caused a moral and material prejudice to LVMH's image, which justifies reparations".
The findings were being picked over yesterday by compliance officers in the City but, pending a successful appeal by Morgan Stanley, the LVMH victory could have serious implications for the way the City works.
Some of the City's leading figures predicted a reduction in the number of analysts and the amount they are paid as research suddenly became a potential legal liability, thanks to the LVMH ruling.
"This is bound to make compliance departments look at what is written in research much more critically and restrict what analysts can say," said Will Samuel, the vice-chairman of Lazard & Co in London.
The most opinionated and often the best research would probably be disseminated over the telephone to favoured clients rather than risk publication and a expensive law suit, investment bankers said. This could lead to more inefficient markets, they warned.
"Capital markets tend to work best when good research is in the public domain," said one leading broker.
The court said that Morgan Stanley's research "constitutes a serious fault on the side of Morgan Stanley to the detriment of LVMH".
The luxury goods group had been seeking €100m in damages from Morgan Stanley after alleging that the bank's research was undermined by Morgan Stanley's banking relationship with Gucci, LVMH's bitter rival.
Ms Kent had cut her recommendation for LVMH from "outperform" to "neutral" in May 2000. LVMH said it had found 178 errors in research carried out by Ms Kent and her team. It said Morgan Stanley had published research that was damaging to it at a time when the bank's corporate finance advisers were helping Gucci fend off a takeover bid from LVMH.
Morgan Stanley said: "This judgment is completely wrong and sets a dangerous precedent. This opens the floodgates for companies to use the threat of legal action to persuade analysts only to make positive statements about them." The bank said it would be standing behind Ms Kent, who was last year ranked as the No 1 analyst in her sector.
The relationship between a bank's corporate finance department and its research analysts has already come under intense scrutiny in the US.
Elliot Spitzer, the New York Attorney General, succeeded in forcing nine US investment banks, including Morgan Stanley, to pay $1.4bn (£760m) to settle conflict of interest claims last year. Philip Purcell, the chief executive of Morgan Stanley, was subsequently forced to apologise to Mr Spitzer after making comments that suggested Morgan Stanley was not taking the settlement seriously.
The publication of equity research plays a crucial role in the way investment banks fund and organise their businesses. The banks hope that good research, provided at no cost to fund managers, will generate share trades from them, earning the banks' broking arms huge commissions. These so called secondary commissions are a valuable source of income that not only pay for the research analysts but also contribute to profits. Research is also used to impress potential corporate clients who can provide banks with lucrative corporate finance advisory fees.
If research is now a legal liability, the role of the analyst could be curtailed, with their numbers and salaries slashed as a result. The big investment banks will find alternatives to drive share trades through their dealing room, mainly by using their enormous balance sheets to greater effect and committing more capital to share trading operations.
LVMH said that the decision marked a precedent that would ensure the separation of investment banking and financial research activities.
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