“Five big Wall Street securities firms found a new way to issue tainted stock research to investors during the stock-market bubble, according to regulators,” writes Randall Smith in today’s Wall Street Journal.

“In one of the most surprising elements of Monday’s $1.4 billion research settlement with the government, half of the 10 securities firms cited for civil violations were charged with making or receiving undisclosed payments for research. The upshot, according to regulators: Firms would pay their rivals what were sometimes called ‘research guarantees’ to build more positive ratings on stocks, rigging the system against unwitting investors who didn’t know the game.”

“The alleged payments — involving Morgan Stanley, the UBS Warburg unit of UBS AG, the securities unit of J.P. Morgan Chase & Co., Bear Stearns Cos. and the Piper Jaffray unit of U.S. Bancorp — amounted to yet another way Wall Street firms orchestrated the appearance of numerous favorable research reports for investment-banking clients during the late 1990s, regulators say. The firms agreed to the settlement without admitting or denying the allegations.”

“Asked about the payments Tuesday at a conference for investors, Morgan Stanley Chief Executive Officer Philip Purcell attempted to minimize the charges, saying his firm simply passed the money on to other firms and had no involvement in the research. Mr. Purcell continued to argue that Morgan Stanley’s reputation hadn’t been damaged by the settlement, and that clients had no reason to reconsider doing business with the firm. The other firms declined to comment.”

“It had been widely known for years that securities firms routinely issued overly optimistic stock research to investors to curry favor with corporate clients and win their lucrative investment-banking business. But this system of under-the-table payments wasn’t even widely known within the securities business, people on Wall Street say. Some of the firms that received the payments also didn’t disclose that they had been paid for the research in their written reports, according to regulators.”

“The activity was another way Wall Street firms enticed investors ‘to go into a rigged market,’ asserted Fred Taylor Isquith, a lawyer whose firm represents investors suing the major Wall Street firms in a class-action case alleging market manipulation. A positive report from an analyst who didn’t appear to work for the underwriters could have had more credibility with investors, he said.”

“For investors, the extra research could give the appearance of wider stock interest and trading momentum, regulators said. ‘Initiating coverage is viewed as something positive, particularly when the rating is positive,’ said Barry Goldsmith, chief of enforcement at the National Association of Securities Dealers. ‘An investor is sure to want to know, if you put out a recommendation on a stock, that you were paid to write that report.’ “

“Morgan Stanley paid $2.7 million in underwriting fees for at least 12 offerings it managed to 25 securities firms, according to documents filed by the Securities and Exchange Commission and the NASD. Internal Morgan Stanley documents, the regulators said, described the payments as ‘research guarantees’ or ‘guaranteed economics for research.’ “

“Morgan Stanley made the payments from the offering proceeds at the direction of the corporate investment-banking client companies that issued the securities, the regulators charged. The ‘research guarantee’ payments included $670,000 paid to three securities firms in connection with a December 1999 offering of Veritas Software Corp., $816,000 paid to seven firms in connection with an Agile Software Corp. offering the same month, and $440,000 to five firms in connection with an offering by Atmel Corp. in February 2000. The amounts of the payments ranged from just over $6,000 to $225,000.”

“Although the issuers’ offering statements identified the other firms as part of the underwriting syndicates and as recipients of payments, the statements didn’t disclose that the payments were for research, and Morgan didn’t ensure that the firms disclosed the payments in their reports.”