THE COLOR OF MONEY
Ruling underscores need for investors to be aware of risks

By Michelle Singletary

I was fully prepared to criticize Senior U.S. District Judge Milton Pollack for dismissing two lawsuits against Merrill Lynch & Co. recently.

In one case, investors alleged that analyst research reports were "materially" misleading in violation of federal securities laws. In a second case, an investor in the Merrill Lynch Global Technology Fund alleged that the company failed to disclose that the fund had invested in companies with which the broker-dealer had an investment banking relationship.

When I first heard about Pollack's rulings, I was furious. Here we go again, I told a friend. A judge blaming investors. I thought this was another example of telling investors they were stupid for trusting Wall Street.

Then I read Pollack's written decisions for both cases.

In these particular cases, Pollack didn't believe the investors were victimized. He essentially said the plaintiffs were either gambling with high-risk investments or should have been aware of the conflicts of interest.

Pollack also drew a distinction between lawsuits involving alleged fraud (such as WorldCom Inc. and Enron) and others in which investors were responsible for their own actions.

Pollack pointed out one telling truth about far too many investors: They often aren't informed of, or choose to ignore, the risks they are taking.

For example, over the past several weeks, I've written many columns warning investors about buying stock in companies under bankruptcy protection. In many cases, these companies (WorldCom Inc., Kmart) have come out and said their current stock will be worthless once the company emerges from bankruptcy. And still small investors buy the stock.

One woman recently wrote: "I have several friends, including a bank manager, who have recommended that I purchase WorldCom stock now and hold onto it until after the (company's) restructuring. Is this recommendation in error?"

I know it's hard to figure out who or what information to believe these days, but you definitely shouldn't invest based on investment tips (and uninformed ones at that) from friends. If this woman buys WorldCom shares now and keeps them until the company emerges from bankruptcy, she will have purchased expensive toilet paper.

Pollack also didn't buy the claim from investors who felt cheated because Merrill Lynch didn't disclose the conflicts of interest between its research department and investment banking operation.

"Again, this claim fails if for no other reason than because the information regarding the alleged conflict of interest was public knowledge, and had been for years," Pollack wrote.

Pollack cited numerous newspaper and magazine articles dating to 1995 in which investors were told, among other things:

• "Investors, journalists and others who deal with the Street would do well to keep in mind that, often times, the analyst is wearing two hats." (The Wall Street Journal, 1996)
• "The relationship between the analysts and the investment banking business ... pays their bills." (The Boston Globe, 1996)
• "Brokerage firms are not about to break up the money machine that pairs analysts with dealmakers. And analysts are not about to risk offending the companies they cover. Woe to the investor who doesn't keep these two ideas in mind before investing on a stock recommendation." (BusinessWeek, 1998)
• "Analysts of all stripes ... increasingly derive a portion of their compensation, directly or indirectly, from the companies they cover." (Fortune, 2000)

And here's another fact Pollack cited that I found astounding. The investors admitted they hadn't seen or read the analyst reports that they claimed were misleading.

How can you have been misled by something you didn't even read?

There is no doubt many investors have been harmed by various actions by people working for Wall Street investment firms and publicly traded companies. But there is a limit to crying foul if you chose high-risk investments. It is a gamble. And there is a good chance you will lose, especially if you don't know how the game is played.

Just as it is with the law, ignorance is no excuse. If you don't find out what you don't know before high-risk investing, don't expect to win your money back by telling a tale of woe to a judge — at least not to Pollack.