UNITED STATES DISTRICT COURT
Plaintiff Securities and Exchange Commission ("Commission" or "SEC") alleges:
NATURE OF THE ACTION
1. The Commission brings this action against defendant J.P. Morgan Securities Inc. ("JPMSI" or "Defendant"), to redress its violations of pertinent rules of NASD, Inc. ("NASD") and the New York Stock Exchange, Inc. ("NYSE").
2. During the period July 1, 1999 through June 30, 2001 (the "relevant period"), Defendant engaged in acts and practices that created and/or maintained inappropriate influence by investment banking over research analysts, thereby creating conflicts of interest for its research analysts. Defendant failed to manage these conflicts in an adequate manner. During the relevant period, Defendant encouraged its research analysts to participate in investment banking activities, and used this participation as a factor to evaluate analysts and determine their compensation. The Research Department of Defendant coordinated the decision to initiate and maintain research coverage on certain companies with Defendant's Investment Banking Department, and coverage decisions were influenced by investment banking interests.
3. As a result of the foregoing, research analysts were subject to conflicts of interest between supporting Defendant's investment banking business and publishing objective research. In addition, during the relevant period Defendant made payments for research to other broker-dealers not involved in an underwriting transaction when Defendant knew that these payments were made, at least in part, for research coverage. Defendant did not disclose or cause to be disclosed in offering documents or elsewhere the fact of such payments. Finally, Defendant failed to establish and maintain adequate policies, systems, and procedures reasonably designed to detect and prevent the investment banking influences or manage the conflicts of interest.
4. By its conduct, Defendant violated NASD Rules 2110, 2210(d)(1)(A) and 3010, and NYSE Rules 342, 401, 472, and 476(a)(6).
JURISDICTION AND VENUE
5. This Court has jurisdiction over this matter pursuant to Sections 21(d)(1), 21(e), 21(f), and 27 of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. §§ 78u(d)(1), 78u(e), 78u(f), and 78aa].
6. Defendant, directly or indirectly, used the means and instrumentalities of interstate commerce, of the mails, or of the facilities of a national securities exchange, in connection with the acts, practices, and courses of business alleged herein.
7. Venue is appropriate in this District pursuant to Section 27 of the Exchange Act because Defendant is found, has its headquarters and principal executive offices, and transacts business in this District.
DEFENDANT AND OTHER RELEVANT ENTITIES
8. J.P. Morgan Securities Inc. is a subsidiary of J.P. Morgan Chase & Co. ("JPMC"), a Delaware corporation with its principal place of business in New York, New York. JPMSI provides equity research, sales, and trading services, merger and acquisition advisory services, private banking services, and underwriting services.
9. JPMSI is registered with the Commission, is a member of NASD and the NYSE, and is licensed to conduct securities business on a nationwide basis.
10. During the relevant period, several JPMSI predecessor entities engaged in both research and investment banking activities.
11. Hambrecht & Quist LLC ("H&Q") engaged in research and investment banking activities until it was acquired by The Chase Manhattan Corporation ("Chase") in December 1999. H&Q was merged into Chase Securities Inc. ("CSI"), a subsidiary of Chase, and the merged entity engaged in research and investment banking activities under the name CSI and the trade name Chase H&Q. CSI did not publish equity research prior to the acquisition of H&Q by Chase.
12. In 1999, JPMSI engaged in both research and investment banking activities as a subsidiary of J.P. Morgan & Co. Incorporated ("JPM"). In December 2000, Chase acquired JPM, creating the combined entity JPMC. In May 2001, CSI and JPMSI merged, and CSI assumed the name JPMSI. Since then, JPMSI has engaged in equity research under the name JPMSI and the trade names J.P. Morgan and J.P. Morgan H&Q.
13. For purposes of this Complaint, the JPMSI predecessor entities that engaged in both research and investment banking activities - H&Q, CSI, and JPMSI - shall be referred to unless otherwise specifically stated as "Defendant."
I. RESEARCH ANALYST PARTICIPATION
14. Research analysts were responsible for providing analyses of the financial outlook of particular companies in the context of the business sectors in which those companies operated and the securities market as a whole.
15. Research analysts evaluated companies by, among other things, examining financial and other information contained in public filings, questioning company management, investigating customer and supplier relationships, evaluating companies' business plans and the products or services offered, building financial models, and analyzing competitive trends.
16. After synthesizing and analyzing this information, research analysts drafted research reports and more abbreviated "notes" that typically contained a recommendation, a price target, and a summary and analysis of the factors upon which the analyst relied in issuing the price target and recommendation.
17. Defendant published research on publicly traded companies, and this research was distributed to Defendant's institutional and private equity customers. Published research was made available through mailing lists, Defendant's website, and subscription services provided by First Call. In addition, the research was made available to some retail customers of another broker dealer and offered via websites offering brokerage and investment services.
18. In addition to performing these research functions, certain research analysts participated in investment banking activities.
19. These investment banking activities included identifying and/or vetting companies as prospects for investment banking services, participating in pitches of investment banking services to companies, participating in "roadshows" associated with underwriting transactions, and speaking to investors to generate interest in underwriting transactions. (A "roadshow" is a series of presentations made to potential investors in conjunction with the marketing of an upcoming underwriting.)
20. These investment banking activities also included participating in commitment committee and due diligence activities in connection with underwriting transactions and assisting the Investment Banking Department in providing merger and acquisition ("M&A") and other advisory services to companies. (The commitment committee was responsible for, among other things, evaluating and then either approving or rejecting Defendant's participation in initial public offerings ("IPOs") and other investment banking transactions.)
21. Defendant encouraged all research analysts to support its businesses, including Defendant's investment banking business and, in some cases, research analysts were expected to participate in the foregoing investment banking activities. The level of analyst participation in these investment banking activities was sometimes significant.
22. For example, in an e-mail dated May 23, 2000 and sent by a research analyst to the Head of Research at JPMSI, the analyst requested approval to hire another junior analyst. The analyst stated:
23. Investment banking business was an important source of revenue for Defendant. In 2000, the combined operating revenues for JPM and Chase totaled $32,793,000,000 and the combined revenues for the Equity Capital Markets ("ECM") and the M&A Departments at JPM and Chase totaled $1,687,000,000.
II. PARTICIPATION IN INVESTMENT BANKING ACTIVITIES WAS A
24. The compensation system at Defendant provided an incentive for research analysts to participate in investment banking activities and to assist in generating investment banking business for Defendant.
25. The performance of research analysts was evaluated by the Head of Research through an annual review process and, where not set by contract in advance, the research analyst's bonus was determined through this process.
26. The Head of Research evaluated the research analysts' job performance through responses to self-evaluation forms, surveys of the sales force, input from the Investment Banking, Sales, and Trading departments, consideration of market factors and rankings by investor publications, and, in some cases, written "team reviews" submitted by individual investment bankers.
27. The self-evaluation forms contained questions on areas constituting the major allocations of research analysts' time, including questions relating to participation in investment banking activities.
28. In response to questions relating to participation in investment banking activities, research analysts reported one or more of the following: their investment banking activities, accomplishments, and goals, their participation in lead- and co-managed underwritings, and the fees associated with investment banking transactions on which the analyst worked.
29. For example, the "Investment Banking Activities" section of a 1999 self-evaluation form queried: "In what way have you assisted in discovering or executing banking transactions (i.e., due diligence sessions, pitches)? Be specific." In response, a research analyst stated: "Helped put together and develop pitch books for KV Pharma and King Pharmaceuticals"; "Helping to come up with creative ideas and contributing to brainstorming sessions with bankers - ad hoc and in biweekly Monday meetings"; "Have a good handle on which companies will need financing in the near future and stepping up research efforts to ensure a place for H&Q on the cover"; and "Increasing responsibility in the office allows [another research analyst] to travel and be more active in pitching and winning deals with new companies."
30. In another example, a research analyst stated the following in response to investment banking questions contained in his year 2000 self-evaluation form:
In addition, the analyst listed all deals on which he worked that were "Lead Managed," "Co-managed, "Pitched," and "Pending."
31. The self-evaluation forms conveyed to research analysts some of the criteria used to evaluate their performance. As reflected in the investment banking questions contained in the forms, contribution to Defendant's investment banking business was an important part of the analyst's job.
32. In some circumstances, research analysts requested that individual investment bankers complete a written "team review" of the analyst, which was then submitted to the Head of Research. In these reviews, the investment banker described his or her contact with the analyst and the analyst's participation in investment banking activities, including pitch and underwriting activities.
33. For example, in a 1999 review of a research analyst by an investment banker, the banker stated the following:
34. Research analysts sometimes provided reviews of investment bankers in conjunction with the banker's performance review. In these reviews, analysts described their contact with the banker and referenced participation in specific investment banking activities.
35. For example, in an e-mail dated Dec. 14, 2000, a research analyst provided a review of an investment banker. The analyst stated:
36. Based upon comments in the self-evaluations completed by research analysts and the reviews completed by both analysts and investment bankers, the two groups worked closely on investment banking transactions and shared a common goal of building Defendant's investment banking business.
37. The Head of Research reviewed the self-evaluations and team reviews and provided a verbal and/or written evaluation of the research analyst. The written evaluations provided feedback on the analyst's performance during the year and in certain cases highlighted the analyst's participation in investment banking activities, including the revenues generated by investment banking transactions on which the analyst worked.
38. For example, the Head of Research at JPMSI stated the following in the first paragraph of his year 2000 evaluation of a research analyst:
Later in the evaluation, the Head of Research stated that the analyst's contribution to Defendant's "corporate underwriting business" was "enormous."
39. Comments by the Head of Research conveyed to research analysts the performance areas that were important to research management and Defendant. Based upon these comments, certain analysts were encouraged to participate in investment banking activities, increase investment banking revenues, and enhance the reputation of Defendant's investment banking franchise.
40. Research analyst bonuses were determined by the Head of Research in his discretion after considering several factors that contributed to the analyst's market value.
41. The research analyst's contribution to and impact on Defendant's investment banking business, and the fees generated by investment banking transactions on which the analyst worked, were some of the factors used to determine the analyst's bonus. If the analyst did not disclose in the self-evaluation form the fees generated by the investment banking transactions on which he or she worked, the Head of Research requested this information from the ECM Department at Defendant.
III. INVESTMENT BANKING INTERESTS INFLUENCED DEFENDANT'S
42. In general, Defendant determined whether to initiate and maintain research coverage based upon institutional investors' interest in the company and/or based upon investment banking considerations, such as attracting companies to generate investment banking business or maintaining a positive relationship with existing investment banking clients.
43. Regarding companies for which Defendant lead- or co-managed an underwriting transaction, research coverage was typically initiated and maintained for a period of time beyond the transaction.
44. The Head of Research was responsible for approval of the determination to issue, maintain, and drop research coverage. The Head of Research solicited input from other departments, including the Investment Banking Department, to determine the coverage preferences of those departments. Investment banking considerations sometimes played a role in the decision to initiate and maintain research coverage.
45. For example, after the merger of JPM and Chase, the Director of U.S. Equity Research at JPMSI sent an e-mail entitled "U.S. Equity Research Organizational Announcement." Attached was an internal memorandum "outlining Investment Banking Coordination Responsibilities," which stated: "One of the important duties of the Director of Research is to work closely with Investment Banking to ensure that research resources are appropriately aligned with identified investment banking opportunities."
46. In addition, the Head of Research requested that research analysts obtain from investment bankers lists of companies that the bankers wanted under coverage.
47. For example, an e-mail dated November 4, 1999 from the Head of Research to all equity research analysts stated: "[T]alk to your counterparts in IB and prepare a list of the companies that they would like you to cover. . . . Please be sure to have a conversation with the appropriate bankers before you submit your list."
48. Some research analysts and investment bankers actively coordinated the initiation and maintenance of research coverage based upon, among other things, investment banking considerations. This coordination consisted of meetings and communications by telephone and e-mail.
49. For example, a research analyst sent an e-mail dated March 9, 2001 to the Director of U.S. Equity Research at JPMSI that stated:
50. In another example, an investment banker sent an e-mail dated May 17, 2001 to a group of biotechnology analysts and bankers to arrange a meeting to discuss "coverage strategy." The e-mail stated: "On the heels of [a research analyst and banker] leaving, we probably need to discuss coverage strategy. Also would be a good time to talk about where we might shake loose some business . . . M&A ideas to pitch, IPOs coming in next wave etc."
51. In another example, a research analyst sent an e-mail dated March 1, 2001 to biotechnology analysts and the Head of U.S. Equity Research that contained the following subject line: "bankers wish list for biotech research." The e-mail stated:
52. The following e-mails reflect the investment banking influences in the initiation and maintenance of research coverage as perceived by an individual research analyst.
53. In an e-mail dated November 2, 2000, a research analyst provided a team review of an investment banker that stated the following:
54. In an e-mail dated August 8, 2000, the same research analyst stated:
55. In addition, consideration of "investment banking sensitivities" was included in a discussion of Defendant's "Long Term Buy" ("LTB") research rating.
56. An e-mail dated December 29, 2000 was sent to all Chase H&Q research analysts, including the Head of Research at Chase H&Q, describing the stock rating system to be used after the merger of JPM and Chase. The e-mail's subject line stated: "Public dissemination of coverage and Re-Rating your stocks-IMPORTANT*****." The e-mail stated:
IV. DEFENDANT PROVIDED CERTAIN COMPANIES WITH AN
57. Defendant typically initiated research coverage on companies that engaged Defendant in an investment banking transaction.
58. H&Q and Chase H&Q had an informal policy of providing certain companies with a "warranty" of research coverage in conjunction with investment banking transactions.
59. For example, in an e-mail dated November 22, 2000, and sent by the Head of eBusiness at Chase H&Q to the Head of Research at Chase H&Q and others, the Head of eBusiness stated:
60. Defendant verbally promoted this warranty research coverage in conjunction with pitches of investment banking business to companies, and research coverage would be maintained on certain companies subject to the warranty.
61. For example, in an e-mail dated October 20, 1999 an investment banker sent an e-mail to senior executives at H&Q that contained the following subject line: "Follow Up on a Pitch Please." The e-mail stated:
62. Also, in an e-mail dated December 19, 2000, from an investment banker to a member of the board of directors of Epicor Software Corporation ("Epicor"), the banker stated: "Just a heads up that the extended warranty provided for Epicor is running out." In an e-mail dated December 22, 2000, the board member replied: "not a surprise. thanks for sticking to the deal."
V. DEFENDANT'S PITCH MATERIALS CONTAINED
63. During the relevant period, companies considered research coverage to be an important factor in selecting a firm for an underwriting transaction.
64. In certain pitch materials, the Research Department, and research analysts in particular, were described to implicitly suggest that Defendant would provide favorable research coverage after the investment banking transaction. ("Pitch materials" are the written materials provided to the management of an issuer in conjunction with Defendant's pitch or presentation of its strengths and capabilities in conducting an upcoming IPO or other investment banking transaction.) The research analyst's reputation and industry ranking, statistics regarding the percentage of lead- and co-managed IPOs currently under coverage, and Defendant's "aftermarket support" were promoted in pitch materials. In addition, Defendant utilized "case studies" of companies under coverage that included charts comparing the dates of positive published research to the company's stock price. The case studies showed the stock price increases following the analyst's positive recommendation and/or placement on the analyst's or Defendant's "Focus List."
65. For example, in an e-mail dated February 23, 2000, an investment banker forwarded pitch materials to an employee of Participate.com to persuade the company to employ Defendant as an underwriter for an upcoming IPO and private offering. The pitch materials identified the research analyst who would cover the company after the investment banking transaction. In pages captioned "[Research analyst's name]: Authoritative Voice in the Marketplace," "case studies" were presented on the analyst's past coverage of two companies: Wireless Facilities and AppNet. The case studies contained charts that showed the stock price increases following placement of the stock on the analyst's and Defendant's focus lists. The "Wireless Facilities Case Study" stated the following: "Chase H&Q adds WFI to Focus List: WFI gains 11.7% (1/27/00)." The "AppNet Case Study" stated the following: "Chase H&Q adds AppNet to Focus List: AppNet gains 7.5% (8/2/99). . . . While on [the research analyst's] Focus List, AppNet appreciates 309% (8/2/99-10/26/99)." Also presented were excerpts of positive commentary by the research analyst that accompanied the Buy ratings and/or placement on the focus lists.
VI. RESEARCH ANALYSTS WERE VISIBLE ON STOCKS
66. Research analysts were encouraged to increase their visibility, or level of communication, on certain stocks to generate investment banking business.
67. Lists of stocks were distributed to various departments at Defendant, including the Research Department.
68. The "ECM [Equity Capital Markets] target list" contained stocks of companies from which Defendant was seeking investment banking business during the next 18 months.
69. The "trading focus list" contained stocks of companies from which Defendant was seeking investment banking or underwriting business during the next three months.
70. The Research Department and other departments were at times encouraged to increase the trading volume of the stocks on the lists for investment banking purposes.
71. The following e-mail, dated May 11, 2001 and sent from an investment banker to individuals on the "IB Ebusiness" distribution list, explained the rationale for the two lists:
72. Trading rank was important to a company's choice of a firm for investment banking transactions, and Defendant's trading rank was often promoted in pitch materials to potential investment banking clients.
73. For example, pitch materials provided in conjunction with the AppNet IPO contained a section entitled "Commitment to Corporate Clients Delivers Institutional Credibility and Trading Strength." There, H&Q's Autex trading rank is identified as "#1," "#2," "#3," and "#4" in the stocks of specific companies that engaged H&Q for an IPO.
74. Certain research analysts were encouraged to increase their visibility, or level of communication, on stocks contained in these lists.
75. For example, in an e-mail dated September 27, 2000, from an investment banker to a research analyst and others, the banker forwarded September's focus list and stated:
VII. PAYMENTS FOR RESEARCH
76. During the relevant period, H&Q and Chase H&Q made seven payments totaling $1,312,500 for research issued in conjunction with five underwriting transactions in which Defendant was a lead- or co-manager.
77. H&Q and Chase H&Q made these payments for research without disclosing or ensuring their disclosure in offering documents or elsewhere.
VIII. DEFENDANT FAILED TO ADEQUATELY SUPERVISE ITS RESEARCH AND INVESTMENT BANKING DEPARTMENTS
78. While the role of research analysts was to produce objective research, Defendant also encouraged them to participate in investment banking activities.
79. In addition, the Research and Investment Banking Departments had a formal connection within Defendant's organizational structure. From February to December 2000 at JPMSI, the Head of Research had a dual reporting line to both the Head of Equities and the Head of Investment Banking.
80. Also, in 2000 at Chase H&Q, research analysts were organized and placed into "Analyst Sub-pods" for purposes of managing and monitoring their investment banking activities. Research analysts reported to "Sub-pod Managers," who were investment bankers and were responsible for the day-to-day coordination of the research analysts' investment banking activities.
81. The Analyst Sub-pod system for Chase H&Q "Internet Research and Banking" is explained in a May 2000 Chase H&Q interoffice memorandum which contained a "coordination chart." In the chart, the Analyst Sub-pods had a direct reporting line to the Sub-pod Managers. The memorandum stated the following: "The `Analyst Sub-pod' is the organizational engine for all that we do." Sub-pod Managers, who were investment bankers, were responsible for the
82. The Analyst Sub-pod system was created to provide "enhanced coordination between Banking and Research."
83. As a result of the foregoing, research analysts were subject to investment banking influences and conflicts of interest between supporting Defendant's investment banking business and publishing objective research. Defendant had knowledge of these investment banking influences and conflicts of interest yet failed to manage them adequately to protect the objectivity of published research.
84. Defendant failed to establish and maintain adequate policies, systems, and procedures reasonably designed to ensure the objectivity of its published research. Although Defendant had some policies governing research analysts' activities during the relevant period, these policies were inadequate and did not address the investment banking influences and conflicts of interest that existed.
FIRST CLAIM FOR RELIEF
[Violation of NASD and NYSE Rules Due to Conflicts of Interest Resulting From Investment Banking Influence Over Research Analysts]
85. Paragraphs 1-84 are realleged and incorporated by reference.
86. NASD Conduct Rule 2110 requires members to observe high standards of commercial honor and just and equitable principles of trade.
87. NYSE Rule 401 states that "[e]very member, allied member and member organization shall at all times adhere to the principles of good business practice in the conduct of his or its business affairs."
88. NYSE Rule 476(a)(6) prohibits member organizations, among other things, from engaging in practices that constitute conduct inconsistent with just and equitable principles of trade.
89. As alleged above, during the relevant period JPMSI engaged in acts and practices, including but not limited to providing a "warranty" of research coverage in conjunction with certain investment banking transactions, that created and/or maintained inappropriate influence by investment banking over research analysts, therefore imposing conflicts of interest on its research analysts. JPMSI failed to manage these conflicts in an adequate or appropriate manner.
90. By reason of the foregoing, JPMSI violated NASD Conduct Rule 2110 and NYSE Rules 401 and 476(a)(6).
SECOND CLAIM FOR RELIEF
[Violation of NASD and NYSE Rules by Making Payments to Other Broker-Dealers for Research]
91. Paragraphs 1-84 and 86-88 are realleged and incorporated by reference.
92. NASD Conduct Rule 2210(d)(1)(A) states in part:
93. NYSE Rule 472 governs communications with the public, including requirements relating to research communications and research reports.
94. As alleged above, during the relevant period JPMSI made payments to other broker-dealers not involved in an underwriting transaction when JPMSI knew that these payments were made, at least in part, for research coverage. JPMSI did not disclose or cause to be disclosed in offering documents or elsewhere the fact of such payments.
95. By reason of the foregoing, Defendant violated NASD Conduct Rules 2110 and 2210(d)(1)(A) and NYSE Rules 401, 472 and 476(a)(6).
THIRD CLAIM FOR RELIEF
[Violations of NASD and NYSE Rules by Failing to Supervise]
96. Paragraphs 1-84 are realleged and incorporated by reference.
97. NASD Conduct Rule 3010 requires members, among other things, to "establish and maintain a system to supervise the activities of each registered representative and associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations," including the NASD's own Rules.
98. NYSE Rule 342 requires members, among other things, to maintain "appropriate supervisory control" over all business activities to ensure compliance with securities laws and regulations, including providing "a separate system of follow-up and review to determine that the delegated authority and responsibility is being properly exercised."
99. As alleged above, during the relevant period JPMSI failed to establish and maintain adequate policies, systems, and procedures for supervision and control of the Research and Investment Banking Departments reasonably designed to detect and prevent the foregoing investment banking influences and conflicts of interest, including a separate system of follow-up and review to assure compliance with federal securities laws and applicable NASD and NYSE rules.
100. By reason of the foregoing, Defendant violated NASD Conduct Rule 3010 and NYSE Rule 342.
PRAYER FOR RELIEF
WHEREFORE, the Commission respectfully requests that this Court enter final judgment: