John Spence

Class Action Suit Filed Against Merrill Lynch HOLDRs

Investors who got burned by the dot-com bust may have a chance to reclaim some of their lost money, even if the tech rebound many of them are holding out for fails to materialize.

Two law firms recently filed class action lawsuits against Merrill Lynch on behalf of investors who purchased Internet Infrastructure HOLDRs (IIH) from February 24, 2000 through December 6, 2000.

The suit, which names Merrill Lynch, Pierce, Fenner & Smith Incorporated, and Merrill Lynch & Co. as defendants, contends that the Internet Infrastructure HOLDRs prospectus was "materially false and misleading" because it didn't clearly state that the porfolio consisted of stocks "whose prices had been artificially inflated through the use of improper practices relating to their initial public offering." HOLDRs, which stands for Holding Company Depository Receipts, are static exchange-traded baskets of stocks covering many sectors offered by Merrill Lynch.

Internet Infrastructure HOLDRs shareholders eligible for the suit may finally have something to smile about, because the trust has been hit hard by the dot-com shakeout.

Get Poor Quick Scheme?

Morningstar Data as of 9/30/2001

The class action suit is yet another legal blow for Merrill Lynch that threatens to further tarnish its image. In a landmark July 2001 settlement, Merrill Lynch agreed to pay $400,000 to an investor who claimed his kids' college funds were wiped out when he followed the stock advice of Merrill's celebrated technology analyst, Henry Blodget.

However, a federal judge recently dismissed similar claims against equally famous Morgan Stanley tech stock analyst Mary Meeker. Several investors who bought tech stocks on Meeker's bullish calls said she overly hyped the stocks for the benefit of the investment banking side of her firm. When the federal judge dismissed many of the cases against Meeker in August, he called them examples of "abusive litigation."

Like the recent cases against star tech analysts of yesteryear, the HOLDRs class action suit will be closely followed by the industry because it can set a potentially dangerous precedent for further litigation. Many analysts and fund managers are left wondering just how much intelligence they can assume on the part of investors.

"I haven't reread the HOLDRs prospectus, but you'd think one who was investing in a basket of Internet Infrastructure stocks would certainly understand the risks involved," said Christopher Traulsen, a Morningstar analyst who covers HOLDRs.

Traulsen's colleague, veteran fund analyst Scott Cooley, admitted that he's never seen a suit like the one filed against Merrill Lynch.

"From my point of view, this [class action suit] is definitely a first," said Cooley. "At a minimum, the plaintiffs deserve credit for coming up with a unique litigation strategy."

However, Merrill Lynch and other fund managers won't be laughing if the class action suit is successful. Scores of disgruntled investors were sucked into the Internet bubble, and many could attempt to cut their losses through litigation if the door is opened.