Intellectually Bankrupt, Firms Try to Squash Dissent

Crain’s New York’s Aaron Elstein has a good story about financially troubled corporations suing research firms that issue negative reports.

Elstein writes about a suit that Hertz Global Holdings Inc., the struggling (whoops!) rent-a-car firm, is bringing against Audit Integrity Inc., alleging the New York research firm committed commercial libel and defamation when it listed Hertz among big companies facing the “greatest bankruptcy risk” in the next twelve months.

The financial questions are not the issue, although Audit Integrity has gained plenty of credibility (and paying clients) among institutional investors for its hard-hitting research, Elstein reports, and Hertz has had plenty of trouble all on its own.

The issue is whether a research firm can strongly criticize a public company without the threat of a libel claim hanging over it. The use of libel laws and other legal maneuvers against financial critics is an extreme tactic and ought to be recognized as such. Hertz could have answered Audit’s report with one of its own. Instead, it’s asking the courts, aka, the government, to punish the speaker.

Except in the most blatant cases of reckless and irresponsible speech, such suits, in and of themselves, are bad for markets, bad for financial journalism, bad for expression generally, and bad for the public, which lately has ended up has ended up bailing out firms, (Bear, Lehman, etc.) that dissenters tried to warn about.

Libel suits chill speech. Everybody knows that, including the Supreme Court.

We need more dissent in financial markets, especially about individual companies, not less. In fact, the lack of hard-hitting reporting about individual financial firms was the main reason the public was caught so off-guard by the financial crisis, as we painstakingly documented last spring.

Put it this way: the public is flooded with cheerleading research from the Wall Street sales machine eager to attract retail marks, oops, I mean, investors, to its promising investment opportunities, and to inflate asset bubbles until they explode, as Steve Pearlstein adroitly points out in this morning’s WaPo. It’s why “buy” recommendations still make up 85% to 90% of stock recommendations from Wall Street firms, according to this WSJ story from June documenting faltering efforts to promote independent research.

And let’s face it, the financial press too often goes with the flow. This is because, as everyone knows, writing a positive story is easier than writing a negative one. Investigative reporting is hard. And it’s particularly hard in the area of small public companies fighting for their financial lives, where the resistance tends to be fierce, and the rewards for taking on such journalistic heavy-lifting are few. It’s much easier to avoid the hard cases. The only losers are readers, and who cares about them?

Chill dissenting stock research, and you’ve got less probing financial reporting. Plain and simple.

That’s why it was more than a travesty a couple years ago when the Keystone Cops (h/t: Gary Weiss) over at the Securities and Exchange Commission subpoenaed financial writers Carol S. Remond and Herb Greenberg, reporters who actually took the trouble to look into the finances of small public companies. Believe me, they could have been doing something else.

Here are the details of the Hertz case, plus Elstein’s smart analysis with my emphasis:

Park Ridge, N.J.-based Hertz Global Holdings Inc., struggling to regain its footing after a $1.2 billion net loss last year, sued Audit Integrity and its chief executive, Jack Zwingli, alleging defamation and trade libel. The suit, filed in late September in a New Jersey state court, demands unspecified damages plus a retraction and an apology. If successful, Hertz’s action could set a legal precedent that would muzzle Wall Street analysts who are inclined to publish disagreeable opinions.

No doubt. As if financial naysayers needed more disincentives. Audit (no relation to THE Audit; there’s really only one) is not backing down:

Mr. Zwingli’s 15-employee firm is ready for war with Hertz, which generated $8.5 billion in revenue last year. “We have every right to publish our opinion, and Hertz knows that,” he says. “The only reason they’ve filed this suit is to inflict some pain on us. They won’t succeed.”

Crain’s shows that this is not an isolated case.

At least three other companies have sued disapproving analysts before, with little to show for their efforts. Online retailer Overstock Inc. sued Gradient Analytics in 2005, alleging that its analysts conspired with hedge fund managers who bet against Overstock shares. Biovail, a drugmaker, made similar allegations in a 2006 suit against a former Bank of America analyst and some hedge funds. Last year, BankAtlantic Bancorp of Florida sued prominent banking analyst Dick Bove and brokerage Ladenburg Thalmann, his former employer, after Mr. Bove included BankAtlantic on a list of institutions that he said could fail.

The suits don’t seem to have accomplished much for the plaintiffs. Overstock settled and got a statement of non-apology from Gradient. Biovail settled with the BofA analyst, but the suit prompted an SEC investigation that ended with Biovail paying $10 million to settle charges of committing accounting fraud and misleading analysts and investors. The status of the BankAtlantic suit isn’t clear; none of the parties will comment.

But the suits surely have had a chilling effect on other analysts who might have held negative opinions about stocks, not to mention the journalists who might use them as sources,.

In 2006, 60 Minutes, perversely, for a news organization, aired a piece lauding Biovail for its supposed courage in taking on allegedly rogue analysts supposedly in the hire of marauding hedge funds. The news magazine wound up with several eggs on its face when the SEC ended up suing, not the hedge fund or analysts, but Biovail for securities fraud; the firm then saw its own suit thrown out by a New Jersey judge and pleaded guilty to a federal criminal charge of making illegal payments to induce purchases of one its drugs.

Some victim.

Hertz claims its libel action was warranted:

Hertz contends Audit Integrity’s work went beyond fair opinion and included false accusations made with “a reckless disregard for the truth.”

[Audit CEO Jack Zwingli] questioned the integrity of our financial reporting,” a Hertz spokesman says. “The charges are baseless, and we felt strong countermeasures were warranted.”

“Reckless disregard for the truth”—that’s pretty strong talk. If you think Hertz is going to meet that standard, I’ve got some shares in a rental car company to sell you.

In the meantime, readers should be aware of exactly who, in the long run, is the loser in these suits. They are.

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Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014). Follow Dean on Twitter: @deanstarkman.