Earlier this month, Jeff Miller posted an interesting discussion about The Fly on the Wall litigation (lower court decision here; coverage of appellate arguments here).
For those of you unfamiliar with The Fly, it is an online service that reproduced a headline feed of Wall Street Research coverage: Upgrades, downgrades, price targets. Several firms (Barclays/Lehman, Merrill, Morgan) sued The Fly, who lost the case after a bench trial (no jury).
This was not a First Amendment case (as it might appear), but instead was about protected work product and copyright infringement. Unauthorized parties — including the iBanks’ own employees — were forwarding research to the Fly, who was excerpting the stock calls.1
The Fly was ultimately found guilty under the theory of “hot-news misappropriation” and the plaintiffs were granted injunctive relief.
Here’s where things get rather interesting: When determining the proper scope of injunctive relief, a court may be guided by matters of public policy. Specifically, the court noted that the granting of equitable relief, such as a permanent injunction, “may go much further both to give or to withhold relief in furtherance of the public interest than where only private interests are involved.”
Now, I would argue that this was in fact a dispute between two private parties — The Fly on one hand, and the iBanks on the other. The public interest was not in any way represented here. However, the court inexplicably found a “Public Policy Consideration:”
“It was undisputed at this trial, and explicitly conceded by Fly, that the production of equity research in general, and its production by the plaintiff Firms specifically, is a valuable social good.”
This was a terrible error by the Judge. Wall Street Research does not meet the qualifications of “Valuable Social Good.”
In my opinion, this was an error on the part of legal counsel for the Fly to concede as much. There is no evidence whatsoever that equity research by the firms involved offer any such public good. Indeed, anyone familiar with Wall Street history can demonstrate that over time, the inherent conflicts have cost the public 100s of billions of dollars. It can also be demonstrated that Wall Street research exists to serve the needs of the firm’s syndicate and IPO business, not the public.
Wall Street research is guilty of groupthink, is congenitally too optimistic (by 100% according to McKinsey) — except at bottoms, when it is too pessimistic. Often times, it is a contrary indicator. If we include the fraud of the 1990s and 2000s, Wall Street research has worked as a mechanism for extracting wealth from the public. The nicest thing I can say about Wall Street research is it constitutes a nuisance (perhaps an Attractive Nuisance) at best, and at its worst is a menace to the public.
Let’s look more closely at what the judge found in her decision about Wall Street research:
“Such research plays a vital role in modern capital markets by helping to disclose information material to the market, to price stocks more fairly and, as a result, to produce a more efficient allocation of capital.”
Equity prices are driven over time by a variety of factors: Earnings, Discounted cash flow, dividends, etc. These are facts that comes directly from the comp0anies to the public via SEC filings. They do not come from Wall Street research.
The judge is not simply wrong — she is thoughtlessly repeating a Wall Street myth about equity pricing without any evidence. Companies themselves disclose information to the public about their revenues, sales costs, profitability and earnings. What The Street’s research generates are opinions — sometimes right, often wrong, rarely in doubt.
This myth, not coincidentally, is promulgated by iBanks as a way to help sell their products and generate commissions. Study after study shows that the more an investor trades, the worse their performance is. Pray tell, how is generating more trading activity a “public good” if it hurts investor returns?
Some hedge funds and other active traders may find these calls valuable, as they swing in and out of equities. But is that a public good? I doubt it — and the judge, despite a lack of any evidence whatsoever, appeared to merely assume so.
Indeed, according to Graham and Dodd, the factors that matter the most to the valuation of any equity are not the opinions issued from Wall Street, but are the specific factors that describe the companies actual performance over time. And as laws (such as Sarbanes-Oxeley) require, that data comes from the companies themselves — and are not subject tot hew opinions of Wall Street.
In other words, the Judge based part of her remedy on a faulty understanding of equity pricing models:
“Although the gains from immediate trading and rapid stock movement based on knowledge of Recommendations may be realized initially only by sophisticated investors, all market participants benefit from a market operating to align prices with underlying value as quickly as possible. Indeed, three decades of jurisprudence in federal securities law have built upon the understanding that investors may rely in bringing a securities fraud lawsuit on the integrity of the market price of a stock to create a presumption of transaction causation.” (emphasis added)
The judge cites “three decades of jurisprudence” that is loosely based on the Efficient Market Hypothesis — a mostly discredited view of how markets operate, whose value was eviscerated by the financial crisis.
Conclusion: I have no opinion on whether The Fly should have won its case or not. But the remedy fashioned was based on a market urban legend that has no basis in fact. Wall Street myths have worked their way onto American legal jurisprudence. It would be helpful if attorneys could understand these myths, and at the very least challenged them in open court.
Until then, Judges are issuing orders that have no basis in reality. This does not serve investors or a “social good” in any appreciable way.
And on the possibility that future cases are against not obscure investing websites, but Google News, Yahoo Finance, or even Bloomberg, this decision could have lasting importance.
Lawyer: Finance firms’ suit not free-speech attack
AP Aug 6, 2010
Website’s instant posts of Wall Street research banned
Jonathan Stempel and Grant McCool
Reuters, March 18, 2010
Barclays v. TheFlyOnTheWall.com: Hot News Doctrine Alive and Kicking; Will News Aggregators Be Next?
Citizen Media Law Project, March 23rd, 2010
Barclays Capital Inc. v. Theflyonthewall.com, Inc. (06 Civ. 4908).
1. The Fly did not help its case by suing a competitor for essentially the same claims the iBanks made against it.
Further, the Wall Street firms’ research had inscriptions such as “This material may not be reproduced, forwarded, excerpted, etc, without prior wrritten permission.”
The Fly’s own website had a similar disclaimer: “The material presented on this Web Site is the property of Theflyonthewall.com, Inc. and is protected by copyright. None of it may be reproduced, broadcast or resold without our permission.”
Thus, the judge appears to have found the Fly’s copyright position both novel and hypocritical.
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