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Last Friday, the SEC filed an amicus brief in a 2nd Circuit court appeal from a district court decision certifying a class of investors who alleged that they were defrauded in purchasing WorldCom, Inc.’s securities based in large part upon misrepresentations contained in defendants’ analyst reports.

As the NY Times noted in an article earlier in the week, the SEC’s brief supports the lead plaintiff – New York State Retirement Fund – by arging that analysts like Jack Grubman affect the price of a company’s stock and bonds and may be held accountable for misrepresentations they may make. Citigroup, the parent of Grubman’s employer, is contending that his unrelenting enthusiasm for WorldCom securities had no impact – and therefore investors were not harmed when they relied on his reports. Here is more from the NY Times’ article:

“At issue is a bedrock concept in securities law known as the fraud-on-the-market theory, used in many securities fraud cases. Under this concept, all widely disseminated information about a publicly traded security is reflected in its market price, and investors rely on the integrity of this price when deciding whether to buy or sell a security. Therefore, any information about the company that is false or misleading is reflected in the market price and can harm investors who buy or sell relying on that market price.

Lawyers at Paul, Weiss, Rifkind, Wharton & Garrison in New York, representing Citigroup in the class action, argue in their brief that this legal theory should apply neither to analysts in general nor to Mr. Grubman in particular. Their brief states that institutional investors ignore analysts’ reports and that analysts’ opinions – including that of Mr. Grubman – are simply part of a conglomeration of information and do not have a distinct effect on securities prices.

There is no reason to believe that Mr. Grubman’s opinions, which relied on WorldCom’s disclosures, had any distinct price impact “over and above the price consequences of WorldCom’s massive ongoing fraud,” Citigroup’s lawyers said in their brief. As such, each investor should have to prove that he was harmed by Mr. Grubman and Salomon in individual cases, not as a class action.

But lawyers at the S.E.C. countered that economic studies showed that analysts’ reports affect securities prices and that their very purpose was to provide information upon which investors base their decisions.

In arguing that Mr. Grubman’s opinions did have an impact on WorldCom’s stock and bond prices, lawyers for the New York State fund noted in their brief the “unusually close relationship” between Mr. Grubman and WorldCom, citing the analyst’s attendance at board meetings where acquisitions were discussed.

Mr. Grubman’s influence was so pervasive that Salomon specifically solicited prospective investment banking clients by promising them that Mr. Grubman would “support” the stock with favorable research reports if they retained Salomon as their investment banker, the brief stated.

The brief also noted that the New York fund has uncovered new evidence showing that Mr. Grubman “fraudulently manipulated the underlying financial analyses he used to value WorldCom stock to maintain falsely inflated target prices for the stock and justify a buy rating, even though WorldCom’s performance did not satisfy Salomon’s own criteria to earn such a rating.”

It is unclear what prompted the WorldCom filing. But the brief seems to be evidence of continued vigilance by the S.E.C. on issues related to brokerage firm research even after its historic settlement with Citigroup and other Wall Street firms over analyst conflicts more than a year ago.”