Paying Analysts

Is it fraudulent to pay analysts to promote your company’s stock? In a break from the run-of-the-mill securities class action, investors in Diomed Holdings, Inc. alleged that, in 2002, the company and its chairman “devised a plan to artificially inflate the price of Diomed’s stock by secretly paying stock analysts to tout Diomed to unsuspecting investors.” The plaintiffs argued that this was part of a “pump and dump” scheme and and unlawful pursuant to Rule 10b-5.

The court disagreed. In Garvey v. Arkoosh, 2005 WL 273135 (D. Mass. Feb. 4, 2005), the court held that “nothing in the securities laws bars the issuer of a regulated security from paying an analyst for a stock recommendation.” While the applicable regulatory scheme requires the person who publishes the report to disclose a conflict of interest (see Section 17(b) of the ’33 Act), there is no similar duty imposed on the issuer who paid for the promotion. Moreover, the analysts had clearly stated in their reports that they were being paid to tout the stock, even if the disclosures did not directly connect Diomed to the payments.

Holding: Motion to dismiss granted.

Quote of note: “Any reasonable investor told that the publisher of an investment report had received $700,000, $100,000, or even $50,000 to tout a particular stock would give the analyst’s recommendation the proverbial grain of salt regardless of the source of the funds.”

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