Harvard raised some eyebrows this fall when it brashly decided to sue Merrill Lynch for $135 million after an investment went bust.

The lawsuit was one of the largest claims ever made against an investment firm, and a prominent investor like Harvard setting its sights on a top Wall Street firm like Merrill Lynch was not a common occurence.

But the University's decision started to look more reasonable this week, as a federal judge rejected Merrill Lynch's first attempt to short-circuit the case.

It's still too early to tell if Harvard will actually win. But at the very least, this week's decision proves that Harvard has a worthy case.

The lawsuit, filed in November, charges that Merrill Lynch "misrepresented" the fiscal condition of the Lomas Financial Corporation, a financial house based in Texas.

Merrill Lynch's Advice to Harvard

According to Harvard's outside counsel Richard W. Renehan, Merrill Lynch advised Harvard that the Lomas stock was "as liquid as commercial paper" and of "investment grade." Harvard listened, and sunk $45 million into the company's "preferred" stock.

But less than six months later, Lomas encountered serious financial difficulties, and filed for bankruptcy under the provisions of Chapter 11.

Harvard was smarting from the loss--which amounted to one percent of its total endowment--and sent its lawyers after Merrill Lynch for triple damages. Those lawyers say Merrill Lynch intentionally kept Harvard unaware of important information in order to further its own interests.

At a hearing earlier this month, Renehan said that Merrill Lynch had salvaged Lomas from collapse early in 1989--before Harvard made its investment--with an "eleventh hour purchase" of Lomas stock to protect the company from seizure by banks.

Yet Merrill Lynch made no mention of "its clandestine role in propping [Lomas] up, or of the big deal... in the works" when it sent private placement information to Harvard, according to Renehan.

Furthermore, Merrill Lynch continued doing business with Lomas after it sold Harvard the stock, eventually acquiring the company's valuable credit card division shortly before Lomas declared bankruptcy in September. Again, Renehan said, Merrill Lynch did not inform Harvard.

From the beginning, Merrill Lynch has countered such arguments by using Harvard's prominence on Wall Street as proof that the University is no novice investor. Merrill Lynch lawyer Kenneth M. Kramer argued that Harvard knew well the risks of buying the Lomas stock.

"In sum, when the investigation ball was in Harvard's court, Harvard hit the showers," Kramer said. "And it cannot blame Merrill Lynch."

Merrill Lynch has not responded to Harvard's charges about the credit card division purchase, and other alleged improper business dealings with Lomas. But even if those charges prove to be true, Kramer said Merrill Lynch was not obligated to provide Harvard all the information.