PAUL SOLMAN: It's not often that an attorney general makes the cover of Fortune Magazine. But New York Attorney General Eliot Spitzer is more than just a state official. To the chagrin of some, the approval of many, Spitzer has become perhaps the most vigorous enforcer of the rules against corporate malfeasance in America, and in the process, has become one of the Democratic Party's bright lights. He used his New York jurisdiction to go after Wall Street analysts for touting stocks they didn't believe in.
ELIOT SPITZER: The motive was investment banking fees and enormous personal compensation for the analysts.
PAUL SOLMAN: Ten investment banks paid $1.4 billion to settle the matter, and Spitzer moved on to another scandal he calls equally egregious: Abuses in the mutual fund industry that may have cost investors billions of dollars. Since Labor Day, he's filed several criminal cases and civil suits, with promises of many more to come. Recently, we sat down with him for an extended chat.
PAUL SOLMAN: Eliot Spitzer, welcome.
ELIOT SPITZER: Thank you.
PAUL SOLMAN: You became attorney general of New York in 1998...
ELIOT SPITZER: Right.
PAUL SOLMAN: ...and immediately took on, or pretty soon took on Wall Street. Why?
ELIOT SPITZER: When it came to investor protection, the issue that should have, I think, been there in a rather significant way for any prosecutorial office was, is the research that the public is getting honest research? And it's not that we're so smart that we latched onto this because we had an intuitive understanding that was better than anybody else. Journalists had written about it. People on the street were talking about it. So the issue ... it was almost low-hanging fruit. And yet nobody had ever done anything about it.
PAUL SOLMAN: What was the closest thing you had to, or your first example of, the smoking gun?
ELIOT SPITZER: There were certain, what I call eureka moments, where you see an e-mail or a piece of evidence that is just so overwhelming. And one of them for me was an e-mail from an analyst inside Merrill Lynch who wrote, "I feel bad about this because we're losing money for Mr. And Mrs. Smith." And the e-mail then continued, "We are afraid to tell them the truth because we'll alienate a client." And she was basically saying, "Gee, I'm beginning to feel bad that we're giving out this false advice and we're doing it because we have to appease our clients," meaning the investment banking clients who were generating the enormous fees for the investment house. And who was paying the price for this? The quintessential small investor, who I believe it's my job to protect. Now, not protect them in terms of guaranteeing a return -- has nothing to do with that. Protect them in terms of guaranteeing integrity in the marketplace.
PAUL SOLMAN: Why did it have to be the attorney general of New York? You would think that this was something that the Securities and Exchange Commission, for example, would have long since looked into by the time you got into office.
ELIOT SPITZER: Maybe it's because everybody enjoyed the creation of the wealth in that period so much that nobody wanted to look too hard at some of what underlay it.
PAUL SOLMAN: I've seen you quoted as saying that the difference between you and them was a difference in emotional context.
ELIOT SPITZER: Right. We feel as though we're fighting a guerrilla war. Every day we're saying, "How do we best use our resources? Where can we dive in and have the greatest incremental impact? What is the biggest problem that isn't being attacked?" Whereas the SEC is more akin to a World War I type of army that digs its trenches and marches forward ten feet at a time.
PAUL SOLMAN: This is when people refer to you as opportunistic; this is the positive side of opportunism.
ELIOT SPITZER: Opportunism is what prosecutors should try to be, because we will never have the resources to find every impropriety out there. What we have to do is make it clear to those who are trying to play games that there is a sufficient likelihood of their being caught and a sufficiently significant risk, downside risk once they are caught, that they're going to say the risk/reward ratio doesn't make it worthwhile.
PAUL SOLMAN: Could you have gone further? That is, pursued some of these people criminally? And if so, why didn't you?
ELIOT SPITZER: There's no question we could have indicted some of the individuals criminally. We could have indicted some of the companies, some of the major entities criminally. And perhaps the hardest decisions last year related to that very issue: Should we have indicted a Merrill Lynch or a Salomon Smith Barney, some of the other major investment houses?
PAUL SOLMAN: The way, for example, Arthur Andersen was...
ELIOT SPITZER: The way Arthur Andersen was. It was a very tough decision, and the judgment call that I made -- I think it's the right judgment cal l-- was that we did not want to destroy a Merrill Lynch or a Salomon Smith Barney. We wanted to change the rules of the game. The rules of the game were fundamentally flawed when it came to the way research was being generated, when it came to the dynamic between research and investment banking. Had we indicted the companies, it could have been a cataclysm for the capital markets that I think at the end of the day would have been more damaging than fruitful.
PAUL SOLMAN: But you could have indicted the individuals. I mean, there are so few white collar criminals who actually are indicted, much less go to jail in this country, even after convicted.
ELIOT SPITZER: Here's the distinction. When it came to the research cases last year ... as I said, our objective was to change the rules. There was an accepted set of rules by which everybody was playing. And it seemed almost a little bit unfair to go ... to say to them, "We're now changing the rules, and we're going to prosecute you because you're not playing by the new rules." Now this year, in the cases we're making with respect to mutual funds, we have already brought multiple criminal cases, and people are going to go to jail because they were breaking rules that were understood and that were accepted and that the rules were proper, but they were breaking them. Last year we had to change the rules because the entire system was corrupted. So there's a difference there.
PAUL SOLMAN: What do you think the worst abuses are that you've seen?
ELIOT SPITZER: Two that I would point to. The dissemination of knowingly bad research is an abomination, because small investors who were putting their life savings, relying upon the honesty of the investment banks, were being defrauded, and their life savings were being destroyed out of the malicious self-interest of investment bankers, and that tore me apart. Just as bad is what some of the mutual funds have been permitted, which is the late-day trading and the timing which, again, amounts to an enormous transfer of wealth from your long-term investors -- mom-and- pop investors -- to the highly sophisticated ... whether they're hedge funds or others, who were trading in and out, taking advantage of the game, and the mutual funds and others have permitted this. Why? Because they got some extra money. And who loses? Again, the mom-and-pop investors who are investing based upon the goodwill and presumption of integrity of these institutions.
PAUL SOLMAN: A finance professor I know has often talked about Wall Street as a game of the wolves living off the sheep. That is, the insiders...
ELIOT SPITZER: Right.
PAUL SOLMAN: ...living off the outsiders, the individual investors.
ELIOT SPITZER: Right. Here's the interesting thing about the market over the last ten or 15 years. There has been a conscious effort on the part of the investment houses, the mutual funds to Democratize the marketplace, to the point where 80 or 90 million Americans now do have capital invested, equity investments in the marketplace, and that's great.
It's good for the capital markets -- more capital flow, more equity for our businesses -- pure upside to that. The consequence of that is that there are more and more less-sophisticated investors whom we have to protect. If the only investors on Wall Street were the ten major investment houses, we could almost say, "Look, you guys are all sophisticated, smart; you're all wolves, and the wolves ... you know, the best wolf will win. But you're all wolves and, you know, go at it." Because there are now 90 million sheep, we've got to protect those 90 million sheep from the thousand wolves, and that's why the job is getting more complicated.
PAUL SOLMAN: What's your analysis of why it happened? It certainly was worse in the last few years than it seemed to have been, I don't know, eight or ten years ago.
ELIOT SPITZER: Right. The only metaphor that I ... that has had any traction with me is one that somebody whom I describe as my political hero and also perhaps my intellectual hero came up with, and that's Pat Moynihan, great senator from New York who came up with the phrase, "defining deviancy down."
PAUL SOLMAN: Defining...
ELIOT SPITZER: Defining deviancy down. And he wrote about this, he came up with the phrase talking about criminal justice and crime and why there was an explosion of street crime in the '70s and the '80s. And what he said was that over time, there was a dissipation in our moral standards.
We tolerated violations, and it began as a toleration ... tolerance of small violations, but that grew over time until we lost the capacity to distinguish good from wrong, and important from unimportant. Perhaps the same thing happened in the boardroom and elsewhere, where over time what began as a small transgression was tolerated, and then over time things spiraled out of control. That's the only sort of explanation that has had any meaning to me.
PAUL SOLMAN: Any worries that in this increased law enforcement that you're doing and believe in, that we will make American business too risk-averse, that we'll...
ELIOT SPITZER: Sure.
PAUL SOLMAN: ...simply lose this great, sort of pioneering business spirit which involves taking chances?
ELIOT SPITZER: Absolutely. I -- the law of unintended consequences is the most powerful law out there but I do not want people to be encouraging others to invest based upon lies and deceit. Encourage them to invest based upon an honest articulation of risks: Possible upside, possible downside. Risk is distinct from fraud. We want to encourage risk-taking; we want to discourage fraud.
PAUL SOLMAN: Eliot Spitzer, thanks very much.
ELIOT SPITZER: Thank you.