The Wall Street Fix
In January 2000, three months before the end of the Internet and telecom boom on Wall Street, former Treasury Secretary Bob Rubin delivered a stunning warning to several hundred of America's biggest telecom investors. Rubin, just hired as top advisor to Citigroup CEO Sanford Weill, foreshadowed the imminent bust in the telecom boom that had made companies like WorldCom into Wall Street darlings.
Yet despite Rubin's call for greater caution in issuing credit--and despite a glut in telecom capacity and plummeting long distance prices that hurt telecom companies --Citigroup led two bank syndicates that sold the investing public $17 billion in WorldCom bonds over the next sixteen months. At the same time, Citigroup's top telecom analyst, Jack Grubman, continued to promote WorldCom stock to investors for two more years, right up until the company was on the verge of bankruptcy.
Now, as the nation's biggest banks prepare to finalize a record $1.4 billion settlement for securities violations, FRONTLINE investigates what New York's attorney general has called Wall Street's "corrupt business model" that cost American investors trillions. In "The Wall Street Fix," airing Thursday, May 8, at 9 P.M. on PBS (check local listings), FRONTLINE correspondent Hedrick Smith reveals the hidden ties that enabled superbanks and Wall Street insiders to shape--and profit from--the 1990s telecom boom while leaving ordinary investors holding worthless stock when the bubble burst.
"All told, American investors lost $7 trillion in the market--$2 trillion in telecom alone," Smith says. "But what most people don't know is the back story--how bankers and Wall Street analysts misled the public with hype about a telecom gold rush even after there were clear signs that the telecom boom was about to go bust."
Smith examines the closely intertwined relationships between up-and-coming companies and the large investment banks hungry for their business. The key to these relationships, industry insiders say, were the Wall Street analysts who were supposed to provide investors with objective reports on which stocks to buy. The analysts, however, worked for the investment banks; so instead of issuing objective reports, insiders say, these analysts were helping their employers secure the lucrative banking business of the companies they were supposed to be objectively reviewing.
"What we found was that analysts were involved from the very beginning of the investment banking relationship--going out there, soliciting a client, promising that if you bring your business to our firm, we will take your company [and] proclaim to the world that it is the best thing since sliced bread," asserts New York State Attorney General Eliot Spitzer.
"It wasn't just one corrupt individual. It was an entire business model that was flawed," Spitzer adds. "It wasn't so complicated that you said, 'Wow at least they're smart in the way they're doing it.' It was simple. It was brazen. The evidence of it was overwhelming."
In "The Wall Street Fix," FRONTLINE illustrates the role that investment banks and their analysts played in making or breaking new companies by tracing the meteoric rise and sudden collapse of WorldCom-- a small-time, Mississippi-based long-distance carrier that rose to become the toast of Wall Street before crashing and burning as the Street's biggest bankruptcy ever. It was a rise, insiders say, boosted by Jack Grubman, a telecom analyst for Salomon Smith Barney, the investment banking arm of Citigroup.
"Jack Grubman and Salomon Smith Barney were essential enablers for WorldCom to take off," says Scott Cleland, CEO of the Precursor Group, an independent research firm specializing in high tech and telecom. "It took a rising stock price. It took some very good investment banking, and some very good salesmanship in order to sell the marketplace [on the company]."
The power of Wall Street banks was also dramatically increased, observers say, by Federal Reserve Board decisions and by Congress's eventual repeal of the Glass-Steagall Act, a 70-year-old law aimed at protecting investors by separating investment and commercial banking.
"The repeal of Glass-Steagall was a big deal because it enabled kind of colossal combinations that just weren't envisioned before," Cleland says, "where you brought the savvy of an investment banking house like Salomon Smith Barney together with a Citibank. And Citibank could loan an enormous amount of money."
But the creation of conglomerates like Citigroup--which combined Salomon Smith Barney with Citibank, a giant commercial bank, and Travelers, an insurance giant, under one corporate umbrella--also created more potential conflicts of interest.
In "The Wall Street Fix," FRONTLINE reveals that Travelers gave WorldCom CEO Bernie Ebbers a personal mortgage for $1 billion. Ebbers would use the loan to build a personal business empire by purchasing half a million acres of timberlands in Mississippi, Alabama, and Tennessee. In addition, Citibank gave Ebbers another loan that he used to finance ownership of a 500,000-acre ranch in Canada--a loan that attorneys representing irate stockholders charge was backed by 2.3 million shares of Ebbers' WorldCom stock.
"That's a very troubling link in our view," says attorney Sean Coffey, whose client, the New York State Employees Pension Fund, has sued Wall Street banks to recover $300 million in WorldCom losses. "Citibank [had] an interest in the stock price of WorldCom being high enough to cover the loans they've made to Mr. Ebbers. And yet, in another part of the same building you've got Jack Grubman issuing analyst reports saying, 'Buy, buy, buy that stock' to drive the price up."
Coffey also questions whether Grubman's close relationship with WorldCom executives would have alerted him to signs of the accounting fraud with which WorldCom has been charged. According to Coffey, Grubman's e-mails confirm that instead of objectively analyzing WorldCom's performance, Grubman was coaching WorldCom executives on what to tell other stock analysts about the company's accounting practices.
"The fact that [Grubman] is so tight with them raises the question of how he could not know about $9 billion in overstated earnings," says Coffey. "Our lawsuit alleges that, at a minimum, he saw red flags and decided to ignore them, as he continued to tout WorldCom stock to the investing public."
FRONTLINE also speaks with two former Salomon Smith Barney brokers, who describe in detail how their firm steered choice initial public offerings (IPOs) to telecom CEOs like WorldCom's Ebbers far more frequently than was reported to Congress. By offering large blocks of IPO stock at the typically low, opening-day price--even after the actual price had doubled, tripled, or quadrupled in trading--these brokers say, Salomon was essentially giving millions of dollars in "free money" to CEOs in exchange for their investment banking business.
"How do you pay a corporate officer five, ten, $20 million in risk-free profits and not have it influence his decisions?" asks David Chacon, a former Salomon Smith Barney broker who handled IPO offerings. "It's an impossibility. Of course it's quid pro quo."
[Ebbers, Grubman, and Weill declined FRONTLINE's requests to be interviewed for this program.]
"The Wall Street Fix" concludes with the settlement reached by twelve Wall Street banks and several regulators. The settlement combines $1.4 billion in fines with a handful of reforms, such as prohibiting IPO giveaways to CEOs and creating more distance between Wall Street analysts and investment banking deals.
But several Wall Street veterans and investors tell FRONTLINE that the settlement does not adequately protect investors. Some Wall Street experts say that research analysts should be totally separated from investment banking, while others say the banks should be forced to publicly acknowledge how they hurt investors. Still others believe that criminal prosecution is necessary to restore investor confidence in Wall Street.
"Is Wall Street fixed? Ha! Not by a long shot," investor George Mickelis says. Mickelis, the owner of a family restaurant in Houston, lost $300,000 that he invested in telecom stocks for his children's college education. "I have no faith and no confidence--not in the companies, not in the brokerage firms.... What have they done to restore my faith and confidence as an individual investor? Zero. Zip."
"The Wall Street Fix" is a FRONTLINE co-production with Hedrick Smith Productions in association with South Carolina Educational TV. Hedrick Smith is senior producer and correspondent for the program. The producer-director is Rick Young. The editor is Cliff Hackel.
Funding for FRONTLINE is provided through the support of PBS viewers. Additional funding for "The Wall Street Fix" was provided by The Schumann Center for Media and Democracy, The Nathan Cummings Foundation, The Consumer Trusts Fund, Gilliland Family Fund, Paul Newman, Bernard Rapoport, The Brightman Hill Foundation, and Edson W. Spencer.
FRONTLINE is produced by WGBH Boston and is broadcast nationwide on PBS.
FRONTLINE is closed-captioned for deaf and hard-of-hearing viewers.
The executive producer for FRONTLINE is David Fanning.Press contacts:
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FRONTLINE XXI/May 2003
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