dot con
photo of weiss
homeipo gamecrying foulbeyondhistorydiscussion
interview: mel weiss

Why don't we start by you telling me about the lawsuit against the investment banks? What did you file, when, and why?

We have a number of lawsuits. We have about 13 so far. These lawsuits arise as a result of manipulation of the IPOs that they initiated. The issuers themselves aren't the main focus of the allegations concerning the manipulation. They were the instruments for the manipulation. The whole scheme, which I will describe in a few minutes, has to be looked at in context.

We had a very long bull market for 10 years. If you think about it logically, the best companies are the ones that are found upfront. And Wall Street is now riding the crest of a big bull market -- a thriving economy. So a lot of money is there to be made, and they're making it. But they want to continue this moneymaking machine. More and more people are being hired and brought into Wall Street. They're being given big stock options.

The venture capitalists are priming companies to bring out. Of course companies that are going to be sold as IPOs [are] the product of Wall Street. The better product is starting to dissipate, so they're going down further deep in the barrel to find something that they can gussy up and they can sell. They have a lot of money out there, and people are now scrambling to get into the game. So now the precious commodity is the ability to get the IPO when it's first sold. So they came up with a variety of ways where Wall Street could profit and keep the money machine going.

What were the ways? If a hedge fund, as an example, wanted in on the game, they were told: "For every 1000 shares that I give you in the IPO, you have to buy 3000 in the aftermarket to give an illusion of momentum going up and liquidity. The second thing you have to do before you can even walk in the door, you have to generate commission income for me, the underwriter, and show me how you can do that and how well you can do it."

So that created was what we call "washed sales" -- purchases and sales -- not so that the investor can make profit, but merely to generate commission income for the underwriters, the investment bankers.



A senior partner at Milberg Weiss Bershad Hynes & Lerach LLP, he is a leading practitioner in the fields of securities, insurance, environmental, antitrust, and consumer litigation, often representing plaintiffs in class actions. His firm has filed 110 lawsuits against scores of companies and 7 investment banks alleging IPO fraud and price manipulation. Weiss tells FRONTLINE that he believes the investment banks conspired to manipulate the market by creating an illusion of post-IPO liquidity and momentum through kickbacks and other illegal actions. This interview was conducted by FRONTLINE producer Martin Smith in May 2001.

Once that's done... "OK, now you can have your 1000 shares, but you have to buy three for every one I give you." Then on top of that, if the market really takes off and there is a tremendous amount of profit for the investor, for the IPO purchaser, then you have to kick back a certain percentage by creating more washed transactions to create commission income for the investment banker.

So these are the different things that were going on. They really started in earnest in the last three years of the bull market, because that's when the game really got interesting. The product wasn't so great. They had to create an illusion of post-IPO offering liquidity and momentum, and this is the way they did it.

You sound as if you are saying there was a conspiracy at work here. Did it have the trappings of a classic conspiracy? Did people get together and plan this?

Yes, and we allege that in our antitrust action, which we filed a couple of weeks ago. The thing about this market is that it combined a lot of different elements. Not only did the practices that I just described become routine; but then they had to gussy it all up with a rationale. So they had their analysts start creating new language -- "a new economy," "emerging markets." They started to talk about the Internet and how tremendous this is going to be for new business.

All they were doing was really creating a machine to raise money for companies that subsequently failed. But the fact is that it gave a rationale at that point in time for people to believe that a stock could go from $6 to $60, or from $15 to $300 -- and that was logical.

If they didn't create that language and that rationale, then people would have not believed it. So you know all of these learned investment banker-types are saying the same things. It's on CNBC. It's on every other TV program that hypes the market and talks about the market. And people got to believe. They actually were believing what they were doing.

... Was there a conspiracy? Think about how the market operates. You have a handful of leading investment banking firms. They become the managing underwriters. OK? The managing underwriters form syndicates. If you take a look, the same underwriters are either the co-managers or in the syndicates in many, many deals. So there's a lot of cross-dissemination of ideas, of practices, of strategies. And one has to rub the shoulder of the other in order to get into the next deal.

So they're all doing pretty much the same things. If they weren't doing the same things, they couldn't get away with it, because somebody, some honest broker, would have to blow the whistle at some point. So everybody was is in on the game.

The alternative to the conspiracy theory is that the technology was truly exciting to people, and like other boom parts of cycles, there was this excitement. It was infectious, and everybody believed it. And analysts and bankers and venture capitalists all got behind these entrepreneurs, and they got carried away.

I think that happened also because they started to believe in their own BS. One thing I've learned is that most people who are in these executive positions and create massive losses for investors because of artificial reporting of earnings or product development or future prospects start believing their own BS. ...

They also start believing that, even if they're not telling the truth about something today, they'll be able to cure it tomorrow, so it won't harm anybody. I don't think they're really out to cause people losses. But they lose control of their own of their own judgment. ... I truly believe that.

The problem that we have from time to time is that our government doesn't keep attenuated to that thought, and starts permitting itself to believe that, without oversight and without controls by governmental entities like the Securities and Exchange Commission, people that will act in a positive, rational fashion when it comes to honesty and integrity in a business environment. ...

[Fraud] happens, unfortunately, and far too often. And if we keep our guard down, it's going to happen in massive ways. And I think that's exactly what happened with the SEC and with the federal government. When the Republicans came in and they passed this reform act, the Securities Reform Act in 1995, they sent out a signal: "We're not going to police you. We're not going to look at your conduct." ...

We are interviewing Arthur Levitt, the former chairman of the SEC. What do you suggest we ask him?

I think that you can ask Arthur whether he ever really believed he had the sufficient resources to take care of the problems that I've just described. ...

Like any other executive, you have to use your resources in areas that you think you can be most efficient. He did it in other ways, in other areas of need. He left basically the policing of the kind of wrongdoing that I'm describing to the private sector, meaning the private litigation arena. ...

Let's get back to the nitty-gritty of these allegations. What is wrong with an investment banker rewarding their best customers with allocations?

If that's all they do, it probably isn't wrong. If they say, "OK, you are my best customer, so I am going to give you x number of shares on the offering," that's business. But when you couple the giving of the shares to a customer with a kickback with a requirement that they buy in the aftermarket even though it's a wash transaction -- it's just a transaction to create an illusory market -- that's wrong. That's a manipulative device.

Keep in mind also that there's a limit on what investment bankers can make as fees and commissions -- compensation on an offering. So let's say ... it's a 7 percent amount. Instead of making 7 percent on these offerings through these extra commissions, both upfront and after the fact, I've been told that a $4 1/2 million deal for the underwriter -- in other words, what the underwriter would normally make $4 million on -- they can make $20 million or $30 million because of all of the kickbacks.

Describe again for me, if you can, the kickback. What are they getting? There are several different kinds. Can you name them and go through them?

One is an upfront price for entry. "I want to get an allocation from your IPO. What do I have to pay you?" The underwriter says, "You have to produce x dollars in commission income up front before any deal takes place. When you show me that good faith, then I will start giving you an IPO allocation. In addition to that, for every one share I give you in the IPO allocation, you have to commit to buy three shares in the aftermarket. And then on top of that, if you make a lot of profit in the aftermarket, I want you to give me back 20 percent, 35 percent of what you make." ...

In addition to all of that, I have heard that there are venture capitalists who are also members of the underwriting firms. In other words, the underwriter has somebody in the company that has been a venture capital investor in the deal.

That venture capitalist has an interest in having his stock go up more quickly, because in a lot of these deals, there is a lockup provision -- that the venture capitalist can sell in the aftermarket for a certain period of time unless the stock goes up a certain percentage after the offering.

So if it doubles, for instance, it might create an end to the lockup period, and the venture capitalist can sell his or her stock immediately at that point, which is what the venture capitalist wants to do; because if you think about it, the VC investor got in for pennies on a relative basis, and is probably a long-term holder. From the time the VC investment is made until the time the offering takes place, more than a year has passed. So they're getting long-term capital gains -- and they're getting huge returns.

So the general public is left holding the bag?

Exactly.

Because they are hyped to come in and prop up this whole pyramid?

Right. And as I said before, Wall Street is creating a rationale to make it appear as if it's logical for these stocks to go up, because there's a new economy, there's new emerging markets that are opening up.

The investment banking community that has a fiduciary responsibility and a statutory responsibility to protect the customer is actually creating artificiality in the market. ... When we get in as litigators, we're able to see what really was happening at the company. And we can take frequently a timeline and the market performance of the stock, show what was said about the stock, either by the company or by the analysts, and show what the inside documents actually reflect at that point in time. And frequently the statements about the company are diametrically opposite from what was really happening.

With respect to the practices and how they went about getting the kickbacks, there were two other ways that they were doing it. One was by charging rates of interest that were peculiarly high for the kinds of businesses that they were doing with these customers. The other way was charging higher commissions for each transaction.

These people think they were so clever, you know, that they can just cover up what they were doing by having business together. But if you take a look at the amount of business that some of these customers did pre the IPO allocations and post the IPO allocations, you'll see that suddenly the interest rate charges and the commissions on each transaction went up.

Interest rate charges? What are those?

On debit balances. The customer who got the IPO allocation has a debit balance, so it owes money to the investment banking firm. And on that money, there's an interest charge.

So who was doing this?

Well, the allegations in our complaint name many of the biggest investment banks; which is different from historical allegations of this type where fringe players were the ones who were engaged, or at least they were the ones that were being fingered.

Now there are investigations that are ongoing with respect to CS First Boston, Morgan Stanley, Merrill Lynch -- I mean, these are the biggest players. And that's what makes this so shocking -- that it could infect even institutions of that size -- Goldman Sachs. These are revered institutions in Wall Street. But the profit from these activities became so enormous that the temptation to do it was just overwhelming. ...

So what is different [this time] and how upset should people be about this?

I think they should be very upset, because the investment banker is supposed to be a watchdog in the role of the underwriter. It's supposed to do due diligence. It's supposed to protect its customer. It has a know-your-customer rule. It has been invested with the ability to make money if it does the right thing by the investor. It is supposed to be looking for quality; or if it's not quality, to tell all of the truth about the product, so people can make an informed investment decision.

What is different here is that our typical case under the federal securities laws deals in the company's statements about itself. If it makes a material misstatement or omission about its financial results about its prospects, about its product development, its expectation as a competitor within the industry, and it is either recklessly made or made intentionally false, then we can bring an action. And if it's in the prospectus and the underwriter fails to do his due diligence, then we can sue the underwriter as well, and sometimes the accountants with respect to the expertized portion of the prospectus.

But here we're dealing with a market manipulation by, not the issuer, but the underwriter, by the investment banking community. And that's the scary thing -- that the investment banking community that has a fiduciary responsibility and a statutory responsibility to protect the customer is actually creating the artificiality in the market. ...

When I talk to people down on Wall Street or Silicon Valley, they say, "Milberg Weiss -- they just sue everybody, and then some of it sticks."

... Silicon Valley has good reason to try to demonize Milberg Weiss, because there are no other policemen looking at them in the same way as we are. So they are trying to discredit us. ...

Approximately how many cases have you filed against companies with precipitous stock drops that you have pending today?

Let's look at the whole number of filings nationwide by all law firms. It's probably about 250 to 300 a year. That's all. And when you think about the number of securities transactions and public statements by companies, which are in the thousands, that's not a big number. And if you take a look back at 1975, the number of lawsuits filed in those days was approximately the same number -- maybe 200.

So with the explosion in capital formation, with the huge increase in IPOs and numbers of publicly traded companies, you would think that that 200 would be 1,000 or 2,000 today. And it's not. So Silicon Valley is creating an illusion of a litigation explosion. But there isn't. And the reason why they're squealing like stuck pigs is because they are used to having the world to themselves.

And if you take a look at the number of companies in Silicon Valley who only reported a profit for one quarter in their whole corporate life -- and it happened to be the quarter when they were going public -- it would surprise you. ...

home · ipo game · crying foul · beyond the bubble · historical perspectives
discussion · interviews · readings & links · producer's chat
tapes & transcripts · press reaction · credits · privacy policy
FRONTLINE · wgbh · pbs online

some photographs copyright ©1998 sam bailey
web site copyright 1995-2014 WGBH educational foundation

SUPPORT PROVIDED BY

FRONTLINE on

ShopPBS