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THE WALL STREET FIX

Senior Producer and Correspondent Hedrick Smith
Written by Hedrick Smith and Rick Young
Produced and Directed by Rick Young

ELIOT SPITZER, NY Attorney General: What we demand is integrity and honesty.

ANNOUNCER: Last week, regulators hit Wall Street with its biggest fines ever.

ELIOT SPITZER: What is not tolerated, however, is fraud.

ANNOUNCER: Tonight on FRONTLINE, the story behind the fraud that cost investors tens of billions of dollars.

GEORGE MICKELIS, Investor: I was robbed. I was lied to. I was stolen from.

LISA MCADAMS: It will be years and years before I ever get over what's happened.

PHIL SPARTIS, Former Salomon Broker: They were duped. They believed the research. They bought the research. They bought the stocks based on the research.

ANNOUNCER: Correspondent Hedrick Smith goes inside Wall Street, investigating the scam--

ELIOT SPITZER: It was brazen. The evidence of it was overwhelming.

ANNOUNCER: --uncovering the hype--

SCOTT CLELAND, Telecom Analyst: We called that the trillion-dollar fib.

ANNOUNCER: --exposing the hidden connections--

SEAN COFFEY, Pension Fund Attorney: This is a mortgage for a billion dollars.

ANNOUNCER: --and digging into Wall Street's biggest bank.

KEN GUENTHER, Pres, Community Bankers Assn.: This is hubris in the worst sense of the word. Who do they think they are?

ANNOUNCER: Tonight, how Wall Street fixed the game.

[July 8, 2002]

Rep. MICHAEL OXLEY (R-OH), Committee Chairman: The committee will come to order. This hearing of the Committee on Financial Services will begin. And as you all know, we have a number of witnesses to hear from today.

WITNESS: Can I just ask that my opening statement be entered in the record?

Rep. MICHAEL OXLEY: Without objection, all these statements made part of the record. I would ask the witnesses to rise and raise your right hand.

HEDRICK SMITH, FRONTLINE CORRESPONDENT: [voice-over] An all too familiar scene--

Rep. MICHAEL OXLEY: Do you swear that the testimony you're about to give is the truth--

HEDRICK SMITH: --a corporate CEO hauled before Congress, called to account for cooking the company's books.

Rep. MICHAEL OXLEY: You're sworn in.

HEDRICK SMITH: Over a decade, Bernie Ebbers's WorldCom was America's hottest telecom stock. It got as high as $96.75 a share. Now it's worth just pennies.

Rep. MAX SANDLIN, Jr. (D), Texas: Mr. Ebbers, you're the former CEO of WorldCom, is that correct? Mr. Ebbers?

BERNIE EBBERS: On instruction of counsel, I respectfully decline to answer on the basis of my constitutional rights.

Rep. GARY ACKERMAN (D), New York: What I would like to know--

HEDRICK SMITH: WorldCom was the most costly business scandal in U.S. history.

Rep. GARY ACKERMAN: Do you sleep well at night, Mr. Ebbers?

BERNIE EBBERS: I respectfully decline to answer on the basis of my 5th Amendment constitutional rights.

HEDRICK SMITH: [on camera] Corporate fraud -- that's the story we know. But the real story behind WorldCom's stunning rise and fall is more sinister. It's a story of pervasive corruption here on Wall Street, how brokers and analysts shaped and hyped the telecom boom, pocketed enormous profits and then took millions of ordinary investors on a catastrophic ride, $2 trillion in losses on WorldCom and other telecom stocks.

So before you bet again, watch as we peel back the layers and look inside the culture of Wall Street and the world of investment banking and examine the minds and the motives of the analysts.

[voice-over] To understand Wall Street's role in the WorldCom story, I headed south, seeking clues to how things went so terribly wrong. I found an all-American story, entrepreneurs starting from scratch, raising money from friends and neighbors and riding the incredible tide of telecom.

The story begins here, in the quiet backwater of Brookhaven, Mississippi, where I met the man who gave birth to the idea that would become WorldCom, small-town businessman Murray Waldron.

[on camera] You had some experience in telecom, right? Not much, but you had some.

MURRAY WALDRON, Company Founder: Yeah, not much. You're right.

HEDRICK SMITH: Are you a businessman or are you an engineer?

MURRAY WALDRON: Neither one. Well, I-- I had been in several different kinds of business. I was in the grocery business, a used car lot-- just different things.

HEDRICK SMITH: [voice-over] With the breakup of AT&T in the early '80s, Waldron saw a golden opportunity to sell cheaper long-distance service in places like Hattiesburg, Mississippi.

MURRAY WALDRON: I went into the Chamber of Commerce office. The lady asked if she could help us, and I says, "Yeah. You can tell me how many long distance companies you have that service Hattiesburg." And she said, "What is that?" And I said, "Never mind. We're at the right place." So that's where we started.

HEDRICK SMITH: They didn't even know what long distance was.

MURRAY WALDRON: No.

HEDRICK SMITH: [voice-over] Waldron hooked up with Dave Singleton, who'd raised money for various local ventures, including some motels run by the man who would eventually make WorldCom a household word, Bernie Ebbers.

DAVID SINGLETON, Company Director: Bernie was a friend. He was a friend both in the church and in business. We had been involved in some of his motel things together.

HEDRICK SMITH: Ebbers grew up in Canada, came to Mississippi for college in the 1960s and stayed. He became a high school basketball coach and then tried his hand at business with some church buddies.

BERNIE EBBERS: [National Press Club] I actually started my working life as a bouncer in a bar, but I don't like to say that publicly.

DAVID SINGLETON: He knew how to manage and enjoyed managing a profit-and-loss statement-- revenue in, control of-- of expenses and driving it to the bottom line, looking for good margins. He ran a very tight ship with his motels, in terms of controlling his cost.

HEDRICK SMITH: Ebbers saw an opportunity when Singleton suggested investing in Waldron's long distance telephone company. Ebbers and his partners got a $650,000 loan from a local bank to buy a computer switch to route long distance calls.

HEDRICK SMITH: [on camera] And what have we got here?

MURRAY WALDRON: That's the switch in Hattiesburg. At least about the size of four big, over-sized refrigerators down there.

We had a service that was good, that would save people money. And at that time, people were paying a lot of money for long distance phone calls.

HEDRICK SMITH: [voice-over] Long distance discount service -- or LDDS for short -- offered cut rates to small businesses. They could do that because AT&T was under court order to lease its phone lines cheaply to start-ups like LDDS.

[on camera] So you're reselling?

DAVID SINGLETON: That's right. That's basically all it was.

HEDRICK SMITH: Reselling and marketing, but not building, no big overhead.

DAVID SINGLETON: That's exactly right. The telephone business, as we came into it back then, was not asset-based. You didn't have to have a huge amount of equipment. So it was just a huge cash flow stream.

BRIAN THOMPSON, Former VP, MCI: Anybody could start up a company, and people did. There were-- almost overnight, some 400 companies were established, didn't exist before that, by people that said, "Well, gee, here's the chance to do something. Here's a great opportunity." It was better than the gold rush.

HEDRICK SMITH: [voice-over] One of those who signed on early to Ebbers's gold rush was Lisa McAdams.

LISA McADAMS: Yeah, here are some things I pulled together in 1988, which was the year I was hired.

HEDRICK SMITH: It paid off handsomely. Hired as a technician, McAdams worked like crazy, won Ebbers's confidence and wound up as a WorldCom vice president.

LISA McADAMS: It was exhilarating. I mean, we knew we were doing something very unique in this country. I mean, it was growing, it was building.

HEDRICK SMITH: Ebbers grew his business the same way he'd built his motel chain, buying up regional rivals one by one.

LISA McADAMS: As we grew, we grew into the adjoining states. We grew out from the Mississippi, Tennessee area, and we just kept expanding out further.

HEDRICK SMITH: Ebbers's currency for the buy-outs was LDDS stock, selling in the late 1980s at a couple of dollars a share.

SCOTT CLELAND, Telecom Analyst: Bernie Ebbers was a roll-up artist. And what that is, is he realized if he took a fragmented industry and he rolled it up, essentially rolled the revenues into one big pot, he could dramatically lower costs. That's the simple math of Bernie Ebbers. He was a roll-up artist.

HEDRICK SMITH: Within 10 years, Ebbers rolled together 30 companies. Sales reached nearly a billion dollars. The original plan was to sell out.

MURRAY WALDRON: It didn't work out because the thing was making money. And then it just-- you know, it just kept on growing and getting bigger and bigger and bigger. It was a great feeling. I mean, you talk about an old country boy's dream? This was a dream, I'll tell you.

HEDRICK SMITH: But country boy Bernie Ebbers now had bigger dreams. He renamed his company WorldCom, and when Congress threw competition wide open with the Telecom Act of 1996, Ebbers went hunting bigger game. And his timing was right.

The dawning of the Internet age was transforming Ma Bell's old-fashioned phone network into the backbone for the World Wide Web and the high-tech channel for rivers of data flowing across corporate America.

SUSAN KALLA, Telecom Analyst: There was a thought that the information superhighway was going to be enormous. There was going to a huge build-out everywhere in broadband to every doorstep of every business, every doorstep of every house. And so it looked like an upgrade that people were beginning to think would be $300 billion to $500 billion in build-out.

HEDRICK SMITH: A potential gold mine for Wall Street banks.

[on camera] What's their role in the whole telecom bubble, the investment banks?

SCOTT CLELAND: Well, they were really the glue that brought it all together. They were the enablers. You know, if you didn't have Wall Street, you wouldn't have had a bubble because you wouldn't have been able to bring together all the pieces necessary-- the hype, the analysis the credibility, the distribution system, the smarts. It wouldn't have happened.

HEDRICK SMITH: And the money.

SCOTT CLELAND:: And the money.

HEDRICK SMITH: Big, big money.

SCOTT CLELAND: Big money.

HEDRICK SMITH: [voice-over] To outsiders, Wall Street is overwhelming in its power, its immensity. It is the Mount Olympus of finance, deciding the destinies of legions of companies like WorldCom. Wall Street's huge investment banks are the engines that drive corporate America. They raise the money to finance corporate mergers, sell corporate bonds, bring hot new companies public. And their brokerage houses market stocks to investors.

[television broadcast]

1st ANALYST: We want to be 100 percent invested, and we think we have the right sectors by overweighting telecom and tech.

HEDRICK SMITH: To most of us, the face of Wall Street is the market gurus--

2nd ANALYST: To look into the future of communication services, you need several assets.

HEDRICK SMITH: --the research analysts, keeping score on corporate America--

3rd ANALYST: We rate shares of WorldCom a buy.

HEDRICK SMITH: --coaching investors on winners and losers.

GEORGE MICKELIS, Investor: I originally thought to myself, "Gosh, what do I know about stocks and the stock market?" So I thought, "Let me go out to a really reputable brokerage firm that I could trust." And so I picked Salomon Smith Barney.

ANNOUNCER: [television commercial] At Salomon Smith Barney, our research analysts have the resources and determination to find the year's most promising stocks.

STEPHEN FRASER, Wall Street Historian: People are relying on Wall Street to sanction, to give them confidence in what they're investing in. Wall Street is like the seal of approval from Good Housekeeping for a consumer product. If Wall Street says this is a viable company worth investing in, if Wall Street says it's worth X amount of money, people assume it's acting prudently, soberly.

HEDRICK SMITH: George Mickelis runs a family restaurant in Houston. Like millions of others, Mickelis put his faith in market analysts. He invested almost $300,000 of his portfolio in telecom stocks to pay for his children's college education, relying on advice from his broker.

GEORGE MICKELIS: He would constantly refer to a guy named Jack Grubman. Never heard of the man before in my life, but he would say, "This is Salomon Smith Barney's top analyst. He is the man. This man eats, sleeps, drinks, breathes telecom. And if this man says to buy something, we need to listen to him and we need to buy it."

HEDRICK SMITH: On Wall Street in the '90s, no one had a nose for telecom like Jack Grubman.

4th ANALYST: He has generated a pile of cash for Salomon Smith Barney.

HEDRICK SMITH: Grubman knew telecom from the inside. He'd been a math and marketing whiz at AT&T for eight years before moving to Wall Street.

SUSAN KALLA: He had the industry contacts. He was friends with most of the CEOs. He was very well connected within the industry. So he really worked the system very well.

HEDRICK SMITH: But Grubman wasn't really doing what George Mickelis thought.

ARTHUR LEVITT, SEC Chairman 1993-2001: The analysts morphed from being the serious, almost nerd-like students of numbers and corporate strategies into being hyper-salespeople, as an adjunct of the investment banking departments of the firms that employed them.

HEDRICK SMITH: Analysts like Grubman were not really working for investors. They were the bird dogs for the banks, sniffing out hot new corporate properties.

[on camera] Grubman said on television that he first picked up Bernie Ebbers at LDDS in 1986.

KEVIN MOORE, Telecom Analyst: Absolutely. Absolutely. Now, as you know, 50 percent of all businesses fail in five years. This is the risk Grubman had to take if he was ever going to be great. And every analyst--

HEDRICK SMITH: What was the risk he was taking? Explain it to me.

KEVIN MOORE: The risk of going down there, finding a guy in cowboy boots in Jackson, Mississippi, in a pool hall and saying, "This guy is going to be great. He is going to do something on the Street. And if I hitch my career to him, this could make my career."

HEDRICK SMITH: [voice-over] Getting to know WorldCom meant getting to know Bernie, and that meant hanging out with Bernie in his favorite local haunt, the Cherokee Inn.

ROB GENSLER, Telecom Portfolio Mgr: It was a great place. It was a great place. It's a-- it's a dive, where people over the years have taken their knife out and carved in their girlfriend's name. And only one or two pool tables in the place, really cheap burgers and beer, and you sit around and chat.

HEDRICK SMITH: Grubman wasn't just playing pool, he was shooting for a jackpot with Ebbers and WorldCom.

KEVIN MOORE: They're in a generally capital-intensive industry, which means they'll be raising lots of money, which means lots of banking fees. They are going to be doing lots of acquisitions, which is lots of M&A banking fees, OK? They're in this growth industry of telecom. This is the-- this is the mother lode for Jack Grubman. That is the dream of every analyst, to be able to do what Jack did.

HEDRICK SMITH: On Wall Street, Grubman personified the new-age analysts, the power brokers who connected companies with banks and banks with corporate decision-makers. These close links between stock analysts and Wall Street's corporate clients were the focus of a two-year investigation by New York attorney general Eliot Spitzer.

ELIOT SPITZER, NY Attorney General: 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, proclaim to the world that it is the best thing since sliced bread, take your company public, keep a strong buy on your stock and become part of your management team."

HEDRICK SMITH: Gone was the very idea of independent analysis for ordinary investors.

ARTHUR LEVITT: And the companies say to the analysts, "Look, we'll choose your employer, but we expect coverage." And what they mean by coverage is they expect that analyst to write favorable research reports about their company.

HEDRICK SMITH: [on camera] So there's a quid pro quo.

ARTHUR LEVITT: There's an absolute quid pro quo. And coverage means "We're going to promote the heck out of your stock."

HEDRICK SMITH: [voice-over] But if that's how an analyst like Grubman worked, where did that leave investors?

ELIOT SPITZER: It means you're turning your back on one set of clients. That's what he did. That's what the analysts were doing when they played ball just with the investment bankers.

HEDRICK SMITH: [on camera] And the people who got hurt were the investors, the ordinary investors.

ELIOT SPITZER: It was the ordinary investors, who didn't understand the game.

HEDRICK SMITH: [voice-over] A game with huge payoffs for Wall Street banks.

ELIOT SPITZER: There were billions of dollars in investment banking fees generated by the telecom sector. It was the sector where there was a vast infrastructure being built, vast amounts of capital being raised to build it.

HEDRICK SMITH: The banks were the midwives, selling multi-billion-dollar deals to companies and then getting investors to finance them.

SCOTT CLELAND: Generally, the ideas come from investment bankers. They're the ones out there that are thinking of deals because they're the ones that will benefit from a deal.

HEDRICK SMITH: So as Ebbers was gobbling up companies one after another, Grubman was whispering in his ear, egging Bernie on.

SUSAN KALLA: You had a very small player that came from nowhere, with a CEO that did not have a technical background, did not have a financial background and did not have an industry background. And he was being catapulted into number one. You couldn't do it with a-- without a lot of help.

[www.pbs.org: The WorldCom-Wall St. connection]

SCOTT CLELAND: Jack Grubman and Salomon Smith Barney were essential enablers for WorldCom to take off. It took a rising stock price. It took some very good investment banking and some very good salesmanship in order to sell the marketplace.

HEDRICK SMITH: And the marketplace for big money was selling institutional investors-- pension funds, mutual funds. And in that league, Jack Grubman was the Pied Piper of telecom.

SUSAN KALLA: Could Jack Grubman move markets? Absolutely. Unqualified. Yes. Did people believe him? Yes. Was he very good at putting together the details? Did he know the business? Did he understand the players? Did he understand investors? Yes to all of those.

HEDRICK SMITH: Rob Gensler, as manager of the telecom portfolio for T. Rowe Price mutual funds, heard many a pitch from Grubman.

ROB GENSLER, Telecom Portfolio Mgr: Jack Grubman was a shoe salesman. The shoe salesman wants you to buy the shoes. And in fact, they want you to buy the more expensive shoes. Not to take anything away, but they are selling stocks. They are selling ideas. And one should never forget the term "selling." Like all sales people, they'd like to sell you what profits their organization.

HEDRICK SMITH: Grubman's prime selling turf was the annual gathering of telecom's top tier at the La Quinta resort in Palm Springs, California. They came for Salomon Smith Barney's annual telecom conference.

DAN HESSE, Former CEO, AT&T Wireless: All the major players wanted to be there. As a telecom company or CEO, you wanted to be on the stage because the audience, in terms of the institutions, was-- was fantastic.

HEDRICK SMITH: They came to be seen with Jack Grubman, who was mobbed like a rock star.

DAN HESSE: Jack was the one who gave out the invitations. He decided who was going to speak and whether you were by yourself or on a panel. So Jack pretty much set the agenda. Jack also did lots of the introductions.

HEDRICK SMITH: [on camera] Jack was the Johnny Carson?

DAN HESSE: Jack was Johnny Carson, in that he-- he decided who he was going to have on the show and where they were going to sit. And Bernie Ebbers, at least in the couple conferences I remember, always had a very prominent position.

HEDRICK SMITH: [voice-over] But Grubman did more than give his favorites the spotlight. Salomon awarded them sweetheart deals so hush-hush that even insiders, like former Salomon Smith Barney broker Phil Spartis, were kept in the dark. Spartis, who was dismissed and later sued Salomon, used to manage personal stock option accounts for WorldCom's top brass. But one thing puzzled Spartis: He had all the WorldCom executives except Bernie Ebbers.

So in August, 1999, Spartis called Ebbers's personal financial manager to solicit Ebbers's business and stumbled into a surprising discovery.

PHIL SPARTIS, Former Salomon Broker: And he said, "Well, Bernie already has an account at Smith Barney." And I said, "What do you mean?" And he said, "Well, he's had an account for over a year in L.A." And I said something to the effect, "With who?" And he said, "With Rick Olson." I said, "Rick Olson? Who's that?" He said, "Well, he was referred to Bernie by Jack Grubman. He's one of Jack's boys."

HEDRICK SMITH: What Spartis had discovered was Salomon's exclusive boutique brokerage in Los Angeles run by Rick Olson and his former deputy, David Chacon, who was forced out after blowing the whistle.

DAVID CHACON, Former Salomon Broker: At one point, our clients collectively controlled, according to Olson, over $100 billion in assets. You probably had, you know, eight to ten billionaires as clients under one roof.

HEDRICK SMITH: Salomon's strategy, Chacon said, was to win telecom banking deals by giving personal windfalls to corporate VIPs, a strategy guided by Jack Grubman and run by a team nicknamed the "Telecom Mafia."

DAVID CHACON: The point is, if you can dominate the relationships within a sector that's tremendous in size and scope and has very few individuals whom you need to use as a pawn to accomplish your objective, well, then, you know, you have a winning business plan.

HEDRICK SMITH: The crown jewels were shares of hot telecom IPOs, or initial public offerings. Premium clients got huge IPO allocations of new companies on the first day of trading and made a killing.

DAVID CHACON: These shares would rise by, you know, 30, 40, 50, 100 percent the first day. So that, in itself, is free money. But Salomon took it to another level. Oftentimes, they did not allocate these shares until after the stock had been trading. Salomon would be able to call these same officers and directors, saying, "Look, I have," you know, "20,000 shares of this company. It's trading at $85 right now, and wanted to give you," you know, "the opportunity to invest at the IPO price."

HEDRICK SMITH: [on camera] Which is much lower.

DAVID CHACON: Fifteen dollars, twenty dollars. It allowed the-- Salomon Smith Barney to buy people, to buy their decisions, to buy their influence, and to buy their business.

HEDRICK SMITH: By handing them free money.

DAVID CHACON: By handing them free money.

HEDRICK SMITH: [voice-over] The company reported to Congress that Salomon had handed Bernie Ebbers $11 million through 21 IPOs. But David Chacon recalls hearing from his boss, Rick Olson, who handled Ebbers's accounts, that Ebbers made far more than that from IPOs. Just one example. A company called Rhythms Net Connections, which Salomon took public in an IPO in April, 1999.

DAVID CHACON: Well, several days after the stock was trading, I sat right next to Rick, and he said, "Well, between us girls" -- and what that meant was, you know, that's kind of telecom mafia lingo for, "This doesn't leave the room" -- "Bernie Ebbers just got 350,000 shares."

HEDRICK SMITH: [on camera] Now, are you sure he said 350,000 shares?

DAVID CHACON: I'm sure he said 350,000 shares.

[www.pbs.org: Read Chacon's interview]

HEDRICK SMITH: [voice-over] Olson would not talk to FRONTLINE, but Chacon, in a lawsuit disputed by Salomon, said that Salomon gave Bernie Ebbers an immediate kickback of $16 million on that one IPO.

PHIL SPARTIS: This was a well-orchestrated con game, meaning that here's this group of elite telecom executives that were given preferential treatment on IPOs and loans and other things so that the firm could generate their banking business.

HEDRICK SMITH: Wall Street, like telecom, was booming. Salomon's profits from WorldCom's investment banking business were huge, but they wanted more. What if Salomon merged with a commercial bank, like Citibank, so as one bank, a superbank, they could handle all the needs of a cash cow like WorldCom?

SCOTT CLELAND: If you're Citicorp, you see WorldCom as a meal ticket. It is the perfect, quintessential client. They have tons of investment banking needs and tons of debt needs. You can't find a better client than a telecom serial acquirer.

HEDRICK SMITH: If one man understood the potential power of a superbank, it was Sandy Weill. Weill began on Wall Street as a stock runner, and over 50 years, made himself the street's dominant banker. Like Bernie Ebbers, Weill is a deal-maker, a master of the merger, the bold buyout. Like Ebbers, Weill is an imperial boss, a ruthless cost-cutter driven to be king of the hill. And now a billionaire.

As a superstar among New York's financial elite, Weill was crowned in 2002 as CEO of the Year. His crowning glory was putting together Citigroup, the largest financial institution in the world, 250,000 employees in over 100 countries.

But it almost didn't happen, for smack in the way of Weill's superbank stood a 1930s law that prohibited commercial banks from selling securities. The law was called Glass-Steagall.

ARTHUR LEVITT, SEC Chairman 1993-2001: Glass-Steagall was enacted to respond to some of the scandals of the early part of the century, where individual investors were grievously hurt by banks who were promoting stocks that were of interest to the banks rather than to investors. And that was a very sensible division of investment banking and commercial banking.

HEDRICK SMITH: For decades, the big banks had pushed Congress to repeal Glass-Steagall, but Congress had refused. Then in 1987, the big banks got a break. Wall Street's own Alan Greenspan, a critic of Glass-Steagall, was named chairman of the Federal Reserve Board. Greenspan favored greater deregulation to help U.S. banks compete with big foreign banks, and he found room to reinterpret existing law.

CHARLES GEISST, Wall Street Historian: Alan Greenspan is central to the change in banking that we saw in the 1990s. By looking at the loopholes, Alan Greenspan began to allow commercial banks, including Morgan at the time -- and Citibank -- into the corporate securities business on a limited basis. And that began to increase as the 1990s rolled on.

HEDRICK SMITH: Greenspan let banks do up to 25 percent of their business in securities-- enough for most, but not for Sandy Weill. As head of Travelers Insurance, Weill bought Salomon in 1997 and then set his sights on the biggest commercial bank, Citicorp.

KEN GUENTHER, Pres, Community Bankers Assn.: We are talking about the largest financial merger in the world. We are talking about, for the first time in the modern history of the United States, since 1933, the largest bank, one of the largest securities firms, one of the largest insurance firms being put together under common ownership.

HEDRICK SMITH: But that was against the law, so Weill privately lobbied Greenspan, Treasury Secretary Robert Rubin and President Clinton. Then he made a breathtaking announcement.

SANDY WEILL: I think what we are doing is creating a model of the financial services company of the future that will--

KEN GUENTHER: And here you have the leadership -- Sandy Weill of Travelers and John Reed of Citicorp -- saying, "Look, the Congress isn't moving fast enough. Let's do it on our own. The heck with the Congress. Let us effect this." I mean, this is hubris in the worst sense of the word. Who do they think they are? Other people, firms cannot act like this.

[www.pbs.org: More on Weill's Washington clout]

HEDRICK SMITH: It was a brazen gamble, upstaging Congress. But Weill had made a deal with Greenspan. The Fed gave temporary approval for Weill to operate his superbank for two years. And if Congress repealed Glass-Steagall within two years, Weill was home free.

Rep. JOHN DINGELL (D), Michigan: I think it's pretty clear to say that Sandy Weill forced the hand of Congress. I think it's equally clear to say that the Fed forced the hand of Congress to do something that they knew full well could not be done. What they said was, "At the end of two years, if you haven't-- haven't gotten it done, you will have to disgorge." But everybody up here said, "Oh, my. We can't do that to our dear friend, Sandy Weill."

HEDRICK SMITH: Congress relented and finally buried Glass-Steagall by repealing it in November, 1999.

SCOTT CLELAND: The repeal of Glass-Steagall was a big deal because it enabled kind of colossal combinations that just weren't envisioned before, 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.

HEDRICK SMITH: [on camera] So Sandy Weill and his team can market across the board to Bernie Ebbers. "You don't need to go anywhere else, Bernie."

SCOTT CLELAND: It's a one-stop-shop strategy. It's very powerful.

HEDRICK SMITH: [voice-over] I found evidence of the new powers of the superbank in a surprising place, among these Mississippi pines. Land records show that these pines belong to a company called Joshua Timberlands, a company controlled by Bernie Ebbers. Ebbers bought nearly half a million acres of timberland sprawling across Mississippi, Alabama and Tennessee in late 1999, thanks to Sandy Weill's superbank, which arranged the loan and gave Ebbers a $1 billion mortgage.

SEAN COFFEY, Pension Fund Attorney: This is a mortgage for a billion dollars. It's a mortgage that Joshua Timberlands, which is the Ebbers-controlled entity, got from Travelers, the Citigroup unit, in February of 2000.

HEDRICK SMITH: [on camera] Is it conceivable that a loan of this size could be made to Bernie Ebbers through his entity, Joshua Timberlands, without the chief honcho at Citigroup, Sandy Weill, knowing?

SEAN COFFEY: Not the Sandy Weill I've read about.

HEDRICK SMITH: [voice-over] Attorney Sean Coffey has sued Wall Street banks to recover $300 million in WorldCom losses for the pension fund of New York state employees. One thing not disclosed to investors, he says, was that Weill's superbank became Bernie Ebbers's business partner in the timber deal.

SEAN COFFEY: I think the average investor would like to know, "Well, is there something here about the relationship between Salomon or its parent, Citigroup, and the people at this company which should give me pause about how objective they are being?"

HEDRICK SMITH: The whole deal was kept sub rosa because it didn't look good on Wall Street for Ebbers to sell WorldCom stock. So the superbank devised a scheme to help Ebbers convert his WorldCom wealth into hard assets: Don't sell stock, take a loan.

SEAN COFFEY: So here you have Bernie Ebbers getting cash in his pocket by virtue of getting a loan from Travelers to buy this timberland, and then turning around and selling part of it for cash.

HEDRICK SMITH: Timber was just part of Ebbers's private business empire-- luxury yachts, a boat-building company, a lumber mill, a ranch in Canada-- not just any ranch, but the biggest ranch in all of Canada, 500,000 acres, financed with a $43 million loan from Citibank. And the superbank's loan, Coffey says, was backed by 2.3 million shares of Ebbers's WorldCom stock.

SEAN COFFEY: That's a very troubling link, in our view. because Citibank has an interest in the stock price of WorldCom being high enough to cover the loans they've made to Mr. Ebbers. And in yet 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.

HEDRICK SMITH: So Ebbers, WorldCom, Grubman and Weill's superbank had become so intertwined that the ordinary investor was lost in the trees.

TOM BROKAW, NBC News: Another record day on Wall Street, another few points closer to the magic mark of 10,000--

DAN RATHER, CBS News: The Dow soared another 184 points today--

PETER JENNINGS, ABC News: The Dow finished above 11,000 for the first time today--

HEDRICK SMITH: As the new century approached, it all looked so good. It seemed as though the raging bull market would never end. Wall Street can be deceiving.

STEPHEN FRASER, Wall Street Historian: I think Wall Street is distinctly different than every other part of the economy because Wall Street, in the end, deals in fantasies. They trade in the promise. And when the trading and the promises get completely out of hand and Wall Street is really just dealing in phantoms, that's where the danger comes.

HEDRICK SMITH: The real danger for WorldCom and its investors began with its biggest deal.

TOM BROKAW, NBC News: Some very big business news tonight. The battle to take over this country's second largest long distance telephone company, MCI, has been won by that upstart, WorldCom.

HEDRICK SMITH: It sounded great, taking out telecom's number two.

DAN RATHER, CBS News: The record-breaking $37 billion dollar deal -- that's with a "B"--

HEDRICK SMITH: But was Bernie Ebbers overreaching?

SCOTT CLELAND: It was the goldfish swallowing the whale. I mean, WorldCom was nowhere near the size of MCI, and it surprised everybody that they had the audaciousness to try. And they pulled it off.

HEDRICK SMITH: Ebbers dared because the superbank engineered the deal. Jack Grubman was so involved that the WorldCom board listed him as a financial adviser. Grubman wouldn't talk to FRONTLINE. But he did talk to Congress.

[House Financial Services Committee hearing]

Rep. MICHAEL OXLEY: Did you ever attend a board meeting for WorldCom?

JACK GRUBMAN: Yes.

Rep. MICHAEL OXLEY: Is it rather unusual for analysts to attend board meetings?

JACK GRUBMAN: It is rare, as it has been for me over the years.

HEDRICK SMITH: Grubman was giving Bernie Ebbers guidance on corporate strategy.

SUSAN KALLA: His point of view on the industry was that the best way to be successful was to build out the biggest global network possible. So suddenly, you heard Bernie starting to talk about the same thing,   It was a completely different strategy than what he had talked about prior, a few years prior.

HEDRICK SMITH: A strategy that turned sour because it was based on a wildly inflated premise for the whole telecom boom.

SCOTT CLELAND: WorldCom said that data traffic, the thing that everybody was interested in, was doubling every 90 days. At one point, data traffic was doubling every 90 days. But what happened is, WorldCom repeated it and kept repeating it, and so for three or four years, that became the mantra, and it just was flat wrong. Data traffic hadn't been growing at that rate since at least 1997. So the hype was a lie for three or four years before it burst.

HEDRICK SMITH: That phantom mantra, Cleland says, powered a $1 trillion increase in the stock of 14 core telecom companies that evaporated when the bubble burst.

SCOTT CLELAND: We called that the trillion-dollar fib.

HEDRICK SMITH: [on camera] You call it a trillion-dollar fib.

SCOTT CLELAND: Yes.

HEDRICK SMITH: They knew it was phony?

SCOTT CLELAND: Oh, I think the companies knew that data traffic wasn't growing that fast.

SUSAN KALLA: there were very few faint voices that were saying it was wrong. But by then, the-- everyone was listening to the up-side story. And why shouldn't they? They were all making so much money.

SCOTT CLELAND: WorldCom was a gravy train for almost everybody. It was a gravy train for the investment bankers. It was a gravy train for the-- for the stockbrokers that were advising it. It was a gravy train for investors who owned it and benefited from its skyrocketing stock price.

HEDRICK SMITH: For Salomon Smith Barney, the gravy train delivered more than $1.1 billion in investment banking fees from the telecom sector in just four years, roughly $140 million from WorldCom.

[House Financial Services Committee hearing]

Rep. TUBB JONES (D), Ohio: --how much financially you have benefited from working for Salomon Smith Barney--

HEDRICK SMITH: Big bucks for the banks meant big money for Grubman.

JACK GRUBMAN: I've been compensated over the past four years roughly $20 million per year, on average. But that is not tied to any one company.

HEDRICK SMITH: But to his bosses at Salomon, Grubman justified his huge pay bonuses as rainmaker for the bank deal by deal, company by company, claiming credit for landing $1 billion in bank fees between 1998 and 2001.

ELIOT SPITZER: He didn't argue, "Pay me as an analyst because I'm a good stock picker." He said, "Pay me a lot because I bring in investment banking revenue to the firm, in essence, by promising those firms that I'm going to push their stocks."

HEDRICK SMITH: Even when WorldCom stock hit its peak of $96.75 a share, Grubman kept pushing it, predicting it would go much higher.

WYONZIE KRAFT, Investor: WorldCom-- it sounded very, very good. I invested a total of about $32,000 in it. I was planning on that doubling for my old age.

GEORGE MICKELIS, INVESTOR: My broker said, "Look, these people are saying, 'Buy these stocks. These stocks are good to buy at this time.'" And so I trusted him when he told me I was listening to the best and the brightest analysts in the world.

HEDRICK SMITH: But at Grubman's telecom bash, insiders were getting drastically different advice on the market.

SUSAN KALLA: It was January of 2000. And I was at the Salomon Smith Barney media and telecom conference, and we were at a very big dinner that probably housed 500 people.

ROB GENSLER, Telecom Portfolio Manager: The market's flying. We'd just had a year where telecom stock doubled.

SUSAN KALLA: And then suddenly, Bob Rubin shows up

HEDRICK SMITH: Bob Rubin, former head of a major Wall Street firm, then Clinton's secretary of treasury, had just become Sandy Weill's chief lieutenant at Citigroup.

SUSAN KALLA: And then we had had some wine at the dinner. And then Bob opens up saying that Sandy Weill had asked him not to give the speech.

HEDRICK SMITH: But Rubin gave the speech anyway.

SUSAN KALLA: And he suggested in no uncertain terms that the stocks were way too high, they were on a levitation zone, and they couldn't be sustainable. So as he was speaking, my palms were sweating.

He was making the case that there was a bubble, there was an Internet bubble, there was a telecom bubble. And this was three months before the Internet bubble collapsed. So he gave every investor in this room, which was every investor on the planet that mattered, three months to recalibrate and to get out of these stocks.

DAN HESSE: And privately, at his table -- I was fortunate enough to be at his head table. But he told us that he had no money in the stock market. I wish I had taken his advice. And I think there's a lot of other guys at the table that would say the same thing.

HEDRICK SMITH: [on camera] Did you talk to Grubman?

SUSAN KALLA: I did talk to Grubman afterwards. My hands were shaking. I said to him, "What did you think of Bob's speech? And he goes, "Stocks go up, stocks go down. Doesn't matter." He was completely blowing it off.

[www.pbs.org: Read Kalla's interview]

HEDRICK SMITH: [voice-over] What's more, Grubman kept pushing Bernie Ebbers to maintain the image of growth momentum and reach for the moon. But the regulators blocked him.

NEWSCASTER: Today the WorldCom-Sprint merger became the biggest deal ever to collapse.

SCOTT CLELAND: The beginning of the end for WorldCom was when he couldn't buy Sprint because how WorldCom kept the story going is, is they would have a big acquisition and then they would do the accounting magic, where they hid what was going on, and then they'd move on and operate until they had the next merger.

BRIAN THOMPSON: And it looked like your company was growing beautifully, and it looked like all your costs were under control. And underneath all of this, you really weren't merging companies.

SCOTT CLELAND: So what happened is, when the Sprint merger was denied, the beast couldn't get fed again. They didn't have another opportunity to cook the books.

HEDRICK SMITH: Long distance prices were plummeting. Telecom hype had produced a glut of overcapacity. Some analysts warned investors to get out.

SUSAN KALLA: We came out with a call that said that the revenues are shrinking and that these companies are not going to be able to cover the cost of servicing their debt.

HEDRICK SMITH: [on camera] So you said underperform?

SUSAN KALLA: We said underperform, which was "sell."

HEDRICK SMITH: [voice-over] With WorldCom's stock tumbling, Bernie Ebbers was in trouble. The company was desperate for cash. Weill's superbank came to the rescue. Despite the telecom capacity glut, despite plummeting phone prices, despite Rubin's personal warnings, Citigroup led bank syndicates that sold investors $17 billion of WorldCom bonds.

SEAN COFFEY: In effect, you have the investing public giving money to WorldCom, which it then turned around and gave some-- at least some of it to the banks, so that the banks' exposure from loans to WorldCom was either reduced or eliminated.

HEDRICK SMITH: [on camera] When they're floating the WorldCom debt offerings in 2000, 2001, Citigroup and these other big banks have a financial self-interest.

SEAN COFFEY: Well, in addition to the investment banking fees, yes, some of the banks were looking to eliminate some of the exposure they had from their loans to WorldCom.

HEDRICK SMITH: [on camera] And while Citigroup was limiting its own risk, its star analyst told investors WorldCom's plunging stock was now an incredible bargain.

GEORGE MICKELIS: At this point, as the stocks are starting to really get hammered, I'm talking to my broker two and three times a day to see what kind of damage control we can do here. When WorldCom got down below $10, it was, like, "This is a big company. Our analysts are still feeling good about these companies. They still have strong buy recommendations."

LOU DOBBS, CNN "Moneyline": Good evening. We begin tonight with the most egregious case of corporate corruption.

HEDRICK SMITH: Then the bombshell, June, 2002, charges of massive corporate fraud from inside WorldCom.

SEAN COFFEY: But we're not talking about a few pencils missing from the stockroom. We're talking about $9 billion of earnings that were suddenly wiped out. And the investment bankers have an obligation to look for the signs.

HEDRICK SMITH: The question remains: Just what did Citigroup know about WorldCom's bogus bookkeeping?

Rep. ACKERMAN: Did you analyze everything, or did you just take their word for it?

JACK GRUBMAN: No. We analyzed it based on the financial results, stress testing the results, the reasonableness of their capital spending trends, their margin trends, their financial performance relative to their competitors. There were no red flags.

HEDRICK SMITH: But Grubman knew WorldCom almost like an insider. In fact, he wrote emails coaching Bernie Ebbers what to tell Wall Street about WorldCom's finances.

SEAN COFFEY: But there's one particular email, Grubman is saying, "You got to talk about your accounting." And what does Ebbers do during the phone call?

[conference call February 7, 2002]

BERNIE EBBERS: First, accounting. Let me be clear. We stand by our accounting."

SEAN COFFEY: He actually ticks off the things that he was told to say by Grubman

HEDRICK SMITH: [on camera] So he's in bed with management. Is that illegal?

SEAN COFFEY: Well, I think the fact that he's so tight with them raises the question of how he could not know about $9 billion in overstated earnings. And 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.

HEDRICK SMITH: [voice-over] Not until April, 2002, just weeks before WorldCom was charged with fraud, did Grubman drop his buy rating. And he never did say "sell."

SCOTT CLELAND: Well, I think the simple thing that we learned about WorldCom is if it looks too good to be true, it is too good to be true. Now, what did we learn about Wall Street? We learned that they don't work for us, the investor. They work for the company. And it should be investor beware.

HEDRICK SMITH: Two years of investigating the world of investment banks led New York attorney general Eliot Spitzer to a harsh conclusion: Wall Street was riddled with abuses.

ELIOT SPITZER: It wasn't just one corrupt individual. It was an entire business model that was flawed.

HEDRICK SMITH: [on camera] As you got into this, are these issues complicated and difficult to follow?

ELIOT SPITZER: It was incredibly-- it was distressing to me how simple and outrageous it was. 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.

[www.pbs.org: Read Spitzer's interview]

HEDRICK SMITH: [voice-over] Spitzer found damning evidence in firm after firm, but one celebrated case embodied the cynicism of Wall Street. It was not about WorldCom but AT&T. And it reached to the highest levels of Citigroup, to CEO Sandy Weill.

ELIOT SPITZER: Well, there's an interesting record on the AT&T upgrade.

HEDRICK SMITH: Jack Grubman had long been a bear about his old employer, AT&T. But Sandy Weill, who had a cozy relationship with AT&T'S chairman, Mike Armstrong, was bullish on AT&T.

ELIOT SPITZER: He felt that it would be good for the stock to get an upgrade, and he wanted his analysts to take another look at it. And he basically arranged for Jack Grubman to gain access to the AT&T hierarchy. And there was a fair bit of back and forth between Sandy Weill and Jack Grubman that led to Jack's changing his view.

HEDRICK SMITH: Weill denied giving Grubman a direct order to upgrade AT&T, but bank records show Weill's relentless pressure on Grubman, who finally double-jumped his AT&T rating from a neutral to a buy.

PHIL SPARTIS: After hearing it, I leaned back and said to Amy Elias, my partner, I said, "Amy, there's got to be banking deal coming. Why would-- why would Jack do that?" And sure enough, AT&T announced a few months later that they were going to be spinning off AT&T Wireless as an IPO.

HEDRICK SMITH: [on camera] And who got the business, the banking business?

PHIL SPARTIS: And sure enough, Salomon Smith Barney was the lead banker in the deal.

NEWSCASTER: AT&T Wireless making a big splash today on Wall Street.

HEDRICK SMITH: [voice-over] It was the largest IPO in history, raising more than $10 billion. Citigroup made more than $63 million on the deal.

For five months, FRONTLINE asked to interview Sandy Weill about his pressuring Grubman on the AT&T rating, about his bank's ties with Bernie Ebbers and whether Weill's leadership permitted conflicts of interest and fraudulent recommendations that hurt ordinary investors. Sandy Weill declined to answer FRONTLINE's questions.

[on camera] What's the fraud that Citigroup and Salomon Smith Barney have been charged with?

ELIOT SPITZER: The bank recommended a stock when it knew the stock was a bad investment. What was so revealing was this divide between the advice that was rendered publicly -- wherein they said buy, strong buy, great stock, great investment -- and the internal communications that made it eminently clear that these investments were not worthy.

HEDRICK SMITH: Does the formation of superbanks increase conflicts of interest that have the potential of hurting investors?

ELIOT SPITZER: Absolutely. No question about it. There is no question that we have created a web of relationships that provide the opportunity for massive abuse. And what we uncovered last year demonstrates there was massive abuse.

HEDRICK SMITH: [voice-over] Eager to get the scandals behind them, Citigroup and nine other Wall Street banks struck a deal last December with Spitzer and other regulators.

OFFICIAL: _[news conference]* It is time to close this, perhaps one of the darkest chapters in the history of modern finance.

HEDRICK SMITH: The banks agreed to pay $1.4 billion in penalties. Citigroup's levy was $400 million. To get the banks' agreement, Spitzer had to make a deal: no criminal prosecutions. Good news for Sandy Weill.

ELIOT SPITZER: [news conference] --and there will not be any charges filed against Sandy Weill.

HEDRICK SMITH: No charges against Jack Grubman, either.

ELIOT SPITZER: With respect to Mr. Grubman, there has been-- there's a tentative resolution, a lifetime bar, a $15 million fine.

HEDRICK SMITH: [on camera] Are you saying the evidence was not sufficient to bring criminal charges against Jack Grubman or anybody else in the Salomon Smith Barney Citigroup hierarchy?

ELIOT SPITZER: No. I believe that there are theoretical criminal cases that could have been brought. The judgment call that I have made is to bring civil resolution that imposes a financial penalty and imposes on the company the structural reforms that we sought.

[news conference] There are many very carefully articulated rules that--

HEDRICK SMITH: Under the new rules, the banks agreed to stop IPO giveaways to CEOs and promised to insulate research analysts from investment banking. But the ultimate test is whether investors get honest advice from Wall Street in the future.

ELIOT SPITZER: I want to see the analysts put out a sell recommendation on a stock that they brought into the marketplace.

HEDRICK SMITH: And even Spitzer is not sure.

ELIOT SPITZER: And I feel good about having moved things forward, but there's a much larger question in my mind whether this will work.

HEDRICK SMITH: Even those who cheered Spitzer's investigation say that the reform won't work because it's not tough enough.

PHIL SPARTIS: It's really very simple. You have to separate banking and research. Period. The end. Two separate companies.

SCOTT CLELAND: We've had good rules for a long time, and the only thing that's going to make the situation get better is if those rules are enforced and they have bite.

ROB GENSLER: People did things that are wrong. They should go to jail. It's just that simple.

HEDRICK SMITH: [on camera] And if they don't, then the message is?

ROB GENSLER: It's the wrong message. That you can make multiple millions of dollars and dodge the bullet of breaking laws? It's ridiculous.

HEDRICK SMITH: [voice-over] The Wall Street deal did little to repay investors. Spitzer released some key documents on Wall Street abuses, but it's now up to stockholders to file suit to recoup billions in losses. And the banks are girding for battle.

GEORGE MICKELIS: Is Wall Street fixed? Hah! Not by a long shot. What have they done to restore my faith and confidence as an individual investor? Zero. Zip.

WYONZIE KRAFT, Investor: I still have the stock today. They say it's worth 14 cents, but I can't find anybody who would give me 14 cents for it. I still have it.

GEORGE MICKELIS: I have no faith and no confidence, not in the companies, not in the brokerage firms, not in the people that own the brokerage firms, like Citigroup. I don't believe in you. I don't trust you. I don't want a thing to do with you.

HEDRICK SMITH: Bernie Ebbers, facing civil suits but no criminal charges, is living on his 2,100-acre estate. Jack Grubman was forced out of Citigroup and handed a severance package worth $30 million. Sandy Weill got a vote of confidence from Citigroup's board of directors, plus a bonus of $18 million in stock options.

THE WALL STREET FIX

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ANNOUNCER: This report continues on our Web site with analysis of the historic settlement with 10 investment banks and whether the reforms can fix Wall Street, more on the politics behind the rise of Citigroup and Wall Street's lobbying power in Washington, a chronology of the meteoric rise and fall of WorldCom, FRONTLINE's extended interviews with Eliot Spitzer, Arthur Levitt and others. And you watch the full program again on line or find out on the Web site if your PBS station will be airing it again. Then join the discussion at pbs.org.

Next time on FRONTLINE: Since 1995, this company has been cited for more than 100 environmental violations.

1st MAN: This is the source of the spill.

ANNOUNCER: --and more than 400 safety violations.

WOMAN: They didn't care about my daddy. They killed him.

2nd MAN: If a guy got killed, well, that's bad. "But now get him out of the way. We've got to make production."

ANNOUNCER: Why hasn't this company been stopped? FRONTLINE and The New York Times investigate A Dangerous Business.

To obtain a VHS copy of The Wall Street Fix, call PBS Home Video at 1-800-PLAY-PBS. [$29.98 plus s&h]

This program was made possible in part by the Schumann Center for Media and Democracy, the Nathan Cummings Foundation, the Consumer Trusts Fund, the Gilliland Family Fund, Paul Newman, Bernard Rapoport, the Brightman Hill Charitable Foundation and Edson W. Spencer.

FRONTLINE is made possible by contributions to your PBS station from viewers like you. Thank you.

 

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