The Wall Street Fix
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New York State Attorney General Eliot Spitzer spearheaded the investigations into Wall Street practices that led to the historic $1.4 billion "global settlement" between regulators and 10 Wall Street firms, first announced on Dec. 20, 2002, and finalized on April 28, 2003. Spitzer tells FRONTLINE that his investigation led him to the conclusion that Wall Street's whole business model in the late-1990s, in which stock analysts were fully integrated into the investment banking operations of brokerage houses, was not only "fundamentally corrupt" but, in fact, fraudulent. The only solution, he believes, is for Wall Street to implement the "structural reforms" agreed upon in the settlement, in which analysis and investment banking are walled off. And if abuses continue, he says, "The next time there will be absolutely no inhibition to bringing criminal cases" against individuals and the institutions. FRONTLINE correspondent Hedrick Smith conducted two interviews with Spitzer, the first on Dec. 19, 2002, and the second on April 16, 2003.

Second interview - April 16, 2003

[How are you feeling about the settlement?]

... I feel good about ... having moved things forward. But there's a much larger question in my mind [as to] whether it will work. I'm an optimist by nature, and I obviously [believe] that what we've done is designed to work, and will work. But the law of unintended consequences being what it is, and the difficulty of predicting how a market reacts to any shifts being what it is, I'll feel good two years or five years from now if I can look back and say, "Yes, things really changed." I mean, it will take time for this to work its way through the market.

There were some epiphany moments when the e-mails started to unfold. At a certain point, we looked at each other and said, 'This is fundamentally corrupt. This isn't merely one aberrant act. This is pervasive.'

So it's always nice to get something completed. But if the measure of success is what happens in the marketplace prospectively, I'd have to wait to see what happens.

What's the big question in your mind about whether or not this [settlement and the reforms it requires] will work?

The marketplace is dynamic, and the marketplace is impossible to predict. I think that, at the core of what we have done in the settlement is the separation of analytical work from investment banking. Our firm belief is that the analytical work that people rely on for their investment decisions will improve in its quality, because it will not be tainted by the underwriting desires and the desires of investment bankers to generate revenue streams. So I have every reason to believe that analytical work will be better, investment decisions will be sounder, investors won't be led astray. All of that will be great.

But you're not sure?

Well, you never know. ...

But you're dealing with ingrained practices, you're dealing with institutional inertia, and you're also dealing with high financial incentive, which behaves differently. So when you say you're not sure it will work, if you were looking for the danger areas, what are you looking at?

I want to see the analysts at the major houses begin to say critical things about companies with whom the bank has an investment banking relationship. I want to see them admit to the company for whom they did an underwriting six months, a year ago, that the business model of that company hasn't worked, and see the analyst put out a "sell" recommendation on a stock that they brought into the marketplace.

When that begins to happen, then I will know that the cultural effort -- that is, the effort to create a different culture for the analyst -- has succeeded.

So the test is whether or not an analyst is willing to go against the self-interests of his own bank?

Correct, because the principle that we have articulated -- that analysts need to tell the truth, analysts need to be surrounded by a cocoon that will permit him to be honest and straightforward -- is readily stated. Measuring whether we've created an appropriate system by separating their compensation, by creating all sorts of buffers, by ripping them out of the investment banking piece of the bank, only retrospectively will we be able to look and say, "Aha, they are not acting differently."

Citigroup, CFSB, and Merrill Lynch have been charged with fraud. Let's just take Citigroup. What's the fraud, in simple terms? What's the fraud that Citigroup and Salomon Smith Barney have been charged with?

At its core, the wrongdoing was as simple as one can imagine. The bank recommended a stock when it knew that stock was a bad deal. You can't go to an investor and say, "Buy this stock because I trust it, it's good," when you know it isn't, and when the reason for that mistake is that you have a conflict of interest, and you are being paid by the company [whose] stock you recommended. That, in our view, is a fraud, and that is what underlies this entire set of relationships. ...

So you're saying the advice from Citigroup to buy WorldCom stock, to buy WorldCom debt offerings, was a fraud?

We're saying that the advice that said, "We believe in this stock" ... when the analysts had a conflict of interest and the internal e-mails demonstrated [they] didn't really believe that that was a good stock or debt purchase, yes, that was a fraudulent act. ...

So there are internal communications ... that show either Jack Grubman or Michael Carpenter, or others in the Citigroup/Salomon Smith Barney hierarchy, did not believe what they said to the public?

What was so revealing about the internal communications is that they demonstrate this divide between what was said publicly -- 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.

Are you talking about Jack Grubman? Or are you talking about Michael Carpenter? Or are you talking about Sandy Weill?

We are talking primarily about analysts. The degree to which one can attribute this knowledge up the chain, obviously, is more and more attenuated as you move up the chain. That is why perhaps the most difficult judgment call we've needed to make relates to how you handle these individuals, especially individuals who are more senior in the organization, where clearly they understood the business dynamic. Clearly, they benefited from this, and yet it is difficult -- if not impossible -- to attribute to them the specific knowledge of the tension between the public recommendation and the privately held view.

That is why these judgment calls are subtle, and do not lend themselves to the bright-line clarity that perhaps I would always like. We have ended up with institutional liability at this point to a greater extent than we have been able to prove the individual liability of those most senior in the institution.

Is the evidence so clear that you could have brought criminal cases against somebody in the Citigroup/Salomon Smith Barney hierarchy, and others?

The question doesn't lend itself to that clear an answer. These are very difficult criminal cases. The reason for that is that you're dealing with subjective beliefs. Proving a subjective belief beyond a reasonable doubt, even when you have these e-mails, is very, very difficult. I'll give you an example.

Somebody says this stock is no good, but has put out a buy recommendation. You charge somebody with criminal fraud. You have to prove, beyond a reasonable doubt, that that was fraudulent advice. The defendant could take the stand and say, "I knew that at a pure equity level, in terms of the value invested for a five-year period, that stock was a dog. But I'm riding a wave, and I know that stock is going to go up for some period of time. As long as I get my guys out before that wave crests, I've made them money. The reason I said 'Buy the stock' is not because I think that the valuation long-term is sound, but because I know there's market momentum." ...

That's why these are difficult, difficult cases to prove at a criminal level.

You're saying the evidence was not sufficient to bring criminal charges against Jack Grubman or anybody else in the Salomon Smith Barney/Citigroup hierarchy?

No, I believe that there are theoretical criminal cases that could have been brought, speaking about the theoretical cases that one looks at as a prosecutor. ... The judgment call that I have made, obviously, is, in the context of Jack Grubman and others at Citi, to bring civil cases, civil charges, leading to a civil resolution that bans Grubman from the industry for life, imposes a financial penalty, and imposes on the company a structural reform.

What do you say to people who say we have had the rules on the books for years. The real problem has been that self-policing hasn't worked, that enforcement hasn't worked, and if we're ever going to make rules work, to be taken seriously, the real test is to give them bite -- and that means criminal prosecution?

I agree with some of that. I agree that self-regulation failed. I agree that the rules were on the books, but not enforced. What we did over the last year, I believe, was begin to enforce those rules and then change the rules. The problem wasn't just that there were rules that were inadequate; there was an absence of rules in certain areas. We have created those rules through this global resolution. So that is what we have been trying to do. [But] I don't disagree -- criminal cases ultimately will have the greatest bite. ...

I've had a trilogy of objectives throughout. First, it was structural reform. Second, restitution. Third, individual cases demonstrating individual liability.

We have made great progress on the first, and that's what this global deal is designed to do. Restitution will flow from the cases that are brought based on the information that will become part of it. The third area, the individual liability, is a continuing operation. That is where we're seeing a number of inquiries that are ongoing relating to individuals in these firms.

But first and foremost, it was important to get structural reform.

What about investors? Where do they go, how do they get their money back? ...

We have made public the information that they need to bring a lawsuit. That information will let them go to court and say, "You lied to me, gave me fraudulent advice. Now pay up."

Another thing that has been said is that the fines, in terms of institutions of this size, sound big to the ordinary person. But if you've got $15 billion, $16 billion profits a year, and you're Citigroup, and you pay a $400 million fine, that's maybe what you spend on postage or something like that. People will say the amount of money doesn't matter, what really matters is that these institutions have got to admit exactly what you're saying: "We lied to you, we misled you, we put our corporate clients ahead of you." The standard formula is for the SEC and other institutions to bring fraud charges, and banks to say they either admit or deny. We're in a "neither admit nor deny" situation here ...

There will be public statements, and there have been public statements that acknowledge that the business model was wrong and that acts were wrong. Merrill Lynch publicly apologized in April of last year, five days after we brought the allegations against them. So yes, I agree. The "neither admit nor deny" is always problematic. But the investment banks also know they have lost the trust of the American public. They will have to earn it back day by day.

Forgive me, I want to believe that desperately, but I've got a couple of things going on. Citigroup has just announced higher profits than ever, and I've talked to people who say, "Well, the question of public trust is demonstrated. Our credit card business is up, our profits are up, the public trusts us OK." That's one thing. The second thing is we get Dick Grasso [of the New York Stock Exchange] and Sandy Weill agreeing that Sandy Weill can go on the board of the New York Stock Exchange as the consumer's representative. Now, how does that represent any significant change in mindset? ...

You're right, which is precisely why the nomination of Sandy Weill to the board position was so problematic to me -- fortunately, didn't last very long after we began to focus on that.

But less important than the individual act, was what he may have said with that mindset, and here's what I would say to it. I and others are going to continue to be extraordinarily vigilant and examine their behavior, and that is the best we can do -- just as I reacted very quickly when Sandy was nominated to the board. They withdrew that very properly. Just as I am now pushing very aggressively about another change they want in Washington that would be misguided, I'm going to be vigilant, the public will be vigilant and other regulators will be vigilant. That's what our job is.

Let me ask you about a couple of things specifically. ... How did Sandy Weill communicate to Jack Grubman the message to take another look at AT&T? Did he write a memo? Did he call Grubman in personally? Did he have a telephone call?

They spoke, they had phone calls. They had oral communications that we know of, that we've documented from phone records demonstrating the frequency of their communications. Obviously, phone records don't tell you what the substance of the conversation was. But we know of their phone calls and when they spoke. ...

The documents that you have made public -- do they demonstrate that Sandy Weill was giving this instruction to Jack Grubman to "take another look" at AT&T?

No, the documents don't prove that he said, "Take another look." There are references in e-mails to the fact that they spoke. In our investigation, we probed that course of communication to try to develop the best understanding we could of the nature of that dialogue.

When you questioned Sandy Weill, did he acknowledge that he had said to Grubman, "Take another look at AT&T?"

Oh yes, there is not a denial that he made comments -- if not those precise words -- in sum and substance. Absolutely. ...

When we talked before, you said there was a good deal of back and forth between Grubman and Weill. ... We talked to Citigroup people, and they'll say Grubman's memo to Sandy Weill is headed "AT&T and the 92nd Street Y." That indicates what Grubman thought, but that doesn't demonstrate what Weill thought. I'm wondering if there's evidence that does show that Weill made the same connection that Grubman did. Did he write any notations on the documents, did he say anything?

There is no documentary evidence that would establish that Sandy Weill shared the view that Jack Grubman articulated, that there was a connection between those two.

Did your questioning of Weill confirm that Weill understood there was a connection between the AT&T rating and the 92nd Street Y donation?

No. Just the opposite.

He denied it?

He denied it, yes. Let me answer the question more directly, which is implicitly why was Sandy not alleged to have individually acted improperly. The answer to that is very simple. Sandy Weill has always maintained that [the AT&T stock] should have been upgraded based on the merits of the stock itself, and there is nothing to challenge that articulation of Sandy Weill. There is nothing that establishes that he did not believe the stock was a good stock. He was buying it.

Is there anything to establish that Jack Grubman didn't believe that -- that he only changed it because Sandy Weill put pressure on him to do that?

Oh sure, Jack Grubman's e-mail. Jack Grubman's e-mails clearly reflect -- if you credit the e-mails as being truthful statements -- that Jack Grubman said, "Well, I'm changing this for all sorts of collateral reasons." It could have been 92nd Street Y, it could have been the board vote, it could have been the underwriting. So Jack Grubman clearly created a paper trail, an expansive paper trail, that suggests, proves -- or however you want to read the evidence -- that his motive for the upgrading was tainted. ...

There is not sufficient evidence to have brought a criminal case against Sandy Weill?

Correct. Absolutely. There is no way you could have brought that case.

Now I want to ask you about the question of conflicts of interest that affect investors. One of the allegations made by a number of people who follow the banking industry is that the mere formation of a superbank like Citigroup, and putting insurance, brokerage, investment banking, and commercial banking under one roof, inherently increases the conflicts of interests. I just wonder what your take is on that. In an era of superbanking, when you have more and more of this brought together -- you have the repeal, and even before the repeal, the effective repeal of Glass-Steagall. Does the formation of superbanks increase conflicts of interest that have the potential of hurting investors?

Absolutely. No question about it. There is no question that we have created a web of relationships that provide the opportunity for massive abuse. What we uncovered last year demonstrates there was massive abuse. The only remaining question, then, is do you create -- and can you create -- a way to mediate among these conflicts to protect the consumer? Or do you have to rip apart the structure? I think we have an enormous policy debate that is facing us.

You're saying, in other words, we have to go back and reconsider whether or not it was smart to allow the formation of these superbanks?

I think that's absolutely something we have to reconsider. I don't think that Congress and the Fed right now are willing to ask that fundamental question. I think they are trying to create firewalls between or among these various pieces, to protect against the conflicts. But the enormous question facing us is, how do you protect consumers -- and businesses that are consumers, in their own way -- against this web of conflicts of interest? ...

The very notion that underlay the creation of these banks was that we needed a concentration of capital to compete against foreign banking entities that were more deeply capitalized, and therefore we had to break down the walls that had been created to protect against these conflicts. We saw last year, when we began to look at what had happened between analysts and investment bankers, what happens when those walls are broken down, and the problems and enormous harm that results to consumers.

Specifically, I was wondering whether or not you all looked at the fact that the Travelers arm of Citigroup granted a $1 billion mortgage to Bernie Ebbers, which he used half of to buy timberlands in the Southeast, and then went on and bought some other things. Did you look at that, and is there evidence that a personal loan of that size requires top-level approval from the CEO, from the board of directors? That's a staggering sum.

We looked at some of those issues relating to CEOs and Bernie Ebbers and the way that money flowed to him. In fact, we brought lawsuits against some CEOs, alleging that these conflicts were civil wrongs. So, yes, we are deeply troubled by that, and it's one more manifestation of the failure of the bank to operate within proper business parameters.

Are you talking about that billion-dollar mortgage?

We're talking about the fact that loans were being made, and at the same time, that those CEOs were being solicited for investment banking, underwriting business. We view that as intentionally -- and in some cases, illegally -- improper.

Does that implicate the leadership of the banks, such as Sandy Weill at Citigroup? Again, the size of the loan to Bernie Ebbers was so large.

We were not able to investigate it, and the matter seemed to be whether that particular loan could be tracked up to the most senior ranks. We did not ask that particular question. ...

Another issue that has come up recently. There have been some e-mails from Grubman to Bernie Ebbers in February 2002. He is giving very specific guidance to Bernie Ebbers on what to say during an upcoming conference call. First of all, I'd like to have you tell me about those e-mails, and then what do those e-mails say to you about the nature of the relationship? Who's guiding who? Who's in charge of--

These e-mails reflected to us that Jack Grubman was almost scripting Bernie Ebbers' responses to inquiries about the business model and the business plan of the company.

And accounting?

Yes, and accounting, and that Jack Grubman was not an arm's-length analyst who could, with some dispassionate analytical skill, determine whether this was a company whose stock you wanted to buy yourself. He was emotionally, personally, at a business level, fully invested in the success of this company.

Does it also raise a question as to what Jack Grubman knew and whether or not Jack Grubman, being that close to the leadership of the company, could have missed the transfer of $9 billion in current expenses to capital expenses?

It raises the question, but I don't have the answer to it. ...

Let me put it this way: What questions does that raise in your mind in terms of what he understood, or should have understood and might have understood about WorldCom's finances?

It certainly makes one think that somebody who was that intimately involved with the CEO of the company and with the chairman and the leadership -- with everybody at WorldCom -- must have known the numbers well enough to think that there was a problem. But again, this is an area where we have no proof, and that we have to wait to see what emerges.

Does the settlement that you and other regulators have preclude the Department of Justice, the U.S. attorney, taking legal action against Jack Grubman or anybody else, if there is evidence that they were knowledgeable about the fraud at WorldCom?

No, no.

So that action could be taken?

That action could be taken by Southern District. It could be taken by many entities.

Could it be undertaken by you?

No, it would not be undertaken by me. ... I am done. But there are many other regulatory entities would could initiate those inquiries and prosecute.

From the standpoint of the banks and the analysts, what do you think is the most serious deterrent to future misbehavior, abuse, corruption, and fraud, versus investing?

The next time there will be absolutely no inhibition to bringing criminal cases.

This time, because the business model that led to the problem had almost been encouraged by the government -- abused by the banks, but encouraged by the government, in the sense that we wanted this concentration of power and capital in these [single] institutions -- there was a hesitancy to pick out individuals, when the structure had generated the problem. Next time, if there continues to be abuse, the institution can be--

So you're saying the repeal of Glass-Steagall and the permission for these huge superbanks is one of the proximate causes of the corruption on Wall Street?

Absolutely. There's no question about it. On the day that I announced the global settlement, on Dec. 20, [2002], I began by saying that the problem at its root is a flawed business model, and that business model is the product of a government regulatory decision to repeal Glass-Steagall administratively and legislatively, and to seek this tremendous concentration of power; and then the abuse of that power by the investment houses.

But it was that effort to create these one full-service banks, and that model that was the proximate cause for all of this.

Do you see evidence that anybody wants to break that model up?

I see evidence that very thoughtful people are questioning it. I don't see any evidence in Washington that there is a will to do so.

Do you see Sandy Weill doing it at Citigroup?

The bankers are never going to do it themselves. They benefit from it. Only when Congress, which has the power to pass the laws, or the Fed that has the power ultimately to make the rules about banks, or the SEC, determines that the conflicts of interest are so intractable and so beyond the capacity of the investment houses to mediate -- only when they reach that conclusion will they be forced to say this model isn't going to work.

One of the arguments made to me by one of the former members of the Federal Reserve Board at the time ... was that the kind of problem that you had with Jack Grubman, and the conflict of interest you had, including advising investors and advising investment banking clients, was not the product of the repeal of Glass-Steagall -- that you could have had this in an investment house.

That particular problem was not a Glass-Steagall problem, but all of the other collateral issues that we had [were].

What other problems arose from the repeal of Glass-Steagall?

For instance, the opportunity to give a line of credit, a $2 billion line of credit, to the bank that brings in your investment banking, ultimately is going to be just as injurious to a banking system. That line of credit, the Enron lines of credit, the fact that the companies default, the banking system is saddled with bad debt -- we all pay the price, because we can't let the banks fail. So you have the instability that can result, because we use lines of credit as the bait for investment banking bills. Remember, the traditional divide between investment banking and commercial lending was designed to prevent that risk from being linked.

So you think we should go back to separating commercial banking and the securities business?

I don't know. I don't pretend to be the expert. I have serious doubts. Here's what I do know. ... I do know that the banks are not properly handling these conflicts of interest, and there's a real risk they pose in that. Whether there's a way to get them to act properly is what we have to find out.

But you did say, the next time, you'll throw the book at them. Why give the banks a second chance?

Because the harm to our economy that would result from eliminating a Citigroup or a Merrill Lynch is enormous, and it's disproportionate to the remedy that we want. What we want to do is clean up the system and hold the individuals accountable, and that is what we have tried to do. There will be people who disagree, who say we were too tough, and some who are going to say we should have indicted the company and hold the company accountable and eliminate it. I understand that, and I've heard both perspectives.

But what you're really saying, though, in the charges of fraud against Citigroup and other banks, and the decision not to take criminal action against individuals is that you've really decided to penalize the institutions -- much more than to go after individuals.

So far, that's correct. So far the institutions have paid, the institutional rules have been changed, and the inquiries about the individuals will continue ... except in the case of my office with respect to Grubman, where he's barred from the industry for life. ...

Could you have gotten the settlement last December without making an agreement that the criminal actions against the CEOs of these Wall Street banks were off the table?

I don't know.

Did you consider trying to get a settlement, or did you try to get a settlement and get told you couldn't?

One thing I can't [do] is begin to tell you all the things that I did.

No, but did you push for, and find that the banks were not buying in with you on structural reforms if you proceeded down the criminal path?

There was a concern on the part of the banks that structural reform would end up being meaningless if criminal sanctions were sought, against either the institutions, or the most senior individuals, because that would be tantamount to destroying those institutions.

So you were actually faced with a choice by the banks -- either to proceed on criminal prosecutions or go for structural reform? You couldn't do both.

It was never quite that brazen a choice. But there was an understanding that if we were to seek criminal sanctions against either the institution or the most senior people of the institution, the practical impact in our regulatory environment would have been to destroy those institutions, and then structural reform would be meaningless.

First interview - Dec. 19, 2002

Let me just take you back to the beginning. What got you into this subject? Why did you decide this was a field you ought to investigate?

We have, in the AG's office, an enormous jurisdiction. One of the traditional jurisdictions of the office has been investor protection, something this office has done for decades, since the Martin Act was passed, going on 80 years ago. Now, the traditional role of the Investor Protection Bureau has been to go after what we would call boiler-room operations, the real sort of Ponzi scheme -- sham stock sellers, whose name comes from the fact that they exist down in these hot rooms. They're selling stocks that are overheated, over-inflated.

Never before had this office pursued the top-tier elite investment banks. About a year and a half ago, when I was sitting down with one of my bureau chiefs and we were trying to generate a set of priorities for inquiries that we should undertake, I said to him, "Where are there problems in the market that are not being addressed?"

Frankly, the journalistic world has been -- as it often is -- ahead of the regulatory world, and had written and documented to a certain extent the tension between analysts and investment bankers. "Tension," meaning that there were rumors, stories of conflicts of interest tainting the research that was being generated and being disseminated to the investing public.

Some of those stories had begun to be fleshed out with enough evidentiary support to get the attention of a prosecutor, and indeed, there had even been an arbitration award that was slightly above the norm. There had been a press article about it caught my eye. ...

This suggested to me that there was something bigger, and that this was an issue worth pursuing. ...

Now, for you personally, what was the first big kind of revelation that you said to yourself, "Aha," or "My God," or "I didn't know this?"

There were some epiphany moments, some eureka moments, when the e-mails started to unfold, when the Investor Protection Bureau was reading through the e-mails -- the e-mails back and forth between the analysts and the investment bankers. About once a week, folks in the bureau would come up and say, "Take a look at this." ... At a certain point, we looked at each other and said, "This is fundamentally corrupt. This isn't merely one aberrant act. This is pervasive."

There was a tipping point, where we went from viewing this as a problem that was isolated and could be carved out, probably one analyst or two analysts and no more, to the recognition that we had suddenly arrived at -- that the entire structure was fraud.

One of the things that I concluded is that the very business plan that the investment banks have relied upon for the past five or so years, of fully integrating their analysts into the investment banking part of their house, doesn't work. That is what led to all the problems. It wasn't necessarily just one corrupt individual. It was an entire business model that was fraud.

So the kind of superbank that a guy like Sandy Well was building, was building in conflicts of interest?

Whether it was Sandy Weill's Citibank or Merrill Lynch or CSFB -- any one of the major houses that had an investment banking piece, where they would underwrite stocks and analysts would generate research that went out to the retail public -- when those two pieces were integrated, as they were in virtually all these banks, the conflicts of interest were pervasive, were impossible to control, and generated the flawed research that flooded the marketplace.

What do you think at that point? Are you looking at a con game? Are you looking at a bunch of insiders who are playing the game for their own advantage at the expense of outsiders, the ordinary investors? I mean, what is it you think you're seeing?

Here's where you get into sort of reflective moments: Are these corrupt individuals, or are they individuals of morally sound judgment who just went off the tracks because of the structure? I've gone back and forth.

Somebody said to me, "People say it's a few rotten apples." He said, "I thought about it. It's not the apples that are rotten, it's the system that's rotten."

I agree with that. It wasn't that there were individuals who were corrupt and built a bad system knowingly. It was a system that emerged out of a sense of what the business community wanted and needed, and that system created tensions that otherwise decent people couldn't resist. They became individuals who were acting in a way that they came to realize was immoral. But they weren't necessarily corrupt and bad, invidious people to begin with.

Couldn't resist because there was so much money in it?

There was so much money, and the context in which they were operating had begun to fudge what should have been a certain clarity about what they had to do. At the end of the day, you had the analysts writing reports that they looked at and they said, "Well, I don't necessarily believe this. But the investment bankers want me to say it, and so I'll put it out."

And that's wrong. Most of the time they realized that was wrong. But these weren't evil people who woke up in the morning and said, "How can we go out and steal money?" They weren't even necessarily profiting day to day from that particular transaction.

You're talking about a systemic problem that's fairly pervasive. In fall of 2002, you file a lawsuit against five leading telecom executives. Essentially, you talked about a systemic problem involving analysts and involving hot IPOs. What's the heart of that suit? ...

The "spinning" lawsuit, as we refer to it, was designed to paint the full picture of the corrupt triangular relationship, where you have investment bankers who want to do an underwriting, who lean on an analyst to generate a strong buy on a stock. In order to get the business in the door, they promised the CEOs, not only the strong buy, but also allocations of hot stocks in the IPO market.

So the CEO gets a lot of money in the allocation and a strong buy on the underwriting. The investment banker gets the underwriting business and the revenues that come from that, and the analysts got paid based upon how much investment banking business he or she brought in. So that relationship, and that set of relationships, is what was flawed.

Well, you not only said flawed, you said it was fraudulent.

Fraudulent. It was violative of the law, because what was going on. On the spinning piece of it, CEOs were being given money that should have gone, if it was going to go anywhere, to the company and the shareholders. To be crass about it, it was no different than the store manager at a shoe store being given $5000 in cash to put somebody's shoes at the front of his store.

If the company wants to say, "You pay us, we'll put your product in a good location," that might be fine, but the company gets the payment. When the store manager takes the cash and puts it into his pocket, we call it bribery. In a sense, that's what was going on.

Let's take just one example here -- Bernie Ebbers. ... What does a guy like Bernie Ebbers, the CEO of WorldCom, get, according to your suit?

Bernie Ebbers and the company WorldCom was doing $100 million of business with Salomon Smith Barney -- business, underwriting business, streams of income from his company to Salomon Smith Barney. In return, Bernie Ebbers got $11 million personally. It didn't go to his company. It went into his bank account in hot stock allocations. Why? We allege that the purpose here was to persuade him to be a loyal customer to Salomon Smith Barney.

And give WorldCom's business to Smith Barney?

Absolutely. Now, if Salomon Smith Barney had wanted to give a discount to WorldCom, they could have said, "You know what, it was $100 million worth of business, but you only pay us $89 million, because you're a good customer," and given the $11 million back to WorldCom as a discount. That would have been legal. They would have been giving a discount. But they can't give it to Bernie Ebbers individually so that he takes his company's business and brings it to them.

So is that an executive perk for a valued CEO, or is that commercial bribery?

Well, sometimes the distinction is a subtle one. But we would allege that where there's been a failure to disclose, where people don't know about it, where it's done in secret, it is a violation of the Martin Act -- violative of the law -- and he has to return that money.

I just want to ask you again. Is that a perk, or is that commercial bribery to a guy like Bernie Ebbers and others?

It is commercial bribery.

OK, now, who's deciding this? I mean, Jack Grubman was very close to Bernie Ebbers. What did you find the relationship to be between Grubman and Ebbers?

I don't want to personalize this too much, but we found that the CEOs of these companies had a very close relationship with analysts and investment bankers. That triangle of people, those three people, would insure that you got a strong vibe on the stock, that the investment banking business went to the particular firm, and that the CEO got the hot stock allocation.

Well, in the case of Salomon Smith Barney you're talking about Jack Grubman being right at the heart of it. You're talking about Eduardo Mestre, you're talking about Michael Carpenter. I mean, you're talking about this core of people, right?

Right, correct.

Would Sandy Weill have known anything about that?

That is a matter of conjecture.

It's a lot of money. ... The reason I ask about Mr. Well is your initial point, which was this is a system you're talking about, and Grubman and others were not operating as freelancers. This was, as you say, a business model.

It was a business model that was flawed. As a consequence of that, the very first imperative that I felt as attorney general, working with the SEC and the other regulators, was to rewrite the rules, was to take this apart, take apart what had become a corrupt system and say, "That's not the way business should be done." Get rid of spinning, make it simply illegal to give allocations of hot stocks to CEOs. Say you can't do it. Make it improper and illegal for analysts to be pressured to put a "buy" on a stock when they don't believe it. Make it improper and illegal for analysts to have their compensation depend upon the investment banking revenue. In other words, give them that comfort and independence that they need to provide the public with genuine research.

But to do this, you have to talk to the leadership of the firms. You're not talking to the guys in the trenches, because it's the leadership of the firms. Again, I come back to Sandy Weill, because we're interested in Citigroup. But you have to talk to a Sandy Weill, the leadership of the firm, because it's the firm's business model; it's not just a bunch of freelance analysts.

No question about it. In order to get the change that we wanted, the change that was needed to deconstruct the system, we had to negotiate with the very top leadership -- not only of one firm, but all the firms. You can't change the system by saying this one bank will operate by a different set of playing rules. Everybody has to operate on the same rules. Hence, the negotiations we've been involved in for many months took the form of a multi-party negotiation.

But you had to talk with folks at the top, like Sandy Weill, who put the system in place.

No question about it. We had to negotiate with those at the very top, who understood how the various pieces interacted.

Now let me move on to the ratings and the function of the analyst. One of the things that you said [in your September 2002 lawsuit] was that the analysts were involved at every step of the business. What did you find that analysts like Jack Grubman were doing?

What we found was that analysts were involved from the very beginning of the investment banking relationship: going out there, soliciting a client, promising, "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, ensure that we keep a strong buy on your stock all the way through, and become part of your management team." There were analysts who routinely were present at board meetings.

Jack Grubman?

Jack Grubman participated in management decisions relating to fundamental choices like acquisitions, targets of acquisitions, strategic decision-making of all sorts. Hence, they lost the objectivity -- not only because they became an integral part of the company and an integral part of the investment banking function within their own firms -- but their revenue, their salary, their compensation was directly pegged, not to the accuracy of their analytical work, as it should have been, but to their ability to bring in investment banking.

You have a section in this lawsuit, as I recall, in which Jack Grubman says he filed annual reports to his chiefs, [boasting] that he had generated -- I added the numbers up -- more than $1 billion worth of underwriting fees by getting involved in investment banking deals.

Absolutely. He didn't argue, "Pay me as an analyst because I'm a good stock picker, because the companies that I critique perform the way I predict they will." 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."

So at the end, is Jack Grubman an analyst or an investment banker?

At the end, he's a salesman. He's a salesman with an enormous vested interest in pushing the stocks that he was covering. ... He's an investment banker, but he's not even an objective investment banker. He's a salesman to the investment banking deals.

In your suit, you quote a number of Salomon Smith Barney brokers. These are brokers inside the firm. One of them says, "Grubman is an absolute disgrace to our firm as an analyst." Another speaks of "misguided, horrific recommendations" that cost clients millions of dollars. "Grubman is an investment bank whore," says a third. "When is the firm going to stop pimping him?" Did you find outrage among Salomon's own troops?

The most outraged group was the Salomon brokerage group. They were the ones in the front lines, who had to deal with clients every day, who had to say to a client, "Yes, I know you've lost a ton of money in this stock, but my analyst still has a strong buy on it." They were the ones who had to deal with the angry consumers who were saying, "You told me, you, to buy WorldCom at 50. You told me to hold it at 40, to hold it at 30, to buy it again at 20. Now it's worthless. What kind of analysis and recommendations are you giving me?"

They were on the front lines, and they were the ones who got the angriest response from the investing public. Yet they didn't have the ability to go back to Jack Grubman and say, "You're full of it. Stop it." They were stuck with the analysis that he generated -- improper analyses, flawed, tainted, the product of all this conflict of interest -- and they were the angriest group.

Yet you have higher-ups at Citibank, by your own documents, who know this is going on. John Hoffman said, "The research we're producing is worthless." The head of the retail division says he doesn't even want to finance the analysis anymore, because it's not worth anything.

Right, right. There was within certain parts of the investment bank, absolutely, a recognition that what was going on was flawed, was wrong, that there was this essentially corrupt research flying out the door into the hands of investors, and yet nothing was done about it.

Let me just ask you about one rating in particular which doesn't happen to be part of this lawsuit. That's the rating on AT&T, which Grubman had sort of treated rather negatively for several years, and then suddenly, in November 1999, he jumps it up to the equivalent of a strong buy. What was going on there?

Well, there's an interesting record on the AT&T upgrade, and the record is one that shows several strains of reasoning. At the time of the upgrade, there was a vast group of analysts out there, people who were really independent, who thought AT&T was a great stock. Some of the smartest people in the press actually said this is a great stock. Jack Grubman had always been a skeptic. He had said this isn't going to work.

Right around then, AT&T was coming out with a huge underwriting. He had a situation where Sandy Weill sat on the board of both AT&T and Citigroup. He was close to [AT&T's CEO] Mike Armstrong. He believed in the stock. He really did believe in that stock. He felt that it would be good for the stock to get an upgrade, and he wanted his analyst to take another look at it.

This language was, what, "Jack, take a fresh look"?

"Take a fresh look." He basically arranged for Jack Grubman to gain access to the AT&T hierarchy. There was a fair bit of back and forth between Sandy Weill and Jack Grubman that led to Jack's changing his view, right around the time of the underwriting. AT&T then chose Salomon Smith Barney as one of its underwriters, and generated over $40 million in revenues for Salomon as a result. Certainly, you know, one wonders whether there was causation.

Don't you more than wonder? I mean, Sandy Weill is a leader of this bank, commanding one of his troops to take another look, and they all know how the game is played. ... If you're playing that game -- which, according to your lawsuit, Grubman and Salomon Smith Barney have been playing for years -- if you suddenly get that from the chief, isn't that pretty much a direct order, even though he hasn't used those words?

It is a problematic change of events.

What does that mean, "problematic?"

It means it's troubling.

It's a troubling chain of events?

It means that it certainly raises questions, with a record that was not as pure and pristine in any direction as you might have wanted to establish any clear conclusion about what happened. It is perhaps one of the best paradigms of what is wrong when you have analysts and investment bankers and centralized decision making all under one roof. As a consequence, you have the potential for real misinformation getting out in the marketplace.

You say it's a paradigm for what was wrong. What was wrong there? I mean, this was not the investment bankers. This is the CEO.

What was wrong with it, the analyst was not in a position to do his or her work free of the pressures being applied -- either genuine pressures, or the appearance of pressures -- to alter an analysis in a way that would make it more likely that the investment bank would get, would generate, underwriting fees.

You have e-mails from Grubman to a friend of his, an associate, saying -- boasting -- "I did this to help Sandy Weill beat John Reed with a vote on the [Citigroup] board." You had another e-mail saying, "I did this because I got Sandy Weill to help my kids get into the 92nd Street Y nursery school." None of those have anything to do with business and rating companies. What do you make of those e-mails?

Well, you read those e-mails and all the surrounding e-mails, and you wonder, are they true? Are they boasts? Are they sort of yammerings of somebody who's trying to impress, in what was sort of an odd personal relationship? You'll never know. We'll never know.

You may not know about the e-mails. But on Nov. 5, 1999, Jack Grubman writes a memo to Sandy Weill and he says, "I've been down to AT&T. I met with Mike Armstrong. Thanks a lot. I think things are going to come out positive." And the e-mail is headed "AT&T and the 92nd Street Y."


That's an internal document. That's not to a girlfriend; that's an internal document from the guy to the top boss.

Right, right. It is a remarkable document, and it is one that we have examined at length and that we have questioned witnesses about. It is one which certainly raises and suggests the possibility that Jack Grubman, at least, believed that the opportunity to have Sandy Weill help his kids get into the Y was perhaps related to Jack Grubman's desire to upgrade AT&T, because he believed Sandy wanted that.

Do you have Weill saying that's absolutely not true?

There are now denials from everybody that that was true -- from Jack Grubman, Sandy Weill, and everybody else involved. So we are trying in these investigations to reconstruct events, where we look at the chain of events and we say, "Wait a minute. Isn't it pretty clear that the motivations here were to get the upgrade, get the business, perhaps to satisfy a board member to insure a vote at a transitional moment, perhaps to help kids into a school?" ...

But you're perhaps beyond getting the kids into school. Citibank made a contribution of $1 million for the 92nd Street Y, which Mr. Weill himself ordered be done, and it didn't come out of the charitable foundation, it came directly from Citibank funds. You got his memo, "AT&T and the 92nd Street Y," you've got the delivery of $1 million to the Y, and lo and behold, Mr. Grubman's kids get into the Y nursery school.

That is precisely why we have undertaken a very lengthy set of negotiations: to take apart this process that we view as being fundamentally flawed -- giving investors bad information, permitting analysts to take advantage of the system, permitting CEOs to take advantage of the system, and has led to enormous losses for retail investors. ...

There was a point at which you, I believe, put Sandy Weill on notice that he should get a personal lawyer, because perhaps his interest and the company's interest were not exactly parallel. Is that right? You are essentially communicating with him, "We are investigating you as an individual, not just your company?"


"So you should be legally protected?"

That is correct.

Then, I gather, at that point, did you actually interview him?

We have interviewed Sandy Weill. We have spoken to him. We have spoken to many of the senior executives at Citigroup and Salomon Smith Barney in an effort to figure out exactly what the record was, and is, with respect to, not only AT&T, but other transactions as well.

You've been negotiating for eight months. Periodically you've been optimistic, as anybody naturally would be. "We're going to wrap it up by Thanksgiving," and then, I don't know, maybe you're going to wrap it up in December. Last night I heard on Charlie Rose, you're talking maybe it will be early January. What have been the toughest issues to deal with, to get resolution on?

When we first announced the case, I thought the hardest issue was going to be persuading the investment banking world that we had diagnosed the problem properly. I thought we would have to really fight long and hard just to get them to accept the notion that analysts and investment bankers shouldn't be integrated into one sort of seamless web. ... That spinning wasn't a good idea, that analysts pumping stocks because their pay was contingent on investment-banking revenue was not a good idea.

We crossed that bridge pretty quickly. The evidence of improper analysis was so overwhelming that very quickly the investment banks said, "OK, you know what? You're right."

Then the debate changed. ...

So the first thing you were worried about was persuading them you had a case, and you found out that wasn't so hard. But what was hard?

What then became very difficult was persuading the investment banks that the right remedy was the structural reform that they needed, so we really had to carve analysts out from the investment banking world. Since the middle of the summer of 2002, we have needed to be involved in that very careful parsing of what analysts can do, what they can't do, when they can communicate with investment bankers, when they can't.

Can they go on the pitch? [That] is when the investment bank tries to market itself to a company, to say, "We want to do the underwriting, and here's our analyst who will be the one who pumps your stock." We said, "No, you can't take an analyst on a pitch, because when you do that, you make the analyst part of the investment banking team. You then emotionally twist and taint that analyst. So we think we will forbid that."

You can't take him on the road show, where they market the securities, because then again they lose their objectivity. They are not sitting out there as the dispassionate critic, which is what they're supposed to be. You can't make them part of the investment bank team. Their compensation has to be separated. Their evaluations have to be separated.

I think that is now a world which we are beginning to define. ...

Telecom was a big industry. What would that mean, just to give dollars and cents to the public, if you got the underwriting business from just telecom, just one sector, a $2 trillion sector?

There were billions of dollars in investment banking fees generated by the telecom sector. It was the sector in the mid- to late-1990s where, every week, there was a new IPO. There was a vast infrastructure being built, vast amounts of capital being raised to build it. And let's be clear; we've all benefited from that enormous investment with our cell phones and our high-speed broadband to cable access and Internet access. Those are great things.

So if you're going to put together a superbank with services all across the board, the way Sandy Weill did at Citigroup, telecom is going to be the prize plum?

Telecom was where the action was. That is where the analysts wanted to play. That's where the investment bankers wanted to be. That's where the capital was coming in. That's where the revenues were enormous. It wasn't in oil and gas. It wasn't in coal. It wasn't in sort of traditional sectors, traditional industrial sectors. It was in this new technological sector of telecom, where vast amounts of capital were flowing in -- big, big fees.

And also enormous exaggeration of demand. I mean, we talked to one telecom analyst. He calls it "the trillion-dollar fib." ...

Right, right, right. You know, to a certain extent we all fell prey to what investment bankers have always done, which is to draw a line that continues out in perpetuity. If revenue went up 50 percent this year over last year, that trend is going to continue forever. We should have been smart enough, I suppose, to look at it and say "That can't be." You know, every company is going to be bigger than General Motors three years from now. It simply doesn't work. ...

We're actually talking about the kinds of things that Jack Grubman was supposed to point out. I mean, he was in board meetings with the boards of directors. He was claiming he had landed a billion dollars' worth of underwriting fees. He was writing the ratings, he was running telecom conferences. So you're really kind of going after that syndrome.

We are trying to recreate the world where you have two separate universes -- analysts and investment bankers -- and the world of Jack Grubman had led to the complete merger of the two.

What was his phrase?

He said -- and it's brilliant -- "What used to be viewed as a conflict of interest is now viewed as a synergy." And he's wrong. The only way you make a conflict of interest into a synergy is by making money on both sides of the equation, and that's wrong. It shouldn't happen. It means you're violating somebody's fiduciary duties. 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.

And the people who got hurt were the investors, the ordinary investors?

It was the ordinary investors who didn't understand the game. The institutional investors -- to a much greater extent, though not entirely -- but to a much greater extent, were sophisticated enough to know how this game was being played. But Joe Smith in Utica, or Jane Smith in Topeka, Kansas, they were given a glossy report by Jack Grubman, the number-one ranked Institutional Investor analyst. Therefore the logic was "Trust them," and when he put a buy on a WorldCom, they were told to believe it.

What they were not told was that the reason he has us buying WorldCom is because he is bringing in a billion dollars in revenue because WorldCom keeps coming back to his company.

You're talking about an insider-outsider game. You're talking about insiders understanding the rules, writing it, working it, profiting from it, and the general public, the outsiders, being taken for a ride.

Yes, and that's why there has been such anger, because the public has awakened to this. The public has seen these conflicts of interest discussed and revealed, and as they've been revealed, people have said, "Wait a minute. I was told to invest in that stock because I was told it was good. But they knew it wasn't good. They knew they were telling me that just to get business. That's not fair."

So the public's sense of fairness, sense of equity, sense of fair play, has been violated. That's why there's such outrage.

At one point, I think back in April 2002, I remember seeing you quoted in articles saying that there had to be a complete separation between analysts and investment bankers. Are we going to see that -- two separate firms?

I don't think we're going to see two separate firms in every instance. I think there will be some firms that just do investment banking, some firms that just do analytical work and research. There will still be at the major firms both under the same roof, but with a completely redefined way of interacting.

Now, would it be preferable theoretically to separate them? I suppose so. But the firms that are full-service firms say, "We need analytical work for our retail side. If we can take advantage of that without tainting the analytical work, that should be permitted." We're willing to see if it works. We have been negotiating with these firms -- and by "we," I mean the SEC, the NASD, the New York Stock Exchange, my office, other state AGs -- to see if we can create a world that will permit fair play, even though you don't have this sort of radical surgical approach.

Has that been a tough issue to negotiate?

Very tough, very tough, but we've tried our best to get it right.

Because the banks don't want to change?

I think they want to change it, but there is sometimes a well-founded disagreement about where that change should go. I'm willing to give some of the leaders of the industry -- not all, but some of them -- the benefit of the doubt, because they know that they depend on restoring the integrity of the marketplace. They also depend on getting it right. And I'm not an investment banker, I'm a lawyer.

We are trying to tap into their understanding of the industry, trying to take our understanding of what went wrong, marry the two and come up with a solution. I just hope we got it right, because we need capital formation. We need fair play out there for investors. We need this process to work.

What about the issue of laying the public record out? Are you going to lay out the full record here, all the documents that you've got?

Well, I shouldn't say we're going to lay out all the 500,000 e-mails that are--

Are we going to get as fat a book on the industry as we got on Merrill Lynch? Because the public's getting the knowledge is part of -- well, everybody talks about clean air and fresh air.

Sunlight is the best in this endeavor. No question about it. Sunlight means transparency. It means disclosure. It means that we are going to release, not only conclusions, but also the underlying data and evidence that will permit the public to say, "Here is what happened."

That is critical, because it was only by doing that -- and you alluded to Merrill -- it was only by doing that in the early case, in April 2002 against Merrill Lynch, that we were able to begin this process. Only when that evidence was entered into the public record could people look at it and say, "Man, if that's what's happening, something's wrong." We will do that again.

So we're going to see those e-mails about the 92nd Street Y? We're going to see that kind of thing?


What has been the path of the negotiations on the IPOs and the awarding of IPOs to CEOs for what you said was commercial bribery? I think a lot of people would see that way.

It has been a very simple negotiation for one reason. I made it eminently clear that I would not be party to any deal without an absolute, bright-line prohibition on distribution of hot stocks to CEOs and members of boards of public companies.


CFOs, and that will now be prohibited. Simply won't happen.

A flat ban?

Flat out, bright line, prohibition. The reason is that that behavior was so corrosive to the public's confidence in the marketplace, and was also so fundamentally wrong, that there was, in my view, no justification for continuing it. I said there will be no deal if it continues, and there will be a prohibition.

One of the things that struck me when we looked at Enron, I thought I was going to be baffled by the accounting, derivatives, and all kinds of other things. But when we looked at the accounting processes at Sunbeam, they were astonishingly simple; saying where they'd sold stuff, they hadn't sold [stuff]. You looked at it at Waste Management, and they just changed the depreciation schedules on a million garbage trucks. I want to ask you, as you got into this, are these issues complicated and difficult to follow, or are they strikingly simple and outrageous?

It was incredible. 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.

It's just that it hadn't been revealed to the public, and that's why could get away with it.

But doesn't it also say that something happened? What was it? I mean, it's as if a whole industry lost its moral compass. I don't mean literally every single person in it, but enough people so that the public feels as though the industry lost its moral compass.

You are asking perhaps the hardest question. I can't pretend to answer how it is that an industry that has had a certain moral stability, certain moral foundation for many years, would appear to lose that moral compass for so long. Part of it may be that there was so much money floating around. Temptation simply overwhelmed reason.

Part of it was that, bit by bit, there was a dissipation, so that with Enron, for instance, what began as one off-balance sheet partnership one year that wasn't material, exploded. Suddenly it was 10, then 50, then 100, and it overwhelmed the system. It was sort of a gradual dissipation, a gradual sliding of standards, and that may be what happens.

You ask people who were on the Street 20 years ago, "Would this have occurred?" And they say "Never. We wouldn't have operated that way." Now, I hope they're telling the truth, but you wonder. ...

One of the things you did successfully in Merrill Lynch was you got the CEO of the company to personally, publicly, make a statement of apology and admit he did wrong. Are we going to see a guy like Sandy Weill of Citigroup do the same thing?

I think we will see statements of contrition from a number of people and institutions, and that is a healthy thing. It's not that it gives money back to people. But an acknowledgement of contrition and wrongdoing helps clear the air and permits the public to say, "OK, now let's go forward."

Are we talking about a collective statement, or are we talking about people? Accountability is a big part of our system.

Right, we have seen a failure of accountability -- what I call a crisis of accountability -- over the past decade, in many institutions. Part of overcoming that is a statement of apology. We will see statements of apology.

One of the things that people have said is "Leave it to the New York Stock Exchange, leave it to the accounting industry, leave it to us. We'll police it ourselves." Does self-policing work on the basis of the investigation you've done?

No. Very simple answer -- it failed. That is, again, a policy issue we've got to confront.

Over the past decade we've wanted to deregulate, and we've said, "Let's get government out of the business of looking at these issues, and permit industry to control itself, because we can trust them." Maybe that's been a very good thing in some ways.

One of the things that is eminently clear from our investigation is that all the compliance departments, all the self-regulation is nothing. They watched it, but they did nothing. So we've got to think this through, and it's not only the financial community. There are a lot of sectors where we have said self-regulation is the answer. We've got to think about it.


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published may 8, 2003

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