The Wall Street Fix
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photo of grubman testifyingjack grubman - in his own words

Although he declined to speak to FRONTLINE, Jack Grubman appeared before the House Committee on Financial Services on July 8, 2002 -- before many of the specific allegations in New York State Attorney General Eliot Spitzer's investigation became public -- to answer questions about the collapse of WorldCom. Here are excerpts from his written statement and oral testimony, in which he discusses his "telecom thesis," his relationship with the boards of companies whose stock he covered, his attendance at WorldCom board meetings and allegations of his involvement in preferential IPO allocations to WorldCom execs. [Editor's Note: Grubman was not asked about former Salomon Smith Barney broker David Chacon's allegation that Bernie Ebbers received 350,000 shares in the Rhythms NetConnections IPO.]

On his telecom thesis:

"For the past seventeen years, I have held a consistent thesis that the newer, more nimble and entrepreneurial telecom companies such as WorldCom could successfully compete with and even outperform the industry giants. This thesis did, in fact, unfold for competitive long-distance providers such as WorldCom during the decade and a half after the 1984 AT&T divestiture. And I thought that passage of the Telecommunications Act of 1996 would allow my thesis to unfold with equal force in local telephone markets. More recently, in the mid-1990s, I amplified my thesis to include the notion of global spheres of influence where the most successful companies in the industry would be those that combined entrepreneurial drive with a scale and scope of 'end-to-end' network assets and operations.

"From the late 1990s, until a few months ago, I believed that WorldCom was the company best positioned in terms of assets, earnings and business model to outperform the industry over the long term. During that period, various factors led to my positive views about WorldCom, including its ownership of an unparalleled array of 'end-to-end' network assets on a global basis. As I noted in an April 9, 1998 research report, after WorldCom's merger with MCI, the company was the second largest long-distance carrier in the U.S., the largest Internet service provider in the world, the second largest carrier of international voice traffic in the world, the largest Competitive Local Exchange Carrier in the U.S., Western Europe, and Japan, and the largest U.S. provider of overseas private line networks. Moreover, it also had an impressive base of corporate customers, and reported consistently healthy profit margins. Finally, both WorldCom and MCI had the entrepreneurial culture of competitive upstarts, as compared to the slower, more staid incumbents like the regional Bells, with their monopoly birthright."

On his relationship with companies he covers:

"I make a point of trying to develop good working relationships with management. Sometimes, working relationships of this kind include a social element, whether an occasional dinner or other outing, as is true in virtually all walks of life. Some think such relationships are inappropriate for research analysts. Respectfully, I disagree. As I see it, part of my job is to know how an industry is developing and to engage in a serious, active dialogue with the people who make the decisions in order to put SEC filings and audited financials into context and to assess management's capability to execute its plans. There's no question that you have to manage these relationships carefully, and it is critical not to let your own judgment get clouded. But if you strike the right balance, your opinions will be more informed."

"You have to put context around the numbers. You have to assess their ability to run their business. In some of those occasions there are social events. When you talk to a management team, there is information that you glean that may not be public but may not be material. For example, if an analyst talks to companies regularly and learns about their views on pricing an industry, demand trends in the industry, their opinion about regulatory policies, that is appropriate color to get from management."

"Analysts are always going to try to get to know management, and I think if you attempt to somehow forbid that from happening, that will -- despite why we're here today -- that will damage investors."

On WorldCom CEO Bernard Ebbers:

"I consider Mr. Ebbers someone I like, someone, you know, I liked to be around when I was around. But it was clearly based on work. There was almost never an occasion, or very rare, where we were together that work wasn't a dominant topic. So it was a relationship that I liked. And I [am] not going to sit here and deny that I didn't like Mr. Ebbers, clearly. ... I view as having a personal relationship with people who I see every day, I talk to every day, I do things with every day. That was not the case here."

On attending WorldCom board meetings:

"My testimony is, when I attended these board meetings, which was only, perhaps only three times over 12 years, it was for a specific transaction that Salomon Smith Barney was advising WorldCom on. At those board meetings I was privy to material, nonpublic information, that was then released and publicly disseminated, usually within one to two days after those board meetings. After then I was able to conduct my business as normal."

"My role in those meetings was to basically, you know, give my view on -- usually this was only a day or so before, not always, but it was usually short duration before a transaction was announced. And I have done this with other companies, too, where they have a deal, they're going to announce, and I'm the one who talks to investors. Bankers don't talk to investors. I talk to investors every day. So I give, at least in my view, of what I thought the investor reaction would be, the type of issues they would have to, you know, talk about."

On his relationship with investment banking:

"It is the nature of the business that companies seeking to raise capital by issuing securities look for a firm with both strong investment banking ability and a strong research reputation. This should never mean that a research analyst alters his genuinely held view about a company in order to win investment banking business, but it does mean that companies looking to issue stocks will naturally be more inclined to choose underwriters whose research analyst is a credible voice to investors and who tends to have a positive view of the company. Conversely, if a company knows that the research arm of a firm views it negatively, the company will generally go elsewhere, since these negative views will undermine the potential success of the underwriting."

"As far as my compensation, it is a function of many factors, one of which that goes into that factor is banking revenues to the firm. I have no direct tie to banking revenues in terms of a direct percent of banking revenues or a fee-by-fee type of thing."

On allegations of preferential IPO offerings to WorldCom execs:

[Editor's Note: In this quote, Grubman is responding to the following question by Rep. Paul Kanjorski (D-Penn): "Do you know or have you heard or are you in possession of any indication that special friend IPO offerings were made available to certain executives and members of the board of WorldCom from your investment banking company?"]

"I'm trying to think if I can answer that specifically yes or no. I just don't recall, because that's not something that I would be involved with, so I can't recall. I'm not saying no, I'm not saying yes. I just can't recall. ... My company is a big company, so therefore I cannot say definitively one way or the other if what you're saying is true or not."

[Editor's Note: Grubman later has the following exchange with Rep. Christopher Shays (R-Conn.):]

Mr. SHAYS: In response to Mr. Kanjorski's question, I wasn't clear as to what your answer was. He asked you if Smith Barney provided any special IPO opportunities for any Board of Directors management family members of WorldCom. And what was your answer?

Mr. GRUBMAN: My answer is I don't know if that's true or not. That's not what I do. That's not my job, so I don't know.

Mr. SHAYS: Well, that's not your job. But I don't understand that's not your job. How does that relate to whether or not you knew? You seem to suggest that you might know. Are you saying, categorically under oath, that you are not aware of any sweetheart financial opportunities for anyone at WorldCom?

Mr. GRUBMAN: What I'm saying is I can't recall if anything like that happened because it's not something that I paid attention to. But I can't categorically say it didn't happen. At this -- I just can't recall, I just can't recall.

On switching his rating on AT&T:

[Editor's Note: This testimony was given before the release of Grubman's "AT&T and the 92nd Street Y" memo.]

"Our work on the AT&T research started in August of 1999. AT&T, who I was cautious on, to say the least, from about 1995 onward, was undergoing a huge transformation. They had bought two cable companies. They were the largest cable company in the United States. They were a large company in my group. And it is my obligation, when a company like that goes through a massive transformation, to take a second look, which we did.

"Secondly, we have had a long-held view that the regional Bell operating companies were particularly vulnerable on all sorts of fronts, most notably on the residential side from cable companies, and a view we reiterated just a few months ago in a big report.

"So on AT&T, this was a company we had not liked very much, undergoing a massive transformation in terms of its asset base. We owed it to ourselves and our investors to take a fresh look, which we did, and we wrote a very large report. The investment thesis there was AT&T, by virtue of being the biggest cable company in the United States, we thought over a three to five-year period would develop what we call the 'triple play' of voice, video and data to a large swath of customers. A collateral benefit of that was going to be that it would be able to protect a big chunk of its consumer long distance base as a result of that."

Read the full transcript of the hearing.


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published may 8, 2003

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