- The Washington Times - Wednesday, October 2, 2002

New York Attorney General Eliot Spitzer, who earlier this year recovered $100 million in fines from Merrill Lynch for its corrupt practices during the stock market's boom years, has ratcheted up the pressure on Salomon Smith Barney, the arguably more culpable investment-banking unit of the Citigroup financial conglomerate. Mr. Spitzer has sued five former and current executives of telecommunications firms, including Bernard Ebbers, the former chief executive of once-high-flying, now-bankrupt WorldCom Inc.
The suit seeks to recover more than $1.5 billion in "ill gotten" profits the executives allegedly reaped from their mutually self-serving relationships with Salomon Smith Barney. The executives earned the vast majority of the profits in question by selling their own firms' shares, including those obtained through stock-option programs. The suit alleges that overly optimistic research reports written by Jack Grubman, Salomon's now-disgraced stock analyst, had inflated the share prices of the executives' firms, allowing them to "unjustly enrich" themselves.
The suit also seeks to recover an additional $28 million in profits that the executives earned from shares in initial public offerings (IPOs) that Salomon set aside for them. In a practice known as "spinning" or "flipping," investment banks routinely allocated hot IPO shares to the personal accounts of executives of firms whose investment-banking business was sought. After the prices of the IPO shares had soared as expected, the banks would "spin" or "flip" the executives' shares to less-favored clients, whose demand for the stocks was stoked by favorable "research" reports.
Arguing that "spinning" illustrated the pervasive "conflicts of interest on Wall Street," Mr. Spitzer charged that the practice "was an integral part of a fraudulent scheme to win new investment-banking business" for Salomon. Noting that Mr. Ebbers made more than $11 million over four years from 21 IPOs, the suit observes that Salomon pocketed more than $100 million in investment-banking fees from WorldCom. Clark McLeod, former CEO of McLeod USA, pocketed $9 million in IPO profits while his eventually bankrupt firm paid $50 million in fees to Salomon.
As was the case with Merrill Lynch, some controversial e-mail messages at Salomon have raised questions. In an e-mail note explaining to the head of Salomon's research management why he had not downgraded some telecom stocks he covered, Mr. Grubman said, "[M]ost of our [investment] banking clients are going to zero and you know I wanted to downgrade them months ago but got huge pushback from banking." Another Salomon e-mail characterized the firm's research as "basically worthless," while retail brokers accused Mr. Grubman of being "unethical" and a "disgrace."
The National Association of Securities Dealers (NASD), a regulatory arm of the industry, recently sued Mr. Grubman and levied a $5 million fine on Citigroup for misleading research reports on Winstar Communications, the now-bankrupt telecom that had paid $24 million in banking fees to Salomon. NASD charged that Salomon's reports on Winstar represented "a serious breach of trust between Salomon and its investors." The $5 million fine represented about 15 percent of the $32 million platinum parachute Citigroup gave Mr. Grubman when he was forced out.
Interestingly, neither Citigroup nor Mr. Grubman was named in the civil suit filed by Mr. Spitzer, who said both were excluded because New York is involved in settlement talks with them. With its stock price in a virtual free-fall, Citigroup, which also helped Enron hide billions of dollars in debt from investors while denying any wrongdoing, understandably wants to settle quickly. Before any global settlement is reached, however, Congress and other investigators must look under all the rocks and make sure that any penalties adequately address all the issues. At this stage of the investigation, there is talk of fines totaling several hundreds of millions of dollars, which, given the damage, seems to be quite cheap.

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