In a "global settlement" that involved Federal and State prosecutors, the Securities and Exchange Commission (SEC), and major stock exchanges, the agencies and prosecutors moved to punish the sins of the telecom and Internet bubble years with a landmark settlement involving 10 investment banks, which agreed on $1.4 billion in fines and related penalties designed at cleaning up fraudulent research and investment banking activity.
Telecom research was at the heart of the settlement. Salomon Smith Barney and their former lead telecom analyst Jack Grubman featured prominently in the settlement, with Salomon paying the largest fines of all the banks and Grubman being banned for life from the securities industry. Salomon was the investment banking division of Citigroup that was closely involved in financing many of the largest telecom busts, including global carrier WorldCom Inc. (OTC: WCOEQ) and satellite provider WinStar Communications Inc., as well as numerous other service providers, such as XO Communications Inc. (OTC: XOXO) and Focal Communications Corp. (Nasdaq: FCOM).
At $1.4 billion, the settlement sounds big. It sounds righteous. But is it? Initial reaction indicates it will do little to assuage the damage that has been done. Some Wall Street observers indicated that the penalties do not jibe with the extent of the crimes.
"It's a joke," says one fund manager who asked not to be named. "Investors are getting nothing out of this. All it has done is open the flood gates for lawsuits. It will be worse than the asbestos litigation. Law firms will be advertising, 'Did Salomon Smith Barney lose all your money? We can help you get it back!' It's ridiculous."
At least one observer thinks the compensation is symbolic and that adequately replacing what was lost would be largely impossible: "There's no way they can do enough for what's been done. They'd have to pay $40,000 apiece to at least 10 percent of the population," quips Jim Lawrence, program director at Stratecast Partners.
$1.4 Billion Settlement
Ten investment banks will pay fines, restitution, and penalties totaling $1.4 billion, according to joint statements issued by the SEC and the New York State Attorney General's office. The investment banks are:
- Bear Stearns & Co. Inc.
- Credit Suisse First Boston Corp.
- Goldman Sachs & Co.
- J.P. Morgan Chase Bank & Co.
- Lehman Brothers
- Merrill Lynch & Co. Inc.
- Morgan Stanley
- UBS Warburg LLC
- U.S. Bancorp Piper Jaffray
At a press conference held in New York, Spitzer ironically noted a description of the industry that was made by Salomon analyst Jack Grubman: “I quote Jack Grubman,” he said. “ ‘We have turned conflicts of interest into synergies.’ ”
Spitzer described the mélange of investment banking and research as “fraud” that led to huge losses for small investors. “Investor’s understand risk -- but we demand honesty and integrity in the research that was delivered. The business model had completely integrated investment and research… Everybody won, except for the investor."
While the Attorney General’s office focused on the wrongdoing of the offenders, the SEC and stock exchanges outlined new rules to prevent a recurrence of such offenses. As part of the settlement, the SEC, along with stock exchange organizations including the Nasdaq and NYSE, took a number of steps to force investment banks to separate their research departments and forbid analysts’ compensation to be determined by investment banking activity.
For details of the SEC’s actions and a joint statement with the stock exchanges and Attorney General, click here .
Meanwhile, the banks looked to put the scandals of the bubble behind them by settling with the SEC and the Attorney General’s office. In doing so, they avoid criminal indictment for the offenses, though they are certain to continue to be threatened by civil lawsuits. So far, the only significant criminal investigation to result from the investment banking boom years is focused on former CSFB technology banker Frank Quattrone, who is alleged to have destroyed evidence about the practice of IPO “spinning," whereby hot IPO allocations were guided toward the best investment banking clients.
The SEC said in the “global settlement” statement that it was banning spinning of IPOs, a practice in which, it said, both Salomon Smith Barney and CSFB had been involved. Many of the investment banks issued statements regarding the settlement. Charles O. Prince, chairman and chief executive officer of Citigroup’s Global Corporate and Investment Bank, said: “This settlement, and the resulting reforms, are immensely important to the future of our financial system and the critical goal of restoring the confidence of investors in our markets... We deeply regret that our past research, IPO, and distribution practices raised concerns about the integrity of our company, and we want to take this opportunity to publicly apologize to our clients, shareholders, and employees. We do, however, take pride in the way this company responded once the concerns were raised, and we are proud of the progress we have made."
The Sordid Details
The Attorney General’s office provided hundreds of pages of supporting documents in the research debacle, many of them including juicy tidbits.
Supporting documents for the Salomon investigation showed an organization torn internally by the divisions between research and investment banking. In one case, the head of Salomon’s Equity Research division had commented in an internal memo that “research has become ridiculous on its face.”
Grubman, Salomon’s star telecom research analyst, appeared to be caught pleasantly in the middle -- the tune of more than $60 million in compensation over four years. While complaining on the private side about investment banking pressure, Grubman seemed eager to please with innocuous research reports on failing CLECs.
On the Grubman matters, the Attorney General charged that Grubman had issued “fraudulent" research reports on Focal Communications and Metromedia Fiber Network Inc.(MFN) (Nasdaq: MFNX), in which he privately said one thing while doing another, and that he had issued “misleading research on Level 3, Focal, RCN, Adelphia, Williams Communications Group, and XO Communications.”
In the example of Focal, a CLEC, Grubman issued research supporting a Buy recommendation on the stock at the same time as he said privately that it should be rated Underperform. In an email exchange with investment bankers, Grubman portrayed the severity of the conflict: “I hear company complained about the note,” wrote Grubman to the investment bankers. “I did too. I screamed at the analyst for saying ‘reiterate buy.’ If I so much as hear as a fucking peep out of them I will put the proper rating (ie 4 not even 3) on this stock which every single smart buysider feels is going to zero.” The documents also describe Grubman’s detailed history of analysis of AT&T Corp. (NYSE: T), in which he started as an ardent critic, but later softened his stance, particularly after being asked by Citgroup CEO Sandy Weill to take a “fresh view.” At the same time that Grubman started heeding Weill’s advice, he was working the now-famous angle of asking the Citigroup CEO for help in getting his children into the elite 92nd St. Y private school in New York. After Grubman upgraded the stock, Citigroup was granted investment banking business in the AT&T Wireless Services Inc. (NYSE: AWE) IPO. Grubman later downgraded AT&T.
The documents also show that Grubman was successfully pressured to maintain positive ratings on stocks by investment bankers.
Documents supplied in the investigation showed that Grubman earned $25.1 million in salary and bonuses in 1999, $23.2 million in salary and bonuses in 2000, and $10 million in salary and bonuses in 2001.
Detailed supporting documents for the investigations at Morgan Stanley and Salomon Smith Barney, are available on the New York State Attorney General’s Website: www.oag.state.ny.us/press/2003/apr/apr28a_03.html. According to the terms of the settlement, Salomon must adopt all of the terms and provisions of the global resolution reached with the banks and pay the largest fine of them all, $300 million. The company will also contribute $75 million to an independent research fund and $25 million for investor education.
Grubman is permanently banned from the securities industry and will pay out a total of $15 million in his settlement.
Another notable Internet analyst, Henry Blodget of Merrill Lynch, was also permanently banned from the securities industry and ordered to pay $4 million.
Detailed amounts of the global settlement are shown in the chart below:
Table 1: Settlement Loot (US$Millions)
|Firm||Penalty||Disgorgement||Independent Research||Investors Education||Total|
— R. Scott Raynovich, US Editor, Light Reading
Marguerite Reardon, Senior Editor, contributed to this report.