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Salomon Slammed in Settlement

Light Reading
News Analysis
Light Reading
4/28/2003

The Feds -- and New York State Attorney General Eliot Spitzer -- tried to put their finishing touches on the bursting of the telecom bubble today.

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:

Attorney General Spitzer’s office supplied a trove of damaging evidence that described the systematic mingling of investment banking and research activities, in which star analysts were rewarded for generating investment banking fees -- while executives sat idly by as research and retail brokerage employees complained of the mounting disconnect between research and reality.

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
Bear Stearns 25 25 25 5 80
CSFB 75 75 50 0 200
Goldman 25 25 50 10 110
J.P. Morgan 25 25 25 5 80
Lehman 25 25 25 5 80
Merrill Lynch 100* 0 75 25 200
Morgan Stanley 25 25 75 0 125
Piper Jaffray 12.5 12.5 7.5 0 32.5
SSB 150 150 75 25 400
UBS 25 25 25 5 80
Total 487.5 387.5 432.5 80 1,387.50
Source: SEC


— R. Scott Raynovich, US Editor, Light Reading
Marguerite Reardon, Senior Editor, contributed to this report.

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Soup
Soup
12/5/2012 | 12:09:28 AM
re: Salomon Slammed in Settlement
Grubman, and anyone like him in the false-analysis game, should lose every penny he ever earned and be forced to flip fast-food burgers the rest of his life. There is not enough justice in the world to properly punish that type of person. He got off way too easy.
single mode figure
single mode figure
12/5/2012 | 12:09:27 AM
re: Salomon Slammed in Settlement
Grubman buy a Cayman retreat and renames himself Grabman, gets sent to prison and the immates rename him Grabass...
whyiswhy
whyiswhy
12/5/2012 | 12:09:23 AM
re: Salomon Slammed in Settlement
The really big fish is:

http://www.fortune.com/fortune...

He and Jack had a good scam going. The fines, as usual, are a small percentage of the pillage. Cost of business. As long as white colar crime is not punished, it will continue. Punishment is not a fine, it is hard time and being someones "mamma". That might slow it down a bit.

-Why
whyiswhy
whyiswhy
12/5/2012 | 12:09:21 AM
re: Salomon Slammed in Settlement
Most still don't get the concept of honesty, and instead call it just the risk of business:

http://online.wsj.com/article/...

Anyone want to put their money in this guys hands? He is flat out telling you he is a crook, but he will make you money too.

-Why
fhe
fhe
12/5/2012 | 12:09:17 AM
re: Salomon Slammed in Settlement
they should be banned from any human activities!
jimmy
jimmy
12/5/2012 | 12:09:16 AM
re: Salomon Slammed in Settlement
Does anyone know the status of the class-action lawsuit brought-on by Williams shareholders against Bross? Did Williams liability end with Ch 11? How about Corvis et all who were giving Matt success warrants for his 'valuable input'? Can they be implicated?

atmforever
atmforever
12/5/2012 | 12:09:15 AM
re: Salomon Slammed in Settlement
Its nice that finally there is some action on these firms. They caused millions of people lose their life savings. Relative to the millions they plundered, the fine is almost negligible.

Is there any action on Sandy Weill (CEO of Citigroup)?. According to the report, he actively encouraged Grubman to change his views on AT&T. As a CEO he has enough power to entyce his employees to author false reasearch reports. Its surprising that they are punishing ONLY the anlysts but not higher executives. I am not supporting Grubman and others - in fact I think the penalty is lighter even on them. But why single out this low level employees and let the higher ups go scot free. If the report is correct, CEO has actively participated in the scam; and he is still holding the job and taking bonus/salary. In any industry these so called executives save their ass however bad their performance is (in this case outright unethical). The real "reform" is to make these people accountable.
rjmcmahon
rjmcmahon
12/5/2012 | 12:09:14 AM
re: Salomon Slammed in Settlement
The real "reform" is to make these people accountable.

Unfortunately, it's about power and those who pull its levers.

Our society will imprison 1/4 of all black men between the ages of 20-29 for drug addiction, yesterday's War, while we idly sit by and watch crooks steal something of real value, our futures and baby boomers' 401Ks. Why is that?

And it's hard to say what is more of an injustice, these cover up deals or the fact that the public's power is so easily abused.

Hell, we're still looking for weapons of mass destruction, the Shiites are moving in, and meanwhile Rumsfeld gloats on television about how he has been so right and the problem is all but over. We could laugh if it weren't so real and so hurtful.

Let's hope we find our voices soon and we stop yielding our power to these misguided ones.
Soup
Soup
12/5/2012 | 12:09:12 AM
re: Salomon Slammed in Settlement
It seems everyone below the glass ceiling agrees that those above it are far too abusive of their positions of power (what's new?). Investing in their scams was very expensive for the great majority (as usual). Now we're hearing lots of angry talk (myself included), but that doesn't make a difference. Should we all write our congressmen letters of disgruntlement to help put some umpf behind our talk? Or is there a better way to draw a bead on the offenders? C'mon, we're (mostly) smarter than "they" are . . .
but they're still laughing at us all the way to the bank.
Soup.
opticalphaggot
opticalphaggot
12/5/2012 | 12:09:00 AM
re: Salomon Slammed in Settlement
These old foggies who need extra starch on their shirts, that give shoe shine boyz jobs at airports, that drive up prices for sporting events, that IPO shares in worthless companies with no products and no business structure, that are in cohoots with the government types, but wait, there were also suckers who believed in all the tech hype. The question you have to ask yourselves is, when will Light Reading go under and will Scott Raynovich ever be able to write an objective article without getting a 10 spot to do it? Inquiring idiots like myself want to know. Oh and if any company professionals read this board. Do something worthwhile with your money and go feed children in other countries! Get out of your sheltered corpses you call your lifestyle and do something of value for the world. It's not just about people without opportunity, it's about rich people's fear of not being poor again and poor people's stupidity and laziness, especially in this country. Heck, ship 90% of America overseas, then replace them with their village idiots. Then repeat every two presidential terms. Keep the affirmative action people guessin
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