New York Attorney General Spitzer Discusses Research Probe
Thu, 16 May 2002, 7:57pm EDT
New York, May 16 (Bloomberg) -- The following are excerpts
from a Bloomberg News discussion with New York Attorney General
Eliot Spitzer about his probe of analyst conflicts on Wall Street
and his settlement talks with Merrill Lynch & Co.
Merrill is a passive, minority investor in Bloomberg LP, the
parent of Bloomberg News.
BLOOMBERG: How do you respond to claims that in building your
argument that Merrill Lynch & Co.'s research was misleading, you
took e-mails from the firm's analysts and bankers out of context?
How confident are you about the evidence you have amassed? How do
you propose resolving the issue of analyst conflicts?
SPITZER: Let me say, I've tried cases for years. I've gone
through thousands of boxes of documents in my years as a lawyer --
as a prosecutor (and) on the defense side.
The evidence here is overwhelming. You can debate in
individual cases whether their numerical rating was right or wrong
and what the mitigating factors were, but when you look at the
volume of evidence, the overwhelming conclusion that there is a
problem that needs to be addressed to insure the integrity of the
analysts' research is almost necessarily the conclusion you come
to. And I think the fact that Merrill quickly made a strategic
decision -- I don't want to comment on their lawyering, their
gamesmanship in this -- but quickly made a strategic decision to
move from the ``out of context'' defense to the ``apology/let's
negotiate'' strategy reflected.the conclusion that the objective
facts were there.
Having gone through the -- not I individually, but my office
-- having gone through the entirety of the evidence, that
conclusion is correct. And it is a conclusion that I believe
resonated. And the reason it got frankly exponentially more
attention than I believed it would, the reason is that journalists
knew this was the case. People who invested knew it was the case.
I think everybody in this room either knew or suspected that it
was a problem. And as a consequence, it wasn't as though I stood
up and said, ``Gee, I have a new theory, here's the evidence.''
It was, ``Here's the evidence that corroborates something that
frankly people have known for quite some time.''
And so the debate properly then shifted to, ``How do we
resolve it? What can we do to ensure the integrity of research
that investors have to rely on while ensuring that the capital
formation function played by the investment houses continues?''
The two are not inconsistent, obviously, but it's a question of
how do we structure it.
For years there have been rules in place. Maybe those rules
are antiquated. Maybe those rules weren't being enforced. Maybe
they need to be tinkered with. Who knows? That's the discussion
I'm in with Merrill Lynch, but clearly there had been a breakdown.
The editorials that bothered me the most, quite frankly, were the
ones which said -- and I won't name names -- it said, ``Well, who
believed the research anyway?'' It was sort of an attitude of,
``Oh, well, we were too smart to believe it because we all knew
that this was a problem.''
BLOOMBERG: Do you think there's some risk that you're holding
Merrill Lynch to a higher standard than General Motors Corp. and
its relationship with its advertising department? General Motors
runs advertisements about its automobiles and says all sorts of
things in those ads. What is the difference, one could argue,
between so-called investment research, even if it's gussied up as
something more prestigious than an ad?
SPITZER: Because, first of all, we have specific statutory
mandates that require that this be honest, that it be believed,
that it be based upon a reality and not be subjected to a conflict
of interest. It's not a question of right or wrong. Analysis can
be wrong -- that's fine. Too bad, but it's legally fine. What's
wrong is when you have a conflict of interest that is not
disclosed.
What makes it different from an auto ad, of course, is that
you know it's General Motors telling you to buy their car. The
difference here is that you have Merrill Lynch saying to the
public, ``We are objective. We are giving you advice that you are
paying for and that you are relying upon.''
BLOOMBERG: Their business is selling..
SPITZER: Let me finish this, let me finish. If General Motors
sells a car and says it has 30,000 miles on the odometer, and it
really has 50,000 and they've rolled it back, they're guilty of a
crime. If Merrill Lynch says, ``Buy this stock because we think
that it's going to hit `X' earnings per share and therefore it's a
good buy,'' and indeed they don't believe that, they're guilty of
a crime.
Indeed, the analogy could work in a crude sense where there's
a misrepresentation, but there is the additional obligation in the
securities markets, hence we have an entire array of statutes that
are designed to provide and ensure the integrity of the securities
markets, that's an entirely distinct set of obligations which they
have to abide by. So, they are not selling cars. They're selling
securities. Securities are a different species of products, and
hence, they have an obligation, which they understand, that every
securities lawyer understands, that every analyst should
understand and, indeed they do, to abide by a higher standard of
ethics.
BLOOMBERG: But you're the one that's going to decide that?
SPITZER: That's my job. That's exactly right.
BLOOMBERG: For the entire securities industry?
SPITZER: Where they violate the Martin Act, absolutely.
BLOOMBERG: You're going to decide for the entire securities
industry?
SPITZER: Well, I'm going to decide for the state of New York.
I'm going to decide for the state of New York where they
violate the Martin Act. I will not hesitate to indict, I will not
hesitate to enforce the law where they violate the law. And
that's my job. And that has been the law since 1921, and I think
they understand that. And (Securities and Exchange Commission
Chairman) Harvey Pitt understands that. And the Southern District
understands that. And you have these multi-layered ...
BLOOMBERG: So you think the SEC is irrelevant here?
SPITZER: No, not in the slightest bit. The SEC and I are
partners, enforcing, to a certain extent a common set of statutes,
to a certain extent different statutes. I enforce the Martin Act
in addition to the federal statutes. They don't enforce the Martin
Act. I don't think they have the jurisdiction to, but we are there
as partners, and we'll work as partners.
They have joined this investigation; we've had more meetings
with them than I can count, discussions, joint subpoenas --
parallel subpoenas that have gone out to the various entities.
They're not irrelevant, just as I'm not irrelevant. We have a
federalist structure that is very much the creation of the
Reagan/Bush world. They wanted this. This is their desire to have
this -- these dual jurisdictions who have the capacity to enforce.
And that is exactly what we're doing.
BLOOMBERG: If you get a deal with Merrill or any other bank
who you're looking at, and you impose new regulations on them as
part of the settlement, are you going to try to coordinate that
with the SEC so that these companies don't have to worry about two
sets of rules?
SPITZER: Well, we would -- one of the things that I've made
very clear is, first, I don't believe in new regulations. I think
that what we're trying to do is put structures in place that will
embody the principles of the current statutes. That is what we
are trying to do. I'm not -- I don't believe in new regulations.
They don't usually work, it's intervention.
The first thing we did, remember, when we went into court on
April 8 was get an obligation on the part of Merrill to disclose
the conflicts that would permit investors to understand where
these tensions exist because light is the best disinfectant. But
there will not be sort of ungainly regulations. that is not where
we're going.
BLOOMBERG: What isn't happening that has to happen?
SPITZER: Let me only give you one issue because I -- we are
negotiating in private, but the issue of compensation, I think,
has been central to this and I think even (Citigroup Inc. Chief
Executive Officer) Sandy Weill -- what I saw recounted was Sandy
Weill saying that he believed that the NASD regulations that were
approved by the SEC last week were perhaps insufficient. So I
think that when it comes to compensation, there is a rather broad
consensus that we have to do a little bit better to separate out
the analysts from the compensation drive, that is very real, that
would lead them to be too conciliatory to the investment banking
side of the house. I don't think anybody -- you know, one of the
better metaphors I heard was you don't want the restaurant
reviewer to be a partner and have an ownership in the restaurant.
But the analysts are giving -- are touting or theoretically
criticizing stocks where they have derived a fee for bringing the
deal in the door. There's a problem. And so, I think we need to
parse that relationship a bit more carefully.
BLOOMBERG: How do you ever get around that?
SPITZER: Well, as long as Merrill has analysts, it's always
going to have a restaurant reviewer working with the same company
that owns the restaurant. But there are ways to insulate.
BLOOMBERG: That doesn't work in the restaurant business. So
why should it work in the securities business?
SPITZER: Well, because securities are different. And I think
we can create firewalls and we can create -- you would -- your
logic would take you to the point where you're saying you have to
rip the analyst out of the company, which I am not saying, and I'm
not for.
BLOOMBERG: That's what I keep hearing from you.
SPITZER: No, not at all. What I'm saying is that, just as
lawyers deal with conflicts of interest, sometimes not
effectively, but sometimes effectively, so, too, investment houses
have been designed to deal all the time with segregating
information, segregating types of considerations that are relevant
on one side of the house but not elsewhere in the house. And that
is what we have to create.
If they can't be created, then your logic is perhaps
irrefutable. But I don't think we're there and I don't think
Merrill Lynch is there. I don't think the SEC thinks we're there.
BLOOMBERG: I don't think there is any precedent. And you're
saying the problem is precisely that -- the analysts are working
side by side with the salesmen and the investment bankers.
SPITZER: But they don't need to work side by side. You have
to create -- look, I'm the one who has diagnosed the problem, so I
don't disagree that that is the problem. The question is, how do
we craft the remedy that will be sufficiently rigorous to protect
the analysts from the untoward pressure that they have felt in the
past?
BLOOMBERG: You don't think you're going where no one's ever
gone before?
SPITZER: Oh, I don't think so -- which is where?
BLOOMBERG: Well, you used the example of a law firm.
SPITZER: That's right.
BLOOMBERG: Lawyers don't issue opinions. They perceived a
conflict of interest. Analysts at Merrill Lynch get paid to issue
opinions, and they'll continue to issue opinions.
SPITZER: Correct.
Well, look. Some of the proposed rules provide black-out
periods during which they can't issue opinions. There's a whole
range of solutions that are feasible, that are --that are real and
that we're discussing.
I don't think you need to go either to the apocalyptic notion
that it can't work or to the more radical solution that hence, it
can only work if you rip the house apart.
We have to craft something that works. I'm not a nihilist and
I'm not one who's going to say we have to rip the houses apart.
But we can do better than we've done.
BLOOMBERG: You said that the SEC is a partner. How good a
partner has Harvey Pitt been?
SPITZER: I always like my partners. He's been a pretty good
partner.
BLOOMBERG: Why did you call him inadequate?
SPITZER: No. I didn't call him inadequate. What I said was
the rules that were proposed last week were inadequate. And I
think that even the SEC said that they were perhaps a stopgap.
BLOOMBERG: I can't think of partners at law firms getting up
and saying publicly about themselves that their colleagues'
proposals are inadequate. You kept saying that you're a partner. I
would never embarrass somebody in public by saying..
SPITZER: Well, I'm not embarrassing Harvey.
BLOOMBERG: ... that what he's just proposed is inadequate.
It doesn't sound like much of a partnership.
SPITZER: Well, first of all, this is a very different
context. We are discussing public policy issues, not individuals.
And Harvey knows that I have enormous respect for him as an
individual and like him, get along well with him.
We will not always agree on policy resolutions and we will
articulate those differences in a civil and respectful way and in
public. But that is a different matter than to say we're not
partners and we're not going to continue working together.
BLOOMBERG: It comes across as you're on opposite sides. It's
sort of like (Senate Majority Leader Tom) Daschle and (Minority
Leader) Trent Lott saying they're partners.
SPITZER: Well, on some issues, they might be. But I wouldn't
subscribe to that metaphor because I think that -- I think that
the SEC and my office are genuinely working together to diagnose a
problem, to gather information, to determine where remedies should
be put in place and how to use them.
BLOOMBERG: Lloyd Constantine, your former law partner, said
that you were -- and I'm paraphrasing -- sort of dragging Harvey
Pitt and the SEC along and, kind of, driving this process. Do you
agree with that characterization? Do you think you've been
driving SEC policy?
SPITZER: I'm -- don't even go there. I mean, I'm not going to
characterize our relationship in any such way. All I know is that
we're working together.
BLOOMBERG: But is your office driving the SEC policy?
SPITZER: We're not driving anywhere or anybody. We're just
not driving.
BLOOMBERG: Could you take us through where we're, kind of,
going from now, not in terms of remedy but in terms of the
companies?
SPITZER: That I can't do just because I cannot publicly even
acknowledge who we have served subpoenas on. That is something
that we just don't do.
BLOOMBERG: Can you say that the fact that you started with
Merrill Lynch, that they're worse than anybody else on the Street?
SPITZER: I'm not even sure we started with them.
BLOOMBERG: Can you tell us the status of settlement talks
with Merrill?
SPITZER: Negotiations have ups and downs and moments where
you think they're close and then you realize you've been hearing
the same sentence in different ways and moments when you're far
apart. So I don't want to characterize right now, except to say
where I think both sides are working hard in this.
And I know that from the hours we've been spending talking to
each other, sometimes past each other, but certainly the hours
we've been putting into this.
BLOOMBERG: How much money did you originally invest in Jim
Cramer's hedge fund and how much profit did you see from it?
SPITZER: I have no recollection. I invested a substantial sum
and it did very nicely. The precise numbers I just couldn't give
you. They were reported in my tax returns. They were all public at
various times. But you know, just so it's clear, Jim is a friend
of mine. We studied securities law together. I knew -- have known
him since '81. He's a friend and he had a hedge fund -- has a
hedge fund -- he's not in it anymore. And we -- I invested with
him in some point in the '90s and got out in '97.
BLOOMBERG: How many years?
SPITZER: I was a personal investor for three, four years.
BLOOMBERG: So, you must have some roughly some idea of --
surely you can remember the aggregate that it was.
SPITZER: It was -- on my recollection, it was under a million
dollars and it performed well. Jim's fund did well.
BLOOMBERG: In your 1999 tax return, it said you made about --
you cashed out your share at approximately $730,000. Is that --
was that profit? Was that all that you withdrew? Is that the
totality of your investment?
SPITZER: Well, the tax return -- I don't remember the
schedule. But that was the totality of my investment. Whether that
return listed the aggregate investment or reflected the gain, I
don't know. So, obviously, you pay tax on the gain. Whether that
schedule reflected the investment or the gain, I don't know.
BLOOMBERG: But you invested considerably less than $730,000
when you originally invested in the fund?
SPITZER: I couldn't tell you. I just couldn't tell you. I
mean, if you have the tax returns, then you can figure it out.
BLOOMBERG: You've done a lot of investing?
SPITZER: Both individually and on behalf of close friends.
BLOOMBERG: Not just with Jim.
SPITZER: Not just with Jim.
BLOOMBERG: Lots of them?
SPITZER: Many -- yes.
BLOOMBERG: That's why it's difficult to remember.
SPITZER: Precisely, look, I ...
BLOOMBERG: You were a busy investor then?
SPITZER: I -- no. I would not say that. It's that I have,
over the years since I handled many investments. And what
particular number there was, I simply do not remember. But, as I
said, it has never been a secret. It has been very public in
whatever the numbers are that you have.
BLOOMBERG: Cramer said in his book that he would do a massive
amount of commission business with firms all along the Street. And
then, he would learn positive news about a company, then he would
do the business to cultivate the relationships with analysts. Then
he would run positive news about companies. Then we would load up
with call options and common stock. Then give the news -- the good
news to our favorite analysts who liked the stock so they could do
the promotion. That would get the buzz going and he would then be
able to liquidate the position into the buzz for a handsome
profit.
Were you aware that he was doing this and is that ...
SPITZER: Was I aware? I mean, no.
BLOOMBERG: Do you think that's an appropriate -- do you think
his techniques were appropriate and were legal, based on ...
SPITZER: I have absolutely no reason to think that there was
anything illegal done there, but I'm going to read the book just
as you are.
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