Too little security
Editorial / Salt Lake Tribune / Nov 23, 2003
Once again, the SEC is behind the curve in the latest Wall Street scandal. State regulators, not the market's federal watchdog, dug up the dirt on Putnam and other mutual fund companies. Congress, predictably, is scurrying around looking for a scapegoat. It need only look in the mirror.
For decades, the folks on Capitol Hill have underfunded the SEC. In the aftermath of the Enron mess, shocked investors learned that the SEC employed only about 3,100 people, including 144 lawyers and 107 accountants in its corporate finance division who were responsible for reviewing 14,600 annual corporate filings.
Congress may or may not have been chastened by these revelations, but it did increase funding for the agency by 63 % last fiscal year.
Now it must do something similar again. The SEC has about 350 examiners and support staff to ride herd on 13,000 mutual funds and investment advisers, according to The New York Times.
If a person were cynical, he might conclude that a Congress that sees government regulation as evil has decided to hire as few regulators as possible.
But funding is only part of the story. The SEC apparently was blissfully unaware of problems within the mutual funds companies. That is perhaps understandable considering that the agency was busy trying to clean up corruption in corporate accounting and conflicts of interest involving securities analysis and investment banking. Corporate governance -- the failure of boards of directors to protect stockholders -- has been another little embarrassment.
But the SEC was pretty much asleep when those ugly bubbles of swamp gas burst, too.
In fact, it seems fair to ask who is looking out for the small investor these days. That question lies at the heart of the mutual funds scandal, where managers are accused of trading in and out of their own funds quickly to reap profits that are unavailable to the poor sap who has parked part of his 401(k) in a mutual fund.
Longtime observers charge that the SEC and Congress are captive to the Investment Company Institute, the industry trade organization. For example, Congress exempted the mutual funds outfits from some of the reforms that flowed from the earlier scandals at Enron, et al.
The House of Representatives, filled with righteous indignation, passed a bill last week by a 418-2 vote that would impose new penalties for fund-trading abuses, make company directors more independent from managers and require companies to disclose more information to investors. Somehow, that is small comfort.
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N.Y. attorney general vs. financial Goliaths
Impact: Eliot Spitzer is altering the landscape of Wall Street. Some doubt the changes will last.
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By Bill Atkinson / Baltimore Sun Staff Nov 23, 2003
At a time of broad skepticism and disenchantment with government's ability to regulate America's economic giants, Eliot Spitzer has captured the public imagination as a modern-day crusader for the common man.
As New York's attorney general, Spitzer is shaking the foundations of the $7 trillion mutual fund industry with a team of 15 lawyers - a tiny force compared with the legions of federal regulators and prosecutors who have been driven by his revelations to confess their failure to adequately regulate fund trading.
His 6-month probe has uncovered significant problems among the country's biggest and best-known fund families. Since the investigation began, Spitzer's office has brought three criminal cases and has won two felony pleas.
The still-unfolding mutual fund probe is just the latest in a series of regulatory triumphs for the 44-year-old prosecutor.
With small teams of attorneys, Spitzer has gone after General Electric for polluting the Hudson River, sued power companies in the Midwest for causing acid rain and taken on armies of Korean grocers for not paying minimum wage.
Last year, he shook up Wall Street with the zeal of a 1930s reformer when he uncovered corruption involving stock analysts and the powerful investment banking firms they work for.
That investigation led to sweeping changes in the way analysts do their jobs and forced the nation's largest investment firms, including Merrill Lynch & Co., Morgan Stanley and Citigroup Inc., to pay more than a billion dollars in fines in a settlement agreed to in April.
Spitzer makes no effort to hide his disdain for the federal regulators he regularly shows up. In one recent speech he declared that he "wouldn't let [the SEC] handle a house closing," according to media reports.
Some critics scorn his crusades as being fueled by raw political ambition, while others question his ability to bring about lasting change.
Still, there is little doubt that Spitzer has done more recently to address corrupt financial practices than any other official or institution in the country, including William H. Donaldson, chairman of the Securities and Exchange Commission, U.S. Attorney General John Ashcroft and Congress.
"I think he is a hero," said Amy Domini, founder and chief executive of Domini Social Investments LLC, a New York mutual fund company. "Finally, somebody who is an elected official is running on protecting the population ... from malfeasance and outright robbery."
"He is a take-no-prisoners guy," said William Sorrell, Vermont's attorney general and a co-combatant in multistate regulatory efforts. He doesn't "worry about the niceties. There tends to be some scars and bodies" in his wake.
Others call Spitzer a grandstander, a headline grabber whose clear aim is to boost his popularity so he can run for governor of New York.
"I've seen this movie before," said Michael Holland, chairman of Holland & Co. LLC, a New York-based investment company, and former general partner of the Blackstone Group, a global investment advisory firm. "I do recall a predecessor who had some of the same script; his name was Rudy Giuliani. It is clearly good politics for Eliot Spitzer - brilliant politics."
Politics or not, Spitzer says his motivation is straightforward - to punish wrongdoers and help small investors, especially when no one else is doing it.
"When there is a void, and you have an enormous issue that is going unaddressed and there is exposure for small investors, somebody has got to step in and do it," Spitzer said during an interview in his Manhattan office on the 25th floor of 120 Broadway. "The reality is that other people should have done it first and yet they didn't."
Spitzer looks like a crusader sitting in his sprawling office with its royal blue carpeting. Dressed in a crisp white shirt, tie and charcoal pinstriped suit, he is lean, athletic and has a mischievous smile.
His deep-set eyes flicker when he discusses the impact his office's investigation has had on the mutual fund industry.
"Remarkable," he said. "Never could have predicted it. Back before we announced this, I said to some folks here, 'This will be interesting, but there is no way it will compare in impact to last year's investigations of the investment banks.' I was wrong. For the 90-plus million Americans who have mutual funds, this is perhaps even more significant."
And the investigation is just cranking up.
"The problems we have seen are deeply troubling," Spitzer continued. "There will be more criminal cases. There is the very good possibility that there will be criminal cases brought against entities, corporations as well as individuals."
Spitzer's quest to clean up Wall Street has made him famous. Newspapers, magazines and television stations barrage his office each day with requests for interviews. His exploits are regular fare in papers and magazines across the country.
He is swarmed by reporters after testimony on Capitol Hill because he delivers memorable comments in a clear, booming voice. He called the mutual fund industry a "cesspool" after one subcommittee hearing this month.
"He certainly is not shy about getting published, but on the other hand, he has gotten results," said Sorrell, of Vermont. "When push comes to shove, he has the beef."
Spitzer's fascination with Wall Street began in early 2001, after Eric R. Dinallo, then head of the investor protection bureau in his office, suggested Wall Street might be worth investigating. Dinallo and others noticed that research analysts often assigned "buy" recommendations to companies whose shares had plunged in value.
It was the usual way the office began an investigation. Tips and ideas came from newspaper articles, consumer complaints or simply by looking at issues that affected New York.
Using its broad powers to investigate securities matters, Spitzer's office subpoenaed internal documents at Merrill Lynch. The firm turned over box after box packed with copies of e-mail messages between analysts and brokers. The lawyers pored over the documents and focused the investigation on Henry M. Blodget, a star analyst for the firm who had praised Internet stocks even as their prices plunged.
The boxes produced a treasure-trove of information and confirmed the lawyers' suspicions. Blodget disparaged stocks in private only to recommend them to investors. In one revealing e-mail message, he said he was going to "just start calling the stocks ... like we see them, no matter what the ancillary business consequences are."
The investigation widened as Spitzer's office probed other analysts, including Salomon Smith Barney telecommunications analyst Jack B. Grubman. The findings were similar. Grubman was accused of producing fraudulent stock reports and upgrading his rating on AT&T to get his children into an exclusive Manhattan preschool.
Rattled by the evidence, the Wall Street firms settled, paying $1.4 billion in fines and vowing to break the links between research and investment banking. Blodget paid a fine of $4 million and Grubman $15 million. Both were barred from the securities industry for life.
The investigation vaulted Spitzer into the headlines. He was dubbed the "sheriff of Wall Street," "the Enforcer," the "People's Lawyer" and "Rambo Regulator."
No sooner had the agreement been reached than Spitzer's office was after the mutual funds.
Attorneys at the office believed fund companies were sticking investors with exorbitant fees. The investigation moved at a casual pace until June, when the office got a tip about Canary Capital Partners LLC, a big hedge fund.
Lawyers in Spitzer's office discovered that Bank of America's mutual fund arm had allowed Canary to make trades after the stock market closed, which is illegal. They also found that Bank of America, Janus, Strong Capital Management and Banc One allowed Canary to make rapid-fire trades, forcing investors to pay higher fees.
Canary quickly settled Sept. 3, agreeing to pay $30 million restitution for illegal profits and a $10 million penalty. The mutual fund companies agreed to cooperate in the investigation, which is continuing.
The announcement was a blockbuster. It unleashed a widespread investigation into fund companies. The Massachusetts secretary of the commonwealth launched investigations into Prudential Securities and, together with the SEC, probed industry giant Putnam Investments in Boston.
Since then, brokers and mutual fund executives have been fired for cheating investors, and more are likely to lose their jobs as the investigations unfold. The probes have shaken the executive suites at several large firms.
This month alone, Putnam Investments' chief executive resigned, the top two executives at Alliance Capital Management were forced out, and the co-founders of Pilgrim Baxter & Associates, Gary L. Pilgrim and Harold J. Baxter, were told to leave. Richard S. Strong, chairman of Strong Mutual Funds, stepped down after he was accused of making hundreds of thousands of dollars at the expense of investors through improper short-term trading in his company's mutual funds. He could face criminal charges from Spitzer's office.
"I think it is very safe to say had he [Spitzer] not discovered the evidence he did ... that the system would have sort of limped along pretty much the way it was before," said Tom Miller, Iowa's attorney general.
"I think he is on the side of good," said Don Phillips, managing director of Morningstar Inc., the Chicago-based firm that tracks the mutual fund industry. "I think he is asking tough questions, the questions that need to be asked. I think investors are better off for Eliot Spitzer and his actions."
Domini, the New York mutual fund executive, said Spitzer's investigation is "on target and a great relief for those of us who are trying to play on one rule book."
Many experts wonder why it took Spitzer's office to unearth the investment banking and mutual fund industry scandals, when it should have been the SEC. The agency has lagged so far behind Spitzer's office that SEC Chairman Donaldson all but apologized to Senate Banking Committee members last week for the agency's poor performance.
The difference between the two offices, Spitzer says, is in mindset. The SEC is bulky and bureaucratic, while the attorney general's office has no choice but to be nimble and react quickly to events because it has so little manpower, he said.
"We are 15 lawyers total, one-five, who are handling all of our investor protection cases," Spitzer said. "Some of it is just that we are a bit more aggressive than they, perhaps. The way I look at it is they're an army fighting a World War I battle. They dig trenches and grind forward three feet at a time. They are just marching forward, sometimes they are building the Maginot line and not responding to the next challenge. They are fighting the last war."
Spitzer, who is married and has three daughters, lives in an apartment in Manhattan and has a weekend home 100 miles north of the city. His day begins at 5:05 a.m., when he gets up to run. He feeds his children breakfast and at 7:20 a.m. puts his oldest daughter on the bus. The days are filled with meetings, interviews and speeches.
"I can get by on five, five and a half [hours of sleep] during the week and then crash on the weekend," Spitzer said.
One of three children, Spitzer grew up in Riverdale, a wealthy section of the Bronx. His father, Bernard Spitzer, was trained as an engineer and amassed a fortune in real estate. As a youngster, Spitzer excelled in sports and in the classroom. After graduating from Princeton University in 1981, he went to Harvard Law School and graduated in 1984.
Two years later, he joined the Manhattan district attorney's office and showed his mettle by breaking up the Mob-controlled trucking business in New York's garment district.
In a daring move, Spitzer, who was in his early 30s and chief of the labor--racketeering division, set up a garment shop, hired workers and manufactured pants, shirts and sweaters. He also persuaded state troopers from upstate New York to conduct the undercover operation.
Spitzer's crew slipped into Gambino family offices at night and gathered enough evidence to bring an antitrust case against the families. Thomas and Joseph Gambino and two other defendants pleaded guilty, agreeing to get out of the garment trucking business and pay $12 million in fines.
When those prosecutions ended, Spitzer joined Skadden, Arps, Slate, Meagher & Flom in 1992 but left two years later to make a futile bid for the attorney general job. He went back to practicing law and ran again in 1998, winning the office, and was re-elected to a second four-year term last year.
Spitzer's successes have come at some personal expense. He has lost friendships, and he is hated by some on Wall Street.
"Eliot is regarded as being an opportunistic but intelligent guy who stands for one thing, which is making it so you [Wall Street executives] make less money," said James J. Cramer, co-founder of TheStreet.com and a CNBC financial commentator.
Some say he can be abrupt and single-minded. He once challenged California Attorney General Bill Lockyer to a fistfight after the two clashed over the selection of an underwriter for a National Association of Attorneys General banquet. Lockyer didn't back down, and the two cooled off.
Cramer, who has been a friend of Spitzer since they went to Harvard Law School together, said Spitzer is "totally rule-bent."
"He lives in a complete glass house, but the rocks bounce off," Cramer said. "This is a guy who picks up the paper and is outraged by things. He is just this indefatigable crusader. He is Don Quixote, but the windmills are so corrupt that they do fall."
Michael G. Cherkasky, who was chief of the investigations division for the Manhattan attorney's office and is now president and chief executive of Kroll Inc., an international risk-consulting firm, sees Spitzer as an agent of change.
"Eliot wants to approach things [where] he can have an impact of creating institutional organization change," said Cherkasky. "You are hunting for big game."
Spitzer believes he has a chance to remake the mutual fund industry, beyond forcing wrongdoers to compensate investors for the money they stole.
"If we can create a market mechanism to drive the fees in the mutual fund sector down, then we will have done something very important, and very worthwhile," Spitzer said.
But not everyone is certain the changes Spitzer is triggering will be lasting.
"I am not sure there is any such thing as lasting change," said Arthur Levitt, former SEC chairman and a senior adviser to the Carlyle Group, a Washington private equity firm. "Everyone believes that if you send a few people to jail and you pass a law, that is the end of it. It's never the end of it."
Still, many believe that Spitzer's Wall Street crackdown could give him a strong tailwind if he decides to run for governor of New York in 2006. Spitzer, a Democrat, said he is "thinking" about making the run.
"Politics is like the stock market," said Spitzer. "You can have a wonderful ride up, but then you can have a very quick fall if you are not real careful and if you make a few mistakes. I just take one case at a time and one issue at a time." |
