GV - *OT* Personally I have a somewhat dim view of the brokerage community, but that's just me. I'm sure lots of folks were blinded by the greed factor last year and did what are in retrospect some fairly dumb things. In either case, here is what was said...
John
Salomon Faces Complaints Over Options at WorldCom
By GRETCHEN MORGENSON
More than a dozen current or former employees of WorldCom are accusing brokers at Salomon Smith Barney, the firm hired to oversee the company's employee stock option program, of pressing them into a risky investment strategy that left them with significant losses and onerous tax bills when WorldCom shares fell last year.
According to regulatory records, at least a handful of customer complaints have been lodged with securities regulators about the matter in recent months. One arbitration case has also been filed against Salomon Smith Barney, a subsidiary of Citigroup.
According to the aggrieved employees, Salomon's brokers pushed them to exercise their options and borrow against the shares by placing the acquired stock in a margin account. In some cases, they were called repeatedly and urged to buy the stock. Most of these people say the brokers discouraged diversification and did not fully explain the risks should WorldCom's stock decline.
All the complaints focus on the activities of a handful of brokers in a Salomon branch office in Atlanta.
Terri J. Howell, a former chief spokeswoman at WorldCom, is one of the Salomon clients who agreed to tell her story. She left the company after its merger with MCI Communications in the fall of 1998 and had one year to exercise her options. She said a WorldCom executive identified the brokerage firm's Atlanta office as the group assigned to handle WorldCom executive stock option portfolios.
Ms. Howell said that when she exercised her options in early 1999, the Salomon broker encouraged her to borrow from the brokerage firm, using the shares as collateral, to pay income taxes and to cover the costs of buying the shares. Such borrowing is done by placing the underlying shares in a margin account on which the broker charges interest each month. Yet Ms. Howell said her broker never explained that he was opening a margin account for her, instead calling it a "portfolio credit line." She said she thought it was akin to a home equity loan.
More disappointing, Ms. Howell said, the Salomon broker discouraged diversification even as WorldCom's stock was plummeting last year. Such advice raises broad questions of suitability, as defined by securities regulators.
"I deposited my entire inheritance from my dear mother into that account, and within a short time I lost it all," Ms. Howell said. "These were utility stocks, mortgage bond funds, and I was advised to sell those first to cover my margin calls."
A spokeswoman for Salomon declined to discuss Ms. Howell's complaint. She said the firm was "committed to providing the highest level of client service to all our clients," adding, "We take seriously any issues raised by clients and will carefully review the specifics of each situation."
A spokesman for WorldCom, in Clinton, Miss., declined to comment on the complaints.
Brokerage firms that oversee employee stock option programs hope to bring in additional assets. Bruce Brumberg, co-founder of myStockOptions.com, which provides educational materials on options, said: "To run a plan is very expensive. A lot of brokerage firms stayed away from it because it is not a money maker. Only selected brokerage firms decided to do it because they want to keep the assets under management."
Salomon Smith Barney is one of the three biggest firms in the business, Mr. Brumberg said. It runs Microsoft's plan, and some employees there have also complained about aggressive brokerage tactics. Salomon's main competitors are Merrill Lynch and PaineWebber.
According to someone close to the situation, the contract between WorldCom and Salomon does not allow the brokerage firm to solicit the company's employees to exercise options. WorldCom and Salomon would not discuss the terms of the contract.
Brokerage firms have good reason to want the employee assets that often follow stock option plans. In recent years, the firms have been valued based on their ability to increase assets under management. So a brokerage firm that keeps an employee's assets after options have been exercised stands to profit now and in the future when those assets are redeployed.
Interest on margin loans — now at rates of about 8 percent a year — can be a significant profit source, too; for example, Salomon says it shares with its brokers a small percentage of the interest earned from their customers' accounts but only when margin interest exceeds $100,000.
Like many technology companies, WorldCom has awarded numerous stock options to its employees. When its shares were rising in the mid- to late-1990s, many employees became wealthy by exercising their options, paying their taxes and holding onto the highflying stock. And companies embraced options in part because they did not have to account for them as an employee cost and therefore could keep corporate expenses down.
When employees exercise the most popular type of stock options, known as nonqualified options, they must pay taxes at ordinary income rates on the difference between the price paid for the shares and the market price of the stock on the day they exercise. That difference in prices is known as the spread.
Companies receive many benefits when their employees exercise stock options. First is a tax deduction in the amount of the spread, which is the amount on which the employee pays income tax. That tax deduction has radically reduced or even eliminated tax bills in recent years for highly profitable companies, including Microsoft, Dell Computer and Cisco Systems.
But other benefits accrue to corporations. When employees exercise options and pay the strike price, they may provide cash infusions for companies that might otherwise have to enter the capital markets for financing.
(Page 2 of 2)
According to the complaints lodged by WorldCom employees against Salomon, 1999 was the year in which the firm's brokers became particularly aggressive in urging that options be exercised. WorldCom financial statements show that 1999 was indeed a big year for option exercises. The stock peaked that year at $63.50, adjusted for splits. Its employees exercised options on 61 million shares, at an average price of $15.32 each, or roughly 20 percent more options than they had exercised a year earlier.
All these exercises could have been useful for WorldCom. If the 61 million shares were bought at the average price, they would have generated almost $935 million for the company. That is equal to 12 percent of WorldCom's operating income in 1999 and almost all — 97 percent — of the interest expense WorldCom paid on its $18.1 billion in debt that year.
Employees with options also benefited until the stock began to fall and the consequences of the margin accounts became apparent. Margin calls can be devastating when stock prices fall because the shares that are held as collateral for the loan lose value and the investor is required to come up with more money to shore up the account.
Harry S. Miller, a partner at the law firm of Perkins Smith & Cohen in Boston, said that about a dozen individuals with WorldCom stock options had approached him with stories about being pushed to exercise options by Salomon brokers and to use the proceeds of margin loans to pay their taxes and cover the cost of buying the shares.
"Many of these individuals had minimal prior securities investing experience," Mr. Miller said. "There were no disclosures by Salomon Smith Barney as to the risks of margin and the lack of diversification. In all cases they were never advised by Salomon Smith Barney to diversify, and none were told what the tax consequences would be if value went down."
Mr. Miller said that he had heard from WorldCom employees in Colorado, Connecticut, Maryland, Nebraska, New Jersey and Texas but that all were advised by Salomon brokers in the Atlanta branch office. "We are forming a group for purposes of filing their claims in the appropriate legal forum," he added.
One employee that Mr. Miller represents who demanded anonymity said that some $700,000 was lost following the advice of the Salomon broker. Seven years' of options earned at WorldCom are gone, this individual said.
This person said that in the fall of last year, the Salomon broker became extremely insistent that the options be exercised, even though none were close to expiration. The broker made repeated phone calls during November. Finally, this person said, the broker warned that if the employee did not exercise the options, Salomon might have to close the customer's account.
Seth Lipner, a partner at Deutsch & Lipner in Garden City, N.Y., represents a former WorldCom employee in an arbitration case filed in February against Salomon. In April 2000, the former employee had WorldCom shares worth about $700,000, net of margin borrowings, according to the complaint filed with the National Association of Securities Dealers. Some 83 percent of the client's brokerage account was in WorldCom stock.
This customer, who began a relationship with Salomon in late 1998 holding 44,574 options, now has just 1,000 shares after paying taxes. WorldCom stock closed yesterday at $18.79.
"I have spoken to a number of people around the country," Mr. Lipner said, "all of whom tell the same story." |
