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Citigroup, Morgan Stanley CEOs Risk SEC Penalties

Jun 4, 2003 | Bloomberg

Citigroup Inc.'s Sanford Weill, Morgan Stanley's Philip Purcell and other Wall Street chief executives may be penalized for biased research published by their firms, even without willfully violating securities laws, lawyers said.

Regulators from the U.S. Securities and Exchange Commission in Washington, who have subpoenaed documents from the executives, have broad authority under U.S. law to impose civil punishment for failure to properly supervise lower-level employees.

The subpoenas are the first to directly target Wall Street chief executives over allegations their firms misled investors with biased stock research. In April, Citigroup, Merrill Lynch & Co. and eight other firms agreed to pay $1.4 billion to settle accusations they misled investors.

``Anyone who had responsibility for supervision can potentially be implicated in the investigation,'' said Jacob S. Frenkel, a former enforcement attorney for the SEC. ``How far up the chain of command the regulators may take this remains to be seen.''

Senior executives can be fined, suspended or even banned for life from the securities industry, legal experts said. Analysts Henry Blodget of Merrill Lynch and Jack Grubman of Citigroup were barred from Wall Street for life under the terms of the April settlement.

Legal penalties apply to ``people who blessed the practice or looked the other way,'' said J. Bradley Bennett, a former SEC enforcement lawyer who is a partner in the Washington office of the Houston-based law firm Baker Botts LLP.

Civil Proceeding

The subpoenas from the SEC began arriving at the firms last week. The New York Stock Exchange and the National Association of Securities Dealers also are participating in the investigation.

``I think we have to pursue this to its ultimate end,'' New York Stock Exchange Chairman and Chief Executive Richard Grasso said in an interview Monday.

In contrast to a criminal prosecution for violating securities laws, a civil proceeding for failure to supervise requires only that regulators show the executives should have done a better job of overseeing their employees.

Under the Securities Exchange Act of 1934, the SEC has the power to suspend or ban a broker who ``has failed reasonably to supervise'' an employee who has violated securities laws. The supervisor can defend against the charge by showing the firm had procedures intended to prevent violations and that the supervisor followed them.

In 2002, the SEC filed actions against 14 people for allegedly failing to supervise subordinates, commission records show.

Proving Negligence?

In 1991, John Gutfreund paid a $100,000 civil penalty and resigned as chairman of Salomon Inc., now part of Citigroup, after the SEC charged him and other Salomon executives with failing to supervise subordinates. In that case, Salomon admitted to violating Treasury auction rules and agreed to pay $290 million in fines.

Supervisors and executives can be liable if they fail to set up systems to prevent violations or fail to fix problems they should have known about. Regulators don't have to prove executives aided in the violations, simply that they were negligent, said Bennett, the former SEC attorney.

The SEC declined to discuss the details of the inquiry. ``Subpoenas are nothing other than a means of obtaining information,'' said SEC spokesman Herb Perone. ``They certainly don't suggest that the commission has reached any conclusions about their subjects or that a case is likely to or even could be brought against their recipients.''

Citigroup, Merrill Lynch, CSFB, Bear Stearns Cos., Goldman Sachs, J.P. Morgan Chase & Co., Lehman Brothers, Morgan Stanley UBS Warburg LLC and U.S. Bancorp were the securities firms involved in the April settlement. Those firms and Deutsche Bank AG were subpoenaed in the latest phase of the probe. Spokespeople for the firms declined to comment or did not return phone calls.


The latest SEC probe has so far had little impact on share prices. Citigroup shares had today gained 1 percent to $42.66 by 10:30 a.m. New York time; Morgan Stanley stock rose 1.2 percent to $47.57. Merrill Lynch stock rose 1.4 percent to $45.

The settlement, the biggest ever in a securities investigation, requires the banks to separate their research and investment banking departments, to stop giving banking clients shares in initial public offerings and to make the $1.4 billion payment. Citigroup, Credit Suisse First Boston and Merrill Lynch were alleged by regulators to have committed fraud.

The new subpoenas come a month after SEC Chairman William Donaldson criticized Morgan Stanley's Purcell for a ``troubling lack of contrition,'' after Purcell told investors he did not see anything in the analyst settlement that would concern retail investors about the firm.

Attempts by the banks to minimize the effect of the settlement may have helped precipitate the renewed enforcement efforts, said Bennett, the former SEC lawyer.


``If you pretend the SEC hasn't taken serious action against you, you're just asking for another punch in the nose,'' said Bennett. ``Nothing makes them more furious than people being dismissive of their actions.''

E-mails and internal documents disclosed in the earlier investigation show that Citigroup's Weill in 1999 urged Grubman, then the firm's star telecommunications analyst, to reconsider his ``neutral'' rating on AT&T Corp. The bank was seeking an assignment to help the phone company sell stock in its wireless unit. Grubman changed his recommendation to ``buy.''

At about the same time, Grubman asked Weill for help in getting his twin children into an exclusive Manhattan nursery school. Citigroup donated $1 million to the school organization. Grubman's daughters were admitted.

In 2000, Grubman was ranked last among analysts rated by Citigroup's sales force, according to documents released by New York Attorney General Eliot Spitzer.

Some called him a ``bum,'' a ``total loser'' and other unflattering names, and complained that his investment recommendations caused their retail clients to lose money as shares in such companies as WorldCom Inc. and Mpower Communications Corp. fell by 75 percent and 85 percent respectively in 2000.

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