Day of Reckoning
host The settlemeof American regulators and ten Wall Street banks, signed this week, shows worse and more widespread wrongdoing than had been expected. Allegations of fraud against some of the banks will encourage investors to sueApr 29, 2003 | The Economist Global Agenda THE party has long been over on Wall Street. In December, regulators agreed the outline of a settlement under which eleven investment banks (Thomas Wiesel has since been excluded from the settlement) would pay a total of $1.4 billion in fines and contributions to good causes such as investor education, over allegations that they published biased “research” on companies’ shares to attract banking business from them.
Some incriminating evidence, in the form of embarrassing e-mails, has already been published by Eliot Spitzer, the zealous New York attorney-general, who instigated the investigation into conflicts of interest on Wall Street. Even so, when the final settlement was signed on April 28th, the breadth of evidence against the banks, and the language used to describe what they got up to, made for shocking reading. William Donaldson, chairman of the Securities and Exchange Commission (SEC), said he was “profoundly saddened and angry” at the banks’ conduct.
As Mr Spitzer intended, the evidence and the charges against the banks contained in the settlement should give plenty of ammunition to lawyers wishing to take action against them on behalf of disgruntled investors. The banks have, as usual, admitted no wrongdoing. But with this much compromising evidence now in the public domain, as Mr Spitzer himself ominously said: “It is not the end, it is very much the beginning.”
As the table shows, three banks bear the bulk of the financial cost: Citigroup, for its Salomon Smith Barney unit, Credit Suisse First Boston (CSFB) and Merrill Lynch. The amounts had been known, but it was only when the settlement was published on Monday, apportioning the blame among the participants, that the reasons for the ranking were known. The settlement accuses all three of issuing “fraudulent research reports” and CSFB and Salomon were also found to have engaged in the practice known as spinning—awarding stock in “hot” initial public offerings (IPOs) to executives at client companies who were in a position to steer investment banking business their way.
One of the most notable punishments is that issued against Sandy Weill, chairman of Citigroup. He has been accused of putting pressure on Jack Grubman, Salomon’s star telecoms analyst, to give AT&T a favourable rating, both because Mr Weill was on its board and also because he wanted to attract some lucrative banking business from the company. Mr Weill has been told that he and other senior executives will not be allowed to contact research staff without a monitor. Moreover, Sallie Krawcheck, hired with great fanfare from Sanford Bernstein, a house known for its independent research, to show Citigroup’s good intentions, will have to report to a board committee rather than to Mr Weill.
Some of the star analysts and bankers at the three banks accused of issuing fraudulent research have themselves come under regulatory fire. As part of the settlement, Mr Grubman, and Henry Blodget, formerly Merrill’s star internet analyst, were both fined—$15m in Mr Grubman’s case, and $4m in Mr Blodget’s—and barred from the securities industry for life. Frank Quattrone, who until recently worked at CSFB, where he was a star technology-industry banker, was charged last week with the criminal offence of obstructing a grand-jury investigation. The SEC released details of e-mails showing just how much influence Mr Quattrone, a banker, exerted over the supposedly independent research analysts. One unhappy analyst wrote: “I have ‘learned’ to adapt to a set of rules that have been imposed by Tech Group banking so as to keep our corporate clients appeased.”
The settlement reveals some damning e-mails from Morgan Stanley and Goldman Sachs, hitherto regarded as minor offenders: one Goldman analyst lists his three most important goals for 2000 as “1) Get more investment banking revenue. 2) Get more investment banking revenue. 3) Get more investment banking revenue.” A Morgan Stanley counterpart wrote: “Bottom line, my highest and best use is to help [the bank] win the best internet IPO mandates.” Similarly, at Merrill Lynch, conflicts of interest were not limited to Mr Blodget’s group. One analyst outside the group passed on important, unpublished information about companies to favoured institutional clients. It also appeared to be common practice at Merrill for analysts to send draft research to the companies they covered, seeking feedback on what to write.
All ten banks were judged by the regulators—the SEC; the National Association of Securities Dealers, the self-regulatory body for brokers; Mr Spitzer and the New York Stock Exchange—to have failed to maintain appropriate supervision over their research and investment-banking operations. Bear Stearns, CSFB, Goldman, Lehman, Merrill, Piper Jaffray, Citigroup and UBS are also accused of issuing research reports not based on principles of fair dealing, and which did not provide a sound basis for evaluating facts and which contained exaggerated claims. Thomas Wiesel, which objected to the use of the word “fraud”, and Deutsche Bank, are still negotiating separately with regulators.
Shares in bank stocks rose on April 28th following publication of the settlement, reflecting relief that this phase of the controversy over conflicts of interest was over. But the saga will run and run. For starters, Mr Spitzer has made it clear that he wishes to go after the executives who failed properly to supervise research departments. Investors will seize on the e-mail evidence to take their claims for compensation to arbitration. As part of the settlement, banks have to pay for independent research, which they will have to offer to clients, for five years.
Congress will also try to muscle in on banking regulation: at the very least, it will try to ensure that state attorneys-general, like Mr Spitzer, no longer drive a process that they believe to be the preserve of the federal government and federal agencies. In an era of bear markets and little of the lucrative mergers-and-acquisitions activity that sustained banks in the late 1990s, it seems likely that research departments will continue to shrink. Last but not least, the age of analyst as master-of-the-universe seems to have come to an end. We may never see the likes of Grubman and Blodget again.