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Spitzer Sets Sights On Spinning

Oct 1, 2002 | The Toronto Star If I so much as hear one more f---ing peep out of them (Focal) we will put a proper rating on this stock which every single smart buysider [institutional investor] feels is going to zero. We lost credibility on MCLD and XO because we support pigs like Focal.

Jack Grubman, Star telecom analyst Salomon Smith Barney

WE KNOW THIS by now. When New York Attorney-General Eliot Spitzer drops a bomb, he drops it with some expletive pungency so we will keep on reading.

In this instance, what we are reading is Mr. Spitzer's hot-off-the-press lawsuit, launched yesterday, against five executives, including Edmonton's own Bernie Ebbers, former chief executive officer, WorldCom Inc., last seen riding off into the sunset somewhere in the Foothills.

If you're wondering something like, what is Mr. Ebbers alleged to have done this time, here's the answer.


What's "spinning" you ask?

Spinning is the practice by which shares in companies on the verge of going public are spun from powerful investment banks to powerful people in a position to do the powerful investment bank a favour. Then the powerful person spins the virtually risk-free shares into the secondary market and makes out like a bandit, or, as Spitzer prefers, a profiteer.

The effect, said Spitzer at a news conference yesterday, is that the CEOs are "bought off" and investors are left "holding the bag." Again.

None of the named executives has filed a defence.

What size of money are we talking about?

Well, in the case of Ebbers, Spitzer's lawsuit alleges that Ebbers reaped a personal gain of $11.5 million (U.S.) thanks to the sale of stock in 21 initial public offerings allocated to him by investment bank Salomon Smith Barney between June, 1996, and August, 2000. And why would Salomon do Ebbers such a favour? Because, asserts Spitzer, Salomon wanted WorldCom's business.

According to yesterday's filing, Ebbers' receipt of Salomon-led IPO shares predated WorldCom's decision to retain Salomon and its investment banking expertise. Subsequent to Salomon being hired by WorldCom, Salomon advised the long-distance carrier on approximately 23 investment banking deals, garnering fees in excess of $107 million.

Ebbers isn't the only executive in Spitzer's sights. Metromedia Fiber Network Inc. chairman Stephen Garofalo, former Qwest Communications International Inc. chairman Philip Anschutz, Qwest ex-chief executive officer Joseph Nacchio and former McLeod USA Inc. CEO Clark McLeod are all named in the lawsuit. Collectively, the lawsuit seeks to require the defendants to disgorge more than $28 million in personal profits as well as more than $1.5 billion in winnings the same group of men reaped by selling stock in their own companies.

The defendants "unjustly enriched themselves" and "deprived the investing public of a fair marketplace," says the lawsuit. The undisclosed underwriting relationship left the public "irreparably harmed."

The spider in Spitzer's web is disgraced telecom analyst Jack Grubman, who was ousted by Salomon in August and who, the suit alleges, ensured that the shares in the executives' own companies would be held artificially aloft via boosterish ratings analysis regardless of the true value of those stocks.

"Grubman was, in reality, an investment banker," says the lawsuit.

Should anyone dispute that, he or she should consider that Salomon's own sales force rated Grubman as the worst analyst among the firm's more than 100-strong team of equities followers. Why? Because every stock was, in Grubman's eyes, a "buy," and because those same recommendations kept Salomon in favour with investing banking clients.

Grubman followed between 20 and 36 stocks at any given time. He never issued a "sell" recommendation; 16 went bankrupt.

Take Winstar Communications Inc. Grubman issued a "buy" at $40, at $16 and, on April 2, 2001, at a buck. On April 18, the company went bankrupt. There was a similarly fun ride on XO Communications Inc., $33 to bankruptcy. And Metromedia Fiber, $40 to bankruptcy. Grubman reiterated his "buy" recommendation on Focal Communications Corp. in February, 2001, but the company gave him grief anyway, prompting him to e-mail two investment bankers at Salomon with the missive printed at the beginning of this column. He liked WorldCom a lot, and even sat in on directors meetings. The company's bankrupt.

Salomon's brokers, who were supposed to persuade clients of Grubman's recommendations, thought his work was "misguided," "horrific" and "egregious." "Grubman is an investment banking whore!" lamented one Salomon broker. "When is the firm going to stop pimping him?"

Spitzer has been after the analysts for more than a year. Spitzer testified before Congress last June, lamenting the "diminished faith" investors now hold in Wall Street. Spitzer unveiled all those memos from Merrill Lynch & Co. — the external ones that exhorted investors to "buy," and the internal ones that admitted the stock in question was a "piece of crap."

Spitzer wrested a $100 million settlement from Merrill, but he hasn't given up on his reform hopes of seeing a formalized split between research and investment banking. His office continues settlement negotiations with Salomon's parent, Citigroup Inc., which was not named in yesterday's suit.

Last week, the National Association of Securities Dealers fined Salomon $5 million for Grubman's "misleading" Winstar research.

By suing the executives, Spitzer has now taken his investigation into an examination of IPO allocation. Investors, say the ones left holding Winstar, would surely love to know whether they've been gamed in this way, too.

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