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Spitzer Targets Telecom Executives

Sep 30, 2002 | Thestreet.com New York Attorney General Eliot Spitzer otherwise known as Wall Street's dragon slayer wielded his legal sword today at five telecom executives who made a bundle during the bull market on initial public offerings underwritten by Citigroup's Salomon Smith Barney investment banking division.

Spitzer is seeking to recoup the $28 million in profits the executives reaped on those red-hot IPOs, claiming the only reason the executives got to invest in those stock deals was because Salomon wanted their companies' investment banking business.

In a lawsuit filed Monday in New York state court, Spitzer contends former WorldCom Chairman Bernard Ebbers and former top executives of Qwest, Metromedia Fiber and McLeod were unjustly enriched and that money they made on the Salomon IPOs should go back to the shareholders of their respective companies, many of which are either in bankruptcy or struggling to avoid it.

"These CEOs were personally bought off by getting IPO allocations," Spitzer said at a press conference announcing the lawsuit. "If this should have happened, it should have gone to the shareholders not the CEOs."

Of the five executives, Ebbers allegedly was the main beneficiary of Salomon's largesse, taking in some $11 million in IPO profits. Also on the Salomon IPO dole were former Qwest CEO Joseph Naccio; former Qwest Chairman Philip Anschutz; Clark McLeod, former chairman of McLeod; and Stephen Garofalo, chairman of Metromedia Fiber.

Together, the five companies generated $277 million in investment banking fees for Salomon, which was one of the telecom industries main bond underwriters in the 1990s.

Taken for a Spin

Spitzer's actions comes roughly a month after the House Financial Services Committee released information last month showing that the five telecom executives all had gotten shares in Salomon-led IPOs. The House committee gathered the information as part of an investigation into a Wall Street practice known as "spinning," in which corporate executives get to invest in IPOs as a perk or an inducement for sending investment banking business to a particular Wall Street firm.

The filing of the lawsuit also comes at a time that Citigroup has opened negotiations with the Securities and Exchange Commission about a possible resolution of an investigation that agency is conducting into conflicts of interest between investment bankers and research analysts at Salomon.

It's because of those negotiations that Spitzer said he held off on naming Citigroup as a defendant in the litigation, although he said his investigation into the firm's activities continues and that his inquiry has not concluded.

Right now, Citigroup is talking to the SEC about potentially putting its research analysts under a different corporate structure and one not directly controlled by the investment bankers at Salomon. But the nation's biggest financial-services firm isn't likely to agree to such a draconian plan, unless the SEC orders all of Wall Street's other big securities firms to follow suit.

Citigroup, citing the ongoing talks with the SEC, declined to comment on the specific allegations in Spitzer's suits. But the bank, in a prepared statement, said: "We are moving aggressively to resolve questions about past practices and to institute far-reaching reforms."

Still, Citigroup Catches a Rally

Ironically, news of the lawsuit seemed to spark a rally in Citigroup shares. After trading lower for much of the morning, the stock was trading nearly 75 cents higher to just under $30 a share in afternoon trading.

It's possible investors were heartened by the news that Citigroup wasn't named as a defendant in the litigation. Investors may have also seen the Spitzer filing as a sign that regulators are moving to wrap up their many investigations into Salomon's business practices.

But investors should make no mistake that Citigroup is very much a part of Spitzer's latest action. Although the bank isn't named a defendant, the civil complaint reads like a virtual indictment of its business practices in particular, Salomon's stock research department.

Although the lawsuit doesn't contain any specific allegations of a quid pro quo between the five executives and Salomon, it notes that all of the executives' companies received unfailingly positive research coverage from Jack Grubman, the former Salomon telecom analyst who left the investment bank in disgrace this summer.

It also notes that Salomon stock research in the 1990s was colored and influenced by the amount of investment banking business the firm got from a company.

Using a strategy that it employed earlier this year against Merrill Lynch Spitzer's office included copies of internal Salomon email messages showing that the firm's employees had serious questions about the integrity of its stock analysis.

In particular, brokers at the firm seemed to have no love for Grubman, who at one point had a $20 million salary. The complaint cites a number of anonymous emails from Salomon brokers in which Grubman is referred to an "absolute disgrace," "an overpriced cheerleader" and "an investment bank whore."

Oink, Oink

Grubman, who has always sought to portray himself as a true believer in the telecom industry, is seen as two-faced in the complaint. The analyst who garnered the wrath of investors for maintaining buy ratings on stocks, even as they were hurtling toward bankruptcy, referred privately to stocks like McLeod, XO Communications and Focal Communications as "pigs."

The pig description is eerily familiar to a TV commercial aired earlier this year by Charles Schwab, the nation's biggest discount brokerage. In the ad, an executive at some big unnamed Wall Street brokerage is seen telling a group of weary brokers to go out and sell a dud of a stock by "putting some lipstick on this pig."

At the time, many thought the ad was intended to poke some fun at Merrill. That's because the ad began airing shortly after Spitzer had filed an earlier lawsuit, which accused the nation's biggest brokerage of allowing investment banking deals to influence the stock ratings of its analysts.

But with this latest Spitzer action, it appears that Schwab ad may again see new life on TV.

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