New York State’s attorney general will move to force certain top corporate executives to give up large profits they made by selling shares of companies going public during the Internet boom, people familiar with the plan said today.
The sources said the plan by Eliot Spitzer would seek the return of profits from executives who received shares in initial public offerings from Salomon Smith Barney Inc. while their companies were also lucrative investment banking clients of the Wall Street firm, now a unit of Citigroup Inc.
The sources did not say which executives would be targeted. They said that Spitzer could act as early as next week, though the plans could still change.
Spitzer plans to file his complaint under the state’s Martin Act, which addresses securities fraud and allows him to seek the return of gains achieved “directly or indirectly” through fraudulent practice, the sources said. Spitzer has already used the Martin Act to pressure Wall Street analysts who publicly touted stocks that they denigrated in internal memos. In May, Merrill Lynch agreed to a $100 million settlement of such charges and adopted reforms that have been largely copied by other investment houses.
Recently Spitzer has been examining whether Salomon or other Wall Street firms awarded hot IPO shares virtually unobtainable by small investors during the bull market in return for banking business. This process, called “spinning,” is banned, but some say weak regulations allowed the practice to go unchecked into the late 1990s.
In remarks at a conference of pension-fund managers on Tuesday, Spitzer said IPO spinning amounted to “commercial bribery.” He said fund managers should pressure the companies they hold in their portfolios to force executives to give back profits they made selling IPO shares.
Spinning also emerged as an issue in Congress last month when documents released by the House Financial Services Committee showed that the former chief executive of WorldCom Inc., Bernard J. Ebbers, made nearly $11 million from initial public offerings by selling shares, mainly in hot technology stocks, awarded to him by Salomon Brothers and its successor firm, Salomon Smith Barney. During the same period Ebbers received the shares, WorldCom was paying Salomon hundreds of millions of dollars in investment-banking fees.
The documents also showed that Salomon brokers sought to award tens of thousands of IPO shares to other favored telecommunications executives. It is not clear whether many of these executives actually received the shares. Salomon was the leading banker for telecom firms in the late 1990s.
Rep. John J. LaFalce (D-N.Y.), the ranking member of the House Financial Services Committee, recently said the Salomon IPO awards to Ebbers and others suggest that spinning laws may need to be rewritten. Other Wall Street firms, including Credit Suisse First Boston Corp., are also being investigated by the New York attorney general and NASD, formerly known as the National Association of Securities Dealers, the industry’s self-regulatory body, for alleged IPO spinning.
Salomon has said it awarded IPO shares to Ebbers and others at WorldCom, including former chief financial officer Scott D. Sullivan and director Stiles A. Kellet Jr., because they were good brokerage clients, not because of any banking fees. (Sullivan, who is under indictment for securities fraud, would be an unlikely target for disgorgement because documents show he lost money on IPO shares from Salomon.)
Ebbers’s attorney, Reid Weingarten, did not return telephone calls seeking comment on Spitzer’s possible action. He has said the allocations to Ebbers were legal and not influenced by banking fees. He has also noted that Ebbers lost money on some of the IPO deals and held some shares for lengthy periods of time and did not “spin” them.
Kellet, who according to documents made around $200,000 on IPO awards from Salomon, did not return a call for comment.
Henry T.C. Hu, a professor of corporate and securities law at the University of Texas at Austin, said that unlike federal law, which generally requires an act of direct fraud to allow for the return of ill-gotten gains, Spitzer could argue under the Martin Act that the sales of the IPO shares and subsequent profits were achieved indirectly through fraud.
“The way it is stated is very, very broad,” Hu said. “The disgorgement provision gives the attorney general some very potent ammunition.”
In addition to investigating whether Salomon engaged in spinning, Spitzer is looking into whether Jack B. Grubman, the firm’s former star telecommunications analyst, issued overly bullish research reports in order to generate banking business.
Grubman has also been linked to the spinning case. He has acknowledged having a close relationship with Ebbers, and he was copied on a Salomon document listing certain executives who were to receive IPO shares. In recent congressional testimony, Grubman said he could not recall whether WorldCom officials received IPO shares. A source close to Grubman said the former Salomon analyst had nothing to do with IPO allocations and any charges that he did would lead down a “blind alley.”
Earlier this week, Salomon settled a complaint filed by NASD that it published overly positive reports on Winstar Communications Inc. Salomon agreed to pay a $5 million fine but did not admit or deny wrongdoing. NASD filed separate complaints against Grubman and an assistant who co-wrote the reports. The agency is still looking into other issues surrounding practices at Salomon.
Salomon has been seeking a global settlement of all pending inquiries by the New York attorney general, the Securities and Exchange Commission, and NASD into its analyst research and IPO stock allocations but Spitzer’s office has so far resisted any settlement talks.