Wall St. firms hit by biggest fines ever

10 must pay $1.4 billion for defrauding investors, ignoring traditional ethics

April 29, 2003|By James Toedtman | James Toedtman,SPECIAL TO THE SUN

WASHINGTON - Regulators leveled the heaviest fines in the history of the securities markets yesterday in a wide-reaching settlement aimed at punishing fraudulent brokerage firms and restoring credibility to Wall Street research analysts and investment banks.

The Securities and Exchange Commission, New York Attorney General Eliot Spitzer and top officials of the nation's stock exchanges announced that 10 Wall Street firms would pay $1.4 billion in penalties, start-up costs for independent research providers and investor education. The settlement is based on a tentative agreement reached in December.

As part of the settlement, two high-profile analysts - Jack Grubman, formerly of Salomon Smith Barney, and Henry Blodget, formerly Merrill Lynch's Internet analyst - were heavily fined and barred from the securities industry for life.

"Analysts should resume their traditional role of gatekeeper and not cheerleaders for the market," said SEC Chairman William Donaldson. He was flanked by Spitzer, New York Stock Exchange Chairman Richard Grasso and other state and market regulators as he announced the agreement.

The regulators released thousands of pages of documents, legal papers and e-mail communications that portrayed an industry that routinely misled public investors and ignored traditional ethics.

The documents indicated that the line separating investment banks from their firms' research units was frequently crossed. Investment bank profits helped determine the pay for research analysts, and analysts frequently hyped ratings of firms being wooed by their employers as bank clients.

Also, officials of potential clients were occasionally given early access to "hot" new companies just going public. As part of the settlement, brokerages agreed to ban that practice, called "IPO spinning," a reference to initial public offerings.

About a third of the case regulators presented yesterday was devoted to Grubman's transgressions at Salomon Smith Barney. E-mails released as evidence suggest that he produced fraudulent reports on some companies and that he stated privately that he had upgraded his rating on AT&T stock to help get his children into a Manhattan preschool.

Grubman, who was penalized $15 million in fines and repayments of alleged ill-gotten gains, left Smith Barney last year with a $19 million severance package and $13 million in deferred compensation.

Blodget, Merrill Lynch's former Internet analyst, was penalized a total of $4 million.

Details of the conflicts of interest were provided for each of the 10 firms. At Morgan Stanley, the promise of coverage by its analysts was included in "pitch books" Morgan Stanley presented to potential investment banking clients.

Morgan Stanley also used its investment banking profits as a basis for compensating its analysts.

The settlement makes virtually no provision for returning lost investments to shareholders. Instead, Spitzer said, the documents could be used to facilitate shareholder lawsuits.

The settlement will use $432 million of the proceeds to fund independent research that will be available to investors alongside each brokerage firm's reports. Independent monitors will make sure that the brokerages get research from at least three independent firms.

The firms also will contribute $80 million for investor education, half of it going to the states and the rest to the SEC's investor training program.

Donaldson said he was "profoundly disappointed" in the pattern of behavior and warned companies that there was no way they could put a positive spin on the penalties.

Although some firms had tried in their current annual reports to put the investigation in a positive light, they acknowledged their embarrassment yesterday.

"We deeply regret that our past research ... and distribution practices raised concerns about the integrity of our company, and we want to take this opportunity to publicly apologize to our clients, shareholders and employees," said Charles O. Prince, chairman and chief executive of Citigroup's Global Corporate and Investment Bank. Citigroup's brokerage unit, Salomon Smith Barney. was ordered to pay the biggest fine, $300 million.

Sanford Weill, Citigroup's chief executive officer, got a guarantee in the settlement that he will not be prosecuted. He will, however, be required to report to separate committees of the company's board of directors on the objectivity, independence and quality of research.

The settlement includes a provision that the firms will not seek tax deductions or insurance coverage for the fines they are paying.

Spitzer and Stephen Cutler, the SEC's top enforcement officer, agreed that because the law is murky, the firms may challenge any Internal Revenue Service ruling on tax deductibility.

Almost as soon as the settlement was announced, Senate Finance Committee Chairman Charles E. Grassley, an Iowa Republican, criticized the restriction on tax deductibility as "half a loaf" because the prohibition covers only the $800 million in penalties and disgorgement, not the funds the firms provide for independent research or investor education.

James Toedtman is a reporter for Newsday, a Tribune Publishing newspaper.

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