(Updates to clarify first reference to Jack Grubman in fifth paragraph)
In an unprecedented action, New York’s Attorney General Eliot Spitzer has sued five former and current executives of telecommunications companies to return $1.5 billion they allegedly gleaned from “phony stock ratings.”
The action is the latest in Spitzer’s ongoing investigations into whether Wall Street firms inflated stock ratings in order to win underwriting of hot IPOs, which were later sold before their prices collapsed.
The suit names former Qwest Communications
Chairman Philip F. Anschutz; former Worldcom
CEO Bernard J. Ebbers; Metromedia Fiber Networks Chairman Stephen A. Garofalo, former McLeod USA CEO Clark E. McLeod and former Qwest CEO Joseph P. Nacchio.
The suit charges that Salomon Smith Barney, a unit of Citigroup, distributed large numbers of shares to select individuals at the companies, specifically corporate executives who were in a position to influence investment banking decisions of their companies.
Although the suit does not name Jack Grubman, Salomon’s former star telecom analyst who resigned from the firm in August, his buy ratings on telecom companies that later collapsed in bankruptcy and internal communications about his actions are at the center of the complaint.
The lawsuit seeks to require the executives to return over $28 million they made by selling the IPO shares that were allocated by Salomon. The civil action is also seeking the return of $1.5 billion that executives of the five telecom companies obtained from the sale of stock in their own companies, including the exercise of options.
Spitzer said his investigation uncovered evidence of both inflated ratings and IPO “spinning,” i.e., allocating shares of hot IPO stocks to favored executives.
In this regard, Spitzer said the executives’ IPO profits and the nature of their investment banking relationship with Salomon, whereby the executives received strong stock ratings for their companies, were never disclosed to investors or shareholders.
“This case exposes further conflicts of interest on Wall Street,” Spitzer said. “The spinning of hot IPO shares was not a harmless corporate perk. Instead, it was an integral part of a fraudulent scheme to win new investment banking business. And, once again, we see enormous pressure being placed on research analysts to issue misleading stock ratings in order to secure that business.”
During a press conference Monday, Spitzer said the executives named in the suit received “huge perks” from Salomon which sought their business. “This clearly was unjust enrichment, and it violated the disclosure requirements of state law. Uninformed shareholders, meanwhile, lost millions of dollars when the stocks in the defendants companies crashed”
According to the complaint, Ebbers allegedly pulled in $11.5 million from shares in IPOs and options that were sold before the prices collapsed. Spitzer said McLeod made $9.4 million, that Nacchio netted over $1 million and that Garofalo pulled in $1.5 million in similar moves. The profits for Anschutz were $4.8 million, Spitzer said in the complaint.
Spitzer’s action is the latest in his two-year investigation into Wall Street brokerage firms over how they allocated IPOs and whether investors were misled by their stock research on the companies they underwrote. His probe of Merrill Lynch’s former star Internet stock analyst Henry Blodget resulted in a $100 million fine to settle the case.
One of the core issues in the Merrill case was whether analysts were being truthful and fair in their public pronouncements on stocks of companies for which the firm performed investment banking business.
Like the Merrill case, the latest complaint includes statements and e-mails by Salomon’s brokers complaining that the firm’s research reports on the telecom companies were “basically worthless.”
A stockbroker at Salomon wrote about Grubman: “In my 16 years in the retail brokerage business, NEVER have I received such misguided, horrific recommendations from an analyst. Some of his calls may, perhaps, put us in positions where we have to defend ourselves legally. Why does management and our research department continually defend his advice. Perhaps as brokers we should should subscribe to Morningstar or Valueline where research opinions are not based on influence on underwriting fees or the interest of the firm but on the best interest.”
Other e-mails from Salomon brokers called Grubman “unethical” and a “disgrace” to the firm.
In one e-mail, Grubman wrote to Kevin McCaffrey, a head of the investment firm’s U.S. research: “Most of our banking clients are going to zero and you know I wanted to downgrade them months ago but got a huge pushback from banking. I wonder what use bankers are if all they can depend on to get business is analysts who recommend their banking clients.”
Grubman’s attorney issued a statement saying his client had no responsibility for, nor did he influence, IPO allocations to telecommunications executives.
“Mr. Grubman’s analysis was diligently researched, was based upon what he knew about the companies at the time, and contained his honestly held views about those companies,” the statement said.
Nacchio’s spokesman disputed the claims. A statement from Anschutz Corp. on behalf of Anschutz called the suit unfounded and absolutely without merit. Other executives were unreachable.
Salomon has reached a $5 million settlement with the National Association of Securities Dealers over charges Grubman misled investors with attractive ratings on telecom stocks the firm underwrote, which he maintained even as their share prices were plummeting. Some have ended up in bankruptcy.
Spitzer said the investigation of other Wall Street firm’s practices is ongoing.