Tipster Set Fund Scandal Snowballing

Naftalis had negotiated a "queen for a day" arrangement, which meant that nothing Stern said to Spitzer's team could be used against him in court unless he lied. But that didn't stop Spitzer's staff from asking the key question.

"Did you do late trading?" they pressed him.

"Yes," Stern replied, his body hunched over, his arms crossed across his chest and his hands cupping his elbows.

The Tennis Deal

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Negotiating the outlines of a settlement did not take long. The two sides agreed that Canary would make a total payment of $40 million -- $30 million in restitution to investors in the mutual funds in which Canary had made improper trades and a $10 million penalty -- and Spitzer would agree not to go after the investors who had profited from Canary's trades, including Stern's family and friends. Stern himself was banned from managing mutual fund investments for anyone other than members of his family.

But as Labor Day weekend approached, the deal started coming apart as disagreements arose over the details. Spitzer had been getting briefings from his team, who wanted to get the Stern settlement done, then move on to the mutual funds with the momentum of one deal under their belts and the credibility to press for structural reform.

Spitzer was in North Carolina watching the U.S. Open tennis tournament on television. He sent word to the Canary defense team that if they couldn't work out a deal by the time the match finished, all bets were off. Finally, between 10 and 11 p.m., he and Naftalis were able to cut through the clutter. The were ready to fax each other final language.

But the fax machine at Spitzer's beach house had broken down. He went down the street to a local deli.

"They wondered who I was," Spitzer recalled, but they let him use the fax machine anyway. As a result, the settlement papers that sparked one of the biggest scandals in the history of the mutual fund industry were all stamped "Tommy's Market."