Wall Street's biggest firms, which profited enormously from the 1990s stock market boom through practices that came under tough scrutiny from state and federal regulators, today agreed to fundamentally change the way they do business and to pay $1.4 billion to settle conflict-of-interest charges.
In addition, Jack Grubman, a former telecommunications analyst for Citigroup Inc.'s Salomon Smith Barney unit who became one of Wall Street's most controversial figures, agreed to pay $15 million to avoid criminal fraud charges.
The state and federal investigations of the financial giants found that stock market analysts publicly touted shares of companies they harshly criticized in private e-mails. Companies that did investment-banking business with a Wall Street firm, investigators said, often seemed to get better stock ratings from the firm's analysts. And some investment banks awarded shares of hot new stocks to favored corporate clients.
Under the agreement, Wall Street's 10 largest firms agreed to a total ban on allocating shares of valuable initial public offerings to executives or directors of publicly traded companies. Regulators say Wall Street regularly doled out these shares to lure in or reward lucrative banking clients.
The deal also envisions a "cocoon," as New York Attorney General Eliot L. Spitzer described it, that will insulate analysts from investment bankers. The language formalizing this cocoon -- wording the Securities and Exchange Commission says may ultimately become law -- has yet to be fully drafted. But in principle, firms have agreed to no longer compensate analysts based on the amount of investment-banking revenue they generate.
Analysts will also be barred from participating in "pitch meetings," in which bankers try to win stock- and bond-underwriting business. Investment bankers have often tried to snare new business by promising positive research coverage in return, according to regulators. Analysts would also be barred from "road shows," events at which bankers visit institutional investors to persuade them to buy shares in initial public offerings.
The firms agreed to publish their analysts' performance every quarter, including recommendations they made on stocks and the prices they predicted stocks would hit. Regulators said they hope entrepreneurs will package this information in a way that allows investors to see which analysts performed well and which ones faltered.
Each firm that signed the deal will also, for five years, pay $25 million to $75 million per year, depending on the number of individual investors they have, to a fund that will purchase independent research from firms that do no investment banking. Regulators say they think this research will be more impartial because the firm providing it faces no conflicts of interest. The brokerage firms will be required to distribute at least three sources of independent research to their clients.
Regulators will choose monitors for each firm who will have final authority to buy the research from independent providers.
Firms will also generally pay $5 million to $25 million into an $85 million fund that will pay for investor-education programs intended to help citizens better understand how Wall Street works. It has not been determined who will run the program.
Firms that regulators say published the most overly bullish reports and committed the most abuses when allocating shares of initial public offerings will pay the most. Citigroup will pay $300 million. Credit Suisse First Boston Corp. will pay $150 million. Both firms suffered weeks of embarrassing headlines this year as regulators slowly leaked e-mails and other damaging documents to the media. Bear Stearns & Co., Deutsche Bank AG, Goldman Sachs & Co., Lehman Brothers, Morgan Stanley and UBS Warburg will pay $50 million each. U.S. Bancorp Piper Jaffray Inc. and Thomas Weisel Partners LLC will probably pay $20 million each, but that has not been finalized, a spokesman for Spitzer said.
Regulators said they hoped some of the $900 million in fines could be distributed to investors who lost money when the market plunged. But they also said determining who should get money, and how much, would be a daunting task. "I'm not Publishers Clearing House," Spitzer joked, saying investors "won't be getting checks in the mail anytime soon."
None of the firms admitted wrongdoing as part of the settlement.
In the next few months, the SEC plans to publish a lengthy report on findings that led to the settlement. Spitzer, who focused his investigation on Salomon Smith Barney, is expected to release a detailed account of his findings, which he said would serve as a road map for shareholders who wish to pursue lawsuits.
Spitzer and other regulators said criminal or civil fraud cases could still proceed against individual analysts. But Grubman agreed to pay $15 million to settle with Spitzer and avoid any criminal charges. He will also be permanently barred from the securities business. Sources said Grubman's deal has the blessing of the SEC's enforcement staff but still requires approval by the full commission. It also requires approval by NASD, the securities industry's self-regulatory body. Both the full SEC and NASD are expected to sign off on the deal.
Grubman, who became a poster child for conflicted research because of his bullish calls on firms such as WorldCom Inc. and Global Crossing Ltd. that plummeted in value even as Grubman continued to urge investors to buy, declined to comment. His attorney, Lee Richards, issued a statement saying in part: "As you can appreciate this has been an extremely difficult time for Mr. Grubman and his family and they are very pleased these issues are behind them."
Grubman, who received a $30 million severance package when he left Salomon, still faces multiple potentially costly civil lawsuits.
New York Stock Exchange Chairman Dick Grasso said he hoped the agreement would bring to a close "one of the darkest chapters in the history of modern finance." Most Wall Street firms said only that they hoped the deal would restore investors' trust in capital markets.
"I believe this settlement will result in significant reforms that will serve investors for many years to come," said the SEC's enforcement director, Stephen M. Cutler, a principal architect of the deal.
Spitzer, who sparked many of the probes that led to today's settlement with his aggressive investigation into Merrill Lynch & Co. this spring, said the deal will "permanently change the way Wall Street operates."
Industry experts generally agreed that the changes would address many of the abuses that sprang up, particularly during the stock market boom. But several also cautioned against assuming that the settlement, which today consisted of three brief pages, would wipe out Wall Street conflicts and protect individual investors.
"The first test of the settlement's success will be in accountability and how the government responds if it is dissatisfied with the progress of implementation," said Jacob Frenkel, a former federal prosecutor and SEC enforcement lawyer. Frenkel said he has seen settlement agreements fail in the past when overburdened regulators move on to other topics.
Cutler and Spitzer tried to calm such fears, saying the settlement will have the force of law and that any firm failing to implement it would face contempt-of-court charges. Cutler also dismissed complaints that the size of the fines amount to a slap on the wrist for Wall Street firms, which made a record $58 billion in pretax profit in the boom year of 2000, according to the Securities Industry Association. "I don't think you can call $1.4 billion a slap on the wrist," he said. "It will be felt very seriously by the firms."
Although some critics said the punishment should have been tougher, most observers said the settlement was a victory for regulators, especially Spitzer, who last year dusted off a little-used New York banking law, the Martin Act, and weilded it to pry into Merrill Lynch's operations. Wall Street firms quickly complained to their traditional regulators, the SEC and NASD, that Spitzer did not understand their business. But public outrage backed Spitzer, and other regulators joined him.