|Banks in the firing line (The Economist)
Economic crisis section
> In the firing line
> Oct 4th 2002
> From The Economist Global Agenda
> In a week when prosecutors have finally charged the former chief
>officer of Enron, New Yorkâ€ôs feisty attorney-general,
Eliot Spitzer, is
>joining forces with the Securities and Exchange Commission to root
>corporate wrongdoing in America. Investment banks beware
> Spitzer sues again
> THE might of Wall Street is under attack from all sides. In filing
>alleging fraud, money laundering and conspiracy against Andrew Fastow,
>former chief financial officer of Enron and the first of the companyâ€ôs
>â€úinner circleâ€? of senior executives to be
indicted, federal prosecutors
>have also pointed the finger at Merrill Lynch. A criminal complaint,
>in a Houston court on October 2nd, alleges that the investment bank
>Enron to conceal debt and hide its true financial position. One of
>charges against Mr Fastow, who was given bail of $5m, involves a Nigerian
>company which Enron is said to have sold to Merrill and then repurchased
>order, it is claimed, to inflate Enronâ€ôs earnings. The
transaction was a
>â€úshamâ€?, say prosecutors, in which Merrill
assumed no risk.
> Such allegations, which have been vehemently denied by Merrill, are
>example of the whirlwind of claim and counterclaim that is engulfing
>Streetâ€ôs finest and many of its former clients. On the
day that Mr Fastow
>gave himself up to FBI agents, a Congessional committee was chipping
>at the reputations of Goldman Sachs and two other investment banks.
>House Financial Services Committee accused Goldman, Credit Suisse
>Boston and Salomon Smith Barney, part of Citigroup, of making preferential
>allocations of shares in sought-after initial public offerings (IPOs)
>their favoured clients, so that the latter could make a quick profit
>selling the shares on. In return, the banks are said to have received
>lucrative banking mandates. Among the executives named was Kenneth
>former chief executive of Enron. The committee concluded that the
>known as â€úspinningâ€?, had not only led to
the false pricing of IPOs but
>had harmed ordinary investors. â€úThere is no equity in
>market,â€? lamented the committeeâ€ôs chairman,
Michael Oxley, the
>Republican member for Ohio.
> Congress is not the only body making accusations about the cosy
>relationship between investment banks and their clients. On September
>Eliot Spitzer, New York's attorney-general, filed a lawsuit seeking
>once high-flying telecoms executives return over $1.5 billion in profits
>allegedly obtained illegally thanks to their links with bankers at
>Smith Barney. Most of the money was made when the executives sold
>their own companies that was inflated by overly optimistic reports
>Salomonâ€ôs recently departed star analyst, Jack Grubman.
>also pocketed some $28m when they sold shares they were allocated
>of â€úhotâ€? technology clients of Salomon's,
allegedly as a payback for
>giving investment-banking business to Salomon.
> The executives involved include Bernie Ebbers, the disgraced former
>of WorldCom, which filed for bankruptcy in July and which has admitted
>overstating profits by $4 billion; Philip Anschutz, former chairman
>founder of Qwest Communications; and Joseph Nacchio, Qwestâ€ôs
>executive. Neither Salomon nor Mr Grubman were named, but correspondence
>that embarrasses them has been included in the evidence. In one e-mail,
>Grubman wrote to the head of research, explaining why certain stocks
>not been downgraded: â€úMost of our [investment] banking
clients are going
>to zero and you know I wanted to downgrade them months ago but got
>pushback from banking."
> &&&T and United Technologies, â€úas part of
our continuing effort to
>assure that our corporate governance reflects best practices.â€?
>same day, Citigroup announced that Michael Masin, currently vice-chairman
>of Verizon, a regional telecoms firm in the north-eastern United States
>a Citigroup director, would become chief operating officer. Mr Masin
>chair a committee reviewing Citigroup's business practices.
> Citigroup is also in negotiation with both Mr Spitzer and the Securities
>and Exchange Commission (SEC) over new arrangements that would remove
>conflicts of interest inherent in having analysts and investment bankers
>under the same roof. The SEC worries in particular that analysts are
>rewarded on the basis of investment-banking mandates they help their
>to win rather than the quality of their research.
> Citigroup is reported to have already offered to create a separate
>to house its investment-banking research, though this would still
>the Citigroup empire. The spin-off would serve mainly institutional
>investors as well as the small number of retail investors who trade
>Salomon. Its analysts would no longer be allowed to attend â€úpitchâ€?
>meetings with investment bankers. Citigroup has resisted making any
>unless and until they can be imposed on other Wall Street firms as
>CSFB, which is under scrutiny itself over the alleged allocation of
>to â€úfriends of Frankâ€?â€ĒFrank
Quattrone, its star technology
>bankerâ€Ēis known to be willing to go along with such changes.
>Lynch, which has already made some changes to the way its analysts
>organised and paid, and which has paid a $100m fine following an earlier
>investigation by Mr Spitzer, is opposed to further reform.
> In bringing his latest charges, Mr Spitzer has not only upset Wall
>Streetâ€ôs big banks. He has also upstaged the SEC and
its chairman, Harvey
>Pitt, a former securities lawyer who stands accused of being too soft
>the big firms that used to count among his clients. The SEC, along
>New York Stock Exchange and the National Association of Securities
>Wall Streetâ€ôs self-regulatory organisation, have been
looking into IPO
>spinning for years, but have yet to bring any actions. This may now
>Messrs Pitt and Spitzer have patched up their differences and are
>forces to press for changes in the way investment banks go about their
>business. Egged on by Mr Spitzer, his opposite numbers in other states
>also divided up their investigations into the big investment banks:
>looking into Goldman Sachs, Texas J. P. Morgan Chase, and Alabama
>Brothers, for instance. This will not please those who believe that
>zest for re-regulation is getting out of hand. Siren voices including
>of Bill Harrison, chief executive of J. P. Morgan Chase, are beginning
>warn that a raft of new regulations and moves to break up the industry
>could shackle investment banks at a time when their profits are already
> Nevertheless, reform of how research is conducted by investment banks
>seems inevitable. There are few examples on Wall Streetâ€ĒSanford
>is oneâ€Ēof truly independent research houses. It is notoriously
>to get investors to pay for research, especially since academic studies
>suggest that it is extremely difficult to beat the market consistently.
>Still, observers increasingly believe that the collapse of the bull
>will lead to the break-up of financial â€úone-stop-shopsâ€?
>Citigroup, because no firm will want to risk the sort of
>conflict-of-interest lawsuits to which it is now being subjected.
> Quite apart from any fine, Citigroupâ€ôs share price has
fallen by nearly
>40% this year, despite healthy operating profits. Even if it does
>to break-ups, it is hard to see analysts retaining the status they
>in the late 1990s. Briefly masters of the universe, they will return
>being the backroom geeks they once were.