State Suit Seeks Repayment Of Ipo And Stock Option Profits Of Corporate Executives

In a first-of-its-kind legal action, Attorney General Spitzer today sued five corporate executives for repayment of funds garnered through profiteering in Initial Public Offerings (IPOs) and phony stock ratings.

According to the suit, underwriting business of these executives’ companies was obtained by a leading brokerage firm -- Salomon Smith Barney (SSB) -- that offered the executives access to lucrative IPO shares. Once the IPO share prices soared in active trading, the stocks were often sold, netting the executives millions of dollars in personal profits.

Furthermore, the relationship between SSB and the executives rested on a presumption that SSB would deliver favorable stock ratings for the executives’ companies as an inducement and reward for obtaining the investment banking business.

"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."

The case against the executives cites New York’s Martin Act and Executive Law. These laws do not require evidence of a quid pro quo between the executives and SSB. Instead, the Attorney General must prove that there was a failure to disclose material facts that could affect the value of an investment. In this regard, the executives’ IPO profits and the nature of their investment banking relationship with SSB, whereby the executives received strong stock ratings for their companies, were never disclosed to investors or shareholders.

The Attorney General’s lawsuit seeks restitution from the executives, including disgorgement of profits from IPOs and stock options, and injunctive relief. The executives named in Spitzer’s suit are: 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.

Spitzer’s action grew out of a broad conflict of interest investigation into Wall Street brokerage firms. In the course of investigating whether SSB analysts inflated stock ratings to win investment banking business, Spitzer’s investigation uncovered evidence of both inflated ratings and IPO "spinning," i.e., allocating shares of hot IPO stocks to favored executives.

Spitzer’s complaint cites statements by SSB employees indicating that the company’s "research was basically worthless." Other documents show how analysts were pressured to issue ratings that helped generate and retain investment banking clients.

In a particularly dramatic set of internal communications, SSB’s retail brokers complained bitterly about the activities of SSB’s star telecom analyst Jack Grubman, who was said to be "unethical" and a "disgrace." Grubman is believed to have been central to many of the investment banking deals using IPO offerings and phony ratings.

Spitzer’s lawsuit alleges that SSB distributed large numbers of shares to select individuals, specifically, corporate executives who were in a position to influence investment banking decisions of their companies.

For example, from September 1998 to February 2002, more than 21 IPO offerings were made to Worldcom executives, including former CEO Bernard Ebbers, who individually made more than $11 million on the deals. During approximately the same period, SSB obtained 23 investment banking contracts with Worldcom, generating $107 million in fees.

From March 1996 through June 2001, 57 IPO offerings were made to executives of Qwest Communications, including the company’s former chairman, Philip Anschutz, who made $5 million in profits on the deals; and former CEO Joseph Nacchio, who received 42 IPO allocations and made more than $1 million in profits. SSB earned $37 million in underwriting and investment banking fees from Qwest during that same period.

SSB provided 37 IPO offerings to the founder and chairman of Metromedia Fiber Networks, Stephen Garofalo, who made more than $1.5 million on the deals during the period from November 1997 until October 2000. SSB made more than $47 million in investment banking fees during that same period.

SSB provided 32 IPO offerings to Clark McLeod, former CEO of McLeodUSA, from September 1997 to June 2000. McLeod personally made more than $9 million on the deals. SSB received some 16 investment banking deals during the period and received fees approximately $49 million.

Defendants also made between $16 million and $1.4 billion by each selling shares in his own company’s stock, including shares obtained through company stock options.

Throughout the period that SSB was involved in investment banking business with each of these companies, SSB maintained high ratings on the companies’ stocks, despite evidence of financial problems.

Spitzer said the inflated ratings and the IPO "spinning" together were part of an integrated effort by Grubman and SSB to obtain and retain investment banking business. Grubman was a central figure in the relationship between the executives and Salomon, and, as analyst, maintained high ratings for the companies of these executives, regardless of the true value of their stocks. This further allowed the executives to reap huge profits when they sold their shares in their own companies.

Today’s legal action focuses on the activities of executives, not the role of analysts. Spitzer’s investigation of analyst conflict of interests at Salomon Smith Barney continues.

"The executives received huge perks from a vendor who 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," Spitzer said.

The case is being handled by Assistant Attorneys General Bruce Topman, Harriet Rosen, Patricia Cheng, Bill Estes and Gary Connor of the Attorney General’s Investment Protection Bureau, which is under the direction of Bureau Chief Eric Dinallo.


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