Confessions of a Wall Street Analyst (45 page)

What they were asking about was the phenomenon of IPO spinning, in which investment banks gave corporate executives shares in companies about to go public, allegedly in return for those executives sending business to those investment banks. In effect, spinning was a quid pro quo, or a payoff: in return for a company’s choosing a certain bank, its top executives would get a special bonus of a few thousand shares of stock in companies that bank was about to take public. This way, the executives would get the almost guaranteed quick profit that accompanied hot IPOs. Apparently, Salomon Smith Barney had been pretty expert at this game. I had only heard about spinning by reading it in the paper, but I quickly realized it must have been going on all around me for quite some time.

I suddenly flashed back to a strange conversation with Clark McLeod, CEO of McLeodUSA Communications, in late 1997. McLeodUSA was a startup local phone company headquartered in Iowa and covered by my colleague Mark Kastan. McLeod himself was a former schoolteacher who’d taken a flier on telecom, much as Bernie had, and had scored big before the you-know-what hit the fan.

Clark had never called me before, so I was surprised to hear his voice. I figured he either wanted to hear my views on the sector and his company’s place in it or had a complaint about Mark’s research. But he had something else on his mind. He asked me, instead, if I could get him some shares in the upcoming Teligent IPO.

Teligent was another startup local phone company, run by Alex Mandl, the former president of AT&T. It planned to use the less expensive wireless technology instead of fiber to carry the local portion of calls for business customers. Salomon and my firm at the time, Merrill, were the lead bankers for its IPO and thus determined which investors received shares the day of the offering.

It took me a while to realize that he was asking me to get him on the “friends and family” list of people who received shares in advance of an IPO. Usually, the only people who got pre-IPO shares were executives and employees of the company and a very small list of people whom the executives designated—hence the “friends and family” term. With the IPO market as hot as it was, anyone with these shares would probably see a significant first
day pop in the stock and, if they sold into the market, could make some serious dough very quickly.

I didn’t know what to tell this guy. I didn’t understand why he thought I had anything to do with handing out IPO shares, and it made me very uncomfortable. “Do you have a Merrill broker?” I asked. “That’s probably your best bet.”

“No,” he said, “But I can get shares in IPOs from Salomon and I wondered if there was anything you could do for me.”

I sputtered that I’d try to help him and got off the phone, both perplexed and a bit worried. What was Salomon doing now? I called up a guy I knew on Merrill’s syndicate desk, which is in charge of allocating IPO shares, and told him the story.

“There’s not much we can do,” he said. “We don’t do that.” Whatever “that” was, I didn’t really want to know more about it. I left it with him and washed my hands of the whole thing. Merrill Lynch was never named in the investigations that followed. But now, in 2002, this technique, which had somehow gotten the name “spinning,” was all over the news.

I suddenly understood what I had been too naïve to comprehend before: someone at Salomon, possibly Jack, was able to exert “special” insider influence in yet another way—by making sure his nearest and dearest telecom execs got IPO shares. But it wasn’t just Salomon. It would later be alleged that Frank Quattrone of CSFB, my firm, was one of the most blatant users of this innovative approach to customer service. Combined with the earlier scandal, in which inflated commissions were charged for hot IPO shares, Frank was in serious, serious trouble. He’d had his contract renegotiated the previous year by John Mack to one that no longer gave him a big piece of the action (not that there was any action anymore), and word had it that he was in very hot legal water. I thought to myself once again what a good move it had been to have negotiated a chain of command that went nowhere near him.

But at this moment it was Jack who was on the congressional hot seat, and when asked whether he knew about Salomon’s spinning of IPO shares to telecom executives, he suddenly looked as if he had swallowed a few chili peppers. Rather than deflecting the question, Jack, as always, opened his mouth.

“I’m trying to think if I can answer that specifically yes or no,” he stammered, trying to have it both ways as usual. “I just don’t recall because that’s not something I would be involved with. So I can’t recall. I’m not saying no;
I’m not saying yes. I just can’t recall.”
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The answer made him look even slimier, if that were possible.

I watched, riveted by the testimony, with an odd mixture of relief and dread. Finally, finally, Jack was getting his. I wanted to feel victorious, but instead I felt nervous. I wondered if there was any chance that I’d end up testifying before millions of people too. The previous weeks had taught me that public opinion can turn on a dime.

Just look at Jack. He had been a hero for so many years, and now the whole world assumed he was a total crook. In fact, the press seemed convinced that he knew about and had perhaps had a part in orchestrating WorldCom’s massive fraud. Clients later e-mailed me that Jack had come off terribly, managing to appear both squirrelly and uncaring about the amounts of money lost.

But no one asked Jack about inside information, which I saw as the key to his success. I was glad the hammer was finally coming down on Jack, but I thought the investigators were missing a lot too. The problem was not that Jack had had a hand in WorldCom’s fraud, because it was unlikely he had. The problem was that IPO shares were getting spun, certain investors got insider information, and the rest of the investing public was playing in a rigged game and didn’t even know it.

B
Y THIS TIME
my marketing had come to a halt, and my research had slowed down a lot too. Partly it was because I was spending so much time chewing over the WorldCom disaster and trying to figure out why everyone (including me) had missed such a colossal fraud. Had we simply been duped, or had we been the best-paid people on the planet to have done the worst job?

Partly it was because several of my stocks had essentially ceased to exist. But mostly it was because I was done. The analyst role had shifted from anonymous wonk to glamorous networker and rainmaker to pathetic pariah, and I just wanted to make it to my early retirement date. I had only a few more months to go.

On July 21, 2002, WorldCom filed for bankruptcy. People had been totally horrified by the size and scope of Enron’s bankruptcy the previous December—the largest ever in American financial history, eliminating $70 billion dollars of shareholder value—until WorldCom took over the top spot just months later. It was an utterly ignominious end to the fairy tale that had
begun with a milkman turned gym teacher and a bunch of scribbles on a napkin. Scott Sullivan was probably facing indictment, and so was Bernie—who, unlike many CEOs in trouble, was facing financial ruin as well.

The fraud, it turned out, had occurred mostly in the way line costs were accounted for. Line costs were those costs WorldCom paid to local phone carriers for originating and completing phone calls (the so-called last mile) and were WorldCom’s single largest expense. Apparently, Scott Sullivan and whoever else knew about it had decided to capitalize line costs, which meant spreading the costs over ten or more years instead of over one year, which juiced earnings and just so happened to be totally inconsistent with accounting rules. The idea of messing with such a large and important part of a company’s business was so audacious that it never occurred to most people that someone would try to do such a thing. It was the elephant in the room, the fraud too huge to fathom. Any auditor should have seen it a mile away. But somehow, neither Andersen—nor anyone else—ever did.

WorldCom had gone bust with Bernie Ebbers, its former CEO, still owing it an unbelievable $400 million. He was still on the hook, even with the company’s bankruptcy filing, and had five years to pay back his debts. He owned 17 million nearly worthless shares of WorldCom, along with a yacht-building business, a soybean farm, a timber business, a stake in a refrigerated trucking company, and the Canadian ranch.
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These were not the sorts of assets that could be easily liquidated to raise cash.

In the meantime, Eliot Spitzer continued to turn over rocks in the hope of finding something on which to nail Jack Grubman. Juicy little tidbits leaked out every so often to Charles Gasparino, a reporter at
The Wall Street Journal,
and a few other reporters. Jack was as famous as he’d ever been—but now for all the wrong reasons. He made the cover of the August 5, 2002,
Business Week.
The headline: “Inside the Telecom Game: How Salomon’s Jack Grubman wheeled and dealed with WorldCom, Qwest, Global Crossing, and others.”
¹¹
The story essentially blamed Jack for the collapse of the entire industry. The mania was still present, just reversed: if the market had once believed Jack was responsible for the rise in Telecom Wonderland, now he was just as culpable for its fall. Even I thought that was going too far.

Jack’s regular morning run didn’t guarantee him any relief either. One August morning, he literally ran into Spitzer himself in Central Park, who, in an uncharacteristic display of goodwill, jogged up alongside him and shook his hand. Jack, trying to blame the system, said, “Conflicts are inherent on Wall Street.”
¹²
Spitzer agreed. That’s true, I thought while reading the press
reports of the impromptu meeting, but the real issue was how individuals chose to handle them.

By the middle of August, it was clear that Jack’s support from the top of Salomon Smith Barney and, its owner, Citigroup, had evaporated as quickly as WorldCom’s market value. Press reports suggested that Sandy Weill had watched Grubman’s congressional testimony and was peeved.
¹³
On August 15, Jack announced his resignation from Salomon Smith Barney, though not before he had received a $32 million severance package consisting of stock, options, forgiveness of a loan, a consulting contract, and an agreement by Citi to pay his legal expenses, which were likely to run in the millions. In exchange, he would sign a confidentiality agreement—thus, Citi apparently hoped, keeping whatever skeletons remained in its closet carefully hidden away.

“The relentless series of negative statements about my work, all of which I believe unfairly single me out, has begun to undermine my efforts to analyze telecommunications companies,” he wrote in his good-bye letter sent to colleagues and clients.
¹⁴
I finally felt a sense of closure. Even Sandy Weill, Jack’s biggest benefactor and beneficiary, as it would turn out, had ditched the guy. The role Jack had redefined had come back to bite him—hard.

“What’s a Level 3?”

I watched the decline of my industry and the collapse of the reputations of some of my competitors and colleagues with a jumble of bewilderment, frustration, mortification, schadenfreude, and, perhaps most significant, relief that I wasn’t going to be dragged into this mess. At least, that’s what I was hoping.

But on September 30, 2002, when I got a call from a CSFB attorney named Jennifer Huffman, I couldn’t help but feel my heart sink.

Spitzer was, by this point, investigating all of the major investment banks. The various regulatory agencies, from NASD to the NYSE to numerous state attorneys general, had each been assigned to investigate research practices at various banks. Huffman told me that NASD and the Massachusetts attorney general were working on CSFB and that its investigators had sent a list of 24 CSFB research analysts who might be interviewed, one of whom was me. She said the investigation covered such things as IPO spin
ning and biased, potentially fraudulent, research—the same issues that Spitzer had brought out in the open in his investigations of Merrill Lynch with Henry Blodget and Salomon Smith Barney with Jack Grubman.

Indeed, on that same day, Spitzer filed suit against five telecom executives, charging them with making $28 million in illegal IPO gains—Joe Nacchio, Metromedia Fiber Network chairman Stephen Garofalo, Qwest chairman Phil Anschutz, Bernie Ebbers, and Clark McLeod, my IPO-seeking buddy from McLeodUSA. All of them had used Salomon as their banker. And they’d all allegedly been personally rewarded for doing so by being granted pre-IPO shares in hot SSB-underwritten stocks. The suit sought fines of $28 million as well as the return of over $1.6 billion obtained through sales of shares in their own companies. Ebbers, Anschutz, Nacchio, and Garofalo settled the charges, paying $6.3 million in aggregate, far less than their alleged IPO profits. They neither admitted nor denied guilt. The case against McLeod remains open.

CSFB would pay all my legal expenses related to the investigation, CSFB’s Huffman said, using the top New York law firm Davis, Polk & Wardwell, but I could choose an additional lawyer to personally represent me if I wished. I jumped at the chance, figuring two heads were always better than one and that I should be ready just in case CSFB wanted me to answer questions in a way that made me uncomfortable. So Huffman set me up with another lawyer, David Fein of Wiggin and Dana, a New York University Law School graduate who had been a prosecutor with the U.S. Attorney’s Office in Manhattan and associate counsel in the Clinton White House. David’s job was to find out what, if anything, in my background presented a potential problem, and to prep me for a meeting with Davis Polk’s lawyers, who, along with David, would be preparing me for a possible meeting with the NASD.

The goal, I soon learned, was to answer truthfully, but succinctly. In other words, they wanted me to give yes or no answers without speculating or hypothesizing. In effect, they wanted me to avoid giving any of the kind of analytical or predictive answers I had been providing for the past 14 years. CSFB sent five enormous boxes containing my e-mails and research reports for David to review. I also received copies and spent several days reading over them myself. NASD also asked for my trading records and my CSFB personnel file.