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STATE OF
OFFICE OF
SECURITIES
121 STATE HOUSE STATION
AUGUSTA, ME 04333
In
the matter of CITIGROUP
GLOBAL MARKETS INC. (formerly
known as Salomon Smith Barney Inc.) Respondent. |
) ) ) ) ) ) ) ) |
No. 03-108 CONSENT
ORDER |
WHEREAS, Salomon Smith Barney Inc. (“SSB”),[1]
now known as Citigroup Global, is a broker-dealer licensed in the State of
WHEREAS, an investigation into the
practices, procedures and conduct of SSB respecting: (a) the preparation and
issuance by SSB’s U.S. equity research analysts (“Research Analysts”) of
research, analysis, ratings, recommendations and communications concerning
common stocks of publicly traded companies covered by such analysts (“Research
Coverage”), during the period 1999 through June 2002, including, without
limitation, commencement and discontinuance of Research Coverage, actual or
potential conflicts of interests affecting Research Coverage, Research Analysts
or termination of Research Analysts, and misleading statements, opinions,
representations or non-disclosure of material facts in Research Coverage; (b)
the allocation by SSB and its predecessor Salomon Brothers, Inc. of stock from
initial public offerings that traded at a premium in the secondary market when
trading in the secondary market begins and spinning by SSB (i.e.,
allocating such offerings as preferential treatment to officers and directors
of companies having or potentially having investment banking business with
SSB), during the period 1996 through 2001 (“IPO Allocations”); and (c) any
other conduct referred to in the Findings of Fact set forth below in paragraphs
3 through 153 has been conducted by a
multi-state task force of which Maine was a part (the “Investigation”);
WHEREAS,
the Investigation was conducted in connection with a joint task force of the
U.S. Securities and Exchange Commission, the New York Stock Exchange, and the
National Association of Securities Dealers (together with the multi-state task
force referred to above, the “regulators”);
WHEREAS, the New
York Attorney General and Citigroup Global have previously entered into an
Assurance of Discontinuance, dated April 24, 2003 (the "New York Assurance
of Discontinuance"), a copy of which has been provided to the State of
Maine Office of Securities concerning the practices, policies and
procedures of SSB which were the subject of the Investigation;
WHEREAS, SSB has cooperated with
regulators conducting the Investigation by responding to inquiries, providing
documentary evidence and other materials, and providing regulators with access
to facts relating to the Investigation;
WHEREAS, Citigroup Global has advised regulators of its agreement to resolve
the Investigation;
WHEREAS, Citigroup Global agrees to
implement certain changes with respect to research and stock allocation
practices, and to make certain payments;
and
WHEREAS, Citigroup Global elects to permanently waive any right to a hearing
and appeal under 32 M.R.S.A. §§ 10708-10709 with respect to this Consent Order
(the “Order”);
NOW, THEREFORE, the Securities
Administrator of the State of Maine Office of Securities, as administrator of
the Revised Maine Securities Act, 32 M.R.S.A. §§ 10101-10713, hereby enters
this Order:
I.
B. SSB Failed to Manage Conflicts of Interest Between Research and
Investment Banking
12. SSB’s
business practices intertwined research with investment banking, thus creating
the vehicle for investment banking to exert inappropriate influence over
research analysts. SSB failed to manage
the resulting conflicts of interest in an adequate or appropriate manner.
1. SSB’s Business Practices
Required Research Analysts to Support Investment Bankers
13. Companies
paid SSB’s investment bankers to assist them with (a) capital raising activities
such as IPOs, “follow on” offerings (subsequent offerings of stock to the
public), and private placements of stock, and (b) other corporate transactions,
such as mergers and acquisitions. During
the relevant period, investment banking was an important source of revenue for
SSB; revenues from investment banking grew from approximately $3.0 billion in
1999, to approximately $3.6 billion in 2000, and to approximately $3.9 billion
in 2001. Investment banking fees
comprised over 21% of SSB’s revenue in 1999, over 22% in 2000, and over 25% in
2001.
·
SSB expected research analysts to prepare business plans each year
that, among other things, highlighted what the research analysts had done and
would do to help SSB’s investment bankers;
·
SSB’s research analysts were encouraged to develop investment banking
business from issuers and private companies in their sectors;
·
SSB’s research analysts were expected to support investment banking by
pitching business to prospective clients and marketing investment banking deals
to institutional customers through roadshows;
·
Investment banking concerns sometimes affected research analysts’
decisions to initiate coverage, rate companies, and drop coverage. SSB’s research analysts were generally
expected to initiate coverage of SSB’s investment banking clients with
favorable ratings;
·
Investment bankers reviewed the performance of the principal research
analysts in their sector as part of the analysts’ annual review; and
·
Investment banking revenue generated in an analyst’s sector and
attributable to an analyst was an important factor SSB used to evaluate an
analyst’s performance and determine an analyst’s compensation.
16. This integration of research analysts with investment banking was
an SSB objective. In a January 1998
presentation to senior management at Travelers Corporation, then the parent of
SSB, the head of SSB wrote: “There is a
continuing shift in the realization that an analyst is the key element in
banking success.” Underscoring the same
theme two years later, on
17. In reviewing his performance for 2000, the head of SSB’s Global
Equity Research stated:
"We have become much more closely linked to investment banking
this year as a result of participating in their much-improved franchise review
process this year. There has been a yearend [sic] cross review of senior
analysts and bankers particularly in the U.S. and Europe and with the
development of the Platinum Program in the investment bank, the analyst’s
understanding of the relative importance of clients for IB [investment banking]
and GRB [global relationship bank] is much improved."
18. In January 2000, SSB held a “Best Practices Seminar” for research
analysts that was hosted by the head of U.S. Equity Research Management. At that seminar, a senior member of Research
Management stated:
[W]hen you look at the market share gap between us and the three competitors who are trying to close. When I just eyeballed it, it looked like to me there is something like roughly a billion dollars of, maybe not Equity Capital Markets but Investment Banking revenues, on the table for this firm. And that’s a lot of money.
And it's clear...that
Research is driving a lot of this increasingly. And therefore, as a [research]
department our goal has to be, to be a really effective partner in terms of
helping drive initiation, execution and everything else. Because there is a lot
of money on the table for this company.
And we’ll all benefit from it.
2. SSB Analysts Helped
Investment Bankers Identify and Obtain Business
3. SSB’s Research Analysts
Supported Investment Banking Through Their Ratings and Coverage
1 - Buy
2 - Outperform
3 - Neutral
4 - Underperform
5 - Sell
24. In addition, SSB during the relevant period
included in each research report a risk rating of L (low risk), M (moderate
risk), H (high risk), S (Speculative), or V (Venture). Each of the research reports and call notes
discussed below, other than those on AT&T, rated the company S
(Speculative).
[W]e in U.S. Research
currently have no “4” (Underperform) or “5” (Sell) ratings. We use neutral rating as a statement that we
are not at all enthusiastic about a stock.
That effectively conveys the message that customers should not be in the
stock. If we were to use 4 or 5 ratings
that approach would be perceived as highly antagonistic to buy side accounts .
. . [and] company management teams.
26. In a
later e-mail, the same person suggested that the common terms SSB used to rate
stocks did not mean what they said:
“various people in research and media relations are very easy targets
for irate phone calls from clients, reporters, etc. who make a very literal
reading of the rating . . . . [I]f someone wants to read the ratings system for
exactly what it says they have a perfect right to do that.”
27. The head of SSB’s Global Equity Research raised the issue of
research integrity directly with the head of SSB in a memorandum entitled “2000
Performance Review,” when he expressed a “legitimate concern about the
objectivity of our analysts which we must allay in 2001.” The head of Global
Equity Research also addressed the nature of the research ratings at an SSB
equities management meeting. He made a
presentation regarding the SSB “Stock Recommendations as of
28. SSB did not change its rating system, however, and the de facto
three-category rating system remained in place throughout 2001. As of the end of 2001, SSB covered over 1000
4. Investment Banking
Influenced SSB’s Evaluation and Compensation of Research Analysts
29. SSB
established a compensation structure that linked research analysts with
investment banking. Research analysts
were requested to draft business plans that discussed, among other things,
their steps to support investment banking business in the past year and their
plans to support investment banking in the upcoming year.
30. In
addition, investment bankers among others evaluated the performance of research
analysts. Bonuses for research analysts
– comprising most of their compensation – were tied to several factors, one of
the most important of which was the investment banking revenue SSB attributed
to the research analyst.
C. Grubman Supported SSB’s Investment Banking
Business in the Telecom Sector
31. During
the relevant period, Grubman was one of the most prominent analysts on Wall
Street. He was a Managing Director of
SSB, and the preeminent research analyst at SSB. He managed a team of analysts who issued
research reports (“Reports”) and call notes (“Notes) on telecom companies. Grubman was principally responsible for each
Report and Note SSB issued on these companies.
1.
Grubman Helped Obtain Investment Banking Clients for SSB
32. Grubman
helped to obtain and maintain business for SSB’s investment bankers from
telecom companies in his sector. Grubman
also vetted proposed transactions involving telecom companies and vetoed those
he could not view favorably. Once he
determined he could support a proposed transaction, he and other telecom
analysts who reported to him often participated in pitching the potential
client to award SSB investment banking business and in roadshows that marketed
offerings to investors.
2.
Grubman’s Ratings Assisted SSB’s Investment Banking Business
33. During
the relevant period, SSB was the lead underwriter on 6 IPOs for telecom
companies. For each company, Grubman
initiated coverage with a 1 (Buy) recommendation. In virtually every instance, Grubman also
issued favorable research reports on telecom companies for which SSB acted as
lead or co-manager of a secondary offering of equity stock offering. In fact, Grubman and his group, with only one
exception, did not rate a stock a 4 during the relevant period and never rated
a stock a 5. Rather, he and the research
personnel who reported to him would drop coverage altogether rather than rate a
stock at less than a Neutral.
3.
Grubman Helped Generate Substantial Revenue for SSB’s Investment
Banking Department and Was Highly Compensated
34. Grubman’s
efforts contributed to the telecom sector generating substantial investment
banking revenue for SSB. During the
relevant period, as reflected in documents prepared in connection with
Grubman’s evaluation and compensation, SSB earned more than $790 million in
total gross investment banking fees from telecom companies covered by
Grubman: approximately $359 million in
1999, $331 million in 2000, and $101 million in 2001.
35. Grubman
was well paid for his efforts. During
the relevant period, he was one of the most highly compensated research
analysts at SSB. His total compensation
(including deferred compensation) from 1999-2001 exceeded $48 million: over $22
million in 1999, over $20.2 million in 2000, and over $6.5 million in
2001. In light of the importance
investment banking played in SSB’s annual evaluations, Grubman and two of his
assistants in their 2001 performance evaluation highlighted the investment
banking deals for which they had been responsible.
36. As was
true of other research analysts, Grubman was evaluated by investment bankers,
institutional sales, and retail sales.
Grubman received high scores and evaluations from investment bankers in
2000 and 2001 that reflected his importance to investment banking. Investment bankers rated analysts on a scale
from 1 (lowest) to 5 (highest). For
2000, Grubman received a 5 rating overall from investment bankers, who ranked
him first among all analysts. His
ratings and rankings in specific investment banking categories, such as
pre-marketing, marketing, and follow-up were also at the top levels. For 2001, Grubman’s average score (the only
score presented that year) from investment bankers was 4.382, ranking him 23rd
among the 98 analysts reviewed.
37. SSB’s
institutional sales force rated Grubman 16th out of 113 analysts in
2000 and 46th out of 115 analysts in 2001.
38. Retail
brokers ranked analysts on a scale from -1 (lowest) to 2 (highest). For 1999, the retail sales force gave Grubman
an average score of 1.59, ranking him 4th out of 159 analysts
evaluated. In contrast, for 2000 and
2001, Grubman’s evaluations from retail were dramatically lower and well below
his scores from investment bankers and the institutional sales force in both years. In 2000, retail ranked Grubman last among all
analysts with a score of –0.64. The same
was true for 2001 -- the retail force ranked Grubman last among all analysts
reviewed, and his score fell to -0.906.
39. Moreover,
Grubman received scathing written evaluations from the retail sales force in
2000 and 2001. Hundreds of retail sales
people sent negative written evaluations of Grubman in both years.
·
Many claimed Grubman had a conflict of interest between his role as an
analyst and his role assisting investment banking:
o
“poster child for conspicuous conflicts of interest”;
o
“I hope Smith Barney enjoyed the investment banking fees he generated,
because they come at the expense of the retail clients”;
o
“Let him be a banker, not a research analyst”;
o
“His opinions are completely tainted by ‘investment banking’
relationships (padding his business)”;
o
“Investment banker, or research analyst? He should be fired”;
o
“Grubman has made a fortune for himself personally and for the
investment banking division. However,
his investment recommendations have impoverished the portfolio of my clients
and I have had to spend endless hours with my clients discussing the losses
Grubman has caused them.”
·
Many criticized his support of companies that were SSB investment
banking clients:
o
“Grubman’s analysis and recommendations to buy (1 Ranking) WCOM
[Worldcom], GX [Global Crossing], Q [Qwest] is/was careless”;
o
“His ridiculously bullish calls on WCOM and GX cost our clients a lot
of money”;
o
“How can an analyst be so wrong and still keep his job? RTHM [Rhythm NetConnections], WCOM, etc.,
etc.”;
o
“Downgrading a stock at $1/sh is useless to us”;
o
“How many bombs do we tolerate before we totally lose credibility with
clients?”
40. The
evaluations and comments from retail did not appear to affect Grubman. In a January 2001 e-mail, he stated:
I never much worry about
review. For example, this year I was rated last by retail (actually had a
negative score) thanks to T [AT&T] and carnage in new names. As the global
head of research was haranguing me about this I asked him if he thought Sandy
[Weill] liked $300 million in trading commission and $400 million (only my
direct credit not counting things like NTT [Nippon Telecom] or KPN [KPN Qwest]
our total telecom was over $600 million) in banking revenues. So, grin and bear
it. . . .
41. When Grubman left SSB in August 2002, he signed a separation
agreement that included compensation worth approximately $19.5 million plus
approximately $13 million in deferred compensation previously accrued in 1999,
2000, and 2001.
42. Investment
bankers pressured Grubman to maintain positive ratings on companies in part to
avoid angering the covered companies and causing them to take their investment
banking business elsewhere.
43. On
Also to be blunt we in
research have to downgrade stocks lest our retail force (which
44. Thereafter,
the then-head of investment banking for SSB and the head of telecom investment
banking called Grubman separately. The
head of investment banking told him not to downgrade the stocks because doing
so would anger these companies and hurt SSB’s investment banking business. The head of telecom investment banking told
him that they should discuss his proposed downgrades because some of the names
were more sensitive than others. SSB and
Grubman did not downgrade these stocks until months thereafter, continued to
advise investors to buy these stocks and, in the weeks and months following,
merely lowered the target prices for each of these companies.
45. Grubman
acknowledged that investment banking influenced his publicly expressed views
about the companies he covered. He
stated in a May 2001 e-mail to an analyst who reported to him:
. . . If anything the record
shows we support our banking clients too well and for too long.
46. The
analyst agreed and stated that Grubman had helped SSB’s investment banking
business by using his influence to sell securities for questionable companies:
. . . I told [an investment
banker] that you get the good and the bad with you [Grubman] and to look at all
the bad deals we sold for them in the past.
He agreed.
47. On
Another one. I hope we were not wrong in not
downgrading. Try to talk to folks to
see what they think of these downgrades.
Maybe we should have done like I wanted to. Now it’s too late. (Emphasis added.)
48. A
research analyst who reported to Grubman responded to this e-mail by
reiterating a negative view of XO and Level 3:
. . . XOXO is a lost cause,
its [sic] never too late to do the call, we could downgrade XO, LVLT, etc.
49. Later
the same day, the same analyst e-mailed Grubman, warning him that an
institutional investor thought downgrading XO would:
definitely get the Lame-O
award on CNBC & wouldn’t help anyone out, it would just call attention to
our negligence on not downgrading sooner.
50. A few
weeks later, Grubman was invited to a dinner with the head of U.S. Equity
Research and two senior investment bankers.
Grubman anticipated discussing banking’s displeasure with his commentary
on telecom stocks. Grubman e-mailed one
of his research colleagues:
. . . I have dinner with [a
senior investment banker and the head of U.S. Equity Research] I bet to discuss
banking’s displeasure with our commentary on some names. Screw [the investment bankers]. We should have put a Sell on everything a
year ago. (Emphasis added.)
51. The next day, Grubman e-mailed the head of U.S. Equity Research, stating that the pressure from investment banking had caused him not to downgrade stocks he covered:
See you at dinner. If [a senior investment banker] starts up I
will lace into him. . . . most of our banking clients are going to zero and you
know I wanted to downgrade them months ago but got huge pushback from
banking.
52. SSB and
Grubman maintained Buy ratings on Level 3, WCG, XO, RCN, Adelphia, and Focal
for months after April 2001. SSB and Grubman did not downgrade Level 3 until
53. SSB and Grubman published certain fraudulent research reports on
Focal Communications and Metromedia Fiber, two investment banking clients of
SSB. As described below, certain
research reports on these companies were contrary to Grubman’s private views
and those of his team. Moreover, certain
research reports on these two companies presented an optimistic picture that
overlooked or minimized the risk of investing in these companies and predicted
substantial growth in the companies’ revenues and earnings without a reasonable
basis.
1. SSB and Grubman Published Fraudulent Research Reports on Focal
54. Focal
was a CLEC – a broadband telecommunications provider of limited reach. As of
55. Focal
was an investment banking client for SSB.
SSB underwrote Focal’s initial public offering in July 1999. It also assisted the company in other
investment banking transactions. In
total, SSB earned approximately $11.8 million in investment banking fees from
Focal.
56. Shortly
after SSB underwrote Focal’s initial public offering, it initiated coverage
with a Buy (1) rating and maintained that rating until
57. SSB and
Grubman published two Notes on Focal that were fraudulent – one issued on
The quarter’s results were
in line with our expectations. The
revenue and line mix is improving but the fact remains that FCOM still has
exposure to recip comp and exposure to ISPs, which are areas of concern for
investors. While FCOM is collecting
recip comp and is good at reviewing its customer credit profiles with ISPs,
which are areas of concern for investors, we believe it is prudent to see a few
more quarters of good execution and growth before we change numbers. We continue to remain prudent and thus, we
don’t think we should raise our price target to above $30 when the stock is
only trading at $15. But, as we stated
in our 3Q note, if [Focal] management continues to execute and also delivers on
its data strategy, we believe this will be reflected in its stock price, and
thus, we will be in a better position to raise numbers.
58. The same
day as the February 21 Note, however, Grubman stated that he believed Focal
should be rated an Underperform (4) rather than a Buy(1), that “every single
smart buysider” believed its stock price was going to zero, and that the
company was a “pig.” Focal apparently
complained about the February 21 Note.
When Grubman heard of the complaint, he e-mailed two investment bankers:
I hear company complained
about our note. I did too. I screamed at [the analyst] for saying
“reiterate buy.” If I so much as hear
one more fucking peep out of them we will put the proper rating (ie 4 not even
3) on this stock which every single smart buysider feels is going to zero. We lose credibility on MCLD and XO because we
support pigs like Focal.
59. Also on
February 21, an institutional investor e-mailed a research analyst who worked
for Grubman, “Mcld [McLeod USA, Inc.] and Focal are pigs aren’t they?” and
asked whether Focal was “a short.” The
analyst responded to the e-mail: “Focal
definitely . . . .”
60. Grubman
continued to express his true view of Focal in a subsequent communication. As described in Section D above, he stated on
61. Contrary
to these negative views of Grubman and his colleague, the April 30 Note on
Focal again advised investors to buy Focal.
By April 30, the stock price had fallen to $6.48. Although the April 30 Note lowered the target
price to $15, calling the previous target price of $30 “stale,” the new target
price was still more than twice the stock price. The April 30 Note stated that the company had
reported quarterly results in line with estimates, repeated that Focal’s
“revenue mix is improving towards telecom,” and noted the “line mix” continued
to improve.
62. Neither
the February 21 Note nor the April 30 Note disclosed the actual views of
Grubman and his colleague about Focal.
Indeed, both Notes contradicted such views. Neither Note described the company as a “pig”
or a “short,” disclosed that “smart buysiders” were predicting that Focal’s
stock price was going to zero, or indicated that the proper rating for Focal
was an Underperform (4). The February 21
Note and the April 30 Note did not provide any other reason the stock should be
downgraded. To the contrary, both Notes
advised investors to buy the stock, predicted that the company’s stock price
could at least double over the next 12 to 18 months, and indicated that the
company’s numbers were “in line” and in some respects improving. Accordingly, the Notes issued on
2. SSB and Grubman Issued Fraudulent Research
Reports on Metromedia Fiber
63. Metromedia
Fiber built and operated fiber optic systems nationally and in
64. Metromedia
Fiber was an investment banking client for SSB.
SSB underwrote Metromedia Fiber’s IPO in 1997 and a secondary offering
in November 1999. In addition, SSB
engaged in other investment banking transactions for the company. In total, SSB earned approximately $49
million in investment banking fees in Metromedia Fiber deals. After Metromedia Fiber’s IPO, SSB and Grubman
initiated coverage of the company with a Buy (1) rating and maintained that
rating until
65. In 2001,
the company entered into an agreement with Citicorp USA, Inc. (an SSB
affiliate) to provide it with a credit facility that it needed to fund its
operations. The deadline for closing on
the facility was extended twice and, in the end, the facility was completed for
less than half its full amount. The
Notes on Metromedia Fiber issued between April 2001 and July 2001 did not adequately
disclose the red flags concerning the credit facility or Grubman’s view that
the company might not get the funding.
Moreover, in June 2001, a research analyst working for Grubman told him
that while the company had funds through the end of 2001, thereafter the
company’s fundamentals would deteriorate.
This contradicted the ratings and price targets SSB and Grubman
published on the stock in a Note dated
66. Metromedia
Fiber announced on
67. As of
March 2001, Metromedia Fiber faced a risk of not obtaining financing for its
operations, had sufficient funds for its operations through the end of 2001,
and may not have had sources for additional capital to finance its operations
after the end of 2001. In particular,
the company stated at the time that it may not be able to close on the pending
$350 million credit facility from Citicorp
68. In an
69. Nevertheless, on
As noted in our previous
note, MFN has obtained a commitment for a fully underwritten credit facility
for $350 million from Citicorp USA, Inc., which it expects will fully fund its
current business plan....
70. The April 30 Note failed to disclose that the company believed it
might not consummate the credit facility and that Grubman had expressed doubt
that the company might get funding.
71. Metromedia
Fiber subsequently announced that the deadline for closing on the credit facility
had been extended from May 15 to
72. In a
We continue to believe the $350 million
bank loan, which will bring MFNX to fully-funded status, will close by the end
of June.
*
* *
...The lack of available capital for
MFNX-lookalikes only strengthens MFNX’s position. Most recently private
companies, such as OnFiber and other metro builders, have failed in getting
private financing and other companies in the metro space have an extremely
difficult time.
* * *
MFNX has a business plan that is fully
funded and many “would-be” competitors are never getting to the market.
73. The Note did not disclose that (a) the deadline for consummating
the bank loan had been extended from May 15 to the end of June; or (b) after
announcing the funding commitment, the company had determined that it may not
be able to successfully consummate the senior credit facilities. The Note also did not reflect Grubman’s
opinion that Metromedia Fiber might not secure the financing. As described above, the Note emphasized and
recognized the importance of Metromedia Fiber’s fully-funded position.
74. In its
June 28, 2001 Note, two days before the expiration of the funding commitment,
SSB and Grubman disclosed that Metromedia Fiber had not consummated the bank loan
and that the deadline had been extended from May 15 to June 30. SSB and Grubman minimized the funding problem
by advising investors that the company had other options for financing, but
added that they "can only guess on the nature or terms of the alternative
financing [Metromedia Fiber] would agree to." Nevertheless, the Note analyzed the
company’s financing needs assuming the company could secure the $350 million in
additional funds under the loan or by other means and therefore would be fully
funded through 2003. The Note continued
to project a positive EBITDA for 2003 and reiterated its Buy (1) rating.
75. The
Notes published from April to July 2001 on Metromedia Fiber minimized the risks
facing the company, assumed the company was going to be fully funded, and
estimated that the company would enjoy explosive growth in revenues and
earnings. The $25 price target issued on
76. These
reports, and the ratings and price targets included in them, reflected SSB’s
and Grubman’s publicly expressed opinion that the company’s future was
secure. This view was contrary to the
actual views of SSB’s analysts, which were expressed privately and not
disclosed. On
I have received over 50
calls today on MFNX (its down $0.20 again to $1.51). . . . Most people have
written off this stock saying that it will go bankrupt, even if they could get
an equity infusion here it would be massively dilutive. At lease [sic] they have some cash through the
end of the year but I doubt the fundamentals recover which is actually the
important thing. I think downgrading
right now is not advisable since everyone would say “gee thanks.” I think we need an exuse [sic] from the
company, we should have done it the day they lowered guidance but of course we
were restricted.
77. SSB did
not downgrade Metromedia Fiber until
F. SSB Issued Misleading Research Reports on Level 3, Focal,
RCN, Adelphia, WCG, and XO
78. Research
reports must not contain misleading statements, analysts must have a reasonable
basis for their recommendations, and reports must present a fair, balanced
picture of the risks and benefits of investing in the covered companies and
avoid exaggerated or unwarranted claims regarding the covered companies. As described below, certain research reports
issued on Level 3, Focal, RCN, Adelphia, WCG, and XO violated these
requirements.
1. SSB Issued Misleading
Research on Focal
79. As stated above, on
80. In April 2000, Focal selected SSB to be the
joint book runner for a secondary offering of its stock. Focal also announced a major expansion of its
business plan. At the time, the company
had significant capital expenditures and required additional capital to
complete its new business plan. It faced
the risks that it could not raise such capital and could not complete its new
plan, and that, because of its capital expenditures, it would potentially have
substantial negative operating cash flow and substantial net operating losses
for the foreseeable future, including through 2000 and 2001. Nevertheless, the Notes SSB and Grubman
published on
81. On
82. On
83. On
From a liquidity standpoint, no matter what happens
with the capital markets, between the money [Focal] has on hand and its bank
facilities commitments, we believe that [Focal] will be fully funded through
mid- to late-2001. During the first
quarter, [Focal] completed a $275 million offering of 11 7/8% senior notes due
2010 through a private placement.
84. The Note concluded with another
recommendation for investors to buy the stock:
“We continue to be very bullish on [Focal] and believe the stock is
undervalued at current levels.” The Note
did not disclose the additional capital expenditures that would be necessary to
fund Focal’s expanded business plan or the risk the company may not be able to
obtain such capital. It did not disclose
the likelihood that the expanded business plan would increase the substantial
negative operating cash flow and substantial net operating losses the company
faced in the foreseeable future.
85. The Note SSB and Grubman published on
From a liquidity standpoint, [Focal] received a
commitment for $300 million of senior secured credit facilities during the
quarter. Capital expenditures totaled
$77 million this quarter and we still expect [Focal] to spend $300 million and
$305 million in 2001. We estimate that
with the cash on hand of $342 million and the available credit, [Focal] will be
fully funded through 2001.
86. Missing from the July 31 Note, however, were
sufficient risk disclosures adequate to warn investors of the funding needs
facing Focal. The Note did not disclose
the additional capital expenditures that would be necessary to fund Focal’s
expanded business plan or the risk that the company may not be able to obtain
such capital. It did not disclose the
likelihood that the expanded business plan would increase the substantial
negative operating cash flow and substantial net operating losses the company
faced in the foreseeable future.
87. By
2. Level 3, Focal, RCN,
Adelphia, WCG and XO
88. As
described above in Section D, in April 2001 Grubman expressed the need to
downgrade Level 3, Focal, RCN, Adelphia, WCG, and XO in the aftermath of the
Winstar bankruptcy. Investment bankers
pressured Grubman not to change the Buy ratings on these stocks and he did not
downgrade them until months later.
89. None of
the following Notes for these companies issued between April 18, 2001 and the
date the stocks were downgraded disclosed the pressure the investment bankers
had exerted on Grubman or the fact that he had acceded to it; these Notes were
inconsistent with the views Grubman had expressed, as reflected in the e-mails
described in Section D. above, concerning these stocks:[3]
Level 3: Report
issued on
WCG: Reports issued on
XO:
Reports issued on
Adelphia: Report issued on
RCN: Report issued on May 3, 2001.
3. WCG
90. The
91. The May
1 Note, however, reiterated a Buy recommendation on the stock. It noted that “visibility on funding better
vs. 6 mos. ago.” It reassured investors
that WCG had adequate funds “into 2003.”
The Note stated that the company had reduced capital expenditures and
“has made steps to improve its funding situation since the beginning of the
year and have [sic] raised additional liquidity of more than $2 billion.” While predicting that the company may need $1
billion to fund its operations in 2003, the Note stated “frankly, if the second
tranche of the bank facility gets fully syndicated out, and WCG does perform as
it expects . . . then our funding gap will be cut dramatically.”
92. The May
1 Note failed to accurately describe the negative view of Grubman and the
analyst who reported to him of the company’s funding concerns. Rather than informing investors that WCG’s
business was merely “ok” or a “tough one,” the May 2001 Note advised investors
to “be more aggressive on [WCG].” The
Note did not warn investors to “be careful” with WCG and did not fully reflect
the analysts’ views on the company’s funding needs.
G. Undisclosed Conflicts of Interest Pervaded Grubman’s Upgrade of
AT&T in November 1999
1. AT&T Complained About Grubman’s Views of the Company
93. From
1995 through November 1999, Grubman maintained a Neutral (3) rating on
AT&T. Though at times he offered
qualified approval of AT&T’s
strategy, he also repeatedly disparaged the company in his research and
his public comments.
94. Beginning
in July 1998 and continuing through the relevant period, Sanford Weill, then
co-CEO and Chairman of Citigroup, was a member of the AT&T Board of
Directors. Prior to November 1999,
AT&T management complained to Weill and other SSB representatives about the
tone of Grubman’s comments. In
particular, the AT&T CEO told Weill that Grubman’s unprofessional tone and
comments about AT&T made it difficult for AT&T to do business with SSB.
95. At an
October 1998 industry trade show, Grubman failed to mention AT&T as one of
the important telecommunications companies of the future. AT&T complained to Weill, and Weill
relayed the complaint to senior SSB investment bankers. As a result, Grubman wrote a letter of apology
dated
It has come to my attention
that a speech I made offended AT&T.
I want to make it perfectly clear that the last thing I want to do is
embarrass the firm or myself or for that matter have AT&T put in an awkward
position in dealing with Salomon Smith Barney. To the extent I have done so, I
apologize to you and to the firm. I will also find the appropriate time and
place to apologize directly to AT&T.
Despite our current
investment stance on AT&T, I view AT&T as one of the most significant
companies in this industry, a company that I hope we can build a long and
valued relationship with and one where I truly am open-minded about changes in
investment views.
96. In his
cover memo to the head of SSB investment banking, and the SSB investment banker
covering AT&T, Grubman indicated that his letter was suitable to send to
AT&T. On October 12, Weill and the
investment banker covering AT&T traveled to AT&T’s
2. Weill Asked Grubman to “Take a Fresh Look” at AT&T
97. A few
months later, in late 1998 or early 1999, Weill asked Grubman to “take a fresh
look” at AT&T in the hope that Grubman might change his opinion of the
company. Weill had a positive view of
AT&T and its CEO whom Weill had known personally for years. AT&T’s CEO was a member of Citigroup’s
Board of Directors during the relevant period and, prior to the merger of
Citicorp and Travelers Corporation (SSB’s corporate parent), had been a member
of the Travelers’ Board of Directors since 1993.
98. Thereafter,
on
99. On
I am writing to follow up on
our meeting with
100. Grubman sent a copy of his August 19, 1999
letter to Weill, SSB’s head of investment banking, and the SSB investment
banker covering AT&T.
3. Grubman Requested Weill’s Assistance to Get His Children
Accepted to the 92nd St. Y Preschool and AT&T Considered Issuing a Tracking
Stock for Its Wireless Unit
101. In
September 1999, Grubman began his efforts to get his children admitted to the
prestigious and competitive preschool at the
102. On
October 20, 1999, the AT&T Board of Directors began discussing whether to
issue a tracking stock for its wireless unit.
That day, Weill attended an all-day meeting of the AT&T Board, at
which AT&T’s management presented a
number of strategic alternatives, including issuing a tracking stock for
AT&T’s wireless business.
103. On
October 29, 1999, Weill and Grubman had a 14 minute telephone conversation
during which they discussed the status of Grubman’s “fresh look” at
AT&T. In that conversation or one
shortly thereafter, they also discussed Grubman’s desire to send his children
to the 92nd Street Y preschool in New York City.
104. By
November 2, AT&T had taken its first steps towards issuing a tracker stock
for its wireless unit. That day, an investment
banking firm advising AT&T on financial strategies met with AT&T’s
outside counsel to discuss a proxy statement for AT&T shareholder approval
of the wireless tracker.
105. On
November 5, 1999, Grubman sent a memo to Weill entitled “AT&T and 92nd
Street Y.” In it, Grubman updated Weill
on his progress in “taking a fresh look” at AT&T and outlined the future
steps he would take to reexamine the company.
He referred to his earlier meeting with AT&T’s CEO and to his
scheduled meetings in Denver with the head of AT&T’s cable operations and
in Basking Ridge with AT&T’s network operations personnel. Grubman also sought Weill’s assistance in
getting his children admitted to the 92nd Street Y preschool. Noting the difficulty in getting into the
school, Grubman stated that “there are no bounds for what you do for your
children. . . . it comes down to ‘who you know.’” In the last paragraph of his memo, Grubman
concluded: “Anyway, anything you could
do Sandy would be greatly appreciated.
As I mentioned, I will keep you posted on the progress with AT&T
which I think is going well.”
4. Grubman Kept Weill Apprised of His Reevaluation of AT&T
in November 1999; AT&T Management Recommended That AT&T Issue a
Tracking Stock
106. During
November 1999, Grubman intensified his “fresh look” at AT&T. He met and spoke by telephone with AT&T’s
CEO and traveled to AT&T’s Denver and New Jersey offices to meet with
company officials and view AT&T’s operations. Grubman reported on his efforts to Weill
during an unprecedented number of telephone calls on November 3, 11, 17, 22, 24
and 30.
107. On the
morning of November 17, Weill attended an AT&T board meeting at which
senior AT&T management recommended that the board approve the issuance of a
tracking stock for the wireless business.
Grubman called Weill from Milan, Italy late that night and the two
discussed the status of Grubman’s “fresh look” at AT&T. During a call on November 22 or November 24,
Grubman informed Weill that he soon would be issuing a report upgrading AT&T.
5. Grubman Upgraded AT&T and Subsequently Stated He Did So
to Get His Children Into the
108. Grubman
announced on
The AT&T Report must be
edited and mailed out to the printers today so that it can be distributed in
time to meet Sandy Weill’s deadline (before the AT&T meeting.)
109. The next
day, Grubman issued a 36-page Report setting forth his new rating and
rationale. In his November 30 Report,
Grubman wrote that his upgrade rested largely on two points: (1) the “real economics” of AT&T’s cable
strategy and (2) AT&T’s ability to upgrade its cable technology to deliver
a range of different services to consumers’ homes. Grubman commented positively in his report
about the widely-reported wireless tracking stock but denied upgrading because
of the possible IPO.
110. After
issuing the report, Grubman told an analyst who reported to him and an
institutional investor, in separate conversations, that he upgraded AT&T to
help get his children into the 92nd St. Y preschool.
111. Roughly a
year after the upgrade, on January 13, 2001, in an e-mail to a friend, Grubman
stated:
You know everyone thinks I
upgraded T [AT&T] to get lead for AWE [AT&T Wireless tracker]. Nope.
I used Sandy to get my kids into 92nd St Y pre-school (which
is harder than Harvard) and Sandy needed [the AT&T’s CEO’s] vote on our
board to nuke [John] Reed in showdown.
Once coast was clear for both of us (ie Sandy clear victor and my kids
confirmed) I went back to my normal negative self on T. [AT&T’s CEO] never knew that we both
(Sandy and I) played him like a fiddle.
112. The
following day, Grubman e-mailed the same friend: “I always viewed T [AT&T] as a business
deal between me and Sandy.”
6. After the AT&T Upgrade, Weill Helped Facilitate the
Admission of Grubman’s Children to the
113. After
Grubman issued his November 1999 report on AT&T, Weill helped gain
admission for Grubman’s children to the
114. In March
2000, Grubman’s children were admitted to the Y preschool. Subsequently, the board member called Weill,
suggested a donation be made to the Y, and may have suggested the amount. Weill agreed.
Weill was one of three corporate officers who approved charitable
donations from Citigroup or the Citigroup Foundation. During a subsequent conversation with the
president of the Citigroup Foundation, Weill indicated that the Foundation
should make a $1 million donation to the Y and instructed the Foundation
president to work with the Y to develop a suitable program with the
donation. The program that was
subsequently developed consisted of a series of 10 events per year that had
cultural, artistic, and educational aims.
Weill, the president of the Foundation, and another Citigroup corporate
officer approved the donation on July 24, 2000[4]
and the first installment of the donation ($200,000) was sent to the Y in
September 2000. The president of the
Foundation understood the donation was a “thank you” for the admission of the
Grubman children to the preschool at the 92nd St. Y.
7. After Grubman’s Upgrade of AT&T, AT&T Selected SSB
as a Lead Underwriter in the AT&T Wireless IPO
115. Grubman’s
upgrade of AT&T assisted SSB in being selected as a lead underwriter and
joint book-runner for the IPO of a tracking stock for AT&T’s wireless
subsidiary.
116. The
AT&T Board approved the IPO during its December 5, 1999 Board meeting. AT&T announced its plans at a meeting
with analysts the following day.
117. In January
2000, SSB competed to be named a lead underwriter and book-runner for the
offering. In its pitch book, it
highlighted the experience, prominence, and support for AT&T of Grubman and
the SSB wireless analyst. Among other
things, SSB’s pitch book contained numerous statements about Grubman’s views
regarding the positive impact the wireless tracking stock would have on
AT&T’s shares, as well as promises about the role he would play in
marketing the deal to investors.
118. In evaluating the various proposals from SSB
and other investment banks, AT&T assigned significant weight (55%) to its
views of each investment bank's wireline and wireless telecommunications
analysts. Because Grubman was a highly
rated and highly respected analyst, had a "strong buy" on AT&T
stock, and was a "strong supporter" of the company, AT&T gave him
the highest possible score in the internal matrix it used to rank the competing
investment banks. In February 2000,
based in large part on this positive evaluation of Grubman, AT&T named SSB
as one of three joint book-runners for the AT&T Wireless IPO. The IPO occurred on April 27, 2000. It was the largest equity offering ever in
the
8. Grubman Downgraded AT&T
119. On
120. Institutional
investors viewed Grubman’s report as a “virtual downgrade” because of his
unfavorable comparisons of AT&T to WorldCom. An internal AT&T document also reported
that Grubman was privately making comments to investors that were considerably
more critical than those in his written reports.
121. Grubman subsequently downgraded AT&T twice
in October 2000: on October 6 he downgraded the stock to an Outperform (2) and
on October 25 he downgraded it to a Neutral (3), citing what he described as
negative news from the company.
9. SSB’s
Policies Were Not Reasonably Designed To Prevent The Potential Misuse Of
Material, Non-Public Information
122. During
the relevant period, SSB had general policies in place requiring its employees
to obtain approval before becoming a director of another company and to keep
non-public information about that company confidential. SSB did not, however, have adequate policies
and procedures in place to ensure that communications between a person
associated with SSB who served as a director of another company and the SSB
research analyst who covered that company would not result in the misuse of
material, non-public information by the research analyst. For example, one such step SSB could have
taken would have been to require that a company be placed on its watch list if
a person associated with SSB served as a director of that company. Such a procedure would have helped SSB to
monitor whether a research analyst, before publishing research on a company,
had received material non-public information on it from a person associated
with SSB who also served as one of the company’s outside directors.
123. Members of research management received copies
of research reports and call notes when they were issued and routinely reviewed
research. Based on this review,
complaints from SSB employees and customers, and otherwise, SSB was aware of
problems with its research. Indeed, as
described in Section B above, members of research management themselves
expressed reservations about SSB’s research.
Nevertheless, SSB did not take steps to supervise the activities of
research analysts adequately.
124. By early
2001, one of Grubman’s supervisors believed that Grubman’s ratings were
inconsistent with the performance and prospects of the some of the companies he
covered.
125. Moreover,
on July 2, 2001, a Director who provided Research Management Support sent an
e-mail to all research personnel, and others, warning that the models SSB
analysts, including Grubman, used to predict future revenues and earnings and
generate target prices “must make sense” (emphasis in original) and must
be “smell tested.” He criticized these
models for using “aggressive inputs to arrive at a predetermined
valuation/outcome.” He concluded by
noting that, “Clearly, projected
long-term growth rates for many of our companies are too high and would benefit
from a thoughtful reappraisal.”
(Emphasis in original.) At least
one recipient of this e-mail thought he was referring to Grubman (“Amen! You should have cc’d this to Grubman just to
make sure.”) The author of the e-mail
did not disabuse the recipient of this assumption: “No comment on that, at least not in
writing.”
126. The same
person specifically criticized Grubman’s research in a later e-mail to a senior
member of research management, implying that the research had been compromised
by investment banking concerns and acknowledging that SSB’s lax supervision of
Grubman was at least partly to blame. He
focused in particular on Grubman’s coverage of Metromedia Fiber and the
Explaining this isn’t
easy. My candid opinion is that, until
quite recently, Jack Grubman’s team had not yet come to terms with the debacle
in this sector. While share prices
plummeted, they remained convinced of the longer-term potential of their group
and were unwilling to cut ratings and adopt a more cautious stance. When you add the heavy layer of banking
involvement into the mix this very problematic situation gets easier to
understand. (Emphasis added.)
127. He
criticized Grubman’s coverage of Metromedia Fiber in particular. He noted that Grubman’s
[e]xcessive optimism led to
unattainable target prices that should have been brought down much more quickly
and earlier, than they had been. . . . [T]he target prices were cut again and
again, but never enough to bring them into a more rational alignment with the
share price. The
128. He
concluded by acknowledging that SSB’s supervision of Grubman had been
inadequate:
What could have prevented
this? . . . Even with all notes going through an SA [supervising analyst] and
many being scrutinized by research legal as well, we clearly rely on senior
analysts to do careful work, disclose all important data and denote all
material risks. In the case of MFNX, and
in other telecom situations that I could name, our approach was
inadequate. There was a failure of
analysis and, it pains me to confess, a failure of management. This is the only explanation I can
offer. (Emphasis added.)
2. SSB Knew SSB Investment Bankers Pressured Research Analysts
129. SSB knew that its business practices, which intertwined
research and investment banking, created a conflict of interest between
investment banking and research, that investment banking pressured research
analysts, and that investment banking concerns had the potential to affect,
and, as described above with respect to Grubman, did affect, the decisions of
research analysts on ratings and coverage.
Nevertheless, SSB failed to take adequate steps to prevent such pressure
or ensure that SSB’s research was independent and objective.
130. SSB was aware that investment bankers
pressured Grubman to maintain positive ratings or change negative ratings on
companies. Moreover, on
I think all legal stuff on ATT should be forwarded to
Sandy [Weill] and [the head of SSB Investment Banking] as Exhibit A on why
research needs to be left alone. These
guys never understand the lingering consequences.
I. SSB Engaged in
Improper Spinning and IPO Distribution Practices
131. SSB engaged in improper spinning practices
whereby it provided preferential access to valuable IPO shares to the
executives of corporations from which SSB sought or had obtained investment
banking business. During the years 1999
and 2000, SSB earned over $6.6 billion in investment banking revenue. Obtaining this investment banking business
was critical to SSB’s success. For
example, investment banking fees comprised over 21% of SSB’s revenue in 1999,
and over 22% in 2000.
132. SSB failed to appropriately administer
numerous Issuer Directed Share Programs (“DSPs”) it managed during this same
period. Further, SSB engaged in
significant “as of” trading in IPOs and failed to ensure that its distribution
of IPO shares, both through DSPs and its branch offices, was timely and
accurately reflected in its books and records.
1. SSB Established a Special Branch to
Facilitate Its Spinning Practices
133. SSB
employed two registered representatives (“RRs”) whose primary function was to
open and service accounts for high net worth individuals who were founders,
officers or directors of current and potential banking clients (“Executive
Accounts”). The two RRs had begun servicing
these types of accounts at Salomon Brothers and continued to perform this
function after Salomon merged with Travelers in 1997 to create SSB. SSB took steps and entered into written
agreements to provide these two RRs with preferential, special, and unusual
treatment including the following:
·
SSB
gave each of these two RRs special compensation, including a draw of $1 million
for the first 6 months of their employment and a minimum of $500,000 for the
second 6 months;
·
SSB
provided office space for one of the two RRs on SSB’s equities trading floor in
·
SSB
treated the business of the two RRs, designated “Private Wealth Management,” as
if it were a separate SSB branch office (“PWM Branch”) for the purpose of
determining IPO allocations, when it was actually only 2 brokers;[5]
·
SSB
provided the two RRs with unique access to hot IPO shares to distribute to the
Executive Accounts that was far above and beyond that of any other broker or
branch; and
·
SSB
provided the two RRs with access to IPO shares for distribution to the
Executive accounts from (i) the SSB Branch retail allocation, with PWM being
treated as a “branch office”; and (ii) the institutional pot, In some cases, the two RRs were able to
obtain access to DSP shares from issuers for distribution to the Executive
Accounts.
2. SSB Provided Preferential Treatment to
Executive Accounts in the Allocation of Hot IPOs
134. SSB
distributed its IPO shares by dividing the firm’s allocation between its retail
and institutional clients. Generally,
SSB allocated to its retail clients, as a group, approximately 20-30% of the
firm’s allotment in any specific IPO, with a majority of the remaining shares
designated for allocations to institutional clients. Those shares set aside for
retail clients were designated as the “retail retention,” and the remaining
shares were designated as the “institutional pot.”
135. The
retail shares were distributed to specific accounts through SSB’s branch
managers. For every IPO, SSB gave each
branch manager a specific number of shares, and the manager determined which
retail brokers received shares and how many shares each retail broker
received. The retail broker then
determined the allocation of shares among his or her retail accounts, subject
to the branch manager’s final approval.
136. The
PWM Branch and its clients, however, were treated differently. As noted, the two RRs’ client base consisted
primarily of high net worth individuals
whose companies were potential investment banking clients or had provided
investment banking business to SSB, and these two individual brokers were
designated as a special branch with a separate profit and loss assessment. The PWM Branch received favorable treatment
in the allocation of hot IPO shares.
Although SSB’s written procedures for the distribution of IPO shares specifically
prohibited favoritism for the personal accounts of corporate executives, SSB in
fact provided preferential treatment to Executive Accounts in connection with
the distribution of hot IPO shares throughout the relevant period.
a. Special
Access to Retail and Institutional Shares
137. While
other SSB retail branches were ordinarily limited to receiving IPO shares for
clients from the retail retention, in many instances the two RRs in the PWM
Branch obtained shares from both the retail retention and the institutional
pot. This arrangement enabled them to
consistently provide the Executive Accounts with larger numbers of shares in
lucrative hot IPOs than were allocated to other retail accounts.
138. For
example, from June
1996 through August 2000, WorldCom’s then-President and CEO received IPO
allocations in 9 offerings from Salomon and 12 offerings from SSB. He made profits of $10,612,680 and $923,360
respectively, totaling $11,536,041 on these IPO allocations. From 1996 through 2000, WorldCom paid
$75,955,000 in investment banking fees to SSB.
139. During
1999 and 2000, the two RRs in the PWM Branch received 35% of the total IPO
shares allocated for distribution to SSB’s ten largest branches and PWM
combined. During this same period, these
two brokers generated less than 3% of this combined group’s commission revenue
and had less than 5% of the group’s assets under management. In 5.3% of the IPOs during this period, the
two PWM brokers alone received a greater IPO allocation than the total shares
distributed to SSB’s ten largest branches.
b. PWM’s
Solicitation of Syndicate for Additional IPO Shares
140. In
addition to the arrangement that provided the two PWM brokers with special
access to large numbers of IPO shares for its client base, these two RRs
aggressively solicited the Syndicate Department for additional shares in order
to give preferential treatment to founders, officers, and directors of
investment banking clients. PWM brokers
regularly requested additional shares from Syndicate, while retail brokers did
so rarely. This occurred as early as
1996 and continued throughout the relevant period. For example, in a
c. Special Access to DSP Shares
141. As well as obtaining hot IPO shares for
Executive Accounts from the retail retention and institutional pot, a PWM
broker sought access, on at least one occasion, to shares reserved for an Issuer’s Directed Share Program for
allocation to Executive Accounts.[6]
142. In a
143. SSB also directly allocated issuers’ DSP
shares to the Executive Accounts. When
trades through an Issuer’s DSP program could not be confirmed, SSB used those
shares for its own clients and distributed them to its favored accounts. For example, one of the PWM RRs was assigned
by SSB to administer the KQIP DSP. KQIP
began trading in the aftermarket on
144. Additionally, several Executive Accounts
serviced by the PWM brokers received IPO shares from a significant number of
DSPs. For example, DSP shares were
allocated in more than one-third of the SSB IPOs awarded to the former
Executive Vice President of Qwest Communications International from May 1998
through September 2000. Likewise, DSP
shares were allocated in half of the SSB IPOs awarded to the President of Qwest
Communications International from June 1999 through September 2000.
145. The spinning practices engaged in by Salomon
before the merger with Citigroup, and then by SSB after the merger through the
PWM Branch proved very lucrative to both the firm and the executives of the
firm’s investment banking clients.
Executives of five telecom companies made approximately $40 million in
profits from approximately 3.4 million IPO shares allocated from 1996 – 2001,
and SSB earned over $404 million in investment banking fees from those
companies during the same period.
Company |
IPO
Shares to Company Executives Pre-Merger (1/96-11/97) |
IPO
Shares to Company Executives Post-Merger (12/97-12/01) |
Net
Profits of Executives on Pre‑Merger IPO Shares (1/96 – 11/97) (to nearest 000) |
Net
Profits of Executives on Post‑Merger IPO Shares (12/97 – 12/01) (to nearest 000) |
Investment
Banking Fees Paid to SSB, Pre‑Merger (1/96 – 11/97) (to
nearest 000) |
Investment
Banking Fees Paid to SSB, Post‑Merger (12/97 – 12-01) (to nearest 000) |
Global
Crossing |
0 |
37,000 |
$
0 |
$254,000 |
$0 |
$121,049,000 |
Metromedia
Fiber Network |
3,000 |
98,300 |
$11,000 |
$1,511,000 |
$5,243,000 |
$43,865,000 |
McLeodUSA |
198,500 |
459,500 |
$4,849,000 |
$4,582,000 |
$23,071,000 |
$48,810,000 |
Qwest |
254,654 |
838,822 |
$1,272,000 |
$7,763,000 |
$13,998,000 |
$32,810,000 |
WorldCom |
1,236,400 |
262,000 |
$20,146,000 |
($273,000) |
$17,631,000 |
$97,857,000 |
Totals |
1,692,554 |
1,695,622 |
$26,278,000 |
$13,837,000 |
$59,943,000 |
$344,391,000 |
4. SSB Could Not Rely on Its Records to Determine if IPOs Were
Fully Distributed
146. SSB’s
record keeping and its system of assessing whether the IPO distribution was
completed were totally inadequate. The
records failed to timely and accurately record the firm’s distribution of IPO
shares to its clients. As a result, the
firm could not rely on these records to ensure that the distribution was complete.
This faulty record keeping was particularly evident in the areas of “as of”
trades and the distribution of DSP shares.
These “as of” trades frequently provided immediate profits to the
recipients.
a. “As Of” Trades
147. In
the Metromedia Fiber offering, SSB booked approximately 68% of all allocations
on an “as of” basis two days or more after the IPO date and well after
secondary market trading had begun in each stock. In the Juniper Networks offering, over 80% of
all allocations booked by SSB were booked on an “as of” basis two days or more
after the IPO date. In at least 10
offerings, over 10% of the offering was booked on an “as of” basis two or more
days after the IPO date.
148. SSB
placed a number of these “as of” IPO trades in Executive Accounts. In addition, SSB’s inadequate record keeping
led to the appearance that certain IPO allocations were sold short in violation
of industry regulations. For example,
Juniper Networks (“JNPR”) IPO stock went public on
149. Similarly,
the former Chairman of Qwest Communications also received several “as of” IPO
allocations that traded at a substantial profit in the aftermarket. For example, SSB booked 5000 JNPR IPO shares
into the account of the Qwest Chairman on
b. Directed Share Programs
150. In
many instances in which SSB was retained to administer the issuer’s DSP, a
large number of allocations were booked into customers’ accounts after the
stock began trading in the secondary market, resulting in a substantial number
of “as of” trades. Some of these
instances resulted directly from SSB’s failure to ensure that orders for DSP
shares were confirmed prior to the start of secondary market trading. In fact, one of the PWM brokers acknowledged
that, if he could not confirm a DSP allocation with a program participant, he
would continue to attempt to contact participants even after secondary market
trading had begun in the stock. SSB’s
inadequate record keeping left the firm unable to ensure that the distribution
of DSP shares had been completed before the stock began trading in the
secondary market.
151. Moreover,
SSB did not appropriately administer DSPs.
For example, SSB relied upon branch offices and their staff to manage
these labor-intensive programs without adequate central supervision and
coordination. Further, despite managing
numerous DSPs, SSB had no written procedures or supervisory system in effect to
ensure the appropriate administration of these programs and the complete and
timely distribution of DSP shares.
5. SSB
Failed to Supervise Reasonably the Activities of the PWM Branch and Others to
Prevent Spinning
152. SSB
failed to have supervisory procedures and systems in place to (i) prevent
spinning; (ii) create records it could reasonably rely upon to assess whether
or not the distribution of IPO shares was completed in compliance with
applicable law; and (iii) ensure that issuers’ DSP programs were managed in
conformance with all applicable industry rules and regulations.
153. By
establishing the PWM Branch and providing the two RRs with several special
considerations, including the ability to obtain significantly larger hot IPO
allocations than other brokers, SSB ensured favorable treatment for the
Executive Accounts. Moreover, SSB
management failed to adequately supervise the allocation process and
specifically failed to take steps to ensure that the PWM Branch complied with
SSB’s policy prohibiting favoritism for the personal accounts of corporate
executives. SSB also failed to
accurately and timely record its distribution of IPO shares and failed to have
a system to ensure that IPO distributions were completed, and recorded as
completed, prior to the initiation of aftermarket trading. Finally, SSB failed to adopt written
supervisory procedures and a supervisory system sufficient to ensure that the
firm appropriately administered DSPs.
II.
CONCLUSIONS OF LAW
1. The Office
of Securities has jurisdiction over this matter pursuant to the Revised Maine
Securities Act, 32 M.R.S.A. §§ 10101-10713.
2. SSB
Published Fraudulent Research on Focal and Metromedia Fiber
As described in the Findings of Fact above, SSB publicly issued the
following fraudulent reports on Focal
Communications and Metromedia Fiber that contained misstatements and omissions
of material facts about the companies covered, contained recommendations that
were contrary to the actual views of its analysts, overlooked or minimized the
risk of investing in these companies and predicted substantial growth in the
companies’ revenues and earnings without a reasonable basis:
· Focal: Reports issued on
· Metromedia Fiber: Reports
issued on
As a result, SSB violated 32 M.R.S.A. § 10201.
3. SSB Published Exaggerated, Unbalanced
or Unwarranted Statements and Made Recommendations Without a Reasonable Basis
As described in the Findings
of Fact above, SSB issued certain research reports for Focal, RCN
Communications, Level 3 Communications, XO Communications, Adelphia Business
Solutions, and Williams Communications Group that did not disclose the pressure
exerted by investment banking on Grubman not to downgrade those stocks, did not
disclose other relevant facts, and did not provide a sound basis for evaluating
facts regarding these companies business prospects. In addition, certain of the reports for
Williams and Focal contained exaggerated or unwarranted statements or claims
about these companies, and opinions for which there was no reasonable basis.
The treatment of risks and potential benefits in the reports also was not
adequately balanced. As a result, SSB
violated 32 M.R.S.A. § 10313(1)(G) in publishing the following misleading
reports, as described in paragraphs 78 - 92:
·
Focal: Reports issued on
·
Level 3: Report issued on
·
WCG: Reports issued on
·
XO: Reports issued on
·
Adelphia: Report issued on
·
RCN: Report issued on
4. SSB
Published a Misleading Recommendation on AT&T
As described in the Findings of Fact above, SSB did not, in the
November 1999 research report upgrading AT&T, disclose that Grubman’s
objectivity had been compromised by the facts described above in paragraphs 93
- 122. This would have been material to
investors. As a result, such report was
misleading and SSB violated 32 M.R.S.A. 10313(1)(G).
5. SSB’s
Business Practices Created Conflicts of Interest
As described in the Findings of Fact above, SSB’s business practices allowed
investment bankers to wield inappropriate influence over research
analysts. SSB failed to manage, in an
adequate or appropriate manner, the conflicts of interest these practices
generated. These SSB business practices
fostered the flawed research reports described in Sections I.E and I.F
above. Accordingly, SSB violated 32 M.R.S.A. § 10313(1)(G).
6. SSB’s Policies Were Not Reasonably Designed To Prevent the
Potential Misuse of Material, Non-Public Information
As described in the Findings of Fact above, during the relevant period
SSB did not maintain written policies and procedures reasonably designed to
prevent the sharing and misuse of material, non-public information between an
affiliated person of SSB who served as a director of another company and an SSB
research analyst covering that company.
By reason of the foregoing, SSB violated 32 M.R.S.A. § 10313(1)(G).
7. SSB Engaged in Spinning
As described in the Findings of Fact above,
SSB provided favorable and profitable allocations of hot IPO shares to officers
of existing or potential investment banking clients who were in a position to
direct their companies’ investment banking business to SSB. The officers sold the shares provided to them
for substantial profit. Subsequently, the
companies for which the officers worked provided SSB with investment banking
business. As a result of these actions,
SSB violated 32
M.R.S.A. § 10313(1)(G).
8. SSB Maintained Inaccurate Books and
Records in Connection with its Spinning Activities and IPO Distribution
Practices
As described in the Findings of Fact above,
SSB allowed its employees to engage in “as of” trading and otherwise failed to
maintain accurate books and records with respect to spinning. SSB also failed to maintain adequate books
and records to ensure that its distributions of IPO shares were completed prior
to the initiation of secondary market trading.
As a result, SSB violated 32 M.R.S.A. § 10313(1)(G).
9. SSB Failed to Supervise
As described in the Findings of Fact above,
SSB failed to establish and maintain adequate procedures to protect research
analysts from conflicts of interest from its investment banking operation. Moreover, SSB failed adequately to supervise
the activities of its research analysts: it failed to respond to indications
that SSB research was misleading and failed to have a system to provide
reasonable assurances that its research reports complied with applicable law. SSB also failed adequately to supervise the
employees engaged in spinning. Finally,
SSB failed to establish and maintain adequate procedures to ensure the proper
administration of Issuer Directed Share Programs. As a result, SSB violated 32 M.R.S.A. § 10313(1)(J).
10. The
Securities Administrator finds the following sanctions appropriate and in the
public interest.
On the basis of the Findings of
Fact, Conclusions of Law, and Respondent Citigroup Global’s consent to
the entry of this Order, for the sole purpose of settling this matter, prior to
a hearing and without admitting or denying any of the Findings of Fact or
Conclusions of Law,
IT IS HEREBY ORDERED:
IT IS
FURTHER ORDERED that:
3. As a
result of the Findings of Fact and Conclusions of Law contained in this Order,
Respondent Citigroup Global shall pay a total amount of $400,000,000.00. This total amount shall be paid as specified
in the final judgment in the related action by the Securities and Exchange
Commission against Respondent Citigroup Global (“SEC Final Judgment”) as
follows:
a) $150,000,000 to the states (50
states, plus the
b) $150,000,000 as
disgorgement of commissions, fees and other monies as specified in the SEC
Final Judgment;
c) $75,000,000, to be used
for the procurement of independent research, as described in the SEC Final
Judgment;
d) $25,000,000, to be used for
investor education, as described in the SEC Final Judgment.
Respondent Citigroup Global agrees that it shall not seek or accept,
directly or indirectly, reimbursement or indemnification, including, but not
limited to payment made pursuant to any insurance policy, with regard to all
penalty amounts that Respondent Citigroup Global shall pay pursuant to this
Order or Section II of the SEC Final Judgment, regardless of whether such
penalty amounts or any part thereof are added to the Distribution Fund Account
referred to in the SEC Final Judgment or otherwise used for the benefit of
investors. Respondent Citigroup Global further
agrees that it shall not claim, assert, or apply for a tax deduction or tax
credit with regard to any state, federal or local tax for any penalty amounts
that Respondent Citigroup Global shall pay pursuant to this Order or Section II
of the SEC Final Judgment, regardless of whether such penalty amounts or any
part thereof are added to the Distribution Fund Account referred to in the SEC
Final Judgment or otherwise used for the benefit of investors. Respondent Citigroup Global understands and
acknowledges that these provisions are not intended to imply that the Office of Securities would agree that
any other amounts Respondent Citigroup Global shall pay pursuant to the SEC
Final Judgment may be reimbursed or indemnified (whether pursuant to an
insurance policy or otherwise) under applicable law or may be the basis for any
tax deduction or tax credit with regard to any state, federal or local tax.
No portion of the payments for independent research or investor
education shall be considered disgorgement or restitution, and/or used for
compensatory purposes.
4. If payment is not made by Respondent Citigroup Global or if Respondent Citigroup Global defaults in any of its obligations set forth in this Order, the Office of Securities may vacate this Order, at its sole discretion, upon 10 days notice to Respondent Citigroup Global and without opportunity for administrative hearing and Respondent Citigroup Global agrees that any statute of limitations applicable to the subject of the Investigation and any claims arising from or relating thereto are tolled from and after the date of this Order.
5. This Order is not intended by the Office of Securities to subject any Covered Person to any disqualifications under the laws of any state, the District of Columbia or Puerto Rico (collectively, “State”), including, without limitation, any disqualifications from relying upon the State registration exemptions or State safe harbor provisions. "Covered Person" means Respondent Citigroup Global, or any of its officers, directors, affiliates, current or former employees, or other persons that would otherwise be disqualified as a result of the Orders (as defined below).
6. The SEC Final Judgment, the NYSE Stipulation and Consent, the NASD Letter of Acceptance, Waiver and Consent, this Order and the order of any other State in related proceedings against Respondent Citigroup Global (collectively, the “Orders”) shall not disqualify any Covered Person from any business that they otherwise are qualified, licensed or permitted to perform under the applicable law of Maine and any disqualifications from relying upon this state’s registration exemptions or safe harbor provisions that arise from the Orders are hereby waived.
7. For any person or entity not a party to this Order, this Order does not prohibit, limit or create: (1) any private rights or remedies against Respondent Citigroup Global; (2) liability of Respondent Citigroup Global; or (3) defenses of Respondent Citigroup Global to any claims. Nothing herein shall be construed to prohibit the use of any e-mails or other documents of Respondent Citigroup Global or of others.
8. Nothing herein shall preclude the State of Maine, its departments, agencies, boards, commissions, authorities, political subdivisions and corporations, other than the Office of Securities and only to the extent set forth in paragraph 1 above, (collectively, “State Entities”) and the officers, agents or employees of State Entities from asserting any claims, causes of action, or applications for compensatory, nominal and/or punitive damages, administrative, civil, criminal, or injunctive relief against Respondent Citigroup Global arising from or relating to the subject of the Investigation.
9.
This Order and any dispute related thereto shall
be construed and enforced in accordance with, and governed by, the laws of
10.
Respondent Citigroup Global agrees not to take
any action or to make or permit to be made any public statement denying,
directly or indirectly, any finding in this Order or creating the impression
that this Order is without factual basis. Nothing in this Paragraph affects
Respondent Citigroup Global’s: (i) testimonial obligations, or (ii) right to
take legal or factual positions in defense of litigation or in defense of other
legal proceedings in which the Office of Securities is not a party.
11. Respondent Citigroup Global, through its execution of this Consent Order, voluntarily waives their right to a hearing on this matter and to judicial review of this Consent Order under 32 M.R.S.A. §§ 10708-10709.
12. Respondent Citigroup Global enters into this Consent Order voluntarily and represents that no threats, offers, promises, or inducements of any kind have been made by the Office of Securities or any member, officer, employee, agent, or representative of the Office of Securities to induce Respondent Citigroup Global to enter into this Consent Order.
13. This Order shall be binding upon Respondent Citigroup Global and its successors and assigns. Further, with respect to all conduct subject to Paragraph 2 above and all future obligations, responsibilities, undertakings, commitments, limitations, restrictions, events, and conditions, the terms “Citigroup Global” and “Citigroup Global’s” as used herein shall include Respondent Citigroup Global’s successors and assigns (which, for these purposes, shall include a successor or assign to Respondent Citigroup Global’s investment banking and research operations, and in the case of an affiliate of Respondent Citigroup Global, a successor or assign to Respondent Citigroup Global’s investment banking or research operations).
14. This Consent Order shall become final upon entry.
By: s/Christine A. Bruenn
Christine
A. Bruenn, Securities Administrator
State
of
Respondent Citigroup Global hereby acknowledges that it has
been served with a copy of this Order, has read the foregoing Order, is aware
of its right to a hearing and appeal in this matter, and has waived the same.
Respondent Citigroup Global admits the jurisdiction of the
Office of Securities, neither admits nor denies the Findings of Fact and
Conclusions of Law contained in this Order; and consents to entry of this Order
by the Securities Administrator as settlement of the issues contained in this
Order.
Respondent Citigroup Global states that no promise of any
kind or nature whatsoever was made to it to induce it to enter into this Order
and that it has entered into this Order voluntarily.
Richard Ketchum represents
that he/she is General Counsel of Respondent Citigroup Global and that, as such, has been
authorized by Respondent
Citigroup Global to
enter into this Order for and on behalf of Respondent Citigroup Global.
Dated this 3rd day of September,
2003.
Citigroup Global
By: s/Richard Ketchum
Title: General Counsel
SUBSCRIBED AND SWORN TO before
me this _____ day of __________________, 2003.
____________________________________________
Notary Public
My Commission expires:
____________________
[1] On
or about
[2] A “hot IPO” is one that trades at a premium in the secondary market whenever trading in the secondary market begins.
[3] For the additional
reasons set forth in Section E, the Note on Focal for
[4] Because of certain tax considerations, and in light of benefits Citigroup employees received from the program supported by the donation, Citigroup, not Citigroup Foundation, made the donation to the Y. The $1 million donation was payable in equal amounts over five years.
[5] The two RRs ended their partnership in 1999 after which each operated as a separate branch and the practices described herein continued. However, the two RRs are referred to as the “PWM Branch.”
[6] In each IPO, shares were set aside for distribution
to a group of individuals designated by the Issuer through its Directed Share
Program, sometimes referred to as the
“friends and family” program.