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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.)
WHEREAS, Salomon Smith Barney Inc. (“SSB”),
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:
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.
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.
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
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.
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 . . . .”
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.
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
Fiber built and operated fiber optic systems nationally and in
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
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
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.
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.
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
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
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
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.
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:
Level 3: Report
WCG: Reports issued on
Reports issued on
Adelphia: Report issued on
RCN: Report issued on May 3, 2001.
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
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.
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
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
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
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 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
8. Grubman Downgraded AT&T
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;
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;
· 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
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.
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.
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)
Metromedia Fiber Network
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.
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
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.
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
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.
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
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
/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.
By: s/Richard Ketchum
Title: General Counsel
SUBSCRIBED AND SWORN TO before me this _____ day of __________________, 2003.
My Commission expires:
 A “hot IPO” is one that trades at a premium in the secondary market whenever trading in the secondary market begins.
 For the additional
reasons set forth in Section E, the Note on Focal for
 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.
 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.”
 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.