The New Republic

George Zicarelli is the kind of voter that must give his party fits.
A longtime resident of New York City's Upper East Side, he is a
self-described "conservative Democrat" who has now voted for
Republican Governor George Pataki in two successive elections--in
1998 and again this November. "I like Pataki on a fiscal level,"
Zicarelli explains.But Zicarelli did vote for at least one Democrat on the statewide
ballot this year: Attorney General Eliot Spitzer. Zicarelli, it
turns out, lost several hundred thousand dollars in the stock
market after his broker at Salomon Smith Barney encouraged him to
invest in stocks recommended by the firm's star telecom analyst,
Jack Grubman. As a result, Zicarelli has derived no small amount of
satisfaction from watching Spitzer investigate analysts such as
Grubman and Merrill Lynch's Henry Blodget for promoting stocks they
didn't believe in. In fact, Zicarelli is so grateful for Spitzer's
activism on behalf of investors that when I asked him who his
favorite politician is, he hesitated briefly before conceding that,
"to be honest, if it was between Pataki and Spitzer, I'd have to
vote for Spitzer."

Zicarelli, in short, is the sort of middle-of-the-road voter many
Democrats failed to impress on Election Day but whom Spitzer won in
droves en route to racking up 66 percent of the vote in his
reelection campaign. Spitzer won 2.5 million votes in all--over one
million more than the state's Democratic candidate for governor,
Carl McCall, and almost half a million more than Pataki. As
Democratic political consultant Richard Schrader told The New York
Times two weeks ago, Spitzer "is the one politician nationally who
has been able to capitalize on the issue of corporate misconduct."

It's not as though other politicians didn't try. National Democrats
responded to the collapse of Enron and WorldCom by condemning the
corporate world as greedy and corrupt, and then assailing
Republicans for their corporate ties. In late June, Majority Leader
Tom Daschle declared on the Senate floor that "it is as if the line
between right and wrong ... was so little enforced that it became
blurred. Bringing it back into focus--as Enron's collapse did--
revealed more than a few businesses standing on the wrong side." One
week later, on "Face the Nation," he made the connection to the
Bush administration: "We've even seen [a permissive atmosphere] in
relationships that some of the members of the administration have
had with their own corporate roles and the responsibilities they
had in the corporate sector." Daschle's Democratic counterpart in
the House, Dick Gephardt, went even further. "I think we're in a
world of George Orwell, only Big Brother is not the government, Big
Brother is corporate America," Gephardt alleged at a press
conference shortly after WorldCom's collapse in July. "This is a
Republican majority in the House that is of, by, and for corporate
America."

Unfortunately for the Democrats, most Americans simply didn't agree
with Gephardt's analysis. In June, on the eve of WorldCom's
collapse, 38 percent of respondents to a USA Today/Gallup poll
viewed "big business" as the greatest threat to the future of the
country. But 47 percent gave that distinction to "big government."
One reason is that, although Americans were outraged by the
corporate scandals, more than half of them--and two-thirds of
voters--own stock in some form. Any attack on business that seemed
to hint at excessive fines or burdensome new regulations could
therefore be seen as an attack on their personal financial
interests. That helps explain why a poll released by the Pew
Research Center in early September showed registered voters giving
Republicans a five-point edge when it came to "dealing with
corporate corruption." And it helps explain why, according to a Pew
poll the following month, investors who by their own description
"lost a lot of money recently"--the George Zicarellis of the
world--planned to vote Republican by a six-point margin.

Spitzer grasps this problem intuitively. "I think there is some
anger," he told me in a recent interview. "But nobody wants the
marketplace to crumble and to see their 401(k) drop even more."
Spitzer's solution hasn't been to do nothing; it has been to focus
more narrowly on the harm done to investors--who, after all, were
the people hurt by the scandals in the first place. Spitzer argued,
in effect, that buying stock is in a fundamental way like buying
any other product: The buyer needs quality information in order to
decide among numerous options. If for some reason investors had
been getting misleading information, they couldn't possibly have
made intelligent decisions.

Like other Democrats, Spitzer advocated reform. But, unlike other
Democrats, Spitzer's reforms weren't designed to punish or rein in
inherently corrupt executives. They were designed to give
essentially amoral corporations incentives to better serve their
customers. Spitzer, in other words, wasn't anti-business so much as
pro-consumer. And that made all the difference in the world.

Spitzer's reluctance to demonize business follows from his
biography. The youngest child of a New York City real estate
magnate, Spitzer--after Harvard Law School and a stint in the
Manhattan District Attorney's office--spent two years working on
mergers and acquisitions at the corporate behemoth Skadden Arps. In
many ways, he resembles the young, Harvard-trained corporate
lawyers who wrote many of the federal statutes that govern the
financial markets today. New Dealers like Tommy Corcoran and
Benjamin Cohen had lost money in the market crash of 1929, but, in
the words of one contemporary, "They want[ed] to reform the system,
not take revenge on it." Spitzer, likewise, is a reformer with a
large personal stake in preserving "the system." He is fond of
joking that "[h]alf his friends are investment bankers, and the
other half are lawyers who represent investment bankers," as
Fortune magazine recently put it. Spitzer's friend, the hedge-fund
manager and financial commentator Jim Cramer, points out that "he's
really one of them. He could have been general counsel of Merrill."
In our interview, Spitzer confided that he'd seriously considered a
career in business himself. "There's always been a piece of me that
wants to be in the private sector. There is an element of dynamism
and risk-taking that is very appealing, to actually be out there in
the business world."

So, when Spitzer squeaked into office by fewer than 30,000 votes in
1998 (out of nearly 4.5 million cast), it was only natural that
he'd look for an uncontroversial way to pursue his reform agenda.
He found it in consumer protection. Some of his early cases were
downright middling--one investigation focused on whether Pfizer
overstated the effectiveness of its lice-treatment products--but
others were bolder. Spitzer took the lead, for example, in a
multistate price-fixing suit alleging that CD manufacturers had
colluded with retailers to bilk consumers out of nearly $500
million.

Whatever the size of the case, though, Spitzer's approach was
reliably pragmatic. He staked out an aggressive position among the
18 state attorneys general suing Microsoft for anti-competitive
behavior shortly after entering office. But, when the Bush Justice
Department reached an agreement with the company after its
court-ordered breakup had been overturned, Spitzer led a group of
attorneys general who signed on over the bitter objections of their
more hard-line colleagues. "I stood to gain more by negotiating with
Microsoft if I could get something from them; whereas the other
argument was to litigate and ask for more and get nothing," Spitzer
says. "That's what happened to the litigating states."

Spitzer's centrist approach earned him the affection of conservative
editorial pages around the country. The Orange County Register even
held him up as an example to California Attorney General Bill
Lockyer, who, it complained, was "continuing his quixotic antitrust
attack on Microsoft Corp., with taxpayers picking up the legal
tab." But Spitzer's real innovation was to extend his pragmatic,
consumer-oriented approach beyond conventional consumer issues. "I
hear the derisive comments that somehow a consumer case is less
intellectually stimulating," he told me. "But I think we have
expanded the mandate of the office beyond that traditional image."
Perhaps the most significant of these cases involved General
Electric (G.E.). In the 1940s, two of the company's upstate
facilities began dumping a class of compound called polychlorinated
biphenyls, or PCBs, into the Hudson River. The federal government
finally banned PCBs in 1976, after research demonstrated that they
could be cancer causing in sufficient quantities. But by this point
there were already one million pounds of PCBs lying at the bottom
of the Hudson. Despite periodic prodding from environmental
activists and state and federal officials, G.E. never did anything
about them.

Enter Spitzer. In November 1999, he announced that the state was
suing G.E. over the PCBs. The move was fraught with risk. At the
time, the company stood at the very top of the business world, its
CEO, Jack Welch, held up as a hero of American enterprise. In this
context, few believed Spitzer would be able to paint G.E. as an
evil colossus out to harm the residents of upstate New York
(particularly since many of those residents actually worked for
G.E.). But, given the tenuous scientific evidence surrounding the
case, winning a claim based on the harm done to wildlife and human
beings would have required just that.

So Spitzer took another route altogether. He argued only that the
accumulation of PCB sediment in the Hudson had rendered parts of the
river impossible to navigate. Spitzer didn't even threaten the
company with a massive damage award. He simply asked G.E. to cover
the costs of the dredging.

The strategy proved to be inspired. Spitzer tapped a reservoir of
public support by casting the despoiling of the river as
essentially a consumer issue: Upstate businesses that depended on
the river were being deprived of its use. According to his
pollster, Jef Pollock, "[Spitzer's] numbers shot up upstate, where
it's really hard for a New York City person to become known." That
gave Spitzer a mandate to press on even after a federal judge ruled
that the suit couldn't go forward before the Environmental
Protection Agency (EPA) had studied the matter. And many observers
feel that Spitzer's pressure helped build momentum for the
dredging, which the EPA eventually ruled in favor of. "Some people
don't buy the health issue and the contamination-of-fish issue,"
says Rich Schiafo, a spokesman for the environmental group Scenic
Hudson. "Some of those same people said, `Yeah, part of the
economic engine of the Hudson has been damaged.'"

Given Spitzer's pro-consumer agenda, it's not surprising that he
suspected his office might have a role to play after the
spectacular meltdown of companies like Enron helped bleed investors
of billions of dollars. He found that role in July 2001, when a
Queens pediatrician named Debases Kanjilal won a surprising
concession from Merrill Lynch.

In January 2000, Kanjilal had instructed Michael Healy, his Merrill
Lynch broker, to take his daughter's college savings out of
name-brand stocks like America Online and Microsoft and invest them
in the speculative telecom sector. But, by May, the telecom stocks
had begun to tank. So Kanjilal did what any panicky investor would:
He called Healy and asked him to sell.

That didn't happen. Instead, Kanjilal said in an arbitration claim,
Healy encouraged him to ride out the dip. According to Kanjilal,
Healy would cite the bullish buy recommendation that Henry Blodget,
Merrill's star telecom analyst, had placed on the stocks. Kanjilal
also said that Healy once even claimed Blodget had personally
assured him that one stock, for a company called InfoSpace, would
recover to $100 per share from its then-price of $60. (Merrill
Lynch denies that Healy made these statements.) By the time Kanjilal
finally sold the InfoSpace stock in December, its share price had
plummeted to $11. His overall portfolio, once worth $1.2 million,
stood at a meager $95,000.

Not surprisingly, Kanjilal blamed Healy and Blodget for the losses
he racked up between May and December. "He felt he had been misled
by the top analyst at Merrill," says Kanjilal's lawyer, Jake
Zamansky. So Zamansky filed a $500,000 claim against Merrill with
the New York Stock Exchange, alleging that Blodget had been
pressured to talk up a loser like InfoSpace because Merrill's
investment-banking arm counted the company's parent as a client.
Merrill quickly caved and agreed to a $400,000 settlement before
the case even entered the arbitration phase.; "'Spitzer is a wild
man,' one Wall Street veteran recently complained to me. 'He can do
enormous damage.'"

The settlement sent tremors up and down Wall Street. According to
Brad Hintz, a longtime brokerage analyst at Sanford Bernstein, it
was not the $400,000 figure itself that was particularly
eye-opening. "The issue was the eighty cents on the dollar," he
says. Most settlements between clients and firms tend to hover at
somewhere between 40 and 60 percent of the reported loss. That
Merrill was paying 80 percent so early in the process seemed to
indicate the company had something to hide. Or, as Spitzer put it
to me, "There are two risks that a company faces in that
negotiation. One is the risk of not settling and going to trial and
having it all come out. The other is the risk of settling and
having the settlement amount be noticed. They took the latter
approach, hoping that it would disappear into the ether."

It didn't. Spitzer had already launched a preliminary investigation
into the way companies like Merrill were promoting stocks. But the
Kanjilal deal was like a bolt of lightening: By focusing on the
analyst/investment-banking relationship, Spitzer could highlight
the bill of goods investors had been sold without risking a much
cruder attack on Wall Street as a whole.

Of course, given Merrill's sterling reputation and vast legal
apparatus, the company wasn't about to roll over-- particularly in
the face of a challenge from a state official like Spitzer, whom
Wall Street considered out of his league. The main regulator of
financial markets, after all, is the federal Securities and
Exchange Commission (SEC). And, over the years, Wall Street firms
have developed a fairly cushy relationship with the commission. At
the very least, says Jacob Frenkel, a securities litigator and
former SEC enforcement lawyer, "Firms know where they stand with
the agency."

For the first six months of the investigation, Merrill's confidence
seemed well-placed: Spitzer made little progress, and the SEC was
nowhere to be found. But, in January 2002, Spitzer's investigators
stumbled onto e-mails in which Merrill's analysts privately derided
the very same stocks they were hyping to clients. Spitzer couldn't
believe his eyes when he saw the documents himself. "Get me the
damn e-mails! All of them," Spitzer told a top aide, according to
The Wall Street Journal. Before long, Spitzer's office had
subpoenaed 30,000 e- mails, which his lawyers spent the next
several months poring through. They'd amassed a damning pile of
evidence by the time they'd finished. In perhaps the most infamous
message, Blodget referred to one stock as "a piece of junk."
Another e-mail documented an exchange between an analyst and an
institutional investor who asked, "What's so interesting about [the
Internet company] GoTo except banking fees?" "Nothing," the analyst
replied.

Merrill Lynch now had a real problem, and it wasted little time
responding. The company brought in a partner from Skadden Arps,
Spitzer's one-time employer, to handle its negotiations with the
attorney general's office. It subsequently lobbied New York Senator
Chuck Schumer to intervene on its behalf. Merrill even hired former
New York Mayor Rudy Giuliani to remind Spitzer that the firm was a
vital part of the local economy and that it had returned to its Wall
Street headquarters as soon as possible after the September 11
attacks. Or, as Giuliani put it to the Journal, "Merrill is an
enormously important player in New York in the right sense."

But Merrill's lobbying campaign had almost no effect. For one thing,
Spitzer has little patience for special pleaders. Cramer, a friend
of Spitzer's from law school, is fond of telling a story about an
abortive plan to send a proxy to their third-year criminal
procedure class. "Eliot shamed me into going," Cramer recalls. "He
hates system gamers." Last year, Spitzer nearly came to blows with
California's Lockyer over $50 million left over from the states'
tobacco settlement, which he accused Lockyer of wasting on various
pet projects. (According to an article in The American Lawyer,
Spitzer, who preferred sending the money back to the states for
tobacco-related health initiatives, bellowed, "You want to step
outside, that's fine! I grew up in the Bronx!")

More importantly, though, Giuliani didn't need to remind Spitzer
that bringing Merrill to its knees would deal a blow to the city's
economy: Spitzer never intended to bring Merrill to its knees. Far
from seeing his investigation of Merrill as an assault on the firm,
Spitzer saw it as a way to save Merrill from itself, since
investors who repeatedly get bad information will eventually lose
confidence in the market and stop providing capital to businesses
altogether. This is a point Spitzer stresses repeatedly. In our
interview, he used the phrase "capital formation" at least four
times--as in, "ensuring that the investment banks continue their
function of facilitating capital formation, " and, "This is an
effort to improve upon the capital-formation structure to see that
it works."

But to do that Spitzer had to first convince Merrill that the
alternative to negotiating with him could be disastrous. So, on
April 8, Spitzer decided to play his hand, releasing the e-mails
and putting Merrill unambiguously on notice. "We are revealing
today evidence that demonstrates that Merrill Lynch's advice to the
investing public was fundamentally flawed and skewed," Spitzer told
a group of reporters. "The desire to generate more
investment-banking clients overwhelmed the obligation to provide
straightforward, honest analysis to the investing public, and the
internal e-mails from Merrill Lynch demonstrate that."

As it happened, Merrill was the perfect foil for Spitzer. Whereas
other Wall Street firms almost exclusively serve large,
institutional clients who don't rely on the firms' research anyway,
Merrill owes much of its reputation to its services for small-time
investors--the real consumers of analysts' research. Over the
years, Merrill has built one of the largest retail (i.e., small-
investor) businesses on Wall Street--about 30 percent of its
revenues, compared with about 15 percent for a higher-end firm like
Morgan Stanley. And, as participation in the market shot up during
the '90s--stock and mutual-fund ownership (excluding pension funds)
rose from 23 percent in 1990 to 46 percent by the end of the
decade--Merrill became a symbol of middle-class investing.
Commercials featured middle-class parents coaching their children's
soccer games while an announcer explained that their college
savings were safe and sound with Merrill Lynch. Wall Street
analysts even dubbed the firm "Mother Merrill."

All of which convinced Spitzer that the firm was particularly
vulnerable to evidence that it had misled its customers. "That's
the critical factor," he says. "An entity such as Merrill ... that
has a more expansive retail operation, that reaches farther out to
Main Street, is a different type of entity with a more vulnerable
consumer." It's also why the Merrill brass knew Spitzer had the
company dead to rights when he produced his evidence. Merrill's
chief executive, David Komansky, later acknowledged to The New York
Times that he "found it quite embarrassing" when he learned of
Spitzer's documents. He subsequently conceded to employees that the
firm's reputation had suffered and even apologized at a
shareholders' meeting a few weeks later. By late May, Merrill had
agreed to a $100 million settlement.

More significantly, the settlement forced the company to become a
kind of laboratory for reform. Spitzer argued that the reason
Merrill's research analysts spent so much time talking up lousy
companies was that they were compensated--like most analysts on
Wall Street--partly according to how many of these companies did
business with the company's investment-banking arm. So, as a
condition of the settlement, he insisted that the link between
analysts' compensation and investment-banking business be severed.

The most common criticism you hear from Wall Street is that Spitzer,
who's now wrapping up a similar investigation of Salomon Smith
Barney (a division of the financial conglomerate Citigroup),
doesn't know what he's doing. "Spitzer is a wild man," one Wall
Street veteran recently complained to me. "He can do enormous
damage." But the more you know about Spitzer, the more you realize
that what such critics mean isn't so much "damage" as "change." In
fact, Spitzer knows exactly what he's doing. A former law review
editor, he has a voracious appetite for detail--he frequently tries
his own cases, something unusual for a state attorney general--and
a hyperrational approach to reform. As Spitzer explained the
analyst/investment-banker issue to me, "It's difficult because it
poses theoretical issues about who needs research, how it's used,
how you pay for it, how the marketplace will get access to it. Good
people sharing common objectives could still disagree about what
the best formulation on that one is."

In the next couple of weeks, Spitzer and SEC enforcement chief
Stephen Cutler are expected to announce a "global settlement" that
will apply to all the major Wall Street firms and will, once and
for all, resolve those theoretical issues. Though the details are
still subject to negotiation, early reports suggest it will require
companies to subsidize independent research for their retail
customers--something that could cost as much as $1 billion over
five years--and to hire an internal "ombudsman" to see to it that
the research is distributed properly. The agreement will also use
the Merrill settlement as a benchmark for levying fines, which
could run into the hundreds of millions of dollars for firms like
Citigroup and Credit Suisse First Boston.

Increasingly, even people on Wall Street are grudgingly conceding
that Spitzer's efforts have been largely on target. There is ready
acknowledgement, for example, that analysts at Merrill and Salomon
breached the so-called "Chinese Wall" that's supposed to separate
research and investment banking. "The impression I have is that, in
their eagerness to increase market share, Blodget and, to a larger
extent, Grubman threw the rule book out," says one longtime Wall
Street lawyer.

Perhaps the more biting criticism comes from those who argue that
Spitzer has actually been too easy on companies like Merrill, which
he never forced to compensate investors. (There have been reports
that the global settlement being negotiated will require a modest
restitution fund for investors.) And, while Spitzer's $100 million
settlement with Merrill seems large, it is mostly symbolic, little
more than a pinprick for a company that earned $2.4 billion in
profits last year and will have no trouble withstanding even the $4
billion some estimate it will have to shell out in arbitration
claims and class-action suits over the next couple of years. "I
think $100 million is chump change for Merrill Lynch, and it's
almost a sign that the attorney general of the state of New York is
settling this much too easily," Boston University economist Allen
J. Michel told The Boston Globe in May.

But, however morally satisfying it might be to punish corporate
evildoers, there's little evidence that this is what the public
wants--particularly as a greater and greater percentage of that
public owns stocks. In recent years, a number of commentators,
mostly on the right, have written extensively about the political
implications of this phenomenon. The basic assumption is that
investors have a shared political philosophy that leads them to
favor limited government and deference to business. Since more and
more people are becoming investors, the argument goes, reflecting
that philosophy is becoming increasingly important for successful
politicians.

In some sense, the results of this month's elections confirm that
theory. In races where the Democrats' approach to the corporate
scandals was seen as retributive, the investing public--which is
increasingly the public itself-- largely favored their opponents.
In one Indiana swing district, for example, congressional candidate
Jill Long Thompson flatly accused her opponent, the chairman of a
local farm-equipment manufacturer, of epitomizing "corporate greed"
in a widely publicized campaign mailing. She lost by four
percentage points. Democrat Ronnie Shows fared no better in the
Mississippi district that WorldCom calls home. Shows spent much of
his campaign emphasizing WorldCom's shenanigans and scolding his
opponent for refusing to return the outsized campaign contributions
he'd received from the company. Voters would have none of it, going
so far as to boo Shows when he suggested in a public debate that
the election was about "jobs, greed, and trade." Shows lost by 29
points.

But Spitzer's victory suggests that investors do have some
interests--their interests as consumers--which only government can
protect. And, while it's true that the range of projects that can
be justified under the banner of consumer protection is less
ambitious than the range that can be justified in the service of
grander objectives, such as economic justice, many of those more
ambitious projects may not be politically feasible.

When I asked Spitzer whether he regretted not pressing Merrill Lynch
for large, punitive-damage awards, he was basically unapologetic.
"This is not a Robin Hood effort," he told me. Democrats who don't
want the growth of the investor class to mean the end of government
activism would be wise to learn that lesson.

share this article on facebook or twitter print this article