Litigation Release No. 18111 / April 28, 2003
Securities and Exchange Commission v. Citigroup Global Markets Inc., f/k/a Salomon Smith Barney Inc., 03 CV 2945 (WHP) (S.D.N.Y.)
Securities and Exchange Commission v. Jack Benjamin Grubman, 03 CV 2938 (WHP) (S.D.N.Y.)
SEC SUES CITIGROUP GLOBAL MARKETS, FORMERLY KNOWN AS SALOMON SMITH BARNEY, AND FORMER RESEARCH ANALYST JACK B. GRUBMAN FOR RESEARCH ANALYST CONFLICTS OF INTEREST
FIRM TO SETTLE WITH SEC, NASD, NYSE, NY ATTORNEY GENERAL, AND STATE REGULATORS; GRUBMAN TO SETTLE WITH SEC, NASD, NYSE, AND NY ATTORNEY GENERAL
The Securities and Exchange Commission announced today that it has settled charges against Citigroup Global Markets Inc., formerly known as Salomon Smith Barney Inc. ("SSB"), a New York-based brokerage firm and investment bank, arising from an investigation of research analyst conflicts of interest. This settlement, and settlements with nine other brokerage firms, are part of the global settlement the firms have reached with the Commission, NASD, Inc., the New York Stock Exchange, Inc. ("NYSE"), the New York Attorney General, and other state regulators. As part of the settlement, SSB has agreed to pay $150 million as disgorgement and an additional $150 million in penalties. One-half of the total of these payments - $150 million - will be paid in connection with the SEC action and related proceedings by the NASD and NYSE and will be placed into a distribution fund for the benefit of customers of the firm. The remainder will be paid to resolve related proceedings by state regulators. In the SEC action, SSB has agreed to a federal court order that will enjoin the firm from future violations of the federal securities laws and NASD and NYSE rules and require the firm to make changes in the operations of its equity research and investment banking departments. In addition, SSB will pay, over five years, $75 million to provide the firm's clients with independent research, and $25 million to be used for investor education.
The Commission also announced today that it has settled charges against Jack B. Grubman, formerly a research analyst at Salomon Smith Barney, arising from an investigation of his research on companies in the telecommunications ("telecom") sector. As part of the settlement, Grubman has agreed to pay $7.5 million as disgorgement and an additional $7.5 million in penalties. One-half of the total of these payments - $7.5 million - will be paid in connection with the SEC action and related proceedings by the NASD and NYSE and will be placed into the distribution fund that will be created pursuant to the Final Judgment against SSB. The remainder will be paid to resolve related proceedings by the Office of the New York Attorney General. Grubman also has consented to be barred from associating with a broker, dealer, or investment adviser.
In connection with these matters, the Commission today filed separate Complaints against SSB and Grubman in the U.S. District Court for the Southern District of New York, alleging direct and aiding-and-abetting violations of the federal securities laws and NASD and NYSE rules. According to the Commission's Complaints, from 1999 through 2001, research analysts at SSB - including Grubman - were subject to inappropriate influence by investment banking at the firm. The Complaints also allege that SSB and Grubman published false or misleading research reports and published research reports that were exaggerated, unwarranted, or lacked a reasonable basis. The Complaint against SSB further alleges that the firm engaged in "spinning" of hot initial public offering ("IPO") shares to executives of investment banking clients, and failed to maintain appropriate supervision over its research and investment banking operations.
Specifically, the Commission's Complaints allege that:
- Research analysts at SSB were expected to promote SSB's investment banking business to issuers during "pitches" and to market investment banking deals to the firm's customers. When SSB secured investment banking business, research analysts were expected to provide favorable coverage of SSB's investment banking clients. Investment banker evaluations and investment banking revenues generated in an analyst's sector were important factors in evaluating an analyst's performance and determining his or her compensation. These business practices created a culture in which investment bankers could and did pressure research analysts to maintain coverage or favorable ratings for investment banking clients and created the incentive for analysts to use research to obtain, retain, and increase revenue from investment banking deals. SSB failed to manage the conflicts created by its practices.
- Grubman was one of the most prominent analysts on Wall Street and the linchpin for SSB's investment banking efforts in the telecom sector. During 1999-2001, SSB earned approximately $790 million in investment banking fees from companies in the telecom sector. Between 1999 and August 2002, when he left the firm, Grubman's total compensation exceeded $67.5 million, including his multi-million dollar separation agreement.
- SSB and Grubman published certain fraudulent research reports on two of the firm's telecom investment banking clients, Focal and Metromedia Fiber Networks, Inc. These reports were contrary to the true views that Grubman and another analyst on his team privately expressed, presented an optimistic picture that overlooked and minimized the risk of investing in these companies, predicted substantial growth in the companies' revenues and earnings without a reasonable basis, did not disclose material facts about these companies, and contained material misstatements about the companies.
- On February 21, 2001, Grubman issued a note on Focal that "reiterated" a 1 (Buy) recommendation and left the target price unchanged from $30 (approximately twice the stock price of $15.50). The company, however, apparently complained about the note. When Grubman heard about 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 f----g 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.
On the same day, 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, "Focal definitely . . . ." Later, in an April 18, 2001 e-mail, Grubman stated the need to downgrade Focal, among other companies. Nevertheless, he issued a note on April 30, 2001 that again advised investors to buy Focal. Neither the February 21 note nor the April 30 note disclosed the actual views of Grubman and his colleague regarding Focal.
- Like Focal, Metromedia Fiber was an investment banking client of SSB. In early 2001, the company entered into an agreement with Citicorp USA, Inc. (a 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 Grubman issued on Metromedia Fiber 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 June 28, 2001. For these reasons, the notes dated April 30, 2001, June 6, 2001, and June 28, 2001 were fraudulent and misleading.
- On February 21, 2001, Grubman issued a note on Focal that "reiterated" a 1 (Buy) recommendation and left the target price unchanged from $30 (approximately twice the stock price of $15.50). The company, however, apparently complained about the note. When Grubman heard about the complaint, he e-mailed two investment bankers:
- In April 2001, Grubman expressed a need to downgrade six telecom companies: Level 3 Communications, Inc., Williams Communications Group, Inc., XO Communications, Inc., Focal Communications Corp., Adelphia Business Solutions, Inc., and RCN Corporation. Investment bankers pressured Grubman not to downgrade these companies, and Grubman did not. He continued to advise investors to buy these stocks and did not disclose the influence of investment bankers on his ratings.
- In late November 1999, Grubman upgraded AT&T Corporation from a Neutral (3) - his longtime rating on the stock - to a Buy (1). SSB and Grubman did not disclose in the report that Grubman had a conflict of interest relating to his evaluation of AT&T or that his objectivity had been compromised. Prior to the upgrade, Sanford I. Weill, the co-CEO and Chairman of Citigroup (and a member of the AT&T board of directors), had asked Grubman to take a "fresh look" at AT&T. Thereafter, during the time that Grubman was conducting his "fresh look" at the company, Grubman had asked Weill for assistance in gaining admission for his children to the selective 92nd Street Y preschool in New York City. After Grubman upgraded AT&T and his children had been admitted to the preschool, Grubman stated privately that he had upgraded AT&T to help his children get into the 92nd Street Y preschool.
- 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 a person affiliated with SSB who served as a director of another company and a SSB research analyst covering that company.
- SSB, in a practice known as "spinning," provided preferential access to 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. 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.
- Finally, SSB failed to establish and maintain adequate procedures to protect research analysts from conflicts of interest from its investment banking operation. SSB failed to supervise adequately the activities of its research analysts and failed to respond to indications that its research was misleading. SSB also failed to supervise adequately its employees engaged in spinning.
SSB has agreed to settle the Commission's action and has consented, without admitting or denying the allegations of the Complaint, to the entry of a final judgment that, if approved by the court, permanently enjoins SSB from violations of antifraud provision Section 15(c) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 15c1-2 thereunder, Section 15(f) of the Exchange Act, Section 17(a) of the Exchange Act and Rule 17a-3 thereunder, and NASD and NYSE rules pertaining to just and equitable principles of trade (NASD Rule 2110; NYSE Rules 401 and 476), advertising (NASD Rule 2210; NYSE Rule 472), broker-dealer record keeping (NASD Rule 3110; NYSE Rule 440), and supervisory procedures (NASD Rule 3010; NYSE Rule 342). The final judgment also orders the firm to make the payments described above, and provides for the appointment of a fund administrator who, subject to court approval, will formulate and administer a plan of distribution for those monies placed into the distribution fund.
Grubman has agreed to settle the Commission's action and has consented, without admitting or denying the allegations of the Complaint, to the entry of a final judgment that, if court-approved, permanently enjoins him from aiding and abetting violations of Section 15(c) of the Exchange Act and Rule 15c1-2 thereunder, and from violating NASD and NYSE rules governing just and equitable principles of trade and advertising. The final judgment also orders him to make the payments described above, and provides that the amount he pays as disgorgement will be added to the SSB distribution fund. Grubman also has agreed to settle administrative proceedings that will be instituted by the Commission based upon the entry of the final judgment by consenting to the issuance of a Commission order that permanently bars him from associating with any broker, dealer, or investment adviser.
In addition, the final judgment against SSB orders SSB to implement structural reforms and provide enhanced disclosure to investors, including a broad range of changes relating to the operations of its equity research and investment banking operations. SSB has agreed to sever the links between research and investment banking, such that: research and investment banking are physically separated with completely separate reporting lines; analysts' compensation cannot be based directly or indirectly upon investment banking revenues; investment bankers may no longer evaluate analysts; investment bankers will have no role in determining what companies are covered by the analysts; and research analysts will be prohibited from participating in efforts to solicit investment banking business, including pitches and roadshows. In addition, SSB must disclose on the first page of each research report whether the firm does or seeks to do investment banking business with that issuer, and when SSB decides to terminate coverage of an issuer, SSB must issue a final research report discussing the reasons for the termination. Each quarter, SSB also will publish on its website a chart showing its analysts' performance, including each analyst's name, ratings, price targets, and earnings per share forecasts for each covered company, as well as an explanation of the firm's rating system.
SSB also has agreed as part of this settlement to retain, at its own expense, an Independent Monitor to conduct a review to provide reasonable assurance that the firm is complying with the structural reforms. This review will be conducted eighteen months after the date of the entry of the Final Judgment and the Independent Monitor will submit a written report of his or her findings to the SEC, NASD, and NYSE within six months after the review begins. Five years after the entry of the final judgment, SSB must certify to the SEC and other regulators that it has complied in all material respects with the requirements and prohibitions of the structural reforms.
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The Commission acknowledges the assistance of NASD, NYSE, the Office of the New York Attorney General, and other state regulators in the investigation of this matter.
SEC Complaint in this matter (Citigroup Global Markets)SEC Complaint in this matter (Jack B. Grubman)SEC Final Judgment in this matter (Citigroup Global Markets)SEC Final Judgment in this matter (Jack B. Grubman)Final Judgment Appendix A (PDF)Final Judgment Appendix B (PDF)Consent (Citigroup Global Markets) (PDF)Consent (Jack B. Grubman) (PDF available)