Commentary: Banking's Bigwigs May Be Beyond the Law's Reach

Making the charge of failure to supervise stick in court will be tough. But without top execs paying a price, Wall Street is unlikely to change its ways

Regulators have brought Wall Street's biggest banks to heel on charges that they published misleading stock research. But that's only half the battle. Even with a $1.4 billion payout in fines and restitution, Wall Street won't get the message that research and investment banking don't mix until individual analysts, bankers, and supervisors pay a penalty for ignoring their legal and ethical duties. "Without holding executives and CEOs personally accountable, I do not believe that Wall Street will change its ways," Senate Banking Committee Chairman Richard C. Shelby declared on May 7.

Investigators say they're delivering that message. They charged two of the 1990s' highest-flying analysts -- Henry M. Blodget, formerly of Merrill, Lynch & Co., and Jack B. Grubman, formerly of Citigroup (C ) Salomon Smith Barney unit -- with producing fraudulent reports. The analysts settled without admitting or denying the charges. In the next phase, the Securities & Exchange Commission, NASD, and state regulators are examining the behavior of up to two dozen individuals. The regulators won't name names, but their priority is examining the chain of command at the three banks that settled, without admitting or denying, charges of fraud: Merrill, Citi, and Credit Suisse First Boston. "We'll go as far up the chain as we can," says an investigator.

But that's unlikely to be far enough. That's because regulators will find it tough to thread together the legal requirements to bring charges against even conflicted analysts and their direct supervisors, let alone top executives.

Under federal law, securities execs have a duty to supervise most actions their firms take, by establishing policies to prevent rule violations and systems to catch offenders. The reams of e-mails, employee evaluations, and pitchbooks turned over to regulators show that, time and again, research was warped by the need to sell banking services to companies analysts covered.

So it would seem easy for either the SEC or NASD to charge managers who didn't enforce their firms' policies with failure to supervise -- a civil charge that carries a fine and can lead to banishment from the industry. Problem is, says a senior regulator, "the legal standards for supervision [charges] are not easy to meet, particularly as you get more layers away from the actual miscreant."

With Blodget and Grubman, regulators alleged fraud by showing a clear contradiction between the analysts' stock picks and their private opinions. And Citi execs were warned of conflicts: Michael A. Carpenter, who oversaw SSB, was warned by its head of global equity research in a December, 2000, memo that "there is legitimate concern about the objectivity of our analysts." Sources familiar with the probe say Carpenter is being investigated and could face failure to supervise charges. Citi and Carpenter refused to comment.

At Merrill, while Blodget shared his doubts about stocks with colleagues, investigators haven't yet released any e-mails or memos that warn his superiors that his ratings were skewed. While investigators are looking into the behavior of Andrew J. Melnick, Blodget's former boss at Merrill, who is now co-head of research at Goldman, Sachs & Co, that gap could make it hard to charge him. Melnick's attorney, Ira Sorkin, says he knows of "no actions, present or pending," against Melnick.

Top execs may be beyond regulators' reach. Citigroup Chairman and CEO Sanford I. "Sandy" Weill urged Grubman to review his negative rating on AT&T (T ). But New York State Attorney General Eliot Spitzer couldn't prove that his interest in a better rating for AT&T was insincere or a cynical grab for banking business -- after all, Weill serves on AT&T's board. So while Weill remains under investigation, regulators will have to stretch to make a case. Weill's attorney dismisses charges as "unimaginable."

Regulators know investors will be frustrated if Wall Street's onetime Masters of the Universe are unscathed. But common sense and the law often part company -- and in this case, the long arm of the law may well fall short.

By Mike McNamee

With reporting by Nanette Byrnes and Emily Thornton in New York

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