By taking on the powerful financial services industry that's headquartered just steps from his offices in Lower Manhattan, New York State Attorney General Eliot Spitzer has emerged as the most aggressive shareholder advocate in recent memory. He's both the people's lawyer and the most disliked person on Wall Street. Just weeks after announcing a sweeping inquiry into the mutual-fund business and two days after indicting the first alleged wrongdoer, Spitzer sat down with Editor-in-Chief Stephen B. Shepard on Sept. 18 as part of the Captains of Industry series at New York's 92nd Street Y.
How optimistic are you that we have really changed the way business is done on Wall Street?
We've gone through a crisis of accountability that spanned many sectors; it was not merely Wall Street. It was government. It was not-for-profits. It was religious institutions. It was even the media. We have seen failures of governance that, to a certain extent, reflected a larger societal issue, a dislocation, a disjunction between people being put in positions of authority and their understanding of their fiduciary duties.
Now, having gone through this series of scandals, I believe there has been a fundamental change that will last for some time. For one thing, the consequence of the publicity that has attended all the scandals has shamed those who were in positions of governance to reconsider their behavior. As a consequence, boards of directors are acting in a very different manner today than they were two years ago.
In the Wall Street research investigations, why didn't you try to send anybody to jail?
When we diagnosed what was going on with respect to the research problem, [we saw] that a business model had become accepted by all of the Wall Street firms. The model had integrated research and investment banking, which led to subjugation of research to investment banking and the complete loss of integrity of research. The rules had become so ambiguous and the lack of enforcement of rules of fiduciary duty and integrity had become so pervasive that everybody was playing improperly. The rules themselves needed to be changed.
Changing the rules in midstream and going to the investment banks and saying, "We are now writing a new set of rules for you to play by," in a way undercut the validity of subsequent criminal cases. There is something problematic about saying, "We're changing the rules, but because you're playing by the old rules, we're sending you to jail." The rules should have been changed before by other enforcement entities, but that's a separate issue.
Now fast forward to the mutual fund context, where the rules are unambiguous, where what we call late trading is clearly defined as being a criminal wrong and a civil wrong. That has led to one criminal charge, and there is a good possibility there will be a significant number of other charges.
Did you ever think seriously that somebody like Sandy Weill would be indicted?
I don't want to personalize this to Sandy, so let me tell you how we viewed every case. We examined every fact pattern to determine whether an individual and/or an institution had knowingly disseminated research that that institution or that individual did not believe to be true. We asked: "Can we prove that those who distributed the research, those who authored it, didn't believe it, and that they were writing and crafting this research for an ulterior motive because of the conflicts of interest?"
We considered [indicting a major bank] but determined that even though its behavior had been highly improper and theoretically criminal, the wiser course for the marketplace, for investors, for the economy, was to get agreement about a set of rules, prospectively have a huge restitution effort that is ongoing, and then go forward.
One particularly egregious case was the Enron (ENRNQ ) off-balance sheet partnerships and their bankers. In this instance, there was no admission of guilt, no jail time, only fines. This is not your case, but what do you think about it?
I have a policy of not passing judgment on other prosecutors' resolutions. But having said that, I said forthrightly to the CEO of a major institution: "Understand something. You, collectively -- as institutions, as CEOs -- to a certain extent were given a pass in the past year or two. It was said to you, 'the collateral consequences to our economy, to thousands of employees, of bringing criminal actions against your institutions are so vast that we decided not to do so,"' and hence settlements such as the one you just described. I said: "Those days are over. If you have not yet learned the lesson, my tolerance and the tolerance of others who make this determination to give you the pass next time is diminished to zero."
You were not in favor of indicting the entire firm of Arthur Andersen, which subsequently went out of business.
The consequence of indicting Arthur Andersen was we went from five major accounting firms to four, and 60,000 people were thrown out of work. The indictment was predicated on destruction-of-evidence charges. That destruction of evidence was criminal. However, there was no corporate-wide policy to destroy evidence. Therefore, I felt that if you're going to indict the entire company and destroy the company, do it for a policy that went to the core of its business.
If you could prove that fundamentally Arthur Andersen was deceptive with its audit practices, then they deserved to be indicted. But because a small core of individuals destroyed some evidence, that did not speak to corruption throughout the entire company, and should not have been a sufficient predicate for destroying the entire company.
There are all kinds of concerns with mutual funds other than after-hours trading. Is this just the tip of the iceberg?
We don't know quite what the dimensions of this problem are, although I will tell you that it is radiating out at a surprising and discouraging pace, meaning that there are other funds being implicated.
From an investor's point of view, the concerns are about excessive fees, poor disclosure of fees and trading costs, poor governance. Are you going to get into those things?
We might take a look at those issues, but governance issues may not be violations of law but issues of good and bad practice. That is where the Securities & Exchange Commission properly would say "here are the governing standards we expect you to live up to." It may be legal but poor practice.
Where do you draw the line about what the SEC's responsibility is and what the state attorney general's is?
I have always agreed that we need uniformity in terms of the rules that dictate how our capital markets function. We do not want balkanization. That would be bad for capital formation, bad for investors, bad for the economy.
Having said that, enforcement has always been distributed among various layers of government. We have federal, state, and local enforcement. That has been the case since the early part of the last century. In fact, the New York State securities laws preceded the federal laws by a good decade. We have had this duality of enforcement for the past 80 or so years without confusion or dislocation. Point to an instance where there has been an absence of uniformity or where the capacity of states to enforce state securities laws has led to an unfortunate consequence in the capital markets.
We have just been through this situation with the New York Stock Exchange and Dick Grasso.
What needs to be resolved are the governing problems at the NYSE. The NYSE is, and hopefully will continue to be, the preeminent exchange that major companies want and have to be traded on. It lends vitality to our economy.
Do you think regulatory oversight of the New York Stock Exchange should be separated from the exchange itself?
Has that interweaving of the two functions led to a failure of regulation? Yes. So must the two somehow be separated to ensure the integrity of each? Absolutely.
[In general] I have been very critical of the self-regulatory organizations, both the NYSE and the NASD, for their failure to confront some of the structural problems. Articles have been written about the failure of research and the subjugation of research to investment banking, yet the SROs did nothing about it.
You have to believe that this was because the SROs were controlled. Their boards were dominated by the very entities that would have been subject to that regulation. So clearly that model is flawed. Something has to be done about it. The SEC is looking at that and looking at it very aggressively.
Are you concerned that in a bid to address corporate corruption, the government through Sarbanes-Oxley has made oversight too stringent?
Absolutely. The concern relates to the unintended consequences of well-meaning statutes....Sarbanes-Oxley may go too far. I hear complaints all the time from executives, from lawyers, that too much time is being wasted on ministerial activity. We have to see how it plays out. There will be time to change it, but we're worried about that.
What do you think about the future of hedge funds?
There was a fair bit of noise about hedge funds offered to short-sellers, and everybody said: "Short-sellers are bad. Therefore, regulate them." I don't buy that logic. Short-selling is healthy in the marketplace when it is based upon honestly held beliefs. Indeed, it was the short-sellers who first revealed the problems at Enron -- a bunch of hedge funds that did good, solid research that said: "Wait a minute. Enron is a house of cards." And they began to short-sell and educated the rest of the investing public. That is good.
As hedge funds are made available to a broader base of our society, and as the definition of sophisticated investor -- which is the sort of threshold you have to overcome to participate in a hedge fund -- is relaxed, greater disclosure will and should be required of hedge funds. But hedge funds serve a useful function.
In light of the Iraq war and the faltering economy, will corporate ethics receive the attention they deserve in the coming Presidential election?
[The issue] has received more attention than I ever thought it would. The day before we announced the initial case against Merrill Lynch & Co. last April, I said: "Well, this will be an interesting story for a day or two." I never dreamt it would touch a nerve in the public psyche, as all the other scandals have. The public cares deeply because [it] is invested. Elected officials, as a consequence, will care.
Now that we're on a political subject, how do you get along with [New York State] Governor George Pataki?
He's a bright individual with whom I disagree on certain policy issues, but I have made it my practice to disagree primarily in private. On the other hand, where there are theoretical disagreements, I will occasionally articulate them, such as I have recently with respect to energy and education policy. Over time, there will be more.
How do you feel about his raising money for [House Majority Leader] Tom DeLay?
I'm not going to say he can't exercise his First Amendment rights to do that, but boy, I haven't seen Tom DeLay doing anything terribly good, either for the city or the state. Along the political spectrum, Tom DeLay seems to be rather far from where I think most of us are. So I'm not sure why he's doing it. But it's his choice. You won't find me doing it.
What would you like to do next?
What am I doing in 2006? I don't know. I have said, and I will repeat it like a mantra: I am considering whether to run for governor down the road. I hopefully will have spent eight successful years as attorney general. I will make the determination in a year or so. But until then, having just been reelected, my one job is to do this job as best I can.
For a video version of this interview with New York State Attorney General Eliot Spitzer, go to BusinessWeek Online's Media Center