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In a Broker's Notes, Trouble for Salomon

By GRETCHEN MORGENSON

NY Times, September 22, 2002

Carol Halebian for The New York Times

Philip L. Spartis with some of the notes he took while he was a broker at Salomon Smith Barney

AS investigators pore over WorldCom, the telecommunications giant that collapsed in July, their work has increasingly become a study of the close and intricate relationship between it and its equally large financial partner, Citigroup.

The prosecutors, securities regulators and, more recently, Congressional committees trying to piece together that relationship have focused so far on why Citigroup's brokerage firm, Salomon Smith Barney, allocated a million shares of hot new stock offerings to WorldCom executives. They are trying to determine whether those allocations, which usually generated large, instant and virtually risk-free profits, were given in exchange for investment banking assignments from the company.

But new evidence suggests problems in other areas of the Citigroup empire's relationship with WorldCom, while further illuminating those that have already come to light.

A lawsuit filed by a former high-level broker in Salomon's office in Atlanta indicates that different, ostensibly independent, businesses within Salomon shared significant information about WorldCom employees' investing plans, putting Salomon in a position to profit at the expense of those customers. Notebooks and diaries kept by the broker also contain more examples of how Salomon's star research analyst, Jack B. Grubman, served as a nexus through which privileged information flowed between telecommunications companies and Salomon, and among nominally distinct units within Citigroup.

The notes also show the potential conflicts of interest that can arise at huge financial conglomerates and the perils that consumers may face when they entrust these companies with control over many aspects of their lives.

The lawsuit was filed last week by Philip L. Spartis, who handled the WorldCom employee stock option plan and the accounts of many top WorldCom executives and officers. His notes, which fill seven spiral notebooks and three calendars, detail the daily conversations he had with clients and with other Salomon employees from 1997 to 2001. Salomon fired him this year for what it called job abandonment.

Mr. Spartis and Amy Elias, a broker who worked with him, are suing Citigroup for wrongful termination. Mr. Spartis handed over his notebooks last week to Eliot Spitzer, the New York attorney general, who is investigating whether Mr. Grubman's role as a close adviser to Salomon's telecommunications clients colored his research coverage of them and encouraged him to be too upbeat about the companies for too long.

The extent of the association between WorldCom and Salomon may also get a fresh look in Congress as some lawmakers question whether eliminating barriers between investment banks and commercial banks in 1999 was good for consumers. Representative John J. LaFalce, a New York Democrat and the ranking minority member on the House Financial Services Committee, has asked the committee chairman to investigate whether conflicts between the banking and investment advisory arms of Citigroup and other banking behemoths put clients at risk.

"What is striking is how many pages of detail there are" in the notebooks, said Jeffrey L. Liddle, a lawyer representing Mr. Spartis in his suits against Salomon. "It tells you that the 18 pages that Salomon produced to the House Financial Services Committee was inadequate. If one guy out of the entire system has this in his daily notebooks there's a lot of other information that has yet to be turned over and reviewed."

A Salomon spokeswoman said, "Though we have not yet seen this newest claim, his numerous past claims have been without merit." She refused to comment on specifics or to make executives available.

Mr. Spartis may also shed light on the symbiotic dealings of WorldCom and Salomon. He managed the accounts of Scott D. Sullivan, the former WorldCom chief financial officer who was indicted Aug. 1 in the multibillion-dollar accounting scandal at the company, for example. He also managed the account of Stiles A. Kellett Jr., a WorldCom director who is under fire for his role in approving a $400 million loan the company made to its chief executive, Bernard J. Ebbers, who has since resigned.

PERHAPS the most intriguing entries in Mr. Spartis's diaries involve the administration of WorldCom's stock option plan, particularly at the end of 1999.

WorldCom issued millions of stock options to its executives and employees each year, and as WorldCom's stock climbed in the late 1990's, they exercised millions of options every year. In 1998, for example, WorldCom employees bought 49 million shares using options, about 5 percent of the shares outstanding. In 1999, employees exercised options on an additional 61 million shares.

Salomon was the only brokerage firm that WorldCom's employees could use to exercise their options. In 1999, Salomon gave Mr. Spartis a plaque for managing the WorldCom plan, which generated more revenue that year than any other at the firm. Over the four years before he was fired, he generated $2.3 million a year, on average, in gross commissions.

Salomon administers stock option plans for more companies than any other Wall Street firm, according to stock plan specialists. Its recent clients have included AT&T, Verizon Communications, Tyco International, Toys "R" Us, Compaq, and Electronic Data Systems.

Under WorldCom's plan, the annual vesting date for options — when employees could exercise their right to buy WorldCom shares at a discount — was the first day of trading in January. Advance knowledge of how many WorldCom employees had arranged to exercise their options and immediately sell their shares was a potentially valuable piece of information. Someone who knew that a lot of stock would be for sale, for example, could have profited handsomely (and virtually risk-free) by borrowing shares and selling them in anticipation that the big sale by employees would drive down the price. When stock fell, the so-called short-seller could buy back shares at lower prices, return the borrowed stock and pocket the difference.

On the other hand, if someone knew that most employees planned to exercise their options and keep the shares, the resulting flood of buy orders would drive up the stock price. Traders who knew such a flood was coming could profit by buying shares in December and selling them when the price spiked in January.

Mr. Spartis recalled a conference call at the end of 1999 in which Michael Santomossimo, an employee in Salomon's stock option administration group in New York, suggested that they give Michael P. Molnar, then managing director of global retail sales and trading, a "heads up" about the number of options that would be vesting.

"It seemed very routine for him to do this," Mr. Spartis said. "Santomossimo told Molnar that we have a major vesting coming up. Molnar asked how many WorldCom options would be vesting and how many orders to sell were in the electronic queue." Such information is not available publicly.

"I told him I didn't have those numbers off the top of my head," Mr. Spartis recalled. "And I thought, `I wouldn't tell you if I did.' " To Mr. Spartis, giving away such information meant that the firm's trading desk could be in a position to profit at the expense of his customers because shorting the stock could exaggerate any declines and selling into a rally could blunt the gain. In industry parlance this is known as "front running," or trading ahead of customers, and is forbidden by the Securities and Exchange Commission and by Salomon's own code of ethics.

Although Mr. Spartis declined to share the information with others at Salomon, he recalled, Mr. Santomossimo said he could provide the figures Mr. Molnar wanted. The three men made a date to talk again before the market opened on Jan. 3, 2000.

Mr. Spartis said that before the market opened that day there were several conversations about the hundreds of thousands of shares waiting to be sold. One involved whether to execute each order individually and give WorldCom employees the actual prices at which the trades occurred or to bunch up all the orders and give all the sellers the average price received for those large sales. Mr. Molnar, the New York executive, decided to group the shares and put an average price on them, Mr. Spartis recalled. "I was given one price and every trade was assigned that price," he said. WorldCom shares rose after the trades were executed in batches, Mr. Spartis recalled. This could have indicated that a large short-seller had closed out his position.

"Should the trading desk have had that information?" asked William Fleckenstein, a money manager at Fleckenstein Capital in Seattle. "My guess is probably not. If they used it to get a better execution for the customer, God bless 'em. But if they used it to profit for the firm disproportionately, it's wrong."

A study of the prices that WorldCom employees received on their trades may be worthwhile and would indicate whether the employees received good executions.

Mr. Spartis recalled that he was disappointed in the prices at which many of his customers' trades were executed. "For larger trades, the executions were sloppy, delayed, away from the market at times and embarrassing," he said. "When we would challenge the traders, they wouldn't do anything about it." He also remembered that on many occasions "the stock would take off" after options were exercised.

Administering stock option plans is not always profitable, but firms want the business because it brings in customer assets that can earn fees when invested elsewhere. To woo clients, the biggest brokerage firms often underbid the transfer agents, who used to manage the plans but not the assets generated as a result.

According to Mr. Spartis, after Salomon won the exclusive right to WorldCom's stock option administration, the firm encouraged its brokers to offer clients mortgages that used the stock they held in their accounts as collateral. "I'm sure people have lost their homes," Mr. Spartis said. "The firm's objective seemed to be to get every dollar from every corner there was."

Salomon also became much more lax in approving loans for people who wanted to buy more stock than they had the money for, Mr. Spartis said. "Prior to the bubble, margin loans had to be preapproved before you could commit to the client," he said. "There were three approval levels that margin loans had to go through where compliance people considered suitability. But later, our margin loans were processed without any questions."

During the boom years at WorldCom, in the late 1990's, Mr. Spartis earned enough money to put him in the top ranks of Salomon's brokers. But his fortunes began to fall with those of his clients at WorldCom when that company's stock began to plummet in the fall of 2000. Several WorldCom employees who were his clients eventually sued him, contending that they borrowed money from Salomon to exercise stock options and then lost millions when they held onto the shares as they fell. Most of the suits have been dropped in recent months, but Mr. Spartis has filed third-party suits against Mr. Grubman, contending that Mr. Grubman's unceasing promotion of WorldCom shares was responsible for many clients' losses.

Many entries in Mr. Spartis's notebooks relate to Mr. Grubman's upbeat comments over the years about the telecommunications companies he followed as Salomon's most powerful analyst. Anytime Mr. Grubman spoke on the firm's internal communications system, Mr. Spartis took notes.

Other entries confirm that Mr. Grubman also had a role at Salomon that would not be viewed as traditional for a research analyst. For instance, in August 1999, Mr. Spartis recorded a conversation he had with Mr. Ebbers's personal chief financial officer. Mr. Spartis quoted him as saying that Mr. Grubman had recommended that Mr. Ebbers deal with Rick Olson, a private client broker in Salomon's office in Los Angeles. Analysts do not usually give personal advice to or solicit business from the executives of companies they are responsible for analyzing; to do so gives the appearance of a conflict of interest.

Another series of conversations shows that telecommunications executives hoping to raise money on Wall Street did indeed need to court Mr. Grubman. In August 1998, for example, Mr. Spartis introduced executives at EconoPhone, a small, private telecommunications concern based in Paramus, N.J., to investment bankers at Salomon to discuss a public offering of EconoPhone's shares. After a meeting among EconoPhone executives, Salomon bankers, Mr. Grubman and Robert Waldman, a debt analyst at the firm, the broker's notes indicate, Mr. Grubman rejected the idea of an offering. According to Mr. Spartis's conversation with one of the bankers at the meeting, Mr. Grubman said EconoPhone was not a good candidate because it had "limited bandwidth."

Mr. Grubman made the right call on EconoPhone, as it turned out. Morgan Stanley did the underwriting in May 1999. EconoPhone, which has since changed its name to Destia and merged with Viatel, filed for Chapter 11 bankruptcy protection two years later.

MR. SPARTIS'S dealings with WorldCom executives also provide a glimpse into how that company was run. In 1997, for example, after Mr. Spartis won WorldCom's employee stock option plan for Salomon, he tried to persuade the company's executives to set up a deferred compensation plan that the firm would manage.

But according to Mr. Spartis, Mr. Sullivan, the WorldCom chief financial officer, rejected the idea because such a plan required the use of a so-called rabbi trust, which makes the officers of a company liable if the company goes bankrupt. "Scott said if we can do it without a rabbi trust we might think about it," Mr. Spartis recalled. "It was kind of disturbing to me, talking about bankruptcy and WorldCom in the same sentence in 1997."

WorldCom filed for bankruptcy protection in July, shortly after it disclosed $3.8 billion in accounting misstatements stretching back to 1999. Since the filing, the company has uncovered an additional $3.2 billion in accounting irregularities. Mr. Sullivan was indicted on fraud charges in the case in August. 

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