He's the Other Force in the Fund Investigation

back

He's the Other Force in the Fund Investigation

By Riva D. Atlas, The New York Times

December 27, 2003

Eliot Spitzer and David D. Brown IV were both in the class of '84 at Harvard Law School, but they moved in different circles. Mr. Spitzer was an editor of the law review; Mr. Brown joined a student organization that represented prisoners up for parole or disciplinary hearings.

The two men barely knew each other then. But now, nearly two decades after graduating from law school, they are collaborating on an investigation into mutual fund trading that has led to the biggest scandal ever to hit the $7 trillion mutual fund industry.

Mr. Spitzer is now the attorney general of New York. And Mr. Brown is the man he has put in charge of his Investment Protection Bureau, managing the investigation day to day and drafting lawsuits against some of the biggest names in the fund industry.

While Mr. Spitzer, 44, likes the limelight, Mr. Brown 45, comes across more as an academic than a politician. Their different personalities complement each other, said one person friendly with both men. ''Eliot is just a force of nature,'' the person said. ''He has immediate, visceral reactions to stuff. David is a check on Eliot's impulses.''

Mr. Brown started working for the attorney general's office last May after years as a Wall Street lawyer, most recently at Goldman Sachs, where he was a vice president and associate general counsel.

In an interview, Mr. Brown seemed a bit stunned at the pace at which the investigation was proceeding and the toll it was taking on some of the fund industry's biggest names. In a matter of weeks, top executives have resigned from Alliance Capital, Putnam Investments, PBHG, Strong Financial and other companies.

''It's like we tapped on the edifice and it crumbled,'' Mr. Brown said, shaking his head.

Mr. Brown oversees 15 lawyers based in the attorney general's office in Lower Manhattan. They are struggling not to become overwhelmed by the documents piling up as company after company steps forward and confesses its sins or rebuts the accusations. The office has announced eight suits or settlements involving companies or individuals since the beginning of September, and Mr. Brown said he expected many more in the coming months.

''From an investigator's perspective, it's an embarrassment of riches,'' he said.

Mr. Brown said he did not miss Wall Street, despite the lower pay and long hours of his new job.

''This is as intense as my work at Goldman, but it is qualitatively different,'' he said. Mr. Brown, the son of a corporate lawyer, added that he had ''always had an interest in public interest law'' -- an interest he traced back to the year he spent between high school and college living and working in a poor community in the Appalachians.

Gregory K. Palm, general counsel of Goldman Sachs, and Mr. Brown's former boss, said, ''I have to believe David is quite happy with what he is doing, because, with this investigation, he is making a difference.''

In some ways, Mr. Brown is the perfect person to take on the mutual fund industry. He is not an active investor, though he has some mutual funds through his old 401(k) plan at Goldman Sachs, and a small sum in the New York State retirement plan. Mr. Brown says he does not remember who manages the funds, and, in the middle of his office's investigation, is not inclined to check. (Other liquid assets, he said, are in a money market fund at Citibank.)

His previous job experience is also a plus. Few public prosecutors have a background in finance, said Carey R. Dunne, a partner at Davis Polk & Wardwell. ''David is steeped in this area of the law, and he knows how to interact with the S.E.C.,'' Mr. Dunne said, adding, ''You couldn't find a better fit if you went to central casting.''

Mr. Dunne is in a good position to know. Not only is he a friend of Mr. Brown from law school; he was the one who referred his friend to Mr. Spitzer -- and he now has clients caught up in the mutual fund scandal. Mr. Brown's background means that he comes across a lot of familiar faces as he goes about investigating some of the nation's largest investment firms.

After working for eight years as an associate at Davis Polk, a corporate law firm, and nine years as an in-house lawyer, first for Bankers Trust and then at Goldman Sachs, he knows many of the nation's white-collar defense lawyers.

At Bankers Trust, Mr. Brown helped resolve lawsuits relating to hundreds of millions in losses by bank clients from derivatives trades the bank arranged.

''I'm in the funny position of having hired these people'' at various times to represent Goldman or Bankers Trust, he said. ''I've seen a tremendous amount of legal horseflesh.'' He says he is able to put friendship aside and has never felt a conflict.

Mr. Brown started investigating mutual fund trading last spring on a hunch and a tip. Soon after he began working for Mr. Spitzer as a staff lawyer, he began looking at mutual fund fees, inspired by an academic study he had read.

''From Day 1, he was saying that mutual funds and the fees they scrape off from individual investors deserved a very hard look,'' Mr. Spitzer said.
In June, less than a month after Mr. Brown was drafting his first subpoena addressing fund fees, ''in a total coincidence someone came in with a tip related in a backhanded way to what I was looking at: tension between the mutual fund managers and the funds,'' he said. That informant has since been revealed as Noreen Harrington, a trader who, by coincidence, had also once worked at Goldman Sachs.

By the end of that month, Mr. Brown had sent out the first subpoenas to fund companies.

His investigation has focused on two types of trading at mutual funds. The first, late-day trading, involves trading in funds after the market has closed but with the trading being done at an earlier price. The other, known as market timing, is the rapid purchase and sale of shares of funds for short-term profit. Fund companies allowed certain investors to make these rapid trades, even when their prospectuses said they discouraged the practice.

''I find both kinds of trading reprehensible,'' Mr. Brown said, although he acknowledged that while late trading is clearly illegal, the legality of market timing ''is less black and white.''

He also acknowledged that the violations might seem somewhat abstract to the ordinary investor. But the harm inflicted on ordinary investors became clear to him, he said, when he examined the trading records of one mutual fund company in which a large hedge fund traded.

''There were 13 boxes of monthly statements,'' Mr. Brown said. He dipped his hand into one box, and pulled out one random statement, and was shocked by the frenetic activity. On one day, he said, citing a hypothetical example, the hedge fund might have invested $5 million in a mutual fund; the next day, the hedge fund would trade out of it, for an immediate profit of tens of thousands of dollars.

''It was then that I understood what was going on, and how gross and obvious it was,'' Mr. Brown said.

So far, Mr. Brown and his boss, Mr. Spitzer, have been talking tough about the penalties they will extract from the fund managers they, along with other regulators, are investigating. But given his Wall Street background, Mr. Brown is likely to be mindful of the impact his actions might have on the financial markets, said Melvin A. Yellin, formerly general counsel at Bankers Trust, where he was Mr. Brown's boss. ''He has the opportunity to use what he has seen on the inside of the financial services industry,'' he said.

It may come as some small comfort to anxious mutual fund executives that Mr. Brown also has some restless nights. Mr. Brown moved his family to a house near Albany, from Jersey City, when he started working at the attorney general's office there last May. But since being promoted in October to head the Investment Protection Bureau, he has spent three days a week in Manhattan.

On those nights, Mr. Brown must find a hotel that offers a discount to state employees. Since those rooms are filled up quickly, ''I can't go to the same one consistently,'' he said. He used to scramble late at night to find a place to stay, he said, but now he has put his secretary in charge of the task.