February 2004

by Jon Entine

Eliot Spitzer has been accused of launching "a regulatory reign of terror" on the US financial services industry. Jon Entine investigates the terror of Wall Street

In politics and business, you can judge your effectiveness by the decibel level of your critics. Forbes magazine, notorious for its wink and nod version of Wall Street journalism, calls him a hypocrite engaged in a "witch hunt." He's been variously described and oftentimes derisively dismissed as a "sheriff", a "crusader," a "grandstander," "self-serving," a "zealot," the "Rambo Regulator", and shame of all shame, "politically ambitious."

Well, if that's true, let's ask for more of the same. If New York Attorney General Eliot Spitzer is merely an opportunist, as his detractors insist, it may be the fault of the financial community and federal regulators for providing him with the opening.

In case your head has been in the sand, Spitzer is currently shaking up of the $7 trillion U.S. mutual fund industry. Top officials at Putnam Investments, Alliance Capital Management, Pilgrim Baxter & Associates, and Strong Mutual Funds have been forced out or to step down. The still-unfolding probe­­Spitzer has sent letters of inquiry to more than 200 mutual funds, over 75 percent of the industry—is just the latest in a series of triumphs for the 44-year-old prosecutor.

Spitzer, re-elected in 2002 with a stunning two-thirds of the vote, has gone after General Electric for polluting New York's Hudson River, sued power companies in the Midwest for causing acid rain and even taken on Korean grocers for not paying the minimum wage. His campaign against corporate corruption accelerated when he forced the nation's largest investment firms, including Merrill Lynch, Morgan Stanley and Citigroup, to pay more than a billion dollars in fines for putting out fraudulent investment advice. Here's a man who tilts at windmills and wins. In this age of Parmalat and Enron, where some of the world's top financial and accounting institutions looked the other way or themselves have their hand in the cookie jar, it's refreshing to find a law enforcement official who takes his public responsibilities seriously.

It's tough for hard-boiled capitalists to trash someone whose investigations are helping ensure a more efficient functioning of capitalism, but that hasn't stopped Spitzer's reflexive critics from trying. The Wall Street Journal editorial page, among others, has attacked him as a loose canon for supposedly usurping the responsibilities of federal regulators and pursuing an ideological agenda that, while popular with the anti-big business crowd, will have unintended consequences and open the legal door to demagogues.

Spitzer's tart response: "The system was rotten, and no one seemed interested in fixing it, so we moved in." Spitzer, who leads a brash and lean team of only 15 lawyers, has so far thumbed his nose at the critics and firmly established a populist crusade on behalf of the average investor. He's one administrator who has the guts to enforce the laws while others are asleep at the switch.

He may be in part grandstanding with his eye on higher political office, and he's been ignoring deeper Wall Street issues while focusing on the prosecution of high-profile bogeymen like Jack Grubman and Henry Blodget, but the guy just keeps drawing blood. When Sandy Weill, the CEO of Citibank, was nominated last year as "a director to represent public investors" on the board of the New York Stock Exchange, Spitzer went ballistic. "I can think of few people less-suited to represent the public interest on the New York Stock Exchange board than Sandy Weill," Spitzer said. "His company is paying one of the largest fines in history for perpetrating one of the largest frauds on the investing public. To imagine he should be the voice of the small investor is ludicrous."

It was a stunning statement, even though painfully obvious. This is just not the kind of thing we are used to hearing government officials say publicly about the head of a major corporation like Citibank. It was great to read it on the front page of The Wall Street Journal. The public outcry Spitzer helped fuel forced Weill to withdraw his nomination a few days later. Some of the criticism directed at him is on the mark, though not in the way his critics intend. "Spitzer's campaign against Wall Street adds up to snatching some cash and a few eye-popping headlines from structural conflicts of interest that have existed for decades and were well reported in this newspaper," charged the Journal. "Those conflicts were also well known to regulators, who didn't become shocked and appalled until stock prices fell."

The editorialists mocked him for writing "parking tickets," and they're right. Although his success in these improbable prosecutions has been nothing short of miraculous, the actual return to individual investors has been more symbolic than real. Even though Citibank was fined $400 million for defrauding investors (with Weill directly implicated in the chicanery), the money is small potatoes. Merrill Lynch, forced to cough up $100 million, has averaged $3.39 billion in profits over the past four years. The $1.4 billion universal settlement agreed to by top Wall Street investment firms amounts to far less than the wealth created or destroyed by a meager 1 percent fluctuation in GE's share price.

The question facing Spitzer is whether he can move from pursuing high-profile but mostly symbolic, penny-ante prosecutions to fishing in the really big corporate cesspools: the tax shelters, shell partnerships, foreign subsidiaries and other sophisticated tools developed by corporations to move assets off American shores and off their bank sheets to avoid paying their fair share of taxes.

"Corporate managers have spent the last century developing tools for avoiding regulation and taxation," notes Jack A. Blum, a lawyer with Americans for Democratic Action, a Washington liberal activist group. "They brag that acts of tax avoidance are part of corporate productivity. For them, each dollar of tax not paid because of their machinations is the added value they bring to a company. Tax avoidance is a profit center. Avoidance of regulation and supervision is an equally high priority."

The real fear of the plutocracy is that Spitzer will unleash—or horror of all horrors, politically lead as a future presidential candidate—an assault on the virtually untaxable offshore money pot made possible by slippery auditing and accounting standards.

Spitzer clearly has the financial community sweating bullets. All told, as much as $5 trillion of U.S. corporate assets are sheltered offshore, $3 trillion of which is in foreign bank deposits, much of it in "special purpose entities" (SPEs) and other tax avoidance structures. "If even a relatively small fraction of these SPEs are required to be returned to the balance sheet, the required additional capital will be in the many billions of dollars," says H. Rodgin Cohen, the chairman and president of Sullivan & Cromwell, a noted Wall Street legal firm. We're talking about real money here. It's estimated that the U.S. loses as much as $70 billion every year in revenue to this sort of tax evasion.

Spitzer makes corporate insiders so nervous because, unlike Washington regulators whose response to corporate malfeasance has traditionally been to shrug their collective shoulders (Republicans) or over-regulate (Democrats), he has recognized that the issue is not the law but the will. An economist at ASB Capital Management in Maryland (which has not been charged with any crime) accuses him of launching "a regulatory reign of terror" on the financial services communities.

It's painfully clear that Washington will not try to reign in this corruption. Let's hope Spitzer and the new breed of aggressive state attorney generals that are emulating him have the vision and chutzpah to use the full powers of the law to step in where the American federal government has failed so miserably.

Jon Entine is scholar-in-residence at Miami University (Ohio) and adjunct fellow with the American Enterprise Institute in Washington, DC. Jon is also an award-winning freelance journalist.