Sun, Sep 22, 2002 page10

• Investigation could impact Salomon

  TAKING NOTE A former high-level broker in Salomon's office in Atlanta recorded his company's dealings with WorldCom when he detected a string of irregularities

  • By Gretchen Morgenson / NY TIMES NEWS SERVICE
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  As investigators study 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.

  

  Philip L. Spartis, a former high-level broker at Salomon Smith Barney's Atlanta office, handled the WorldCom employee stock option plan as well as the accounts of many top WorldCom executives. Between 1997 and last year he kept notes that fill seven notebooks. Spartis in his lawyer's office in New York last week.

  PHOTO: NY TIMES

  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.

  Spartis and Amy Elias, a broker who worked with him, are suing Citigroup for wrongful termination. Spartis handed over his notebooks last week to Eliot Spitzer, the New York attorney general, who is investigating whether 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.

  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 US$400 million loan the company made to its chief executive, Bernard J. Ebbers, who has since resigned.

  Perhaps the most intriguing entries in Spartis' 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 1990s, 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 an additional 61 million shares.

  No choice

  Salomon was the only brokerage firm that WorldCom's employees could use to exercise their options.

  In 1999, Salomon gave 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 US$2.3 million, 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, Tyco, Toys `R' Us, Compaq, Bank of America and EDS.

  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.

  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 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," 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," Spartis recalled. "And I thought, 'I wouldn't tell you if I did."' To 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 Spartis declined to share the information with others at Salomon, he recalled, Santomossimo said he could provide the figures Molnar wanted. The three men made a date to talk again before the market opened on Jan. 3, 2000.

  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. Molnar, the New York executive, decided to group the shares and put an average price on them, 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, Spartis recalled. This could have indicated that a large short-seller had closed out his position.

  Question of intent

  "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.

  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 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," Spartis said.

  "The firm's objective seemed to be to get every dollar from every corner there was."

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

  Other entries confirm that Grubman also had a role at Salomon that would not be viewed as traditional for a research analyst. For instance, in August 1999, Spartis recorded a conversation he had with Ebbers' personal chief financial officer. Spartis quoted him as saying that Grubman had recommended that 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 Grubman. In August 1998, for example, Spartis introduced executives at EconoPhone, a small, private telecommunications concern based in Paramus, New Jersey, to investment bankers at Salomon to discuss a public offering of EconoPhone's shares. After a meeting among EconoPhone executives, Salomon bankers, Grubman and Robert Waldman, a debt analyst at the firm, the broker's notes indicate, Grubman rejected the idea of an offering. According to Spartis' conversation with one of the bankers at the meeting, Grubman said EconoPhone was not a good candidate because it had "limited bandwidth."

  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.
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