Institutional Investor

Jenny Anderson

NEW COPS ON THE BEAT July 2002 By Jenny Anderson REGULATION New cops on the beat State attorneys general are no longer simply chasing telemarketers and cross-border pyramid schemes. They are taking on global giants, from Wall Street to the pharmaceuticals industry, and business is complaining. By Jenny Anderson July 2002 Institutional Investor Magazine "Our job is to enforce the law if companies violate it," says Alabama Attorney General Bill Pryor. "Our role is not to use that threat of litigation to restructure the marketplace. That is more properly done through legislation or regulation." Pryor's voice is an increasingly lonely one. The scope of actions undertaken by the states in recent months is breathtaking and unprecedented. In May, for example, New York Attorney General Eliot Spitzer muscled Merrill Lynch & Co. into ponying up $100 million to settle a ten-month investigation that uncovered e-mails revealing that analysts had issued false and misleading stock recommendations to win banking business. Merrill also agreed to change the way it issues research reports and how it evaluates and pays its analysts. In June, 29 states announced that they were suing Bristol-Myers Squibb Co. for fraudulently preventing a cheaper, generic version of its cancer-fighting drug, Taxol, from getting to market. Several state attorneys general are considering whether to challenge the proposed $26 billion merger of satellite television companies EchoStar Communications Corp. and DirecTV on antitrust grounds. And after rejecting the antitrust deal the federal government cut with Microsoft Corp. in November 2001, nine states and the District of Columbia continue to battle the software maker in court, seeking harsher penalties. For the denizens of Wall Street and America's corporate boardrooms, the surge of activism by state attorneys general may present the biggest threat to their way of doing business -- to say nothing of their financial well-being -- since the plaintiffs' bar made the Dalkon Shield and asbestos synonyms for personal injury. Although Merrill Lynch admitted no wrongdoing in its settlement, the e-mails open the firm to hundreds of millions of dollars in potential liabilities from civil litigation. "The e-mails are overwhelming in demonstrating the breach of the responsibility that investment banks have to render fair, objective advice," says Spitzer. Like the trial lawyers, the state AGs increase the cost of doing business and, critics complain, occasionally step over the line. They say that AGs too often have weak cases but rely on their collective power to bully companies into settling rather than fighting long, costly battles. The states also draw fire for usurping the roles of regulators like the Department of Justice, the National Association of Securities Dealers and the Securities and Exchange Commission. "Spitzer got Merrill Lynch by the throat, and the fear at the NASD, the SEC and on the Street is that you have the New York state attorney general setting securities law," says one bulge-bracket executive. Spitzer is unfazed by the criticism. "The SEC was not doing enough," he says. "Frankly, we saw an enforcement issue that wasn't being tended to." And like the plaintiffs' bar, the state attorneys general have also done considerable good. Their activism has forced Congress and the federal agencies charged with oversight to stop dragging their feet on numerous issues and prompted corporations to review their behavior. On the heels of Spitzer's suit, the SEC started its own investigation into Wall Street's research practices, and companies have rushed to draw up new policies. Salomon Smith Barney set up a research review committee and has said that it will prohibit investment bankers from participating in the evaluation of research analysts' compensation. Goldman, Sachs & Co. appointed former New York Federal Reserve Bank president E. Gerald Corrigan as research ombudsman. Merrill itself announced it would switch from its highly complex and nuanced rating system to a simple buy-hold-sell policy -- an idea it eschewed a year ago, insisting at the time that it had different client bases with very different needs and tolerances for risk. But Wall Street firms, though bending before the states' attack, are fighting back. In June Morgan Stanley CEO Philip Purcell sought support from other firms to get an amendment tacked on to the Senate version of the Public Company Accounting Reform and Investor Protection Act that would have prohibited states from regulating any entity already overseen by the SEC. Purcell refuses to comment, but a Morgan Stanley spokeswoman says, "We believe that legislation at the federal level is a good way to restore investor trust and confidence." The effort failed. Says one Wall Street executive: "At some point, in a less politicized environment, there is going to have to be a discussion among grown-ups about what to do. The answer cannot be balkanizing the regulation of the American capital markets." Though thwarted, Wall Street's end run to the Senate back room infuriated state AGs and state securities regulators. "They got caught by Eliot, and their response is to make sure they won't get caught by the states' AGs," says Iowa Attorney General Tom Miller (see box, page 81). As of mid-June, 40 states had joined Spitzer in the investigation of analysts' conflicts at Wall Street firms. "We are the first line of defense," says Alabama state securities chief Joseph Borg, president of the North American Securities Administrators Association. "I have a statute that says I will protect the citizens of my state." Twelve states have divvied up the firms that remain to be investigated. For example, Massachusetts will look into Credit Suisse First Boston; Connecticut will handle UBS Warburg; Texas and Alabama will investigate J.P. Morgan Chase & Co. and Lehman Brothers; and Utah will check out Goldman. Spitzer is keeping Morgan Stanley and Salomon Smith Barney for himself. The attorneys general and state securities regulators have jumped at the chance to remind Congress and the public that investors would be at great risk without the states' oversight protection. "Consumers ought to have protection, and if there are overlapping layers of protection, that's a good thing," says Missouri assistant attorney general Chuck Hatfield. The financial community does have some supporters on the Hill, including Republican Congressman Richard Baker of Louisiana, chairman of the House subcommittee on capital markets. In a May 24 letter, he urged state AGs not to adopt Spitzer's template for reform at Merrill. "Should you decide to proceed in state rulemaking in this area, know that I will consider the advisability of introducing legislation which could supercede such an attempt," Baker wrote. In late June Spitzer testified before a Senate commerce subcommittee and once again criticized Washington for inaction. Although Baker has been a vocal critic of Wall Street's conflicts of interest, his response to Spitzer was scathing -- and personal. Referring to the AG's unsuccessful investment in founder James Cramer's hedge fund, Baker said, "To me, it simply doesn't inspire confidence -- something investors desperately need today -- to have a failed investor who didn't understand the markets then to be making up his own rules about how to protect all other investors now, especially when it seems clear he still just doesn't get it." A DOZEN YEARS AGO A STATE ATTORNEY GENERAL would have been far more likely to try to take down a sweepstakes scammer or a telemarketer hawking fake insurance to the elderly than attempt to enforce the rules for the world's largest software company, a global securities firm or a pharmaceuticals behemoth. But beginning with the $246 billion tobacco settlement in 1998, the AGs' success in pursuing high-profile, multistate cases, in both the antitrust and consumer protection arenas, has bred confidence, coordination and a template for action against a seemingly endless array of industries. Most strikingly, the state AGs are joining forces to sue, behaving almost like a multistate law firm. "We are gaining more public attention because we have become more effective," says Connecticut's Richard Blumenthal, one of the nation's most aggressive AGs (see box, page 82). One result of the AGs' aggressiveness, say corporate lawyers, is that the cases open the door for trial lawyers to win billions in judgments. "The state AGs are elected, and the trial lawyers are heavy contributors," notes one antitrust attorney in New York who has worked with and against the AGs. "It's a dangerous circle when the trial bar supports activist AGs who by being activist AGs support the work of the trial lawyers." Other complaints include the charge that the AGs' actions can lead to the amending of regulations already in place -- as with Merrill, which was already subject to the industrywide rules of the New York Stock Exchange and the NASD. Worse, federal authorities might be pushed to regulate simply because they have been one-upped. Critics assert that the state AGs are subject to political pressures: 43 of the 50 AGs are elected, and many are motivated by aspirations toward higher state office. AG, they snipe, stands for "aspiring governor." "What they are pursuing," argues Dominick Armentano, professor of economics emeritus at the University of Hartford and the author of Antitrust Policy: The Case for Repeal, "is competitor protection, not consumer protection. You'll get more antitrust cases, and this creates a lot more inefficiency, greater costs to business and higher prices." Adds Michael DeBow, a fellow at the Cato Institute, a libertarian think tank: "The cost of all this -- of the litigation and the settlement -- is passed on through higher prices to the consumer. The idea that this is pro-consumer is ridiculous." But the AGs argue that the behavior of corporate America has made it crystal clear that more, not less, enforcement is necessary. On balance, they say, state AGs can be closer to many issues than the feds, and better able to uncover abuses. "We can't make laws," says Connecticut's Blumenthal. "We just ask the courts that they be enforced in a certain way." The AGs dismiss the criticism that they bring cases to force settlements, insisting that they could take any of the cases to trial. "We are not in the business of bringing cases we cannot defend," says Missouri Attorney General Jay Nixon. "We look at matters from a legal standpoint, and this rambling that we litigate by press release is total hogwash." Says James Tierney, a former Maine attorney general (see box, page 80) who remains active as a consultant to AGs, "There's not an AG in the country that is not ready to go to court if they file a lawsuit." The AGs' success, he adds, is born of meticulous preparation, not nuisance value. State AGs note that they have been working together on cases for years. In 1973, for example, six states accused oil companies of price-fixing and won $150 million. In 1977, 48 states went after General Motors Corp. and proved that the automaker had installed Chevrolet engines in more-expensive Oldsmobiles, Pontiacs and Buicks; in 1980 GM agreed to pay for the repairs of cars it built with nonmatching engines. The AGs' strategy of collective action is also the result of macroeconomic reality. "The centralization of the economy means that for an AG to get the same impact today, it makes sense for him or her to cooperate with their colleagues," says Tierney. THE AGS GAINED POWER in the 1980s, when then-president Ronald Reagan weakened federal regulatory agencies like the DoJ and the Federal Trade Commission in an attempt to devolve power to states. His success paved the way for as many as 50 separate sets of regulations -- a far cry from the laissez-faire system he hoped to promote. "Under Reagan the AGs realized the playing field was more open -- there was a less activist federal government -- and certain state AGs said, 'Why don't I do this?'" says Blair Levin, a regulatory analyst at Legg Mason and chief of staff at the Federal Communications Commission from 1993 to 1997. Part of the states' power comes from broad antitrust authority provided by the Hart-Scott- Rodino Antitrust Improvements Act of 1976, amending the Clayton Antitrust Act of 1914. It allows states to sue on behalf of their citizens to block any merger that comes under Department of Justice review. States generally accept a DoJ ruling in an antitrust review, but in a landmark state authority case, the California attorney general rejected the FTC's 1988 approval of a merger between grocery store chains American Stores Co. and Alpha Beta. After the U.S. Supreme Court ruled that states had the authority to sue, American Stores had to sell the bulk of its supermarkets. The AGs' power grew in the 1990s. The major coup came when they extracted the huge settlement from the tobacco industry in 1998 -- something that the federal government and the plaintiffs' bar had tried, unsuccessfully, to do for decades. "The handiwork of the activist AGs is the largest tax increase in the history of our republic, and we did it without a vote by the Congress or any state legislature," fumes Alabama's Pryor of the victory. His indignation did not keep him from accepting his state's share of the settlement. The AGs next focused on Microsoft, helping the DOJ win an antitrust ruling against the company in 2000. When the Bush administration made a deal with Microsoft in 2001, nine states and the District of Columbia, led by California AG Bill Lockyer (see box, page 79), Connecticut's Blumenthal and Iowa's Miller, rejected what they felt was a sweetheart deal for the software maker. "A settlement wouldn't be effective if we were condemned to repeating history," says Miller. In April New York AG Spitzer dropped his bomb on Wall Street and Merrill. Last month Ohio AG Betty Montgomery (see box, page 78) charged Bristol-Myers Squibb with monopolizing the market. At a time when Bristol-Myers already faced pressure on earnings and a barrage of lawsuits from consumer protection groups and other states, Montgomery alleged that the company secured patents that had no validity. Other AGs are considering banding together to block the merger of EchoStar and DirecTV (Institutional Investor, March 2002) on the grounds that if approved, the deal would lower the number of pay television competitors in rural areas. "EchoStar's approach is that if they get approval from the FCC and the DoJ, they don't need to worry about the states," says Missouri's Hatfield. "I think they are wrong." Microsoft represents the latest challenge by the states to federal authority. The company argued in its brief that the states did not have the authority to impose a different settlement from the DoJ. In June U.S. District Court Judge Colleen Kollar-Kotelly ruled that the states not only have standing but have the right to seek remedies that would apply nationwide. "The decision confirms the rightful role of the state attorneys general to prosecute antitrust violations," Iowa AG Miller told Institutional Investor after the judge's decision. The AGs may be a few steps ahead of the pack in recognizing that corporate excess can breed corruption, that enforcement has grown lackadaisical and that consumers have been harmed. If they continue to act as a catalyst for reform -- as they have done in the Merrill Lynch case -- industries like financial services have no one to blame but themselves. Says Missouri's Nixon, "Because of legislative inaction, litigation action is solving the problem." ------------------------------------------------------------------------ Drug Buster Drug manufacturers beware: Betty Montgomery has your number -- or wants it. In June the Ohio attorney general announced that she was leading a 29-state case against Bristol-Myers Squibb Co. charging that the company illegally delayed generic competition for Taxol, a cancer-fighting drug. It is the second time Montgomery has brought a multistate case against a pharmaceuticals company: She led all 50 states against Mylan Laboratories, alleging illegal restraint of trade for two generic drugs, and won $100 million in a 2001 settlement. "We want to stop the marketplace manipulation," says Montgomery, 53. "We want to send a signal to the market about what can and can't be done." Some might say that the drug case echoes the one made against Big Tobacco: Multiple states take on a deep-pocketed industry to recover money for ballooning Medicaid budgets. But Montgomery, a second-term Republican, dismisses the analogy. In the tobacco case the plaintiffs' bar walked away with billions of dollars in contingency fees -- and later sued some states for more. Montgomery refuses to hire private attorneys. "Our interests as AGs and the interests of private attorneys are very different," she says. "Our major task is to change behavior. Money is incidental. We see a problem that violates the law, and we've decided to go forward." One of just three female -- and only 15 Republican -- state attorneys general, Montgomery obtained her law degree from the University of Toledo. She was a prosecuting attorney in northwest Ohio before being elected to the state senate in 1988 and AG in 1994. Her interest in pharmaceuticals is partly personal, spurred by the high prescription bills her elderly parents are facing. "It really hit home," she says. Montgomery also saw that high drug prices were sending the cost of Medicaid soaring, creating budget deficits for states. Skyrocketing drug costs have led to a rash of suits against pharmaceuticals companies. In December Texas led 29 states in a case charging Bristol-Myers with illegally trying to protect its patent on BuSpar, an antianxiety drug; Nevada and Montana are suing 17 drug companies for illegal pricing. Montgomery suggested that the National Association of Attorneys General set up a pharmaceuticals pricing task force. It was created in December, and she is heading it. Because of term limits, Montgomery cannot run for reelection this fall. She is running, instead, for the job of state auditor. -- J.A. ------------------------------------------------------------------------ California Wave “New York and California are like small countries," says Missouri assistant attorney general Chuck Hatfield. "All of the states look to them to see what they are doing." Microsoft Corp. certainly learned that lesson. Since taking office in 1998, Bill Lockyer, a California Democrat, has assumed a prominent and contentious role in the Microsoft antitrust action as one of three AGs leading the fight for a tougher settlement. After challenging the Bush administration's proposed settlement in 2001, he wrangled $3.7 million from the state legislature to continue the battle with the software giant. His critics charge that it's a battle fueled by a cozy relationship with -- and campaign contributions from -- major California-based Microsoft rivals. Lockyer defends his meetings with the competitors as standard practice in an investigation. "It's asking experts to help add to your knowledge," he says. Lockyer has received $50,000 from Oracle Corp., which was returned for unrelated reasons. He is unapologetic about that, too, arguing that California elections are expensive: "Every interest of every sort contributes." Lockyer has powerful resources at his fingertips: The 1,100 lawyers in the California Department of Justice generally manage 55,000 lawsuits at any given time. Lockyer's focus on forging a new settlement with Microsoft is based, he says, on a need to remedy what was clearly proved to be wrong. "The settlement was toothless," he says. "It doesn't require significant change in [Microsoft's] business or address how to stop anticompetitive practices." He doesn't buy the argument that the states have no right to set national technology policy -- nor is he impressed by the fact that most states opted not to sue Microsoft, or that many that did have settled. "Every court has concluded that the law allows the AGs to defend the interests of their state's residents," he says. "I'm grateful there are others with the will to keep fighting." Lockyer has also taken a lead role on the Internet and privacy task force of the National Association of Attorneys General. He is involved in the 29-state case against Bristol-Myers Squibb Co. that charges that the pharmaceuticals company illegally kept a generic version of its cancer-fighting drug, Taxol, off the market. And in 2000 and 2001 he was active in settling a series of cases forcing national sweepstakes companies to disclose more information about their contests. "I don't relish these fights with the most powerful people in the country," says Lockyer. Perhaps, but that doesn't stop him from waging them. -- J.A. ------------------------------------------------------------------------ The Maine Man Think of James Tierney as the 51st state attorney general. On an average morning Maine's onetime AG (he served from 1980 to 1990) sips coffee in his Lisbon Falls log cabin while perusing newspapers and clipping articles that might be of interest to the attorneys general he e-mails each day. Part coordinator, part writer and activist, Tierney, 55, sees his role -- and that of state AGs in general -- as a simple one: "To help government do its job well so that the marketplace will function in a way that is legally correct and ethically appropriate." Tierney, who helped the states broker their $246 billion settlement with Big Tobacco in 1998, offers AGs his advice for free, but has a private law practice on the side. He won't name clients, but he has advised some of Microsoft Corp.'s rivals, raising eyebrows among skeptics of state activism. A special assistant to Democratic Florida Attorney General Robert Butterworth in the 2000 presidential recount, Tierney teaches a course in multistate litigation at Columbia Law School and is a prolific writer on a range of topics, including the frequently contentious relationship between state AGs and their governors. He dismisses critics who assert that attorneys general are too aggressive. "In a world of Enron and Arthur Andersen and Global Crossing, to cast blame on the AGs is ridiculous," he says. "It's the feds' fault, it's the regulators' fault, and it's the companies' fault. I mean, excuse me, who was shredding the documents? Who sent the e-mails?" Elected a Democratic state representative in 1972 when he was just 25, Tierney rose to majority leader at 29 and became Maine attorney general at 33. In that post he pursued innovative multistate cases, including a six-state lawsuit against Ronald Reagan's Environmental Protection Agency for allowing acid rain in the Northeast. Tierney was also involved in an effort to alter a federal settlement with insurance company Baldwin United Corp., which sold $4 billion in annuities and later collapsed. He ran unsuccessfully for governor in 1986 and for Congress in 1990. "The American people and the economy need a certain amount of oversight and regulation that keeps us obeying the law," Tierney says. "The vast majority of the time, those should be decided by the federal government, but there are times when state enforcement is more effective. The states are part of the game, and they are not going away. They will be major players." -- J.A. ------------------------------------------------------------------------ Iowa's Beef Call Iowa's Tom Miller the dean of activist attorneys general. First elected to office in 1978, Miller, now 58, has been involved in about every significant multistate case since then, from actions against Big Tobacco and Microsoft Corp. to suits charging pharmaceuticals companies with illegal pricing and anticompetitive behavior. He has fought battles with airlines on antitrust issues, skirmished with fraudulent telemarketers and waged war on telecommunications firms for unfair pricing. On an average day Miller plots strategy with two or three of his fellow state AGs; when things heat up, he may telephone a dozen. A native Iowan, Miller earned his law degree at Harvard University, then went to work for Volunteers in Service to America in inner-city Baltimore. A Democrat, he moved to Capitol Hill as a legislative assistant to then-representative John Culver of Iowa before returning to his home state and starting a private practice. In 1974 Miller ran for state AG and lost. Four years later, at 34, he won. After an abortive run for governor in 1990 -- he lost in the primary -- he returned to private practice until 1994, when he was again elected Iowa AG. Like many of his peers, Miller attributes the AGs' growing power to former president Ronald Reagan's emphasis on states' rights and his efforts to scale back federal consumer protection and antitrust regulation. "We saw what they did at the Department of Justice, and we were horrified," Miller says. "The Federal Trade Commission tried to roll back the definition of deception. We had to respond." In 2000 Iowa and 22 states joined the DoJ in opposing the proposed merger of UAL Corp. and US Airways Group, arguing that it would reduce competition, raise fares and harm Iowa consumers. The deal was withdrawn in 2001. Currently, Miller is a leader in the fight against the Bush administration's proposed settlement with Microsoft. "In the past six months, we are increasingly convinced we were right about not settling," he says. Motivated by what he sees as issues harmful to his constituents, Miller is highly regarded, even by lawyers who oppose him. "He is thoughtful -- a lot more thoughtful than many of his peers," says an attorney for Microsoft. Does Miller plan to run for governor again? "This is too good a job," he says. "We have a lot more independence and freedom, even though the governor has a lot more power." -- J.A. ------------------------------------------------------------------------ The Activist's Activist Is it possible for an attorney general to be too active? Connecticut's Richard Blumenthal may find out at the polls this fall. First elected in 1990, Blumenthal made a name for himself as an aggressive, vocal AG, taking part in virtually every major multistate action. The list includes cases against the tobacco and pharmaceuticals industries and against utilities for contributing to acid rain in the Northeast. Most recently, he has led the charge -- with California AG Bill Lockyer and Iowa AG Tom Miller -- to rewrite the federal government's settlement with Microsoft Corp. Now Republican Martha Dean, Blumenthal's opponent in this year's election, is trying to turn that image against him, arguing that the AG is out of control. "He's a federal government in exile," she asserts. If elected, Dean says she would take Connecticut out of the Microsoft case, put a stop to "government lawsuit abuse" and rein in the number of cases the attorney general is pursuing. To be sure, Blumenthal has gotten involved in a number of cases that critics say have weak legal merits but great publicity value. For example, he supported a Bridgeport, Connecticut, lawsuit that sought to blame firearms manufacturers for violence involving guns. The case was tossed out of court last October as lacking legal merit. And in 2000 he sued four Connecticut health maintenance organizations for ERISA violations. That case was thrown out, too. Blumenthal is now suing Arthur Andersen for its auditing of two failed Connecticut companies and has issued subpoenas to recover documents related to their collapse. The Connecticut AG wrote to U.S. Attorney General John Ashcroft on April 16, asking that he look into Andersen's role in the collapse of the two companies but urging the federal government not to settle in a way that would preclude future state action. It is not surprising, then, that he waxes indignant about a proposed amendment to the Senate version of the Public Company Accounting Reform and Investor Protection Act that would strip states of their power to act against Wall Street. Says Blumenthal: "This amendment is outrageous. It limits the very important enforcement authority of the states in protecting the public interest -- an authority that is well established in filling the gaps when the federal government lacks the interest or the ability to act." Blumenthal defends his actions on the grounds that each case was pursued to protect the citizens he is elected to defend. "There's a financial impact from Microsoft and Arthur Andersen on our citizens," he says, "even if they may seem to be national cases." -- J.A. ©Copyright 2002 Institutional Investor, Inc. Write a letter to the editor Americas Table of Contents International Edition-Europe Table of Contents International Edition-Asia Table of Contents The 2002 All-Europe Fixed-Income Research Team "Credit-specific event risk is the biggest problem in this market right now," says a research director. No kidding. All Rankings Search through Institutional Investor's benchmark rankings of equity research analysts in the US, Europe, Asia, and Latin America.