New York Democrats practically tremble with glee when they talk about state Attorney General Eliot Spitzer. The likely future governor of the Empire State, Spitzer has emerged as the scourge of the mutual fund and financial services industries. Working with the Securities and Exchange Commission, and occasionally with other state regulators, Spitzer has systematically publicized white-collar sleaze, then extracted settlement packages from many of the large companies practicing it. The packages typically involve a combination of profit disgorgements, penalties, restitution, and fee reductions.
Last September he reached a settlement with Canary Capital Partners on issues relating to the hedge fund's secret deals with mutual funds to engage in definitely illegal late trading and possibly illegal "market-timing." Canary has since squealed on a host of other fund managers and investment bankers and helped spur a wide-ranging investigation of the entire industry. Last December, Alliance Capital Management agreed to a $600 million package to cover its mutual-fund misdeeds. So far this year, MFS ($350 million), Bank of America and Fleet Boston ($675 million), and Janus ($225 million) have cut deals.
The latest scalp: Richard Strong, the founder and chairman of Strong Capital Management. Yesterday, as the New York Times reported on its front page, Strong and the mutual-fund company that bears his name signed a $175-million settlement. Strong himself will contribute $60 million and accept a lifetime ban from the industry.
Spitzer's admirers portray him as the caped crusader of lower Manhattan. And at first glance his settlements seem like harsh justice. If you screw your customers and betray your fiduciary duties, then you have to return profits, pay a massive penalty, make amends by slashing fees for future customers, and promise—cross your heart—never to do it again. In exchange, you are spared a trial and possible jail time.
In fact, it appears Spitzer is more like a toll collector than a tough cop. And he may be letting some of the bad actors—particularly Strong—get off too easy.
For starters, Spitzer has avoided treating the mutual-fund scammers like crooks, even though some of them appear to be just that. So far, Spitzer hasn't taken any of the cases stemming from the mutual fund scandal to trial. He's been reluctant to make the case in court that the market-timing is criminal, preferring to settle quickly and avoid having the courts rule on the legality of it. He seems eager to settle the cases quickly and—despite the large numbers involved—on relatively generous terms. How else to explain that no targets of the investigation have been presented with settlement terms that were so onerous that they chose instead to try their luck in court?
There is, of course, a sound rationale for Spitzer to seek settlements rather than indict individuals and companies. Indicting and prosecuting an entire company could result in massive losses for public shareholders and innocent employees—especially at diversified companies where the rot was confined to a single unit. Prosecutors—especially elected ones with larger political ambitions such as Spitzer—must always strike a balance between nailing evildoers and not putting secretaries and janitors out on the street. But that willingness to settle has made life easier for financial services companies. They seem to be treating settlements as a regular cost of doing business.
If you read the press releases Spitzer's office publishes after the settlements, the deals seem like they're all in a day's work for the government, too. The headline on the MFS settlement release was, "Leading Mutual Fund Enters $350 Million Agreement with State and Federal Regulators." It sounds like something you might read on the wires when a software company lands a new client. The Strong agreement, Spitzer's office noted, "establishes structural reforms for fees, sets new standards for board independence and accountability at the mutual fund company and preserves jobs at SCM." A win-win situation!
The Strong settlement is particularly squirrelly since Strong seemed an excellent candidate for a test prosecution of market-timing. There's no settled law confirming that the market-timing by Strong and others was a crime. But Spitzer could have tried to set that precedent with Strong, whose behavior was particularly craven. The 318th richest American, according to Forbes,Strong engaged in market-timing that was blatant, selfish, and penny-ante. Over a period of several years he made hundreds of trades in and out of the funds, exploiting terms his investors didn't enjoy, to earn a mere (for him) $1.8 million. Since Strong is a private company—indeed, Strong himself owns 85 percent of it—no public shareholders would have been hurt by his prosecution. And since plenty of mutual fund firms are eager to acquire Strong's business, an indictment of its founder wouldn't harm low-level employees.
Instead, Strong managed to get out from under a potentially life-ruining indictment and trial by parting with roughly 10 percent of his net worth, penning a lame two-paragraph apology, and agreeing to retire. That's a pretty good deal. It's one most accused criminals—from petty drug dealers to embezzlers—would gladly take.
So, why isn't Spitzer driving tougher bargains? Cases involving capital markets and securities trading are complex. Trying to persuade a jury that market-timing is criminal and not merely sleazy would be particularly difficult. As we've seen with Dennis Kozlowski and Frank Quattrone, prosecutors run the risk of an acquittal or a hung jury. Easier to declare victory, cash the settlement check, and move on. What's more, the wheels of white-collar justice turn remarkably slowly. The trial of the executives accused of perpetrating a massive fraud against HFS (now Cendant) in 1997 is just getting under way. Spitzer, who's on the fast track for the 2006 governor's race, doesn't want to be filing discovery motions when he could be shaking hands in Utica.