Rapid reformer: An interview with Eliot Spitzer, New York state attorney general

Eliot Spitzer targets fraud on Wall Street, in the mutual-fund business, and in the insurance industry. He says he wants the marketplace to work more efficiently, honestly, and fairly. Spitzer's methods offer lessons for fraud examiners.  

Some have called him a "champion of the people" who fights for the little guy ignored by big business. others say he's an ambitious politician whose attacks on U.S. companies cause unneeded instability. Regardless, New York state attorney general Eliot Spitzer's investigations into alleged improprieties and fraud on Wall Street, in the mutual-fund business, and, most recently, in the insurance industry, have had impressive and speedy results.

In 2003, 10 Wall Street securities firms paid a $1.4 billion settlement after Spitzer's allegations that they and others had distributed misleading stock research to investors.

In an ongoing mutual fund investigation, Spitzer has negotiated scores of financial settlements with companies that he said have potentially cost mutual fund shareholders billions of dollars annually. When first announcing evidence of widespread illegal trading schemes in September of 2003, Spitzer said that the "mutual fund industry operates on a double standard. Certain companies and individuals have been given the opportunity to manipulate the system. They make illegal after-hours trades and improperly exploit market swings in ways that harm ordinary long-term investors." The investigation focuses on practices known as "late trading" and "market timing." (See sidebar on page 39.)

And then on October 14 of last year, Spitzer sued the nation's leading insurance commercial brokerage firm, Marsh & McLennan Companies, alleging that it steered unsuspecting clients to insurers with whom it had lucrative payoff agreements and that it solicited rigged bids for insurance contracts.

At the time, Spitzer said that "the insurance industry needs to take a long, hard look at itself. If the practices identified in our suit are as widespread as they appear to be, then the industry's fundamental business model needs major corrective action and reform."

The civil complaint alleged that Marsh received special payments from insurance companies that were above and beyond normal sales commissions. These payments - known as "contingent commissions" - were characterized as compensation for "market services." Insurance industry representatives, according to the N.Y. attorney general's office, defended this long-standing practice as acceptable and even beneficial to clients.

But the civil complaint said that in addition to steering business to its insurance company partners, Marsh, at times, solicited fake bids, which deceived its customers into thinking that true competition had taken place. Marsh did this even as it claimed in public statements that its "guiding principle" was to always consider its client's best interests.

According to the complaint, Marsh collected approximately $800 million in contingent commissions in 2003. Spitzer's civil complaint seeks an end to steering and bid rigging, disgorgement of improper payments, restitution, and punitive damages.

About 10 days after Spitzer's suit against Marsh, its chairman and chief executive resigned. On November 18, five of Marsh's executive board members stepped down. At that point, the company took a 40 percent drop in the stock market and began laying off 3,000 employees.

Spitzer has delved into areas that others haven't, couldn't, or wouldn't. But during a recent interview with Fraud Magazine in his Manhattan, N.Y. office, Spitzer said he and his staff aren't "doing things in a fundamentally different way. I think we are challenging ways of doing business that had become accepted by those who were participating and had not been subjected to sufficient scrutiny."

Did you expect when you took office as attorney general for the State of New York that you would have such a big impact?
Without the notion that we've made such a major impact, certainly I didn't envision the particular cases or the depth to which we would be involved in the financial services sector ferreting out the fundamental structural issues there. I presumed that in the context of environmental litigation, perhaps antitrust litigation, consumer protection cases we would be having an impact of some magnitude and I thought a fair bit about those agendas. But I did not appreciate the degree to which we would be able to delve into financial service issues as we have done.

You have accomplished radical reforms of business practices said by some to help level the playing field for the "little guy" in a remarkably short time. Have you created a new, better approach for addressing rigged markets, or are you simply more willing to use existing tools?
I think it's really more the latter than the former. I don't accept the notion that we're doing things in a fundamentally different way. I think we are challenging ways of doing business that had become accepted by those who were participating and had not been subjected to sufficient scrutiny. I don't think we were using tools that are fundamentally different. We have been more willing to challenge the premise and ask why are we tolerating the practice that is unfair to an investor because the analytical work is not accurate or even believed. Dilution is occurring in the mutual funds sector or insurance markets being rigged. I think we've taken traditional prosecutorial approaches but challenged accepted ways of doing business that deserved to be challenged and consequently have been able to reveal some structural flaws that needed to be changed.

What motivates you to tackle white-collar crime and fraud? Where do you think your tenacity comes from?
Motivations are always hard to decipher. But the objective I bring to this is simply insuring integrity, transparency, and fair dealing in the marketplace. I am absolutely dedicated to the notion that the market is the best arbiter of value, of capital that's determinant of pricing. But as a prerequisite to market success you need to have certain rules and laws by which people operate. Among those rules and laws are transparency and integrity and a devotion to upholding fiduciary duty. Unfortunately those notions have been frayed over the last few years partly because of the increased concentration within the financial services sector, partly because the numbers got so big people fell prey to temptation. Whatever the reason may be, there was a crying need for some challenge to certain business practices and much to my surprise some of those cases have fallen into the lap of this office and I'm certainly happy to have played the role because in the long run it's therapeutic and important for the marketplace.

In previous jobs, you prosecuted organized crime and political corruption cases but then worked for two law firms before running for attorney general. Did your early prosecutorial experience whet your appetite for what you're doing now?
In an odd way working on both sides of the aisle was critically important. Sure ... I loved the work when I was ... (prosecuting) organized crime and some fraud cases ... and street crime and political corruption but also being exposed to what was goes on in the marketplace while I was at more traditional Park Avenue-type firms. And also having seen the business world through the eyes of an investor through a family business that's involved with many of these issues. It was important for me to understand the business world but also to understand the rules you learn as a prosecutor.

Do you think Marsh & McLennan somehow convinced themselves through the years that $800 million in yearly "contingent commissions" was a legitimate part of doing business and not a kickback scheme that ultimately would raise insurance rates and inhibit competition?
Again it's hard to know what was inside their psyche but we need to understand that there's nothing illegal per se about contingent commissions. ... I think what happened with these contingent commissions is that they morphed into something much more insidious because there was a failure to manage the potential corrosive effect on decision making that necessarily flows from contingent commissions. When you have a revenue stream as significant as Marsh had, you need to protect against distorted behavior. They didn't do that; in fact they ended up encouraging the distorted behavior and that is where things really went off track. When you have $800 million plus being generated by the contingent fees, the risk of the impropriety grows exponentially and I think they got trapped by that risk. It was easy money that ultimately they could not turn off. And it got impossible to turn it down.

It appears your insurance probe will reach beyond U.S. borders. At this point, how extensive would you say is the global problem in the insurance industry?
It's hard for me to say. The companies we're dealing with are global in their reach, their practices. It seems to be international. I've seen news articles from foreign newspapers and journals that suggest the structure of contingency commissions. And possible downside consequences exist elsewhere in the world. I'm talking about the European and Asian markets. Forget Bermuda and the tax havens where obviously the behavior is affected by the fact that the companies are domiciled there. But in due course we'll find out.

Why do you think corporate executives continue to hang themselves through incriminating e-mails?
You know, I ask myself that question and occasionally when I'm speaking in front of audiences I'll say, "Let me give you a piece of gratuitous advice: 'Don't write it down!' But on the other hand, wearing my hat as a prosecutor, 'Please do!' " Without the e-mail trails that we have garnered through discovery we never would have been able to make these cases. We never would have been able to generate the evidence simply through deposing people. It doesn't work that way. You need the written record that e-mails have given to us. It is mystifying to me why people reduce some of this stuff to writing. And they continue to do it. It will probably change. We're in a rare moment. For decades, if not centuries, people wrote letters and the letters became the best way to recreate history because you have the personal accounts and thoughts of people. This was pre-telephone. Then once we began communicating orally and there was no record anymore we lost a large part of our history. E-mail has become once again what letters and diaries used to be. So we're learning a lot more what people think. But my guess is that it will tail off as people realize the risk attached to it.

You've demonstrated how the Office of the New York State Attorney General can be used to accomplish change that benefits people throughout the United States. Do you get concerned that national regulatory bodies might think you are doing too good a job and making them look bad?
Well, let me state it another way. Competition is good. That's why we believe in the marketplace. Competition is healthy whether it's between two actors in the private sector or government regulatory entities who want to show that they can perform their jobs properly. Academics, who have judgment on this, also observe that there is a risk that in this competition between and among regulators one or more of the parties will be overly obtrusive in an effort to demonstrate how effective they can be. So surely that is a downside risk. It is one that we have to guard against. I'm not sure that we're there yet but it is a very legitimate concern.

Do New York state laws - such as the 1921 Martin Act and the 1893 Donnelly Act - give you powers that are unique among attorneys general?
The Martin Act and the Donnelly Act are useful. It's certainly the case that they are written in a more expansive way than many other statutes. Having said that, the cases we have brought do not depend upon that marginal statutory advantage that we have. Every case that we brought we could have brought under federal law. And so while it's interesting and appropriate to observe that we have greater statutory power that is really not, at the end of the day, why we've been able to bring the cases we've brought. We've also invoked federal statutes on a regular basis.

How can you encourage companies and other attorneys general to move from the initial headline-grabbing shakeups and toward long-term fraud prevention?
A large part of it is the culture you find inside a company. One of the frustrating issues has been the lack of self-reporting, the lack of self-regulation, the lack of internal self-discipline in many companies that have ... permitted improper behavior to continue. I've observed before that one of the frustrations for me is that not once in the course of everything we have done has a corporate executive stopped these practices before we've found them. And I look forward to the day when that happens. We need to breed a new culture of responsibility inside the company so that competitive pressure doesn't drive companies to the lowest common denominator, which is too often what is happening. We need to say, forgot the once in every five years that a major CEO is fired because of this type of impropriety. Day-to-day think about growing a culture of responsibility inside a company so we'll do better on a regular basis.

On a broad scale, beyond the monetary fines, can you predict the long-term results of your investigations of Wall Street and the corporate world? Is that possible?
No, I wish I could. It's one of those imponderables. Every time I say "Gee, we've made real progress," something else crops up. I'm reminded of the reality that these problems are cyclical; they emerge with some regularity every number of years, we respond hopefully proportionately and hopefully improper behavior is diminished but then they come back. So ... it will be interesting to see 10 years from now as we look back, will we think we've done something useful and successful or will this have been an exercise in futility. I just don't know.

You've identified your issues or targets in a lot of different ways. How are you able to come up with targets that others have not even though they have been sitting clearly in front of others' eyes in the past?
We've just tried to understand what's going on the marketplace and ask where there are tensions, conflicts, problems that deserve to be addressed. We looked at (stock) analysts because there has been so much chatter about there being a problem. ... We're not any smarter, better, or different. Let's dig a little bit and we did it aggressively. We said mutual funds were worth examining because we had a suspicion that there were some problems there because fees were so high and we heard some rumblings. That case took an enormous turn for the better ... after (a tip came in). But we were already looking at it because we thought it was ripe for inquiry. (On) insurance (bid rigging) we got (an anonymous) letter. So it's a question of being attuned to where there are conflicts and problems and trying to think more creatively than we have in the past.

What advice would you give Certified Fraud Examiners as they work to prevent, discover, and examine fraud for possible prosecution?
I would begin with a simple question. Where is there potential conflict of interest that creates an ambiguous incentive structure for the employees in our company? Where do we create a perverse incentive because of a compensation structure that (causes people) to do something that might not otherwise be in the best interests of our clients. If you ask and answer those questions you will probably be able to discover 80 percent of what goes on out there.

And you seem to go for the middlemen many times because they're pulled in two different directions. Should CFEs look for those particular people themselves?
The bottleneck in industry is often where you find problems - where you see people in a position to play one side against the other, capitalize on tensions. Those are the places where we've found fertile territory with regularity.

What's next on the horizon for the New York Attorney General's Office?
The horizon is pretty far away right now. We're still ... digging out from the mutual fund cases. We're buried - sinking deeply into quicksand on the insurance cases which are taking us in many different directions. It's simply impossible now to think beyond that.

You've made the decision to run for New York governor in 2006. How do you think your experience fighting fraud as attorney general would help you as governor?
I try to find problems and I fix them. And the next governor of this state needs to deal with structures and decision making that is archaic, ossified, and not living up to what one would hope to see in New York, it's the same sort of model of problem solving.

What gives you pleasure at the end of the business day?
The feeling that we actually accomplished something significant or even small that will either affect an individual because we're getting a recovery for someone who wasn't dealt with fairly or in a more theoretical way has done something to make the market work more efficiently, more honestly, and more fairly. It's a satisfying feeling.

1 This fictitious case is used for illustrative purposes. 

Dick Carozza is the editor of Fraud Magazine.