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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."
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